Tuesday, June 19, 2018

China's Currency Manipulation Does NOT Harm Its Trading Partners



Americans are being told that China's currency manipulations are causing harm to its trading partners, America being the main victim. Nothing could be further from the truth. China's currency manipulations certainly cause harm, but to China itself!
No country can cause harm to another by adopting any economic intervention. All economic interventions cause harm only to the country that adopts them. This applies to subsidies of home industries, quotas restricting import volumes, tariffs imposed on imports, and currency manipulations.
A nation typically manipulates its currency by giving more of its own currency in exchange for the currency of other countries. Thus foreign importers can buy more goods per unit of currency exchanged. In other words, if the free market exchange rate between the dollar and the yuan is six yuan per dollar, an importer would be able to buy goods costing six yuan by tendering one dollar. If the Bank of China arbitrarily decides to boost imports, it can give eight or ten yuan for each dollar presented. Chinese goods drop in price on the American market.
Protectionists such as President Trump view this as harm, but where exactly is the harm? A Chinese good that previously cost a dollar now may be purchased for sixty or eighty cents. Our American standard of living goes up at China's expense! The extra money in Americans' pockets may be used to consume or invest more. This is a very strange definition of harm.
The real harm occurs in China. The Bank of China sets off price inflation in its own country. It may try to mitigate this inflation by raising the interest rate on its own debt in order to withdraw the extra yuan from circulation. This is known as "sterilization". It then appears as if China has achieved greater exports with no price inflation. However, China's debt rises. Eventually holders of Chinese debt will desire to draw down their yuan-denominated debt. Demand for yuan for spending purposes will increase. At that point China will be faced with a dilemma. Either it can raise the interest rate high enough to entice enough marginal holders of debt to roll over their holdings or it can print yuan. The former causes a recession and the latter causes price inflation.

There is no such thing as a free lunch or an economic intervention that causes harm to others and not one's own country.

Sunday, May 20, 2018

The market provides its own punishment for irrelevant discrimination

My letter to the Mercatus Center:


Excellent points by Omar Ahmad Al-Ubaydli, but aren't all forms of irrelevant discrimination self-correcting and self-penalizing? If a company hires only beautiful workers and ignores ugly ones who may be better qualified, won't this company suffer in the market place? Same with height, etc. If the stockholders of a company accept lower dividends because they like the idea that their company employs lots of beautiful people, so what? They are the ones deciding to accept lower dividends. In other words, let the market work and leave people alone.

Wednesday, March 21, 2018

Unilateral Free Trade Would Benefit All UK Citizens


From today's Open Europe news summary:

Removing tariffs post-Brexit could see prices fall up to 1.2%, suggests new study

According to a report by the Institute of Fiscal Studies, UK households could see prices fall by around 0.7-1.2% if the UK were to eliminate tariffs on all goods after Brexit. The report noted, “This compares with the estimated 2% increase in prices that followed the depreciation in Sterling in the wake of the referendum result. This suggests that the scale of ‘quick wins’ from running an independent trade policy is relatively small.” The report also argued that removing tariffs could “be very damaging for some UK industries in the short run.” The director of the IFS, Paul Johnson, said, “If we leave the customs union, we can come to our own trade deals with other countries, we can reduce tariffs. But even if we reduce that as much as possible, the effect on prices will be really quite small relative to what is still a big cost of leaving the customs union because it would make trade with the rest of Europe so much more expensive.”
Separately, UK inflation rate fell to 2.7% in February, down from 3% in January. This is also closer to the annual UK wage growth, which was estimated at 2.8% in December.

Despite the negative tone of this report, it illustrates that tariffs are harmful to the nation and merely transfer wealth from one's own citizens to a few politically connected companies. By declaring unilateral free trade all UK citizens would get the equivalence of a 0.7 to 1.2% tax free pay increase. Sounds pretty good to me!

Thursday, March 15, 2018

The EU elite are ignorant of the true meaning and importance of "comparative advantage"


From Open Europe news summary of 14 March 2018 (my highlight):

Commenting on Prime Minister Theresa May’s Mansion House speech earlier this month, the EU’s chief Brexit negotiator Michel Barnier called it a “surprising idea” that the UK would be allowed to benefit from convergence with EU rules in some areas while “open[ing] up the possibility of divergence when there is the comparative advantage for it.” He stressed the importance of social and environmental standards to the EU’s regulatory framework, asking, “Does the UK also want to distance itself from this model which they have constructed gradually with us and engage in dumping against us?”

To answer Barnier's question--emphatically YES! The UK should seek to benefit where it has a comparative advantage. In fact every person on earth should seek to so benefit. A comparative advantage means that people engage in the division of labor/specialization, and allow others to do the same, in order to produce more goods and services for the market. Note that no one needs to possess an absolute advantage, meaning that he can produce a good or service better or more cheaply than all others in the market. For example, a brilliant lawyer may be able to perform secretarial services better than anyone on the planet; nevertheless, it is to his and everyone else's advantage for him to hire these services in order than he may perform his more highly rewarding legal services. Therefore, everyone is able to participate and succeed in the market economy. In short, Michel Barnier, and I'm sure others in the EU elite, are completely ignorant of economic science.

Saturday, January 20, 2018

Can an Economy Advance Without Savings?


According to Frank Decker, Honorary Associate at the University of Sydney Law School, it certainly can. Not only that, but eschewing savings in favor of "monetisation of assets" will yield better results! I refer to his article in Economic Affairs--Volume 37, Number 3, October 2017--, a publication of the Institute of Economic Affairs, London.

Mr. Decker purports to answer the question "Central Bank or Monetary Authority? Three Views on Money and Monetary Reform." The three views examined are commodity money, state money, and money as a derivative of property. All three views are explained very well, and a beginner to the study of the role of money will learn a lot in a short period of time.

Commodity money is the name Decker aptly gives to money backed by gold or some other widely accepted medium of indirect exchange. Commodity money's proponents see two major advantages--that it ends inflation and the business cycle. He quotes Mises and Rothbard to good effect.

State money, or money as a state liability, is fiat money that all the world knows today. Its two most famous proponents are Keynes and Friedman. State money's main advantages, as seen by Decker, are that the state can engage in countercyclical spending and the state can fund itself by printing all the money that it needs for current expenditures.

Decker's third type of money--money as a derivative of property--sounds no different than fractional reserve banking, except that the fraction of reserves required to be held by the lending banks is so low that it is not a factor of lending restraint. Decker gives the example of a business that uses its assets as loan collateral. According to Decker, the money that the bank creates is NOT created out of thin air, because it is backed by private property; i.e., the loan collateral. According to this theory, money can be created ad infinitum, because each round of loans creates new property with which to engage in another round of  property-backed money creation. If this isn't money "out of thin air", I don't know what is!

Decker desires to find the best monetary regime to promote economic development. Of the three money systems, he settles upon a property based system with a central bank as benign overseer. His choice of this system, such as it is, shows his lack of knowledge of economic theory. In fact, he is a thorough empiricist, with all the limitations that are emblematic of trying to gather billions of facts with which to determine cause and effect. Austrian economists know that economics is a deductive science in which reliable conclusions can be drawn by using proper logic based upon irrefutable maxims.

Decker's two reasons for passing over commodity money are rather astounding. He believes that commodity money would "impose limitations on civil liberties and property rights", because "Countless episodes of monetary history show that economic actors will always find ways to monetise their assets.". He is certain that banks will continue to engage in creating money substitutes out of thin air--i.e., paper money and/or book deposits--even though it is against normal commercial law or, under a free banking system, that money creation would be limited by normal banking presentment practices. But most damaging, according to Decker, is that commodity money would restrict a nation's development. Astonishingly he states that "Commodity money would also retard economic development, as the monetisation of assets allows investment without the prior accumulation of savings,..."! In other words, why save when capital can be created ex nihilo at the stroke of a computer key? Counterfeiters must be wondering why they are persecuted when their actions are actually beneficial!

Decker equates capital with book entry capital accounts. It is as if an Iowa farmer believed that he could acquire seed corn by making an entry on his books. He would not have to save some corn from last year's crop; he could consume it all and perhaps plant pieces of paper. Of course, this capital that Decker believes appears magically actually comes from real people giving up real assets. Frederic Bastiat's That Which Is Seen, and That Which Is Not Seen and Richard Cantillon's insight that money enters the economy at specific places, unduly rewarding specific individuals (the Cantillon Effect), could not be more appropriate.

In order for Decker to be correct he must see new factories, houses, etc. arising and believe that nothing was sacrificed to build them. But clearly that is not how the world works. The sacrifice is there, even if NOT seen. Inflating the money supply robs current holders of assets, those who sacrificed and saved, for the benefit of the earlier receivers of the new money. It is a transfer of wealth, not an increase in wealth.

Decker sounds like a gambling addict who counts only his winnings and not his losses. The winners are the earliest receivers of the new money, who can buy at existing prices. Later receivers see increasingly higher prices and/or lower returns on investment.

Today's interest rate suppressions that favor borrowers come at the considerable expense of savers, many of whom are retired. Their standard of living deteriorates, but, since Decker cannot find statistics to record this fact, he believes that it is not happening. He fails to go that next and necessary step to consider that which is both seen and unseen, per Bastiat's timeless insight.

No individual or group of supposedly wise men should ever be given the power to create money out of thin air or to manipulate the interest rate. Only commodity money, which is controlled by no one, can protect private property and perform the market's time coordination function, AKA the interest rate. Spending requires prior savings, and savings cannot be spent twice.


The old saving that "there is no such thing as a free lunch" needs an addendum--Somebody always pays.

Monday, January 8, 2018

Bastiat and the Hubble Space Telescope


A few days ago my wife and I watched a fascinating program on PBS. The long running Nova series featured the history and accomplishments of the Hubble Space Telescope. The program was titled Invisible Universe Revealed. This episode was composed of three parts.

The first third of the program explained how the astronomers secured funding for the space telescope and successfully built and launched it. Senator William Proxmire, Democrat from Wisconsin, had the space telescope in his sights. From 1975 to 1988 the senator awarded his monthly Golden Fleece Award for egregiously wasteful spending. According to Nova, funding for Hubble was secured when Nancy Roman, Chief Astronomer-to-be, pointed out, apparently to the satisfaction of Congress, that for the cost of a night at the movies, every American would enjoy fifteen years of astronomical revelations. Hubble was launched by the Space Shuttle on April 24, 1990 and deployed a day later. That's when the real problems began.

The second part of the program was devoted to the thrilling repair conducted by astronauts on the orbiting telescope. Construction faults in the giant reflecting mirror made the telescope unusable. Incredibly these faults were not discovered until the telescope was in earth orbit. Nevertheless, the telescope was fixed, and this is the best part of the program. From diagnosing the problem, agreeing upon a feasible fix, to astronauts practicing the repair in a giant water tank (20 months of training!), and finally conducting the repair in space, the viewer is astonished at the knowledge, dedication, and skill of everyone associated with this NASA program.

The third part of the program attempts to sell the results of the Hubble program to the viewers. In my opinion, this is the weakest part of the program. The astronomers do their best to get the viewer excited about the things that they themselves feel are important, explaining difficult concepts in lay terms and showing beautiful pictures taken by Hubble. But for this viewer, it just didn't work. And here is where my economist side started thinking about Frederic Bastiat's timeless essay That Which Is Seen and That Which is Not Seen.

The astronomers seem truly excited that now they can answer two questions that (they claim) have perplexed mankind from time immemorial; i.e., how old is the universe and how many stars are there.
The answer is 13.7 billion years. The number of stars is a so large that it's beyond human comprehension:  2 with twenty zeroes behind it, which is called 200 quintillion! There are 200 billion galaxies in the universe and each galaxy has 100 billion stars. (I must confess that these questions have not caused me to lose even one minute of sleep...ever.) Furthermore, the telescope has revealed many facets of the universe that are of great interest to astronomers. Did you know that the universe is expanding at an ever increasing rate; that there are black holes at the center of all galaxies, and that there is a previously unknown force, called black energy, which makes up seventy percent of all the "stuff" in the universe? Me neither, but I must confess that, even after learning of my ignorance of these matters, I'm still not clear how my life has been made better. And this is where Bastiat comes in.

Even though the program honestly gives some air time to the skepticism the astronomers faced in order to secure funding, it makes no attempt to show that all that money and all that new knowledge has translated into even a smidgen of the improvement of mankind and how the project meets even the most expansive description of the proper role of government. Bastiat would point out that all that funding came at a cost, even if a relatively small per citizen cost, of real improvement in mankind's satisfaction. Each citizen did NOT have some higher satisfaction met, otherwise government funding would not have been necessary. Furthermore, the small-per-citizen cost argument used by Nancy Roman to justify the spending really doesn't stand up to serious analysis. If every American gave me just one cent each year, I could live very well and no one would be able to say honestly that his satisfaction was impaired even in the smallest way much less foregoing a night at the movies. You can see that almost any specious program can be justified by this type argument.

I dare say that a survey of most Americans would find that few know anything about the Hubble Space Telescope and its accomplishments to improve mankind's knowledge of the universe. In fact I question that the Hubble Space Telescope has done one positive thing for the improvement of mankind beyond the satisfaction felt by the very few in the astronomy field. Pure knowledge may be important in some way to those who seek it, but why force others to forego even the smallest satisfaction in order to provide it to an elite few?


So, should and would the Hubble have been built? This question cannot be answered unless individuals are allowed to fund it voluntarily and not have government coercively extract the funds from them through taxes. Perhaps some very wealthy individuals could have been convinced to fund the project. Maybe some sharp Madison Avenue marketers would have developed a program to raise the funds from a vast, interested citizenry. Furthermore, there is such a thing as pursuing an end before its time has come. Perhaps a Hubble-type telescope could have been placed in orbit a few years later at a greatly reduced cost, a cost that could have been borne by private donors. Who knows. But we do know that the Hubble Space Telescope has reduced the quality of our lives in a small way that can never be recovered. Personally, as much as I was impressed by the Hubble's accomplishments, I would have preferred a night at the movies.

Sunday, December 31, 2017

The Economic Benefits of Ending the Fraud of Fractional Reserve Banking

Fractional reserve banking (FRB) is fraudulent. It should be prosecuted as a crime rather than accepted as normal practice under current banking laws. Any society that respects property rights and the rule of law would not allow it. For those unfamiliar with the term fractional reserve banking or not quite confident of its complete meaning, let’s cover some basics.

What Is Fractional Reserve Banking?

All financial transactions must be settled ultimately by an exchange of standard money, otherwise known as "reserves". Reserves in the US are composed of federal reserve notes (good old paper money in your wallet, piggy bank, retailers' cash register tills, or bank vaults) plus reserve account balances held by banks at their local Federal Reserve Bank that may be exchanged for federal reserve notes on demand. The important point is that reserves are not the same thing as the money supply. The money supply is composed of cash outside bank vaults plus demand (checking) accounts at banks. A financial transaction is not complete until reserves are exchanged. For example, accepting a check from your neighbor for selling him your used car is not final settlement, because reserves have not yet been exchanged. The check might bounce. Or the bank upon which the check is drawn might become insolvent ; i.e., it does not have and cannot raise the reserves with which to pay you, the check's payee, even though the bank balance of the payor, your neighbor, was at least as large as the check.

Most people assume that their money held at banks can always be exchanged for reserves, but such is not the case. Under a fractional reserve banking system banks are not required to keep one hundred percent reserves. Rather, they keep a fraction of their obligation to you in reserve (thus, the name "fractional reserve banking" system), under the assumption that not all depositors will want their money back at the same time.

How can this be? If you deposit a dollar into your account at the bank, isn't the bank required to keep that dollar in its vault or at its own reserve account at its local Federal Reserve Bank? The short answer is NO! The bank is allowed to lend most of that money to someone else and keep only a fraction in reserve in order to satisfy your withdrawal request! This is fraud. Through the lending process the bank has created money out of thin air. It is not backed by one hundred percent by reserves. If too many depositors demand their money at the same time, the bank would not be able to satisfy all withdrawal requests. It would not have sufficient reserves to do so. It's as simple as that. Any other commercial business that accepted your property with the promise to return it to you and then lent that property to someone else would be guilty of fraud. But banks are allowed to do just this! Hard to believe, isn't it!

Some present the argument that FRB should continue, because the depositor should have the freedom to take the risk that, if the bank should fail, his money might not be returned to him upon demand or perhaps not at all. But the ethical issue is not about the depositor's choice but the payee's risk in accepting a check drawn on an FRB bank. The depositor may have sufficient funds in his bank account, but the bank itself might not have sufficient reserves to honor the check. How is the payee to know? It is against the law in most states for a payor to knowingly pass a check that exceeds the funds in his bank account. Why then do we accept as part and parcel of the fractional reserve banking system that the bank itself is not required to hold sufficient reserves to honor all its obligations?

FRB Gives Rise to Regulation and Government Money Printing

Volumes of bank regulation, armies of bank regulators, and government money printing have arisen because banks are allowed the privilege of fractional reserve banking. Bank runs were common occurrences before the federal government forced all banks into its deposit guarantee program (the FDIC), itself a fractional reserve institution in that it has a mere fraction of the reserves to honor the vast deposit balances of American banks. During the so-called subprime lending crisis of 2008, so many banks failed that the FDIC itself ran out of reserves (which it had obtained via mandatory premiums from the banks) and had to be bailed out by the Federal Reserve Bank itself, which resorted to the time honored practiced of all counterfeiters by creating reserves out of thin air.

Bank regulation, enforced by the above mentioned armies of regulators (surely you did not think the government would have just ONE regulatory agency for banks!), attempts to do the impossible, to wit, prevent bank loan losses. FRB expands the money supply, which itself causes disruption to the structure of production, an unsustainable boom, and the inevitable crash. This so-called business cycle is not some sort of inevitable consequence of normal business exuberance or lack thereof, but is caused by FRB credit expansion by banks, a phenomenon well explained by Austrian school economists and labeled by them as the Austrian Business Cycle Theory (ABCT).

In the absence of fractional reserve banking, the banks would not be able to expand credit beyond the funds actually saved by its depositors. (Wouldn't that be something!) There could be no disruption to the structure of production; thus, there would be no need for bank regulations or regulators. All funds placed in demand accounts would be secured one hundred percent by reserves. Depositors who wished to earn interest on excess saved funds would open savings/investment accounts with the banks or some other institution specially formed for profitable investment of the public's savings. These investment accounts would not be insured by anything other than the banker's capital account and his reputation for sound lending. Loan losses would be borne by the banker to the extent of his capital account and then the savings fund itself. Naturally, the depositor's demand funds would be completely secured by the bank's reserves. Only the funds placed in the bank's savings/investment accounts would be at risk. Bankers with poor lending acumen would find themselves quickly out of business rather than receiving bailout money from the government. Such bailout money itself comes from Federal Reserve money printing, which itself exacerbates the boom/bust business cycle!

Conclusion

Ending fractional reserve banking would restore the rule of law to the banking system, end the need for expensive and harmful bank regulation, and eliminate the boom/bust business cycle. Bank demand deposits would be backed one hundred percent by reserves, which any competent local auditor could verify at little expense. Banks found in violation of this law would be seized by state authorities and the officers charged with a crime – the crime of counterfeiting. Unnecessary bank regulatory agencies would be shut down, because they would have nothing to do.

This reform to the banking system is so simple that it will be opposed by all the parasitic government agencies now promising to prevent something that they themselves cause; i.e., the boom/ bust business cycle and bank losses that harm depositors and cripple the economy. Nevertheless, let us pursue this reform with all the confidence and courage of Ludwig von Mises that we are doing the right thing and will not be deterred.

Recommended reading:

The Mystery of Banking, by Murray N. Rothbard


The Essential von Mises, by Murray N. Rothbard