“The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing consequences of that not merely for one group, but for all groups.” -Henry Hazlitt
A SPECIFIC PLAN – THE ONLY PLAN – TO ENGENDER AN ECONOMIC RECOVERY WITHOUT HYPERINFLATING
Former Federal Reserve Chairman Paul Volcker, whom I have much respect for, pointed out that a 2% inflation rate means confiscating half of one generation’s wealth. In the end, he settled with price stability for the Fed’s mission. Far better than inflation targeting.
Federal Reserve Vice Chairman Donald Kohn promised that the Fed would turn off inflation if it happens (is the guy myopic, since it’s here already?). Ben Bernanke was talking about “green shoots” many months ago. Politicians were talking about a “glimmering of hope.” The Fed tells us it will stay loose until there’s an economic recovery, as though artificially low interest rates are therapeutic in nature. The parlance used engenders confusion, and it’s my purpose here to deconstruct a few fallacies.
Let’s start with this axiom: prevailing economic orthodoxy is wrong. If prevailing economic orthodoxy is so great, then how did the orthodox practitioners get us into this mess? Even I saw this one coming. See: http://libertyeconomics.com/be-afraid-of-the-dollar-not-gold/
What is it that we are all pursuing and seeking? The betterment of our lives (i.e. economic growth). When government officials and politicians speak of economic growth, they should be able to define the phrase. If they can’t define it, then they have no business talking about economic growth. So what is economic growth?
Wealth is that which satisfies demands. Inasmuch as businesses satisfy consumer demands, they are being productive. Within the construct of the unhampered market, productivity can be measured by income, since income is earned by satisfying consumer demands. The government, on the other hand, does not sustain itself by satisfying consumer demands (i.e. earning its income). The government uses the threat of violence, or actual violence, to obtain its revenue (i.e. compulsory taxation). Thus the government can’t get away with saying that the more it taxes and spends the more productive it’s becoming.
The technocrats had to invent a different excuse for government: its spending is productive! So government spending – as well as private sector spending – has been placed into the GDP. The kleptocracy tries to camouflage itself with Keynesian formulas (e.g. the “multiplier effect”).
Nevermind the fact that if the “multiplier effect” held truth, so long as nobody saved anything – meaning zero-liquidity preference, in which case we would have hyperinflation – the “multiplier” would be infinity!
If you look at the textbook definitions of economic growth, objectively, it’s defined as a rising GDP. A rising GDP means we are having “economic growth,” because the GDP supposedly measures “economic growth,” and “economic growth” is defined as a rising GDP. Do you see any tautology here whatsoever? Even I noticed the tautology all on my own without anybody to point it out to me in any book. This is “Mark original” analysis.
Before economic growth can possibly be measured, it must be defined. Defining economic growth as a rise in the very indicator that supposedly measures economic growth is self-evidently flawed. Look at it another way. Measuring wealth in terms of a depreciating currency is akin to changing around the definitions of inches and feet in order to say that a person is changing in size. If the technocrats and politicians in Washington can’t figure this one out, then everything is hopeless.
The simplest definition of economic growth is a lessening of the unsatisfaction of wants or demands. We are diverse, and our wants, or demands, are subjective. Politicians and econometricians are not psychics. There is no way to quantitatively measure economic growth. Even Alan Greenspan wrote a piece – even while maintaining the fiction that the Fed is blameless – in which he claimed the Fed is blameless because it’s impossible to model malinvestment. See: http://us.ft.com/ftgateway/superpage.ft?news_id=fto031620081437534087 If it’s impossible to model malinvestment, then it’s impossible to model economic growth.
Prevailing economic orthodoxy tells us that there are two kinds of GDP growth: nominal and real. This is where thinking on the subject becomes dubious at best. Real GDP growth is defined as nominal GDP growth discounted for inflation, which is determined by the unreliable GDP deflator (I won’t belabor the reasons why in this piece, but I have done so before and will do so again).
Let’s start with what should be a self-evident absolute: economic growth need not be discounted for inflation. Either we are having economic growth, or we aren’t. If the GDP must be discounted for an inflation component, then this means that some GDP growth is good, but other GDP growth is bad. But if the GDP is measuring the same thing(s) constantly, this makes little sense. Either the GDP measures economic growth and any rise in the GDP is good, or the GDP measures inflation and any rise in the GDP is bad. If the GDP can rise, but only in nominal terms, then this must mean that it can fall, but only in nominal terms.
When Fed officials and other D.C. technocrats speak of “economic growth,” they’re talking about rising prices in absolute terms, which is not inflation but the result of inflation (i.e. monetary expansion). If a person conflates rising prices with economic growth, they’re boxed into an awfully awkward position. The only way to have a fast economic recovery would be to have prices rise fast (i.e. hyperinflation).
Real economic growth engenders falling prices. Falling prices increases the ROR (rate of return) in real terms. I remember when I was growing up during the 1980s, and if I wanted to make a photocopy, I had to walk down to the drug store to use the big, bulky copy machine. If I had to send a fax, I went to Kinko’s, or another commercial location. At that time, nobody would have thought that the average household might have its very own fax/copy machine. Today, you can get an all-in-one for under $100. Who would have thought a century ago we would go from horses and buggies to automobiles?
Undoubtedly, this is a positive development. Albeit demand for the copy machine at Kinko’s and horses and buggies has dropped. But those things have been replaced by at-home copy machines and automobiles. This drop-off in demand for Kinko’s and horses and buggies would be detected by the GDP as economic decline. The political response would be to bailout Kinko’s and the horses and buggies industry, as though market share is supposed to remain static. One man’s loss of market share is another man’s gain of market share.
Conversely, if the western part of the United States went to war against the eastern part of the United States, the GDP could rise exponentially. But would that be a positive development for the economy? Hardly.
For the Fed to keep the price level the same in nominal terms requires inflation (i.e. an expansion of the money supply). Thus, even if prices were to remain stagnant, we can still be suffering from the effects of lost deflation. The question is: what would prices otherwise be absent central bank manipulation? We don’t know, but it’s safe to say prices would be a lot lower.
It’s the effort to prop up prices through stimulus that’s preventing the economic recovery. People are losing their homes because homes are unaffordable (not because they are too cheap). Thus deflation is the cure (not the problem). What sense does it make to provide somebody with a cheaper mortgage – by interest rate manipulation through loose monetary policy at the FOMC – on a more expensive house that costs more to maintain? But that is what present policy is aimed at pursuing. What sense does it make to stimulate more home building when housing isn’t clearing the market as is?
No matter which way the government inserts itself into the housing market, this diminishes the need for sellers to set prices pursuant to supply vs. demand (i.e. market-clearing prices). Whether the government buys up bad mortgages, bails out the homeowner or the bank, this interferes with the price mechanism. If we continue down the current policy path, one will have to be politically connected to get an “education,” get a job, get healthcare, and…get a house!
Suppose there’s a shop owner whose inventory is piling up because nobody can afford to pay for his prices. What does the shop owner have to do? Lower prices. But suppose the government inserts itself into the picture and subsidizes the shop owner. No longer is the shop owner’s sustenance dependent upon having to satisfy consumer demands, thus diminishing the need to set market-clearing prices. Within the construct of the unhampered free market there can’t be price gouging any more than there can be wage gouging, since vendors can’t short inventory at prices above what consumers are both willing and able to pay.
Let’s try another scenario. Suppose the government distributed “credits” or “vouchers” to this shop owner’s customers. This would be perceived as an “enlightened” form of welfare for the shop owner’s customers. However, this is yet a different way to subsidize the shop owner, by letting the shop owner sell at artificially high prices. A move like this prices the poorer, non-recipients of “credits” or “vouchers” out of the marketplace. No surprise that education and healthcare – two of the most government subsidized cartels – have also had the highest levels of price inflation. This begets the erroneous perception that the problem is a dollar shortage for the one who didn’t receive “stimulus.”
The mistaken conclusion is that we need these subsidies and stimulus rather than understanding that it’s the subsidies and stimulus pricing the little guy out of the marketplace. The poor person has been priced out of the marketplace. The problem isn’t a dollar shortage, but a dollar leakage thanks to promiscuous spending.
I’ve always said that, by rights, the impoverished belong to the free market movement. With the government as large as it is today, would it not be a fair assumption that many people who are poor are so precisely due to big government, whereas many people who are wealthy are so precisely due to big government? You see, big business uses big government to manipulate the marketplace on its behalf.
The flawed assumption made by some progressives is that big government is somehow less dangerous than big business. This begets the erroneous conclusion that the problem is an absence of regulation. It’s paramount to understand that we can’t regulate away insolvency. We can’t regulate away past mistakes. But we sure can regulate everybody except the big cartels out of existence.
Furthermore, it’s loose monetary policy that engenders speculation, as lenders/investors are compelled to hedge against a depreciating currency. Holding (i.e. investing in) dollars guarantees losses. Politicians have no right debasing the currency to then regulate away that behavior. The simple solution is to stop the printing press. Politicians have no right to punish us for their past transgressions through cumbersome regulations. The most efficient way to mitigate excessive risk taking is by letting the market set interest rates pursuant to the true supply of savings. Subsidizing risk taking while privatizing the profits is not a real free market. Size-capping should not be conflated with risk-capping.
Ludwig von Mises and Eugen von Bohm-Bawerk saliently articulated how labor can’t increase its share at the expense of capital. Nobody can argue against capital without arguing for a reduction in their own standard of living. Thus the problem for the progressive should not be with capital per se, but that capital is so inaccessible to the common person.
Why is capital so inaccessible to the common person? Every tax, every regulation, every government program drives up the cost of capital. Politicians love this, because they get power. Big business loves this, because it creates barriers to competition. Big government creates monopolies, as a monopoly is a state of imperfect competition, and imperfect competition is begotten by government interference in the marketplace.
The situation with housing is no different than that of the shop owner I described above. In a market unhampered by government, sellers are sustained by selling inventory. When the government inserts itself into the picture, sellers are no longer dependent upon having to satisfy consumer demands by selling inventory. Sustenance is disconnected from the satisfaction of consumer demands. In the case of housing, the government and the Fed are subsidizing the loan market to hold back inventory. See: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/04/08/MNL516UG90.DTL&type=realestate
Simultaneously people are living in tents. The mission of politicians in Washington is literally to keep people homeless. Do not let those kleptocrats masquerade as philanthropists. It’s not their money they’re spending; it’s your money they’re spending – and on themselves. So long as the government keeps trying to prop up prices, as it has done with healthcare and education, real estate won’t clear the market and we won’t have a recovery.
Economic recovery rests upon a smooth-functioning price mechanism, where the market can discover real prices. How is Ben Bernanke or anybody else supposed to know what prices of everything are supposed to be? Would politicians mind telling me what housing prices are supposed to be? How is it good to stimulate home building when there are homes on the market not clearing?
The pursuit of price stability means the Fed will constantly be chasing its own tail. The Fed doesn’t want to allow deflation, so it deliberately tries to create inflation. But then the Fed also promises to intervene if inflation surpasses some level that central planners supposedly have the wisdom to know is wrong. This makes no sense. It’s impossible for the Fed to fight both deflation and inflation. If inflation is good, then bring it on Zimbabwe-style. If inflation is bad, and must be turned off after it starts, then why start the inflation to begin with? In other words: central planners have promised to do an intervention on their own intervention.
If prices fall, this isn’t a bad thing. If we had propped up the economy of, say, 1900, we would still be riding around in horses and buggies. While Paul Volcker is right that expanding the money supply by 2% every year wipes out at least half of one generation’s wealth, the Fed should not be pursuing price stability. We should, instead, be concerned with monetary stability.
Inflation is not economic growth. Just as inflation begets a negative RRR (i.e. real rate of return), deflation begets a positive RRR. Falling prices means rising real incomes. No nation has ever succeeded in substituting a printing press for income-generating investment.
Our only ticket out of this mess is to stop the printing press, which will bring false economic activity to an end, allowing for what remains of the productive and profitable elements of the economy to lead us into an economic recovery. The government is leading us over a cliff. There can’t be a systemic collapse without a systemic cause. Until systemic changes are made to Washington (not the private sector), there will be no economic recovery.
DEBUNKING MYTHS & OFFERING THE SOLUTION
Myth: The problem is “toxic” assets (e.g. mortgage-backed securities) which have created systemic risk
When a hospital can’t collect payment, the hospital sells this debt to a collection agency. This doesn’t create booms and busts. The risk is asystemic unless the government bails out every debtor and/or creditor.
Myth: Present problems were caused by bad lending (i.e. sub-prime loans)
Promiscuous lending is a symptom – not a cause – of economic conditions. Take bad lending to its own logical conclusion: creditors give away money as an act of charity, getting nothing in return. Does charity cause booms and busts? No. Promiscuous lending is a symptom of loose monetary policy at the Fed, which tricks the loan market into consummating unjustifiable loans.
It’s primarily through FOMC operations that interest rates are determined (until the Fed loses control, which will eventually happen). By expanding the money supply, this increases the supply of loanable funds without an expansion of genuine savings. In doing so, the loan market appears to be more solvent than it truly is, tricking the loan market into consummating unjustifiable loans. This artificially suppresses nominal interest rates below their natural level (i.e. where they should be pursuant to the true supply of savings). By expanding the money supply, this allows debtors/borrowers to pay lenders/creditors with devalued dollars, thus lowering the real rate of interest.
A credit transaction involves trading present goods for future goods. If there are no present goods (i.e. savings, which aren’t created on a printing press), then credit has to be curtailed. The problem isn’t a credit crunch, but a savings crunch. Investment can only come out of savings because producers must consume in order to sustain the process of production. In order for the baker to make more bread, the baker himself must eat. Thus somebody must forego present consumption in order to fund credit expansion.
The rate of interest is the discount rate of future goods as against present goods. An example would be what an investor pays for a printing press. Suppose the printing press will generate five-hundred thousand dollars in net income throughout a ten-year life. The entrepreneur will certaintly not bid up the price of the capital equipment to five-hundred thousand dollars. The entrepreneur is willing to invest, say, fifty-thousand dollars for the printing press and the vendor is willing to part ways with the printing press in exchange for an immediate fifty-thousand dollars. The entrepreneur and capital equipment vendor mutually settle upon fifty-thousand dollars – a sum far less than the five-hundred thousand dollars – in exchange for the printing press.
How much present income (i.e. present goods) is an entrepreneur willing to invest in order to garner five-hundred thousand dollars in future net income (i.e. future goods) over a ten year period? Reflected in the transaction is the rate of interest as determined by time preferences. Interest rates represent an agio on present goods since present goods are more valuable than are future goods. A person would rather eat an apple today than eat an apple ten years from now. Interest rates must be set pursuant to the true supply of savings and are determined by time preferences. If everybody wants to consume without saving, then interest rates must rise to reflect time preferences.
There is no right way to extend credit at negative real rates, which is a negative rate of return in real terms. It’s a calculus for the loan market to go bust. Any person, firm, or institution (e.g. government) that’s dependent upon inflationary credit expansion is, by definition, insolvent (i.e. a non-income generator). Failure has to be an option for bad business decisions. That’s the check on excessive risk taking.
Capital naturally gravitates to lower priced, higher-yielding economies. It’s called arbitrage. Artificially low interest rates engenders capital outflow. Capital goes racing overseas. The problem isn’t a dollar shortage, but a dollar leakage. The dollars are out there; they’re just piled up in foreign reserves. The way to repatriate these dollars is for the Fed to tighten, interest rates rise, prices collapse to reflect wages, which will then beget capital inflow thus lowering the natural rate of interest. If I give you $10 in exchange for a book and you turn around and give me that $10 in exchange for a DVD, the real means of purchase for the book was the DVD and the real means of purchase for the DVD was the book. Increasing the quantity of dollars creates no benefit for the economy.
Myth: The FDIC is good for depositors
The FDIC offers deposit insurance for bank customers, which is really a backdoor way to bailout insolvent banks. Could you imagine being able to run a ponzi scheme (e.g. fractional-reserve banking), knowing that when your insolvency is exposed the government will pay off your customers (i.e. a de facto bailout of you)? This creates yet another layer of moral hazard on top of the central bank injecting “liquidity” into the loan market. Thus FDIC’s true purpose is designed to keep the unsustainable intact.
Needing to insure bank deposits should raise questions in and of itself. Unlike natural disasters, economic risk can’t be pooled. It’s one thing to guarantee one’s solvency should they get wiped out due to, say, a flood. It’s quite another thing to guarantee solvency, per se. It’s impossible to insure against economic miscalculation and loss. If I were to go into business and you offered to insure me against business failure, you become the true entrepreneur in the deal by underwriting/assuming risk.
The FDIC (insolvent) is backed by the Treasury (insolvent) which is backed by the Federal Reserve (insolvent). The Federal Reserve is backed by a printing press which is backed by the savings of Americans. Not only is the concept of insuring economic risk altogether chimerical, but there’s a reason why only a government-backed entity would offer insurance to banks. Inflationary credit expansion makes banks inherently insolvent. Demand deposits are payable on demand, while banks are lent long. Thus the time structure of assets and liabilities does not match.
At the end of the day, the FDIC/Treasury/Federal Reserve – all three of which are insolvent – can guarantee depositors pull money out of their bank, but there’s no guarantee of the currency’s value. By guaranteeing solvency, this inherently places the currency’s value at risk. Deposits are guaranteed in nominal terms, but not in real terms.
When one scrutinizes the role of the FDIC more closely, they can see that its entire purpose is keeping the good ole’ boy network intact, leaving Americans with nothing. If the free market were allowed to function, the government’s role would be limited to enforcing contracts. If homeowners default, the bank would foreclose. But if the bank defaults, the bank’s creditors – i.e. its depositors – would become receiver for the failed bank’s assets. Depositors should be senior to all other creditors. Thus, in the event of a bank run, depositors have the first legal claim to a bank’s housing inventory.
What does the insolvent FDIC do? If a bank fails, the FDIC sends in federal regulators to protect the bank’s assets from its depositors by becoming receiver for a failed bank’s assets. In many instances, the FDIC has arranged shotgun mergers with investment banks on Wall Street, turning investment banks into bank holding companies.
So we can see this sleight-of-hand trick – under the guise of protecting depositors – is designed to transfer real assets (i.e. housing inventories) from failed banks to Wall Street, while promising depositors nothing more than globs of Ben Bernanke’s “liquidity.”
There’s no way the FDIC/Fed can guarantee the solvency of the banking system or depositors, which will destroy the currency (measure purchasing power in terms of gold) thus destroying the very depositors (anybody holding dollars) those institutions are supposedly designed to protect.
The solution, then, is to put a failed bank’s assets into the receivership of its depositors. Any other efforts to prop up the housing and/or bond market will prevent the market from clearing and block those who have already lost homes from ever regaining possession. We are now doing to the housing market the same thing that has already been done to healthcare and education.
If you want to figure out how to get your homes back, then make an inquiry into where they’ve gone. The Fed is sitting on at least $1 trillion worth of Mortgage Backed Securities. We can go a long ways towards saving the dollar and getting people back into homes by having the Fed liquidate the MBS on its balance sheet.
In my estimation, any other plan will engender homeless people and peopleless homes.