Are Austrians Hypocrites for Wanting a Gold Standard

The director of LvMIC asked me to reply to an anonymous blogger, perhaps it will turn into a LvMI article.  Not sure yet as it needs more work:

An anonymous blogger thinks they found a contradiction:

I noticed a contradiction: the Austrian School advocates against price fixing and economic planning, and the Austrian School advocates a gold standard, which can be seen as a way of fixing the rate of change of the size of the money supply through economic planning.

While it’s true that many Austrian economists (Mises, Rothbard, Hayek, etc.) write in reference to gold as money and use such definitions in their thought constructs, the context of their writing must first be understood.  The majority of the dominant Austrian economic literature today was composed at a time when gold was still considered money in some aspects of the global economy.  It was only after 1971 when Richard Nixon took the U.S. off the gold standard (not a true gold standard bu bear with me) completely, thus shattering the Bretton Woods agreement, that the transformation of the dollar into a full fiat currency backed only by the “full faith and credit of the United States” was complete.   The “full faith and credit” of course refers to the government’s ability to pillage its citizens of their earned wealth.

So many times when Mises or Rothbard refer to money as gold, it’s because an international gold standard, albeit an incredibly flawed one, was still in operation at the time of most of their writings.

As far as Austrians advocating a return to a gold standard, this is an often misinterpreted position.  Austrians recognize the efficiencies and wealth generating ability of the uninhibited market.  They are wary of government intervention which interferes in the process of billions of remunerated individual transactions en masse that encompasses a market economy.  Austrians merely wish to extend their laissez-faire views to the creation and sale of a specific commodity: money.

Rothbard, writing in The Case for a Genuine Gold  Dollar, summarizes what such a standpoint would mean:

The best known proposal to separate money from the state is that of F.A. Hayek and his followers.  Hayek’s “denationalization of money” would eliminate legal tender laws, and allow every individual and organization to issue its own currency, as paper tickets with its own names and marks attached. The central government would retain its monopoly over the dollar, or franc, but other institutions would be allowed to compete in the money creation business by offering their own brand name currencies. Thus, Hayek would be able to print Hayeks, the present author to issue Rothbards, and so on. Mixed in with Hayek’s suggested legal change is an entrepreneurial scheme by which a Hayek-inspired bank would issue “ducats,” which would be issued in such a way as to keep prices in terms’ of ducats constant. Hayek is confident that his ducat would easily out- compete the inflated dollar, pound, mark, or whatever.

Market competition always vets out the inefficiencies of lackluster firms while improving the quality and lowering the price of whatever good or service is produced.  Extending this outcome to the sphere of currency production would generate the same results as those currencies that are perceived as low in value or purchasing power would fail to garner widespread use.  Prices are only ever determined by consumer valuation; this is no different when applied to currency and its purchasing power.

If I were to obtain a printing press and begin producing sheets of “James E. Millers” and attempted to pass them off as currency, no one outside of a few naive children would likely accept them as money.  The promise of value from a lone seller is normally not sufficient for the universal acceptance of a medium of exchange.  Money acts best to facilitate transactions when it holds a few specific qualities: it’s recognizable, easily divisible, and durable.  This is why gold, which holds all of the listed qualities, was historically used as a currency for thousands of years.  When Austrians advocate for a return to a gold standard, there is an implicit assumption that if legal tender laws, capital gain taxes on alternative currencies, and the requirement that taxes in general are paid in dollars (or whatever country’s respective currency) are abolished, gold would most likely make a roaring return as a universally accepted medium of exchange.

Gold’s historical use also explains why it acts as a hedge against profligate government spending and currency debasement.  See the past ten years alone in the U.S.:




Austrians are not on the side of government enforcement of a gold standard outside of basic contract enforcement.  As Gary North puts it, “whenever governments enter the money business, the public should expect monkey business.”  The government must relinquish itself from all monetary control as such inevitably leads to indirect public debt monetization, perpetual inflation, the boom and bust business cycle, and banking sector cartelization.  The free market, meaning the decentralized actions of millions, must dictate how currency develops to prevent the mentioned abuses.

In short, the Austrian position is that people can use whatever commodity they desire as money.  However, an archaic system of multiple types of money (think chickens, cattle, eggs, butter, grains, cigarettes, pebbles, seashells, etc.) isn’t the best way to foster a dynamic and encompassing economy.  This is why a universal good such as gold and silver end up emerging as a widely accepted medium.  Government interference or acquisition of this process distorts a once democratic market process in favor of a coercive system that enriches a few at the expense of the general public.

As far as the asinine Warren Buffet quote (“[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”), all Mr. Buffet must ask himself is if gold really has no utility, why is it dug up in the first place?  Are gold miners nothing more than mindless drones infatuated with its shiny luster?  I think we can agree not for man acts with purpose- the purpose of gold mining being that gold itself is accepted as valuable.

Opponents of the gold standard fail to understand what money really is, the danger in state control over money, and how the market process is capable of creating a sustainable monetary system.  This is why they come up with illogical claims such as Mr. Buffet’s.  For those that derive a great deal of their income by influencing government policy, they want nothing more than to prevent and marginalize the return of a true gold standard.

Entrepreneurship and a Few Secrets

Didn't have much time today so after seeing it up at RealClearMarkets.com, I decided to post on James Altucher's recent column on entrepreneurship.  About halfway through, I realized Robert Wenzel's covered it a few days ago.  So now I once again look like an unoriginal fool but never the matter:

LvMIC:

When discussing the process of the market, Austrian economists often emphasize the importance of entrepreneurship and why it aids in the allocation of scarce resources.  In Man, Economy, and State, Murray Rothbard wrote this in regard to entrepreneurs:

The essence of production for the market, therefore, is entrepreneurship.  The key consideration is demand schedules, and consequently the future prices, are not and can never be definitely and automatically known known to the producers.  They must estimate the future state of demand as best they can.
Entrepreneurship is also the dominant characteristic of buyers and sellers who act speculatively, who specialize in anticipating higher or lower prices in the future.

When John M. Keynes wrote The General Theory, he criticized the classical school of economic thought for supposing that free, uninhibited markets were always at perfect equilibrium.  Of course this was wrong as the type of knowledge problems that are ever present due to unpredictable human behavior prevent such equilibrium from ever being reached.  Free and fluid markets only have the tendency toward a true equilibrium.  Mises and Rothbard both referred to this fictional state of perfect equilibrium as the "evenly rotating economy" (ERE) and both acknowledged it could never truly exist.  Since prices act as signals for entrepreneurs to meet demand, Austrians recognize the importance of allowing them to remain undistorted by government regulation and intervention.

Perhaps the most famous Austrian economists who wrote heavily on entrepreneurship was Israel M. Kirzner.  Not only did Kirzner warn about government perversion of market signals but also emphasized the importance of “awareness” that entrepreneurs must posses in order to be successful.  In summarizing Kirzner’s work, Richard Ebeling writes:

What guides entrepreneurs in this task is the anticipation of profits — revenues in excess of the expenses to bring goods to market — and the avoidance of losses. But one of the insights that Kirzner has highlighted is that while entrepreneurship is crucial to the workings of the market, it cannot be bought and sold like other goods or resources for a certain price. The reason is that the essence of entrepreneurial activity is “alertness,” an attention to scanning the market horizon for opportunities and innovations that can result in making better goods, or new goods, or bringing less-expensively manufactured goods to the market place.But to be “alert” is to notice something that others have neither seen nor thought of before. Alertness means thinking and seeing “outside the box” of the known set of opportunities and routine ways of doing things. It is the process of discovering new knowledge and possibilities that no one has either previously imagined or noticed.

In Israel Kirzner’s view, one of the most important reasons for open, competitive markets is for individuals to have the profit incentives and the chance to benefit from alertness.

Investor James Altucher’s recent Tech Crunch column lists some unorthodox tips one must consider in regards to being an entrepreneur.  While Altucher isn’t a follower of the Austrian school, his insights are in line with Kirzner’s concept of awareness.  Here are a few:

• The economy doesn’t matter. Groupon started in November, 2008. The news media is always going to say the economy is in the crapper. For once in your life, and for the rest of your entrepreneurship, turn the TV off.
• You are constantly going to be gripped with thoughts that your competitors are all better than you. And guess what, they are. So now you have to lie to all of your investors who are constantly calling you before their “Monday morning meetings” asking you, “can you tell me one more time why you’re better than so-and-so?”
• Calling your buddy and saying, “I hate this stupid company already. I wish I can sell it and start the other five ideas I have.” And, by the way, you might be right. Time to transform your crappy company into one of those five ideas. My first company made websites for Fortune 500 companies. At different points we almost became a record label, a tea company, a TV production company, and a half-dozen other things. Maybe one of those would’ve worked out even better. I’m not smart enough to know. But always be writing down the next ideas and see how your company can transform. If you aren’t writing down ten ideas a day then you’re failing.
• And note: Its ok to fail. We all make mistakes. We all crush the hope and spirit out of our friends, investors, and loved ones. It’s ok if you do it also. But be ready to start again and do it again. Avoid the shame. Crush them again and again. Until finally you squeeze juice out of them. Then it’s all worth it. Did that analogy just work? If so, then congratulations. You’re an entrepreneur.

Altucher is a great writer and his column, as well as his blog, are both entertaining and informative.  His story telling ability is top notch.  Though Altucher is correct in that the role of the entrepreneur can be incredibly stressful, it is necessary for an economy driven by subjective demand.  The individual methodology that dominates the Austrian school comes to the same conclusion.  Scarcity is, and forever will be, a fact of life.  Entrepreneurs ultimately look to use this reality as a means to sell a product or service at a profit.  Back in Man, Economy, and State, Rothbard resolves that every man, in essence, displays entrepreneurship when engaged in acting:

Thus, to some extent at least, every man is an entrepreneur.  Every actor makes his estimate of the uncertainty situation with regard to his forthcoming action.

-----------------------------------------------------------------------
By the way, I can never get over how similar Altucher's writing style is to Charles Bukowski, one of my favorite authors.  I guess Steve Jobs was right, great artists really don't imitate, they steal.

Austrian Economics and Other Heterodoxical Schools

The director of LvMIC asked me to write a post about a new article in The Economist:

The Economist is out with a new piece highlighting a few schools of economic thought that are putting pressure on what has been considered the conventional view among the profession over the past few decades.  Entitled, “Heterodox Economics: Marginal Revolutionaries,’ the piece summarizes these new schools as follows:

Warren Mosler, an innovative carmaker, a successful bond-investor and an idiosyncratic economist, moved to St Croix in 2003 to take advantage of a hospitable tax code and clement weather. From his perch on America’s periphery, Mr Mosler champions a doctrine on the edge of economics: neo-chartalism, sometimes called “Modern Monetary Theory”. The neo-chartalists believe that because paper currency is a creature of the state, governments enjoy more financial freedom than they recognise. The fiscal authorities are free to spend whatever is required to revive their economies and restore employment. They can spend without first collecting taxes; they can borrow without fear of default. Budget-makers need not cower before the bond-market vigilantes. In fact, they need not bother with bond markets at all.

The neo-chartalists are not the only people telling governments mired in the aftermath of the global financial crisis that they could make things better if they would shed old inhibitions. “Market monetarists” favour more audacity in the monetary realm. Tight money caused America’s Great Recession, they argue, and easy money can end it. They do not think the federal government can or should rescue the economy, because they believe the Federal Reserve can.

The “Austrian” school of economics, which traces its roots to 19th-century Vienna, is more sternly pre-Freudian: more inhibition, not less, is its prescription. Its adherents believe that part of the economy’s suffering is necessary, an inevitable consequence of past excesses. They do not think the Federal Reserve can rescue the economy. They seek instead to rescue the economy from the Fed.

The article does a rather lacking job of summarizing the Austrian school (no mention of praxeology or individual methodology?) and dedicates more print to Scott Sumner and Warren Mosler.  However, it’s always nice to see the Ludwig von Mises Institute receiving some mainstream attention:

The resurgence of Austrian analysis is not merely a web-based phenomenon. In 1981 Margit von Mises approved the establishment of an institute in the name of her late husband, Ludwig von Mises, one of the giants of the Austrian tradition of economic thinking. The Mises Institute set up shop at Auburn University in Alabama, attracted by a couple of “Austrian-friendly” faculty members and a timber owner willing to donate money to the cause. From early days in the shadow of the football stands, the institute now boasts its own amphitheatre, conservatory, recording studio and library. At one of the institute’s soirées, accompanied by a recital on its Bösendorfer piano, Vienna may not seem so very far away. Yet the institute’s impressive web presence, with ever more signing up for its online classes, makes its ideas, if not its ambience, available to all.

Despite its emphasis on MMT and market monetarism, the article brings up an important point.  Mainstream Keynesians and monetarists missed the financial crisis with flying colors.  This was a clear signal that a more developed theory needed to be heard and vetted which described why the crisis occurred and what the proper solution was.  In a guest post I had over at the Austrian economist Robert P. Murphy’s blog, I praised what I termed the financial/economic punkosphere:

This is precisely what encapsulates the financial/economic punkosphere.  It is composed of a minority of like-minded individuals spontaneously coming together who reject conventional wisdom and aren’t beholden to academic tenure.  In a global economic system defined by the collusion of government and large financial institutions, these bloggers and commentors try to make sense of the world while calling out idiocy whenever they deem fit.  Keep in mind; the label “punk” is used as a term of endearment for its rebellious connotation and not an insult.In this spirit, I praise what has become the financial/economic punkosphere that consistently challenges the establishment.  The internet has done wonders in the decentralization of information and knowledge.  No longer do ivory tower academics hold all the sway when it comes to economics.  Thanks to this new outlet of blogs, the Federal Reserve has never faced such scrutiny by the public in its almost century-long existence.

While the Austrian school has seen a resurgence thanks to the financial crisis, other schools such as Modern Monetary Theory have gained prominence as well.  What sets the above mentioned schools apart from the Austrian view is an almost fanatical belief in the sanctity of central banking.  Both MMT and market monetarism advocate for more aggressive monetary easing as a cure for the current downturn.  Economist Scott Sumner, who popularized National Gross Domestic Product targeting, has been drawing a lot of attention lately from the likes of Paul Krugman and former Obama economic adviser Christina Romer.  His rise to fame as a leading market monetarist is documented within The Economist article.  I have already covered the issues associated with the “targeting NGDP” in my American Thinker piece entitled “The Problem with the Fed’s Targeting.”

The idea behind targeting NGDP assumes that Bernanke, after failing to boost the economy for over three years, can somehow hit a target that’s dictated by the actions of billions acting homogenously.  Putting money in the hands of banks and individuals doesn’t guarantee that said money is spent in a fashion to boost NGDP.  As financial blogger Mike “Mish” Shedlock puts it, “[f]or starters the Fed cannot spend money, it can only lend it. Thus the Fed has at best an indirect affect on GDP.”  The real danger lies in the overshooting of a target which can lead to out-of-control inflation.

In the end, businessmen and entrepreneurs don’t keep their eyes on potential nominal gross domestic product.  The owner of my preferred local pizza shop isn’t scanning national economic statistics to see if NGDP has a possibility of hitting 5% a year from now.  He monitors a number of factors including input and output prices, tax rates, regulations, and profitability potential in order to decide if he should expand business or pack up shop.

Market monetarism buys into the same myth many Keynesians do: that the Great Depression was caused in part due to tight monetary policy from the Federal Reserve.  But as Gary North has pointed out, the monetary base did not shrink during the first few years of the crisis and in fact increased after the advent of the FDIC:

Money supply fell due to bank closings, but the Fed kept the monetary base stable and then went about increasing it.  After 1934, the printing press really began to prove its worth.  Market monetarists hardly mention this historical occurrence.  The cheap money narrative is far too appealing for their policy prescriptions.  The same goes for the erroneous belief that the Federal Reserve, with its inflationary practice from 1927-1929, didn’t cause the Depression.  Central bank apologists were fooled by the stable price level during that time period despite the overwhelming evidence of monetary prime pumping occurring at the time.

In short, the market monetarism solution for any economic problem is inflation- plain and simple.  The irony being that Modern Monetary Theory holds the same views.  While market monetarism is wary of government spending as an effective remedy for downturns, MMT is a no holds bar endorsement of the type of print-and-spending tactics that lead to bubbles and bursts.  According to MMTers, currency gains its value with the direct threat of taxation imposed via the government.  MMT giant Warren Mosler describes this concept in this eerie thought experiment:

The following is not merely a theoretical concept. It’s exactly what happened in Africa in the 1800’s, when the British established colonies there to grow crops. The British offered jobs to the local population, but none of them were interested in earning British coins. So the British placed a “hut tax” on all of their dwellings, payable only in British coins. Suddenly, the area was “monetized,” as everyone now needed British coins, and the local population started offering things for sale, as well as their labor, to get the needed coins. The British could then hire them and pay them in British coins to work the fields and grow their crops.

Simply incredible.  The MMTers believe that in order for private savings to occur, the government must spend first.  Deficits then never matter in terms of borrowing costs since the printing press is always available.  Inflation, according to the MMT doctrine, can be controlled through taxation, no matter how high, to suck money out of the economy should things become overheated.

There are a number of fallacies in these concepts.  While government has monopolized currency creation, currency was originally a product of the free market.  There is no requirement outside the state’s infinite lust for control that currency creation can’t be left to the private sector. While inflation can in theory be controlled by taxation, it can’t be guaranteed that it would be an effective means to cool down accelerating prices.  The epistemological problems such as how central planners know the correct tax rate or when to even implement it is also never answered by MMTers.
 
In short, both the MMT school and market monetarism rely heavily on the belief that central bankers are capable of fine tuning the economy to their liking.  They ignore the Cantillion effects new money creates when making its way through the economy.  Asset bubbles, inflation, and malinvestments are of no concern to either views.  The Austrians on the other hand recognize the fallacy of central planning and have a developed theory of the business cycle.  They saw the financial crisis coming from miles away unlike one leading MMT proponent.

Though its a wonderful development that mainstream economics is being challenged, Modern Monetary Theory and market monetarism hold very few differences from Keynesiansim.  All three advocate for central banking as a remedy for crisis.  None have an adequate theory on booms and busts outside of “print more money.”  They will therefore never hold a candle to the Austrian school and its insights.

Defending Kim Kardashian

LvMIC:

Yup, you read that title correctly.

Unlike the majority of us who live relatively boring lives, Ms. Kardashian has made a career out of selling the public an up close and personal view of her own private affairs.  This recently includes a rumored farce of a wedding to NBA superstar Kris Humphries which fizzled after only three days but made the reality star millions.

Ms. Kardashian’s financial success hasn’t been met warmly by everyone however.  According to the Wall Street Journal, an activist group composed of union and left-wing political interests has started a campaign to push for a millionaire’s tax in California and is targeting Kardashian directly.  Titling themselves “Courage Campaign,” this association is dedicated to “bringing progressive change and full equality in California and across the country.”  In addition to their website TaxKimK.com, the group has created a video to promote their agenda which can be viewed here.  The video, set to an overbearing type of trance music, claims that Ms. Kardashian made more than $12 million in 2010 yet only paid 10.3% in taxes.  That’s only 1% above the 9.3% that middle class Californians pay.

Like ravenous sharks at the smell of blood, Courage Campaign has its eyes set on more income ripe for plundering through taxation.  Their aim is an increase in California’s millionaire tax from 10.3% to 13.3% for income over $1 million and 15.3% for income over $2 million.  On top of California’s already horrendous business climate, this tax will undoubtedly provide more of an incentive for Atlases to do the proverbial shrugging and flee overzealous and overburdening government regulation.

Whether or not you agree with the type of lifestyle Kim Kardashian leads is ultimately a question of morality and ethics.  However, her ability to attract fans and monetary compensation is something to be admired.  Unlike the government, Kardashian forces no one to purchase the products she endorses, view her television reality shows, attend her birthday party, or cover her exploits for various media publications.  What she gives up in terms of a private life has brought her and her family a financially comfortable standard of living.

But like Frédéric Bastiat’s important lesson on accounting for the unseen in economic affairs, the Kardashian tale goes far beyond the millions she rakes in every year.  As Mises wrote in The Anti-Capitalist Mentality:

The only source of the generation of additional capital goods is saving.  If all the goods produced are consumed, no new capital comes into being.  But if consumption lags behind production and the surplus of goods newly produced over goods consumed is utilized in further production process, these processes are henceworth carried out by the aid of more capital good…Capital is not a free gift of God or of nature.  It is the outcome of a provident restriction of consumption on the part of man.  It is created and increased by saving and maintained by the abstention from dissaving.

From the theory of diminishing marginal utility, it is derived that those with more income are in a better position to add to their saving balances.  The act of savings both forestalls immediate consumption and, when placed into a bank or financial institution, adds to the amount of available funds able to be lent to aspiring entrepreneurs.  With more funds available, longer term and better methods of production can be sought to increase the supply of consumer goods.  In an economy not subject to continual monetary debasement and inflation via a central bank, prices are allowed to fall, thus raising real income for consumers.

Reality stars such as Kim Kardashian aid in this process as their revenue generating ability allows them to set aside more of their income.  This accumulation of savings leaves more money to be invested in base capital which increases the productive capacity of the economy.  This isn’t supply side economics, it’s a simple acknowledgement of the scarcity that dominates our world.

Courage campaign wishes more money to be confiscated from the productive citizens of California and given to bureaucrats to divvy how they see fit.  But the political class will never be capable of the type of efficiency-driven economic calculation private individuals must utilize when limited in their income earned through voluntary means.  If California ever wants to improve its economy, both taxes and public sector spending must be cut significantly.  This in turn frees up more money for the private sector to create jobs fulfilling demand.  The government should not be looked at as a job creator but the parasitic institution it really is.  To really improve the lives of its citizens, California must attract successful individuals like Kim Kardashian, not scare them away with the threat of more thievery.
---------------------------------------------------
I think I am gonna turn this into an article for Mises Daily, we will see.

Jim Rogers and Marc Faber Predictions for 2012

LvMIC:

Often the only two Austrian-minded investors with a clue, both Rogers and Faber see the same things coming in 2012: more government spending, more debt accumulation, another economic downturn, and, of course, more money printing.

Examiner.com:

Australia Financial News Network:  Well you’re clearly an investor with eyes on global horizons, but what’t your outlook for global growth stepping into next year?

Jim Rogers:  Well, I’m not too optimistic about what’s going to happening in the world in the next two or three years, and maybe longer.  We have serious problems in the United States.  You know in 2002 we had an economic slowdown, 2008 was even worse because the debt was so much higher and the next time around the debt is going to be staggeringly higher.  So the problems are going to continue to get worse until someone solves the basic underlying problem of too much spending and too much debt.

AFNN:  Elaborating on that problem of too much spending and too much debt, what do you believe is the biggest risk to global growth in 2012?

JR:  In a nutshell, too much debt and of course, the biggest risk is the central bank in the US which keeps printing money.  We have big problems of money printing, debt, too much consumption… be careful.

Business Intelligence Middle East:

Speaking in an interview with Jeanne Yurman of Reuters on the sidelines of the IndexUniverse’s 4th Annual “Inside Commodities” conference held on December 8 at the New York Stock Exchange, Faber said: “There is no doubt that QE3 will come in one form or the other, and in Europe also”.

“They will monetize,” he stressed.

Because of impending additional quantitative easing, Faber, who predicted the stock market crash in 1987 and turned bearish shortly before the 2007-2009 bear market, is less bearish on equities now.

If the S&P drops 10%-15% here [the US] and in Europe, “they are going to print money,” he predicted.

“When the EU [and the eurozone] were formed, in the Maastricht treaty it was stated that no country should have a fiscal deficit of more than 3% and the debt to GDP ratio should not exceed 60%, but nobody kept that promise, Faber reminded his host.

The first one to violate [the rules] was Germany, he added.

When you look at what happened subsequently where countries had huge expansions in debt/GDP, you have to ask yourself what did these bureaucrats do all day? asked Faber.

The renowned investor clearly disagrees with Keynesian policies that seek to get out of the crisis caused by too much borrowing and spending by spending and borrowing even more.

The limit of these [Keynesian monetary] actions has been reached he said. You can increase debt but it doesn’t increase prosperity or economic growth, because there is a point where the excessive debt growth doesn’t stimulate economic activity any more, but it does create bubbles in different sectors of the economy.

And because we’re in a global economy, the intended consequences of the actions may not even happen in the US. “Mr. Bernanke’s monetary policy was designed to lift the housing market. The only asset that didn’t go up since 2008 is housing.”

Rogers is long commodities like always.   Faber speaks highly of gold which he says is cheaper today than ten years ago when compared to monetary base expansion and government debt.

While looking at the financial laughingstocks that are the Eurozone and U.S. government, it’s obvious how addicted politicians are to spending.  U.S. Congressman Ron Paul is running for president on a plan to cut $1 trillion from the federal budget in his first year in office alone.  The plan is considered radical by the media and virtually the rest of Washington D.C.  The irony is that such cuts only bring government spending back to 2006 levels; hardly radical by any means.  But like any addict, the political class will go to any means to meet their next fix of being reelected.  This means keeping the gravy train rolling with buying more votes.  To keep the borrowing frenzy going, the Federal Reserve will keep suppressing interest rates by priming the monetary pump.  Meanwhile, the European Central Bank is keeping the EZ afloat through backdoor monetary easing.  China, facing its own inflationary bust, recently relaxed banking reserve requirements for the first time in years as it struggles to both cool down rampant inflation and keep its own property bubble from rapidly bursting.  Rumor is, the former communist nation will cut reserve requirements again soon- yet another admission of the inability of central bankers to come up with a solution beyond the printing press.


The biggest economies in the world are stuck between a rock and a hard place.  The good times of the inflation-fueled boom have come to an end.  Since market corrections don’t bode well for winning reelection; they are avoided like the plague by prescribing the exact same remedy that brought on the sickness to begin with.  This is why Rogers, Faber, and anyone familiar with the Austrian school sees nothing but more money printing in the future.  2012 is going to be a bumpy ride. 

Did Repealing Glass Steagal Really Matter and Is the Fed Really Protecting Us From Europe?

Got an article and blog post over at Mises Canada today.  Here is an excerpt from the article entitled "Did Repealing Glass-Steagal Really Matter?"

The financial crisis was caused primarily by the sharp decline in value of housing and once-AAA rated mortgages backed securities that garnered profitable yields. It was the Fed-induced bubble and subsequent burst that wreaked havoc on big bank balance sheets; not the crumbling of the barrier between two institutions that virtually performed the same functions of issuing commercial paper and investing in securities. By citing GS, proponents of financial regulation put the cart before the horse by not addressing the true cause of the bubble. After all, Bear Sterns and Lehman Brothers, both of whose collapse induced the 2008 crisis, were investment banks only as noted by David Leonhardt of the New York Times.ⁱ For the amending GS theory to work, one would have expected to see both Lehman and Bear Sterns using demand deposits of their commercial banking accompaniments as collateral for risky mortgage lending. That is the narrative, is it not?

In their recent book “Engineering the Financial Crisis,” Jeffrey Friedman and Wladimir Kraus back up Leonhardt’s assertion by noting that if the GS explanation were plausible, investment banks needed to transfer their losses to their affiliated commercial banks under the same holding company. Under the provisions of Gramm-Leach-Bliley however, commercial banks are not affected by the losses of their investment banking counterparts. According to Friedman and Kraus,

“Under GLBA, a bank holding company is merely a shareholder in its affiliates; it has no liabilities for their debts, and if either an investment-bank subsidiary of a BHC (bank holding company) or the BHC itself fails, the commercial banking subsidiary is unaffected.”ⁱⁱ

Interestingly enough, Canada had no form of Glass-Steagal and its banking system didn’t see as intensive of a downturn as the U.S.’s. In fact, many countries don’t have a divide between commercial and investment banking. Indeed, it would seem like the invocation of Glass-Steagal is nothing more than a desperate attempt by government interventionists to find a slightly relevant regulation to grasp on to and wave around. Even if GS hadn’t been amended, former Federal Reserve chairman Alan Greenspan’s unprecedented dropping of interest rates in the early 2000’s most likely would have occurred anyway; hence setting the foundation for an unsustainable asset bubble. Government regulation, no matter how substantive and strictly enforced, will always be avoided by profit seekers forever looking for more lucrative opportunities. Even the murder and violence that plagued communist Russia didn’t prevent a black market from emerging and flourishing.

And here is my post from today:

At least that is what economist Tyler Cowen argues in his recent New York Times column.  Due to the unprecedented increase in excess reserves held by banks, Cowen claims that the Federal Reserve has provided a nice cushion for threat a destabilized Europe might bring:

Starting in late 2008, as a response to our financial crisis, the Fed bought government and mortgage securities from banks on a very large scale.Bank reserves at the Fed rose from virtually nothing to more than $1.6 trillion. Then the Fed paid interest on those reserves to help keep them on bank balance sheets.
It is estimated by Moody’s that America’s biggest banks now have liquid assets that are 3 to 11 times their short-term borrowings. In other words, it’s the cushion we’ve been seeking. Furthermore, a lot of those reserves sit in the American subsidiaries of large foreign-owned banks, protecting the European system, too.

THE Fed’s stockpiled liquid reserves have met some heavy criticism. Hard-money advocates contend that they are a prelude to hyperinflation — although market forecasts and bond yields don’t bear this out — while proponents of monetary expansion have wished that banks would more actively lend out those reserves to stimulate the economy. That second view assumes that the financial crisis is essentially over, but maybe it’s not. As the euro zone crisis continues, it seems that Ben S. Bernanke has been a smarter central banker than we had realized.

Cowen is right about one thing, just take a look at excess reserves sitting on the sidelines at the Fed, via FRED:

Calling Bernanke, who’s widely praised scholarship amounts to nothing more than a childlike fear of deflation, a smart central banker is protesting too much.  If anything, Bernanke’s incredible liquidity injection was sheer dumb luck as it now provides a nice buffer from the EZ.  But then again, any promise to print on demand ultimately provides a backstop for banking crises.  Why should large financial institutions fret about  losses in the long run when their balance sheets have a direct line to the printing press?  This question is never answered by central banking proponents.

Even so, Bernanke’s “Man of the Year” solution wasn’t actually a solution at all.  It was simply another shot of high-grade heroine to stave off the after effects of the previous bout of low interest rate fueled gorging.  It prevented the rotten mortgage debt, the by-product of the housing bubble, from being liquidated.  Losses that should have happened didn’t.  One day they will be realized but hopefully we will all be “dead” by then; just as Keynes hoped.  Future generations will end up having the bill passed to them.

Cowen mentions that central banking “is the most powerful and most influential financial regulator..”  He is correct but surprisingly doesn’t make the connection that central planning is exactly what got us into this mess.  Central banks have no other tools at their disposal besides printing money.  If printing money to suppress interest rates got us here, why would it ever get us out?  It’s kind of like when former Treasury Secretary Lawrence Sumner declared:

The central irony of a financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it can be resolved only with more confidence, borrowing and lending, and spending.

Can these guys be any more Orwellian?

While Bernanke’s great showering of liquidity may provide some protection from Europe, it’s just one of many unintended consequences such a policy brings.  Turning the printing press on its “high” setting and paying banks not to lend in order to control inflation took no real talent.  Bernanke will only prove his worth as central banker if he is able to wind down the Fed’s balance sheet ultimately without sparking another recession.  Judging by his past record of deflation fear mongering, let’s just say I am skeptical of his willingness to do it.

Merry Christmas- Grandma Got Detained by TSA

Via Reason TV (ht Mish):

Not too much to type about being that it's Christmas and there isn't much news.  I improved on my post from yesterday a bit and got it on the American Thinker today:

In The Christmas Carol, Ebenezer Scrooge is portrayed as a stingy and greedy businessman. Dickens describes his mythical character as "...a squeezing, wrenching, grasping, scraping, clutching, covetous old sinner!"  Mr. Scrooge gives little to nothing in direct charity and rebukes a couple of men from his place of business for requesting a monetary donation for the poor.  He offers this infamous suggestion instead:

"If they'd rather die they better do it now and decrease the surplus population."

The character of Scrooge has been used to demonize those with wealth and who give little to charity for decades.  Generations upon generations of children are spoon fed The Christmas Carol as a cautionary tale that one should give back to those less unfortunate if you posses the means to do so.  While there is nothing morally or ethically wrong with voluntary charitable donations, the narrative surrounding Scrooge's supposed tightfistedness ignores the important role businessmen similar to Dickens' less-than-favorable characterization really play in a market economy.

Consumer demand is often lauded as an all-important indicator and driver of economic growth.  Yet it's always prior production itself that makes consumption possible.  The economic truth known as Say's Law tends to be defined as simply "there is no demand without supply."  What this means is that in order for one to consume, one must produce first in order to obtain the funds, goods, credit, etc. to engage in a transaction.  Even if someone in destitution were to be given a charitable donation, those funds must first come from the donator's previous production.  The same applies to welfare payments via the government.  Government can only redistribute what it first confiscates from those who produce.  Though consumption makes up a far greater portion of the overall spending in an economy, production is always the key enabler of economic growth.

It turns out, and I was unaware of this when I started typing that article, Steve Landsburg had a similar piece in The Slate a few years ago.  Now I look like a cheap imitation; oh well.

Happy holidays everyone!

Ebenezer Scrooge the Philanthropist

LvMIC:

Much to the joy of wealth redistribution types, it turns out that the real life individual who inspired Charles Dickens' famous character Ebenezer Scrooge was actually related to renowned free market economist Adam Smith.  From The Scotsman (ht Alex Tabarrok):

The real “Scrooge”, an Edinburgh merchant, could not have been more different from his literary counterpart.

But the gloaming of an evening in the Capital, allied with an episode of mild dyslexia suffered by Charles Dickens, has forever associated Ebenezer Lennox Scroggie with one of the Victorian author’s most famous characters.

In life, Scroggie was apparently a rambunctious, generous and licentious man who gave wild parties, impregnated the odd serving wench and once wonderfully interrupted the General Assembly of the Church of Scotland by grabbing the buttocks of a hapless countess.

Scroggie was born in Kirkcaldy, Fife; his mother was the niece of Adam Smith, the 18th century political economist and philosopher.

In the Christmas Carol, Scrooge is portrayed as a stingy and greedy businessman. Dickens describes him as “…a squeezing, wrenching, grasping, scraping, clutching, covetous old sinner!”  Scrooge gives little to nothing in direct charity and rebukes a couple of men from his place of business for requesting a monetary donation for the poor.  He offers this infamous suggestion instead:

“If they’d rather die they better do it now and decrease the surplus population.”

The character of Ebenezer Scrooge has thus been used to demonize those with wealth and who give little to charity for decades.  Generations upon generations of children are spoon fed The Christmas Carol as a teaching lesson that one should give back to those less unfortunate if you posses the means to do so.  While there is nothing morally or ethically wrong with voluntary charitable donations, the narrative surrounding Scrooge’s supposed tightfistedness ignores the important role businessmen similar to Dickens’ less-than-favorable characterization really play in a market economy.

Consumer demand is often lauded as an all-important indicator and driver of economic growth.  Yet it's always prior production itself that makes consumption possible.  Say’s Law tends to be defined as simply “there is no demand without supply.”  What this means is that in order for one to consume, one must produce first in order to obtain the funds, goods, credit, etc. to engage in a transaction.  Even if someone in destitution were to be given a charitable donation, those funds must first come from the donator’s previous production.  The same applies to welfare payments via the government.  Government can only redistribute what it first confiscates from those who produce.  Though consumption makes up a far greater portion of the overall spending in an economy, production is always the key enabler of economic growth.

The fact that our world is dominated by material scarcity makes financing the only way to allow production to be possible.  Offset consumption allows saving to take place and funds be available for longer term production.  Mises explains:

Capital goods come into existence by saving. A part of the goods produced is withheld from immediate consumption and employed for processes the fruits of which will only mature at a later date. All material civilization is based upon this “capitalistic” approach to the problems of production.

Those saving-that is consuming less than their share of the goods produced-inaugurate progress toward general prosperity. The seed they have sown enriches not only themselves but also all other strata of society. It benefits the consumers.

Greedy capitalist like Ebenezer Scrooge are not the vile human beings they are often portrayed as by those in the high arches of academia and the media.  By setting aside his own income and living rather minimally, Scrooge increases the amount of loanable funds to entrepreneurs and other businessmen who may seek to fulfill consumer demand.  The amount of consumer goods becomes capable of increasing to drive prices down.  Contrary to popular myth, scarcity will never be overcome by politicians fiddling with tax money.  The only way to increase real wealth and the standard of living in society is through deferring consumption presently to enable future use.

Scrooge’s business and personal practices are to be commended and replicated.  Taken to its logical conclusion, the ” we must have more consumption” doctrine leads to a depletion of resources to be used as capital goods.  It is ultimately a policy of immediate satisfaction at the expense of future prosperity.

Keep in mind the necessary burden folks like Ebenezer Scrooge take on for all of us this holiday season.

The Robber Barons of Christmas

LvMIC:

At least I am surprised that wasn’t headline of this New York Times article:

Half off at the entire store at Ann Taylor. Sixty percent at Gap. Forty percent off almost everything at Abercrombie & Fitch.Aggressive last-minute deals in the days before Christmas are good for procrastinators, but they could be an alarm bell for the retail industry.

While scattered markdowns are standard every year, discounts across entire stores — which analysts say are more widespread than last year — suggest merchants are stuck with too much merchandise.

“It’s really a game of chicken,” said David Bassuk, managing director and head of the retail practice at the consultant firm AlixPartners.

Toys “R” Us announced on Thursday new deals on dozens of items for Friday and Saturday, including ‘buy one, get one half off” on popular toys like Legos. A sampling of other promotions: Up to 70 percent off toys at Amazon; up to 50 percent off gifts at Restoration Hardware; 40 percent off almost everything at American Eagle Outfitters, Talbots, Limited and Wet Seal; and 30 percent off everything at J. Crew.

“There’s been kind of a waiting game with retailers,” Gerald L. Storch, the chief executive of Toys “R” Us, told CNBC last week. “And it looks like the consumer wins.”

Reports of cutthroat competition often go hand in hand with pleas of worker/consumer protection from the state.  Since mom-and-pop (remember you are supposed to love these stores, don’t ask why) businesses have a tougher time competing with behemoths like Walmart, the media often champions the enactment of antitrust legislation to ensure a monopoly doesn’t take hold.  The same type of vitriol was thrust at industry leader Standard Oil over a century ago for its practice of aggressive cost cutting that brought cheap oil to millions.  In Power and Market, Murray Rothbard cites a passage from Isabel Paterson on this historic injustice:

Standard Oil did not restrain trade; it went out to the ends of the earth to make a market. Can the corporations be said to have “restrained trade” when the trade they cater to had no existence until they produced and sold the goods? Were the motor car manufacturers restraining trade during the period in which they made and sold fifty million cars, where there had been no cars before.… Surely … nothing more preposterous could have been imagined than to fix upon the American corporations, which have created and carried on, in ever-increasing magnitude, a volume and variety of trade so vast that it makes all previous production and exchange look like a rural roadside stand, and call this performance “restraint of trade,” further stigmatizing it as a crime!

When businesses shed costs, increase production, and lower prices, consumers always win.  The losers are those incapable of competing with newly adapted market practices.  They will find employment elsewhere satisfying man’s infinite desire.

This Christmas season, it looks like gift-seeking dawdlers are benefiting from clearing markets and stores such as Toys “R” Us, Gap, and Abercrombie & Fitch.  A happy holiday indeed.

EU Wants to Spend Billions on "Culture"

LvMIC:

Unbelievable.  Even in the midst of a sovereign debt crisis that threatens the stability of the world economy, it looks like funding special interests with taxpayer money never goes out of style.  From The Art Newspaper:

As the economic crisis deepens across Europe, the European Commission plans to launch the world’s largest ever cultural funding programme, with €1.8bn allocated for visual and performing arts, film, music, literature and architecture. The commission’s Creative Europe project plans to release the money between 2014 and 2020. If the scheme is approved late 2012, an estimated 300,000 artists are due to receive funding.

The proposal has received a mixed response from key cultural commentators, with some saying that banking on culture and the arts to help prop up EU member states and stimulate the economy is unlikely to work.

“Some say that banking on culture and the arts to help prop up EU member states and stimulate the economy is unlikely to work.”  Gee, you think?

If art, theater, music, literature were really worth their weight in funding, consenting individuals would be paying for them already.  Just look at popular musical artists such as Lady Gaga who need no assistance in selling their craft.

The use of taxpayer money ultimately demeans the quality of work produced as these “cultural” projects are no longer aimed at satisfying consumer demand.  Suppose an artist muddles through an overly bureaucratic application process, receives a grant, and sets about painting a mural that no one would pay a dime for. Has wealth been created? How does the artist know if their work is valued if it fails to be purchased?  As Mises theorized, without pricing signals economic calculation becomes impossible.  How do artists improve if not reliant on appeasing their customer base?  How do bureaucrats assess the value of art when not beholden to financial losses that guide efficiency?

Lawrence Reed sums up the effect government subsidization has on any industry or service:

The surest way I know to sap the vitality of almost any worthwhile endeavor is to send a message that says, “You can slack off; the government will now do it.” That sort of flight from responsibility, frankly, is at the source of many societal ills today: Many people don’t take care of their parents in their old age because a federal program will do it. Most parents these days shirk their duties to educate their kids because government schools are supposed to do that (even though many of them do a miserable and expensive job of it).

Questions of efficiency and economization are never answered by those who emphasize the benefits art brings “society.”  Their focus begins revolving solely around acquiring funds, not the quality of the final product.  End government subsidization of the arts and those truly passionate or capable of selling their work will thrive.
As Mises wrote in regard to the market for the literary arts:

Profit is the prize of successful deviation from customary types of procedure; loss is the penalty of those who sluggishly cling to obsolete methods. The individual is free to show what he can do in a better way than other people.

However, this freedom of the individual is limited. It is an outcome of the democracy of the market and therefore depends on the appreciation of the individual’s achievements on the part of the sovereign consumers. What pays on the market is not the good performance as such, but the performance recognized as good by a sufficient number of customers. If the buying public is too dull to appreciate duly the worth of a product, however excellent, all the trouble and expense were spent in vain.

The Underlying Goal of of the Bank of Canada Lawsuit

LvMIC:

Earlier today, Redmond (director of the Ludwig von Mises Institute of Canada) pointed out this little gem of a lawsuit:

PRESS RELEASE TORONTO, ON., CANADA- 19/12/2011
ECONOMIC THINK TANK CONFRONTS THE GLOBAL FINANCIAL POWERS IN CANADIAN FEDERAL COURT.
RESTORE THE USE OF THE BANK OF CANADA FOR THE BENEFIT OF CANADIANS AND REMOVE IT FROM THE CONTROL OF INTERNATIONAL PRIVATE ENTITIES WHOSE INTERESTS AND DIRECTIVES ARE PLACED ABOVE THE INTEREST OF CANADIANS AND THE PRIMACY OF THE CONSTITUTION OF CANADA
Canadian constitutional lawyer, Rocco Galati, on behalf of Canadians William Krehm, and Ann Emmett, and COMER (Committee for Monetary and Economic Reform) on December 12th, 2011 filed an action in Federal Court, to restore the use of the Bank of Canada to its original purpose, by exercising its public statutory duty and responsibility. That purpose includes making interest free loans to municipal/provincial/federal governments for “human capital” expenditures (education, health, other social services) and /or infrastructure expenditures.

So what should be made of this?  For those versed in the Austrian Business Cycle theory and aware of the destructive consequences brought by central bank manipulation of the borrowing interest rate, perhaps joy should be expressed as one more central bank is having its feet put to the proverbial fire.

But before anyone starts championing COMER’s cause, their motive must be thoroughly examined.  From the press release, it’s obvious that the Committee of Monetary and Ethical Reform is in favor of more money printing to finance endeavors they find favorable.  But what should really be emphasized is the push for “interest free loans.”

The idea of “interest free loans” should sound familiar to anyone acquainted with a particular school of economic thought that has dominated the profession for decades.  I am of course referring to Keynesiansim and its underscoring of government spending funded by central bank monetary easing as the prescription for full employment.

In chapter 24 of The General Theory of Employment, Interest, and Money, Keynes writes:

Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation [sic] of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative. (my emphasis added)

In Keynes’ utopia, bureaucrats are capable of abolishing the law of scarcity and allocating money to those ventures most profitable and efficient.  It’s no wonder why Keynesian took off as a plausible theory as it provided political cover for politicians to do what they do best: buy political favors with squandered funds.
This passing suggestion by Keynes has bolder implications however.  In his brilliant The Failure of New Economics, Henry Hazlitt connects the dots:

It is hard to believe that Keynes is as naive as he pretends, and that he is not laughing up his sleeve.  The rate of interest- the valuation of time and of all investments- is to be taken out of the market and put completely in the hands of the State.  But Keynes ignores the complete interconnectedness of all prices.  This especially includes the prize of capital loans, any state tinkering with which must necessarily affect and distort all prices and price relationships throughout the economy.  Through its socialized investment, moreover, the State would decide which firms or industries to expand and which to freeze or contract.  Even though the State did not technically own the instruments of production, this would lead to a de facto socialism.

So is COMER an advocate of de facto socialism?  Take a look at their description from their own website:

About Us

Whether you know a little – or a lot – about economics, our website is for everyone. An understanding of economics (not outer space!) is the “final frontier.” The realization of a workable and equitable national, global economic theory may well determine how we are to live from here on in, in a reasonable fashion, on Planet Earth.

COMER is an international publishing and education resource based in Toronto, Canada, and is comprised of people who are concerned about the destabilizing effects current economic and monetary policies have had, and are having, on the citizens of Canada and other countries.
COMER argues for prices in a mixed economy (economic reform), and advocates for changes in monetary policy (monetary reform) through revisions in the Bank of Canada Act.
The Journal of the Committee on Monetary and Economic Reform was launched as COMER Comments in 1988. Its purpose was to study the strange turn that monetary policy was taking under the aggressive leadership of the world’s central banks and, in particular, the 1991 proclamation of John Crow, then Governor of the Bank of Canada, who declared “zero inflation” to be the primary concern of the central bank.

Overview

In Canada, we have all the manpower, natural resources and know-how we need – at our fingertips – to create a better world. Canadians could live in a safe, quality-based environment, secure in the trust that social programs, set within the context of Canadian resources and jobs, would be secure for them, their children, and generations to come.
Standing steadfastly in the way of The Dream of Canada are well-organized, well-presented rationalizations that champion marketplace greed and foster political doubt as to what the best policies might be.

The Committee on Monetary and Economic Reform advocates for necessary changes in monetary policy, and for economic reform. We argue that a fair, equitable economic theory is well within our grasp, a theory within which monetary policy may be constructively brought into being for the benefit of all Canadians.

Let’s see: “equitable” economic policy, “mixed economy,” “safe” and “quality-based environments,” and securing “jobs” and “social programs.”  If it walks like a duck and talks like a duck…

While COMER is correct that central banks around the world have been engaged in destabilizing monetary policy, their solution of what amounts to institutional inflation is not only a further destabilizing policy but a giant step down the road of serfdom where the State becomes the ultimate gatekeeper of which businesses are allowed to succeed to prosper.  This lawsuit will most likely not amount to anything but it’s certainly an interesting development.  At least COMER has now revealed itself for the de facto socialist organization they really are.

Is Extreme Financial Interconnectedness a Problem?

LvMIC:

A recently released research paper from a number of economists titled “Econometric Measures of Connectedness and Systematic Risk In The Finance and Insurance Sectors” contains this interesting graphic highlighting the substantial increase in financial interconnectedness over the past 15 years (ht Big Picture):


To the layman or government bureaucrat hell-bent on wielding absolute control over societal function, this incredible jump in financial interconnectedness may send a shudder down their respective spines.  It wouldn’t be a stretch to assume this growth is due to an increase in communication technology and globalization.  Here is the abstract from the cited paper:

We propose several econometric measures of connectedness based on principal-components analysis and Granger-causality networks, and apply them to the monthly returns of hedge funds, banks, broker/dealers, and insurance companies. We find that all four sectors have become highly interrelated over the past decade, likely increasing the level of systemic risk in the finance and insurance industries through a complex and time-varying network of relationships. These measures can also identify and quantify financial crisis periods, and seem to contain predictive power in out-of-sample tests. Our results show an asymmetry in the degree of connectedness among the four sectors, with banks playing a much more important role in transmitting shocks than other financial institutions.

Years after the financial crisis, the cause is still attributed to an unregulated financial industry by those who hold prominent positions in academia and the media.  Though there is merit to the “Wall Street went hog wild” argument, the notion that the industry operated in a laissez-faire environment is pure fantasy.  George Reisman does a phenomenal job explaining why here.

While some fear this industry interconnectedness because of the systematic risk it presents, this fear should not be based on ideological perceptions of free market capitalism but of the type of “tragedy of commons” guarantee by governments that incentivize extreme risk taking and regulatory barriers that deter open competition in this vital industry.

From a free market perspective, the growth in interconnectedness of “hedge funds, banks, broker/dealers, and insurance companies” is not a phenomena to decry but celebrate.  It means market information is exchanged more frequently.  The increase in the exchange rate of market information, the sooner relevant information gets in the hands of actors better able to make use of it.  The division of labor expands as more opportunities become available through the increase in efficient use of scarce resources.  With the implicit backing of the government however, risk-taking takes on a whole new role as profits can be sought without consideration of insolvency or massive losses.  Bailouts, besides acting as political fascism in disguise, distort the all-important consequence income loss play in guiding the market process.  Firms and companies that fail to make productive use of their assets or shareholder money should, in most circumstances where private investors cease from offering their own funds, undergo restructuring of their operations or cease business all together.  Opportunities will always exist elsewhere to displaced workers so long as wages and prices are allowed to adjust uninhibited of market intervention via the state.

Those who advocate for further government regulation of this industry assume bureaucrats, limited by knowledge constraints, are capable of controlling these complex transactions.  Hayek spent a a good portion of his career explaining this concept which is summarized in both “The Use of Knowledge in Society” and his Nobel acceptance speech “The Pretense of Knowledge.”

As with any government intervention, such brings a coercive threat into the free transactions of individuals looking to reciprocate one service for another.  As Mises elucidated:

It is important to remember that government interference always means either violent action or the threat of such action.  The essential feature of government is the enforcement of its decrees by beating, killing, and imprisoning.

The only justifiable reason why any proponent of free market capitalism should oppose an increase in industry-wide interconnectedness is not the potential risk it brings by itself but government policies intentionally and unintentionally supporting its growth.  Regulation ultimately translates into cost barriers preventing start ups from competing, hence perpetuating cartel like conditions.  Bailouts, or their implicit guarantees, give all the reason in the world for those politically connected to profit on extreme risk.  Market knowledge disbursement should be encouraged as much as possible.  The government’s “hands on” economic policies are what should be fought against for not only the impoverishment they bring but benefits they render to those well connected.

Paul Krugman on China

 LvMIC:

Keynesian champion Paul Krugman finally weighed in on China’s imploding property bubble in his New York Times article today.  Let me just say, it’s better late than never.  Reports on China ghost cities and looming bust have been floating around for years and are only now becoming more frequent.  As I posted on earlier, the bust is really getting underway.

While Krugman is finally acknowledging what should be a crash for the history books, his partisan ideology once again gets in the way of property diagnosing its true cause.  He writes:

Do we actually know that real estate was a bubble? It exhibited all the signs: not just rising prices, but also the kind of speculative fever all too familiar from our own experiences just a few years back — think coastal Florida.

And there was another parallel with U.S. experience: as credit boomed, much of it came not from banks but from an unsupervised, unprotected shadow banking system. There were huge differences in detail: shadow banking American style tended to involve prestigious Wall Street firms and complex financial instruments, while the Chinese version tends to run through underground banks and even pawnshops. Yet the consequences were similar: in China as in America a few years ago, the financial system may be much more vulnerable than data on conventional banking reveal.

Much like he goes about in describing the financial crisis in the U.S., Krugman attributes China’s property bubble to a lack of bank regulation.  To anyone who understands the nuances of the Austrian Business Cycle theory, this claim is absurd.  Not only is China’s property bubble a byproduct of the country’s inflationary currency peg to the dollar but it was openly encouraged by local governments!  From Seeking Alpha (my emphasis added):

China’s growth curve has gone parabolic in recent years. For the last couple of decades, China has typically averaged 10% GDP growth, and it has maintained that growth even as a multi-trillion dollar economy. Of course, 10% growth in an economy already worth trillions is an astounding achievement, but it can also lead to severe economic tribulations, such as soaring housing and food prices. China has incurred both of these troubles. As a growing middle class emerges, demand for beef has far outstripped supply growth, and beef is typically making record highs every month. Additionally, the usage of real estate as collateral for local government loans, amongst other factors, has led to soaring housing prices. 

Besides encouragement from local governments, money flowed into China’s real estate sector thanks to artificially low interest rates.  For years, China has pegged the yuan to the U.S. dollar in order to boost its own exports.  To maintain its peg amidst a continually devaluing dollar, the People’s Bank of China purchased dollars and sold yuan.  This monetary expansion lead to high inflation and misallocations of resources toward real estate.  In other words, the property bubble is textbook Austrian Business Cycle Theory.

While China has attempted to slowly deflate the bubble by raising interest rates and banking reserve requirements multiple times over the past year, these efforts have been in vain.  China is due for a hard landing; one which will have global implications.  As damaging as this bubble burst will be, it must be encouraged along with a ceasing of monetary manipulation that sets the basis for business cycle booms and busts.  Remember your Rothbard:

Once an inflationary boom is launched, a recession is not only inevitable but is also the only way of correcting the distortions of the boom and returning the economy to health.

Krugman’s attempt to paint a picture of China’s imploding property bubble being the result of a lack of banking regulation is both flat out wrong and disingenuous.  Local governments thrived on rising property prices and promoted them through unorthodox lending outlets (via Bloomberg):

Local governments, barred from borrowing debt directly, set up 6,576 financing vehicles by the end of 2010 to fund projects such as new roads and airports, according to a report from the National Audit Office on June 27. They had 10.7 trillion yuan ($1.7 trillion) in outstanding liabilities at the end of 2010, of which 8.5 trillion yuan was from bank loans, it said.

The type of policies Keynesian advocates (currency debasement to boost exports) are precisely what set the stage for this property bubble.  Krugman may be reluctant to admit this as it flies in the face of his ideology but sooner or later, more people are going to be looking at the Austrian Business Cycle Theory to make sense of what is happening in China.  Economist Tyler Cowen, who has been openly critical of the theory, is now embracing its relevance to the bust.  That’s one down and thousands of economists to go.

For a great explanation of China’s forthcoming bust, see Kel Kelly’s “The China Bust: Tic Toc.”

Employee of St. Louis Fed Takes on Ron Paul

LvMIC:

Earlier today I came upon an article written last spring by David Andolfatto, teacher of economics at Simon Frasier University and currently employed at the Research Division of the St. Louis Federal Reserve, that is heavily critical of U.S. Congressman and Presidential candidate Ron Paul’s view on monetary policy.  As anyone who follows politics knows, Paul is ardent follower of the Austrian school of economic thought and is currently bringing its teachings to wide audience thanks to his campaign for president.  Andlfatto’s article is an attempt to discredit Paul and “end the Fed” advocates by praising the institution that cuts him a check.  While I certainly can’t blame him for defending his employer, his reasoning is elementary at best (ht Daniel Kuehn):

There are legitimate arguments one could make against the Fed as an institution and/or about the conduct of Fed policy. And then there are the stupid arguments, for example, the one contained on pg. 25 of his book End the Fed:

One only needs to reflect on the dramatic decline in the value of the dollar that has taken place since the Fed was established in 1913. The goods and services you could buy for $1.00 in 1913 now cost nearly $21.00. Another way to look at this is from the perspective of the purchasing power of the dollar itself. It has fallen to less than $0.05 of its 1913 value. We might say that the government and its banking cartel have together stolen $0.95 of every dollar as they have pursued a relentlessly inflationary policy.

One might indeed say that, Mr. Congressman. But if one did, one would behaving like an opportunistic politician, which I know you are not.

Now, let us examine what is wrong or misleading in the statement above.
Yes, what cost $1 in 1913 now costs $20. But so what? Money neutrality states that if you were earning $1 per hour in 1913, you are now earning $20 per hour (and even more, if labor productivity is higher).

So there you go, the Fed is responsible for increasing your nominal wage by a factor of 20. How do all you workers out there like them apples? Ron Paul wants to rob you of these wage increases!

Now Andolfatto is correct insofar as once all is said and done, wages adjust to new price settings as new money becomes completely integrated into the economy.  Yet Andolfatto doesn’t mention this very key understanding of inflation that Henry Hazlitt succinctly identified nearly half a century ago:

“no actual inflation happens by a simultaneous or proportional increase in everybody’s money supply or money income.”

New money hits the economy in stages, enriching those who received the newly created funds first.  The way Andolfatto paints the picture, it would seem like wages and prices adjust simultaneously when the Fed turns the printing press on.  Nothing could be further from the truth however.  The Fed isn’t responsible for increasing wages, it’s responsible for increasing the size of the money supply.  Wages in nominal terms adjust to reflect this new norm after prices have been bid up.  Increasing nominal wages is only a byproduct of inflation.  If anyone is being misleading, it’s Andolfatto, not Dr. Paul.

Here is another example of the Congressman misleading the public (perhaps unintentionally); see his recent interview here with CNBC’s Larry Kudlow: Fed Under Fire.
At the 3:50 mark, Kudlow asks Paul: “Would oil be at $102 a barrel now if we had a sound dollar policy?” Paul’s reply is that, if Bretton Woods had not been abandoned (in 1971), oil would now be trading closer to $5 a barrel.

I ask you…how embarrassing of an answer is that? I mean, maybe oil would be trading at $5 a barrel. But what he is implicitly suggesting is that your nominal wage would not be scaled back in proportion. That is, he is suggesting that by cutting the value of paper, the Fed has somehow diminished the purchasing power of your labor over the past 100 years. Can he be serious?

So Paul didn’t come out and say nominal wages would be less had Bretton Woods not been abandoned.  Andolfatto neglected to say that time plays an important role in monetary policy.  Somehow he comes to the conclusion that the Fed devalues labor through printing dollars.  I have never heard Paul make such a illogical statement.  Paul only speaks to currency devaluation.

And, as an aside, am I the only one who chuckles whenever he berates the Fed for creating money “out of thin air?” (I reiterate, there may be many legitimate complaints one could make against the Fed, but the “out of thin air” charge…well, let’s just say it…lacks substance).

So whenever the Fed conducts open market operations, where exactly does the newly created money come from besides the keying in of numerical balances?  How is “out of thin air” not a apt charge?  Andolfatto does not say.

Is it not true that the Treasury also creates its debt “out of thin air?” Do you think getting rid of the Fed (which, in conducting monetary policy, is simply swapping one form of thin air for another) will prevent Congress from issuing its own thin air?

Paul never levies a charge that the U.S. Treasury doesn’t create debt out of thin air. Andolfatto is correct that when bonds are sold in a fiat economy, they are created out of the same “thin air.”  And of course getting rid of the Fed wouldn’t prevent the Treasury from issuing bonds.  The Treasury can only sell bonds if there are buyers.

Do you really believe that a gold standard would mitigate the government’s ability to tax?

Again, Paul makes no such claim.  What he does say is that a true gold standard would put more of a limit on government spending.

Though dated, Andolfatto’s piece is incredibly lacking as far as a substantial rebuttal to Paul’s (and most Austrian’s) criticism of the Fed.  He fails to address the fact that inflation doesn’t effect the economy ceteris paribus.  There is no mention of the elite primary dealers that receive new money first before prices and wages fully adjust.  Most central bank apologists ignore this as it would be clear endorsement of the kind of crony capitalism that would have Mussolini cheering in his grave.

Now Andolfatto had a follow up post to his article that is a much more thoughtful argument.  He makes many of the same arguments as before but provides some data to back him up.  He cites “low and stable” inflation over the past 30 years without addressing the concern many free market oriented economists have made over the calculation of the CPI.  He also claims that the Fed will one day unwind its balance sheet despite the amount of junk it has accumulated that may or may not be repurchased.  In short, Andolfatto attempts to show that nominal wage increases have adjusted to inflation, thus keeping things relatively equal and not resulting stolen wealth opportunities.  But if this were the case with inflation, what would be the point of monetary policy?  If wages and prices adjust automatically, there is no real justification of increasing the monetary base.  But as we know, the point of monetary policy is to enrich some at the expense of others to “boost” spending.

All in all, Andolfatto falls into the same trap that central bankers do when justifying their job.  They attempt to demonstrate the neutrality of monetary manipulation when the manipulation can never be neutral in regards to who benefits and who doesn’t.