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How Central Banks Fund Our Age of Endless War

How Central Banks Fund Our Age of Endless War

[This talk was delivered at the Mises Circle in New York City on September 14, 2012.]

The 20th century was the century of total war. Limitations on the scope of war, built up over many centuries, had already begun to break down in the 19th century, but they were altogether obliterated in the 20th. And of course the sheer amount of resources that centralized states could bring to bear in war, and the terrible new technologies of killing that became available to them, made the 20th a century of almost unimaginable horror.

It isn’t terribly often that people discuss the development of total war in tandem with the development of modern central banking, which — although antecedents existed long before — also came into its own in the 20th century. It’s no surprise that Ron Paul, the man in public life who has done more than anyone to break through the limits of what is permissible to say in polite society about both these things, has also been so insistent that the twin phenomena of war and central banking are linked. “It is no coincidence,” Dr. Paul said, “that the century of total war coincided with the century of central banking.”

He added:

If every American taxpayer had to submit an extra five or ten thousand dollars to the IRS this April to pay for the war, I’m quite certain it would end very quickly. The problem is that government finances war by borrowing and printing money, rather than presenting a bill directly in the form of higher taxes. When the costs are obscured, the question of whether any war is worth it becomes distorted.

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Central Bank “Stimulus” is Really a Huge Redistribution Scheme

Central Bank “Stimulus” is Really a Huge Redistribution Scheme

When an economy turns from expansion to contraction there is an order of events. The first signs are an unexpected increase in inventories of unsold goods, both accompanied with and followed by business surveys indicating a general softening in demand. For monetarists, this is often confirmed by an inverting yield curve, which tells them that at the margin the short-term rates set by the central bank are becoming too high for business conditions.

That was the position for the US 10-year bond less the 2-year bond very briefly at the end of August, since when this measure, which is often taken to predict recessions, has turned mildly positive again. A generally negative sentiment, fueled mainly by the escalating tariff war between America and China, had earlier alerted investors to an international trade slowdown, expected to undermine the American economy in due course along with all the others. It stands to reason that backward-looking statistics have yet to reflect the global slowdown on the US economy, which is still buoyed up by consumer credit. The German economy, which is driven by production rather than consumption is perhaps a better guide and is already in recession.

After an initial hit, a small recovery in investor sentiment is understandable, with the negative outlook perhaps having got ahead of itself. But we must look beyond that. History shows the combination of a peak in the credit cycle and tariffs can be economically lethal. A brief return to a positive yield curve achieves little more than a sucker rally. It may be enough to put further monetary expansion on pause. But when that is over, and jobs begin to be threatened, there can be no doubt that central banks will ramp up the printing presses.

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Markets Rely on Accurate and Honest Information — But Governments Want the Opposite

Markets Rely on Accurate and Honest Information — But Governments Want the Opposite

Have you ever worked with people you couldn’t trust to tell you the truth? It isn’t pretty. Without the ability to rely on what you’ve been told (or that you’ve been told everything relevant), effective cooperation at almost every margin of choice is reduced, because its foundation has been undermined. A new episode of To Tell the Truthmust precede every decision.

That problem of effective cooperation is exponentially increased when we expand our horizons to the many margins of choice at which people in society, the vast majority of which do not even know each other, interact. In a modern economy, all of us are dependent on multitudes of strangers not just for our prospering, but our survival.

The reason people don’t always communicate truthfully is that our reason serves our self-interest. Sometimes we perceive a strategic advantage at other people’s expense from intentionally deceiving them. Our words are also often ex post rationalizations to ourselves and others of why whatever we chose or did was a good idea. But that often makes what people say a frail reed to rely upon. And when political power is involved, the incentives for such deception and self-delusion are put on steroids, because the payoffs are far greater when backed by government’s coercive power.

As a consequence, accurate information about the issues most important to our ability to co-operate with others is often among the scarcest and most valuable of goods. Making it worse, the unknowably vast amount of potentially useful information—the infinite permutations of who, what, when, where, why and how–exceeds any individual or group’s ability to comprehend and integrate it. But voluntary market arrangements based on private property rights provide a powerful mechanism of cutting that problem down to manageable size.

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Negative Interest Rates are the Price We Pay for De-Civilization

Negative Interest Rates are the Price We Pay for De-Civilization

Do central bankers really think negative interest rates are rational? 

“Calculation Error,” which Bloomberg terminals sometimes display1, is an apt metaphor for the current state of central bank policy. Both Europe and Asia are now awash in $13 trillion worth of negative-yielding sovereign and corporate bonds, and Alan Greenspan suggests negative interest rates soon will arrive in the US. Despite claims by both Mr. Trump and Fed Chair Jerome Powell concerning the health of the American economy, the Fed’s Open Market Committee moved closer to negative territory today — with another quarter-point cut in the Fed Funds rate, below even a measly 2%. 

Negative interest rates are just the latest front in the post-2008 era of “extraordinary” monetary policy. They represent a Hail Mary pass from central bankers to stimulate more borrowing and more debt, though there is far more global debt today than in 2007. Stimulus is the assumed goal of all economic policy, both fiscal and monetary. Demand-side stimulus is the mania bequeathed to us by Keynes, or more accurately by his followers. It is the absurd idea, that an economy prospers by consuming and borrowing instead of producing and saving. Negative interest rates turn everything we know about economics upside down.

Under what scenario would anyone lend $1,000 to receive $900 in return at some point in the future? Only when the alternative is to receive $800 back instead, due to the predicted interventions of central banks and governments. Only then would locking in a set rate of capital loss make sense. By “capital loss” I mean just that; when there is no positive interest paid, the principal itself must be consumed. There is no “market” for negative rates.

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Why the Dollar Rules the World — And Why Its Reign Could End

Why the Dollar Rules the World — And Why Its Reign Could End

President Donald Trump wants a lower US dollar. He complains about the over-valuation of the American currency. Yet, is he right to accuse other countries of a “currency manipulation”? Is the position of the US dollar in the international monetary arena not a manipulation in its own right? How much has the United States benefitted from the global role of the dollar, and is this “exorbitant privilege” coming to end? In order to find an answer to these questions, we must take a look at the monetary side of the rise of the American Empire.

Trump is right. The American dollar is overvalued. According to the latest version of the Economist’s “ Big Mac Index,” for example, only three currencies rank higher than the US dollar. Yet the main reason for this is not currency manipulation but the fact that the US dollar serves as the main international reserve currency.

This is both a boon and a curse. It is a boon because the country that emits the leading international reserve currency can have trade deficits without worrying about a growing foreign debt. Because the American foreign debt is in the country’s own currency, the government can always honor its foreign obligations as it can produce any amount of money that it wants in its own currency.

Yet the international reserve status comes also with the curse that the persistent trade deficits weaken the country’s industrial base. Instead of paying for the import of foreign goods with the export of domestic production, the United States can simply export money.

American Supremacy

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The Fed’s Dangerous Game: A Fourth Round of Stimulus in a Single Growth Cycle

The Fed’s Dangerous Game: A Fourth Round of Stimulus in a Single Growth Cycle

The longer the signals in capital markets go haywire under the influence of “monetary stimulus,” the bigger is the cumulative economic cost. That is one big reason why this fourth Fed stimulus — in the present already-longest (but lowest-growth) of super-long business cycles — is so dangerous.

True, there is nothing new about the Fed imparting stimulus well into a business cycle expansion with the intention of combating a threat of recession. Think of 1927, 1962, 1967, 1985, 1988, 1995, and 1998.

This time, though, we’ve seen it four times (2010/11, 2012/13, 2016/17, 2019) in a single cycle. That is a record. Normally, a jump in recorded goods and services inflation, or concerns about rampant speculation, have trumped the inclination to stimulate after one — or at most two — episodes of stimulus.

Also we should recognize that the length of time during which capital-market signaling remains haywire, is only one of several variables determining the overall economic cost of monetary “stimulus.” But it is a very important one.

Haywire signaling is not just a matter of interest rates being artificially low. Alongside this there is extensive mis-pricing of risk capital. Some of this is related to the flourishing of speculative hypotheses freed from the normal constraints (operative under sound money) of rational cynicism. Enterprises at the center of such stories enjoy super-favorable conditions for raising capital.

There are also the giant carry trades into high-yielding debt, long-maturity bonds, high-interest currencies, and illiquid assets, driven by some combination of hunger for yield and super-confidence in trend extrapolation. In consequence, premiums for credit risk, currency risk, illiquidity, and term risk, are artificially low. Meanwhile a boom in financial engineering — the camouflaging of leverage to produce high momentum gains — adds to the overall distortion of market signals.

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Why Powell Fears a Gold Standard

Why Powell Fears a Gold Standard

Chairman Powell’s testimony last week was closely scrutinized not just for its economic implications but also for its political overtones. Powell cited “trade tensions” as cause for concern about the strength of the global economy. He clearly seemed to be blaming President Trump’s tariffs.

But if the tariffs are what ultimately move the Fed to cut rates, Trump will have finally gotten what he wants out of Powell. In recent weeks, Trump has stepped up his attacks on the central bank, calling it the biggest problem facing the economy, floating the idea of firing Powell, and suggesting his administration would match China’s and Europe’s “currency manipulation game.”

Although many presidents before have pursued currency interventions and quibbled with Fed chairmen over interest rate policy, none have ever done it as openly and directly as the current one. Fed apologists in the media and in Congress view the central bank’s “independence” as being under assault.

The notion that the Fed ever was or could be independent of politics is a fanciful one. When a small group of people — appointed and confirmed by politicians — are empowered to make decisions that can make or break markets, economies, and elections, politics will inevitably intrude.

Fed chairman Jerome Powell may sincerely want to make monetary policy without regard to politics. But when political forces exert themselves on the Fed, he finds himself in an impossible catch-22. If he fails to cut rates, then the central bank risks becoming seen as the enemy of half the country as President Trump makes it his foil at campaign rallies. If Powell does what the President wants, then Democrats will accuse him of succumbing to political pressure from the White House.

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How to Destroy a Civilization

How to Destroy a Civilization

There are lots of ways to kill off a civilization. Wars, politics, economic collapse. But what are the actual mechanics? It might be a useful thing to know whether or not we are killing ourselves off.

Ancient Rome is a good place to start. They had an advanced civilization. They had running water, sewers, flush toilets, concrete, roads, bridges, dams, an international highway system, mechanical reapers, water-powered mills, public baths, soap, banking, commerce, free trade, a legal code, a court system, science, literature, and a republican system of government. And a strong army to enforce stability and peace (Pax Romana). It wasn’t perfect, but they were on their way to modernity.

One of my favorite quotes is from Marcus Tullius Cicero, statesman, orator and writer (106-43 BCE):

Times are bad. Children no longer obey their parents, and everyone is writing a book.

If that isn’t a mark of a civilized society I don’t know what is.

But Rome collapsed. I often wonder what would have happened if it hadn’t. Could we have avoided a thousand years of the Dark Ages. Could we have been flying airplanes and driving cars in the year 1000?

What the hell happened to Rome?

Dictators. After 500 years, the famous Roman Republic ended with the dictator Julius Caesar taking power. Four hundred years later his progeny and usurpers ran the Empire into the ground and Rome fell to invading barbarians.

The standard explanation for Rome’s decline and fall is that they devolved into dictatorships (true, but not the cause of their fall). Or they became decadent and corrupt (true, but not the cause of their fall). They fell to barbarian invasions (true, but not the cause of their fall).

Rome fell because the dictators ruined the Roman economy and the institutions that had made it prosperous. Rome was falling apart before the barbarian invasions.

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How Central-Bank Interest-Rate Policy Is Destabilizing Banks

How Central-Bank Interest-Rate Policy Is Destabilizing Banks

Broadly speaking, banks operate under the concept of maturity transformation. Banks take short-term – less than one year – financing vehicles, such as customer deposits, and use that to finance long-term – more than one year – returns. These returns range from the most commonly understood loans, such as auto loans and mortgages, to investments in equity, bonds and public debt. Banks make money on the interest spread between what they pay to the owners of the money and what is earned from the operations. Banks also make money on other services, such as wealth management and account fees, though these are relatively small compared to the maturity transformation business.

In terms of assets, the primary asset a bank holds is the demand deposit, also referred to as the core deposit. These are your everyday savings and checking accounts. Banks also sell Wholesale Deposits, such as CDs, have shareholder equity and also can take out debt, such as interbank lending. As these assets are owned by someone else, each of them demands a return for the use of those assets. These are part of the costs of operation for a bank. There are also more fixed operating costs, such as employees, buildings and equipment that must also be financed.

So, a bank will take assets and formulate loans on them. Like most of the world, the US operates on a fractional reserve system, one where banks originate loans in excess of the deposits on-hand. Take a look at the balance sheet of a large regional bank, 5/3 Bank, for example. For the 2018 fiscal year, 5/3 reported non-capital assets of $94 billion and a deposit base of $108 billion. However, the cash and cash equivalent component of these assets stood at $4.4 billion, or just 4% of demand deposits.

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ECB Inflationists are Crippling Europe

ECB Inflationists are Crippling Europe

Last week, the ECB announced the reintroduction of targeted long-term refinancing operations for the third time. TLTRO-III is scheduled to start from next September. The idea is to make yet more money available for the banks at attractive rates on condition they increase their lending to non-financial entities.

The policy is justified because the ECB sees growing signs the Eurozone economy is stalling, possibly badly. The weaker Eurozone economies are moving into outright recession, and Germany’s motor exports appear to have dramatically slowed, putting a constraint on her whole economy. 

The ECB’s reintroduction of TLTRO is an offer of yet more monetary and credit inflation, despite the evidence that unprecedented waves of monetary inflation in the last ten years have failed in all the objectives for which they were designed, except two: governments have continued to get the funds to spend without meaningful restraint, and insolvent banks have been preserved.

Only two months after its asset purchase programme officially ended, the inflationists are at it again. But one wonders why the ECB bothers to delay TLTRO-III until September. If it is such a good thing, why not introduce it now?

There is another explanation, and that is the ECB is intellectually adrift with no economic compass. We do not know how many economists and monetary specialists are employed in the Eurosystem, which includes the ECB and the regional central banks, but they are certainly not economists, otherwise they would understand money. They may be technicians, which is not the same thing. If they were economists, or more precisely properly schooled in the human sub-science of catallactics (the theory of exchange ratios and prices) they would more fully appreciate the consequences of monetary inflation.

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Electoral College: Why We Must Decentralize Democracy

Electoral College: Why We Must Decentralize Democracy

Although it was long assumed that the electoral college favored Democrats — and this assumption continued right up to election night 2016 — Democrats in the United States have now decided the electoral college is a bad thing. Thus, we continue to see legislative efforts to do away with the electoral college, accompanied by claims that it’s undemocratic.

Not All Democracy Is Created Equal

In fact, the electoral college is neither more nor less democratic than the electoral college system. It’s unclear by what standard winning the presidency through 50 separate state-level elections is “less democratic” than winning one large national election.

What makes the electoral college different, however, is that it was born out of recognition that the interests, concerns, and values of voters can differ greatly from place to place. Moreover, the system anticipated the phenomenon in which people in large densely populated areas would have different political values from people in other areas. The electoral college was designed to make it less likely that voters from a single region — or small number of regions — could impose their will across the entire nation.

In contrast, one large national election — as envisioned by the critics of the electoral college system — could hand national rule over to a small number of cities and regions.

But even the electoral college system is too much slanted in favor of national politics and large majorities. Far better strategies for governance can be found Swiss democracy. Thanks to the presence of a multi-lingual, culturally diverse population, the creators of the Swiss confederation sought to ensure that no single linguistic, religious, or cultural group could impose its will nationwide. Thus, Swiss democracy includes a number of provisions requiring a “double majority.” That is, not only must an overall majority of Swiss voters approve certain measures, a majority of the voters in the majority of Swiss cantons must also approve.

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Can the EU Survive the Next Financial Crisis?

Can the EU Survive the Next Financial Crisis?

Despite the ECB’s subsidy of the Eurozone’s banking system, it remains in a sleepwalking state similar to the non-financial, non-crony-capitalist zombified economy. Gone are the heady days of investment banking. There is now a legacy of derivatives and regulators’ fines. Technology has made the over-extended branch network, typical of a European retail bank, a costly white elephant. The market for emptying bank buildings in the towns and villages throughout Europe must be dire, a source of under-provisioned losses. On top of this, the ECB’s interest rate policy has led to lending margins becoming paper-thin. 

A negative deposit rate of 0.4% at the ECB has led to negative wholesale (Euribor) money market rates along the yield curve to at least 12 months. This has allowed French banks, for example, to fund Italian government bond positions, stripping out 33 basis points on a “riskless” one-year bond. It’s the peak of collapsed lending margins when even the hare-brained can see the risk is greater than the reward, whatever the regulator says. The entire yield curve is considerably lower than Italian risk implies it should be, given its existing debt obligations, with 10-year Italian government bonds yielding only 2.55%. That’s less than equivalent US Treasuries, the global risk-free standard.

Government bond yields have been and remain considerably reduced through the ECB’s interest rate suppression and its bond-buying programs. The expansion of Eurozone government debt since the Lehman crisis has been about 50% to €9.69 trillion. This expansion, representing €3.1 trillion, compares with the expansion of the Eurosystem’s own balance sheet of €2.8 trillion since 2009. In other words, the expansion of Eurozone government debt has been nearly matched by the ECB’s monetary creation.

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How Asset Inflation Will End — This Time

How Asset Inflation Will End — This Time

Life after death for asset inflation: this is what happens when “speculative fever” remains high even after monetary inflation has paused. This may well have been the situation in global markets during 2019 so far. But history and principle suggest that life after death in this monetary sense is short.

Readers may find it odd to be talking about a pause in monetary inflation at a time when the Fed has cancelled programmed rate rises and the ECB has embarked (March 7) on yet further “radical” policy moves. Moreover, the “core” US inflation rate (as measured by PCE) is still at virtually 2 per cent year-on-year.

Yet we know from past cycles that in the early stages of recession many market participants — and, crucially, central banks — mistakenly view a stall in rate rises or actual rate cuts as stimulatory. Later with the benefit of hindsight these policy moves turn out to be insufficient to prevent a tightening of monetary conditions already in process but unrecognized.

Even had monetary conditions been easing rather than tightening, it is highly dubious whether this difference would have meant the powerful momentum behind the business cycle moving into its recession phase would have lessened substantially.

(As a footnote here: under a gold standard regime there is no claim that monetary conditions will evolve perfectly in line with contracyclical fine-tuning. Both in principle and fact monetary conditions could tighten there at first as recessionary forces gathered. Under sound money, however, contracyclical forces would emerge strongly into the recession as directed by the invisible hand.)

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A Modest Proposal for the Fed

A Modest Proposal for the Fed

Quantitative easing, the program of asset buying initiated by the US Federal Reserve Bank in 2008, represents the most profound monetary experiment in the history of the world. Between fall of 2008 and fall of 2014, three successive rounds of QE quadrupled the monetary base of the world’s most-used and dominant currency, from less than $1 trillion to more than $4 trillion. The Fed literally created new money, bought Treasury debt and mortgage-backed debt (of dubious character) from commercial banks, and credited them with new reserves.

fredgraph (1)_1.png

It was a great trick. If QE can be done without adverse effects or with few adverse effects, it represents nothing short of monetary alchemy (h/t Nomi Prins). Everything we thought we knew about the Fed as backstop lender of last resort to commercial banks, as hallway monitor of inflation and unemployment, is out the window.

If QE works, then every government on earth must take notice of the opportunity to effectively recapitalize their own banks and industries free of charge. QE turns central banks into kings of capital markets, into active participants in the economy. As one twitterati put it, expansionary QE created the biggest untold American story of the last twenty years: the Fed can now inflate and deflate assets, devalue savings, influence wages and productivity, encourage corporate malfeasance, and engineer balance sheets—all the while creating economic winners and losers. 

What politician or central banker could resist?

Recall how defenders of QE not only argued it was necessary, but beneficial. Paul Krugman was among the worst offenders, insisting that low interest rates would mitigate any harms from such rapid monetary expansion. These defenders dismissed, and continue to dismiss, what is now obvious: since 2008 the US economy has experienced significant asset inflation in equity markets and certain housing markets, plus a creeping but steady rise in many consumer prices.  

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The State Expands its Responsibilities In Order to Expand Its Power

The State Expands its Responsibilities In Order to Expand Its Power

Many moviegoers might recognize the following quotation: “with great power comes great responsibility.”

Reality, however, is the exact opposite of what the quote describes. In reality, it is responsibility that precedes power. In a corporation, for instance, when you’re hired you are told your responsibilities and the powers granted to you are those that are necessary for you to accomplish your responsibility.

In John’s family, John’s father demands that everyone stay out of the kitchen while he cooks, lest they distract him. It is not because John’s father has the power to keep everyone out of the kitchen that he has accepted the responsibility of cooking; it is because he is responsible for cooking that he has the power to keep everyone out of the kitchen.

A vast number of self-help books focus on self-responsibility. This is no coincidence. It is only by accepting responsibility for our lives that we can acquire power over our lives. On the other hand, by blaming others for our conditions, we forfeit our responsibility, and consequently, our power.

Responsibility is important not just because it provides power but also because, as psychologist Jordan Peterson has often remarked, most people find the meaning of their lives through responsibility.

Examining American history, it is evident that the expansion of government powers has been a direct result of the government’s theft of the responsibilities of the individual.

There is a rather straightforward argument that is consistently presented by the government in order to justify its theft of responsibilities that rightfully belong to others.

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Olduvai IV: Courage
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Olduvai II: Exodus
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