Sunday, October 26, 2014
Saturday, October 25, 2014
Europe's Gong Show at Work: Back Taxes and Busted Banks
The EU is doing everything it can to paper over the fact that its policies have turned the banks into what David Stockman likes to call "Roach Hotels", where bad investments enter and never leave. I particularly like the concluding paragraph about how the EU has added the likely economic value of drugs and prostitutes to its GDP:
"The best part is that everyone’s falling over one another to assure us that the new accounting methods, which include drugs and prostitution, have nothing to do with this madness. But isn’t it just great to ponder that Britain has to fork over an additional billion only because the French have cheaper hookers?"
Earlier in Mr. Meijer's essay he offers us this quote:
There is also disagreement over how certain assets may be classed. In weaker economies like Portugal, Greece, Spain and Italy, the governments have passed laws allowing banks to convert deferred tax assets (DTAs), which are tax payment deferrals generally awarded during times of weaker profitability, into more capital-enhancing deferred tax credits (DTCs).
Now I interpret this statement as saying that previous loans to weak banks in Portugal, Greece, Spain and Italy have bee classified as assets. What? How can a loan be an asset? Yet now these governments are going to allow the banks to keep the money and classify it as capital.
To update Shakespeare, there's something rotten in more European countries than Denmark.
Monday, October 20, 2014
The economic phenomenon known as the "Tragedy of the Commons" instructs us that commonly held resources that are insufficiently protected will be plundered to extinction. The phenomenon was recognized in the early nineteenth century to explain why the commons in England quickly came to be denuded by sheep. All sheepherders had an equal right to graze sheep on the commons. There often was no agreement as to how many sheep each could graze, so it was sheer rational self-interest for each to graze as many sheep on the common ground as possible. In short order the commons came to be overgrazed. What later came to be called "the tragedy of the commons" was a simple and imminently understandable explanation.
Is security an economic resource?
One can easily accept that grassland is an economic resource that must be protected, but what about security and, if security is held collectively, can collective security agreements also be vulnerable to the tragedy of the commons? Security is a service that usually requires economic resources. We secure our personal possessions when we take precautions such as padlocking our bicycles, locking our car doors and the house, buying monitored security systems, purchasing heavy safes, and the like. These are all economic goods to secure our personal property. But what about protecting our physical selves? It is on a somewhat different plane but the purpose is the same. We may carry concealed weapons, take personal self-defense courses, or hire personal body guards. All these things require the expenditure of time and money to acquire economic goods to make us more secure. On a more subtle level, we modify our behavior to avoid giving offense to complete strangers about whom we know nothing. We especially do not deliberately seek confrontations over minor things like the last parking spot in the lot. Similarly we avoid dangerous parts of town or parts of town that are dangerous at night or on special occasions. For example, my wife and I were in downtown Chicago in the late 1990's when the Chicago Bulls professional basketball team was winning the NBA championship. We were not fans and gave little thought to the fact that there might be what we shall call "excessive celebrations" after the final victory. As we strolled downtown Chicago after dinner we were advised by a Chicago policeman to leave, because the "excessive celebrations" often became excuses for certain people to behave criminally. Rather than assert our right to window shop whenever and wherever we darned-well pleased and discretion being the better part of valor, we went home. This aspect of security--i.e., avoiding unnecessary confrontation-- is often overlooked.
Collective security brings in economic problems
Ah, but would we have reacted the same way had we been in a group? Perhaps we would have felt more secure to window shop by assuming that others in the group would protect us. Our behavior would have changed to become a bit more willing to take risk due to an implicit assumption of collective security. This willingness to take more risk because others may bear some or even all of the cost is known as moral hazard.
So we see that providing our own personal security of our physical bodies and our possessions requires that we expend resources that perhaps we would rather employ elsewhere. We pay for these ourselves and we modify our behavior to avoid the necessity of employing them with uncertain result and to minimize the cost.
But all this changes under collective security agreements.
Moral hazard and socialism cause a tragedy of the commons in collective security
Under a collective security agreement, all who join are obligated to provide security to all others in the alliance. Each member must expend resources to provide such security, which naturally means sacrificing the satisfaction of other preferences.
However, since all contribute to the security pot, all know that their individual sacrifice may be claimed by others. Therefore, there will be a reluctance to spend resources on security that may be used by others, while encouraging, at least to some extent, claims upon security that one would not have made in the absence of the security agreement.
The latter phenomenon, the increased willingness to call upon alliance members, is moral hazard at work and the former phenomenon, the reluctance to expend resources that may be claimed by others, is a well-known consequence of socialism.
Mises explained that socialism discourages production while it increases demand. Why produce only to be forced to share with others when one can demand to share in the production of others without regard to having previously produced something of value to those same others? Eventually all altruism vanishes in a sea of cynicism and nothing is produced for anyone to share. The result is a tragedy of the commons fed by moral hazard and socialism.
The tragedy of NATO
Today we see the above destructive economic forces at work in NATO expansion. When the Soviet Union disintegrated in 1990, the reason for NATO's existence vanished. But rather than declare NATO to have been a success in deterring war in Europe, possibly disbanding the alliance and building a new Concert of Europe that would include Russia, NATO bureaucrats set about to expand the alliance to the east. Whereas the Concert of Europe after the Napoleonic Wars had quickly embraced France as an important member, NATO expanded to isolate Russia by absorbing its former satellite nations.
The last NATO expansion prior to the disintegration of the Soviet Union had occurred in 1982 when Spain joined the alliance. At that point in time NATO was composed of sixteen nations. Starting in 1999 twelve countries have joined NATO, ten of them former members of the Warsaw Pact. The other two, Slovenia and Croatia, were previously part of Yugoslavia, officially a non-aligned nation, but a communist dictatorship all the same. With the possible exception of Poland, none of these new members contribute much to the alliance's military capability, meaning that the older members are shouldering their security burden. Naturally expanding NATO to the east has resulted in isolating and antagonizing Russia, who feels its security threatened. So, NATO has succumbed to the socialist phenomenon by adding new members who demand security without much of an obligation and to the moral hazard phenomenon by adding new members whose territories could be used to house American nuclear weapons, a situation that may yet provoke a major world crisis with Russia, which is precisely what NATO was formed to avoid.
Ukraine and Finland as examples of moral hazard and socialist demands
Both Ukraine and Finland are lobbying NATO for membership. President Poroshenko of Ukraine is lobbying for membership in both the European Union and NATO. The fact that Russia already has taken the Crimea following anti-Russian riots apparently means nothing as long as Ukraine believes that mighty NATO will intervene on its behalf. If NATO did admit Ukraine, one wonders if Ukraine would invoke the collective security clause and demand that NATO go to war with Russia. Finland is already a member of the EU and now is openly lobbying for NATO membership. In a recent interview with der Spiegel, Finnish president Alexander Stubb was dismissive of Russia's stated concerns about Finland joining NATO. His interview has to be read to be believed. Both presidents' behavior illustrate the moral hazard nature of collective security agreements. And neither country would contribute anything to the security of current NATO members. On the contrary, Ukrainian and/or Finnish membership would cause an escalation in tensions in Europe and take us right back to the Cold War...or worse! Neither country considers the possibility that NATO might not honor its military commitment. It is one thing for NATO bureaucrats to admit new members. It is another thing for current members to expend blood and treasure, especially when the possibility of nuclear war is wafting through the air. Does anyone remember the Cuban Missile Crisis?
In conclusion, due to the inherent problems with collective security alliances--tragedy of the commons fed by socialism and moral hazard--nations should enter into them with great caution. George Washington's farewell address has never sounded more prescient: Beware foreign entanglements.
Sunday, October 19, 2014
In this thirty minute interview on Power Trading Radio I discuss fractional reserve banking, the euro, and the beneficial effect of a reinstated German deutsche mark.Interview with Patrick Barron on Power Trading Radio
Friday, October 10, 2014
Re: Germany's Insistence on Austerity Meets With Revolt in the Eurozone
These two article in the New York Times from Wednesday of this week illustrate the confusion and increasing stridency of Keynesian school economists. All the Eurozone countries except Germany are heavily in debt with no real prospect for reducing their annual budget deficits. Only Germany has a balanced budget. This is what Keynesians falsely label as "austerity". It is no such thing. It is merely being responsible. The I.M.F. and other nations of the Eurozone want Germany to spend more as the cure to other nations' debt problems. Their sole rational is the typical Keynesian dogma that it is spending that drives an economy forward. The I.M.F.'s chief economist, Olivier Blanchard, states that large scale infrastructure projects funded by debt, if properly undertaken, are beneficial and will bring quick growth benefits. How German infrastructure projects will cure Greece's bloated welfare state bureaucracy is beyond me. It is well past time for the other nations of the Eurozone to stop criticizing Germany and start emulating her.
From today's Open Europe news summary:
Hans-Werner Sinn: Some countries should be allowed to temporarily leave the euroOpen Europe yesterday hosted the launch of Professor Hans-Werner Sinn’s new book, ‘The euro trap: on bursting bubbles, budgets and beliefs’. At the beginning of his presentation, Professor Sinn described Open Europe as “one of the most important platforms for the public discourse on the continent.” He argued that “there is no real solution” to the Eurozone’s problems, therefore “we need to choose among evils”. Professor Sinn suggested three steps: forgive part of the debt of the Eurozone’s peripheral countries; let some countries leave the single currency temporarily to regain competitiveness while giving them the chance to re-join later; impose stricter budget constraints on central banks.Andrew Sentance CBE, senior economic adviser at PwC and a former external member of the Bank of England’s Monetary Policy Committee, said that “real depreciation” of the euro would be a “more hopeful” solution than a break-up. He added, “There are too many hidden barriers to trade in services in Europe. Removing them would be a very pro-growth measure.” A video summary of the event will be available on the Open Europe website shortly.
I fear that Professor Sinn squandered an opportunity to educate the public. The true problem with the euro is that it is a fiat currency managed by a central bank that is under constant political pressure to print money as the solution to all ills. Mr. Sentance's comments confirm this view. But a nation cannot become more competitive by depreciating its currency. An honest currency reveals problems that need to be solved, such as onerous labor laws, restrictive business regulations, high taxes, and lack of adequate defense of property rights. The solution to Europe's economic problems is to reverse its century old retreat from free market capitalism, most importantly its retreat from sound money.
Thursday, October 9, 2014
Here's an interesting little calculation of how many dollars the Fed would have to charge for an ounce of its gold reserve in order to cover all of M1. (M1 is the narrowest definition of money, which includes cash and bank checking accounts.)
- In 1960 the Fed owned 506 million ounces of gold and M1 stood at $140 billion. So the Fed could "cover" its gold reserves at $277 per ounce.
- In August 2014 the Fed owned 261 million ounces of gold, slightly more than half of what it owned in 1960, and M1 stood at $2,856 billion. So today the Fed would have to charge just under $11,000 per ounce in order to buy back all of M1 and not run out of gold.
Even the comparatively low cost of covering M1 in 1960 does not mean that the Fed had been an honest bank up until that time. At the 1944 Bretton Woods Conference the Fed promised to maintain a dollar price of gold at only $35 per ounce. The International Monetary Fund (IMF) was created to ensure that the Fed did not print money unless its gold reserves increased. Needless to say, the Fed did print money and the IMF did nothing.