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Does the Central Bank Determine Interest Rates?

According to mainstream thinking, the central bank is the key factor in determining interest rates.

By setting short-term interest rates, the central bank, it is argued, through expectations about the future course of its interest rate policy can influence the entire interest rate structure.

Thus according to the popular way of thinking, the long-term rate is an average of current and expected short-term interest rates. If today’s one year rate is 4% and next year’s one-year rate expected to be 5%, then the two-year rate today should be 4.5% (4+5)/2=4.5%.

Conversely, if today’s one year rate is 4% and next year’s one-year rate expected to be 3%, then the two-year rate today should be 3.5% (4+3)/2=3.5%.

Note that interest rates in this way of thinking are established by the central bank whilst individuals in all this have almost nothing to do and just form mechanically expectations about the future interest rate policy of the central Bank.

Individuals here are passively responding to the possible interest rate policy of the central bank. However, does it make much sense?

We suggest that the key in interest rates determination is people’s time preferences. What is it all about?

People assign higher valuation to present goods versus future goods

As a rule, people assign a higher valuation to present goods versus future goods. This means that present goods are valued at a premium to future goods.

This stems from the fact that a lender or an investor gives up some benefits at present. Hence, the essence of the phenomenon of interest is the cost that a lender or an investor endures.

On this Mises wrote,

That which is abandoned is called the price paid for the attainment of the end sought. The value of the price paid is called cost. Costs are equal to the value attached to the satisfaction which one must forego in order to attain the end aimed at.[1]

…click on the above link to read the rest of the article…

Is Chinese Growth About to Falter?

  • The IMF revised Chinese growth forecasts higher in July – were they premature?
  • Retail sales, industrial output and fixed investment have slowed
  • The Real Estate sector is still buoyant but home price increases are moderating
  • Narrow money supply growth has slowed, other parts of the economy will follow

China has long been the marginal driver of demand for a wide array of commodities. In an attempt to understand the recent rise in the price of industrial metals, the strength of Chinese demand is a key factor. The picture is mixed.

The chart and commentary below is taken from Sean Corrigan’s August newsletter – Cantillon Consulting – China: Is the tide turning?:-

China_Money_Supply_-_Cantillon_August_2017

Source: Cantillon Consulting

As Corrigan goes on to say:-

As the deceleration has progressed, the PMI has shown its expected downward response. In due course, company revenues – and ultimately profits – will follow if this is long maintained.

Greater recourse to receivables financing (funded partly by recourse to shadow finance) can delay full recognition of this awhile, but it cannot fail to impair either the magnitude or the quality of earnings as it works through the economy.

At the heart of the credit equation lies the Real Estate market:-

China_Real-Estate_and_M1_-_Cantillon_-_August_2017

Source: Cantillon Consulting

During 2016 property prices in China increased by 19%, new homes by 12.4%, the fastest since 2011, but the market has cooled of late due to government intervention to subdue its speculative excess. New-home prices, excluding government-subsidized housing, gained from the previous month in 56 of 70 cities in July, compared with 60 in June. New Home Sales for August were the weakest in three years at +3.8%, however, investment in Real Estate development increased 7.8% last month – this is hardly a collapse. House prices are still forecast to rise by 6.8% in 2017 with growth driven by continued increases in second and third tier cities:-

…click on the above link to read the rest of the article…

Further Thoughts on Gibson’s Paradox

“The paradox is one of the most completely established empirical facts in the whole field of quantitative economics.” – John Maynard Keynes

“The Gibson paradox remains an empirical phenomenon without a theoretical explanation” -Friedman and Schwartz

“No problem in economics has been more hotly debated.” – Irving Fisher


Introduction

Two years ago, I found a satisfactory solution to Gibson’s paradox.i The paradox is important, because it demonstrated that between 1750-1930, interest rates in Britain correlated with the general price level, and had no correlation with the rate of price inflation. And as Friedman and Schwartz wrote, a theoretical explanation eluded even eminent economists, so economists preferred to assume the quantity theory of money was the correct guide to the relationship between interest rates and prices. Therefore, the consequence of resolving the paradox is that the supposed linkage between interest rates, the quantity of money and the effect on prices is disproved.

Gibson’s paradox tells us that the basis of monetary policy is fundamentally flawed. The reason this error has been ignored is that no neo-classical economist has been able to establish why Gibson’s paradox is valid, as the introductory quotes tell us. Consequently, this little-know but very important subject is hardly ever discussed nowadays, and it’s a fair bet most of today’s central bankers are unaware of it.

The relationship between interest rates and the general level of prices held until the 1970s. This article summarises why Gibson’s paradox functioned, why interest rates do not correlate with price inflation, and the reasons it failed to be evident after the 1970s.

For ease of reference, here are the two charts reproduced from my original paper that the paradox refers to, the first illustrating the correlation between interest rates and the price level, and the second the lack of correlation between interest rates and the inflation rate in Britain, the only country where such a long run of statistics is available.

Gibson's Paradox

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Money Multiplier is Really About Credit Out of “Thin Air”

According to traditional economics textbooks, the current monetary system amplifies the initial monetary injections of money. The popular story goes as follows: if the central bank injects $1 billion into the economy and banks have to hold 10% in reserve against their deposits the initial injection of $1 billion will become $10 billion i.e. money supply will expand by a multiple of 10. Note that in this example the central bank has actively initiated monetary pumping of $1 billion, which in turn banks have amplified to $10 billion.

Economists from the post-Keynesian school of economics (PK) have expressed doubt about the validity of this popular framework of thinking[1]. One of the advocates of this school, Bill Mitchell, in an article on his blog – Money Multiplier and other Myths – wrote that,

It (money multiplier) is also not even a slightly accurate depiction of the way banks operate in a modern monetary economy characterised by a fiat currency and a flexible exchange rate. In the present monetary framework, it is held the job of the central bank is to ensure that the level of cash in the money market is in tune with the interest rate target.

According to Mitchell,

The way banks actually operate is to seek to attract credit-worthy customers to which they can loan funds to and thereby make profit.

Furthermore, according to Mitchell,

So the idea that reserve balances are required initially to “finance” bank balance sheet expansion via rising excess reserves is inapplicable. A bank’s ability to expand its balance sheet is not constrained by the quantity of reserves it holds or any fractional reserve requirements. The bank expands its balance sheet by lending. Loans create deposits which are then backed by reserves after the fact. The process of extending loans (credit) which creates new bank liabilities is unrelated to the reserve position of the bank.

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Deaf blind

“Most economists, it seems, believe strongly in their own superior intelligence and take themselves far too seriously. In his open letter of 22 July 2001 to Joseph Stiglitz, Kenneth Rogoff identified this problem. ‘One of my favourite stories from that era is a lunch with you and our former colleague Carl Shapiro, at which the two of you started discussing whether Paul Volcker merited your vote for a tenured appointment at Princeton. At one point, you turned to me and said, “Ken, you used to work for Volcker at the Fed. Tell me, is he really smart ?” I responded something to the effect of, “Well, he was arguably the greatest Federal Reserve Chairman of the twentieth century.”

To which you replied, “But is he smart like us ?””

Few things have the capacity to trigger an intense emotional response more effectively than this video of a 29-year-old deaf person hearing for the first time. For the able bodied, trying to imagine the life of someone missing one or more of the core senses feels pretty much impossible. In the UK, the Oily Cart theatre company specialise in providing entertainment for young people with profound disabilities. Their current show, an adaptation of Samuel Taylor Coleridge’s Kubla Khan, endeavours to create a theatrical spectacle for children who are both deaf and blind – which at first seems like an insurmountable challenge. But if you cannot engage with two senses, make the most of appeals to the rest. So for the participants in Kubla Khan, the seating revolves; the smell of incense wafts across the stage; the audience dip their hands into water, into which the stage crew blow bubbles through straws to conjure up a swirling River Alph. There are times when human ingenuity can be inspiring.

…click on the above link to read the rest of the article…

See No Evil, Speak No Evil…

The Jackson Hole speeches of Janet Yellen and Mario Draghi last week were notable for the omission of any comment about the burning issues of the day:

…where do the Fed and the ECB respectively think America and the Eurozone are in the central bank induced credit cycle, and therefore, what are the Fed and the ECB going to do with interest rates? And why is it still appropriate for the ECB to be injecting raw money into the Eurozone banks to the tune of $60bn per month, if the great financial crisis is over?i

Instead, they stuck firmly to their topics, the Jackson Hole theme for 2017 being Fostering a dynamic global economy. Both central bankers told us how good they have been at controlling events since the last financial crisis. Ms Yellen majored on regulation, bolstering her earlier-expressed belief that financial crises are now unlikely to happen again, because American banks are properly regulated and capitalised.

Incidentally, more regulation hampers economic dynamism, contra to the subject under discussion, and confirms Ms Yellen has little understanding of free markets. Mario Draghi, however, told us of the benefits of financial regulation and globalisation, and how that fostered a dynamic global economy. But a cynic reading between the lines would argue that Mr Draghi’s speech confirms the ECB is in thrall to Brussels and big business, and is merely representing their interests. And he couldn’t resist the temptation to have a poke at President Trump by expressing the benefits of free trade.

Hold on a moment, free trade? Does Mr Draghi really understand the benefits of free trade?

That’s what he said, but his speech was all about the importance of regulating everything Eurozone citizens can or cannot do. It is permitted free trade in a state-regulated environment. It is a version of free trade according to the EU rule book, agreed with big European business, which advises Brussels, which then sets the regulations. It is a latter-day Comintern that allows you to trade freely only on terms set by the state for prescribed goods with other states of a similar disposition. Draghi’s speech was essentially justifying the status quo laced with Keynesian-based central bank dogma.

Taken to the Cleaners

Introduction

Should regulators call the market? It has been a matter of vigorous debate in the regulatory community since the crisis. ‘Cleaners’ think you shouldn’t mess around with the market, although be prepared to clean up if markets collapse. ‘Leaners’ take the opposite view, divided between those who want to lean on the asset side of overheated balance sheets, principally by increasing capital requirements, and those who want to lean on overheated liabilities, using an ingenious accounting method called ‘matching adjustment’, which allows firms to reduce the present value of future liabilities by increasing the rate at which they are discounted. If spreads blow out on your assets you are allowed to add some of that spread to the discount rate for your liabilities, which cushions the impact in the short term.[1]

This article focuses on whether economists can identify trends or bubbles in the residential property market. The question is important for insurers, whose balance sheets have been damaged by the protracted fall in long gilt yields, and who are hunting for yield in alternative assets such as commercial and residential property. I asked three economists for their views.

John Cochrane of Stanford’s Hoover Institution, author of the magisterial Asset Pricing, complains about a common misunderstanding: ‘people say the market can’t be efficient, because it didn’t predict the 2008 crash. That’s exactly backward. Efficient markets theory says that the market aggregates all information that people have – and no more. The market is not clairvoyant.  Consequently, the central empirical prediction of the efficient markets hypothesis is precisely that nobody can reliably tell where markets are going – neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics. This is probably the best-tested proposition in all the social sciences.’

…click on the above link to read the rest of the article…

The Golden Revolution, Revisited

The latest edition of The Golden Revolution is available from Amazon here https://www.amazon.com/dp/1535608994

Back in 2012 John Wiley and Sons published my first book, The Golden Revolution, the core thesis of which was that a longer-term consequence of the global financial crisis of 2008 would be the remonetization of gold. This would occur initially at the international level, that is, as a mean to settle accumulated international imbalances in trade and cross-border investment. The book then also explored how this might come about, what the implications were for the price of gold and for the financial markets more generally.

Now, five years later, it is my pleasure to announce the arrival of the new, Revisited edition, containing an entirely new section on the monetary sources of inequality; multiple new chapters on ‘FinTech’, including cryptocurrencies and digital gold; and updating the text throughout for recent developments in international economic and monetary affairs.

This new, Revisited edition will be published by Goldmoney and will also appear as a special series of Goldmoney Insights over the coming months. In this first instalment I introduce the new book while also including the original introduction from the 2012 edition.

INTRODUCTION TO THE REVISITED EDITION

“If we went back on the gold standard and we adhered to the actual structure of the gold standard as it existed prior to 1914, we’d be fine. Remember that the period 1870 to 1913 was one of the most aggressive periods economically that we’ve had in the United States, and that was a golden period of the gold standard. I’m known as a gold bug and everyone laughs at me, but why do central banks own gold now?”

—       Alan Greenspan, June 2016[1]

…click on the above link to read the rest of the article…

Austrian Monetary Theory vs. Federal Reserve Inflation Targeting

One of the leading policy guideposts for central banks and many monetary policy proponents nowadays is the idea of “inflation targeting.” Several major central banks around the world, including the Federal Reserve in the United States, have set a goal of two percent price inflation. The problem is, what central bankers are targeting is a phantom that does not exist.

Perhaps we can best approach an understanding of this through an appreciation of some of the writings by members of the Austrian School of Economics on matters of monetary theory and policy. Carl Menger (1840-1921), the founder of the Austrian School in the 1870s, had explained in his Principles of Economics (1871) and his monograph on “Money” (1892), that money is not a creation of the State.

Money Emerges from Markets, Not the State

A widely used and generally accepted medium of exchange emerged “spontaneously” – that is, without intentional government plan or design – out of the interactions of multitudes of people over a long period of time, as they attempted to successfully consummate potentially mutually advantageous exchanges. For example, Sam has product “A” and Bob has product “B”. Sam would be happy to trade some amount of his product “A” for some quantity of Bob’s product “B”. But Bob, on the other hand, does not want any of Sam’s “A”, due to either having no use for it or already having enough of “A” for his own purposes.

…click on the above link to read the rest of the article…

Should Bank Regulation be Relaxed?

Leading Federal Reserve policymaker Stanley Fischer has hit out at plans to unwind banking regulation, calling it a “terrible mistake.”

President Donald Trump and republican politicians have advocated the repeal of Dodd Frank, a major piece of post-crisis legislation, and the loosening of some capital and liquidity requirements in a bid to ease banks’ ability to lend.

In an interview with the Financial Times on August 16 2017, Fischer said that loosening capital and liquidity requirements is dangerous and could lead to a new economic crisis. “I find that really, extremely dangerous and extremely short-sighted.”

Whilst Fischer is not a friend of a free market, in this case we are in agreement with Fischer’s comment.

True free financial environment versus financial environment controlled by central bank

The proponents for less control in financial markets hold that fewer restrictions imply a better use of scarce resources, which leads to the generation of more real wealth.

It is true that a free financial environment is an agent of wealth promotion through the efficient use of scarce real resources, whilst a controlled financial sector stifles the process of real wealth formation. The proponents of deregulated financial markets have overlooked the fact that the present financial system has nothing to do with a free market.  What we have at present is a financial system within the framework of the central bank, which promotes monetary inflation and the destruction of the process of real wealth generation through fractional reserve banking. In the present system the more unrestricted the banks are the more money out of “thin air” generated and hence greater damage inflicted upon the wealth generation process. (Note that in the genuine free banking i.e. the absence of the central bank, the potential for the creation of money out of “thin air” is minimal).

…click on the above link to read the rest of the article…

The 2017 Stress Tests: Are US Banks Really in Good Shape?

“… equally efficacious, and equally a hoax.” – Benjamin Disraeli, 1848[1]

One of the highlights of the U.S. summer for Fed watchers is the annual ritual in which the Fed’s economic soothsayers peer into their crystal balls, a.k.a. their stress tests, to reassure us that the U.S. banking system is robust and getting stronger all the time.

You see, while the future is uncertain, the results of the stress tests are not. Praise be that the news is always good and getting better.

This year, the news is particularly good. As usual, the key capital metrics across the system are better than ever. And whereas in previous years there were always dunces who failed, the latest set of stress tests are the first in which all the banks passed and this year’s class laggard, Capital One, got only the mildest of slaps on the wrist.

As James Ferguson of The MacroStrategy Partnership notes in a recent commentary on the latest stress tests:

… everywhere you look, the Fed now seems to be bending the rules  in the banks’ favour. … This [stress test] appears to be a test that has been designed to be passed.”[2]

In fact, the Fed is so pleased with the performance of its stress-test examinees that it decided to reward them (or, more precisely, their shareholders) with a big dividend/buyback party that will give them a big windfall.[3] The Fed provides the punchbowl which will be paid for by other bank stakeholders including taxpayers — yes, the same taxpayers who are still being compelled to subsidize the banks (via Too Big to Fail, deposit insurance, and such like) to take excessive risks and overleverage themselves, and who stand to pay the bill if there is another crisis and the banks get bailed out again.[4]

…click on the above link to read the rest of the article…

Can Switzerland Survive Today’s Assault on Cash and Sound Money?

“Switzerland will have the last word,” wrote Victor Hugo in the late 19th century. “It possesses one of the most perfect forms of government in the world.” A contemporary of his, Frederick Kuenzli, a scholar of the Swiss Army, boasted: “No purer type of Republican ideals, no more fixed and devoted adherence to those ideals can be found in all the world than in Switzerland.”

On many levels, there is reason to believe that, indeed, Switzerland remains a unique oasis of rationality and intelligence in the ocean-wide bloodbath that is contemporary Western fiscal and social self-sabotage. On the other hand, there is the Swiss National Bank — the central bank — that oddly appears to be encouraging the same monetary policy dance-with-death that has tripped up the country’s masochistic neighbors. How viable yet is the Swiss element in that which we still admire as the nation of Switzerland? First the good news:

Direct democracy is alive and kicking: No mere opinion poll, the power and vibrancy of the referendum — one that can be launched by any local who can gather 100,000 signatures in support — constitutes one of the most impressive displays of true citizen-republicanism that there is. There is an upcoming vote on the Swiss Sovereign Money Initiative — a movement to obstruct financial speculation; recent referendums that were voted into law include a phasing out of nuclear energy to be replaced by renewables, and easier naturalization of third-generation immigrants.

Cash is still very much king and carrying around personal debt is a social blackmark. In fact, the love of cash has a counter-cultural dimension to it as an anti-State, anti-globalist, anti-anti-privacy gesture intended to underscore the Swiss love of freedom.

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Lord Liverpool and the Return to Gold

The following is an excerpt from Martin Hutchinson’s forthcoming book, “Britain’s Greatest Prime Minister”, a biography of Robert Banks Jenkinson, 2nd Earl of Liverpool (1770-1828). Lord Liverpool was Prime Minister from 1812 to 1827 and had led Britain through the later part of the Napoleonic Wars.

The following is an excerpt from Martin Hutchinson’s forthcoming book, “Britain’s Greatest Prime Minister”, a biography of Robert Banks Jenkinson, 2nd Earl of Liverpool (1770-1828). Lord Liverpool was Prime Minister from 1812 to 1827 and had led Britain through the later part of the Napoleonic Wars.

He was the decisive player in Britain’s resumption of the gold standard in 1821.

Parliamentary background

Definitive reports on cash payments resumption from the Commons and Lords Select Committees were presented on May 6 and 7, 1819. By this time, the economy had definitively turned down, with the temporary euphoria of 1817-18 having ended and a deflation in anticipation of the return to gold having set in.

The Commons report showed that, while the Bank of England, had in 1817 enjoyed gold and cash reserves larger than at any previous time in its history, redemption of old notes had since drained £6.76 million of bullion from it, which had mostly been sold by speculators at a profit, of which around £5 million had been carried to France, according to Alexander Baring.[1] The Commons Committee had accordingly recommended that notes redemption should cease temporarily, since only by a sharp contraction in its notes issue could the Bank reduce the bullion price to a level at which arbitrage was unprofitable.

Bank advances to the government totalled £19.4 million in Exchequer Bills at April 29, 1819, down from a maximum of £34.9 million in August 1814. Conversely, the public balances held by the Bank had declined from around £11 million in 1807 to £7 million currently (in consideration of which the Bank had lent the government £3 million interest-free in 1808).

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Freedom and the Fear of Self-Responsibility

Liberty is under a renewed challenge and attack in the contemporary world. From “political correctness” and its accompanying growing totalitarian closed-mindedness at institutions of higher learning in both America and Europe, to the rebirth of economic nationalism with its rejection of freedom of trade, investment and people in places like the United States, along with the continuing stranglehold of the interventionist-welfare state seemingly everywhere, we are facing possible reductions in the degrees of individual liberty still remaining in our lives.

The question is, why? Various attempted answers have been offered by those deeply fearful of this direction, especially in “the West,” where the idea, ideal and practice of personal and economic freedom first emerged and took significant hold over the last three hundred years.

This trend has seemed most peculiar in the face of the dramatic, and “miraculous” transformation of the human condition in the last two hundred years, during which life for the ordinary person has gone from abject economic poverty and political oppression to a world of amazing affluence and material comfort for the vast, vast majority, with the institutionalization (if not always the practice) of respect for and protection of wide array of civil liberties.

The Trend Away From Freedom, Back to Paternalism

This trend, alas, has been going on for some time. For instance, in 1936, the noted Swiss economist and political scientist, William E. Rappard (1883-1958) delivered a lecture in Philadelphia on, “The Relation of the Individual to the State.” Looking back at the trend of political and economic events in the nineteenth and twentieth centuries, Rappard explained:

The revolutions at the end of the eighteenth century . . . were essentially revolts of the individual against the traditional state – expressions of his desire to emancipate himself from the ties and inhibitions which the traditional state had imposed on him . . . which one may define as the emancipation of the individual from the state, to the will of the individual.

…click on the above link to read the rest of the article…

Saving and Money–What is the Relationship?

Conventional wisdom says that savings is the amount of money left after monetary income was used for consumer outlays, implying that saving is synonymous with money. Hence, for a given consumer outlays an increase in money income implies more saving and thus more funding for investment. This in turn sets the platform for higher economic growth.

Following this logic, one could also establish that increases in money supply are beneficial to the entire process of capital formation and economic growth. (Note increases in money supply result in increases in monetary income and this in turn for a given consumer outlays implies an increase in savings).

Relation between saving and money

Saving as such has nothing to do with money. It is the amount of final consumer goods produced in excess of present consumption.

The producers of final consumer goods can trade saved goods with each other or for intermediate goods such as raw materials and services.  Observe that the saved goods support all the stages of production, from the producers of final consumer goods down to the producers of raw materials, services and all other intermediate stages.

Support means that these savings enable all these producers to maintain their lives and wellbeing whilst they are busy producing things. Also, note that if the production of final consumer goods were to rise, all other things being equal, this would expand the pool of real savings and would increase the ability to further produce a greater variety of consumer goods i.e. wealth.

Note that people do not want various means as such but rather final consumer goods. This means that in order to maintain their life people require an access to consumer goods.

 

…click on the above link to read the rest of the article…

Olduvai II: Exodus
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Olduvai
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Olduvai II: Exodus
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Olduvai III: Cataclysm
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