Radio Free Market

Let me disclose right up front that I have not yet completely read David A. Stockman’s seven hundred page bombshell of a book The Great Deformation: The Corruption of Capitalism in America.  It arrived a few days ago and I am making steady progress, however.  From several laudatory reviews, such as that by Detlev Schlichter, I know that my blood will boil as Mr. Stockman recounts much known insults to the free market system but with an in-depth knowledge, born of successful careers in politics and business, that few possess.  It is remarkable that someone who has been so successful navigating the modern financial system can also look objectively upon its inherent corruptions.

Nevertheless, as much as I know I will enjoy (if that is the right word) reading this book, I must disclose that I do not agree with Mr. Stockman’s prescription for curing the deformation disease.   You see, I read the last chapter first.  It is titled “Another Road That Could Be Taken”.  In it Mr. Stockman lists thirteen steps that he believes will prevent the “State-Wreck Ahead”.  There is little here with which I agree.  Mr. Stockman wants to retain the Fed, albeit with fewer powers, increase regulation, change the length of the terms of Congressmen, Senators, and the President and limit them to but one term, eliminate the electoral college, retain a means-tested safety net, and confiscate thirty percent of all the wealth in the nation to pay off the debt.  On the positive side he does want to eliminate FDIC insurance and ten major federal agencies and departments, separate the state and the free market, end bailouts and subsidies, and return defense spending to that of actual defense.  His prescription relies too heavily on retaining the superstructure of the current monetary system but supposedly controlling the beast with prohibitions on its powers.  There is much naiveté here from someone who has seen so much.

The cure for the great deformation: Adherence to civil and commercial law

The cure for the great deformation is rather simple.  The core of the problem lies in the government’s control of money and banking.  These vital services must be returned to the complete control of the free market and subject them to normal civil and commercial law.  No entity would be given a monopoly on money production.  Banking would be divided, naturally by the market, into deposit banking and loan banking as described by Murray N. Rothbard in The Mystery of Banking.  The government would prosecute any money issuer or banker who did not maintain one hundred percent reserves against demand deposits.  There are some Austrian economists who posit that in a free banking environment such laws would not need to be enforced and/or should not be enforced.  A person might accept that his banker lend out some of his demand money, thus maintaining less than one hundred percent reserves.  The problem with squaring this supposedly free market rule with civil and commercial law is that the money and/or checkbook deposit is created in order to be transferred at some point to others who have no way of knowing that they might be accepting a certificate or check backed by less than one hundred percent reserves.  The essence of a sound monetary system is that the commodity itself is the money; certificates and bank book entry demand deposits are money substitutes and may be redeemed for the commodity money upon demand.  It is fraud for a money issuer to produce a certificate or demand account that claims to represent a specific weight or volume of a commodity and yet hold less than that commodity in reserve.

Civil and commercial law does not recognize special privileges for any economic actor.  A banker could not refuse to redeem his demand instruments in specie without violating the law, for which he would go to jail and have both his business and personal assets distributed to his creditors.  Keep in mind that I refer here only to the deposit banking side.  On the loan banking side, the customer is not a bailor–that is, a person who retains ownership of goods but entrusts possession of them to another under a bailment, as is the case on the deposit banking side–but a lender of funds to his banker for a set term for which he receives interest.  There can be no absolute guarantee of the return of the funds, however, since the banker lends them out at risk.  The customer’s only security is in the banker’s capital account and reputation for having exercised previous good judgment.

Privileged immunity from law made the great deformation possible

Under this system most of the abuses that I expect to find detailed by Mr. Stockman could not exist, for it is the special privileges accorded to the Fed and the banking system in general that makes them possible.  As usual Ludwig von Mises says it best:

There was no reason whatever to abandon the principle of free enterprise in the field of banking…What is needed to prevent any further credit expansion is to place the banking business under the general rules of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of the contract.Human Action, p. 440; p. 443

No doubt government may still find a way to bail out and/or subsidize favored industries, but it could do so only with sound money, obtained from the citizenry through taxes or the bond market.  There is a natural limit to how much can be raised from either source.  The people do not like paying higher taxes, and the bond market would require higher interest rates for increased deficit spending.  Both avenues reveal to all that resources are limited and that government cannot call them into existence but must obtain them from the private sector one way or another.  Printing money masks this irrefutable fact, leading the people to believe that government spending not only is costless but actually beneficial.  Thusly, under the current fiat money system, which was made possible by removing money and banking from the control of civil and commercial law, the Fed printed $700 billion to fund its Toxic Asset Relief Program (TARP) in 2008 and has engaged in massive asset purchases under its quantitative easing program ever since.  None of this would have been possible under a sound money and banking system.  Furthermore, the government’s bailout of General Motors at the expense of the bond holders would never pass court muster even if government could raise the billions of sound money to finance the takeover.

Adherence to law returns sovereignty to the people

Placing money and banking under civil and commercial law may not appear to be dramatic as Mr. Stockman’s thirteen points, but it would change the nature of government’s relationship to the people, restoring our liberty and placing government as our servant and not our master.  Losses would be borne by the individuals involved and not made into a social responsibility of the entire body politic, ending massive financial moral hazard.  Governments could still squander our money to some extent, but we would no longer be blind to the claim that they are doing so for our own benefit.  Sound money would reveal the true nature of corrupt practices which government now claims are necessary to stimulate the economy to recovery.  A free democracy always requires constant vigilance by the people of its government’s actions.  Placing all society under civil and commercial law is a prerequisite for such vigilance.  Patrick Barron

From today’s Open Europe news summary:

Separately, the leader of Silvio Berlusconi’s MPs Renato Brunetta told Italian daily Il Messaggero, “The German Chancellor [Angela Merkel] is destroying the euro and Europe. After provoking two World Wars, Germany has triggered an economic war which has only caused destruction.”

This is what happens in any socialist organization.  When the internal misconstructions reveal themselves, the scapegoating begins.  The root cause is never identified, because no one wants to think and no one wants to admit that the entire project was an enormous mistake.  In this case, the Germans are being blamed for upholding the Maastricht Treaty restrictions on the European Central Bank’s prohibitions against buying sovereign debt.  These restrictions were supposed to prevent the very condition that has been allowed to happen; i.e., the socialization of debt among all the eurozone members.  But the irresponsible nations, like Italy, want the ECB to shower them with fiat money forever.  Today is never the right time to get one’s financial house in order. This accusation by the leader of that crackpot Silvio Berlusconi’s party is as odious as it is fallacious.  The Italians ought to be ashamed of themselves.  Germany should get out of the eurozone; then the irresponsible nations that remain will see the real enemy–themselves.  Patrick Barron

A wonderful interview with Godfrey Bloom, member of the European Parliament for Yorkshire and North Lincolnshire.

Godfrey makes so many good points, but I really liked his observation that the Middle Englishman may not know monetary policy but he knows that he is being cheated.  I also liked his question about why are we concerned that the price of bread doubles in a decade but not the price of housing.

Listen and hear more insights into real economics.  Thirty-two minutes well spent.

Pat Barron

[youtube http://www.youtube.com/watch?v=1Z8rDguEoYM]

How vulnerable is the US to financial ruin?  I say it is very vulnerable, and here’s the reason.  At the Bretton Woods Agreement in 1944 the US had promised to redeem gold at $35 per ounce, which meant that it could not increase outstanding dollars unless it received more gold to back the issue.  Keep that number in mind as I go over some vital monetary statistics.

The US owns 261.5 million troy ounces of gold.  M1, the narrowest measure of the US money supply (checking accounts and cash held outside bank vaults) stood at $2.523 trillion at the end of April 2013.  M2, the broader measure of the US money supply (which adds savings accounts and short term CDs to M1) stood at $10.526 trillion.  Now just do the math.  For the US to redeem M1 in gold without running out of gold, the price would have to be set at $9,648.  For the US to redeem M2, which I consider to be the true US money supply–since savings accounts can be transferred into one’s checking account at the click of a computer from home–, the price would have to be $40,252.  So, just think about that…since the Bretton Woods Agreement in 1944 the US has inflated the dollar by over one thousand times, from $35 per ounce to over $40,000 per ounce!

The US has been papering the world with its unbacked money to placate its growing dependent welfare class–eleven million on government disability and forty million receiving government issued food stamps, just to name two completely corrupt programs–and fund its worldwide military machine.  (The US just sent the Colorado Air Guard, which flies F-16s, to Jordan, just so you are not surprised by some future intervention.)

The implications of this massive act of irresponsibility are for all of us to ponder.  But who would deny that the US is extremely vulnerable to financial ruin, which can lead only to geopolitical chaos.  Patrick Barron

Re: Father of the Euro calls for new world currency

The man who convince the European Union to adopt the disastrous euro project now wants to up the ante and impose a new world currency.  This tactic was predicted by Ludwig von Mises as the final play by the inflationists who want to cut off any escape from the consequences of their fallacious monetary policies.  Note that “Mundell blamed the European Central Bank for aggravating the Euro because of tolerating the Euro appreciation against the US dollar, which led to further debts to many EU countries.”  In other words, Mundell wanted the ECB to be even more inflationist!  If this man were running a corporation, he would have been fired years ago and never entrusted again with managing the resources of others.  Yet, here he is…advocating even more of the same snake oil…and getting a hearing!

Patrick Barron

From today’s Open Europe news summary:

Influential Conservative MPs call for tougher rules on EU migrants’ access to benefits The Times reports that the Fresh Start Group of Conservative MPs has today published a new report calling on the UK Government to renegotiate a number of EU directives and regulations to toughen up the EU’s rules on migrants’ access to benefits. The MPs suggest that certain benefits should only be paid to those who have “contributed a significant amount to that state’s system” and that the Government should be allowed to claim back any benefits from a recipient’s home country if they had not paid into the British social security system. The Fresh Start Project report is drawn from a public evidence session of the APPG for European Reform and the subsequent report prepared by Open Europe, which acts as the Secretariat to the APPG. Open Europe: Work in Parliament Open Europe research: EU free movement Times

Requiring people to have “contributed a significant amount to that state’s system” is a worthy, short term goal, but let’s continue the thought process.  Why offer state-sponsored welfare at all?  Let each man contribute to his own, personal welfare program.  We old timers used to call this “saving for a rainy day”, “becoming self-reliant”, “accepting personal responsibility”, etc.  Until we return to these time-honored and time-tested personal virtues, state-sponsored welfare will be a cancer on the body politic…enticing the young to believe that they have a right to become a permanent burden upon their fellow man and have no need to prepare themselves for a world of scarcity and uncertainty.

Patrick Barron

All throughout his new book, The Great Deformation: The Corruption of Capitalism in America, David A. Stockman is critical of the Chicago School, especially its intellectual leader during the last half of the twentieth century, Milton Friedman. He captures the irony of the so-called free-market Chicago School on the very first page of his introduction, where he writes of the “capture of the state, especially its central bank, the Federal Reserve, by crony capitalist forces deeply inimical to free markets and democracy.”

This is a deep irony because it was Chicago School economists such as George Stigler who wrote of the “capture theory of regulation” when it came to the trucking industry, the airline industry, and many others. That is, they produced dozens of scholarly articles demonstrating how government regulatory agencies ostensibly created to regulate industry “in the public interest” are most often “captured” by the industry itself and then used not to protect the public but to enforce cartel pricing arrangements.

This was all good, solid, applied free-market economics, but at the same time the Chicago Schoolers ignored the biggest and most important regulatory capture of all — the creation of the Fed. The Chicago School simply ignored the obvious fact that the Fed was created as a governmental cartel enforcement mechanism for the banking industry — during an era when many other kinds of regulatory institutions were being created for the same purpose (i.e., “natural monopoly” regulation).

Not only did the Chicago School ignore this glaring omission from its “capture theory” tradition of research on regulation; it also ignored the realistic, economic analysis of political decision making that was an important part of the research of the two most famous Chicago School Nobel laureates next to Friedman — George Stigler and Gary Becker. Stigler and Becker published some important articles in the field that is better known as public choice, or the economics of political decision making. Friedman himself had long been an advisor to Republican politicians, so no one could credibly argue that Chicago School economists were naïve about the realities of politics.

However, if Friedmanite monetarism was anything, it was naïve about political reality. The fatal flaw of Friedman’s famous “monetary rule” of constant growth of the money supply in the 3-4 percent range was premised on the assumption that a machine-like Fed chairman would selflessly pursue the public interest by enforcing Friedman’s monetary rule. According to Friedman, Stockman writes, “inflation would be rapidly extinguished if money supply was harnessed to a fixed and unwavering rate of growth, such as 3 percent per annum.” This was the fundamental assumption behind monetarism, and it flew in the face of everything the Chicago Schoolers purported to know about political reality. In other words, Friedmanite monetarism was never a realistic possibility, for as Friedman himself frequently said of all other governmental institutions besides the Fed, a government institution that is not political is as likely as a cat that barks like a dog. Friedman’s monetary rule, Stockman concludes, was “basically academic poppycock.” He mocks the idea of a “monetary rule” as the “idea that the FOMC [Federal Reserve Open Market Committee] would function as faithful monetary eunuchs, keeping their eyes on the M1 gauge and deftly adjusting the dial in either direction upon any deviation from the 3 percent target.” This was “sheer fantasy,” says Stockman, and an extreme example of “political naivete.”

Stockman also takes Friedman and the Chicago School to task by writing that “Friedman thoroughly misunderstood the Great Depression and concluded erroneously that undue regard for the gold standard rules by the Fed during 1929-1933 had resulted in its failure to conduct aggressive open market purchases of government debt.” Stockman debunks the notion that the Fed failed to pump enough liquidity into the banking system by merely noting that “there was no liquidity shortage” during that period and “commercial banks were not constrained at all in their ability to make loans or generate demand deposits (M1). “Friedman thus sided with the central planners,” writes Stockman, in “contending that the … thousands of banks that already had excess reserves should have been doused with more and still more reserves, until they started lending and creating deposits in accordance with the dictates of the monetarist gospel.” As a matter of historical fact, Stockman points out, “excess reserves in the banking system grew dramatically during the forty-five month period, implying just the opposite of monetary stringency” (i.e., Friedman’s main argument). Thus, “there is simply no case that monetary stringency caused the Great Depression.”

The current Fed chairman, Ben Bernanke, based his academic career on the false Friedmanite theory of the Great Depression, Stockman writes. Bernanke’s “sole contribution to this truly wrong-headed proposition was a few essays consisting mainly of dense math equations. They showed the undeniable correlation between the collapse of GDP and money supply, but proved no causation whatsoever.” Thus, the old saying about “how to lie with statistics” was matched by “how to mislead with mathematical models.”

Stockman makes the case that the Austrian business cycle theory is a far more reliable source of understanding about the Great Depression. “[T]he great contraction of 1929-1933 was rooted in the bubble of debt and financial speculation that built up in the years before 1929,” he writes, and “not from mistakes made by the Fed after the bubble collapsed.” Friedman’s monetary theory, in other words, was not based on “positive economics” or historical reality, but was assumed to be “an a priori truth” merely because it was the “great” Milton Friedman who authored it. In any event, Friedman’s entire theory of the Great Depression has been “demolished” by his intellectual disciple, Ben Bernanke, who increased the excess reserves of the U.S. banking system from $40 billion to $1.7 trillion as of 2012 with little or no recognizable effect on the real economy.

Perhaps Friedman’s biggest sin, according to Stockman, was being the “brains” behind Richard Nixon’s executive order in 1971 that removed gold standard restraints on monetary printing. Friedman therefore assisted in the institutionalization of “a regime which allowed politicians to chronically spend without taxing,” he writes. Ironically, “the nation’s most famous modern conservative economist became the father of Big Government, chronic deficits, and national fiscal bankruptcy.” “For all practical purposes … it was Friedman who shifted the foundation of the nation’s money supply from gold to T-bills.”

Stockman describes Friedman’s political naivete as mind boggling. “Friedman never even entertained the possibility that once the central bank was freed from the stern discipline of protecting its gold reserves, it would fall into the hands of monetary activists and central planners” and that the Fed would “become a fount of rationalizations for incessant tinkering and intervention in financial markets.” Printing dollars with reckless abandon, the Fed fueled commodity booms in the 1970s, followed by busts and crashes, and then did the same with stock and real estate markets in the succeeding decades.

Re: Europe’s Green-Fuel Search Turns to America’s Forest

Just a few miles from the Yorkshire home of member of the European Parliament Godfrey Bloom sits a giant power plant that was converted at enormous cost from burning plentiful local coal to burning wood chips from Canada.  The old joke about “carrying coal to Newcastle” has been replaced by “carrying woodchips across an ocean to Newcastle”.

Madness!

Patrick Barron

Re: A Keynesian Victory, But Austerity Stands Firm, by Eduardo Porter

Dear Sirs:
Mr. Porter bases his Keynesian bias in favor of stimulus upon the fallacious concept that saving may be good for the individual but bad for the overall economy.  This simple proposition illustrates the fundamental difference between the Keynesian and Austrian schools of economics.  Fundamentally, Austrians are micro-economists; i.e., that all economics is conducted by individuals and macro aggregates have no life of their own.  Therefore, what is good for the individual IS good for the “economy”, because the individual IS the economy.  Furthermore, Austrians understand that saving does not mean that no one spends.  Saving means that real funds, representing real resources, are provided for business investment out of reduced current consumption.  Not only do GDP statistics fail to capture the fact that over seventy percent of the economy is business-to-business transactions, but an economy cannot recover much less grow without real savings.  Its capital base will shrink.  We can party hearty now, but we will become impoverished in the future.  To escape this fate, we must end monetary debasement and reduce government spending, taxes, and regulations.  Patrick Barron