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By Steven Baker, on 9 March 10
 This post is excerpted from Mises’ “The Causes of the Economic Crisis and Other Essays Before and After the Great Depression” which is available to buy here and download here. Both Andreas Acavalos and Toby Baxendale supported the production of this book.
Emphasis mine.
On covering government deficits by creating new money (pp 2-3):
If the practice persists of covering government deficits with the issue of notes, then the day will come without fail, sooner or later, when the monetary systems of those nations pursuing this course will break down completely. The purchasing power of the monetary unit will decline more and more, until finally it disappears completely. To be sure, one could conceive of the possibility that the process of monetary depreciation could go on forever. The purchasing power of the monetary unit could become increasingly smaller without ever disappearing entirely. Prices would then rise more and more. It would still continue to be possible to exchange notes for commodities. Finally, the situation would reach such a state that people would be operating with billions and trillions and then even higher sums for small transactions. The monetary system would still continue to function. However, this prospect scarcely resembles reality.
On credit expansion by banks, its effects on the economy and the ensuing crisis (pp 113-115):
The crisis breaks out only when the banks alter their conduct to the extent that they discontinue issuing any more new fiduciary media and stop undercutting the “natural interest rate.” They may even take steps to restrict circulation credit. When they actually do this, and why, is still to be examined. First of all, however, we must ask ourselves whether it is possible for the banks to stay on the course upon which they have embarked, permitting new quantities of fiduciary media to flow into circulation continuously and proceeding always to make loans below the rate of interest which would prevail on the market in the absence of their interference with newly created fiduciary media.
If the banks could proceed in this manner, with businesses improving continually, could they then provide for lasting good times? Would they then be able to make the boom eternal?
They cannot do this. The reason they cannot is that inflationism carried on ad infinitum is not a workable policy. If the issue of fiduciary media is expanded continuously, prices rise ever higher and at the same time the positive price premium also rises. (We shall disregard the fact that consideration for (1) the continually declining monetary reserves relative to fiduciary media and (2) the banks’ operating costs must sooner or later compel them to discontinue the further expansion of circulation credit.) It is precisely because, and only because, no end to the prolonged “flood” of expanding fiduciary media is foreseen, that it leads to still sharper price increases and, finally, to a panic in which prices and the loan rate move erratically upward.
Suppose the banks still did not want to give up the race? Suppose, in order to depress the loan rate, they wanted to satisfy the continuously expanding desire for credit by issuing still more circulation credit? Then they would only hasten the end, the collapse of the entire system of fiduciary media. The inflation can continue only so long as the conviction persists that it will one day cease. Once people are persuaded that the inflation will not stop, they turn from the use of this money. They flee then to “real values,” foreign money, the precious metals, and barter.
Sooner or later, the crisis must inevitably break out as the result of a change in the conduct of the banks. The later the crack-up comes, the longer the period in which the calculation of the entrepreneurs is misguided by the issue of additional fiduciary media. The greater this additional quantity of fiduciary money, the more factors of production have been firmly committed in the form of investments which appeared profitable only because of the artificially reduced interest rate and which prove to be unprofitable now that the interest rate has again been raised.
Great losses are sustained as a result of misdirected capital investments. Many new structures remain unfinished. Others, already completed, close down operations. Still others are carried on because, after writing off losses which represent a waste of capital, operation of the existing structure pays at least something.
The crisis, with its unique characteristics, is followed by stagnation. The misguided enterprises and businesses of the boom period are already liquidated. Bankruptcy and adjustment have cleared up the situation. The banks have become cautious. They fight shy of expanding circulation credit. They are not inclined to give an ear to credit applications from schemers and promoters. Not only is the artificial stimulus to business, through the expansion of circulation credit, lacking, but even businesses which would be feasible, considering the capital goods available, are not attempted because the general feeling of discouragement makes every innovation appear doubtful. Prevailing “money interest rates” fall below the “natural interest rates.”
When the crisis breaks out, loan rates bound sharply upward because threatened enterprises offer extremely high interest rates for the funds to acquire the resources, with the help of which they hope to save themselves. Later, as the panic subsides, a situation develops, as a result of the restriction of circulation credit and attempts to dispose of large inventories, causing prices [and the “money interest rate”] to fall steadily and leading to the appearance of a negative price premium. This reduced rate of loan interest is adhered to for some time, even after the decline in prices comes to a standstill, when a negative price premium no longer corresponds to conditions. Thus, it comes about that the “money interest rate” is lower than the “natural rate.” Yet, because the unfortunate experiences of the recent crisis have made everyone uneasy, the incentive to business activity is not as strong as circumstances would otherwise warrant. Quite a time passes before capital funds, increased once again by savings accumulated in the meantime, exert sufficient pressure on the loan interest rate for an expansion of entrepreneurial activity to resume. With this development, the low point is passed and the new boom begins.
Further reading
By Toby Baxendale, on 24 February 10
Our Corporate Affairs Director Steve Baker has posed this question to some of his fellow board members, “Would be great to nail this phenomenon on the system of money – that is to demonstrate clearly that it is credit expansion which redistributes wealth to the wealthy:
In other words, the trickle-down effect that is meant to spring from wealth accumulation has not worked as it should have. Flexible labour markets have delivered big time for bankers and shareholders, but failed to improve the lot of ordinary workers in the same way. In Britain, growth in consumption was funded not by real economic advancement, but by the fool’s paradise of ever-increasing debt.
http://www.telegraph.co.uk/finance/comment/jeremy-warner/7105004/Capitalism-has-forgotten-to-share-the-wealth.html
The essence of a credit expansion starts with the policy of the Treasury / Bank of England aka “the State”. The aim is to make money cheaper so that more money / credit is granted to borrowers, more economic activity is then meant to take place.
How is this done?
If you wanted to make jam cheaper, you would need to produce more of it for the same level of demand. The only way the jam market would clear is for the jam to sell at that demand for a lower price.
The State has the monopoly issue of money under its control. If the whole history of man was displayed in the form of a 12 hour clock, with today being the 12th hour, the State has only had this monopoly of the production of money since the end of the Gold Standard at the outbreak of the 1st World War. Attempts to get back on the Standard took place in the 20’s but were abandoned in the 30’s. Post World War II until 1971 there was a weak form of Gold Standard under the Bretton Woods system. Since that date, there has only been paper standards in different countries. So from the dawn of civilization until about the 11th hour and the 59th minute of human existence, Gold was money. It was a commodity for which all things exchanged for, it was produced by private individuals and no one person controlled the production of gold. Like language, it was a spontaneous invention of human beings to facilitate working together. It is thus one of the greatest inventions of man.
If the the State, as the monopoly issuer of paper money decided that the economy needs more liquidity (we have done this with our £200bn QE program), the bank will buy its governments outstanding debt obligations , or IOU’s, commonly called Gilts or Bonds, with newly minted money (to monetize). Thus the new money, like the new jam, or the jam over supply illustrated in the above example , enters the economy via the recipients of the new money.
Dear reader, I would like you to pause for a minute and ask yourself how comfortable would you feel about the government setting the price of jam and issuing all of its supply? Is this not what they tried to do in the Soviet Union? Absenting the price mechanism, that coordinates the choices of many millions of people, to allow suppliers of jam to know how much to produce to satisfy the demand for jam, and we have shortages for jam leaving shops empty for sometimes many months on end. Why do we trust the State to do this?
We seem to accept that the government, in its wisdom, that must be greater than that of all its citizens , can plan the production and supply of money as the old Soviet system did for a whole host of goods and services, for its subjects.
Experience will tell us, that like the Soviet production of jam, our State production of money will cause shortages and surpluses of varying degrees. Worst still, constructivist policy activism by the State via its agents at the Bank of England attempt each time they set the interest rate, to produce just enough money to keep the economy on an even keel. The evidence that they get this wrong is called “Boom and Bust.”
If you got jam production wrong, your surplus jam goes to waste or you can not feed your demand.
An over supply of money is called a “boom.” An undersupply is called “bust.” Every single boom from the Soutth Sea Bubble onwards can be traced back to some artificial expansion of money / credit not brought about by the free interplay of market forces determining the production of money. As money permeates every aspect of the economy, an over or under supply of it has far more consequences than an over or under supply of money. In this current “bust” I would submit that virtually all people in the world wide system of capitalistic production have been effected in their personal lives to some degree of negativity as they have had to adjust to the new world order.
The effects of this over supply are so little understood, it is worth while explaining once more by looking Richard Cantillon in his Essai sur la Nature du Commerce en Général (1755). This showed us that if money supply doubled, prices do not necessarily double. Money is not neutral in terms of consumption and production. Money goes into the system when created by the government to the bond holders whose bonds are redeemed. With this new money they have the first wealth effect of this new money. Like a counterfeiter he exchanges his new bits of paper for real goods and services, bidding up the prices of these goods and services. The producers of these initial goods and services then do the same with the goods and services that they buy and so on and so forth until the prices for the last people, those who spend less in the economy, the poor, those on fixed income (pensioners, the thrifty saver) etc, spend on goods and services that now have a higher money price. Thus, the insidious effect is a transfer of wealth away from the poorest in society to the richest in society: those banksters who buy / sell the bonds and the bond holders who have received the newly minted money.
We must remember, the bankster in all of this is often the agent of the State when he sells and buys the government debt either creating over supply or under supply of money. He takes his commission right at the well spring or the fountain of this money making process. He gets the first ability to benefit from the wealth effect as he can spend his money on goods and services at the same time as the bond investor. He is a direct recipient of the first order of the wealth transferred from the poorest to the richest members of society. The bankster is on the welfare state of credit. The government is totally in control of this process yet does not seem to realize it.
This is why Jeremy Warner in his well argued Telegraph article wonders how so much wealth has been created for so few and why his the trickle down did not have a positive effect on the poorest members of our society. I hope I have demonstrated that as the production of paper money in itself does not create wealth , as if it did, world poverty could be ended tomorrow, like a counterfeiter, new money allows its first recipients to exchange nothing (bits of paper) for real things such as Mayfair town houses etc. The sad salient point, is as the “wealth effect” works its way through society bidding up prices, the poorest people pay more for their goods and services. They have what little wealth they have confiscated to the benefit of the likes of the banksters who are knee deep on the welfare state of credit. Real wealth creation happens when entrepreneurs start coming up with better methods of production to make better goods and services more efficiently then before. There has been too much of the former providing the illusion of wealth and too little of the latter.
By Toby Baxendale, on 22 February 10
I went to this event today.
“22/02/2010 – Ideas Space
Quantitative Easing: Friend or Future Foe?
The Bank of England entered unchartered territory in January last year when the Treasury authorised it to begin a radical monetary policy experiment that we now know as “Quantitative Easing”. Given the unprecedented monetary conditions resulting from the liquidity crisis, the Asset Purchase Facility has been welcomed with open arms, and now stands at almost £200bn invested in UK gilts and corporate debt. But has QE had an economic impact to match its political use? Will the cure prove as dangerous as the disease? How and when should the Bank close the lid on this potential Pandora’s Box?”
Several leading economic figures including Roger Bootle, Tim Congdon and Allister Heath, chaired by Policy Exchange’s Chief Economist, Andrew Lilico, will debate and discuss the merits of quantitative easing, the exit strategies for the Bank of England, the main challenges the UK’s economy will face as a result of the program in 2010 and beyond, and how policymakers should face them.”
These are my notes:
Tim Congdon spoke first , this basic message was that unless money supply, primarily bank deposits, is kept very tight and only moderately growing, there will be trouble ahead with boom or bust. QE has kept the economy on the road and the money supply has not fallen. He acknowledges that there were some problems in measuring this.
Roger Bootle second, he opened by accusing one of our columnist, Liam Halligan of being intellectually devoid of any understanding of economics as he viewed Liam’s world to be predicated on massive inflation and a bond strike and this would never happen. He also said that QE could happen an infinitum. I tell no lie, this is what he said. In fact he was of the view that this should go on and on for whatever amount of time until we were out of trouble. People needed to believe that this policy was going to be the policy that would sort out the economy and indeed he agreed with Krugman, that crude of all the crude Keynesians, that Japan had actually done too little to stop the ongoing deflation. The UK’s risk was never going to be inflation but deflation.
Allister Heath opened with saying he reluctantly supported QE as the key thing was to stop a monetary deflation but questioned why we were having a debate in the first place about the merits of QE and should we do more etc when we should be questioning why do we inflation targeting ? As this has given us the biggest boom and bust in living memory should we not dispense with this independent Bank of England , FSA and other so called control bodies and centralise further into one overall controlling body that controls the broad money supply?
I was utterly bemused by all this tosh spoken in the name of economics with glimmers of hope only coming from Allister Heath.
The chairman asked three questions and the audience were asked three questions with one follow up.
I asked “in business I create wealth by making my factors of production work more efficiently to produce more goods and services. I invariably have to lengthen the structure of my production by saving and investing this money in new and more efficient kit to produce more of my goods and services for better prices and service level for my customers. With those goods I can exchange them with other entrepreneurs, shop keepers etc for my basic food, rent for my roof over my head etc via the medium of money. Money is bits of paper in this country and an electronic bank deposit, so having more of the bits of paper and banks deposits to exchange for the same goods and services would only mean my purchasing power had been debased, so no wealth would have been created. I thought this question go to the heart of the matter.
The second was about bond yields – had they or had they not moved up or down.
The third as about what the panel thought about the questioner’s view that we could only get out of this mess via and export related recovery.
Peter Bottomley asked a question that I cannot remember.
The Chairman then had another round of questions.
Mine was relegated to the bottom by the Chairman. Roger Bootle thought it should be answered by Tim Congdon and in the end Allister Heath did give an answer which acknowledged that no wealth could be created by paper alone and that there was a large body of work in Mises and Hayek showing that the creation of credit causes boom and bust . He was reluctant to support QE as it at least kept money supply near static as opposed to imploding, but saw no ability for it to create wealth . I was not allowed time to debate this with Allister , but did mention afterwards that as he said to me, the Austrian School was divided between those who would support a printing of money to offset a fall in V and those who would just advocate a deflation to allow the market to clear at new lower prices. Having to go I should have added, there is a third camp based around the Cobden Centre who would advocate 100% reserves as this would fix the money supply and you can never have a run on the bank with 100% reserves in place. This is explained here http://www.cobdencentre.org/2010/02/a-day-of-reckoning/ .
Allister framed his discussion in the mainstream language of the Quantity Theory of Money, more I suspect to engage with his fellow economists rather than he having any belief in it being more than a tautology. For a refutation of the Quantity Theory see here http://www.cobdencentre.org/2009/09/qe-errors/ . I did point out at the end after the event had finished that if V went down, how could me selling a house to someone, real bricks and mortar exchanging for money and having it sold back to me for the same 10 times create any wealth? Yes we can increase the velocity of the circulation of money by doing daft things like I describe, but Allister accepted nothing like wealth creation will come of it.
The medium of exchange will not create wealth on its own. It is not wealth. If you hold these bits of paper you hold claims to wealth. The retained goods and the savings we have are wealth. The whole capital infrastructure of our companies and private balance sheets are wealth . This infrastructure drives wealth creation via the dynamic entrepreneurial spirit of men of action who mix the factors of production into the most efficient combinations to satisfy the most amounts of needs. No small matter of printing paper that facilitates exchange or adding electronic reserves to banks will make that wealth creation process any easier. The second part of this article explains how wealth is created http://www.cobdencentre.org/2009/09/can-the-manipulation-of-interest-rates-create-wealth/ .
A poor day for economics!
By Toby Baxendale, on 4 February 10
Drawing on the work of Nobel Laureates in economics from three traditions, plus numerous other distinguished scholars, Cobden Centre Chairman, economist and successful entrepreneur Toby Baxendale presents an informal introduction to our proposal for honest money and the benefits consequent on the reform. See also our precis of Irving Fisher’s 100% Money.
Fact
- The average overhang of credit to money of all banks in the United Kingdom is 34 x to its reserves i.e. its actual money base.
- If more than one person in 34 walks into all banks simultaneously to withdraw their deposits, there will be a system wide bank run and a mass liquidity event with systematic default and insolvency.
- We saw the start of this with Northern Rock in the summer of 2007.
- We attempt to paper over the cracks and restore confidence in the banking system still today – with little success.
 Sterling Liquid Assets (BoE FSR, Jun 2009) A practical, politically-acceptable proposal
Our proposal is, as Irving Fisher wrote, “The opposite of radical”:
- Require 100% cash reserves to be held against all demand deposits; there can never be a crisis if a bank always holds 100% cash against all its demand deposits.
- Parliament can do this with one Act.
A similar Act took place in 1844. The Bank Charter Act or “Peel’s Act” established a 100% reserve requirement for bank notes that were issued claiming to be redeemable in gold. The reality was that there were 23 notes in issue for every one unit of gold at the time, creating instability, “panic” and general economic chaos. Not a too dissimilar situation from today where we have 34 claims on money to one unit of money. Politicians in the 19th century did not see the creation of unbacked credit through accounting entries as a problem, since it was only done on a very small scale. The problem then was rampant note issue (claims to real money) well over and above the monetary base, as this was the preferred method the bankers used at the time.
It is often forgotten but when you place £1m in a savings account (in cash) in say the Royal Bank of Scotland, which has no legal reserve requirement, they then lend £970k (in credit) , keeping on average 3% of cash back in reserves, to an entrepreneur in say HSBC, who then deposits that money in HSBC. We now have one claim to the original £1m and one claim to the £970k. The money supply has moved from £1m to £1.97m – just like magic! This is credit expansion.
The reality is that across all the banks in the United Kingdom licensed by the Bank of England, we have for every £1 of money (in cash), £34 in claims to money (credit)!
Peel’s problem was the over issue of notes to gold: our problem is the over issue of credit to money.
Continue reading “A day of reckoning: how to end the banking crisis now”
By James, on 26 January 10
Mr Smith works hard, plans carefully, and saves what he can, putting his money into a building society. He pays his credit card bills off each month, and tries to overpay his mortgage when he can.
Mr Smith got a 3% pay rise last year – inflation was only 2% – so he felt good about that. But… he doesn’t feel any wealthier.
Year after year, the government had said that the economy was growing strongly, but still, things seemed harder for his family and him. Train ticket prices up again. Heating bills rocketed when the price of oil went up, but never seemed to come down. He swears a loaf of bread and a pint of milk were much cheaper in years gone by.
When he changes his cash for Euros, he realises that his holiday in France is now unbearably expensive. His tax rates didn’t go up, but still, after all his bills were paid, he seemed to have less and less spare cash than he remembers a few years ago.
There are Mr Smiths everywhere. Careful folk, who plan, save for a rainy day and have a sense of personal responsibility.
Smith is the target.
It is Mr Smith who is going to pay for the banking crisis.
His saved wealth will pay the national debt.
His prudence will bail out Gordon Brown’s profligacy.
His forgone holiday will pay the banker’s bonuses.
His careful spending will pay for the vast number of quangos.
His financial planning will bail out the failed NHS computer project, over-budget military programs and ID cards.
His sense of responsibility will end up funding the destruction meted out in Iraq and Afghanistan.
It won’t be the politicians or the bankers who pay for global warming – he will.
He knows he pays tax… but what is hard for him to comprehend is that there is another pernicious process draining his wealth and subverting his hard work towards paying for the misjudgement of others. Whether he likes it or not, he naively pays for the decisions made by the political class.
He has no choice. No option. He was never asked to vote for it. And for the most part, the act of theft is so subtle he doesn’t even know it is happening.
Why does he feel poorer?
Why is it that Mr Smith seemed to miss the ‘boom’, yet is hurting more in the bust? Why doesn’t life get easier for him? What is going on?
Inflation.
As technology produces things more cheaply, Mr Smith should have been able to reap the rewards – except that things don’t get cheaper for him. Society cheats him when the government opens the spigot of new money, washing this value away as the torrent of new money chases prices higher beyond his reach.
The winners are always those close to the gusher – the banks, financiers and politicians. These are the ones who get to spend the new money first, thus chase prices up before Mr Smith gets any sniff of what is happening.
To save or to invest?
Think about your personal circumstances. Every time your payslip comes in, you have a choice of how much to spend and how much to save. Every rational person knows that there is a balance to be struck between current enjoyment (consumption) and future enjoyment (savings – or deferred consumption).
This choice is exactly the same for society as a whole. As a country, we must decide how much to consume, and how much to defer consumption in order to allow our children and us to enjoy things in the future.
The choice for us all is simple. Defer consumption and invest for the future, or consume and enjoy now.
What is the process by which we save for the future? There are two ways.
- Voluntary saving. If society needs to invest for the future, but people prefer to consume, then the savings rate – the profits paid on investments and/or the interest rate paid on deposits, rises until people choose to defer consumption and invest.
- Forced saving. Government policy forces a decrease of the purchasing power of money via inflation of the money supply. The net effect is a transference of wealth from savers and fixed income groups towards net borrowers (itself included). It also creates an artificial pool of liquidity into which the government can sell its IOUs.
The evil of Forced Saving
The natural state of affairs in a free market, with a more consistent supply of money, is that general prices fall as technology advances. The prudent are rewarded, and borrowers have to carefully evaluate and moderate their flights of fancy, only investing borrowed funds carefully in sound projects.
When the value of money declines, savers find that their money buys less, whilst borrowers are happy to find that they can repay their debts with money of a decreased value. It’s like borrowing five books from the library and finding that you are only required to give four back!
By setting a target for rising prices and then pulling levers to increase the supply of money in the economy to achieve it, the government prevents the natural response of general prices to competition, increased efficiency and innovation: they stop prices from falling.
Entrepreneurs, innovators, inventors and new businesses exist because they believe that they can satisfy society’s wants better than they have been served before. They have ideas, innovations and take risks in order to provide goods that are cheaper than they otherwise would be. Businesses operating in a competitive environment always seek to reduce costs, be that one step more efficient and produce a cheaper or better widget. As group of people, entrepreneurs bring efficiency and innovation, and they make stuff cheaper.
The benefit to Mr Smith should be that his income goes further. As time progresses, technological innovation should mean he can buy more with the same cash. But that’s not what happens, as any pensioner knows. Saved money buys far less now than it did at the time it was saved.
Governments achieve rising prices by encouraging the supply of new money. This new money comes from the central bank via its control of the banking system. The first users of this new money are invariably politicians, finance capitalism and big business. These guys get to use the newly minted money first, and thus spend it first. This process bids up prices, leaving everyone else chasing behind, and poor old Mr Smith last in the queue.
What an evil system it is then, when government can control money in such a way as to give it a first user advantage that penalises all those in the general population whose wealth is being rapidly diluted. A process that systematically violates and loots pensions, savings, fixed incomes and the actions of prudent, and rewards the profligate, the speculative borrowers and above all, rewards the biggest borrower of all: Government.
Let’s be clear. The current system is a process that diverts the benefits of innovation and technological advancement that should accrue to the general population, and thrusts it towards the desired spending of the well connected and the political class.
We need to stop this continual violation of the little man. Mr Smith has to start realising what is happening to him.
That’s why I’m proud to support the efforts of the Cobden Centre.
By Steven Baker, on 22 January 10
Today, we publish our brief guide to money and banking.
The Guide comprises:
- Four charts showing how Baxendale and Evans’ measure of the money supply correlates to economic activity whereas the Bank of England’s measures do not,
- How wealth is created,
- What is and is not money,
- What is wrong with the mechanistic Quantity Theory of Money,
- The role of the interest rate in the business cycle,
- How banking has become socialised through legal privilege and taxpayer guarantee,
- The shape of the debate on money and banking.
By Steven Baker, on 19 January 10
This article has been brought forward in response to the widespread positive reception of Baxendale and Evan’s measure of the money supply at Conservative Party Conference.
 In their working paper Assessing UK money supply measures in the light of the credit crunch, Toby Baxendale and Anthony J. Evans provide a better measure of the money supply. In this article, Steven Baker explores the background to the paper and indicates some key findings.
Many people know the Bank of England is creating new money through quantitative easing but if the quantity of money is being increased, how is that quantity being measured? What is counted as money?
As the Bank of England explains:
When the Bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero.
So if they are almost at zero, and there is still a significant risk of very low inflation, the Bank can increase the quantity of money – in other words, inject money directly into the economy. That process is sometimes known as ‘quantitative easing’.
But when I consider quantitative easing, I am concerned with the following problems:
- It is not clear that the Bank of England has a useful definition of the money supply. The present measures do not correspond to economic activity — which is what the Bank is trying to increase with new money — and this crisis was famously not foreseen.
- As commentators have reported, “the Bank’s Governor, Mervyn King, seemed pretty confident that QE could work. But even he would admit he has no idea how long it will take – or how much money he will have to print to get there.” This uncertainty seems less than ideal given the risk of price inflation.
- As the end of the present round of QE approached, it appeared it was not working.
- According to Austrian-School economic scholars including Hayek and Huerta de Soto, injecting new money can create only a harmful illusion of prosperity.
As my colleagues point out in their working paper, the fact that the monetary authorities have turned to increasing the quantity of money will focus attention on how that quantity is measured. This article provides some background information and indicates Baxendale and Evans’ key findings.
Continue reading “What is money?”
By Gordon Kerr, on 15 January 10
One day in October 2008, the UK’s banks all collapsed.
Perhaps it would be more accurate to date stamp the collapse one year earlier when Northern Rock failed and was rescued. UK Banking, in a commercial sense, ended on that date. We now have a state sponsored banking system. Some would disagree because banks such as Barclays have not actually grabbed the lifeboat, but I beg to differ. If the Government removed support from the banks it has underwritten then Barclays too would fail, so the entire UK system is effectively nationalised.
Most politicians and media commentators appear to have accepted the state bailout as a reasonable response to the banking collapse. We are asked to believe that the lifeblood of the economy, bank lending, is flowing again. However, data supporting this contention is hard to find. That which does exist is artificially enhanced by the Government’s injection of artificial, printed money.
The media soothe us with frequent assertions that the bailout and its sister policy, QE, are working, but they are clutching at straws. The banking bailout combined with the printing of money taken together is the single worst economic decision ever made by any UK Government. Let me prove this by way of simple analogy.
Just for one moment let us imagine that October 2007 did not portend the banking crisis that would shortly unfold, but a different and even worse catastrophe. Let us pretend that we woke up that autumnal morning to discover that there would be no more food.
We all listened in silence as our tearful Prime Minister announced that Al Qaeda had won. All of the world’s soil had just been contaminated with a terrible and genocidal bug. There was no antidote to, nor means of arresting the spread of, this terrible bug. There was no hope of killing it.
We could no longer eat anything grown in the ground. Nor could we ever consume farm animals, because they of course graze on land. An emergency measure dictated that we put our pets to death to conserve precious food supplies. We could eat them now, but this would only delay the inevitable starvation for a few days.
We were all certain to die if we ate any food harvested from October 2007. All our international trading partners had been similarly infected. No other country would send us any food, they all had the same problem. A raft of worldwide emergency measures would ensure that no food would be imported to the UK.
Happily there was one exception, one strain of produce that was immune to the bug - wheat. There was one food we could still eat, bread.
Ironically the bread baking industry was going through its own mini crisis as this news broke. The bakers were all on the verge of bankruptcy because, a month earlier, the UK’s dominant retailing business, Tescopoly, had decided to sell bread at 1p per loaf in order to rid the nation’s high streets of the few remaining shops that were preventing its continued expansion.
The Government had not worried about the strangulation of the high street baker when Tescopoly had launched that attack, but the new food crisis brought an immediate change of policy. Every baker in the UK was to be bailed out by the taxpayer. The practical measures were in three parts. The Government would immediately and indefinitely:
- Service the rents and business debts of every bakery in the UK;
- Pay senior bakery staff their base salaries plus substantial bonuses in return merely for agreeing to keep their bakeries open and turning up for work;
- Fix the price of all bread to be produced. Prior to the Tescopoly assault bakers were selling standard loaves at an average price of £2. Even at that price they only made a 10% profit, or 20p per loaf. The deadly bug was hardly likely to lower the costs of wheat, and yet the Government decided to fix the price of a standard loaf at 40p, a reduction of 80%. [Sharp readers will note that by October 2008 UK interest rates had been fixed at 1%, an 80% reduction from the pre-crash level of 5%].
The Government anticipated difficulties in selling this policy to the public. It easily persuaded the bakers (in return for the free money they would enjoy) to issue statements to the effect that they would make “every effort” to bake as much bread and feed the starving population. However these palliative words were accompanied by the stark warning that, of course, the Government could not actually run the bakeries nor guarantee levels of bread production.
How much bread do you think the bakers produced after this bailout?
As soon as the disappointing news about continued bread shortages broke, the Government announced that it was surprised that the rate of increase of bread production was disappointing. Swathes of the population were starving to death. The Government spin machine turned on the bakers who were castigated as socially irresponsible. The press reported a new era of zombie bakers, and the nation’s patience was further tested when it was reported that many bakers were stockpiling wheat, not even turning their ovens on in the mornings, yet ordering lots of new Ferraris.
Desperate to defend itself the Government dreamed up another wheeze designed to confuse the public and mask the problem: falsifying the wheat accounts. Because the original emergency measures had provided that the Government was now the sole auditor of the wheat supply, the Chancellor of the Wheat Exchequer decided simply to pretend that we had twice as much of it.
Eminent economists and nutritional experts were wheeled out to explain that “cooking the books” made sense. The public were brazenly told that the exercise was simple false accounting, but they did not object, so desperate were they for any hope of increased bread production.
To maintain the pretence, the virtual wheat was treated as if it were real. It was manufactured on a computer overnight by the Chancellor and was kept in a virtual cold store. The policy was given a fancy name – “Quantitative Freezing”.
Incredibly this policy boosted morale for a year or so and was presented as working. The Government basked in the glory of saving the nation from starvation. However the burial grounds were filling rapidly and the emperor’s true nakedness was exposed when the crematoria sought permission from the Department for Climate Change to burn bodies 24/7.
By Toby Baxendale, on 21 December 09
Sean Corrigan of Diapason Commodities Management packs more sound applied economics into this report than ever: Toby Baxendale provides a commentary. This is a great Christmas read for us all: download the report here.
 Bastiat's Iceberg On the Errors of GDP Accounting
- For the USA economy, Corrigan shows the utter futility of using the conventional GDP measure. The same applies for any of the OECD countries who use the same measure.
- Business spending in 2006 in the USA was $31 trillion vs a GDP of $13.4 trillion.
- Businesses were spending $4.30 for every $1 spend on personal consumption.
- Policy makers from around the world, if any of you are reading this article, please take note of the significance of this fact!
- This focuses on something that all Austrian economists know: the desire by the mainstream economists is not to double-count. In the end, they do not count much at all!
- As a catering fish monger myself, I buy fish off farms, boats and auctions around the world. I cut and prepare the fish and send it to my customers, the hotels and restaurants of the UK. Yet none of my spending exists in the GDP figures! My wealth and that of my suppliers does not exist as far as the authorities are concerned. I only wish that I could get the tax man to take this view like his economist colleagues in the Revenue Department!
- I had this discussion with a member of the MPC some months ago: how if my salmon was bought at the fish farm for £1 per kg and we put a £1 mark-up on after cutting it up and the end user put a £1 mark up on, it is double counting as far as he was concerned. He reasoned that to count all of the stages of production when it only finally gets sold for £3 would be an overstatement as the price of the inputs is in the final price of £3. They miss out the significance that I and my supplier have our profit to the spend in the wider economy after we have spent our companies’ resources on continuing investment and consumption. This is all real activity! This is the danger of having statisticians running the economy.
- All that matters, we are told, is that GDP is composed of 70% of final consumption expenditure. In reality, the final consumption element is more like a quarter of real GDP, once the production sector is included.
- As I have always said, the health of the production sector is driven by its ability to invest in replacement capital to make more efficient production techniques, to supply more goods and services to people at better prices and with better service levels. This is the essence of entrepreneurship, the essence of wealth creation and the essence of the recovery: magic tricks perpetrated by the economic witch doctors, who wish to pursue a policy of QE or similar, will only consume capital and not replace it with some better means of production.
Continue reading “Bastiat’s Iceberg: A Sean Corrigan Masterpiece for Christmas”
By Steven Baker, on 18 December 09
Via Edmund Conway at The Telegraph we learn that the debt today cannot be inflated away:
In fact, around four fifths of the state’s debt bill is inflation-proof. The only way ministers and mandarins could inflate their way out of the crisis would be to rip up all the contracts that tie these debts to inflation: possible in the case of the state pension (which is one reason why Gordon Brown’s pledge to link it to earnings is probably doomed), difficult for all the rest.
Thankfully, James Tyler has explained How to deal with the Banksters, a proposal in the tradition of Fisher, de Soto and others which just happens to deal with the debt too.
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