Booms and Busts: Recent Episodes
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Search Booms and Busts for examples of how intervention in the economy causes business cycles and their affect on the economy; along with historical cases.
We should not just be concerned about problems in the American banking system, but also about the proliferation of Eurodollars.
Original Article: "Eurodollars as a Fractional Reserve Market"
In this episode, Mark examines Fed Chairman Jay Powell's recent confession that the Fed is "navigating by the stars on a cloudy night." This reveals the fundamental methodological weakness of the Fed's economic policy and mainstream economics in general ("data dependency"). In contrast, it also reveals the strengths of Austrian economics, economic theory, and the self regulation of the free market. Mark suggests that we all be prepared for big negative surprises in the economy and additional Federal Reserve and government power grabs.
Be sure to follow Minor Issues at Mises.org/MinorIssues.
Recommended Reading "What the Central Bank Cartel has Planned for You" by Thorsten Polleit: Mises.org/Minor34A
"Transparency or Deception: What the Fed Was Saying in 2007" by Mark Thornton: Mises.org/Minor34B
In this episode, Mark explains why we need a Crash (or very Hard) Landing in the US economy and the world economy. Specifically, why is a crash landing better to resolve the malinvestments caused by the Fed? Why is a crash landing better in many ways for the productive class of workers and savers? And, how would a crash landing place much of the pain and the overall burden on the rich, politically-connected classes?
Be sure to follow Minor Issues at Mises.org/MinorIssues.
Additional Resources "The Fed's Real Mandate": Mises.org/Minor33A
"Black Hole or Shock Absorber: How Does a Free-Market Economy Respond to Crises?": Mises.org/Minor33B
"The REAL Solution to the Coming Economic Crisis": Mises.org/Minor33C
"Eliminating Economic Crises": Mises.org/Minor33D
"Austerity: A Real Solution to Help Heal the US Economy": Mises.org/Minor33E
"US Labor Market: Help Wanted!": Mises.org/Minor33F
"After the Boom Must Come the Bust" (Radio Rothbard): Mises.org/Minor33G
"Here's What Mounting Corporate Layoffs Tell Us about the Economy" (Radio Rothbard): Mises.org/Minor33H
Peter St. Onge joins Bob to discuss his latest piece at Mises.org on "China's Doom Loop." They cover a wide range of topics, including the contrast in leadership between Xi Jinping and Deng Xiaoping, the dollar as global reserve currency, the Belt and Road Initiative, and Jim Rogers' prediction that the 21st century would belong to the Chinese empire.
Peter's Article on China: Mises.org/HAP410a
Join us in Nashville on September 23rd for a no-holds-barred discussion against the regime. Use Code "HA23" for $45 off admission: Mises.org/Nashville23
On this episode of Good Money with Tho Bishop, Dr. Murray Sabrin joins the show. Dr. Sabrin shares his story of how he became an Austrian economist and discusses his analysis predicting a recession later in the year. Tho and Dr. Sabrin also talk about this week's anniversary of Nixon closing the gold window.
Join Dr. Sabrin in November for a Mises Circle in Ft. Meyers, FL on The White House, the Fed, and the Economy. Use promo code Tampa23 for $10 off registration.
Dr. Sabrin's Article on the Coming Recession: Mises.org/GM19a
Good Money listeners can order a special $5 book bundle that includes How To Think About the Economy and What Has Government Done to Our Money? with free shipping using promo code "GoodMoney" at Mises.org/Good
Receive a free subscription to The Austrian magazine at Mises.org/Magazine
Jonathan Newman joins Bob to discuss the argument being put forth by Alan Blinder, James Galbraith, and other progressive economists, who claim that the Federal Reserve's rate hikes couldn't possibly be responsible for the quelling of consumer price inflation.
Jonathan and Bob stress the important role of expectations as a "transmission mechanism" from Fed policy to impacts on prices.
Galbraith's Article on the Fed's 'Soft Landing': Mises.org/HAP409a The Paper on the Forward Guidance Paradox That Mentions Krugman: Mises.org/HAP409b
Join us in Nashville on September 23rd for a no-holds-barred discussion against the regime: Mises.org/Nashville23
Study of business cycles must be based upon a satisfactory cycle theory. Gazing at sheaves of statistics without "pre-judgment" is futile. A cycle takes place in the economic world, and therefore a usable cycle theory must be integrated with general economic theory. And yet, remarkably, such integration, even attempted integration, is the exception, not the rule. Economics, in the last two decades, has fissured badly into a host of airtight compartments—each sphere hardly related to the others. Only in the theories of Schumpeter and Mises has cycle theory been integrated into general economics.Various neo-Keynesians have advanced cycle theories. They are integrated, however, not with general economic theory, but with holistic Keynesian systems—systems which are very partial indeed.
The bulk of cycle specialists, who spurn any systematic integration as impossibly deductive and overly simplified, are thereby (wittingly or unwittingly) rejecting economics itself. For if one may forge a theory of the cycle with little or no relation to general economics, then general economics must be incorrect, failing as it does to account for such a vital economic phenomenon. For institutionalists—the pure data collectors—if not for others, this is a welcome conclusion. Even institutionalists, however, must use theory sometimes, in analysis and recommendation; in fact, they end by using a concoction of ad hoc hunches, insights, etc., plucked unsystematically from various theoretical gardens. Few, if any, economists have realized that the Mises theory of the trade cycle is not just another theory: that, in fact, it meshes closely with a general theory of the economic system.There is, for example, not a hint of such knowledge in Haberler's well-known discussion. See Gottfried Haberler, Prosperity and Depression (2nd ed., Geneva, Switzerland: League of Nations, 1939). The Mises theory is, in fact, the economic analysis of the necessary consequences of intervention in the free market by bank credit expansion. Followers of the Misesian theory have often displayed excessive modesty in pressing its claims; they have widely protested that the theory is "only one of many possible explanations of business cycles," and that each cycle may fit a different causal theory. In this, as in so many other realms, eclecticism is misplaced. Since the Mises theory is the only one that stems from a general economic theory, it is the only one that can provide a correct explanation. Unless we are prepared to abandon general theory, we must reject all proposed explanations that do not mesh with general economics.
Business Cycles and Business Fluctuations It is important, first, to distinguish between business cycles and ordinary business fluctuations. We live necessarily in a society of continual and unending change, change that can never be precisely charted in advance. People try to forecast and anticipate changes as best they can, but such forecasting can never be reduced to an exact science. Entrepreneurs are in the business of forecasting changes on the market, both for conditions of demand and of supply. The more successful ones make profits pari passus with their accuracy of judgment, while the unsuccessful forecasters fall by the wayside. As a result, the successful entrepreneurs on the free market will be the ones most adept at anticipating future business conditions. Yet, the forecasting can never be perfect, and entrepreneurs will continue to differ in the success of their judgments. If this were not so, no profits or losses would ever be made in business.
Changes, then, take place continually in all spheres of the economy. Consumer tastes shift; time preferences and consequent proportions of investment and consumption change; the labor force changes in quantity, quality, and location; natural resources are discovered and others are used up; technological changes alter production possibilities; vagaries of climate alter crops, etc. All these changes are typical features of any economic system. In fact, we could not truly conceive of a changeless society, in which everyone did exactly the same things day after day, and no economic data ever changed. And even if we could conceive of such a society, it is doubtful whether many people would wish to bring it about.
It is, therefore, absurd to expect every business activity to be "stabilized" as if these changes were not taking place. To stabilize and "iron out" these fluctuations would, in effect, eradicate any rational productive activity. To take a simple, hypothetical case, suppose that a community is visited every seven years by the seven-year locust. Every seven years, therefore, many people launch preparations to deal with the locusts: produce anti-locust equipment, hire trained locust specialists, etc. Obviously, every seven years there is a "boom" in the locust-fighting industry, which, happily, is "depressed" the other six years. Would it help or harm matters if everyone decided to "stabilize" the locust-fighting industry by insisting on producing the machinery evenly every year, only to have it rust and become obsolete? Must people be forced to build machines before they want them; or to hire people before they are needed; or, conversely, to delay building machines they want—all in the name of "stabilization"? If people desire more autos and fewer houses than formerly, should they be forced to keep buying houses and be prevented from buying the autos, all for the sake of stabilization? As Dr. F.A. Harper has stated:
This sort of business fluctuation runs all through our daily lives. There is a violent fluctuation, for instance, in the harvest of strawberries at different times during the year. Should we grow enough strawberries in greenhouses so as to stabilize that part of our economy throughout the year.F.A. Harper, Why Wages Rise (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1957), pp. 118–19.
We may, therefore, expect specific business fluctuations all the time. There is no need for any special "cycle theory" to account for them. They are simply the results of changes in economic data and are fully explained by economic theory. Many economists, however, attribute general business depression to "weaknesses" caused by a "depression in building" or a "farm depression." But declines in specific industries can never ignite a general depression. Shifts in data will cause increases in activity in one field, declines in another. There is nothing here to account for a general business depression—a phenomenon of the true "business cycle." Suppose, for example, that a shift in consumer tastes, and technologies, causes a shift in demand from farm products to other goods. It is pointless to say, as many people do, that a farm depression will ignite a general depression, because farmers will buy less goods, the people in industries selling to farmers will buy less, etc. This ignores the fact that people producing the other goods now favored by consumers will prosper; their demands will increase.
The problem of the business cycle is one of general boom and depression; it is not a problem of exploring specific industries and wondering what factors make each one of them relatively prosperous or depressed. Some economists—such as Warren and Pearson or Dewey and Dakin—have believed that there are no such things as general business fluctuations—that general movements are but the results of different cycles that take place, at different specific time-lengths, in the various economic activities. To the extent that such varying cycles (such as the 20-year "building cycle" or the seven-year locust cycle) may exist, however, they are irrelevant to a study of business cycles in general or to business depressions in particular. What we are trying to explain are general booms and busts in business.
In considering general movements in business, then, it is immediately evident that such movements must be transmitted through the general medium of exchange—money. Money forges the connecting link between all economic activities. If one price goes up and another down, we may conclude that demand has shifted from one industry to another; but if all prices move up or down together, some change must have occurred in the monetary sphere. Only changes in the demand for, and/or the supply of, money will cause general price changes. An increase in the supply of money, the demand for money remaining the same, will cause a fall in the purchasing power of each dollar, i.e., a general rise in prices; conversely, a drop in the money supply will cause a general decline in prices. On the other hand, an increase in the general demand for money, the supply remaining given, will bring about a rise in the purchasing power of the dollar (a general fall in prices); while a fall in demand will lead to a general rise in prices. Changes in prices in general, then, are determined by changes in the supply of and demand for money. The supply of money consists of the stock of money existing in the society. The demand for money is, in the final analysis, the willingness of people to hold cash balances, and this can be expressed as eagerness to acquire money in exchange, and as eagerness to retain money in cash balance. The supply of goods in the economy is one component in the social demand for money; an increased supply of goods will, other things being equal, increase the demand for money and therefore tend to lower prices. Demand for money will tend to be lower when the purchasing power of the money-unit is higher, for then each dollar is more effective in cash balance. Conversely, a lower purchasing power (higher prices) means that each dollar is less effective, and more dollars will be needed to carry on the same work.
The purchasing power of the dollar, then, will remain constant when the stock of, and demand for, money are in equilibrium with each other: i.e., when people are willing to hold in their cash balances the exact amount of money in existence. If the demand for money exceeds the stock, the purchasing power of money will rise until the demand is no longer excessive and the market is cleared; conversely, a demand lower than supply will lower the purchasing power of the dollar, i.e., raise prices.
Yet, fluctuations in general business, in the "money relation," do not by themselves provide the clue to the mysterious business cycle. It is true that any cycle in general business must be transmitted through this money relation: the relation between the stock of, and the demand for, money. But these changes in themselves explain little. If the money supply increases or demand falls, for example, prices will rise; but why should this generate a "business cycle"? Specifically, why should it bring about a depression? The early business cycle theorists were correct in focusing their attention on the crisis and depression: for these are the phases that puzzle and shock economists and laymen alike, and these are the phases that most need to be explained.
The Problem: The Cluster of Error The explanation of depressions, then, will not be found by referring to specific or even general business fluctuations per se. The main problem that a theory of depression must explain is: why is there a sudden general cluster of business errors? This is the first question for any cycle theory. Business activity moves along nicely with most business firms making handsome profits. Suddenly, without warning, conditions change and the bulk of business firms are experiencing losses; they are suddenly revealed to have made grievous errors in forecasting.
A general review of entrepreneurship is now in order. Entrepreneurs are largely in the business of forecasting. They must invest and pay costs in the present, in the expectation of recouping a profit by sale either to consumers or to other entrepreneurs further down in the economy's structure of production. The better entrepreneurs, with better judgment in forecasting consumer or other producer demands, make profits; the inefficient entrepreneurs suffer losses. The market, therefore, provides a training ground for the reward and expansion of successful, far-sighted entrepreneurs and the weeding out of inefficient businessmen. As a rule only some businessmen suffer losses at any one time; the bulk either break even or earn profits. How, then, do we explain the curious phenomenon of the crisis when almost all entrepreneurs suffer sudden losses? In short, how did all the country's astute businessmen come to make such errors together, and why were they all suddenly revealed at this particular time? This is the great problem of cycle theory.
It is not legitimate to reply that sudden changes in the data are responsible. It is, after all, the business of entrepreneurs to forecast future changes, some of which are sudden. Why did their forecasts fail so abysmally?
Another common feature of the business cycle also calls for an explanation. It is the well-known fact that capital-goods industries fluctuate more widely than do the consumer-goods industries. The capital-goods industries—especially the industries supplying raw materials, construction, and equipment to other industries—expand much further in the boom, and are hit far more severely in the depression.
A third feature of every boom that needs explaining is the increase in the quantity of money in the economy. Conversely, there is generally, though not universally, a fall in the money supply during the depression.
The Explanation: Boom and Depression In the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors at the same time.Siegfried Budge, Grundzüge der Theoretische Nationalökonomie (Jena, 1925), quoted in Simon S. Kuznets, "Monetary Business Cycle Theory in Germany," Journal of Political Economy (April, 1930): 127–28."Under conditions of free competition . . . the market is . . . dependent upon supply and demand . . . there could [not] develop a disproportionality in the production of goods, which could draw in the whole economic system . . . such a disproportionality can arise only when, at some decisive point, the price structure does not base itself upon the play of only free competition, so that some arbitrary influence becomes possible."Kuznets himself criticizes the Austrian theory from his empiricist, anti-cause and effect-standpoint, and also erroneously considers this theory to be "static." The "boom-bust" cycle is generated by monetary intervention in the market, specifically bank credit expansion to business. Let us suppose an economy with a given supply of money. Some of the money is spent in consumption; the rest is saved and invested in a mighty structure of capital, in various orders of production. The proportion of consumption to saving or investment is determined by people's time preferences—the degree to which they prefer present to future satisfactions. The less they prefer them in the present, the lower will their time preference rate be, and the lower therefore will be the pure interest rate, which is determined by the time preferences of the individuals in society. A lower time-preference rate will be reflected in greater proportions of investment to consumption, a lengthening of the structure of production, and a building-up of capital. Higher time preferences, on the other hand, will be reflected in higher pure interest rates and a lower proportion of investment to consumption. The final market rates of interest reflect the pure interest rate plus or minus entrepreneurial risk and purchasing power components. Varying degrees of entrepreneurial risk bring about a structure of interest rates instead of a single uniform one, and purchasing-power components reflect changes in the purchasing power of the dollar, as well as in the specific position of an entrepreneur in relation to price changes. The crucial factor, however, is the pure interest rate. This interest rate first manifests itself in the "natural rate" or what is generally called the going "rate of profit." This going rate is reflected in the interest rate on the loan market, a rate which is determined by the going profit rate.This is the "pure time preference theory" of the rate of interest; it can be found in Ludwig von Mises, Human Action (New Haven, Conn.: Yale University Press, 1949); in Frank A. Fetter, Economic Principles (New York: Century, 1915), and idem, "Interest Theories Old and New," American Economic Review (March, 1914): 68–92.
Now what happens when banks print new money (whether as bank notes or bank deposits) and lend it to business?"Banks," for many purposes, include also savings and loan associations, and life insurance companies, both of which create new money via credit expansion to business. See below for further discussion of the money and banking question. The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in "longer processes of production," i.e., the capital structure is lengthened, especially in the "higher orders" most remote from the consumer. Businessmen take their newly acquired funds and bid up the prices of capital and other producers' goods, and this stimulates a shift of investment from the "lower" (near the consumer) to the "higher" orders of production (furthest from the consumer)—from consumer goods to capital goods industries.On the structure of production, and its relation to investment and bank credit, see F.A. Hayek, Prices and Production (2nd ed., London: Routledge and Kegan Paul, 1935); Mises, Human Action; and Eugen von Böhm-Bawerk, "Positive Theory of Capital," in Capital and Interest (South Holland, Ill.: Libertarian Press, 1959), vol. 2.
If this were the effect of a genuine fall in time preferences and an increase in saving, all would be well and good, and the new lengthened structure of production could be indefinitely sustained. But this shift is the product of bank credit expansion. Soon the new money percolates downward from the business borrowers to the factors of production: in wages, rents, interest. Now, unless time preferences have changed, and there is no reason to think that they have, people will rush to spend the higher incomes in the old consumption-investment proportions. In short, people will rush to reestablish the old proportions, and demand will shift back from the higher to the lower orders. Capital goods industries will find that their investments have been in error: that what they thought profitable really fails for lack of demand by their entrepreneurial customers. Higher orders of production have turned out to be wasteful, and the malinvestment must be liquidated.
A favorite explanation of the crisis is that it stems from "underconsumption"—from a failure of consumer demand for goods at prices that could be profitable. But this runs contrary to the commonly known fact that it is capital goods, and not consumer goods, industries that really suffer in a depression. The failure is one of entrepreneurial demand for the higher order goods, and this in turn is caused by the shift of demand back to the old proportions.
In sum, businessmen were misled by bank credit inflation to invest too much in higher-order capital goods, which could only be prosperously sustained through lower time preferences and greater savings and investment; as soon as the inflation permeates to the mass of the people, the old consumption-investment proportion is reestablished, and business investments in the higher orders are seen to have been wasteful."Inflation" is here defined as an increase in the money supply not consisting of an increase in the money metal. Businessmen were led to this error by the credit expansion and its tampering with the free-market rate of interest.
The "boom," then, is actually a period of wasteful misinvestment. It is the time when errors are made, due to bank credit's tampering with the free market. The "crisis" arrives when the consumers come to reestablish their desired proportions. The "depression" is actually the process by which the economy adjusts to the wastes and errors of the boom, and reestablishes efficient service of consumer desires. The adjustment process consists in rapid liquidation of the wasteful investments. Some of these will be abandoned altogether (like the Western ghost towns constructed in the boom of 1816-1818 and deserted during the Panic of 1819); others will be shifted to other uses. Always the principle will be not to mourn past errors, but to make most efficient use of the existing stock of capital. In sum, the free market tends to satisfy voluntarily-expressed consumer desires with maximum efficiency, and this includes the public's relative desires for present and future consumption. The inflationary boom hobbles this efficiency, and distorts the structure of production, which no longer serves consumers properly. The crisis signals the end of this inflationary distortion, and the depression is the process by which the economy returns to the efficient service of consumers. In short, and this is a highly important point to grasp, the depression is the "recovery" process, and the end of the depression heralds the return to normal, and to optimum efficiency. The depression, then, far from being an evil scourge, is the necessary and beneficial return of the economy to normal after the distortions imposed by the boom. The boom, then, requires a "bust."
Since it clearly takes very little time for the new money to filter down from business to factors of production, why don't all booms come quickly to an end? The reason is that the banks come to the rescue. Seeing factors bid away from them by consumer goods industries, finding their costs rising and themselves short of funds, the borrowing firms turn once again to the banks. If the banks expand credit further, they can again keep the borrowers afloat. The new money again pours into business, and they can again bid factors away from the consumer goods industries. In short, continually expanded bank credit can keep the borrowers one step ahead of consumer retribution. For this, we have seen, is what the crisis and depression are: the restoration by consumers of an efficient economy, and the ending of the distortions of the boom. Clearly, the greater the credit expansion and the longer it lasts, the longer will the boom last. The boom will end when bank credit expansion finally stops. Evidently, the longer the boom goes on the more wasteful the errors committed, and the longer and more severe will be the necessary depression readjustment.
Thus, bank credit expansion sets into motion the business cycle in all its phases: the inflationary boom, marked by expansion of the money supply and by malinvestment; the crisis, which arrives when credit expansion ceases and malinvestments become evident; and the depression recovery, the necessary adjustment process by which the economy returns to the most efficient ways of satisfying consumer desires.This "Austrian" cycle theory settles the ancient economic controversy on whether or not changes in the quantity of money can affect the rate of interest. It supports the "modern" doctrine that an increase in the quantity of money lowers the rate of interest (if it first enters the loan market); on the other hand, it supports the classical view that, in the long run, quantity of money does not affect the interest rate (or can only do so if time preferences change). In fact, the depression-readjustment is the market's return to the desired free-market rate of interest.
What, specifically, are the essential features of the depression-recovery phase? Wasteful projects, as we have said, must either be abandoned or used as best they can be. Inefficient firms, buoyed up by the artificial boom, must be liquidated or have their debts scaled down or be turned over to their creditors. Prices of producers' goods must fall, particularly in the higher orders of production—this includes capital goods, lands, and wage rates. Just as the boom was marked by a fall in the rate of interest, i.e., of price differentials between stages of production (the "natural rate" or going rate of profit) as well as the loan rate, so the depression-recovery consists of a rise in this interest differential. In practice, this means a fall in the prices of the higher-order goods relative to prices in the consumer goods industries. Not only prices of particular machines must fall, but also the prices of whole aggregates of capital, e.g., stock market and real estate values. In fact, these values must fall more than the earnings from the assets, through reflecting the general rise in the rate of interest return.
Since factors must shift from the higher to the lower orders of production, there is inevitable "frictional" unemployment in a depression, but it need not be greater than unemployment attending any other large shift in production. In practice, unemployment will be aggravated by the numerous bankruptcies, and the large errors revealed, but it still need only be temporary. The speedier the adjustment, the more fleeting will the unemployment be. Unemployment will progress beyond the "frictional" stage and become really severe and lasting only if wage rates are kept artificially high and are prevented from falling. If wage rates are kept above the free-market level that clears the demand for and supply of labor, laborers will remain permanently unemployed. The greater the degree of discrepancy, the more severe will the unemployment be.
Secondary Features of Depression: Deflationary Credit Contraction The above are the essential features of a depression. Other secondary features may also develop. There is no need, for example, for deflation (lowering of the money supply) during a depression. The depression phase begins with the end of inflation, and can proceed without any further changes from the side of money. Deflation has almost always set in, however. In the first place, the inflation took place as an expansion of bank credit; now, the financial difficulties and bankruptcies among borrowers cause banks to pull in their horns and contract credit.It is often maintained that since business firms can find few profitable opportunities in a depression, business demand for loans falls off, and hence loans and money supply will contract. But this argument overlooks the fact that the banks, if they want to, can purchase securities, and thereby sustain the money supply by increasing their investments to compensate for dwindling loans. Contractionist pressure therefore always stems from banks and not from business borrowers. Under the gold standard, banks have another reason for contracting credit—if they had ended inflation because of a gold drain to foreign countries. The threat of this drain forces them to contract their outstanding loans. Furthermore the rash of business failures may cause questions to be raised about the banks; and banks, being inherently bankrupt anyway, can ill afford such questions.Banks are "inherently bankrupt" because they issue far more warehouse receipts to cash (nowadays in the form of "deposits" redeemable in cash on demand) than they have cash available. Hence, they are always vulnerable to bank runs. These runs are not like any other business failures, because they simply consist of depositors claiming their own rightful property, which the banks do not have. "Inherent bankruptcy," then, is an essential feature of any "fractional reserve" banking system. As Frank Graham stated:"The attempt of the banks to realize the inconsistent aims of lending cash, or merely multiplied claims to cash, and still to represent that cash is available on demand is even more preposterous than . . . eating one's cake and counting on it for future consumption. . . . The alleged convertibility is a delusion dependent upon the right's not being unduly exercised."Frank D. Graham, "Partial Reserve Money and the 100% Proposal," American Economic Review (September, 1936): 436. Hence, the money supply will contract because of actual bank runs, and because banks will tighten their position in fear of such runs.
Another common secondary feature of depressions is an increase in the demand for money. This "scramble for liquidity" is the result of several factors: (1) people expect falling prices, due to the depression and deflation, and will therefore hold more money and spend less on goods, awaiting the price fall; (2) borrowers will try to pay off their debts, now being called by banks and by business creditors, by liquidating other assets in exchange for money; (3) the rash of business losses and bankruptcies makes businessmen cautious about investing until the liquidation process is over.
With the supply of money falling, and the demand for money increasing, generally falling prices are a consequent feature of most depressions. A general price fall, however, is caused by the secondary, rather than by the inherent, features of depressions. Almost all economists, even those who see that the depression adjustment process should be permitted to function unhampered, take a very gloomy view of the secondary deflation and price fall, and assert that they unnecessarily aggravate the severity of depressions. This view, however, is incorrect. These processes not only do not aggravate the depression, they have positively beneficial effects.
There is, for example, no warrant whatever for the common hostility toward "hoarding." There is no criterion, first of all, to define "hoarding"; the charge inevitably boils down to mean that A thinks that B is keeping more cash balances than A deems appropriate for B. Certainly there is no objective criterion to decide when an increase in cash balance becomes a "hoard." Second, we have seen that the demand for money increases as a result of certain needs and values of the people; in a depression, fears of business liquidation and expectations of price declines particularly spur this rise. By what standards can these valuations be called "illegitimate"? A general price fall is the way that an increase in the demand for money can be satisfied; for lower prices mean that the same total cash balances have greater effectiveness, greater "real" command over goods and services. In short, the desire for increased real cash balances has now been satisfied.
Furthermore, the demand for money will decline again as soon as the liquidation and adjustment processes are finished. For the completion of liquidation removes the uncertainties of impending bankruptcy and ends the borrowers' scramble for cash. A rapid unhampered fall in prices, both in general (adjusting to the changed money-relation), and particularly in goods of higher orders (adjusting to the malinvestments of the boom) will speedily end the realignment processes and remove expectations of further declines. Thus, the sooner the various adjustments, primary and secondary, are carried out, the sooner will the demand for money fall once again. This, of course, is just one part of the general economic "return to normal."
Neither does the increased "hoarding" nor the fall of prices at all interfere with the primary depression-adjustment. The important feature of the primary adjustment is that the prices of producers' goods fall more rapidly than do consumer good prices (or, more accurately, that higher order prices fall more rapidly than do those of lower order goods); it does not interfere with the primary adjustment if all prices are falling to some degree. It is, moreover, a common myth among laymen and economists alike, that falling prices have a depressing effect on business. This is not necessarily true. What matters for business is not the general behavior of prices, but the price differentials between selling prices and costs (the "natural rate of interest"). If wage rates, for example, fall more rapidly than product prices, this stimulates business activity and employment.
Deflation of the money supply (via credit contraction) has fared as badly as hoarding in the eyes of economists. Even the Misesian theorists deplore deflation and have seen no benefits accruing from it.In a gold standard country (such as America during the 1929 depression), Austrian economists accepted credit contraction as a perhaps necessary price to pay for remaining on gold. But few saw any remedial virtues in the deflation process itself. Yet, deflationary credit contraction greatly helps to speed up the adjustment process, and hence the completion of business recovery, in ways as yet unrecognized. The adjustment consists, as we know, of a return to the desired consumption-saving pattern. Less adjustment is needed, however, if time preferences themselves change: i.e., if savings increase and consumption relatively declines. In short, what can help a depression is not more consumption, but, on the contrary, less consumption and more savings (and, concomitantly, more investment). Falling prices encourage greater savings and decreased consumption by fostering an accounting illusion. Business accounting records the value of assets at their original cost. It is well known that general price increases distort the accounting-record: what seems to be a large "profit" may only be just sufficient to replace the now higher-priced assets. During an inflation, therefore, business "profits" are greatly overstated, and consumption is greater than it would be if the accounting illusion were not operating—perhaps capital is even consumed without the individual's knowledge. In a time of deflation, the accounting illusion is reversed: what seem like losses and capital consumption, may actually mean profits for the firm, since assets now cost much less to be replaced. This overstatement of losses, however, restricts consumption and encourages saving; a man may merely think he is replacing capital, when he is actually making an added investment in the business.
Credit contraction will have another beneficial effect in promoting recovery. For bank credit expansion, we have seen, distorts the free market by lowering price differentials (the "natural rate of interest" or going rate of profit) on the market. Credit contraction, on the other hand, distorts the free market in the reverse direction. Deflationary credit contraction's first effect is to lower the money supply in the hands of business, particularly in the higher stages of production. This reduces the demand for factors in the higher stages, lowers factor prices and incomes, and increases price differentials and the interest rate. It spurs the shift of factors, in short, from the higher to the lower stages. But this means that credit contraction, when it follows upon credit expansion, speeds the market's adjustment process. Credit contraction returns the economy to free-market proportions much sooner than otherwise.
But, it may be objected, may not credit contraction overcompensate the errors of the boom and itself cause distortions that need correction? It is true that credit contraction may overcompensate, and, while contraction proceeds, it may cause interest rates to be higher than free-market levels, and investment lower than in the free market. But since contraction causes no positive mal-investments, it will not lead to any painful period of depression and adjustment. If businessmen are misled into thinking that less capital is available for investment than is really the case, no lasting damage in the form of wasted investments will ensue.Some readers may ask: why doesn't credit contraction lead to malinvestment, by causing overinvestment in lower-order goods and underinvestment in higher-order goods, thus reversing the consequences of credit expansion? The answer stems from the Austrian analysis of the structure of production. There is no arbitrary choice of investing in lower or higher-order goods. Any increased investment must be made in the higher-order goods, must lengthen the structure of production. A decreased amount of investment in the economy simply reduces higher-order capital. Thus, credit contraction will cause not excess of investment in the lower orders, but simply a shorter structure than would otherwise have been established. Furthermore, in the nature of things, credit contraction is severely limited—it cannot progress beyond the extent of the preceding inflation.In a gold standard economy, credit contraction is limited by the total size of the gold stock. Credit expansion faces no such limit.
Government Depression Policy: Laissez-Faire If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don't interfere with the market's adjustment process. The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favorite "anti-depression" arsenal of government policy. Thus, here are the ways the adjustment process can be hobbled:
Prevent or delay liquidation. Lend money to shaky businesses, call on banks to lend further, etc.
Inflate further. Further inflation blocks the necessary fall in prices, thus delaying adjustment and prolonging depression. Further credit expansion creates more malinvestments, which, in their turn, will have to be liquidated in some later depression. A government "easy money" policy prevents the market's return to the necessary higher interest rates.
Keep wage rates up. Artificial maintenance of wage rates in a depression insures permanent mass unemployment. Furthermore, in a deflation, when prices are falling, keeping the same rate of money wages means that real wage rates have been pushed higher. In the face of falling business demand, this greatly aggravates the unemployment problem.
Keep prices up. Keeping prices above their free-market levels will create unsalable surpluses, and prevent a return to prosperity.
Stimulate consumption and discourage saving. We have seen that more saving and less consumption would speed recovery; more consumption and less saving aggravate the shortage of saved-capital even further. Government can encourage consumption by "food stamp plans" and relief payments. It can discourage savings and investment by higher taxes, particularly on the wealthy and on corporations and estates. As a matter of fact, any increase of taxes and government spending will discourage saving and investment and stimulate consumption, since government spending is all consumption. Some of the private funds would have been saved and invested; all of the government funds are consumed.In recent years, particularly in the literature on the "under-developed countries," there has been a great deal of discussion of government "investment." There can be no such investment, however. "Investment" is defined as expenditures made not for the direct satisfaction of those who make it, but for other, ultimate consumers. Machines are produced not to serve the entrepreneur, but to serve the ultimate consumers, who in turn remunerate the entrepreneurs. But government acquires its funds by seizing them from private individuals; the spending of the funds, therefore, gratifies the desires of government officials. Government officials have forcibly shifted production from satisfying private consumers to satisfying themselves; their spending is therefore pure consumption and can by no stretch of the term be called "investment." (Of course, to the extent that government officials do not realize this, their "consumption" is really waste-spending.) Any increase in the relative size of government in the economy, therefore, shifts the societal consumption-investment ratio in favor of consumption, and prolongs the depression.
Subsidize unemployment. Any subsidization of unemployment (via unemployment "insurance," relief, etc.) will prolong unemployment indefinitely, and delay the shift of workers to the fields where jobs are available.
These, then, are the measures which will delay the recovery process and aggravate the depression. Yet, they are the time-honored favorites of government policy, and, as we shall see, they were the policies adopted in the 1929-1933 depression, by a government known to many historians as a "laissez-faire" administration.
Since deflation also speeds recovery, the government should encourage, rather than interfere with, a credit contraction. In a gold-standard economy, such as we had in 1929, blocking deflation has further unfortunate consequences. For a deflation increases the reserve ratios of the banking system, and generates more confidence in citizen and foreigner alike that the gold standard will be retained. Fear for the gold standard will precipitate the very bank runs that the government is anxious to avoid. There are other values in deflation, even in bank runs, which should not be overlooked. Banks should no more be exempt from paying their obligations than is any other business. Any interference with their comeuppance via bank runs will establish banks as a specially privileged group, not obligated to pay their debts, and will lead to later inflations, credit expansions, and depressions. And if, as we contend, banks are inherently bankrupt and "runs" simply reveal that bankruptcy, it is beneficial for the economy for the banking system to be reformed, once and for all, by a thorough purge of the fractional-reserve banking system. Such a purge would bring home forcefully to the public the dangers of fractional-reserve banking, and, more than any academic theorizing, insure against such banking evils in the future.For more on the problems of fractional-reserve banking, see below.
The most important canon of sound government policy in a depression, then, is to keep itself from interfering in the adjustment process. Can it do anything more positive to aid the adjustment? Some economists have advocated a government-decreed wage cut to spur employment, e.g., a 10 percent across-the-board reduction. But free-market adjustment is the reverse of any "across-the-board" policy. Not all wages need to be cut; the degree of required adjustments of prices and wages differs from case to case, and can only be determined on the processes of the free and unhampered market.See W.H. Hutt, "The Significance of Price Flexibility," in Henry Hazlitt, ed., The Critics of Keynesian Economics (Princeton, N.J.: D. Van Nostrand, 1960), pp. 390–92. Government intervention can only distort the market further.
There is one thing the government can do positively, however: it can drastically lower its relative role in the economy, slashing its own expenditures and taxes, particularly taxes that interfere with saving and investment. Reducing its tax-spending level will automatically shift the societal saving-investment-consumption ratio in favor of saving and investment, thus greatly lowering the time required for returning to a prosperous economy.I am indebted to Mr. Rae C. Heiple, II, for pointing this out to me. Reducing taxes that bear most heavily on savings and investment will further lower social time preferences.Could government increase the investment-consumption ratio by raising taxes in any way? It could not tax only consumption even if it tried; it can be shown (and Prof. Harry Gunnison Brown has gone a long way to show) that any ostensible tax on "consumption" becomes, on the market, a tax on incomes, hurting saving as well as consumption. If we assume that the poor consume a greater proportion of their income than the rich, we might say that a tax on the poor used to subsidize the rich will raise the saving-consumption ratio and thereby help cure a depression. On the other hand, the poor do not necessarily have higher time preferences than the rich, and the rich might well treat government subsidies as special windfalls to be consumed. Furthermore, Harold Lubell has maintained that the effects of a change in income distribution on social consumption would be negligible, even though the absolute proportion of consumption is greater among the poor. See Harry Gunnison Brown, "The Incidence of a General Output or a General Sales Tax," Journal of Political Economy (April, 1939): 254–62; Harold Lubell, "Effects of Redistribution of Income on Consumers' Expenditures," American Economic Review (March, 1947): 157–70. Furthermore, depression is a time of economic strain. Any reduction of taxes, or of any regulations interfering with the free market, will stimulate healthy economic activity; any increase in taxes or other intervention will depress the economy further.
In sum, the proper governmental policy in a depression is strict laissez-faire, including stringent budget slashing, and coupled perhaps with positive encouragement for credit contraction. For decades such a program has been labeled "ignorant," "reactionary," or "Neanderthal" by conventional economists. On the contrary, it is the policy clearly dictated by economic science to those who wish to end the depression as quickly and as cleanly as possible.Advocacy of any governmental policy must rest, in the final analysis, on a system of ethical principles. We do not attempt to discuss ethics in this book. Those who wish to prolong a depression, for whatever reason, will, of course, enthusiastically support these government interventions, as will those whose prime aim is the accretion of power in the hands of the state.
It might be objected that depression only began when credit expansion ceased. Why shouldn't the government continue credit expansion indefinitely? In the first place, the longer the inflationary boom continues, the more painful and severe will be the necessary adjustment process, Second, the boom cannot continue indefinitely, because eventually the public awakens to the governmental policy of permanent inflation, and flees from money into goods, making its purchases while the dollar is worth more than it will be in future. The result will be a "runaway" or hyperinflation, so familiar to history, and particularly to the modern world.For the classic treatment of hyperinflation, see Costantino Bresciani-Turroni, The Economics of Inflation (London: George Allen and Unwin, 1937). Hyperinflation, on any count, is far worse than any depression: it destroys the currency—the lifeblood of the economy; it ruins and shatters the middle class and all "fixed income groups"; it wreaks havoc unbounded. And furthermore, it leads finally to unemployment and lower living standards, since there is little point in working when earned income depreciates by the hour. More time is spent hunting goods to buy. To avoid such a calamity, then, credit expansion must stop sometime, and this will bring a depression into being.
Preventing Depressions Preventing a depression is clearly better than having to suffer it. If the government's proper policy during a depression is laissez-faire, what should it do to prevent a depression from beginning? Obviously, since credit expansion necessarily sows the seeds of later depression, the proper course for the government is to stop any inflationary credit expansion from getting under way. This is not a very difficult injunction, for government's most important task is to keep itself from generating inflation. For government is an inherently inflationary institution, and consequently has almost always triggered, encouraged, and directed the inflationary boom. Government is inherently inflationary because it has, over the centuries, acquired control over the monetary system. Having the power to print money (including the "printing" of bank deposits) gives it the power to tap a ready source of revenue. Inflation is a form of taxation, since the government can create new money out of thin air and use it to bid away resources from private individuals, who are barred by heavy penalty from similar "counterfeiting." Inflation therefore makes a pleasant substitute for taxation for the government officials and their favored groups, and it is a subtle substitute which the general public can easily—and can be encouraged to—overlook. The government can also pin the blame for the rising prices, which are the inevitable consequence of inflation, upon the general public or some disliked segments of the public, e.g., business, speculators, foreigners. Only the unlikely adoption of sound economic doctrine could lead the public to pin the responsibility where it belongs: on the government itself.
Private banks, it is true, can themselves inflate the money supply by issuing more claims to standard money (whether gold or government paper) than they could possibly redeem. A bank deposit is equivalent to a warehouse receipt for cash, a receipt which the bank pledges to redeem at any time the customer wishes to take his money out of the bank's vaults. The whole system of "fractional-reserve banking" involves the issuance of receipts which cannot possibly be redeemed. But Mises has shown that, by themselves, private banks could not inflate the money supply by a great deal.See Mises, Human Action, pp. 429–45, and Theory of Money and Credit (New Haven, Conn.: Yale University Press, 1953). In the first place, each bank would find its newly issued uncovered, or "pseudo," receipts (uncovered by cash) soon transferred to the clients of other banks, who would call on the bank for redemption. The narrower the clientele of each bank, then, the less scope for its issue of pseudo-receipts. All the banks could join together and agree to expand at the same rate, but such agreement would be difficult to achieve. Second, the banks would be limited by the degree to which the public used bank deposits or notes as against standard cash; and third, they would be limited by the confidence of the clients in their banks, which could be wrecked by runs at any time.
Instead of preventing inflation by prohibiting fractional-reserve banking as fraudulent, governments have uniformly moved in the opposite direction, and have step-by-step removed these free-market checks to bank credit expansion, at the same time putting themselves in a position to direct the inflation. In various ways, they have artificially bolstered public confidence in the banks, encouraged public use of paper and deposits instead of gold (finally outlawing gold), and shepherded all the banks under one roof so that they can all expand together. The main device for accomplishing these aims has been Central Banking, an institution which America finally acquired as the Federal Reserve System in 1913. Central Banking permitted the centralization and absorption of gold into government vaults, greatly enlarging the national base for credit expansion:When gold—formerly the banks' reserves—is transferred to a newly established Central Bank, the latter keeps only a fractional reserve, and thus the total credit base and potential monetary supply are enlarged. See C.A. Phillips, T.F. McManus, and R.W. Nelson, Banking and the Business Cycle (New York: Macmillan, 1937), pp. 24ff. it also insured uniform action by the banks through basing their reserves on deposit accounts at the Central Bank instead of on gold. Upon establishment of a Central Bank, each private bank no longer gauges its policy according to its particular gold reserve; all banks are now tied together and regulated by Central Bank action. The Central Bank, furthermore, by proclaiming its function to be a "lender of last resort" to banks in trouble, enormously increases public confidence in the banking system. For it is tacitly assumed by everyone that the government would never permit its own organ—the Central Bank—to fail. A Central Bank, even when on the gold standard, has little need to worry about demands for gold from its own citizens. Only possible drains of gold to foreign countries (i.e., by non-clients of the Central Bank) may cause worry.
The government assured Federal Reserve control over the banks by (1) granting to the Federal Reserve System (FRS) a monopoly over note issue; (2) compelling all the existing "national banks" to join the Federal Reserve System, and to keep all their legal reserves as deposits at the Federal ReserveMany "state banks" were induced to join the FRS by patriotic appeals and offers of free services. Even the banks that did not join, however, are effectively controlled by the System, for, in order to obtain paper money, they must keep reserves in some member bank.; and (3) fixing the minimum reserve ratio of deposits at the Reserve to bank deposits (money owned by the public). The establishment of the FRS was furthermore inflationary in directly reducing existing reserve-ratio requirements.The average reserve requirements of all banks before 1913 was estimated at approximately 21 percent. By mid-1917, when the FRS had fully taken shape, the average required ratio was 10 percent. Phillips et al. estimate that the inherent inflationary impact of the FRS (pointed out in footnote 23) increased the expansive power of the banking system three-fold. Thus, the two factors (the inherent impact, and the deliberate lowering of reserve requirements) combined to inflate the monetary potential of the American banking system six-fold as a result of the inauguration of the FRS. See Phillips, et al., Banking and the Business Cycle, pp. 23ff. The Reserve could then control the volume of money by governing two things: the volume of bank reserves, and the legal reserve requirements. The Reserve can govern the volume of bank reserves (in ways which will be explained below), and the government sets the legal ratio, but admittedly control over the money supply is not perfect, as banks can keep "excess reserves." Normally, however, reassured by the existence of a lender of last resort, and making profits by maximizing its assets and deposits, a bank will keep fully "loaned up" to its legal ratio.
While unregulated private banking would be checked within narrow limits and would be far less inflationary than Central Bank manipulation,The horrors of "wildcat banking" in America before the Civil War stemmed from two factors, both due to government rather than free banking: (1) Since the beginnings of banking, in 1814 and then in every ensuing panic, state governments permitted banks to continue operating, making and calling loans, etc. without having to redeem in specie. In short, banks were privileged to operate without paying their obligations. (2) Prohibitions on interstate branch banking (which still exist), coupled with poor transportation, prevented banks from promptly calling on distant banks for redemption of notes. the clearest way of preventing inflation is to outlaw fractional-reserve banking, and to impose a 100 percent gold reserve to all notes and deposits. Bank cartels, for example, are not very likely under unregulated, or "free" banking, but they could nevertheless occur. Professor Mises, while recognizing the superior economic merits of 100 percent gold money to free banking, prefers the latter because 100 percent reserves would concede to the government control over banking, and government could easily change these requirements to conform to its inflationist bias.Mises, Human Action, p. 440. But a 100 percent gold reserve requirement would not be just another administrative control by government; it would be part and parcel of the general libertarian legal prohibition against fraud. Everyone except absolute pacifists concedes that violence against person and property should be outlawed, and that agencies, operating under this general law, should defend person and property against attack. Libertarians, advocates of laissez-faire, believe that "governments" should confine themselves to being defense agencies only. Fraud is equivalent to theft, for fraud is committed when one part of an exchange contract is deliberately not fulfilled after the other's property has been taken. Banks that issue receipts to non-existent gold are really committing fraud, because it is then impossible for all property owners (of claims to gold) to claim their rightful property. Therefore, prohibition of such practices would not be an act of government intervention in the free market; it would be part of the general legal defense of property against attack which a free market requires.A common analogy states that banks simply count on people not redeeming all their property at once, and that engineers who build bridges operate also on the principle that not everyone in a city will wish to cross the bridge at once. But the cases are entirely different. The people crossing a bridge are simply requesting a service; they are not trying to take possession of their lawful property, as are the bank depositors. A more fitting analogy would defend embezzlers who would never have been caught if someone hadn't fortuitously inspected the books. The crime comes when the theft or fraud is committed, not when it is finally revealed., Perhaps a libertarian legal system would consider "general deposit warrants" (which allow a warehouse to return any homogeneous good to the depositor) as "specific deposit warrants," which, like bills of lading, pawn tickets, dock-warrants, etc. establish ownership to specific, earmarked objects. As Jevons stated, "It used to be held as a general rule of law, that any present grant or assignment of goods not in existence is without operation." See W. Stanley Jevons, Money and the Mechanism of Exchange (London: Kegan Paul, 1905), pp. 207–12. For an excellent discussion of the problems of a fractional-reserve money, see Amasa Walker, The Science of Wealth (3rd ed., Boston: Little, Brown, 1867), pp. 126–32, esp. pp. 139–41.
What, then, was the proper government policy during the 1920s? What should government have done to prevent the crash? Its best policy would have been to liquidate the Federal Reserve System, and to erect a 100 percent gold reserve money; failing that, it should have liquidated the FRS and left private banks unregulated, but subject to prompt, rigorous bankruptcy upon failure to redeem their notes and deposits. Failing these drastic measures, and given the existence of the Federal Reserve System, what should its policy have been? The government should have exercised full vigilance in not supporting or permitting any inflationary credit expansion. We have seen that the Fed—the Federal Reserve System—does not have complete control over money because it cannot force banks to lend up to their reserves; but it does have absolute anti-inflationary control over the banking system. For it does have the power to reduce bank reserves at will, and thereby force the banks to cease inflating, or even to contract if necessary. By lowering the volume of bank reserves and/or raising reserve requirements, the federal government, in the 1920s as well as today, has had the absolute power to prevent any increase in the total volume of money and credit. It is true that the FRS has no direct control over such money creators as savings banks, savings and loan associations, and life insurance companies, but any credit expansion from these sources could be offset by deflationary pressure upon the commercial banks. This is especially true because commercial bank deposits (1) form the monetary base for the credit extended by the other financial institutions, and (2) are the most actively circulating part of the money supply. Given the Federal Reserve System and its absolute power over the nation's money, the federal government, since 1913, must bear the complete responsibility for any inflation. The banks cannot inflate on their own; any credit expansion can only take place with the support and acquiescence of the federal government and its Federal Reserve authorities. The banks are virtual pawns of the government, and have been since 1913. Any guilt for credit expansion and the consequent depression must be borne by the federal government and by it alone.Some writers make a great to-do over the legal fiction that the Federal Reserve System is "owned" by its member banks. In practice, this simply means that these banks are taxed to help pay for the support of the Federal Reserve. If the private banks really "own" the Fed, then how can its officials be appointed by the government, and the "owners" compelled to "own" the Federal Reserve Board by force of government statute? The Federal Reserve Banks should simply be regarded as governmental agencies.
This excerpt is taken from the first chapters of Murray Rothbard's .America's Great Depression, published in 1963.
The Biden Administration is attempting to do a victory lap for "Bidenomics", but the public isn't buying it. On this episode of Good Money, Dr. Jonathan Newman joins the show to talk about his doubts of a "soft landing" for the economy, and the lies being told to sell Central Bank Digital Currencies.
Jonathan Newman's article on CBDCs: Mises.org/GM18a Jonathan Newman's article on "Soft Landing" headlines from 2007: Mises.org/GM18b
Good Money listeners can order a special $5 book bundle that includes How To Think About the Economy and What Has Government Done to Our Money? with free shipping using promo code "GoodMoney" at Mises.org/Good
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As Fed staffers no longer predict an impending recession, economists on social media are all assuring themselves that Americans are in store for a "soft landing." Mises Fellow Jonathan Newman joins Bob to explain why the data still support the case for recession and point out the eerie similarity to the calm before the storm in 2008.
Robert Lucas' Nobel Prize Winning Lecture: Mises.org/HAP407a Bob's Eerie Article from 2007 on the Recession: Mises.org/HAP407b 'Bernanke Was Wrong' Compilation: Mises.org/HAP407c 'Peter Schiff Was Right' Compilation: Mises.org/HAP407d
Join us in Nashville on September 23rd for a no-holds-barred discussion against the regime: Mises.org/Nashville23
How can a bank “create money out of thin air”? We must enter the magical kingdom of “fractional-reserve banking,” where deposits are turned into loans, loans are turned into money, and so on, to find out.
Original Article: "Banks Create Money out of Thin Air. What Could Possibly Go Wrong?"
In this week's episode, Mark looks back at the history of the Inverted Yield Curve. While many observers have now dismissed the significance of the yield curve inversion in 2022—and no recession, yet—Mark shows that the history of the IYC may back a completely opposite interpretation.
Be sure to follow Minor Issues at Mises.org/MinorIssues.
The Mises Institute's Executive Editor Ryan McMaken joins Bob to discuss his latest article, in which Ryan spells out the state of the M2 money supply and possible implications for consumer prices and an impending recession.
Ryan's Mises.org article on M2: Mises.org/HAP402a Ryan's QJAE article on the inverted yield curve: Mises.org/HAP402b
As we enter the dog days of summer, I have heard several media conversations and a few private ones that express exasperation over languishing capital markets. Why do things take so long to unravel? What will happen next? When will X, Y, or Z happen? Why are tech stocks so bullish now? The market takes time to process the information that it already has — or is in "process" — and everyday brings new data.
The Austrian perspective highlights the role of reality in the market process. This is especially important in this period of unprecedented government intervention and the chaos it has generated in markets.
Be sure to follow Minor Issues at Mises.org/MinorIssues.
As the Fed increases interest rates to reverse the inflation it has caused, firms that depended on easy money will face the bankruptcy judge. Stay tuned; there's more to come.
Original Article: "The Bankruptcy Caravan Is Now Arriving: Time to Pay for the Easy Money"
The usual suspects such as Robert Reich claim that corporate profits are causing inflation. Actually, increases in corporate profits are tied to increases in inflation.
Original Article: "Higher Corporate Profit Margins Aren't Causing Inflation"
While talk of high gas prices is no longer a headline issue, energy economics is still a vitally important aspect of understanding the economy, including the business cycle. Mark explains the basics, tells us where we now stand, and what the major implications are for the near future.
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Be sure to follow Minor Issues at Mises.org/MinorIssues.
Mark takes a look at all the wrong predictions of recession in recent years, including those of Austrian School economists. While the MSM and Fed officials try to downplay the coming of a recession, many of the statistics and facts that Austrian consider important are indicating a looming recession, if not a full-blown economic crisis.
Check out Anatomy of the Crash: The Financial Crisis of 2020, edited by Tho Bishop: Mises.org/AnatomyOfTheCrash
Be sure to follow Minor Issues at Mises.org/MinorIssues.
In this week's episode, Mark explains why the market for existing homes has been diverging from the market for new houses. The Fed ZIRP, QE and Covid bailouts have locked Americans into their mortgages and low payments, reducing the supply of existing homes. This keeps them off the market and home prices high in an economy that is headed for a recession or crisis. Buyers have been diverted to newly constructed homes where builders have more flexibility to sell and there are no existing homeowners locked into mortgages.
Be sure to follow Minor Issues at Mises.org/MinorIssues.
The most popular measure of economic growth is GDP. However, GDP movement is driven by changes in the money supply, not real economic factors.
Original Article: "Does GDP Present an Accurate Picture of the Economy? Not Likely"
Austrian business cycle theory points out that easy money leads to malinvestments. Once easy money disappears, the crash begins. Time to clean up malinvested assets.
Original Article: "Paying the Piper: Time to Clean Up the Latest Malinvestments"
Like the USA, Canada has had a central bank–fueled housing boom. Like all other booms, it also has an inevitable ending.
Original Article: "Canada’s Housing Boom Was a Bubble. Now Comes the Bust"
After a long series of rate hikes, Fed officials and asset markets are expecting a long series of interest rate cuts. This is based on the tried and hue Phillips Curve analysis. In color theory, "hue" is the technical appearance of color that can be described mechanically as a number. Let's hope interest rate expectations are not being distorted by other factors of reality, and that current Phillips Curve model perceptions of hue are also true.
Be sure to follow Minor Issues at Mises.org/MinorIssues.
Dr. Paul Cwik joins Bob to discuss the inverted yield curve's "signal" of an impending recession.
Dr. Cwik's dissertation on inverted yield curves and economic downturns: Mises.org/HAP395a
Bob on the link between inverted yield curves and recessions: Mises.org/HAP395b
Bob's Understanding Money Mechanics: Mises.org/Mechanics
Bank reserves are seldom mentioned except in cases of bank runs. The other possible mention is all the interest money the Fed pays to banks simply for holding reserves. Mark explains the role of bank reserves in the current "system" and gives a brief explanation of why the Austrian view is better and actually gets the job done.
Be sure to follow Minor Issues at Mises.org/MinorIssues.
The current banking crises have deep roots in US financial history. Monetary authorities have engaged in inflationary behavior for more than a hundred years.
Original Article: "A Pyrrhic End to 130 Years of Vicious Bad Money and Banking Crises"
After years of inflationary intervention, the Federal Reserve has no more rabbits to pull out of the hat.
Original Article: "The Failure of the Federal Reserve: The Covid Boom and Unnecessary Intervention"
Mark discusses something bigger than the Disney layoffs: the Wall Street Journal's April 25 frontpage article on investing in gold. It would seem that the recent rise of the price of gold is the result of tired, dumb, and disillusioned crypto currency investors throwing in the towel to "chase shiny new object—gold." Mark explains that the rational reasons for investing in gold loom larger than the entire Magic Kingdom!
Be sure to follow Minor Issues at Mises.org/MinorIssues.
Ryan McMaken and Dr. Mark Thornton cover the state of the dollar as global reserve currency, and why employers are laying off more and more of their highest paid workers.
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Subscribe to Mark's weekly Minor Issues podcast at Mises.org/MinorIssues.
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
On this episode of Radio Rothbard, Ryan McMaken and Tho Bishop look at common American history myths baked into government school curriculums. While Republican governors have begun to prioritize removing "critical race theory" and other forms of modern "leftwing indoctrination" from textbooks, there are a number of historical episodes left unchallenged that all lead to a deification of state power and a celebration of progressive politics.
PROMO CODE: RothPod for 20% off
Recommended Reading"The Meat Packing Myth" by Murray Rothbard: Mises.org/RR_130_A
"Krugman's Hoover History" by Robert Murphy: Mises.org/RR_130_B
"Why the 1787 Constitution Did Not Bring Republican Government to America" Mises.org/RR_130_C
The Progressive Era by Murray Rothbard Mises.org/RR_130_D
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
On this episode of Radio Rothbard, Ryan McMaken and Tho Bishop discuss recent reveals about new lows for the FBI. Ryan discusses new reports about the targeting of traditional Catholic churches and the history of the American Stasi, while Tho highlights new evidence about the role of federal agents in escalating January 6.
Recommended Reading"The FBI’s Forgotten Criminal Record" by Jim Bovard: Mises.org/RR_129_A
"Abolish the FBI" by Ryan McMaken: Mises.org/RR_129_B
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
Ryan and Tho talk about why Trump is the only former president to be prosecuted for crimes. The ruling class has agreed to not prosecute their own, but since they see Trump as an outsider, he is fair game. In truth, we'd be better off if more presidents and former presidents faced prosecution.
Recommended Reading"With the Trump Indictment, America Is a Step Closer to Being a Banana Republic" by Bill Anderson: Mises.org/RR_128_A
"Politics Is Turning Us into Idiots" by Lipton Matthews: Mises.org/RR_128_B
Anatomy of the State by Murray N. Rothbard: Mises.org/RR_128_C
"Yes, Virginia, There IS a Deep State—and It Is Worse than You Think" by Bill Anderson: Mises.org/RR_128_D
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
On this episode of Radio Rothbard, Ryan McMaken and Tho Bishop discuss the global moves being made against the US dollar. The regime's decade long weaponization of money and banking has both international rivals and historical allies looking for alternatives. Ryan and Tho discuss what that means for Americans, and what may come next.
Recommended Reading"World needs to end risky reliance on U.S. dollar: BoE's Carney" (Reuters, 2019): Mises.org/RR_127_A
"Governments Can't Blame Inflation on Energy and Putin Anymore" by Daniel Lacalle: Mises.org/RR_127_B
"Is the Fed Trying to Bail Out the World? Sure Looks Like It" by Kristoffer Hansen: Mises.org/RR_127_C
"Why Fractional Reserve Banking Is behind Bank Failures" by Jonathan Newman: Mises.org/RR_127_D
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
Keynesian economists claim that cutting costs in a business slowdown is counterproductive. As usual, the Keynesians have it backward.
Original Article: "Does Cost Cutting Undermine Economic Growth?"
This Audio Mises Wire is generously sponsored by Christopher Condon.
With commercial banks exposed by the recent bailouts, Americans question whether “their money” is truly safe despite the promises of FDIC insurance.
Jeff and Bob walk through the mechanics of how a full reserve bank could work in a truly free market based on the concepts and taxonomy of Mises’s Theory of Money and Credit.
Mises's A Theory of Money and Credit: Mises.org/TMC
Bob's study guide to A Theory of Money and Credit: Mises.org/HAP388a
John Cochran, 'The Safest Bank the Fed Won't Sanction': Mises.org/HAP388b
This week on Radio Rothbard, Ryan McMaken and Tho Bishop are joined by Peter St. Onge, a fellow at the Heritage Foundation and a regular contributor to the Mises Wire. This episode looks at the political response to the recent turmoil in the banking system and how the Austrian position looks today relative to 2008. St. Onge makes a case for optimism.
Recommended Reading"It Turns Out That Hundreds of Banks Are at Risk" by Peter St. Onge: Mises.org/RR_126_A
"The Fed Backtracks on Future Rate Hikes as Bank Failures Loom Large" by Ryan McMaken: Mises.org/RR_126_B
"Looming Bank Failures Point to More Price Inflation as Real Wages Fall Again" by Ryan McMaken: Mises.org/RR_126_C
Peter St. Onge's Substack: StOnge.substack.com
2023 Libertarian Scholars Conference: Mises.org/LSC23
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
The story of the failure of Silicon Valley Bank is the story of nearly every bank failure. Fractional reserve banking invites the risky behavior that brings down the banking system.
Original Article: "Silicon Valley Bank and the Failure of Fractional Reserve Banking"
This Audio Mises Wire is generously sponsored by Christopher Condon.
SVB Bank and Signature Bank failed this week and were bailed out. Mark explains why the banks failed and why it was bound to happen. The minor issue is that the total FDIC bailout fund is actually smaller than either one of the banks.
Be sure to follow Minor Issues at Mises.org/MinorIssues.
This past weekend saw extraordinary actions by the Fed to address the meltdown of Silicon Valley Bank. Did the central bank break the law by effectively authorizing unsecured loans to banks based on the face value—rather than significantly lower market value—of those banks' Treasury holdings?
Bob's study guide to A Theory of Money and Credit: Mises.org/HAP387a
Jeff on the Fed as the ultimate bank: Mises.org/HAP387b
While the Biden White House claims we are on a steady course of prosperity, the more realistic future is that of a global recession.
Original Article: "The Coming Recession Will Be a Global One"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Mark talks about the recent price inflation reports, as well as reports of job openings from private sector job placement companies. Inflation was higher than expected and job openings declined. What will the Fed do? People are making painful adjustments—Domino's reported disappointing sales, because their customers are "eating in".
Be sure to follow Minor Issues at Mises.org/MinorIssues.
Mark uses Intel Corporation, the computer chip manufacturer, as a barometer of the business cycle. He looks at the stock price in recent years, its production capacity expansion, and the company's very recent cost- and dividend-cutting moves.
Check out Mark Thornton's free book, The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century: Mises.org/Curse
Be sure to follow Minor Issues at Mises.org/MinorIssues.
Economists and pundits mistakenly call the Federal Reserve System's security holdings a portfolio. It is anything but.
Original Article: "The Fed’s Portfolio Is Nonexistent: The Fed Does Not Invest. It Destroys Investments"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Mark Thornton takes a look back at US stock markets, the national debt, and Fed policy (ZIRP, money supply, and its balance sheet).
"After the Boom Must Come the Bust" (Radio Rothbard): Mises.org/MI_06_A
Austrian Economic Research Conference: AustrianEconomics.org
Be sure to follow Minor Issues at Mises.org/MinorIssues.
The empty shopping mall: a story of how government actions created a huge malinvestment in western Pennsylvania.
Original Article: "Empty Malls and Shopping Centers: How Government Fuels Malinvestments"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Mark Thornton discusses the history of record low unemployment rates and the business cycle.
See "Unemployment Rate" (UNRATE) from the Federal Reserve Bank of St. Louis: Mises.org/MI_04_Chart
Be sure to follow Minor Issues at Mises.org/MinorIssues.
Will the Fed be successful with its "Immaculate Disinflation"? Or, will we still have to "pay an even higher price" for their use of Weapons of Massive Monetary Destruction in 2020-21?
Be sure to follow Minor Issues at Mises.org/MinorIssues.
The Federal Reserve has created a huge boom full of bubbles. But after the boom must eventually come a bust. Ryan and Tho talk to Mises Institute Senior Fellow Mark Thornton about what to expect from the next recession and how we got ourselves into our current inflationary mess.
Recommended Reading"Eliminating Economic Crises" by Mark Thornton: Mises.org/RR_118_A
"The REAL Solution to the Coming Economic Crisis" by Mark Thornton: Mises.org/RR_118_B
"Wholesale Price Inflation Is Slowing as Economy Worsens" by Ryan McMaken: Mises.org/RR_118_C
The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century by Mark Thornton: Mises.org/RR_118_D
"Will the Fed Pop the Everything Bubble?" by Daniel Lacalle: Mises.org/RR_118_E
"The Trillion-Dollar Coin Idea Is Just Another Way to Rip Us Off" by Ryan McMaken: Mises.org/RR_118_F
"The Fed's Real Mandate" by Mark Thornton: Mises.org/RR_118_G
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
While an increase in the supply of gold money would lead to higher consumer prices, such increases in the gold supply do not lead to boom-bust cycles.
Original Article: "Can Increases in the Supply of Gold Lead to Boom-Bust Cycles?"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Keynesian economists fantasize that a market economy cannot "gain traction" without "stimulus" schemes from the government. In the end, the only thing stimulated are inflation and recession.
Original Article: "Why Economic Stimulus Can't Work"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Unemployment remains low but for the wrong reasons. Low unemployment rates are not a sign that the economy is doing well.
Original Article: "US Labor Market: Help Wanted!"
This Audio Mises Wire is generously sponsored by Christopher Condon.
There is no real housing market in the US. Instead, an unholy trinity of Fannie/Freddie, the US Treasury, and the Federal Reserve Bank operate to distort the market at every turn and drive home prices up dramatically. Mises Institute Senior Fellow Alex Pollock, an economist and former mortgage banker, joins Jeff to describe the reality few Americans know.
Alex Pollock's new book Surprised Again: The Covid Crisis and the New Market Bubble : Mises.org/HAP377a
Alex Pollock on how the Fed became the world's biggest S&L: Mises.org/HAP377b
By all measures, the economic downturn that began in 1920 was worse than what occurred in 1930, yet the economy recovered quickly in 1921. Why the difference?
Original Article: "The Economic Superbowl: 1920–21 versus 1930–31"
This Audio Mises Wire is generously sponsored by Christopher Condon.
For nearly two decades, business, academic, and political elites have spread the fiction that central banks can engineer prosperity by printing more money. Markets now are discrediting that fairy tale.
Original Article: "The Corporate Fairy Tale Is Dying as Economic Reality Sets In"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Cheap money in the last decade has meant good times for companies that barely make money and hire employees who barely work. But those times are now ending.
Original Article: "Without Easy Money, the Tech Sector Faces Layoffs and Losses"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Jeff and Bob record a special Thanksgiving episode for Money Talk 1010 AM on what it really takes to fix the US economy.
Mark Thornton on the coming economic crisis: Mises.org/HAP371A
Listen to Jeff on Money Talk 1010 every Thursday at 9:00am ET: Mises.org/MoneyTalk
On this episode of Radio Rothbard, Ryan McMaken and Tho Bishop look at conman Sam Bankman-Fried, the scam of FTX, and how regime legitimacy has fueled several fraudulent companies with unprofitable business practices.
Did post-2008 monetary policy fuel a bubble in "effective altruism?" Do examples like Elon Musk's restructuring of Twitter offer an illustration of what Big Tech firms will have to do to survive in a time of less-than-easy money, or will the regime bailout out the corporate extensions of techno-managerialism? What killed Silicon Valley's once-promising techno-libertarian style? Ryan and Tho look at this and more on this episode of Radio Rothbard.
Looking for Christmas gifts? Use promo code ROTHPOD for a 20% discount on select books featured on Radio Rothbard. Or, use code MURRAYCHRISTMAS for a special 10% discount on select new Mises apparel: Mises.org/RR_109_Store
Recommended Reading "How Easy Money Fueled the FTX Crypto Collapse" by Ryan McMaken: Mises.org/RR_109_A
"Sound Money Is Our Best Hope Against the Monopolists' Threat" by Brendan Brown: Mises.org/RR_109_B
"How Fiat Money Enriches the Unproductive" by George Ford Smith: Mises.org/RR_109_C
"Without Easy Money, the Tech Sector Faces Layoffs and Losses" by Ryan McMaken: Mises.org/RR_109_D
"The Housing Boom Is Already Over. The Housing Shortage Will Continue." by Ryan McMaken: Mises.org/RR_109_E
"Will the FTX Scandal Bring Down 'Crypto'?" by Jeff Deist and Bob Murphy (video): Mises.org/RR_109_F
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
The 2004 Nobel Prize in economics was awarded to two economists for their claim that "technology shocks" cause boom-bust cycles. They have it wrong.
Original Article: "Do "Technology Shocks" Create the Boom-Bust Cycles?"
This Audio Mises Wire is generously sponsored by Christopher Condon. '
After following hyper-Keynesian policies for more than two decades, the Fed is about to create the conditions that Keynesians claimed were impossible: an inflationary recession.
Original Article: "The Fed's Current Monetary Stance Will Lead to Stagflation, Not Deflation"
This Audio Mises Wire is generously sponsored by Christopher Condon. '
This year's trio of Nobel winners in economics are short on actual economics and long on government intervention.
Original Article: "The Nobel for Government Intervention: Bernanke and Others Rewarded for Flawed Theories"
This Audio Mises Wire is generously sponsored by Christopher Condon. '
Recovery is genuine only when it reaches the masses of individuals. And recovery comes only from the actions of individuals acting in a free market.
Original Article: "Genuine Recovery Is Up to Investors, Producers, and Consumer Choice"
This Audio Mises Wire is generously sponsored by Christopher Condon.
The Fed claims 2 percent inflation promotes "price stability." However, that policy also causes the boom-and-bust cycle, which is anything but stable.
Original Article: "How the Policy of Price Stability Generates Greater Economic Instability"
This Audio Mises Wire is generously sponsored by Christopher Condon. '
Conservatives have missed the point that it is not students particularly that are at fault for the student loan crises, but the entire bureaucratic economic-political system.
Original Article: "Seeing the Student Loan Crisis as a Form of Boom and Bust"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Post-Keynesians believe that capitalism is internally unstable, leading to necessary intervention by the central bank. Austrians see that as backward reasoning, as policies by the central bank to create credit from nothing is the problem.
Original Article: "Does Capitalism Itself Create Economic Instability or Is Central Banking the Culprit?"
This Audio Mises Wire is generously sponsored by Christopher Condon.
The Fed is slowly increasing interest rates in the hopes that the economy will experience a "soft landing." However, there is no way to soften the blows about to fall on the economy.
Original Article: "Powell's Pivot to "Pain" but No Gain: Triggering the Coming Recession"
This Audio Mises Wire is generously sponsored by Christopher Condon.
The Fed’s tampering with market signals undermines the process of wealth generation, thereby exerting an upward pressure on the time preference interest rate and the market interest rate.
Original Article: "Throwing the Fed's Machinery in Reverse: Fed Interest Rate Policies Continue to Damage the Economy"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Paul Krugman recently argued that the Federal Reserve can engineer a "soft landing" for the economy as it tries to deal with inflation. Such a view ignores economic realities.
Original Article: "Looking at the Economic Myth of the "Soft Landing""
This Audio Mises Wire is generously sponsored by Christopher Condon.
Bob and Jeff unravel the corrosive and nonsensical policy of "inflationism," and consider its deep cultural effects.
Read Jeff's talk from the recent Ron Paul Institute conference: Mises.org/HAP360-1
New York City’s subways have become a nightmare, with rampant crime, delays, derailments, and poorly capitalized. This is a gift from "backdoor socialism."
Original Article: "New York City Subways: The Woes of Socialist Enterprises"
This Audio Mises Wire is generously sponsored by Christopher Condon.
The "official" definition of a recession is a two-consecutive-quarter decline in GDP, but there are problems with GDP measurement in the first place.
Original Article: "Is a Recession Simply a Decline in GDP? What Does That Mean?"
This Audio Mises Wire is generously sponsored by Christopher Condon.
On this episode of Radio Rothbard, Ryan McMaken and Tho Bishop discuss the regime's latest Orwellian word game to avoid acknowledging a recession. Is this an attempt to gaslight the country, or a reflection of economic pain being less obvious to the beltway class?
Recommended Reading "GDP Shrinks Again as Biden Quibbles over the Definition of Recession" by Ryan McMaken: Mises.org/RR_93_A
"The Fed Is Making It Up as It Goes, So It Ditched Forward Guidance" by Ryan McMaken: Mises.org/RR_93_B
"Yellen: Recession Doesn't Mean What You Think It Means" by Ryan McMaken: Mises.org/RR_93_C
"The Economy Needs a Volcker Moment" by Connor Mortell: Mises.org/RR_93_D
Be sure to follow Radio Rothbard at Mises.org/RadioRothbard.
Most economists see GDP as a snapshot of the performance of the economy. However, it is better understood as a misleading statistic which fails to accurately describe what really is happening economically.
Original Article: "GDP Provides a False Reading of the State of the Economy"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Mortgage companies and realtors are today's canaries. They're in deep trouble, and so are the rest of us.
Original Article: "The Canaries in the Coal Mines Are No Longer Singing"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Jeff and Bob discuss the effect of rising interest rates on Uncle Sam's ability to service debt—and promote the increasingly less radical idea that a default on Treasury debt is both inevitable and good.
Jeff's article on rising rates: Mises.org/HAP351-1 House Budget Committee report on higher interest rates and US debt service: Mises.org/HAP351-2 Rothbard on the ethics of debt repudiation: Mises.org/HAP351-3
The relative lack of inflation in Japan doesn't mean real wages haven't fallen.
Original Article: "Here We Go Again: The Fed Is Causing Another Recession"
This Audio Mises Wire is generously sponsored by Christopher Condon.
The Federal Reserve was supposed to prevent recessions that people blamed on the lack of central banking. Not surprisingly, the post-Fed recessions have been worse.
Original Article: "How Bad Were Recessions before the Fed? Not as Bad as They Are Now"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Ben Bernanke once claimed that a monetary gold standard caused economic instability. He failed to mention that his fiat money standard causes the boom-and-bust cycles.
Original Article: "Contra Ben Bernanke, the Gold Standard Promotes Economic Stability"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Mises.org economist and senior editor Ryan McMaken joins Jeff and Bob for a hard look at the economic reality Americans face today.
Shostak on the true definition of a recession: Mises.org/HAP349-Shostak Bob's article in the QJAE: Mises.org/HAP349-Murphy
The Federal Reserve is raising interest rates in hopes of reversing some of the inflationary damage it has done for more than a decade. Unfortunately, the Fed already has done incalculable damage to the economy.
Original Article: "Interest Rates Are Rising, but the Fed Continues to Be Reckless"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Though Kuttner thinks the New Deal a great success, he himself lays out some of its many problems.
Original Article: "The New Deal: Admissions against Interest"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Today, inflation and prices are soaring. We know that Federal Reserve monetary policy is the cause. But why didn't something similar happen after the 2008 financial crash?
Bob Murphy and professor Ross McKitrick discuss the government policies, Fed actions, and banking movements that lead up to the 2008 crisis, and why the current economic situation is different.
Ross McKitrick on inflation then versus now: Mises.org/HAP-McKitrick Bob explains how Keynesians missed the latest bout of price inflation: Mises.org/HAP347-Murphy Bob's book Understanding Money Mechanics: Mises.org/Mechanics
The Fed's reckless behavior has undermined Netflix more than the losses at CNN+.
Original Article: "How Did CNN+ Get Canned by Netflix? Austrian Economists Might Have an Answer"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Despite assurances from politicians and the media, the Federal Reserve System is not a collection of geniuses who stand guard against inflation and recession. Instead, think of the Fed policy makers as the Keystone Cops of central banking.
Original Article: "The Fed Can't Fix the Economy, but It Can Break It"
This Audio Mises Wire is generously sponsored by Christopher Condon.
Jeff and Bob discuss the dynamics of the housing market in the context of a recent talk by Alex Pollock.
"Hazlitt, Hayek, and How the Fed Made Itself into the World's Biggest Savings and Loan": mises.org/PollockAERC
Contractionary monetary policy may be necessary to slow the rise of inflation, but the recessionary results of this remind us why the Fed's inflationary policy is so dangerous.
Original Article: "Inflation or Recession? The Fed Faces a Choice."
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Economic depressions are not caused by a strong decline in the money stock, but by a depleted stock of real savings.
Original Article: "How to Avoid Depressions? Foster Saving and Investment"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Tho Bishop, guest-hosting A Neighbor's Choice, interviews Jonathan Newman, author of The Broken Window.
Tho and Jonathan discuss the supposedly transitory aspect of inflation, the overshadowing of economics by central planning, Keynesian economics, and more.
Purchase The Broken Window online at Mises.org/BWindow.
In spite of what they say, governments will do nothing about inflation. Even though "money printing" is the real cause of this, governments will just keep blaming red herrings like supply chain problems.
Original Article: "Governments Love Inflation, and They Won't Do Anything to Stop It"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
It will come as yesterday's news that the speculator is perennially under attack by the social justice warriors. Yet speculators serve a crucial and valuable role in surviving economic disasters.
Original Article: "In Defense of the Speculator"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
The Fed is dumping cash into Fannie and Freddie which is helping investors buy up more trailer parks.
Original Article: "The Fed Is Helping Facilitate Trailer Park Evictions"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
While bankruptcy has a negative connotation in the business world, “Bankruptcy fulfills the crucially important social function of preserving the available stock of capital."
Original Article: "Preserving Capital through Bankruptcy"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
We may be told price controls are a temporary necessity, as in 1971 under Nixon. But one thing is certain: price controls will do nothing to resolve the issues underlying the inflation.
Original Article: "Will the Feds Try Price Controls to "Fix" Price Inflation?"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
With such a messed-up economy, why is it still hard to spot a bust on the horizon?
Original Article: "Investors Are on the Lookout for a Crash. But Prices Keep Going Up."
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
The concerns about a bubble implies those shopping for a new home are wondering if they are walking into a trap. Home prices have soared and no one wants to buy at the top.
Original Article: "With Home Prices Soaring, Shoppers Fear Buying at the Top of a Bubble"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Many have long speculated that there is a correlation between economic prosperity and the length of women's hemlines. But perhaps it's now "mom jeans," with their high waists and ample fit, that indicate the true state of the economy.
Original Article: "Forget Hemlines. Mom Jeans Are Now an Economic Indicator."
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Two things should concern us. First, the weakness of the recovery in the middle of the largest fiscal and monetary stimulus seen in decades, and second, the short and diminishing effect of these programs.
Original Article: "More Evidence the American Economic "Recovery" Will Disappoint"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
We've seen pictures of empty shelves in Venezuela. Meantime, the one-year return on the Caracas stock exchange is 1,804.92 percent. If you're already rich in assets, inflation is a big nothing burger. But it's a problem if you're poor.
Original Article: "Inflation Is Great If You're Already Rich"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
In Las Vegas, airline passengers plummeted 64 percent during 2020, and the convention business has collapsed. For Vegas, there are troubling signs that the world is not in a hurry to spend freely on extravagant face-to-face meetings.
Original Article: "Can Las Vegas Recover from Covid?"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
The answer lies in audacious economic reforms that favor markets and entrepreneurs: liquidate bad investments, let deflation happen, cut government spending, cut taxes, let wages fall.
Original Article: "Rothbard Explains How to Recover from an Economic Crisis"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
In a 2019 article, Bob quoted Mises who believed that new gold discoveries, in principle, could cause a (small) boom-bust cycle if the gold hit the loan market before other sectors. Walter Block and Bill Barnett have responded in a new article, arguing that in a free market, new commodity money can't cause such distortions.
Mentioned in the Episode and Other Links of Interest: The YouTube version of this interviewBob’s 2019 QJAE article, which Block & Barnett (2020) criticizesBob’s blog post explaining why Block & Barnett (2020) misunderstands his argument in his 2019 QJAE paperBob Murphy Show ep. 67, in which Block and Barnett explained their problems with the Hayekian triangleRothbard’s classic essays on utility & welfare economics and the legal treatment of air pollutionBlock and Barnett’s paper on the optimal quantity of moneyOne entry in Block and Barnett’s debate over maturity mismatching; it contains references to the earlier volleys for the interested reader. For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
An unheralded work on the Austrian business cycle that rivals the work of the greats is Jesús Huerta de Soto’s Money, Bank Credit, and Economic Cycles, which outlines a multistate process of boom and bust.
Original Article: "Jesús Huerta de Soto’s Six Stages of the Austrian Business Cycle: Which Stage Are We in Now?"
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Professor Jonathan Newman joins the show for a look at America's Great Depression, Rothbard's classic explanation of a terrible period in US history. This book provides one of the best short surveys of Austrian business cycle theory, along with deep history surrounding the inflationary run-up of the 1920s and the disastrous mistakes made by the "laissez-faire" Hoover administration in the 1930s. Any serious student of booms and busts needs to read this cautionary tale, as does anyone worried about unconstrained monetary policy in the wake of Covid-19 lockdowns. It can happen here, and it can happen again, if Rothbard's counsel goes unheard.
Find the online version of the book at Mises.org/GreatDepression Receive a discount on America's Great Depression in the Mises Bookstore with code HAPOD15%
Even when an economic bust appears, there may still be enough real savings in the economy to quickly put the economy back on track. This is what brings economic recovery, not artificial "stimulus."
Original Article: "Why Government Stimulus Sometimes Looks like It Revives the Economy".
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Circa casino’s new three-story, 78 million–pixel, high-definition screen in its sportsbook gambling compound may represent a new frontier in mega–building trends similar to those of skyscrapers.
Original Article: "The Rise of Mega–Gambling Facilities: A New Skyscraper Curse?".
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Michael Stack.
Even if the central bank were to be successful in preventing the fall of the money stock, this would not be able to prevent a depression if the pool of real savings is declining.
Original Article: "A Drop in the Money Supply Was Not the Cause of the Great Depression".
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Money printing—even at a constant rate—is going to generate the same result as any other money printing. The reason lies in the fact that money creation transfers wealth from productive to unproductive enterprises.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Printing Money at a "Constant" or "Stable" Rate Won't Prevent Boom-Bust Cycles".
Despite double-digit unemployment rates, banks are keeping loan-loss provisions low, no doubt assuming Uncle Sam will keep everyone’s boat afloat. But all good things come to an end.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "How the CARES Act Is Still Kicking the Can"
If we can spend a few trillion overnight to bail out investors and send out 150 million stimulus checks, why not also launch a universal basic income and a slavery reparations program?
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "How Bailouts and Stimulus Pave the Way for a Lot More Spending on Everything".
The crisis we faced in 2008 has not gone away, as we failed to heed its warning to change course and reduce debt levels. Instead, it has become bigger and more dangerous.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Throwing Printed Money at This Problem Won't Make It Go Away".
Economic growth results from increasing production, and the money supply is always sufficient to foster exchange. The boom-bust cycle only occurs when production is distorted by a growing money supply.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Say's Law and the Effects of a Growing Money Supply".
The Human Action podcast with Jeff Deist continues tracking Rothbard's Man, Economy, and State, this time focusing on the role of entrepreneurs in the production process (Chapter 8).
Hunter Hastings joins the show with great insights into the social benefits of profit vs. interest, entrepreneurial risk, progressing and retrogressing economies, and the bunkum known as the "Paradox of Saving." This chapter presents Rothbard's exposition of the individual's (or firm's) role in bringing goods and services to us—while Keynesian and classical economists see capital as a homogenous blog and try to wedge entrepreneurs into mathematical models. You'll also hear why Jeff Bezos is not the devil, why rich kids tend to waste the fortunes created by their parents or grandparents, and why Marx was dead wrong about the little guy.
Read the book free of charge in searchable HTML format here.
Use the code HAPOD for a discount on Man, Economy, and State from our bookstore: Mises.org/BuyMES
Additional Resources Economics for Entrepreneurs Podcast: Mises.org/E4Epod
Dr. Joe Salerno's introduction to Man, Economy, and State: Mises.org/SalernoMES
Man, Economy, and State: Mises.org/MES
The massive bailout of indebted sectors that already had overcapacity and were in process of obsolescence may also drive the largest wave of malinvestment in decades. If the previous recoveries came with poor wage and capital expenditure growth and high debt, the next one will likely be even worse.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "An L-Shaped Recovery Is Not an Anomaly, It Is the Norm."
The 1958 pandemic killed twice as many people as COVID-19 has so far. Yet, the economy in 2020 has collapsed far worse than either in 1958 or the far worse pandemic of 1918.
Narrated by Daniella Bassi.
Original Article: "Why Didn't the 1958 and 1918 Pandemics Destroy the Economy? Hint: It's the Lockdowns"
Paul Krugman is now claiming that reopening the economy and allowing people to go to work almost surely will cause a depression.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Krugman: We Need More Unemployment—to Save Us from Unemployment"
Crashes are fast, like that first hill on a coaster. Recoveries are not, for the simple reason that production is more difficult than destruction.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "How Bad Is It?"
How do the shutdowns increase ageism? Because millions have arguably been thrown out of work in the name of protecting the elderly. The resulting economic devastation comes at the expense of younger workers, parents, students, and families.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "How the COVID-19 Lockdowns Will Increase Resentment of the Elderly"
In this crisis the money supply has already increased far more than during the last crisis. But it's hard to say when this will produce inflation because we're still in the midst of a demand shock and a collapse in oil prices.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "How This Crisis Differs from the 2008–2009 Financial Crisis"
The COVID-19 panic may have sped up the beginning of this economic crisis, but the virus wasn’t the cause. The real cause of the crisis was the boom that came before it.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "This Bust Wasn't Caused by a Virus"
Wouldn’t you feel great knowing that your stock picking is fully insured by the Fed? Billionaires and wealthy hedge fund managers know the feeling.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "Why Markets Are Rallying as Millions Become Unemployed"
The COVID-19 depression will expose the Las Vegas convention center bubble for what it is: a massive malinvestment.
This Audio Mises Wire is generously sponsored by Christopher Condon. Narrated by Millian Quinteros.
Original Article: "The Convention Center Bubble Will Soon Pop"
Harry Dent is the founder of Dent Research, which provides economic forecasting and financial recommendations. He is the author of numerous books, including Zero Hour (2017). Harry argues that demographic trends set the U.S. economy up for a major adjustment that the Federal Reserve merely postponed with its easy-money policies in 2008 and beyond. Harry now believes that a major crash is coming, which will probably begin this year.
For more information, see BobMurphyShow.com. The Bob Murphy Show is also available on iTunes, Stitcher, Spotify, and via RSS.
What's the biggest and most dangerous financial bubble? Sovereign debt issued by profligate governments. And unlike stocks or corporate debt, government bond bubbles harm millions of ordinary people when they burst.
Economist Daniel Lacalle joins Jeff Deist to figure out the bizarro world of the bond bubble: negative interest rates, anemic rate spreads between government bonds and "high yield" bonds, and central banks as the unseemly buyers of last resort. They discuss the Fed's interest rate hikes, Jerome Powell's focus on data, the US housing market, and why all of us have a stake in seeing central bank balance sheets shrink.
Related article: Daniel Lacalle on the Bond Bubble
Featuring the following authors:
Patrick Newman, The Progressive Era and Conceived in Liberty, Vol. 5Connor Boyack, The Tuttle Twins and the Fate of the FutureDavid Gordon, Preview of Rothbard A – ZMark Thornton, The Skyscraper Curse
Presented at the Mises Institute's 2018 Supporters Summit in Auburn, Alabama. Recorded on September 28, 2018.
Presented at the Mises Institute's 2018 Supporters Summit in Auburn, Alabama. Recorded on September 27, 2018.
"Higher order" industries like manufacturing and mining are particularly sensitive to changes in interest rates. And it doesn't look like anything's different this time around.
Original article: British Manufacturing Slumps as Bank of England Raises Interest Rates
[Foreword to Mark Thornton's new book The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century (Auburn, AL: Mises Institute, 2018).]
In the wake of the financial crisis of 2008, the economics profession suffered a blow to what reputation it had. But unlike most of his colleagues, Mark Thornton was vindicated by 2008. Mark has been a voice of sanity at times when the wild interventions of the Federal Reserve have caused otherwise sensible people to lose their minds.
One rule of thumb I’ve adopted is: whenever the idea that the business cycle may have been tamed forever starts to become mainstream, the bust is around the corner.
After reading this book, you’ll see why. Mark discusses the very different records of Irving Fisher and Ludwig von Mises in the 1920s, with the former saying (in late 1929!) that stock prices had reached a “permanently high plateau” and Mises warning that all the artificial credit creation of the world’s central banks meant a reckoning was coming.
At the end of the 1960s, presidential economic adviser Arthur Okun announced that wise fiscal and monetary policy was making boom and bust a thing of the past. One month after his book on the subject was released, the United States was officially in recession.
The dot-com bubble of the 1990s continued the pattern. Federal Reserve chairman Alan Greenspan even speculated that we had entered an age in which booms no longer necessarily had to be followed by busts.
I trust you know what happened next.
The most recent financial crisis, which was connected to an especially destructive housing bubble, yielded the same kind of crazy commentary: why, real estate prices never fall!
I trust you know what happened next.
In fact, Mark Thornton was one of a handful of economists to warn — as early as 2004 — of a housing bubble and its inevitable consequence. That was a lonely position to adopt in those days. Nobody wanted to hear the words “unsustainable” or “bubble” when buying multiple properties and sitting on them seemed to be a path to certain riches. Of course, Mark was the voice that would have done them the most good had they bothered to listen, because they might thereby have limited their exposure to the bust that was surely coming.
But when all so-called respectable voices are assuring everyone that all is well, it is the wise man who appears to be the crank.
Now had Mark been known for nothing more than being a conscientious historian of these earlier business cycles and an accurate prognosticator of the housing bust and financial crisis, that would be ample reason to respect him as a scholar worthy of our attention and respect.
But of course Mark has done much more than this. In this book, for instance, you will encounter Mark’s work on the so-called “skyscraper curse.” I shall not here disclose Mark’s thesis on the matter; the author of a foreword ought to know his place, and stealing the author’s thunder is rather unbecoming.
For now, I can say this: although a correlation between the setting of new skyscraper records on the one hand and plunges into recession on the other had been noted by certain writers, the connection had been generally dismissed as little more than a curious coincidence. Mark, on the other hand, has shown how the two phenomena are connected — not that tall skyscrapers cause the business cycle, of course, but rather that they embody numerous features of the boom period described by Austrian business cycle theory.
Austrian business cycle theory, in turn, is probably the most important piece of economic information and understanding for Americans and indeed the world to understand right now. Again I shall leave the full exposition to Mark. For now, what matters is that according to economists of the Austrian school, the familiar pattern of economic boom and bust is not an inherent feature of the market economy, but instead the product of intervention into the economy by the monetary authority. When the central bank lowers interest rates below what they would have reached on the market, it sets in motion a series of responses by investors and consumers that will prove to be incompatible. The result is the recession, which is the economy’s return to health: the economy’s unsustainable configuration is unwound, and resources (including labor) are reallocated to lines of production that make sense in terms of resource availability and consumer preferences.
In the pages that follow, Mark explains the theory, applies it to various historical (and present) cases, and rebuts the most common objections.
In short, this collection serves the valuable purpose of defending the market economy against the conventional view that freedom has failed us and we need still more controls. We had plenty of rules and bureaucrats on the eve of the financial crisis. A lot of good that did us. Pretty much none of them saw any problems on the horizon, and the sheafs of rules and regulations were aimed in the wrong direction: while the private sector operated in the equivalent of a Kafka novel, the Federal Reserve was able to carry out its mischief unimpeded.
Here’s a crazy thought: maybe this time we might consider a real free market, with sound money and market interest rates, and abolish the giant bubble machine once and for all. Read Mark Thornton and you’ll entertain this and other forbidden thoughts.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years." This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 2: "And How Austrian Economists Predicted Every Major Economic Crisis of the Last 100 Years". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
From Section 1: "The Skyscraper Curse". This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
Mark Thornton's definitive work on booms and busts. His now-infamous Skyscraper Index theory draws the connection between loose monetary policy, artificially low interest rates, and vanity construction projects.
This audiobook is made available through the generosity of Mr. Tyler Folger. Narrated by Graham Wright.
Download the complete audiobook (27 MP3 files) here. This audiobook is also available on Soundcloud, Apple Podcasts, Google Podcasts, and via RSS.
Private Graduate Seminar. Recorded at the Mises Institute in Auburn, Alabama, on July 17, 2018.
With stock markets in turmoil earlier this week, the Mises Institute's resident expert on booms and busts joins Jeff Deist to make sense of it. Will new Fed Chair Jerome Powell do everything possible to prop up markets, or will he be more hawkish than Janet Yellen? What kinds of indicators does Mark look for to predict trouble (hint: it's not the VIX). Why does the volume of margin loans matter, and why is the Russell 2000 Index a better predictor than the Dow or Nasdaq? Are cryptocurrencies now bound up with macro trends? And is Austrian business cycle theory necessarily incomplete as a tool to help investors?
See Mark Thornton's 2004 article "Housing: Too Good to be True".
Journal of Libertarian Studies 15, no. 3 (Summer 2001) And the taxpayer, not content with thus ruining political science, added insult to injury by damning all its chief ornaments as thieves, and by swearing that he would never let them rook him again. His bellow was now for the most rigid economy, and he swore that he would have it if the heavens fell. There was no holding him while the fit was on him. In many American cities, public expenditures were actually reduced. — H.L. MenckenH.L. Mencken, “What is Going on in the World,” American Mercury 30, no. 119 (November 1933), pp. 259–60.
David Beito did a great service for the scholarship of liberty and American history with his rediscovery of the Great Depression-era tax resistance movement.David T. Beito, Taxpayers in Revolt: Tax Resistance During the Great Depression (Chapel Hill: University of North Carolina Press, 1989). While it would be logical to assume that, during the depression, people simply could not pay their taxes, Beito provides evidence that the vast majority of tax resisters could have paid their taxes but refused to do so. Further, his evidence on the occupations of the members of tax resistance organizations makes clear that this movement was not just made up of wealthy opportunists refusing to pay taxes. He uncovered evidence of widespread opposition to property taxes across America. However, the anti-tax rebellion declined as quickly as it started, a demise that he attrib-utes to a lack of a “focused ideological program” that could capture the popular anti-tax sentiment of the time.Beito, Taxpayers in Revolt, p. 164. Thus, Beito concludes, this tax resistance movement was a failure.Beito, Taxpayers in Revolt, pp. 160–64. On the dust jacket, the publisher notes that the tax resisters “failed ... to offer clear and persuasive pro-posals outlining specific services that could be reduced or eliminated. Their lack of a genuine political program, Beito argues, led to the downfall of a surprisingly potent and popular rebellion.” While his contribution has been praised, questions have been raised concerning Beito’s explanation for the demise of the tax revolt.For example, Mark Leff, in his review of Beito’s book, argued that Beito’s “evidence comes up short” when he tries to explain the precipitous decline in tax resistance after 1933 on a lack of a systematic ideological program. See Mark Leff, American Historical Review 95, no. 5 (December 1990), pp. 1648–49.
In this paper, we argue that the anti-tax movement was a genuine success, and that this success is the reason the revolt ended.This tax revolt was non-violent, unlike previous tax revolts including the American Revolution, the Whiskey Rebellion, and the Civil War. Also, it was far less spectacular than other events of the time, such as the stock market crash, Prohibition, and Roosevelt’s New Deal. This success took two major forms. The first and most obvious was the tax limitation movement, which provided the political pressure to cut taxes and establish limitations on property tax rates. The second, which was both more important and far less obvious, was the passage of the Twenty-first Amendment, which repealed alcohol prohibition (hereafter, Repeal). Under intense political pressure from the tax revolt, politicians supported Repeal in order to provide federal, state, and local government with increased revenues to offset cuts in property taxes while simultaneously providing a drastic decrease in the price of alcohol, and, in effect, granting the American public a gigantic tax cut.The following analysis is based on the initial findings in Chetley Dale Weise, “The Political Economy of Prohibition and Repeal: Ideology, Political Self-Interest, and Information Control” (master’s thesis, Auburn University, 1998).
These policy victories mark the end of the revolt because the primary goals of the movement had been achieved. How else would one explain the rather sudden demise of a movement that consisted of local organizations that were not connected by a national network? The timing of these events supports our hypothesis that the revolt was a success, and that Repeal, which affected the entire nation, was a pivotal event for the tax resistance movement.
The Rise and Fall of Tax Resistance The obvious reason for the rise of tax resistance was that the burden of taxation increased greatly with the onset of the Great Depression. Most Americans had experienced the effects of a relatively good tax policy during the 1920s, with federal income tax rates cut by more than half for all income brackets. The economy expanded during the “roaring ’20s” in response to these tax cuts.Robert B. Ekelund, Jr. and Mark Thornton, “Schumpeterian Analysis, Supply-Side Economics, and Macroeconomic Policy in the 1920s,” Review of Social Economy 44, no. 3 (December 1986), pp. 221–37. The Great Depression brought an end to this growth, and replaced it with record levels of unemployment, mammoth losses of wealth, and a slew of government policies designed to reduce production and sustain high prices.Murray N. Rothbard, America’s Great Depression, 3rd ed. (Kansas City: Sheed and Ward, 1975).
The most burdensome tax for most Americans was the property tax. Property taxes required taxpayers to make an explicit payment of a significant amount, a payment the taxpayer could not evade without losing what was often his most significant piece of wealth and property.
Property taxes had increased significantly in the decade prior to the Great Depression. City government had grown enormously in size, scope, and debt during the 1920s, and revenues for city governments had become more dependent on property taxes. According to Beito, “throughout the 1920s, the general property tax accounted for over 90 percent of taxes levied by all cities over 30,000 in population.”Beito, Taxpayers in Revolt, p. 1. The primary reason for this dependence was that alcohol revenue from sales taxes and licenses had “dried up” due to prohibition.
Higher property taxes and a narrower tax base were largely tolerated during the 1920s because economic growth meant that property tax revenue could be increased via higher property values and assessments rather than higher tax rates. Taxpayers were more willing and able to pay rising property tax bills during the 1920s because wages, incomes, and the stock market were rising along with the value of homes and businesses.
The stock market crash and the Great Depression changed everything. The real burden of taxes on the American people increased significantly. Even if tax rates remained the same, tax burdens increased because the market value of property fell relative to assessed values. The real burden also increased because personal income was falling relative to property tax bills. Finally, the real burden of property taxes rose because price deflation increased the purchasing power of the dollar.
Beito described this crushing burden by comparing total tax payments as a percentage of income:
As a percentage of the national income, perhaps the most pertinent measure of the burden’s impact, taxes nearly doubled from 11.6 percent in 1929 to 21.1 in 1932. In just three years, the tax load on the American people increased more than it had in the 1920s. Not even during World War I had taxes ever taken such a large percentage of the national income. Taxes at the local level more than doubled, rising from 5.4 percent of the national income in 1929 to an unheard of 11.7 percent in 1932. Surging even faster, state taxes went from 1.9 percent in 1929 to 4.6 in 1932. At the same time, federal tax collections stayed relatively constant, inching up from 4.2 percent in 1929 to 4.7 in 1932.Beito, Taxpayers in Revolt, p. 6.
Clearly, the tax burden rose substantially, and most of the increase occurred at the state and local level. As the main weapon in the government’s arsenal, the property tax naturally became the focal point of the tax resistance movement.
With the tax burden, tax delinquency, and bankruptcy rising, the country became increasingly ripe for a tax revolt. Tax delinquency increased from its normal rate of 10 percent to more than 30 percent,Fred Rogers Fairchild, “The Problem of Tax Delinquency,” American Economic Review (March 1934), pp. 140–50. According to Fairchild, “that tax delinquency has at present reached the proportions of a major problem in the finances of many cities, counties, and towns is realized in a general way by all well-informed persons” (p. 140). Fairchild goes on to describe statistically the giant increases in the burden of government by noting that the “total of all taxes in the United States absorbed 7.2 per cent of the total income of the people in 1890; in 1930 it took 14.4 per cent, exactly twice as large a share of national income” (p. 147). and tax protest organizations formed spontaneously in rural regions, in response to attempts to sell the property of farmers to meet their tax obligations. Likewise, taxpayer leagues formed in urban areas to protest high taxes and property foreclosures. Estimates placed the number of such organizations at between 3,000 and 4,000 nationwide.Weise, “The Political Economy of Prohibition and Repeal,” p. 62.
Beito attributes the failure of tax resistance to two problems: lack of a well-developed ideological platform, and the lack of a professional organization. Indeed, the lack of an effective national organization that might control and manage tax resistance led local groups to organize along different lines, develop different strategies, and employ different tactics. However, despite these differences, thousands of local tax resistance groups disbanded at the same time as Repeal and the passage of numerous tax limitation statutes. The timing of these events clearly supports our conclusion that the movement was, indeed, a success.
Prohibition and Public Finance The Repeal of Prohibition provided several significant victories to the tax resistance movement. Repeal caused the price of alcohol to plummet and allowed local, state, and federal governments to reinstate alcohol taxes and increase government revenues. State and local governments also gained additional revenue via licensing fees and other alcohol-related charges, and federal alcohol taxes freed up additional money that could be provided to state and city governments through grants, public works, and other assistance. This revenue helped offset revenue lost from property tax cuts and tax limitation statutes. Additionally, Repeal also reduced spending on the enforcement of prohibition, reduced political corruption, and greatly alleviated the aggregate burden of crime.Mark Thornton, “Alcohol Prohibition was a Failure,” Policy Analysis no. 157 (Washington, D.C.: Cato Institute, 1991).
Prior to the income tax, tariffs and alcohol taxes provided the bulk of federal government revenues. From 1870 to 1920, customs and liquor taxes provided nearly 80 percent of all federal revenue. When the income tax amendment was passed in 1913, its revenue-raising ability was quickly realized. Revenues in 1917 were nearly three times those of 1916. Congress amended the tax in October of 1917, and revenues increased enormously in 1918, just as they had estimated. The income tax therefore provided a revenue substitute that permitted passage of the Eighteenth Amendment and the loss of alcohol tax revenues.Donald Boudreaux and A.C. Pritchard, “The Price of Prohibition,” Arizona Law Review 36 (Spring 1994), p. 3.
However, the Great Depression placed a severe financial constraint on Congress by reducing income tax revenue by 60 percent between 1930 and 1933. The search for alternative revenue led to Franklin Roosevelt’s conversion from a “dry” to a “wet,” and led to the Democratic Party’s endorsement of Repeal in their 1932 platform to provide “a proper and needed revenue.”Boudreaux and Pritchard, “The Price of Prohibition,” pp. 6–7.
Prohibition also wiped out alcohol sales tax and licensing revenues going to city, county, and state governments. Repeal re-established these revenues, permitting property taxes to be reduced. Repeal, therefore, brought victory to the tax resistance movement, whose primary aim was to reduce the burden of the property tax. Evidence from four major cities demonstrates that property taxes declined in overall importance after 1933. Property taxes decreased as a percentage of the overall city revenue from 67 percent during 1930–1932 to only 61 percent during 1933–1940—a shift in the structure of local government revenue and a victory for the tax resistance movement.
The most direct channel for increased revenues for local governments was the sales and excise taxes on alcohol and license fees from alcohol vendors. While most non-property income sources were stagnant throughout the Great Depression, business taxes were an important exception, growing an average 900 percent in five large cities between 1933 and 1940. This category is where most of the alcohol tax and license fee revenues accrued.Bruce Allen Hardy, “American Privatism and the Urban Fiscal Crisis of the Interwar Years: A Financial Study of the Cities of New York, Chicago, Philadelphia, Detroit, and Boston, 1915–1945” (Ph.D. diss., Wayne State University, 1977), p. 407. The Bureau of the Census noted that cities were “experimenting” with licensing to raise revenue, and that liquor licensing was the main target for enhanced revenues, increasing from zero in 1932 to more than $40 million in 1936, to $70 million by the end of the decade.United States Bureau of the Census, Financial Statistics of Cities over 100,000 Population: 1937 (Washington, D.C.: U.S. Government Printing Office, 1940), p. 21. See also Weise, “The Political Economy of Prohibition and Repeal,” p. 87.
The second channel by which alcohol revenues displaced property taxes was state government. By 1938, state governments received more than $250 million in alcohol tax revenue, and more than $60 million from state liquor monopolies.United States Bureau of the Census, Historical Statistics of the United States: Colonial Times to 1970, Part 2 (Washington, D.C.: U.S. Government Printing Office, 1975), p. 1130. Increased state revenues via alcohol sales tax collections permitted state governments to return money to city governments in the form of aid and grants. For example, alcohol tax revenue in Illinois was more than $4 million in the first full year after Repeal, and climbed to $12 million by the end of the decade. Between 1934 and 1938, Chicago received a 700% increase in state aid.Hardy, “American Privatism,” p. 407.
The third channel for alcohol-related tax revenue was the federal government. According to Hardy, there was recognition that “city governments could not carry the entire burden of unemployment when it was a national problem. Financial assistance would have to come from Washington.”Hardy, “American Privatism,” p. 360. Federal alcohol tax revenue went from zero before Repeal to $259 million in 1934, to $624 million by the end of the decade.Tax Institute, Tax Yields: 1940 (Philadelphia: College Offset Press, 1941), p. 36. This increased revenue allowed the federal government to play a greatly enhanced role in local public finance.
Normally, tax redistribution would not be considered a tax reform victory, but, in this case, Repeal produced a clear defeat for taxes and government authority. Property taxes were cut and alcohol consumers received what amounted to a substantial tax cut equal to more than 2.5 percent of Gross Domestic Product.Normally, falling prices would not be considered a tax cut. However, because the fall in price from black-market levels to “sin tax” levels was entirely the result of a change in government policy, it can be viewed as a type of tax cut.
The total price or cost of alcohol during Prohibition was higher than legal alcohol in three respects. First, the basic monetary price was as much as 500 percent higher than either before or after Prohibition.Mark Thornton, The Economics of Prohibition (Salt Lake City: University of Utah Press, 1991), p. 102. Alcohol products were also more costly because of the decrease in quality of products produced and sold in black markets as compared to those in free markets.Mark Thornton, “The Potency of Illegal Drugs,” Journal of Drug Issues 28, no. 3 (Summer 1998), pp. 725–40. Finally, illegal alcohol products were more costly because of the reduced information and increased transaction costs typically associated with black markets.Mark Thornton, “Perfect Drug Legalization,” in How to Legalize Drugs: Public Health, Social Science, and Civil Liberties Perspectives, ed. Jefferson Fish (Northvale, N.J.: Jason Aronson, 1998), pp. 638–60.
Even if we ignore quality, information, and transactions costs, the Repeal of Prohibition, along with a 100 percent tax on alcohol products, would still leave the American alcohol consumer better off. In an economy of approximately $100 billion and an alcohol products industry of approximately $5 billion, a reduction in prices in excess of 50 percent amounts to a substantial tax cut for the country in general, and for alcohol-consuming households in particular. Surely, this must have been one of the main reasons for Franklin Roosevelt’s popularity.Tax resistance groups were naturally reluctant to take an official position on alcohol policy for fear of dividing their membership and reducing their effectiveness.
Tax Limitation: The Legacy of Resistance The success of efforts to establish property tax limitation policies was another important victory for the tax revolt that had a lasting impact. Arthur O’Sullivan, Terri Sexton, and Steven Sheffrin speak highly of “organized tax-resistance movements throughout the country” during the Great Depression, noting that
The tax revolts of recent years pale in comparison to the activities that took place during the Great Depression. In 1932 and 1933 alone, 16 states and numerous localities enacted property tax limitations.Arthur O’Sullivan, Terri A. Sexton, and Steven M. Sheffrin, Property Taxes and Tax Revolts: The Legacy of Proposition 13 (Cambridge: Cambridge University Press, 1995), p. 1.
For these experts on tax revolts, tax limitations were the successful outcome of the tax resistance movement during the Great Depression. The timing of these successes helps explain why the movement ended.
Experts at the time also recognized the connection between the property tax revolt and tax limitations as “common knowledge.” Economist and public finance expert Paul Wueller put it succinctly:
Complaints regarding the “burden” of the realty tax have multiplied manifold. Legislators from coast to coast responded to delinquencies and clamor by providing for over-all realty tax limits.Paul H. Wueller, “Real Property as a Tax and Reimbursement Base during the Depression,” in Property Taxes (New York: Tax Policy League, 1940), p. 21.
Property taxes were further reduced by the adoption of homestead exemptions and reductions in property assessments such that overall local real estate taxes declined from $4,337 million in 1929 to $3,744 million in 1934, and that state realty taxes declined from 27 percent of total revenue in 1929, to 19 percent in 1932, to only 7 percent in 1937.Wueller, “Real Property as a Tax and Reimbursement Base during the Depression,” pp. 21–40. Tax limitations were clearly a success for the tax resistance movement. They greatly reduced property taxes, gave greater security of property rights to homeowners, and reduced overall revenues to state and local governments.
However, these victories were not without their drawbacks, as local governments began to develop new sources of revenue such as the sales tax. Another major drawback of tax limitation was that local governments became more dependent on the state and federal government. Donovan F. Emch, a Great Depression-era expert on local public finance, described these local governments as “but humble mendicants daily seeking succor at the hands of the state.”Donovan F. Emch, “The Effects of Tax Limitation in Ohio,” in Property Taxes (New York: Tax Policy League, 1940), p. 69.
One modern-day expert examines the negative implications of tax limitation at greater length. Glenn Fisher cautions that constraining local government but leaving state and federal government unconstrained only encourages local governments to become more dependent on state and federal governments for resources. As a result, overall government in America has become more centralized and powerful.Glenn W. Fisher, The Worst Tax? A History of the Property Tax in America (Lawrence: University of Kansas Press, 1996).
Therefore, while successful in its narrow mission to reduce and control property taxes, the tax revolt movement did fall short of reducing and controlling taxation in the long run. Here, Beito’s complaint about the lack of a “focused ideological program” rings true. Such a program would have made tax protestors resistant to compromise, steeled them against new taxes, and compelled them to form national organizations capable of more formidably challenging government’s power to tax.
Our final show of the year features a talk given by Dr. Bob Murphy at a recent Mises Institute event in Orlando. His topic is the culture wars—and if you think America is divided now, just wait until we have another crash like '08. But Bob is ready with a prescription: less politics & smaller polities. It's time to stop hating each other and start reducing the political power wielded over us, as Bob conveys in his own unique and humorous style.
Listen to Jeff's talk from the event here.
Quarterly Journal of Austrian Economics 20, no. 2 (Summer 2017)ABSTRACT: This paper deals with the relationship between deflation and economic growth. Although there are numerous theories on the potential effects of deflation on real output, empirical evidence in this field is still incomplete. In order to explore the relationship between prices and output in a more comprehensive way, I use a large panel data set of 20 countries over roughly 150 years, which contains frequent deflationary episodes. Since mainstream macroeconomists often refer to alleged bad historical experience with deflation, I employ an econometric model to examine both contemporaneous and lagged correlation between prices and output. There are two important results. First, there is no general relationship between price growth and output growth. Coefficient estimates have very small magnitude in both the whole sample and in different monetary regimes. Second, well-known episodes of deflation differ a lot. The Great Depression is the only period where deflation seems to be strongly associated with recession. By contrast, Japan in the 1990s and 2000s bears no resemblance to it. Here, both empirically and theoretically, deflation is highly unlikely to have caused economic stagnation.
KEYWORDS: deflation, price level, economic growth, monetary systems, panel data, economic historyJEL CLASSIFICATION: E31, E42, C33, N10
Dr. Mark Thornton joins Mises Weekends to explain the "business cycle" for what it really is: a series of booms (credit expansion) and busts (debt de-leveraging) engineered by central banks.
There's nothing natural, real, or sustainable about the current Yellen boom—so stay tuned for Mark's explanation of how it can all unravel.
Beyond the behavior of speculators or OPEC—which some consider a cartel, if there is anything we can learn is that the fall in oil prices responds to the forces of supply and demand. On the demand side, lower economic activity throughout the world, specially in China, has lowered the price of oil. Projections by the International Energy Agency show how demand weakened in 2014, although it rebounded in 2016.
However, there is no doubt that the supply side saw the most significant change. There has been much talk about fracking and how this technology—implemented primarily in the United States—has affected the oil supply. Between 2008 and 2014, the US oil supply increased by 76%.
This shock in the supply of oil and the weak demand has accustomed people to low oil prices. In 2016, the average price of a WTI barrel was valued at $43.15. In June 2016, the price was over $90. In just one year, from June 2014 to June 2015, the price of a barrel fell 43%.
The shock in the supply will not last forever: producers have different marginal costs. In the past, high oil prices made new forms of production with greater marginal costs profitable. If prices remain low, some producers could exit the market and there would be a price adjustment. Yet, there are good reasons to think that oil won’t reach the exorbitant prices of early 2014.
The question many are asking is: why hasn’t OPEC acted to keep prices from remaining low? To answer this question, we need to examine whether OPEC is able to manipulate prices.
Is OPEC a Cartel?Economists define a cartel as a group of producers that come together to plot in the market. In other words, a group of producers agree to restrict supply and maintain prices at a certain level, making their incomes greater. However, for this to happen the members of the cartel need to have a dominant position in the market.
Although many economists consider OPEC a cartel, the question becomes difficult to answer when we look at historical data. In their book The Price of Oil, Roberto Aguilera and Marian Radetzki lay out empirical evidence showing that, historically, OPEC has not been able to act as a cartel. OPEC’s policy has always consisted in setting maximum production quotas to keep the supply below a certain level; yet these quotas are rarely followed and OPEC countries generally produce at 94% of their capacity.
On the other hand, OPEC’s market share does not clearly show a dominant position in the market that would allow them to directly influence prices. According to Aguilera and Radetzki, OPEC’s market share has varied between 31% and 56%. Although it might seems like a large share it is not, especially if we compare it to other minerals such as bauxite where there is a supply concentration of 73% to 81%.
OPEC has announced that it hoped to reach an agreement to extend the output cuts of major oil-producing countries. Certainly, the quotas fixed by OPEC have an influence on the price of oil, but this does not make OPEC a cartel. Only the future will tell if OPEC’s measures have any effect on oil prices or if our interpretation that they aren’t able to move prices is true.
Reprinted from Market Trends at Universidad Francisco Marroquin.
Ryan McMaken interviewed by Daniel Brigman on The Power Hour radio show. Produced by www.gcnlive.com
Topics for this wide ranging interview include: booms and busts, private money, bitcoin, central banks, Brexit, protectionist policy under Trump, and trade barriers.
Statistics issued by the federal government about the economy—from CPI to GDP—are fake, and our guest John Williams of Shadowstats.com explains how and why.
John is a vocal critic of modern economic reporting, which is manipulated to make the economy appear stronger than it is. So, he devoted his professional life to telling the real story, through statistics he painstakingly compiles himself. And, his statistics paint an alarming picture: virtually all "growth" in the US economy since the Crash of '08 has been artificially engineered by the Fed, while the risk of debt contagion has increased.
Jeff and John discuss the "Fed tax," what a radical increase in the monetary base means for your financial future, and whether Janet Yellen will be forced to resort to more QE in 2017.
This is a must-hear interview if you're interested in sober economic reality.
Recorded at the Mises Circle in Boston, on the campus of Harvard University, on 1 October 2016.
Quarterly Journal of Austrian Economics 19, no. 2 (Summer 2016)The recent financial crisis of 2007–2008 generated a debate among economists over whether the leading central banks' unprecedented monetary intervention would spark a massive inflation and depreciation of currencies in the near future. During the meltdown of the banking system, central banks engaged in enormous monetary expansion and drastically increased member bank reserves in an effort to save the financial system and stimulate the economy. Despite this, inflation, at least judged by reported consumer price indexes, has grown at a relatively moderate rate in the period since the crisis. Why is this? Have we entered into a special period where monetary economics is no longer valid, and inflation is no longer a monetary phenomenon? Can central banks around the world now increase their respective money supplies ad libitum without suffering any consequences?
Answering these questions is partly one of the justifications for Peter Bernholz, renowned historian of inflation, to publish a second edition of Monetary Regimes and Inflation.
The Quarterly Journal of Austrian Economics
Vol. 19 | No. 2 | 187–191Summer 2016
Book Review
Monetary Regimes and Inflation: History, Economic, and Political Relationships, Second Edition
Peter BernholzCheltenham, U.K.: Edward Elgar, 2015, 240 pp.
Patrick NewmanPatrick Newman (patrick.newm@yahoo.com) is a visiting assistant professor in the Economics and Finance Department at Florida Gulf Coast University.
The recent financial crisis of 2007–2008 generated a debate among economists over whether the leading central banks’ unprecedented monetary intervention would spark a massive inflation and depreciation of currencies in the near future. During the meltdown of the banking system, central banks engaged in enormous monetary expansion and drastically increased member bank reserves in an effort to save the financial system and stimulate the economy. Despite this, inflation, at least judged by reported consumer price indexes, has grown at a relatively moderate rate in the period since the crisis. Why is this? Have we entered into a special period where monetary economics is no longer valid, and inflation is no longer a monetary phenomenon? Can central banks around the world now increase their respective money supplies ad libitum without suffering any consequences?
Answering these questions is partly one of the justifications for Peter Bernholz, renowned historian of inflation, to publish a second edition of Monetary Regimes and Inflation. The first edition of the book, which was published in 2003, concentrated on providing a concise overview of various inflationary episodes over the centuries. Bernholz analyzed inflation under different monetary regimes, such as metallic (i.e. gold or silver) and fiat standards, and what caused them. He also looked at eras with either moderate inflation or hyperinflation, and how they were ended. Overall, the book is a nice, concise survey of various periods of inflation on what caused them, how they compare with other episodes, and what ended them.
With a favorable reception to the first edition in 2003, Bernholz has decided to keep most of the slim volume (roughly 230 pages) intact and add only two new revisions to the second edition in 2014 (pp. x–xi). The first is a section in Chapter 2 about the recent financial crisis and why central banks’ monetary expansions have not led to present day inflation, and whether or not they will lead to it in the future. The second is an entirely new Chapter 9 about how historically stable monetary regimes (that is, monetary regimes that were constrained and did not lead to significant inflation) were eroded. Given that these are the two new additions to a book originally published over ten years ago, I will spend the rest of the review on them.
In the new Section 2.1, Bernholz tries to answer the question that everyone was asking in the years after the financial crisis: Where is all of the inflation everyone was worried about? For example, in the United States, from December 2007 to April 2014 M0, or the monetary base (currency in circulation plus member bank reserves) increased by 363.87 percent, yet the rise in consumer prices was nowhere near that amount (p. 4).
Bernholz first answers this using a number of illustrative figures. He first shows that the enormous increase in M0 in various countries led to moderate increases in M2 (p. 5). Although the rise in M0 has not led to a rise in M2 now, Bernholz concludes that it provides a permanent potential for inflation in the years to come, once banks start to engage in credit expansion (p. 8). Then, even with the current increase in M2, Bernholz argues that the rise in consumer prices was mitigated because velocity during this period fell (i.e., money demand rose) and most of the new money was not spent on consumer goods, but on goods not included in a cost of living index, such as houses and stocks (pp. 8–9). Bernholz concludes by arguing that many banks have not engaged in credit expansion because they are pessimistic about the state of the economy (pp. 9–10).
At the outset, it would have helped Bernholz’s argument enormously if he not only provided illustrative figures but also numerical figures. Aside from the precise increases in M0 in the USA, the euro area, and Switzerland from December 2007 to April 2014, he only provides illustrations of M2, the M2 money multiplier, and velocity. Why not also provided quantitative estimates for them as well? For example, it would have been nice to know that from the beginning of December 2007 to the beginning of December 2013 (the latter being the last full year before the book came out), despite the enormous M0 growth of 334.99 percent (27.76 percent per annum), M2 growth in the U.S increased only 47.42 percent (6.68 percent per annum), and the CPI increased even less than that at 10.99 percent (1.75 percent per annum).Data for these numbers is obtained from BLS (2015), BOG (2015), and FRED (2015). And so on for velocity, the money multiplier, and housing and stock prices. The figures, while helpful illustratively for understanding the big picture, are not really helpful for those interested in using this section of the book for research.
In addition, when discussing why the increase in M0 did not translate into a concurrent increase in M2, Bernholz should have also mentioned, at least for the United States, the use of the contemporary new policy tool by the Federal Reserve to pay interest on member bank deposits. With this new proviso, banks no longer have as much of an incentive to engage in credit expansion in order to earn interest and to cover the cost of inflation eroding away idle balances. Certainly this, in conjunction with the regime uncertainty and economic malaise from the contemporary political climate, goes a long way towards explaining why the equally sizable M0 increase has not translated to an equally sizable M2 increase.
Although not directly related to current events, the other new addition of the book, Chapter 9, seeks to answer two questions: Why did some stable monetary regimes arise when there was no large inflation beforehand to incentivize their adoption, and under what circumstances did stable monetary regimes become abolished? Bernholz answers the first question with the theory that countries enacted stable monetary regimes so they would have an international currency that could be used in foreign trade. Bernholz uses examples from antiquity, such as the Athenian drachms and Corinthian staters, and argues that the sovereigns did not engage in debasement because the long term benefits from having an internationally used currency outweighed the short term benefits of debasement. Bernholz also argues that for some time the US dollar and British pound before World War I enjoyed relative stability for similar reasons. Bernholz answers the second question by arguing that countries are able to dismantle their stable monetary regimes and engage in inflationary policies whenever there is an “emergency.” Bernholz provides a brief table of various governments that suspended gold convertibility or devalued their currency with a list of emergencies, ranging from domestic and international wars, government bankruptcy, and economic calamity (such as the Great Depression). To anyone familiar with Robert Higgs’ Crisis and Leviathan (1987), the idea that emergencies, or crises, allow governments to engage in unprecedented usurpations of economic liberties (which includes money) is unsurprising. But it is nice to see the idea being taken seriously by others. A passage on the inherent incentive of governments to call a “national emergency” is all too revealing:
Given the inflationary bias of governments and politicians we should not be surprised that they grasped any critical situation to declare an emergency with the purpose of eroding or abolishing the factual legal or constitutional limits on their control of the currency. For it is only in emergencies that important changes appear to be warranted. As Carl Schmitt [German professor and early Nazi] pointed out: … “Sovereign is he who decides on the state of emergency.” (p. 209)
Bernholz also argues that the reintroduction of stable monetary regimes has occurred when countries try to mimic other countries who have already adopted a stable monetary regime. But without a first mover, the only other reasons have historically been after the end of a war or a hyperinflation. This empirical reality is quite unfortunate for anyone who wishes to enact some form of monetary constitution that ensures price stability or deflation (such as a return to the gold standard) in the United States. Will it take a hyperinflation and destruction of the dollar in order for the public and politicians to learn that our present practices are unsustainable?
Overall, the book is informative about inflation in all periods of human history, and researchers looking for concise overviews will find much use in it.
REFERENCES
BLS. 2015. Consumer Price Index for All Urban Consumers: All Items. Retrieved from FRED, Federal Reserve Bank of St. Louis: https://research.stlouisfed.org/fred2/series/CPIAUCSL/, December 14, 2015
BOG. 2015. M2 Money Stock. Retrieved from Fred, Federal Reserve Bank of St. Louis: https://research.stlouisfed.org/fred2/series/M2/
FRED. 2015. St. Louis Adjusted Monetary Base. Retrieved from FRED, Federal Reserve Bank of St. Louis: https://research.stlouisfed.org/fred2/series/BASE/
Higgs, Robert. 1987. Crisis and Leviathan. Oakland, Calif.: The Independent Institute, 2012.
This weekend, Jeff Diest and John O'Donnell discuss central banking and culture. We tend to think of central banking as a dry subject for professional economists, rather than a cultural and even moral issue. But the Fed and other central banks create huge moral hazards, degrade longstanding social mores like hard work and thrift, and encourage economic hedonism today at the expense of tomorrow. Every healthy society is built on capital accumulation and building for a future beyond lives, whereas central banks encourage consumption and turn us into zombie debtors. What happens to the future when ultra-low interest rates mean saving is for chumps? And why have we allowed Greenspan, Bernanke, and Yellen to hide the Fed's harmful cultural effects behind a wall of technical Fed-speak?
Thirty-five years ago, Ron Paul and Lewis Lehrman published The Case for Gold, their minority report from Reagan's gold commission. Today, Jim Rickards has written The New Case for Gold, an uncompromising call for using gold as money and reestablishing a gold standard for central banks.
In this wide-ranging interview, Jeff Deist and Jim Rickards discuss gold in the context of current geopolitics and enduring myths about monetary growth. While the "anti-gold reflex" is strong among older generation monetary economists in the west, a new gold-friendly order is emerging in Asia. Jeff and Jim even discuss whether Hillary will be indicted, leading to a Joe Biden/Elizabeth Warren ticket. This is a fascinating interview that you won't want to miss.
Our guest this week is James Grant, founder and editor of Grant's Interest Rate Observer. Jeff and Jim discuss Jim's recent cover article in Time magazine, and the reaction it received from Krugman and others on the left.
They also discuss comments recently made by Ben Bernanke, who argued in favor of the Fed looking into helicopter money. When did fiscal and monetary sanity become a radical position in America?
“Our greatest enemy today, in short, is the economic illiteracy and confusion on the part of those who insist on “planning,” “stabilizing,” and straitjacketing the economy and who have the political power to do it.” So wrote Henry Hazlitt in 1946, words that sadly retain their relevancy today. The consequences of this pervasive fallacy takes many forms. Ryan McMaken this week highlighted how soaring university tuition is fueled largely by a government fueled boom in student loans, while Paul-Martin Foss highlighted the alarming signals coming from international shipping. Around the world, people are coming to realize what Austrians have long warned, that the increasingly absurd policies of central banks offer no hope for true, sustainable economic growth. Sadly there is a firmer grasp of economics to be found in a Harry Potter novel, than the halls of the Federal Reserve.
Mises Weekends this week focuses on the true foundations for economic prosperity: innovation and entrepreneurship. At last week’s AERC, Hunter Hastings — a leading business and marketing consultant — discussed how technology breakthroughs and smart machines can power a new age of individualism.
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Keynes in 1939: The Coming War Will Solve Our Unemployment Program by Carmen Elena DorobățAnd So It Begins… Negative Interest Rates Trickle Down in Japan by Paul-Martin FossRothbard: Essentials of Money and Inflation by Murray N. RothbardThe Fed's Firepower by Jonathan NewmanEconomists as Modern Astrologers by Ryan McMakenCash Banned, Freedom Gone by Thorsten PolleitDumb and Dumber – From Negative Interest to Helicopter Money by Paul-Martin FossThe Fed Can't Save Us by Robert MurphyMises: Politics and Liberty by Ludwig von MisesThe Real Meaning of Competition by Peter KleinWhat Harry Potter Can Teach the Federal Reserve by Tho BishopMill Power Is Trump's Card by Joseph SalernoDon’t Confuse the Cost of College with the Cost of Education by Ryan McMakenLiberty Defined by Ron PaulWhat Would Trump Economics Mean for America? by Mark ThorntonThe Skyscraper Index Meets the Supertanker Index by Paul-Martin Foss30 Years of Mises University by Ryan McMakenThree Lessons Learned from Tesla’s Success by Mateusz Machaj"Free Stuff" Isn't All That It's Cracked Up to Be by Louis RouanetHazlitt, 1946: Inflation, Deflation, Confusion by Henry Hazlitt
The endgame of monetary side manipulations is upon us. Since 2008, central banks have done what they thought was needed to bring the markets back from the pain they experienced during the crash. The problem, of course, is that these Keynesians and Monetarists placed the high level of stock markets as the goal of “policy” and confused booming asset levels with economic growth.
The enemy of prosperity, in the eyes of global economic policymakers, is the desire of the consumer to save and businesses to refrain — even in the short term — from investment. As such, their “solution” was the very poison that has infected the Western world over the decades: more credit, lower costs of money, more push for “consumer demand.”
The Current Orthodoxy Is FailingBut “easy” monetary policy has merely led to debt-ridden economies and a bubble that is increasingly being exposed as a complete farce. January saw a market pullback tease that reminded investors that what was pushed up artificially can’t be sustained forever. Monetary policy, even if it goes to negative interest rate territory with a vengeance, isn’t going to be the miracle drug needed to provide a better economic foundation. Austrians have long known this. The mainstream is just starting to publicly admit it.
The Savings-Glut MythHowever, the right lessons are not being learned by either the economic policymakers or the financial pundits. In fact, the most dangerous economic fallacies still underlie their entire financial worldview. For instance, there is the ever-constant theme that there is a “glut of savings” and that low consumer demand is the chief villain that stands opposed to economic stabilization. Martin Wolf, writes in The Financial Times:
that the global economy is slowing durably. The OECD now forecasts growth of global output in 2016 “to be no higher than in 2015, itself the slowest pace in the past five years”. Behind this is a simple reality: the global savings glut — the tendency for desired savings to rise more than desired investment — is growing and so the “chronic demand deficiency syndrome” is worsening.
The proper economic way of thinking does not blame the economic pain on savings, nor does it desire an artificial, government-driven, attempt to coax people into consuming and “investing.” In fact, the economic reality of the situation is that savers are to be praised, not admonished; and that the refraining from consumption is the very means by which malinvestment can be most swiftly liquidated.
For the Austrian-school thinkers, the collapsing of the bubble that results from people “hoarding” their money and refusing to purchase over-priced “assets” is the precondition for future economic growth. This is because it is the bubble, not the bust, that is the problem. The bubble is the time of malinvestment and mismatch between consumer time preferences and resource allocation that results from the artificial expansion of the supply of money. It is the falsification of interest rates that encourages investment into areas that the economy is not prepared to handle. And while in the near term the bubble appears as prosperity and good times, it is actually the very seeds of destruction being sown. It is this piece of the boom-bust cycle that is destructive and impoverishing. The bust is merely the needed adjustment that gives society the wonderful opportunity to “start over” and do it right this time. Unfortunately, we never actually get to do things right, because the economic bureaucrats in our unfree-market system fear the bust more than the boom. They have it all backward!
How Saving Heals the Problems Caused by BubblesSo then, the so-called “global savings glut,” has the economic role of encouraging the readjustment of capital asset prices back toward their proper levels. The refusal to participate in the bubble, it is true, is harmful for the overvalued stock market levels worldwide. But what the mainstream does not understand is that overvalued stock market levels is a result of the underlying rot in the system itself. The pain to be experienced in a collapse will surely shock an entire generation of unprepared retirees, especially those relying on pension levels which are tied closely to stock market performance in the near to medium term.
But if the economy is ever going to slough off generations of central bank-induced malinvestment, if the economy is ever going to shift to a proper and sustainable foundation of capital accumulation, if future generations are going to live in a truly prosperous world, the pain is unavoidable. Propping up the markets and encouraging misguided consumption and malinvestments will be the death blow to western civilization. Only near-term pain can allow long-term growth. Economic savings are the cure, and to be welcomed with open arms.
Interviewed by Scott Horton, Dr. Mark Thornton discusses how the Fed is responsible for economic booms and busts; the increase of economic inequality after the gold standard was abandoned in 1971; and the introduction of negative interest rates.
Visit The Scott Horton Show website by clicking here.
Fear is in the air. Central bankers are warning of crisis, stock markets are falling, and even the media is realizing that the economy may not be as stable as our central planners would have us believe. Of course, while mainstream economists fear the falling prices that are on the horizon in our post-boom world, Austrians know that deflation and recessions are both inevitable and necessary when the economy is based on debt and fiat money.
Dr. Mark Thornton joined Jeff Deist on Mises Weekends to dive deeper on the current economic headlines. Why don’t central bankers understand deflation? A they really Keynesians or some variant thereof? What might a “crack-up boom” look like? And what does the Skyscraper Index tell us about the future of the global economy?
This is an episode you won’t want to miss.
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Un-PC Lego Making Toys Girls Like by Ryan McMakenIn a Post-Boom World, Auto Prices Will Fall by Patrick BarronWhy We Need a Recession by Ronald-Peter StöferleThree Centuries of Boom-Bust in Spain by Daniel Fernández-Renau Atienza and David HowdenMises in Four Easy Pieces by Dan SanchezBorderland Homicides Show Mexico's Gun Control Has Failed by Ryan McMakenRon Paul's Pillars of Prosperity in ChineseTexas Adopts New York Values on Fantasy Football by Tho BishopPennies And Nickels: More Expensive To Mint Than To Use by Paul-Martin Foss"Stocks Are Not Overvalued": Supply Siders Drop the (Crystal) Ball Again by Joseph SalernoMedia Catches Up to Economic Reality by Tho BishopBarron's Is Talking Skyscraper Curse by Mark Thornton1916 and the Health of the State by T. Hunt TooleyPer Bylund on the Sharing Economy in EntrepreneurThree Reasons Oil Prices Can Still Go Lower by Troy VincentCentral Banker Warns of Coming Financial Collapse by Joseph SalernoBernie Sanders Says We Should be Spending Less on Health Care by Ryan McMakenRepent and Believe in the Data! by Jonathan Newman
Our guest this weekend is Dr. Mark Thornton, a senior fellow here at the Mises Institute, and our topic is booms and busts. Falling stock prices are in the news lately, so Mark and Jeff talk about how and why central bankers don't understand deflation, whether they are really Keynesians or some variant thereof, what a "crack-up boom" might look like, and what the Skyscraper Index and other symptoms of irrational spending might tell us about the future of the global economy.
For Spain, 1492 was a transcendent year. The discovery of the New World and the vast hordes of gold and new riches was a springboard vaulting Spain from a barely-known kingdom in medieval Europe, to the most influential global power of the day.
However, this process was not immediate. Despite the vast gold inflows that Spain received, the discovery was a mixed blessing. During this prosperous time, the Spanish Crown declared itself bankrupt nine times: 1557, 1575, 1596, 1607, 1627, 1647, 1652, 1662, and 1666. Spanish finances did not improve significantly until after the War of the Spanish Succession (1701–14) when the Bourbons succeeded the Habsburgs to the Spanish throne.
War and Inflation under the HabsburgsThe seeds of modern Spain were sown when Queen Isabella and King Ferdinand unified the Kingdoms of Castile and Aragon in the fifteenth century. Their eldest daughter, Juana, was crowned upon their deaths. Since Juana’s husband, Philip, was Austrian, this also meant that the Habsburgs became the royal house of the newly unified Spain.
It was during the reigns of Philip and Juana’s son Charles I (1500–58) — and, in turn, his son Philip II (1527–98) — that Spain achieved its pinnacle of international power and influence. Rich with gold from the New World, the later Spanish Habsburgs poured great amounts of money into the military and pursued a religious crusade against the growing Protestant secessionist movement in Northern Europe.
The result of this flow of gold from Spain to Northern Europe has been well-studied. Richard Cantillon described the pernicious effects of monetary expansion with what is now called the Cantillon effect. Inflation caused high prices to spread like a wave across Europe, mostly following the path of the Spanish troops as they marched to the drum.
It is important to note, however, that the average Spaniard’s income did not increase over this period as only a few directly benefited from trade with the Americas or were involved in the new wartime economy. Spaniards as a whole were becoming poorer since the discovery of the Americas.
During the reign of Philip III (1578–1621) the crown declared its fourth bankruptcy. As a mercantilist economy, new policies were implemented in a vain effort to escape the crown’s financial problems. The government issued a new copper coinage aimed at paying off its creditors without resorting to direct taxation. Much to the crown’s dismay, the new “vellón” was not well received because it was not made of gold, and it never attained widespread acceptance.
Monopoly, Mercantilism, and More WarDuring the reign of his successor, Philip IV (1605–1665), Spanish wars continued throughout Europe. Meanwhile, in Spain, farmers struggled with frequent droughts which made food expensive and scarce, while government-backed privileges to the elites continued mismanagement of much of the land. Chief among these privileges was the “Mesta” (an association of sheep ranchers) who enjoyed the right to graze their animals freely anywhere in the kingdom. Making the situation worse, the Black Death made a brief reappearance.
With a decreasing population and active war fronts in Europe, the king needed a solution that would expand Spain’s military forces. The king’s prime minister, the Count-Duke of Olivares, came up with the “Union of Arms,” a new law that would increase military cooperation between the kingdoms ruled by Philip IV (Castile, Aragon, Portugal, Naples, Sicily, Milan, and Spanish Netherlands).
Before this, it was Castile and its people — plus the Americas — which bore all military expenses. The Union of Arms distributed the cost of war across all the kingdoms, and thus diffused the full cost away from the King’s native Castile. But, by the end of Philip’s reign, gold coming from the Americas was still being spent on an increasingly inefficient military that was losing wars. These defeats led to independence movements in both Portugal and the United Provinces (the Netherlands).
The Empire Enters Its Final DecadesThe last Habsburg monarch of Spain, Charles II (1661–1700) did not father an heir. After his death, the pretenders to the Spanish throne were his great-nephews Charles (Austria) and the future Philip V (France). The War of the Spanish Succession began with France and Spain united against Austria. The war ended in 1713 with the Treaty of Utrecht in which Spain lost its European territories to Austria.
As a broken nation with a newly established French dynasty under the Bourbons, Spain faced many challenges. The Spanish economy had foundered under Carlos II, particularly in Castile. The country’s population decreased by nearly two million people during the seventeenth century, partially due to plagues and wartime causalities, but more so due to emigration to the New World as Spaniards sought a better life.
The first Bourbon monarchs of Spain were Philip V and his sons: Louis I, Ferdinand VI, and Charles III. The country’s structures were still medieval with each region having its own laws and privileges as opposed to the centralist mentality of the Bourbons, who firmly believed in uniformity.
Small Steps toward LiberalizationCharles III (1716–1788) is referred to as either an enlightened despot or a liberal reformer as his reforms responded to the deficiencies of the previous mercantilist period. Charles adopted a relatively peaceful attitude toward foreign affairs. Having cut wartime expenditures, he explored new possibilities for filling the state’s coffers.
His first measure was building new shipyards to improve Spanish shipping and speed up the arrival of gold from the Americas. Charles could be considered an early liberal in the sense that his reforms were oriented to opening trade relations and removing special privileges that certain groups held. (Of course, not all his policies were beneficial: in order to stimulate Spanish industries he placed levies on foreign products, though at least he had the prescience to remove internal barriers in the Iberian Peninsula so that goods could be traded freely throughout the territory.)
Charles also sought to improve Spanish competitiveness when trading with the colonies by opening commerce with the Americas to eight new ports in Spain in 1765. Previous to the liberalization, Cadiz held a monopoly.
With these reforms, the Spanish economy started its revive. Charles planned further reforms in the agricultural sector, and he reduced the privileges of the sheep ranchers and expropriated the communal lands of the Spanish countryside to sell them to private individuals, thus ending centuries of neglect created by what can today be seen as a tragedy of the commons.
This period of liberalization and relative prosperity lasted until 1808 when Napoleon invaded Spain.
Lessons from Three Centuries of Booms and BustsThe Napoleonic Wars marked the end of a three-centuries long “boom-bust-boom” cycle in Spain that started with the discovery of the New World in 1492, and was marked by inflation, war, mercantilism, and a variety of government monopolies and interventions.
Although the country seemed wealthy at many times during this period, the average Spaniard lived in continued poverty, and it was only with the reforms brought by the early Bourbon monarchs that many Spaniards began to enjoy the benefits of trade and liberalization that many Europeans elsewhere had long since discovered.
According to the National Bureau of Economic Research (NBER), a recession is defined as a “significant decline in economic activity spread across the economy, lasting more than a few months.” Often, this is understood as two consecutive quarters of negative economic growth as measured by a country’s GDP.
Public opinion is generally quite simple in regard to recession: upswings are generally welcomed, recessions are to be avoided. The “Austrians” are however at odds with this general consensus — we regard recessions as healthy and necessary. Economic downturns only correct the aberrations and excesses of a boom. The benefits of recessions include:
Sclerotic structures in the labor market are broken up and labor costs decline.Productivity and competitiveness increase.Misallocations are corrected and unprofitable investments abandoned, written off, or liquidated.Government mismanagement of the economy is exposed.Investors and entrepreneurs who were taking too great risks suffer losses and prices adjust to reflect consumer preferences.Recessions also allow a restructuring of production processes.At the end of the corrective process, the foundation for a renewed upswing is more stable and healthy. We thus see deflationary corrections as a precondition for growth in prosperity that is sustainable in the long term. Ludwig von Mises understood this when he observed:
The return to monetary stability does not generate a crisis. It only brings to light the malinvestments and other mistakes that were made under the hallucination of the illusory prosperity created by the easy money.
Can the Government Save Face?However, in addition to leading to true temporary hardship for the malinvestment-affected areas of the economy, an economic recession in the near future would represent a harsh loss of face for central bankers. Their controversial monetary policy measures were justified as an appropriate means to nurse the economy back to health. That is, their efforts to end or avoid helpful recessions were claimed to contribute to the eagerly awaited self-sustaining recovery.
But the attempt to combat a crisis that was triggered by too loose monetary policy by the very same means will not lead to sustainable prosperity. It will only delay the crucial adjustment processes of a deflationary phase. The longer they are delayed and the more the central bankers and politicians attempt to keep them at bay, the more uncomfortable this adjustment will become.
Politics Trumps EconomicsIn general, there is the tendency in every democratic system to prevent too-painful adjustment processes as its nature of short-term bitterness and long-term benefits conflicts with the result scheme politicians are reelected for. No democratic government that is presented with the bill for the obvious successes and failures of its administration at the next election, will voluntarily allow a deep recession to occur — even if it were to agree that the adjustment was necessary.
Hence, inflationary policy is always a welcome method of impoverishing the population by decree and thereby pushing through a real adjustment of prices by force. The debasement of money as a rule always hits a society’s most underprivileged the hardest, as rich people can more easily avoid a devaluation of their wealth.
Concern from Outside the Austrian CampNonetheless, representatives of the Austrian school are no longer alone in warning about the fatal long-term consequences of the zero interest rate policy. Even the Bank for International Settlements, often referred to as the “central bank of central banks,” understands that endless attempts at avoiding recessions can have truly negative effects.
The BIS’s 2014 report warns of overly euphoric financial markets which, according to The Financial Times are “out of step with reality.”
The BIS explains:
Particularly for countries in the late stages of financial booms, the trade-off is now between the risk of bringing forward the downward leg of the cycle and that of suffering a bigger bust later on.
New debt serves primarily to keep the fragile edifice of debt from collapsing; it doesn’t lead to new investment activity. In this respect, the BIS sees parallels between Western industrialized nations today and Japan in the 1990s. These policies, the BIS contends “destabilises the banking sector directly but also acts as a drag on the supply of credit and leads to its misallocation.”
This year, the ECB, which as the successor of the German Bundesbank has long kept the flag of inflation reservation flying, finally capitulated and began betting on increased monetary stimulus — in keeping with the motto: “It isn’t working, so let’s do more of it!”
Nevertheless, according to F.A. Hayek, these united global crisis defense mechanisms only postpone the crisis which will take place at any rate, only later and much more severely:
To combat a depression by a forced credit expansion, is akin to the attempt to fight an evil by its own causes; because we suffer from a misdirection of production, we want even more misdirection — an approach that necessarily leads to an even more serious crisis once the credit expansion comes to an end.
It seems that each new bubble brings forth claims that, although the bubble may be the result of artificially created demand, prices of this or that product will not fall and may even continue to rise. How many so-called real estate and financial planning “experts” claimed that the surest path to financial security was in buying the largest house possible with the least amount of one’s own money?
The Boom: McMansions and Luxury CarsSince home prices never go down — we were told — the gain from using OPM (other people’s money) resulted in huge multiples of gain for the little invested of one’s own money. Thus, in the first decade of the new century, Americans were buying so-called McMansions: huge homes with every imaginable feature. When the bubble burst, the leverage effect worked in reverse. Mortgage balances far exceeded the lower market price, creating the so-called “underwater mortgage.” Lower prices had wiped out not only the little equity contributed by the buyer, but created a negative equity balance. Buyers abandoned their heavy mortgages and sought smaller, lower priced homes. It turned out that home prices did not grow to the sky, as the pundits had predicted.
The same is true of automobiles, and especially those bought with auto loans. Easy credit has enticed car buyers into ever more luxurious and amenity-laden vehicles. It is nearly impossible today to buy a new car that is not loaded with luxury entertainment, navigation, and safety features that were unknown only a few years ago.
Many of these features would never have been sold in such quantities without the benefit of easy credit. As a frequent car rental customer, I have been exposed to these features and have found them difficult to use at best and completely unnecessary and distracting at the worst. On a recent business trip my modest sized four door Buick sedan’s speedometer was projected onto the windscreen and the lane proximity warnings beeped at me constantly. I never did figure out how to turn off these annoying devices, which, I admit, may be desired by a marginal few drivers. But we Austrians know that all economic choice is based on a hierarchy of preferences. The cost of each preference is measured in the alternative preferences one sacrifices. Make some preferences cheaper and they move up our personal scale. Easy auto credit meant that buyers did not have to sacrifice as many alternative uses for their money.
Last week, Tommy Behnke in Mises Daily predicted that auto prices will fall as the bubble bursts from the artificially created demand generated from excessive credit creation. Behnke pointed out that car production has increased a whopping 100 percent since 2009, but that apologists for government’s monetary stimulus programs see this fact as proof of the success of their Keynesian, aggregate demand hypothesis.
Behnke, on the other hand, took the Austrian perspective that the government has simply substituted a bubble in subprime auto loans for the bubble in subprime home loans. As defaults rise and automobile loan credit tightens, the result will be the same. Namely, a flood of used cars, and falling prices. The same happened with homes following the burst of the last bubble: a flood of “used” houses, and falling prices.
Surprisingly, the article attracted a number of reader comments predicting that used car prices would not fall, allegedly due to increases in complexity of cars or increases in the difficulty of repairing them. Another suggestion was that large dealers will dominate the used car market and simply raise prices at will.
While it’s certainly true that government interference — such as Cash for Clunkers — can raise the prices of cars, it is not true that private dealers (or any other private party) can simply raise the price. More complex and difficult-to-fix cars will not keep prices from falling in an environment in which the inventory of used cars is increasing.
Used Car Dealer or Used Car Collector?There is one thing that we can know a priori: that an increase in the supply of some good or a drop in its demand will cause its price to be lower than that which it otherwise would be. There is no other way to clear the market.
Mises explained that, eventually, even a monopolist would prefer any price to zero price. Maintaining a price above the market clearing price produces zero revenue. In a flooded used-car market, car dealers must reduce their prices in order to avoid bankruptcy. Otherwise, the used car dealer ceases to be a dealer and becomes a collector. The laws of supply and demand have not been rescinded, even in a world with very expensive-to-build and complex cars. As the automobile bubble bursts, quality used cars will flood the market, creating a buying opportunity for those with cash.
As with houses, it doesn’t matter how big or luxurious or complex you make new cars. When the credit bubble bursts, auto prices will not “always go up.”
The global economy continues to wrestle with deflation, with oil reaching its lowest price in over a decade. The economic winds continue to look ominous, with even mainstream outlets questioning whether 2016 could be worse than 2008. Of course much of the week headliners was dominated by political theater, first with the annual absurdity of the President’s State of the Union address and then Thursday’s Republican so-called debate. While it’s nice to see politicians quote Ludwig von Mises, this political season has as much of a chance of resulting in economic sanity as Joe Biden does curing cancer.
The newest episode of Mises Weekends continues the theme of political theater, taking a look at the visceral reaction to Ted Cruz’s earlier debate comments about gold and monetary policy. Dr. Joseph Salerno joins Jeff to discuss why gold — or currency competition in general — is so offensive to the central planners of both parties. They dive deeper into the fundamental question of a gold standard itself: would it really need to be “imposed” on a country? And how do the Fed's interest rate targeting and open market operations obscure what is really going on with our money?
And in case you were fortunate enough to gain some monetary value on your Powerball ticket, we hope you will consider becoming a Member of the Mises Institute — or join us at our upcoming Houston Mises Circle on January 30!
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Is the Auto Loan Bubble Ready to Pop? by Tommy BehnkeAustrian Economics Is More than Free-Market Economics by Matt McCaffreyWill Immigration Force a Change in Sweden’s Labor Laws? by Per BylundIs Eating a Cinnamon Roll Irrational? by Tyler KubikDo Video-Game Worlds Need Government Regulation? by Giuliano MillanThe Big Short by Mark ThorntonThe Real Value of a Powerball Ticket by Matt McCaffreyThe Swiss Consider a National Referendum on Fractional Reserve Banking by Jeff DeistRand Paul Quotes Mises in Time by Tho BishopDavid Bowie, RIP by Joseph T. SalernoOil Price at 11-Year Low as Economy Falls, Dollar Rises by Ryan McMakenRepublican AGs Declare Colorado a "Drug Cartel," Demand Federal Intervention by Ryan McMakenThe Times They Are A Changin' by Carmen Elena DorobățCalling All Mises AlumniHow Price Controls Leads to Socialism by Ludwig von MisesWhy We Need Markets To Know Who Should Own Western Lands by Ryan McMaken
Why is the boom-and-bust cycle so persistent? Why did economists fail to predict the recent economic meltdown--or to pull us out of the crisis more quickly? And how can we prevent future calamities?
Mainstream economics has no adequate answers for these pressing questions. In the powerful and eye-opening new book It Didn't Have to Be This Way, Harry Veryser shows how the Austrian School of economic provides the proper alternative to the failed interventionist approach: liberty, private property, and the unhampered market.
In The Real Crash, New York Times bestselling author Peter D. Schiff argues that America is enjoying a government-inflated bubble, one that reality will explode . . . with disastrous consequences for the economy and for each of us. Schiff demonstrates how the infusion of billions of dollars of stimulus money has only dug a deeper hole: the United States government simply spends too much and does not collect enough money to pay its debts, and in the end, Americans from all walks of life will face a crushing consequence.
We’re in hock to China, we can’t afford the homes we own, and the entire premise of our currency---backed by the full faith and credit of the United States---is false. Our system is broken, Schiff says, and there are only two paths forward. The one we’re on now leads to a currency and sovereign debt crisis that will utterly destroy our economy and impoverish the vast majority of our citizens.
However, if we change course, the road ahead will be a bit rockier at first, but the final destination will be far more appealing. If we want to avoid complete collapse, we must drastically reduce government spending---eliminate entire agencies, end costly foreign military escapades and focus only on national defense---and stop student loan or mortgage interest deductions, as well as drug wars and bank-and-business bailouts. We must also do what no politician or pundit has proposed: America should declare bankruptcy, restructure its debts, and reform our system from the ground up.
Persuasively argued and provocative, The Real Crash explains how we got into this mess, how we might get out of it, and what happens if we don’t. And, with wisdom born from having predicted the Crash of 2008, Peter Schiff explains how to protect yourself, your family, your money, and your country against what he predicts.
The life and work of Ludwig von Mises is marked by the appearances of large treatises, on topics from money to methodology. But along the way, he also wrote many shorter articles and essays. The essays collected in this volume are from the interwar period, when Mises was working for the Vienna Chamber of Commerce. They concern monetary policy, fiscal policy, the boom and bust cycle, trade, economic calculation, socialism, and the history of ideas.
Some of the essays have never before appeared in print, and only surfaced with the discovery of Mises's personal papers, which had landed in Moscow after World War II. This volume is beautifully produced and printed, with outstanding editorial work by Richard Ebeling. A special bonus is a Soviet-sponsored attack on Mises, appearing in a Soviet journal, and published here for the first time.
The first full week of 2016 has been an eventful start to the year.
In Oregon, the Federal government’s control over most of the American west continues to cause issues with ranchers — even though they themselves enjoy benefits from the arrangement. On Tuesday, President Obama continued the bipartisan assault on gun rights with an argument reliant on inflated statistics. Meanwhile, Rand Paul finds Mises, Bernie Sanders still hasn’t learned that price controls are bad, and Americans are voting with their feet for lower taxes.
On the global stage, China’s unsustainable economy continues to show signs of weakness, while new data shows Krugman is still very wrong about Europe, and socialism has done funny things to Venezuelan exchange rates.
We also took a moment to consider the legacy of Murray Rothbard twenty-one years after his passing. Luckily the ideas of Rothbard, Mises, and the rest of the Austrian school have never been more widely spread, in large part due to the work of a new generation of scholars that have come through the Mises Fellowship program.
Our latest Mises Weekends focuses on the Switzerland referendum on 100 percent reserve banking. Our friend Claudio Grass, managing director of Global Gold in Switzerland, joins Jeff Deist to give his thoughts. Who’s behind the referendum? How have the Swiss public reacted? Does it have a chance?
Jeff and Claudio offer comprehensive analysis you won’t get anywhere else.
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Why Austrians Are Not Neoliberals by Philipp BagusAre We Headed for Another Bust? by Frank Shostak"Paradise for an Austrian Researcher" by David Sanz BasVenezuela's Bizarre System of Exchange Rates by Emiliana Disilvestro and David HowdenEnd Injustices Now, Not Later by Gary GallesOn Gun Control, Obama Looks like Reagan and Bush by Ryan McMakenRand Paul Echoes Mises on Money by Tho BishopOregon and the Problem of Federal Lands by Ryan McMakenRemembering the First World War: the Centennial of the 1916 Slaughters by T. Hunt TooleyGuns Don't Cause Suicide by Ryan McMakenThe Basic Lessons of Keynesian Economics by Joseph SalernoPolice Departments Overflowing with Extra Time, Money by Ryan McMakenWould President Sanders Repeal Dodd-Frank? by Tho BishopCensus Data Shows People Are Fleeing High-Tax States by Ryan McMakenMost Market Criticism is Simply Poor Science by Per BylundMurray Rothbard by David GordonA Call to Activism from the Late Margit von Mises by Jeff DeistRothbard's Legacy, 21 Years Later by Ryan McMakenCultural Marxism Explained in 7 Minutes by Joseph SalernoPaul Krugman is Still Wrong on Europe by Louis RouanetHow The Feds Got All That Western Land (and Why It's a Problem) by Ryan McMaken
On Tuesday, it was announced that over seventeen million new vehicles were sold in 2015, the highest it’s ever been in United States history.
While the media claims that this record has been reached because of drastic improvements to the US economy, they are once again failing to account for the central factor: credit expansion.
When interest rates are kept artificially low, individuals are misled into spending more than they otherwise would. In hindsight, they discover that their judgment errors wreaked havoc on their financial well-being.
This is a lesson that the country should have learned from the Subprime Crisis of 2008. Excessive credit creation led too many individuals to buy homes, build homes, and invest in the housing industry. This surge in artificial demand temporarily spiked prices, resulting in over four million foreclosed homes and the killing of over nine million US jobs.
Instead of learning from the mistakes that sent shock waves throughout most of the planet, the Federal Reserve has continued with its expansionist policies. Since 2009, the money supply has increased by four trillion, while the federal funds rate has remained at or near zero percent. Consequently, the housing bubble has been replaced with several other bubbles, including one in the automotive industry.
Automotive companies have taken advantage of the cheap borrowing costs, increasing vehicle production by over 100 percent since 2009:
Source: OICAIn order to generate more vehicle purchases, these companies have incentivized consumers with hot, hard-to-resist offers, similar to the infamous “liar loans” and “no-money down” loans of the 2008 recession. Dealerships have increased spending on sales incentives by 14 percent since last year alone, and the banners in their shops now proudly proclaim their acceptance of any and all loan applications — “No Credit. Bad Credit. All Credit. 100 Percent Approval.” As a result, auto loans have increased by nearly $80 billion since 2009, many of which have been given to individuals with far-from-stellar credit scores. Today, almost 20 percent of all auto loans are given to individuals with credit scores below 620:
Source: New York FedNot only are more auto loans being originated, but they are also increasing in duration. The average loan term is now sixty-seven months (that’s 5.58 years) for new cars and sixty-two (that’s 5.16 years) months for used cars. Both are record numbers.
Average transaction prices for new and used cars are also at their record highs. Used car prices have increased by nearly 25 percent since 2009, while new car prices have increased by over 15 percent. Part of this has to do with the increasing demand for cars generated by the upsurge in auto loans. The main reason, however, is that consumers — taking advantage of the accessibility of cheap credit — are purchasing more expensive body styles. This follows the housing bubble trend, when the median size of a newly built single-family home rose to 2,272 square feet at the start of 2007.
We all know the end result of the Great Recession — prices soared, millions of houses were foreclosed, and unemployment surged. Demand for homes then plummeted, and home prices ultimately dropped by 20 percent each month.
The auto bubble has yet to burst, but its negative effects are already starting to gradually appear. For one, delinquencies on car loans have increased by nearly 120 percent, from just over 1 percent in 2010 to 2.62 percent in 2014. Since cars rapidly depreciate in value, this number is projected to spike. By the time these six, seven, and eight year no-money down loans are due to be paid in full, many of these vehicles won’t be worth paying off anymore — maintenance and loan costs will start exceeding the value of the cars.
According to the Center for Responsible Lending, one in every six title-loan borrowers is already facing repossession fees. If defaults sharply increase in the coming years as projected, the market will become flooded with used cars, and their prices will, with near certainty, fall to a significant degree.
Other pieces of economic data indicate that the automotive bubble may already be starting to pop. Non-revolving credit — fixed-payment plan credit — rose by just $8.3 billion in November, the smallest monthly increase since February 2012. This is a far cry from the $15.5 billion increase in October and $22 billion rise in September.
Although 2015 was a record-setting year for the automobile industry, individuals have been purchasing fewer and fewer cars each month. Seasonally-adjusted sales have declined by nearly 1 million since October. As a result, auto sales are now sitting at a 6 month low. ZeroHedge has reported that fewer Americans are expecting to purchase automobiles now than at any time since January 2013 — an alarming statistic given that the motor vehicle inventory-to-sales ratio is now at its highest point since August 2008.
At a time when labor force participation is at its lowest level since 1977 — at a time when real wages are rising less than they have since at least the 1980s — it is imperative that the Federal Reserve stop misleading individuals into making irrational investments. The economy is simply too frail to continue weathering these endless business cycles. Economists, politicians, and the general populace need to start learning from their economic history so they can begin recognizing that favoring debt over thrift isn’t beneficial to the country’s financial well-being. Failure to do so will simply lead to more bubbles, more malinvestment, and more economic headaches in the years to come.
Happy New Year from everyone at the Mises Institute. After an exciting 2015 filled with important research, exciting global growth, and widespread recognition for our success in spreading the cause of Austrian economics, freedom, and peace, we look forward to what 2016 will bring.
We hope you will make a resolution to join us at one of our events this year and thank you again for your continued support.
Mises Weekends this week features Fox News Senior Judicial Analyst and Distinguished Scholar in Law and Jurisprudence at the Mises Institute, Judge Andrew P. Napolitano. Judge Napolitano discusses the difference between natural and legislative law. You won't want to miss this talk with one of the most prominent advocates of liberty in America today.
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
PC Is About Control, Not Etiquette by Jeff DeistMises: An Audacious Champion of Freedom by Lew RockwellThe Formlessness of Progressivism by Yonathan AmselemEntrepreneur, Economy, and State by Greg MoranWill 2016 Be the End of the Current Skyscraper Boom? by Mark ThorntonSwitzerland to Vote on 100% Reserve Banking by Mark Thornton2015: The Year in Austrian Economic Research by Matt McCaffreyThe Big Short's Michael Burry on the Crash by Hunter LewisWhat Populism Is And Isn't by Hunter Lewis
[Greg Morin is the CEO and owner of Seachem Laboratories Inc. Greg is a chemist, entrepreneur, writer/blogger on a host of libertarian topics, and a Mises Institute Society Member.]
THE AUSTRIAN: How did you first discover the Mises Institute?
GREG MORIN: Quite by chance, actually. Back when the bubble was collapsing in the fall of 2008 I was on an adult recreational league soccer team and one of the other team members was Erich Mattei — a former Mises U grad and student of Walter Block’s. There was an email exchange between some of us on the team about all the silly things they were doing to stem the market collapse and after the jokes died down Erich suggested I check out the Mises Institute if I wanted to learn more about what was actually going on. So I did. And I ended up buying The Mystery of Banking by Murray Rothbard, and that was that. I was drawn in by the clarity of his prose and the undeniable logic of the ideas and soon ordered book after book.
TA: Why did you decide that the Mises Institute was something you wanted to support?
GM: I decided to support the Mises Institute after attending some of their events (Mises Circle events and the Austrian Economics Research Conference) and it became clear that everyone involved or associated with the Institute were true scholars and professionals. I knew my money would not be wasted. I also quickly came to appreciate the importance of what the Institute was doing — not merely acting as a think tank or clearing house of information but rather as a catalyst to ensure these ideas are passed on specifically to the next generation. Although “the children are our future” is certainly a clichéd insight it is nevertheless true. The more of the youth who understand the foundations of liberty today the greater the likelihood we will have a freer future. That mission, perhaps more than any other, is why I support the Mises Institute.
TA: As a business owner, what do you think, for you, are the most valuable insights the Austrian school has to offer?
GM: To be honest, I’m not sure. I say that not to discount the Austrian school but rather because of the fact that I’ve never taken any formal economics classes. I was not exposed to the subject at all until I encountered the Institute, so in learning economics the “proper” way from the beginning, I’m not sure what would be different had I learned it the other way. One tangible effect it has had in my business is how it has shaped our market investment decisions relative to my awareness of the market distortions caused by state intervention. I definitely don’t invest in any sort of government bond!
I’ve also mostly divested out of the market because it is apparent it is more akin to a government-run casino than a real market. Manipulation of the market fosters volatility and that makes it very difficult to make rational investments. I suppose I can say though that the purchase of gold and silver as an inflation hedge are definitely an outgrowth of my knowledge of AE. I’ve also come to realize that as entrepreneurs, none of us has any idea what we are doing! We make the best guess with the information we have and hope for the best and if we are wise (and lucky) we’ll adjust quickly if we can.
Ultimately it is the market that decides if we know what we are doing or not. I guess to sum it all up, Austrian insights distill the complexity of what we business owners do down to a very simple mantra: satisfy the desires of others. That’s it, that’s all any of us are trying to do. As an aside I’d say unexpectedly it’s given me better insights into how an employee relates to an employer. An employee is like any other vendor. They are a business unto themselves. If they wish to “win” in the employment market they must do what any vendor would, offer a product so good your customers wouldn’t dream of going anywhere else.
TA: Having worked in your field for more than one business cycle, how has the boom-bust cycle impacted your business and your employees, and how has your knowledge of Austrian economics helped you gain insight into the process?
GM: I’ve always run my business very conservatively even before I was aware of Austrian economics, so perhaps I was predisposed to its teachings as they made a lot of sense to someone that rejects the notion of massive amounts of leverage in order to foster growth. Prior to exposure to the Austrian school things like the Accumulated Earnings Tax were a baffling mystery to me. Now the motivation for this tax is all too transparent: the more times cash churns back and forth through the economy the more opportunities the state has to take its cut. Likewise, compelling companies to run on a shoe-string of cash means they have to borrow simply to maintain operations — and more borrowing means more inflation (due to fractional reserve lending) which means more tax revenue. I recognize how this mode of operation leaves a business financially fragile and at the mercy of the banks. I refuse to play that game. We maintain “large” (what I consider reasonable) cash balances and the stability we have gained from owning our cash (vs borrowing it) has allowed us to weather these storms. During the downturn in 2000 I learned the hard way the truth of the aphorism that a banker will give you an umbrella when it is sunny and take it away when it rains. Never again.
TA: Has Austrian economics helped you better understand how the government’s response (i.e., stimulus, taxation, regulation) to economic busts has impacted you and your business?
GM: I already had an intuitive sense on these things that they were bad for business (well everyone knows taxes are bad!). But yes, Austrian economics did help bring some focus in my mind as to just how disruptive state interference can be to running a business. The pain of these things has always been there, AE simply helped bring it into sharper focus. Unfortunately there’s not much one can do with that knowledge in either case. The state will do what the state will do and as business owners we are powerless to stop it. We have large capital investments and are relatively immobile. We are also “plugged into” the banking system. We cannot simply choose to go our own way or thumb our nose at the state. We are under constant threat of financial retaliation if we do not comply. Even if relocation were a viable option (it’s not for us because of the enormous capital investment needed to make that transition) there really isn’t any place on this planet significantly better. So as I mentioned with the second question, all we can do is hope that the next generation is influenced by the Mises Institute and that the investment we make now in supporting the Institute will pay out dividends of liberty in the future.
On Wednesday December 16, 2015, Federal Reserve Bank policymakers raised the federal funds rate target by 0.25 percent to 0.5 percent for the first time since December 2008. There is the possibility that the target could be lifted gradually to 1.25 percent by December next year.
Fed policymakers have justified this increase with the view that the economy is strong enough and can stand on its own feet. “The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident the inflation will rise over the medium term to its 2 percent objective,” the Fed said in its policy statement.
Unwarranted OptimismVarious key economic indicators such as industrial production don’t support this optimism. The yearly growth rate of production fell to minus 1.2 percent in November versus 4.5 percent in November last year. According to our model the yearly growth rate could fall to minus 3.4 percent by August.
Although the yearly growth rate of the CPI rose to 0.5 percent in November from 0.2 percent in October according to our model the CPI growth rate is likely to visibly weaken.
The yearly growth rate is forecast to fall to minus 0.1 percent by April before stabilizing at 0.1 percent by December next year.
So from this perspective Fed policymakers did not have much of a case to tighten their stance.
Fed policymakers seem to be of the view that the almost zero federal funds rate and their massive monetary pumping has cured the economy, which now seems to be approaching a path of stable economic growth and price stability, so it is held.
With this way of thinking the role of monetary policy is to make sure that the economy is kept at the “correct path” over time.
Following in Greenspan’s FootstepsDeviations from the “correct path,” it is held, occur on account of various shocks, which are often seen as a mysterious nature. We suggest that the present Fed is following the footpath of Greenspan’s Fed, which was instrumental in setting in motion the 2008 economic crisis.
An important factor behind the 2008 economic crisis was the previous loose monetary stance of the Fed, headed at the time by Alan Greenspan. The federal funds rate target was lowered from 6.5 percent in December 2000 to 1 percent by May 2004.
This massive lowering of interest rates was instrumental in triggering the economic boom that followed, in particular in the real estate market. Also, the then Fed policymakers were arguing that the aggressive lowering of interest rates was necessary to stabilize the economy, i.e., to bring it on the “right path.”
By June 2004, Fed policymakers had reached the conclusion that the economy didn’t require more help from the Fed and could stand on its own feet. Consequently, the central bank lifted the federal funds rate target by 0.25 percent in June 2004 to 1.25 percent. The Fed adopted a policy of a gradual tightening of interest rates until June 2006. Note that by June 2006 the target was set at 5.25 percent and was kept at that level until August 2007.
The 2008 Crisis Exposed the Problems of Fed PolicyThe Fed’s view at the time was that a gradual tightening (each time by 0.25 percent) of the interest rate stance would prevent the unnecessary disruptions and would permit Fed policymakers to navigate the economy more accurately toward a path of stable economic growth and stable prices. The economic crisis of 2008 shattered all that.
Yet, manipulations by the Fed could not bring the economy onto a path of stability and prosperity but, on the contrary, set in motion the menace of the boom-bust cycle.
The Boom Creates the BustBy means of an artificial lowering of interest rates the central bank gives rise to various activities that cannot support themselves without the easy monetary stance of the central bank.
The lower interest rate stance, which is also accompanied by increases in the money supply growth, sets in motion the diversion of real wealth from wealth generators to various nonproductive or bubble activities. (These activities cannot support themselves and couldn’t have emerged in a free market environment.)
The emerging economic boom, which is falsely labeled as an economic prosperity, leads to the weakening of the wealth generation process.
At some stage the central bank, which follows various economic indicators to justify interest rate manipulations, reaches the conclusion that the economy is starting to deviate from the “correct path.”
Consequently the loose interest rate stance is reversed. This begins to undermine the survival of various bubble activities — an economic bust ensues.
The magnitude of the bust is influenced by the extent of the previous loose monetary stance and by the state of the pool of real wealth. (Note that what permits economic growth is the pool of real wealth which funds economic activities.)
Now, if the pool of real wealth is stagnating or shrinking, then regardless of the Fed’s policy, the economy can’t show a general economic growth.
A tighter interest rate stance coupled with a shrinking pool of real wealth will not only undermine bubble activities but also good activities, which couldn’t be introduced on account of the lack of real funding.
As time goes by though a tighter stance will eliminate bubble activities and will leave more real wealth at the disposal of wealth generators and will permit the introduction of various wealth generating activities.
The prolonged low interest rate policy of the Fed, on top of the Fed’s previous loose monetary policies (during Greenspan’s era), has severely weakened the pool of real wealth, which is currently in a dire state.
This raises the likelihood that the elimination of bubbles as a result of a tighter stance while good in the long-term for wealth generators is likely to trigger a severe economic slump in the near to medium term.
With more financing in place, the world’s tallest skyscraper is moving forward.
Recent media reports indicate that the final segment of financing has been obtained for the $1.2 billion Jeddah Tower project in Saudi Arabia. This is the financing that would be necessary to bring the project to record heights. Media reports also show that the structure has risen to more than seventy-five meters (246 feet) and construction is proceeding at an uninterrupted pace.
Above ground construction on the long delayed Jeddah Tower started in September 2014, but there was considerable doubt that the financing of the one kilometer (3,280.84 feet) tower could be obtained, given the shaky financial conditions in Saudi Arabia.
But the Jeddah Tower is only the latest phase in an enormous boom that began setting new records in 2014. As I reported nearly a year ago:
Super tall buildings, or skyscrapers, are being built at an astonishing rate. Ninety-seven buildings that exceed 200 meters (656 feet) high were constructed in 2014, setting a new record. The previous record was eighty-one buildings completed in 2011. The total number of skyscrapers in existence now is 935, a whopping 350 percent increase since the year 2000.
If completed as planned, the Jeddah Tower will be the tallest in the world. The International Business Times reports:
Saudi Arabia’s Kingdom Tower in Jeddah is slated to become the world’s highest skyscraper when it is erected in 2020, knocking Dubai’s Burj Khalifa tower from its perch as tallest building at 2,716 feet. The new tower will claim the title if it reaches its planned height of 3,280 feet. …The 200-floor Kingdom Tower will be part of a reported $8.4 billion project to construct Jeddah City. Construction of the skyscraper will entail 5.7 million square feet of concrete and 80,000 tons of steel …
Time for a Skyscraper Alert?In other words, the Tower is just part of an even more massive project, and it’s time for a new skyscraper alert.
A skyscraper alert is a market indicator suggesting a significant economic crisis in the near future. This alert could have been issued earlier because the alert is based on the ground breaking ceremonies of a world record setting skyscraper, not the initial announcement of the project which occurred in August of 2011.
The completion of record-setting skyscrapers has long seemed to indicate the beginning of economic crises.
The Singer Building (September 1906) and Metropolitan Life Insurance Building (1907) began construction before the Panic of 1907 and were later completed in 1908 and 1909, respectively.
Construction began on 40 Wall Street (now the Trump Building), Chrysler Building, and the Empire State Building all prior to the crash on Wall Street which began in the fall of 1929 only to have the record-setting buildings open in the beginning of the Great Depression in 1929, 1930, and 1931, respectively.
Construction of the World Trade Center towers began in August 1968 and January 1969 and opened in December 1970 and January 1972, respectively. The economy was then in a bad recession and the Bretton Woods Crisis at hand. The Sears Tower (now the Willis Tower) began construction in April of 1971 and opened in May of 1973 during the 1973–1974 stock market crash and the 1973 oil crisis.
Such alerts indicate looming danger in the economy of significance. However, the danger is not necessarily imminent. The next pivotal date is when the construction project reaches a point where it has broken the record. That date is difficult to estimate given the whims of construction. Media reports indicate that the Jeddah project will possibly be completed in 2020 without indicating whether that date is the record setting date, the completion date, or the opening ceremonies.
It is significant that the record being broken by the Jeddah Tower is the record set by the Burj Khalifa in Dubai. In some ways, the Burj Khalifa has become something of a symbol of the excesses of the last bubble.
Set to become the tallest building in the world, the Burj Khalifa in 2009 began to experience financial trouble and had to delay payment on its debt to finance construction. When the Burj Khalifa officially opened in January of 2010, the sovereign fund of the United Arab Emirates, which built the skyscraper, was broke and had to be bailed out by the sheikh of Abu Dhabi for $10 billion.
So, will this latest frenzy of new construction tip us off to the next bust? The skyscraper index is silent on the issue of timing so the dating of when the skyscraper curse is apparent is just guess work. It seems that the boom-bust cycle reaches its peak around the time the new record is set and is called a Skyscraper Signal, if imminent economic danger is looming. In most episodes, record breaking skyscrapers have their opening ceremonies when the economic crisis is readily apparent.
The important thing to remember is that skyscrapers do not cause economic crises. Rather they are just a very noticeable example of the distortions taking place throughout the economy when interest rates are kept artificially low by the central bank.
In addition to record breaking skyscrapers, there are many less perceptible changes taking place. Entrepreneurs are building bigger, longer term projects and production processes. Relative prices, i.e., interest, land, capital, and labor prices, are being distorted. Technology, nearly everywhere, is on the fast track. The economy is booming.
If the Skyscraper Curse is at work, then these distorted economic activities will soon be revealed to be malinvestments.
Merry Christmas and Happy Holidays from everyone here at the Mises Institute!
As an exciting year comes to a close, we want to thank all of our incredible members that allow us to do the work we do in advancing Austrian economics, freedom, and peace.
In honor of the season, John Denson joined Jeff Deist for a special episode of Mises Weekends to discuss the Christmas Truce. This incredible moment during World War I, often completely ignored by historians, is a wonderful celebration of the human spirit — even in the darkest of times. We hope you and yours will enjoy this extraordinary testament of the power of the Christmas season.
And in case you missed any of them, here are this week’s featured Mises Daily articles, some of our most popular articles at Mises Wire, and some holiday selections from the Mises archive:
Half of Britain Wants To Leave the EU by Ryan McMakenWhy Capitalists Are Repeatedly "Fooled" By Business Cycles by Frank ShostakGet More Bang for Your Buck by Jeff DeistThere's No Such Thing As a Neutral Government by David GordonPoland, Free Markets, and the Eurozone by Mateusz MachajA Will To Peace by John V. DensonIn Defense of Scrooge by Michael LevinA Capitalist Christmas by Dale SteinreichSimple Economic Truths for Entrepreneurs by Per Bylund
We are now living in a post-ZIRP world. On Wednesday, Janet Yellen announced that the Federal Reserve will increase the target Federal Funds rate from 0.00-0.25 percent up to 0.25-0.5 percent. While Wall Street approved of the move, Ryan McMaken notes, “The fact that this is being labeled such a large change underscores just how fragile the current economic ‘recovery’ is.” Indeed, the new Fed target would itself have been unprecedentedly low if it had occurred prior to 2008. Bottom line, the Fed still hasn’t learned its lesson on interest rates.
What does this mean going forward? Well, while Austrians have long been calling for higher interest rates, the Austrian business cycle theory makes clear that any transition to what was once considered the monetary status quo is likely to cause economic pain. As Robert Murphy illustrates in his response to advocates of Market Monetarism:
[A]fter a credit-fueled boom, the precise timing of the crash will probably occur when the central bank “tightens. … Ultimately, the only way to prevent painful busts is to
Mises Weekends this week features a lecture from Dr. Murphy on what makes the Austrian approach to economics stand apart: its focus on human action.
It's this foundation in methodological individualism that has made Austrian economics an indispensable part of a consistent defense of liberty. If you’re interested in building upon your understanding of praxeology and the economic insights of Menger and Mises, this is an episode you won’t want to miss.
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Why Doctors Are Entrepreneurs by Dr. Michel AccadThe Dreary Utopia of the Socialists by David GordonLudwig von Mises Is Winning by Tho BishopDid "Tight" Fed Policy Cause the Financial Crisis? by Robert MurphyTechnology and Government Shouldn't Mix by Benjamin M. WiegoldNo, There’s No Economic Case for the Minimum Wage by Per BylundAre Entrepreneurs Naturally Talented, or Just Hard Workers? by Matt McCaffreyThe Diabolical Side of ZIRP by Mark ThorntonMises Institute Ranked 9th Most Influential US Think TankMises Brasil Parabéns Pelo Trabalho Bem Feito! by Joseph SalernoTrue Money Supply Growth Rises Slightly to Eight Percent in November by Ryan McMakenLudwig von Mises is the Most Searched Economist in Brazil by Tho BishopThe Fed Still Hasn't Learned Its Lesson on Interest Rates by Troy VincentStudents Forget About Keynes In The Summer by Jonathan NewmanWith Few Gun Laws, New Hampshire Is Safer Than Canada by Ryan McMakenThe Stock Market Reacts to the Fed’s Interest Rate Hike by Randall G. HolcombeFed (Slightly) Raises Target Fed Funds Rate After Seven Years by Ryan McMakenSEC Approves Patrick Byrne’s Plan to Issue Stock Via Blockchain by Tho BishopThe Absurdity of Negative Interest Rates by Paul-Martin FossCato on the Basic Income by David GordonMartin Shkreli To Learn a Hard Lesson? by Ryan McMakenThe Bill of Rights: The Only Good Part of the Constitution by Ryan McMakenThe Fed Can Do Real Damage Without Even Trying by Jonathan NewmanSo Much for "Rules-Based" Policy at the IMF by Paul-Martin Foss
According to the Austrian business cycle theory (ABCT) the artificial lowering of interest rates by the central bank leads to a misallocation of resources because businesses undertake various capital projects that — prior to the lowering of interest rates —weren’t considered as viable. This misallocation of resources is commonly described as an economic boom.
As a rule, businessmen discover their error once the central bank — which was instrumental in the artificial lowering of interest rates — reverses its stance, which in turn brings to a halt capital expansion and an ensuing economic bust.
From the ABCT one can infer that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are only exposed once the central bank tightens its interest rate stance.
Critics of the ABCT maintain that there is no reason why businessmen should fall prey again and again to an artificial lowering of interest rates.
Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates.
Correct expectations will undo or neutralize the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates.
Hence, it is held, the ABCT is not a serious contender in the explanation of modern business cycle phenomena. According to a prominent critic of the ABCT, Gordon Tullock,
One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.
Even Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle. In his reply to Lachmann (Economica, August 1943) Mises wrote,
It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.
Do Expectations Matter?According to the critics then, if businessmen were to anticipate that the artificial lowering of interest rates is likely to be followed some time in the future by a tighter interest rate stance, their conduct in response to this anticipation will neutralize the occurrence of the boom-bust cycle phenomenon. But is it true that businessmen are likely to act on correct expectations as critics are suggesting?
Furthermore, the key to business cycles is not just businessmen’s conduct but also the conduct of consumers in response to the artificial lowering of interest rates — after all, businessmen adjust their activities in accordance with expected consumer demand. So on this ground one could generalize and suggest that correct expectations by people in an economy should prevent the boom-bust cycle phenomenon. But would it?
For instance, if an individual John, as a result of a loose central bank stance, could lower his interest rate payment on his mortgage why would he refuse to do that even if he knows that a lower interest rate leads to boom-bust cycles?
As an individual the only concern John has is his own well being. By paying less interest on his existent debt John’s means have now expanded. He can now afford various ends that previously he couldn’t undertake.
As a result of the central bank’s easy stance the demand for John’s goods and services and other mortgage holders has risen. (Again it must be realized that all this couldn’t have taken place without the support from the central bank, which accommodates the lower interest rate stance.)
Now, the job of a businessman is to cater to consumers’ future requirements. So whenever he observes a lowering in interest rates he knows that this most likely will provide a boost to the demand for various goods and services in the months ahead.
Hence if he wants to make a profit he would have to make the necessary arrangements to meet the future demand.
For instance, if a builder refuses to act on the likely increase in the demand for houses because he believes that this is on account of the loose monetary policy of the central bank and cannot be sustainable, then he will be out of business very quickly.
To be in the building business means that he must be in tune with the demand for housing. Likewise any other businessman in a given field will have to respond to the likely changes in demand in the area of his involvement if he wants to stay in business.
A businessman has only two options — either to be in a particular business or not to be there at all. Once he has decided to be in a given business this means that the businessman is likely to cater for changes in the demand for goods and services in this particular business irrespective of the underlying causes behind changes in demand.
Failing to do so will put him out of business very quickly. Now, regardless of expectations once the central bank tightens its stance most businessmen will “get caught.” A tighter stance will undermine demand for goods and services and this will put pressure on various business activities that sprang up while the interest rate stance was loose. An economic bust emerges.
We can conclude that correct expectations cannot prevent boom-bust cycles once the central bank has eased its interest rate stance. The only way to stop the menace of boom-bust cycles is for the central bank to stop the tampering with financial markets. As a rule however, central banks respond to the bust by again loosening their stance and thereby starting the new boom-bust cycle phase.
Recently Senator Ted Cruz aggressively questioned Janet Yellen on the Fed’s possible role in causing the financial crisis and subsequent recession. In particular, he claimed that “in the summer of 2008” the Fed “told markets that it was shifting to a tighter monetary policy,” and that this announcement “set off a scramble for cash, which caused the dollar to soar, asset prices to collapse, and CPI [growth — RPM] to fall below zero, which set the stage for the crisis.” Cruz asked Yellen if she agreed with Bernanke’s view from his new book, in which he says the Fed made a mistake by not cutting rates in September 2008.
In response, Yellen at first seemed befuddled by Cruz’s line of inquiry. She said that without further review she wasn’t going to second-guess Bernanke’s opinion that the Fed should’ve cut rates sooner. But she was quite sure that the Fed’s possibly delayed reaction didn’t cause the financial crisis, and in any event, Yellen reminded Cruz that by December 2008 the Fed had cut the federal funds rates down to 0 percent.
Several prominent “Market Monetarists” (such as Scott Sumner and David Beckworth) applauded Cruz’s position, because it dovetails nicely with their explanation that it was actually the Fed’s incredibly tight monetary policy that was ultimately responsible for the financial crisis and the Great Recession. In their view, “real factors” such as the collapsing housing market may have generated a run-of-the-mill recession, but it was Fed timidity that turned it into the worst economy since the 1930s.
The Market Monetarists chose their name out of deference to their intellectual heritage, namely the monetarism of Milton Friedman. Just as Friedman and Schwartz overturned the traditional Keynesian explanation of the Great Depression, by arguing that it was Fed inaction in the early 1930s that made the depression Great, so too do Sumner et al. in our time say that it was “tight money” that ultimately caused the Great Recession.
The Fed Dunnit, But Through Tight or Easy Money?Ironically, many fans of the free market are attracted to Friedman’s explanation of the Great Depression, and the modern Market Monetarist explanation of the Great Recession, because these hypotheses still blame government and exonerate capitalism. Yet in the interest of accuracy and intellectual honesty, we have to ask: Do these explanations actually make sense?
The standard Austrian view is arguably the opposite of the Friedmanite/Market Monetarist views. Rather than blaming the Fed for “tight money” in the early 1930s and then again in 2008, the orthodox Austrian says that the Fed caused unsustainable booms through “easy money” in the 1920s and in the 2000s.
For more specifics, the interested reader should consult this lecture at Mises University where I sketch the different approaches to the Great Depression. For a longer treatment here is Murray Rothbard’s book on the causes of the 1929 crash and Hoover’s role in starting the Great Depression.
Regarding the housing bubble of our time, here is Mark Thornton’s prescient 2004 mises.org article. And although I certainly have not been Nostradamus at every turn, in the fall of 2007 (a year before the crisis) on these pages I used Austrian business cycle theory to warn that the US was in store for a recession that could be the worst in decades.
Does Cruz’s Story Make Sense?For a detailed critique of the Market Monetarist approach from an Austrian perspective, see Shawn Ritenour’s 2013 article. For our purposes in the present piece, let me try a different approach to showcase the weakness of the approach.
Remember, Ted Cruz told Janet Yellen that in the summer of 2008, the “Fed told markets that it was shifting to a tighter monetary policy,” and that this is what ultimately caused the financial crisis a few months later. In other words, Cruz is not blaming “real forces” such as an unsustainable capital structure and the need to reallocate resources after the housing bubble. Instead, Cruz is blaming the Fed for shifting expectations in a way that increased the demand for money, and then not providing the market with the money it so desperately wanted.
In order to demonstrate how empty this explanation is, below I will reproduce three different Fed policy statements. Two of the statements had no dramatic effect on markets. However, one of the Fed statements below comes from the summer of 2008, and so (if Cruz is right) is responsible for creating a global financial panic and the worst economy since the 1930s.
So my question for the reader: Can you tell which of the following three Fed statements was the one Cruz is referring to? Which of the below caused global panic, and which two did investors shrug off? I have stripped out the level of interest rates and a few key phrases to keep things ambiguous about the date of the announcement, but not in a way that changes the tone of the three Fed statements as they originally appeared to markets.
Fed Statement #1:
The Federal Open Market Committee decided today to keep its target for the federal funds rate at _____ percent.
Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of ____ _____ ______ and the lagged effects of increases in interest rates and energy prices.
Readings on core inflation have been elevated in recent months, and the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.
Nonetheless, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.
Fed Statement #2:
The Federal Open Market Committee decided today to keep its target for the federal funds rate at _____ percent.
Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing ______ ______, and the rise in energy prices are likely to weigh on economic growth over the next few quarters.
The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.
The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
Fed Statement #3:
The Federal Open Market Committee decided today to keep its target for the federal funds rate at _____ percent.
Recent indicators have been mixed and the adjustment in the ______ sector is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters.
Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.
In these circumstances, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.
Scoring the TestHow did you do? I intentionally picked three Fed statements where the initial announcement was that the target interest rate was the same, so that any “signal” about looseness or tightness would have to be inferred from their discussion of the future. Could you tell which two of the above announcements were innocuous, and which one signaled a new tight money stance that caused a global financial crash not seen since the 1930s?
The answers are that Statement 1 was from August 2006, Statement 2 was from June 2008, and Statement 3 was from March 2007. Does it really sound plausible that the middle statement above was provocative enough to cause Lehman Brothers to fail and a major money market fund to “break the buck” a few months later?
ConclusionIt has been said that in Austrian theory “monetary factors cause the cycle but real phenomena constitute it.” In his canonical treatment, Ludwig von Mises certainly admitted that the commercial banks — through their policies of credit contraction and interest rate movements — could influence the precise timing of a crash. However, once an unsustainable boom was underway, a crash was inevitable. It would be foolish to think that a recession was due merely to the unwillingness of banks to continue with monetary inflation and artificially low interest rates.
Ted Cruz and the Market Monetarists are right to blame the Fed for the financial crisis, but they are focusing on the wrong end. The real problem was the Fed’s inflation of the early and mid-2000s that fueled the housing bubble and related malinvestments.
Yes, after a credit-fueled boom, the precise timing of the crash will probably occur when the central bank “tightens.” Yet that hardly means the recession is the fault of timidity. Ultimately, the only way to prevent painful busts is to avoid the pleasurable booms that precede them.
The world waits to see if next week is finally the week that the groundhogs at the Fed announce their long-anticipated interest rate hike. Can the economy survive whatever small bump the Fed deals out? Perhaps, but any temporary stability doesn’t change the inherent instability of our current monetary regime. Even with today’s technology, central planners can’t predict the future or know the “optimal quantity of money.” Only by returning to true sound money, and a proper appreciation for the market, will true, sustainable prosperity emerge.
In honor of the twenty-fourth anniversary of the collapse of the Soviet Union, we have a special guest on the latest episode of Mises Weekends, Dr. Yuri Maltsev. A Mises Senior Fellow and a Soviet economist during the Gorbachev era, Maltsev shares his thoughts on the West’s enduring love affair with socialism. He and Jeff also discuss its political consequences in regard to Obama, Trump, and the Bernie Sanders phenomenon. This is an interview you won’t want to miss.
And in case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Piketty Is Wrong: Markets Don’t Concentrate Wealth by Louis RouanetWhy Gold-Backed Money Doesn’t Bring Booms and Busts by Frank ShostakEnd the Sugar Tax Now by Gary GallesGovernment Debt Is Not Like Private Debt by Simon WilsonNo, "Big Data" Can’t Predict the Future by Per Bylund"Capitalism" Destroyed Itself? by Matt McCaffreyBlowing Up the Death Star Didn’t Destroy Economy, Building It Did by Tho BishopMan, Economy, and Beer: Rothbard-Themed Gastropub Opens in ConnecticutArticle Submission Guidelines for Mises DailyIndia’s Failing Gold Monetization Scheme: Seizure Imminent? by Paul-Martin FossViva Venezuela ... But Not Yet by Carmen Elena DorobățGun Control Fails: What Happened in England, Ireland, and Canada by Ryan McMakenTranscript: Ask David Gordon AnythingTop Ten Most-Read mises.org Articles in NovemberGerman translation of "PC is Control, Not Etiquette"Thanks, Janet Yellen: Homeownership in US Falls to 25-Year Low by Ryan McMakenWhy the No-Fly-List Gun Ban Is a Terrible Idea by Tho BishopBubble Watch: No-Down-Payment Jumbo Mortgage Makes a Comeback by Paul-Martin Foss
According to popular thinking, not every increase in the supply of money will have an effect on economic activity. For instance, if an increase in supply is matched by a corresponding increase in the demand for money, we are told, then there won’t be any effect on the economy. The increase in the supply of money is neutralized, so to speak, by an increase in the demand for money, or the willingness to hold a greater amount of money than before.
What do we mean by demand for money? And how does this demand differ from demand for goods and services?
Now, demand for a good is not a demand for a particular good, as such, but a demand for the services that the good offers. For instance, individuals’ demand for food is on account of the fact that food provides the necessary elements that sustain an individual’s life and well-being. Demand here means that people want to consume the food in order to secure the necessary elements that sustain life and well-being.
Also, the demand for money arises on account of the services that money provides. However, instead of consuming money, people demand money in order to exchange it for goods and services. With the help of money, various goods become more marketable — they can secure more goods than in the barter economy. What enables this is the fact that money is the most marketable commodity.
Why People Demand MoneyTake for instance a baker, John, who produces ten loaves of bread per day and consumes two loaves. The eight loaves he exchanges for various goods such as fruits and vegetables. Observe that John’s ability to secure fruits and vegetables is on account of the fact that he has produced the means to pay for them, which are eight loaves of bread. The baker pays for fruits and vegetables with the bread he has produced. Also note that the aim of his production of bread, apart from having some of it for himself, is to acquire other consumer goods.
Now, an increase in John’s production of bread, let us say from ten loaves to twenty a day, enables him to acquire a greater quantity and a greater variety of goods than before. As a result of the increase in the production of bread, John’s purchasing power has increased. This increase in the purchasing power does not necessarily translate into securing a greater amount of goods and services in the barter economy, however.
In the world of barter, John may have difficulties to secure by means of bread various goods he wants. It may happen that a vegetable farmer may not want to exchange his vegetables for bread. To overcome this problem John would have to exchange his bread first for some other commodity, which has much wider acceptance than bread. John is now going to exchange his bread for the acceptable commodity and then use that commodity to exchange for goods he really wants.
Note that by exchanging his bread for a more acceptable commodity, John in fact raises his demand for this commodity. Also, note that John’s demand for the acceptable commodity is not to hold it as such but to exchange it for the goods he wants. Again the reason why he demands the acceptable commodity is because he knows that with the help of this commodity he can convert the bread he produced more easily into the goods he wants.
Now let us say that an increase in the production of the acceptable commodity has taken place. As a result of a greater amount of the acceptable commodity relative to the quantities of other goods the unitary price of the acceptable commodity in terms of goods has fallen. All this, however, has nothing to do with the production of goods. The increase in the supply of an acceptable commodity is not going to disrupt the production of goods and services. Obviously if the purchasing power of the commodity were to continue declining then people are likely to replace it with some other more stable commodity.
Historically, in many societies, through a process of selection, people have settled on gold as the most accepted commodity in exchange. Gold has become money.
Real Money versus Money “Out of Thin Air”Let us now assume that some individual’s demand for money has risen. One way to accommodate this demand is for banks to find willing lenders of money. With the help of the mediation of banks, willing lenders can transfer their gold money to borrowers. Obviously, such a transaction is not harmful to anyone.
Another way to accommodate the demand is, instead of finding willing lenders, the bank can create fictitious money — money unbacked by gold — and lend it out.
Note that the increase in the supply of newly created money is given to some individuals. There must always be a first recipient of the newly created money by the banks.
This money, which was created out of “thin air,” is going to be employed in an exchange for goods and services (i.e., it will set in motion an exchange of nothing for something). The exchange of nothing for something amounts to the diversion of real wealth from wealth to non-wealth generating activities, which masquerades as economic prosperity.
In the process, genuine wealth generators are left with fewer resources at their disposal, which in turn weakens the wealth generators’ ability to grow the economy.
Will More “Demand for Money” Save Us?Could a corresponding increase in the demand for money prevent the damage that money out of “thin air” inflicts on wealth generators?
Let us say that on account of an increase in the production of goods, the demand for money increases to the same extent as the supply of money out of “thin air.” Recall that people demand money in order to exchange it for goods. Hence at some point the holders of money out of “thin air” will exchange their money for goods. Once this happens an exchange of nothing for something emerges, which undermines wealth generators.
We can thus conclude that irrespective of whether the total demand for money is rising or falling what matters here is that individuals employ money in their transactions. As we have seen, once money out of “thin air” is introduced into the process of exchange, this weakens wealth generators and this in turn undermines potential economic growth. Clearly then, the expansion of money out of “thin air” is always bad news for the economy. Hence, the view that it is harmless to have an increase in money out of “thin air” — if fully “backed by demand”— doesn’t hold water.
In contrast, an increase in the supply of gold money is not going to set an exchange of nothing for something. Also, an increase in the supply of commodity money doesn’t set boom-bust cycles.
We can further infer that it is only the increase in money out of “thin air” that is responsible for the boom-bust cycle menace. This increase sets the boom-bust cycle irrespective of the so-called overall demand for money.
Does Gold Cause Boom-Bust Cycles?According to most economists however, in an economy with a gold standard, an increase in the supply of gold generates similar distortions that money out of “thin air” does.
This is not the case.
Let us start with a barter economy. John the miner produces ten ounces of gold. The reason he mines gold is he believes there is a market for it. Since people demand it, we know that gold contributes to the well-being of individuals. John exchanges his ten ounces of gold for various goods such as potatoes and tomatoes.
Now people have discovered that gold, apart from being useful in making jewelry, is also useful for some other applications. They now assign a much greater exchange value to gold than before. As a result John the miner could exchange his ten ounces of gold for more potatoes and tomatoes.
Should we condemn this as bad news because John is now diverting more resources to himself?
No, because this is just what happens all the time in the market. As time goes by people assign greater importance to some goods and diminish the importance of some other goods. Some goods are now considered as more important than other goods in supporting people’s life and well-being. Now people have discovered that gold is useful for another use such as to serve as the medium of the exchange. Consequently they lift further the price of gold in terms of tomatoes and potatoes. Gold is now predominantly demanded as a medium of exchange — the demand for other services of gold such as ornaments is now much lower than before.
Let us see what is going to happen if John were to increase the production of gold. The benefit that gold now supplies people is by providing the services of the medium of the exchange. In this sense it is a part of the pool of real wealth and promotes people’s life and well-being. One of the attributes for selecting gold as the medium of exchange is that it is relatively scarce.
This means that a producer of a good who has exchanged this good for gold expects the purchasing power of his effort to be preserved over time by holding gold. If for some reason there is a large increase in the production of gold and this trend were to persist the exchange value of the gold would be subject to a persistent decline versus other goods, all other things being equal. Within such conditions people are likely to abandon gold as the medium of the exchange and look for other commodities to fulfill this role.
As the supply of gold starts to increase its role as the medium of exchange diminishes while the demand for it for some other usages is likely to be retained or increase. So in this sense the increase in the production of gold is not a waste and adds to the pool of real wealth. When John the miner exchanges gold for goods he is engaged in an exchange of something for something. He is exchanging wealth for wealth.
Contrast all this with the printing of gold receipts (i.e., receipts that are not backed 100 percent by gold). This is an act of fraud, which is what inflation is all about, it sets a platform for consumption without making any contribution to the pool of real wealth. Empty certificates set in motion an exchange of nothing for something, which in turn leads to boom-bust cycles. The printing of unbacked-by-gold certificates divert real savings from wealth generating activities to the holders of unbacked certificates. This leads to the so-called economic boom.
The diversion of real savings is done by means of unbacked certificates (i.e., unbacked money). Once the printing of unbacked money slows down or stops all together this stops the flow of real savings to various activities that emerged on the back of unbacked money. As a result, these activities fall apart — an economic bust emerges.
In the case of the increase in the supply of gold no fraud is committed here. The supplier of gold has simply increased the production of a useful commodity. So in this sense we don’t have an exchange of nothing for something. Consequently we also don’t have an emergence of bubble activities. Again the wealth producer on account of the fact that he has produced something useful can exchange it for other goods. He doesn’t require empty money to divert real wealth to himself. Note that a major factor for the emergence of a boom is the injections into the economy of money out of “thin air.” The disappearance of money out of “thin air” is the major cause of an economic bust. The injection of money out of “thin air” generates bubble activities while the disappearance of money out of “thin air” destroys these bubble activities.
On the gold standard — a true gold standard without central bank manipulation — this cannot take place. Consequently on the gold standard, money cannot disappear since gold cannot disappear. We can thus conclude that the gold standard, if not abused, is not conducive of boom-bust cycles.
The holiday weekend gave way to a tumultuous week full of significant and somber headlines. Here are three stories we've been following closely:
On Monday, the IMF announced that they will include the Chinese yuan in the SDR's basket of currencies. When James Rickards appeared on Mises Weekends in September, he discussed the interest of financial elites in making the SDR the new reserve currency of the world. This week, he reminded us, “The decision to include the yuan in the SDR is a political decision, not an economic one.”
Meanwhile in Brazil, facing a collapsing economy and months of street protests, impeachment charges were announced against President Dilma Rousseff. While the serious challenges facing Brazil go far beyond a single politician, the work of Helio Beltrão and Mises Institute Brazil offers hope for a freer future.
Lastly, Wednesday's tragic shooting in San Bernardino is already being exploited by the Obama administration and others on the left for a renewed push for gun control. Of course it is government, not gun ownership, that makes Americans less safe. As Jeff Deist noted following the attacks in Paris, "when state intelligence and security agencies fail spectacularly, their budgets and personnel increase. Nobody gets fired, nobody apologizes."
Our Mises Weekends guest is Łukasz Dominiak, a professor at Nicolaus Copernicus University and a former Mises Fellow, he joins Jeff to discuss the recent elections in Poland. The media characterized those elections as a triumph for the right-wing, and dismissed large street protests as xenophobic nationalism. But the truth as Łukasz explains is quite different: it's a strange mix of both left and right politics in a country that is not afraid to embrace its Catholic roots and its cultural identity.
And in case you missed any of them, here are this week's featured Mises Daily articles and some of our most popular articles at Mises Wire:
The Problem With "Rules-Based" Monetary Policy by Tommy BehnkeCan the US Dollar Face Down the Chinese Yuan? by James RickardsHow Money Disappears in a Fractional-Reserve Money System by Frank ShostakWe Must Be "Opportunists" In Dismantling the State by Joseph SalernoWill Brazil Impeach Rousseff? by Bruno Gonçalves RosiBorders Closing Across Europe: Norway Joins In by Ryan McMakenHunger and War in WWI Germany: Remembering the Slaughter of Pigs by T. Hunt TooleyTranscript: Jim Rickards on Currency WarsBrazil: Big Government, Small Wages by Ryan McMakenA Behind the Scenes Look at the November Jobs Report by Jonathan NewmanRothbard on Libertarian Populism by Jeff DeistHow Governments Can Manipulate Murder Rates by Excluding "Terrorist" Killings by Ryan McMakenIncentives, Ideology, and Climate Change by Peter G. KleinExtreme Poverty Worldwide Has Plummeted as Market Economics Has Spread by Ryan McMakenIn the 19th Century, Non-Citizens in the US Could Vote in 22 States and Territories by Ryan McMakenRobert Wenzel on the Cato Monetary Conference by David GordonThe November-December Issue of 'The Austrian' Is Now Online
A few years ago, in 2009, The Economist magazine published an issue with its front cover showing a picture of the statue of Christ the Redeemer, one of the main symbols of Brazil, taking off like a rocket. This symbolized the country’s growing economy. The title of the article read “Brazil takes off.” However, in 2013, the same magazine published another issue with its front cover showing a picture of the statue going down like a misfired rocket. The title of the main article asked “Has Brazil blown it?” Yes. It blew it. An even more recent issue, from 2015, states that the country is in a quagmire.
With President Dilma Rousseff now facing impeachment, doubts may arise about the future of Brazil. How likely is this impeachment to remove her from office? And what changes will occur in case it does happen? To answer, I’m going to briefly analyze the last twenty years of Brazilian politics.
Along with Latin America and Eastern Europe, Brazil went through a series of reforms during the 1990s, especially in the government of Fernando Henrique Cardoso (also known as FHC) from 1995 to 2002. FHC actually started the reforms when he was finance minister in the government of his predecessor, Itamar Franco (1992–1994). During the administration of FHC’s successor Lula da Silva (2003–2006), the reforms seemed to continue, paving the way for the prosperity observed in 2009. But things just appeared that way.
FHC and Lula are the better known former presidents in Brazil since 1985, when the country resumed governmental democracy after twenty years of military presidencies. And the two were also heads of the country’s two major political parties, respectively PSDB (Brazilian Social Democracy Party, or Partido da Social Democracia Brasileira) and PT (Worker’s Party, or Partido dos Trabalhadores).
PSDB and PT have similarities and differences. Both parties define themselves as center-left in the single-axis political spectrum. Both parties came into existence in the late 1970s or early 1980s, coming from a prior condition of bipartisanship forced by the military. Both parties include social democracy as part of their political ideology.
But the similarities end there. PT came into existence from three main segments: first, the basic ecclesial communities linked to the Liberation Theology in Latin America, especially in the ABC Region, an industrial region in Greater São Paulo. In the 1970s these communities tried to combine Marxism and Catholicism, turning Jesus into a first century Palestine social revolutionary. Second, PT has its origins in the labor movement of the same region in Sao Paulo — that’s where Lula came from. And finally, the party’s founders were die-hard radical socialists that participated in guerrilla activity against the military government — financed and trained mainly by Cuba — that’s where Rousseff came from.
A more detailed analysis might show that the party had more pragmatic, power-seeking wing — represented by Lula — and a more ideological one.
Among PSDB’s founders were well-established politicians from the PMDB (the opposition party to the military government). Like the founders of the PT, the PMDB opposed the dictatorship, but without the backing of outside communist regimes.
Instead, the PMDB used the legal institutional means available at the time. Although “social democracy” is in its name, PSDB was a much more pragmatic party from its inception, leaning toward a radical centrism, in the sense of calling for fundamental reform of institutions and believing that “genuine solutions require realism and pragmatism, not just idealism and emotion.”
Over time the party was much more willing to support market-based solutions to social problems than its counterpart. The party — and specially FHC — can also be identified with the Third Way, much like Bill Clinton and Tony Blair.
For other countries, the Third Way may be “the fastest route to the Third World.” But in Brazil’s case, coming from a situation of extreme statism since the 1930s, the reforms undertaken by FHC during the nineties were a major relief by comparison. But because of them, the president was accused of being neoliberal, meaning, a follower of Ronald Reagan and Margaret Thatcher (or even worse — from the left-wing point of view — a follower of F.A. Hayek or Milton Friedman).
Lula came to power in 2003 promising to leave behind the more radical positions of his party and to adopt a more pragmatic approach, not much different from that of FHC. That seemed to be the case for a while, and that’s when The Economist committed the mistake of believing Brazil was taking off. But for the more attentive observer it was clear that this could not be the case. Lula slowly but certainly abandoned the more market-oriented policies, a gesture consolidated by his successor, Dilma Rousseff. Instead of deepening the reforms started by FHC, PT was satisfied with keeping them in place for a while, and then abandoning them altogether.
I could go further in the past to explain how Brazil had an anti-liberal mentality from its beginning. But here it’s sufficient to say that, although being a multi-party country, Brazil has two major political forces: the PT and the PSDB. Neither of them is essentially market-friendly. But that’s not to say there are no differences between them. Even a pragmatist like Lula has to please his followers. With its socialist DNA, there’s no hope that PT will do what Brazil needs. And while they stay in power, Brazil’s economy is not resurging any time soon.
In 1992, then-President Fernando Collor was impeached, and what followed were the liberal reforms of FHC. But Collor didn’t have one thing Dilma has: a strong party.
The PT may throw Dilma to the lions in order to appease opposition and the population, but it won’t abandon its skepticism of liberalism, and there are no market-friendly political forces to fill any political vacuum that may result from Rousseff’s removal. With or without Dilma, this is still not time for optimism. Maybe a more pragmatic hope will do.
As the Labour Party fights with Tories over the need to slightly rein in government spending in the UK, opponents of even the slightest bit of austerity have turned out to claim that there is no virtue in “living within your means.”
In a recent article in The Guardian, Ha-Joon Chang, attacked even the Tory government’s timid claim that it wasn’t a great idea to spend more than the government collects in tax revenues. But for the new radical left Labour Party on whose behalf Chang’s article was written, this notion is as quaint as it is “simply wrong.”
For Chang, whether it derives from political expedience or a deeper philosophical current, a claim that one should live “within your means” is wrong because it assumes that our means are and always will be a fixed quantity. In fact, we can determine what our future means will be with actions we take in the present. Chang writes,
If you borrow money to do a degree or get a technical qualification, you will be spending beyond your means today. But your new qualification will increase your future earning power. Your future means will be greater than they would have been if you hadn’t taken out the loan. In this case, living beyond your means is the right thing to do.
Well, that’s that then. In one fell swoop, Chang thinks he demolishes the “homespun philosophies” of fiscal conservatism and “austerity” politics. Of course borrowing is good, Chang tells us. What economic illiteracy it is to suggest otherwise!
The problem for Chang here, however, is that he is really attacking a straw man.
Borrowing Is Not Inherently Good or BadAll he has stated is the obvious truth that investing in the present is likely to yield greater returns in the future — and this is good.
However, the source of an investment could just as well come from saving as from borrowing. The student in Chang’s example could, instead of taking out a loan, restrict his consumption (undergoing his own “mini recession”) in the years prior to study and pay his college fees outright so he can enjoy increased future returns all without the burden of interest. Wouldn’t this prove the inherent virtue of saving over borrowing?
In reality, neither borrowing nor saving is inherently good or bad. At least in the private sector. Whether one chooses to save or borrow to finance a project depends upon a subjective assessment of the relative trade-offs.
Is It Voluntary?It’s another matter entirely, though, when we’re talking about the government sector. Chang attempts to dismiss arguments for living within one’s means by comparing private-sector borrowing to government borrowing. But, the two are not comparable.
For example, when Lenin requisitioned grain from the peasants in the Russian countryside to feed workers in the cities, he too was “living beyond his means” in the present to create an industrial base that would provide for greater means in the future. We could say that Lenin was borrowing or maybe “bailing in” the peasants or we could say that the requisitions were a tax forming the “savings” necessary to realize the future socialist paradise.
The problem here is not that wealth was transferred from farmers to city dwellers. Farmers could have, of course, voluntarily lent their wealth to city dwellers had they wanted to. The problem is that their wealth was transferred against their will and without their consent. Lenin was living beyond his means, and others paid the price.
It is unlikely that Chang sees himself as advocating violent transfers of property, however. When he encourages governments to live beyond their means, he may just think he means creating something from nothing, and “borrowing” from the central bank by creating money that will be spent into the economy. According to Chang, this is a recipe for success:
If enough businesses and consumers form positive expectations as a result, they will invest and spend more. Increased investment and consumption then generate higher incomes and higher tax revenues. If the tax take increases sufficiently, the government deficit may be eliminated, which means that the government had the money that it spent after all.
Sadly the difference between Leninist primitive accumulation and modern Keynesianism easy-money policies are only one of degree. Credit expansion deflates the value of the currency, imposing a hidden tax on all to who hold it. It also confers an unparalleled privilege upon all those nearest to where the credit enters the economy (the state, the banking system, and connected business elites). Of course one can always justify this, like Lenin, to the individuals affected by telling them they will be compensated in the form of a boost to economic growth resulting in improved standards of living in the future.
With Government, “Living Beyond Your Means” Is a Moral ProblemThe problem is when you throw out morality, you also throw out economy. When the Soviets abolished private property, they removed the ability of individuals to exchange property at a price of their choosing, measure profits, or make economic calculations as to where productive resources should be allocated. With price signals gone, the soviets had to rely on guess work leading to large vanity projects being built which didn’t serve anyone.
The same is true of Keynesian-style money printing and borrowing. Government spending takes resources serving individual’s ends and diverts them to government-chosen ends, thus creating an artificial demand in those sectors of the economy where the money is spent. Without a market in public goods to indicate which are most valuable to consumers, governments essentially are driving blind, trying to pick winners and hoping for the best. You might not get empty missile silos, but you will get chronic debt and a squandering of resources that could otherwise have been more efficiently used by individuals.
Contra Chang, to not “live beyond your means" where government is concerned, is no mere mantra. It is a moral injunction to refrain from violence.
Elections took place across the country this past Tuesday with some interesting results. Voters in Ohio decided they hated monopolies more than they liked marijuana, while residents in Houston voted down the left’s latest egalitarian menace. While there is never a reason to trust the empty promises of pandering politicians, elections can occasionally offer insight into who is winning the battle for ideas. So there may be reason for optimism when you see Hawaiians’ discussing secession or the fact that there is global momentum in the fight against prohibition. While central planners struggle — both in the US and abroad — to maintain the status quo, bad government will never be able to repeal good economics.
The question then turns to how to we advance the cause of Austrian economics, peace, and freedom? That is the topic of this weekends’ Mises Circle in Phoenix, Arizona. One of our speakers, Dr. William Boyes, joined Jeff Deist this week to offer a preview of his talk. The founder of Arizona State University’s Center for Economic Liberty and a successful author of economics textbooks, Dr. Boyes discusses how to advance liberty and capitalism in the face of a statist educational system. One option — our new Online Mises Boot Camp!
In case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular articles at Mises Wire:
Activists Seek to Impoverish Thai Villagers to Save Monkeys from "Slavery" by David AdamsFor WHO, Red Meat Is a Red Herring by Yuri N. MaltsevThe Fed Desperately Tries to Maintain the Status Quo by Ronald-Peter StöferleHow Beijing and the West Work Together to Manipulate the Global Currency War by Brendan BrownWhy We Need Private Property to Deal with Scarce Resources by Patrick Barron"Social Expenditures" In the US Are Higher Than All Other OECD Countries, Except France by Ryan McMakenZwolinski and Woods on the Basic Income Guarantee by David GordonPot Battle in Ohio by Mark ThorntonPoverty Does Not Cause Obesity by Ryan McMakenWill Regulation Destroy a Revolution in Physics? by Matt McCaffreyMy Irish Eyes Are Smiling by Mark ThorntonA Practical Guide to Hawaiian Secession by Ryan McMakenMexico, Canada, and Ten American States Look Toward Marijuana Legalization by Ryan McMakenYellen on Negative Interest Rates by Jonathan Newman
From reading the commentaries you might have imagined that the process of a currency winning international reserve status depends on getting the IMF seal of approval. At least that seems to be the story with China.
So, strange to tell, the great international monies of the past evolved either before the IMF was created or without its help. Think of the Deutsche mark and Swiss franc — the two upstarts of the 1970s and 1980s — or briefly the Japanese yen when it enjoyed great popularity. Their emergence was due to the path of monetary stability chosen by their issuing authorities together with complete freedom from restrictions.
So why is the world of currency diplomacy now playing along with the nonsense of the IMF examining whether the Chinese yuan has met the criterion to become a reserve currency?
Incidentally, the last time that Washington body bestowed “reserve currency status” it was with respect to the Australian dollar and Canadian dollar, on the eve of the bust for the respective commodity and carry trade bubbles which sent them to their respective skies.
Beijing and DC Pick the Winners and LosersThe question as to why the Western world is playing along with the official Chinese currency charade is part of a more general point. Why do Western governments pursue non-market trade diplomacy so enthusiastically with Beijing?
Think of the repeated times that Chinese communist party dictators traveled to a particular Western capital to hand out their list of chosen beneficiaries of Chinese corporate (mostly state) spending. These dictators were welcomed by fawning officials and bureaucrats who assured us that they also brought up, with muted whispers and inaudible comments, the problem of human rights to their guest.
And, by the same token, why are there high profile visits of Western leaders to China, presenting their own list of chosen industrialists selected to pick up the new business deals? This is not the way free markets, and global free trade, in particular, is meant to work.
If it smells like a rat it probably is a rat, and so it is with respect to these deals by collusion between China and Western governments, and their chosen corporate protégés, whether on currency or trade or investment matters. This is all an exercise in some combination of crony capitalism (with cronies on both sides!) and diplomacy by stealth. The gains and gainers are deliberately kept opaque. The losers are much less evident than the gainers, on whichever side of the fence, but principle and practice tells us that the total losses are much larger than the gains.
The Cronies’ Currency WarIn particular, how much more prosperous would China be today under a regime of currency freedom and well-functioning markets, than under the cozy order of restrictions and preferred access (to capital and trade) put together by Beijing and foreign governments in cahoots? And how much are Western priority systems for getting Chinese capital and orders to favored domestic destinations distorting the signals which guide the invisible hands? And how far is the secret — or not so secret — G-20 currency diplomacy, related to China, abetting the most serious episode of currency warfare since the 1930s?
Think about the new currency offensive launched by Europe last month when ECB Chief Draghi’s calibrated remarks about further QE drove the euro down by 3–4 percent against the US dollar in 24 hours, which was double the extent of any Chinese currency maneuvers earlier in the summer. And in the bigger picture, China’s mini currency devaluation hardly smacks of currency warfare compared to moves ten or even twenty times greater by Europe and Japan in the past three years.
So why did Beijing agree to the mild censoring which occurred at the last G-20 meeting (in Lima) of its own mini-devaluation when it could have called on Europe and Japan to halt their currency warfare?
A plausible answer is that Beijing has no interest in facilitating the emergence of a free market in its currency together with full convertibility. If silence is required on currency warfare as the price of getting its coveted currency reserve status, then so be it.
Yes, a fully convertible Chinese currency might well find a substantially lower level than today’s official rate. Much would depend on what steps accompany the road to convertibility. Would there be broad-based liberalization in the Chinese economy and markets such as to make assets there more attractive to both domestic and international investors in the context of improved prospects of economic prosperity? Or would the road to convertibility simply facilitate a flight of capital out of the country with little foreign appetite to engage in the opposite direction?
There is little indication that the Chinese leadership would take the market reform route, which incidentally might seriously undermine the basis of the rents enjoyed by themselves and their connected state enterprises. In effect, there is an unholy alliance between the West and Beijing on only limited reforms and the currency status quo as blessed by the IMF. Meanwhile, currency wars remain a protected activity of the large powers outside China.
Official game plans do not always work out as hoped. It remains to be seen whether the continued and accelerated path of monetary easing by Beijing is consistent with only a mini-devaluation of the Chinese currency. There is anecdotal evidence of Chinese retail investors now engaging themselves in a new bout of yield-search frenzy in the local high-yield bond markets. That may not endure in the face of a rising tide of default. And the massive yuan carry trade which built up in the past few years could contract much more forcefully in coming months in the context of shrunken yield gaps and credit market cool-down.
On Wednesday, the Federal Reserve once again reaffirmed its zero-interest rate policy. Amusingly, this commitment to the monetary status quo is being seen by some as “hawkish” which, as Ryan McMaken points out, “shows just how much the goal posts have been moved in recent years.” Unfortunately all the spin and promises of future rate hikes doesn’t change the fact that we are nearing the seven year anniversary of ZIRP with an economy Janet Yellen doesn’t think is strong enough to survive the reversal of the Fed’s monetary morphine. Hopefully our central bankers will one day realize their war on deflation is leaving us poorer, but in the meantime — at least we can laugh about it.
In this edition of the Mises Weekends, we have the third in our series on the current state of healthcare. Our first episode featured Charles Hugh Smith who discussed the consequences of a healthcare market taken over by government regulators and insurance lobbyists. Our second featured Dr. Michel Accad giving his perspective as a practicing doctor in a post-Obamacare world. This week, Robert Murphy discusses his new book, The Primal Prescription, which he co-wrote with Dr. Doug McGuff. Murphy not only applies his understanding of Austrian economics to highlight the problems plaguing us today, but offers advice on how to navigate through the current state of American healthcare.
In case you missed any of them, here are this week’s featured Mises Daily articles and some of our most popular posts at Mises Wire:
The Fed Can’t Raise Rates, But Must Pretend It Will by Thorsten PolleitRobert Shiller Imagines What Consumers Should Want, While Ignoring What They Do Want by G.P. ManishThe War on Cars Is a War on Workers and the Poor by Gary GallesToday's War Against Deflation Will Make Us Poorer by Frank ShostakThe World Bank Threatens Free Markets in Peru by Simon WilsonIf Sweden and Germany Became US States, They Would be Among the Poorest States by Ryan McMakenThere’s More to Money than Hyperinflation by Matt McCaffreyPew: Homicide Rates Cut in Half Over Past 20 Years (While New Gun Ownership Soared) by Ryan McMakenSpectre by Matt McCaffreySunday of the Blind, or the Failed Revolution by Carmen Elena DorobățUS Soldiers Are Paid Significantly More than Civilians with Similar Skills and Education by Ryan McMakenWith Interest Rates, "There Are Two, Opposite Causal Chains at Work" Murray RothbardFOMC: We'll Raise Rates Some Day; We're "Hawkish" Now by Ryan McMakenUnderwear Prices to Remain Near Zero by Peter KleinTextbook Definitions of Economics: An Informal Survey by Jonathan NewmanPoliticians Pander to an Anti-Fed Public by Tho BishopIn Sweden Cash Is Becoming Radioactive by Joseph SalernoFirst they came for the cash, then they came for the microwaves by David Howden
The yearly growth rate of the US consumer price index (CPI) fell to 0 percent in September 2015, from 0.2 percent in August and, 1.7 percent in September last year.
The yearly growth rate of the European Monetary Union CPI fell to minus 0.1 percent in September from 0.1 percent in the previous month and 0.3 percent in September last year.
Also, the growth momentum of the UK CPI fell into the negative in September with the yearly growth rate closing at minus 0.1 percent from 0 percent in August and 1.2 percent in September last year.
The growth momentum of China’s CPI eased in September with the yearly growth rate falling to 1.6 percent from 2 percent in August.
Deflation Fears Gain SteamConsequently, many experts are expressing concern regarding the declining growth momentum of the CPI and are of the view that rather than tightening the monetary stance, central banks should loosen their stance further in order to counter the emergence of deflation, which is regarded as a major threat to economic well-being of individuals.
For most experts, deflation is bad news since it generates expectations of a decline in prices. As a result, they believe, consumers are likely to postpone their buying of goods at present since they expect to buy these goods at lower prices in the future.
This weakens the overall flow of spending and in turn weakens the economy. Hence, such commentators believe that policies that counter deflation will also counter the slump.
Will Reversing Deflation Prevent a Slump?If deflation leads to an economic slump, then policies that reverse deflation should be good for the economy, so it is held.
Reversing deflation will simply involve introducing policies that support general increases in the prices of goods, i.e., price inflation. With this way of thinking inflation could actually be an agent of economic growth.
According to most experts, a little bit of inflation can actually be a good thing. Mainstream economists believe that inflation of 2 percent is not harmful to economic growth, but that inflation of 10 percent could be bad for the economy.
There’s good reason to believe, however, that at a rate of inflation of 10 percent, it is likely that consumers are going to form rising inflation expectations.
According to popular thinking, in response to a high rate of inflation, consumers will speed up their expenditures on goods at present, which should boost economic growth. So why then is a rate of inflation of 10 percent or higher regarded by experts as a bad thing?
Clearly there is a problem with the popular way of thinking.
Price Inflation vs. Money-Supply InflationInflation is not about general increases in prices as such, but about the increase in the money supply. As a rule the increase in the money supply sets in motion general increases in prices. This, however, need not always be the case.
The price of a good is the amount of money asked per unit of it. For a constant amount of money and an expanding quantity of goods, prices will actually fall.
Prices will also fall when the rate of increase in the supply of goods exceeds the rate of increase in the money supply.
For instance, if the money supply increases by 5 percent and the quantity of goods increases by 10 percent, prices will fall by 5 percent.
A fall in prices cannot conceal the fact that we have inflation of 5 percent here on account of the increase in the money supply.
The Problem Is Really Wealth Formation, not Rising PricesThe reason why inflation is bad news is not because of increases in prices as such, but because of the damage inflation inflicts to the wealth-formation process. Here is why:
The chief role of money is the medium of exchange. Money enables us to exchange something we have for something we want.
Before an exchange can take place, an individual must have something useful that he can exchange for money. Once he secures the money, he can then exchange it for the good he wants.
But now consider a situation in which the money is created "out of thin air," increasing the money supply.
This new money is no different from counterfeit money. The counterfeiter exchanges the printed money for goods without producing anything useful.
He in fact exchanges nothing for something. He takes from the pool of real goods without making any contribution to the pool.
The economic effect of money that was created out of thin air is exactly the same as that of counterfeit money — it impoverishes wealth generators.
The money created out of thin air diverts real wealth toward the holders of new money. This weakens the wealth generators ability to generate wealth and this in turn leads to a weakening in economic growth.
Note that as a result of the increase in the money supply what we have here is more money per unit of goods, and thus, higher prices.
What matters however is not that price rises, but the increase in the money supply that sets in motion the exchange of nothing for something, or "the counterfeit effect."
The exchange of nothing for something, as we have seen, weakens the process of real wealth formation. Therefore, anything that promotes increases in the money supply can only make things much worse.
Why Falling Prices Are GoodSince changes in prices are just a symptom, as it were — and not the primary causative factor — obviously countering a falling growth momentum of the CPI by means of loose a monetary policy (i.e., by creating inflation) is bad news for the process of wealth generation, and hence for the economy.
In order to maintain their lives and well-being, individuals must buy goods and services in the present. So from this perspective a fall in prices cannot be bad for the economy.
Furthermore, if a fall in the growth momentum of prices emerges on the back of the collapse of bubble activities in response to a softer monetary growth then this should be seen as good news. The less non-productive bubble activities that are around the better it is for the wealth generators and hence for the overall pool of real wealth.
Likewise, if a fall in the growth momentum of the CPI emerges on account of the expansion in real wealth for a given stock of money, this is obviously great news since many more people could now benefit from the expanding pool of real wealth.
We can thus conclude that contrary to the popular view, a fall in the growth momentum of prices is always good news for the wealth generating process and hence for the economy.
Waiting for Godot is a play written by the Irish novelist Samuel B. Beckett in the late 1940s in which two characters, Vladimir and Estragon, keep waiting endlessly and in vain for the coming of someone named Godot. The storyline bears some resemblance to the Federal Reserve’s talk about raising interest rates.
Since spring 2013, the Fed has been playing with the idea of raising rates, which it had suppressed to basically zero percent in December 2008. So far, however, it has not taken any action. Upon closer inspection, the reason is obvious. With its policy of extremely low interest rates, the Fed is fueling an artificial economic expansion and inflating asset prices.
Selected US Interest Rates in Percent
Source: Thomson FinancialRaising short-term rates would be like taking away the punch bowl just as the party gets going. As rates rise, the economy’s production and employment structure couldn’t be upheld. Neither could inflated bond, equity, and housing prices. If the economy slows down, let alone falls back into recession, the Fed’s fiat money pipe dream would run into serious trouble.
This is the reason why the Fed would like to keep rates at the current suppressed levels. A delicate obstacle to such a policy remains, though: If savers and investors expect that interest rates will remain at rock bottom forever, they would presumably turn their backs on the credit market. The ensuing decline in the supply of credit would spell trouble for the fiat money system.
To prevent this from happening, the Fed must achieve two things. First, it needs to uphold the expectation in financial markets that current low interest rates will be increased again at some point in the future. If savers and investors buy this story, they will hold onto their bank deposits, money market funds, bonds, and other fixed income products despite minuscule yields.
Second, the Fed must succeed in continuing to postpone rate hikes into the future without breaking peoples’ expectation that rates will rise at some point. It has to send out the message that rates will be increased at, say, the forthcoming FOMC meeting. But, as the meeting approaches, the Fed would have to repeat its trickery, pushing the possible date for a rate hike still further out.
If the Fed gets away with this “Waiting for Godot” strategy, savings will keep flowing into credit markets. Borrowers can refinance their maturing debt with new loans and also increase total borrowing at suppressed interest rates. The economy’s debt load can continue to build up, with the day of reckoning being postponed for yet again.
However, there is the famous saying: “You can fool all the people some of the time and some of the people all the time, but you cannot fool all the people all the time.” What if savers and investors eventually become aware that the Fed will not bring interest rates back to “normal” but keep them at basically zero, or even push them into negative territory?
If a rush for the credit market exit would set in, it would be upon the Fed to fill debtors’ funding gap in order to prevent the fiat system from collapsing. The central bank would have to monetize outstanding and newly originated debt on a grand scale, sending downward the purchasing power of the US dollar — and with it many other fiat currencies around the world.
The “Waiting for Godot” strategy does not rule out that the Fed might, at some stage, nudge upward short-term borrowing costs. However, any rate action should be minor and rather short-lived (like they were in Japan), and it wouldn’t bring interest rates back to “normal.” The underlying logic of the fiat money system simply wouldn’t admit it.
Selected Japanese Interest Rates in Percent
Source: Thomson FinancialThe Fed — and basically all central banks around the world — are unlikely to accept deflation clearing out the debt, which would topple the economic and political structures built upon it. Fending off an approaching recession-depression with more credit-created fiat money and extremely low, perhaps even negative, interest rates is what one can expect them to do.
Murray N. Rothbard put it succinctly: “We can look forward … not precisely to a 1929-type depression, but to an inflationary depression of massive proportions.”
International trade grabbed headlines this week with Monday’s announcement that twelve governments have reached agreement on the Trans-Pacific Partnership. While it should be of no surprise to see the news celebrated in the editorial pages of the Wall Street Journal or the Council of Foreign Relations blog, it is unfortunate even libertarian organizations are praising the agreement.
Of course, this is not the first time alleged defenders of lassiez-faire have endorsed intergovernmental agreements that enhance the power of the state. Ferghane Azihari and Louis Rouanet put TPP in historical context in Wednesday’s Mises Daily:
Murray Rothbard opposed NAFTA and showed that what the Orwellians were calling a “free trade” agreement was in reality a means to cartelize and increase government control over the economy. Several clues lead us to the conclusion that protectionist policies often hide behind free trade agreements, for as Rothbard said, “genuine free trade doesn’t require a treaty.”
Dr. Ed Stringham takes on the notion that government is necessary at all for markets and trade to thrive in his new book Private Governance. He joined Jeff Deist to discuss his work on the latest episode of Mises Weekends. Listen as Jeff and Ed destroy the argument that markets rely on government to protect property rights, mediate contracts, and numerous other excuses interventionists make in defense of the state.
In case you missed any of them, here are articles from this past week’s Mises Daily and Mises Wire:
The TPP and the Trade Rhetoric by Carmen Elena DorobățTPP: The Latest Assault on Free Trade by Ryan McMakenRothbard: Gun Regulation Explained by Murray RothbardIn Policy Debates, Can Economics Trump Ethics? by Matt McCaffreyThe Future Is Decentralized by Patrick ByrneNo More "Free Trade" Treaties: It's Time for Genuine Free Trade by Ferghane Azihari and Louis RouanetThe Menace of Egalitarianism by Lew RockwellFashionable Prohibition for Modern Lawmakers by Ryan McMakenIn Brazil, Free-Market Ideas Rise as the Economy Falls by Antony P. MuellerMissed last Saturday’s Mises Circle? Watch Jeff Deist, Tom DiLorenzo, Tom Woods and Lew Rockwell tackle the threat of political correctness.
The Mises Institute spoke with Associated Scholar Antony Mueller last week about recent economic and ideological trends in Brazil. Prof. Mueller teaches economics at Federal University of Sergipe (UFS) in Brazil.
Mises Institute: For those of us not in Brazil, it is hard to interpret the commentary on Brazil’s economy right now. Brazil’s debt was recently reduced to junk status, and we can see that Brazil’s economy is not doing well. But how severe is the crisis?
Antony Mueller: Part of the explanation is that for a large part of the population and for the government itself, the crisis came as a shock. At first, the Brazilian government ignored the coming of the crisis and when it arrived, the government ignored its existence.
Imagine Brazil like a family with a lot of inherited wealth that spends as if there were no tomorrow. Yet someday this family wakes up to the fact that its wealth has been squandered and its financial accounts are in the red. The government did not recognize that the boom would be temporary. The Brazilian economy began to sputter as commodity prices fell and the demand from China decreased. Yet in order to adapt to the new situation and cut expenditures, the Brazilian government spent even more.
Incumbent President Dilma Rousseff from the Workers Party, which has been in power since 2003, won a second term in 2014 with a campaign that deceived the population about the true state of the economy. The government implemented a series of cheap financial tricks such as delaying the rise of the prices for fuel and electricity and of other items in the large list of administered prices.
After the election, hell broke loose and the true state of the economy became visible for the broad public. The popularity of the president began to fall to single-digit approval ratings. The crisis is serious in itself, yet its psychological impact becomes more severe because of the shock of disillusion. In part, this shock also applies to foreign observers and investors who bought into government propaganda or based their outlook on the projections of the International Monetary Fund whose prognosis in 2013 said that Brazil would maintain economic growth rates of at least over 4 percent for each of the years to come up to 2018.
MI: Ambrose Evans-Pritchard is writing off Brazil as if it’s a total disaster area, and he quotes one observer who says “things will get much worse before they get better.” Is this true, and if so, what are the obstacles to improvement?
AM: Evans-Pritchard’s remarks reflect the consensus among foreign observers and there is indeed little doubt that the crisis will deteriorate before it gets better. Even worse, the recuperation could take much longer than is generally assumed. The reason for a pessimistic outlook comes from the fact that the crisis is not only economic, but also political in character. Not only members of the present government, but also figures of the opposition parties are under investigation about massive corruption linked to the major Brazilian oil company Petrobras. There is much frustration in the country because there is no promising alternative in sight.
MI: Assuming we are looking at real declines in standards of living, how long will it take the country to get back to where it was at the height of the boom?
AM: This is a difficult question for a specific answer. So let me answer in a more fundamental way. Brazil’s economic development has been on a roller coaster ride for centuries. Phases of extraordinary booms were followed by long periods of busts and stagnation.
In the second half of the twentieth century, the boom of the 1950s, with the promise that Brazil would achieve growth and development of “fifty years in five years” ended in economic disaster and the military dictatorship that lasted from 1964 to 1985, which in turn ended with Brazil’s catastrophic foreign debt crisis. It took a “lost decade” for the country to recuperate.
The 1990s saw a series of reforms that put the country back on the track. In 2003, when the newly elected president, Luiz Inácio “Lula” da Silva from the Workers Party took over the government, the economy was already on a growth path. Then came the commodity boom with a seemingly insatiable appetite for Brazilian natural and agricultural products. Yet, instead of using the good times that filled the coffers of the Brazilian treasury to carry out highly necessary reforms, the Labor government pursued a populist policy of generous social spending, particularly for the poor parts of the population.
Now, these achievements of reducing poverty and inequality have come under threat because of the lack of financial funds. This means that Brazil must face not only an economic and a political crisis, but also a social crisis. The confluence of such a triple crisis increases the risks that any one of them gets worse because each individual crisis affects negatively the other crises. The consequential chain from the economic to the political and from there to the social crisis then goes into reverse and the social crisis worsens the outlook to get out of the political and the economic crisis.
MI: Brazil was a big part of the BRICS effort to create a group of up-and-coming economies that could rival the big economies like the US and Germany. Is that idea totally dead, or is the demise of BRICS overstated?
AM: The BRICS never managed to operate as a coherent group. Now, that not only Brazil is in crisis, but also Russia, and that China is in troubled waters, the outlook for the BRICS as a group of playing a major role in global affairs has diminished even more.
It is similar with MERCOSUL, the common market project in South America. Instead of achieving free exchange, trade conflicts are on the rise and not a single supranational institution has become effective. From my observations of Latin America and of Brazil in particular, I conclude that there are still vast mental and ideological barriers in place that work against sustained prosperity. The ideological dominance of statism, socialism, and interventionism is present in every layer of the Brazilian society — not only in politics or academia, but also in the business community itself.
Bureaucracy is a nightmare without end. Taxation is high and brings little return. The public educational system is in shambles. The legal system is unable to cope with an enormous backlog of unresolved cases, while at the same time, judges and other legal authorities enjoy grandiose privileges. Salaries in the judiciary are astronomical compared to what the average person or the poorer parts of the Brazilian society earn.
The public sector in general is extremely inefficient and is an El Dorado of rent-seekers. I do not expect that any of these obstacles will be resolved in the coming years. I fear that it is not much different in some other BRICS countries. They are all stuck in the “middle income trap,” as they are apparently unable to change from a statist to a free market system. There are many vested interests in place, in both politics and in established business, preventing change from state capitalism to an entrepreneurial capitalism. Only based on a fundamental change of ideology in favor of markets and individual and entrepreneurial liberty, will countries like Brazil gain long-term prosperity. I would also say that the same holds for China and the other members of the BRICS and emerging markets in general.
MI: Ideologically, is there any hope of a shift in Brazilian ideology? Some in the US media have featured libertarian free market groups in Brazil and suggested there is a change going on. Do you see any of that?
AM: Well, there is hope, yet it is a long way down the road. The Brazilian libertarian movement is gaining strength, particularly among students and young people in general. In fact, the spread of libertarian ideas among young Brazilians is amazing. The Brazilian Mises Institute is overwhelmed by visits to its site and the Institute’s events are grandiose. There is much good will, high hopes, a lot of serious dedication and extreme diligence at work in the libertarian movement of Brazil. If this trend continues, the walls that surround the established ideology will finally crumble. Anybody with an alert mind must see that statism has failed; that the ideas of socialism and interventionism are sterile and that they produce mainly frustration, stagnation, and crises. The libertarian movement in Brazil is the new avant-garde; its members are the true “progressives.”
The modern electronic media help to accelerate their ascendancy to influence and recognition. The current crisis will be a further wake-up call for young people to recognize that it is their future which is at stake if Brazil should continue in its old ways. With ever more young people joining the libertarian movement, I am sure that sometime in the future a critical mass will be reached and things will change.
Senior Fellow Mark Thornton is interviewed on The Power & Market Report. Dr. Thornton discusses the Skyscraper curse in Auburn, Alabama, the relationship between skyscrapers and the Austrian business cycle, and why the market forgets about crises.
Read the Mises Daily article mentioned in the interview here.
Thirteen powerpoint slides lead you through Dr. Thornton's presentation. There exist strong correlations between either the announcement or the completion of the world's tallest building and GDP, but it is not held that you can accurately forecast a recession or financial panic by this measurement. Thornton suggests the common cause is artificially low interest rates.
This lecture was presented to the Economics Club of Auburn University at the Mises Institute in Auburn, Alabama, on 8 September 2015.
The PowerPoint presentation used in the lecture is available here.
Our guest this weekend is Jim Rickards, the author of the New York Times bestseller The Death of Money and a well-known expert in geopolitics and global capital.
Jim and Jeff discuss the unfolding drama at the Fed, which can't decide when—if ever—QE will come to an end. They also discuss possible endgame scenarios for liquidating unprecedented amounts of sovereign, commercial, and household debt; whether coming monetary shocks will present the IMF with an opportunity to demand a global currency reset, and who wins and loses when the game of musical chairs stops. This is a must-hear interview for anyone interested in currency wars, central banks, and the unholy politics behind it all.
See Jim Rickards' Strategic Intelligence newsletter.
See the transcript of this interview.
US real gross domestic product (GDP) grew faster than initially thought in Q2. GDP expanded at a 3.7 percent annual rate during the second quarter, instead of the 2.3 percent rate reported for the quarter last month. The annual change for the first quarter was also revised up to 0.6 percent for Q1. Most experts, in response to these figures, are now arguing that the US economy is strengthening visibly.
This, coupled with a relatively stable price level, raises the likelihood that the economy is approaching the path of healthy economic growth with stable price inflation.
When we talk about economic strength on an individual level by this we mean an individual’s real wealth. On a national level, one could talk about overall real wealth by adding up the real wealth of individuals.
GDP Can’t Measure Real WealthAs simple as it sounds however, this cannot be done since we cannot add up potatoes to tomatoes to obtain a meaningful total. So from this perspective we cannot ascertain the total real wealth in an economy:
[T]here are serious problems regarding the calculation of the GDP statistic. To calculate a total, several things must be added together. To add things together, they must have some unit in common. It is not possible to add refrigerators to cars and shirts to obtain the total of final goods. Since the total real output cannot be meaningfully defined, obviously it cannot be quantified …
It is interesting to note that in commodity markets, prices are quoted as Dollars/barrel of oil, Dollars/ounce of gold, Dollars/tonne of copper, etc. Obviously, it wouldn’t make much sense to establish an average of these prices. On this Rothbard wrote, “Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate.”
The employment of various sophisticated methods to calculate the average price level cannot bypass the essential issue that it is not possible to establish an average price of various goods and services …
So what are we to make out of the periodical pronouncements that the economy, as depicted by real GDP, grew by a particular percentage? All we can say is that this percentage has nothing to do with real economic growth and that it most likely mirrors the pace of monetary pumping.
As a rule, the more money created by the central bank and the banking sector, the larger the monetary spending will be. This in turn means that the rate of growth of what is labeled as the real economy will closely mirror rises in money supply.
GDP Follows Money SupplyThus, real GDP doesn’t measure the real strength of an economy, but rather reflects monetary turnover adjusted by a dubious statistic called the price deflator.
Obviously then, the more money is pumped, all other things being equal, the stronger the economy appears to be.
In this framework of thinking one is not surprised that the Fed can drive the economy since by means of monetary pumping the central bank can influence the GDP rate of growth.
While we cannot establish total real wealth we can, however, ascertain factors that undermine the real wealth formation.
Malinvestment: The Fed’s Balance Sheet Jumped 421 PercentOne of the key factors here, apart from government outlays, is the monetary policy of the Fed.
On this, the Fed’s balance sheet jumped from $861 billion in January 2007 to $4,484 billion by August this year — an increase of 421 percent or an average increase of 55 percent per annum during this period.
Furthermore, since December 2008 the Federal Reserve interest rate target was kept at 0.25 percent.
This aggressive monetary pumping coupled with an almost-zero interest rate must have severely misallocated real resources and thereby severely undermined the process of real wealth generation.
So, from this perspective, a strengthening in GDP doesn’t reflect an economic strengthening but actually the exact opposite.
Now, even in terms of the government’s own data such as real income, economic activity doesn’t look that great, with the growth momentum of real income actually showing a visible softening.
The yearly rate of growth fell to 2.2 percent in Q2 from 3.3 percent in Q1. The key factor behind this emerging softening is a fall in the growth momentum of money supply during October 2011 to October 2013.
It is likely, however, that this fall is positive for the health of the economy since it puts pressure on various bubble activities that undermine the wealth generation process.
This article is a selection from a June 19 presentation at a lunchtime meeting of the Grassroot Institute in Honolulu at the Pacific Club. The talk was part of the Mises Institute’s Private Seminar series for lay audiences. To schedule your own Private Seminar with a Mises Institute speaker, please contact Kristy Holmes at the Mises Institute.
First let me say that what we today call “Austrian economics” flows from the great legacy of classical economics, with the very important modification economists now call the “marginal revolution.” Austrian economics is also a term that describes a healthy and vibrant (though often oppositional) modern school of economic thought. It originated with intellectual giants like Carl Menger and Ludwig von Mises, names I’m sure many of you are familiar with. These economists were from Austria, hence the term.
There was a landmark conference at South Royalton, Vermont in 1974, attended by the likes of Murray Rothbard and Milton Friedman, that revitalized the Austrian movement and helped it regain prominence in the latter part of the twentieth century. Milton Friedman was in attendance, and that’s when he famously remarked that “There is only good economics and bad economics.”
And of course that’s true. Schools of thought should not be rigid, or dogmatic, or too narrowly defined. But classifying various economists and theories into groups or family trees does indeed help us make sense of economics. It helps us understand how we arrived at a time and place where Ben Bernanke, Paul Krugman, Thomas Piketty, and Christine Lagarde are viewed as modern mainstream thinkers rather than the radicals they are when compared to the whole history of the field.
Image courtesy of Peter Cresswell.We supplied some photocopies that roughly trace the history of economic thought. Notice the split in the 1930s, not coincidentally during the Great Depression, between Mises and John Maynard Keynes. Up until then, from about 1850 forward, Austrian economics was mainstream economics. But as you can see, most of today’s mainstream economists fall somewhere under the umbrella of Keynes, and they tend to focus on variants of Keynes’s ideas about aggregate demand.
But at least they focus on something!
Ignorance of Economics Is not BlissWhich leads me to my topic today: “Why Any Economics Matters.” I say “any” because at this point the entire subject appears to be lost on the average American. Economics is not a popular topic among the general population, it would seem. When economics is discussed at all, it’s in the context of politics — and politics gives us only the blandest, safest, most meaningless platitudes about economic affairs.
Bernie Sanders or Hillary Clinton simply are not going to talk much in economic terms or present detailed economic “plans.” On the contrary, they — will assume rightly — that most Americans just don’t have any interest beyond sloganeering like “1%,” “social justice,” “greed,” “paying their fair share,” and the like.
Candidates on the Right won’t be much better. They’d prefer to talk about other subjects, but when they do broach economics they’re either outwardly protectionist like Donald Trump or deadly dull. Who is inspired by flat tax proposals?
Americans simply aren’t much interested in the details, or even the accuracy, of the economic pronouncements of the political class. We want bread and circuses.
Consider what people talk about on Facebook: lots of posts about family. Lots of posts about celebrities, and sports. Lots of posts about food, health, and exercise. Some posts about politics, culture, race, and sex, but usually only to support one side or bash the other.
Not much, ladies and gentlemen, in the way of economics. And I submit that might be a very healthy thing. After all — we’re rich! Only a wealthy society does not have to focus on the subsistence-level concerns of adequate food and shelter, hot running water, clothing, electricity, and the like.
So let’s not be too hard on people for not spending their free time reading economics. Leisure itself is a very important activity, and represents a form of economic trade-off.
But economics matters very much, and we ignore it at our own peril. Economics is like gravity, or math, or politics — we may not understand it, or even think about it much, but it profoundly affects us whether we like it or not.
Economics as a subject has been captured by academia, and academics like Krugman are not so subtle when they imply that lay persons should leave things to the experts. It’s like team sports — we may be introduced to it when we’re young, but only the professionals do it for a living as adults.
Yet once we understand that all human action is economic action, we understand that we can’t escape or evade our responsibility to understand at least basic economics. To think otherwise is to avoid responsibility for our own lives.
While we shake our heads when twenty year olds can’t read at the college level or do simple algebra, we don’t worry much whether they never take economics. We would be alarmed if our children couldn’t perform basic math to know how much change they should get at a cash register, but we send them out into the world far more susceptible to being cheated by politicians. Why do we want our kids to learn at least basic geography, chemistry, and physics? And grammar, spelling, literature, history, and civics? We want them to know these things so they can navigate their lives properly as adults
But somehow we’ve come to believe economics should be left to academics and policy wonks. And worse yet, we don’t protest when kids grow up to become adults with little or no knowledge of economics, yet still have strong opinions about economic issues.
Ignorance of basic economics is so widespread that we ought to have a specific word for it, like we have for illiteracy or innumeracy.
The aforementioned Murray Rothbard had this to say:
It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a “dismal science.” But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.
I’m sure we’re all familiar with this phenomenon on social media, which seems perfectly suited to vociferous unfounded opinions.
Let’s consider the minimum wage issue, as one example that’s been in the news lately:
Wages are nothing more than prices for labor services. When the price for something rises, demand drops — and you have more unemployed people than you otherwise would. Pure and simple Econ 101.
Yet what percentage of Americans today have even seen a downward sloping demand chart in a high school or college class?
It is this great and widespread ignorance of economics that plagues our ludicrous political landscape. It allows politicians to attack capitalism, and make demagogues out of entrepreneurs. It allows politicians to blame free markets for the very economic problems caused by the state and its central bank in the first place — like the dot com implosion, like the housing bubble, like the Crash of 2008, like the unsustainable equity prices commanded by US stock markets today.
In short, ignorance of economics allows some very big falsehoods to be accepted as fact by large numbers of people. And it’s only going to get worse as the presidential election of 2016 unfolds.
Read the full text here.
The “Skyscraper Curse” describes the eerie connection between record-breaking skyscrapers and global economic crises. There are no true skyscrapers being built in Auburn, Alabama, home of Auburn University. But, there has been a great deal of building big and tall.
Luxury student apartment building leads the way, followed by high-end restaurants, and retail space. Two student apartment buildings were torn down this past week to make room for yet more building. The city government is also spending truckloads of money on street improvements and a state-of-the-art high school.
What are people thinking? Don’t they realize we are in one of the weakest recoveries on record and possibly headed for another recession? Is it greedy bankers and construction companies run amuck? Is it out-of-control architects and chefs that are to blame? Or is it the spoiled rich college kids who demand luxury apartments and locally grown veggies?
The rush to build bigger, taller, and more luxurious buildings actually has little to do with any of these groups, but it has divided us as a city. On the one hand, there are many people upset because it is changing “the loveliest village on the plains.” Local residents are seeing “Keep Auburn Lovely: Save Our Village” signs popping up all over town. They oppose the building.
On the other hand, construction workers, cement dealers, building supply companies, and heavy equipment operators must love the fast-paced business and full-time jobs with overtime. They love it.
This has all happened before. Remember?
Washington, DC: Where Booms BeginThe problem actually starts in Washington, DC in an unremarkable building on 20th Street and Constitution Avenue, NW which houses the Board of Governors of the Federal Reserve. The Board, along with a rotating selection of Regional Federal Reserve Bank presidents form the Open Market Committee which sets an interest rate policy targeting the interest rate that banks charge other banks for short-term loans — the Federal Funds rate.
When the Federal Reserve’s Open Market Committee sets the target lower, it sets off a tendency for interest rates to fall across the economy. When they raise the target for the Federal Funds rate, interest rates tend to rise across the economy. For the last seven-and-a-half plus years they have kept the target under a quarter of 1 percent. This type of policy has never happened before. This explains the ultra low rates on your savings account, CD, and mortgage over the last several years.
It also explains the luxury-building mania. When the Federal Reserve first lowered rates bankers burned by bad mortgages after the housing bubble along with luxury game day condo builders would not take the bait. Once bitten, twice shy. However, eventually low interest rates are too tempting to resist, especially as new bankers and construction companies come onto the scene.
The Effects of Low Interest RatesLower rates have several effects, including less saving and more spending. Low rates also increase stock market prices because lower rates increase the value of corporations, reduce the cost of borrowing, inducing individuals to move money from bank accounts to stock market accounts and to be more fully invested in stocks. When the policy is successful at increasing stock prices, people reduce savings further and spend more on luxury goods. Lower rates also boost borrowing and investment.
If you think that the combination of reduced savings and increased luxury spending sounds contradictory, you are correct.
In any case, lower interest rates also tend to increase the price of land, particularly in the center city. In contrast, higher interest rates encourage land and real estate owners to part with their properties at lower prices. Higher land prices make development deals harder to generate profits. The solution is to build more intensively and to make buildings taller. A $1 million piece of land could be profitable by building just one story, but if that same lot is $2 million then you might have to build three stories to make it profitable. A one story building is relatively inexpensive to build compared to a three story building which requires stairways, elevators, and sturdier construction techniques. However, the three story building also produces two-and-a-half times more rentable space.
How Malinvestment Leads to BustsIs it better to just build something, even if it is the wrong thing? Well, even if interest rates could stay near zero forever, it still means we are deploying our resources incorrectly. The things we are building will not be as profitable as originally projected and the excess capacity means that long existing projects will also become less profitable. In other words, eventually, their economic values will be less than the amount invested in them. It will also make it more difficult to pay back the loans, especially if you reduce savings and increase your borrowing and luxury spending.
These circumstances are in no one’s best long-term interests. But, apparently, eliminating the cause in Washington is currently beyond our collective ability.
Last Monday's mini-crash in equity markets reminded many people of the dark days following the Crash of 2008. The 400 richest people in the world collectively lost $124 billion—at least on paper—in a single day. And the average investor may get tired of seeing his or her net worth take a nosedive every 7 or 8 years.
Here to make sense of market crashes is our own Dr. Joe Salerno. Why does the financial press fail to see monetary inflation as the cause of stock bubbles? Why is deflation portrayed as an enemy to be defeated, rather than a sign of a more productive economy? Why do even seasoned financial experts fail at timing the market? And are deflationary crashes actually the cure for a sick economy?
[First published in Inquiry, November 12, 1979.]
A half-century ago, America — and then the world — was rocked by a mighty stock-market crash that soon turned into the steepest and longest-lasting depression of all time.
It was not only the sharpness and depth of the depression that stunned the world and changed the face of modern history: it was the length, the chronic economic morass persisting throughout the 1930s, that caused intellectuals and the general public to despair of the market economy and the capitalist system.
Previous depressions, no matter how sharp, generally lasted no more than a year or two. But now, for over a decade, poverty, unemployment, and hopelessness led millions to seek some new economic system that would cure the depression and avoid a repetition of it.
Political solutions and panaceas differed. For some it was Marxian socialism — for others, one or another form of fascism. In the United States the accepted solution was a Keynesian mixed-economy or welfare-warfare state. Harvard was the focus of Keynesian economics in the United States, and Seymour Harris, a prominent Keynesian teaching there, titled one of his many books Saving American Capitalism. That title encapsulated the spirit of the New Deal reformers of the '30s and '40s. By the massive use of state power and government spending, capitalism was going to be saved from the challenges of communism and fascism.
One common guiding assumption characterized the Keynesians, socialists, and fascists of the 1930s: that laissez-faire, free-market capitalism had been the touchstone of the US economy during the 1920s, and that this old-fashioned form of capitalism had manifestly failed us by generating, or at least allowing, the most catastrophic depression in history to strike at the United States and the entire Western world.
Well, weren't the 1920s, with their burgeoning optimism, their speculation, their enshrinement of big business in politics, their Republican dominance, their individualism, their hedonistic cultural decadence, weren't these years indeed the heyday of laissez-faire? Certainly the decade looked that way to most observers, and hence it was natural that the free market should take the blame for the consequences of unbridled capitalism in 1929 and after.
Unfortunately for the course of history, the common interpretation was dead wrong: there was very little laissez-faire capitalism in the 1920s. Indeed the opposite was true: significant parts of the economy were infused with proto–New Deal statism, a statism that plunged us into the Great Depression and prolonged this miasma for more than a decade.
In the first place, everyone forgot that the Republicans had never been the laissez-faire party. On the contrary, it was the Democrats who had always championed free markets and minimal government, while the Republicans had crusaded for a protective tariff that would shield domestic industry from efficient competition, for huge land grants and other subsidies to railroads, and for inflation and cheap credit to stimulate purchasing power and apparent prosperity.
It was the Republicans who championed paternalistic big government and the partnership of business and government while the Democrats sought free trade and free competition, denounced the tariff as the "mother of trusts," and argued for the gold standard and the separation of government and banking as the only way to guard against inflation and the destruction of people's savings. At least that was the policy of the Democrats before Bryan and Wilson at the start of the 20th century, when the party shifted to a position not very far from its ancient Republican rivals.
The Republicans never shifted, and their reign in the 1920s brought the federal government to its greatest intensity of peacetime spending and hiked the tariff to new, stratospheric levels. A minority of old-fashioned "Cleveland" Democrats continued to hammer away at Republican extravagance and big government during the Coolidge and Hoover eras. Those included Governor Albert Ritchie of Maryland, Senator James Reed of Missouri, and former Solicitor General James M. Beck, who wrote two characteristic books in this era: The Vanishing Rights of the States and Our Wonderland of Bureaucracy.
But most important in terms of the depression was the new statism that the Republicans, following on the Wilson administration, brought to the vital but arcane field of money and banking. How many Americans know or care anything about banking? Yet it was in this neglected but crucial area that the seeds of 1929 were sown and cultivated by the American government.
The United States was the last major country to enjoy, or be saddled with, a central bank. All the major European countries had adopted central banks during the 18th and 19th centuries, which enabled governments to control and dominate commercial banks, to bail out banking firms whenever they got into trouble, and to inflate money and credit in ways controlled and regulated by the government. Only the United States, as a result of Democratic agitation during the Jacksonian era, had had the courage to extend the doctrine of classical liberalism to the banking system, thereby separating government from money and banking.
Having deposed the central bank in the 1830s, the United States enjoyed a freely competitive banking system — and hence a relatively "hard" and noninflated money — until the Civil War. During that catastrophe, the Republicans used their one-party dominance to push through their interventionist economic program. It included a protective tariff and land grants to railroads, as well as inflationary paper money and a "national banking system" that in effect crippled state-chartered banks and paved the way for the later central bank.
The United States adopted its central bank, the Federal Reserve System, in 1913, backed by a consensus of Democrats and Republicans. This virtual nationalization of the banking system was unopposed by the big banks; in fact, Wall Street and the other large banks had actively sought such a central system for many years. The result was the cartelization of banking under federal control, with the government standing ready to bail out banks in trouble, and also ready to inflate money and credit to whatever extent the banks felt was necessary.
Without a functioning Federal Reserve System available to inflate the money supply, the United States could not have financed its participation in World War I: that war was fueled by heavy government deficits and by the creation of new money to pay for swollen federal expenditures.
One point is undisputed: the autocratic ruler of the Federal Reserve System, from its inception in 1914 to his death in 1928, was Benjamin Strong, a New York banker who had been named governor of the Federal Reserve Bank of New York. Strong consistently and repeatedly used his power to force an inflationary increase of money and bank credit in the American economy, thereby driving prices higher than they would have been and stimulating disastrous booms in the stock and real-estate markets. In 1927, Strong gaily told a French central banker that he was going to give "a little coup de whiskey to the stock market." What was the point? Why did Strong pursue a policy that now can seem only heedless, dangerous, and recklessly extravagant?
Once the government has assumed absolute control of the money-creating machinery in society, it benefits — as would any other group — by using that power. Anyone would benefit, at least in the short run, by printing or creating new money for his own use or for the use of his economic or political allies.
Strong had several motives for supporting an inflationary boom in the 1920s. One was to stimulate foreign loans and foreign exports. The Republican party was committed to a policy of partnership of government and industry, and to subsidizing domestic and export firms. A protective tariff aided inefficient domestic producers by keeping out foreign competition. But if foreigners were shut out of our markets, how in the world were they going to buy our exports? The Republican administration thought it had solved this dilemma by stimulating American loans to foreigners so that they could buy our products.
A fine solution in the short run, but how were these loans to be kept up, and, more important, how were they to be repaid? The banking community was also confronted with the curious and ultimately self-defeating policy of preventing foreigners from selling us their products, and then lending them the money to keep buying ours. Benjamin Strong's inflationary policy meant repeated doses of cheap credit to stimulate this foreign lending. It should also be noted that this policy subsidized American investment banks in making foreign loans.
Among the exports stimulated by cheap credit and foreign loans were farm products. American agriculture, overstimulated by the swollen demands of warring European nations during World War I, was a chronically sick industry during the 1920s. It had awakened after the resumption of peace to find that farm prices had fallen and that European demand was down. Rather than adjusting to postwar realities, however, American farmers preferred to organize and agitate to force taxpayers and consumers to keep them in the style to which they had become accustomed during the palmy "parity" years of the war. One way for the federal government to bow to this political pressure was to stimulate foreign loans and hence to encourage foreign purchases of American farm products.
The "farm bloc," it should be noted, included not only farmers; more indirect and considerably less rustic interests were also busily at work. The postwar farm bloc gained strong support from George N. Peek and General Hugh S. Johnson; both, later prominent in the New Deal, were heads of the Moline Plow Company, a major manufacturer of farm machinery that stood to benefit handsomely from government subsidies to farmers. When Herbert Hoover, in one of his first acts as president — considerably before the crash — established the Federal Farm Board to raise farm prices, he installed as head of the FFB Alexander Legge, chairman of International Harvester, the nation's leading producer of farm machinery. Such was the Republican devotion to "laissez faire."
But a more indirect and ultimately more important motivation for Benjamin Strong's inflationary credit policies in the 1920s was his view that it was vitally important to "help England," even at American expense. Thus, in the spring of 1928, his assistant noted Strong's displeasure at the American public's outcry against the "speculative excesses" of the stock market.
The public didn't realize, Strong thought, that "we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis." An unexceptionable statement, provided that we clear up some euphemisms. For the "decision" was taken by Strong in camera, without the knowledge or participation of the American people; the decision was to inflate money and credit, and it was done not to help the "rest of the world" but to help sustain Britain's unsound and inflationary policies.
Before the World War, all the major nations were on the gold standard, which meant that the various currencies — the dollar, pound, mark, franc, etc. — were redeemable in fixed weights of gold. This gold requirement ensured that governments were strictly limited in the amount of scrip they could print and pour into circulation, whether by spending to finance government deficits or by lending to favored economic or political groups. Consequently, inflation had been kept in check throughout the 19th century when this system was in force.
But world war ruptured all that, just as it destroyed so many other aspects of the classical-liberal polity. The major warring powers spent heavily on the war effort, creating new money in bushel baskets to pay the expense. Inflation was consequently rampant during and after World War I and, since there were far more pounds, marks, and francs in circulation than could possibly be redeemed in gold, the warring countries were forced to go off the gold standard and to fall back on paper currencies — all, that is, except for the United States, which was embroiled in the war for a relatively short time and could therefore afford to remain on the gold standard.
After the war, the nations faced a world currency breakdown with rampant inflation and chaotically falling exchange rates. What was to be done? There was a general consensus on the need to go back to gold, and thereby to eliminate inflation and frantically fluctuating exchange rates. But how to go back? That is, what should be the relations between gold and the various currencies?
Specifically, Britain had been the world's financial center for a century before the war, and the British pound and the dollar had been fixed all that time in terms of gold so that the pound would always be worth $4.86. But during and after the war the pound had been inflated relatively far more than the dollar, and thus had fallen to about $3.50 on the foreign-exchange market. But Britain was adamant about returning the pound, not to the realistic level of $3.50, but rather to the old prewar par of $4.86.
Why the stubborn insistence on going back to gold at the obsolete prewar par? Part of the reason was a stubborn and mindless concentration on saving face and British honor, on showing that the old lion was just as strong and tough as before the war. Partly, it was a shrewd realization by British bankers that if the pound were devalued from prewar levels England would lose its financial preeminence, perhaps to the United States, which had been able to retain its gold status.
So, under the spell of its bankers, England made the fateful decision to go back to gold at $4.86. But this meant that Britain's exports were now made artificially expensive and its imports cheaper, and since England lived by selling coal, textiles, and other products, while importing food, the resulting chronic depression in its export industries had serious consequences for the British economy. Unemployment remained high in Britain, especially in its export industries, throughout the boom of the 1920s.
To make this leap backward to $4.86 viable, Britain would have had to deflate its economy so as to bring about lower prices and wages and make its exports once again inexpensive abroad. But it wasn't willing to deflate since that would have meant a bitter confrontation with Britain's now-powerful unions. Ever since the imposition of an extensive unemployment-insurance system, wages in Britain were no longer flexible downward as they had been before the war. In fact, rather than deflate, the British government wanted the freedom to keep inflating, in order to raise prices, do an end run around union wage rates, and ensure cheap credit for business.
The British authorities had boxed themselves in: They insisted on several axioms. One was to go back to gold at the old prewar par of $4.86. This would have made deflation necessary, except that a second axiom was that the British continue to pursue a cheap credit, inflationary policy rather than deflation. How to square the circle? What the British tried was political pressure and arm-twisting on other countries, to try to induce or force them to inflate too. If other countries would also inflate, the pound would remain stable in relation to other currencies; Britain would not keep losing gold to other nations, which endangered its own jerry-built monetary structure.
On the defeated and small new countries of Europe, Britain's pressure was notably successful. Using their dominance in the League of Nations and especially in its Financial Committee, the British forced country after country not only to return to gold, but to do so at overvalued rates, thereby endangering those nations' exports and stimulating imports from Britain. And the British also flummoxed these countries into adopting a new form of gold "exchange" standard, in which they kept their reserves not in gold, as before, but in sterling balances in London.
In this way, the British could continue to inflate; and pounds, instead of being redeemed in gold, were used by other countries as reserves on which to pyramid their own paper inflation. The only stubborn resistance to the new order came from France, which had a hard-money policy into the late 1920s. It was French resistance to the new British monetary order that was ultimately fatal to the house of cards the British attempted to construct in the 1920s.
The United States was a different situation altogether. Britain could not coerce the United States into inflating in order to save the misbegotten pound, but it could cajole and persuade. In particular, it had a staunch ally in Benjamin Strong, who could always be relied on to be a willing servitor of British interests. By repeatedly agreeing to inflate the dollar at British urging, Benjamin Strong won the plaudits of the British financial press as the best friend of Great Britain since Ambassador Walter Hines Page, who had played a key role in inducing the United States to enter the war on the British side.
Why did Strong do it? We know that he formed a close friendship with British financial autocrat Montagu Norman, longtime head of the Bank of England. Norman would make secret visits to the United States, checking in at a Saratoga Springs resort under an assumed name, and Strong would join him there for the weekend, also incognito, there to agree on yet another inflationary coup de whiskey to the market.
Surely this Strong–Norman tie was crucial, but what was its basic nature? Some writers have improbably speculated on a homosexual liaison to explain the otherwise mysterious subservience of Strong to Norman's wishes. But there was another, and more concrete and provable, tie that bound these two financial autocrats together.
That tie involved the Morgan banking interests. Benjamin Strong had lived his life in the Morgan ambit. Before being named head of the Federal Reserve, Strong had risen to head of the Bankers Trust Company, a creature of the Morgan bank. When asked to be head of the Fed, he was persuaded to take the job by two of his best friends, Henry P. Davison and Dwight Morrow, both partners of J.P. Morgan & Co.
The Federal Reserve System arrived at a good time for the Morgans. It was needed to finance America's participation in World War I, a participation strongly supported by the Morgans, who played a major role in bringing the Wilson administration into the war. The Morgans, heavily invested in rail securities, had been caught short by the boom in industrial stocks that emerged at the turn of the century. Consequently, much of their position in investment-banking was being eroded by Kuhn, Loeb & Co., which had been faster off the mark on investment in industrial securities.
World War I meant economic boom or collapse for the Morgans. The House of Morgan was the fiscal agent for the Bank of England: it had the underwriting concession for all sales of British and French bonds in the United States during the war, and it helped finance US arms and munitions sales to Britain and France. The House of Morgan had a very heavy investment in an Anglo-French victory and a German-Austrian defeat. Kuhn, Loeb, on the other hand, was pro-German, and therefore was tied more to the fate of the Central Powers.
The cement binding Strong and Norman was the Morgan connection. Not only was the House of Morgan intimately wrapped up in British finance, but Norman himself — as well as his grandfather — in earlier days had worked in New York for the powerful investment banking firm of Brown Brothers, and hence had developed close personal ties with the New York banking community. For Benjamin Strong, helping Britain meant helping the House of Morgan to shore up the internally contradictory monetary structure it had constructed for the postwar world.
The result was inflationary credit, a speculative boom that could not last, and the Great Crash whose 50th anniversary we observe this year. After Strong's death in late 1928, the new Federal Reserve authorities, while confused on many issues, were no longer consistent servitors of Britain and the Morgans. The deliberate and consistent policy of inflation came to an end, and a corrective depression soon arrived.
There are two mysteries about the Great Depression, mysteries having two separate and distinct solutions. One is, why the crash? Why the sudden crash and depression in the midst of boom and seemingly permanent prosperity? We have seen the answer: inflationary credit expansion propelled by the Federal Reserve System in the service of various motives, including helping Britain and the House of Morgan.
But there is another vital and very different problem. Given the crash, why did the recovery take so long? Usually, when a crash or financial panic strikes, the economic and financial depression, be it slight or severe, is over in a few months or a year or two at the most. After that, economic recovery will have arrived. The crucial difference between earlier depressions and that of 1929 was that the 1929 crash became chronic and seemed permanent.
What is seldom realized is that depressions, despite their evident hardship on so many, perform an important corrective function. They serve to eliminate the distortions introduced into the economy by an inflationary boom. When the boom is over, the many distortions that have entered the system become clear: prices and wage rates have been driven too high, and much unsound investment has taken place, particularly in capital-goods industries.
The recession or depression serves to lower the swollen prices and to liquidate the unsound and uneconomic investments; it directs resources into those areas and industries that will most-effectively serve consumer demands — and were not allowed to do so during the artificial boom. Workers previously misdirected into uneconomic production, unstable at best, will, as the economy corrects itself, end up in more secure and productive employment.
The recession must be allowed to perform its work of liquidation and restoration as quickly as possible, so that the economy can be allowed to recover from boom and depression and get back to a healthy footing. Before 1929, this hands-off policy was precisely what all US governments had followed, and hence depressions, however sharp, would disappear after a year or so.
But when the Great Crash hit, America had recently elected a new kind of president. Until the past decade, historians have regarded Herbert Clark Hoover as the last of the laissez-faire presidents. Instead, he was the first New Dealer.
Hoover had his bipartisan aura, and was devoted to corporatist cartelization under the aegis of big government; indeed, he originated the New Deal farm-price-support program. His New Deal specifically centered on his program for fighting depressions. Before he assumed office, Hoover determined that should a depression strike during his term of office, he would use the massive powers of the federal government to combat it. No more would the government, as in the past, pursue a hands-off policy.
As Hoover himself recalled the crash and its aftermath,
The primary question at once arose as to whether the President and the federal government should undertake to investigate and remedy the evils. … No President before had ever believed that there was a governmental responsibility in such cases. … Presidents steadfastly had maintained that the federal government was apart from such eruptions … therefore, we had to pioneer a new field.
In his acceptance speech for the presidential renomination in 1932, Herbert Hoover summed it up:
We might have done nothing. … Instead, we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action. … No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such times.
The massive Hoover program was, indeed, a characteristically New Deal one: vigorous action to keep up wage rates and prices, to expand public works and government deficits, to lend money to failing businesses to try to keep them afloat, and to inflate the supply of money and credit to try to stimulate purchasing power and recovery. Herbert Hoover during the 1920s had pioneered the proto-Keynesian idea that high wages are necessary to assure sufficient purchasing power and a healthy economy. The notion led him to artificially raising wages — and consequently to aggravating the unemployment problem — during the depression.
As soon as the stock market crashed, Hoover called in all the leading industrialists in the country for a series of White House conferences in which he successfully bludgeoned the industrialists, under the threat of coercive government action, into propping up wage rates — and hence causing massive unemployment — while prices were falling sharply. After Hoover's term, Franklin D. Roosevelt simply continued and expanded Hoover's policies across the board, adding considerably more coercion along the way. Between them, the two New Deal presidents managed the unprecedented feat of making the depression last a decade, until we were lifted out of it by our entry into World War II.
If Benjamin Strong got us into a depression and Herbert Hoover and Franklin D. Roosevelt kept us in it, what was the role in all this of the nation's economists, watchdogs of our economic health? Unsurprisingly, most economists, during the depression and ever since, have been much more part of the problem than of the solution. During the 1920s, establishment economists, led by Professor Irving Fisher of Yale, hailed the 20s as the start of a "New Era," one in which the new Federal Reserve System would ensure permanently stable prices, avoiding either booms or busts.
Unfortunately, the Fisherites, in their quest for stability, failed to realize that the trend of the free and unhampered market is always toward lower prices as productivity rises and mass markets develop for particular products. Keeping the price level stable in an era of rising productivity, as in the 1920s, requires a massive artificial expansion of money and credit. Focusing only on wholesale prices, Strong and the economists of the 1920s were willing to engender artificial booms in real estate and stocks, as well as malinvestments in capital goods, so long as the wholesale price level remained constant.
As a result, Irving Fisher and the leading economists of the 1920s failed to recognize that a dangerous inflationary boom was taking place. When the crash came, Fisher and his disciples of the Chicago School again pinned the blame on the wrong culprit. Instead of realizing that the depression process should be left alone to work itself out as rapidly as possible, Fisher and his colleagues laid the blame on the deflation after the crash and demanded a reinflation (or "reflation") back to 1929 levels.
In this way, even before Keynes, the leading economists of the day managed to miss the problem of inflation and cheap credit and to demand policies that only prolonged the depression and made it worse. After all, Keynesianism did not spring forth full-blown with the publication of Keynes's General Theory in 1936.
We are still pursuing the policies of the 1920s that led to eventual disaster. The Federal Reserve is still inflating the money supply and inflates it even further with the merest hint that a recession is in the offing. The Fed is still trying to fuel a perpetual boom while avoiding a correction on the one hand or a great deal of inflation on the other.
In a sense, things have gotten worse. For while the hard-money economists of the 1920s and 1930s wished to retain and tighten up the gold standard, the "hard-money" monetarists of today scorn gold, are happy to rely on paper currency, and feel that they are boldly courageous for proposing not to stop the inflation of money altogether, but to limit the expansion to a supposedly fixed amount.
Those who ignore the lessons of history are doomed to repeat it — except that now, with gold abandoned and each nation able to print currency ad lib, we are likely to wind up, not with a repeat of 1929, but with something far worse: the holocaust of runaway inflation that ravaged Germany in 1923 and many other countries during World War II. To avoid such a catastrophe we must have the resolve and the will to cease the inflationary expansion of credit, and to force the Federal Reserve System to stop purchasing assets, and thereby to stop its continued generation of chronic, accelerating inflation.
The yearly rate of growth of the personal consumption expenditure (PCE) price index adjusted for food and energy stood at 1.3 percent in June — the same figure as in May. Note that on average since the beginning of this year the yearly rate of growth stood at 1.3 percent. Many economists have expressed satisfaction that the yearly rate of growth has been stable so far notwithstanding that it stood below the Fed’s target of 2 percent.
Meanwhile, the yearly rate of growth of the overall personal consumption expenditure price deflator stood at minus 0.01 percent in June, versus minus 0.1 percent in May, and 1.4 percent in June last year.
Stability in the yearly rate of growth of the PCE less food and energy price deflator is regarded as a very important thing for most economists. It is held that a stable price level will make the movement in the relative prices of goods and services more visible, thereby allowing a more efficient allocation of resources.
There is the danger that focusing on so-called price stability may cause economists to overlook the underlying factor that is likely to set in motion an economic bust. However, this underlying factor may be the decline in the growth momentum of the money supply during October 2011 to October 2013.
Note that during 1927 to the end of 1928, the US consumer price index was displaying relative stability (see first chart below).
This caused many commentators to suggest that the US economy had reached a state of economic stability and to ignore the fact that the growth momentum of the money supply fell sharply during February 1925 to June 1927.
This sharp decline set in motion an economic bust of the stock market in October 1929 and the following collapse of economic activity.
According to Murray Rothbard,
One of the reasons that most economists of the 1920’s did not recognize the existence of an inflationary problem was the widespread adoption of a stable price level as the goal and criterion for monetary policy. … The fact that general prices were more or less stable during the 1920’s told most economists that there was no inflationary threat, and therefore the events of the great depression caught them completely unaware.
(Note that for most economists inflation is persistent rises in prices rather than increases in money supply.)
Observe that the yearly rate of growth of industrial production climbed from 4.6 percent in February 1927 to 16.6 percent by July 1929, before plunging to minus 31 percent by July 1932.
It is likely that the severity of a bust is dictated by the state of the pool of real wealth, namely, whether or not there are still a sufficient number of wealth generators to support various bubble activities that have emerged on the back of the loose monetary policy of the Fed.
The US Federal Reserve is playing with the idea of raising interest rates, possibly as early as September this year. After a six-year period of virtually zero interest rates, a ramping up of borrowing costs will certainly have tremendous consequences. It will be like taking away the punch bowl on which all the party fun rests.
Low Central Bank Rates have been Fueling Asset Price InflationThe current situation has, of course, a history to it. Around the middle of the 1990s, the Fed’s easy monetary policy — that of Chairman Alan Greenspan — ushered in the “New Economy” boom. Generous credit and money expansion resulted in a pumping up of asset prices, in particular stock prices and their valuations.
A Brief History of Low Interest RatesWhen this boom-bubble burst, the Fed slashed rates from 6.5 percent in January 2001 to 1 percent in June 2003. It held borrowing costs at this level until June 2004. This easy Fed policy not only halted the slowdown in bank credit and money expansion, it sowed the seeds for an unprecedented credit boom which took off as early as the middle of 2002.
When the Fed had put on the brakes by having pushed rates back up to 5.25 percent in June 2006, the credit boom was pretty much doomed. The ensuing bust grew into the most severe financial and economic meltdown seen since the late 1920s and early 1930s. It affected not only in the US, but the world economy on a grand scale.
Thanks to Austrian-school insights, we can know the real source of all this trouble. The root cause is central banks’ producing fake money out of thin air. This induces, and necessarily so, a recurrence of boom and bust, bringing great misery for many people and businesses and eventually ruining the monetary and economic system.
Central banks — in cooperation with commercial banks — create additional money through credit expansion, thereby artificially lowering the market interest rates to below the level that would prevail if there was no credit and money expansion “out of thin air.”
Such a boom will end in a bust if and when credit and money expansion dries up and interest rates go up. In For A New Liberty (1973), Murray N. Rothbard put this insight succinctly:
Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance by repeated and accelerating doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop or sharply slow down, either because the banks are getting shaky or because the public is getting restive at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, the piper must be paid, and the inevitable readjustments must liquidate the unsound over-investments of the boom and redirect the economy more toward consumer goods production. And, of course, the longer the boom is kept going, the greater the malinvestments that must be liquidated, and the more harrowing the readjustments that must be made.
To keep the credit induced boom going, more credit and more money, provided at ever lower interest rates, are required. Somehow central bankers around the world seem to know this economic insight, as their policies have been desperately trying to encourage additional bank lending and money creation.
Why Raise Rates Now?Why then do the decision makers at the Fed want to increase rates? Perhaps some think that a policy of de facto zero rates is no longer warranted, as the US economy is showing signs of returning to positive and sustainable growth, which the official statistics seem to suggest.
Others might fear that credit market investors will jump ship once they convince themselves that US interest rates will stay at rock bottom forever. Such an expectation could deal a heavy, if not deadly, blow to credit markets, making the unbacked paper money system come crashing down.
In any case, if Fed members follow up their words with deeds, they might soon learn that the ghosts they have been calling will indeed appear — and possibly won’t go away. For instance, higher US rates will suck in capital from around the word, pulling the rug out from under many emerging and developed markets.
What is more, credit and liquidity conditions around the world will tighten, giving credit-hungry governments, corporate banks, and consumers a painful awakening after having been surfing the wave of easy credit for quite some time.
China, which devalued the renminbi exchange rate against the US dollar by a total of 3.5 percent on August 11 and 12, seems to have sent the message that it doesn’t want to follow the Fed’s policy — and has by its devaluation made the Fed’s hiking plan appear as an extravagant undertaking.
A normalization of interest rates, after years of excessively low interest rates, is not possible without a likely crash in production and employment. If the Fed goes ahead with its plan to raise rates, times will get tough in the world’s economic and financial system.
To be on the safe side: It would be the right thing to do. The sooner the artificial boom comes to an end, the sooner the recession-depression sets in, which is the inevitable process of adjusting the economy and allowing an economically sound recovery to begin.
Asset price inflation, a disease whose source always lies in monetary disorder, is not a new affliction. It was virtually inevitable that the present wild experimentation by the Federal Reserve — joined by the Bank of Japan and ECB — would produce a severe outbreak. And indications from the markets are that the disease is in a late phase, though still short of the final deadly stage characterized by pervasive falls in asset markets, sometimes financial panic, and the onset of recession.
Global Signs of DangerA key sign of danger, recognizable from historical patterns of how the disease progresses, is the combination of steep speculative temperature falls in some markets, with still-high — and in some cases, soaring — temperatures in other markets. Another sign is some pull-back in the carry trade, featuring, in particular, the uncovered arbitrage between a low (or zero) interest rate, and higher rate currencies. For now, however, this is still booming in some areas of the global market-place.
Specifically, we now observe steep falls in commodity markets (also in commodity currencies and mining equities) which were the original area of the global market-place where the QE-asset price inflation disease attacked (back in 2009–11).
Previously hot real estate markets in emerging market economies (especially China and Brazil) have cooled at least to a moderate extent. Most emerging market currencies — with the key exception of the Chinese yuan — once the darling of the carry traders, are in ugly bear markets. The Shanghai equity market bubble has burst.
Yet in large areas of the high-yield credit markets (including in particular the so-called covenant-lite paper issued by highly leveraged corporations) speculative temperatures remain at scorching levels. Meanwhile, Silicon Valley equities (both in the public and private markets), and private equity funds enjoy fantasy valuations. Ten-year Spanish and Italian government bond yields are hovering below 2 percent, and hot spots in global advanced-economy real estate — whether San Francisco, Sydney, or Vancouver — just seem to get hotter, even though we should qualify these last two observations by noting the slump in the Canadian and Australian dollars. Also, there is tentative evidence that London high-end real estate is weakening somewhat.
How to Identify Late Stages of Asset InflationWe can identify similar late phases of asset price inflation characterized by highly divergent speculative temperatures across markets in past episodes of the disease. In 1927–28, steep drops of speculative temperature in Florida real estate, the Berlin stock market, and then more generally in US real estate, occurred at the same time as speculative temperatures continued to soar in the US equity market. In the late 1980s, a crash in Wall Street equities (October 1987) did not mark the end-stage of asset price inflation but a late phase of the disease which featured still-rising speculation in real estate and high-yield credits.
In the next episode of asset price inflation (the mid-late 1990s), the Asian currency and debt crisis in 1997, and the bursting of the Russian debt bubble the following year, accompanied still rising speculation in equities culminating in the Nasdaq bubble. In the episode of the mid-2000s, the first quakes in the credit markets during summer 2007 did not prevent a further build-up of speculation in equity markets and a soaring of speculative temperatures in winter 2007–08 and spring 2008 in commodity markets, especially oil.
What insights can we gain from the identification of the QE-asset price inflation disease as being in a late phase?
The skeptics would say not much. Each episode is highly distinct and the disease can “progress” in very different ways. Any prediction as to the next stage and its severity has much more to do with intuition than scientific observation. Indeed some critics go as far as to suggest that diagnosis and prognosis of this disease is so difficult that we should not even list it as such. Historically, such critics have ranged from Milton Friedman and Anna Schwartz (who do not even mention the disease in their epic monetary history of the US), to Alan Greenspan and Ben Bernanke who claimed throughout their years in power — and these included three virulent attacks of asset price inflation originating in the Federal Reserve — that it was futile to try to diagnose bubbles.
We Can’t Ignore the Problem Just Because It’s Hard to MeasureDifficulties in diagnosis though do not mean that the disease is phantom or safely ignored as just a minor nuisance. That observation holds as much in the field of economics as medicine. And indeed there may be a reliable way in which to prevent the disease from emerging in the first place. The critics do not engage with those who argue that the free society’s best defense against the asset price inflation disease is to follow John Stuart Mill’s prescription of making sure that “the monkey wrench does not get into the machinery of money.”
Instead, the practitioners of “positive economics” demonstrate an aversion to analyzing a disease which cannot be readily identified by scientific measurement. Yes, the disease corrupts market signals, but by how much, where, and in what time sequence? Some empiricists might acknowledge the defining characteristic of the disease as “where monetary disequilibrium empowers forces of irrationality in global markets.” They might agree that flawed mental processes as described by the behavioral finance theorists become apparent at such times. But they despair at the lack of testable propositions.
Mis-Measuring Increases in Asset PricesThe critics who reject the usefulness of studying asset price inflation have no such qualms with respect to its twin disease — goods and services inflation. After all, we can depend on the official statisticians!
In the present monetary inflation, a cumulative large decline in equilibrium real wages across much of the labor market, together with state of the art “hedonic accounting” (adjusting prices downward to take account of quality improvements) has meant that the official CPI has climbed by “only” 11 percent since the peak of the last business cycle (December 2007). The severity of the asset price inflation disease makes it implausible that the official statisticians are measuring correctly the force of monetary inflation in goods and services markets.
What Is the Final Stage?A progression of the asset price inflation disease into its final stage (general speculative bust and recession) would mean the end of monetary inflation and also inflation in goods and services markets. What could bring about this transition? Most plausibly it will be a splintering of rose-colored spectacles worn by investors in the still hot speculative markets rather than Janet Yellen’s much heralded “lift-off” (raising official short-term rates from zero). What could cause the splinter?
Perhaps it will be a sudden rush for the exit in the high-yield credit markets, provoked by alarm at losses on energy-related and emerging market paper. Or financial system stress could jump in consequence of the steep falls of speculative temperature already occurring (including China and commodities). Perhaps there will be a run from those European banks and credit funds which are up to their neck in Spanish and Italian government bonds. Or the Chinese currency could tumble as Beijing pulls back its support and the one trillion US dollar carry trade into the People’s Republic implodes. Perhaps scandal and shock, accompanied by economic disappointment will break the fantasy spell regarding US corporate earnings, especially in Silicon Valley. As the late French President Mitterrand used to say, “give time to Time!”
October 30, 1929. A brisk autumn’s day in Manhattan. The Savoy-Plaza Hotel’s thirty-three stories cast a long shadow over Central Park. At the base of the hotel a financier lies freshly fallen, motionless, while his last breath, wrenched from the lungs by force of impact, is now a red mist of gore in the air.
Sirens and uniforms. The suicide spot quickly becomes crowded by spectators, who form a vision-impairing ring-fence of backs, much to the annoyance of elbow-throwers at the periphery. Winston Churchill stands at his hotel window looking down on the mess. To nobody’s surprise, the police will find an empty wallet and five margin calls in the dead man's pockets.This is a dramatization of an event reported by Winston Churchill. Quoted on p. 7 of Robert P. Murphy’s Politically Incorrect Guide To The Great Depression and the New Deal.
Churchill’s curtains flutter shut, and we are left to wonder whether anyone — Churchill included — can yet see his clumsy, cigar-wielding hand in it all; whether anyone realizes that, had Churchill as Chancellor of the Exchequer only restored the gold standard at a lower exchange rate, as Keynes had recommended, the Wall Street Crash of 1929 could have been averted (or at least ameliorated).
Alas, by ignoring Keynes in 1925, Churchill triggered a calamity so severe that it not only inspired one man to kill himself beneath the British statesman’s very window but, more insidiously, also provided the impetus for the economics profession’s rejection of the “classical” axioms. As Keynes’s biographer Robert Skidelsky writes, Keynes “did not believe in the system of the ideas by which economists lived; he did not worship at the temple.” And while “in former times he would have been forced to recant, perhaps burnt at the stake, as it was ... the exigencies of his times enabled him to force himself on his church.”
1925: Britain’s Return to the Gold StandardThe pound sterling’s link to gold was severed at the start of WWI. After eleven years of unfettered inflation, Chancellor of the Exchequer Winston Churchill restored convertibility at the pre-war level of 4.25 pounds per ounce of gold.
Keynes, quite rightly, took exception to this particular detail: expecting Britain’s global customers to go on paying the same gold-price for the weakened pound was unrealistic. At this exchange rate the pound would be overvalued, and the only cure would be a sustained period of deflation — which was “certain to involve unemployment and industrial disputes.” Indeed, in 1926 a general strike crippled Britain for nine days.
What Keynes did not predict, however, was how Churchill’s blunder would later bring about an easing of monetary policy in America. And even supposing Keynes had predicted this side effect, would he have understood its implications for long-run sustainability? (Recall that both F.A. Hayek and Keynes predicted a crash would occur in 1929: Hayek because interest rates were too low, Keynes because they were too high!)
1927: At the Fed (With Cap in Hand)American sellers (in particular) were accepting British gold in exchange for goods, but were dissuaded from returning it due to the unfavorable rate of exchange. As a result, Britain’s gold supplies diminished at a rapid rate, which made the authorities understandably twitchy: how could they keep their pledge to convert pounds into gold if they had none?
In response, the Governor of the Bank of England, Montagu Norman, set off across the Atlantic and, with much pleading, persuaded the Federal Reserve to ease monetary policy. By lowering interest rates and raising inflation, the Fed stemmed gold flows into America, giving the British a much-needed respite from the ill-effects of Churchill’s costly pound.
With this episode of soft-hearted internationalism came an upswing in the Wall Street boom and “from that date,” wrote Lionel Robbins, “according to all the evidence, the situation got completely out of control.”
In The Great Crash, a very popular account of the lead up to the Great Depression, John Kenneth Galbraith writes:
the rediscount rate of the New York Federal Reserve was cut from 4 to 3.5 percent. Government securities were purchased in considerable volume with the mathematical consequence of leaving the banks and individuals who had sold them with money to spare. The funds that the Federal Reserve made available were either invested in common stocks or ... they became available to help finance the purchase of common stocks by others. So provided with funds, people rushed into the market.
Galbraith goes on to quote a member of the Federal Reserve Board who, with hindsight, called the operation “one of the most costly errors” committed by a banking system “in 75 years.”
Galbraith finishes: “the view that the action of the Federal Reserve in 1927 was responsible for the speculation and collapse which followed has never been seriously shaken.”
John Maynard Who?When Keynes wrote against returning to the gold standard at pre-war parity in 1925, he did so with the expectation that he might actually influence policy. As a younger, unknown man he had worked at the Treasury for a brief stint, leaving a legendary impression; and by 1925, six years after his best-seller The Economic Consequences of the Peace, he was a famous man whose words carried weight.
It is not outlandish then to imagine a world in which Keynes got his way. In such a world, the Wall Street crash and ensuing depression might never have happened — without the costly pound, the Fed would have had no impetus to inflate. Keynes would subsequently have found the economics profession less rattled, less willing to abandon its “classical” axioms in favor of his new-fangled approach. Keynes might have averted Keynesianism.
In a dynamic economy, an action not only triggers just one effect, but always an entire series of different consequences. While the cause of the first effect is easily recognizable, the other effects often occur only later and no such recognition occurs. Frédéric Bastiat described this phenomenon in 1850 in his ground-breaking essay “What Is Seen and What is Not Seen”:
In the economic sphere, an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them …
There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen. Yet this difference is tremendous; for it is almost always the case that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Hence it follows that the bad economist pursues a small present good that will be followed by a great evil, while the good economist pursues a great good to come, at the risk of a small present evil.
A similar phenomenon can be seen with the consequences of artificially suppressed interest rates and monetary stimulus: in the short term, they appear to have positive effects, the long term effects are, however, disastrous. If one studies these processes closely, it becomes clear that the underlying problems cannot be solved by global zero-interest-rate policy (ZIRP), but that this instead undermines the natural selection process of the market.
With artificial stimulus like ZIRP, we only end up with a situation in which governments, financial institutions, entrepreneurs, and consumers who should actually be declared insolvent all remain on artificial life support.
In line with Bastiat’s thoughts, numerous fatal long-term consequences of zero-interest-rate policies can be identified, but are generally ignored:
Conservative investors by nature come under increasing pressure with respect to their investments and take on excessive risks in light of the prospect that interest rates will remain low in the long term. This leads to capital misallocation and the emergence of bubbles.The sweet poison of low interest rates leads to massive asset price inflation (stocks, bonds, works of art, real estate).Structurally too low interest rates in industrialized nations due to carry trades lead to the emergence of asset price bubbles and contagion effects in emerging markets.Changes in human behavior patterns occur, due to continually declining purchasing power. While thrift is increasingly mutating into a relic of the past, taking on debt comes to be seen as rational.As a result of the structurally too low level of interest rates, a “culture of instant gratification” is created, which is among other things characterized by the fact that consumption is financed with credit instead of savings. The formation of wealth becomes steadily more difficult.The medium of exchange and unit of account function of money increases in importance, while its role as a store of value declines.Incentives for fiscal discipline decline.Zombie banks are created: Low interest rates prevent the healthy process of creative destruction. Banks are enabled to roll over potentially non-performing loans practically indefinitely and can thus lower their write-off requirements.Newly created money is neither uniformly nor simultaneously distributed amongst the population. This results in a permanent transfer of wealth from later receivers to earlier receivers of newly created money.Conventional monetary policy — that is, the promotion of credit creation by lowering interest rates — reaches its limits once the “zero-bound” is reached. In order to continue the spiral of stimulus, “unconventional monetary policy” becomes ever more important. The multitude of “newfangled” monetary policy measures is seemingly only limited by the imagination of central bankers, whereby recent years have shown that central bankers can be extraordinarily creative. That this phenomenon is nothing new, is inter alia shown by this observation by Ludwig von Mises in 1922:
But an increase in the quantity of money and fiduciary media will not enrich the world. … Expansion of circulation credit does lead to a boom at first, it is true, but sooner or later this boom is bound to crash and bring about a new depression. Only apparent and temporary relief can be won by tricks of banking and currency. In the long run they must lead to an all the more profound catastrophe.
You’ve probably read that there is a “war on cash” being waged on various fronts around the world. What exactly does a “war on cash” mean?
It means governments are limiting the use of cash and a variety of official-mouthpiece economists are calling for the outright abolition of cash. Authorities are both restricting the amount of cash that can be withdrawn from banks, and limiting what can be purchased with cash.
These limits are broadly called “capital controls.”
Why Now?Before we get to that, let’s distinguish between physical cash — currency and coins in your possession — and digital cash in the bank. The difference is self-evident: cash in hand cannot be confiscated by a “bail-in” (i.e., officially sanctioned theft) in which the government or bank expropriates a percentage of cash deposited in the bank. Cash in hand cannot be chipped away by negative interest rates or fees.
Cash in the bank cannot be withdrawn in a financial emergency that shutters the banks (i.e., a bank holiday).
When pundits suggest cash is “obsolete,” they mean physical paper money and coins, not cash in a bank. Cash in the bank is perfectly fine with the government and its well-paid yes-men (paging Mr. Rogoff and Mr. Buiter) because this cash can be expropriated by either “bail-ins” or by negative interest rates.
Inflation and Negative Interest RatesMr. Buiter, for example, recently opined that the spot of bother in 2008–09 (the Global Financial Meltdown) could have been avoided if banks had only charged a 6 percent negative interest rate on cash: in effect, taking 6 percent of the depositor’s cash to force everyone to spend what cash they might have.
Both cash in hand and cash in the bank are subject to one favored method of expropriation, inflation. Inflation — the single most cherished goal of every central bank — steals purchasing power from physical cash and digital cash alike. Inflation punishes holders of cash and benefits those with debt, as debt becomes cheaper to service.
The beneficial effect of inflation on debt has been in play for decades, so it can’t be the cause of governments’ recent interest in eliminating physical cash.
So now we return to the question: Why are governments suddenly declaring war on physical cash, the oldest officially issued form of money?
Why They Hate Cash in HandThe first reason: physical cash has the potential to evade both taxes as well as officially sanctioned theft via bail-ins and negative interest rates. In short, physical cash is extremely difficult for governments to steal.
Some of you may find the word theft harsh or even offensive. But we must differentiate between taxes — which are levied to pay for the state’s programs that in principle benefit all citizens — and bail-ins, i.e., the taking of depositors’ cash to bail out banks that became insolvent through the actions of the banks’ management, not the actions of depositors.
Bail-ins are theft, pure and simple. Since the government enforces the taking, it is officially sanctioned theft, but theft nonetheless.
Negative interest rates are another form of officially sanctioned theft. In a world without the financial repression of zero-interest rates (ZIRP — central banks’ most beloved policy), lenders would charge borrowers enough interest to pay depositors for the use of their cash and earn the lender a profit.
If borrowers are paying interest, negative interest rates are theft, pure and simple.
Why are governments suddenly so keen to ban physical cash? The answer appears to be that the banks and government authorities are anticipating bail-ins, steeply negative interest rates and hefty fees on cash, and they want to close any opening regular depositors might have to escape these forms of officially sanctioned theft. The escape mechanism from bail-ins and fees on cash deposits is physical cash, and hence the sudden flurry of calls to eliminate cash as a relic of a bygone age — that is, an age when commoners had some way to safeguard their money from bail-ins and bankers’ control.
Forcing Those With Cash To Spend or Gamble Their CashNegative interest rates (and fees on cash, which are equivalently punitive to savers) raise another question: why are governments suddenly obsessed with forcing owners of cash to either spend it or gamble it in the financial-market casinos?
The conventional answer voiced by Mr. Buiter is that recession and credit contraction result from households and enterprises hoarding cash instead of spending it. The solution to recession is thus to force all those stingy cash hoarders to spend their money.
There are three enormous flaws in this thinking.
One is that households and businesses have cash to hoard. The reality is the bottom 90 percent of households have less income now than they did fifteen years ago, which means their spending has declined not from hoarding but from declining income.
While corporate America has basked in the glory of sharply rising profits, small business has not prospered in the same fashion. Indeed, by some measures, small business has been in a six-year recession.
The bottom 90 percent has less income and faces higher living expenses, so only the top slice of households has any substantial cash. This top slice may see few safe opportunities to invest their savings, so they choose to keep their savings in cash rather than gamble it in a rigged casino (i.e., the stock market).
The second flaw is that hoarding cash is the only rational, prudent response in an era of financial repression and economic insecurity. What central banks are demanding — that we spend every penny of our earnings rather than save some for investments we control or emergencies — is counter to our best interests.
A War on Cash Is a War on CapitalThis leads to the third flaw: capital — which begins its life as savings — is the foundation of capitalism. If you attack savings as a scourge, you are attacking capitalism and upward mobility, for only those who save capital can invest it to build wealth. By attacking cash, the central banks and governments are attacking capital and upward mobility.
Those who already own the majority of productive assets are able to borrow essentially unlimited sums at near-zero interest rates, which they can use to buy more productive assets. Everyone else — the bottom 99.5 percent — is reduced to consumer-serfdom: you are not supposed to accumulate productive capital, you are supposed to spend every penny you earn on interest payments, goods, and services.
This inversion of capitalism dooms an economy to all the ills we are experiencing in abundance: rising income inequality, reduced opportunities for entrepreneurship, rising debt burdens, and a short-term perspective that voids the longer-term planning required to build sustainable productivity and wealth.
Physical Cash: Only $1.36 TrillionAccording to the Federal Reserve, total outstanding physical cash amounts to $1.36 trillion.
Given that a substantial amount of this cash is held overseas, physical cash is a tiny part of the domestic economy and the nation’s total assets. For context: the US economy is $17.5 trillion, total financial assets of households and nonprofit organizations total $68 trillion, base money is around $4 trillion, and total money (currency in circulation and demand deposits) is over $10 trillion (source).
Given the relatively modest quantity of physical cash, claims that eliminating it will boost the economy ring hollow.
Following the principle of cui bono — to whose benefit? — let’s ask: What are the benefits of eliminating physical cash to banks and the government?
Benefits To Banks and the Government of Eliminating Physical CashThe benefits to banks and governments by eliminating cash are self-evident:
Every financial transaction can be taxed. Every financial transaction can be charged a fee. Bank runs are eliminated.In fractional reserve systems such as ours, banks are only required to hold a fraction of their assets in cash. Thus a bank might only have 1 percent of its assets in cash. If customers fear the bank might be insolvent, they crowd the bank and demand their deposits in physical cash. The bank quickly runs out of physical cash and closes its doors, further fueling a panic.
The federal government began insuring deposits after the Great Depression triggered the collapse of hundreds of banks, and that guarantee limited bank runs, as depositors no longer needed to fear a bank closing would mean their money on deposit was lost.
But since people could conceivably sense a disturbance in the Financial Force and decide to turn digital cash into physical cash as a precaution, eliminating physical cash also eliminates the possibility of bank runs, as there will be no form of cash that isn’t controlled by banks.
Presented at Mises Boot Camp, a one-day seminar for anyone seeking to learn the fundamentals of the Austrian school. Download the Syllabus.
Recorded at the Mises Institute in Auburn, Alabama, on 25 July 2015.
In the early nineteenth century, Bastiat posed the story of a young man who throws a brick through the window of a baker’s shop. We’re told that this may have a bright side — that the baker must now pay a glazier to fix the window, who will then use that income to spend elsewhere, creating a ripple effect that benefits many.
Such thinking is reminiscent of what would later be used to justify the logic behind the Keynesian multiplier. Keynes would later write in the General Theory, “Pyramid building, earthquakes, even wars may serve to increase wealth.”
The Opportunity Cost of Fixing ThingsAs many readers already know, such logic fails to take into account the opportunity cost of the broken window. Had the window not been broken, the baker wouldn’t have paid the glazier, but maybe he would’ve spent the money on a pair of shoes instead. The shoemaker would then have income to spend elsewhere, and the same multiplier would take place — but society would be better off by exactly one window.
Before diving into the modern real-world evidence that substantiates Bastiat’s brilliant essays, it’s important to distinguish between income and wealth. Destruction may boost income in the short run, but reduce a society’s net amount of wealth (the purpose of production in the first place). To play off an interesting piece by Ryan Young in the American Spectator, Suppose we have a small island, whereas all wealth is in the value of homes, personal property, business properties, and infrastructure, with a value of $10 million. Now let’s say that economic growth is slow, many are unemployed, and aggregate wealth is projected to increase to $11 million next year.
Next, a violent natural disaster occurs, destroying the nation’s entire stock of wealth. Since economic growth was slow and many were unemployed, everyone on the island directs their attention to rebuilding from the disaster, and within a year, everything is back to normal. In the statistics, GDP is boosted by $10 million — ten times higher than it would’ve otherwise risen, yet the wealth of society remains unchanged.
Such a scenario is reflective of what occurs in the short run. In May of 2012, Paul Krugman highlighted Japan’s superior first quarter economic growth relative to other nations, attributing it to increased government spending following the tsunami in 2011. But as Young noted, this doesn’t take into effect that natural disasters have on a nation’s stock of wealth.
The “Benefits” of Deadly CyclonesNow, onto the real-world evidence. Published in the National Bureau of Economic Research, economists Solomon M. Hsiang and Amir S. Jina looked at the long-run economic effects of environmental catastrophe, focusing on destruction from cyclones in particular. Nearly seven thousand cyclones that occurred from 1950–2008 were studied. The conclusions were that the worse the disaster, the worse long-run economic growth suffered. According to their data, “fifteen years after a strike, GDP is 0.38 percentage points lower for every 1 m/s of wind speed.”
While I constructed an example earlier where destruction would have positive effects on income in the short run, such effects disappear when the short run becomes the long run. Their research also found that a disaster in the 90th percentile reduced incomes by 7.4 percent two decades after. This led the authors to reject the “creative destruction” hypothesis in regards to natural disasters.
Defenders of the supposed blessings of destruction also have to take into account another variable: the value of human life. Following an earthquake in May of 2008 that killed 80,000 in the Sichuan Province, the Chinese government’s State Information Center found a silver lining: economic growth would be boosted by an additional 0.3 percent that year due to money spent on rebuilding the devastated region. Even assuming that this growth wasn’t offset by slower growth in the long run, it’s still not a viable plan. Economic growth in China was 18.1 percent in 2009, growing by nearly five trillion yuan from the year prior. Assuming that the Chinese government is correct and 0.3 percent of that was attributable to rebuilding from the disaster, this means that GDP was boosted by roughly 5,300,000 yuan for each death, or roughly $860,000. To put that in perspective, the Environmental Protection agency in the US sets the value of a human life at $9.1 million, while the Food and Drug Administration pegs that figure at $7.9 million.
The purpose of Bastiat’s essay on the broken window was to illustrate the concept of opportunity cost at a minor level, focusing on a minor act of vandalism. As we’ve seen from real-world evidence, the opportunity cost of destruction is seldom society being worse off by only a single window, but much worse when we take into account the long-run effects it has on income and wealth, and human life.
Patrick and Jeff discuss European integration, which pits creditor nations like Germany against hapless debtors like Greece under the yoke of the Eurozone. With the Euro operating as a political project rather than a real currency, spendthrifts like Greece chronically find themselves unable to service debt. Greece, says Patrick, represents an example of Say's Law in action and a clear refutation of Keynes's belief that creating artificial demand via cheap credit stimulates production.
Think Greece can't happen here? Look no further than California, with its public pension crisis and huge debts.
If you're looking for a sober and hard-hitting analysis of what's really at issue in Greece, stay tuned for a great discussion with Patrick Barron.
Greece cannot pay its debts ... ever. Nor can several other members of the European Union. That’s why Europe’s elite are loath to place Greece in default. If Greece is allowed to abrogate its debts, why should any of the other debtor members of the EU pay up? The financial consequences of massive default by most of the EU members is hard to predict, but it won't be pretty. Europe has built a financial house of cards, and the slightest loss of confidence will bring it crashing down.
The tragedy of Europe has socialism at its core. Europe has flirted with socialism since the late nineteenth century. Nineteenth century Bismarckian socialism produced two world wars. Leninist socialism slaughtered and enslaved hundreds of millions until it collapsed, mercifully without a third world war. Yet, not to be deterred, in the ashes of World War II, Europe’s socialists embarked on a new socialist dream. If socialism fails in one country, perhaps it will succeed if all of Europe joined a supra-national socialist organization. Oh, they don't call what has evolved from this dream “socialism,” but it is socialism nonetheless.
Socialism will not work, whether in one country, a multi-state region such as Europe, or the entire world. Ludwig von Mises explained that socialism is not an alternative economic system. It is a program for consumption. It tells us nothing about economic production. Since each man's production must be distributed to all of mankind, there is no economic incentive to produce anything, although there may be the incentive of coercion and threats of violence. Conversely, free market capitalism is an economic system of production, whereby each man owns the product of his own labors and, therefore, has great economic incentives to produce both for himself, his family, and has surplus goods to trade for the surplus product of others. Even under life and death threats neither the socialist worker nor his overseer would know what to produce, how to produce it, or in what quantities and qualities. These economic cues are the product of free market capitalism and money prices.
Under capitalism, man specializes to produce trade goods for the product of others. This is just one way of stating Say’s Law; i.e., that production precedes consumption and that production itself creates demand. For example, a farmer may grow some corn for his family to consume or to feed to his own livestock, but he sells most of his corn on the market in exchange for money with which to buy all the many other necessities and luxuries of life. His corn crop is his demand and money is simply the indirect medium of exchange.
Keynes attempted to deny Say’s Law, claiming that demand itself — created artificially by central bank money printing — would spur production. He attempted, illogically and unsuccessfully, to place consumption ahead of production. To this day Keynes is very popular with spendthrift politicians, to whom he bestowed a moral imperative to spend money that they did not have.
We see the result of 150 years of European socialism playing out in grand style in Greece today. The producing countries are beginning to realize that they have been robbed by the EU’s socialist guarantee that no nation will be allowed to default on its bonds. Greece merely accepted this guarantee at face value and spent itself into national bankruptcy. Other EU nations are not far behind. It’s time to give free market capitalism and sound money a chance: it’s worked every time it’s been tried.
You’d think with all the “stimulus” from Washington over the fifteen years since the dotcom bust, American capitalism would be booming. It’s not. On the measures which count when it comes to sustainable growth and real wealth creation, the trends are slipping backwards — not leaping higher.
After a look at new jobs data in April, we find the number of breadwinner jobs in the US economy is still two million below where it was when Bill Clinton still had his hands on matters in the Oval Office. Since then we have had two presidents boasting about how many millions of jobs they have created and three Fed chairmen taking bows for deftly guiding the US economy toward the nirvana of “full employment.”
When you look under the hood, it’s actually worse. These “breadwinner jobs” are important because they’re the only sector of the payroll employment report where jobs generate enough annual wage income — about $50k — to actually support a family without public assistance.
Moreover, within the 70 million breadwinner jobs category, the highest paying jobs which add the most to national productivity and growth — goods production — have slipped backward even more dramatically. There were actually 21 percent fewer payroll jobs in manufacturing, construction and mining/energy production reported in April than existed in early 2000.
Now let’s look at productivity growth. If you don’t have it, incomes and living standard gains become a matter of brute labor hours thrown against the economy. In theory, of course, all the business cycle boosting and fine-tuning from fiscal and monetary policy, especially since the September 2008 crisis, should be lifting the actual GDP closer to its “potential” path, and thereby generating a robust rate of measured productivity growth.
Not so. Despite massive policy stimulus since the late 2007 peak, nonfinancial business productivity has grown at just 1.1 percent per annum. That is just half the 2.2 percent annual gain from 1953 until 2000. So Washington-engineered demand stimulus is self-evidently not pulling up productivity by its bootstraps.
Indeed, if you go back to the 1953–1973 peak-to peak period, which also encompassed several business cycles, the annual productivity growth rate averaged 2.7 percent, or two and one-half times the last fifteen year outcome.
The same picture occurs on real median household income. During the same 1953–1973 interval, real median family income grew at 3.0 percent annually, rising from $26k to $46k during the period.
By contrast, over the course of the next twenty-seven years, and after Washington ended both the Bretton Woods gold standard anchor on money and the practice of balanced budgets, real median incomes grew by only 0.8 percent annually, rising to $57k by the year 2000.
Needless to say, it’s been all downhill since then. Real median income was $53k in 2014. That means median living standards of US households have been falling at a 0.5 percent annual rate since the turn of the century. There is no prior fifteen year period that bad, including the years after the 1929 crash.
Labor Force Fundamentals DecliningThe argument of the Keynesians is that capitalism is a chronic underperformer. Left to its own devices it is always leaving idle labor and capital resources on the table, and is even prone to bouts of depressionary collapse absent the counter-cyclical ministrations of the state and its central banking branch.
Well, then, given the monumental size and chronic intensity of policy stimulus during the last fifteen years, that particular disability should have been eliminated long ago. The US economy should be surfing near its full potential.
In that regard, one measure of high resource utilization most surely would be the labor force participation rate. However, after the one-time boost of increased female participation after 1980, the trend has been in a nose-dive. And it’s not due to the baby-boomers getting old and repairing to the shuffleboard courts.
Since the year 2000 — a time when the Fed’s balance sheet soared by nine-fold from $500 billion to $4.5 trillion — the prime age labor force participation rate has plummeted by 10 percentage points.
A similar trend can be seen in the measures of aggregate labor hours. Even if productivity has turned punk, it might be thought that all this policy stimulus would flush labor hours into the economy. But despite an increase from 212 million to 250 million of the working age population since the year 2000, there has been virtually no gains in labor hours utilized by the private business economy, and this is all the more obvious when we remember that not all headline jobs are created equal — even though it is well known that the BLS counts a four hour window-washing gig and a 40-hour week in a steel mill the same.
So the underlying truth is that actual apples-to-apples labor utilization has been going nowhere. In Q4 2014, the index of non-farm labor hours utilized by the business sector posted at 109.8 — virtually the identical level recorded in early 2000.
That’s right. After growing at a 1.6 percent annual rate for a half-century running (1953 to 2000), labor resources deployed have flat-lined for the past 15 years. Rather than contributing to higher utilization of resources, the massive, chronic stimulus policies of recent years have been associated with just the opposite.
So when it comes to the building blocks of prosperity, policy stimulus has not been stimulating much of anything — except a slide downhill.
And while the American economy stagnates, serious global risks remain on the horizon.
China at RiskIn China, the most fantastic credit bubble in recorded history is beginning to burst. That is, notwithstanding Wall Street’s sell-side propaganda, China’s vaunted $10 trillion GDP is not capitalist GDP in any familiar or meaningful sense; nor is it the product of organic market-based economic growth.
Instead, it is “constructed GDP” which has been fabricated out of centrally issued and allocated fiat credit. Over the past two decades the People’s Printing Press of China issued virtually unlimited bank reserves in the process of buying up dollars to peg the RMB exchange rate in support of its national policy of export mercantilism. This, in turn, has enabled China’s total public and private credit outstanding to soar from $2 trillion at the turn of the century to $28 trillion today.
In short, the overlords of red capitalism in Beijing caused the entire nation to borrow itself silly in order to fund a construction and investment mania that has no historical parallel. Indeed, the fourteen-fold explosion of debt in fourteen years has resulted in not only trillions of artificial “printing press GDP,” but, more importantly, in a stupendous accumulation of over-valued and uneconomic “assets” on both public and private accounts.
There are currently an estimated seventy million empty high rise apartment units in China, for example, because under the baleful influence of unlimited credit these apartments were built for asset appreciation, not occupancy. In fact, most of China’s tens of million of punters who have invested in these units have taken pains to keep them empty and spanking new; like contemporary works of art, appreciation potential can be impaired by marks and scrapes.
Needless to say, there is a huge problem when you turn rebar, concrete, and wallboard into tulip bulbs. Namely, when the price mania finally stops not only do the speculators who put their savings into empty apartment units get crushed, but, more importantly, demand for new units quickly evaporates, causing a devastating contraction up and down the building supply chain.
The Eurozone’s Wishful ThinkingMeanwhile, in Europe, Greece and the EU are pinned between a rock and a hard place. There is not a chance that Greece can service its monumental debt, yet the eurozone politicians are now petrified by the fiscal trap they have concocted during their can-kicking rituals since 2010.
So the baleful facts bear repeating. The eurozone governments have committed to $200 billion of direct fiscal guarantees to Greece, but in cobbling these expedients together during the 2010 and 2011 crises what the politicians of Brussels really did was to stick the ECB with the ultimate Old Maid’s card.
Stated differently, in the process of bailing out their own banks, which were stuffed with Greek sovereign and private credits, Brussels did just enough to stabilize the private credit markets and ward off the vultures. This, in turn, allowed the ECB to pretend that Greek collateral was money and to pacify the German monetary sticklers about the sin of monetizing state debt. At length, the ECB became the money market for the entire Greek economy.
Greece owes the ECB upward of $140 billion. That is, the Greek state and banking system owes the ECB more money than the entire deposits of the Greek banking system!
Altogether then, Greece owes the politicians and apparatchiks who rule the continent from Brussels and Frankfurt the staggering sum of $340 billion. In fact, the sum is not staggering; it is lunacy itself. The cowardly, self-perpetuating rulers of the European superstate have managed to loan Greece what amounts to 3 percent of their own GDP when Greece itself only accounts for 2 percent of eurozone economic output.
In the event of a blow-up and Grexit, exactly how would this mountain of Greek collateral be collected? Would it be done by the German army sent in to occupy the Greek ports and railway stations?
The Serial Bubble MachineWith our own flat-lining economy at home and serious risks of implosions abroad, one would think that now is a good time to take an honest look at the state of the global economy and do some serious planning.
But there’s no danger of that happening because the monetary politburo in the Eccles Building ignores all these fundamentals in order to focus on the short-run “incoming data.” It actually believes it can steer the business cycle as in times of yesteryear when the credit channel of monetary transmission still functioned effectively — even if destructively in the long-run.
But that was a one-time parlor trick. Nowadays, American households are at “peak debt” and on a net basis can no longer raise their leverage ratios to supplement wage- and salary-based income with more borrowings. Likewise, business borrows hand-over-fist in response to the Fed’s dirt-cheap cost of debt, but the proceeds go into financial engineering, not productive investment.
So the Fed blunders forward, oblivious to the fact that it is now 2015, not 1965, maintaining the lunacy of zero or soon near-zero interest rates. That maneuver creates floods of new credits, but in the form of gambling stakes which never leave the canyons of Wall Street. In so doing, they inflate financial assets values until they reach such absurd heights that they collapse of their own weight.
The Fed has thus become little more than a serial bubble machine. Tracking the incoming data during the intervals between financial boom and bust, it mistakes unsustainable short-run gains for real economic growth. But overwhelmingly, the incoming data has been recording temporary GDP and born again jobs.
For the second time this century we have had a boom in the part-time economy of jobs in bars, restaurants, retail, leisure and personal services. These jobs on average represent twenty-six hours of work per week and average wage rates of around $14/hour, thereby generating less than $20k on an annual basis.
Since the top 10 percent of households account for upward of 40 percent of consumer spending it is not hard to see what will happen next. When this third and greatest financial bubble of this century finally collapses, the bread and circuses jobs will vanish in a heartbeat.
Those of us leaning in the Austrian direction see bubbles and malinvestments around every corner and assume, wrongly as it turns out, the market will right these wrongs lickety-split. But, for the moment a rational market is no match for cheap money. “Any college that is thinking about capital expansion, now is a very good time,” Robert Murray, an economist at Dodge Data told the Wall Street Journal. “Several years down the road, the climate might not be as good.”
Now being a good time because stock market gains have pumped up endowments, “and low interest rates have created a favorable environment for colleges to build,” writes Constance Mitchell Ford. The campus building boom marches on.
In 2014 colleges and universities commenced construction on $11.4 billion worth of projects, a 13 percent increase from the previous year. It’s the largest dollar value of construction starts since the heady days of 2008.
Ms. Ford’s piece highlights a $2 billion project at Cornell and sixteen new buildings at Columbia worth $6 billion. But here in Auburn, Alabama the campus has been a construction zone since 2008 when I arrived. Multiple new dorms, a basketball arena, a fancy student center, and various new classroom buildings have been constructed at a time when funding from the state has been cut back. What’s now underway is the largest scoreboard in college football, with a plan to expand the stadium next.
Back in the 1985–86 school year, full time tuition at Auburn for a non-resident was $2,585. Thirty years later it is now $28,040. That’s a compounded annual growth rate of 8.27 percent.
According to Bloomberg, college tuition and fees have increased 1,120 percent since records began in 1978, and the rate of increase in college costs has been “four times faster than the increase in the consumer price index.”
Tuiton at state schools is rising even faster says Peter Cappelli, professor of management at the Wharton School of the University of Pennsylvania. He told Becky Quick on CNBC’s “Squawk Box” the cost of an education has risen 50 percent faster at state schools versus private in roughly the last decade.
Cappelli said a critical question is whether students will graduate in the first place, noting that only 40 percent of full-time students earn a degree within four years, and 30 million — and perhaps as many as 35 million — young adults do not finish their studies.
Unfinished college is as useful as an unfinished building.
College degrees are similar to what Austrians call higher-order goods. It’s believed a student will gain knowledge and seasoning in college, making him or her more productive and a candidate for a high-paying career. The investment of time and money in knowledge are undertaken for the payoff of higher productivity and a high future income. Higher education is the higher-order means to a successful career.
The assumption is those high-pay jobs, (A) will require a college degree, and (B) they will be plentiful when the student graduates. Borrowing $100,000 to earn a law degree is a malinvestment if the student ends up writing briefs for $15 per hour. A recent graduate of the Charlotte School of Law put fliers on cars announcing that he or she had borrowed $200,000 to attend school and is now working at Walmart for $35,000 a year.
A post on the “Above The Law” blog revealed, “As of the 2013–2014 academic year, the total cost of a three-year J.D. degree from Charlotte Law was $123,792.00, while the median loan debt per graduate was $159,208.00. Just 34 percent of the class of 2014 was employed in full-time, long-term jobs where bar passage was required. ...”
“More college graduates are working in second jobs that don’t require college degrees,” writes Hannah Seligson in the New York Times, “part of a phenomenon called ‘mal-employment.’ In short, many baby-sitters, sales clerks, telemarketers and bartenders are overqualified for their jobs.”
Ludwig von Mises wrote in Human Action,
The whole entrepreneurial class is, as it were, in the position of a master builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master builder’s fault was not overinvestment, but an inappropriate employment of the means at his disposal.
As it is now, parents and students still have the belief that college is the way to, if not riches, at least a well-paying career. In a 2011 piece for mises.org with what turned out to be the hasty title of “The Higher-Education Bubble Has Popped” I quoted PayPal founder and early Facebook investor Peter Thiel, who questioned the value of higher education. He told TechCrunch,
A true bubble is when something is overvalued and intensely believed. Education may be the only thing people still believe in in the United States. To question education is really dangerous. It is the absolute taboo. It’s like telling the world there’s no Santa Claus.
Like most bubbles this one is being fueled by debt. USA Today reports, 40 million borrowers owe $29,000 each, totaling $1.2 trillion outstanding. Student loan debt is easy to get, but hard to get rid of. It’s hard to pay back without a high salary, nor can it be bankrupted away. “Government either guarantees or owns most of the student loans and has the power to sue and to garnish wages, tax refunds, and federal benefits like Social Security when borrowers default,” Kelley Holland writes.
Defaults are plentiful. In the third quarter of last year, the three-year default rate was roughly 13.7 percent, with the average amount in default per borrower just over $14,000.
These debtors “are postponing marriage, childbearing and home purchases, and ... pretty evidently limiting the percentage of young people who start a business or try to do something entrepreneurial,” says Mitch Daniels, president of Purdue University
I administer funds for a small scholarship for graduating high school seniors in my old home town. This year, for the first time, an applicant wrote that he needed financial help for college because his father, a veterinarian, can’t help his children because he’s struggling to make payments on his own student debt.
The college boom is not just on campus. Student housing developers have been riding the college boom as well. Two years ago in a piece for The Freeman, I wrote about developers cashing in building dorms. These developers have even found Auburn, with its population of only 50,000. A project called 160 Ross has long-time residents in an uproar with its high density. But as much as locals don’t like it, students have snapped up units at $599 a bed.
That rack rate has large student housing developers coming to town and CV Ventures is ready to break ground for a six-story mixed-used project on just one acre featuring 456 beds, stumbling distance from the college bars, with a Waffle House across the street.
Meanwhile, everyday we hear about how online courses being the death knell for brick-and-mortar institutions. For the moment traditional colleges seem safe. “Because traditional campuses offer peer and teacher interaction,” writes Ron Kennedy, “as well as a plethora of other important benefits often sought by traditional, college-aged students, there will remain a need for traditional education.”
More importantly, Kennedy continues, “Research has shown that students who interact face-to-face with their instructors and other students tend to be more academically balanced than their online counterparts. This is one reason why most employers still prefer students who have attended traditional campuses.”
Trees don’t grow to the sky and neither will tuition. However, it’s doubtful young people will suddenly stay home with their parents and work toward degrees taking online classes. Parents who can afford it want to relive their college days vicariously through their kids.
The higher education bubble continues to inflate.
This weekend, we continue our series featuring some of the young scholars who are spending their summer here at the Mises Institute as summer fellows. One of these young scholars is Jonathan Newman, who is working on a PhD in Economics just across the street from us at Auburn University. Jonathan is not only a thoroughly Austrian scholar, but he is also an excellent teacher. He is concerned about his students—he cares about them—and he cares about being an effective instructor, unlike so many young people who seem to go into academia just to publish. We thought you would enjoy hearing Jonathan teach some high school students on the subject of inflation.
James Grant, of Grant's Interest Rate Observer, recently joined us at our event in Stamford, Connecticut, to discuss his new book, The Forgotten Depression—1921: The Crash That Cured Itself.
If you've never heard of the Depression of 1921, it's because the federal government and the (then new) Federal Reserve did the opposite of what they did in 2008: federal spending was cut, the federal budget was balanced, and interest rates were allowed to rise. In other words, real austerity measures were implemented. The result? A short economic contraction that healed itself.
If you want to understand why TARP stimulus, too big to fail bank bailouts, and quantitative easing make our current economic crisis worse, there's nobody better than Jim Grant to explain.
Argentina will hold elections this year, and a number of provinces will be electing governors. Buenos Aires, the capital city, is holding elections for mayor, and Mauricio Macri, who is stepping down as mayor, is a favorite to become the next president. Toward the end of the year, a presidential election will be held and Cristina Kirchner, after two consecutive mandates, will have to step down because she cannot be re-elected.
Like Chávez and Maduro in Venezuela, Argentina can be described as a country that fell victim to extreme populism during the Nestor and Cristina Kirchner administrations, which began in 2003. Twelve years later, this populist political project is about to end.
The economic policy of populism is characterized by massive intervention, high consumption (and low investment), and government deficits. This is unsustainable and we can identify several stages as it moves toward its inevitable economic failure. The last decade of extreme populism in Argentina can be described as following just such a pattern.
After observing the populist experience in several Latin American countries, Rudiger Dornbusch and Sebastián Edwards identified four universal stages inherent in populism in their article “Macroeconomic Populism” (1990). Even though populism can present a wide array of policies, certain characteristics seem to be present in most of the cases.
Populism usually fosters social mobilization, political propaganda, and the use of symbols and marketing practices designed to appeal to voter’s sentiments. Populism is especially aimed at those with low income, even if the ruling party cannot explain the source of its leaders’ high income. Populist rulers find it easy to use scapegoats and conspiracy theories to explain why the country is going through a hard time, while at the same time present themselves as the saviors of the nation. It is not surprising that for some, populism is associated with the left and socialist movements, and by others with the right and fascist policies.
The four stages of populism identified by Dornbusch and Edwards are:
Stage IThe populist diagnosis of what is wrong with an economy is confirmed during the first years of the new government. Macroeconomic policy shows good results like growing GDP, a reduction in unemployment, increase in real wages, etc. Because of output gaps, imports paid with central bank reserves, and regulations (maximum prices coupled with subsidies to the firms), inflation is mostly under control.
Stage IIBottleneck effects start to appear because the populist policies have emphasized consumption over investment, the use of reserves to pay for imports, and the consumption of capital stock. Changes in sensitive relative prices start to become necessary, and this often leads to a devaluation of the exchange rate, price changes in utilities (usually through regulation), and the imposition of capital controls. Government tries, but fails, to control government spending and budget deficits.
The underground economy starts to increase as the fiscal deficit worsens because the cost of the promised subsidies need to keep up with a now-rising inflation. Fiscal reforms are necessary, but avoided by the populist government because they go against the government’s own rhetoric and core base of support.
Stage IIIShortage problems become significant, inflation accelerates, and because the nominal exchange rate did not keep pace with inflation, there is an outflow of capital (reserves). High inflation pushes the economy to a de-monetization. The local currency is used only for domestic transactions, but people save in US dollars.
The fall in economic activity negatively affects tax receipts increasing the deficit even more. The government needs to cut subsidies and increases the rate of the exchange rate, depreciation. Real income starts to fall and signs of political and social instability start to appear. At this point the failure of the populist project becomes apparent.
Stage IVA new government is swept into office and is forced to engage in “orthodox” adjustments, possibly under the supervision of the IMF or an international organization that provides the funds required to go through policy reforms. Because capital has been consumed and destroyed, real wages fall to levels even lower than those that existed at the beginning of the populist government’s election. The “orthodox” government is then responsible for picking up the pieces and covering the costs of failed policies left from the previous populist regime. The populists are gone, but the ravages of their policies continue to manifest themselves. In Argentina the expression “economic bomb” is used to describe the economic imbalances that government leaves for the next one.
Economic Populism is Alive and WellEven though Dornbusch and Edwards wrote their article in 1990, the similarities to the situation in countries like Venezuela, Bolivia, and Argentina is notable. In recent years, to keep populist ideas going in the minds of voters, Venezuela created the Ministry of Happiness, and Argentina created a new Secretary of National Thought.
These four stages are actually cyclical. The populist movement uses the fourth stage to criticize the orthodox party, and argues that during the populists’ tenure, things were better. The public opinion discontent with stage IV allows the populist movement to win new elections, receive an economy in a crisis or recession and the cycle starts over again from stage I. It is not surprising that populist governments usually appear following the hard times caused by economic crisis. A more bold populist government could avoid stage IV by finding a way to remain in office, calling off elections, or creating fake election results (as was the case in Venezuela). At such a point, the populist government succeeds in turning the country into a fully authoritarian nation.
In recent years, home price indices have seemed to proliferate. Case-Shiller, of course, has been around for a long time, but over the past decade, additional measures have been marketed aggressively by Trulia, CoreLogic, and Zillow, just to name a few.
Measuring home prices has taken on an urgency beyond the real estate industry because for many, home price growth has become something of an indicator of the economy as a whole. If home prices are going up, it is assumed, “the economy” must be doing well. Indeed, we are encouraged to relax when home prices are increasing or holding steady, and we’re supposed to become concerned if home prices are going down.
This is a rather odd way of looking at the price of a basic necessity. If the price of food were going upward at the rate of 7 or 8 percent each year (as has been the case with houses in many markets in recent years) would we all be patting ourselves on the back and telling ourselves how wonderful economic conditions are? Or would we be rightly concerned if incomes were not also going up at a similar rate? Would we do the same with shoes and clothing? How about with education?
With housing, though, increases in prices are to be lauded, we are told, even if they outpace wage growth.
We’re Told to Want High Home PricesBut in today’s economy, if home prices are outpacing wage growth, then housing is becoming less affordable. This is grudgingly admitted even by the supporters of ginning up home prices, but the affordability of housing takes a back seat to the insistence that home prices be preserved at all costs.
Behind all of this is the philosophy that even if the home-price/household-income relationship gets out of whack, most problems will nevertheless be solved if we can just get people into a house. Once someone becomes a homeowner, the theory goes, he’ll be sitting on a huge asset that (almost) always goes up in price, meaning that any homeowner will increase in net worth as the equity in his home increases.
Then, the homeowner can use that equity to buy furniture, appliances, and a host of other consumer goods. With all that consumer spending, the economy takes off and we all win. Rising home prices are just a bump in the road, we are told, because if we can just get everyone into a home, the overall benefit to the economy will be immense.
Making Homes Affordable with More Cheap DebtNot surprisingly, we find a sort of crude Keynesianism behind this philosophy. In this way of thinking, the point of homeownership is not to have shelter, but to acquire something that will encourage more consumer spending. In other words, the purpose of homeownership is to increase aggregate demand. The fact that you can live in the house is just a fringe benefit. This macro-obsession is part of the reason why the government has pushed homeownership so aggressively in recent decades.
The fly in the ointment, of course, is if home prices keep going up faster than wages — ceteris paribus — fewer people will be able to save enough money to come up with either the full amount or even a sizable down payment on a loan.
Not to worry, the experts tell us. We’ll just make it easier, with the help of inflationary fiat money, to get an enormous loan that will allow you to buy a house. Thus, rock-bottom interest rates and low down payments have been the name of the game since the late 1980s.
We started to see the end game at work during the last housing bubble when Fannie Mae introduced the 40-year mortgage in 2005, which just emphasized that when it comes to being a homeowner, the idea is not to pay off the mortgage, but to “buy” a house and just pay the monthly payment until one moves to another house and gets a new thirty- or forty-year loan.
It Pays To Be in DebtOn the surface of it, it’s hard to see how this scenario is fundamentally different from just paying rent every month. If the homeowner stops paying the monthly payment, he’s out on the street, and the bank keeps the house, which is very similar to the scenario in which a renter stops paying a landlord. There’s (at least) one big difference here, however. It makes sense for the homeowner to get a home loan rather than rent an apartment because — if it’s a fixed-rate loan — price inflation ensures the real monthly payment will go down every month. Residential rents, on the other hand, tend to keep up with inflation.
But why would any lending institution make these sorts of long-term loans if the payment in real terms keeps getting smaller? After all, thirty years is a long time for something to go wrong.
Lenders are willing and able to do this because the loans are subsidized and underwritten through government creations like Fannie Mae (which buys up these loans on the secondary market), through bailouts, and through a myriad of other federal programs such as FHA. Naturally, in an unhampered market, a loan of such a long term would require high interest rates to cover the risk. But, Congress and the Fed have come to the rescue with promises of bailouts and easy money, meaning cheap thirty-year loans continue to live on.
So, what we end up with is a complex system of subsidies and favoritism on the part of lenders, homeowners, government agencies, and the Fed. The price of homes keeps going up, increasing the net worth of homeowners, and banks can make long-term loans on fairly risky terms because they know bailouts of various sorts will come if things go wrong.
But problems begin to arise when increases in home prices begin to outpace access to easy money and cheap loans. Indeed, we’re now seeing that homeownership rates are going down in spite of low interest rates, and vacancy rates in rental housing are at a twenty-year low. Meanwhile, new production in housing units is at 1992 levels, offering little relief from rising prices and rents. Obviously, something isn’t going according to plan.
Who Loses?The old debt-based tricks that once kept homeownership climbing and accessible in the face of rising home prices are no longer working.
From a free market’s perspective, renting a home is neither good nor bad, but American policymakers long ago decided to favor homeowners over renters. Consequently, we’re faced with an economic system that pushes renters toward homeownership — price inflation and the tax code punishes renters more than owners — while simultaneously pushing home prices higher and higher.
During the last housing bubble, however, as homeownership levels climbed, few noticed or cared about this. So many renters became homeowners that rental vacancies climbed to record highs from 2004 to 2009. But in our current economy, one cannot avoid rising rents or hedge against inflation by easily leaving rental housing behind.
This time around, the cost of purchasing housing is going up by 6 to 10 percent per year, but few renters can join the ranks of the homeowners to enjoy the windfall. Instead, they just face record-high rent increases and a record-low inventory in for-sale houses.
There once was a time when rising home prices and rising homeownership rates could happen at the same time; it was possible for the government to stick to its unofficial policy of propping up home prices while also claiming to be pushing homeownership. We no longer live in such a time.
It is accepted by most economists that initial increases in consumer spending or other outlays tend to set in motion a reinforcing process which supposedly strengthens the economic growth by a multiple of initial spending.
The Multiplier ExplainedAn example will illustrate how initial spending raises the overall output by the multiple of this spending. Let us assume that out of an additional dollar received, individuals spend 90 cents and save 10 cents. Also, let us assume that consumers have increased their expenditures by $100 million. As a result of this, retailers' revenue rises by $100 million. Retailers in response to the increase in their income consume 90 percent of the $100 million. That is, they raise expenditures on goods and services by $90 million. The recipients of the $90 million in turn spend 90 percent of the $90 million, i.e., $81 million. Then the recipients of the $81 million spend 90 percent of this sum, which is $72.9 million and so on. Note that the key in this way of thinking is that the expenditure by one person becomes the income of another person. At each stage in the spending chain, people spend 90 percent of the additional income they receive. This process eventually ends, so it is held, with total output higher by $1 billion (10x$100 million) than it was before consumers had increased their initial expenditure by $100 million.
Observe that the more that is being spent from additional income, the greater the multiplier is and therefore the impact of the initial spending on overall output is larger. For instance, if people change their habits and spend 95 percent from each dollar the multiplier will become 20. Conversely, if they decide to spend only 80 percent and save 20 percent then the multiplier will be 5.
The Key Role of SavingsUnderlying all of this is the assumption that the less that is saved, the larger is the impact of an increase in overall demand on overall output. But is more saving bad for the economy as the Keynesian multiplier model implies?
As we shall see, it is an increase in saving and production, and not an increase in consumption that leads to more economic activity.
Take, for instance, Bob the farmer who has produced twenty tomatoes and consumes five tomatoes. What is left at his disposal is fifteen saved tomatoes (real savings). With the help of the saved fifteen tomatoes Bob can now secure various other goods.
For example, he secures one loaf of bread from John the baker by paying for the loaf of bread with five tomatoes. Bob also buys a pair of shoes from Paul the shoemaker by paying for the shoes with ten tomatoes. Note that real savings at his disposal limits the amount of consumer goods that Bob can secure for himself.
When Bob the farmer exercises his demand for one loaf of bread and one pair of shoes he is transferring five tomatoes to John the baker and ten tomatoes to Paul the shoemaker. Bob's saved tomatoes maintains and enhances the life and well being of the baker and the shoemaker. Likewise, the saved loaf of bread and the saved pair of shoes maintain the life and well being of Bob the farmer. Note that it is saved final consumer goods which sustain the baker, the farmer, and the shoemaker, that makes it possible to keep the flow of production going.
Turning Savings into ProductionNow, the owners of final consumer goods, rather than exchanging them for other consumer goods, could decide to use them to secure better tools and machinery. With better tools and machinery a greater output and a better quality of consumer goods can be produced some time in the future. Note that by exchanging a portion of their saved consumer goods for tools and machinery, the owners of consumer goods are in fact transferring their real savings to individuals that specialize in making these tools and machinery. Real savings sustain these individuals whilst they are busy making these tools and machinery.
Once these tools and machinery are built, this permits an increase in the production of consumer goods. As the flow of production expands, this permits more savings all other things being equal. This in turn permits a further increase in the production of tools and machinery. This makes it possible to lift further the production of consumer goods (i.e., raise the purchasing power in the economy). So, contrary to popular thinking, more savings actually expands and not contracts the production flow of consumer goods.
Can the increase in the demand for consumer goods lead to an increase in the overall output by the multiple of the increase in demand? To be able to accommodate the increase in his demand for goods, the baker must have means of payment (i.e., bread to pay for goods and services that he desires). We have seen that the baker secures five tomatoes by paying for them with a loaf of bread. Likewise the shoemaker supports his demand for ten tomatoes with a pair of shoes. The tomato farmer supports his demand for bread and shoes with his saved fifteen tomatoes.
More Production Leads to More ConsumptionWhenever the supply of final goods increases, this permits an increase in demand for goods. The baker’s increase in the production of bread permits him to increase demand for other goods. In this sense, the increase in the production of goods gives rise to demand for goods. People are engaged in production in order to be able to exercise demand for goods to maintain their life and well being. We have seen that what enables the expansion in the supply of final consumer goods is the increase in capital goods or tools and machinery. What in turn permits the increase in tools and machinery is real savings. We can thus infer that the increase in consumption must be in line with the increase in production.
From this we can also deduce that consumption doesn’t cause production to increase by the multiple of the increase in consumption. The increase in production is in accordance with what the pool of real savings permits and is not constrained by consumers’ demand as such. Production cannot expand without support from the pool of real savings.
Government and the MultiplierLet us examine the effect of an increase in the government's demand on an economy's overall output. In an economy which is comprised of a baker, a shoemaker, and a tomato grower, another individual enters the scene. This individual is an enforcer who is exercising his demand for goods by means of force.
Can such demand give rise to more output as the popular thinking has it? On the contrary, it will impoverish the producers. The baker, the shoemaker, and the farmer will be forced to part with their product in an exchange for nothing and this in turn will weaken the flow of production of final consumer goods. Again, as one can see, not only does the increase in government outlays not raise overall output by a positive multiple, but on the contrary this leads to the weakening in the process of wealth generation in general. According to Mises in Human Action, "… there is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity."
The Murray N. Rothbard Lecture, sponsored by Caitlin Long. Recorded at the New York Area Mises Circle in Stamford, Connecticut, on 7 May 2015.
David Stockman is our guest this week in the second of a two-part interview. Stockman was a congressman, Ronald Reagan’s budget director, and a private equity fund manager who saw the devastation brought to American companies by an economy built on cheap debt instead of real productivity. His book The Great Deformation is a tour de force exposé of crony capitalism, an indictment of Treasury Department and Federal Reserve bailouts following the crash of 2008, and one of the most important books on crony capitalism ever written. His Contra Corner website is a daily must-read for anyone interested in the truth about our rigged economy.
David Stockman is our guest this week in the first of a two-part interview. He is also speaking at our Mises Circle event in Stamford, Connecticut, next week, along with Jim Grant and Judge Andrew Napolitano (watch for free at Mises.org/Live). Stockman was a congressman, Ronald Reagan’s budget director, and a private equity fund manager who saw the devastation brought to American companies by an economy built on cheap debt instead of real productivity. His book The Great Deformation is a tour de force exposé of crony capitalism, an indictment of Treasury Department and Federal Reserve bailouts following the crash of 2008, and one of the most important books on crony capitalism ever written. His Contra Corner website is a daily must-read for anyone interested in the truth about our rigged economy.
Interviewed by host Jack Thompson, Mark Thornton discusses discusses his work on what is known as "The Skyscraper Index," which posits that each time the world's largest skyscraper is built, an economic crisis follows.
The prime minister of Iceland recently commissioned a report by Frosti Sigurjonsson to recommend a better money and banking system for Iceland. The recently released report recaps Iceland's sorry history of money and banking disasters and lays the majority of the blame for the 2008 collapse on the institution of fractional reserve banking, which caused an out-of-control increase in the money supply. Sigurjonsson recommends the abolition of fractional reserve banking, a separation of deposit and loan banking, and an end to deposit insurance.
Unfortunately, Sigurjonsson also recommends more power for the central bank through what he calls the “sovereign money system.”
An Out-of-Control Money Creation ProcessSigurjonsson is correct that the central bank lost control of the money supply in the years leading up to 2008 as the banks leveraged their excess reserves into new loans, which created new money. In turn, this led to greater involvement from the central banks since, as Sigurjonsson notes, it was the duty of the Central Bank of Iceland (CBI) to "provide banks with reserves as needed in order to not lose control of interest rates or even trigger a liquidity crisis between banks."
He then accuses the private banks of lending for speculative rather than worthwhile purposes. Curiously, though, he has no such concern over government control over this powerful economic lever. He is confident that the central bank would expand and contract the money supply in a fashion that would be beneficial to all society and that government would spend new monies only for purposes that would benefit the nation.
Limiting Money Creation to the Central BankSigurjonsson believes that government needs the power to introduce new money to meet the needs of an expanding economy and that the central bank and government will do so for the good of the nation as a whole and not for private purposes. At a minimum he believes that the money supply must expand in order for the economy to expand. In this regard he is a full-fledged Friedmanite, who little understands the adverse impact of even a low level of money growth on the structure of production. On the contrary, he sees money growth as necessary for economic growth and has full confidence that government will spend any newly created money only for good.
It is obvious that either he's never heard of public choice theory or does not subscribe to its conclusions. Really, who today believes that government, which after all is manned by some of the most fallible humans in society, can (1) be completely altruistic in its spending decisions and (2) would know what is best anyway? (I refer Sigurjonsson to F. A. Hayek's wonderful Nobel speech in which he clearly articulates his theory of the pretense of knowledge.)
Sigurjonsson concludes his proposal with a call for what he terms the "sovereign money system." Right away we have reason to be concerned when he states "The CBI will create enough money to promote the non-inflationary growth of the economy." He would separate money creation from money allocation. A money creation committee would decide how much money to create and then the parliament would decide how to spend it. New money would serve five purposes: fund new government spending, reduce taxes, pay off the public debt, provide a citizen bonus, and increase lending to business. Money would not be backed by debt, but would be a sovereign asset created at will.
Transferring More Power to GovernmentThe proposal does remove the ability of banks to increase the money supply through the lending process. All to the good so far. But it then transfers this power to government. It allows government to spend what it wishes, as long as the money creation committee goes along, by counterfeiting whatever amount is desired. Government would not be required to increase taxes or issue new debt. This is a counterfeiter's dream! It’s also a government dream. Somehow, I have little confidence that the money creation committee will not go along with whatever spending plans the parliament desires.
In short, Sigurjonsson wants to rein in the ability of private banks to expand the fiat money supply while giving free rein to central banks.
On the other hand, perhaps Iceland's central bank and government will exercise their money printing power with discretion long enough for the rest of the world to see the benefits of abolishing fractional reserve banking and moving toward a one hundred percent fiat reserve system. After that we can fight the next battle — prohibiting central banks from expanding the fiat money supply and then finally tying money to specie at a legally enforceable ratio. At that point money production can be turned over completely to private hands and the central bank abolished.
Image source: iStockphoto
In recent years, Paul Krugman has incessantly defended France and its welfare state, even going so far as to pretend that the French economy was in fact in better shape than the British economy. According to him, “To an important extent, what ails France in 2014 is hypochondria, belief that it has illnesses it doesn’t.” However, except for some Keynesian propagandists, nobody believes that the French economy is not deeply in crisis and it is now more and more obvious that Krugman is wrong.
The UK, on the other hand, is growing faster than any other major advanced economy this year. Growth has picked up since the first quarter of 2013 to 2.6 percent in 2014 — a seven fold higher rate than for France — and employment in Britain, both in absolute terms and as a share of the adult population, has never been higher. Even wages, which were constantly depressed after the 2008 crisis, has begun to rise again.
As usual, British politicians took advantage of the British economy’s good performances to make fun of France. Chancellor Mr. Osborne has claimed: “And which county has created more jobs than the whole of France? The great county of Yorkshire,” after the latest UK jobs figures showed employment at a record high. David Cameron recently stated that “Labour will make us as bad as France.” French bashing is almost part of the British culture, it is true, but for now, the UK is indeed in better shape than France.
Fiscal Austerity vs. Spending AusteritySince 2009, France and the UK have used opposing economic policies. France increased taxes and didn’t decrease government expenditures. The UK, on the other hand, decreased government expenditures but didn’t increase taxes. Between 2010 and 2013, the UK reduced its structural deficit by more than any other advanced economy (4.7 percent of GDP).
If you follow Krugman’s ideas, then this should suggest to you that there was less economic growth in the United Kingdom and more in France. Not very surprisingly, however, the exact opposite happened, and while the French economy stagnates, the UK has mounted an economic recovery.
Public spending in France is now more than eleven points of GDP higher than public spending in the UK. Taxes are also much higher in France and government regulations, particularly in the labor market, are not as problematic in the UK. Thus, it was easier for the structure of production to adapt itself after the crisis in UK than in France.
But while the public sector shrank in the UK, it expanded in France. Therefore, measuring economic progress via GDP — a deeply flawed strategy — underestimates the development of the British economy.
People who are forced to pay for public expenditures via taxation were not expressing actual preferences. Thus, as Dr. Salerno put it: “it is certainly true that a reduction in real government spending causes a reduction in real GDP, as it is officially calculated. But ... the reduction in government spending does not retard the growth of production of goods that satisfy consumer demands and, in fact, most likely accelerates it.”
But even if the French economy is as great as Paul Krugman says it is, why then are so many French leaving their country to cross the English Channel? When you want to know if an economy is thriving look how people vote with their feet. If Krugman had done that, he could have seen that it is mainly the French that are immigrating to London, and not the English to Paris. Indeed, the number of French immigrants in the UK has increased dramatically over the past twenty years. The mayor of London, Boris Johnson, likes to say that he is the mayor of the sixth largest French city in the world. There are now more than 200,000 French immigrants in London alone.
Of course, the UK is far from perfect. Public debt and deficits remain too high and much needs to be done, mainly in the very public British healthcare sector. Indeed, health care public spending is still rising — 4 percent in volume between 2010–2011 and 2014–2015. Moreover, the Bank of England has conducted an expansionary monetary policy which could lead to instability and further crisis. There could be, for example, a new real estate bubble in England in the works.
Krugman’s Data vs. Actual DataOn November 8, 2013, Krugman denounced the S&P decision to downgrade France:
I’m sorry, but I think that when S&P complains about lack of reform, it’s actually complaining that Hollande is raising, not cutting taxes on the wealthy, and in general isn’t free market enough to satisfy the Davos set.
A few days after Krugman wrote those lines, better than expected employment figures where published for Britain whereas France still had a double digit unemployment rate. Already in 2013, it was visible that something was wrong with France’s economic policies. But Krugman was convinced otherwise.
Early in January 2015, Krugman published another article which aimed at showing the superiority of the French economy over the British economy. And again, it wasn’t long before new statistics showed that what Krugman was saying was simply wrong. To sustain his argument, he published the following graph without any sources:
Krugman wrote:
Austerity triumphant. Or, maybe not. Part of this is the growth rate fallacy — no matter how badly an economy has done over an extended period, you proclaim success after a year or two of good growth.
There are two major problems with Krugman’s claim. First of all, if you look at GDP per capita growth since 2000, the UK outpaces France. Second, Krugman’s graph is wrong. Whether you look at the data of the IMF, the World Bank, or Eurostat, no one matches with his data. The graph actually looks like this:
Source: EurostatFurthermore, austerity policies in the UK were introduced only after 2009. Thus, the Keynesian orthodoxy is unable to explain why growth, decrease of unemployment, and austerity took place at the same time. Krugman gave no explanation.
UnemploymentFrom December 2009 to December 2014, in Britain, the number of employees in the public sector went from 6,370,000 to 5,397,000 whereas total employment went up by about 1,700,000. However, the public and private sector employment series have been affected by a number of major reclassifications where bodies employing large numbers of people have moved between the public and private sectors. But even if you take this into account, the number of jobs created by the private sector is still very impressive. On the other hand, the number of government employees in France never stopped increasing and unemployment is still at a very high level. Keynesianism is completely unable to explain what happened. They expected that austerity would have led to a strong recessionary effect. This is not what happened.
For those not bogged down by Keynesianism, however, the graph can certainly be explained, as can the relatively superior growth levels experienced in the UK. A reduction in the number of government employees is good because that labor becomes available for private companies, and wages fall. This fall makes new investment projects viable. When the public sector shrinks, it becomes relatively more attractive to work in the private sector. Only then can entrepreneurial energies be used to serve consumers on the market place rather than being directed toward rent-seeking in the political arena.
The future of France is not as bright as Paul Krugman thinks it is and his recommendations are far from being verified by theory and facts. During a crisis, the best rule the government can follow is, as Rothbard wrote “don’t interfere with the market’s adjustment process.” One other thing the government can do however is to slash government spending and taxes. To an extent, this is more or less what was done in the UK, especially when compared to France. As Rothbard showed, “depression is a time of economic strain. Any reduction of taxes, or any regulations interfering with the free market, will stimulate healthy economic activity; any increase in taxes will depress the economy further.”
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Even as the Saudi Arabian state steps up bombing raids in Yemen and spends billions on new military infrastructure, plans are moving forward for the Kingdom Tower in Jeddah. The new tower is to be a kilometer tall and will contain at least 200 floors. It will include both a luxury hotel, class A office space, residences, and many other luxury features. It represents phase 1 of a multiphase development just north of the city of Jeddah on the Red Sea.
The Kingdom Tower project is organized by the Kingdom Holding Company, the chairman of which is Saudi Arabian Prince Al-Waleed bin Talal. He is nephew of the late King Abdullah and is the wealthiest Arab in the Middle East.
The project has been in the works for several years. Between 2008 and 2013 contracts were negotiated and signed, technologies were selected and developed, and preliminary work was carried out. In early 2013 work was begun on the underground foundation and was completed in early 2014. The above-ground construction commenced in the fall of 2014 and is proceeding apace.
The Latest Skyscraper Alert?Since the 1990s, when James Grant and Andrew Lawrence noticed a correlation between the construction of record-setting skyscrapers and economic busts, so-called skyscraper alerts — to warn of a possible “skyscraper curse” — are issued shortly after a building project to set a new world record for the tallest building has broken ground, and is well under way.
The connection between skyscrapers and economic crises dates back a century. For example, the Panic of 1907 occurred while the Singer Building and the Metropolitan Life Building were under construction. The Empire State Building opened in 1931 in the depths of the Great Depression. Construction on the Burj Khalifa Tower surpassed the height of the then record holding Taipei 101 on July 21, 2007 just as the housing crash began. The correlation sounds farfetched, but in 2005, I explored the connection further, and found that it can, in fact, be explained by Austrian business cycle theory and its emphasis on central-bank induced malinvestment and Cantillon effects.
Will This Time Be Different?The Burj Khalifa, the current tallest skyscraper, stands 830 meters tall. It opened in January 2010 as its owner was forced to accept a $10 billion bailout. The physical topping-off of the tower occurred in mid-January of 2009. Like the Empire State Building, it opened in the depths of a major recession.
For now, we can only speculate about timing, but the Kingdom Tower also shares many of the financial and physical features of the Burj Khalifa, including the highly speculative nature of building such a structure in a sparsely populated desert. Both projects were designed and begun during periods of artificially low interest rates. Both buildings are symbols of lavishness, opulence, and extravagance as such projects are the classic “high end” in luxury spending.
Both projects represent the need for a large number of new technologies (elevators, cement pumping, temperature control, exterior finishes, etc.) as well as an expansion of the bundling of consumer goods (hotel, residents, entertainment, shopping, office space, etc.) under one roof.
Based on projected reports, tenants will begin moving into the Kingdom Tower in 2019, though construction should be completed in 2017. During construction it will surpass the height of the Burj Khalifa, and thus become the world’s tallest building, sometime in 2016.
Adding to the bubble-like feeling in the region, and the global economy in general, is the fact that Saudi Arabia, where the line is blurry between the regime’s money and the ruling family’s money, continues to move forward simultaneously with a myriad of new spending projects.
There is the new tower, and the fact that the military spending was boosted 17 percent in 2014. The Saudi state has also announced it may decide to develop nuclear weapons at any time, and in January, it announced it plans to build a 600-mile wide barrier from Jordan to Kuwait.
Image source: iStockphoto
Brazil's government has long been devoted to the idea that more government spending will create more economic prosperity. For a time, it seemed to work, but now reality and disillusionment have set in, writes Antony Mueller.
This audio Mises Daily is narrated by Robert Hale.
Recorded at the Mises Institute in Auburn, Alabama, on 10 April 2014. Includes an introduction by Jeff Deist.
President Obama and Fed Chair Janet Yellen have been crowing about improving economic conditions in the US. Unemployment is down to 5.5 percent and growth in 2014 hit 2.2 percent.
Journalists and economists point to this improvement as proof that quantitative easing was effective.
Pile on More DebtUnfortunately, this latest boom is artificial and has been built by adding debt on top of debt. Total household debt increased 2.5 percent in 2014 — the highest level since 2010. Mortgage loans increased 1.5 percent, student loans 6.6 percent while auto loans increased a hefty 9.6 percent. The improving auto sales are built mostly on a bubble of sub-prime borrowers. Auto sales have been brisk because of a surge in loans to individuals with credit scores below 620. Since 2010, such loans have increased over 100 percent and have gone from 20 percent of originations in 2009 to 27 percent in 2013. Yet, auto loans to individuals with strong credit scores, above 760, have barely budged over the last year.
Subprime consumer borrowing climbed $189 billion in the first eleven months of 2014. Excluding home mortgages, this accounted for 41 percent of total consumer lending. This is exactly the kind of lending that got us into trouble less than a decade ago, and for many consumers, this will only end in tears.
But we need to ask ourselves: is the current boom built on sound foundations? In other words, do we have sharp increases in productivity or real wage growth?
Productivity increased less than 1 percent on average in the last three years and real wages have flat lined or declined for decades. From mid-2007 to mid-2014, real wages declined 4.9 percent for workers with a high school degree, dropped 2.5 percent for workers with a college degree and rose just 0.2 percent for workers with an advanced degree.
Is the boom being built on broad base investment in plant and equipment? The current average age of working plants and equipment in the US is one of the oldest on record.
Meanwhile, it is now clear that the shale boom was an illusion of prosperity. Oil prices have dipped below $50 with some analysts calling for $20 oil by the end of the year. This is a drop from over $100 from last year. Many shale outfits need oil above $65 just to break even. Massive layoffs in the energy sector are now a certainty. Few realize that most of the gains in employment in the US since 2008 have been in shale states. Yet the carnage is not over. Induced by low interest, investment banks loaned over 1 trillion dollars to the energy industry. The impact on the financial sector is still to be felt.
There Has Not Been a True Home Price CorrectionThe same is true about current increases in housing prices and construction costs. Following the financial crisis of 2008, real estate prices should have dropped much more than they did relative to other prices. The new reality between supply and demand would have led to a price correction similar to the ones we see in oil prices today or to high-flying internet stocks after the dot-com bubble burst. Housing should then have remained in a slump possibly for a decade or more, until the overhang of empty residential and commercial real estate had been cleared off.
Today, housing is back, with price increases at bubble-era levels and construction activity is picking up. The improvement is being driven by professional investors stretching for yield in the buy-to-rent market and by historically low long-term mortgage rates of below 4 percent. Yet, the overhang of empty commercial properties from the previous boom has not disappeared. It has just been left in limbo, because of the “extend and pretend” strategy of banks made possible by the central bank’s massive printing over the last six years. The number of vacant units (table 7) in the US still stands at over 18 million units — a level reached back in 2008–2009. As of 2014, the number of units held off the market was still at a record level of over 7 million units.
Will Easy Money Fix Everything?Current policy coming from the fed seems to be geared to create a never-ending series of booms and busts, with the hope that the busts can be shortened with more debt and easy money.
Yet one major driver behind the financial crisis in 2008 was too much debt — much of which led to taxpayer-funded bailouts. In spite of this, the best the Fed can come up with now is to lower interest rates to boost demand to induce households and governments to borrow even more.
Interfering with interest rates, however, is by far the most damaging policy. The economy is not a car, and interest rates are not the gas petal. Interest rates play a critical role in aligning output with society’s demand across time. Fiddling with them only creates an ever-growing misalignment between demand and supply across time requiring an ever larger and more painful adjustment.
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The Fed is seemingly slightly out of step with other central bankers as it recently hinted at possible future rate hikes in the official announcement following its March 20, 2015 meeting. But as many commentators have recognized, Janet Yellen, a strong proponent of Keynesian more-inflation-as-cure-for-unemployment policy, later downplayed the significance of the announcement. She was careful to indicate that rates would stay low for the near future and when (and if) rate increases begin, they will be measured. The Fed, like central bankers elsewhere, stays committed to a 2 percent inflation target as it continues a policy driven by a fear of deflation, a fear that is not supported by either good economic theory or economic history properly interpreted.
The errors of deflation-phobia can be drawn from Philipp Bagus’s excellent and recently released In Defense of Deflation. Bagus points out
In the economic mainstream, there are basically two main strands in contemporary deflation theories. The first strand can be represented by economists who in some way are inspired by Keynesian theories like Ben Bernanke, Lars E.O. Svensson, Marvin Goodfriend, or Paul Krugman. The first group fears that price deflation might put the economy in a liquidity trap and opposes all price deflation categorically. It represents the deflation phobia in its clearest form.
It is these theorists and their colleagues who currently dominate central bank thinking and make the case (weak and often only asserted as an imperative) for a positive inflation buffer.
Bagus does recognize a second group of mainstream economists with a more balanced view of deflation:
The second strand has representatives like Claudio Borio, Andrew Filardo, Michael Bordo, John L. Lane, and Angela Redish. Inspired by the Chicago School, the second group is more free market oriented. Bordo, for instance, received his doctoral degree from the University of Chicago. This group distinguishes between two types of deflation: good deflation and bad deflation.
Deflation Leads to Increases in Real Interest Rates, Which Brings RecoveryHowever, the main water carriers against this erroneous overemphasis by economists and the mainstream press on the alleged evils of deflation have been the Austrians. In his essays “A Reformulation of the Austrian Business Cycle Theory” and “An Austrian Taxonomy of Deflation” Joseph Salerno dismantles deflation-phobia and illustrates the benefits of higher interest rates. Moreover, “A Reformulation” is also a strong argument on why current policy retards recovery and why a policy which would allow financial markets to adjust to a new higher natural rate of interest is essential for restoring normalcy and prosperity. Salerno begins with examining why it is so unpleasant when an economy must adjust to fix the malinvestments and overconsumption that appeared in the boom phase:
The ABCT, when correctly formulated, does indeed explain the asymmetry between the boom and bust phases of the business cycle. The malinvestment and overconsumption that occur during the inflationary boom cause a shattering of the production structure that accounts for the pervasive unemployment and impoverishment that is observed during the recession. Before recovery can begin, the production structure must be painstakingly pieced back together again in a new pattern, because the intertemporal preferences of consumers have changed dramatically due to the redistribution and losses of income and wealth incurred during the inflation. This of course takes time.
At the heart of the problem is the fact that central bank-induced inflation has “wreaked havoc” on prices and consequently on economic calculation:
In addition, the recession-adjustment process is further prolonged by the fact that the boom has wreaked havoc with monetary calculation, the very moorings of the market economy. Entrepreneurs have discovered that their spectacular successes during the boom were merely a prelude to a sudden and profound failure of their forecasts and calculations to be realized. Until they have regained confidence in their forecasting abilities and in the reliability of economic calculation they will be understandably averse to initiating risky ventures even if they appear profitable. But if the market is permitted to work, this entrepreneurial malaise cures itself as the restriction of demand for factors of production drives down wages and other costs of production relative to anticipated product prices. The “natural interest rate,” i.e., the rate of return on investment in the structure of production, thus increases to the point where entrepreneurs are enticed to renew their investment activities and initiate the adjustment process. Success feeds on itself, entrepreneurs’ spirits rise, and the recovery gains momentum.
The market can only cure itself, Salerno explains, if prices are allowed to adjust, including decreases in “wages and other costs of production relative to anticipated product prices.” At the same time, it’s the resulting “steep rise” in real interest rates that draws capitalists and entrepreneurs back into the marketplace:
The rise in the natural interest rate that overcomes the pandemic demoralization among capitalists and entrepreneurs and sparks the recovery is reflected in the credit markets. For recovery to begin again, there needs to be a steep rise in the “real,” or inflation-adjusted, interest rate observed in financial markets. High interest rates do not stifle the recovery but are the sure sign that the readjustment of relative prices required to realign the production structure with economic reality is proceeding apace. The mislabeled “secondary deflation,” whether or not it is accompanied by an incidental monetary contraction, is thus an integral part of the adjustment process. It is the prerequisite for the renewal of entrepreneurial boldness and the restoration of confidence in monetary calculation. Decisions by banks and capitalist-entrepreneurs to temporarily hold rather than lend or invest a portion of accumulated savings in employing the factors of production and the corresponding rise of the loan and natural rates above some estimated “true” time preference rate does not impede but speeds up the recovery. This implies, of course, that any political attempt to arrest or reverse the decline in factor and asset prices through monetary manipulations or fiscal stimulus programs will retard or derail the recession-adjustment process.
New Defenders of DeflationCiting work by Claudio Borio, head of the Monetary and Economic department at the BIS, listed above by Bagus, The Telegraph, ran a recent story by Szu Ping Chan, “Low Rates Will Trigger Civil Unrest as Central Banks Lose Control,” also highly critical of fear-of-deflation policy committed to 2 percent (or higher) inflation targets. Ms. Chan highlights work by Borio:
A separate paper co-authored by Mr Borio argued that periods of deflation has less economic costs than sustained falls in property prices. Its analysis of 38 economies over a period of more than 100 years showed economies grew by an average of 3.2pc during deflationary periods, compared with 2.7pc when prices were rising.
It said drawing blind comparisons with the 1930s were misguided. “The historical evidence suggests that the Great Depression was the exception rather than the rule,” said Hyun Shin, head of research at the BIS.
Mr. Bagus, Ms. Chan, and Mr. Borio have highlighted for us yet again why it is essential that institutional changes be made that lead to withering away of fiat money and create the possibility for sound money.
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All Keynesian roads lead to stagflation. That was the case in Europe and in the United States in the 1970s when both stagnation and inflation hit the economies at the same time. Currently, this is the case in Brazil.
Since coming into power in 2003, the Brazilian labor government has religiously implemented the economic policy doctrine of growth by spending. Now, the country has fallen into stagnation with a recession looming while inflation is on the rise. All economic indicators flash red lights: from economic growth to inflation and the exchange rate, from productivity to investment and industrial production.
Booms and Bubbles, Brazilian StyleOnce again, Keynesian policies have led to stagflation. Reality has finally set in. The illusion of easy wealth is shattered. The Keynesian wonder weapon has become impotent. The economic policy teams at the Ministry of Finance and the Central Bank have no notion what to do now. After all, they know of no other economic policy doctrine than to stimulate the economy by spending ever more. Yet with the government’s coffers empty and inflation high and rising, the policy tools of deficit spending and monetary expansion have run out of fuel. Favorable external conditions such as the China boom and high demand for commodities had benefited the Brazilian economy during the presidency of Luiz Inácio “Lula” da Silva. These external factors together with massive internal stimuli accelerated economic growth. With the end of the commodities boom and the slowing of economic growth in China, the external environment factors no longer helped when at the same time internal consumption hit the wall, as consumers had to scale back along with the government as the debt burden approaches its limit.
In early 2015, it became obvious that the country has lived in an illusionary world under the Labor Party over the past twelve years. Now it seems like a joke that President Lula once announced that Brazil’s economy was about to overtake that of the United Kingdom and from then on move upward on the ladder of the large economies. Yet when it was announced in 2007 that Brazil was to host the Soccer World Championship in 2014 and when in 2009 the Olympic Committee selected Rio de Janeiro for the Olympic Games in 2016, it seemed that the much-wanted international recognition of the president’s achievements had arrived. The jubilation at home was fully matched by the exuberance abroad about how Lula would lead Brazil into the twenty-first century.
Just as much as many Brazilians did not want to recognize, foreign observers, too, shut their eyes to the fact that the Brazilian Labor Party has been practicing one of the crudest forms of Keynesianism. The Brazilian kind of Keynesianism is deeply mixed with the Marxism of Michal Kalecki. In Europe and the United States remnants of sound economics survived at the onset of the “new economics,” and later on partially recovered classical and neoclassical principles. In Brazil there has been an almost complete victory of “Kaleckian Keynesianism” with most other types of macroeconomics cast aside.
Can the Government Turn Stones into Bread?Even today, the Polish economist Kalecki is still held in high esteem at some of the most prominent Brazilian universities. The version of “Keynesianism” that he developed in the 1930s has become the leading paradigm for economic policymaking albeit this type of macroeconomics lacks any micro-foundation and is largely void of realistic content. The Kaleckian version of Keynesianism takes the macroeconomic symbols for real and by moving them around according to the basic rules of algebra, the model finally is brought to the conclusion that “workers spend what they earn,” while “capitalists earn what they spend” (as this theory was once summarized by Kaldor).
Kalecki and his Marxist followers consequently decided that when the state assumes the capitalist function, government could spend the country to wealth while workers would get their fair share as consumers. Even more so than Keynes, Kalecki’s gospel preached that its believers could turn stones into bread. Government spending for whatever purpose combined with mass consumption promised a most pleasurable way to prosperity. This promise has been the economic policy principle of the Brazilian Labor Party government over the past twelve years.
During much of the two presidential periods of da Silva from the beginning of 2003 to the end of 2010, the Kaleckian-Keynesian recipe seemed to work. The Brazilian government under the former trade union leader spent, the consumers consumed, and the economy grew. All the while, price inflation remained subdued and the unemployment rate fell. No wonder that President Lula enjoyed immense popularity during his two terms and that Lula’s Labor Party would remain in power when his handpicked successor won the elections for presidency in 2010 and in 2014.
Dilma Rousseff, however, a politician by trade and former urban guerilla fighter, had a hard time winning the elections. When running for her second mandate, dark clouds began to overshadow the still blatant optimism of the ruling party. In 2011, the economic growth rate began to fall. The government first brushed it away as a temporary dip, yet when the rate continued to decline even more in 2012, the government began to panic. With the election coming up in 2014, the government did what the Kaleckian-Keynesian recipe prescribes and accelerated even more its expansive policies. This may have won the election for her, but the price to pay came in high later on.
Disillusion Sets InNow, in early 2015, disillusion has fully set in. People feel cheated by the false optimism of the government. The corruption scandal of the Brazilian oil company Petrobras together with the rapidly deteriorating economic conditions drove over a million of Brazilians to the streets on March 15 in protest against the government.
What many of the protesters fail to see, however, is that Brazil needs more than just a change of government. The country needs a change of mind. In order to get on to the path of prosperity, Brazil has to discard its prevalent economic ideology. Brazil has to get rid of its tradition of profligate government spending and easy money, Marxist-inspired state involvement in the economy, and the protectionism that had come with the adoption of Cepalism (the economic policy concept of the Economic Commission of Latin America). Not special circumstances lie at the heart of the current malaise, but wrong ideas about economic policy.
Brazil needs a huge dosage of economic liberalization to find its way out of the current crisis. Less state intervention and much more freedom of doing business must be the first steps. For this to happen a change of mind is needed. Brazilians must open up to an alternative beyond state capitalism. Brazil must embrace laissez-faire in order to prosper.
This task is tremendous and not much different from earlier elections, almost all parties currently represented in the Brazilian Congress belong to the left and the extreme left. There is neither a truly conservative nor an authentic pro-market political party. This situation is more than peculiar because, as surveys consistently show, most of the Brazilians locate their political orientation at the center-right and in favor of free markets.
Marxism Still Dominates the UniversitiesThe reason for this discrepancy lies in the fact that the left dominates higher education, particularly in the social sciences, economics, and law. It is from this group that most political activists come. When the military dictatorship ended in 1984, the university system fell under almost complete control by leftists of all kinds. This way, academic life is ideologically very different from the rest of the Brazilian society where common sense still has prevailed.
Fortunately, intellectual evolution is no longer largely dependent on academia. While the Kaleckian brand of Keynesianism and Marxism still dominates the universities, a strong libertarian movement is on the rise spearheaded by the Brazilian Mises Institute. Young people in particular flock to this site like the proverbial wanderer in the desert in the search for water. In the past, changes of mentality took decades and even centuries in order to unfold.
Nowadays, with the internet, ideas have a market place of their own with free access for all. It should be easy for the Brazilians to learn that it is not enough to be fed up with the present government, but it is high time to transform the country’s state capitalism into a free market system in order to prosper.
Image source: iStockphoto
The Fed, the ECB, and the Bank of England repeatedly tell us that deflation is extremely dangerous for an economy. Central bankers, most economists, and the media speak of deflation as one of the greatest disasters that can strike an economy.
It is stunning then, given the apparent importance of the subject — and the possible collateral damage of pro-inflation policies — that few seem to bother to ask the deeper, fundamental question: does the historical data show that deflation is actually a terrible thing? The data suggests that it is not. In fact, looking at recent GDP, inflation, and employment data, one could even say that a shot of deflation is what many economies need. Let us take a look at the recent real-life examples.
JapanJapan is the only Western country that has experienced protracted deflation in recent decades. According to those with deflation-phobia, deflation is a disaster in part because it causes households to postpone their spending, leading to falling consumption and high unemployment. Thus, Japan should be a country characterized by high unemployment, everything but a bustling shopping scene, and a much lower standard of living than, say, twenty years ago. Japan should also be absent from every international comparison of economies in terms of innovation. Instead, Japan features at least in the top 5 of every ranking of the most innovative countries in the world, consumption has increased in spite of years of falling prices, the unemployment rate is lower than 4 percent, and Japanese streets are filled with shops selling everything known to man.
Of course, the Japanese experience with deflation might just be an exception to the rule. Luckily, we have data for other economies as well.
GreeceIn the eurozone, there are two countries that recently have fallen into deflation. In Greece, prices have been falling since the beginning of 2013. In Spain, the annual inflation rate started to nosedive at the end of the spring 2013 and it fell sharply, to 0 percent, in the autumn of the same year. It has stayed there ever since, dipping below zero in the summer of 2014.
If we take a look at the GDP growth in Greece, we find out that in the first quarter of 2013 it shrunk by a staggering 5.8 percent. In all subsequent quarters of that year, the Greek GDP continued to shrink, but the rate at which it did so decreased. In the first quarter of 2014 the economy lost just 0.4 percent of its size. That was the last quarter the Greek GDP shrank. Since then, economic growth has returned, first at only 0.4 percent, but soon the growth rate rose to almost 2 percent. So the economy started to recover at the same time the prices started to fall.
SpainIn Spain we see the same scenario unfolding. At the end of January of 2015, Spain reported 0.7 percent economic growth in the final quarter of 2014, the highest growth percentage in seven years. When we plot the growth of the Spanish GDP in recent years, we see that the rate of decline started to slow in the first quarter of 2013 and the economy actually started to grow in the third quarter of that year. The Spanish GDP has been growing ever since and the growth rate has been picking up: from 0.2 percent in the third quarter of 2013 to 0.7 percent in the last three months of 2014. As in the case of Greece, one can make the case that the economic recovery coincides with the moment the prices started to fall sharply and the recovery took off when the inflation rate turned negative.
The NetherlandsFurther up in the north of the eurozone, in the Netherlands, the inflation rate started its rapid decent in the summer of 2013. The annual rate of inflation fell from more than 3 percent to 1.5 percent in just a couple of months and then some more. In less than a year, the inflation rate dropped from more than 3 percent to almost 0 percent and has been hovering just above that level until recently, when the prices fell even below 0 percent.
When we plot the unemployment rate, consumer confidence and consumer spending in the Netherlands in the same graph as the annual inflation rate, we see the same pattern we have seen in Greece and Spain: almost at the same time the inflation rate tanked, consumer spending started to increase faster (it even increased at the fastest rate in years at one point), the unemployment rate started to fall and the consumer confidence staged a strong recovery. The GDP, which was contracting in every quarter starting with the beginning of 2012, started its ascent in the third quarter of 2013 and has returned to positive territory in the final months of 2013 where it has been ever since.
The Benefits of Falling PricesWhy do these developments contradict what we’ve been hearing from central bankers and economists? First of all, the general inflation rate started to decline mainly due to a fall or a relatively modest increase of food prices, for example. Then, in the last couple of months, the sharp fall in oil prices pushed the energy-category of the inflation basket sharply lower. Food and energy are the two categories people spend a large part of their money on. If they need less money for those things, they can spend more on other goods and services. After years of tax hikes and other assaults on their income, people in various eurozone countries actually started to have more money to spend in real terms. In the Netherlands for example, the fall of inflation had led to something the Dutch had not experienced in years: their wages rose faster than prices. Still, central bankers refuse to acknowledge this and keep going on about the danger of deflation, often referring to the Great Depression.
At the same time, one thing we know for sure about deflation is that it increases the debt burden in real terms. So, one cannot help but wonder whether this insistence on deflation as the reason for quantitative easing in the eurozone has anything to do with the fact that many euro area governments carry a large debt which would become even larger with protracted deflation. Central banks are throwing everything at falling prices, something Joe Average actually needs badly.
Recently I spoke to the legendary former chairman of the Fed, Paul Volcker. According to Volcker “the idea that when people see prices falling they will stop buying those cheaper goods or cheaper food does not make much sense. And aiming for 2 percent inflation every year means that after a decade prices are more than 25 percent higher and the price level doubles every generation. That is not price stability, yet they call it price stability. I just do not understand central banks wanting a little inflation.”
Perhaps the central bankers and economists from all over the world should take a break from the theory and their focus on economic models and instead have a look at the real world and spend some time talking to Volcker in order to remember that deflation is not the disaster they imagine it to be.
Image source: iStockphoto
Historically, low oil prices have been perceived by many as an overriding positive for the economy. This has especially been the case in the United States where most households rely on car travel as a primary means of transport. Low oil prices allow households to spend more on economic activities other than gasoline and other oil-related expenses. Historically, every time the oil price soared — such as the 1973 oil crisis, the 1991 Gulf War, and in 2008 when oil reached a historical high of $147 a barrel — public opinion always regarded these events as a serious threat to the economy.
It was often understood that falling oil prices have many benefits both for the economy and for those subject to monetary policy. For example, price inflation is reduced when oil prices fall, which lowers pressure on the central bank to raise interest rates. And, all things being equal, the economy benefits from the price stability and lessened intervention on the part of the central bank.
Oil Prices and the “New Normal”However, by the third quarter of last year, falling oil prices were not being hailed as good fortune. Instead, commentators claimed the economy would suffer as a result. In fact, ever since the global financial crisis of 2008 occurred, this counter-intuitive analysis is promoted as a part of the “New Normal” which is widely believed to be kick-started by the Fed’s unprecedented easy-money policies.
Nevertheless, the argument in favor of high oil prices is logically not difficult to grasp: the longer oil prices stay above $100, the more investment would pour into new oil fields and also new energy alternatives to oil and shale gas. The result is an increase in employment in the oil industry.
The costs of such projects were only justified in the case of high oil prices. So, when oil prices go into decline, many companies — or at least many extraction operations — will consequently lose competitiveness and be forced to shut down. Layoffs will follow and the ripple effect brings more unemployment and an unwanted increase in bad debts.
Will Central Banks Hit the Panic Button?At this point, Keynesians step in and argue central banks have an important role in “fixing” the problem. That is, they will argue that the central banks should offset the subsequent risk of deflation by increasing the money supply.
First of all, note there is a double standard at work here. When oil prices rise, the central bankers claim there is too much volatility in oil prices and so the central bank will exclude energy prices from core inflation and postpone an interest rate hike. But when oil prices fall, the central bank no longer focuses on core inflation, but looks to a broader deflationary view that includes energy prices. Then, the response is to cut interest rates further.
Regardless of whether the oil price is high or low, central banks can come up with a rationale to adopt a loose monetary policy in order to fit the agenda that suits them.
It is important to clarify that falling oil prices that follow massive investment in extraction (causing layoffs, unemployment, and increases in bad debts) may harm a set of individuals or certain industries, but for the long-term development of the overall economy, it is a good thing. We must understand that after the financial crisis of 2008, a variety of resources — including oil prices — experienced a V-shaped rebound because both the US and China, the biggest two economies in the world, undertook a substantial increase in government spending and embarked on unprecedented credit-creation programs.
These government “stimulus” programs inevitably caused overinvestment (i.e., malinvestment) in many industries, and, in the most recent cycle, the oil industry is one such industry.
The Role of ChinaHowever, in 2010, the Chinese government became concerned about malinvestments and inflation and the People’s Bank of China began significantly tightening the money supply (although they again turned to easy money last November). This led to a slowdown in China's economic growth, and falling demand led to a drop in the prices of commodities — first copper and iron, and subsequently energy.
Moreover, the increase in the oil supply (due to the shale gas revolution), and reduced demand, combined for a double attack, until finally a substantial decline in oil prices appeared this year.
A Necessary CorrectionThe oil industry and related industries are facing the inevitable: companies which miscalculated and predicted ongoing price growth will go bankrupt, and industry resources will be acquired by investors with more insight. The short-term pain the oil industry is currently facing is necessary, and governments and central banks must not stop this natural process through misguided stimulus in an effort to prevent oil company layoffs. Such efforts are likely to only benefit the giant oil companies, as we witnessed in the wake of the 2008 crisis where the biggest banks were the biggest winners.
Image source: iStockphoto
The Henry Hazlitt Memorial Lecture, sponsored by James M. Rodney. Recorded at the Austrian Economics Research Conference at the Mises Institute in Auburn, Alabama, on 12 March 2015. Includes an introduction by Joseph T. Salerno.
We all know about Milton Friedman’s money helicopter idiom and how President Obama’s architect in chief of Quantitative Easing used it to justify his “Great Monetary Experiment.” Less well known is Friedman’s idiom about daylight saving time, how he used this to illustrate the case for flexible exchange rates, and how it is now apparently justifying the plunge of money market rates in Europe to sub-zero levels.
Let’s go to the original quote in The Case for Flexible Exchange Rates:
The argument for a flexible exchange rate is, strange to say, very nearly identical with the argument for daylight saving time. Isn’t it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? All that is required is that everyone decide to come to his office an hour earlier, have lunch an hour earlier etc. etc. But obviously it is much simpler to change the clock that guides all than to have each individual separately change his pattern of reaction to the clock, even though all want to do so. The situation is exactly the same in the exchange market. It is far simpler to allow one price to change — namely the price of foreign exchange — than to rely upon changes in the multitude of prices that together constitute the internal price structure.
What Friedman failed to mention or foresee was that once the US moved into “daylight saving” and devalued the dollar in the early 1970s, there has never been a return to “normal” time. The Federal Reserve became free from any external constraint, whether in the form of gold convertibility, or a fixed rate against a relatively hard money (which the Deutsche mark was in the early 70s). So, the Fed unleashed easy money on such a scale as to spread goods inflation and asset price inflation around the globe.
The Goal: Never Let Wages and Prices FallToday, daylight saving time in the form of the central bank — in this case the European Central Bank — sending interest rates below zero has created a similar hazard. The advocates of this policy point out that it is more “efficient” to introduce negative rates than have many wages and prices follow a pro-cyclical path such as would occur in principle under monetary orthodoxy. They also hypothesize about the frictional costs avoided by not allowing nominal wages and prices to fall from bubble levels.
Indeed under a regime of monetary stability — in contrast to the present inflation-targeting by deflation-phobic central banks — prices, on average, would fall to a below-normal level in the weak phase of the business cycle. Then, expectations of a subsequent climb during the expansion phase ahead would stimulate business and household spending in the present with nominal interest rates still at significantly positive levels.
But why endure all the frictional costs of wage and price cuts when a simple change of the clock to daylight saving — in this case, negative rates — could achieve the same result? In the contemporary European context, daylight saving means (according to its advocates) the avoidance of painful decline of prices and wages in Spain or Italy, which in many cases soared during the construction and real estate booms of the 2000s.
Why not instead simply drive rates below zero and power a construction and consumer-spending boom in Germany which would lift all boats in Europe’s periphery? And presto, the devaluation of the euro means also Friedmanite daylight saving time in the currency market, with all Europe’s exporters set to gain!
Britain’s famous financial commentator of the mid-nineteenth century, Walter Bagehot, had the answer when he wrote “John Bull will stand for many things but he will not stand for 2 percent interest.” As AEI scholar Alex Pollock points out, Bagehot meant that sub-2 percent rates would drive the British investor into a speculative frenzy with fatal economic consequences. Fortunately, at that time, strong demand for gold coin and a strong pro-cyclical pattern of wages and prices meant that money rates under the gold standard never fell below 2 percent in London.
What would Bagehot have made of today’s sub-zero rates? Well he would surely have predicted the speculative fantasies these have created in the minds of investors desperate for yield amidst an interest- income famine. The most vivid example of this may be 10-year French government bond yields at 0.65 percent. Not far behind is the Italian and Spanish government raising 10-year funds at around 1.30 percent.
Real Negative Rates Can Occur Without Central BanksWhy is this financial version of daylight saving time having such a powerful effect in unleashing irrational forces upon global financial markets? The source of the problem is not that interest rates have been negative in real terms for some time.
After all, even under a hypothetical regime of monetary stability or in the actual history of the gold standard, expectations of a rise in prices from their recession lows could mean that real interest rates would be negative for some time. Yet these naturally-occurring negative real rates, accompanied by nominal rates which are low but still significantly positive, do not by themselves stimulate market irrationality.
On the Other Hand: When Central Banks Cause Negative RatesFriedmanite daylight saving time is different in at least two respects. First, there is the scary psychological effect of sub-zero nominal interest rates (the scare is wholly rational given the history of monetary experimentation). Second, the holders of money and short-maturity bonds have not had the opportunity to make real gains from a fall in prices during the period of severe recession just before the negative real rates set in. Indeed if the inflation-targeting central bank is successful, prices rise throughout the entire cycle.
It is this cushion formed from real gains on monetary assets during the severe recession phase when prices fall to a low level which helps to prevent investors under a stable money regime from panicking into irrationality in response to negative real rates. Under such a regime in Europe, there would have been a decline of many wages and prices during the recent business cycle downturn.
With the central-bank having stepped in to prevent deflation throughout the cycle, holders of monetary assets in Europe now enter daylight saving time with no such cushion. And there is no finishing date in view. Most likely the European Central Bank will extend and expand its negative interest rate experiment.
Perhaps a strong economic upturn ahead or even an economic miracle (meaning an autonomous sustained strong rise in productivity growth) will force the European Central Bank to end daylight saving time. But there is the danger that the end — or the anticipated end — could bring a steep fall of speculative temperatures across a wide range of markets now enjoying the heat of asset price inflation.
It is also possible that these temperatures could start to fall without a strong upturn or miracle if anything causes the rose-colored spectacles worn by investors to fall off.
Image source: iStockphoto
This weekend, we feature our own Senior Fellow Mark Thornton in an appearance on Paul Molloy’s "Freedom Works" radio show.
Mark is known for his work on the Skyscraper Index Model, which can help us understand why booms are followed by busts, why malinvestment is inevitable in an era of artificial interest rates, and how central banks cause so much harm.
Building booms—especially in the context of big city skyscrapers—can be clear signs of dangerous bubbles and hubris. It’s no coincidence that the Empire State Building was built on the cusp of the Great Depression, and Moscow’s empty new financial center is an eerie reminder that phony growth can end very quickly. With huge mega-towers planned for China, Korea, Saudi Arabia, among others, the “skyscraper curse” may strike again.
Jeff Deist and Jay Taylor, host of Taylor’s Hard Money Advisers, discuss the role of Austrian economics in understanding the market crash of 2008; and how some institutional investors used Austrian theory to get very rich shorting that crash. If you are interested in markets, business cycle theory, and what Austrian theory has to say about the even bigger bubble created by the Fed since 2008, you will enjoy this episode.
Super tall buildings, or skyscrapers, are being built at an astonishing rate. Ninety-seven buildings that exceed 200 meters (656 feet) high were constructed in 2014, setting a new record. The previous record was eighty-one buildings completed in 2011. The total number of skyscrapers in existence now is 935, a whopping 350 percent increase since the year 2000.
Another record set in 2014 was the completion of eleven super-tall skyscrapers of over 300 meters or nearly 1,000 feet. That is the distance in height of over three football fields. The tallest skyscraper completed in 2014 was One World Trade Center in New York City. It is the third tallest skyscraper in the world, and the tallest in the western hemisphere, but only if you count the antenna/spire in the building’s height.
The tallest skyscraper in the world is the Burj Khalifa in Dubai, United Arab Emirates. On July 21, 2007 it surpassed the height of the then-reigning record holder Taipei 101.
The Shanghai Tower, which is the tallest skyscraper in China, opens for business in mid-2015. The third tallest is the Makkah Royal Clock Tower in Saudi Arabia.
What is the Skyscraper Curse?The reason all of this is important is the “skyscraper curse.” The curse is based on the correlation between the setting of new record heights in skyscrapers and the onset of economic crisis over the last century, or longer.
The last clear global signal of the curse was the Burj Khalifa, which saw the ruler of Dubai unable to repay the loans for all his elaborate real estate development projects. However, the Shard building in London set a new European record and ushered in the European economic and debt crisis.
Skyscraper Curse watchers have recently returned their attention to the Middle East. According to the Wall Street Journal Dubai’s real estate moguls have embarked on another “Go-Go Era” of boom and bust:
Dubai has slowly but surely clawed its way out of the hole it dug for itself in 2009 when a series of government-linked companies, including several under the direct control of ruler Sheikh Mohammed bin Rashid Al Maktoum, were unable to pay lenders on time and called for a standstill on repayments. The move signaled the death knell for an economic boom that had been fueled by real estate for almost a decade.
Dubai has again succeeded in convincing lenders — both international titans like HSBC and Standard Chartered and dozens of local banks — to support its government-linked real-estate developers. Investors, analysts and the emirate’s new crop of leaders all say this time is different to the previous boom running up to 2009.
Not only is the world teeming with real estate speculation and skyscraper building from China, to New York, to London, and the Middle East, there is a new world record setting skyscraper being constructed in Jeddah, Saudi Arabia. The Kingdom Tower is designed to be over one kilometer in height, or more than eleven football fields. It is to be completed in late 2016 or 2017. As designed, the Kingdom Tower will exceed the height of the Burj Khalifa by more than 500 feet. If events proceed as the skyscraper curse predicts, the beginning of construction of the Kingdom Tower signals a crisis alert (when a new record setter has begun) and will change to a crisis signal (when a new record is set) between now and the end of 2016.
Record-Setting Skyscrapers are Symptoms, Not CausesOf course, the building of record-setting skyscrapers does not cause world economic crisis. The records are merely symptoms of the underlying cause of world economic bubbles: sustained artificially low interest rates by central banks. I explain the process and the theoretical connections between record-setting skyscrapers and world economic crises here in the Quarterly Journal of Austrian Economics.
The skyscrapers can sometimes tell us about the geography of world economic bubbles. The last bubble occurred in the oil rich Middle East and the next one would also seem to be in the Middle East. Both bubbles began when oil prices exceeded $100 a barrel.
It is interesting to note that Prince Alwaleed, the owner of the Kingdom Tower project recently and unexpectedly sold most of his large stake of stock in News Corp, Rupert Murdoch’s media conglomerate, to raise nearly $200 million. The move was said to have been part of an overall review and rebalancing of the Prince’s $20 billion portfolio. This is probably a smart move given the collapse of oil prices and the hefty price tag of $1.25 billion for the Prince’s Kingdom Tower.
Image source: iStockphoto.
People accuse Austrian economics of being overly theoretical—but our guest John O’Donnell proves them wrong. He’s applied Austrian economics consistently over his long career both as a successful investment banker and the CEO of several public companies.
John met Murray Rothbard in the 1970s, and everything changed. He became a thorough Rothbardian and a dedicated libertarian—not to mention a close friend of hard money stalwarts like Doug Casey and Harry Browne.
You’ll enjoy hearing his memories of how Murray owned a room, how Murray’s incredible sense of humor was matched by his sheer endurance for late nights, how measuring investment returns in fiat currency is nonsensical, and how Wharton, Harvard, and the London School of Economics produce so many clueless Keynesian MBAs.
The Birth of Korean Cool, by Euny Hong, Picador Press, 2014
Those of us who have reached a certain age remember the late 80s and early 90s when we were told that the Japanese were taking over the world. We bought their cars. We played their video games. We used their technology for pretty much everything. The Japanese were destined for world domination, we were told. They were better team players. They put more emphasis on the group than on the individual. They worked harder. In 1992, a high-ranking Japanese politician, Yoshio Sakurauchi, declared that Americans are “too lazy” to compete with Japanese workers, and that a third of American workers “cannot even read.” Michael Crichton’s 1992 novel Rising Sun (and the 1993 movie adaptation) fueled these controversies further in the minds of many Americans.
Nobody thinks the Japanese are taking over the world anymore. It turned out that the supposedly ironclad Japanese economy was less reliant on team players and hard work than it was on central planning, easy money, corporate welfare, and trade barriers. Thus, the bust that followed the boom should have surprised no one.
Today, South Korea (which I’ll simply call “Korea” in this article) appears to have, in many respects, taken up where Japan left off. Japan’s Sony has gone into deep decline, but Korean brands Samsung and LG are now internationally respected brands. Hyundai, while still regarded as a low-quality by many, has nonetheless expanded massively in the past decade, with Hyundai building a billion-dollar factory in Alabama in 2005, and a second in Georgia in 2009.
Korea’s Rise On the Global StageBut Korea’s attempt at global domination is different from Japan’s. While Japanese pop music, film, and TV never attained much popularity outside Japan, Korean pop culture has become a global phenomenon. We drive their cars and use their mobile phones, but Koreans also want us to listen to their music and watch their movies.
Few in the US noticed the rise of Korean pop culture until 2012 when the music video for Korean rapper PSY’s single “Gangnam Style” became one of the most-viewed YouTube videos of all time. Suddenly, almost everyone had heard of “K-pop.”
Moreover, anyone who browses new releases on Netflix is likely to have noticed a sizable increase in the number of Korean-language films available, including internationally successful films such as 2003’s action-thriller Old Boy and 2006’s monster movie The Host.
The rise of Korean music, film and TV — and also video games — is not an accident of free markets, however. It’s the result of Korean government policy that coordinates, subsidizes, and protects Korean pop-culture industries, among many others.
In her new book The Birth of Korean Cool, Euny Hong explores the origins and successes of this program, heavily supported and coordinated by Korean government agencies, and known as Hallyu, or “the Korean Wave.” It’s not just about economic power, but about international relations, and the Korean state uses Hallyu as part of a larger program designed to project Korean soft power.
They Do Things Differently In KoreaHong, a journalist, approaches the topic through her own experiences as an American-born ethnic Korean who lived in Korea during her teen years. She recounts the rampant nationalism in Korean schools and society, the necessity of conformity, the general deference of Koreans toward the state and the nation, while “individualistic” behavior is regarded as a type of social pathology.
Hong relates many anecdotes illustrating these points with a sympathy for Korea and Koreans, although laissez-faire minded Westerners will likely view such experiences with bemusement and perhaps even dismay. That all-American personality type, the “bad boy,” so prominent in American pop culture, is non-existent in Korea, Hong tells us.
This comes through in the country’s popular culture. The closest thing the Korean pop-music scene has to a “bad boy” is the rapper PSY, who is regarded as rebellious because he didn’t get straight-A’s in school and occasionally disappointed his parents.
Not surprisingly, then, Hong tells us, popular culture in Korea is regimented, corporate, planned, and governed by an ethic of commitment to the group and the subversion of the individual artist.
Through a government agency called “The Ministry of Future Creation,” the Korean government works with ostensibly private sector pop-culture enterprises to maximize the influence of Korean pop culture both domestically and abroad.
Historically, the Korean government has employed protectionism to encourage Korean pop culture. For example, Hong notes that in decades past, the Korean government required Korean movie theaters to show Korean-made movies a minimum of 146 days per year, and that “[f]ilm companies had to produce one Korean film for every non-Korean movie they imported. It’s safe to say the Korean film industry benefited from this kind of protectionism. …The government also built and operated art house theaters.”
Since the Asian financial crisis of the late 1990s, however, the Korean government has also taken to widespread assistance of Korean pop culture in international markets, using taxes to finance dubbing of Korean programs in foreign languages and using diplomats to negotiate scheduling of Korean programs on foreign television stations.
Government-Corporate “Cooperation”This all fits well within Korea’s established political practices.
Just as the Japanese economy has long been influenced and even dominated by major government-connected corporate entities known as keiretsu and zaibatsu, Korea has somewhat analogous corporations known as chaebols. The Korean version of “too-big-to-fail,” but far more significant to the overall Korean economy, these entities have been key in executing Korean government policy through “government-chaebol cooperation.”
Hong notes that the rise of government-promoted pop culture in Korea cannot be fully understood outside this context, and in the final chapters of her book, she examines this tradition of corporate-government cooperation by looking at the case of Samsung, LG, and other recently-successful Korean business enterprises that are nonetheless built on government favors and taxation.
Hong writes: “As with many of Korea’s success stories discussed in this book, Samsung’s rise to the world stage is attributable [to] … the direct intervention of the Korean government at crucial stages.”
And lest anyone think that Samsung is just another corporation, Hong reminds us that “Samsung alone generates one-fifth of the country’s GDP.” It’s not hard to see how the Korean state would see Samsung as essentially an adjunct of itself. “What’s good for Samsung is good for Korea” is no doubt a sentiment in the halls of Korean government agencies.
Hong, being a journalist, simply accepts the economic policy of the Korean state at face value. Of course all this central planning of the Korean economy has been an enormous success. We can see it in how the Korean standard of living has grown by leaps and bounds since the 1960s when Korea was essentially a third world country.
It’s yet another success story — we’re told — of Keynesian neo-mercantilism in which government-owned or -subsidized corporations execute government plans for improving the economy based on the decisions of government agents.
For one with an understanding of classical or Austrian economics, however, you can only look at this economic set-up and wonder what is “the unseen” behind all the government favoritism and centralized decision-making. What would Koreans spend their money on if it weren’t confiscated and given to the chaebols and spent on guaranteeing loans for government-favored enterprises? What innovations might occur if small enterprises and start-ups in Korea had the opportunity to actually compete against huge too-big-to-fail enterprises? We’ll never know.
Cautionary TalesWhat we do know, however, is that when a national government puts most of its eggs in one basket, as the Korean state has done, success can be fleeting, indeed. What happens when Samsung goes the way of Sony? Or Hyundai goes the way of General Motors? Will there just be more bailouts, more “stimulus,” and as the Japanese and American experiences suggest, more tidal waves of easy money?
In a culture where leisure is regarded by many as suspect, and students are expected to study eighteen hours per day, it’s possible to go on seemingly indefinitely while malinvestments pile up and government siphons off more and more wealth to prop up its favored corporations. But, in the end, as Japan — and increasingly the United States — have shown, such policies eventually lead to stagnation and capital consumption. Under such conditions, Japanese and American workers can work harder and longer hours to maintain a standard of living, but disposable income never seems to increase.
Japan, the once-future-ruler-of-the-world is a cautionary tale here, but so is the United States. True, the US economy is more diverse and entrepreneurial than either the Japanese of Korean economies, but how many more decades can the American economy endure its own devotion to propping up a financial sector and other corporate friends-of-government all at the expense of taxpayers and entrepreneurs? We may be experiencing the answer to that question already.
A reading of The Birth of Korean Cool tells us that Korea is still in the boom phase. But we’ve seen this movie before, albeit not in Korean.
Image source: iStockphoto.
The announcement of the euro-QE was not the start of Europe’s monetary Dark Age. That started many years ago with Chancellor Kohl’s undermining of the “hard deutsche mark Bundesbank” in the late 1980s. The darkness further descended when the newly created European Central Bank (ECB) implemented monetary frameworks which essentially tied Europe into a global 2-percent-inflation standard, following the US Federal Reserve.
The darkness continues unabated with the ECB’s decision in January to pursue its own version of the “Great Monetary Experiment” (GME), launched first by Obama’s architect-in-chief Professor Ben Bernanke and his fellow travelers in the Federal Open Market Committee (FOMC). One would have thought that before this could happen there would have been exhaustive hearings both within the ECB and the German and French parliaments about just how successful, or not, the GME had been. They should also have looked at the record of Abenomics in Japan. And even as the final hour approached, with the die all but cast, no one at the ECB press conference asked the question:
Signore Draghi, why are we in Europe embarking on a monetary experiment which has already failed in the US and Japan? I mean by failure, the fact that this is the weakest economic expansion ever following a Great Recession in the US. And we are already witnessing the bursting of a huge oil and commodity bubble with, yet unknown but almost certainly, severe consequences, whilst in Japan there has been a second recession, not economic renaissance as Prime Minister Shinzo Abe promised.
The Easy-Money Enthusiasts are EmboldenedBut no, there was none of that. Instead on the eve of the launch, even more monetary nonsense was to emerge. First, from Rome there was socialist Prime Minister Renzi calling for the euro to make its smooth descent to parity against the US dollar — its “natural level.” And then, ex-ECB board member Professor Lorenzo Bini-Smaghi, in an editorial for London’s leading Keynesian financial newspaper, The Financial Times (January 20), admired how the ECB was about to repudiate political interference from Berlin in defense of “price stability” (meaning 2 percent inflation). The ECB was establishing its “independence,” Bini-Smaghi wrote, just as the Bundesbank had done against Chancellor Adenauer in raising rates by 2 percentage points when he had demanded no rise at all. In the monetary cult, 2 percent inflation forever and a recurrent deadly plague of market irrationality (what Keynesians describe as “animal spirits”) represents the ideal resting place.
Now that the monetary barbarians have finally sacked Frankfurt, with the incredible cooperation of Chancellor Merkel, it is not too early to ask when a system based on stable money might return. The answer is: don’t look to Rome! Although both improbable and risky, one option is a political earthquake in Germany which would lay waste to the current system, and thrust that country out of the European Monetary Union and toward the resurrection of the “hard deutsche mark.”
Are Central Banks Too Weak?But let’s take one step back and review Kenneth Rogoff's recent comments from Davos. In spite of himself, Rogoff managed to utter some truth about the likely future for long-term inflation. In a January 21 Bloomberg TV interview with Tom Keene, Rogoff gave a gloomy warning, though it’s unclear whether or not he would view it as gloomy. The long-term bond markets are now assuming that central banks in the US, Europe, and Japan will be unsuccessful in achieving their 2 percent inflation targets, and that inflation will remain well below that level, even in the long-run. That is foolhardy. The central banks may seem weak for now, but do not underestimate their power to achieve inflation in the long-run! Professor Rogoff did not go into details about how this ability might return, but in technical terms we could say that will happen when the neutral level of interest rate rises — whether (optimistically) due to blossoming of investment opportunity or (pessimistically) due to growing capital shortage (in the worst cases triggered by war or other disasters). At that stage, the massive excess reserves now in the various monetary systems would feed a wider monetary and lending boom.
That is how the failed Roosevelt QE policies of 1934–36 ended — after the Crash and Great Recession of 1937–38 came the war and high inflation. Let’s hope the sequel to Obama-Merkel-Abe QE is different.
Image source: iStockphoto.
The European Central Bank (ECB) is planning to pump 1.1 trillion euros into the banking system to fend off price deflation and revive economic activity. The ECB president and his executive board are planning to spend 60 billion euros per month from March 2015 to September 2016.
Most experts hold that the ECB must start acting aggressively against the danger of deflation. The yearly rate of growth of the consumer price index (CPI) fell to minus 0.2 percent in December 2014 from 0.3 percent in November, and 0.8 percent in December 2013.
Many commentators are of the view that the ECB should initiate an aggressive phase of monetary pumping along the lines of the US central bank. Moreover the balance sheet of the ECB has in fact been shrinking. The yearly rate of growth of the ECB balance sheet stood at minus 2.1 percent in January against minus 8.5 percent in December. Note that in January last year the yearly rate of growth stood at minus 24.4 percent.
The Fear: People Might Save Instead of Spend
Why is a declining rate of inflation bad for economic growth? According to the popular way of thinking, declining price inflation sets in motion declining inflation expectations. This, in turn, is likely to cause consumers to postpone their buying at present and that in turn is likely to undermine the pace of economic growth.
But, in fact, in order to maintain their lives and well-being, individuals must buy present goods and services. So from this perspective a fall in prices as such is not going to curtail consumer outlays. Furthermore, a fall in the growth momentum of prices is always good for the economy.
A Fall in Prices Can Mean an Expansion of Real Wealth
For example, an expansion of real wealth for a given stock of money is going to manifest in a decline in prices (remember a price is the amount of money per unit of real stuff), so why should this be regarded as bad for the economy?
After all, what we have here is an expansion of real wealth. A fall in prices implies a rise in the purchasing power of money, and this in turn means that many more individuals can now benefit from the expansion in real wealth.
What If Prices Fall As a Result of a Bust?
Now, if we observe a decline in prices on account of an economic bust, which eliminates various non-productive bubble activities, why is this bad for the economy?
The liquidation of non-productive bubble activities — which is associated with a decline in the growth momentum of prices of various goods previously supported by non-productive activities — is good news for wealth generation.
The liquidation of bubble activities implies that less real wealth is going to be diverted to malinvestments from wealth generators. Consequently, this will enable investors to lift the pace of wealth generation. (With more wealth at their disposal they will be able to generate more wealth.)
So, as one can see, a fall in price momentum is always good news for the economy since it reflects an expansion or a potential expansion in real wealth.
Hence, a policy aimed at reversing a fall in the growth momentum of prices is going to undermine — not strengthen — economic growth.
We hold that the various government measures of economic activity reflect monetary pumping and have nothing to do with true economic growth.
An increase in monetary pumping may set in motion a stronger pace of growth in an economic measure such as gross domestic product. This stronger growth, however, should be regarded as a strengthening in the pace of economic impoverishment.
It is not possible to produce genuine economic growth by means of monetary pumping and an artificial lowering of interest rates. If this could have been done, world poverty would have been erased by now.
Image source: iStockphoto.
Quarterly Journal of Austrian Economics 17, No. 4 (Winter 2014) KEYWORDS: Panic of 1873, Austrian Business Cycle Theory, Depression of 1873–1879, national banking systemJEL CLASSIFICATION: E2, E3, E4, N1, N2SECTION I: INTRODUCTIONWith the recent financial meltdown in 2008, Austrian economics has experienced a revival by both professional and popular commentators. As documented by Cachanosky and Salter (2013) and Salerno (2012), much of this attention is directed towards Austrian Business Cycle Theory (ABCT), which places government manipulations of the interest rate and distortions in the production structure as the cause of economic booms. Significant focus is also placed on critically examining the policy of laissez faire that is often associated with the theory during the ensuing bust (e.g., Horwitz, 2011; Kuehn, 2011; Murphy, 2009; Thornton, 2010).
Since the advent of the economic crisis also reinvigorated a general interest in studying business cycles and the application and efficacy of monetary and fiscal policies, this paper provides an analysis of ABCT by examining an American business cycle from the 19th century. The 19th century was a period of relatively minimal government action compared to the 20th century, and as a result a detailed study of this period provides a different perspective on the effects of macroeconomic policies. Specifically, it allows for an analysis of the 1870's boom (1870–1873) and bust (1873–1879), which the NBER designates as the longest contraction in modern American history (Sutch, 2006a, series Cb5–8). The experience of the 1870's provides a unique window into economic history because the data from this period are more accurate compared to the early 19th century, and it allows for a rare investigation of output growth during a monetary contraction.
The present work is closer in line with those papers that analyze ABCT from a historical-economic perspective (e.g. Callahan and Garrison, 2003; Hughes, 1997; Powell, 2002; Rothbard [1963] 2008; Salerno [1988] 2010, 2012) instead of an econometric study (e.g. Bismans and Mougeot, 2009; Fisher, 2013; Keeler, 2001; Lester and Wolff, 2013; Luther and Cohen, 2014; Mulligan, 2006; Wainhouse, 1984; Young, 2012). The existence of an ABC in the 1870s is illustrated by showing the appearance of a significant credit expansion and confirming that prices and production behaved in a manner explainable by the theory.Space constraints preclude a more thorough study that distinguishes among other rival business cycle theories. The paper shows how political legislation allowed for monetary inflation to cause a boom and bust in the 1870's that is explainable by ABCT. Furthermore, since the federal government pursued a policy of relative laissez faire, the economy successfully recovered and the length of the perceived bust (1873–1879) is grossly exaggerated.
The paper is structured as follows: Section II provides a summary analysis of ABCT and related theories. Section III explains the relevant data, especially the figures regarding the money supply and industrial production, as well as describing how they will be used to show an ABC in the paper. Section IV provides the necessary historical analysis of monetary institutions and the economic narrative for the three time periods of study: 1867–1873, 1873–1875, and 1875–1879. Section V concludes the paper and Section VI is the Appendix, where the referenced tables and figures can be found.
SECTION II: THEORYThe following section provides a brief summary of what can be called “capital based macroeconomics” (Garrison, 2001, pp. 7–8). This review is essential as capital based macroeconomics is extensively used to interpret the economic landscape from 1867–1879, particularly the movements in relative prices and production, and as a result it is important to have the theories clearly stated.
Capital based macroeconomics emphasizes the importance and interrelatedness of time preference (the proportion of consumption to investment spending), the interest rate (the price spread or rate of return between stages of production), and the structure of production. The structure of production can be described as the temporal process where goods in the “higher order” stages (a shorthand term for those production processes that are more temporally remote from consumption) are worked on and sold to the “lower order” stages (a shorthand term for those production processes that are more temporally close to consumption) until they become finished goods and sold to the consumer. These relationships are graphically represented in the simplified diagram in Figure 1.
In capital based macroeconomics, changes in the production structure occur through changes in time preference. A decrease in time preference results in a lower interest rate and the creation of additional stages of production. Savings are channeled through the credit market and the loanable funds interest rate drops. The decline in consumption spending reduces prices in the lower orders, while the increase in investment spending raises prices in the higher orders, i.e., prices in the former fall relative to before as well as to the latter. The additional investment funds are spent on creating higher order goods as the economy engages in relatively more long term production processes. The process continues as the public spends its constant money income at their lower time preferences. The opposite occurs with an increase in time preferences. The process is depicted in Figure 2.For a more in depth overview of Austrian structure of production theory and this basic growth scenario, see Garrison (2001, pp. 33–67), Hayek ([1931] 2008a, pp. 223–240), Huerta de Soto (2006, pp. 266–346), Rothbard ([1962] 2009, pp. 319–555), and Skousen (2007, pp. 133–264).
The situation is different when the increase in investment is financed through credit expansion. Here the money supply increases as additional bank credit enters the loanable funds market. This can be called inflation.More specifically, inflation occurs when the increase in the money supply is not offset by an increase in the demand for money (Mises, [1953] 2009, p. 240; 2004, pp. 44–45). This definition is different from the one proposed by Rothbard ([1962] 2009, p. 990; [1963] 2008, p. 12). As a result, the loanable funds interest rate drops and is distorted because it no longer reflects time preferences. Firms that receive the additional supply of bank credit respond by increasing investment in the higher orders, and because of the increase in spending, aggregate money incomes also increase. A boom begins.
Since time preferences have not changed, the public spends its enlarged income at its old time preference spending patterns, which pushes prices up in the lower orders.The inflation can actually cause capital consumption through an accounting illusion (Mises, [1949] 2008, pp. 549–550; Rothbard, [1962] 2009, pp. 993–994). When this occurs, time preferences increase. Whereas in the earlier growth scenario, lower order prices fall both relatively to higher order prices and to before, now lower order prices rise relative to before. The reassertion in time preferences relative to the period of credit expansion and the resultant price increases in the lower orders reveals the unprofitability of the newly embarked investment projects, known as malinvestments. In a modern complex economy, booms are prolonged because banks continue to expand credit and entrepreneurs temporarily mask the unprofitability of the increased investment through additional borrowing. However, the bank credit still filters down and enlarges money incomes, which causes another rise in consumer spending and reassertion of time preferences. Through a combination of tightened money from overexpanded banks and the eventual realization of entrepreneurs that many of their investment projects are unprofitable, the boom ends.For a more in depth analysis of ABCT, see Garrison (2001, pp. 67–83), Hayek ([1931] 2008a, pp. 241–247), Huerta de Soto (2006, pp. 347–384), Mises ([1949] 2008, pp. 542–563), Rothbard ([1962] 2009, pp. 994–1004), and Skousen (2007, pp. 282–331).
The next phase of the cycle is the necessary liquidation of unprofitable lines of production and the reorganization of the economy according to current time preferences. Since time preferences are actually higher than planned by entrepreneurs, the capital structure must shorten and the rate of interest rise. In order for that to occur, relative prices are bid down in the overextended lines of production to reflect the higher price spread and infeasibility of the more temporally remote production stages. Unprofitable businesses contract and allow their resources to be reabsorbed and more efficiently used elsewhere, particularly in the comparatively more lucrative shorter production processes. In essence, it calls for a policy of laissez faire. The entire cycle of boom and bust (ABC) is shown in Figure 3. Phase 1 represents the initial expansion of investment spending into the higher orders. Phase 2 shows the reassertion of time preferences and the unprofitability of investment projects. Phase 3 depicts the necessary corrections.
Although during the bust the main adjustments that must take place are relative to reflect higher time preferences, contractions in the money supply can also occur. This credit contraction is called deflation.More specifically, it is a decrease in the supply of money not offset by a decrease in the demand for money (Mises, [1953] 2009, p. 240). Under such a scenario, prices in the economy must adjust both relatively to reflect the higher price spread and nominally to reflect the changes in total spending.The following arguments regarding a decline in nominal spending are different than those Austrians who adhere to Monetary Disequilibrium Theory. For supporters of this theory, such a scenario of “secondary deflation” (declines in nominal spending during the bust) aggravates the downturn through various sticky-price induced arguments and necessitates the need for a stabilization in nominal spending either by government or private banks. See Garrison (2001, pp. 221–243) and Horwitz (2000, pp. 141–175; 2006; 2014) for a more in depth explanation. Credit contraction also has other effects. Firstly, it can cause unanticipated capital accumulation that provokes lower time preferences which increases the relative profitability of the malinvested investment goods and allows for prices to fall less than they would have in the absence of the effect. Unlike inflation that causes capital consumption because individuals do not realize their profits are fictitious, deflation overstates losses and causes businessmen to spend the same amount of money on factor inputs in the economy even though their prices have fallen. Instead of not saving enough for factor inputs whose prices have risen, the fall in spending provokes the opposite effect (Mises, [1949] 2008, p. 547; Rothbard, [1962] 2009, p. 1006).
Just as the credit expansion described above distorts interest rates, so too can credit contraction. There are, however, important differences between the two. Credit contraction is directly beneficial to speeding up the adjustment process during a bust by correcting both the loan market and production structure’s rates of interest to the higher one supportable by current time preferences. It results in a higher price spread by stopping the growth in loans to businesses that have facilitated the boom, which causes the demand for factor inputs and products in the temporally remote stages of the economy to fall and relatively lowers their prices. Credit contraction may raise loan and production structure rates of interest higher than deemed necessary by existing time preferences, and in this sense can be considered distortionary. However, due to the reduction in investment businesses pay smaller amounts to original factors, who in turn, with reduced money incomes, spend less on consumption. Price spreads fall in accordance with the lower time preferences and the market rates adjust (Mises, [1949] 2008, pp. 564–565; Rothbard, [1963] 2008, p. 18; Rothbard, [1962] 2009, pp. 1005–1006).
SECTION III: DATAThis section presents the rationale behind the particular data sources and series used. Much of this analysis may seem overly technical and out of place, but since this paper applies ABCT and other Austrian economic insights, there must be a proper analysis behind the data that are used to describe these theories. For example, the selected Austrian definitions of the money supply and the breakdown of the structure of production into higher orders and lower orders are cited extensively in Section IV and therefore must be accurately defined in order to provide a clear exposition of the relevant economic concepts.
The numerical data are presented in Tables 2–4. They include data on money supply, interest rates, prices, and production. The per annum growth rates of all data except interest rates are presented, in addition to the level figures of interest rates in relevant years. Growth rates are used to show relative movements over time.
Gross National ProductBecause the United States only started recording Gross National Product (GNP) figures in 1929, a variety of historical series were created in an attempt to present an accurate picture of the macro-economy in earlier years. The construction of such series has been described as a “work in progress,” and they are less precise than modern figures as the underlying data were not collected for the purpose of making GNP estimates (Rhodes and Sutch, 2006, pp. 3–12).
The three GNP series used in the analysis are taken from Balke and Gordon (1989), Johnston and Williamson (2008), and Romer (1989). These three are the latest GNP series devised for the period and are more accurate for measuring annual movements than earlier series that were designed for more long term measurements. In addition, the annual industrial production index by Davis (2004a) that is used to analyze specific compositional changes in the production structure (see below) serves as a suitable proxy for GNP and is also included. Numbers for the series can be found in Davis (2004b), Johnston and Williamson (2013) and Sutch (2006b, series Ca213 and Ca216).It should be noted that the Johnston and Williamson series incorporates the Davis industrial production index in its annual observations (Johnston and Williamson, 2008).
Since the series were composed using different methods and none have been conclusively accepted as the most accurate, it is best to incorporate them all. The discrepancy among them suggests that the best conclusion is to use the averages of small intervals for the individual series, and use the smallest as the average lower bound and the highest as the average upper bound. To use these series with individual years seems inappropriate, especially since there will be an urge to compare them to more accurate modern estimates that incorporate a much larger pool of data and can be precisely broken down in minute detail. A rationale for the particular bounds chosen is given at the beginning of Section IV.
Government Spending and TaxationWhile analyzing changes in government spending and taxation is undoubtedly important for a paper that deals with historical macroeconomic policy, its small size relative to output makes it inconsequential for this period. After steeply rising during the Civil War, federal spending sharply declined in the post-war period and then gently fell throughout the 1870's (Wallis, 2006a, series Ea584–587). In addition, save for the Civil War, the federal government during this period ran surpluses, as tax revenue was greater than expenditures. Given the chosen method for estimating annual GNP figures and the dearth of annual figures for state and local governments (Wallis, 2006b, 5–3), it is hard to paint a reliable picture of annual changes in total government spending and taxation to gauge fiscal policy. It is for this reason that detailed figures on annual changes in taxation and spending have not been included. However, it can safely be said that significant activist fiscal policy was nonexistent in this period, including the depression years.
Interest RatesUnfortunately, detailed collection of interest rates during this period is scanty. The most reliable figures are yields on government bonds and short term interest rates on commercial paper and call money. Given the limited data, the interest rates used are the rates on 60–90 day commercial paper. Their movements are assumed to roughly mirror interest rates on general loans. It is important to remember that during a credit expansion there are other factors that influence the rates of interest on various financial assets. For example, during a credit expansion, other economic factors such as a rise in the risk premium or an expectation of a rise in prices may counteract the increase in the supply of loanable funds from credit expansion and raise the loan interest rate (Mises, [1949] 2008, pp. 549–550, 556; Rothbard [1963] 2008, p. 85). The interest rates are taken from James and Sylla (2006, series Cj1223).
Money SupplyIn order to appropriately depict changes in the monetary environment during this period, proper money supply figures are needed. Following Rothbard ([1978] 2011, pp. 736–739), a general money supply figure, Ma (a = Austrian), and a more specific figure, Mb (b = business cycle) are defined. The first is useful for showing aggregate monetary influences on the economy, while the second serves as a suitable estimate for gauging business cycle generating bank credit.
The general money supply Ma consists of the base money (specie) and all money substitutes. The definition of a money substitute here comes from Mises ([1949] 2008, pp. 429–431) and includes all notes and deposits that the public perceives as always redeemable for a definite amount of the base money (such as the par value). This not only includes money that is usable in exchange, but also instruments that must first be converted into an exchangeable type of money. For the relevant period, Ma includes specie, government notes (such as greenbacks), bank notes, commercial bank demand and time deposits, and mutual savings bank time deposits.This particular definition of Ma, best defended in Rothbard ([1978] 2011, pp. 727–739) and Salerno ([1978] 2010, pp. 115–130), is different from other Austrian definitions such as Mises ([1949] 2008, pp. 429–431, 459–463) and White (1989, pp. 203–217) mainly because it considers time deposits that are in and of themselves not exchangeable for goods as money substitutes. While space constraints unfortunately preclude a thorough defense of this definition, it should be noted that for this time period it essentially corresponds to the M3 definition provided by Friedman and Schwartz (1970, pp. 79–81).
In order to accurately depict the effects of credit expansion on the structure of production one must concentrate solely on the increases in Ma created through business loans and investments (Mb). Specie and notes can be removed because they are currency and do not cause a business cycle. Deposits at mutual savings banks can also be removed as most of their investments during this period were in government securities or small residential mortgages and were thus not cycle generating (Teck, 1968, p. 42; Welfling, 1968, p. 67). This leaves us with total commercial demand and time deposits. With this in mind, it can be stated that ceteris paribus (i.e., the demand for money), an increase in commercial bank deposits is synonymous with an increase in business cycle generating bank credit and investments to private firms.
The specific money supply figures are taken from Friedman and Schwartz ([1963] 1993, p. 704) as opposed to the figures used by Rothbard ([1983] 2005, pp. 153–154). Due to the imperfections of the statistical collection of the figures used by the latter, they are undoubtedly inferior to the Friedman and Schwartz estimates.Due to new Civil War legislation (explained below), the government stopped collecting statistics on state banks based on the belief that they would disappear, which turned out to be untrue (Friedman and Schwartz [1963] 1993, p. 3). As a result there is a large drop in state bank figures at the end of the Civil War, which continued until the early 1870s. Furthermore, the figures may include mutual savings banks as well as loan and trust companies (Bodenhorn, 2006, pp. 3-634). Using those figures would significantly overstate credit expansion during the boom and would in fact continue to show credit expansion after the bust, which was not the case.
Prices and ProductionAs explained earlier, ABCT describes a structural adjustment in the macroeconomy that manifests itself through relative changes in prices and production. In order to show this, prices from Hanes (2006, series Cc114–121), and sector specific industrial figures from Davis (2004b) are used. The individual price and production series are divided into the higher orders and the lower orders and are presented in Table 1. This dichotomization is not meant to be literal. Indeed, such an inappropriate categorization is akin to organizing the production structure into strict “consumer goods” and “producer goods” industries (Hayek [1931] 2008b, p.444; Rothbard, [1962] 2009, p. 543). To reiterate, the “stages” or “orders” of an economy are merely shorthand reference for the length of production processes and/or the temporal distance of a good from the consumer good it helps to produce. The distinctions are only meant to distinguish those sectors of the economy whose profitability would be most likely affected by credit expansion. Those industries designated as higher orders are the most capital intensive and temporally remote from consumption.
During the post-Civil war era there was a large expansion in the railroad and railroad related industries (Cain, 2006, series Df874; Fishlow, 2000, pp. 583–584). They were a major American industry and financially accounted for 15–20 percent of American capital investment (Moseley, 1997, p. 148). Economically, they were large projects that required a variety of land, labor, and capital, and completing a railroad was a significant long term investment dependent on heavy financing. Because the federal government was eager to create transcontinental railroads to stimulate growth into the Western States, in the Civil War and post-Civil War era an enormous amount of government railroad land grants and subsidies were given and a little over a third of the increase in railroad production during this period came from land grants (Burch, 1981, p. 16; Fishlow, 2000, p. 585).In particular, in 1862 Congress passed the Pacific Railway Act, which created the Union Pacific and Central Pacific, and in 1864 Congress also created the Northern Pacific. The first two received money subsidies, and all three received land subsidies. (Folsom, 1991, pp. 18, 22–23). However, undoubtedly a significant factor was also credit expansion as railroad production and its related industries constitute long term production processes which credit expansion increases the profitability of most. The changes in production in this industry will be shown through the Transport Equipment and Machinery figures, which contains locomotives as an included series.Railroad track mileage will not be included in the relative structure of production comparisons in the economic analysis. The Davis series is a self-contained industrial production index; to compare railroad miles with those figures would be inappropriate as it was neither designed like the other series nor meant to be compared in such a fashion.
As stated earlier, an inflationary boom is signaled through a relative increase in the prices and production of the higher orders while at the same time a relative increase in the lower orders to before, with the opposite occurring during the bust. Likewise, a recovery driven by lower time preferences manifests itself as a relative increase in the higher orders with both a relative decline in the prices of the lower orders to the higher orders and to before. Of course, in the real world, one change never occurs isolated, so other factors are always influencing the economic landscape and counteract the visible effects of credit expansion. But what matters is that these credit induced restructuring processes still occur alongside the other forces.Historically an increase in saving or technological innovation usually occurs alongside a credit expansion. In this case (which applied to this period) during the boom prices may decline, but still change relative to what they would have been had the credit expansion not taken place. Such economic forces do not eliminate the boom but only obscure it (Mises, [1949] 2008, p. 558; Rothbard, [1963] 2008, pp. 169–170). This fact reinforces the use of per annum growth rates to show movements in relative prices. If a price is falling in one period but then falls less (i.e. the growth rate becomes less negative) in the next period, it can be said that the price relatively increased.
SECTION IV: HISTORICAL AND ECONOMIC ANALYSIS, 1867–1879The intervals were chosen to best capture the macroeconomic trends during each period. The first two periods, 1867–1870 and 1870–1873, were chosen to best distinguish changes in the economy during periods of credit expansion. The third period, 1873–1875, was chosen because it was the post-panic years listed by Wicker (2000, pp. 30–31) while the fourth period, 1875–1879, was chosen to include the rest of the purported depression years listed by Sutch (2006a, series Cb5–8) and the monetary contraction that ended in early 1879 by Friedman and Schwartz ([1963] 1993, p. 704). It is noticeable in the output series that exceptionally strong growth occurred in 1879. Extending the growth analysis to 1875–1879 would overestimate GNP growth and give a less than accurate picture of the time period. Therefore, only the money supply and interest rate figures are extended to early 1879 (to include the rest of the monetary contraction in 1878) while the other series end in 1878. Each section contains a historical analysis of the relevant monetary institutions and an economic analysis of the production structure and other pertinent information.
Part 1: The Post-Civil War Boom, 1867–1873Historical AnalysisAfter severe difficulties in financing the war, in late 1861 private banks suspended specie conversion on their notes and deposits as well as the federal government on its Treasury demand notes. Thus, for roughly the next 20 years the United States was off the gold standard. Subsequently, Congress passed several Legal Tender Acts that provided the Treasury with $449 million “greenbacks” for the war effort (Friedman and Schwartz [1963] 1993, p. 24). At the end of the war in 1865 the total supply of greenbacks stood at $400 million (Timberlake, 1993, p. 133), and afterwards Congress contracted them to $356 million by the end of 1867. From 1867–1870 the federal government retired most of the Treasury demand notes that were remnants of the wartime economy (Friedman and Schwartz [1963] 1993, pp. 24, 54).
In addition, in 1863 and 1864 Congress passed the National Currency Acts (later known as the National Banking Acts) which caused a complete overhaul of the previous decentralized banking system by creating a group of so called national banks. For such institutions the legislation stipulated minimum capital requirements, restricted real estate loans, prevented branch banking and created an Office of the Comptroller of the Currency that had the ability to charter new banks and supervise them (White, 1982, p. 34). National banks could only issue notes up to 90 percent of the value of federal government securities they deposited with the Treasury (Klein, 1970, p. 141). This bond backing requirement and the total ceiling limit on national bank note issues (at $300 million) made their issuance very restrictive, and in 1870 Congress increased the maximum number of national bank notes oustanding (to $354 million). These notes soon became the only bank notes available after Congress passed a law in 1865 that stipulated a 10 percent annual tax on all state bank note issues after July 1866 in order to force all state banks to become national banks (Friedman and Schwartz [1963] 1993, pp. 18–21). However, the punitive tax on state bank notes only reduced their note issues and did not force them out of business. The growing use of deposits and the lower regulatory requirements still made state banks a profitable institution, and they became an important factor in much of the credit expansion of this period.
More importantly, the acts created a multi-tiered financial system that allowed banks to pyramid credit on the same set of reserves (Klein, 1970, p. 144).The term “pyramiding of credit” refers to when one bank holds part of their reserves in the form of another bank’s liability, and banks “pyramid” credit off the same base reserves (in this period, lawful money). Before, in the pre-Civil War era system, each bank held its own reserves in terms of its own specie, and excessive credit expansion was prevented by other banks and depositors redeeming their notes and deposits. However, now banks could consider interest paying deposits at other banks as reserves, which weakened this mechanism and led to greater credit creation.
The system worked as follows. The National Banks were divided into three subcategories based on size and location: central reserve city banks, reserve city banks, and country banks. Central reserve city and reserve city banks faced reserve requirements of 25 percent, while country banks had 15 percent. While central reserve city banks had to keep 25 percent of their notes and deposits in “lawful money”, i.e., greenbacks and specie, reserve city banks could split their reserves into a minimum of 50 percent lawful money and up to 50 percent in interest-paying deposits at central reserve city banks. Country banks had a minimum of only 40 percent lawful money reserves and could keep up to 60 percent in interest-paying deposits at either central reserve city or reserve city banks (Friedman and Schwartz [1963] 1993, pp. 56–57; Rothbard [1983] 2005, pp. 136–137). Furthermore, most states allowed state banks to use national bank notes as reserves. State banks held deposits at national banks where they could “buy” notes to redeem deposits, as their own notes were unprofitable to circulate due to the federal tax (Friedman and Schwartz [1963] 1993, p. 21; Rothbard, 2005, p. 144). Thus a multi-layered credit pyramid was formed with state banks pyramiding off any national bank, country banks off central reserve city and reserve city banks, and reserve city banks off central reserve city banks, where lawful money reserves were generally concentrated.
Overall, the National Banking Act encouraged greater credit expansion by thwarting the competitive adverse clearing mechanism that would normally limit excessive deposit and note issuance. Much of the monetary expansion during this period was due to the banks adapting to this new system.
Economic AnalysisThe economic climate in this period can be broken up into two parts: from 1867–1870, when there was mild growth in Ma and Mb, and from 1870–1873, when there was large increase in both. The results, presented in Table 2, show that in the latter period the familiar symptoms of an Austrian style boom appeared, which would make sense given the run-up in credit expansion.
From 1867–1870 both Ma and Mb increased by a relatively small amount. The growth in Ma was due mainly to the increase in both commercial and mutual savings bank deposits as currency during this period actually declined. In the second period, however, monetary conditions were much different. From 1870–1873 both Ma and Mb increased by enormous annual rates compared to the prior period.
While this was partly due to currency increasing, most of the rise came from an increase in mutual savings bank and nonnational bank deposits. The nonnational banks were able to expand credit from both the increase in national bank notes made possible in 1870 and the lawful money reserves that came from the national banking system. As explained earlier, the national banking system allowed banks to hold a large portion of their reserves in interbank deposits, which made it possible for them to decrease their lawful money reserves. As time progressed and the national banking system matured, many of these lawful money reserves found their way into the nonnational banking system (which had lower reserve requirements on average) and caused an increase in credit expansion that impacted both Ma and Mb (Friedman and Schwartz [1963] 1993, pp. 56–57).
It is clear that during both periods there was strong growth. Comparisons of GNP between 1867–1870 and 1870–1873 can only be made with the Davis and the Johnston and Williamson figures as the Balke and Gordon and Romer series start later. One can observe the difference between the Davis and the Johnston and Williamson figures and in the overall bounds to see that there was a marked increase in growth rates.
Crucial to showing an ABC is comparing the production structures in the two periods. As stated above, there was a large increase in credit expansion starting in 1870. Consequently, one would expect the familiar symptoms. Production-wise, when comparing the two periods the higher order industries expanded the most.In this analysis based on the earlier classification of higher and lower orders the Textile group played the role of an outlier as evident in Table 2. However, its unusual growth appears to be the result of its own industry specific fluctuations, as it experienced virtually no growth from 1865–1870, unlike every other group in the Davis series. One could be tempted to include it as a higher order industry, but it is far more conservative for the study to not change its categorization. In particular, Machinery experienced a large jump in growth rates between the periods, which fits neatly with the railroad boom at the time.
However, movements in prices tell a more revealing story. Since the end of the Civil War, massive growth in the money supply subsided and combined with large increases in the output of goods, prices began a long secular downward trend that would last until the late 1890's. As explained earlier, what matters are the relative prices between the higher orders and the lower orders. In the period of low credit expansion, prices in both groups decreased at roughly similar rates. During the second period of high credit expansion, prices in the higher orders relatively rose to the lower orders and in almost all cases rose in even nominal amounts.Though they still rose relative to before, chemicals prices did continue to fall during this period, although they increased absolutely from 1871 onward. By comparing the relative prices, it is clear that the economy was attempting to conform to a longer capital structure. But since the prices in industries closest to consumption were also rising relative to before, the change in the economy was symptom of an ABC. Interest rates also tell a similar story. From 1867–1870 interest rates slightly fell.There was a sharp run up in interest rates in 1869, but this was almost certainly a consequence of the attempted cornering of the gold market by Jay Gould and James Fisk that culminated in “Black Friday” (Morris, 2006b, pp. 69–75). At the beginning of the significant credit expansion from 1870–1871 interest rates continued to fall. However from 1871–1873 interest rates began to rise.Part of the rise in 1873 was due to the Panic of 1873, but what matters is that the trend had begun in 1872. This reflects the increased demand for loans by entrepreneurs in order to bid away factors of production and continue to embark upon their production processes. The changes in the production structure during this time are graphically shown by Figure 3, particularly Phases 1 and 2.
As shown above, credit expansion induced changes in the structure of production cannot last forever, and a correction in prices and production would have to occur in the near future.
Part II: The Panic of 1873 and Bust, 1873–1875Historical AnalysisIn late 1872 and early 1873, financial and economic conditions started to decline, and investors began to pull money out of businesses, particularly railroads. In the first eight months of 1872 bank loans increased slowly, and at the end of August depositors withdrew large amounts of cash from New York banks. The Treasury shored up the situation by purchasing $5 million worth of bonds to increase bank reserves, but by the spring of 1873 another seasonal difficulty developed, and banks struggled to raise cash to meet withdrawals by selling securities due to the weakening bond market (Studenski and Krooss, 1952, p. 181).
Despite avoiding spillover effects from a Vienna stock market crash in May of 1873, Wall Street was hit with a great shock when Jay Cooke and Co. closed its doors on September 18th, full of worthless Northern Pacific railroad securities (Wicker, 2000, p. 20). Stocks plummeted and the New York Stock exchange responded by closing for 10 days on September 20th (Glasner, 1997, p. 133). The concentration of funds in New York’s central reserve city banks lead to a withdrawal by other banks calling in their deposits. With the New York City banks unable to meet all of their demands, the New York Clearing House (NYCH) stepped in and issued clearinghouse loan certificates and pooled reserves. The equalization of reserves allowed seven major New York banks to meet banker demands for withdrawal and pay out cash. Despite the noble efforts, cash payment to depositors was suspended (Wicker, 2000, p. 31). In addition, during the crisis there were a number of bank suspensions, which occur when a bank either temporarily or permanently closes. The number of banks that suspended payment totaled 101, the majority coming from New York and Pennsylvania, which had a combined 59 bank suspensions (Wicker, 2000, p. 19). By the end of October, cash redemption was resumed in most banks except a few in the South (Sprague, 1968, pp. 68–71).
Wicker (2000, p. 33) analyzed the surrounding financial events and concluded that the suspension of cash payments was actually unnecessary, given that the banks were in good shape. Most of the suspensions came from brokerage houses, which were banks with variably priced deposits based on the value of assets (in essence speculative investments and not money) and not commercial banks. Contrary to its purpose, it ended up aggravating hoarding and uncertainty, making it harder for businesses near banks to continue daily operations. The incentive to deposit cash in banks was lowered for many people and some chose to deposit currency in their own safes instead. In fact, the suspension may have even led to panic among reserve city and country banks, contributing to further withdrawals from New York.
Government action during this time period could be considered mildly expansionary. There was a temporary $26 million increase in retired greenbacks from the Treasury following the panic that were legalized (i.e., made permanent) by a bill in 1874, bringing the total up to $382 million (Friedman and Schwartz [1963] 1993, pp. 24, 47). Ultimately the bill was more expansionary through its changes with regards to the national banking system by removing reserve requirements against notes, and its consequences are explained below. However, changing economic realities and government policy starting in 1875 prevented the act from having an expansionary impact for the rest of the decade.
Economic AnalysisThe turbulent crisis years following the Panic of 1873 are compared with the prior boom period of 1870–1873. It is apparent after looking at the figures presented in Table 3 that output growth definitely entered a slowdown and was mainly concentrated in higher order goods that were most affected by credit expansion, which is what one would expect under ABCT.
Overall, the panic did not cause a devastating monetary contraction and in fact both Ma and Mb grew. The rates of increase were definitely smaller compared to the prior period, although they were higher than the amounts from 1867–1870. The increases in Ma predominantly and in Mb entirely came during 1874–1875. The source was mostly due to the recent monetary legislation in 1874 which freed the national banks from the requirement of a reserve against note issue. This in effect released base lawful money into the banking system that could be used for the additional creation of deposits (Friedman and Schwartz [1963] 1993, p. 57; Rothbard [1983] 2005, p. 141). It would have been far better for the economy if the government had not intervened in the monetary affairs by making it easier to increase credit. The government promoted expansion in credit distorts prices and production compared to what they would have been at a time when the market was adjusting them downwards. After rising during the panic, interest rates then sharply fell below their pre-panic level. This was undoubtedly due both to the increase in bank credit as well as a large drop in business demand for loans after businesses realized that many of their projects were unprofitable.
Looking at revised GNP estimates, growth only contracted in the Davis series and slowed down in the others. Despite the sharp downturn in his series, Davis concluded that the depression in fact only lasted from 1873–75 (Davis, 2006, p. 106). In the other series, while severe slowdowns occurred, they were certainly not the massive decline in output one would label as the beginning of a depression.Rockoff and Wicker also have somewhat similar views on the economic effects of the panic, with Rockoff (2000, p. 669) stating that “The crisis did not leave a strong impression on the aggregate economic statistics,” and Wicker (2000, p. 30) commenting that “Contemporary accounts describe the post-panic [1873–1875] years of contraction as years of almost unrelieved gloom. But the evidence for such gloom is certainly not apparent in the Romer-Balke-Gordon estimates of real GNP.” As can be seen in Table 3, the drop in output was not uniform among sectors, and instead was concentrated in the higher order industries that were the most affected by credit expansion (specifically in Machinery and Metals) while the lower orders were much less relatively affected. With regards to prices, the situation was similar, with the higher orders (particularly Metals) taking the brunt of the fall in prices, while lower order goods fell at a much weaker rate.The exception in this period being again Textiles. It is clear that the sectors with the largest contractions in prices and production were the industries that were most affected by the boom. Consequently, they needed their prices and production levels to fall the most in order to allow the economy to properly adjust to the steeper production structure price spread. This paved the way for a subsequent recovery during the latter half of the 1870s. Overall, the movements in prices and production can be shown by Phase 3 of Figure 3.
Part III: The Recovery and Resumption, 1875–1879Historical AnalysisIn January of 1875 Congress passed the Specie Resumption Act, which planned to bring the nation back on the gold standard at the prewar parity by January of 1879. It allowed the Treasury to accumulate a gold reserve using surplus revenue and proceeds from bond sales that would act as a “redemption fund” for specie convertibility. It also allowed for a retirement of greenbacks through an increase in national bank notes, though retirement was suspended in mid-1878, capping the greenbacks at $347 million (Friedman and Schwartz [1963] 1993, pp. 24, 48). Due to the perceived downturn caused by the panic, there was continued agitation for monetary expansion, which partly took the form of the “free silver” movement that advocated the remonetization of silver. Despite the passage of the Bland Allison Act in 1878 that forced the Treasury to purchase $2 to 4 million of silver a month for coinage, the Treasury was able to work towards resumption and from 1877–1879 refunded a large amount of debt to build up a redemption fund (Friedman and Schwartz [1963] 1993, pp. 82–84). In the end, on January 2nd 1879, the U.S successfully resumed specie payments and returned to the gold standard.
Economic AnalysisThe rest of the supposed depression years of the 1870s are compared with the initial crisis years of 1873–1875. Despite a declining money supply, Table 4 shows that in virtually all of the economic indicators there was a visible recovery. In addition, qualitative evidence is presented that suggests the reason that there was perceived to be an enormous depression from 1873–1879 was mainly due to faulty economic statistics and reliance on nominal rather than real values.
Both Ma and Mb in this period declined at significant rates that were only very rarely seen in U.S economic history (Friedman and Schwartz [1963] 1993, pp. 31, 299). Although this was partly due to the government-enforced monetary contraction following the Resumption Act, the decline was mainly due to the contraction of credit following a series of bank runs after 1876. The run on banks was fostered by weakened confidence in the banking system, and led to multiple nonnational bank suspensions; banks responded by building up their reserves (Friedman and Schwartz [1963] 1993, pp. 56–57, 82). As explained earlier, this type of monetary contraction can be part of a healthy process of recovery by speeding up the economy’s return to its sustainable price spread.
It is partly due to this decline in the money supply, alongside the falling price level, that justified the belief that there was a long and protracted depression up until the beginning of 1879. However, it is certainly not apparent from the GNP estimates, as almost all of the series from 1875–1878 show a sharp rebound in growth as compared to 1873–1875. The only one that did not was the Balke and Gordon index, which one could reasonably argue understates growth in the mid to late 1870's because one of the main series they build on was the railroad output-dominated Frickey transportation and communications index (Balke and Gordon, 1989, p. 53). Despite having shown enormous growth during the boom, it is well known to both contemporaries and economic historians that railroads suffered an especially severe decline relative to the rest of the economy during this period (Morris, 2006b, pp. 105–106). From an Austrian perspective, one would certainly expect poor growth after a period of excessive expansion. Thus, basing a GNP series partly on railroads would reasonably underestimate expansion. Production figures show that the sectors with the sharpest recovery were those of the higher orders, particularly in Machinery and Metals. Recovery was also apparent in the price indexes as prices of the higher orders relatively rose compared to the lower orders, which mostly fell relative to before.Textiles again serving as an outlier. Wages were also flexible during this period and fell from 1873–1879. After rising 5.55 percent from 1870–1873, hourly nominal manufacturing wage rates fell 3.27 percent from 1873–1875, and from 1875–1879 fell 13.27 percent. In total, from 1873–1879 they fell 16.11 percent (Margo, 2006, series Ba4290).On the lack of downward nominal wage rigidity in the late 19th century in the 1860s and 1870s, see Hanes and James (2003). Similarly, interest rates throughout this period also fell. The growth for this period was healthy and sustainable, as it signified a lowering of time preferences and was not influenced by an expansion in bank credit. It is graphically portrayed by Figure 2.
So why did contemporary reports describe awful conditions in economic welfare? The main reason is that prices fell all around. If businesses based their outlooks on nominal series, they could be fooled by the appearance of a contracting economy. This belief, however, was purely an illusion, and in fact encouraged capital accumulation and a lowering of time preferences through the reasoning described earlier. Overall, businessmen did not consider the decline in the cost of their inputs, and hence overstated their losses. Wage earners did not realize that consumer prices also dropped, and their real income did not decline as much as they thought (Morris, 2006b, pp. 103–104).Real income for unskilled labor did decline during this period before drastically catching up throughout the 1880s. However, the decline in real income was much less than the decline in nominal income, which undoubtedly exacerbated the perceived effects of income stagnation (Morris, 2006b, p. 103). A similar argument can be found in Davis (2006, p. 115). After he determined new recession-year benchmarks for the 19th century, Davis found that the years with the biggest differences were during recessions with large price and monetary contractions. Davis’ reasoning was similar: that businesses concentrated on nominal series rather than real series. Falling prices, however, do not imply a depression.
Popular news reports also had little way of knowing entire nationwide estimates of economic performance and tended to poorly estimate production. The Commissioner of Labor at the time stated, “There was much apprehension to be added to reality” (Kleppner, 1979, pp. 124–125). Reznack (1950, p. 497), whose classic article famously gave a negative picture of the 1870's, even admitted that “contemporary appraisals of the intensity of depression tended to be the more alarming by their very vagueness and contributed to the prevailing pessimism.”
Americans were also confused by the growing modernization of the country. Large grain farmers began to replace smaller family owned farms, newly emerging department stores and mail order catalogs broke up previous local artisanal monopolies, increasing social and geographic mobility disturbed older traditional family security, and rising inequality from both market and political entrepreneurs bred resentment (Morris, 2006a). Overall, the lack of reliable information and the changing economic environment brought exaggerated conditions with regard to the depth of the depression, especially concerning unemployment.For example, a New York relief agency estimated that during 1873 roughly 25 percent of the city’s working force was unemployed. They arrived at this estimate by counting all of the people whom they helped during the year. Their error came in including nonworking children and housewives, and by simply adding up the sum of the people they helped in each month without realizing they were double counting (Feder, 1936, pp. 39–40). Many other figures, such as those of the Chronicle newspaper, were also erroneous as some of their unemployment reports for certain industries were grossly exaggerated and based on incomplete information (Morris, 2006b, pp. 104–105). Modern estimates of unemployment also tend to be inaccurate in light of more recent economic data. Lebergott (1971, p. 80) provides an estimate of over two million, which would roughly correspond to 13 percent in the depths of the depression. Vernon’s (1994, p. 710) annual unemployment series is more reasonable, but still shows unemployment rising until it peaks at 8.25 percent in 1878, which seems hard to believe given the GNP growth rates.After selecting full employment benchmark years, he derives his estimates by regressing on the Balke and Gordon series and uses Okun’s law to get a figure of deviations from trend of output to produce annual unemployment rates (Vernon, 1994, pp. 702–707). With respect to the period under analysis, there are a number of problems with this approach. Firstly, although growth was undeniably lower in the mid-1870s compared to before 1873, this does not mean that economic stagnation occurred and unemployment rose, especially considering that the boom years were infeasible and not really “trend” growth. While it is reasonable to see unemployment rising during the recession of 1873–1875, after a sufficient fall in costs and reallocation of resources the idle labor would have been reabsorbed into the economy. Under such a dramatic change in production, one would not see growing unemployment throughout the recovery, which is what the series suggests. Secondly, it is important to note that Vernon derives his Okun’s law percentage from the years 1900–1940, a period of greater policy mandated wage rigidity, especially during the Great Depression, and of much greater rigidity than what actually occurred in the 1870s. Thirdly, he uses Balke and Gordon’s annual series, which one can reasonably expect to understate growth.
Overall, both quantitative and qualitative suggest that the contraction in the 1870s was much shorter than previously assumed and there was no prolonged slump during this period.
SECTION V: CONCLUSIONABCT explains the boom and bust that stretched across the time period analyzed. Following a run-up in credit expansion that occurred in the early 1870s, a visible widening in both relative prices and production compared to the late 1860s emerged that fostered multiple malinvestments in the higher orders. The expansion was largely caused by the Civil War monetary legislation that created the National Banking System. Both state and national banks were able to pyramid credit on the same set of lawful money reserves through the use of interest paying interbank deposits. The money supply continued to expand during the bust years, which showed symptoms of an Austrian contraction with the decline in output and prices concentrated in industries that overexpanded during the boom. Largely the result of bank runs, the money supply contracted for the remainder of the supposed depression years. This decline was shown to have actually hastened the recovery and during this period there was a noticeable rebound in growth.
The length of the depression was perceived to be from 1873–1879 when in reality it was closer to 1873–1875 because contemporary accounts relied on nominal series and had poor access to aggregate economic information. And aside from some monetary interventions from 1873–1879, there was no significant fiscal or monetary stimulus—yet the economy recovered. Indeed, the recovery is an example of how an economy can successfully correct itself when the government steps out of the way and allows the market to reallocate resources. It can be concluded that there was no prolonged depression in the 1870's. On this period Rothbard ([1983] 2005, pp. 154–155) appropriately writes, “It should be clear, then, that the ‘great depression’ of the 1870s is merely a myth—a myth brought about by misinterpretation that prices in general fell sharply during the entire period.”
SECTION VI: APPENDIXFor more intricate structure of production diagrams, the following sources can be consulted: for Figure 1, see Hayek ([1931] 2008a, p. 233), Garrison (2001, p. 47), Huerta de Soto (2006, p. 293), Rothbard ([1962] 2009, p. 369) and Skousen (2007, p. 203); Figure 2, see Hayek ([1931] 2008a, p. 239), Garrison (2001, p. 62), Huerta de Soto (2006, p. 334), Rothbard ([1962] 2009, p. 521), and Skousen (2007, p. 235); Figure 3, see Hayek ([1931] 2008a, pp. 242, 244), Garrison (2001, p. 69), Huerta de Soto (2006, pp. 356, 383) and Skousen (2007, pp. 288, 296).
Sources for the components of the Production industries can be found in Davis (2004a, p. 1188). The components are taken from the largest series in the 1880 weights.
All growth rates are compounded annually. For the monetary periods 1873–1875 and 1875–1879, the intervals also include half years, and as such the growth rates are adjusted accordingly.
Figure 1. The Structure of ProductionFigure 2. Time Preference Induced GrowthFigure 3. Credit Expansion Induced GrowthTable 1. Prices and Production SeriesTable 2. U.S Economy, 1867–1873 (per annum growth rates and levels)Table 3. U.S Economy, 1870–1875 (per annum growth rates and levels)Table 4. U.S Economy, 1875–1879 (per annum growth rates and levels)
Pierre Lemieux wrote an indispensible book (Somebody in Charge: A Solution to Recession) for anyone who wishes to understand the before, during, and immediate aftermath of the “Great Recession.”
The book’s importance is greater than just his analysis of the crisis. He thoroughly exposes the underlying weaknesses and fallacies of the whole Keynesian policy-activism agenda driven by the “animal spirits,” the irresistible urge to action of those who wrongly deem themselves in charge.
Lemieux concludes, “[t]he causes and legacy of the economic crisis of 2007–2009 reveal a deeper underlying crisis, which is a crisis of authority” (p. 162). As I concluded in my detailed review essay of Lemieux’s book, “If this book were widely read in and out of classrooms, it might be very useful in awaking more of the public to the fact that we do not need somebody in charge.” A free economy will do just fine if left to its own devices, and if agents are left relatively unhindered by government actions. Such economy-impairing actions include — but are not limited to — Fed and fiscal mis-direction of production, regulatory burdens, and misguided policies that distort incentives.
In the winter 2014–2105 issue of Regulation, Professor Lemieux returns to the same theme but in a slightly different guise, when he asks (and answers) “Why hasn’t regulation crushed the American economy?” His answer: markets are resilient. Regulation is to entrepreneurs as putting barbed wire on a banister is to keeping grandma from sliding down; it slows her down but doesn’t stop her. In the process of answering his question, he also provides an explanation of why the aftermath of the 2007–2009 crisis is often referred to as the Great Stagnation. According to Lemieux (p. 15), “regulation is quite probably the invisible elephant in the room.” I would look broader to Higgs’s regime uncertainty, but that is a small quibble.
David Henderson and Peter Boettke provide the insight into both why markets are resilient and under what circumstances markets most enhance prosperity. Henderson makes his contribution from his Ten Pillars of Economic Wisdom. The one most relevant here and one that should be more broadly understood is “Pillar #10: “competition is a hardy weed, not a delicate flower.” Boettke makes a similar point with two addendums; first, even minimal economic freedom provides people a way to make their lives better under even the most trying of circumstances, and second, markets lead to prosperity when embedded in an appropriate institutional setting. His summary:
Markets are like weeds. They are impossible to stamp out. Markets emerge wherever and whenever there exist opportunities for individuals to gain through exchange. But not all markets are equal. Market exchanges in the absence of property rules take place, but possess characteristics which are not desirable for long-term economic growth.
Markets do not need de jure sanction to exist, but for market activity to serve as the basis of general economic prosperity in a given society, they must exist within a body of law. … The rules of the game are probably the most significant determinant of economic performance. (p. 198)
While regulation has retarded — but not crashed — the economy, just how much damage has regulation perhaps done long term? Relying on a study by John W. Dawson and John J. Seater (“Federal Regulation and Aggregate Economic Growth”), Lemieux answers that, counterfactually, the impact is more significant than one might think:
Dawson and Seater thus claim that if federal regulation had remained at its 1949 level, 2011 U.S. GDP would have been $54 trillion instead of its actual $15 trillion. Seen from another point of view, the average American (man, woman, and child) would now have about $125,000 more per year to spend, which amounts to more than three times GDP per capita. If this is not an economic collapse, what is? Dawson and Seater’s estimates suggest that total factor productivity has been negatively affected by regulation during the whole 57-year period they studied, but with a higher negative effect from the mid-1960s to about 1980, a somewhat less negative effect from then on to the late 1990s, and a large negative effect again in the early 2000s. (p. 15)
Overall, it’s a slow steady decline from potential of just over $2,000 per year, per captia.
Supporting data comes from studies that examine not just the effect of regulation on growth, but the size of government on economic growth. Results from Gwartney, Holcombe, and Lawson ("The Scope of Government and the Wealth of Nations") and Vedder and Gallaway ("Government Size and Economic Growth") imply that the losses from even a small increase in federal government spending are big. Writing in 2009, I estimated that an increase in spending from 20 percent to 22 percent of GDP over a ten year period might reduce real GDP per person by about $4,400 in just the tenth year alone.
Lemieux concludes:
The marginal cost of regulation must rise as its stock increases. Moreover, the market rigidities caused by regulation increase the cost of adapting to the creative destruction brought by technological change. The role of regulation could explain why Europe, where the labor market is more regulated than in America, is stagnating even more.
The resilience of markets, especially in a rich and sometimes still flexible economy like the United States, has dampened the effect of regulation. However, it is reasonable to believe that, over the more than six decades since World War II, regulation has deleted a big chunk of potential prosperity. It has not actually cut into the average standard of living, but this is only a consolation prize, for worse could come if the regulatory bulldozer is not pushed back.
Unless we solve the “crisis of authority,” the current stagnation is likely to continue for the foreseeable future. As I concluded in 2009, while the impact to prosperity and innovation is significant, “the cost in lost freedom may be immeasurable.”
Image source: iStockphoto.
One of the great debates today between left and right is whether government stimulus is worth it. The left says “yes, early and often.” And the right says “only in the right circumstances.” Unsurprisingly, both left and right are completely off — stimulus is the quickest way to impoverish an economy.
To see why, we’ll start with America’s most famous burglar, Richard Nixon.
Nixon is said to have remarked that “We are all Keynesians.” This is probably true; everybody Richard Nixon listened to was “all Keynesians.” And even today nearly every talking head on TV or in major newspapers is “all Keynesians.” Right-wing, left-wing, it’s just a big pile of Keynesians.
This is important when we see “balanced” debates among prestigious economists — “prestige” in mainstream economics is short-hand for “Keynesian.” Future generations may well find this funny, but today this is where we are.
Why does this matter? Because if the Keynesian orthodoxy is ridiculous, say, then all we get is “balanced” flavors of ridiculous.
Why ridiculous? Keynesians’ original sin is that it proposes that spending makes us richer. The other fallacies flow out of that core error. This rich-by-spending doctrine obviously doesn’t work in real life — if you’re poor, the solution is not to borrow money and have a party about it. The solution is to work hard and save up. It’s not rocket science.
Why the appeal? Why are nearly all economists, left and right, Keynesians? The idea that spending makes us richer is a very old one. It’s not original to Keynes, who wasn't much of an economic or original thinker anyway. Keynes was just regurgitating the age-old fallacy known as “underconsumption."
“Underconsumption”Underconsumptionism holds that economies do well when the cash flows. It seems intuitive from the top-down: if people are spending money then times must be good. If they’re not spending money there must be a problem.
Unsurprisingly, this gets it exactly backward. Spending is what happens once you're rich. It doesn’t actually make you rich. So if an economy is doing well then people do indeed buy more swimming pools. But it’s obviously not the swimming pools that made them rich.
So what did make them rich? Investment. More specifically, market-led investment. Why the “market-led” part? Because zany bureaucrats define their bridges to nowhere and squirrel-menstruation research as “investment.”
Now, it’s not that all government spending is useless — they do build gutters and sewage plants, after all. But we’ve really got no way to know whether some bureaucrat’s “investment” is growing the economy. Hence it’s tempting to say “private investment” is all that matters, but I’ll be open-minded and just say “market-led.” Meaning that a government that actually did find out market demand (for a bridge from Manhattan to New Jersey, say) would qualify as “market-led” investment and make us wealthier.
We can see the role of private investment in the classic Robinson Crusoe picture. Poor Robinson wakes up hungry, wet, and cold. It rained all night, and he’s picked up a nasty cough. Robinson looks up at the sky, shaking his fist at the Gods of Poverty.
How does Robinson improve his lot? Why, he invests. He builds fishing hooks, fish-nets, berry-shaking sticks. He collects wood, first to build a shelter then to keep a fire going. Investments all.
And over there, in the corner, you can see the Keynesian tsk-tsking, “Why do all that hard work investing when you can just spend more, Robinson?” Remember, these are “prestigious” economists.
So how does this fatal error translate into policy today? The key thing to remember is that when the government increases “spending” it is simply making pieces of paper — known as “dollars.” Not fish hooks. Not firewood. Bidding tickets is what government makes. Why do they do this? Partly to buy votes, of course: if I could print up dollars, I guarantee I’d have a lot of Facebook friends. And partly to “boost” the economy with all that spending.
Fiat Money ≠ WealthThe problem is, printing tickets isn’t a real resource. You don’t eat paper, as they say. Printing dollars merely bids away resources from other uses.
Let’s say Fed Chair Yellen made an error and printed me up a trillion dollars. Why, I’d use those dollars to buy all — and I do mean all — the beach-front property. I would have the most galactic beach-front party in history. Thing is, Yellen just gave me bidding tickets. She didn't give me the booze, the DJ’s, the concrete, or the wood.
So how do I put this party on? Why, I use Yellen's dollars to bid it all away from you. Yep, you. Building a factory? Too bad: I've outbid you for the concrete. Building a back deck? Too bad: it's my lumber. There’s a party on, didn’t you hear? A Keynesian party.
So is my resource-sucking mega-party making the economy grow? Nope. When it’s all over, when the hangovers along with the ear-ringing subsides are gone, we’ve used real resources. We've got no factories. No decks. We’re all poorer. But the politicians did get re-elected, right?
This, in a nutshell, is Keynesian “stimulus.” Whether it comes from government spending (“fiscal stimulus”) or from Federal Reserve money-printing (monetary stimulus). In either case, real resources were bid away from the rest of us and handed out to others.
Stimulus isn’t some magical leprechaun dropping ice cream and puppies from heaven — it’s merely redistribution of resources. Stimulus is taking from those who have and giving to the government’s pals.
So the question “does stimulus work?” is completely missing the point. Putting aside the injustice of redistributive theft, the productivity question is whether the guys who got the bidding tickets did more market-led investment than the guys whose tickets were devalued.
There is no economic reason to think mere redistribution would make us richer. In fact, there are excellent reasons that show redistribution hurts the economy. “Stimulus” itself is nothing more than widespread impoverishment so a clutch of politicians can buy friends.
Image source: iStockphoto.
In this fascinating interview, Mark Thornton explains how the Austrian business cycle predicted the housing bubble, and how those cashing in on it criticized him until the bubble burst. Dr. Thornton and host Justin Mohr also discuss the US economy and how it isn't recovering, how bubble blowing from the fed might end, and the increasingly popular topic of low oil prices.
Amongst the big winners from the Obama Fed’s Great Monetary Experiment has been the private equity industry. Indeed this went through a near-death experience in the Great Panic (2008) before its savior — Fed quantitative easing — propelled it forward into new riches. There is no surprise therefore that its barons who join the political stage (think of the last Republican presidential candidate) have no interest in monetary reform. And the same attitude is common amongst leading politicians who hope private equity will provide them high-paid jobs when they quit Washington.
The ex-politicians are expected by their new bosses to join the intense lobbying effort aimed at preserving the industry’s unique tax advantages, especially with respect to deductibility of interest and carry income. They are also expected to do this while establishing the links with regulators and governments (state and federal) that help generate business opportunities for the private equity groups themselves. The special ability of these political actors to take advantage of the monetarily induced frenzy in high-yield debt markets — and secure spectacularly cheap funds — means they become leading agents of malinvestment in various key sectors of the economy.
What’s Makes Private Equity Run?Spokespersons for the industry claim that the private equity business is all about spotting opportunities to take over already established businesses, and then using home-grown talent (within the private equity management team) to transform their organization so as to create value for shareholders. And this can all be accomplished, they say, without the burden of frequent reporting requirements as in public equity.
That is all very laudable, but why all the leverage, why all the political connections, and why all the tax advantages? And even before getting to these questions, why should we praise the secrecy? After all, public equity markets are meant to do a good job of incentivizing and disciplining management, especially in this age of shareholder activism. So why is private equity supposedly superior?
Perhaps there are instances where companies which are now in the public equity market cannot economically justify the fixed costs of maintaining their presence there (filing reports, auditing, etc.). In practice, though, this public-to-private conversion function of the private equity industry has been dwindling in overall significance compared to private-to-private acquisitions and new ventures.
Why There’s So Much LeverageBut why should there be so much leverage? Why could their economic functions not be achieved on a purely or largely equity basis?
After all, there are reports of private equity groups turning away would-be new participating partners offering to bring in zillions of new funds to the party. If individual investors in private equity wanted high leverage they could do this on their own account without saddling the particular enterprises with large debts.
The obvious answer to this conundrum is that the private equity groups are in fact risk-arbitragers (and tax arbitragers) between what they view as greatly over-priced high-yield debt markets (sometimes described as junk-debt markets) and less overpriced equity markets.
How Easy Money Enables Private EquityThe Great Monetary Experiment has induced such a plague of market irrationality characterized by desperation for yield that the price of junk has reached the sky. On top of this, the US tax-code incentivizes such arbitrage by allowing full deduction of interest from corporate profit. Why are some affiliates of private equity groups buying the junk? Perhaps that has to do with the benefits to be derived in the event of any particular enterprise owned by the group filing for bankruptcy. The private equity group would be in a better position to negotiate a debt-equity swap if it is on both sides of the deal.
The name of the game is achieving as high a leverage as possible and nothing brings success here like success. Specifically, as private equity investments have produced a series of great returns in recent years — as indeed we should expect from highly leveraged strategies in a powerfully rising equity market — the speculative story that their managers really have talent has attracted more and more believers who are willing to back it with their funds. One aspect of this has been the ability of private equity groups to leverage up their businesses to an extent never previously achieved as the buyers of their junk debt believe that unique talents of the partners and their managers make this acceptable. And the cost of equity to the private equity groups falls as a wider span of potential partners believes in their power of magic.
The Crony Capitalist ConnectionThe new business ventures on which private equity has concentrated in recent years are often in areas where regulatory or political connection is important — whether in finance, real estate, energy extraction, or providing health-care facilities. A private equity group buys the advantages of “connections” (otherwise described as cronyism) for all the small or medium-sized enterprises operating within its fold. If each one were to build up its connections independently that would be much more expensive per unit of enterprise capital.
Hence one essential feature of private equity is the taking advantage of economies of scale in cronyism. And the tax advantages secured by political connections are crucial to the private equity model. The case for a reform of the tax code which would lower the overall rate on corporate profits but end the tax deductibility of interest is strong. But how could this ever make headway against the private equity industry and its deep roots in Washington, DC?
Private Equity, Shale Oil, and Other BubblesIn thinking about the downside of private equity for economic prosperity there is much more to consider than stalemate on tax reform. There is the specter of the infernal combination of monetary disequilibrium and cronyism producing huge malinvestment. That picture is already emerging in the shale oil and gas industries where private equity with its highly leveraged structures has been prominent. Elsewhere, the finance companies spawned by private equity and outside the ever-more regulated traditional bank sector. These have played a lead role in rapid growth of sub-prime auto-loans which have contributed importantly to the boom in vehicle sales. Private equity owned leasing companies have outsmarted their competition to provide enticingly cheap terms to aircraft carriers especially in Asia and helped fuel a tremendous boom in sales by Boeing and Airbus. Private equity participation in investing in apartment blocks has helped fuel the mini-boom in multifamily housing construction.
This is all fine whilst folks are dancing to the music of the Great Monetary Experiment. But what will happen when speculative temperatures fall across a wide range of markets presently infected by asset price inflation? We know much about the disease of asset price inflation from the past 100 years of fiat money under the leadership of the Federal Reserve. Each episode of disease is different but there are common elements. One of these is a deadly end phase featuring plunging speculative temperatures, great recession, and the revelation of huge capital squandered in previous years. The private equity story is new, but there is nothing new under the sun.
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The homeownership rate is now back where it was forty years ago. So what did all that federally-subsidized homebuying over the past decade accomplish? There was a lot of malinvestment, and a lot of politically-favored interest groups that got richer, writes Ryan McMaken.
This audio Mises Daily is narrated by Clay Barnett.
Another year is under way, and we are in the midst of yet another central bank-induced credit bubble. This time, the culprit is shaping up to be the oil and gas industry. Hydraulic fracturing, or “fracking,” has seen a marked rise in usage in the United States over the last six years. It represented a new and innovative way to extract hydrocarbons from rock formations deep underground. Many may be tempted to say that the emergence of fracking, as well as the jobs it has created, is further evidence of the free market at work. However, as David Stockman makes clear in this excellent article, the fracking bubble would never have materialized if not for artificially low interest rates instituted by the Federal Reserve in the advent of the 2007–2009 financial crisis.
Oil and natural gas exploration and extraction via hydraulic fracturing is a highly capital-intensive venture. Given that the shelf life of a typical oil well is only two years, these firms need to establish new ones as maintaining existing wells proves too expensive. If not for the six years of Zero Interest Rate Policy (ZIRP) and several rounds of Quantitative Easing (QE) from the Federal Reserve, many of these upstart wildcatting firms would not be able to sustain the cost of exploration and extraction. Having record low borrowing costs has led to massive increases in production, and an influx of new jobs in the field due to economies of scale. In fact, a large percentage of the job gains we have seen since 2008 have been in the fracking industry.
The situation bears strong similarities to the inflating of the housing bubble from 2002–2007. Overproduction due to expectations of increasing demand because of the false impression of a strong economy, a large spike in job growth in the sector that will surely reverse as the bubble bursts, and companies (oil and gas wildcatters in place of homebuilders) issuing large sums of debt to fund their seemingly profitable ventures. However, just as in the case with the housing bubble, this boom was not induced by market fundamentals and an increased demand to feed this increase in supply. Firms, able to see energy as an indispensable sector just as housing, began directing their resources there and had no reason to believe oil prices would crash (sound familiar?).
Now companies and media outlets are scrambling to discover what the break-even oil prices are, because as the price continues to fall so does the collateral underpinning the large sums of bank debt. It is also worth mentioning that these oil and gas companies comprise approximately 17 percent of the overall high-yield debt market. This is a debt market for businesses with shorter track records of debt service and lower credit ratings, and offers slightly higher interest rates than standard investment-grade corporate bond markets in order to compensate the investor for heightened risk of default. A wave of defaults from these fracking companies would lead to ripples in the overall high-yield debt market, contributing to a market sell-off in the asset class that drives bond prices down sharply and inversely raises borrowing costs for other firms in the junk bond space.
Given the tentative strategy of the Federal Reserve in raising the benchmark interest rate, a sudden and unexpected increase in borrowing costs for businesses in the high-yield debt space is a serious cause for concern. The potential damage could be severe, as many of those bubble-created jobs would be in jeopardy. Whatever the result, the slowly unwinding fracking bubble should serve as a stark reminder about the importance of the Austrian business cycle theory. Years of QE and ZIRP have recreated an asset bubble in our economy with tremendous implications, and as the specific asset class may continue to change the same underlying problem of malinvestment and misallocation of resources will persist if central bankers do not change course.
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Martin Armstrong is one of the most famous economic forecasters alive, but you wouldn’t know it after the whitewashing job he’s suffered at the hands of the federal government and the mainstream financial press. The man who in the 1980s and 90s had central bankers and politicians calling him for advice is now scrubbed from the memory banks of sites like Bloomberg.com.
He’s famous—or infamous—for having predicted the October 1987 Black Monday crash to the very day. He also called the Nikkei stock market collapse in 1989 and the Russian financial collapse in 1998. And he hasn’t lost his touch, outfoxing hedge fund managers by predicting last week’s Swiss National Bank decision to abandon its peg to the euro.
Martin is not an Austrian by any stretch, relying on complex mathematical and historical models rather than economic theory. But he is strongly anti-state, anti-central bank, and quick to criticize Keynesian orthodoxy.
Martin spent more than a decade in a government cage after being prosecuted by the SEC, including seven years for the non-crime of contempt of court. His story—both as a forecaster and a stubborn thorn in the side of federal prosecutors—will be told in an upcoming documentary. It’s a story you won’t want to miss.
Originally, paper money was not regarded as money but merely as a representation of a commodity (namely, gold). Various paper certificates represented claims on gold stored with the banks. Holders of paper certificates could convert them into gold whenever they deemed necessary. Because people found it more convenient to use paper certificates to exchange for goods and services, these certificates came to be regarded as money.
Paper certificates that are accepted as the medium of exchange open the scope for fraudulent practices. Banks could now be tempted to boost their profits by lending certificates that were not covered by gold. In a free-market economy, a bank that overissues paper certificates will quickly find out that the exchange value of its certificates in terms of goods and services will fall. To protect their purchasing power, holders of the overi-ssued certificates naturally attempt to convert them back to gold. If all of them were to demand gold back at the same time, this would bankrupt the bank. In a free market then, the threat of bankruptcy would restrain banks from issuing paper certificates unbacked by gold. Mises wrote on this in Human Action,
People often refer to the dictum of an anonymous American quoted by Tooke: "Free trade in banking is free trade in swindling." However, freedom in the issuance of banknotes would have narrowed down the use of banknotes considerably if it had not entirely suppressed it. It was this idea which Cernuschi advanced in the hearings of the French Banking Inquiry on October 24, 1865: "I believe that what is called freedom of banking would result in a total suppression of banknotes in France. I want to give everybody the right to issue banknotes so that nobody should take any banknotes any longer."
This means that in a free-market economy, paper money cannot assume a "life of its own" and become independent of commodity money.
The government can, however, bypass the free-market discipline. It can issue a decree that makes it legal (or effectively legal) for the over-issued bank not to redeem paper certificates into gold. Once banks are not obliged to redeem paper certificates into gold, opportunities for large profits are created that set incentives to pursue an unrestrained expansion of the supply of paper certificates. The uncurbed expansion of paper certificates raises the likelihood of setting off a galloping rise in the prices of goods and services that can lead to the breakdown of the market economy.
Central Banks Protect Private Banks from the MarketTo prevent such a breakdown, the supply of the paper money must be managed. The main purpose of managing the supply is to prevent various competing banks from overissuing paper certificates and from bankrupting each other. This can be achieved by establishing a monopoly bank, i.e., a central bank-that manages the expansion of paper money.
To assert its authority, the central bank introduces its paper certificates, which replace the certificates of various banks. (The central bank's money purchasing power is established on account of the fact that various paper certificates, which carry purchasing power, are exchanged for the central bank money at a fixed rate. In short, the central bank paper certificates are fully backed by banks’ certificates, which have a historical link to gold.)
The central bank paper money, which is declared as the legal tender, also serves as a reserve asset for banks. This enables the central bank to set a limit on the credit expansion by the banking system. Note that through ongoing monetary management, i.e., monetary pumping, the central bank makes sure that all the banks can engage jointly in the expansion of credit out of “thin air” via the practice of fractional reserve banking. The joint expansion in turn guarantees that checks presented for redemption by banks to each other are netted out, because the redemption of each will cancel the other redemption out. In short, by means of monetary injections, the central bank makes sure that the banking system is "liquid enough" so that banks will not bankrupt each other.
Central Banks Take Over Where Inflationist Private Banks Left OffIt would appear that the central bank can manage and stabilize the monetary system. The truth, however, is the exact opposite. To manage the system, the central bank must constantly create money "out of thin air" to prevent banks from bankrupting each other. This leads to persistent declines in money's purchasing power, which destabilizes the entire monetary system.
Observe that while, in the free market, people will not accept a commodity as money if its purchasing power is subject to a persistent decline. In the present environment, however, central authorities make it impractical to use any currency other than dollars even if suffering from a steady decline in its purchasing power.
In this environment, the central bank can keep the present paper standard going as long as the pool of real wealth is still expanding. Once the pool begins to stagnate — or, worse, shrinks — then no monetary pumping will be able to prevent the plunge of the system. A better solution is of course to have a true free market and allow commodity money to assert its monetary role.
The Boom-Bust ConnectionAs opposed to the present monetary system in the framework of a commodity-money standard, money cannot disappear and set in motion the menace of the boom-bust cycles. In fractional reserve banking, when money is repaid and the bank doesn’t renew the loan, money evaporates (leading to a bust). Because the loan has originated out of nothing, it obviously couldn’t have had an owner. In a free market, in contrast, when true commodity money is repaid, it is passed back to the original lender; the money stock stays intact.
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In 2014, the US homeownership rate fell below 65 percent, which means it’s back to where it was during the 1970s and much of the 1990s. Various federal agencies have long made homeownership a priority, and have introduced a bevy of government and quasi-government programs including the GSEs like Fannie Mae, FHA-insured loans, VA-insured loans, the Bush administration’s “American Dream Downpayment Initiative” and, of course central bank meddling to keep interest rates nice and low for the mortgage markets.
And for all their efforts, all the inflation, and all the taxpayer-funded subsidies poured into bailouts, we have a homeownership rate at where it was forty years ago. During the housing boom, though, homeownership rates climbed to unprecedented levels, cracking 70 percent or more in many parts of the country. When the boom in homeownership came to an end, it was not a painless matter of people selling their homes. It was a very costly readjustment process, and it was something that would have been completely unnecessary and would never have happened to the degree it did without the interference of Congress, the central bank, and the easy-money induced boom they engineered.
The American Dream = HomeownershipHomeownership rates have never been an indicator of economic prosperity. Switzerland, for example, has a homeownership rate half of the US rate. Nevertheless, raising the homeownership rate has long been a pet project of politicians in Washington.
The political obsession with raising homeownership rates dates back to the New Deal when Roosevelt began introducing a variety of homeownership programs designed to drive down the percentage of households that were renting their homes. Based on romantic ideas of frontier homesteading, it was assumed that owning a house was the only truly American way of living. It was during this time that the thirty-year mortgage — an artifact of government intervention — became a fixture of the mortgage landscape. And homeownership rates did indeed increase. And with it, debt loads increased as well.
By the 1990s, central-bank engineered low interest rates propelled mortgage debt loads to awe inspiring new levels, and houses kept getting bigger as families got smaller. Government-sponsored entities like Fannie Mae and Freddie Mac kept the liquidity flowing and home equity lines of credit turned houses into sources of income.
From 2002 to 2007, those of us who worked in or around the mortgage industry were amazed at just how easy it was to get a loan even with a very sketchy credit history and unreliable income. Only token down payments were necessary. Many of these less-than-impressive borrowers bought multiple houses. Behind all of it was the Federal government and the Fed forever repeating the mantra of more homeownership, lower interest rates, more mortgages, and rising home prices. The rising homeownership levels were for the populists. The rising home prices were for the bankers and the existing homeowners.
A Housing-Related Employment BubbleThe housing bubble became the gift that seemingly never stopped giving because with all this home buying came millions of new jobs in real estate, construction, and home mortgages. Seemingly everyone looked to real estate as a source of easy money. The bag boy at your local grocery store was selling condos on the side, and everyone seemed to be selling new home loans. Home builders couldn’t keep up with the orders and contractors had six-week waiting lists.
We know how that all ended. The foreclosure rate doubled from 2002 to 2010. Implied government backing of Fannie Mae and Freddie Mac became explicit government backing, and numerous too-big-to-fail banks which had invested in home mortgages were bailed out to the tune of hundreds of billions of taxpayer dollars. Some lenders like Countrywide and Indymac essentially went out of business, and all lenders (including many who were not bailed out) faced costs ranging from 20,000 to 40,000 per foreclosure in lost revenue, legal fees, and other costs. Foreclosures begat foreclosures as foreclosure-dense neighborhoods were most prone to price drops, leading to negative equity, which in turn led to even more foreclosures. Ironically, the most responsible borrowers — the ones who made sizable down payments and reliably made payments, and thus had more skin in the game — were the ones who suffered the most and who had the most to lose by simply walking away from their homes.
Real estate agents, loan industry professionals, construction workers, and others who relied on the home purchase industry lost their jobs and had to spend time and money on retraining in completely new industries. Or they were simply among the millions who collected unemployment checks and food stamps supplied by those who still had jobs.
Was the Bubble Worth It?And for what? The opportunity cost of it all was immense and during the bubble years, total workers in housing-related employment ballooned to 7.4 million, many of whom were fooled by the bubble into thinking the home-sales industry was a good long-term career. To get these jobs they spent many hours and thousands of dollars on certification, training, and job experience. After the bubble popped, three million of those jobs disappeared. From 2001 to 2006, employment in the mortgage industry increased by 119 percent, only to have most of those jobs disappear from 2006 to 2009.
Now, there will always be people who make bad career decisions, and there will always be frictional unemployment, but without the housing bubble and the myriad of federal programs and central bank pumping behind it, would millions of workers have flooded into these industries knowing that most of them would be unemployable in that same industry only a few years later? That seems unlikely.
Moreover, might we be better off today if those same people, many of whom were very talented, had invested their time and money into other fields and other endeavors? What businesses were never opened and what products were never made because so many flocked to the housing sector? We’ll never know.
Thanks to the government’s relentless drive for more homeownership and ever-increasing home prices, millions of workers concluded that real-estate jobs were the best bet in the modern economy. They thought this because investors chasing yield in a low-interest-rate environment were pouring their money into owner-occupant housing in response to government guarantees on single-family loans and easy money for mortgage lending.
The people were promised more homeownership, but after just a few years, it has become clear they didn’t get it. At the same time, Wall Street was promised high home prices, and when the prices faltered, it was offered bailouts instead. Wall Street got its bailouts.
The cost of the housing bubble is often calculated in dollar amounts that can easily be counted on Wall Street, but for those who aren’t politically well-connected — for ordinary workers, homeowners, construction firms, and many others — the cost in time and lost opportunities will forever remain among the many unseen costs of government intervention.
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Interviewed by Albert Lu, host of the Power & Market Report, Mark Thornton talks about the collapse in oil prices.
Looking back on our first year of Mises Weekends, we decided to check the numbers and run the program with the highest ratings as we close out 2014. So based on analytics from YouTube, iTunesU, and Stitcher, the #1 show of the year is none other than Patrick Barron in a two-part interview on the end of US dollar supremacy.
Recorded in October, Patrick and Jeff discuss how the dollar became the world’s reserve currency after Bretton Woods, the dollar’s evolution as a weapon of mass US imperialism, and how its inevitable decline will have horrific consequences for those nations—and individuals—not prepared for it.
We’d love to know what guests you’d like to hear—and what questions you’d like asked—on Mises Weekends in 2015. Let us know via twitter @mises_media, or by emailing weekends@mises.org.
Booms and busts are not endemic to the free market, argues the Austrian theory of the business cycle, but come about through manipulation of money and credit by central banks. In this monograph, Austrian giants explain and defend the theory against alternatives. Includes essays by Mises, Rothbard, Haberler, and Hayek. In his later years, Professor Haberler distributed many of these monographs to friends and associates.
Narrated by Gennady Stolyarov II. The complete audio book (6 MP3 audio files) in a single zip file.
Download the complete audiobook (six MP3 files) here. This audiobook is also available on Apple Podcasts, Google Podcasts, and via RSS.
Earlier this month, the IMF released a new report noting that via Purchasing Power Parity (PPP) calculations, China’s GDP in 2014 is estimated at $17.6 trillion (all dollars in this article are US dollars), surpassing the US’s $17.4 trillion to become the world’s largest economy. MarketWatch subsequently published a recent article titled “It’s Official: America is now No. 2.” The article points out that since Ulysses S. Grant took office as president in 1869, the United States for the first time fell from its leading position in the global economy, to second place. And although long aware of China’s rise, those who have prided themselves on the US’s economic domination are facing an uneasy reality.
Measuring GDP and MoreOf course, in many aspects — and at least under nominal GDP in which exchange rates are taken into account — American output is still 70 percent higher than that of China’s. America’s per capita GDP has significantly outperformed China in this respect. But at the rate of China’s present economic growth, a gap of 70 percent can be easily closed within a decade. In the year 2000, I remember searching the CIA website for economic data per country where China’s GDP, in PPP terms, had already surpassed Japan’s. Finally in 2010, the nominal GDP had officially surpassed that of the Japanese, and the lead by China has been widening ever since. With regards to per capita GDP, China will not outperform the United States in the foreseeable future; however, it is important to understand that the competition for global leadership is actually determined by the country’s overall economic strength. While many European countries (e.g., Switzerland, Norway, and Liechtenstein) have a higher production per capita than America, their small populations and scale allow very limited influence in the global arena. It is no wonder MarketWatch refers to China’s rise as a historical moment, describing a “geopolitical earthquake with a high reading on the Richter Scale.” Marketwatch then describes the declines of the British, French, and Spanish empires as caused by their respective economies, implying that the United States has embarked on the same path as the old empires.
Although Chinese, I am hesitant to be too enthusiastic soley about the rise of China’s economy and new-found international status. US-Chinese dynamics have made me reflect on the United States post-World War II, where the US attracted internationally acclaimed talent across various sectors from around the world. The United States still holds absolute advantage in this area, and holds the highest number of Nobel Laureate recipients for innovation and technology annually. Chinese closed-door plagiarism can only come so close. So how can the Chinese, still relying heavily on labor-intensive, low-technology manufacturing exports, catch up to America?
The Benefits of SavingsWith respect to the quality of the most productive echelon of society within a nation, I believe the United States still holds a leading position by far. The problem for the US, however, is the majority population that contributes little to the economy in terms of savings and investment in comparison to their overseas counterparts. In China, the advantage lies in the mainstream — from low income groups to the middle class — which boast of savings habits more conducive toward economic diligence and resilience in general. This provides a sound platform for China’s rapid rise.
Furthermore, America’s mainstream financial media often stresses the importance of consumption for economic growth. The belief that if citizens refuse to spend (the media often takes Japan as an example), the government will need to spend on people’s behalf to encourage economic circulation. This flimsy theory goes further and claims that if growth is far from the target rate, the central bank will have to intervene, printing money to stimulate consumption or use negative interest rates to punish savers, forcing them to spend. For decades after World War II, only the top 10 percent who really understood the rules of the game invested their savings in multinational stocks, real estate, jewelry, antiques, and artwork. Apart from this group of asset holders, who are difficult to punish through induced inflation, the majority of people avoid government penalties through consumption and low savings rates. The problems begin when consumption becomes a habit, most people lose the ability to save, and the government is forcing itself to bear future responsibilities of these short-term thinking and welfare-reliant individuals.
According to 2011 data, 108 million low-income Americans receive welfare, exceeding the 110 million full-time employed individuals in the country. Together with non-means-tested welfare programs, including social security and veteran living expenses, the total number of people receiving benefits amounts to 150 million, which is nearly half of the US population. The question must then be asked: despite boasting top innovators that contribute strongly to society, due to America’s large scale of non-saving and highly non-productive citizens who are a huge burden on the state, how can such a nation not fall behind eventually?
Chinese Savings Help Fix Economic FlawsObserving China, we can easily criticize the authoritarian ruling party, but there is one thing the Communist Party is yet to change successfully, and that is the industrious temperament and high savings habits among the Chinese, particularly in the older generation. At present, when the younger generation might be praised for saving 20 to 30 percent of their income, many Chinese still choose to only spend 30 percent of their income, and pile the remaining 70 percent up into savings and investments. Because of high accumulations of wealth, the Chinese will be able to continue construction and exports, and earn foreign exchange to patch up for mistakes in government policies. Recent heavy speculation of Shanghai stocks were possible thanks to retail investors’ fat savings. Irrespective of the final speculative success of these individual investors, it is evident that private capital is abundant.
If the bad debt-ridden state-owned banks can still raise funds from the savings of millions of Chinese (through high placements), it is still possible to address the side effects of the 2008–2009 stimulus programs, which created production overcapacity (i.e., malinvestments) in many industries. If a bull market were to occur in China, high placement, which was the Communist Party’s sophisticated plan to use people’s savings to repair the balance sheets of many state owned enterprises (SOE’s) — not necessarily what I consider the best policy — unfortunately remains a rational reaction for the Communists in China to utilize this method to resolve its debt-ridden banking sector.
Looking at the ups and downs of the Chinese and US economies once again proves the validity of the Austrian business cycle theory’s key insights, that savings are necessary in laying the foundation for economic growth, and that Keynesian stimulus spending only worsens recessions. Whether the Chinese economy can truly surpass that of the US will depend on the Chinese people's ability to value their virtue of saving and counter the “spend your way to prosperity” propaganda.
Image Source: iStockphoto.
The Forgotten Depression: 1921 — The Crash That Cured Itself, by James Grant, Simon & Schuster, 2014.
To better understand the current economic environment, financial analyst, historian, journalist, and value investor James Grant, who is informed by both Austrian economics and the value investing theory of the late Benjamin Graham, analyzes the Depression of 1920–1921 in his latest work, The Forgotten Depression: 1921 — The Crash That Cured Itself.
Grant understands that despite the pseudo-natural science veneer of mainstream economics the fact remains that economic value is inherently subjective and thus economic measurement is also subjective. Mr. Grant confronts the subjectivity of economic measurement head-on in his book in an enlightening discussion of whether the 1921 depression was, in fact, a depression at all.
Was It a Depression?Grant concludes it was a depression, but mainstream economist Christine Romer, for example, concludes it was not a depression. As Grant observes, Ms. “Romer, a former chairman of the Council of Economic Advisors, presented her research, titled ‘World War I and the Postwar Depression,’ in a 1988 essay in the Journal of Monetary Economics. The case she made for discarding one set of GNP estimates for another is highly technical. But the lay reader may be struck by the fact that neither the GNP data she rejected, nor the ones she preferred, were compiled in the moment. Rather, each set was constructed some 30 to 40 years after the events it was intended to document” (p. 68).
In contrast, Mr. Grant surveys economic activity as it existed prior to and during 1920–21 and as it was evaluated during those times. Therefore, five pages into chapter 5 of his book, which is titled “A Depression in Fact,” we read that:
A 1920 recession turned into a 1921 depression, according to [Wesley Clair] Mitchell, whose judgment, as a historian, business-cycle theorist and contemporary observer, is probably as reliable as anyone’s. This was no mere American dislocation but a global depression ensnaring nearly all the former Allied Powers (the defeated Central Powers suffered a slump of their own in 1919). “Though the boom of 1919, the crisis of 1920 and the depression of 1921 followed the patterns of earlier cycles,” wrote Mitchell, “we have seen how much this cycle was influenced by economic conditions resulting from the war and its sudden ending. ... If American business men were betrayed by postwar demands into unwise courses, so were all business men in all countries similarly situated.”
So depression it was … (p. 71)
Interestingly, there are a variety of similarities between “The Forgotten Depression” of 1921 and “The Great Recession” of 2007–2008. For example:
War finance (the currency debasement and credit expansion associated with funding war) has long been associated with economic distortion including World War I, which preceded “The Forgotten Depression.” Such distortions unfortunately continue to the present day.Scandal is also associated with booms and busts; for example, the boom preceding “The Forgotten Depression” had Charles Ponzi while the boom preceding “The Great Recession” had Bernie Madoff.The booms preceding both financial disruptions also saw governmental banking regulators not doing a very good job of regulating the banks under their supervision.Citibank famously fell under significant distress in both events.Both eras had former professors of Princeton University in high-ranking governmental positions: Woodrow Wilson was president of the United States at the beginning of “The Forgotten Depression” while Ben Bernanke was chairman of the Fed during “The Great Recession.” On the practitioner-side, value investor Benjamin Graham profited handsomely from the distressed investments that he made during “The Forgotten Depression” while his best known student, Warren Buffett, profited from the distressed investments that he made during “The Great Recession.”The Crash That Cured ItselfDespite similarities, there are noteworthy differences between these two financial events. Foremost among the differences is the reason why “The Forgotten Depression” has, in fact, been forgotten: the government did nothing to stop it. Not only were interest rates not lowered and public money not spent, but interest rates were actually raised and debt paid down. The context behind these actions is fascinating and superbly told and analyzed by Mr. Grant.
For example, the Fed at the time “shared a generally laissez-faire approach to economic and monetary policy. None expressed a doubt about a dollar defined as a weight of gold. None, with the exception of [John Skelton] Williams, so much as intimated that the Federal Reserve had any business trying to override the structure of the market-determined prices. Inflation had distorted those prices. Now deflation must set them right” (p. 94).
But if government did not drive the economic recovery, how did the economy recover?
In answering this question, Mr. Grant draws on his experience as a financial analyst and value investor to evaluate asset prices during this period of time. His discussion sheds considerable light on the power of the price mechanism to inspire action — interest rates, of course, being a price — even during (especially during!) periods of economic distress, as this quote clearly illustrates:
Stocks were commandingly cheap, the Journal’s capitalist source concluded. “Scores” of companies were valued in the market at less than their working capital — as if the business itself, apart from the net cash, was worthless. The shares of “large numbers” of industrial companies were selling at “one-third of their respective intrinsic values.” (p. 194)
Free the Prices!The year 1920 was economically seminal for a variety of reasons. In addition to “The Forgotten Depression,” Ludwig von Mises published Economic Calculation in the Socialist Commonwealth in 1920. In this paper, perhaps the most important economics paper of the twentieth century, Mises explained that:
Monetary calculation only has meaning within the sphere of economic organization. It is a system whereby the rules of economics may be applied to the disposition of economic goods. Economic goods only have part in this system in proportion to the extent to which they may be exchanged for money.
On the final page of his book, Mr. Grant observed that “the price mechanism worked more freely in 1920–21 than it was allowed to do in 1929–33” (p. 218). As a result, the former depression has largely been “forgotten” while the later one is remembered as “The Great Depression.” This is not to downplay the severity of the 1920–21 depression. Indeed, as Grant himself observes: “The depression of 1920–21 was terrible in its own way. In comparison to what was to follow [e.g., “The Great Depression” and “Great Recession”], it was also, in its own way, a triumph” (p. 218).
Interviewed by Mo Dawoud of the Wall St for Main St podcast, Mark Thornton explains his prediction of the housing bubble in 2004. They also discuss the 'Skyscraper Curse'.
The flowering of the tiny house movement is due in large part to the most recent boom-bust cycle, which left many homeowners wondering if mountain-sized homes are worth equally sized debt or a risky gamble on future housing prices. For some, this meant moving into a house that could be smaller than their previous house’s bathroom.
Although definitions vary for what “tiny” means — from the hardcore enthusiasts to the more inclusive tiny-housers — most agree that any residence smaller than 1,000 square feet fits the bill (but most are less than 500 square feet). And speaking of the bill, such dwellings can range anywhere from $10k to $50k, depending on the size and amenities, and they can enjoy total monthly utilities in the double digits.
Thoreau would be proud, too, as many of the tiny-housers build on their own and/or go “off the grid” (the r/homestead and r/tinyhouses subreddits have notable membership overlap, for example). They eschew public provision of various utilities by collecting rainwater, using solar panels, and installing composting toilets. Another way the tiny-housers thumb their nose at the government is by building on trailers to skirt building codes that dictate minimum square footage or other regulations. Randy England, in an August 2014 Mises Daily article, noted how such laws hurt the poor, who would benefit greatly by accessible cheap housing.
Debt Looking Less AttractiveThe tiny house movement is a natural consequence of the most recent macroeconomic swing. After a boom-bust cycle, capitalist-entrepreneurs attempt to reallocate capital into profitable lines of production. This can be a painful process for many, as workers get laid off and prices adjust. Decision-making is difficult when vital information like interest rates and other prices haven’t accurately reflected consumer demands or time preferences in the past. These necessary market corrections are made even more difficult when central banks and governments get in the way, either by revving another cycle or disrupting prices and market processes even further. In spite of the gargantuan and manifold stimulus programs and expansionary monetary policy since 2008, firms like Tumbleweed Tiny Houses and SmallWorks have grown and thrived, attracting workers, capital, and customers when the powers that be would have them fueling and refueling bubbles.
The average house size has climbed steadily over the past few decades, even though the average number of people per household has fallen over the same time period — an unorthodox sign of a growing housing bubble, albeit in hindsight. At the peak of the crisis in 2007–2008, the average household member had about 985 square feet to himself. The members of the tiny house movement suggest that much space is more than enough for an entire household of 2, 3, or even 4 people.
Volatile home prices, increased underemployment and unemployment, and a growing fear of debt seem like the perfect mix for a popular tiny house movement.
I asked a few tiny house owners about their experience and motivation, and found that avoiding debt was a major factor in their decision to go small. “I could afford this house without a mortgage” one owner observed, while another remarked “We are debt-free, and we didn't want a huge mortgage. Seeing the housing bubble definitely reinforced that view (we are now 29, and it was kind of happening when we were getting married and deciding how our lifestyle should be).”
When asked about the future of the tiny house movement, owners replied with several economic reasons for why they believe there will continue to be a demand.
“Pragmatism will be a driving force. Primarily due to financial constraints,” an owner replied. “These constraints could be external (people can't get a job that pays enough to afford ‘the American dream’) or internal (people choose this option to avoid the economic hardships imposed by buying a McMansion.)”
“I believe [there will continue to be a demand], yes,” another owner said. “Not only has the housing bubble added to the tiny house movement, I think millennials and other young folks who will have crushing student loan debt will find [traditional] home ownership to often be an unattainable dream ...”
Perhaps we can chalk up the tiny house movement as another unintended consequence of the Federal Reserve’s low interest rate setting starting around 2002, and the federal government’s similarly timed initiatives to increase homeownership. Or maybe we are witnessing the start of a major cultural change, and our conceptions of the typical family or community are readjusting in the wake of macroeconomic upheaval. Either way, the movement has urged me to reconsider installing that second bowling alley next to my two-million volume library. Rothbard was very prolific.
Efficient banks have many options for lenders and credit when banking crises hit. It's the inefficient and insolvent banks that must turn to a central bank, writes Nicolás Cachanosky. But do we really want central banks that reward insolvency and encourage inefficiency? This audio Mises Daily is narrated by Keith Hocker.
This lecture by Bob Murphy was presented at the 2012 Mises University in Auburn, Alabama.
Full title: "The Global Curse of the Federal Reserve: How Its Monetary Virus Stimulates Destructive Waves of Irrational Exuberance and Depression" The Murray N. Rothbard Memorial Lecture sponsored by Helio Beltrão, presented at the Austrian Economics Research Conference. Recorded 21 March 2013 at the Ludwig von Mises Institute. Includes an introduction by Joseph T. Salerno. Music by Kevin MacLeod.
The slide of the yen since late summer has brought it to a level some 40 percent lower against the euro and US dollar than just two years go. Yet still Japan’s Prime Minister Shinzo Abe and his central bank chief Haruhiko Kuroda warn that they have not won the battle against deflation. That caution is absurd — all the more so in view of the fact that there was no deflation in the first place.
Some cynics suggest that Abe’s and Haruhiko’s battle cry against this phoney phantom is simply a ruse to gain Washington’s acquiescence in a big devaluation. But whatever the truth about their real intent, Japan’s monetary chaos is deepening.
Japanese Prices Have Been Stable
The CPI in Japan at the peak of the last cycle in 2007 was virtually at the same level as at the trough of the post-bubble recession in 1992, and up a few percentage points from the 1989 cycle peak. Hence, Japan alone has enjoyed the sort of price stability as might be enjoyed in a gold-standard world. Prices have fallen during recessions or during periods of especially-rapid terms-of-trade improvement or productivity growth. They have risen during cyclical booms or at times of big increases in the price of oil.
If price-indices in Japan were adjusted fully to take account of quality improvements they would have been falling slightly throughout, but that would also have been the case under the gold standard and was fully consistent with economic prosperity.Such swings in prices are wholly benign. For example, lower prices during recession coupled with expectation of higher prices in expansion induce businesses and households to spend more. A valid criticism of the Japanese price experience of the past two decades has been that these swings have lacked vigour due to various rigidities. Particularly valid is the claim that price falls should have been larger during the post-bubble recession of 1990-93 and subsequent potential for recovery would have been correspondingly larger.
Prices in Japan did fall steeply during the Great Recession (2008-10) but the perceived potential for recovery was squeezed by the Obama Monetary Experiment (the Fed’s QE) which meant an immediate slide of the US dollar. It was in response to the related spike of the yen that Prime Minister Abe prepared his counter-stroke. This involved importing the same deflation-phobic inflation-targeting policies that the Obama Federal Reserve was pursuing. Washington could hardly criticize Tokyo for imitating its own monetary experiment.
Deflation and “The Lost Decade”
The architects of the Obama Monetary Experiment have cited as justification Japan’s “lost decade” and the supposed source in deflation. In fact, though, the only period during which the Japanese economy underperformed other advanced economies (as measured by the growth of GDP per capita) was from 1992-97. The underperformance of that period had everything to do with insufficient price and wage flexibility downward, the Clinton currency war, and the vast malinvestment wrought by the prior asset price inflation, coupled with a risk-appetite in Japan shrunken by the recent experience of bust.
Moreover, as time went on, from the early 1990s, huge investment into the Tokyo equity market from abroad compensated for ailing domestic risk appetites. Yes, Japan’s economy could have performed better than the average of its OECD peers if progress had been made in de-regulation, and if Japan had had a better-designed framework of monetary stability to insulate itself from the Greenspan-Bernanke asset price inflation virus of the years 2002-07. (The Greenspan-Bernanke inflation caused speculative temperatures in the yen carry trade to reach crazy heights.) But deflation was never an actual or potential restraint on Japanese prosperity during those years.
True, there was a monetary malaise. Japan’s price stability was based on chance, habit, and economic sclerosis rather than the wisdom of its monetary policy. It had been the huge appreciation of the yen during the Clinton currency war that had snuffed out inflation. Then the surge of cheap imports from China had worked to convince the Japanese public that inflation had indeed come to an end. Lack of economic reform meant that the neutral rates of interest remained at a very low level and so the Bank of Japan’s intermittent zero rate policies did not stimulate monetary growth.
The monetary system in Japan had no secure pivot in the form of high and stable demand for non-interest bearing high-powered money. In Japan the reserve component of the monetary base is virtually indistinguishable from a whole range of close substitutes and banks had no reason to hold large amounts of this (given deposit insurance and the virtual assurance of too-big-to-fail help in need). Monetary policy-making in Japan meant highly discretionary manipulation of short-term interest rates in the pursuance of fine-tuning the business cycle rather than following a set of rules for monetary base expansion.
The Yen After Abenomics
When Prime Minister Abe effected his coup against the old guard at the Bank of Japan there was no monetary constitution to flout. Massive purchases of long-dated Japanese government bonds by the Bank of Japan are lowering the proportion of outstanding government debt held by the public in fixed-rate form. But this is all a slow-developing threat given a gross government debt to GDP ratio of around 230 percent and a current fiscal deficit of 6 percent of GDP. Bank of Japan bond-buying has strengthened irrational forces driving 10-year yields down to almost 0.5 percent despite underlying inflation having risen to 1 percent per annum.
It is doubtless the possibility of an eventual monetization of government debt has been one factor in the slump of the yen. More generally, as the neutral level of interest rates in Japan rises in line with demographic pressures (lower private savings, increased social expenditure) one might fear that BoJ manipulation of rates will eventually set off inflation. Part of the yen’s slump, though, is due to a tendency for that currency to fall when asset price inflation is virulent in the global economy. This stems from the huge carry trade in the yen.
The yen could indeed leap when the global asset price-inflation disease — with its origins in Fed QE — moves to its next phase of steep speculative temperature fall. The yen is now in real effective exchange rate terms at the record low point of the Japan banking crisis in 1997 or the global asset inflation peak of 2007. So, the challenge for investors is to decide when the Abe yen has become so cheap in real terms that its hedge properties make it a worthwhile portfolio component.
Image source: iStockphoto
Since the economic crisis of 2008-2009, the Federal Reserve — America’s central bank — has expanded the money supply in the banking system by over $4 trillion, and has manipulated key interest rates to keep them so artificially low that when adjusted for price inflation, several of them have been actually negative. We should not be surprised if this is setting the stage for another serious economic crisis down the road.
Back on December 16, 2009, the Federal Reserve Open Market Committee announced that it was planning to maintain the Federal Funds rate — the rate of interest at which banks lend to each other for short periods of time — between zero and a quarter of a percentage point. The Committee said that it would keep interest rates “exceptionally low” for an “extended period of time,” which has continued up to the present.
Federal Reserve Policy and Monetary ExpansionBeginning in late 2012, the then-Fed Chairman, Ben Bernanke, announced that the Federal Reserve would continue buying US government securities and mortgage-backed securities, but at the rate of an enlarged $85 billion per month, a policy that continued until early 2014. Since then, under the new Federal Reserve chair, Janet Yellen, the Federal Reserve has been “tapering” off its securities purchases until in July of 2014, it was reduced to a “mere” $35 billion a month.
In her recent statements, Yellen has insisted that she and the other members of the Federal Reserve Board of Governors, who serve as America’s monetary central planners, are watching carefully macro-economic indicators to know how to manage the money supply and interest rates to keep the slowing general economic recovery continuing without fear of price inflation.
Some of the significant economic gyrations on the stock markets over the past couple of months have reflected concerns and uncertainties about whether the Fed’s flood of paper money and near zero or negative real interest rates might be coming to an end. In other words, borrowing money to undertake investment projects or to fund stock purchases might actually cost something, rather than seeming to be free.
When the media has not been distracted with the barrage of overseas crises, all of which seem to presume the need for America to play global policeman and financial paymaster to the world at US taxpayers’ expense, the presumption by news pundits and too many economic policy analysts is that the Federal Reserve’s manipulation of interest rates is a good, desirable and necessary responsibility of the central bank.
As a result, virtually all commentaries about the Fed’s announced policies focus on whether it is too soon for the Federal Reserve to raise interest rates given the state of the economy, or whether the Fed should already be raising interest rates to prevent future price inflation.
What is being ignored is the more fundamental question of whether the Fed should be attempting to set or influence interest rates in the market. The presumption is that it is both legitimate and desirable for central banks to manipulate a market price, in this case the price of borrowing and lending. The only disagreements among the analysts and commentators are over whether the central banks should keep interest rates low or nudge them up and if so by how much.
Market-Based Interest Rates Have Work to DoIn the free market, interest rates perform the same functions as all other prices: to provide information to market participants; to serve as an incentive mechanism for buyers and sellers; and to bring market supply and demand into balance. Market prices convey information about what goods consumers want and what it would cost for producers to bring those goods to the market. Market prices serve as an incentive for producers to supply more of a good when the price goes up and to supply less when the price goes down; similarly, a lower or higher price influences consumers to buy more or less of a good. And, finally, the movement of a market price, by stimulating more or less demand and supply, tends to bring the two sides of the market into balance.
Market rates of interest balance the actions and decisions of borrowers (investors) and lenders (savers) just as the prices of shoes, hats, or bananas balance the activities of the suppliers and demanders of those goods. This assures, on the one hand, that resources that are not being used to produce consumer goods are available for future-oriented investment, and, on the other, that investment doesn’t outrun the saved resources available to support it.
Interest rates higher than those that would balance saving with investment stimulate more saving than investors are willing to borrow, and interest rates below that balancing point stimulate more borrowing than savers are willing to supply.
There is one crucial difference, however, between the price of any other good that is pushed below that balancing point and interest rates being set below that point. If the price of hats, for example, is below the balancing point, the result is a shortage; that is, suppliers offer fewer hats than the number consumers are willing to buy at that price. Some consumers, therefore, will have to leave the market disappointed, without a hat in hand.
Central Bank-Caused Imbalances and DistortionsIn contrast, in the market for borrowing and lending the Federal Reserve pushes interest rates below the point at which the market would have set them by increasing the supply of money on the loan market. Even though savers are not willing to supply more of their income for investors to borrow, the central bank provides the required funds by creating them out of thin air and making them available to banks for loans to investors. Investment spending now exceeds the amount of savings available to support the projects undertaken.
Investors who borrow the newly created money spend it to hire or purchase more resources, and their extra spending eventually starts putting upward pressure on prices. At the same time, more resources and workers are attracted to these new investment projects and away from other market activities.
The twin result of the Federal Reserve’s increase in the money supply, which pushes interest rates below that market-balancing point, is an emerging price inflation and an initial investment boom, both of which are unsustainable in the long run. Price inflation is unsustainable because it inescapably reduces the value of the money in everyone’s pockets, and threatens over time to undermine trust in the monetary system.
The boom is unsustainable because the imbalance between savings and investment will eventually necessitate a market correction when it is discovered that the resources available are not enough to produce all the consumer goods people want to buy, as well as all the investment projects borrowers have begun.
The Central Bank Produces Booms and BustsThe unsustainability of such a monetary-induced investment boom was shown, once again, to be true in the latest business cycle. Between 2003 and 2008, the Federal Reserve increased the money supply by at least 50 percent. Key interest rates, including the Federal Funds rate, and the one-year Treasury yield, were either zero or negative for much of this time when adjusted for inflation. The rate on conventional mortgages, when inflation adjusted, was between two and four percent during this same period.
It is no wonder that there emerged the now infamous housing, investment, and consumer credit bubbles that burst in 2008-2009. None of these would have been possible and sustainable for so long as they were if not for the Fed’s flood of money creation and the resulting zero or negative lending rates when adjusted for inflation.
The monetary expansion and the artificially low interest rates generated wide imbalances between investment and housing borrowing on the one hand and low levels of real savings in the economy on the other. It was inevitable that the reality of scarcity would finally catch up with all these mismatches between market supplies and demands.
This was, of course, exacerbated by the Federal government’s housing market creations, Fannie Mae and Freddie Mac. They opened their financial spigots through buying up or guaranteeing ever more home mortgages that were issued to a growing number of high-risk borrowers. But the financial institutions that issued and then marketed those dubious mortgages were, themselves, only responding to the perverse incentives that had been created by the Federal Reserve and by Fannie Mae and Freddie Mac.
Why not extend more and more loans to questionable homebuyers when the money to fund them was virtually interest-free thanks to the Federal Reserve? And why not package them together and pass them on to others, when Fannie Mae and Freddie Mac were subsidizing the risk on the basis of the “full faith and credit” of the United State government?
More Monetary Mischief in the Post-Bubble EraWhat was the Federal Reserve’s response in the face of the busted bubbles its own policies helped to create? Between September 2008 and June 2014, the monetary base (currency in circulation and reserves in the banking system) has been increased by over 440 percent, from $905 billion to more than $4 trillion. At the same time, M-2 (currency in circulation plus demand and a variety of savings and time deposits) grew by 35 percent during this time period.
Why haven’t banks lent out more of this huge amount of newly created money, and generated a much higher degree of price inflation than has been observed so far? Partly, it is due to the fact that after the wild bubble years, many financial institutions returned to the more traditional credit-worthy benchmarks for extending loans to potential borrowers. This has slowed down the approval rate for new loans.
But more importantly, those excess reserves not being lent out by banks are collecting interest from the Federal Reserve. With continuing market uncertainties about government policies concerning environmental regulations, national health care costs, the burden of the Federal debt and other government unfunded liabilities (Social Security and Medicare), as well as other possible political interferences in the marketplace, banks have found it more attractive to be paid interest by the Federal Reserve rather than to lend money to private borrowers. And considering how low Fed policies have pushed down key market lending rates, leaving those excess reserves idle with first Ben Bernanke and now Janet Yellen has seemed the more profitable way of using all that lending power.
Even under the heavy-handed intervention of the government, markets are fundamentally resilient institutions that have the capacity to bounce back unless that governmental hand really chokes the competitive and profit-making life out of capitalism. Any real recovery in the private sector will result in increased demands to borrow that would be satisfied by all of that Fed-created funny money currently sitting idle. Once those hundreds of billions of dollars of excess reserves come flooding into the market, price inflation may not be far behind.
Central Banking as the Problem, Not the SolutionAt the heart of the problem is the fact that the Federal Reserve’s manipulation of the money supply prevents interest rates from telling the truth: How much are people really choosing to save out of income, and therefore how much of the society’s resources — land, labor, capital — are really available to support sustainable investment activities in the longer run? What is the real cost of borrowing, independent of Fed distortions of interest rates, so businessmen could make realistic and fair estimates about which investment projects might be truly profitable, without the unnecessary risk of being drawn into unsustainable bubble ventures?
Unfortunately, as long as there are central banks, we will be the victims of the monetary central planners who have the monopoly power to control the amount of money and credit in the economy; manipulate interest rates by expanding or contracting bank reserves used for lending purposes; threaten the rollercoaster of business cycle booms and busts; and undermine the soundness of the monetary system through debasement of the currency and price inflation.
Interest rates, like market prices in general, cannot tell the truth about real supply and demand conditions when governments and their central banks prevent them from doing their job. All that government produces from its interventions, regulations, and manipulations is false signals and bad information. And all of us suffer from this abridgement of our right to freedom of speech to talk honestly to each other through the competitive communication of market prices and interest rates, without governments and central banks getting in the way.
[This was originally published at Epic Times.]
Image source: flickr.com/photos
This article is also available as an Audio Mises DailyAt the time of this writing, Argentina is a few days away from formally defaulting on its debts.How could this happen three times in just twenty-eight years?
Following the 2001 default, Argentina offered a debt swap (a restructuring of debt) to its creditors in 2005. Many bondholders accepted the Argentine offer, but some of them did not. Those who did not accept the debt swap are called the “holdouts.” When Argentina started to pay the new bonds to those who entered the debt swap (the “holdins”), the holdouts took Argentina to court under New York law, the jurisdiction under which the Argentine debt has been issued. After the US Supreme Court refused to hear the Argentine case a few weeks ago, Judge Griesa’s ruling became final.
The ruling requires Argentina to pay 100 percent of its debt to the holdouts at the same time Argentina pays the restructured bonds to the “holdins.” Argentina is not allowed, under Griesa’s ruling, to pay some creditors but not others. The payment date was June 30. Because Argentina missed its payment, it is now under a 30-day grace period. If Argentina does not pay by the end of July it will, again, be formally in default.
This is a complex case that has produced different, if not opposite, interpretations by analysts and policy makers. Some of these interpretations, however, are not well-founded.
How Argentina Became a Bad DebtorAn understanding of the Argentine situation requires historical context.
At the beginning of the 1990s, Argentina implemented the Convertibility Law as a measure to restrain the central bank and put an end to the hyperinflation that took place in the late 1980s. This law set the exchange rate at one peso per US dollar and stated that the central bank could only issue pesos in fixed relation to the amount of US dollars that entered the country. The Convertibility Law was, then, more than just a fixed-exchange rate scheme. It was legislation that made the central bank a currency board where pesos were convertible to dollars at a “one to one” ratio. However, because the central bank had some flexibility to issue pesos with respect to the inflow of US dollars, it is better described as a “heterodox” rather than “orthodox,” currency board.
Still, under this scheme, Argentina could not monetize its deficit as it did in the 1980s under the government of Ricardo Alfonsín. It was the monetization of debt that produced the high inflation that ended in hyperinflation. Due to the Convertibility Law during the 1990s, Carlos Menem’s government could not finance the fiscal deficit with newly created money. So, rather than reduce the deficit, Menem changed the way it was financed from a money-issuance scheme to a foreign-debt scheme. The foreign debt was in US dollars and this allowed the central bank to issue the corresponding pesos.
The debt issued during the 1990s took place in an Argentina that had already defaulted on its debt six times since its independence from Spain in 1816 (arguably, one-third of Argentine history has taken place in a state of default), while Argentina also exhibited questionable institutional protection of contracts and property rights. With domestic savings destroyed after years of high inflation in the 1980s (and previous decades), Argentina had to turn to international funds to finance its deficit. And because of the lack of creditworthiness, Argentina had to “import” legal credibility by issuing its bonds under New York jurisdiction. Should there be a dispute with creditors, Argentina stated it would accept the ruling of New York courts.
Many opponents of the ruling today claim that Argentina’s creditors have conspired to take away Argentine sovereignty, but the responsibility lies with the Argentine government itself, which has established a long record of unreliability in paying its debts.
The Road to the Latest DefaultThese New York-issued bonds of the 1990s had two other important features besides being issued under New York legal jurisdiction. The incorporation of the paripassu clause and the absence of the collective action clause. The paripassu clause holds that Argentina agrees to treat all creditors on equal terms (especially regarding payments of coupons and capital). The collective action clause states that in the case of a debt restructuring, if a certain percentage of creditors accept the debt swap, then creditors who turn down the offer (the “holdouts”) automatically must accept the new bonds. However, when Argentina defaulted on its bonds at the end of 2001, it did so with bonds that included the paripassu clause but which did not require collective action by creditors.
Under the contract that Argentina itself offered to its creditors, which did not include the collective action clause, any creditor is entitled to receive 100 percent of the bonus even if 99.9 percent of the creditors decided to enter a debt swap. And this is precisely what happened with the 2001 default. When Argentina offered new bonds to its creditors following the default, the “holdouts” let Argentina know that under the contract of Argentine bonds, they still have the right to receive 100 percent of the bonds under “equality of conditions” (paripassu) with those who accepted the restructuring. That is, Argentina cannot pay the “holdins” without paying the “holdouts” according to the terms of the debt.
The governments of Nestor Kirchner and Cristina Kirchner, however, in another sign of their contempt for institutions, decided to ignore the holdouts to the point of erasing them as creditors in their official reports (one of the reasons for which the level of debt on GDP looks lower in official statistics than is truly the case).
It could be said that Judge Griesa had to do little more than read the contract that Argentina offered its creditors. In spite of this, much has been said in Argentina (and abroad) about how Judge Griesa’s ruling damages the legal security of sovereign bonds and debt restructuring.
The problem is not Judge Griesa’s ruling. The problem is that Argentina had decided to once again prefer deficits and unrestrained government spending to paying its obligations. Griesa’s ruling suggests that a default cannot be used as a political tool to ignore contracts at politician’s convenience. In fact, countries with emerging economies should thank Judge Griesa’s ruling since this allows them to borrow at lower rates given that many of these countries are either unable or unwilling to offer credible legal protection to their own creditors. A ruling favorable to Argentina’s government would have allowed a government to violate its own contracts, making it even harder for poor countries to access capital.
We can simplify the case to an analogy on a smaller scale. Try to explain to your bank that since it was you who squandered your earnings for more than a decade,you have the right to not pay the mortgage with which you purchased your home. When the bank takes you to court for not paying your mortgage, explain to the judge that you are a poor victim of evil money vultures and that you have the right to ignore creditors because you couldn’t be bothered with changing your unsustainable spending habits. When the judge rules against you, try to explain to the world in international newspapers how the decision of the judge is an injustice that endangers the international banking market (as the Argentine government has been doing recently). Try now to justify the position of the Argentine government.
Image source: iStockphoto
This article is also available as an Audio Mises Daily
In a 2010 Bloomberg Television interview, Alan Greenspan said, “The general notion the Fed was propagator of the bubble by monetary policy does not hold up to the evidence. ... Everybody missed it — academia, the Federal Reserve, all regulators.”
Everybody missed it? Not according to Axel Leijonhufvud. In 2008 he wrote, “Operating an interest-targeting regime keying on the CPI, the Fed was lured into keeping interest rates far too low far too long. The result was inflation of asset prices combined with a general deterioration of credit ... a variation on the Austrian overinvestment theme.”Axel Leijonhufvud, “Keynes and the Crisis,” CEPR Policy Insight 23 (May 2008). Randall Forsyth concurred, writing the following in early 2009, “The Austrians were the ones who could see the seeds of collapse in the successive credit booms, aided and abetted by Fed policies.”Randall W. Forsyth, “Ignoring the Austrians Got Us in This Mess,” at barrons.com (3/12/2009).
The Failure of the MainstreamDespite the unprecedented fiscal and monetary action taken by the Bush and Obama administrations, which pushed the per capita budget deficit to more than twice the previous record, and the Fed, which quadrupled its balance sheet,The Fed’s balance sheet has grown from $869 billion on August 8, 2007 to $3,470 billion on June 10, 2013. the economy continues to be stuck in a deep recessionary gap. Instead of acknowledging the failure of these actions, policy makers have doubled down. As the Fed continues to print money to buy securities directly from Treasury and hold rates near zero, asset bubbles are reflating,Sam Ro, “Albert Edwards: The Fed Is Inflating a Housing Bubble to Hide a Destabilizing Economic Problem,”, and “General Motors Executive Warns of Impending Auto Bubble,” excess reserves have exploded, and bad economic news pushes stock markets ever higher.See "Nasdaq up for sixth straight day" With the pedal pushed to the metal, economists surveyed by the National Association for Business Economics in 2012 said they wanted current fiscal or monetary policy to continue.See "Tighten Macroeconomic Policies Later Rather than Sooner" A year later, economists in that same survey said monetary policy was about right.See "NABE Policy Survey: Long-Term Fiscal Deficits Should Be Addressed"
In a 2013 New York Times article,"Bernanke, Blower or Bubbles?" Paul Krugman acknowledged that the housing bubble he prescribed for the 2001 recession"Dubya's Double Dip?" had resulted “in the greatest economic crisis since the 1930s,” but called for the Fed to ignore the “babbling barons of bubbleism, and get on with doing [its] job” of fighting high unemployment.
Money printing and low interest rates are part of a much broader problem. The system the Fed oversees is wracked with moral hazard. The FDIC, the Fed being the lender of last resort, the too-big-to-fail doctrine, and mortgage securitization by Fannie and Freddie allow lenders to make riskier loans than they would have otherwise made. Unlike large national banks, credit unions are hesitant to make 30-year fixed rate mortgages. Why? They understand that their net interest margin will be negative if future deposit rates rise above fixed rates on mortgages made years earlier. They also understand that they are too small to be bailed out.
The aforementioned backstops are necessary because fractional reserve banking is inherently unstable. The money that is lent into existence can vanish at a moment’s notice. The bank panic sparked by the Lehman Brothers collapse resulted in a massive shortage of reserves that was filled with a 578 percent increase in discount loans.
Although economic prosperity is linked to core tenets of Austrian economics, namely economic and political freedom,For a review of the literature that examines the link between economic freedom and economic growth, see Niclas Berggren, “The Benefits of Economic Freedom: A Survey” The Independent Review 8, no. 2 (2003): 193–211. the school is routinely dismissed by mainstream macroeconomists.For example, see “Fine Austrian Whines” by Paul Krugman. This is so despite prices falling, quality rising, and consumer choice increasing in markets that are relatively free of government intervention (e.g., cellular phones, televisions, software, and computers). On the other hand, inflation, stagnant quality, inefficiency, or moral hazard is typical of industries regulated, managed, or owned by government (e.g., banking, education, healthcare, and the post office). Thus, it is surprising that the school has not gained wider acceptance. This is perhaps due to mainstream macroeconomics offering sellable solutions. Whereas Austrian economists generally refuse to support politically-popular welfare programs when unemployment is high, mainstream macroeconomists do not. Keynesian “solutions” like public works projects, extensions to unemployment insurance compensation, and payroll tax cuts, are well-received among working-class voters. Supply-side and Chicago-School policy prescriptions, like capital gains tax rate cuts, low interest rates, and deregulation, appeal to investors and entrepreneurs.
Mainstream macroeconomics’ sellable solutions have consequences, which are fixed with additional interventions. The IRS tax code has nearly doubled in length to over 70,000 pages in twenty years.See Putting a Face on America's Tax Return: A Chart Book During that same period, over 1.4 million pages have been added to the Federal Register.See The Towering Federal Register During the last five years, the Fed has held rates near zero and paid banks to not make loans.See Frances Coppola, “Banks Don't Lend Out Reserves,” Forbes.com (2014). Consequently, the accumulation of intervention has coincided with long-run growth slowing to a crawl.
How did mainstream macroeconomics miss it, and why has it doubled down on policies that appear to be setting the table for future asset bubbles and financial crises?
Too much aggregation is mainstream macroeconomics’ fatal conceit.
Capital-Based MacroeconomicsRoger Garrison’s Capital Based Macroeconomics (CBM) avoids mainstream macroeconomics’ fatal conceit by disaggregating economic output by stages of production.See Roger Garrison, Time and Money (London: Routledge, 2001).
Expenditures on final stage goods, like automobiles, are known as consumer expenditures in both macroeconomic views. Consumption and investment are more realistically modeled as short-run tradeoffs in CBM. When consumers save more, the supply of loanable funds rises. This lowers interest rates and raises investment as consumption and profits fall.
Shrinking profits prompts innovation. Lower interest rates promote the discoveries, production, and adoption of new products and cost-saving technologies.
Unlike in mainstream macroeconomics, wages in CBM’s segmented labor markets do not all fall when GDP declines. Though falling profits decrease labor demand and wages in the final stage, labor demand and wages in earlier stages rise as firms redirect resources. The widening wage differential draws workers to earlier production stages. This migration reduces final stage labor supply and raises earlier stage labor supply, resulting in the final stage wage rising up toward the wages that prevail in earlier expanding stages.
After savings-induced investments have worked their way through the economy, the productive capacity of the economy has expanded, resulting in higher overall consumption. Though this contradicts Keynes’s Paradox of Thrift,Thrift may be the handmaiden of Enterprise. But equally she may not. And, perhaps, even usually she is not. — JM Keynes. it does not work well when government interferes in markets.
Market interventions like social security, minimum wages, food stamps, and interest rate setting reduce savings, and make wages and prices sticky. Because persistently high unemployment is the unintended consequence of these interventions, monetary intervention is enacted to cure it.
When the Fed creates reserves, interest rates fall, investment increases, and savings decline. The wedge that is driven between investment and savings equals the amount of money that the Fed creates. The resulting malinvestment and overconsumption represent a competition for resources, which pushes asset prices ever higher and the economy beyond its productive capacity. This is what Austrians refer to as a Fed-induced boom.
ConclusionThe boom is unsustainable. Investment and consumption are higher than they would have been in the absence of monetary intervention. As asset bubbles inflate, yields increase, but so do inflation expectations. To dampen inflation expectations, the Fed withdraws stimulus. As soon as asset prices start to fall, yields on heavily leveraged assets are negative. As asset prices decline, increasingly more investors are underwater. Loan defaults rise as mortgage payments adjust up with rising interest rates. When asset bubbles pop, the boom becomes the bust.
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Argentina’s economic minister, Axel Kicillof, has become famous for his assertion that it is possible to centrally manage the economy now because we have spreadsheets such as Microsoft Excel. This assertion comes from the mistaken view that the cost of production determines final prices, and it reveals a profound misunderstanding of the market process. This issue, however, is not new. The first half of the twentieth century witnessed the debate over economic calculation under socialism. Apparently, Argentine officials have much to learn from this old debate. The problem is not whether or not we have powerful spreadsheets at our disposal; the problem is the impossibility of successfully creating a centrally-planned market.
At the turn of the century Ludwig von Mises, Max Weber, and Boris Brutzkus independently offered critiques on the socialist commonwealth, understood to be a society where there is no privately-held means of production. Mises was simple and direct. Unlike families or small tribes, where there is intimate knowledge among members, a large society requires prices to organize efficiently. The socialists, argues Mises, are quick to point out market failures, but are silent on how to efficiently organize the socialist commonwealth without the existence of prices. Marx, who does not offer an explanation of how socialism would work once capitalism withers away, calls the socialists (i.e., Saint-Simon and Fourier), who do describe the resulting socialist community, “utopians.” Without economic calculation to reveal which activities add value to society (profits) and which do not (losses), it is an illusion to assume that efficiency would just happen. Arguments other than economic calculation can be put forward as a principle to organize society, but the question of how economic efficiency is achieved remains unanswered.
As a response to this critique, writers in the socialist literature went from describing imaginary societies and criticizing capitalism to trying to solve Mises’s challenge. Oskar Lange and Wassily Leontief are two of the most famous authors who tried to solve this problem. One of the answers offered is the assumption of perfect information (still present in economics textbooks). The argument goes, if we assume to have all the required information, then the economy can be at equilibrium, and therefore Mises’s challenge is interesting, but inadequate. A centrally-managed economy is possible, if we have perfect information. At this point in the debate, it is Hayek who responds to the socialists’ contention with four important points:
(1) The amount of information needed and the calculation constraints are prohibitive to the socialist project, even if we grant the assumption of perfect information. But this is just an illustrative point that Hayek is making. Even though socialists and Marxists usually stop at this point, Hayek’s point is much more subtle as the following points show.
(2) The assumption of perfect information is invalid. The challenge is not to be in equilibrium, but in the transition to equilibrium. Just as it is not possible to open a can of food by assuming a can opener, it is not an acceptable response to assume Mises’s challenge away by assuming perfect information. Where does this perfect information come from and to whom is it given? The assumption of perfect information does not simplify the problem to be solved; it alters it and becomes irrelevant to the debate. This is why Austrians have been traditionally more concerned with the market process and less with the equilibrium conditions.
(3) Hayek also distinguishes (admittedly with some confusion) between information and knowledge. Information is a quantitative concept, and as such, can be either complete (perfect) or incomplete (imperfect). This is what socialists refer to as the assumption of perfect information. But knowledge is a qualitative concept, and because of this it can be neither complete nor incomplete. Knowing how to ride a bike or how to successfully run a business is not the type of knowledge that can be input into an Excel spreadsheet. This distinction is important because it is entrepreneurs who are the engine of economic growth and development. In other words, Excel cannot solve the market problem that entrepreneurs have to solve because this requires interpretation and knowledge, not just numerical data. Little is achieved if all information is given to Kicillof’s team if they don’t know how to interpret it.
(4) Information and knowledge are not independent of the market process. Without private property there are no prices; without prices there is no information. Hayek is using the other side of Mises’s argument to say that by getting rid of private property one is at the same time getting rid of the information that the socialists need to assume as given.
As soon as we recognize all of Hayek’s points, we realize that to take the Excel spreadsheet approach is like building a car without an engine (the entrepreneurs) and without road signs (the market) to signal the right way to go. It is no surprise that the Argentine economy malfunctions without a clear route taken by government officials. It is a mistake to confuse market prices with regulated prices, and the prices that provide useful information are the ones that emerge from free exchanges in the market, not government imposed prices originating in an Excel spreadsheet. To use the same word “price” to describe these two different phenomena misleads him who arrogates to himself the right to decide the fate of thousands of people. It is an illusion to believe that the same information that arises from market prices will magically emerge from government-imposed prices. What Kicillof’s team inserts into the Excel spreadsheet are not prices, but expressions of desires detached from economic reality.
The success of economic policy and market regulation, however, is not evaluated on desires and intentions, but on results. The problem with the Excel spreadsheet approach is not the intentions of the policymakers, but that such tools cannot possibly replace the market process.
The undeniable economic problems of Argentina run much deeper than what number to input into Kicillof’s spreadsheet. The problem is a confused reading of how markets work, and how governments continue with deficit spending in the service of favored interest groups.
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The latest GDP report indicates a slowdown in overall economic activity in the first quarter of 2014. Apologists for the Obama administration attribute the recent slowdown to unusual winter weather. Some have even suggested that the first-quarter slowdown sets the stage for rapid economic growth for the remainder of this year: there is pent up demand and untapped potential productivity, they claim. Mobilization of unemployed resources and satisfaction of unmet demands could, in the remainder of 2014, translate into a faster annual rate of GDP growth, perhaps 3.5 percent. The flaws of this argument should be obvious. One can just as easily argue that the much larger slowdown of 2008 set the stage for fast growth in the 2009-2013 time frame. The 2008 crisis left us with much greater pent up demand and untapped productivity. Yet the recovery that began in 2009 nearly stalled in 2010 and has been extraordinarily slow. Why has the recovery been so very slow?
The facts of our recent experiences with harsh winter weather is hardly unprecedented or unimaginable. There have been harsh winters before, and without economic slowdowns. More importantly, officials have pushed the envelope of Keynesian policies. In recent years Federal authorities have implemented some of the most aggressive fiscal and monetary policies in US history. President Obama is on track to double the national debt. Obama’s Recovery and Reinvestment Act was intended to stimulate the economy with massive deficit spending. The US government accumulated 1.4 trillion dollars of extra debt just in 2009. The Council of Economic Advisors predicted that the Recovery and Reinvestment Act would increase economic growth to 3.8 percent. The Federal Reserve has also carried out its program of quantitative easing, a historic increase in bank reserves.
The actual results of the Recovery and Reinvestment Act and of quantitative easing fell well short of expectations. US economic growth has been anemic and unemployment has remained at high levels. Federal officials ran annual deficits of more than one trillion dollars several years in a row, yet measured economic growth remained unusually sluggish. The pace of recovery slowed to 2.1 percent in 2010 and has persisted at a slow rate since then.
Given the enormous number of unemployed workers and growth in the size of the working-age population there was (and still is) potential for rapid economic growth. GDP growth rates of 4 or even 5 percent were not at all unrealistic, given the number of unemployed persons.
It is always possible to concoct an excuse for poor policy results. Some people had earlier suggested that recovery from a major crisis must be slow. The idea that recovery from a large financial crisis must be slow is superficially plausible, and this excuse is oft repeated. President Obama made this claim: “The simple truth is, it took years to dig this hole; it’s going to take more time than any of us would like to climb out of it” (July 9th, 2010 at UNLV). Now the weather is supposedly to blame. What does the historical record suggest about economic recoveries.
There have been ten economic recoveries since the Second World War. Of these ten recoveries, the 1982 recovery was the second-fastest and second-longest expansion. The 2009 recovery is the slowest. These are interesting facts. The 1982 recovery is associated with a severe banking and financial crisis. Inflation rates went into double digits. During the 1970s the Federal Reserve followed a Keynesian policy of quantitative easing as a means of “stimulating the economy.” During the 1980s the Fed abandoned Keynesian policy in favor of quantitative tightening, higher interest rates, and slower money-supply growth. Federal Reserve tightening was needed to control rising inflation, and this was followed by a strong recovery. The 1982 recovery also began with a Federal hiring freeze, and smaller Federal deficits than in recent years.
The record of the past six years is clear. Quantitative easing by Fed Chair Ben Bernanke has failed to produce a strong economic recovery in the short term. This policy has laid the groundwork for a longer term wave of inflation.
Unemployment During RecoveriesStrong economic recoveries translate directly into rapid reductions of unemployment. Statistics on unemployment following each recession are clear. The following chart shows the monthly rate of decline in unemployment rates, and the actual unemployment rate in parentheses. The fastest abatement of unemployment followed the 1948 recession, a monthly rate of .3 percent for one year. The longest expansion began in 1992. The 1992 expansion reached a minimum point in unemployment after 92 months.
The official unemployment rate was higher during the 1981 recession than during the 2008 recession, but what happened afterwards? Unemployment rates fell faster in the 1980s than in any other postwar recovery. High interest rates during the early 1980s put savings and loans institutions in a poor financial position; paying high rates on short-term savings while being paid low rates on long-term mortgages. Banks were also burdened with elevated delinquency rates on loans. The savings and loan crisis lasted close to ten years, during which time half of all S&Ls went under.
The idea that a severe crash can be followed by fast growth can be true, yet this need not always be true. Defenders of Obama policies have switched between arguing that recovery from a crisis must be slow to the idea that a drop in GDP sets the stage for rapid expansion. The change in their reasoning is based on sophistic political and rhetorical expediency rather than on rational thought. Given the large number of unemployed and discouraged workers, and the low capacity utilization of capital, there could have been a faster recovery. Keynesian policies have failed; the fact that a worse-than-usual winter coincided with the latest disappointment does not change this fact. What are the consequences of failed Obama-Bernanke-Keynesian policies?
The Unemployment-Wealth SituationRecent reports indicate that most of the financial gains of recent years have gone to upper income Americans. This data is correct, but relatively unimportant. There is nothing inherently wrong with wealthy people becoming wealthier. The unemployment situation is more serious. What is the unemployment rate among lower income Americans? Incomes in the US correlate with education. High school dropouts have the lowest incomes, and high school graduates have the second lowest incomes, on average.
The unemployment situation with high school dropouts is always relatively high, but it has been particularly bad in recent years.
It is worth noting that unemployment rates among high school dropouts were better during the savings and loan crisis. The inflation and S&L crises did not lead to the appalling results we have seen in recent years. High school graduates have done better than dropouts in recent years. However, unemployment rates did drop to single digits during the late 1980s.
These are important facts. Lack of jobs has left lower-income households with less income and a worsening position in terms of their household wealth. Even a Keynesian should be able to admit that the failure of fiscal stimulus and quantitative easing has made things worse for Americans in lower-income households (among others). The second strongest recovery took place right after an inflation crisis and during a bank-failure crisis, and during a rare effort by the Fed to fight inflation. The weakest recovery took place during the most aggressive uses of fiscal and monetary policy in US history, and the failure of this policy has hit lower income Americans the hardest.
Quantitative easing and fiscal stimulus are failed policies. These policies have unquestionably failed to produce a rapid recovery over the past five years. These policies likely have actually prevented more rapid economic recovery. Quantitative easing and fiscal stimulus have failed to bring unusually high unemployment rates among less-educated Americans closer to “normal” levels.
The policies of quantitative easing and fiscal stimulus derive from false beliefs that real prosperity can be achieved simply by increasing the amounts of money and debt. The idea that we can achieve real prosperity simply by creating more money and debt is akin to belief in magic. Adam Smith and David Hume taught us that prosperity requires real resources, labor and capital. Ludwig von Mises and Friedrich Hayek went further by teaching us all the importance of well-coordinated cost-effective uses of labor and capital. Fed officials should give up trying to create real wealth by creating money. Unfortunately, the new Fed Chair, Janet Yellen, has strong faith in Keynesian magic of creating real wealth from monetary wealth. Yellen and Obama should discard their false and disproved Keynesian beliefs. Better still, the American public could give up waiting for officials to admit to their own failures, and press for a more rational and reliable laissez-faire policy.
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The Free Market 31, no. 11 (November 2013)During the recent financial crisis, Sweden has emerged as one of very few financially sound economies. The country’s strong position, setting it apart from Western nations, makes it an interesting example of what could—or should—have been done. Indeed, Paul Krugman, the economist and Nobel Prize laureate, has repeatedly pointed approvingly at how the Swedes handled their depression in the early 1990s as the reason for their recent success. Specifically, he notes the nationalization of some banks at the time of the crisis. While he misses the point by focusing exclusively on a narrow selection of short-term measures rather than longer-term changes, as is the hall-mark of a Keynesian, Krugman is right that Sweden has done some things right.
In September of 1992 the Riksbank, Sweden’s central bank, raised the interest rate to five hundred (500) percent in a vain attempt to save the fixed exchange rate of the Swedish krona (Sweden’s currency). This drastic measure was taken in conjunction with large spending cuts and tax increases to address the free-fall of the nation’s economy. The economic meltdown was the culmination of two full decades of decline, and it fundamentally changed the political situation in Sweden.
Since that time, Sweden has, across the board, seen consistent government cutbacks while increasing restrictions on welfare policies, deregulating markets, and privatizing former government monopolies. The country has instituted an overall new incentive structure in society making it more favorable to work. The national debt tumbled from almost 80 percent of GDP in 1995 to only 35 percent in 2010.
In other words, the country successfully rolled back its unsustainable but world-renowned welfare state. Despite Krugman’s wishful thinking, this is the real reason for Sweden’s success in riding out the present financial crisis.
The Rise and Fall of the Welfare State
Sweden experienced a century of high economic growth from approximately 1870 to 1970, which literally made one of Europe’s poorest countries into the world’s fourth richest. The first half of this period of growth was marked by extensive free-market reform, and the latter half is notable for Sweden’s staying out of both world wars and thus benefiting from intact industrial infrastructure when the rest of Europe lay in ruins. While a welfare state was established and expanded during the post-war period, it was generally built around capitalist institutions and therefore had limited impact on economic growth.
But the political situation changed. The 1970s and 1980s saw a welfare state run amok with a greatly expanded scope with new government benefits, the introduction of very rigid labor market regulations, active propping up of stagnating sectors of the economy, and drastic increases in tax rates with some marginal rates in excess of 100 percent. In an attempt to fully nationalize the economy, löntagarfonder (“employees’ funds”) were instituted in 1983 to “reinvest” private companies’ profits in stock ownership and to be administered by the national labor unions.
During this period government deficits abounded and the national debt increased almost ten-fold from 1975 to 1985. Sweden also saw high price inflation, a situation aggravated by repeated devaluations of the currency’s exchange rate to boost exports: in 1976 by 3 percent; in 1977 by 6 percent at first, and then an additional 10 percent; in 1981 by 10 percent; and in 1982 by 16 percent.
Overall, the rapid expansion of the welfare state can be illustrated by the ratio between tax-financed and private sector employment, which rose from 0.386 in 1970 to 1.51 in 1990. Sweden was heading for disaster.
Explaining Sweden’s Great Depression
A popular explanation of the meltdown in the 1990s blames deregulation of the financial markets that occurred during November 1985. But as our research (still in progress) suggests, deregulation was an attempt to solve increasing problems to finance the Swedish government’s already weak and deteriorating financial situation. In the fiscal year 1984–85 alone, the interest payments on Sweden’s national debt amounted to 29 percent of tax revenue—equal to the government’s total spending on social security. The country’s unsustainable financial situation made deregulation necessary.
The increased access to financial markets made a desperate situation somewhat more tenable. But Sweden then experienced an immense increase in credit. Our numbers show that the volume of bank loans to non-financial businesses increased from 180 billion in late 1985 to 392 billion in late 1989, an increase of 117 percent total or 21 percent annually. Where did all this money come from? Some of it can be explained by deregulation and the inflow of funds that followed. But it was also made possible by monetary inflation.
Several factors were at work during the 1986–1990 credit-infused boom that ended in the depression of 1990–1994. Some factors had no inflationary effect or even a deflationary effect, but other factors, especially those that relate to government policy, or are driven by government policy, were strongly inflationary and quite substantial. These include increases in the Riksbank’s advances to banks (a 975-percent increase from 1985 to 1989) and purchases of government debt and securities (a 47-percent increase from 1985 to 1987, followed by a 7-percent decrease from 1987 to 1989).
Sweden is an interesting case to study. We do indeed, as Krugman repeatedly tells us, have much to learn from it: from the long-lasting era of economic growth thanks to free markets to the rise and fall of the welfare state. The country’s recently (re)gained financial strength and its ability to resist a global recession are due, not to a strong Sweden is an interesting case to study. We do indeed, as Krugman repeatedly tells us, have much to learn from it: from the long-lasting era of economic growth thanks to free markets to the rise and fall of the welfare state. The country’s recently (re)gained financial strength and its ability to resist a global recession are due, not to a strong welfare state as Krugman claims, but to the long-term rolling back of the expansive welfare that Keynesians so often praise