Radio Free Market

In this under four minute video Godfrey Bloom, member of the European Parliament for Yorkshire and North Lincolnshire, explains the obvious–that the euro was doomed from the start and those who advocated it knew that it could not succeed without a centralized fiscal policy, meaning a centralized European government.  From the very beginning of what is now the EU, with the establishment of the European Coal and Steel Community in the early 1950’s, there were explicit calls for the a centralized European government and an end to national governments.  The problem is that few people in Europe, outside of a political elite who would benefit via jobs and perks, actually want a centralized European government.  That is why there are so few referendums and, when the people are asked about joining a centralized European state, the answer always is NO.

Please see Godfrey’s latest speech – http://tinyurl.com/ou25k87

Below is the link and video to the full one hour presentation delivered by Godfrey Bloom, member of the European Parliament, and me on May 7th of this year.  The speech itself took only ten minutes or so to deliver. The rest of the hour was spent in Q&A, which allowed us to make further important points about the solution to the worldwide debt crisis.  In the introduction Godfrey explains our thesis that Germany holds the key: it can leave the European Monetary System, reinstate the deutsche mark, and tie the new DM to its gold reserves.  This non-coercive act will change the international monetary landscape toward sound money.

Patrick Barron

[youtube http://www.youtube.com/watch?v=B_w6e_3SU2g]

Re: Crime Rises in Spanish Countryside

First the Spaniards lock up their public dust bins so that tourists cannot see impoverished citizens searching or food scraps.  Now thieves are descending upon farms.  As one farmer says:

“You don’t steal eight rabbits to sell them,” said Rosa Marques, 43, who grew up in this village of 800 and is one of the organizers of the patrols. “You steal eight rabbits for food.”

Will the wonders of a common currency–the euro–never end?   Patrick Barron

By Patrick Barron

It is commonly believed that the Federal Reserve Bank controls the money supply, but this is not exactly correct.  There are two definitions of the money supply.  The narrowest measure of the money supply is M1, which consists of money outside bank vaults (in people’s pockets, cash registers at businesses, etc.) plus bank checking accounts.  The broader measure of the money supply is M2, which adds short term bank savings accounts to M1.  As of March 31, 2013, M1 was $2.490 trillion and M2 was $10.561 trillion.

The Federal Reserve Bank creates reserves, not necessarily the same thing as money.  In fact, reserves are not counted either in M1 or M2.  Reserves belong to the banks themselves and are kept either in the form of cash in bank vaults or in a checking account, called a “reserve account”, at one of the twelve branches of the Federal Reserve Bank.  Most reserves are in the latter form.  As of March 31, 2013 total bank reserves were $1.811 trillion, out of which only $.051 trillion was in the form of cash in bank vaults.

Banks are required to keep minimum reserves, called “required reserves”, based upon the total size of their customers’ checking and savings accounts.  Reserves held by banks that exceed their minimum requirement are called “excess reserves”.  Ours is a fractional reserve system, meaning that banks are required to hold only a small percent of reserves to satisfy the anticipated demands of their customers for actual cash.  As of March 31, 2013 excess reserves dwarfed required reserves.  Required reserves totaled only $.113 trillion, whereas excess reserves were $1.698 trillion.  Historically excess reserves were a trivial amount, seldom exceeding $.002 trillion.

Bank Lending Creates Money

Banks create money through their lending operations.  When they make a loan, they credit the borrower’s checking account rather than hand over actual cash.  This is important, because it explains the inflationary danger from the current mountain of excess reserves.  Banks always seek to maximize profit, therefore they seek to lend as much money as possible.  One of the constraints on their ability to lend is the amount of excess reserves they have to support the newly created checking account balances that emerge from their lending operations.  Without new reserves the money supply cannot grow.  But even with new reserves, money supply growth depends upon the additional step of bank lending.

Currently the banks are not expanding their loans, due to another constraint upon their operations–the size of their capital accounts.  When banks write off bad loans, their capital accounts diminish, and the ratio of their capital account (the numerator) to the size of their total assets (the denominator) falls below regulatory (and prudent) minimums.  In recent years the banks have been writing off bad loans from the subprime lending bubble era.  Their capital accounts are under stress from this source.  Plus, the banking regulators are contemplating requiring banks to hold a higher ratio of capital to total assets.

The banks have three options for meeting their capital requirements: one, sell new capital; two, reduce the size of their total assets; or three, allow for retained earnings from their operations to slowly rebuild capital.  The quickest way out of their capital problems would be to sell more capital to investors, but this is difficult in today’s politicized banking market.  Therefore, despite the massive excess reserves, the money supply is unlikely to expand.  This is the reason that all the world’s central banks are seeing their newly created reserves simply become “excess” reserves on their own books.

The Arithmetic Potential of Excess Reserves

But, let’s calculate the potential size of the money supply SHOULD the banks start to lend more, which would move reserves from the “excess” category to the “required” category.  One way to do this is to assume that banks will utilize their reserves as efficiently in the future as they have in the past, eventually moving all reserves into the “required” category.  Since we know the ratio of current “required reserves” to M1 and M2 and since we know the size of total reserves,  we can calculate the potential size of M1 or M2 using the same ratios.

Right now $.113 reserves support $2.489 trillion of M1; therefore, the ratio of required reserves to M1 is 4.54%.  Should all $1.811 trillion total reserves move into the “required” category at the same efficient manner, M1 could expand to $39.9 trillion.  Those same $.113 required reserves support $10.561 trillion of M2; therefore, required reserves to M2 is only 1.07%.  If all $1.811 trillion of reserves were utilized to support bank lending operations and, therefore, expand the money supply, M2 could go to $987.0 trillion!

The Political Elite Want More Bank Lending

Remember, the banks want to make loans and they want to use all of their reserves as efficiently as possible to support their lending operations, of which a byproduct is an increase in the money supply.  There is no doubt that increasing the money supply to its full arithmetic possibilities would cause huge price increases, probably even hyperinflation and the collapse of the dollar as a desire medium of exchange.  Currently capital requirements prevent banks from expanding their lending and increasing the money supply.  But there is no doubt that the political elite view increased lending as a desirable goal to reviving the economy.  Where there is a political will, there usually is a political way.

The Fed’s determination to kick start the economy with injection of reserves has failed so far.  Let’s hope that the Fed comes to its senses and starts to pull some of these reserves from the system through sales of its own assets.  This may trigger increases in the interest rate, but so be it.  A recession is preferable to total monetary collapse, which is a real possibility should the Fed persist in its obsession with quantitative easing and the political elite find a way to release the banks from the constraints imposed by capital requirements.

The Solution to the Worldwide Debt Crisis

by Godfrey Bloom, MEP, and Patrick Barron

May 7, 2013

European Parliament, Brussels

The eurozone debt crisis is the logical and inevitable result of a worldwide delusion that central bank credit expansion is a cure for debt, and that it will stimulate economies to higher levels of prosperity out of which ever increasing welfare entitlements may be paid.  The truth is that credit expansion is the cause of the current debt crisis and all its ancillary evils, which include high unemployment, a lower standard of living, and the threat of civil unrest.  Central banks have distorted the market mechanism in which the interest rate brings the savings of real resources by real people into harmony with the credit demands of business and industry, creating a sustainable economic process.  It is replaced by phony liquidity, which encourages longer term investments which cannot be completed due to lack of resources with which to complete them.

The euro project, which is based upon this delusion of the benefits of unlimited credit, has created a moral hazard monster, whereby risk and profligacy are encouraged and prudence and thrift are punished and vilified.  The EMU is a multi-national “tragedy- of-the-commons”, a well-known economic term that describes the disastrous consequences that follow from a failure to secure property rights in order to protect a commonly held resource from being plundered to extinction.  The commonly held resource is the euro itself.

The “misconstruction” of the EMU rewards high sovereign state deficits with cheap euros, created out of thin air and in unlimited quantities by the ECB.  This is the “tragic” mechanism through which moral hazard is institutionalized in Europe.

Moral hazard, brought forth by lower borrowing cost, is the logical result of the implicitly and even explicitly stated promise that the EMU would prevent sovereign debt default by any EMU member.  The result was an orgy of speculative lending and extensions of welfare state benefits.

Instead of funding sound, profitable, productive investments, the profits of which would amortize and extinguish the debt incurred, this credit expansion funded speculative loans to overbuilt industries and increased welfare “entitlements”.  There are no profits from which debt can be amortized and eventually extinguished.  On the contrary, both speculative lending and welfare benefits can be sustained only by even more debt or higher taxes.  There are natural limits to both, and, as a wise man once said, “that which cannot continue will not continue”.  He also pointed out that “reality is not optional”.  We must look upon the world the way it really is.

It may seem as if every nation of the world subscribes to the “more credit” solution to our current crisis, but this is not so.  In fact there is one nation–and it belongs to the EMU–that has objected to the EMU’s credit expansion policies from the very beginning.  This nation’s representatives on the ECB board resigned in protest to EMU policy and voted against ECB bailouts of sovereign debt with fiat euro credit expansion.  This nation is one of the great trading and exporting nations of the world and a nation with the second largest supply of gold in the world, upon which it could base sound, gold-backed money of its own.  Furthermore, ninety years ago this nation experienced the disastrous consequences of the very policies currently pursued by the EMU.  And this country, alone in the EMU, has balanced its government’s books.  This country, of course, is Germany.

Germany’s capital, its accumulated wealth, is being plundered via this euro debt expansion process that justifies itself in regulation, law, and treaty.  Its effects are delayed and, for awhile, obscure, so that cause-and-effect are not immediately seen.

It takes time for this “Money-Created-Out-of-Thin-Air” to work its way from initial creation to having the effect of diluting the savings of productive people, causing price inflation and ruining the purchasing power of the euro.  This monetary dilution makes the entire euro monetary system weaker.  Because of the inherent time delay, most observers fail to see this cause and effect, but it is there.  It is always there.

Even some who DO understand the effect on Germany, which includes many prominent Germans themselves, justify the plunder out of a false sense of “European Brotherhood” or, even worse, a lingering sense of German war guilt.  But all this is false.  There is no benefit to Germany’s European brothers that would accrue from the destruction of Germany’s capital base.  This is a political cult born of the delusion that fiat euro credit is beneficial and limitless.  But there is always a limit.  Reality is not optional.

Europe’s prosperity and its very survival as a free and democratic continent depend upon German industry.  As Germany goes, so goes Europe.  And, as Europe goes, so goes America and, ultimately, the world.  At this crucial point in history, which is ruled by great delusions, the entire edifice of Western liberty hinges on Germany.

The solution to the euro debt crisis and also the worldwide debt crisis is for Germany to leave the EMU, re-establish the DM, and tie the DM to gold.  These actions are the right of Germany as a sovereign nation and are non-coercive–in that no other nation is forced by Germany to take any specific action.  If Ludwig Erhard could do it in 1948 under even more dire political conditions as existed at the time, Wolfgang Schauble and Jens Weidman can do it today.

The beneficial consequences of reinstating sound money in Germany can hardly be overstated.  The fiat money house of cards depends upon there being no better alternative money for international trade.   By reinstating the DM and backing it with gold, international traders will migrate to the DM as their currency of choice and away from dollars, yen, euros, and yuan.  Demand for the DM will increase, causing German production costs to fall and German industry to become even more competitive.  The only way for the rest of the world to prevent flight from their currencies to the DM will be for them to emulate Germany’s example; i.e., stop inflating their currencies and tie them to their own gold reserves.

I hope you can see that this one non-coercive, peaceful act by a sovereign Germany has the power to change the way the international monetary system works.  Rather than each central bank trying to weaken its currency against all others, it will be forced by the market to strengthen its currency or experience inflation and loss of industrial competitiveness.  The destructive cycle of money debasement will be replaced by a virtuous cycle of money improvement, all directed by market forces and rational self-interest alone.

We call upon German patriots to explain this to their countrymen.

Germany must leave the EMU and reinstate a golden DM.  The world teeters on the brink of monetary collapse, the consequences of which undoubtedly will be massive poverty and possibly revolution and war.  Germany can save itself, save Europe, and save the world simply by exercising its right as a sovereign country to control its own currency.  It will set an example for the world to follow…and follow it will.

From today’s Open Europe news summary:

UK outvoted over €7.3bn top-up to the 2013 EU budget EU finance ministers yesterday agreed to provide an extra €7.3bn in additional funding for the 2013 annual EU budget, despite the UK, Finland and the Netherlands voting against. The UK’s share of the additional funding will be around €1bn, although this could increase further as the Commission has requested a total of €11.2bn. Chancellor George Osborne described the move as “unacceptable”, while Dutch Finance Minister Jeroen Dijsselbloem argued that it would necessitate greater cutbacks in Dutch domestic spending. FT Euractiv NRC EU Observer Volkskrant

So, by majority vote the EU decides to spend more money and force its objecting members to pony up their share.  How can any nation that values its financial future allow itself to remain a part of such an organization?  This is a classic example of “moral hazard”, whereby risks increase because others will foot all or part of the bill.  Moral hazard is institutionalized in the EU.  In other words, the EU is BASED upon moral hazard. There is no way that the EU can exist WITHOUT moral hazard.  Therefore, the EU will collapse; it is only a matter of time.  Patrick Barron

Stop all the clocks, cut off the telephone, prevent the dog from barking with a juicy bone, silence the pianos, and let the aeroplanes circle moaning overhead. Then read this article by Martin Sibileau:

• A View from the Trenches: A short history of currency swaps

(Here’s the PDF version.)

Yes, it is an exceedingly technical article, and I would point-blank refuse to sit a 2-hour examination paper based upon it. However, if you wrap a wet towel around you’re head long enough the article makes sense, particularly its last paragraph, and especially its last line:

“Over almost a century, we have witnessed the slow and progressive destruction of the best global mechanism available to cooperate in the creation and allocation of resources. This process began with the loss of the ability to address flow imbalances (i.e. savings, trade). After the World Wars, it became clear that we had also lost the ability to address stock imbalances, and by 1971 we ensured that any price flexibility left to reset the system in the face of an adjustment would be wiped out too. This occurred in two steps: First at a global level, with the irredeemability of gold: The world could no longer devalue. Second, at a local and inter-temporal level, with zero interest rates: Countries can no longer produce consumption adjustments. From this moment, adjustments can only make way through a growing series of global systemic risk events with increasingly relevant consequences. Swaps, as a tool, will no longer be able to face the upcoming challenges. When this fact finally sets in, governments will be forced to resort directly to basic asset confiscation.“

As they say in cheap novels, you have been warned.