Sunday, March 29, 2015

How money creation threatens hyperinflation

In order to understand the relationship between money creation and the price level, we first need to get some definitions straight.

To Austrians the terms inflation and deflation refer to money and not prices. There is no doubt that money has experienced unprecedented inflation. In February of 2010 base money was $2.1 trillion. Four years later it was $3.8 trillion. In the same time frame, M1 has increased from $1.7 trillion to $2.9 trillion. M2 has gone from $8.5 trillion to $11.7 trillion. Excess reserves have doubled from $1.2 trillion to $2.4 trillion. (Please keep in mind that prior to 2008 excess reserves seldom were more than a few BILLION dollars, which is effectively zero and represented mostly the aggregate of excess reserve cash in thousands of community bank vaults.)

To Austrians changes to the price level, what the public incorrectly calls inflation and deflation, are the result of changes to the aggregate demand for consumers' goods and the aggregate supply of consumers' goods. Think of a simple ratio with the numerator representing demand and the denominator representing supply. Notice that an increase in supply will cause the price level to fall. Aren't we all happy with this? I am. Or a decrease in demand will cause the price level to fall. There can be many causes of a decrease in demand--a fall in the money supply due to bank failures, a change in subjective time preference to save more, or a rational desire to hold more cash during times of uncertainty. None of these are bad for the economy per se. Whatever the cause, the antidote to a fall in demand is falling prices. The relationship between supply and demand must be re-established.

The point I am trying to make is that it is fruitless to attempt to prop up prices with more money creation, as the unprecedented increase in all categories of money in recent years has shown. In fact, excess reserves represent the potential for a massive increase in the money supply. The ratio of mandatory reserves to M1 is around 3%. The ratio of mandatory reserves to M2 is around 1%. Just do the math to find out the mathematical potential increase in the money supply should the banks eventually be able to convert excess reserves into mandatory reserves via the lending process. Keep in mind that this is exactly what the government WANTS banks to do; i.e., make more loans to supposedly stimulate the economy. An increase in the demand for goods of this magnitude, the numerator of our simple equation, would cause the price level to skyrocket perhaps to hyperinflation levels.

Therefore,digging even deeper into our problem, one finds that legal tolerance for fractional reserve banking is at the heart of the problem. Fractional reserves allow banks to create money out of thin via the lending process. Instead of funding an increase in loans by an increase in real savings, loans are "funded" by...well...nothing. This triggers the Austrian business cycle. Production, the denominator in our simple equation, falls. When supply falls, prices rise. Creating even more money will not help the situation, only exacerbate it.

Hyperinflation is a cancer that lurks in our monetary structure. Time to surgically remove it before it metastasizes.

My letter to the NY Times re: New Pay Day Loan regs will hurt the working poor

Re: Agency wants to rein in payday loans

Dear Sirs:
Often payday lenders are the last tool of the working poor to forestall having utilities cut off, having a car repossessed (which can lead to losing one's job), or even going to jail for falling to pay a parking fine. There are two remedies for those who believe that current payday lenders charge too much. Number one, make it easier for new entrants to the payday lending market. Competition will drive down costs and increase service. Number two, those who believe that payday lenders are charging too much must believe that they have identified a profitable business opportunity. They should enter the payday lending market themselves and offer their services at lower prices. Furthermore, no one should believe the specious excuse that new regulations are needed that would "...require lenders to make sure that borrowers have the means to repay them." There is no better or quicker way to lose money than to lend it to people who cannot pay it back.

Thursday, March 26, 2015

My letter to the NY Times re: Setting the record straight on changes to the price level

Re: Eurozone Business Growth Nears 4-year High, by David Jolly

Dear Sirs:
Once again one of your reporters repeats the mantra that there is a "...problem of declining consumer prices...in the eurozone...". Problem for whom? Changes in the price level are the result of changes in the ratio of the aggregate demand for consumers' goods and the aggregate supply of consumers' goods. Think or the demand for goods as the numerator and the supply of goods as the denominator in a simple equation. Notice that an increase in the supply of consumers' goods MUST cause the price level to FALL! A reduction in spending in favor of savings also will cause the price level to fall, which is necessary to re-establish the market clearing price for goods. Measures to prop up prices will result in unsold inventories. However, the only way the price level can rise is for the supply of consumers' goods to fall and/or spending to rise. Spending can rise only from an artificial increase in the money supply or a reduction in savings in favor of spending. Neither of these causes of a rising price level are to be celebrated.  In conclusion, either falling prices are the result of economic progress--i.e., an increase in the supply of goods--or the market clearing antidote to a decrease in spending in favor of saving.

Tuesday, March 24, 2015

A Waste of Time

From today's Open Europe news summary:

Bundesbank proposes new European fiscal authority to replace European Commission

Germany’s Bundesbank proposed in its monthly report yesterday to create “a new European fiscal authority which, in the style of independent national fiscal councils, is bound by a clear mandate to only assess budget developments with a view to complying with fiscal rules.” This new fiscal authority would replace the role of the European Commission as it would run less risk to “agree to inappropriate compromises at the expense of budget discipline.”
Source: Frankfurter Allgemeine Zeitung

The Germans desperately want to believe that somehow they can instill fiscal discipline into the sovereign nations of Europe through something other than normal commercial relationships. They cannot. Every nation Europe has figured out that it can spend more than it makes and cover up its disastrous socialist policies with fiat money from the ECB. As long as the money flows from the ECB, these socialist governments will never have a mandate to reform. The Bundesbank is fooling itself and the German people. Its proposal to form a new entity that is "bound by a clear mandate to only assess budget developments with a view to complying with fiscal rules" is a waste of time. No nation, with the exception of Germany, is complying with the existing fiscal rules, because there is no need to do so and no one can force any nation to do so. A new oversight agency does not change this fact.

At a minimum Germany must leave the European Monetary Union (the eurozone) and reinstate the Deutsche Mark. It may as well recognize that the European integration idea is doomed. There can be no integration of sovereign countries, only free trade of goods, services, and capital. Since free trade requires no supranational organization, Germany should leave the European Union, too. Naturally, other nations will howl that Germany is "abandoning Europe", when in reality it is saving Europe by forcing all nations to adopt sustainable economic policies or go bankrupt.

Monday, March 23, 2015

My letter to the NY Times re: Time for an editorial board reassessment

Re: Japan's Recovery Is Complicated by a Decline in Household Savings, by Jonathan Soble

Dear Sirs:
Mr. Soble (and your editorial board, I'm sure) can't seem to make up his mind whether Japan should spend its way to prosperity or adopt policies that will return it to the savings culture that financed its post WWII economic miracle. Mr. Soble comes very close to breaking with what I am sure is NY Times policy and Keynesian dogma that increasing aggregate demand will do the trick. Japanese households spend every last yen as it is, and the government's debt to GDP is the highest in the industrialized world. So just where will this increased demand originate? Please don't bet too heavily on the BOJ's all-in QE program, which has done zip-a-dee-doo-dah so far, unless you count adding even more zeroes to the government's debt. This is the time for an editorial board reassessment. Does the Times continue with Paul Krugman and his mindless "print money until it's worthless" mantra, or does it open its mind to other explanations? The Austrian school has the answers, and you have one of the world's primary Austrian school monetary scholars right in Manhattan--Dr. Joseph Salerno at Pace University. I'm sure he would be happy to take Krugman's place. Does the Times want to lead the world away from the monetary abyss or does it want to follow the lemmings? Time for a change.

Friday, March 20, 2015

My letter to the NY Times re: Mr. Kuroda has put the cart before the horse

Re: Japan's Central Bank Warns of Temporary Return to Deflation

Dear Sirs:
BOJ governor Kuroda and his supporters should question the very foundation of their beliefs that inflation is "...crucial to rekindling growth..." and that "a 'deflationary mindset' is behind many of Japan's economic woes" as evident in "weak consumer spending and a reluctance by investors and businesses to take financial risks..." This chain of beliefs that falling prices reduce aggregate demand and lead to a vicious downward spiral in the economy is nonsense. Falling prices actually spur spending as households' real income rises. Higher prices, as championed by Mr. Kuroda, destroy household purchasing power and leads to business retrenchment and higher unemployment. Mr. Kuroda needs to let the Japanese people alone for a few years in order for them to rebuild household balance sheets, which will lead to an expanding economy. Mr. Kuroda and his supporters have put the cart before the horse.

Thursday, March 19, 2015

The Federal Reserve Bank Must Be Destroyed!

"Delanda est in Susidium Foederatum Bank"
(The Federal Reserve Bank Must be Destroyed)

by Patrick Barron

During the years of the Roman Republic, Cato the Elder ended every speech with the phrase "Delanda est Carthago" (Carthage must be destroyed). Rome had fought two wars with Carthage, yet the threat to the Republic remained. Cato saw Carthage as an existential threat and concluded that Rome would not be secure as long as Carthage existed. So fervently did he hold this view that he ended every speech, even about completely different subjects, with the famous phrase. I believe that we Austrians need to adopt a similar phrase to remind the American people that the US faces an existential threat from the machinations of the Federal Reserve Bank. "Delanda est in Susidium Foederatum Bank"...The Federal Reserve Bank must be destroyed. Like Carthage, the Federal Reserve Bank cannot be controlled or restrained. Either it or our republic will survive, but not both. For the sake of our nation, the Fed must be destroyed.

Founding the Fed Instead of Ending Fractional Reserve Banking

The Fed was founded under false economic premises--to prevent bank runs by providing temporary liquidity to banks which found themselves unable to redeem their certificates and demand deposits for cash and/or specie. The real cause of illiquid banks--fractional reserve banking--was never seriously addressed. It was assumed that banks had the legal right to invest their customers' demand funds in loans and that runs were caused by over indulging in this practice. But as Murray N. Rothbard explain in What Has Government Done to Our Money?, loaning demand funds instantly places  the bank in an insolvent position, for it cannot redeem all of its demand accounts for cash or specie. Through the process of lending demand funds, the banks have created fiduciary media out of thin air, reducing their reserve ratio below one hundred percent. If the banks do this on a very modest basis, the public may not be aware of the fraud. However, once the rumor starts that the bank is illiquid, there is a literal "run" to the bank to withdraw demand funds. In such a case, even a bank that only modestly lent its demand funds might find itself unable to honor all withdrawal claims and would be forced to close its doors.

(NOTE: Central Banking was established to legitimize counterfeiting fraud, aka - Fractional Reserve Banking)

The Federal Reserve Bank, as the lender of last resort, was supposed to prevent such occurrences by providing temporary, penalty rate loans to struggling banks. Note that there is nothing that a central bank could provide that could not be provided by another private bank. In fact the banking panic of 1907 was stemmed by private bank interventions led by J. P. Morgan. However, Morgan realized that such private bailouts were very risky and presented a case of moral hazard; i.e., that bankers, confident of a bailout by the Morgan banking empire, might  book riskier, higher yielding loans. So rather than face the real cause of banking crises and lobby to outlaw fractional reserve banking, the Morgans, Rockefellers, etc.--who did not want to forego the financial benefits of lending demand deposits--lobbied instead for government to create a lender of last resort, a central bank, which we named the Federal Reserve Bank.

Fed Policy Causes Depressions and Then Prevents Recovery

Over time this entity, new to Americans, would expand its role in fruitless attempts to cure crises caused by ITSELF. The Fed caused and exacerbated crises by allowing, facilitating, and expanding the practice of fractional reserve banking. In the 1920's the Fed began to expand the money supply to prevent prices from falling, justifying its new role as one of maintaining a stable price level. But printing money to prevent falling prices caused malinvestment in the structure of production and led to a depression by the end of the decade.

Rather than do nothing and allow the purging of bad investments and liquidation of malinvestment, which would re-establish a sustainable structure of production, as it had done at the beginning of the decade in the depression that no one remembers, the Fed intervened monetarily to pump up reserves while the Hoover administration intervened fiscally to prevent price deflation and maintain high spending levels. All this is well documented in Murray N. Rothbard's America's Great Depression.

Yet even an interventionist Fed could not prevent the massive bank failures of the 1930's, due to many factors which included restrictive bank branching laws. But the primary cause of the bank failures was *again* the banks' adherence to fractional reserve banking practices which resulted in  their inability to honor all demand deposit redemption requests for specie and/or cash.

In the Roaring Twenties fractional reserve banking had expanded the money supply well beyond the ability of banks to stem all the runs. Again the banks and the politicians refused to dig deeper into the real cause of the problem. Rather than separate banking into deposit and loan functions--the former would require one hundred percent reserves and the latter would require strict asset-liability management to ensure that loans matured on the same schedule as time deposits, what is commonly known as funding loans out of savings--the government suspended specie redemption and eventually formed the FDIC to "ensure" bank deposits.

However, the FDIC's "insurance" program was nothing more than an explicit promise that the Fed would print enough money to redeem all ensured deposits, thus insuring the continuation of fractional reserved banking, the very problem that was used as the excuse to establish the Fed; the very problem--bank instability--the Fed was sold to the public to solve. So, once again, a solution to cure a problem caused by the Fed itself resulted in even more power for the increasingly government run banking system.

The Monetary Genie Was Out of the Bottle

Once the politicians realized that the Fed could print money at will, the genie was out of the bottle. Money growth did expanded at a modest rate for a few decades, due mainly to the efforts of prudent men such as Fed Chairman William McChesney Martin (1951 to 1970) and fiscally conservative politicians such as President Dwight Eisenhower (1953 to 1961). However, it was inevitable that less prudent men, such as President Lyndon Johnson and all Fed chairman with the exception of Paul Volcker, would rise to power on their promises to fund all manner of government programs with what was now seen to be unlimited money.

This was the key revelation!

Money printed in unlimited quantities could cure all ills, or so it was claimed, and to its everlasting shame the economics profession provided sufficient "academic" cover to support these spurious assertions. Now everyone understood that the Fed could monetize--i.e., purchase government debt itself--any amount of government spending. The economics profession refused to consider the inevitable consequences of these irresponsible monetary policies. Instead it cherry picks historic price data to prove them to be non-inflationary and endorses changes to unemployment calculations to prove them to be fiscally sound, too. These whores, these house economists have their eyes glued to the rear view mirror of spurious government statistics as the race car of state hurtles toward an economic cliff of depression and perhaps even hyperinflation.

Money Production and Banking Subject to Commercial and Criminal Law

It matters not who is in charge of the Fed or what rules Congress may insist that it adopts. Once money printing, via fiat or fractional reserve credit creation, is seen to be both feasible, justified, and legal nothing and no one can stop it. The political pressure to fund government programs will be irresistible. Everyone knows that the Fed seemingly has the ability to solve their problem by monetizing the federal debt. Should it refuse to do so, we would see riots in the streets similar to what is happening in Europe as protesters target the European Central Bank.

The only solution is to destroy the monster that makes it all possible, the Fed. Without the ability to sell its debt to its own central bank, government would be forced to live within the means set by the will of the people through their elected representatives. The scales would eventually fall from the eyes of both politicians and public as its becomes clear that what government spends comes at the expense of the private economy. The public would no longer be fooled by government propaganda that its spending spurs the private economy, when it is clear that the only way government can spend is to tax the people or suffer the crowding out effect of private investment by government borrowing. Money production must be moved to private hands that are subject to normal commercial and criminal law, where money printing is nothing more than counterfeiting. Banks, too, must be subject to normal commercial and criminal law, which requires them to treat a demand deposit as a bailment for which they must keep one hundred percent reserves. Loan banking would be subject to the normal principles and well understood practices of sound asset-liability management, whereby loans are funded by real savings and the maturities of both loans and deposits must be coordinated in order for lending banks to honor their liquidity commitments. The path to the destruction of our nation through endless wars and welfare would end with the destruction of the Fed.


Delanda est in Susidium Foederatum Bank!