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We’re Going Deeper into Debt as Real Incomes Fall – Article by Victor Xing

We’re Going Deeper into Debt as Real Incomes Fall – Article by Victor Xing

The New Renaissance HatVictor Xing

New York Fed President Dudley recently commented that “real consumer spending growth appears to have moderated somewhat from the relatively robust pace of the second half of 2015.” While this may suggest headwinds from cyclical economic conditions, there are emerging signs that ultra-accommodative policy also acts as a constraint on consumer spending via income effects. Instead of inducing savers to spend and borrow, rapid asset price appreciation as a result of monetary easing has outpaced wage growth, and pass-through services inflation subsequently reduced discretionary income and forced already-levered consumers to save instead of spend. This unintended consequence worked against accommodative policy’s desired substitution effects and suggests further easing would likely yield diminishing results if asset price appreciation continues to outpace real income growth.

Asset Price and Services Inflation Outpaced Real Wage Growth
Post-2008 policy accommodation broadly lowered funding costs for consumers and businesses to supported asset price appreciation. However, rising prices have also made assets less affordable, and home buyers “priced out” of their respective housing markets subsequently became involuntary renters. Not only do they not benefit from rising home values, higher education, and medical care inflation also outpaced aggregate real wage growth (Chart 1) to weigh on renters’ discretionary spending.

xing1In response with rising commercial real estate prices (Chart 2), businesses also pass on higher operating costs in the form of services inflation. Year-over-year personal consumption expenditure — services (chain-type price index) has been well-anchored in the 2% range (2.13% in Feb 2016) since 4Q 2011.

xing2Another factor constraining consumer spending is the well-publicized effect of student debt burden. This supports a view that household spending may be at a lower potential than during prior cycles, thus magnifying the costs of higher services inflation as a result of asset price appreciation.

Consumers Redlining their Engines: Inability To Pay $400 Emergency Expense
Accommodative monetary policy encourages consumers to spend and borrow rather than hoarding cash. However, cash-strapped consumers already facing the pressure of debt burden would likely do neither.

Federal Reserve’s recent Report on the Economic Well-Being of U.S. Households highlighted signs that some consumers are already stretching their spending power to meet existing obligations. 47% of respondents reported that a $400 emergency expense would be “more challenging to handle” (unable to use cash or a credit card that they pay off at the end of the mouth). Results from middle-income household with $40,000 to $100,000 annual income were similarly downbeat, where 44% of respondents indicated difficulties (Chart 3).

Chart 3: Percent of respondents who would completely pay an emergency expense that costs $400 using cash or a credit card that they pay off at the end of the month (by race/ethnicity and household income)

xing3Source: Federal Reserve Board of Governors

Chart 4: During the past 12 months, was there a time when you needed any of the following, but didn’t get it because you couldn’t afford it?

xing4Source: Federal Reserve Board of Governors

A survey on health-care expenses was also discouraging. 31% of respondents reported going without some type of medical care in the preceding 12 months due to inability to afford the cost. 45% of those surveyed under a household income of $40,000 reported similar decisions to defer treatment.

In the section “spending relative to income,” Fed researchers reported that one-in-five respondents with spending exceeded their income (leveraged spending). These are signs that consumers were taking advantage of lower rates, but the spending does not appear to be sustainable without corresponding rise in real wage growth.

Rising Renter Cost Burden
Another factor constraining discretionary spending is rising renter cost burden. The Harvard Joint Center for Housing Studies projected a “fairly bleak picture of severe renter burden across the U.S. for the coming decade.” The report acknowledged falling incomes among renters and the persisting gap between renter income and renter housing costs (Chart 6), as well as severely burdened renter households (housing costs of more than 50% of household income) reaching 11.8 million in 2015 (Chart 7), or about one in four renters.

Assuming the correlation between rental price inflation and asset price inflation holds, further declines in housing affordability as a result of policy easing would exacerbate renter burden — one likely needs rising real wages to offset.

Chart 5: In the past 12 months, would you say that your household’s total spending was more, less, or the same as your income? (by household income)

xing5Source: Federal Reserve Board of Governors

xing6xing7

Impacts of “Long and Variable Lags” Between Asset Price Inflation and Real Wage Growth
Financial market participants play an essential role in the transmission of Federal Reserve’s monetary policy by affecting financial conditions — the following components are part of the GS Financial Conditions Index:

  • Short-term bond yield
  • Long-term corporate credit spread
  • Stock market variable
  • Exchange rate

The Federal Reserve only has effective control of the very front-end of the Treasury curve via conventional monetary policy. Nevertheless, unconventional policies such as QE, as well as forward guidance on SOMA principal reinvestments also allow the central bank to affect longer-term funding costs via the expectations and “recruitment channel.” Under this mechanism, asset prices take little time to react to changing policy stances, while impacts on income growth and economic conditions would often take longer to manifest.

Such lag between asset price appreciation and changing economic conditions carries a hidden cost — if asset price inflation becomes well entrenched ahead of broad-based economic growth, those without assets would be penalized just to maintain their life-style, and the reduction in their discretionary spending would serve as a disinflationary drag to Federal Reserve’s effort to reflate the economy.

Conclusion
Inefficiencies within the monetary policy transmission mechanism have resulted in income effects becoming greater than the substitution effects. Under this scenario, ultra-accommodative policy may induce further saving by asset-less consumers to further weigh on aggregate demand. Additionally, policymakers should exercise caution if increasingly aggressive and unconventional reflationary policies do not yield intended results.

Victor Xing is founder and investment analyst at Kekselias, Inc. He is formerly a fixed-income trading analyst for the Capital Group Companies with 5 years of experience on its interest rates trading desk.

This article was published on Mises.org and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

Chasing 2 Percent Inflation: A Really Bad Idea – Article by John Chapman

Chasing 2 Percent Inflation: A Really Bad Idea – Article by John Chapman

The New Renaissance HatJohn Chapman

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In just two years, inflation targeting (namely, the quest for 2 percent inflation) has gone from the lunatic fringe of economics to mainstream dogma. Much of the allure springs from notions that a little inflation motivates people to speed up spending, thereby greatly increasing the efficacy of central bank stimulus. It is touted as a cure for sagging demand and a defense against the (overly) dreaded deflation.

Other benefits include melting away some of the massive government and private debts and improving people’s perception of progress as they see their nominal wages rise. Employers can lower real wages without unpopular dollar pay cuts. The Fed can allow price increases to signal the need for production responses, allow for minor supply shocks and for monopolistic industries to increase prices all without a monetary response that would hurt other elements of the economy.

For the politicians it provides a tax windfall in the form of capital gains taxes on inflated assets and income taxes on interest that simply reflects inflation. It also necessitates printing more money thereby earning seigniorage (profits from printing money) for the government. In addition, it provides cover for competitive currency devaluation and is a great excuse to kick the can down the road: “Let’s not tighten before we reach our highly desired inflation target.”

What’s Magical about 2 Percent Inflation?
Then there is the question of why 2 percent? Perhaps that was seen as a still comfortable rate during some past periods of strong growth. Conditions today are very different, which perhaps suggests they are trying to imitate past growth by copying symptoms instead of substance. Of course for politicians, permission to print money is a godsend, and with inflation all around the developed world below 2 percent, it was “all aboard!”

Clearly not all of the features above are desirable, but even some of the touted ones are underwhelming. While increased inflation expectations will speed up spending, it is far from being the reservoir of perpetual demand that some seem to believe. Essentially, a onetime increase in expectations of a new steady rate of inflation would speed up purchases for the period ahead, but with negligible net effects in subsequent periods — a onetime phase shift in demand.

The Danger of Raising Interest Rates
After almost eight years of stimulus, the Fed has taken its first timid steps toward normalizing monetary policy. That means we will soon have to contend with something entirely absent during the years of easy money — a bill for all of the goodies passed out and the distortions created. And what a bill! A 3 percent rise in average interest rates on just our present government debt over the next few years would ultimately amount to over $500 billion a year in additional interest expense, equal to roughly 1/7 of current Federal tax receipts. Those bills start arriving with a vengeance when rates go back up, and for the first time in years the market will see concrete evidence of whether the US and other governments are willing to pay the price of continuing to have viable currencies.

Prior to the appearance of inflation targeting, I was already dreading the impact of political interference with efforts to return to normal. But targeting makes every politician an economist, able to make simplistic, grandstanding statements with the authority of the Fed’s own model. This makes the problem far worse.

Two percent, which has (foolishly) been defined as desirable, will quickly be interpreted as an average. “So what’s the big deal,” critics will say, “about a pop to 3 percent or more, after all it has spent years ‘below target’, and if you excluded a handful of ‘temporary exceptions’, it would still be only 2 percent …?” Imagine the political storm if the Fed decided to quickly raise rates a couple of full percentage points in response to a surge in inflation to 3 percent.

There are a lot of people (especially politicians) whose short-term interests would be harmed by a sharp rise in interest rates. Lulled by today’s relative calm, many fail to appreciate how explosive the situation becomes when we transition from the concerned waiting of the long easy money period to the concrete tests of our credibility during renormalization. If we had to temporarily sacrifice half a percent from our already tepid growth rate to preserve the credibility of the dollar, that would pale next to the cost of worldwide panic and collapse. Unfortunately the sacrifice part is up front.

Americans think of inflation as a purely monetary phenomenon, which the mighty and independent Fed has handled in the past and will again if necessary. Actually once the inflation genie starts to escape from the bottle it becomes purely a political problem. Even the most determined central banker is helpless if the people refuse to accept the paper money, the politicians balk and take away the bank’s independence, or there is an opposition political party promising a credible-sounding and painless alternative plan. It comes down to what the market sees as the political will and ability to pay the short-term cost of reining in the inflation.

The Political Advantages of the 2 Percent Target
Political resistance to the cost of moving back to normal plus our willingness to decisively confront signs of panic will be watched carefully by owners of dollars and dollar instruments. This is a huge liquid pool which could stampede en masse into wealth storage and productive assets. Such a run would quickly become unstoppable and would mean a collapse of the world economy. Inflation targeting greatly facilitates the political opposition to decisive Fed action right at the first critical test points where there might still be hope of heading off an uncontrollable panic.

Deliberately seeking higher inflation amounts to intentionally damaging people’s faith in a fiat currency, one already in danger from massive debt, disquiet over novel monetary policy, and noises from Congress about reducing Fed independence. Targeting also provides a handy excuse to delay returning to normal, thereby worsening the mounting distortions. Finally, it invites wholesale political interference with the Fed’s efforts to manage an orderly return to normal financial conditions.

John Chapman is a retired commodity trader, having headed his own small trading firm for over thirty years. Prior to that he worked in the international division of a large New York bank, managed foreign exchange hedging for a major NY commodity firm, and worked as a silver trader.

Economics, especially money and banking, has been a passion of his since college. In 1990 he took a trip to South America for the express purpose of studying inflation “at its source.” His formal economics credentials consist of half a dozen courses, five of which were as an undergraduate at MIT (where he majored in aeronautical engineering.) He also received an MBA from the University of Arizona.

This article was published on Mises.org and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

What Did Fed Chairman Yellen Tell Obama? – Article by Ron Paul

What Did Fed Chairman Yellen Tell Obama? – Article by Ron Paul

The New Renaissance HatRon Paul
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This week, President Obama and Vice President Biden held a hastily arranged secret meeting with Federal Reserve Chairman Janet Yellen. According to the one paragraph statement released by the White House following the meeting, Yellen, Obama, and Biden simply “exchanged notes” about the economy and the progress of financial reform. Because the meeting was held behind closed doors, the American people have no way of knowing what else the three might have discussed.

Yellen’s secret meeting at the White House followed an emergency secret Federal Reserve Board meeting. The Fed then held another secret meeting to discuss bank reform. These secret meetings come on the heels of the Federal Reserve Bank of Atlanta’s estimate that first quarter GDP growth was .01 percent, dangerously close to the official definition of recession.

Thus the real reason for all these secret meetings could be a panic that the Fed’s eight-year explosion of money creation has not just failed to revive the economy, but is about to cause another major market meltdown.

Establishment politicians and economists find the Fed’s failures puzzling. According to the Keynesian paradigm that still dominates the thinking of most policymakers, the Fed’s money creation should have produced such robust growth that today the Fed would be raising interest rates to prevent the economy from “overheating.”

The Fed’s response to its failures is to find new ways to pump money into the economy. Hence the Fed is actually considering implementing “negative interest rates.” Negative interest rates are a hidden tax on savings. Negative interest rates may create the short-term illusion of growth, but, by discouraging savings, they will cause tremendous long-term economic damage.

Even as Yellen admits that the Fed “has not taken negative interest rates off the table,” she and other Fed officials are still promising to raise rates this year. The Federal Reserve needs to promise future rate increases in order to stop nervous investors from fleeing US markets and challenging the dollar’s reserve currency status.

The Fed can only keep the wolves at bay with promises of future rate increases for so long before its polices cause a major dollar crisis. However, raising rates could also cause major economic problems. Higher interest rates will hurt the millions of Americans struggling with student loan, credit card, and other forms of debt. Already over 40 percent of Americans who owe student loan debt are defaulting on their payments. If Federal Reserve policies increase the burden of student loan debt, the number of defaults will dramatically increase leading to a bursting of the student loan bubble.

By increasing the federal government’s cost of borrowing, an interest rate increase will also make it harder for the federal government to manage its debt. Increased costs of debt financing will place increased burden on the American people and could be the last straw that finally pushes the federal government into a Greek-style financial crisis.

The no-win situation the Fed finds itself in is a sign that we are reaching the inevitable collapse of the fiat currency system. Unless immediate steps are taken to manage the transition, this collapse could usher in an economic catastrophe dwarfing the Great Depression. Therefore, those of us who know the truth must redouble our efforts to spread the ideas of liberty.

If we are successful, we may be able to force Congress to properly manage the transition by cutting spending in all areas and auditing, then ending, the Federal Reserve. We may also be able to ensure the current crisis ends not just the Fed but the entire welfare-warfare state.

Ron Paul, MD, is a former three-time Republican candidate for U. S. President and Congressman from Texas.

This article is reprinted with permission from the Ron Paul Institute for Peace and Prosperity.

Dumb and Dumber – From Negative Interest Rates to Helicopter Money – Article by Paul-Martin Foss

Dumb and Dumber – From Negative Interest Rates to Helicopter Money – Article by Paul-Martin Foss

The New Renaissance Hat
Paul-Martin Foss
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We’ve all run into someone who thinks that all it take to bring about prosperity is to give everyone a million dollars. If everyone is a millionaire, we’ll all be rich and be able to afford anything we want, or so the thinking goes. Any sound economist knows that wouldn’t be the case, however. If everyone were given a million dollars the increased amount of money chasing the existing stock of goods would merely result in a massive rise in prices. No one would be better off, at least not once prices were once again equilibrated. The concept of giving everyone a million dollars is so absurd that no one takes it seriously. That is, they don’t take it seriously when a million dollars is the proposed amount. When the amount is smaller, all of a sudden it becomes a viable and increasingly-discussed policy proposal: helicopter money.

Ben Bernanke was derided for bringing up the possibility of helicopter money in 2002, although the idea dates back to Milton Friedman. What Bernanke did say was:

Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

In fact, if you read that speech you will see Bernanke touting the effectiveness of policies which the Fed has since tried and failed at, as well some policies which the Fed has not yet tried and which we hope it never will.

As a decade of stimulus, quantitative easing, and zero or below-zero interest rates has now proven to be an absolute failure, helicopter money is once again being discussed as a potential central bank action, by central bankers who have no idea what to do and who are grasping at straws. The chief fixed income analyst at Nordea bank has publicly speculated that the European Central Bank (ECB) might be able to distribute 1,300 euros to each European citizen in a bid to boost inflation.

This bid to boost inflation makes the age-old error of confusing more money and higher prices with greater wealth. We know from our million-dollar example that that isn’t the case. So why try on a small scale what fails at the large scale? It is like the minimum wage debate, in which those who favor boosting minimum wages argue that it will result in workers being better-paid and more well-off. Yet we know that raising the minimum wage will result in some workers losing their jobs, as businesses cannot absorb all the increased costs and must dismiss their least-productive workers. The challenge to the proponents of minimum wages always is, if $15 an hour is so good, why not $15,000 an hour? Well, that’s because such a large increase would make abundantly clear what the minimum wage proponents are trying to hide. Minimum wages make some workers better off, but they do so by forcing other workers out of work, thus their wage falls to $0. In the same way, if the ECB could give 1,300 euros to each person, why not 1,300,000 euros? Because prices would rise in result and quickly negate any short-term benefit gained by the monetary increase. That type of hypothetical question exposes the farce of such handouts.

If helicopter money is implemented, those who first gain the use of the new money may benefit by increasing consumption before prices rise, while others will see prices rise before they are able or willing to use the money. But the end result will be higher prices but no overall increase in welfare. The economy will not see any sort of burst in productivity from a one-shot injection. So what will be proposed next? How about multiple injections of helicopter money over extended periods of time? That would seem to follow.

But again, anticipation and expectation of future injections would not lead to economic growth. It would only serve to further raise prices as new money enters the economy and transfers wealth to those who first use the new money from those who don’t. Economic growth comes not from more money or higher prices, but from savings and investment. No matter where in the economy central bank monetary injections enter, they cannot and will not result in real economic growth.

Zero interest rates didn’t do what central banks thought they would do, so they moved to quantitative easing. QE didn’t do what central banks thought it would do, so they moved or are moving to negative interest rates. Negative interest rates won’t work either so, assuming they don’t completely destroy the banking system beforehand, central banks may very well resort to helicopter money. Guess what, that won’t work either. How much more suffering will central banks have to impose on their countries before people realize that they are monetarily, morally, and intellectually bankrupt?

Paul-Martin Foss is the founder, President, and Executive Director of the Carl Menger Center for the Study of Money and Banking, a think tank dedicated to educating the American people on the importance of sound money and sound banking.

This article was published on Mises.org and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

What Markets Are Telling Us – Article by Ron Paul

What Markets Are Telling Us – Article by Ron Paul

The New Renaissance HatRon Paul
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Last week US stock markets tumbled yet again, leaving the Dow Jones index down almost 1500 points for the year. In fact, most major world markets are in negative territory this year. There are many Wall Street cheerleaders who are trying to say that this is just a technical correction, that the bottom is near, and that everything will be getting better soon. They are ignoring the real message the markets are trying to send: you cannot print your way to prosperity.

People throughout history have always sought to acquire wealth. Most of them understand that it takes hard work, sacrifice, savings, and investment. But many are always looking for that “get rich quick” scheme. Monetary cranks throughout history have thought that just printing more money would result in greater wealth and prosperity. Every time this was tried it resulted in failure. Huge economic booms would be followed by even larger busts. But no matter how many times the cranks were debunked both in theory and practice, the same failed ideas kept coming back.

The intellectual descendants of those monetary cranks are now leading the world’s central banks, which is why the last decade has seen an explosion of money creation. And what do the central bankers have to show for it? Lackluster employment numbers that have not kept up with population growth, increasing economic inequality, a rising cost of living, and constant fear and uncertainty about what the future holds.

The past decade has been a lot like the 1920s, when prices would have dropped without intervention, but the Federal Reserve kept the price level steady through injections of easy money into the economy. The result in the 1920s was the Great Depression. But in the 1920s prices were dropping because of increased production. More goods being produced meant lower prices, which the Fed then tried to prop up by printing money. Unlike the “Roaring 20s” however, the economy isn’t quite as strong today. It’s more of a gasp than a roar.

Production today is barely above 2007 levels, while heavily-indebted households already hurt during the financial crisis don’t want to keep spending. The bad debts and mal-investments from the last Federal Reserve-induced boom were never liquidated, they were merely papered over with more easy money. The underlying economic fundamentals remain weak but the monetary cranks who run the Fed keep trying to pump more and more money into the system. They fail to realize that easy money is the cause, not the cure, of recessions and depressions. They didn’t realize that prices needed to drop in order to clear all the bad debt and mal-investments out of the system. Because they don’t realize that, we are on the verge of yet another financial crisis.

Don’t be confused by any stock market rallies over the next few months and think that the worst is over. Remember that after Black Tuesday in 1929 the Dow Jones rallied over the next year before it began slowly and steadily to sink again. The central bankers will do everything they can to delay the inevitable. If they had allowed housing prices to fall in 2008 and hadn’t bailed out the big Wall Street banks, the economy would have corrected itself. Yes, it would have been a severe correction, but it would have been nothing compared to the inevitable correction that will present itself when the Fed runs out of easy money options. The Fed may try to cut interest rates again, maybe even going negative, or it will do more quantitative easing, but that won’t work. Creating more money does not lead to economic growth and well-being. The more money the Federal Reserve creates, the more ordinary Americans will end up suffering.

Ron Paul, MD, is a former three-time Republican candidate for U. S. President and Congressman from Texas.

This article is reprinted with permission from the Ron Paul Institute for Peace and Prosperity.

Venezuela Is Facing Runaway Financial Catastrophe – Article by Emily Skarbek

Venezuela Is Facing Runaway Financial Catastrophe – Article by Emily Skarbek

The New Renaissance HatEmily Skarbek
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Debt, capital flight, food shortages, and hyperinflation take hold

Often, economists want to isolate questions of public debt and analyse these issues as if public choice considerations weren’t at play. Perhaps less studied are the ways in which debt practices can systematically exert pressure on formal political institutions.

But if you want to understand what is going on in Venezuela today, you can’t do so without looking at this political-economy nexus.

For regular people living in Venezuela, the situation is bleak. As the Economist reports, food queues start at 3 am, with the real possibility there won’t be anything for those at the end of the line. And the queues are growing longer and violent.

Real wages fell by 35% last year, 76% of Venezuelans are now poor, supplies of medicines have fallen to 1/5 of their normal level.

The government has admitted that in the 12 months to September 2015 the economy contracted by 7.1% and inflation was 141.5%. Even Nicolás Maduro, Chávez’s hapless heir and successor, called these numbers “catastrophic”.

The IMF thinks worse is in store: it reckons inflation will surge to 720% this year and that the economy will shrink by 8%, after contracting by 10% in 2015. The Central Bank is printing money to cover much of a fiscal deficit of around 20% of GDP.

In a case study of Venezuela from 1984 to 2013, Reinhart and Santos examine the relationship among domestic debt, financial repression, and external vulnerability. The paper begins with a narrative of the evolution of domestic and external debt in Venezuela over the period.

Despite soaring oil prices from 2006 to 2013, net consolidated external debt of Venezuela rose from US $26.9 to US $104.3 billion. The central government, however, only accounted for roughly a fifth of that increment.

The difference, US $60.9 billion (78%), owed to standard practices of the Bolivarian revolution, and was issued by state owned enterprises and the relatively new Fondo Comun China-Venezuela (FCCV). The FCCV is a special-purpose vehicle that allows Venezuela to withdraw from a rolling line of credit at the Chinese Development Bank in exchange for future shipments of oil.

Domestic debt in local currency also climbed, rising from 36.298 million bolivares (VEF) in 2006 to 420.502 million in 2013. The nominal increase of 1,060% (an average annual rate of 42%) was partially offset by an accumulated price increase of 528% (or an average annual rate of 30%), reducing the cumulative increase in real domestic debt to about 85% (or 9% per annum).

During much of this period, the combination of exchange controls and interest ceilings created a captive domestic audience for domestic government debt despite markedly negative real ex post interest rates. The significant losses imposed on domestic bondholders escalated over time, owing to accelerating inflation.

Unlike foreign currency-denominated debt, debt in domestic currency may be reduced through financial repression (i.e., taxes on bondholders and savers producing negative real interest rates). Reinhart and Santos find the financial repression “tax rate” is significantly higher in years of exchange controls and legislated interest rate ceilings. In Venezuela, the “haircut” on depositors and bondholders via negative ex post real interest has exceeded 30% per annum on several occasions.

Confiscating the wealth of those responsible for capital savings can partially ameliorate the existing stock of domestic debt in the short run, but at the expense of encouraging capital flight and undermining any semblance of trust in crucial economic institutions.

The paper documents that capital flight has been a chronic feature in the Venezuelan economy, “representing on average of 4.7% of GDP at the official exchange rate and 7.1% of GDP at the parallel market exchange rate, while siphoning away 17.2% of total exports.”

By all measures, exchange controls proved ineffective at reducing capital flight. In fact, “when measured as percent of GDP at the average parallel market, rate capital flight turned out to be significantly higher in years of controls (8.0% vs 5.2%).

Hayek would not be surprised. Over his professional career he argued disastrous monetary policy commits the state to taking measures that weaken the proper functioning of the market. In order to combat inflation, states will attempt to impose further controls that “would not only make the price mechanism wholly ineffective, but also make inevitable an ever-increasing central direction of all economic activity.”

In Venezuela, Chávez turned the would-be checks and balances of the state — the Supreme Court and the electoral authority — into extensions of executive power. He packed the court and they then threw out those legislators necessary for the opposition to get the two-thirds majority needed to change the constitution.

President Nicolás Maduro seems prepared to continue the repression and price controls, calling the owner of Venezuela’s largest privately-held company a thief and publicly blaming him for the country’s dire economic condition.

It is perhaps fitting that it was at a Mont Pèlerin Conference in Caracas where Hayek famously quipped:

We now have a tiger by the tail: how long can this inflation continue? If the tiger (of inflation) is freed he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished!

I’m glad I won’t be here to see the final outcome…

Emily Skarbek is Lecturer in Political Economy at King’s College London and guest blogs on EconLog. Her website is EmilySkarbek.com. Follow her on Twitter @EmilySkarbek.​

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution 4.0 International License, which requires that credit be given to the author.

Is the Auto-Loan Bubble Ready to Pop? – Article by Tommy Behnke

Is the Auto-Loan Bubble Ready to Pop? – Article by Tommy Behnke

The New Renaissance HatTommy Behnke
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On Tuesday, it was announced that over seventeen million new vehicles were sold in 2015, the highest it’s ever been in United States history.

While the media claims that this record has been reached because of drastic improvements to the US economy, they are once again failing to account for the central factor: credit expansion.

When interest rates are kept artificially low, individuals are misled into spending more than they otherwise would. In hindsight, they discover that their judgment errors wreaked havoc on their financial well-being.

This is a lesson that the country should have learned from the Subprime Crisis of 2008. Excessive credit creation led too many individuals to buy homes, build homes, and invest in the housing industry. This surge in artificial demand temporarily spiked prices, resulting in over four million foreclosed homes and the killing of over nine million US jobs.

Instead of learning from the mistakes that sent shock waves throughout most of the planet, the Federal Reserve has continued with its expansionist policies. Since 2009, the money supply has increased by four trillion, while the federal funds rate has remained at or near zero percent. Consequently, the housing bubble has been replaced with several other bubbles, including one in the automotive industry.

Automotive companies have taken advantage of the cheap borrowing costs, increasing vehicle production by over 100 percent since 2009:

Behnke 1_0Source: OICA

In order to generate more vehicle purchases, these companies have incentivized consumers with hot, hard-to-resist offers, similar to the infamous “liar loans” and “no-money down” loans of the 2008 recession. Dealerships have increased spending on sales incentives by 14 percent since last year alone, and the banners in their shops now proudly proclaim their acceptance of any and all loan applications — “No Credit. Bad Credit. All Credit. 100 Percent Approval.” As a result, auto loans have increased by nearly $80 billion since 2009, many of which have been given to individuals with far-from-stellar credit scores. Today, almost 20 percent of all auto loans are given to individuals with credit scores below 620:

Behnke 2.pngSource: New York Fed

Not only are more auto loans being originated, but they are also increasing in duration. The average loan term is now sixty-seven months (that’s 5.58 years) for new cars and sixty-two (that’s 5.16 years) months for used cars. Both are record numbers.

Average transaction prices for new and used cars are also at their record highs. Used car prices have increased by nearly 25 percent since 2009, while new car prices have increased by over 15 percent. Part of this has to do with the increasing demand for cars generated by the upsurge in auto loans. The main reason, however, is that consumers — taking advantage of the accessibility of cheap credit — are purchasing more expensive body styles. This follows the housing bubble trend, when the median size of a newly built single-family home rose to 2,272 square feet at the start of 2007.

We all know the end result of the Great Recession — prices soared, millions of houses were foreclosed, and unemployment surged. Demand for homes then plummeted, and home prices ultimately dropped by 20 percent each month.

The auto bubble has yet to burst, but its negative effects are already starting to gradually appear. For one, delinquencies on car loans have increased by nearly 120 percent, from just over 1 percent in 2010 to 2.62 percent in 2014. Since cars rapidly depreciate in value, this number is projected to spike. By the time these six, seven, and eight year no-money down loans are due to be paid in full, many of these vehicles won’t be worth paying off anymore — maintenance and loan costs will start exceeding the value of the cars.

According to the Center for Responsible Lending, one in every six title-loan borrowers is already facing repossession fees. If defaults sharply increase in the coming years as projected, the market will become flooded with used cars, and their prices will, with near certainty, fall to a significant degree.

At a time when labor force participation is at its lowest level since 1977 — at a time when real wages are rising less than they have since at least the 1980s — it is imperative that the Federal Reserve stop misleading individuals into making irrational investments. The economy is simply too frail to continue weathering these endless business cycles. Economists, politicians, and the general populace need to start learning from their economic history so they can begin recognizing that favoring debt over thrift isn’t beneficial to the country’s financial well-being. Failure to do so will simply lead to more bubbles, more malinvestment, and more economic headaches in the years to come.

Tommy Behnke is an economics major and Mises University alumnus.

This article was published on Mises.org and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

Do We Need the Fed? – Article by Ron Paul

Do We Need the Fed? – Article by Ron Paul

The New Renaissance HatRon Paul
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Stocks rose Wednesday following the Federal Reserve’s announcement of the first interest rate increase since 2006. However, stocks fell just two days later. One reason the positive reaction to the Fed’s announcement did not last long is that the Fed seems to lack confidence in the economy and is unsure what policies it should adopt in the future.

At her Wednesday press conference, Federal Reserve Chair Janet Yellen acknowledged continuing “cyclical weakness” in the job market. She also suggested that future rate increases are likely to be as small, or even smaller, than Wednesday’s. However, she also expressed concerns over increasing inflation, which suggests the Fed may be open to bigger rate increases.

Many investors and those who rely on interest from savings for a substantial part of their income cheered the increase. However, others expressed concern that even this small rate increase will weaken the already fragile job market.

These critics echo the claims of many economists and economic historians who blame past economic crises, including the Great Depression, on ill-timed money tightening by the Fed. While the Federal Reserve is responsible for our boom-bust economy, recessions and depressions are not caused by tight monetary policy. Instead, the real cause of economic crisis is the loose money policies that precede the Fed’s tightening.

When the Fed floods the market with artificially created money, it lowers the interest rates, which are the price of money. As the price of money, interest rates send signals to businesses and investors regarding the wisdom of making certain types of investments. When the rates are artificially lowered by the Fed instead of naturally lowered by the market, businesses and investors receive distorted signals. The result is over-investment in certain sectors of the economy, such as housing.

This creates the temporary illusion of prosperity. However, since the boom is rooted in the Fed’s manipulation of the interest rates, eventually the bubble will burst and the economy will slide into recession. While the Federal Reserve may tighten the money supply before an economic downturn, the tightening is simply a futile attempt to control the inflation resulting from the Fed’s earlier increases in the money supply.

After the bubble inevitably bursts, the Federal Reserve will inevitably try to revive the economy via new money creation, which starts the whole boom-bust cycle all over again. The only way to avoid future crashes is for the Fed to stop creating inflation and bubbles.

Some economists and policy makers claim that the way to stop the Federal Reserve from causing economic chaos is not to end the Fed but to force the Fed to adopt a “rules-based” monetary policy. Adopting rules-based monetary policy may seem like an improvement, but, because it still allows a secretive central bank to manipulate the money supply, it will still result in Fed-created booms and busts.

The only way to restore economic stability and avoid a major economic crisis is to end the Fed, or at least allow Americans to use alternative currencies. Fortunately, more Americans than ever are studying Austrian economics and working to change our monetary system.

Thanks to the efforts of this growing anti-Fed movement, Audit the Fed had twice passed the House of Representatives, and the Senate is scheduled to vote on it on January 12. Auditing the Fed, so the American people can finally learn the full truth about the Fed’s operations, is an important first step in restoring a sound monetary policy. Hopefully, the Senate will take that step and pass Audit the Fed in January.

Ron Paul, MD, is a former three-time Republican candidate for U. S. President and Congressman from Texas.

This article is reprinted with permission from the Ron Paul Institute for Peace and Prosperity.


How Money Disappears in a Fractional-Reserve Money System – Article by Frank Shostak

How Money Disappears in a Fractional-Reserve Money System – Article by Frank Shostak

The New Renaissance Hat
Frank Shostak
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Most experts are of the view that the massive monetary pumping by the US central bank during the 2008 financial crisis saved the US and the world from another Great Depression. On this the Federal Reserve Chairman at the time Ben Bernanke is considered the man that saved the world. Bernanke in turn attributes his actions to the writings of Professor Milton Friedman who blamed the Federal Reserve for causing the Great Depression of 1930s by allowing the money supply to plunge by over 30 percent.

Careful analysis will however show that it is not a collapse in the money stock that sets in motion an economic slump as such, but rather the prior monetary pumping that undermines the pool of real funding that leads to an economic depression.

Improving the Economy Requires Time and Savings
Essentially, the pool of real funding is the quantity of consumer goods available in an economy to support future production. In the simplest of terms: a lone man on an island is able to pick twenty-five apples an hour. With the aid of a picking tool, he is able to raise his output to fifty apples an hour. Making the tool, (adding a stage of production) however, takes time.

During the time he is busy making the tool, the man will not be able to pick any apples. In order to have the tool, therefore, the man must first have enough apples to sustain himself while he is busy making it. His pool of funding is his means of sustenance for this period—the quantity of apples he has saved for this purpose.

The size of this pool determines whether or not a more sophisticated means of production can be introduced. If it requires one year of work for the man to build this tool, but he has only enough apples saved to sustain him for one month, then the tool will not be built—and the man will not be able to increase his productivity.

The island scenario is complicated by the introduction of multiple individuals who trade with each other and use money. The essence, however, remains the same: the size of the pool of funding sets a brake on the implementation of more productive stages of production.

When Banks Create the Illusion of More Wealth
Trouble erupts whenever the banking system makes it appear that the pool of real funding is larger than it is in reality. When a central bank expands the money stock, it does not enlarge the pool of funding. It gives rise to the consumption of goods, which is not preceded by production. It leads to less means of sustenance.

As long as the pool of real funding continues to expand, loose monetary policies give the impression that economic activity is being boosted. That this is not the case becomes apparent as soon as the pool of real funding begins to stagnate or shrink. Once this happens, the economy begins its downward plunge. The most aggressive loosening of money will not reverse the plunge (for money cannot replace apples).

The introduction of money and lending to our analysis will not alter the fact that the subject matter remains the pool of the means of sustenance. When an individual lends money, what he in fact lends to borrowers is the goods he has not consumed (money is a claim on real goods). Credit then means that unconsumed goods are loaned by one productive individual to another, to be repaid out of future production.

The existence of the central bank and fractional reserve banking permits commercial banks to generate credit, which is not backed up by real funding (i.e., it is credit created out of “thin air”).

Once the unbacked credit is generated it creates activities that the free market would never approve. That is, these activities are consuming and not producing real wealth. As long as the pool of real funding is expanding and banks are eager to expand credit, various false activities continue to prosper.

Whenever the extensive creation of credit out of “thin air” lifts the pace of real-wealth consumption above the pace of real-wealth production this undermines the pool of real funding.

Consequently, the performance of various activities starts to deteriorate and banks’ bad loans start to rise. In response to this, banks curtail their loans and this in turn sets in motion a decline in the money stock.

Does every curtailment of lending cause the decline in the money stock?

For instance, Tom places $1,000 in a savings deposit for three months with Bank X. The bank in turn lends the $1,000 to Mark for three months. On the maturity date, Mark repays the bank $1,000 plus interest. Bank X in turn after deducting its fees returns the original money plus interest to Tom.

So what we have here is that Tom lends (i.e., gives up for three months) $1,000. He transfers the $1,000 through the mediation of Bank X to Mark. On the maturity date Mark repays the money to Bank X. Bank X in turn transfers the $1,000 to Tom. Observe that in this case existent money is moved from Tom to Mark and then back to Tom via the mediation of Bank X. The lending is fully backed here by $1,000. Obviously the $1,000 here doesn’t disappear once the loan is repaid to the bank and in turn to Tom.

Why the Money Supply Shrinks
Things are, however, completely different when Bank X lends money out of thin air. How does this work? For instance, Tom exercises his demand for money by holding some of his money in his pocket and the $1,000 he keeps in the Bank X demand deposit. By placing $1,000 in the demand deposit he maintains total claim on the $1,000. Now, Bank X helps itself and takes $100 from Tom’s deposit and lends this $100 to Mark. As a result of this lending we now have $1,100 which is backed by $1,000 proper. In short, the money stock has increased by $100. Observe that the $100 loaned doesn’t have an original lender as it was generated out of “thin air” by Bank X. On the maturity date, once Mark repays the borrowed $100 to Bank X, the money disappears.

Obviously if the bank is continuously renewing its lending out of thin air then the stock of money will not fall. Observe that only credit that is not backed by money proper can disappear into thin air, which in turn causes the shrinkage in the stock of money.

In other words, the existence of fractional reserve banking (banks creating several claims on a given dollar) is the key instrument as far as money disappearance is concerned. However, it is not the cause of the disappearance of money as such.

Banks Lend Less as the Quality of Borrowers Worsens
There must be a reason why banks don’t renew lending out of thin air. The main reason is the severe erosion of real wealth that makes it much harder to find good quality borrowers. This in turn means that monetary deflation is on account of prior inflation that has diluted the pool of real funding.

It follows then that a fall in the money stock is just a symptom. The fall in the money stock reveals the damage caused by monetary inflation but it however has nothing to do with the damage.

Contrary to Friedman and his followers (including Bernanke), it is not the fall in the money supply and the consequent fall in prices that burdens borrowers. It is the fact that there is less real wealth. The fall in the money supply, which was created out of “thin air,” puts things in proper perspective. Additionally, as a result of the fall in money, various activities that sprang up on the back of the previously expanding money now find it hard going.

It is those non-wealth generating activities that end up having the most difficulties in serving their debt since these activities were never generating any real wealth and were really supported or funded, so to speak, by genuine wealth generators. (Money out of “thin air” sets in motion an exchange of nothing for something — the transferring of real wealth from wealth generators to various false activities.) With the fall in money out of thin air their support is cut-off.

Contrary to the popular view then, a fall in the money supply (i.e., money out of “thin air”), is precisely what is needed to set in motion the build-up of real wealth and a revitalizing of the economy.

Printing money only inflicts more damage and therefore should never be considered as a means to help the economy. Also, even if the central bank were to be successful in preventing a fall in the money supply, this would not be able to prevent an economic slump if the pool of real funding is falling.

Frank Shostak is an Associated Scholar of the Mises Institute. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies. He received his bachelor’s degree from Hebrew University, master’s degree from Witwatersrand University and PhD from Rands Afrikaanse University, and has taught at the University of Pretoria and the Graduate Business School at Witwatersrand University.

This article was originally published by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.

Does the Bell Toll for the Fed? – Article by Ron Paul

Does the Bell Toll for the Fed? – Article by Ron Paul

The New Renaissance HatRon Paul
November 9, 2015
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Last week Federal Reserve Chair Janet Yellen hinted that the Federal Reserve Board will increase interest rates at the board’s December meeting. The positive jobs report that was released following Yellen’s remarks caused many observers to say that the Federal Reserve’s first interest rate increase in almost a decade is practically inevitable.

However, there are several reasons to doubt that the Fed will increase rates anytime in the near future. One reason is that the official unemployment rate understates unemployment by ignoring the over 94 million Americans who have either withdrawn from the labor force or settled for part-time work. Presumably the Federal Reserve Board has access to the real unemployment numbers and is thus aware that the economy is actually far from full employment.

The decline in the stock market following Friday’s jobs report was attributed to many investors’ fears over the impact of the predicted interest rate increase. Wall Street’s jitters about the effects of a rate increase is another reason to doubt that the Fed will soon increase rates. After all, according to former Federal Reserve official Andrew Huszar, protecting Wall Street was the main goal of “quantitative easing,” so why would the Fed now risk a Christmastime downturn in the stock markets?

Donald Trump made headlines last week by accusing Janet Yellen of keeping interest rates low because she does not want to risk another economic downturn in President Obama’s last year in office. I have many disagreements with Mr. Trump, but I do agree with him that the Federal Reserve’s polices may be influenced by partisan politics.

Janet Yellen would hardly be the first Fed chair to allow politics to influence decision-making. Almost all Fed chairs have felt pressure to “adjust” monetary policy to suit the incumbent administration, and almost all have bowed to the pressure. Economists refer to the Fed’s propensity to tailor monetary policy to suit the needs of incumbent presidents as the “political” business cycle.

Presidents of both parties, and all ideologies, have interfered with the Federal Reserve’s conduct of monetary policy. President Dwight D. Eisenhower actually threatened to force the Fed chair to resign if he did not give in to Ike’s demands for easy money, while then-Federal Reserve Chair Arthur Burns was taped joking about Fed independence with President Richard Nixon.

The failure of the Fed’s policies of massive money creation, corporate bailouts, and quantitative easing to produce economic growth is a sign that the fiat money system’s day of reckoning is near. The only way to prevent the monetary system’s inevitable crash from causing a major economic crisis is the restoration of a free-market monetary policy.

One positive step Congress may take this year is passing the Audit the Fed bill. Fortunately, Senator Rand Paul is using Senate rules to force the Senate to hold a roll-call vote on Audit the Fed. The vote is expected to take place in the next two-to-three weeks. If Audit the Fed passes, the American people can finally learn the full truth about the Fed’s operations. If it fails, the American people will at least know which senators side with them and which ones side with the Federal Reserve.

Allowing a secretive central bank to control monetary policy has resulted in an ever-expanding government, growing income inequality, a series of ever-worsening economic crises, and a steady erosion of the dollar’s purchasing power. Unless this system is changed, America, and the world, will soon experience a major economic crisis. It is time to finally audit, then end, the Fed.

Ron Paul, MD, is a former three-time Republican candidate for U. S. President and Congressman from Texas.

This article is reprinted with permission from the Ron Paul Institute for Peace and Prosperity.