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The Economy May Be Finally Peaking, and the Fed Won’t Help Matters

Here we go again it may seem to many. The Fed is preparing us for a policy tightening just when a powerful growth cycle upturn is faltering. Or is it in fact an example of another well-known type of error from Fed history—getting behind the curve of rising inflation? The most plausible answer is that it is neither.

Instead, the huge monetary inflation shock which the Fed has administered so far in this pandemic means that the “normalization steps” now in prospect for 2022 are all but irrelevant to macroeconomic prospects or asset market price trajectories.

The more Federal Reserve chief Jerome Powell has been huffing and puffing, since his renomination (November 22), about normalizing policy, the steeper has been the fall in long-term interest rates. In the first two trading weeks following the renomination, the ten-year yield on US Treasurys was down by thirty basis points to 1.35 percent. A coincidence, surely, explained in part by the possible Omicron menace? Yes, perhaps in part, but not altogether.

The chief’s performance is now in the theater of the absurd. Many in the marketplace have deserted the audience, though the noise still irritates them. Instead, they focus on the drama of monetary reality. The title? “Lost Illusions on the Journey from Mega Pandemic Inflation to Great Depression.” The evolving mood of the audience here will have a powerful effect on financial markets and ultimately the global economy.

Toward understanding the theater of the absurd and its triviality, recall the story of the natural history museum renowned for its dinosaur relics. The guardian there, quizzed by a child as to the age of those specimens, answers: 5 million years and 90 days. How so? Because when he started work there, around three months ago, he was told their age was 5 million years!

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The Futility of Central Bank Policy

It is only now becoming clear to the investing public that the purchasing power of their currencies is declining at an accelerating rate. There is no doubt that yesterday’s announcement that the US CPI rose by 6.2%, compared with the longstanding 2% target, came as a wake-up call to markets.

Along with the other major central banks, the Fed’s reaction is likely to be to double down on interest rate suppression to keep bond yields low and stock valuations intact. The alternative will lead to a major financial, economic and currency shock sooner rather than later.

This article introduces the reader to some of the basic fallacies behind state currencies. It explains the misconceptions policy planners have over interest rates, and how central banks have become contracyclical lenders, replacing commercial banking’s credit creation for non-financial activities.

In effect, narrow money is being used by the major central banks in a vain attempt to shore up government finances and economic activity. The consequences for currency debasement are likely to be more immediate and profound than cyclical bank credit expansion.


It is becoming clear that there has been an unofficial agreement between the US Fed, Bank of England, the ECB and probably the Bank of Japan not to raise interest rates. It is confirmed by remarkably similar statements from the former three in recent days. When, as the cliché has it, they are all singing off the same hymn sheet, those of us not party to agreements between our monetary policy planners are right to suspect they are doubling down on a market rigging exercise encompassing all financial markets.

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Economic Theory and Long-Wave Cycles

Investors and others are confused by the early stages of accelerating price inflation. One misleading belief is in cycles of industrial production, such as Kondratieff’s waves. The Kondratieff cycle began to emerge in financial commentaries during the inflationary 1970s, along with other wacky theories. We should reject them as an explanation for rising prices today.

This article explains why the only cycle that matters is of bank credit, from which all other cyclical observations should be made. But that is not enough, because on their own cycles of bank credit do not destroy currencies — that is the consequence of central bank policies and the expansion of base money.

The relationship between base money and changes in a currency’s purchasing power is not mechanical. It merely sets the scene. What matters is widespread public perceptions of how much spending liquidity is personally needed. It is by altering the ratio of currency-to-hand to anticipated needs that purchasing power is radically altered, and in the earliest stages of a hyperinflation of prices it leads to imbalances between supply and demand, resulting in the panic buying for essentials becoming evident today.

Panics over energy and other necessities are only the start of it. Unless it is checked by halting the expansion of currency and credit, current dislocations will slide rapidly into a wider flight from currency into real goods — a crack-up boom.


For eighteen months, the world has seen a boom in commodity prices, which has inevitably led to speculation about a new Kondratieff, or K-wave. Google it, and we see it described as a long cycle of economic activity in capitalist economies lasting 40—60 years. It marks periods of evolution and correction driven by technological innovation.[i]

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Gold Standard and Boom Bust Cycles

According to the Austrian Business Cycle Theory (ABCT), the boom-bust cycle emerges in response to a deviation in the market interest rate from the natural interest rate, or the equilibrium interest rate. It is held that the major cause for this deviation is increases in the money supply. Based on this it would appear that on a gold standard without the central bank an increase in the supply of gold is also going to set in motion boom-bust cycle.

An increase in the supply of gold is likely to result in the lowering of market interest rates. This in turn is likely to cause the market interest rates to deviate from the equilibrium interest rate. Consequently, following the ABCT an increase in the supply of gold is going to set in motion the boom-bust cycle.

According to Robert P. Murphy “More Than Quibbles: Problems with the Theory and History of Fractional Reserve Free Banking” in the QJAE Volume 22 Spring 2019, Ludwig von Mises held that an increase in the supply of gold could trigger boom-bust cycle.

Whilst suggesting that the gold standard could generate business cycles whenever an increase in the supply of gold causes the market interest rate to deviate from the natural interest rate, or the equilibrium rate, Mises however, viewed this possibility as remote.

Mises regarded the gold standard as the best monetary system as far as keeping the expansion in credit under tight control. Murphy quotes Mises on this,

Even a rapid increase in the production of the precious metals can never have the range which credit expansion can attain. The gold standard was an efficacious check upon credit expansion, as it forced the banks not to exceed certain limits in their expansionist ventures…

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Review: Austrian Economics–An Introduction By Steven Horwitz

June 27 saw the passing of economist Steven Horwitz at the age of 57. His loss will be felt by all who value not just human freedom and dignity, but also good economics, communicated well.

Horwitz was heavily influenced by the ‘Austrian School’ of economics. What this is and what it means are questions Horwitz tackled in his last book, Austrian Economics: An Introduction, published last year.

The school was founded by Carl Menger, an economist in Vienna, Austria, in the late 19th century. The origins of its name lie in a dispute over methodology and the story of its rise to prominence lies in the ‘marginalist’ revolution in economics in the 1870s. Both involve fundamental questions of economics, but they might be heavy going for the moment. Suffice it to say that from these origins a rich and profound body of inquiry and insight has emerged.

Horwitz explains that:

For Menger, economics was the study of how humans possessing limited knowledge and facing an uncertain future attempted to improve their well-being by figuring out what they wanted and how best to get it.

In an article titled ‘On the Origin of Money,’ Menger explained how money, which is a very useful institution, evolved: it wasn’t created. This led him to ask, in his book Investigations into the Methods of the Social Sciences, what is sometimes called the “Mengerian question”:

How can it be that institutions which serve the common welfare and are extremely significant for its development come into being without a common will directed toward establishing them?

In his excellent book Hayek’s Modern Family: Classical Liberalism and the Evolution of Social Institutions, Horwitz applied this analysis to the evolution of the family. As Horwitz notes:

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Commodities, Supply-Chains and Structural Changes in Demand

  • Talk of a new commodity super-cycle may be premature
  • Once GDP growth returns to trend, commodity demand will moderate
  • Fiscal and monetary relief are key to maintaining growth and demand
  • Structural changes in energy demand will prove more persistent

As the spectre of inflation begins to haunt economists, many market commentators have started to focus on commodity prices in an attempt to predict the likely direction of the general price level for goods and services. This indexing of the most heterogeneous asset class has always struck me as destined to disappoint. Commodity prices change in response to, often, small variation in supply or demand and the price of some commodities varies enormously from one geographic location to another. Occasionally the majority of commodities rise in tandem but more frequently they dance to their own peculiar tunes.

Commodity analysts tend to focus on Energy and Industrial Metals foremost; Agricultural Commodities, which are more diverse by nature are often left as a footnote. Occasionally, however, a demand-side event occurs which causes nearly all sectors to rise. The Covid-19 event was just such a shock, disrupting global supply-chains and consumer demand patterns simultaneously.

The chart below shows the CRB Index since 1995: –

Source: CRB, Yardeni

This chart looks very different to the energy heavy GSCI Index, which is weighted on the basis of liquidity and by the respective world production quantities of its underlying components: –

Source: S&P GSCI, Trading Economics

The small rebound on the chart above is not that insignificant, however, it equates to a 55% rise since the lows on 2020. The fact that prices collapsed, as the pandemic broke, and subsequently soared, as vaccines allowed economies to reopen, is hardly surprising. Economic cycles wield a powerful influence over commodity prices; short-term, inelastic, supply, confronted by an unexpected jump in demand, invariably precipitates sharp price increases.

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The Abuse of Public Debt–And How It Sets the Stage For Economic Disaster

The 2020–21 recession has been devastating for the global economy. It has been ninety years since the global economy last suffered through a recession of this magnitude (in the Great Depression). Nonetheless, it seems that the social effects of the current recession have not yet come about. The reason for this disparity between cold macroeconomic data and popular sentiment can be found in the enormous public spending by practically all of the countries in the world.1

This article argues that exorbitant increases in public debt, such as those seen in 2020, are not free. It examines the potential economic effects of accumulating vast quantities of public debt.

The First Problem: Less Economic Growth

The countries with the greatest amount of public debt saw per capita income grow the least, as seen in chart 1.

Chart 1: GDP Growth per Capita

Source: Kumar and Woo. Created with Datawrapper

The economic mechanism that explains this statistical relationship is relatively simple. An excessive public debt causes the so-called expulsion effect, in which credit is redirected from the private sector to the public sector. The growth of public debt deprives the private sector of loanable funds, reducing the generation of wealth. (It is the private sector that generates economic activity. The most the public sector can aspire to do is to establish a framework that favors private endeavors.)

The Second Problem: Disincentivizing Investment and Reducing Productivity

This second problem is an extension of the first. One of the best indicators of an economy’s future growth is its investment rate. When investment increases, so too does productivity, which is accompanied by economic growth.

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Monetary Inflation’s Game of Hide-and-Seek

The May 12, 2021, press release from the Bureau of Labor Statistics reporting on the Consumer Price Index (CPI) for the month of April sent the stock markets tumbling for two days and generated fodder for the news pundits with the announcement that the CPI measure of the cost-of-living had increased 4.2 percent at an annualized rate, or nearly 62 percent higher than in March when the annualized rate was 2.6 percent. The era of relatively low rate of price inflation was feared to be ending.

For almost a decade, despite significant increases in the money supply, CPI-measured price inflation remained “tame.” Between March 2011 and March 2021, the M-2 money supply (cash, checking accounts, and small savings) went from $8.94 trillion to $19.9 trillion, or a 222.5 percent increase. Just in 2020, M-2 expanded by nearly 25 percent.

Yet, despite this, the CPI only went up by a little less than 20 percent, from 223 to 266.8 (100 = 1982-1984) between 2011 and 2021. The annual rates of CPI price inflation for this ten-year period were mostly less than 2 percent. What is called “core” price inflation – the CPI minus energy and food prices – averaged each one of these ten years a bit higher most of the time, but not by much in this period. (See my article, “Dangerous Monetary Manipulations and Fiscal Follies”.)

But what, exactly, does the Consumer Price Index tell us? All price indexes, including the CPI, are statistical constructions created by economists and statisticians that, in fact, have very little to do with the actions and decisions of consumers and producers in the everyday affairs of market demand and supply. And they are certainly not accurate and precise guides for central bank monetary policy.

Overall versus “Core” Price Inflation

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Relation Between Inflation and Deflation

For most commentators inflation is about persistent increases in the prices of goods and services. However, is this the case?  For example, the definition of human action is not that people are engaged in all sorts of activities as such, but that they are engaged in purposeful activities–purpose gives rise to an action.

Similarly, the essence of inflation is not a general rise in prices as such but an increase in the supply of money, which in turn sets in motion a general increase in the prices of goods and services in terms of money.

Consider the case of a fixed stock of money. Whenever people increase their demand for some goods and services, money is going to be allocated towards these goods and services. In response, the prices of these goods and services are likely to increase– more money will be spent on them.

Since we have here an unchanged stock of money, less of it can be now allocated towards other goods and services. Given that the price of a good is the amount of money spent on the good this means that the prices of other goods will decline i.e., less money will be spent on them.

In order for there to be a general rise in prices, there must be an increase in the money stock. With more money and no change in the money demand, people can now allocate a greater amount of money for all goods and services.

According to Mises,

Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check…

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Monetary Pumping and Resources

As a result of the recent strong stimulatory policies employed by the US government and the Fed, most commentators are of the view that the risk of a deepening slump in the US economy on account of the COVID-19 pandemic has now receded.

Some other commentators are not so certain that the risk has declined, arguing that the economy is still heading towards difficult times ahead. These commentators are of the view that to prevent the possible economic difficulties ahead authorities should continue with easy fiscal and monetary policies until the economy safely placed on the trajectory of stable economic growth.

Most commentators are of the view that by failing to act swiftly authorities are running the risk of raising the cost of an economic slump in terms of idle or unutilized resources such as labor and capital.

This way of thinking is succinctly summarized by Ludwig von Mises,

Here, they say, are plants and farms whose capacity to produce is either not used at all or not to its full extent. Here are piles of unsalable commodities and hosts of unemployed workers. But here are also masses of people who would be lucky if they only could satisfy their wants more amply. All that is lacking is credit. Additional credit would enable the entrepreneurs to resume or to expand production. The unemployed would find jobs again and could buy the products. This reasoning seems plausible. Nonetheless it is utterly wrong.

Conventional thinking argues that boosting the overall demand for goods and services is going to strengthen the supply of these goods and services – demand creates supply.

However, why should an increase in the overall demand be followed by the increase in the production of goods and services? This requires a suitable production structure that is going to permit the increase in the production.

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Deflation: Friend or Foe?

Deflation is the most feared economic phenomenon of our time. The reason behind this a priori irrational fear (why should we be afraid of prices going down?) is the Great Depression. The most severe economic crisis of the 20th century was accompanied by a massive deflationary spiral that pushed prices down by 25% between 1929 and 1932 (this is equivalent to an annualized inflation rate of minus 7% over that period). Given the impact that the Great Depression had on the social imaginary of the American and European societies, it isn’t surprising that people tend to associate deflation with crises and economic hardship.

Fears of deflation have even led monetary authorities all over the world to set positive inflation targets. The ECB, for instance, defines price stability as an annual inflation rate of “below, but close to, 2%” even though, strictly speaking, price stability should imply that an annual increase in the price level of 0%.  Similarly, the Federal Reserve aims at an inflation rate of 2% over the long run, whereas the Reserve Bank of Australia has an inflation target of between 2 and 3%.

Despite the bad press deflations gets, the historical evidence suggests that deflation isn’t as bad as people may think. Using a sample of 38 countries over the period 1870-2013, four economists from the Bank for International Settlements find that, on average, countries experienced economic growth during deflation years. In fact, if we look only at the postwar era, data reveals that per capita growth has been higher during deflation years as opposed to inflation years.

This isn’t the only piece of evidence that supports the idea that deflation isn’t necessarily detrimental to economic growth. A 2004 paper covering 17 countries show that the Great Depression is the only period in the 19th and 20th centuries in which there is a strong link between deflation and depression…

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Economic and Monetary Outlook For 2021

The most important event in the new year is likely to be the Fed losing control of its iron grip on markets. The dollar’s declining trend is already well established against other currencies and commodities, leading to this outcome.

Events in 2021 will be the consequence of a developing hyperinflation of the dollar. Foreign holders of dollars and dollar assets — currently totalling $27.7 trillion — are sure to increase the pace of reducing their exposure. This is a primal threat to the Fed’s policy of using QE to continually inflate assets in the name of promoting a wealth effect and continuing to finance a rapidly increasing federal government deficit by supressing interest rates.

Bubbles will then pop, leaving establishment investors exposed to a combined collapse of fiat currencies, bonds and equity markets, which could turn out to be very rapid. The question remaining is what will replace collapsing fiat currencies: limited issue distributed ledger cryptos, such as bitcoin, or precious metals, such as gold?

Clearly, when the dust settles, it will be gold for no other reason that central banks already own it in their reserves, and it has a long track record of success as money in the past.

This article examines the 2020 economic and financial background to likely developments in 2021 before arriving at its conclusions.


It is that time again when we reflect on recent events and what might be ahead of us in the new year. 2020 was dominated by a pre-March descent into a financial slump, when the S&P500 index lost a third of its value between January and March, until the Fed cut its funds rate to zero on 16 March and followed up with a statement of intent to expand QE without limit on the following Monday.

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Open Letter to Gregory Mankiw From Keith Weiner

Dear Professor Mankiw:

I am writing in response to your article in the New York Times, “The Puzzle of Low Interest Rates”. I commend you for recognizing two important truths, which are missed by many other observers. One, that there has been a breathtaking drop in the interest rate over 40 years. Too many dismiss this with an airy hand wave, or deny it.

Two, you see that the cause is not the Federal Reserve, at least not directly. As you note, the Fed aims to set the interest rate at levels determined by “deeper market forces.” In my theory of interest and prices, I show how the Fed sets up a dynamic which is bigger than the central bank itself. Once set in motion, this dynamic moves in one direction for a long time, with positive feedback loops that act like a ratchet. Since 1980, we are in a powerful falling trend.

However, you commit some big blunders too. One is that old saw that rates are falling because of falling inflation expectations. If the Treasury had a penny for every time someone repeated this error, it would have enough to pay off the debt (well, it could—if there were a mechanism to extinguish debt using irredeemable currency).

You cite Irving Fisher for this, but Fisher wrote during the gold standard and virtually all of his work was done prior to when FDR made the dollar irredeemable to American citizens. In the gold standard, of course, people may invest their gold if they like the terms (including the interest rate). Or they can choose not to invest. Gold under the mattress is better than gold committed to a long investment at too-low interest rates.

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Why We Need a Free Market in Money

What is fiat money and what does it do?

This is essential to understand since today’s worldwide unbacked paper, or “fiat,” money regime is an economically and socially destructive scheme—with far-reaching and seriously harmful consequences. There is an answer, though, and this lies in ending the money production monopoly of states.

The Problem of Fiat Money

The US dollar, the Chinese renminbi, the euro, the Japanese yen, the British pound, and the Swiss franc represent fiat money.

Fiat money has three characteristics:

  1. Fiat money is money monopolized by the state’s central bank. It is created by central banks and commercial banks licensed by the state.
  2. Fiat money is mostly produced through bank credit expansion; it is created out of thin air.
  3. Fiat money is dematerialized money, consisting of colorful paper tickets and bits and bytes on computer hard drives.

Fiat money is by no means “harmless.”

Fiat money is inflationary. Its buying power dwindles over time, and history has shown that this entropy is almost as irreversible as gravity. Fiat money makes a select few rich at the expense of many others. The first to get new money benefit to the detriment of those on the bottom rung.

What’s more, fiat money fosters speculative bubbles and capital misallocation, which culminate in crises. This is why economies go through boom and bust cycles. Fiat money lures states, banks, consumers, and firms into the trap of excessive debt. Sooner or later, borrowers find themselves in a deep hole with no way out.

Fiat money is easy to come by, so the government can finance its adventures and misadventures. Easy money; easy come, easy go. And the government keeps growing as it keeps spending…

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Do Not Trust Governments With the Control of Money

If there one thing that is fairly certain in this life – besides the seeming inescapability of death and taxes – is that once someone is appointed to almost any position in the political and bureaucratic structures of a government they soon discover how important and essential is the organization of which they are a part for the well-being of the nation. The country could not exist without it, along with its increasing budget and expanded authority. This applies to the Federal Reserve, America’s central bank, no less than other parts of government.

The news media has reported that the apparently unlikely appointment of Dr. Judy Shelton to the Federal Reserve Board of Governors probably will be successfully maneuvered through the full Senate confirmation process. Shelton would then sit on the Federal Reserve Board for a 14-year term. Hers has been one of the more controversial nominations to the Fed in recent years, with critics fervently expressing their negative views of her.

For instance, Tony Fratto, a former Treasury official and deputy press secretary under George W. Bush, was recently quoted as saying that Shelton’s appointment would be “a discredit to the Senate and the Fed. It screams. Nothing at all is serious. Not us. Not you. Not them.”

Mainstream Economists Against Anyone for Gold

Back in August of this year, over one hundred academic and business economists issued an open letter to members of the U.S. Senate calling for rejection of her nomination to the Fed. Among those who signed were some economics Nobel Laureates, including Robert Lucas and Joseph Stiglitz. They insisted on her unfitness for such an appointment. Why? They said: “She has advocated a return to the gold standard; she has questioned the need for federal deposit insurance; she has even questioned the need for a central bank at all.”

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Olduvai IV: Courage
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Olduvai II: Exodus
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