The Cobden Centre

Must-read

Tim Price — Mon, 21 May 2012 12:30:09 +0000

“Working at my desk today was somewhat surreal. Global risk markets were closing out a dreadful week. Newswires were full of disconcerting articles – J.P. Morgan, Greece, Spain, Italy, China, etc. Meanwhile, CNBC was in the midst of blanket coverage of the Facebook initial public offering. Mark Zuckerberg rang the bell to open Nasdaq trading, while helicopters provided live video of the employee gathering at Facebook’s Menlo Park headquarters. Insiders are now worth billions, the “average” employee millions. Even U2′s Bono pocketed $1.2bn (with a “B”). I noted above how I see J.P. Morgan’s predicament as a microcosm of global financial woes. Well, it is difficult for me today not to see Facebook as emblematic of the incredible transfer of wealth associated with Credit Bubbles. It’s almost as if this historic Bubble has been waiting to end with just such an exclamation point.”
- From ‘The Jig is Up‘, by Doug Noland.

Like us, you may have missed Robert Wilmers’ blistering assault on Wall Street when it was first published. Happily, the Internet occasionally offers up a diamond amongst the garbage. The full letter to shareholders of M&T Bank can be read here (PDF). It is a must-read. (The really good stuff starts on page xi.) Nor is Mr Wilmers some swivel-eyed Occupy Wall Street beatnik. He is the chairman and chief executive officer of the US commercial bank in question. His shareholders’ letter may be just one straw spinning within the eddies of a tempest, but it encapsulates a morsel of hope amidst a morass of inanity, greed and vile corporate behaviour. Credit to Business Insider for bringing it to a wider audience.

At the risk of driving a coach and horses through ‘fair use’ limitations in Anglo-Saxon law, here are some of the choicer nuggets contained within Mr Wilmers’ polemic:

As relatively good a year 2011 was for M&T itself, it was far from an easy one. Indeed, it is difficult, for one who has spent more than a generation in the field, to recall a time when banking as a profession has been publicly held in such persistently low esteem. A 2011 Gallup survey found that only a quarter of the American public expressed confidence in the integrity of bankers. We have reached a point at which not only do public demonstrations specifically target the financial industry but when a leading national newspaper would opine that regulation which might lower bank profits would be “a boon to the broader economy.” What’s worse is that such a view is far from entirely illogical, even if it fails to distinguish between Wall Street banks who, in my view, were central to the financial crisis and continue to distort our economy, and Main Street banks who were often victims of the crisis and are eager, under the right conditions, to extend credit to businesses that need it.

It is no consolation, moreover, to observe that banks and the financial services industry generally were far from alone in sparking the crisis. Nonetheless, it is true, and very much worth keeping in mind, that major institutions in other sectors of the American system – public and private – must be considered complicit, some in ways we are only beginning to learn fully about. As understandable as a search for particular causes, or villains, might be, the truth is that the economic crisis that began in the fall of 2007 implicated a wide range of institutions – not only bankers but their regulators, not only investors but those paid to advise them, not only private finance but its government-sponsored kin. The wide spectrum of the culpable has left the U.S. and the world with a problem which, although related to the financial crisis, transcends it and must be confronted: the decimation of public trust in once-respected institutions and their leaders. This has created a fear among those responsible for forming the rules and standards that shape the American financial services industry. And the outcome of this fear-driven rulemaking is likely to burden the efficiency of the American financial system for years to come and will potentially have broader implications for the overall economy.

..So it is that the crisis was orchestrated by so many who should have, instead, been sounding the alarm – not only bankers but also regulators, rating firms, government agencies, private enterprises and investors. That a former U.S. Senator, Governor and CEO of a big six financial institution was at the helm of MF Global on the eve of its demise due to trading losses, or that the largest-ever Ponzi scheme was run by the former chairman of a major stock exchange will long be remembered by the public. The repercussions have stretched beyond banking, creating an atmosphere of fear affecting and inhibiting those who should be leading us toward a better post- crisis economy.

Bravo, Mr Wilmers. Bravo.

Wading into The Financial Times on an almost daily basis increasingly feels like working for a bomb disposal unit. One dreads to think of what unexploded ‘intellectual’ ordinance one will discover. The weekend edition does not disappoint in this grim respect. With a strange mixture of horror and fascination we stumbled upon the ‘thoughts’ of one Ed Miliband who, nicely displaying the infantilized tenor of our times, was granted a forum to share his ‘thinking’ on economics..

“The divide in politics now,” writes Mr Ed,

is between those who think the lesson of the past two years is to offer more of the same and those of us who know now is the time for a different course. It is a divide between those who face the global economic storm having run out of ideas and those with a plan for putting right what has gone so disastrously wrong.

With what one can only describe as the intellectual equivalent of a million pots calling a million kettles black, Mr Ed suggests that

[Prime Minister] David Cameron’s response to every downturn is to lecture the euro zone and to argue that nothing is his fault.

Mr Ed calls for firm, coordinated action. Action, he repeats, is long overdue. Germany, for example, must support demand. Mr Ed demands that Germany supports demand. He demands demand, and he supports it, too. And yes, uncertainty around the world’s banks should be resolved. Action ! Demand ! Support ! Certainty !

It is very easy to call for grand, magical, all-resolving action when one is in opposition. That is almost what being in opposition is all about – windily opining about things about which one has very little understanding, and almost no power to influence. A bit like being an economics commentator at The Financial Times. I recall a definition of fascism I encountered whilst at school (in a history book, as opposed to the more general experience of being at the school in question, although it was an independent school):

Fascism, n. A supreme belief in the superiority of action over thought.

If I were even remotely associated with the Labour party, an entity which whilst in office oversaw government spending rising from 37% to 52% of gross national product, and which left the incoming coalition to deal with the largest level of peacetime indebtedness in our country’s history, I would not dare raise my head above the economic parapet for fear of having it shot off, by any number of forcibly embezzled taxpayers, pensioners, investors or savers.

This article was previously published at The price of everything.

A Viennese waltz down Wall Street – Austrian economics for investors

Toby Baxendale — Mon, 21 May 2012 08:30:06 +0000

Next Tuesday our friend Mark Skousen will be delivering a lecture for the Adam Smith Institute, which may be of interest to Cobden Centre readers:

A Viennese Waltz Down Wall Street: Austrian Economics for Investors

Speaker: Mark Skousen

Date: Tuesday 29 May 2012

Time: 06:30pm – 08:30pm

RSVP: events@adamsmith.org

Location: Church House Conference Centre, Great Smith Street, Westminster, London

Map: find us!

This lecture will be delivered by Mark Skousen, Ph. D. He is a professional economist, investment expert, university professor, and author of more than 25 books. He earned his Ph. D. in monetary economics at George Washington University in 1977. He currently holds the Benjamin Franklin Chair of Management at Grantham University. He has taught economics and finance at Columbia Business School, Columbia University, Barnard College, Mercy College and Rollins College. He also has been a consultant to IBM, Hutchinson Technology and other Fortune 500 companies.

Currency collapse dynamics

Alasdair Macleod — Sun, 20 May 2012 07:00:30 +0000

The reason we accept paper money as a store of value is habit. This habit has its origins in history, when banks took our gold as deposit and issued paper receipts for it. The gold has gone, but the paper with its habitual value remains, and we accept it without question. The only backing is a vague government promise.

There is no sound theoretical basis for why unbacked government-issued money should retain a store of value: it depends for its value on a market-based acceptance of financial credibility. So it follows that if a government loses all financial credibility in markets, its paper becomes worthless. This is confirmed by experience in all paper money collapses.

The fact it can and has happened elsewhere confirms that all faith can theoretically disappear from the dollar, pound, euro or yen. This is a very different understanding about currency values compared with what is commonly accepted. Instead, we assume that any change in purchasing power is tied firmly to price inflation, and we factor out any reliance upon faith. But this is a cop-out, a way of not addressing the basic assumptions that uplift the value of government-issued money from zero to what it will actually purchase.

It is vital to understand that price inflation and maintenance of fiat currency premiums are only loosely related. In a sound money economy, an economy where the medium of exchange is backed by gold, changes in the available quantity of money will affect the prices of goods and services exchanged for it. This is because sound money is itself a commodity, whose function happens to be to act as a medium of exchange. However, you cannot say this of fiat money, where the link with value is based entirely on faith. It is a mistake to assume that supply and demand factors that give sound money its value as a means of exchange also apply to unbacked government money. The value of fiat currencies is purely subjective.

In the case of fiat money, additional quantities in circulation increases demand for goods, whose prices rise driven by this extra demand: the rise in prices comes from the goods themselves, and not a change in the value of the money. In stagflation, where there is no extra demand, price rises emanate from changing values in the paper money itself, usually tied to foreign exchange movements.

The implications are profound. To state that in hyperinflations fiat money loses purchasing power because of massive issuance of money is a misunderstanding. The collapse in purchasing power is due to loss of faith in fiat money, and not from its extra supply: if it was otherwise, you would have to establish it had an objective value in the first place.

It is entirely possible, even increasingly likely in these times of growing systemic risk, that a collapse of paper-money values will happen not as a result of rising consumer prices, but of its own subjective value. If this happens there will be little or no warning and it could be substantial if not total.

So the argument in favour of a flight into sound money, best exemplified by precious metals, is getting stronger by the day.

This article was previously published at GoldMoney.com.

By abandoning the gold standard we embraced monetary central planning, chaos

Detlev Schlichter — Sat, 19 May 2012 15:45:54 +0000

With this essay I will try to reconcile two apparently conflicting perceptions of the key problems with our present monetary system. I will start by characterizing these two positions.

As readers of this website and my book know, it is my conviction that the central problem with the present system is the high degree of elasticity of the money supply. A system of constant fiat money expansion, of ongoing injections of new money into the economy via financial markets – sometimes slow, sometimes fast – must systematically distort interest rates and disarrange saving and investment. This will lead to capital misallocations and the mispricing of assets. As these distortions are systematic, the resulting dislocations are bound to accumulate over time and thus progressively destabilize the economy. Elastic money is suboptimal, unstable and unsustainable.

The point is not that a gold standard is perfect or ‘perfectly efficient’ or even free of any disturbances or disruptions. The point is simply that by fading out gold as a fairly inelastic basis of the monetary system and replacing it with essentially fully elastic and unlimited fiat money, as happened around the world in the period from 1914 to 1971, we have made the financial system and by extension our economies substantially more unstable. While the system can appear stable on the surface for extended periods, the economy is constantly accumulating imbalances that will finally unhinge it.

The present debacle – characterized by excessive debt, an overstretched and out-of-control financial system, overextended banks, a plethora of asset bubbles, again on a global scale – is the inevitable outcome of our decision, 40 years ago, to abandon a gold anchor completely and go for unrestricted fiat money. The system is presently being kept going by ever more aggressive money injections (in particular base money into the banking system) and other state interventions, but I firmly believe that it is in its endgame.

“Fully flexible” and “unlimited” sound like a crazy ‘free-for-all’ but, of course, that is not what it is. The full flexibility to create any amount of money and inject it into the economy is a unique privilege in our post-gold-standard system that rests with the state and is entrusted to the central bank bureaucracy.

Ben Bernanke, the present US Printmaster, famously boasted in 2002:

The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost…

In moving away from gold, we have replaced the discipline and apolitical rigorousness of hard money that is the very foundation of a private property economy and a free society with full monetary flexibility in the hands of the state bureaucracy. He who has the power to print money can set interest rates, manipulate the credit markets and influence all sorts of asset prices. In fact, he cannot not do it. It is clear that by moving from gold to fiat money, we have abandoned a key pillar of capitalism and have adopted a form of monetary central planning.

Looked at the problem from this angle, my assertion that the present system will lead to ever-larger misallocations of capital, to ever-larger economic distortions, and that it must ultimately collapse, does not seem far-fetched at all. It is the fate of all systems of central planning and systematic market distortions. Just as the communist Soviet Empire collapsed under the weight of its inherent economic contradictions so will the system of politicized fiat money.

Gold and freedom

Central planning is not only rejected on grounds of its economic inefficiency and unsustainability but also rightfully despised for its inherent conflict with human liberty. Critics of paper money and central banking have always stressed that a gold standard is not only an effective counter against excessive risk and thus a guarantor of stability but also a guarantor of freedom.

In his seminal article ‘Gold and Economic Freedom’ from 1966 Alan Greenspan wrote:

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. …The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.

An equally impressive document is the 1948-article by Howard Buffett, Congressman from Nebraska, entitled “Human Freedom Rests on Gold Redeemable Money”:

..when you recall that one of the first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership of gold, you begin to sense that there may be some connection between money, redeemable in gold, and the rare prize known as human liberty.

There is no more important challenge facing us than this issue – the restoration of your freedom to secure gold in exchange for the fruits of your labors.

(Howard Buffett was a man of the Old Right in the US, a friend of anarcho-libertarian Murray Rothbard, and the father of billionaire oligarch Warren Buffett, who is today an outspoken critic of gold, an advocate of government bailouts and the willing poster boy for America’s tax-the-rich-more campaign.)

While my criticism of fiat money is strictly economic and focuses on the fundamental unsuitability of elastic money for capitalism, it is essentially congruous with the political objection to fiat money based on considerations of human freedom. Both aspects are two sides of the same coin. Therefore this forms one consistent anti-fiat-money position: the present system is a system of persistent state interventionism in markets that, very similar to socialism, leads to grave distortions and ultimately economic chaos. It is incompatible with a free society and a market economy.

The populist view: unchecked markets are at fault

Now let’s look at what I would describe as the conflicting, at least superficially conflicting view of what is wrong with our financial system. This view is widespread among the general public today, it heavily influences the discussion in the media and it goes something like this:

Is it really true that we have too-much state involvement in finance? Do we really have some form of monetary central planning? Does this view not completely underestimate the power of the big private banks? When one looks at the gigantic positions these private banks have on their balance sheets (and the even bigger positions they have ‘off balance sheet’), and when one looks at the outsized bonuses the bankers pay themselves, and when one furthermore considers that most money-creation is done by the private banks, then it appears as if ‘central planning’ or ‘the power of the bureaucracy’ appear inaccurate descriptions of the present system. J.P. Morgan just admitted to losing $2 billion and counting on complicated derivative positions. How can that be the fault of central bankers or imaginary monetary ‘central planners’? Isn’t this the opposite of central planning? Is this not capitalism running amok? Maybe we need more regulation and more control by the state authorities. Is the main threat to our economic wellbeing really a too-powerful central bank, or is it not actually a private banking system that is run for the benefit of the bankers rather than the ‘real’ economy and that may collapse as a result of uncontrolled speculation? Our system doesn’t look like grey and boring Soviet-style central planning at all but more like flamboyant capitalism spinning out of control. And by going back to a gold standard would we not restrict the power of the central bank to save us from the mistakes of the bankers? Bringing back gold and restricting the manoeuvring space of central bankers will make things worse.

The way I described the populist view here contains observations and conclusions. I believe the conclusions to be largely incorrect. They may appear intuitively sensible but they do not stand up to closer scrutiny. However, there is no denying that many of the observations that form the basis of this popular view are evidently correct. It is my goal with the following to show that there is no logical conflict between these observations and the critique of fiat money as a form of monetary central planning developed above. In fact, all the symptoms that the populist view concerns itself with and that form the basis of the widespread public anger – the apparent detachment of global finance from the real economy, the outsized and uncontrollable derivatives market, the bonus culture and the instant claims of the private banks on unlimited bank reserves and unlimited bailouts – all have their origin in the decision to abandon the gold standard and replace it with unlimited fiat money under state control. And my hope is that once this connection has become clear, more of the system’s critics will see that the cure is not more power to the bureaucracy and more regulation and controls but simply a return to hard money and thus a return of a system that is controlled, not by bureaucrats and bankers, but by the consumers of financial services.

The power of the consumer

In capitalism, in a truly free market, the consumer decides what is being produced, how resources are allocated, and who makes profits and who doesn’t. By buying from some and not buying from others the consumer ultimately directs production, economic activity and the use of scarce resources. Under capitalism the consumer decides how capital is deployed. Our problem is that today we have no capitalism in finance, and the reason for this is quite simply the abandonment of a gold standard and the establishment in its place of a system of unlimited fiat money and of central banking.

In order to build my argument I will solicit help from an unusual source: Paul Krugman.

Paul Krugman recently debated Congressman Ron Paul on TV. Ron Paul started by making the case I laid out above: that in our system interest rates are set by a state agency and the supply of money is determined by a state agency; that this is some form of price fixing and economic management by the state, which has never worked and is incompatible with a free market system.

Paul Krugman started very poorly. He simply claimed that “you cannot leave the government out of monetary policy”, and that the “Federal Reserve will always be in the business of setting interest rates”. Evidently, this is nonsense. We can discuss whether these arrangements should prevail or not but to claim that there is some inevitability about them is gibberish. Before 1913 there was no Fed and yet there were interest rates and lending and borrowing and growth and jobs and markets. To claim that in the field of money the state simply has to set prices is hogwash, and it exposed Krugman again as a closed-minded statist.

However, then Krugman made a statement that was interesting, essentially correct and that I will use as the basis of my further argument. He said that money was more than just pieces of paper with pictures of dead presidents on them, that the distinction between money and non-money wasn’t clear but that there was a continuum, and that we didn’t even know what money was. I think these are important points, but if we think them through we come to conclusions that are not in support of Paul Krugman’s monetary statism but in fact support Representative Paul’s aversion to state paper money.

What is money?

Gold and silver have been used as money in the form of coins for 2,500 years. ‘Modern’ finance started with the rise of banking, roughly 300 years ago. Banks have never really confined themselves to just taking deposits and making loans but, pretty much from the start, have been in the business of creating money, a business that they invented. Of course, money proper was still gold or silver, and those could not be created by banks, but banks issued what I will call money derivatives. Think banknotes or bank deposits. As these were not gold or silver they were not money proper but they were usually claims on gold or silver, and they began to circulate in the economy and were used by the public as if they were money proper. Of course, if all money derivatives in circulation had been fully backed by gold or silver in the banks’ vaults (i.e. by gold and silver that is not presently in circulation) then the supply of what the public uses as money would not have expanded and the banks would not have become money producers. But as we all know, banks quickly managed to issue money derivatives that were not backed by gold or silver, or at least not fully backed by gold or silver. To the extent that the public accepted uncovered money derivatives as money, the banks had indeed a license to print money, and this allowed the banks to extend more loans and make more profits. But the operative words in the previous sentence are “to the extent that the public accepted”. The consumer of finance, in particular the depositor, decided to what extent bankers could become money producers. If depositors became uncomfortable with the practices of their banker, they no longer accepted his money derivatives but instead removed their deposits and placed it with somebody else, or simply held physical gold and silver again. The consumer had the power to pull the plug on the bankers.

In defence of bank runs

What was money and what was not money had, with the arrival of deposit banking and fractional-reserve banking, become a somewhat fluid concept, and it has remained such ever since. It has become subject to change. There is, in the words of Krugman, a continuum. But under a gold standard, what was accepted as money was ultimately decided by the public. The license to print money could be revoked by the depositors at any time. That put the banker in a perilous position. Being a money creator was lucrative but it placed the banker at the mercy of a fickle public. There was always the risk of a panic and a bank run.

Now, who would be in favour of bank runs and panics? Are they not a sign of a potentially irrational and panic-prone public that fails to make wise decisions in its own best interest? — That is today the generally accepted view, I guess. But the prospect of bank runs is also without question a drastic form of consumer power, of capitalism’s essential checks and balances. The risk of a bank run, of the public’s sudden loss of faith in the prudence, reliability and solvency of a banker, is a powerful check on the banker’s risk-taking and overall business strategy. Not surprisingly, prior to the arrival of lender-of-last resort central banks and unlimited fiat money, banking seemed to have attracted a very different type of individual than it does today. Bankers were (because they had to be) conservative and extremely concerned with a public appearance of restraint, prudence and the utmost reliability. No macho-talk about ‘global business opportunities’, of ‘market share’ and high ‘return on equity’ here.

Power shifts from the depositor to the bureaucrat

Enter the central banks. This is what Milton Friedman and Anna Schwartz had to say in their seminal bookA Monetary History of the United States about the founding of the Federal Reserve:

The Federal Reserve System was created by men whose outlook on the goals of central banking was shaped by their experience of money panics during the national banking era. The basic monetary problem seemed to them to be banking crises produced by or resulting in an attempted shift by the public from deposits to currency [DS: currency meant specie at the time]

This ‘attempted shift by the public’ was none other than the sovereign consumer deciding that there were now too many money derivatives around and that he now preferred to hold money proper again, i.e. gold. It was apparently deemed okay for the consumer to shift from currency (gold) to deposits, thereby widening the definition of what was accepted as money and thus allowing the banks to create more of it. But, so the founders of the Federal Reserve System decreed, it was not acceptable that the consumer would ever narrow the definition of money again and reduce the banks’ ability to place more money derivatives. The state thus entered the scene in order to protect the banks from changing preferences of the public, at least those changes in preferences that were bound to limit money creation and credit expansion.

You may say it was good of the Fed to reduce the risk of bank runs and make banking safe. That is the standard interpretation today. (By the way, the Fed has neither made the economy more stable nor banking safer, as George Selgin demonstrates nicely in this excellent presentation.) However, the good economist does not just look at the immediate and most obvious consequences of policy but also at the long run consequences. There is no escaping the fact that the establishment of a central bank as a backstop for the banks’ production of money derivatives was the starting point of a process of disenfranchisement of the depositor as ultimate controller and arbiter of what is money, of how much there should be of it, and of what makes good and prudent banks. The power of the depositor, the consumer of banking, was weakened, and the power of the central banker, the bureaucrat, as ultimate judge of what is money and what is good banking was strengthened. The bond between banker and depositor was starting to be replaced with the bond between banker and central banker.

It is clear that the interests of banker and bureaucrat were closely aligned and both pointed toward ever more money production. The banker wanted to conduct the lucrative business of creating and placing money derivatives with the public without the risk of sudden changes in consumer preferences. The state officials wanted to encourage monetary expansion as this was deemed to be good for business and because the state itself was of course an important borrower. It is hardly surprising that with the advent of central banking and later unlimited fiat money, state borrowing began to expand.

The score at this point: Bankers/bureaucrats 1 – Consumers 0

There is no such thing as a free lunch. While that is a famous and very fitting quote of Milton Friedman’s (1912-2006), it is Ludwig von Mises (1881-1972) who the bankers and central bankers of the 1920s and 1930s should have listened to. The money-induced credit boom of the 1920s ended in the crash of 1929, and although the public had accepted more money derivatives during the boom as these now came with a government backstop from the young Federal Reserve (and this had made the extended boom possible in the first place), when the bust started the consumer definitely wanted to hold money proper again, and that was still gold. Bank runs still ensued and now were much worse than they ever had been in the pre-Fed era, simply because the Fed had by now encouraged the issuance of vastly more money derivatives. Although the country was officially on a gold standard and the banks had promised their depositors repayment in gold as part of their strategy to place their money derivatives with the public, the state decreed that the banks would collectively default on this promise and that they could still continue as going concerns. The state also decreed that money derivatives were now the new money proper and in order to leave the public no choice whatsoever – and no say in what was money or not – the state confiscated all previous money proper (that is gold) via executive order of the president in 1933. (In the United States of America private ownership of gold remained severely restricted until 1974.)

History is always written by its victors, and the victorious money statists, central bankers and Keynesian economists claim – to this day – that this was all for the better. It ended monetary contraction (true) and ended the Great Depression (not quite true but it probably provided a break). But – oh those long run consequences!

The money consumer had been disenfranchised. What bankers could do and not do, how much money there was in the economy and what interest rates were – none of this was any longer a give and take between profit-seeking bankers and their banking consumers, and thus identical in its dynamics to the relationship between any entrepreneur and his customer, but it was now the outcome of policy. In 1953 the Chamber of Commerce of the United States published a pamphlet entitled The Mystery of Money that roundly stated: “Money is what the government says it is.”

The bankers, by and large, embraced this change. It was better to be in bed with the state than the fickle public. The state had unlimited resources (almost) and could make laws. And most important, the state was interested in constant monetary expansion – a magnificently lucrative proposition for the bankers as money derivative producers.

The score: Bankers/bureaucrats 2 – Consumers 0

Closing another loophole

Were all money consumers disenfranchised? – No, there were still those pesky foreigners who got hold of various forms of money derivatives through trade but who had no use for them in their own local economies. Under the post WWII arrangements (Bretton Woods, which was, unlike the gold standard, not a system that had evolved spontaneously but one that was designed by the bureaucratic elite, only to be then undermined by the same elite – sound familiar?) these foreigners could of course hold on to their paper dollars if they so wished, or they could send them back to the issuers and demand payment in gold. These foreigners were therefore still in a position similar to domestic depositors prior to 1933. They could still threaten a ‘run’ if they felt that the money producers were using their license to print money too liberally.

This remaining constraint on money creation was removed in August 1971 when Nixon closed the gold window. Another group of externals, of finance-consumers outside the state-bank alliance that had some power to pull the plug on the money monopoly, was silenced. Now nothing stood in the way of the growing financial-political complex to expand the issuance of money derivatives further. The government could run budget deficits continuously; the banks could expand their balance sheets and issue money derivatives, which now were the new money proper even globally, to their heart’s content without having to worry too much about a fickle public. Keynesian economists were on hand to explain to the public that this was all to its benefit. Under the new PhD-standard (Jim Grant), enlightened bureaucrats would guide the financial system to constant and smooth expansion, a prospect that contrasted favourably with the official history version of early banking when bankers had to constantly live in fear of their irrational depositors.

Bankers/bureaucrats 3 – Consumers 0

These institutional changes have persistently widened the definition of what is money, they have made the supply of money ever more elastic and they have led to a constant expansion of the money supply, naturally beyond what the public truly demands. The vast amounts of new money could only be placed with the public at an ever-lower purchasing power of every new monetary unit. If the public really demanded to hold that much money, the price of money, i.e. the exchange value of each unit of money, would not have had to decline so much. Since 1933 the dollar has lost 94% of its purchasing power according to official government statistics. Since 1971, 82%.

Of course, I am not claiming that the public was entirely powerless. The public can always reduce its money-balances and keep more wealth in gold. These shifts are particularly pronounced whenever the state-bank alliance uses its money-printing privilege particularly brazenly, such as during the 1970s or recently, 2001 to today, leading to drastic depreciations of paper money versus gold. Since the closing of the international gold window in 1971, the price of gold as measured in paper dollars has gone from $35 to $1585.

Fiat money = disenfranchisement of the public

However, the key point of this essay is not inflation or not even the ever-larger economic dislocations that must result from constant monetary expansion, which is the topic of Paper Money Collapse. The focus here is on who controls banking and finance. Who is the ultimate arbiter of banking practices and even the size and scope of the financial industry? Again, in a proper free market it is the public, the consumer, who decides what products are being produced and where resources go and who makes profits. But for this to happen in banking and finance the public needs to be in control of banking’s raw material. That is no longer the case in our complete fiat money system, in which the raw material is no material at all but unlimited funny money at the full discretion of the central banking bureaucracy.

Gold means consumer power and banking discipline. The official demonetization of gold has severed the link between depositor as banking consumer and ultimate regulator of banking activity and the bankers. The banker is no longer at the mercy of a risk-averse depositor who funds the banker’s business but can demand repayment in gold. The banker does not have to explain the soundness of his operations to the public. As long as he can convince his superiors at the central bank that what he does deserves the generous funding with fiat reserves, or if he astutely figures out which assets the central bank will gladly monetize with its printing press, or if he can simply make the case that if he goes out of business he will hurt a lot of innocent bystanders so he is deserving of more reserve money, he is in business. And the bankers know that the bureaucrats will always tend to support them, to always lean toward a further expansion of the banking industry as that means credit growth. And the state itself has become totally dependent on persistent credit expansion to fund the welfare state and to keep the voters happy. The state bureaucracy is a junkie who is asked to regulate the activities of his own drug dealer.

That is why the Occupy-movement gets it so wrong. The culprit is not capitalism because we largely removed banking and finance from the normal discipline of a capitalist system. In a remarkable article for zerohedge, entitled The Real Debate on Gold and Money, Jeff Snider, President and CIO of Atlantic Capital Management, provided a brilliant description of the bizarre shape that our financial system has adopted:

As long as a bank can pledge some kind of financial collateral with a central bank, that bank will remain in business, regardless of how its depositors (the public) feel about its recklessness. Indeed, most of the credit production accomplished during the past thirty years (encompassing the whole of the Great Moderation) was done by banks that have no depositors whatsoever. The Great Moderation would be more appropriately called the Great Financialization, where securities overtook the role of “reserves”, and central banks committed to unlimited funding of those reserves (to achieve a specified interest rate target, meaning a zero or near-zero interest rate target can lead to the possibility of unlimited reserve creation, but, again, the effective restraint being the supply of “quality” collateral, as defined by central banks themselves).

The public has been so far removed from a controlling function in finance that during the crisis the bureaucracy went to extreme measures to keep it outside. Remember that the US government forced private banks to accept the TARP bailout funds, even if these banks felt they did not need government assistance and that accepting it might tarnish their reputation with their customers. Recently, when some European banks made it known that they had not taken any of the ECB’s emergency LTRO funds, they were rebuked sharply by ECB president Mario Draghi. When gold was money and the state was outside finance, the depositor was in charge and the banker went to great length to distinguish himself from his peers in terms of solidity and reliability. In the new Orwellian world of government-controlled finance, all pigs are equal.

Or so we are to believe. That the truth is different we all know. But I guess it is a case of “You want the truth? You can’t handle the truth!” The bureaucracy knows what is best for us.

The depositor has still one important weapon at his disposal. He can withdraw his funds and by using cash can remove his financial affairs from the banking system. Not surprisingly, this last remnant of consumer power in finance is already under heavy attack from the state. Not only has it become fairly inconvenient in today’s world to use cash, mainly because of high nominal prices as a result of decades of monetary debasement, but also because the state is erecting ever more legal and regulatory barriers to the public’s transacting with the state’s own paper money. In many countries, legal limits on cash transactions have been implemented or are being debated. The official reason is cracking down on tax evasion, drug dealing or terrorist funding. But once we move to a cashless society, not only will every transaction be recorded and the state be able to monitor every individual better, but the inability to transact outside the established and government-controlled banking system will make the bank run impossible. Total disenfranchisement of the finance consumer will have been achieved.

The delusions of bankers and bureaucrats

We, the public, no longer know which banks are sound or even if any sound banks are left. We do not know what interest rates would really reflect the public’s true propensity to save and thus the real availability of resources for long- term investing. We do not know what assets out there are still supported by voluntary saving. We no longer know what the proper prices of any assets are. All of these aspects of our economies are manipulated by the ever-growing banking-bureaucracy cartel. We know that this cartel works toward an ever-larger state-finance complex, and we are supposed to believe that this vast complex is still being controlled in our own best interest.

Calls for more regulation are missing the point. Regulation only shifts power from banks to state within the anti-market state-bank alliance but do not bring back the public and the finance consumer as ultimate power broker into the equation. Those who only see ‘greedy bankers’ and a decline in business morals behind our present financial malaise take a too superficial view of things. Human decency is important but the most powerful check on greed and the most effective enforcer of sound business practice is still the prospect of loss, which in a market economy is the result of not serving your customers adequately. When gold was the basis of the monetary system the depositor was the most powerful banking customer. Gold anchored the financial system in the real economy. It was an enforcer of discipline and of sound banking practices. In our system today, the fate of banks, the prices of financial assets and the structure of the finance industry are largely determined by monetary policy and the various interventions of the financial bureaucracy. Ironically, whenever cracks appear in this new system of monetary central planning, they lead to more intervention and thus to a further removal of the system from the regulating forces of the market.

Bureaucrats and bankers are equally deluded if they believe that they can continue managing this system to their advantage, or even that this system will be sustainable. The bankers believe they can extend the house of cards of ever-bigger balance sheets and ever-bigger derivative positions forever with the help of zero-cost central bank funding and limitless bailouts if things go wrong. They seem to think that they can continue to combine the state-guaranteed security of the post office with compensation-packages that would be suitable only for free-market entrepreneurs. The bureaucrats believe that they can control this overstretched edifice of debt with their various policy tools, and that by tweaking yield curves, by massaging some asset prices higher and some interest rates lower, they can continue manipulating the real economy forever. Both are wrong. A system that is based on central planning, on price fixing and persistent market manipulation must ultimately collapse. Signs that this system has already checkmated itself are accumulating everywhere around us.

In the meantime, the debasement of paper money continues.

This article was previously published at Paper Money Collapse.

Hold onto your hat, we’re in for a wild ride

Damien Phillips — Fri, 18 May 2012 08:30:58 +0000

James Turk interviews Doug Casey, the American-born economist, professional investor, author and advocate of the free market, in an illuminating, entertaining and yet ultimately chilling interview from November 2011.

Doug Casey talks to James Turk

For those of you with busy lives who don’t have the time to sit through an hour of Casey’s sage-like wisdom, this wide-ranging chat with one of the world’s foremost investors covers some key areas of vital importance to the Cobden Centre – namely the role of government and chiefly central banks in causing current and past crises.

On a side note, Casey’s clear thinking on what constitutes a strong economy is particularly timely as the Bank of England’s Governor, Sir Mervyn King, has rejected blame for the financial meltdown and instead lambasted banks that had “grown too quickly and borrowed too much”. He fails to acknowledge the role played by the Bank in creating the crisis – apparently a central interest rate never higher than 6% since 2000 despite a household savings ratio which has plummeted in the same period is nothing to be concerned about. Artificially low interest rates orchestrated by the central bank, which disregarded the level of real resources available, were one of the key ingredients in this unholy mess and the rapid and unsustainable expansion of our banking system that Sir Mervyn decries. The regulatory interventions since the crisis by the Bank and by government to “save the economy” remind me of an arsonist returning to a blaze they started while posing as a fireman.

So the questions for Doug Casey are, what conditions are needed for there to be a healthy, growing economy and why is the model we have today a complete perversion of basic economics?

The way you become wealthy is by producing more than you consume, and by saving the difference… The net savings in society provide the capital to expand and develop new technologies.

Oh that simple? A growing economy based on savings and investment in productive enterprise. Unfortunately, the combination of what Jim Grant calls the “Phd standard” in monetary policy discouraging savings, an economic model which views spending cheap credit as the alpha and omega of economic growth, and successive governments taxing, borrowing and spending their way into bankruptcy is an aberration from Casey’s common sense approach. As he puts it:

The problem we have today is that there are no net savings in the Western World – it’s all debt. Trillions and trillions of dollars of debt, on most levels. And what that means is that we’ve been living out of capital accumulated by generations past, and we’re living out of projected future income.

Turning to the endless merry-go-round of boom and bust, in his view (and that of Austrian economists across the globe) business cycles are “created by the government’s debasement of the currency, which is called inflation”. The new money created to bring this about “causes people to do things that they otherwise wouldn’t.” Also, like debt, it “tends to make people think that they are richer than they are”. In this way, you can see that the present UK government’s policy of trying to reinflate the bubble caused by excessive consumer spending, a low rate of savings and an unsustainable credit boom is simply an attempt to sustain the illusion of prosperity.

Turning to the ongoing and seemingly never-ending crisis we are now experiencing, described as the “greater depression”, Casey establishes three broad definitions of a depression, the effects of which are experienced simultaneously.

The first, is a “period of time during which most people’s standard of living drops significantly”. So far, so horrible.

The second, is a period of time “when the business cycle climaxes”. Again, we’ve certainly had this part – all our chickens tried to come home to roost. Casey claims this would be entirely avoidable under a free market economic system, besides the odd fluctuation.

The third, and most important, depression is when “distortions and misallocations of capital are liquidated”, allowing the economy to recover and grow. Unfortunately, this is exactly what the various stimulus packages, bailouts, and subsidies have prevented from happening. The UK’s over-leveraged banks, overinflated asset and housing markets, a good deal of unviable businesses and a massively bloated service sector have all been allowed to shuffle on, soaking up capital that might be allocated towards more productive purposes and dragging the economy down under a mountain of debt.

In addition to this, the response to the crisis by “stupid governments all over the world, with their quantitative easing measures, are basically going to destroy their national currencies” and “destroy the savings of the middle class”, leading to a “sociological earthquake”. So the arsonist starts the blaze, returns dressed as a fireman, then begins spraying the fire with jet fuel. As it becomes a raging inferno, he tells everyone that it would have been much worse if they hadn’t acted.

If you weren’t already preparing to either kill yourself or hike off into the hills to live out a nomadic existence in the Highlands, to top it off Casey predicts more of the rioting seen in London and Vancouver in recent years as “people find that they aren’t going to be able to improve themselves” and turn violent. Just what everyone needed – a good riot and some overturned cars.

He describes the prevailing perception that government is a “magic cornucopia” that can “make everybody wealthy” or “raise everybody’s wages” as ridiculous, having nothing that it hasn’t stolen first from society as a whole. His disgust with attitudes to government and with government itself is palpable. National debts should be defaulted on for “moral reasons” and to avoid citizens being turned into “veritable serfs” to “repay a mortgage against future generations” that is completely unsustainable and in order to punish those that have financed an ever-expanding state.

Casey is particularly derisive of our dear Continent, describing Europe as “constipated, highly regulated, highly taxed”, going downhill since World War One due to the “wrong philosophical values” and shortly to become no more than a “petting zoo for the Chinese”. Unfortunately, it’s not just us as we are all in an “existential nightmare” with no way out, and the best you can do is “Hold onto your hat” as “we’re in for a wild ride”.

A great teacher

Toby Baxendale — Thu, 17 May 2012 07:45:56 +0000

Professor Pete Boettke is one of our advisors and friends.

In the English speaking world, if you want to know anything about economics – go to Pete, from the most obscure point to the most life changing, Pete will have a good grounding in it. In fact, economics is just a branch of knowledge Pete is familiar with. He is a polymath across the social sciences as all good people who style themselves as economists should be.

He is the father and grandfather now of a growing body of social scientists, schooled in the Austrian tradition. This is a positive thing for the world.

The concept of “Mainline” economics is Pete’s great contribution, in his latest book, to our understanding of economics, as opposed to the hapless mainstream economics we are confronted with in the halls of academia, the media and politics – be it the Platonic abstracters who come up with the mumbo jumbo of perfect competition, rational expectations, modern portfolio theory, the efficient market hypothesis, and so on, or the aggregating Keynesians and monetarists.

What we know as Austrian economics underlies the majority of what is good in economics, the individual human actor being historically specific and unique in all he does, the subjective values of the acting individual being the driving force of the market, the entrepreneur as alpha and omega of the market process, deductive reasoning from solid fact IS the mainline theme. The mainstream have diverted from this plumb line and just as we moved down into the Dark Ages from the age of reason of the Greeks and Romans and back up into the Renaissance of the Europeans, we will eventually move back to mainline economics. This is a hopeful and realistic message from Pete and his new book.

Our friend Jeff Tucker has reviewed Living Economics here.

Pete gives a good talk about his book here.

Professor Gabriel Calzada introduces Pete at the start of this lecture. Gabriel heads the Insituto Juan de Mariana, a leading Spanish Austrian institute and is a Professor at the Universidad Rey Juan Carlos. This is where Professor Jesus Huerta De Soto leads the economics department – a Pete Boettke for the Spanish speaking world.

The Universidad Francisco Marroquin is another leading Spanish speaking university in Guatemala, which has acknowledged Pete with a Honorary Doctorate. It is wonderful to see the English and Spanish speaking world-class institutions link up in this way. In a very humbling speech during his acceptance of the honorary doctorate, Pete reminds us we are always students of life and what we learn best is actually learning how to learn. His acceptance speech starts 7 mins into this video.

Economics by and for human beings

Jeffrey Tucker — Thu, 17 May 2012 07:30:15 +0000

Economics puts parameters on people’s utopias.

Yes. That’s exactly it. That’s why the politicians hate economics. That’s why the media are so… selective in which economists they call on to talk about policy.

That’s why the economics departments in colleges are put down by the sociologists, philosophers, literature professors and just about everyone else who has romantic longings for a coerced utopia.

The teachings of the principles of economics should inform as much on what not to do, perhaps even more than providing a guide to public action.

That’s it again. Don’t control prices. Don’t socialize medicine. Don’t raise taxes. Don’t inflate the money supply. Don’t put up trade barriers. Don’t go to war. Economists just keep bursting people’s bubbles. And it’s because economists say these things that the ruling class wants them to shut up about.

It’s been going on for hundreds of years. Every generation for the past 500 years has seen the battle wage between those who want to use the power of the state to contort and distort the world to fit some daydream on one hand and the economists who have seen the futility in this manipulation and warn against it on the other.

The man who wrote those above words is Peter Boettke, economics professor at George Mason University. He is one of the nation’s leading producers of economists, having directed several dozen dissertations over 20 years and having spread his students to colleges and universities around the country and the world.

His new book, which ought to be read by every college student who secretly suspects that economics is not as dreary as they say, is Living Economics, just published by the Independent Institute. It’s a big book, but a luxurious read from Page 1 to 450.

The phrase “living economics” means two things: 1) economics is part of life whether we recognize it or not, and 2) economics is a living discipline, rooted in universal principles but always changing in nuance and application.

Professor Boettke’s purpose is to provide a guided tour through the profession as it is now and how he would like to see it changed. He does this by first explaining what got him interested in the science.

It turns out that he remembers the gas lines of the 1970s and recalls being amazed to discover that they were wholly manufactured by Washington policy. It was the price control of oil combined with inflationary pressures from bad monetary policy. Contrary to what the media mavens and politicians were saying at the time, it had nothing to do with producer greed, secret price manipulation or financial speculation.

That’s what did it for him. He realized that economics is woven into every aspect of our lives. It is inescapable. When the market is allowed to work, beauty and growth results. Humanity flourishes. When markets are truncated and hobbled, people suffer.

Then he realized how little public understanding there is of economics. And he realized that he could play a role in changing this. He has. His students are now teaching other students in six different Ph.D.-granting institutions, among dozens more institutions.

Here Boettke reflects on the decision to make economics his vocation. Economics as a reality in our world will exist whether there are people around to study and explain it or not. As a discipline, it was very late in developing, mostly during the High Middle Ages. And it came about precisely to elucidate the way the world works in order to prevent kings and other big shots from using force to interfere with its mechanisms.

As Boettke puts it,

We do not need to understand economics in order to experience the benefits of freedom of exchange and production. But we may very well need to understand economics in order to sustain and maintain the institutional framework that enables us to realize the benefits that flow from freedom of exchange and production.

What follows this beginning material is a plunge straight into the core of what economics teaches. Boettke chooses a very engaging path. He tells the story through a series of intellectual biographies of the economists he most admires. We read about his teacher Hans Sennholz, about Ludwig von Mises, F.A. Hayek and Murray Rothbard (his chapter on Rothbard is particularly celebratory). He covers James Buchanan and Gordon Tullock. Perhaps the most-interesting sections are the ones that find “Austrianness” in unusual places — in the work of Kenneth Boulding, for example.

In contrast to most books on economics, this book is very warm and humane. He goes all out to describe economics as the science of human choice in the real world. The prose matches his intellectual sense. We are spared the usual academic pomp and the absurdities of trying to cram people and their spontaneous decisions into mechanical models. He never talks down to his readers. This reader found no showing off, no strutting around, no defensiveness or bickering. The prose and line of thinking are open and generous.

It’s no surprise that the Austrian School is at the core of the narrative. This figures into his choice of biography, of course. And it informs the whole of his worldview, accounts for why he is able to write about real-world problems and explains the failure of planning in such lucid terms.

At the same time, Boettke cautions: “The main thing that makes someone an Austrian is not the willingness to identify one’s work with that label, but the substantive propositions in economics that an economist identifies with.” With this in mind, he shows that Austrian ideas are very more widespread that one might suppose.

In general, Boettke attempts to show that the profession has lost much of the arrogance that it practiced from the 1930s through the 1970s. While methodological positivism and mathematical hubris still exist in form, he attempts to show that the old ways have shifted toward a greater emphasis on institutions and human choice. He detects the rise of a certain humility in the profession, which has made way for a broader and more-eclectic approach that includes even radical libertarians like Boettke himself.

A book like this will provide anyone vast insight into what economics has to offer the world of ideas. It is an excellent overview about what is great and what is awful in the profession today. But even when he criticizes, there is no anger; instead, there is conviction that openness and frankness is the best path to finding truth. I can’t think of a better good for an economics major to have on hand when the lecture content begins to depart from reality.

As for the author himself, I can’t add to what Israel Kirzner has already said (and I’m almost certain that Kirzner has never written an endorsement this over-the-top):

Living Economics is in many ways a remarkable book. The volume luminously reflects the amazing breadth of professor Boettke’s reading, and the deep and careful thoughtfulness with which he reads. But the true distinction of this volume consists of more than the profound economic understanding and wealth of deeply perceptive doctrinal-history observations that fill its pages. Its distinction consists in the delightful circumstances that these riches arise from and express Peter Boettke’s extraordinary intellectual generosity and unmatched intellectual enthusiasm — rare qualities that have enabled him to discover nuggets of valuable theoretical insight in the work of a wide array of economists, many of whom are generally thought to be far away from the Austrian tradition, which Boettke himself splendidly represents. Boettke’s prolific pen is dipped, not in the all-too-common ink of professional one-upmanship, but in the inkwell of an earnest, utterly benevolent — and brilliant — scholar, seeking, with all his intellectual integrity, to learn and to understand.

Many others have said the same: Bruce Yandle, Richard Wagner, Steve Hanke, Randall Holcombe and dozens more. As you read through the tributes, you realize that these are more than coerced blurbs. Boettke has managed to make economists themselves re-excited about what they do. He will do the same for you, and help you appreciate the creativity, courage and sheer adventure associated with this grand craft that elucidates the workings of our world like no other.

This article was previously published at Laissez-Faire Books.

Does JP Morgan’s massive loss favour the argument for more controls?

Dr Frank Shostak — Wed, 16 May 2012 08:45:39 +0000

On Friday May 1 2012, JP Morgan Chase & Co said it suffered a $2 billion trading loss. Some commentators have suggested that the huge loss emanates from so called proprietary trading or placing risky bets using the bank’s money. The loss raised the credibility of the Volcker rule, which restricts banks from trading their own money. Despite JPMorgan’s large loss, the opponents of the Volcker rule are of the view that the rule, if it were introduced, will only destabilize the financial markets and make things much worse. Hence they would like to allow market forces to do their job.

Do reduced banking controls always equate with free market?

The proponents for less control in the banking industry hold that fewer restrictions imply a better use of scarce resources, which leads to the generation of more real wealth.

It is true that a free banking environment is an agent of wealth promotion through the efficient use of scarce real resources, whilst controlled banking stifles the process of real wealth formation. However, it is overlooked by the opponents of the Volcker rule that the present banking system has nothing to do with free banking and thus a free market.

What we have at present is a banking system within the framework of the central bank, which promotes monetary inflation and the destruction of the process of real wealth generation through fractional reserve banking. In the present system the more unrestricted the banks are the more money out of “thin air” can be generated and hence greater damage is inflicted upon the wealth generation process. This must be contrasted with genuine free banking, i.e. the absence of the central bank, where the potential for the creation of money out of “thin air” is minimal.

Elsewhere we have shown that in a free banking environment with many competitive banks, if a particular bank tries to expand credit by practising fractional reserve banking it runs the risk of being “caught”. So it is quite likely that in a free market economy the threat of bankruptcy will bring to a minimum the practice of fractional reserve banking.

The existence of central bank encourages fractional reserve banking

This is, however, not so in the case of the existence of the central bank. By means of monetary policy, which is also termed the reserve management of the banking system, the central bank permits the existence of fractional reserve banking and thus the creation of money out of “thin air”.

The modern banking system can be seen as one huge monopoly bank, which is guided and coordinated by the central bank. Banks in this framework can be regarded as ‘branches’ of the central bank.

For all intents and purposes the banking system can be seen as being comprised of one bank. (Note that a monopoly bank can practice fractional reserve banking without running the risk of being “caught”).

Through ongoing monetary management, i.e. monetary pumping, the central bank makes sure that all the banks engage jointly in the expansion of credit out of “thin air.” The joint expansion in turn guarantees that checks presented for redemption by banks to each other are netted out. By means of monetary injections the central bank makes sure that the banking system is “liquid enough” so banks will not bankrupt each other.

The myth of financial de-regulation

Prior to the 1980’s financial de-regulation we had controlled banking. Banks’ conduct was guided by the central bank. Within this type of environment bank’s profit margins were nearly predetermined (the Fed imposed interest rate ceilings and controlled short term interest rates) hence the “life” of the banks was quite easy, although boring.

The introduction of financial de-regulation and the dismantling of the Glass–Steagall Act changed all that. The de-regulated environment resulted in fierce competition between banks. The previously fixed margins were severely curtailed. This in turn called for an increase in volumes of lending in order to maintain the level of profits.

In the present central banking framework this increase culminated in an explosion in the creation of credit out of “thin air” – a massive explosion in the money supply. In the deregulated environment, banks’ ability to amplify Fed’s pumping has enormously increased.

Rather than promoting an efficient allocation of real savings the current so-called de-regulated monetary system has been promoting channeling of money out of “thin air” across the economy. From this it follows that in the framework of the present monetary system in order to reduce a further weakening of the real wealth generation processes it is necessary to introduce tighter controls on banks. According to Murray Rothbard,

Many free–market advocates wonder: why is it that I am champion of free markets, privatization, and deregulation everywhere else, but not in the banking system? The answer should now be clear: Banking is not a legitimate industry, providing legitimate service, so long as it continues to be a system of fractional-reserve banking: that is, the fraudulent making of contracts that it is impossible to honor.[1]

Pay attention that we don’t suggest here suppressing the free market but suppressing banks ability to generate credit out of “thin air”. Please note the present banking system has nothing to do with a true free market economy.

It must be reiterated here, however, that more controls within the framework of central bank banking can only slow down the pace of the erosion of real wealth formation. It cannot prevent the erosion. (Remember the Fed continues to pump money to navigate the economy). More controls will suppress banks ability to significantly amplify the Fed’s pumping so in this sense it is preferable to a so-called deregulated banking sector.

[1] Murray N. Rothbard – Making Economic Sense, Ludwig von Mises Institute p 279.

Dimon geezers

Tim Price — Tue, 15 May 2012 08:00:02 +0000

“JP Morgan Chase last night announced a surprise $2 billion trading loss on credit derivatives trading, which chief executive Jamie Dimon blamed on “errors, sloppiness and bad judgment”, warning it “could get worse”.

- From The Financial Times, Friday 11th May 2012.

“The best way to build shareholder value is to build a great company, with exemplary products and services, excellent systems, quality accounting and reporting, effective controls and outstanding people.”

- From the JP Morgan Chase Annual Report 2011.

Imagine you are one of two people playing ‘Monopoly’. While you follow the rules religiously, the other player – who also happens to be the banker – does not. He routinely appropriates properties. If he doesn’t like the score on the dice, he simply changes them. He continually takes as much money from the bank as he likes. Whenever the rules don’t suit, he arbitrarily alters them in his favour. And he hates to lose. Rather than concede defeat, he is perfectly willing to set fire to the board. Imagine no longer. This is the state of the financial markets. You are playing against the world’s central banks.

James Grant uses a similar metaphor: the modern investor is like the protagonist in ‘The Truman Show’, unaware until the final reel that everything about his world is artificial – he is living in a TV programme. “By changing interest rates,” observes Grant, “central banks change the perception of every asset class – so what seems cheap may not be cheap.”

For some time now, the Financial Times has been running articles (under the inauspicious label of ‘Collateral Damage’) discussing the merits or demerits of central banking. With so far one exception, that of Congressman Ron Paul, every contributor has sought to defend the status quo. This may be all we have a right to expect from the newspaper in question. As Paul writes, while socialism and centralised economic planning have largely been rejected by free-market economists, the myth persists that central banks are a necessary component of market economies. This investor has grown tired of debating with people who are neither willing nor able to maintain an open mind, but here is the short-hand version: the Austrians are right, and the Keynesians are wrong. We cite one headline to emphasise the broader point (that money, and much more besides, is too important to be left to government), from Friday’s Financial Times:

Flagship coalition scheme pays £200,000 to create just one job

It would be fantastic (perhaps in every sense of the word) if more of the electorate grasped the fact that government does not create jobs. Government does not create wealth. Private citizens known as entrepreneurs do both. Government merely redistributes the outcomes, and like the cheat at monopoly also creams off some of the proceeds for itself.

Analyst Barry Ritholtz recently wrote on the topic of debating policy versus managing assets:

They are two radically different activities.. Anyone who toils in the markets professionally or manages money for other people does not get to enjoy such a lavish, self-indulgent luxury. Their job is not to opine on such matters, but rather, to manage cash in the environment that is – the world that exists presently, and is likely to exist in the near future. It is not their role to manage money based on the way things ought to be – rather than the way things are.

With all due respect to Mr. Ritholtz, not all of us who toil in the markets professionally can sit idly by while the game is being fixed. Simply withdrawing into a shell of professional non-accountability for malign policy is a response that some of us find morally objectionable. It is too close to saying “I’m All Right, Jack!” – a phrase that Urban Dictionary describes as “Narrow focus, narrow-gauge pseudo-Darwinian selfishness glorified as a sensible philosophy of society and life”.

So yes, while our primary responsibility is the fiduciary and prudential management of our clients’ assets, that task is not at all incompatible with a broader discussion of the deeply manipulated financial environment in which we are obligated to conduct that activity. It is not enough to say that we wish things were different. We state with conviction: things should be different. We don’t merely question why self-appointed bureaucrats are permitted to control the rate of monetary interest. We state categorically: the system must be changed. And if such calls don’t come from within the financial establishment, where else will they come from? Ironically, the loudest call to date has come from a member of the medical profession. But then, many of the reader responses to Ron Paul’s op-ed in the FT, “Our central bankers are intellectually bankrupt”, are masterpieces of irony. Note, for example, the ‘thoughts’ of ‘tasdk’ who makes the facile observation:

The problem with blindly accepting Dr Paul’s diagnosis is that he lacks the necessary qualifications to make a diagnosis. Would you trust a medical diagnosis made by Ben Bernanke, Mario Draghi or Mervyn King?

No, ‘tasdk’, I wouldn’t. But to answer your (fatuous) point, I wouldn’t trust an economic diagnosis from any of those individuals either? Why do you?

Getting rid of central banks – over time, let us be realistic – would have at least two benign effects. In the first instance, it would require commercial or investment banks that lose the plot spectacularly to fail properly, as opposed to feeding off the blood of taxpayers indefinitely. Lest anyone regard the $2 billion loss recorded by JP Morgan’s chief investment office as comparatively trivial, it should perhaps be seen in the context of the same bank’s overall derivatives exposure, which is shown graphically below. JP Morgan’s total derivatives exposure stands at $70.1 trillion, or roughly the same size as the entire world economy. Each of the $1 trillion towers in the image below is double-stacked to a height of 930 feet.

JP Morgan Chase total derivatives exposure, as expressed in $1 trillion towers of dollar bills:

Source: Demonocracy.

In the second instance, it would require governments to learn to balance their books. A third outcome would be that asset prices reverted to being determined by the market, and not by unelected economists serving the interests of bankers and politicians. But in the meantime, as Barry Ritholtz makes clear, we have to do our best in the situation we’re already in.

Speaking of which, the consistently excellent Gillian Tett, writing for the FT (“Repression on bonds heralds masochism”) reports that last year, US pension funds for the very first time put more of their assets (41%) into bonds as opposed to equities. With Treasury yields as low as they are, this is unlikely to end well. The chart below shows the impact on Gilt investors of the stagflation suffered in the UK during the 1970s. Investors who bought conventional Gilts in 1973 had to wait for 12 years to earn a positive real return on their investment. Do US pension funds know the risks they’re running ?

Source: Frontier Investment Management

Now THAT is financial repression. Thank heavens the central banks are in charge – nothing could possibly go wrong on their watch.

This article was previously published at The price of everything.

Hard work needs honest money

Steven Baker MP — Mon, 14 May 2012 08:00:41 +0000

In yesterday’s Telegraph, William Hague tells the Government’s business critics to stop complaining and work hard to deliver jobs. However, Mr Hague forgets that a day’s hard work is rewarded with a day’s pay: if that pay is in a money which someone else is producing at near zero cost, the value of hard work is undermined.

People who are slogging their guts out to make ends meet in an environment of rising living costs are bound to take the Telegraph’s reporting of Mr Hague’s remarks badly, and rightly too. The comments on the article are well worth reading.

The original interview is here and there is some good in it:

Things went “wrong over decades”, the Foreign Secretary suggests, with the idea growing that people could “live on expanded debt forever, rather than having to earn what we spend.”

I have argued again and again that 40 years of credit expansion — lending money into existence well in excess of real savings, trebling the money supply under New Labour by expanding debt — is the fundamental cause of this crisis. It is the reason why the distribution of prosperity in our country is manifestly unjust, why wealth is concentrated around London and why the financial, building and state sectors are so dominant in our economic system.

In The Ethics of Money Production (PDF), Jörg Guido Hülsmann writes,

The prevailing ways of money production, relying as they do on a panoply of legal privileges, are alien elements in the capitalist economy. They provide illicit incomes, encourage irresponsibility and dependence, stimulate the artificial centralization of political and economic decision-making, and constantly create fundamental economic disequilibria that threaten the life and welfare of millions of people. In short, paper money and fractional-reserve banking go a long way toward accounting for the excesses for which the capitalist economy is widely chided.

Elsewhere in the book, Hülsmann explains the depth and extent of the damage done by money which is produced by expanding debt. At last a senior member of the Government is beginning to discuss similar ideas.

Senior politicians must realise that hard work cannot produce prosperity without the right institutions. In addition to Adam Smith’s “peace, easy taxes and a tolerable administration of justice”, hard work must be rewarded with honest money which holds its value, not money which the commercial banks and the Bank of England can produce at the touch of a button.

Money loaned into existence in ever greater quantities caused the present crisis. It has given us a society based on crushing burdens of work in exchange for rewards which quickly disintegrate. That is the problem which must be solved if hard work is to have proper meaning and if we are to have a moral and just society which delivers prosperity for all.

See also Ten plans for reform and this superb video:

This article was previously published at stevebaker.info.