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By Anthony J. Evans, on 18 January 12
I was recently quoted in Management Today with some thoughts on current monetary policy:
The Bank of England’s policy rate has been historically low for some time now and this cannot continue indefinitely. The aim of low interest rates is to boost the economy by creating incentives to borrow money and invest. But higher capital requirements and policy uncertainty create counter forces that restrict bank lending.
In these circumstances the purported “benefits” of low interest rates fail to materialise, but the costs certainly do. These include the lack of an incentive to save (and actually rebuild banks’ balance sheets through voluntary lending), distortions to the capital structure of the economy (making white elephants like the HS2 line appear profitable) and the erosion of people’s savings.
The fact that real interest rates (the difference between inflation and the return you get on your savings accounts) is negative is a harmful confiscation of wealth.
When interest rates are close to zero policymakers look to alternatives, and quantitative easing has emerged as their favoured tool. However grateful banks and the financial community are in general to have an injection of freshly-printed money, it’s not clear how much this is helping the real economy. The aim shouldn’t be to preserve the status quo, but to find ways to allow banks to fail without exposing the general public to the fall-out.
Read more.
By Anthony J. Evans, on 16 November 11
I think this is a complicated question to answer, and both sides of the debate have a tendency to over simplify.
If we understand the goal of QE to be an increase in aggregate demand such that the Bank of England’s implicit and explicit objectives are met, I think it’s reasonable to conclude that it worked “better” than its critics feared, but not as well as its advocates hoped. In other words, I think output is higher than it would have been without QE, inflation is lower than some people warned, but the former is lower than and the latter higher than the MPC would like.
In this week’s column for City AM I wanted to highlight an irony in the debate. If “above target inflation makes little difference if expectations remain anchored” one possible explanation of the muted effects of QE is the Bank’s decision to retain an inflation target. Therefore:
We now have the odd situation where those warning of impending hyperinflation – the sternest critics of QE – provide the intellectual prerequisites for it to work. By contrast, in pandering to those concerns, its proponents ensure that it will not.
It strikes me that unless the Bank of England allows inflation expectations to rise, QE will have a muted effect.
Read the whole article here.
By Detlev Schlichter, on 11 October 11
The world is facing the worst financial crisis since at least the 1930s “if not ever,” the Governor of the Bank of England said last week when he explained to an increasingly sceptical and weary public the Bank’s decision to print yet more fiat money and use it to buy yet more government bonds. I doubt that his words or his actions will do much to restore confidence. And they will not mean an end to this crisis.
What type of crisis is this?
This is a financial crisis for sure. Its root causes are firmly located in money, credit, debt and banking. And I don’t think that the Governor was exaggerating when he speculated about its magnitude. This is the Big One.
As we all agree that this is not just another business cycle, the question is, what are we dealing with here? How should we define this crisis and in what context can it best be understood?
This crisis is systemic, not cyclical. It is a crisis of institutions. It is a crisis of policy. It is a crisis of our financial architecture.
When this crisis started in 2007 and intensified throughout 2008, it was often labelled a “crisis of capitalism”. You don’t hear that so often anymore. Granted, there are still the occasional lapses, sadly even by economists, but the longer the crisis goes on and the longer the spotlight remains on money and banking, the more it dawns on the public just how much the present financial architecture is evidently defined not by the “invisible hand” of the market but the controlling hand of the state. When yet another round of bank “recapitalization” is announced, presumably at taxpayers’ expense and thus driving home the point once more that the banks are above the fray of normal and fallible capitalist enterprise, and when the salvation for our debt-laden economy is declared for the umpteenth time to be sought in yet more debt-funded government spending, or in yet another injection of more money created under state monopoly by the central bank and handed to the public as an apparent incentive to take on yet more debt, the public is beginning to wonder if policy makers have not lost the plot, and if we should not fear the ‘stimulus’ more than the unchecked market.
Why are we in this mess?
“Undercapitalized banks” is code for banks that lent too much. How can banks have lent too much, and obviously have done so for years, decades even, and have done so the world over in the most enduring and persistent credit binge in history, when they are all under the control of the state central bank, which in a paper money system has the monopoly of printing (unlimited) bank reserves and administratively setting short-term interest rates, and thus controlling lending conditions? Is this not properly called state failure, rather than market failure?
Please remember, the switch from apolitical, inflexible, and hard commodity money to limitless paper money under state control was a political decision, not the result of market forces. And it only came into full bloom with the closing of the gold window by the politician Richard Nixon in 1971. Our financial system is the outcome of political design and popular macroeconomic theory, both now revealed to have been self-serving and flawed, not the result of spontaneous human cooperation on markets. The move to fully elastic fiat money freed both the state and its protégés, the banks, from the golden fetters of inelastic commodity money. Without the straightjacket of a gold standard, the state obtained unrestricted control over the printing press and could engage in “managing” the economy, saving the banks, avoiding or shortening recessions, and determining borrowing conditions – and setting them more generously, not least for itself.
After 40 years of government-controlled money, this is the result.
This crisis is the inevitable outcome of the dangerous belief that low interest rates, and investment and lasting prosperity, can be had via the short cut of money printing, and its twin sisters, artificially low lending rates and never-ending bank credit creation, rather than the time-honoured hard way (and capitalist way) of saving and true capital formation.
This is not a crisis of capitalism. My good friend Brian Micklethwait coined a much better phrase for it: This is the second crisis of socialism. We are witnessing the demise of the paper money standard, 40 years after the global fiat money system was freed of its last link to gold, and money everywhere became simply an unchecked territorial monopoly of the state. What we are now finding out is this: the state and the banks need a straightjacket or they will sooner or later drag us all into a black hole.
Why is this system socialist?
There are two ways in which a monetary system can be organized: either the market chooses what is money, or the state does.
The money of the free market, of capitalism, has always been commodity money that is outside of political control. Wherever the trading public was free to choose, it picked commodities of fairly inelastic supply as monetary assets. Almost all societies, throughout all cultures and civilizations, have come to use precious metals as money.
Commodity money is apolitical money. Nobody can create it at will and use it to fund himself or to manipulate the economy. Crucially, human cooperation via trade does not stop at political borders, and commodity money has always transcended such borders. If gold was money this side of the border, it was usually equally money on the other side, regardless of whose image was printed on it.
By contrast, complete paper money systems that have no link to an underlying commodity are always creations of politics. In such systems, money can be “printed” at essentially no cost and thus practically without limit. But not by everybody. Money printing is the privilege of the state and its central bank. Money, in this system, is entirely elastic. But it is political money and closely linked to political authority. In a paper money world, if you cross a political border you have to swap your money for different money. All the efficiency of today’s 24-hours-a-day, multi-trillion-dollar foreign exchange market, which so easily impresses the untrained observer to whom it may epitomize global capitalism itself, is nothing but the market’s attempt to cope as best as possible with the inefficiency of monetary nationalism and monetary segregation that is the result of every national government wanting its own paper money under its own territorial political control.
To call this system capitalist means depriving the word capitalism of any meaning.
In this brave new system of fully elastic fiat money we put our financial affairs not in the hands of the unfettered market but in the hands of the state, of politicians and central bankers. This system is properly called a socialist one, not a capitalist one. And this system has failed.
Who are the beneficiaries?
For decades this system has benefitted the state, the banks, the wider financial industry – all of which have grown relative to any other section of society – and those who have assets to be used as collateral for leveraging the balance sheet: real estate, equity portfolios, company stock options. The costs of this system have been spread across the broader public via inflation and the occasional taxpayer bailout. This has been socialism for the rich.
Just like the first crisis of socialism – the collapse of the planned economies under Soviet guidance in 1989 – this crisis, the crisis of government-controlled finance, will also see the overthrow of the present establishment. Although the party leadership is still telling us that they have things under control: “Fear not, comrades, with some deficit spending and some astute money printing, tractor production will soon reach targets again”.
And just like the collapsing socialist state, the state-paper-money bureaucracy, too, has its true believers. People like Adam Posen, the Bank of England’s quantitative-easing enthusiast, who maintains his childlike optimism for and unwavering faith in the power of the printing press. If £200 billion of newly printed money, cleverly placed by the apparatchiks into the coffers of the banks and government, have not solved the crisis, surely the next £75 billion will. And why stop here? With another £175 billion, or £275 billion, or £375 billion, everybody in the UK should find a nicely paying job again. To people like Posen the problem with the planned economy is not that it is planned but that the plan wasn’t bold enough.
Mervin King, on the other hand, strikes me as a more Gorbachev-like figure, not a non-believer but too sceptical and too smart to be a fully signed-up party member. There is a fascinating interview with him from September of last year that got little attention in financial market circles, presumably because it was part of a BBC history program on Chinese paper money rather than on today’s monetary policy. Please check it out here, it is well worth listening to. If you go to 11 min 58 secs, the question asked is this: Are all paper money systems doomed to fail? King answers, no, he thinks, not all of them (although every single one has indeed failed) but he admits that the recent crisis has made him a bit more cautious in his assessment. Maybe the jury on whether paper money could be made to work at all was still out. Remarkable, for a central banker, I thought.
In my new book Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown (John Wiley & Sons, 2011) I show – conclusively, I believe – that systems of elastic money are always inferior to systems of inelastic money, and that elastic money systems cannot be made to be stable, that they must disrupt the market and lead to the accumulation of imbalances over time. They must end in economic disintegration and chaos. Paper money is not only suboptimal it is unsustainable.
This crisis is simply the demise of the latest incarnation of a state fiat money system. Like the first crisis of socialism, this crisis, too, will affect the lives of many people, it will cause upheaval and it will dispossess an elite of its entrenched position of power and privilege. Like the first crisis of socialism, it is an opportunity for liberty.
But unlike the first crisis of socialism, there is, this time, no Berlin Wall that we can tear down, nor some muddy patch in the Hungarian countryside with a hole in the fence through which we can climb. Today’s monetary socialism is global. And the collapse of this system will be global, too.
Obviously, the state has everything to lose, and state power has a habit of not accepting a loss of power lightly. Who knows? Maybe the state will nationalize the banks, introduce capital controls, confiscate private gold ownership or tax it heavily, ban Bitcoin, and force every pension fund to buy more government bonds.
In that case, some may argue that we are not in the summer of 1989 but in the spring of 1968. It wouldn’t change the endgame, just the timeline. But I still believe it is too late. We are closer to this system’s Berlin Wall moment than many people think.
In the meantime, the debasement of paper money continues.
This article was previously published at Paper Money Collapse.
By Sean Corrigan, on 10 October 11
Since the Great Financial Crisis started (in truth, since well before), we have unwaveringly maintained three main tenets in relation to how one should deal with the aftermath of a credit-driven, mass misallocation of resources.
Firstly, we have said that, even if we did accept, arguendo, the trite macroeconomic mumbo-jumbo of over-aggregation, that tired old, maintenance-of-spending-at-any-cost, Keynesian game of trying to compensate for the overstretch of one particular ‘sector’ of the economy by passing ‘the bad, or depreciating, half crown to the other fellow’ is most likely to tangle us in an inextricable knot of surindebtedness if the ‘fellow’ is a governmental body. We say this, since the specious initial advantage of the state’s temporary ability to ignore the imperatives of accounting logic is doomed to be overwhelmed by the legal intractability associated with that same entity’s eventual financial exhaustion. Furthermore, this mere procedural failing is always horribly compounded by the dilution of the sense of direct responsibility which accompanies its involvement in any plight in which the relevant country lands itself.
Secondly, we have stood foursquare behind the idea that all the losses are actually incurred during the heady euphoria of the Boom, that the Bust is nothing more than the overdue recognition of those mistakes, and that to procrastinate thereafter in their acknowledgement is not to avoid the pain, but to exacerbate it in much the same way as a sufferer from a cancer can do himself nothing but harm by trying to delay the awfulness of the therapy which sadly must await him.
Thirdly, it has been our avowed belief that, contrary to the accepted wisdom, there are very few useful macro solutions to such a condition, but only micro ones; that recovery is built one job, one company at a time, from the bottom up.
Therefore, the most beneficial role for Leviathan is not some crazed, Frankenstein process of pulling levers and administering potions in some swivel-eyed, Gene Wilder fashion, but is one of expediting the renegotiation of now-unfulfillable contracts; of impartially overseeing a just transfer of assets from the failed to the well-founded; and of ensuring as few scarce resources as possible—in this time of unexpected penury—are pre-empted by the dead hand of the bureaucracy and, hence, are made available to the putative builders of a new, more prosperous tomorrow.
In all of this, we have been generally cynical of the ability of politicians to deny themselves the chance to carve their effigy on an imaginary Mt Rushmore of interventionists. We have been even more deprecatory of the nomenklatura of would-be Plato’s who advise them, those ’socialists of the chair’ who blindly fill their pink column inches with the ludicrous argument that the only remedy for the failure of government interference is more interference. We have been vehemently opposed to the machinations of central bankers—the ultimate succourers, when not the original seeders, of the Boom—who continue to frame every response in terms of the provision of liquidity to their precious cartel of institutionally parasitic, fractional reserve banks.
Despite this, it has been hard to suppress the faint fluttering of a hope lately freed from its hard chrysalis of doubt by the integrity of some members of the northern European political class and their nominees within the Heart of Darkness of the central bank itself.
Germany—with both tacit and expressed support from among the Dutch, the Finns, the Slovaks, and others—has wrestled itself close enough to doing the right thing—to writing off much of the debt; to making the imprudent private owners and creditors face their responsibilities; and to insisting on guarantees of future good housekeeping from the incontinent debtors—to merit our applause, even if its courage eventually does fail it, or the temptation to take the road to hell along which everyone else is frantically pointing finally does prove too hard to resist.
However, any sense of the victory we entertain in this critical war of ideas—albeit four years late and several trillion dollars short—has to be tempered greatly by the awful truth that two of the major central banks have already succumbed, once more, to their liquidity fetish, while a third is patently ravening for the chance to overcome the present domestic impediments to further action.
One of them, the ECB, is slowly transforming itself into a Fed—over the careers of ex-Bundesbankers perhaps, but nonetheless inexorably so.
Believe, if you will, that all such measures as those announced this week are ‘temporary’—only to be countenanced for the duration of the emergency—and, as our New York friends say, I have a bridge to sell you in Brooklyn.
Yes, it is true that interbank lending has frozen, that the vast apparatus of sovereign finance is creaking alarmingly, and that real money supply growth in the Zone is hovering just above the zero bound. Of these, however, only the third is a potentially justifiable field for central bank intervention in extremis.
The first is a consequence of the long-suppressed mistrust of one another’s balance sheets being expressed by the banks themselves; a fear which could be dispelled overnight if they would each do no more than is required of any public corporation, namely, to produce an honest set of accounts, even if this would be to undertake an exercise in triage—of the merciless sorting of the weak from the strong. To recognise its origin is already to point to where the cure may be found—extended repo operations and expanded bond purchases do not lie along that way.
The second handicap is the legacy of long years of populist vote-buying whereby venal politicians have far too liberally dispensed a morally corrupting patronage, not by having to undertake the invidious task of clearly identifying the winning net recipients of tax monies from the losing net payers standing beside them at the hustings, but by recourse to the seemingly painless expedient of borrowing funds which are never intended to be repaid and which are, in great part, the result of inflationary credit creation on the part of the same central and commercial banks who are now so threatened by the fall of all these democratic Bourbons. Again, to make this diagnosis is to indicate what form the remedy must take and to show that the prostitution of the central bank, so as to maintain the status quo ante, will prove futile, if not fatal, to the patient
As for the Bank of England—well, yes again, real money supply has been running at a negative rate in the UK for some good few months past, dragging activity lower as it has. Yet a very good part of this real contraction is because the Bank has also managed to ignite a nasty rise in prices in violation of its rather open-ended mandate to moderate these over a self-determined and highly elastic ‘medium-term’.
As we have said before, the fact that the UK still manages to run a near-record trade deficit amid a severe recession and during an ostensible private sector credit crunch, despite a 25% drop in sterling’s real effective exchange rate such as to take it to a level only matched during the IMF crisis of the mid-70s Labour administration, is testimony both to the fact that the overall squeeze is not so intense as it seems and to the failure of all this macro-meddling to restore a semblance of competitiveness to a hollowed-out nation.
Where the leakage occurs, of course, is in the realm of the state where, for all the gnashing of teeth and tearing of hair about the ‘austerity’ programme, spending continues to rise, with the change in the state component of expenditures in Q2 outstripping that of households for the fifth quarter out of the last six. Total state outlays are still making new record highs, both outright and as a proportion of non-state GDP—that latter ratio now bumping up against the 60% mark, no less.
So it is all very well for Mervyn King to bleat about facing the most severe financial crisis since the 1930s, or to casually dismiss the cries of the thrifty that their livelihoods are being crushed in the vice of rising prices and falling returns to capital, but it is he and his predecessors, together with the political masters they serve, who have led us into these straits, by dint of their unshrinking embrace of a perverted orthodoxy of inflationary entitlement—of the entitlement of welfare recipients to their doles, of office-seekers to their votes, and of inveterate financial gamblers to their place at the tables of the state-sponsored, state-regulated, and state-underwritten casino.
Mr. King’s response to all this? Why, again to make it easy for the state to spend more and difficult for many of the most vulnerable elements of the nation to spend as much. Bravo, indeed!
So, while Chairman Bernanke can, for now, only threaten to increase the disruption he causes to the market’s pricing signals and to its ability to allocate resources optimally over time, his peers are already at work doing much the same mischief.
Caught up with the demands of their real dual mandate—that of keeping the ruling class happy while looking after the interests of their cabal of big bankers—few of them will stop to listen to what businessmen are telling them, though the message is being broadcast in the most clarion of tones.
Take the most recent Duke University/CFO Magazine quarterly survey of senior US executives as a case in point.
Asked to list external concerns in order of importance, the perennial question of sufficient demand for the firm’s products came top, but a clear second place was secured by the category ‘Federal Government agenda/policies’ – aka, REGIME UNCERTAINTY!
As for internal worries, the ability to maintain margins was top, the cost of health care, second, and the ability to forecast, third—over to you, Mssrs Bernanke and Obama, once more, for creating and fostering such extreme REGIME and MARKET UNCERTAINTY!
And the result of all this? Exactly what we showed in graphical form and briefly discussed in our last edition:-
A third of CFOs say they will not deploy excess cash this year, because they want to retain it should credit markets tighten. Twenty-nine percent say they are hoarding cash due to economic uncertainty, and 31% say they don’t have any excess cash to spend.
More worrying still for all those executives and traders who keep telling us that while business in the Old World may be slow, Asia will keep firing away and so save their bacon, the separate respondents from that particular region also manifested an uncharacteristically subdued tenor. We quote as follows:-
Optimism about the regional economy in Asia (not counting China) fell, with optimists and pessimists now evenly balanced. Last quarter, optimists outnumbered pessimists by two to one. In China, 69 percent of firms have grown more pessimistic about the economic outlook.
The top internal concern among Asian CFOs is difficulty in planning due to extreme uncertainty, working capital management and employee morale. The top external concerns in Asia are global financial instability, intense pricing pressure and weak consumer demand. Chinese CFOs also worry about government policies.
QED
But, carry on regardless! The present approach has been so successful that while one in ten Americans with a full-time job lost it in the slump, barely one in six of those unfortunates has found similar work since, leaving the total at 2000 levels and its fraction of the population at 1975 and 1983 recessionary depths, despite the intervening incorporation of women into the workforce. As for manufacturing—supposedly doing well on the cheapest dollar of the modern era—almost one quarter of the hours worked here were lost from the local maximum of 2006, of which, again, less than a sixth have since been replaced, leaving total hours fully a third below the stationary average of 1984-2001, and still stuck where they were in St. Roosevelt’s bleak 1940s!
Meanwhile, the 3mma of US NAPM new orders has dipped below the 50 watershed for the first time since the crisis, an event which has historically signalled a further deterioration over the succeeding six months in 70% of cases, and an ill omen we must interpret in light of the fact that the magnitude of the last few months’ fall in this component has only been exceeded three times in the past century—in 1974/5, 1980, and in 2009 itself.
Even in Germany, 2009-10’s impressive growth in factory orders has begun to peter out to the point that there has been little further sustained growth so far this year. Meanwhile, at the other end of the world, a PMI of Korean orders languishes at a 2-year low, while exports of capital goods from Taiwan have not been this weak since early 2010.
It may be too much to say that the wheels are coming off the recovery, but they are certainly beginning to wobble.
By Alasdair Macleod, on 10 October 11
Over the last few weeks there has been a growing realisation that the weaker members of the eurozone are caught in debt traps. When the “PIIGS” (Portugal, Ireland, Italy, Greece and Spain) signed up to the eurozone they gave up the right to devalue, which is the traditional and delusionary escape route for sovereign debtors. But when you come up against the realities of hard money, this route is blocked. A temporary solution has been to gets banks to buy government bonds, but the banks can take no more. This leaves us with a banking problem, but fortunately their solvency is being underwritten by the European Central Bank, without which the eurozone would have ground to a financial halt.
The ECB, together with the national central banks, can only support these banks by writing a blank cheque on itself, while using all means possible to conceal and play down the losses in the system. This essentially is what happens with the good-bank/bad-bank solution: if the bad stuff is carted away to be dealt with out of the public gaze leaving the good stuff behind, what is there to worry about?
We have to keep our fingers crossed that the ECB continues to succeed in co-coordinating this vital task, and indeed, its strongest suit is that we all want it to succeed. But this still leaves us with the unanswered question of how to resolve the sovereign debt traps.
The problem is global. The eurozone’s debt problems, which also extend to France and Belgium, have only become obvious because of the inflexibility of the euro. But debt traps have also closed on the US and the UK, who can try to print their way out of trouble. Both these governments are fully committed to monetary inflation as the means to conceal and defer their own financial difficulties. This is what quantitative easing is actually about: it is the way a government funds itself when markets are unable or unwilling to come up with the money required. You bypass markets by printing it for your own banks to lend to you.
The idea that QE is primarily to help the economy recover is Keynesian guff, a cover for the true reason. Without it, the US and UK would have to compete for global savings at far higher interest rates. What price $2 trillion in new Treasuries with no QE? What price £175 billion in new gilts? The debt trap has already sprung. And few investors yet seem aware of the irony that loading up banks with Treasuries and gilts is exactly what the eurozone banks have already done for the PIIGS. Whatever the current difficulties faced by European banks and the US and UK governments and their banking systems, there is only one option for all of them: buy time by printing yet more money. This is why the banking system in the eurozone and elsewhere will survive. Banks need governments as much as governments need them. The cost of this survival will be borne by the unwitting saver, who has been frightened into cash only to find it being debased more rapidly than before.
This makes the recent fall in gold and silver prices nonsensical. But then just as the investment community walked blindly into stock market losses, they are just as clueless about the inflationary implications of rescuing sovereign debt.
This article was previously published at GoldMoney.com
By Toby Baxendale, on 6 October 11
As we feared, the wise men at the Bank of England have decided that what our ailing economy needs is another dose of QE.
I was about to blog the event, but it’s hard to match the eloquence of Daniel Hannan’s latest post:
According to the BBC, the Bank of England has decided to ‘inject a further £75 billion into the economy’. Who knew it was that easy? I mean, why not inject £500 billion? Or a trillion? According to the BBC’s logic, it would surely make us the wealthiest nation on Earth.
I can’t believe I’m having to write this, but nothing new will be manufactured, invented or developed as the result of this monetary splurge, no services offered, no businesses founded. Rather, the money already in circulation – the money in your bank account, in your purse, under your mattress – will be worth less. The government, in other words, is helping itself to your savings – and, in doing so, is damaging productivity, disincentivising work and weakening the competitiveness of the British economy.
These themes will be familiar to regular Cobden Centre readers, as will his conclusion:
It’s a paradox. If I were to print counterfeit £20 notes and buy goods with them, I’d be perpetrating a fraud: I’d be buying something of real value with something I had magicked out of thin air. Yet when a central bank does the same thing, the half-educated economists who dominate our universities and television stations nod approvingly and mumble cliches about ‘boosting demand’.
You can’t keep boosting demand without producing anything, for Heaven’s sake. That’s what got us into this mess.
We’ll post more on this latest act of folly in due course, but in the meantime Steve Baker has posted a warning straight from Human Action:
By Mark Goodhand, on 2 September 11
In his latest article for ConservativeHome, Steve Baker considers the viability of America’s central bank:
A review of the US Federal Reserve’s own document: “FEDERAL RESERVE statistical release, H.4.1: Factors Affecting Reserve Balances of Depository Institutions and
Condition Statement of Federal Reserve Banks”, issued on August 23rd 2011, reveals some interesting information about the state of the Federal Reserve, the US central bank: it’s very nearly bust. As it is indirectly the lynchpin of the global financial system, that matters to the UK.
The size of the Fed’s balance sheet is now about $2,843 billion, up from about $800 billion three years ago. The huge increase in the Fed’s balance sheet stems from bailouts, quantitative easing, and other central bank “liquidity” operations.
…
The Fed’s capital base is $71 billion. That represents about 2.5% of its assets, or a leverage ratio of 40 times its capital. This ratio would have been considered unthinkable prior to the crisis: it is about four times greater than that permitted by the new Basel proposed rules for commercial banks and simply demonstrates that the bailout format and quantitative easing do not make these problems go away. If the patient has been incorrectly diagnosed, taking the wrong medicine will not cure him.
This capital to asset ratio means that a loss on its assets of 2.5% would be enough to make the Fed, by any normal standard, insolvent – unable to pay its debts.
Read the entire article to find out just how likely this is.
By Anthony J. Evans, on 5 August 11
The Cobden Centre’s Jamie Whyte appeared on BBC Radio 4 yesterday morning to discuss the prospect of further quantitative easing in the US and UK.
In my view, three key points came across:
- the economic situation was different in 2008 (only a serious monetary crisis can justify monetary stabilisation);
- central bank interventions get in the way of market discovery processes;
- previously injected money has been hoarded, so it hasn’t had the desired effects on broad money (central bankers are “pushing on the end of a piece of string”)
Excellent stuff!!
If you weren’t up at 6:20 to hear the original broadcast, you can catch it on iPlayer until next Thursday, 11 August, at 9:02 AM.
By Tom Clougherty, on 3 August 11
This article was first published at the Adam Smith Institute on Saturday, 30 July 2011
At the Hayek v Keynes debate at the LSE on Tuesday, George Selgin probably raised a few eyebrows when he pointed out that Hayek would, in theory, have been in favour of quantitative easing to prevent a deflation. That doesn’t really chime with the extreme do-nothing image many people have of the Austrian school of economics.
Yet as Lawrence White pointed out in this paper, Hayek’s position on the correct monetary response to a downturn is more nuanced than is commonly imagined:
Hayek’s business cycle theory led him to the conclusion that intertemporal price equilibrium is best maintained in a monetary economy by constancy of “the total money stream,” or in Fisherian terms the money stock times its velocity of circulation, MV. Hayek was clear about his policy recommendations: the money stock M should vary to offset changes in the velocity of money V, but should be constant in the absence of changes in V.
Essentially, Hayek wanted money to be ‘neutral’ and that meant that it had to be constant. For it to be constant, changes in velocity had to be offset by changes in the money supply. The central bank should not, therefore, permit the kind of monetary deflation that occurred after the crash of 1929 to take place. On this basic point, there is actually little difference between the Hayekian view and the approach taken by Milton Friedman.
Does that make Hayek an apologist for central planning? Well, not exactly. Those in the modern free banking school (like Lawrence White and George Selgin) would argue that in a wholly denationalized banking system, private banks would react to a fall in velocity by issuing more base money (if people were hoarding cash) or by reducing their reserve ratios and lending more (if people were sitting on large deposit balances). That would achieve the constancy of the ‘total money stream’ that Hayek favoured, but would do so spontaneously rather than according to some central plan.
The argument goes, therefore, that central banks should try to mimic this process if faced with the same set of circumstances. Hence Selgin’s comment that Hayek would have favoured quantitative easing. But note that he only said ‘in principle’. In practice, there are a whole host of other considerations.
Firstly, central banks have limited information. As with all central planners, their chances of replicating the outcomes that would prevail in a free market are slim. Secondly, modern central banks tend to have a strong bias towards inflation. The upshot of these two points is that a policy like QE should only be pursued when the downside of doing nothing outweighs the potential cost of getting it wrong. Outside of severe crises, that’s unlikely to be the case. Thirdly, QE as practised today (using ‘new’ money to buy government bonds from a bust banking sector) might not be the best way of achieving the objective of monetary stabilisation. The old-fashioned Bagehot rule – providing liquidity support to solvent banks at a penalty rate – might well be preferable.
Finally, it’s worth stressing that the Hayekian / Free Banking approach is not about stimulating the economy, or bailing out failed institutions. It does not aim to re-inflate old bubbles, or create new ones. Nor is the idea to support wages or prices. The goal is simply to create a stable monetary environment so that economic adjustment and recalculation can take place.
By Detlev Schlichter, on 17 May 11
According to the mainstream press, the reason behind the present sell-off in commodities – and in many so-called ‘risk-assets’ (stupid really, all assets are risky) – is weak growth, not tighter monetary policy. At least this is how I interpret the market commentary in the Financial Times and the Wall Street Journal. The mainstream media often gets it wrong – but let’s assume for a minute that they are right. What does it mean?
Super-easy money was supposed to ‘stimulate’ us into recovery. In fact, it is causing input prices to rise, which in turn squeezes profit margins and chokes off the recovery that easy money was supposed to bring. Now the faltering recovery in turn undermines commodity prices.
Again, we see that, two years after the US recession officially ended, nothing has been solved. Our problems are still with us. In the meantime, the trade-off between growth (even growth of the artificial and therefore short-term type) and inflation is getting progressively worse. The UK offers a powerful illustration of this: again the Bank of England had to revise inflation up and growth down. Her zero-interest rate policy is boosting prices with little lasting effect on growth. It goes to show that once your economy is out of whack because of distorted prices and misallocations of capital as a consequence of previous money injections and excessive indebtedness, you can’t easily get out of this mess by printing more money and keeping rates artificially low for even longer. Bottom-line: the global economy is still very weak. The ‘recovery’ is feeble or non-existent.
Commodities are now correcting because there was too much hot money in them, or because they ran too much ahead of other prices in this mega-trend of inflation that we now entered, thus undermining demand for them.
If this were purely a commodity phenomenon, equities should rally. Lower commodity prices mean lower input prices and higher profit margins. However, equities are presently correcting as well. This is further indication that what is behind this move is concern about the recovery. If that is true, and if it lasts, we won’t see the monetary tightening that is now being talked about. Instead we may see more easing – and then commodities will rally again.
Last week, Trichet already forgot to mention ‘vigilance’ in one of his speeches. If unemployment stays high in the US, and the equity market comes under pressure again, it is only a question of time until we get QE3. Remember, The Bernanke made it his declared goal to boost the economy via high asset prices, including equity prices, thus benefiting Wall Street and the upper echelons of US society whose paper gains would then trickle down to the regular folks – he may have put it somewhat differently. In any case, if the economy is weak, we will get more monetary stimulus – and thus higher commodity prices, in particular a higher gold price.
Continue reading at Paper Money Collapse.
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