Radio Free Market

UKIP’s Roger Helmer on costly “playground technologies“.  The German word for a costly but less efficient product is “ersatz”.  It’s primary use is during wartime, during which the nation is forced to use less suitable products.  Today politicians everywhere are forcing peaceful citizens to adopt wartime measures.  The standard of living of all the world’s citizens will fall due to this fallacious and politically driven ideology.  Free trade and unhampered capitalism will reveal the most efficient use of all resources.  Rather than save resources, these market interventions force us to consume resources unnecessarily.

We use the term “reserve currency” when referring to the common use of the dollar by other countries when settling their international trade accounts.  For example, if Canada buys goods from China, it may pay China in US dollars rather than Canadian dollars, and vice versa.  However, the foundation from which the term originated no longer exists, and today the dollar is called a “reserve currency” because foreign countries hold it in great quantity simply to facilitate trade.  The first reserve currency was the British Pound Sterling.  Because the Pound was “good as gold”, many countries found it more convenient to hold Pounds rather than gold itself during the age of the gold standard.  The world’s great trading nations settled their trade in gold, but they might hold Pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment.  Toward the end of World War II the US dollar was given this status by treaty following the Bretton Woods Agreement.  The International Monetary Fund (IMF) was formed with the express purpose of monitoring the Federal Reserve’s commitment to Bretton Woods by ensuring that the Fed did not inflate the dollar and stood ready to exchange dollars for gold at $35 per ounce.  Thusly, countries had confidence that their dollars held for trading purposes were as “good as gold” as had been the Pound Sterling at one time.

However, the Fed did not maintain its commitment to the Bretton Woods Agreement and the IMF did not attempt to force it to hold enough gold to honor all its outstanding currency in gold at $35 per ounce.  The Fed was called to account in the late 1960s first by France and then by others until its gold reserves were so low that it had no choice by to revalue the dollar at some higher exchange rate or abrogate its responsibilities to honor dollars for gold entirely.  To it everlasting shame, the US chose the latter and “went off the gold standard” in September 1971.

Nevertheless, the dollar was still held by the great trading nations, because it still performed the useful function of settling international trading accounts.  There was no other currency that could match the dollar, despite the fact that it was “delinked” from gold.  There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value vis a vis other commodities over time.  These two factors create a demand for holding a currency in reserve.  Although the dollar was being inflated by the Fed, thusly losing its value vis a vis other commodities over time, there was no real competition.  The German Deutschemark held its value better, but German trade was a fraction of US trade, meaning that holders of marks would find less to buy in Germany than holders of dollars would find in the US.  So demand for the mark was lower than demand for the dollar.  Of course, psychological factors entered the demand for dollars, too, since the US was the military protector of all the Western nations against the communist countries.

Today we are seeing the beginnings of a change.  The Fed has been inflating the dollar massively, reducing its purchasing power vis a vis other commodities, causing many of the world’s great trading nations to use other monies upon occasion.  I have it on good authority that DuPont settles many of its international accounts in Chinese yuan and European euros.  There may be other currencies that are in demand for trade settlement by other international countries.  One factor that has helped the dollar retain its reserve currency demand is that the other currencies have been inflated, too.  For example, Japan has inflated the yen to a greater extent than the dollar in its foolish attempt to revive its stagnant economy by cheapening its currency.  So the monetary destruction disease is not limited to the US alone!

The dollar is very susceptible to losing its vaunted reserve currency position by the first major trading country that stops inflating its currency.  There is evidence that China understands what is at stake; it has increased its gold holdings and has instituted controls to prevent gold from leaving China.  Should the world’s second largest economy and one of the world’s greatest trading nations tie its currency to gold, demand for the yuan would increase and demand for the dollar would decrease.  In practical terms this means that the world’s great trading nations would reduce their holdings of dollars, and dollars held overseas would flow back into the US economy, causing prices to increase.  How much would they increase?  It is hard to say, but keep in mind that there is an equal amount of dollars held outside the US as inside the US.

Perhaps only such non-coercive pressure form a sovereign country like China can wake up the Fed to the consequences of its actions and force it to end its Quantitative Easing policy.

Patrick Barron

Eurozone governments must give up more power to avoid another crisis, say IMF economists

http://www.telegraph.co.uk/finance/financialcrisis/10333439/Eurozone-governments-must-give-up-more-power-to-avoid-another-crisis-say-IMF-economists.html

The IMF–whose mandate for existence ceased when the US went off the gold standard in 1971…yet, like Dracula, it still walks the earth, sucking the lifeblood of more victimes–has recommended that the EU become one, big socialist union in order to fight the scourge of deflation.  God forbid that deficit countries “suffer” deflation, whereby their costs of production fall and the nation becomes more competitive.  Fighting deflation has become one of the world’s greatest fallacies.  Deflation is GOOD.  Lower prices are GOOD.  This is how an individual and an entire nation recovers.  In his seminal book America’s Great Depression Murray N. Rothbard explained how Presidents Hoover and FDR insisted on propping up prices during the Great Depression, which only prolonged the misery.  Jorg Guido Hulsmann explains the economic theory involved in this short book Deflation and Liberty.  Patrick Barron

Draghi wants permanent eurozone bailout fund

ECB president Mario Draghi wants a 500 billion euro bank bailout fund, as if a one time bailout is all that is needed.  However, the core problem has not been addressed.  Fractional reserve banking means that the banks can pyramid multiple amounts of new lending (creating new money in the process) out of a small increase in reserves.  This “something for nothing” credit expansion causes an unsustainable bubble, and that which cannot be sustained will not be sustained.  The malinvestment must be liquidated, and Draghi assumes that his bailout fund is sufficient to save the banks…just this one time.  But Draghi’s proposed one time bailout will be repeated again and again until we realize that lending must be funded from real savings and not newly printed fiat money, created by the banks’ privilege of fractional reserve lending.  The template for an honest and noninflational banking system can be found in Murray N. Rothbard’s The Mystery of Banking.  Patrick Barron

I know, I know. I’m preaching to the choir – and it’s the same sermon taught every Sunday – but let’s talk about the recent announcement by the Federal Reserve. A lot of pieces of advice are given, but I think none are as perceptive as the master himself, Murray Rothbard. Before we revisit his words, let’s take a look at some of the other buzz out there. This comes from a weekly market wrap provided by a financial firm of fine repute:

“The Fed is not the gasoline for the engine [the stock market]. The sustainable source of fuel for market returns comes from economic growth and corporate profitability. But Fed policy has delivered a boost to confidence and continues to provide underlying support for the economy.”

Now, I won’t outright disagree that Fed policy does not provide support – in fact, it does provide support to certain sectors, markets, and firms. However, this “support” is not so much a foundation for growth but is more akin to a diverting of resources from productive sectors to unproductive sectors. Typically, these bubbles are created within markets of what Carl Menger termed higher order goods. Rothbard explains,

“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 face of it, shifting investment focus to higher order goods seems like a boon to the economy! I mean, c’mon, wouldn’t we rather have investors and entrepreneurs concentrate on cranking out highly efficient machines that produce advanced medicines more cheaply rather than better providing some lower order consumer good like… like… a Twinkie? Rothbard tells us that not only do we prefer – by our actions in the market – businesses to focus on catering Twinkies, but that this preference means bad news bears (and future bear markets) for businesses that are misled into investing too much in higher-order capital goods.

“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 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.”

“Liquidated” sounds like a light, fluffy word. Feel-good pictures of ice melting or summer days at a splash pad may color your thoughts. Possibly less vivid, doubtlessly darker, the mental images formed by the phrase “malinvestments must be liquidated” are more alike to these wonderfully happy phrases: the Great Depression, dot-com bubble, 1980s recession, or the Financial Crisis of 2008. The purported “boost to confidence” is undisguised by economic reasoning as nothing more or less than a period of wasteful malinvestment based on miscalculation of businesses misled by bank credit inflation.

Remarkably, the same weekly market wrap shows that the firm is, to a degree, aware of this bust:

“Looking back at the performance of stocks in the mid-1990s, we saw a balanced contribution to market gains from earnings growth and rising valuations, until valuations ultimately began to rise to excessive levels. At some point in the future, valuations will again overshoot.”

Unfortunately, the weekly market wrap makes no direct connection between the bust and the Fed’s bond purchases, but instead heralds Bernanke’s efforts as “an octane boost.” Of course, as long as explanations of economic policy rely on obscure, inappropriate car analgoies like “running out of gas,” “firing on all cylinders,” “fuel,” “octane,” and “engine,” we should expect that the understanding of the repercussions of credit expansion will be lost on financial firms of even the finest repute. These comparisons only bring to mind ideas of controllable machination in lieu of the dynamic change that is the real essence of a market society. As the character representing Hayek retorts to the character depicting Keynes in the YouTube rap video hit “Fight of the Century” (do watch, if you haven’t):

“The economy’s not a car/there’s no engine to stall/no expert can fix it/there’s no “it at all/the economy’s us/we don’t need a mechanic/put away the wrenches/the economy’s organic.”

So please, even if it means plugging your ears during your meeting with your financial advisor, listen to Rothbard, not the car talk.  Trevor Polk

From Open Europe news summary of September 20, 2013:

European Commission finance officials have tentatively reached an agreement to adjust the way the ‘structural deficit’ of eurozone countries is calculated. This could allow for an easing of austerity since more of the deficit could be seen as ‘cyclical’. WSJ

This would be hilarious if it were not so serious.  Since the deficit countries lack the courage to balance their budgets and, furthermore, have no reason to do so in a union without real enforcement, the euro elite have decided to redefine success by lowering the bar!  When will the rest of Europe wake up and realize that the EU and the EMU suffer from structural faults that cannot be avoided?  The EU is a socialist organization, whereby success is punished and failure is rewarded.  There is no way to avoid the inevitable consequences of such a structure.  Europe’s capital base and its world competitiveness is being undermined by its attempt to place entire countries on welfare.  Patrick Barron

From today’s Open Europe news summary:

The ECB’s Money Market Contact Group, a panel of industry members who advise the ECB, have called for the central bank to renew its three year long term refinancing operation (LTRO) next year due to fears over funding pressures as the current loans expire. WSJ

Once again, I’m (not really) Shocked!  Shocked! that politicians are prevailing upon a central bank to keep printing money.   Here is a short explanation of the LTRO.  It means that the European Central Bank can print money and funnel it to European banks so that THEY, and not the ECB itself, can monetize their own governments’ debt.  This is just one of the many backdoor methods by which the ECB violates the Maastricht treaty, which specifically precludes it from buying sovereign debt.  Patrick Barron

A friend asked me if I were surprised by Bernanke’s statement that the Fed would not end or even slow down it $85 billion per month bond purchases.  Here is my reply:

Not at all.  Bernanke knows that he has a Hobson’s Choice or, as Hayek said, a tiger by the tail.  If he keeps printing money, we risk hyperinflation. But if he slows down printing money, we get a recession.  The Fed will always choose to risk hyperinflation, because hyperinflation is not apparent until it is too late.  Thus, we get the inane statements that there is no sign of inflation.  Plus, there are no honorable central bankers anymore.  Paul Volcker was the last of a dying breed.   Here’s my dictum: “If you can print money, you will print money.”  The politicians will not appoint a central bank chairman that might do otherwise.  The political pressure to print money in order to buy the bonds of governments running massive deficits and keep the bubble economy inflated will always outweigh the political pressure to take our medicine and allow the recession to cleanse the economy of malinvestment.   My advice, prepare as best you can for hyperinflation.  Patrick Barron

Greece not meeting Troika’s agreement to cut civil service jobs

I’m shocked!  Shocked! (Not really) that the Greeks are not living up to their promises to cut civil service jobs in order to get the latest round of bailout money.  Wake up, Europe!  There is no enforcement mechanism!  The only real enforcement mechanism is to end the madness of the European Monetary Union.  It is nothing more than a socialist construct that depletes the capital of responsible people without their consent.  Patrick Barron