A Historical Mistake
There once was a time when the science of economics – based on sound reasoning – concluded that economic liberalism was the best way to achieve lasting and growing prosperity. Classical economists may have been stumped by the theory of value, a problem satisfactorily solved by Carl Menger in the 1870's, but on the whole, their teachings were conducive to the adoption of free market capitalism. This ushered in an age of unprecedented capital accumulation and prosperity.
One other area in which 19th century economists were unfortunately deficient was monetary theory. In the battle between the banking and currency schools that culminated in the adoption of the Peel Act in the UK in 1844, the otherwise sound theorists of the currency school made a few crucial mistakes: they failed to recognize that deposit money plays exactly the same role as banknotes and specie, i.e., that it is in fact money, and they erroneously held that it was a good idea to grant a monopoly of money issuance to a central bank. As J.H. de Soto mentions, a third error, or rather omission, was that they failed to connect their monetary theory to trade or business cycle theory, i.e. they did not realize what the effects of monetary expansion on the economy's production structure are.
The Peel Act failed to fulfill its promise precisely because the deposit money problem was not properly considered. While the issuance of unbacked banknotes was curtailed by the act, the issuance of deposit money was not and so the boom-bust cycles which the adherents of the currency school wanted to stop continued to bedevil the economy.
Ludwig von Mises finally did in 1912 what his predecessors failed to do, in that he corrected the errors of the currency school, while building on its sound basic ideas and creating a coherent whole with the publication of the Theory of Money and Credit. Mises' conclusion, namely that the expansion of fiduciary media (deposit money not backed by money proper) was responsible for creating the business cycle made an ironclad case that sound money was the only basis for the realization of smooth economic progress.
Ironically, the Federal Reserve Act was passed just one year later, representing the first crucial step toward the abandonment of sound money in the US. Only eight years after the creation of the Fed, the biggest boom-bust cycle in the nation's entire history up to that point began.
It is highly unfortunate that the language barrier stood in the way of a wider reception of the work of the Austrian school in Anglo-Saxon nations at the time, otherwise a lot of mischief might have been prevented.
When Keynes published his anti-free market screed in the mid 1930's, governments finally got from economics what they always wanted. Instead of economists telling them that they could not achieve their goals with interventionism, here was finally a scientific fig leaf justifying intervention in the economy on a grand scale. Instead of the free market being hailed as the most efficient method of allocating scarce resources and as a system that should be left to work in as unhampered a fashion as possible, here was an economist claiming that government must stand ready to rectify the alleged 'mistakes' of the free market economy.
Intellectuals in turn were eager to be enrolled in support of statism, as this promised them pay and influence way above what they could have expected to achieve in a free market economy.
This is the program that has been adopted and been in force ever since. Not surprisingly, the nations that adopted it would never again replicate the strong economic growth seen in the late 19th century, have ever since been plagued by high institutionalized unemployment and have gone through secular boom-bust cycles of ever increasing amplitude. Along the way, there have been occasional attempts to roll back some of the more pernicious outgrowths of interventionism and mercantilism, while other errors were concurrently intensified (to name some examples, on the positive side of the ledger, trade was made more free, but on the negative side, all vestiges of sound money were dismantled step by step).
In the modern regulatory democracies of the West, we have today a state-capitalistic system drowning in an absurd thicket of regulations and burdened by onerous taxes, which are laid down in what are by now entire libraries of statutes and codes of impenetrable complexity. The economy rests on the quicksand of a central bank-led fractionally reserved banking cartel and the irredeemable fiat money it issues, which has created a gargantuan edifice of unproductive debt that leaves us continually dancing on the edge of an abyss. The vast growth in debt that has commenced with the abandonment of the last link the monetary system had to gold in the early 1970's has coincided with economic growth that was markedly lower than the growth experienced prior to this enormous credit expansion.
This relative weakening in growth happened in spite of enormous technological progress and the vast improvements in economic productivity it made possible. In short, the credit boom and money supply inflation have deprived us of enjoying the fruits of the advance in productivity to its full extent.
Finally, after four decades of unbridled credit expansion, we have arrived at the point where evidently so much capital has been consumed by malinvestment that economic crisis has seemingly become a permanent condition.
However, instead of reflecting on the errors that have led us to this juncture and proposing a different approach, both the academic economic orthodoxy and policymakers are simply repeating the same mistakes all over again, only on an even greater scale.
Euro Area Debt Crisis Galvanizes Interventionists
The latest iteration of the ongoing crisis in the euro area is an interesting test case in that Germany seems to want to resist taking the easy way out. Whether this resistance will be kept up in the face of an ever worsening crisis remains to be seen. Germany can certainly not really claim to be in possession of the moral high ground, given it was among the first nations to break the deficit and debt limits of the Maastricht treaty in the early 2000ds. Even now, Germany's public debt is way above the upper limit set by the so-called growth and stability pact.
Nevertheless, as we have chronicled here over recent months, Germany and the ECB (which has been modeled after the German Bundesbank in terms of its statutes), are both strongly opposed to debt monetization as a 'solution' to the current sovereign debt crisis. Instead they insist that overindebted governments should bite the bullet and adopt a modicum of fiscal responsibility.
Interventionists everywhere are incensed over this stance, demanding immediate action. New plans are proposed every other day as to how the ECB might get around the pesky legalities that keep it from cranking up the printing press.
Below is a , where yet another allegedly 'cunning plan' is proposed for the ECB to throw its principles overboard via a legal loophole:
“One intriguing idea floating around Washington: if the ECB can’t bring itself to bail out Italy direct (sovereign credit risk, no expertise in setting lending conditions) it could in theory, according to Article 23 of its protocol, lend vast amounts to the IMF.
The Fund would then lend them on to Italy, taking on the credit risk and enforcing conditions – both of which are what it is there for.
This would require the ECB’s red lines on financing bailouts to crumble, and might cause the odd raised eyebrow, if not explosion of disbelief, among the IMF’s more assertive emerging market shareholders. But what if it is that, or another Great Depression?”
Note the unquestioned assumption that unless the ECB proceeds to print gobs of money, there will be another 'Great Depression'. This indicates that the author believes that wealth can be created by money printing. If so, then we must ask: why has the expansion of the euro area's true money supply by 135% over the past decade ended in crisis instead of leading us to the land of Cockaigne?
Another quite funny missive reaches us via the always amusing Keynesian statist Brad DeLong, who argues that given the euro area crisis escalation, the US Federal Reserve should immediately proceed to crank up its printing press. In terms of sheer lunacy his proposal is hard to beat:
“Time to Spread Foam on the Runway: The Federal Reserve Needs to Act Now to Firewall Off the Eurocrisis
I have been complaining for some time now that Reinhart and Rogoff think that the time is always 1931 and that we are always Austria – that the great fiscal crisis is about to erupt and send us lurching down toward Great Depression II. Well, right now guess what? The time is 1931, and we are Austria.
The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip. The Federal Reserve Needs to do so now.”
Apparently it hasn't occurred to de Long that if the Federal Reserve did that, another step a little further back into history might be taken – 'we' might end up 'being 1923 Weimar' instead of '1931 Austria'.
De Long approvingly quotes an article by Paul Krugman, who bemoans the possibility of the eurocratic moloch falling apart:
“Seriously, with Italian 10-years now well above 7 percent, we’re now in territory where all the vicious circles get into gear — and European leaders seem like deer caught in the headlights. And as Martin Wolf says today, the unthinkable — a euro breakup — has become all too thinkable:
A eurozone built on one-sided deflationary adjustment will fail. That seems certain. If the leaders of the eurozone insist on that policy, they will have to accept the result.
Every even halfway plausible route to euro salvation now depends on a radical change in policy by the European Central Bank. Yet as John Quiggin says in today’s Times, the ECB has instead been part of the problem.
I believe that the ECB rate hike earlier this year will go down in history as a classic example of policy idiocy. We would probably still be in this mess even if the ECB hadn’t raised rates, but the sheer stupidity of obsessing over inflation when the euro was obviously at risk boggles the mind.”
First of all, who's to say that the euro is worth saving? If saving the euro depends on the central bank rewarding the fiscal profligacy of member nations by monetizing their debt, then obviously we'd be better off without the euro. These nations could then attempt to inflate themselves to prosperity on their own.
Regarding the ECB rate hike earlier this year, it is really hard to argue that it makes any difference whatsoever if the administered interest rate sits at a minuscule 1.25% or a minuscule 1.5%. How can that have any bearing on the insolvency of peripheral governments? Moreover, whether the rate is at 1.25% (where it now is again after the recent rate cut) or 1.5% – in both cases it is well below the official inflation rate of 3%, in other words it represents a negative real interest rate. The ECB is definitely not pursuing a tight monetary policy either way.
The euro system has proven a badly constructed self-destructive system, just as its opponents have claimed from day one. In fact, they have pointed this out well before the euro was introduced. Alas, it does not logically follow from this that it is worth attempting to 'save' it by means of inflation, which is what all the above quoted people evidently want.
The crucial point at issue is whether economic pain can be avoided. We would argue it can not be avoided, since the correction of the errors of the boom can not possibly be 'painless'. The choice is really (leaving aside the details) over whether one is willing to suffer pain in the short term in exchange for long term gain by laying the foundations of a sustainable expansion, or whether one goes down the path of inflation, which might alleviate some of the short term pain but at the price of an even bigger bust down the road. It should always be added to this that the 'deflationary adjustment' that is held to be such a bogeyman by everyone would not represent a problem if not for the fact that the market economy is today hampered by such a plethora of regulations. The rigidities of the labor market for instance ensure that unemployment will increase unnecessarily sharply during recessions.
Lastly, the circle can not be squared. The choices presented by most analysts are always assuming that the giant leviathan the State has become must be preserved at all cost, if not enlarged even more. The fact that governments suddenly find it difficult to obtain financing for their vast debts is almost held to be an affront: how dare the markets refuse to bid for the debt paper of States? The debate ultimately always revolves around the question: how can the status quo be preserved? What can be done to preserve the privileges and exalted positions of millions of politicians, bureaucrats and the intellectual elites in their employ that are the main purveyors of statist propaganda? How can we keep all those precious, irreplaceable people feeding at the trough in peace?
As the speed with which the referendum gambit by George Papandreou was smothered showed, the bureaucratic and monetary elites are deep down deadly afraid that the mob might one day show up and holler for a few heads. In his recent analysis of the euro area crisis (entitled 'Thinking through the unthinkable'), the FT's Martin Wolf for instance writes:
“Efforts to bring the crisis under control have failed, so far. True, the eurozone’s leadership has disposed of George Papandreou’s disruptive desire for democratic legitimacy. But financial stress is entrenched in Italy and Spain, etc….”
Phew! They scuppered that ill-conceived 'disruptive desire for democratic legitimacy' in the nick of time! Wolf at least acknowledges in his latest piece that “it is essential to restore external competitiveness and economic growth”.
Alas, look at it in its entirety – it is all about solutions imposed from above – either a huge dollop of inflation, or a 'deflationary adjustment in the periphery alone', or a permanent transfer union or, lastly, 'the end': debt defaults and a break-up. Wolf is even correct in his description of the political obstacles and economic difficulties involved in all of these options. Inflation is opposed by Germany (he doesn't say that it is anyway not a solution – in his eyes, it apparently is), grinding the peripherals down with years of austerity is not politically doable (at least not unless accompanied by the types of reforms that promise to lay a foundation for future growth), a permanent transfer union is contrary to the EU's treaties and not politically doable in the 'core', and debt defaults and a break-up would be a messy affair.
What is missing from our point of view is a recognition of the root causes of the crisis – and with it an idea of what a way forward could look like. The problem of course is that the one thing that is really 'unthinkable' for all the pundits and policymakers alike is the institution of an unhampered market economy with a free banking system using a market chosen money. This is the one solution to the crisis that no-one wants to even talk about – it is simply deemed 'too radical'.
Instead they all propose new variations on central planning, allegedly 'better ones' than the ones that have just failed. Alas, it becomes ever more difficult to keep the status quo alive the more of its wealth-generating host the statist parasite consumes.
Today an auction of t-bills in Italy went 'surprisingly well' (these auctions somehow always do go well, even Portugal and Ireland had successful auctions up to the eve of declaring their insolvency; readers know what we think about that). The ECB was also seen intervening in the market again and as a result, yields on Italian bonds declined back below the 7% level. However, Italy had to offer the highest yield for the 12-month bills in 14 years.
“Italy paid its highest yield in 14 years to sell 12-month debt on Thursday and although there was relief the sale went smoothly, worries remained that Italy's borrowing costs were unsustainable. The country could face a more rigorous test when it sells up to 3 billion euros of five-year bonds next week, as it struggles to form a new government aimed at restoring market credibility.
Gross yields at Thursday's auction jumped to 6.09 percent — the highest since September 1997 — from 3.57 percent at a sale of 12-month paper in October. That was more than twice the yield on 30-year German Bunds in the secondary market.
"It is better than expected but still not sustainable. There will be some relief that it hasn't printed with a 7 percent (yield) but the idea that Italy can carry on with 6.1 percent for one-year paper is a joke," said Marc Ostwald, an analyst at Monument Securities.
The Treasury sold the full targeted amount, with analysts saying traditional domestic demand for short-term paper as well as European Central Bank bond buying in the secondary market, which helped stabilise Italian yields, had aided the sale.
Italian two-year yields fell back below those of 10-year bonds and were last 65 basis points down on the day at 6.746 percent after the auction. Two-year paper on Wednesday yielded more than 10-year debt for the first time since the euro was launched, reflecting investors' concerns they may not get their money back.
Italian 10-year yields were down 29 basis points at 6.96 percent, just below the 7 percent level analysts see as unsustainable for the country to finance its 2 trillion euro
"For T-Bills there is always domestic demand involved so it's a lot easier for Italy to find buyers to lower the exposure," said Alessandro Giansanti, a strategist at ING.
"But the main point to be concerned about here is the huge 250 basis point jump in yields compared to the last time to roughly 6 percent. If this carries on then next month's yield could be 8.5 percent, which cannot happen."
From the above we conclude that while Italy is by no means out of the woods yet, the immediate danger of a worsening spiral of yield curve inversion and plunging bond prices has been averted. For how long remains to be seen.
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
5 Responses to “Interventionists Are Manning The Barricades”
Most read in the last 20 days:
- Gold Price Skyrockets in India after Currency Ban – Part III
When Money Dies In part-I of the dispatch we talked about what happened during the first two days after Indian Prime Minister, Narendra Modi banned Rs 500 and Rs 1000 banknotes, comprising of 88% of the monetary value of cash in circulation. In part-II, we talked about the scenes, chaos, desperation, and massive loss of productive capacity that this ban had led to over the next few days. Indian prime minister Narendra Modi – another finger-wagger, as can be seen in this...
- Gold Price Skyrockets in India after Currency Ban – Part IV
A Market Gripped by Fear The Indian Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes would no longer be legal tender. Linked are Part-I, Part-II and Part-III updates on the rapidly encroaching police state. The economic and social mess that Modi has created is unprecedented. It will go down in history as an epitome of naivety and arrogance due to Modi’s self-centered desire to increase tax-collection at any cost. Indian jewelry...
- A Note on Gold and India – What is Driving the Gold Price?
Hidden Motives It is well-known that India's government wants to coerce its population into “modernizing” its financial behavior and abandoning its traditions. The recent ban on large-denomination banknotes was not only meant to fight corruption. Obviously, this very bad Indian has way too much cash. Just look at him, he looks suspicious! Photo via thenewsminute.com In fact, as our friend Jayant Bhandari has pointed out, fresh avenues for corruption ...
- Gold Price Skyrockets in India after Currency Ban – Part V
A Brief Recap India's Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes will no longer be legal tender. Linked are Part-I, Part-II, Part-III, and Part-IV, which provide updates on the rapidly encroaching police state Expect a continuation of new social engineering notifications, each sabotaging wealth-creation, confiscating people’s wealth, and tyrannizing those who refuse to be a part of the herd, in the process destroying the very backbone of the...
- Attaining Self-Destruct Velocity
Bad Monday Some Monday mornings are better than others. Others are worse than some. For one Amazon employee, this past Monday morning was particularly bad. No doubt, the poor fellow would have been better off he’d called in sick to work. Such a simple decision would have saved him from extreme agony. But, unfortunately, he showed up at Amazon’s Seattle headquarters and put on a public and painful display of madness. Good-bye cruel world! On this our planet,...
- All Aboard! Trump’s Express Train to the Future
Free Money! BALTIMORE – Last week, the Dow punched up above 19,000 – a new all-time record. And on Monday, the Dow, the S&P 500, the Nasdaq, and the small-cap Russell 2000 each hit new all-time highs. The last time that happened was on the last day of December 1999. Ironically, two events that were almost universally expected to trigger large stock market declines were followed by quite rapid and strong gains. Would the market have fallen if Hillary Clinton had won...
- India's Currency Debacle – An Interview with Jayant Bhandari
A Major Crisis Last week Jayant Bhandari related the story of the overnight ban of certain banknotes in India under cover of “stamping out corruption” (see Gold Price Skyrockets In India after Currency Ban Part 1 and Part 2 for the details). Banned 500 rupee banknotes The problem is inter alia that the sudden ban of these banknotes has hit the Indian economy quite hard, given that 97% of all transactions in the country are cash-based. Not only that, it has...
- Will the Swamp Swallow Trump?
Permanently Skewed TRUMP HOTEL, New York – Trump’s rambling army – professionals, amateurs, camp followers, and profiteers – is marching south, down the I-95 corridor. There, on the banks of the Potomac, it will fight its next big battle. Lieutenants in Trump's army: Bannon, Flynn & Sessions Photo credit: Drew Angerer / AFP Here at the Diary, we do not like to get involved in politics. But this is a special time in the history of our planet – a...
- There Are Two Types of Credit — One of Them Leads to Booms and Busts
Stumped by the Bust In the slump of a cycle, businesses that were thriving begin to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs. What has caused the bust? The modern-day economic orthodoxy continues to be unable to provide...
- Gold Bull Market Remains Intact – Long Term Fundamentals Outweigh Short Term Market Gyrations
A Strong First Half of the Year, Followed by Another Retreat In early 2016 gold had a big bull run. The precious metal rose close to 25% this year, pushed higher in a summer rally that peaked on July 10th. Gold experienced a bumpy ride over the remainder of the summer though, as investors became increasingly concerned about a potential rate hike by the Federal Reserve. Uncertainty returned to gold market and has intensified further since then. Initially, gold rallied sharply...
- Too Early for “Inflation Bets”?
The Trump Trade After 35 years of waiting... so many false signals... so often deceived... so often disappointed... bond bears gathered on rooftops as though awaiting the Second Coming. Many times, investors have said to themselves, “This is it! This is the end of the Great Bull Market in Bonds!” The long bond's long cycle – red rectangles indicate when the post 1980 bull market was held to be “over” or “over for sure” or “100% over”, etc. We have...
- US True Money Supply Growth Jumps, Part 1: A Shift in Liabilities
A Very Odd Growth Spurt in the True Money Supply The growth rates of various “Austrian” measures of the US money supply (such as TMS-2 and money AMS) have accelerated significantly in recent months. That is quite surprising, as the Fed hasn't been engaged in QE for quite some time and year-on-year growth in commercial bank credit has actually slowed down rather than accelerating of late. The only exception to this is mortgage lending growth - at least until recently. Growth in...