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Blame the Federal Reserve, Not China, for Stock-Market Crash – Article by Ron Paul

Blame the Federal Reserve, Not China, for Stock-Market Crash – Article by Ron Paul

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The New Renaissance HatRon Paul
September 6, 2015
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Following the historic stock-market downturn two weeks ago, many politicians and so-called economic experts rushed to the microphones to explain why the market crashed and to propose “solutions” to our economic woes. Not surprisingly, most of those commenting not only failed to give the right answers, they failed to ask the right questions.

Many blamed the crash on China’s recent currency devaluation. It is true that the crash was caused by a flawed monetary policy. However, the fault lies not with China’s central bank but with the US Federal Reserve. The Federal Reserve’s inflationary policies distort the economy, creating bubbles, which in turn create a booming stock market and the illusion of widespread prosperity. Inevitably, the bubble bursts, the market crashes, and the economy sinks into a recession.

An increasing number of politicians have acknowledged the flaws in our monetary system. Unfortunately, some members of Congress think the solution is to force the Fed to follow a “rules-based” monetary policy. Forcing the Fed to “follow a rule” does not change the fact that giving a secretive central bank the power to set interest rates is a recipe for economic chaos. Interest rates are the price of money, and, like all prices, they should be set by the market, not by a central bank and certainly not by Congress.

Instead of trying to “fix” the Federal Reserve, Congress should start restoring a free-market monetary system. The first step is to pass the Audit the Fed legislation so the people can finally learn the full truth about the Fed. Congress should also pass legislation ensuring individuals can use alternative currencies free of federal-government harassment.

When bubbles burst and recessions hit, Congress and the Federal Reserve should refrain from trying to “stimulate” the economy via increased spending, corporate bailouts, and inflation. The only way the economy will ever fully recover is if Congress and the Fed allow the recession to run its course.

Of course, Congress and the Fed are unlikely to “just stand there” if the economy further deteriorates. There have already been reports that the Fed will use last week’s crash as an excuse to once again delay raising interest rates. Increased spending and money creation may temporally boost the economy, but eventually they will lead to a collapse in the dollar’s value and an economic crisis more severe than the Great Depression.

Ironically, considering how popular China-bashing has become, China’s large purchase of US Treasury notes has helped the US postpone the day of reckoning. The main reason countries like China are eager to help finance our debt is the dollar’s world reserve currency status. However, there are signs that concerns over the US government’s fiscal irresponsibility and resentment of our foreign policy will cause another currency (or currencies) to replace the dollar as the world reserve currency. If this occurs, the US will face a major dollar crisis.

Congress will not adopt sensible economic policies until the people demand it. Unfortunately, while an ever-increasing number of Americans are embracing Austrian economics, too many Americans still believe they must sacrifice their liberties in order to obtain economic and personal security. This is why many are embracing a charismatic crony capitalist who is peddling a snake oil composed of protectionism, nationalism, and authoritarianism.

Eventually the United States will have to abandon the warfare state, the welfare state, and the fiat money system that fuels leviathan’s growth. Hopefully the change will happen because the ideas of liberty have triumphed, not because a major economic crisis leaves the US government with no other choice.

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.

The Fed’s Confusion Over the “Natural Rate” of Unemployment and Inflation – Article by Frank Shostak

The Fed’s Confusion Over the “Natural Rate” of Unemployment and Inflation – Article by Frank Shostak

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Frank Shostak
July 20, 2015
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In May, the US unemployment rate stood at 5.5 percent against the rate of 5.3 percent for the “natural unemployment,” also known as the Non-Accelerating Inflation Rate of Unemployment (NAIRU).

According to the popular view, once the actual unemployment rate falls to below the NAIRU, or the natural unemployment rate, the rate of inflation tends to accelerate and economic activity becomes overheated. (This acceleration in the rate of inflation takes place through increases in the demand for goods and services. It also lifts the demand for workers and puts pressure on wages, reinforcing the growth in inflation).

By this way of thinking, the central bank must step in and lift interest rates to prevent the rate of inflation from getting out of control.

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Recently, however, some experts have raised the possibility that the natural unemployment rate is likely to be much lower than the government official estimate of 5.3 percent. In fact, earlier this year, economists at the Chicago Fed argued that the natural unemployment rate since October last year has fallen to 4.3 percent.

The reasons for this decline are demographic changes and an increase in the level of education. (The natural unemployment rate tends to fall, so it is held, with the rising age of the labor force and with its education.)

Experts are of the view that these factors should continue to lower the natural unemployment rate for at least the remainder of the decade.

It is held that a lower natural rate may help explain why wage inflation and price inflation remain low, despite the actual unemployment rate recently reaching 5.5 percent.

Advocates for a lower natural rate also claim a lower rate would mean the Fed can keep interest rates lower for longer without worrying about lifting the rate of inflation.

Why NAIRU Is an Arbitrary Measure

The NAIRU however, is an arbitrary measure; it is derived from a statistical correlation between changes in the consumer price index and the unemployment rate. What matters here for Fed economists and others is whether the theory “works” (i.e., whether it can predict the future rate of increases in the consumer price index).

This way of thinking doesn’t consider whether a theory corresponds to reality. Here we have a framework, which implies that “anything goes” as long as one can make accurate predictions.

The purpose of a theory however is to present the facts of reality in a simplified form. A theory has to originate from reality and not from some arbitrary idea that is based on a statistical correlation.

If “anything goes,” then we could find by means of statistical methods all sorts of formulas that could serve as forecasting devices.

For example, let us assume that high correlation has been established between the income of Mr. Jones and the rate of growth in the consumer price index — the higher the rate of increase of Mr. Jones’s income, the higher the rate of increase in the consumer price index.

Therefore we could easily conclude that in order to exercise control over the rate of inflation the central bank must carefully watch and control the rate of increases in Mr. Jones’s income. The absurdity of this example matches that of the NAIRU framework.

Inflation Is Not Caused by Increased Economic Activity

Contrary to mainstream thinking, strong economic activity as such doesn’t cause a general rise in the prices of goods and services and economic overheating labeled as inflation.

Regardless of the rate of unemployment, as long as every increase in expenditure is supported by production, no overheating can occur.

The overheating emerges once expenditure is rising without the backup of production — for instance, when the money stock is increasing. Once money increases, it generates an exchange of nothing for something, or consumption without preceding production, which leads to the erosion of real wealth.

As a rule, rises in the money stock are followed by rises in the prices of goods and services.

Prices are another name for the amount of money that people spend on goods they buy.

If the amount of money in an economy increases while the number of goods remains unchanged more money will be spent on the given number of goods i.e., prices will increase.

Conversely, if the stock of money remains unchanged it is not possible to spend more on all the goods and services; hence no general rise in prices is possible. By the same logic, in a growing economy with a growing number of goods and an unchanged money stock, prices will fall.

Frank Shostak is an adjunct scholar of the Mises Institute and a frequent contributor to Mises.org. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies.

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.

Why Do We Celebrate Rising Home Prices? – Article by Ryan McMaken

Why Do We Celebrate Rising Home Prices? – Article by Ryan McMaken

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Ryan McMaken
May 26, 2015
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In recent years, home price indices have seemed to proliferate. Case-Shiller, of course, has been around for a long time, but over the past decade, additional measures have been marketed aggressively by Trulia, CoreLogic, and Zillow, just to name a few.

Measuring home prices has taken on an urgency beyond the real estate industry because for many, home price growth has become something of an indicator of the economy as a whole. If home prices are going up, it is assumed, “the economy” must be doing well. Indeed, we are encouraged to relax when home prices are increasing or holding steady, and we’re supposed to become concerned if home prices are going down.

This is a rather odd way of looking at the price of a basic necessity. If the price of food were going upward at the rate of 7 or 8 percent each year (as has been the case with houses in many markets in recent years) would we all be patting ourselves on the back and telling ourselves how wonderful economic conditions are? Or would we be rightly concerned if incomes were not also going up at a similar rate? Would we do the same with shoes and clothing? How about with education?

With housing, though, increases in prices are to be lauded, we are told, even if they outpace wage growth.

We’re Told to Want High Home Prices

But in today’s economy, if home prices are outpacing wage growth, then housing is becoming less affordable. This is grudgingly admitted even by the supporters of ginning up home prices, but the affordability of housing takes a back seat to the insistence that home prices be preserved at all costs.

Behind all of this is the philosophy that even if the home-price/household-income relationship gets out of whack, most problems will nevertheless be solved if we can just get people into a house. Once someone becomes a homeowner, the theory goes, he’ll be sitting on a huge asset that (almost) always goes up in price, meaning that any homeowner will increase in net worth as the equity in his home increases.

Then, the homeowner can use that equity to buy furniture, appliances, and a host of other consumer goods. With all that consumer spending, the economy takes off and we all win. Rising home prices are just a bump in the road, we are told, because if we can just get everyone into a home, the overall benefit to the economy will be immense.

Making Homes Affordable with More Cheap Debt

Not surprisingly, we find a sort of crude Keynesianism behind this philosophy. In this way of thinking, the point of homeownership is not to have shelter, but to acquire something that will encourage more consumer spending. In other words, the purpose of homeownership is to increase aggregate demand. The fact that you can live in the house is just a fringe benefit. This macro-obsession is part of the reason why the government has pushed homeownership so aggressively in recent decades.

The fly in the ointment, of course, is if home prices keep going up faster than wages — ceteris paribus — fewer people will be able to save enough money to come up with either the full amount or even a sizable down payment on a loan.

Not to worry, the experts tell us. We’ll just make it easier, with the help of inflationary fiat money, to get an enormous loan that will allow you to buy a house. Thus, rock-bottom interest rates and low down payments have been the name of the game since the late 1980s.

We started to see the end game at work during the last housing bubble when Fannie Mae introduced the 40-year mortgage in 2005, which just emphasized that when it comes to being a homeowner, the idea is not to pay off the mortgage, but to “buy” a house and just pay the monthly payment until one moves to another house and gets a new thirty- or forty-year loan.

It Pays To Be in Debt

On the surface of it, it’s hard to see how this scenario is fundamentally different from just paying rent every month. If the homeowner stops paying the monthly payment, he’s out on the street, and the bank keeps the house, which is very similar to the scenario in which a renter stops paying a landlord. There’s (at least) one big difference here, however. It makes sense for the homeowner to get a home loan rather than rent an apartment because — if it’s a fixed-rate loan — price inflation ensures the real monthly payment will go down every month. Residential rents, on the other hand, tend to keep up with inflation.

But why would any lending institution make these sorts of long-term loans if the payment in real terms keeps getting smaller? After all, thirty years is a long time for something to go wrong.

Lenders are willing and able to do this because the loans are subsidized and underwritten through government creations like Fannie Mae (which buys up these loans on the secondary market), through bailouts, and through a myriad of other federal programs such as FHA. Naturally, in an unhampered market, a loan of such a long term would require high interest rates to cover the risk. But, Congress and the Fed have come to the rescue with promises of bailouts and easy money, meaning cheap thirty-year loans continue to live on.

So, what we end up with is a complex system of subsidies and favoritism on the part of lenders, homeowners, government agencies, and the Fed. The price of homes keeps going up, increasing the net worth of homeowners, and banks can make long-term loans on fairly risky terms because they know bailouts of various sorts will come if things go wrong.

But problems begin to arise when increases in home prices begin to outpace access to easy money and cheap loans. Indeed, we’re now seeing that homeownership rates are going down in spite of low interest rates, and vacancy rates in rental housing are at a twenty-year low. Meanwhile, new production in housing units is at 1992 levels, offering little relief from rising prices and rents. Obviously, something isn’t going according to plan.

Who Loses?

The old debt-based tricks that once kept homeownership climbing and accessible in the face of rising home prices are no longer working.

From a free market’s perspective, renting a home is neither good nor bad, but American policymakers long ago decided to favor homeowners over renters. Consequently, we’re faced with an economic system that pushes renters toward homeownership — price inflation and the tax code punishes renters more than owners — while simultaneously pushing home prices higher and higher.

During the last housing bubble, however, as homeownership levels climbed, few noticed or cared about this. So many renters became homeowners that rental vacancies climbed to record highs from 2004 to 2009. But in our current economy, one cannot avoid rising rents or hedge against inflation by easily leaving rental housing behind.

This time around, the cost of purchasing housing is going up by 6 to 10 percent per year, but few renters can join the ranks of the homeowners to enjoy the windfall. Instead, they just face record-high rent increases and a record-low inventory in for-sale houses.

There once was a time when rising home prices and rising homeownership rates could happen at the same time; it was possible for the government to stick to its unofficial policy of propping up home prices while also claiming to be pushing homeownership. We no longer live in such a time.

Ryan W. McMaken is the editor of Mises Daily and The Free Market. He has degrees in economics and political science from the University of Colorado, and was the economist for the Colorado Division of Housing from 2009 to 2014. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre. 

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.

Janet Yellen is Right: She Can’t Predict the Future – Article by Ron Paul

Janet Yellen is Right: She Can’t Predict the Future – Article by Ron Paul

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Ron Paul
May 25, 2015
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This week I found myself in rare agreement with Janet Yellen when she admitted that her economic predictions are likely to be wrong. Sadly, Yellen did not follow up her admission by handing in her resignation and joining efforts to end the Fed. An honest examination of the Federal Reserve’s record over the past seven years clearly shows that the American people would be better off without it.

Following the bursting of the Federal Reserve-created housing bubble, the Fed embarked on an unprecedented program of bailouts and money creation via quantitative easing (QE) 1, 2, 3, etc. Not only has QE failed to revive the economy, it has further damaged the average American’s standard of living while benefiting the financial elites. None other than Donald Trump has called QE “a great deal for guys like me.”

The failure of quantitative easing to improve the economy has left the Fed reluctant to raise interest rates. Yet the Fed does not want to appear oblivious to the dangers posed by keeping rates artificially low. This is why the Fed regularly announces that the economy will soon be strong enough to handle a rate increase.

There are signs that investors are beginning to realize that the Fed’s constant talk of raising rates is just talk, so they are looking for investments that will protect them from a Fed-caused collapse in the dollar’s value. For example, the price of gold recently increased following reports of stagnant retail sales. An increased gold price in response to economic sluggishness may appear counterintuitive, but it is a sign that investors are realizing quantitative easing is not ending anytime soon.

The increase in the gold price is not the only sign that investors are interested in hard assets to protect themselves from inflation. Recently a Picasso painting sold for a record 180 million dollars. This record may not last long, as an additional two billion dollars worth of art is expected to go on the market in the next few weeks.

Another sign of the increasing concerns about the dollar’s stability is the growing interest in alternative currencies. Investing and using alternative currencies can help average Americans, who do not have millions to spend on Picasso paintings, protect themselves from a currency crisis.

Congress should ensure that all Americans can protect themselves from a dollar crisis by repealing the legal tender laws.

Congress should also take the first step toward monetary reform by passing the Audit the Fed bill. Unfortunately, Audit the Fed is not a part of the Federal Reserve “reform” bill that was passed by the Senate Banking Committee. Instead, the bill makes some minor changes in the Fed’s governance structure. These “reforms” are the equivalent of rearranging deck chairs as the Titanic crashes into the iceberg. Hopefully, the Senate will vote on, and pass, Audit the Fed this year.

The skyrocketing federal debt is also a major factor in the coming economic collapse. The Federal Reserve facilitates deficit spending by monetizing debt. Congress should make real cuts, not just reductions in the “rate of growth,” in all areas. But it should prioritize cutting the billions spent on the military-industrial complex.

Some say that eliminating the welfare-warfare state and the fiat currency system that props it up will cause the people pain. The truth is the only people who will feel any long-term pain from returning to limited, constitutional government are the special interests that profit from the current system. A return to a true free-market economy will greatly improve the lives of the vast majority of Americans.

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.

The Other Half of the Inflation Story: Credit Expansion Adds Noise to Price Signals – Article by Sanford Ikeda

The Other Half of the Inflation Story: Credit Expansion Adds Noise to Price Signals – Article by Sanford Ikeda

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Sanford Ikeda
May 7, 2015
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More money means higher prices. It’s too bad not everyone understands that connection. Even some economists don’t get it. Readers of the Freeman do, I’m sure. And they also understand why that’s a bad thing.

Increasing the supply of money and credit, other things equal, will cause a general rise in wages and prices across an economy. When the Federal Reserve, the central bank of the United States, excessively “prints money,” the result is “inflation” as it’s now commonly called. For those who get the new money after everyone else has spent theirs, inflation means incomes will now buy fewer goods, and every dollar lent before prices rose will be worth less when it’s returned.

If inflation continues, people will eventually learn to demand more for what they sell and lend in order to compensate for the purchasing power that inflation keeps eating away. That, in turn, will cause prices to rise faster, which makes planning for households and businesses even more difficult. In the past, that difficulty has led to hyperinflation and a breakdown of the entire economic system.

But as awful as all this may be, it’s really only half the story, and perhaps not even the worse half. What follows is a highly simplified story of what happens.

The structure of production

If you’d like to build a sturdy house, you’ll need to have some kind of blueprint or plan that will tell you two things:

  1. how the frame, floor, walls, roof, plumbing, and electrical system will all fit together; and
  2. the order in which to put these components together.

Even if the house was made entirely of identical stones, you would need to know how to fit them together to form the floor, walls, chimney, and other structural components. No two stones would serve exactly the same function in the overall plan.

The economy is like a house in the sense that each of its parts, which we might call “capital,” needs to mesh in a certain way if the eventual result will be order and not chaos. But there are two big differences between a house and an economy. The first is that the economy is not only much bigger, but it consists of a multitude of “houses” or private enterprises that have to fit together or coordinate, and so it’s an unimaginably more complex phenomenon than even the most elaborate house.

The second major difference is that a house is consciously constructed for a purpose, typically for someone to live in it. But an economic system is neither consciously designed by anyone nor intended to fulfill any particular purpose, other than perhaps to enable countless people with plans to do the best they can to achieve success. It’s a spontaneous order.

The way all the pieces of capital, from all the diverse people in the economy who own them, fit together is called the capital structure of production.

Credit expansion distorts the structure of production

When people decide to spend a certain portion of their incomes on consumption today, they are at the same time deciding to save some portion for consumption for the future. The amount that they save then gets lent out to borrowers and investors in the market for loanable funds. The rate of interest is the price of making those transactions across time. That is, when you decide to increase your saving, other things equal, the rate of interest (what some economists call the “natural rate of interest”) will fall. The falling interest rate makes borrowing more attractive to producers who invest today to produce more goods in the future.

That’s great, because when the market for loanable funds is operating freely without distortions, that means when people who saved today try to consume more in the future, there actually is more in the future for them to consume . Businesses today invested more at the lower rates precisely in order to have more to sell in the future when consumers want to buy more.

Now, if the Federal Reserve prints more money and that money goes into the loanable funds market, that will also increase the supply of loans and lower the interest rate and induce more borrowing and investment for future output. The difference here is that the supply of loans increases not because people are saving more now in order to consume more in the future, but only because of the credit expansion. That means that in the future, when businesses have more goods to sell, consumers won’t be able to buy them (because they didn’t save enough to do so) at prices that will cover all of the businesses’ costs. Prices will have to drop in order for markets to clear. Sellers suffer losses and workers lose their jobs.

And, oh yes, all that credit expansion also causes inflation.

While this process sounds rather involved, it’s still a highly simplified version of what has come to be known as the Austrian business cycle theory. (For a more advanced version, see here.) Of course, each instance in reality is significantly different from any other, but the narrative is essentially the same: credit expansion distorts the structure of production, and resources eventually become unemployed.

The explanation is more involved than the typical inflation-is-bad story that we’re more familiar with. Indeed, that probably explains why it’s the less-well-known half of the story. Even Milton Friedman and the monetarists pay little attention to the capital structure, choosing instead to focus on the problems of inflationary expectations.

Again, for Austrians, the problem arises when credit expansion artificially lowers interest rates and sets off an unsustainable “boom”; the solution is when the structure of production comes back into alignment with people’s actual preferences for consumption and saving, which is the “bust.” Most modern macroeconomists see it exactly the opposite way: the bust is the problem, and the boom is the solution.

An intricate, dynamic jigsaw puzzle

To close, I’d like to use an analogy I learned from Steve Horwitz (whom I heartily welcome back as a fellow columnist here at the Freeman).

The market economy is like a giant jigsaw puzzle in which each piece represents a unique unit of capital. When the system is allowed to operate without government intervention, the profit-and-loss motive tends to bring the pieces together in a complementary way to form a harmonious mosaic (although in a dynamic world, it couldn’t achieve perfection).

Credit expansion, then, is like someone coming along and making too many of some pieces and too few of others — and then, during the boom, trying to force them together, severely distorting the overall picture. During the bust, people realize they have to get rid of some pieces and try to discover where the others actually fit. That requires challenging adjustments and may take some time to accomplish. But if the government tries to “help” by stimulating the creation of more superfluous pieces, it will only confuse matters and make the process of adjustment take that much longer.

Inflation is bad enough. Unfortunately, it’s only half the story.

Sanford Ikeda is a professor of economics at Purchase College, SUNY, and the author of The Dynamics of the Mixed Economy: Toward a Theory of Interventionism.

This article was originally published by The Foundation for Economic Education.

Will the Fed Let Innovation Work Its Magic? – Article by Edin Mujagic

Will the Fed Let Innovation Work Its Magic? – Article by Edin Mujagic

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Edin Mujagic
April 21, 2015

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Sometimes one finds true gems in one’s archives. Recently I came across a speech by then-chairman of the Fed, Ben Bernanke, from May 18, 2013. It was the commencement speech at Bard College at Simon´s Rock, in Great Barrington, Massachusetts. In it, Bernanke chose to forget for a while the dire straits the Western economy is in and focused on prospects for economic growth in the long run, which he defined as “measured in decades, not months or quarters.”

In short, Bernanke focused on scientific and technological progress, more commonly described as innovation. He envisaged a fourth wave of innovation — the first three being the early industrial era (mid-1700s until mid-1800s), the modern industrial era (from 1880 onwards), and the IT-revolution.

His commencement speech was a speech of hope and of encouragement. But Bernanke did not tell the whole story. The then-Fed chairman failed to mention that living standards will depend on more than innovation. At least as important is the role of the very institution he chaired, the Federal Reserve, and what it does or does not do. If it allows high inflation to take hold — either through action or inaction — that would annihilate a very substantial part of the increase in living standards due to innovation.

And yet, recent history strongly suggests that the Fed will end up destroying a large part of the increase in living standards of those graduates Bernanke was speaking to. For example, at the beginning of 2013 Bernanke spoke at another American college. During the Q&A session, he said that “the worst mistake the Fed can make is to tighten monetary policy too soon.” In other words, the then-chairman essentially promised to raise interest rates too late. Nowadays, Bernanke may be gone from the Fed, but his line of thinking on monetary policy certainly has not, and indeed, this line of thinking reflects dominant Fed policy well beyond the Bernanke years.

Innovation and Living Standards

Bernanke, like Greenspan before him, is counting on innovation to keep the economy moving. As well he should. Technological innovation often leads to more efficient production and greater worker productivity which leads to higher wages and more affordable goods.

But if Bernanke is going to tell students that technology will make their lives better, he should also mention the role that he himself and other central bankers play in stifling the positive effects of innovation.

We can see multiple examples of this phenomenon in recent decades. For example, if we consider the effect that China’s entrance into the global economy should have had on living standards in the US, we find the actual results to be somewhat underwhelming. We should have witnessed growth in living standards similar to what we witnessed toward the end of the nineteenth century as the US industrialized. But in fact, the record of growth in real wealth in the US has been disappointing at best.

For example, technological progress due to the Industrial Revolution and globalization in the late nineteenth century led to continuous deflation in the US, and hence unprecedented increases in welfare. Research by Michael Bordo at Rutgers, shows that on average, prices fell by 1.2 percent each year between 1870 and 1896. Real living standards increased substantially over the same time period. Labor market economists in the United States have been able to reconstruct wage development in the United States since 1830. In every decade the real wage was higher than the preceding decade. That is, until the 1970s.

In contrast, in the decades since the early 1980s, as Asia was joining the world with its own industrial revolution, each year prices increased in the US by more than 2 percent. According to the statistics available from US Census, real median household income in the United States (i.e., income adjusted for inflation) barely moved between 1980 and 2012. This is odd, given the fact that economic growth averaged some 3 percent per annum and labor productivity soared by some 50 percent in total. A working American male earned approximately $48,000 in 1969. Adjusted for inflation, his income had barely grown by the time the current economic crisis started.

The main difference between the two periods is that in 1800s there was no Federal Reserve, and the money supply, while certainly not completely non-inflationary, was restrained by the absence of a central bank.

Lost Opportunities

In an unhampered market, technological progress, innovation, and globalization in the decades before the current crisis should have led to three things: slower wage growth, larger profits, and lower prices. In other words, what firms like Apple accomplished (i.e., the creation of innovative, labor-saving products made available at ever-lower prices) on a micro scale, should have happened on the macro-level as well. Slower wage growth would have been inevitable because of increased global competition in the labor market and the constant and increasing threat of jobs being offshored. Larger profits would have occurred economy-wide because of this fact, and the fact that production costs fell. And finally, lower prices would have spread throughout the economy because, due to technological progress, globalization, falling wages, and falling transportation costs.

The first two effects manifested themselves. As mentioned, real income barely budged in the last few decades in the United States. This becomes evident when we take a look at the total employee compensation in the United States. Measured as a share of GDP, US wages in recent years have been lower than during any other period since World War II. At the end of the war, the ratio was 53.6 percent. Nowadays, we find it below 45 percent.

Moreover, as a rule of thumb, the lower the share of wages in any country’s GDP, the higher the share of profits. So we find the second effect evident as well: profits increased.The third effect, however, falling prices, has been largely prevented by the intervention of the central bank. In fact, the Fed aimed for, and continues to aim for some 2 percent inflation per annum. The Fed has been very successful in preventing prices from falling even when the downward pressure on prices was strong, due to the aforementioned combination of technological progress, innovation, globalization, and free trade.

In more than a century before the inception of the Fed in 1913, cumulative inflation in the United States was approximately 0 percent. Between January 1, 1914 and July 2013, cumulative inflation in the United States stood at 2,236 percent, prompting Milton Friedman to write — way back in 1988 —that “no major institution in the US has so poor a record of performance over so long a period, yet so high a public reputation.”

A logical consequence of any “fourth wave” of innovation should be deflation, or falling prices. Then and only then will the living standards of those graduates who were listening to Bernanke indeed increase strongly. It will not happen as long as the Fed continues to aim for inflation every year and certainly not if the Fed continues to follow its current policy that will, according to many, cause even higher inflation in years to come.

Edin Mujagic has a Master’s degree in macro and monetary economics from Tilburg University (The Netherlands) and is an independent macro-economist and author of Money Murder: How the Central Banks Are Destroying Our Money (published in Dutch, as Geldmoord). He is the youngest-ever member of the Monetaire Kring (Monetary Circle) in the Netherlands, a by-invitation-only policy forum of university professors and senior officials at the central bank, ministry of Finance, banks, pension funds and other financial institutions.

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.

Why We Need Deflation and Higher Interest Rates – Article by John P. Cochran

Why We Need Deflation and Higher Interest Rates – Article by John P. Cochran

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John P. Cochran
April 5, 2015
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The Fed is seemingly slightly out of step with other central bankers as it recently hinted at possible future rate hikes in the official announcement following its March 20, 2015 meeting. But as many commentators have recognized, Janet Yellen, a strong proponent of Keynesian more-inflation-as-cure-for-unemployment policy, later downplayed the significance of the announcement. She was careful to indicate that rates would stay low for the near future and when (and if) rate increases begin, they will be measured. The Fed, like central bankers elsewhere, stays committed to a 2 percent inflation target as it continues a policy driven by a fear of deflation, a fear that is not supported by either good economic theory or economic history properly interpreted.

The errors of deflation-phobia can be drawn from Philipp Bagus’s excellent and recently released In Defense of Deflation. Bagus points out

In the economic mainstream, there are basically two main strands in contemporary deflation theories. The first strand can be represented by economists who in some way are inspired by Keynesian theories like Ben Bernanke, Lars E.O. Svensson, Marvin Goodfriend, or Paul Krugman. The first group fears that price deflation might put the economy in a liquidity trap and opposes all price deflation categorically. It represents the deflation phobia in its clearest form.

It is these theorists and their colleagues who currently dominate central bank thinking and make the case (weak and often only asserted as an imperative) for a positive inflation buffer.

Bagus does recognize a second group of mainstream economists with a more balanced view of deflation:

The second strand has representatives like Claudio Borio, Andrew Filardo, Michael Bordo, John L. Lane, and Angela Redish. Inspired by the Chicago School, the second group is more free market oriented. Bordo, for instance, received his doctoral degree from the University of Chicago. This group distinguishes between two types of deflation: good deflation and bad deflation.

Deflation Leads to Increases in Real Interest Rates, Which Brings Recovery

However, the main water carriers against this erroneous overemphasis by economists and the mainstream press on the alleged evils of deflation have been the Austrians. In his essays “A Reformulation of the Austrian Business Cycle Theory” and “An Austrian Taxonomy of Deflation” Joseph Salerno dismantles deflation-phobia and illustrates the benefits of higher interest rates. Moreover, “A Reformulation” is also a strong argument on why current policy retards recovery and why a policy which would allow financial markets to adjust to a new higher natural rate of interest is essential for restoring normalcy and prosperity. Salerno begins with examining why it is so unpleasant when an economy must adjust to fix the malinvestments and overconsumption that appeared in the boom phase:

The ABCT, when correctly formulated, does indeed explain the asymmetry between the boom and bust phases of the business cycle. The malinvestment and overconsumption that occur during the inflationary boom cause a shattering of the production structure that accounts for the pervasive unemployment and impoverishment that is observed during the recession. Before recovery can begin, the production structure must be painstakingly pieced back together again in a new pattern, because the intertemporal preferences of consumers have changed dramatically due to the redistribution and losses of income and wealth incurred during the inflation. This of course takes time.

At the heart of the problem is the fact that central bank-induced inflation has “wreaked havoc” on prices and consequently on economic calculation:

In addition, the recession-adjustment process is further prolonged by the fact that the boom has wreaked havoc with monetary calculation, the very moorings of the market economy. Entrepreneurs have discovered that their spectacular successes during the boom were merely a prelude to a sudden and profound failure of their forecasts and calculations to be realized. Until they have regained confidence in their forecasting abilities and in the reliability of economic calculation they will be understandably averse to initiating risky ventures even if they appear profitable. But if the market is permitted to work, this entrepreneurial malaise cures itself as the restriction of demand for factors of production drives down wages and other costs of production relative to anticipated product prices. The “natural interest rate,” i.e., the rate of return on investment in the structure of production, thus increases to the point where entrepreneurs are enticed to renew their investment activities and initiate the adjustment process. Success feeds on itself, entrepreneurs’ spirits rise, and the recovery gains momentum.

The market can only cure itself, Salerno explains, if prices are allowed to adjust, including decreases in “wages and other costs of production relative to anticipated product prices.” At the same time, it’s the resulting “steep rise” in real interest rates that draws capitalists and entrepreneurs back into the marketplace:

The rise in the natural interest rate that overcomes the pandemic demoralization among capitalists and entrepreneurs and sparks the recovery is reflected in the credit markets. For recovery to begin again, there needs to be a steep rise in the “real,” or inflation-adjusted, interest rate observed in financial markets. High interest rates do not stifle the recovery but are the sure sign that the readjustment of relative prices required to realign the production structure with economic reality is proceeding apace. The mislabeled “secondary deflation,” whether or not it is accompanied by an incidental monetary contraction, is thus an integral part of the adjustment process. It is the prerequisite for the renewal of entrepreneurial boldness and the restoration of confidence in monetary calculation. Decisions by banks and capitalist-entrepreneurs to temporarily hold rather than lend or invest a portion of accumulated savings in employing the factors of production and the corresponding rise of the loan and natural rates above some estimated “true” time preference rate does not impede but speeds up the recovery. This implies, of course, that any political attempt to arrest or reverse the decline in factor and asset prices through monetary manipulations or fiscal stimulus programs will retard or derail the recession-adjustment process.

New Defenders of Deflation

Citing work by Claudio Borio, head of the Monetary and Economic department at the BIS, listed above by Bagus, The Telegraph, ran a recent story by Szu Ping Chan, “Low Rates Will Trigger Civil Unrest as Central Banks Lose Control,” also highly critical of fear-of-deflation policy committed to 2 percent (or higher) inflation targets. Ms. Chan highlights work by Borio:

A separate paper co-authored by Mr Borio argued that periods of deflation has less economic costs than sustained falls in property prices. Its analysis of 38 economies over a period of more than 100 years showed economies grew by an average of 3.2pc during deflationary periods, compared with 2.7pc when prices were rising.

It said drawing blind comparisons with the 1930s were misguided. “The historical evidence suggests that the Great Depression was the exception rather than the rule,” said Hyun Shin, head of research at the BIS.

Mr. Bagus, Ms. Chan, and Mr. Borio have highlighted for us yet again why it is essential that institutional changes be made that lead to withering away of fiat money and create the possibility for sound money.

John P. Cochran is emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He is also a senior scholar for the Mises Institute and serves on the editorial board of the Quarterly Journal of Austrian Economics. Send him mail. See John P. Cochran’s article archives.

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.

Repeal, Don’t Reform the IMF! – Article by Ron Paul

Repeal, Don’t Reform the IMF! – Article by Ron Paul

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The New Renaissance Hat
Ron Paul
April 5, 2015
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A responsible financial institution would not extend a new loan of between 17 and 40 billion dollars to a borrower already struggling to pay back an existing multi-billion dollar loan. Yet that is just what the International Monetary Fund (IMF) did last month when it extended a new loan to the government of Ukraine. This new loan may not make much economic sense, but propping up the existing Ukrainian government serves the foreign policy agenda of the US government.

Since the IMF receives most of its funding from the United States, it is hardly surprising that it would tailor its actions to advance the US government’s foreign-policy goals. The IMF also has a history of using the funds provided to it by the American taxpayer to prop up dictatorial regimes and support unsound economic policies.

Some may claim the IMF does promote free markets by requiring that countries receiving IMF loans implement some positive economic reforms, such as reducing government spending. However, other conditions imposed by the IMF, such as that the country receiving the loan deflate its currency and implement an industrial policy promoting exports, do not seem designed to promote a true free market, much less improve the people’s living standards by giving them greater economic opportunities.

The problem with the IMF cannot be fixed by changing the conditions attached to IMF loans. The fundamental problem with the IMF is that it is funded by resources taken forcibly from the private sector. By taking resources out of private hands and giving them to IMF bureaucrats, the US federal government distorts the marketplace, harming both American taxpayers and the citizens of the countries receiving the IMF loans. The idea that the IMF is somehow better able to allocate capital than are private investors is just as flawed as every other form of central planning. The IMF must be repealed, not reformed.

The IMF is not the only US institution that manipulates the global economy. Over the past several years, a mysterious buyer, identified only as “Belgium,” so named because the buyer acts through a Belgian-domiciled account, has become the third-largest holder of Treasury securities. Belgium’s large purchases always occur at opportune times for the US government, such as when a foreign country sells a large amount of Treasuries. “Belgium” also made large purchases in the months just after the Fed launched the quantitative easing program. While there is no evidence this buyer is working directly with the US government, the timing of these purchases does raise suspicions.

It is not out of the realm of possibility that the Federal Reserve is involved in these purchases. The limited audit of the Federal Reserve’s actions during the financial crisis that was authorized by the Dodd-Frank Act revealed that the Fed actively intervenes in global markets.

What other deals with foreign governments is the Fed making? Is the Fed, like the IMF, working to bail out Greece and other EU countries? Is the Fed working secretly to aid US foreign policy as it did in the early 1980s, when it financed loans to then-US ally Saddam Hussein? The lack of transparency about the Fed’s dealings with overseas central banks and foreign governments is one more reason why Congress needs to pass the audit the fed bill.

By taking money from American taxpayers to support economically weak and oftentimes corrupt governments, the IMF distorts the market, enriches corrupt governments, and harms both the American taxpayer and the residents of the counties receiving IMF “aid.” It is past time to end the IMF along with all instruments of American interventionist foreign policy.

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.

Why Is the Fed Punishing My Parents? – Article by Shawn Ritenour

Why Is the Fed Punishing My Parents? – Article by Shawn Ritenour

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The New Renaissance Hat
Shawn Ritenour
March 29, 2015
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In September 1993, President Bill Clinton reassured his radio audience that “if you work hard and play by the rules, you’ll be rewarded with a good life for yourself and a better chance for your children.” Picking up that theme over eighteen years later, President Barack Obama affirmed that “Americans who work hard and play by the rules every day deserve a government and a financial system that does the same.” The trouble is neither the government nor the financial system backed by the Federal Reserve rewards people like my parents, who have worked hard and played by the rules their entire lives, only to have their savings wither away.

Instead, Federal Reserve officials and the intelligentsia who support them are continuously working to make their lives more difficult, frightening the masses of what shoppers look for every day — lower prices. Price deflation, the cry, is disastrous for the economy. They worry that lower prices will reduce profits, leading to shutdowns and lay-offs and that lower prices make it harder for people to pay their debts. Sound economic theory and history, however, both indicate that price deflation is nothing the social economy needs to fear. If prices fall because the economy is more productive, this is unambiguously positive. However, if prices fall because people spend less, their desire is for larger real cash balances. Falling prices help them achieve their goal, which precisely is the purpose of economic activity.

Lower prices and wages can make it harder to pay fixed debt. This, however, serves as an excellent incentive to stay out of debt in the first place, as my parents have done as a result of significant sacrifice. Before creating even more money out of thin are to ward off lower overall prices, we should at least consider some of the ethical issues involved.

Many men from my father’s generation are not unlike John Adams who wrote to his wife that he “must study politics and war, that our sons may have liberty to study mathematics and philosophy.” My father embarked for twenty years of hard labor in a meat packing plant providing for his family until he lost his job due to his union pricing him and his fellow workers out of a job. When his plant closed in the mid-1980s, he embarked on a second successful career with my mother operating their own barbecue business for another twenty-plus years. I saw firsthand the challenges they faced trying to keep quality up and costs down, while producing top-drawer barbecue meat and sandwiches for a demand that was always uncertain. I saw the stress on my mother’s face one week in the early days when they netted a mere $15 before taxes. My father indeed “studied” meat packing and barbecue, in part, so I could go to college and become an economist and college professor.

Additionally, Mom and Dad had the foresight and character to make the sacrifices necessary to stay out of debt. Indeed, they are Paul Krugman’s worst nightmare — a family determined not to live beyond their means. Now retired, like many in their generation they are enjoying life the best they can on an almost fixed income. Because they have no debt, they have been able to live without tremendous economic hardship thus far. The Federal Reserve’s inflationism, however, increasingly makes life for them more difficult as steady price inflation daily chips away at their livelihood. Since 2009, for example, the Consumer Price Index has increased over 9 percent. This masks, however, significantly larger price increases for important necessities. Prices of dairy products are up almost 17 percent since 2009. Gasoline prices are up almost 11 percent despite the recent decline. Prices for meat, poultry, fish, and eggs have increased a whopping 26 percent since 2009. Higher overall prices do not help people like my parents at all. They instead act as a thief, snatching wealth away from them in the form of diminished purchasing power. What they long for is to see the value of their savings increase. Far from creating economic hardship for them, lower overall prices would be a boon.

Both sound economics and ethics, therefore, demand that we give up the anti-deflation rhetoric and the inflation it fuels. Charity demands that we cease striking fear into the hearts of the masses, softening them up for ever higher prices. The Federal Reserve should stop punishing people like my parents who have worked hard and played by the rules their whole lives. After all, what did they ever do to Greenspan, Bernanke, and Yellen?

Shawn Ritenour teaches economics at Grove City College and is the author of Foundations of Economics: A Christian View.

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.

Don’t Be Fooled by the Federal Reserve’s Anti-Audit Propaganda – Article by Ron Paul

Don’t Be Fooled by the Federal Reserve’s Anti-Audit Propaganda – Article by Ron Paul

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The New Renaissance Hat
Ron Paul
March 9, 2015
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In recent weeks, the Federal Reserve and its apologists in Congress and the media have launched numerous attacks on the Audit the Fed legislation. These attacks amount to nothing more than distortions about the effects and intent of the audit bill.

Fed apologists continue to claim that the Audit the Fed bill will somehow limit the Federal Reserve’s independence. Yet neither Federal Reserve Chair Janet Yellen nor any other opponent of the audit bill has ever been able to identify any provision of the bill giving Congress power to dictate monetary policy. The only way this argument makes sense is if the simple act of increasing transparency somehow infringes on the Fed’s independence.

This argument is also flawed since the Federal Reserve has never been independent from political pressure. As economists Daniel Smith and Peter Boettke put it in their paper “An Episodic History of Modern Fed Independence,” the Federal Reserve “regularly accommodates debt, succumbs to political pressures, and follows bureaucratic tendencies, compromising the Fed’s operational independence.”

The most infamous example of a Federal Reserve chair bowing to political pressure is the way Federal Reserve Chairman Arthur Burns tailored monetary policy to accommodate President Richard Nixon’s demands for low interest rates. Nixon and Burns were even recorded mocking the idea of Federal Reserve independence.

Nixon is not the only president to pressure a Federal Reserve chair to tailor monetary policy to the president’s political needs. In the fifties, President Dwight Eisenhower pressured Fed Chairman William Martin to either resign or increase the money supply. Martin eventually gave in to Ike’s wishes for cheap money. During the nineties, Alan Greenspan was accused by many political and financial experts — including then-Federal Reserve Board Member Alan Blinder — of tailoring Federal Reserve policies to help President Bill Clinton.

Some Federal Reserve apologists make the contradictory claim that the audit bill is not only dangerous, but it is also unnecessary since the Fed is already audited. It is true that the Federal Reserve is subject to some limited financial audits, but these audits only reveal the amount of assets on the Fed’s balance sheets. The Audit the Fed bill will reveal what was purchased, when it was acquired, and why it was acquired.

Perhaps the real reason the Federal Reserve fears a full audit can be revealed by examining the one-time audit of the Federal Reserve’s response to the financial crisis authorized by the Dodd-Frank law. This audit found that between 2007 and 2010 the Federal Reserve committed over $16 trillion — more than four times the annual budget of the United States — to foreign central banks and politically influential private companies. Can anyone doubt a full audit would show similar instances of the Fed acting to benefit the political and economic elites?

Some fed apologists are claiming that the audit bill is part of a conspiracy to end the Fed. As the author of a book called End the Fed, I find it laughable to suggest that I, and other audit supporters, are hiding our true agenda. Besides, how could an audit advance efforts to end the Fed unless the audit would prove that the American people would be better off without the Fed? And don’t the people have a right to know if they are being harmed by the current monetary system?

For over a century, the Federal Reserve has operated in secrecy, to the benefit of the elites and the detriment of the people. It is time to finally bring transparency to monetary policy by auditing the Federal Reserve.

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.