Week in Review
Money is a temporary storage of value. We created money to make trade easier. We once bartered. We looked for people to trade with. But trying to find someone with something you wanted (say, a bottle of wine) that wanted what you had (say olive oil) could take a lot of time. Time that could be better spent making wine or olive oil. So the longer it took to search to find someone to trade with the more it cost in lost wine and olive oil production. Which is why we call this looking for people to trade goods with ‘search costs’.
Money changed that. Winemakers could sell their wine for money. And take that money to the supermarket and buy olive oil. And the olive oil maker could do likewise. Greatly increasing the efficiency of the market. There is a very important point here. Money facilitated trade between people who created value. Creating something of value is key. Because if people were just given money without producing anything of value they couldn’t trade that money for anything. For if people didn’t create things of value to buy what good was that money?
Today, thanks to Keynesian economics, governments everywhere believe they can create economic activity with money. And use their monetary powers to try and manipulate things in the economy to favor them. And one of their favorite things to do is to devalue their money. Make it worth less. So governments that borrow a lot of money can repay that money later with devalued money. Money that is worth less. So they are in effect paying back less than they borrowed. And governments love doing that. Of course, people who loan money are none too keen with this. Because they are getting less back than they loaned out originally. And there is another reason why governments love to devalue their money. Especially if they have a large export economy.
Before anyone can buy from another country they have to exchange their money first. And the more money they get in exchange the more they can buy from the exporting country. This is the same reason why you can enjoy a five-star vacation in a tropical resort in some foreign country for about $25. I’m exaggerating here but the point is that if you vacation in a country with a very devalued currency your money will buy a lot there. But the problem with making your exports cheap by devaluing your currency is that it has a down side. For a country to buy imports they, too, first have to exchange their currency. And when they exchange it for a much stronger currency it takes a lot more of it to buy those imports. Which is why when you devalue your currency you raise prices. Because it takes more of a devalued currency to buy things that a stronger currency can buy. Something the good people in Japan are currently experiencing under Abenomics (see Japan Risks Public Souring on Abenomics as Prices Surge by Toru Fujioka and Masahiro Hidaka posted 4/14/2014 on Bloomberg).
Prime Minister Shinzo Abe’s bid to vault Japan out of 15 years of deflation risks losing public support by spurring too much inflation too quickly as companies add extra price increases to this month’s sales-tax bump.
Businesses from Suntory Beverage and Food Ltd. to beef bowl chain Yoshinoya Holdings Co. have raised costs more than the 3 percentage point levy increase. This month’s inflation rate could be 3.5 percent, the fastest since 1982, according to Yoshiki Shinke, the most accurate forecaster of Japan’s economy for two years running in data compiled by Bloomberg…
“Households are already seeing their real incomes eroding and it will get worse with faster inflation,” said Taro Saito, director of economic research at NLI Research Institute, who says he’s seen prices of Chinese food and coffee rising more than the sales levy. “Consumer spending will weaken and a rebound in the economy will lack strength, putting Abe in a difficult position…”
Abe’s attack on deflation — spearheaded by unprecedented easing by the central bank — has helped weaken the yen by 23 percent against the dollar over the past year and a half, boosting the cost of imported goods and energy for Japanese companies.
Japan is an island nation with few raw materials. They have to import a lot. Including much of their energy. Especially since shutting down their nuclear reactors. Japan has a lot of manufacturing. But that manufacturing needs raw materials. And energy. Which are more costly with a devalued yen. Increasing their costs. Which they, of course, have to pay for when they sell their products. So their higher costs increase the prices their customers pay. Leaving the people of Japan with less money to buy their other household goods that are also rising in price. Which is why economies with high rates of inflation go into recession. As the recession will correct those high prices. With, of course, deflation.
Keynesians all think they can manipulate the market place to their favor by playing with monetary policy. But they are losing sight of a fundamental concept in a free market economy. Money doesn’t have value. It only holds value temporarily. It’s the things the factories produce that have value. And whenever you make it more difficult (i.e., raise their costs by devaluing the currency) for them to create value they will create less value. And the economy as a whole will suffer.
Tags: Abenomics, barter, currency, deflation, devalue, devalue their money, devaluing, devaluing your currency, energy, export, imports, inflation, Japan, Keynesian, market, money, prices, raise prices, raw materials, recession, search, search costs, temporary storage of value, trade, value
Week in Review
The Democrats are running out of ways to buy votes. Which they desperately need as more people suffer the ravages of Obamacare. Who will be entering the voting booth angry this fall. Looking for someone to blame for taking away the health insurance and doctors they liked and wanted to keep. And being that Obamacare was passed on purely partisan lines (no Republicans voted for it) the Democrats are sweating bullets as the midterm elections approach. So they turn to an oldie but goldie. The pay gap lie (see What pay gap? Young women out-earn men in cities, GOP pundit claims posted 4/8/2014 on PolitiFact).
We watched the debate play out between conservative pundit Sabrina Schaeffer and liberal pundit Elizabeth Plank on MSNBC’s The Reid Report, and again later between former White House adviser Anita Dunn and conservative pundit Genevieve Wood on CNN’s The Lead with Jake Tapper.
“If you compare women to men in the same job with similar background, similar experiences that they bring to the table, the wage gap all but disappears,” Wood said. “Women have made great strides. Instead of celebrating that, this is a political year, the White House wants to portray this war on women…”
PolitiFact has given you the nuts and bolts about the 77 cents statistic — you can read the two most important works in this area here and here. Basically, there is a wage gap, but it tends to disappear when you compare women and men in the exact same jobs who have the same levels of experience and education.
Well, there it is. Equal pay for equal work. When men and women have the same education, experience and skills doing the same job there is no pay gap. Case closed. In fact, single women without children are actually earning more than single men. Which is the key to this argument. For a woman’s earnings fall with interruptions in her career as she takes time off to have children. Or works reduced hours to care for her children. This is where the pay gap comes in. When you compare apples and oranges. Comparing women who take time off or cut back their working hours or take lower paying jobs that allow her to spend more time with her children to men who don’t. Because they’re single. Or are married and have a wife who takes time off to spend more time with their children.
In fact, women are making great strides. At the expense of men (see Is the Gender Pay Gap Closing or Has Progress Stalled? by Josh Zumbrun posted 4/11/2014 on The Wall Street Journal).
“There’s no question that one of the things that ‘77 cents’ doesn’t emphasize is that there’s been enormous gains,” said Harvard University economist Claudia Goldin.
Looking at the data above shows three clear trends that have emerged since the 1970s:
1) The spread between the sexes narrowed between 1970 and 2000. It has made little progress since.
2) Men have made no income gains in over four decades. Adjusted for inflation, men earn less today than they did in 1972.
3) Women continued to make gains until the recession began. Whatever forces slowed the income growth of men from 1970 to 2000 did not halt the income growth of women.
Simple economics. Supply and demand. Men were making more and more every year. Until the Sexual Revolution. When women began to flood the labor market. With more labor available the cost of labor fell. So as women gained education and experience the supply of educated and experienced workers grew. Allowing employers to pay less for these now more plentiful educated and experienced workers. Which is why as women enjoyed income gains men saw their income decline when adjusted for inflation. Simple economics. Supply and demand.
A long time ago in high school chemistry I remember my lab partner did not complete a homework assignment that was part 1 of a 2-part grade. There was a homework part. And a lab part. Being a nice person I asked the teacher if we could share the grade on the homework part (which I had received an ‘A’ on. Or a 4.0). The teacher was more than generous. He said, “Sure. A 4.0 divided by 2 equals a 2.0 for each.” Or, a ‘C’ for each. Suffice it to say my lab partner did not get a 2.0 on the homework that went undone.
This is why men are earning less. Because women have entered the workforce. The revenue businesses use to pay their employees didn’t increase like the number of educated and experienced workers did. So the amount of available revenue for pay and benefits was shared by more people. Each getting less than a man did before the Sexual Revolution (when adjusted for inflation). So instead of a single paycheck supporting a family these days it now takes two paychecks. Because men are making less today since women have lowered the price of labor. By increasing the supply of labor. Not because they are paid less. But because there are so many workers for so few jobs that businesses don’t have to pay as much as they once did to hire people. Which is more to blame for pressure on wages than any pay gap.
Tags: 77 cents, children, Democrats, education, experience, income, income gains, inflation, jobs, labor, men, pay gap, supply and demand, wage gap, women, workers
Week in Review
Inflation is bad according to Rep. Chris Van Hollen. And, therefore, we need baseline budgeting (taking last years’ spending and automatically adding more to it to arrive at the budget for the following year) to overcome the corrosive effect of inflation on government spending. And he illustrated this by showing how inflation has increased the price of a Big Mac over the years (see Members of Congress debate budget with Big Macs by Eric Pfeiffer posted 4/8/2014 on Yahoo! News).
On Tuesday, two members of Congress got into a detailed discussion over inflation, with Rep. Chris Van Hollen using pictures of hamburgers to argue that inflation estimates are necessary to undercut future budgets.
Holding up a chart that showed the average cost of a McDonald’s Big Mac in 2004 ($2.71) compared with its cost today ($4.62), Maryland Democrat Van Hollen argued that not adjusting budget numbers for inflation equates to a net cut.
But while arguing that we need baseline budgeting to counter rampant inflation we have someone whose job is to keep inflation from rearing its ugly head in the economy saying quite another thing (see Fed’s Evans ‘exasperated’ by inflation warnings by Greg Robb posted 4/9/2014 on MarketWatch).
Many people who argue that inflation is just around the corner have been repeating the same warning for the past five years, said Charles Evans, the president of the Chicago Federal Reserve Bank, on Wednesday. “I confess that I am somewhat exasperated by these repeated warnings given our current environment of very low inflation,” Evan said in a speech at an economic policy conference in Washington D.C. Evans said he still sees the economic environment pointing to below-target inflation “for several years.” Evans debunked current arguments that inflation is just over the horizon. He said that there is “substantial room” for stronger wage growth without inflation pressures building and added the Fed’s large balance sheet is not a “classic warning sign” of inflation. Commodity prices also seem to be an unlikely propellent of inflation at the moment, he said.
So while Rep. Chris Van Hollen is wringing his hands over the rampant inflation everywhere that we can only counter with baseline budgeting the president of the Chicago Federal Reserve Bank gets exasperated by people like Rep. Chris Van Hollen. Because there is no inflation that he can see. And it’s his job to find inflation. So he can stop it. So who’s right? They can’t both be right. Of course, the price of the Big Mac has gone up through the years. But there is only one problem with Rep. Chris Van Hollen presentation in Congress (see the Yahoo! News article linked to previously).
Regardless of which side of the debate you fall on, there was one falsehood on display at the House committee hearing on Tuesday. As The Washington Post noted, those hamburgers used in Van Hollen’s charts weren’t actually Big Macs.
That’s right. With all the resources our representatives have at their disposal they could not even take the time to get a picture of the right hamburger. Perhaps because the only beef our representatives eat is the tenderloin and wouldn’t be caught dead ‘slumming’ it at a McDonald’s. Food the vast majority of Americans find delicious. But then again, we’re not a bunch of pompous, arrogant, condescending prima donnas like our representatives, are we?
Tags: baseline, baseline budgeting, Big Mac, Chris Van Hollen, Federal Reserve, inflation
(Originally published April 1st, 2013)
Money would have No Value if People with Talent didn’t Create things of Value
Money is a temporary storage of wealth. We created it because of the high search costs of the barter system. It took a lot of time for two people to find each other who each had what the other wanted. And we started trading things to have things we couldn’t make efficiently for ourselves. Someone may have been a superb potter but was a horrible farmer. So, instead, the potter did what he did best. And traded the pottery he made for the things he wanted that he was not good at making. Or growing. Before that we were self-sufficient. Whatever you wanted you had to provide it yourself.
As we go back in time we learn why money is a temporary storage of wealth. For it was the final piece in a growing and prosperous economy. And at the beginning it was people with talent, each creating something of value. Something of value that they could trade for something else of value. It’s the creative talent of people that has value. And we see that value in the goods and/or services they make or provide. Money temporarily held that value. So we could carry it with us easier to go to market to trade with other talented and creative people. Who may not have wanted what we made or did. But would gladly take our money.
So we took our goods to market. People that wanted them traded for them. They traded money for our goods. Then we took that money and traded for what we wanted elsewhere in the market. Trade grew. With some people becoming professional traders. By trading money for goods from distant lands. Then trading these goods for money at the local market. People who didn’t spend time creating anything. But bought and sold the creative talent of others. Who were able to do that because of money. The creative talent came first. Then the goods. And then the money. For money is a temporary storage of wealth. Which has no value if no one is making anything of value. Because if you can’t buy anything what good is having money?
There were no more Gold Certificates in Circulation than there was Gold in the Vault to Exchange them For
These early traders used a variety of things for money. Pigs, tobacco, grain, oil, etc. What we call commodity money. Which was valuable by itself. As people consumed these commodities. Which is what gave them the ability to store value. But because we could consume these they did not make the best money. Also, they weren’t that portable. And not easy to make change with. Which is why we turned to specie. Such as gold and silver. Hard money. It was durable. Portable. Divisible. Fungible. For example, all Spanish dollars were the same while all pigs weren’t. One pig could weigh 30 pounds more than another. So pigs weren’t fungible. Or durable. Portable. And, though divisible, making change wasn’t easy.
So in time traders big and small turned to specie as the medium of exchange. For all the reasons noted above. If you worked hard to produce fine pottery you trusted in specie. You would accept specie for your pottery goods. Because you knew this hard money would hold its value. And you could use it in the future to buy what you wanted. No matter how long that may be. Why? Because the money supply remained relatively constant. As it took a lot of work and great expense to mine and refine ore to make specie out of it. So there was little inflation when using hard money. Which meant if you saved for a rainy day that hard money would be there for you.
Gold and silver could be heavy to carry around. Anyone struggling under the weight of their specie were targets for thieves. Who wanted that money. Without creating anything of value to bring to market. So we found a way to improve a little on using gold and silver. By locking our gold and silver in a vault. And carrying around receipts for our gold and silver to use as money. These gold certificates were promises to pay in gold. People could continue to use them as money. Or they could take these receipts back to the vault and exchange them for the gold inside. These gold certificates were as good as gold. And there were no more gold certificates in circulation than there was gold in the vault to exchange them for.
Governments Today use nothing but Paper Money because it gives them Privilege, Wealth and Power
Some saw advantages of expanding the money supply with paper currency. Money that isn’t backed by gold or any other asset. Money easy to print. And easy to borrow. Allowing rich people to borrow large sums of money to buy more assets. And get richer. Giving them more power. And if you were the one printing and loaning that money it gave you great wealth and power. So having a bank charter was a way to wealth and power. You could make it easy for those who can help you to borrow money. While making it difficult for those who oppose you to borrow money. So there were those in business and in government that liked un-backed paper money. Because a select few could borrow it cheaply and get rich and powerful.
While some liked these banks and that paper money there were others who bitterly opposed them. Some who didn’t like to see so much power in so few hands. And the hard money people. Who wanted a money that held its value. The common people. People who couldn’t borrow large sums of cheap money. But people who had to get by on less as the inflation from printing all those paper dollars raised prices. Leaving them with less purchasing power. Making it harder for them to get by. Often having to turn to the hated banks to borrow money. Again and again. Such that the interest on their loans consumed even more of their limited funds. Making life more tenuous. And more bitter between the classes. The rich who benefited from the cheap paper money. And the common people who paid the price of all that inflation.
Rich people, on the other hand, loved that inflation. It helped them make money. When they bought something at a lower price and sold it at a higher price they made a lot of money. The greater the inflation the greater the selling price. And the more profit. Also, the money they owed was easier to pay off with money that was worth less than when they borrowed it. Allowing rich people to get even richer. While the common people saw only higher prices. And the value of their meager savings lose value. So this cheap paper money fostered great class warfare. The hard money people hated the paper money people. Debtors hated creditors. The middling classes hated the large landowners, merchants, manufacturers and, of course, the bankers. And those who had talent to create things hated those who just made money with money. The greater the inflation the greater the divide between the people. And the greater wealth and power that select few acquired. This is what paper money gave you. Privilege. Which is why most governments today use nothing but paper money.
Tags: banks, barter system, class warfare, commodity money, creative talent, divisible, durable, fungible, gold, gold certificates, goods, hard money, inflation, market, medium of exchange, money, money supply, paper currency, paper money, people with talent, portable, power, privilege, purchasing power, search costs, silver, specie, talent, temporary storage of wealth, trade, traders, value, wealth, wealth and power
(Originally published July 30th, 2012)
Before we buy a Country’s Exports we have to Exchange our Currency First
What’s the first thing we do when traveling to a foreign country? Exchange our currency. Something we like to do at our own bank. Before leaving home. Where we can get a fair exchange rate. Instead of someplace in-country where they factor the convenience of location into the exchange rate. Places we go to only after we’ve run out of local currency. And need some of it fast. So we’ll pay the premium on the exchange rate. And get less foreign money in exchange for our own currency.
Why are we willing to accept less money in return for our money? Because when we run out of money in a foreign country we have no choice. If you want to eat at a McDonalds in Canada they expect you to pay with Canadian dollars. Which is why the money in the cash drawer is Canadian money. Because the cashier accepts payment and makes change in Canadian money. Just like they do with American money in the United States.
So currency exchange is very important for foreign purchases. Because foreign goods are priced in a foreign currency. And it’s just not people traveling across the border eating at nice restaurants and buying souvenirs to bring home. But people in their local stores buying goods made in other countries. Before we buy them with our American dollars someone else has to buy them first. Japanese manufacturers need yen to run their businesses. Chinese manufacturers need yuan to run their businesses. Indian manufacturers need rupees to run their businesses. So when they ship container ships full of their goods they expect to get yen, yuan and rupees in return. Which means that before anyone buys their exports someone has to exchange their currency first.
Goods flow One Way while Gold flows the Other until Price Inflation Reverses the Flow of Goods and Gold
We made some of our early coins out of gold. Because different nations used gold, too, it was relatively easy to exchange currencies. Based on the weight of gold in those coins. Imagine one nation using a gold coin the size of a quarter as their main unit of currency. And another nation uses a gold coin the size of a nickel. Let’s say the larger coin weighs twice as much as the smaller coin. Or has twice the amount of gold in it. Making the exchange easy. One big coin equals two small coins in gold value. So if I travel to the country of small coins with three large gold coins I exchange them for six of the local coins. And then go shopping.
The same principle follows in trade between these two countries. To buy a nation’s exports you have to first exchange your currency for theirs. This is how. You go to the exporter country with bags of your gold coins. You exchange them for the local currency. You then use this local currency to pay for the goods they will export to you. Then you go back to your country and wait for the ship to arrive with your goods. When it arrives your nation has a net increase in imported goods (i.e., a trade deficit). And a net decrease in gold. While the other nation has a net increase in exported goods (i.e., a trade surplus). And a net increase in gold.
The quantity theory of money tells us that as the amount of money in circulation increases it creates price inflation. Because there’s more of it in circulation it’s easy to get and worth less. Because the money is worth less it takes more of it to buy the same things it once did. So prices rise. As prices rise in a nation with a trade surplus. And fall in a nation with a trade deficit. Because less money in circulation makes it harder to get and worth more. Because the money is worth more it takes less of it to buy the same things it once did. So prices fall. This helps to make trade neutral (no deficit or surplus). As prices rise in the exporter nation people buy less of their more expensive exports. As prices fall in an importer nation people begin buying their less expensive exports. So as goods flow one way gold flows the other way. Until inflation rises in one country and eventually reverses the flow of goods and gold. We call this the price-specie flow mechanism.
In the Era of Floating Exchange Rates Governments don’t have to Act Responsibly Anymore
This made the gold standard an efficient medium of exchange for international trade. Whether we used gold. Or a currency backed by gold. Which added another element to the exchange rate. For trading paper bills backed by gold required a government to maintain their domestic money supply based on their foreign exchange rate. Meaning that they at times had to adjust the number of bills in circulation to maintain their exchange rate. So if a country wanted to lower their interest rates (to encourage borrowing to stimulate their economy) by increasing the money supply they couldn’t. Limiting what governments could do with their monetary policy. Especially in the age of Keynesian economics. Which was the driving force for abandoning the gold standard.
Most nations today use a floating exchange rate. Where countries treat currencies as commodities. With their own supply and demand determining exchange rates. Or a government’s capital controls (restricting the free flow of money) that overrule market forces. Which you can do when you don’t have to be responsible with your monetary policy. You can print money. You can keep foreign currency out of your county. And you can manipulate your official exchange rate to give you an advantage in international trade by keeping your currency weak. So when trading partners exchange their currency with you they get a lot of yours in exchange. Allowing them to buy more of your goods than they can buy from other nations with the same amount of money. Giving you an unfair trade advantage. Trade surpluses. And lots of foreign currency to invest in things like U.S. treasury bonds.
The gold standard gave us a fixed exchange rate and the free flow of capital. But it limited what a government could do with its monetary policy. An active monetary policy will allow the free flow of capital but not a fixed exchange rate. Capital controls prevent the free flow of capital but allows a fixed exchange rate and an active monetary policy. Governments have tried to do all three of these things. But could never do more than two. Which is why we call these three things the impossible trinity. Which has been a source of policy disputes within a nation. And between nations. Because countries wanted to abandoned the gold standard to adopt policies that favored their nation. And then complained about nations doing the same thing because it was unfair to their own nation. Whereas the gold standard made trade fair. By making governments act responsible. Something they never liked. And in the era of floating exchange rates they don’t have to act responsibly anymore.
Tags: capital controls, currency, currency exchange, exchange rate, exported goods, exports, fixed exchange rate, floating exchange rate, foreign currency, foreign goods, gold, gold standard, goods, inflation, international trade, monetary policy, price inflation, prices, trade deficit, trade surplus
(Originally published February 27th, 2012)
Because of the Unpredictable Human Element in all Economic Exchanges the Austrian School is more Laissez-Faire
Name some of the great inventions economists gave us. The computer? The Internet? The cell phone? The car? The jumbo jet? Television? Air conditioning? The automatic dishwasher? No. Amazingly, economists did not invent any of these brilliant inventions. And economists didn’t predict any of these inventions. Not a one. Despite how brilliant they are. Well, brilliant by their standard. In their particular field. For economists really aren’t that smart. Their ‘expertise’ is in the realm of the social sciences. The faux sciences where people try to quantify the unquantifiable. Using mathematical equations to explain and predict human behavior. Which is what economists do. Especially Keynesian economists. Who think they are smarter than people. And markets.
But there is a school of economic thought that doesn’t believe we can quantify human activity. The Austrian school. Where Austrian economics began. In Vienna. Where the great Austrian economists gathered. Carl Menger. Ludwig von Mises. And Friedrich Hayek. To name a few. Who understood that economics is the sum total of millions of people making individual human decisions. Human being key. And why we can’t reduce economics down to a set of mathematical equations. Because you can’t quantify human behavior. Contrary to what the Keynesians believe. Which is why these two schools are at odds with each other. With people even donning the personas of Keynes and Hayek to engage in economic debate.
Keynesian economics is more mainstream than the Austrian school. Because it calls for the government to interfere with market forces. To manipulate them. To make markets produce different results from those they would have if left alone. Something governments love to do. Especially if it calls for taxing and spending. Which Keynesian economics highly encourage. To fix market ‘failures’. And recessions. By contrast, because of the unpredictable human element in all economic exchanges, the Austrian school is more laissez-faire. They believe more in the separation of the government from things economic. Economic exchanges are best left to the invisible hand. What Adam Smith called the sum total of the millions of human decisions made by millions of people. Who are maximizing their own economic well being. And when we do we maximize the economic well being of the economy as a whole. For the Austrian economist does not believe he or she is smarter than people. Or markets. Which is why an economist never gave us any brilliant invention. Nor did their equations predict any inventor inventing a great invention. And why economists have day jobs. For if they were as brilliant and prophetic as they claim to be they could see into the future and know which stocks to buy to get rich so they could give up their day jobs. When they’re able to do that we should start listening to them. But not before.
Low Interest Rates cause Malinvestment and Speculation which puts Banks in Danger of Financial Collapse
Keynesian economics really took off with central banking. And fractional reserve banking. Monetary tools to control the money supply. That in the Keynesian world was supposed to end business cycles and recessions as we knew them. The Austrian school argues that using these monetary tools only distorts the business cycle. And makes recessions worse. Here’s how it works. The central bank lowers interest rates by increasing the money supply (via open market transactions, lowering reserve requirements in fractional reserve banking or by printing money). Lower interest rates encourage people to borrow money to buy houses, cars, kitchen appliances, home theater systems, etc. This new economic activity encourages businesses to hire new workers to meet the new demand. Ergo, recession over. Simple math, right? Only there’s a bit of a problem. Some of our worst recessions have come during the era of Keynesian economics. Including the worst recession of all time. The Great Depression. Which proves the Austrian point that the use of Keynesian policies to end recessions only makes recessions worse. (Economists debate the causes of the Great Depression to this day. Understanding the causes is not the point here. The point is that it happened. When recessions were supposed to be a thing of the past when using Keynesian policies.)
The problem is that these are not real economic expansions. They’re artificial ones. Created by cheap credit. Which the central bank creates by forcing interest rates below actual market interest rates. Which causes a whole host of problems. In particular corrupting the banking system. Banks offer interest rates to encourage people to save their money for future use (like retirement) instead of spending it in the here and now. This is where savings (or investment capital) come from. Banks pay depositors interest on their deposits. And then loan out this money to others who need investment capital to start businesses. To expand businesses. To buy businesses. Whatever. They borrow money to invest so they can expand economic activity. And make more profits.
But investment capital from savings is different from investment capital from an expansion of the money supply. Because businesses will act as if the trend has shifted from consumption (spending now) to investment (spending later). So they borrow to expand operations. All because of the false signal of the artificially low interest rates. They borrow money. Over-invest. And make bad investments. Even speculate. What Austrians call malinvestments. But there was no shift from consumption to investment. Savings haven’t increased. In fact, with all those new loans on the books the banks see a shift in the other direction. Because they have loaned out more money while the savings rate of their depositors did not change. Which produced on their books a reduction in the net savings rate. Leaving them more dangerously leveraged than before the credit expansion. Also, those lower interest rates also decrease the interest rate on savings accounts. Discouraging people from saving their money. Which further reduces the savings rate of depositors. Finally, those lower interest rates reduce the income stream on their loans. Leaving them even more dangerously leveraged. Putting them at risk of financial collapse should many of their loans go bad.
Keynesian Economics is more about Power whereas the Austrian School is more about Economics
These artificially low interest rates fuel malinvestment and speculation. Cheap credit has everyone, flush with borrowed funds, bidding up prices (real estate, construction, machinery, raw material, etc.). This alters the natural order of things. The automatic pricing mechanism of the free market. And reallocates resources to these higher prices. Away from where the market would have otherwise directed them. Creating great shortages and high prices in some areas. And great surpluses of stuff no one wants to buy at any price in other areas. Sort of like those Soviet stores full of stuff no one wanted to buy while people stood in lines for hours to buy toilet paper and soap. (But not quite that bad.) Then comes the day when all those investments don’t produce any returns. Which leaves these businesses, investors and speculators with a lot of debt with no income stream to pay for it. They drove up prices. Created great asset bubbles. Overbuilt their capacity. Bought assets at such high prices that they’ll never realize a gain from them. They know what’s coming next. And in some darkened office someone pours a glass of scotch and murmurs, “My God, what have we done?”
The central bank may try to delay this day of reckoning. By keeping interest rates low. But that only allows asset bubbles to get bigger. Making the inevitable correction more painful. But eventually the central bank has to step in and raise interest rates. Because all of that ‘bidding up of prices’ finally makes its way down to the consumer level. And sparks off some nasty inflation. So rates go up. Credit becomes more expensive. Often leaving businesses and speculators to try and refinance bad debt at higher rates. Debt that has no income stream to pay for it. Either forcing business to cut costs elsewhere. Or file bankruptcy. Which ripples through the banking system. Causing a lot of those highly leveraged banks to fail with them. Thus making the resulting recession far more painful and more long-lasting than necessary. Thanks to Keynesian economics. At least, according to the Austrian school. And much of the last century of history.
The Austrian school believes the market should determine interest rates. Not central bankers. They’re not big fans of fractional reserve banking, either. Which only empowers central bankers to cause all of their mischief. Which is why Keynesians don’t like Austrians. Because Keynesians, and politicians, like that power. For they believe that they are smarter than the people making economic exchanges. Smarter than the market. And they just love having control over all of that money. Which comes in pretty handy when playing politics. Which is ultimately the goal of Keynesian economics. Whereas the Austrian school is more about economics.
Tags: asset bubbles, Austrian economics, Austrian school, Austrian school of economics, bad debt, banking, banking system, business cycle, businesses, central banking, cheap credit, consumption, credit, debt, depositors, deposits, economic activity, economic exchanges, Economics, economists, fractional reserve banking, free market, Great Depression, Hayek, human behavior, income stream, inflation, interest rates, investment, investment capital, Keynes, Keynesian, Keynesian economists, loan, malinvestment, market forces, market interest rates, mathematical equations, monetary tools, money supply, predict human behavior, prices, quantify, recessions, savings, savings accounts, savings rate, speculation, unquantifiable, workers
Week in Review
George W. Bush’s last deficit was $498.37 billion. President Obama’s deficits were $1,539.22 billion, $1,386.92 billion, $1,350.31 billion, $1,120.16 billion and $680 billion, respectively. President Obama has taken the national debt from $12,973,669,938,453 to $16,738,183,526,697. And increase of $3,764,513,588,244 (29%). Or the amount added to the national debt from 1791 through 1985.
So President Obama did in 5 years what his predecessors did in 194 years. Putting the U.S. dollar in great peril. For the only reason why the United States hasn’t become a third-world economic basket case is because the U.S. dollar is the world’s reserve currency. But once the world loses confidence in the American dollar they may choose another reserve currency. And if they do all of that printing and borrowing will hit the U.S. economy hard. Making the inflation of the stagflation Seventies seem like child’s play.
We can’t keep printing and borrowing money. For we are approaching a tipping point. Yes, having the power to print money can forestall the inevitable. As long as people still have confidence in your currency. But if they don’t there is nothing to prevent the U.S. from spiraling down into third-world status just as every other nation that destroyed their economy with out of control printing and spending. Making these debates over increasing the debt ceiling more than Kabuki Theater (see All’s Fair in Love, War and Government? by Robert Schlesinger posted 2/3/2014 on US News and World Report).
The way that the approach to the debt ceiling has changed – going from a rhetorical opportunity and classic round of Kabuki Theater where lawmakers feign outrage and denounce the debt ceiling increase they know they’re going to vote for anyway to a genuine threat to the economy – illustrates a larger trend in Washington: the movement away from certain accepted norms in our governance. As I’ve written before, there used to be unwritten rules which helped keep the governance train on its rails – they limited the use of the filibuster to rare issues, they made the notion of deliberately shutting down the government in order to extract policy concessions out of bounds and the same with the idea of intentionally harming the economy by not raising the debt ceiling.
Those norms have increasingly been replaced with an ends-justifies-the-means view that the pursuit of power makes anything OK. That’s a real problem for our democracy.
The ends-justifies-the-means in the pursuit of power? Yes, that is a problem for our democracy. Such as passing the Affordable Care Act on partisan lines with back room deals. Causing people to lose the health insurance and doctors they liked and wanted to keep. Higher insurance premiums and higher deductibles. A cost that went from just under $1 trillion over ten years to over $1 trillion each year (if our health care is anything like Canada’s health care). And prolonging the worst economic recovery since that following the Great Depression. Even telling the Lie of the Year. Horrible things for our Democracy. All in the pursuit of power. In the left’s quest for the holy grail of power. National health care.
With our huge debt weighing down our democracy we are fast approaching the tipping point. And raising the debt ceiling may not be the best thing to do. So someone should be trying to get some spending cuts before agreeing to raise the debt ceiling. To save our democracy. Before it’s too late. Thanks to the Democrats’ pursuit of power. Where ‘the ends-justifies-the-means’. Even if it turns the country into a third-world nation.
Tags: American dollar, debt ceiling, deficit, democracy, ends-justifies-the-means, inflation, national debt, President Obama, reserve currency, third-world nation, U.S. dollar
(Originally published 2/5/2013)
The Bretton Woods System was a quasi Gold Standard where the U.S. Dollar replaced Gold
Government grew in the Sixties. LBJ’s Great Society increased government spending. Adding it on top of spending for the Vietnam War. The Apollo Moon Program. As well as the Cold War. The government was spending a lot of money. More money than it had. So they started increasing the money supply (i.e., printing money). But when they did they unleashed inflation. Which devalued the dollar. And eroded savings. Also, because the U.S. was still on a quasi gold standard this also created a problem with their trade partners.
At the time the United States was still in the Bretton Woods System. Along with her trade partners. These nations adopted the U.S. dollar as the world’s reserve currency to facilitate international trade. Which kept trade fair. By preventing anyone from devaluing their currency to give them an unfair trade advantage. They would adjust their monetary policy to maintain a fixed exchange rate with the U.S. dollar. While the U.S. coupled the U.S. dollar to gold at $35/ounce. Which created a quasi gold standard. Where the U.S. dollar replaced gold.
So the U.S. had a problem when they started printing money. They were devaluing the dollar. So those nations holding it as a reserve currency decided to hold gold instead. And exchanged their dollars for gold at $35/ounce. Causing a great outflow of gold from the U.S. Giving the U.S. a choice. Either become responsible and stop printing money. Or decouple the dollar from gold. And no longer exchange gold for dollars. President Nixon chose the latter. And on August 15, 1971, he surprised the world. Without any warning he decoupled the dollar from gold. It was a shock. So much so they call it the Nixon Shock.
To earn a Real 2% Return the Interest Rate would have to be 2% plus the Loss due to Inflation
Once they removed gold from the equation there was nothing stopping them from printing money. The already growing money supply (M2) grew at a greater rate after the Nixon Shock (see M2 Money Stock). The rate of increase (i.e., the inflation rate) declined for a brief period around 1973. Then resumed its sharp rate of growth around 1975. Which you can see in the following chart. Where the increasing graph represents the rising level of M2.
Also plotted on this graph is the effect of this growth in the money supply on retirement savings. In 1966 the U.S. was still on a quasi gold standard. So assume the money supply equaled the gold on deposit in 1966. And as they increased the money supply over the years the amount of gold on deposit remained the same. So if we divide M2 in 1966 by M2 in each year following 1966 we get a declining percentage. M2 in 1966 was only 96% of M2 in 1967. M2 in 1966 was only 88% of M2 in 1968. And so on. Now if we start off with a retirement savings of $750,000 in 1966 we can see the effect of inflation has by multiplying that declining percentage by $750,000. When we do we get the declining graph in the above chart. To offset this decline in the value of retirement savings due to inflation requires those savings to earn a very high interest rate.
This chart starts in 1967 as we’re looking at year-to-year growth in M2. Inflation eroded 4.07% of savings between 1966 and 1967. So to earn a real 2% return the interest rate would have to be 2% plus the loss due to inflation (4.07%). Or a nominal interest rate of 6.07%. The year-to-year loss in 1968 was 8.68%. So the nominal interest rate for a 2% real return would be 10.68% (2% + 8.68%). And so on as summarized in the above chart. Because we’re discussing year-to-year changes on retirement savings we can consider these long-term nominal interest rates.
Just as Inflation can erode someone’s Retirement Savings it can erode the National Debt
To see how this drives interest rates we can overlay some average monthly interest rates for 6 Month CDs (see Historical CD Interest Rate). Which are often a part of someone’s retirement nest egg. The advantage of a CD is that they are short-term. So as interest rates rise they can roll over these short-term instruments and enjoy the rising rates. Of course that advantage is also a disadvantage. For if rates fall they will roll over into a lower rate. Short-term interest rates tend to be volatile. Rising and falling in response to anything that affects the supply and demand of money. Such as the rate of growth of the money supply. As we can see in the following chart.
The average monthly interest rates for 6 Month CDs tracked the long-term nominal interest rates. As the inflationary component of the nominal interest rate soared in 1968 and 1969 the short-term rate trended up. When the long-term rate fell in 1970 the short-term rate peaked and fell in the following year. After the Nixon Shock long-term rates increased in 1971. And soared in 1972 and 1973. The short-term rate trended up during these years. And peaked when the long-term rate fell. The short term rate trended down in 1974 and 1975 as the long-term rate fell. It bottomed out in 1977 in the second year of soaring long-term rates. Where it then trended up at a steeper rate all the way through 1980. Sending short-term rates even higher than long-term rates. As the risk on short-term savings can exceed that on long-term savings. Due to the volatility of short-term interest rates and wild swings in the inflation rate. Things that smooth out over longer periods of time.
Governments like inflationary monetary policies. For it lets them spend more money. But it also erodes savings. Which they like, too. Especially when those savings are invested in the sovereign debt of the government. For just as inflation can erode someone’s retirement savings it can erode the national debt. What we call monetizing the debt. For as you expand the money supply you depreciate the dollar. Making dollars worth less. And when the national debt is made up of depreciated dollars it’s easier to pay it off. But it’s a dangerous game to play. For if they do monetize the debt it will be very difficult to sell new government debt. For investors will demand interest rates with an even larger inflationary component to protect them from further irresponsible monetary policies. Greatly increasing the interest payment on the debt. Forcing spending cuts elsewhere in the budget as those interest payments consume an ever larger chunk of the total budget. Which governments are incapable of doing. Because they love spending too much.
Tags: $35/ounce, Bretton Woods, Bretton Woods System, devalued the dollar, exchange rate, fixed exchange rate, gold, gold on deposit, gold standard, government spending, inflation, interest rate, M2, monetary policy, monetizing the debt, money supply, national debt, Nixon Shock, nominal interest rate, printing money, quasi gold standard, reserve currency, retirement savings, savings, spending, trade, U.S. dollar
Ten Different Obama Job Approval Polls show Higher Disapproves than Approves
President Obama did not have a good 2013. Especially near the end. Because of the Obamacare rollout. With the website being a disaster. The enrollment numbers weren’t as projected. Or needed. And then all the cancellations in the individual market. As people learned they couldn’t keep the policies and doctors they liked. Which gave President Obama the recognition for being the best in at least one thing. As PolitiFact named “if you like your health care plan, you can keep it” as the lie of the year.
The bad news continued into 2014. The Obamacare enrollee numbers didn’t improve. Most of the enrollees are the old and sick. Not the young and healthy the Obama administration told the health insurers would be enrolling. Which is breaking the economic model. Guaranteeing not only that health insurance premiums will rise. But some health care providers are actually requiring payment up front before providing services. As they are not sure what the insurers will pay. Making Obamacare an even bigger disaster. Which is a big factor in driving President Obama’s job approval rating down (see President Obama Job Approval posted on Real Clear Politics).
The ten polls included in the RCP Average all share one thing in common. They all have larger disapproval numbers than approval numbers. With the average disapproval number being 8.4 points greater than the average approval number. However you look at these numbers they are not good for President Obama. For they say President Obama has not been good for the United States.
People don’t Trust President Obama and are beginning to Doubt his Past Claims of Accomplishment
Growing numbers of people don’t trust the president anymore. Including those who were Obama supporters. Who because of the ‘lie of the year’ don’t look at those other scandals as opposition propaganda anymore. These scandals (Benghazi, IRS targeting conservatives, spying on journalists, spying on Americans, Fast and Furious, Solyndra, ‘recess’ appointments, executive orders to bypass the will of the people/Congress, etc.) are now just other things not to trust the president about. The president has been less than honest to get what he wants (power). While the American people don’t get what they want (jobs, affordable health care, etc.). And it’s because of this that his job approval has entered a steady decline.
Following a bump during the 2012 election Obama’s job approval has trended down. The Obama administration lied about what happened in Benghazi to help their reelection chances. Where the campaign message was that al Qaeda was on the run. Which is apparently why the State Department under Secretary Clinton denied Ambassador Steven’s request for additional security to combat the resurgent al Qaeda in Libya. As the recent bipartisan Senate report stated that the killing of four Americans in Benghazi on the anniversary of 9/11 could have been prevented.
Benghazi, the NSA spying on us, the ‘lie of the year’ and the other scandals have had their affect on the American people. And after the Target point-of-sale credit card hack people are very suspect of the Obamacare website. Especially when a security consulting firm says there is no security on the Obamacare website yet the Obama administration keeps telling us to trust them. They’ll keep our data safe. Even though Target couldn’t. And they have functioning security systems in place. Unlike Obamacare. That has none. So people don’t trust President Obama. And they’re beginning to doubt his past claims of accomplishment. As well as those rosy jobs reports from the Bureau of Labor Statistics.
The Lie of the Year appears to have Broken the Spell Obama held over some of his Admirers
The Democrat’s Keynesian economic policies created yet another housing bubble. By keeping interest rates artificially low and relaxing credit standards they stimulated the housing market. And housing prices soared. But buyers didn’t seem to care. Because they were borrowing the money to buy these overpriced houses. Because of those low interest rates. Even people who couldn’t afford to buy a house were buying a house. Thanks to subprime lending like the adjustable rate mortgage (ARM). But when interest rates rose so did those monthly payments on those ARMs. People couldn’t afford their mortgage payments anymore. And defaulted. Giving us the subprime mortgage crisis. Which turned into the Great Recession.
The Democrats blamed the banks for the Great Recession. Not their Keynesian policies. Or President Clinton’s heavy hand on lenders to qualify the unqualified for mortgages (see Bill Clinton created the Subprime Mortgage Crisis with his Policy Statement on Discrimination in Lending posted 11/6/2011 on PITHOCRATES). Not only did they deflect blame for the crisis they used the crisis to implement further Keynesian policies. A near-trillion dollar stimulus bill. Much of which went to Obama’s ‘friends’ in the green energy industry. And to their friends in unions. The government spent a lot of money. They kept interest rates artificially low. And when that didn’t work they used quantitative easing. Basically printing money. The Obama administration said their policies were working. And declared the summer of 2010 ‘Recovery Summer’. The recession was over. Since then they highlighted the new jobs created with every jobs report. While ignoring the number of people who have left the labor force. Greatly skewing the numbers. And grossly understating the real unemployment rate (see Wall Street adviser: Actual unemployment is 37.2%, ‘misery index’ worst in 40 years by Paul Bedard posted 1/21/2014 on the Washington Examiner).
Don’t believe the happy talk coming out of the White House, Federal Reserve and Treasury Department when it comes to the real unemployment rate and the true “Misery Index.” Because, according to an influential Wall Street advisor, the figures are a fraud…
…the Misery Index, which is a calculation based in inflation and unemployment, both numbers the duo say are underscored by the government. He said that the Index doesn’t properly calculate how Uncle Sam is propping up the economy with bond purchases and other actions.
“These tricks, along with a host of other dubious accounting schemes, underreport inflation by about 3 percent,” they wrote, adding that the official inflation rate is just 1.24 percent.
“Today, the Misery Index would be 7.54 using official numbers,” they wrote. But if calculations tabulating the full national unemployment including discouraged workers, which is 10.2 percent, and the historical method of calculating inflation, which is now 4.5 percent, ‘the current misery index is closer to 14.7, worse even than during the Ford administration.”
The 1970s were the heyday of Keynesian economics. With spending out of control Richard Nixon did something that Keynesians longed for. He decoupled the dollar from gold. Allowing the Fed to print money like there was no tomorrow. Igniting inflation. And when the inflation rate was added to the unemployment rate it gave us a record Misery Index. Until now, that is. If you use the real data. And not the ‘massaged’ data that makes their Keynesian policies appear to be working. Telling us the recession ended in 2010. When many feel the Great Recession has never ended. Which is yet another reason not to trust the Obama administration. Or not approve of the job President Obama is doing. As the polls have been showing this past year. And it’s not just because of Obamacare. But the ‘lie of the year’ appears to have broken the spell he held over some of his admirers. Who can now see the king is wearing no clothes. No matter what his administration and those in the mainstream media say.
Tags: Al Qaeda, approval, Benghazi, disapproval, Great Recession, inflation, interest rates, job approval, jobs reports, Keynesian, Keynesian policies, lie of the year, misery index, Obama, Obama administration, Obamacare, Obamacare website, people don't trust President Obama, President Obama, President Obama job approval, recession, trust, unemployment, website
Week in Review
The December jobs report was pretty bleak. It showed that the unemployment rate fell to 6.7% and that the economy added 74,000 jobs. Not great but good enough for some who say that President Obama’s policies are finally working after 5 some years of trying. Which is ridiculous. Because that unemployment rate doesn’t tell you how many people lost their jobs. And how many people disappeared from the civilian labor force as they gave up trying to find work that just isn’t there. Which hides the number of people who lost their jobs. Because the Bureau of Labor Statistics doesn’t count anyone as unemployed if they are no longer looking for work. But if you dig down into the jobs report you’ll find this data. And see that for every person that entered the labor force about seven people left it in December (see The BLS Employment Situation Summary for December 2013 posted January 13th, 2014 on PITHOCRATES). Which is anything but an economic recovery.
All during the Obama presidency the Federal Reserve has been stimulating the economy. Right out of the Keynesian handbook. By keeping interest rates near zero to encourage people to borrow money to buy things they don’t need. But few have. No. The only people borrowing that money are rich investors. Who are borrowing this ‘free’ money to spend in the stock market. Helping Wall Street to do very well during the worst economic recovery since that following the Great Depression. While Main Street sees their median family income fall. Still the chairman of the Federal Reserve, Ben Bernanke, thinks he did a heck of a job (see Bernanke Says QE Effective While Posing No Immediate Bubble Risk by Jeff Kearns and Joshua Zumbrun posted 1/16/2014 on Bloomberg).
Bernanke is seeking to define his legacy before stepping down on Jan. 31. During his eight-year tenure as leader of the Fed he piloted the economy through a financial crisis that led to the longest recession since the 1930s. He has tried to bolster growth by holding the target interest rate near zero and pushing forward with unprecedented bond buying known as QE.
“Those who have been saying for the last five years that we’re just on the brink of hyperinflation, I think I would just point them to this morning’s CPI number and suggest that inflation is not really a significant risk of this policy,” Bernanke said, referring to a Labor Department report showing the consumer price index rose 1.5 percent in the past year. The Fed has set an inflation target of 2 percent…
The Federal Open Market Committee (FDTR) announced plans last month to reduce monthly purchases to $75 billion from $85 billion, citing improvement in the labor market. The jobless rate last month fell to 6.7 percent, a five-year low.
The only reason why we don’t have hyperinflation is that everyone has depreciated their currency so much to boost exports and pay for bloated welfare states that all currencies are losing value. And of all these bad currencies the American currency is the least bad of the lot. Which is why some foreign nationals will pay to park their money in American banks. Because the risk of it losing its value is so much greater in their home country.
But that doesn’t mean inflation hasn’t reared its ugly head in the US economy. Just go to a grocery store and look at a bag of chips. Or a box of cookies. Or any packaged item that didn’t seem to get overly expensive during the Obama recession. A bag of chips may be the same $3-4 it was before the recession. But notice the size of the bag. It’s gotten smaller. So, yes, consumer prices have not shown great inflation. But packaging has gotten smaller. So instead of paying more for the same quantity we are paying the same price for a lesser quantity. Which means we may be buying 4 of something in a month instead of 3 of something. It adds up. Which is why there are so many more people on food stamps. The Bernanke inflation is taking more of our paycheck to buy what it once did.
The economy is horrible. Fewer people are in the labor force with each jobs report. Our grocery packaging is shrinking. And once the Fed stops its bond buying the stock market is going to fall. A lot. For every time rich investors think the economic data will show solid economic activity what do they do? They sell their stocks. Causing a stock market fall. Why? Why would investors leave the stock market when the data say the economy is getting stronger? Which seems to go against common sense? Because they know there’s been only one thing helping them get rich during the Obama presidency. That ‘free’ money. Once that source of cheap money goes away they will sell before those inflated stock prices fall back to earth.
The Obama recovery. Good for Wall Street. Bad for Main Street.
Tags: Ben Bernanke, Bernanke, bond buying, currency, economic recovery, hyperinflation, inflation, interest rate, jobs, jobs report, Keynesian, Main Street, Obama, Obama presidency, Obama recession, recession, unemployment rate, Wall Street
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