Will Pennies and Nickels Disappear? And Charles Hugh Smith On Targeting NGDP

The following is a draft for LvMI:

Will Nickels and Pennies Soon Disappear? 

Back in December 2006, the U.S. Mint, in yet another power grab over economic life, made it illegal to melt pennies and nickels in addition to exporting large quantities of both.  Though the Mint admitted there was no evidence coin melting occurring, this was the government’s attempt at being proactive to the destruction of its legally imposed currency.

So why the concern over people melting down coinage that supposedly belong to them?

Back when the ban was implemented, the high price of copper was responsible for driving up the price of individual nickels and pennies in terms of metal content.  Due to their copper content (nickels minted between 1946-2011 are composed of 75% copper and pennies minted between 1909-1982 are composed of 95% copper), both coins have a higher melt value than as legal tender.

The irony that the government banning the melting of its own issue currency lies in the fact that its own actions contribute to the higher price of copper.  Whenever the Federal Reserve engages in dollar easing (read: money printing), this newly printed “wealth” often translates into higher stock and commodity prices.  Even the very announcement of increased monetary intervention by Fed officials, including Chairman Ben Bernanke, tends to boost market confidence as stocks rally almost immediately.  Recently, commodities and stocks soared when the Fed lowered the interest rate it charges for foreign central banks to utilize its dollar swap lines without explicitly mentioning its intention to sterilize such transactions to prevent an increase in its balance sheet.  Basically, the Fed once again told the world that it opened up the dollar floodgates just a bit more to offset a crisis in Europe.  Along with its intention to hold short term interest rates near zero till “mid 2013,” Bernanke and company are standing by ready to keep borrowing costs suppressed by entering into the market to purchase treasuries.  Presently the M2 money supply has been growing at a 15% annual rate for the past 6 months:

(Chart via FRED)

So what does all this mean for nickels and pennies minted prior to 1983?

Gresham’s Law, named after Sir Thomas Gresham who was a financial agent of the English Crown in the sixteenth century, states that overvalued money drives undervalued money out of circulation; “bad money drives out good” for short.  More accurately, the law should state something along the lines of “government-enforced parities that alter the market value of money have the effect that overvalued money drives out undervalued money.”  Since in a free market those products and goods that are of higher value stick around longer than low quality products, Gresham’s Law only applies when government monetary intervention is present.

To understand the effect of Gresham’s Law, Jörg Guido Hülsmann provides a simple thought construct in Ethics of Money Production:

Suppose for example that both gold and silver are legal tender in Prussia, at a fiat exchange rate of 1/20. Suppose further that the market rate is 1/15. This means that people who owe 20 ounces of silver may discharge their obligation by paying only 1 ounce of gold, even though they thereby pay 33 percent less than they would have had to pay on the free market. Prussians will therefore stop making any further contracts that stipulate silver payments to protect themselves from the possibility of being paid in gold; rather they will begin to stipulate gold payments right away in all further contracts. And another mechanism operates to the same effect. People will sell their silver to the residents of other countries, say England, where the Prussian fiat exchange rate is not enforced and where they can therefore get more gold for their silver. The bottom-line is that silver vanishes from circulation in Prussia; and only gold continues to be used in domestic payments. The overvalued money (here: gold) drives the undervalued money (here: silver) out of the market.

So with nickels worth slightly more than $.05 and pennies minted before 1982 worth almost $.03 due to their copper content, it isn’t hard to imagine that they will someday disappear from circulation as the Fed continues to expand its monetary base.  Kyle Bass, who heads the hedge fund Hayman Capital Management, has already purchased $1 million worth of nickels according to Business Insider.  For any more proof that the $.05 and certain $.01 pieces may disappear soon, just consider how many Roosevelt dimes or Washington quarters minted pre-1965 you see around today.  Both are composed of 90% silver and are worth far more for their metal content than they are as legal tender. 

Anyone looking to make a small investment might think twice about throwing nickels or pre-1983 pennies into a jar with the rest of their accumulated change.  I may not be an investment adviser, but it sure makes economic sense our fiat currency world.

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I keep feeling like I wanted to add something to it but can't figure out what.

Also, I posted this over at LvMIC today:

Charles Hugh Smith On The Futility of NGDP Targeting 

About a week ago, I wrote an article for the American Thinker entitled “The Problem With the Fed’s Targeting” which outlined the kind of knowledge problems behind the push to have the Federal Reserve drop its focus on inflation and the unemployment rate and target nominal gross domestic product to boost economic growth.  So what is NGDP targeting exactly?  From my article:

The monetary policy of targeting nominal gross domestic product (NGDP) is starting to come into vogue in mainstream economic and political circles.  Christina Romer, the architect behind President Obama’s first stimulus failure and professor of economics at the ideology vacuum known as the University of California, Berkley, recently penned a New York Times editorial on the issue:

Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework – in this case, to begin targeting the path of nominal gross domestic product.

Nominal G.D.P. is just a technical term for the dollar value of everything we produce. It is total output (real G.D.P.) times the current prices we pay. Adopting this target would mean that the Fed is making a commitment to keep nominal G.D.P. on a sensible path.

More specifically, normal output growth for our economy is about 2 1/2 percent a year, and the Fed believes that 2 percent inflation is appropriate. So a reasonable target for nominal G.D.P. growth is around 4 1/2 percent.

Sounds simple enough, right?  All Ben Bernanke and the technocrats at the Federal Reserve need to do is simply leave the switch to the money-printer on “high” setting and watch prosperity flow as dollars engulf the world.

Anyone skeptical of the Federal Reserve, as most Austrian-minded thinkers are, should instantly see the risks associated with such a proposal.  One of the big issues behind the “targeting NGDP” proposal rests on the faulty assumption that Bernanke and co. are actually capable of hitting a predetermined target.

Another issue with “targeting NGDP” is what economist and Nobel laureate Friedrich Hayek called “The Pretense of Knowledge.”  Alan Greenspan famously dropped interest rates to historically low levels to fight the dot-com bubble burst he created with the same policies in the late ’90s.  This easy credit financed a housing bubble in turn.  Greenspan was often labeled the “maestro” during his time as Fed head because of his supposedly wondrous skills at “guiding” the economy through interest rate manipulation.  One deep recession later, and we can all see how apt a term that is now.

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.  To think that just a few men are capable of coordinating the independent spending habits of hundreds of millions is sheer idol-worshiping at the altar of governmental central planning.

The targeting NGDP policy has been popularized by Chicago school quasi-monetarist Scott Sumner (the impeccable Robert P. Murphy did a take down of his anti-Rothbard theory on what caused the Great Depression today over at Mises Daily) and is becoming fashionable and seriously considered by many prominent economists.   It’s easy to see why this is after reading Charles Hugh Smith’s great article “Inflation by Any Other Name” that was published in The American Conservative just a few days ago.  Smith is a novelist and economic commentator who runs the blog OfTwoMinds.com and contributes regularly to Zerohedge.com.  On targeting NGDP, he writes:

If we scrape away the econo-speak, we find that nominal GDP targeting is simply code for “let’s stop worrying about inflation and crank up the printing press, baby.” While its proponents are coy about exactly what they’re suggesting the Fed do after targeting nominal GDP growth of, say, 5 percent per year, the basic idea is to flood the economy with even more low-interest money.
The hidden assumption here is insidious: once inflation kicks up—and at 3.9 percent it is already well above the Fed’s “comfort zone” of 3 percent—then Americans will stop trying to save or pay down debt and will instead go back to borrowing and spending freely.
In other words, instead of Americans acting prudently to lower their unprecedented levels of debt and build some capital, the advocates of targeting GDP want us to go back to the go-go days of the housing bubble and borrow and spend more, more, more, all because they believe the key problem is lack of consumer demand.

Smith goes on to show why using inflation to boost NGDP doesn’t actually lead to “real” growth, the risk that such a policy has in inducing stagflation, and the declining bang-for-the-buck on debt financing:

A 5 percent nominal GDP with an inflation rate of 4.5 percent yields real GDP growth of only 0.5 percent. It’s entirely possible to get inflation really fired up and have a 6 percent nominal GDP and a 7 percent inflation rate—in other words, a negative growth rate that is masked by the positive nominal GDP.
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The nightmare scenario that proponents don’t mention is one in which the Fed unleashes a torrent of money into the economy, inflation leaps up, but employment stays subdued. Then, to fight the roaring inflation it created to boost the nominal GDP, the Fed has to raise rates—not by a quarter point, but by a lot, and for a long time. Not only would that tightening suffocate the debt-based “growth”—actually, more inflation than actual growth—it would also trigger new declines in employment. We would end up with the worst of all possible worlds: high inflation, high interest rates, and rising unemployment.

The entire notion that incentivizing more borrowing will lead to growth is suspect. Indeed, if we divide real GDP by the increase in debt (both public and private), we find that the return on debt has been declining for decades and has now fallen to a negative number: in effect, we’re borrowing trillions of dollars—roughly 11 percent of GDP on the federal ledger—each and every year just to stay even.

Each additional dollar of debt added about 70 cents to GDP in 1970. By the early 1990s, the yield had fallen to 50 cents, and when the housing bubble was largest in 2006 it was less than 30 cents. With the explosion of federal debt to bail out the banks and provide fiscal stimulus, we’ve reached a point where real GDP has barely budged from pre-recession 2007 levels, yet we’ve poured roughly $6 trillion in new federal borrowing into the economy.

Don’t expect the “target NGDP” advocates to change their minds over Smith’s article despite its thorough debunking.  With last week’s announcement on lowering the cost for foreign central banks to use its dollar swap lines, the Fed reiterated its position that it stands ready to print in order to prevent a much needed market correction.   Though printing can give the appearance of economic growth, it by no means provides a cure to the real ailments preventing a robust recovery.  Smith’s conclusion is devastating:

The problem with targeting GDP is not just the reality-distortion field required to believe it would work, but also what the proponents dare not ask: what if the U.S. economy is facing structural headwinds that can’t be fixed by more borrowing and more Fed goosing of financial markets (i.e., “quantitative easing”)? What if the fundamental problems are precisely what the GDP targeters propose as solutions: indebtedness, zero-interest rates, rising inflation, and a clueless Federal Reserve that only has two levers to pull—Fed funds rate and quantitative easing—and has been yanking on them for four years?

The supporters of targeting GDP dare not consider this, because they would be revealed as not only lacking answers but also lacking a context for grasping the question.
The conventional fixes haven’t worked; they’ve only deepened the nation’s debt hole and rendered our financial system exquisitely dependent on constant Federal Reserve intervention and “easing.”

“Target NGDP” = more inflation; simple as that.