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Venezuela’s Bizarre System of Exchange Rates – Article by Emiliana Disilvestro & David Howden

Venezuela’s Bizarre System of Exchange Rates – Article by Emiliana Disilvestro & David Howden

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The New Renaissance HatEmiliana Disilvestro & David Howden
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Venezuela is currently going through its worst crisis in history, replete with an endless list of interesting problems. Foremost among these are severe shortages in even the most basic of necessities. Economists have used these shortages as textbook examples to illustrate the pernicious effects of price controls.

Few people, however, are aware that many of the country’s problems are caused by a complex monetary arrangement that makes use of four different exchange rates simultaneously. The result is that Venezuela can either be extremely cheap, or unbearably expensive, depending on the rate used.

Monetary chaos began in 2003 when the late President Hugo Chavez imposed currency controls to stem capital flight after an oil strike. At the time, one US dollar could fetch 1.6 Venezuelan bolivars. Today, barely ten years later, that same dollar can buy 172 bolivars, a devaluation of over 99 percent! Of course, that is in the official (i.e., government regulated) market. On the black market, the exchange rate is currently nearly 900 bolivars to the US dollar. That is, if you can find anyone selling dollars, or more importantly, looking to buy the badly tarnished Venezuelan currency.

This devaluation is in and of itself a large problem, both for consumers who must deal with high degrees of price inflation and for businesses that must undergo long-term capital planning decisions with a constantly moving monetary unit. However, it is the volatility of the exchange rate caused by the government’s continuous changes to currency restrictions and official rates that is proving the most cumbersome problem.

A Very Complex System of Exchange Rates

Currently there are four exchange rates: First is the official one, called CENCOEX, and which charges 6.30 bolivars to the dollar. It is only intended for the importation of food and medicine.

The next two exchange rates are SICAD I (12 bolivars per dollar) and SICAD 2 (50 bolivars per dollar); they assign dollars to enterprises that import all other types of goods. Because of the fact that US dollars are limited, coupons are auctioned only sporadically; usually weekly in the case of SICAD 1 and daily for SICAD 2. However, due to the economic crisis, no dollars have been allocated for these foreign exchange transactions and there hasn’t been an auction since August 18, 2015. As of November 2015, the Venezuelan government held only $16 billion in foreign exchange reserves, the lowest level in over ten years, and an amount that will dry up completely in four years time at the current rate of depletion.

The last and newest exchange rate is the SIMADI, currently at 200 bolivars per dollar. This rate is reserved for the purchase and sale of foreign currency to individuals and businesses.

There are many problems in Venezuela as a result of this complex system. The most obvious is the near impossibility to actually get assigned to these rates due to the complex bureaucratic process one must navigate to apply for them. In response to these difficulties, Venezuelans must rely on the black market to meet their demands for foreign currency. Therefore, people naturally rely on the black market rate, which although it is much less advantageous (at 900 vs. anywhere from 6.3 to 200 bolivars per dollar on the “official” market), at least offers the possibility to procure the much needed foreign exchange.

Corruption, which is a main characteristic of Venezuela’s political regime, is another problem derived from this complex monetary system. Officials within the government and those connected to it have taken advantage of their positions of power and influence to mismanage the money assigned for other, productive and necessary, institutions. Thus, well-connected individuals obtain US dollars through the legal channels and then sell them on the black market at a higher price. (This activity is one of the only ways to consistently earn high levels of profits in the beleaguered Venezuelan economy, and is only available to those privileged few who are connected to the proper government officials.)

This point is especially important when studying the vast array of shortages. The embezzlement of foreign currency intended for importing basic goods, e.g., foreign exchange reserved for the CENCOEX and SICAD exchange rates, leave legitimate businessmen with no options to obtain legally the necessary currencies to import goods. Owing to the rapidly depreciating bolivar, US dollars are hoarded as a means of savings, thus further exacerbating the foreign exchange shortage for importers. As a consequence, imports are unable to be paid for, leading to shortages on top of those already caused by extensive and damaging price controls.

The Poor Suffer the Most

These problems affect directly all citizens, but are especially pernicious to lower-income individuals. Many suppliers will only sell what few goods they have for US dollars, eschewing accepting bolivars in the payment of their wares. Black market currency sellers set up shop outside supermarkets to accommodate this phenomenon, but it must be noted that only the upper-middle and higher income earners are able to afford to pay the black market rate. The result is that the lower-income segment of Venezuelan society, those who price and currency controls are supposedly helping, are not able to obtain the currency necessary to buy simple goods and services (and the wealthy can only do so at a high price).

Although the business community demands to be paid in US dollars this harms lower-income individuals unduly and is a completely rational response. If businesses kept selling their scarce supply of goods at the official rate their shelves would deplete faster than they already do. Venezuelans earn income at the official rate of 6.30 bolivars to the US dollar while businesses must pay a much higher rate in order to import goods. This difference must be accounted for by stores asking for prices commensurate with what they must pay to stock their shelves.

The complex exchange rate system in Venezuela is not only a good example of unnecessary government meddling in the economy, but also explains why a corrupt political regime has been able to retain power for so long despite more than a decade of hardship imposed on the country. The use of several exchange rates has made it easy for the Chávez and Maduro governments and their followers to make enormous profits by embezzling the money assigned to the business community and individuals. By doing so, they have completely devalued the bolivar and impoverished what was once one of the richest countries in the world.

Emiliana Disilvestro studies international business at Saint Louis University at its Madrid campus.

David Howden is Chair of the Department of Business and Economics and professor of economics at St. Louis University’s Madrid Campus, and Academic Vice President of the Ludwig von Mises Institute of Canada.

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 Capitalists Are Repeatedly “Fooled” By Business Cycles – Article by Frank Shostak

Why Capitalists Are Repeatedly “Fooled” By Business Cycles – Article by Frank Shostak

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The New Renaissance Hat
Frank Shostak
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According to the Austrian business cycle theory (ABCT) the artificial lowering of interest rates by the central bank leads to a misallocation of resources because businesses undertake various capital projects that — prior to the lowering of interest rates —weren’t considered as viable. This misallocation of resources is commonly described as an economic boom.

As a rule, businessmen discover their error once the central bank — which was instrumental in the artificial lowering of interest rates — reverses its stance, which in turn brings to a halt capital expansion and an ensuing economic bust.

From the ABCT one can infer that the artificial lowering of interest rates sets a trap for businessmen by luring them into unsustainable business activities that are only exposed once the central bank tightens its interest-rate stance.

Critics of the ABCT maintain that there is no reason why businessmen should fall prey again and again to an artificial lowering of interest rates.

Businessmen are likely to learn from experience, the critics argue, and not fall into the trap produced by an artificial lowering of interest rates.

Correct expectations will undo or neutralize the whole process of the boom-bust cycle that is set in motion by the artificial lowering of interest rates.

Hence, it is held, the ABCT is not a serious contender in the explanation of modern business cycle phenomena. According to a prominent critic of the ABCT, Gordon Tullock,

One would think that business people might be misled in the first couple of runs of the Rothbard cycle and not anticipate that the low interest rate will later be raised. That they would continue to be unable to figure this out, however, seems unlikely. Normally, Rothbard and other Austrians argue that entrepreneurs are well informed and make correct judgments. At the very least, one would assume that a well-informed businessperson interested in important matters concerned with the business would read Mises and Rothbard and, hence, anticipate the government action.

Even Mises himself had conceded that it is possible that some time in the future businessmen will stop responding to loose monetary policy thereby preventing the setting in motion of the boom-bust cycle. In his reply to Lachmann (Economica, August 1943) Mises wrote,

It may be that businessmen will in the future react to credit expansion in another manner than they did in the past. It may be that they will avoid using for an expansion of their operations the easy money available, because they will keep in mind the inevitable end of the boom. Some signs forebode such a change. But it is too early to make a positive statement.

Do Expectations Matter?
According to the critics then, if businessmen were to anticipate that the artificial lowering of interest rates is likely to be followed some time in the future by a tighter interest-rate stance, their conduct in response to this anticipation will neutralize the occurrence of the boom-bust cycle phenomenon. But is it true that businessmen are likely to act on correct expectations as critics are suggesting?

Furthermore, the key to business cycles is not just businessmen’s conduct but also the conduct of consumers in response to the artificial lowering of interest rates — after all, businessmen adjust their activities in accordance with expected consumer demand. So on this ground one could generalize and suggest that correct expectations by people in an economy should prevent the boom-bust cycle phenomenon. But would it?

For instance, if an individual John, as a result of a loose central bank stance, could lower his interest rate payment on his mortgage why would he refuse to do that even if he knows that a lower interest rate leads to boom-bust cycles?

As an individual the only concern John has is his own well-being. By paying less interest on his existent debt John’s means have now expanded. He can now afford various ends that previously he couldn’t undertake.

As a result of the central bank’s easy stance the demand for John’s goods and services and other mortgage holders has risen. (Again it must be realized that all this couldn’t have taken place without the support from the central bank, which accommodates the lower interest-rate stance.)

Now, the job of a businessman is to cater to consumers’ future requirements. So whenever he observes a lowering in interest rates he knows that this most likely will provide a boost to the demand for various goods and services in the months ahead.

Hence if he wants to make a profit he would have to make the necessary arrangements to meet the future demand.

For instance, if a builder refuses to act on the likely increase in the demand for houses because he believes that this is on account of the loose monetary policy of the central bank and cannot be sustainable, then he will be out of business very quickly.

To be in the building business means that he must be in tune with the demand for housing. Likewise any other businessman in a given field will have to respond to the likely changes in demand in the area of his involvement if he wants to stay in business.

A businessman has only two options — either to be in a particular business or not to be there at all. Once he has decided to be in a given business this means that the businessman is likely to cater for changes in the demand for goods and services in this particular business irrespective of the underlying causes behind changes in demand.

Failing to do so will put him out of business very quickly. Now, regardless of expectations once the central bank tightens its stance most businessmen will “get caught.” A tighter stance will undermine demand for goods and services and this will put pressure on various business activities that sprang up while the interest-rate stance was loose. An economic bust emerges.

We can conclude that correct expectations cannot prevent boom-bust cycles once the central bank has eased its interest-rate stance. The only way to stop the menace of boom-bust cycles is for the central bank to stop the tampering with financial markets. As a rule however, central banks respond to the bust by again loosening their stance and thereby starting the new boom-bust cycle phase.

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.

No, “Big Data” Can’t Predict the Future – Article by Per Bylund

No, “Big Data” Can’t Predict the Future – Article by Per Bylund

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The New Renaissance HatPer Bylund
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With Google’s dominance in the online search engine market we entered the Age of Free. Indeed, services offered online are nowadays expected to be offered at no cost. Which, of course, does not mean that there is no cost to it, only that the consumer doesn’t pay it. Early attempts financed the services with ads, but we soon saw a move toward making the consumer the product. Today, free and unfree services alike compete for “users” and then make money off the data they collect.

Data has always been used, but what’s new for our time is the very low (or even zero) marginal cost for collecting and analyzing huge amounts of data. The concept of “Big Data” is taking over and is predicted to be “the future” of business.

There’s a problem here, and it is the over-reliance on the Law of Large Numbers in social forecasting. Statistical probabilities for events may mathematically converge to the mean, but is it applicable in the real world? The answer is most definitely yes in the natural sciences. Repeated controlled experiments will weed out erroneous explanations or causes to phenomena, at least assuming we’re good enough at separating and controlling those causes.

What about the social sciences? In this age of scientism, as Hayek called it, we’re told “Big Data” will completely transform production, logistics, and sales. The reason for this is that vendors can better target customers and even foresee what they might want next. Amazon.com does this on their web site in crude form, where they make suggestions based on your purchase history and what others with similar purchase histories have searched for. Sometimes it works, and sometimes it doesn’t.

There is some regularity to our interests and behavior. All of us are, after all, human beings — and we’re formed in certain cultures. So one American with interests x, y, and z may have other interests similar to another American who also has an interest in x, y, and z.

Human Behavior Is Unpredictable
But similarity is not the same thing as prediction. Amazon.com’s suggestions or the highly annoying ads following you around web sites are useful methods for sellers because they can somewhat accurately identify what not to offer. Exclusion of very low-probability interests increases the probability for suggesting something that the person behind the eyeballs focusing on the computer screen may be interested in.

To use as prediction, however, exclusion of almost-zero probability events is far from sufficient. Indeed, prediction requires that we are able to accurately exclude all but one or a couple highly probable outcomes. And we have to be able to rely on that these predictions turn out to be true. Otherwise we’re just playing games, and so we’re making guesses. Sure, they’re educated guesses (because we’ve excluded the impossible and almost-impossible), but they’re still games and guesses.

Where Big Data Fails
Speaking of guesses, Microsoft’s Bing search engine, which powers the Windows digital assistant Cortana among other things, has produced a prediction engine with the purpose of predicting sports and other results. They rely on very advanced algorithms and huge amounts of collected data.

Amazingly, they did very well initially and predicted the outcomes of the World Cup perfectly. So maybe we can use Big Data to get a glimpse of the future?

No, not so. The Bing teams are learning a lesson only Austrians and, more specifically, Misesian praxeologists, seem to be alone in grasping: that there are no constants in human action, and therefore that predictions of social phenomena are impossible. Pattern predictions, as Hayek called them, may not be impossible, but predictions of exact magnitudes are. For instance, we can rely on economic law (such as “demand curves slope downward”) to estimate an outcome such as “the price will be lower than it otherwise would have been,” but we can’t say exactly what that price will be.

When it comes to sports, reality shows and other competitions between individuals or teams, the story is exactly the same. The team with a better track record doesn’t always win. Why? They have objectively performed better than the other team, perhaps exclusively so, but this doesn’t say anything about the future. We’re not here referring to the philosophical doubt as in “will the sun shine tomorrow?” (maybe something changes completely the sun’s ability to shine during the night).

The Social Sciences Are Different
In the social sciences we’re dealing with complex phenomena. Action and, especially, its outcome is the result of a complex system of social interaction, psychology, and much more. Are the players in both teams as motivated and focused as they were before? Did anything in their personal lives affect their mindsets or psyches? How do the players within their teams and players in other teams react on each other before and during the game? A team with a poor track record can upset a team with an objectively better track record; this happens all the time. Sometimes for the sole reason that the better team underestimates the worse team, or because the underdog feels no pressure to perform and therefore plays less defensively.

Bing’s prediction engine struggles with this, just as we would predict. As Windows Central reported recently, the prediction engine had its “worst week yet” picking only four of fourteen winners in the NFL. Overall, its track record was approximately two-thirds right and one-third wrong (95–53). It’s definitely better than tossing a coin, but pretty far from actually predicting the results.

In other words, if you’re placing bets you may want to use the Bing prediction engine. That is, unless you have the type of tacit, implicit understanding of what’s going on that the engine is missing. Maybe you can beat it, or maybe not. In either case, you cannot count on coming out a victor each and every time.

The reason for this is that the outcome simply cannot be predicted perfectly — or even close to it. Even the players themselves cannot predict who’ll win a game, but they may have inside information about whether their own team seems motivated and focused. It is not a perfect method, however, and it certainly cannot be scientific.

Even with Big Data there’s no predicting of social events — there’s only guessing. Yes, guessing with access to huge amounts of data is easier, at least if the data is reliable and relevant. But a good guess is not the same thing as a prediction; it is still a guess, and it can be wrong. Winning every time requires luck.

Per L. Bylund, PhD, is Assistant Professor of Entrepreneurship and Records-Johnston Professor of Free Enterprise in the School of Entrepreneurship at Oklahoma State University. Visit his website at PerBylund.com.

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.

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

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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.

The Fed Desperately Tries to Maintain the Status Quo – Article by Ronald-Peter Stöferle

The Fed Desperately Tries to Maintain the Status Quo – Article by Ronald-Peter Stöferle

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The New Renaissance HatRonald-Peter Stöferle
November 5, 2015
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During the press conferences of recent FOMC meetings, millions of well-educated investment professionals have been sitting in front of their screens, chewing their fingernails, listening as if spellbound to what Janet Yellen has to tell them. Will she finally raise the federal funds rate that has been zero bound for over six years?

Obviously, each decision is accompanied by nervousness on the markets. Investors are fixated by a fidgety curiosity ahead of each Fed decision and never fail to meticulously observe Janet Yellen and the FOMC, and engage in monetary ornithology on doves (growth- and employment-oriented FOMC members) and hawks (inflation-oriented FOMC members).

Fed watchers also hope for some enlightening information from Ben Bernanke. According to Reuters, some market participants paid some $250,000 just to join one of several dinners, where the ex-chairman spilled the beans. Apparently, he does not expect the federal funds rate to return to its long-term average of about 4 percent during his lifetime.

In a conversation with Jim Rickards, Bernanke stated that a rate hike would only be possible in an environment in which “the U.S. economy is growing strongly enough to bear the costs of higher rates.” Moreover, a rate increase would have to be clearly communicated and anticipated by the markets — not to protect individual investors from losses, Bernanke assures us, but rather to prevent jeopardizing the stability of the “system as a whole.”

It is axiomatic that zero-interest-rate-policy (ZIRP) cannot be a permanent fixture. Indeed, Janet Yellen has been going on about increasing rates for almost two years now. But, how much more lead time will it require to “prepare” the markets? In both September and October the FOMC chickened out, even though we are not talking about hiking the rate back to “monetary normalcy” in one blow. The decision on the table is whether or not to increase the rate by a trifling quarter point!

The Fed’s quandary can be understood a little better by examining what “monetary normalcy,” or a “normal interest rate,” is supposed to be. Or, even more fundamentally: what is an interest rate?

We “Austrians” understand an interest rate as an expression of market participants’ time preference. The underlying assumption is that people are inclined to consume a certain product sooner rather than later. Hence, if savers restrict their current consumption and provide the resources for investment instead, they do so only on condition that they will be compensated by increased opportunities for consumption in the future. In free markets, the interest rate can be regarded as a measure of the compensation payment, where people are willing to trade present goods for future goods. Such an interest rate is commonly referred to as the “natural interest rate.” Consequently, the FOMC bureaucrats would ideally set as a goal a “normal interest rate” that equals the “natural” one.This, however, remains unlikely.

Six Years of “Unconventional” Monetary Policy
ZIRP was introduced six years ago in response to the financial crisis, and three QE programs have been conducted. This so-called “unconventional monetary policy” is supposed to be abandoned as soon as the economy has gathered pace. Despite the tremendous magnitude of these market interventions, the momentum in the US economy is rather lame. Weak Q1 data, which probably resulted from a weak trade balance due to a 15 percent rise of the US dollar, shocked even the most pessimistic of analysts; the OECD and the IMF have revised down their 2015 growth estimates. A long-lasting, self-sustaining growth is out of the question. This confirms the assumption that ZIRP fuels everything under the sun — see “The Unseen Consequences of Zero-Interest-Rate Policy” — except long-term productive investment.And what about unemployment and inflation that are key elements of the Fed’s mandate? The conventional unemployment rate (U3) has returned to its long-run normal level, so the view prevails that things are developing well. However, those figures conceal a workforce participation rate that has fallen by more than 3 percent since 2008, indicating that some 2.5 million Americans are currently no longer actively looking for a new job. However, should the economic situation improve, they would likely rejoin the labor force. Furthermore, the proportion of those only working part-time due to a lack of full-time positions is much higher now than before the crisis. “True” unemployment currently stands rather at about 7.25 percent.

A Weak Economy and Weak Inflation
With regard to inflation, the Fed’s target is 2 percent, as measured by growth of the PCE-index. This aims to buffer the fiat money system against the threat of price deflation. In a deflationary environment, it is believed, the debt-servicing capacity of market participants (e.g., governments, private enterprises, financial institutions, and private households) would come under intense pressure and likely trigger a chain reaction in which loans collapse and the monetary system implodes.

In many countries, and among them the US, inflation is remarkably low — partly due to transitory effects of lower energy and import prices — while low interest rates have merely weaved their way to asset price inflation so far. But, as price reactions to monetary policy maneuvers may occur with a lag of a few years, we should expect that sooner or later inflation will also spill over to normal markets.

As a response to anything short of massive improvement of economic and employment data, a rate hike is scarcely likely, and inflation in the short-term is also unlikely. Moreover, the current composition of the FOMC — which is extremely dovish — implies inflation-sensitive voices are relatively underrepresented. This gives rise to the suspicion that rate hikes are not very likely at all in the scenario in the short-term.

What Will the Fed Do If There’s Real Economic Trouble?
One is concerned about economic development, which has a shaky foundation and headwinds from other parts of the world; it appears that growth has cooled down substantially in the BRICS countries. Meanwhile, China might be on the brink of a severe recession. (Indeed, China was possibly the most decisive factor to nudge the Fed away from raising rates in September and October.) This implies that world-wide interest rates will remain at very low levels and a significant rate hike in the US would represent a sharp deviation in this environment, bringing with it massive competitive disadvantages.

The markets are noticeably pricing out a significant rate hike. The production structure has long since adapted to ZIRP and “short-term gambling, punting on momentum-driven moves, on levered buybacks” are further lifting the opportunity costs of abandoning it. In order to try to rescue its credibility, the Fed may decide to try some timid, quarter-point increases.

But what will they do if markets really crash? Indeed, they are terrified of the avalanche that they might trigger. If there are any symptoms that portend calamity, the Fed will inevitably return to ZIRP, launch a QE4, or might even introduce negative interest rates. Hence, there does not seem to be a considerable degree of latitude such that a return to conventional monetary policy could seriously be expected.

“The Fed is raising rates!” — This has become a running gag.

Ronald-Peter Stöferle is a Chartered Market Technician (CMT) and a Certified Financial Technician (CFTe). During his studies in business administration and finance at the Vienna University of Economics and the University of Illinois at Urbana-Champaign, he worked for Raiffeisen Zentralbank (RZB) in the field of Fixed Income/Credit Investments. In 2006 he began writing reports on gold. His six benchmark reports called “In GOLD we TRUST” drew international coverage on CNBC, Bloomberg, the Wall Street Journal, The Economist and the Financial Times. He was awarded “2nd most accurate gold analyst” by Bloomberg in 2011.

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.

Today’s War Against Deflation Will Make Us Poorer – Article by Frank Shostak

Today’s War Against Deflation Will Make Us Poorer – Article by Frank Shostak

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The New Renaissance HatFrank Shostak
October 29, 2015
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The yearly growth rate of the US consumer price index (CPI) fell to 0 percent in September 2015, from 0.2 percent in August and, 1.7 percent in September last year.

The yearly growth rate of the European Monetary Union CPI fell to minus 0.1 percent in September from 0.1 percent in the previous month and 0.3 percent in September last year.
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Also, the growth momentum of the UK CPI fell into the negative in September with the yearly growth rate closing at minus 0.1 percent from 0 percent in August and 1.2 percent in September last year.

The growth momentum of China’s CPI eased in September with the yearly growth rate falling to 1.6 percent from 2 percent in August.

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Deflation Fears Gain Steam
Consequently, many experts are expressing concern regarding the declining growth momentum of the CPI and are of the view that rather than tightening the monetary stance, central banks should loosen their stance further in order to counter the emergence of deflation, which is regarded as a major threat to economic well-being of individuals. For most experts, deflation is bad news since it generates expectations of a decline in prices. As a result, they believe, consumers are likely to postpone their buying of goods at present since they expect to buy these goods at lower prices in the future. This weakens the overall flow of spending and in turn weakens the economy. Hence, such commentators believe that policies that counter deflation will also counter the slump.
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Will Reversing Deflation Prevent a Slump?

If deflation leads to an economic slump, then policies that reverse deflation should be good for the economy, so it is held.

Reversing deflation will simply involve introducing policies that support general increases in the prices of goods, i.e., price inflation. With this way of thinking inflation could actually be an agent of economic growth.

According to most experts, a little bit of inflation can actually be a good thing. Mainstream economists believe that inflation of 2 percent is not harmful to economic growth, but that inflation of 10 percent could be bad for the economy.

There’s good reason to believe, however, that at a rate of inflation of 10 percent, it is likely that consumers are going to form rising inflation expectations.

According to popular thinking, in response to a high rate of inflation, consumers will speed up their expenditures on goods at present, which should boost economic growth. So why then is a rate of inflation of 10 percent or higher regarded by experts as a bad thing?

Clearly there is a problem with the popular way of thinking.

Price Inflation vs. Money-Supply Inflation
Inflation is not about general increases in prices as such, but about the increase in the money supply. As a rule the increase in the money supply sets in motion general increases in prices. This, however, need not always be the case.

The price of a good is the amount of money asked per unit of it. For a constant amount of money and an expanding quantity of goods, prices will actually fall.

Prices will also fall when the rate of increase in the supply of goods exceeds the rate of increase in the money supply.

For instance, if the money supply increases by 5 percent and the quantity of goods increases by 10 percent, prices will fall by 5 percent.

A fall in prices cannot conceal the fact that we have inflation of 5 percent here on account of the increase in the money supply.

The Problem Is Really Wealth Formation, not Rising Prices
The reason why inflation is bad news is not because of increases in prices as such, but because of the damage inflation inflicts to the wealth-formation process. Here is why:

The chief role of money is the medium of exchange. Money enables us to exchange something we have for something we want.

Before an exchange can take place, an individual must have something useful that he can exchange for money. Once he secures the money, he can then exchange it for the good he wants.

But now consider a situation in which the money is created “out of thin air,” increasing the money supply.

This new money is no different from counterfeit money. The counterfeiter exchanges the printed money for goods without producing anything useful.

He in fact exchanges nothing for something. He takes from the pool of real goods without making any contribution to the pool.

The economic effect of money that was created out of thin air is exactly the same as that of counterfeit money — it impoverishes wealth generators.

The money created out of thin air diverts real wealth toward the holders of new money. This weakens the wealth generators’ ability to generate wealth and this in turn leads to a weakening in economic growth.

Note that as a result of the increase in the money supply what we have here is more money per unit of goods, and thus, higher prices.

What matters however is not that price rises, but the increase in the money supply that sets in motion the exchange of nothing for something, or “the counterfeit effect.”

The exchange of nothing for something, as we have seen, weakens the process of real wealth formation. Therefore, anything that promotes increases in the money supply can only make things much worse.

Why Falling Prices Are Good
Since changes in prices are just a symptom, as it were — and not the primary causative factor — obviously countering a falling growth momentum of the CPI by means of loose a monetary policy (i.e., by creating inflation) is bad news for the process of wealth generation, and hence for the economy.

In order to maintain their lives and well-being, individuals must buy goods and services in the present. So from this perspective a fall in prices cannot be bad for the economy.

Furthermore, if a fall in the growth momentum of prices emerges on the back of the collapse of bubble activities in response to a softer monetary growth then this should be seen as good news. The less non-productive bubble activities that are around the better it is for the wealth generators and hence for the overall pool of real wealth.

Likewise, if a fall in the growth momentum of the CPI emerges on account of the expansion in real wealth for a given stock of money, this is obviously great news since many more people could now benefit from the expanding pool of real wealth.

We can thus conclude that contrary to the popular view, a fall in the growth momentum of prices is always good news for the wealth generating process and hence for the economy.

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.

The Fed Can’t Raise Rates, But Must Pretend It Will – Article by Thorsten Polleit

The Fed Can’t Raise Rates, But Must Pretend It Will – Article by Thorsten Polleit

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The New Renaissance HatThorsten Polleit
October 26, 2015
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Waiting for Godot is a play written by the Irish novelist Samuel B. Beckett in the late 1940s in which two characters, Vladimir and Estragon, keep waiting endlessly and in vain for the coming of someone named Godot. The storyline bears some resemblance to the Federal Reserve’s talk about raising interest rates.

Since spring 2013, the Fed has been playing with the idea of raising rates, which it had suppressed to basically zero percent in December 2008. So far, however, it has not taken any action. Upon closer inspection, the reason is obvious. With its policy of extremely low interest rates, the Fed is fueling an artificial economic expansion and inflating asset prices.

Selected US Interest Rates in Percent
Selected US Interest Rates in Percent

Raising short-term rates would be like taking away the punch bowl just as the party gets going. As rates rise, the economy’s production and employment structure couldn’t be upheld. Neither could inflated bond, equity, and housing prices. If the economy slows down, let alone falls back into recession, the Fed’s fiat money pipe dream would run into serious trouble.

This is the reason why the Fed would like to keep rates at the current suppressed levels. A delicate obstacle to such a policy remains, though: If savers and investors expect that interest rates will remain at rock bottom forever, they would presumably turn their backs on the credit market. The ensuing decline in the supply of credit would spell trouble for the fiat money system.

To prevent this from happening, the Fed must achieve two things. First, it needs to uphold the expectation in financial markets that current low interest rates will be increased again at some point in the future. If savers and investors buy this story, they will hold onto their bank deposits, money market funds, bonds, and other fixed income products despite minuscule yields.

Second, the Fed must succeed in continuing to postpone rate hikes into the future without breaking peoples’ expectation that rates will rise at some point. It has to send out the message that rates will be increased at, say, the forthcoming FOMC meeting. But, as the meeting approaches, the Fed would have to repeat its trickery, pushing the possible date for a rate hike still further out.

If the Fed gets away with this “Waiting for Godot” strategy, savings will keep flowing into credit markets. Borrowers can refinance their maturing debt with new loans and also increase total borrowing at suppressed interest rates. The economy’s debt load can continue to build up, with the day of reckoning being postponed for yet again.

However, there is the famous saying: “You can fool all the people some of the time and some of the people all the time, but you cannot fool all the people all the time.” What if savers and investors eventually become aware that the Fed will not bring interest rates back to “normal” but keep them at basically zero, or even push them into negative territory?

If a rush for the credit market exit would set in, it would be upon the Fed to fill debtors’ funding gap in order to prevent the fiat system from collapsing. The central bank would have to monetize outstanding and newly originated debt on a grand scale, sending downward the purchasing power of the US dollar — and with it many other fiat currencies around the world.

The “Waiting for Godot” strategy does not rule out that the Fed might, at some stage, nudge upward short-term borrowing costs. However, any rate action should be minor and rather short-lived (like they were in Japan), and it wouldn’t bring interest rates back to “normal.” The underlying logic of the fiat money system simply wouldn’t admit it.

Selected Japanese Interest Rates in Percent
Selected Japanese Interest Rates in Percent

The Fed — and basically all central banks around the world — are unlikely to accept deflation clearing out the debt, which would topple the economic and political structures built upon it. Fending off an approaching recession-depression with more credit-created fiat money and extremely low, perhaps even negative, interest rates is what one can expect them to do.

Murray N. Rothbard put it succinctly: “We can look forward … not precisely to a 1929-type depression, but to an inflationary depression of massive proportions.”

Dr. Thorsten Polleit is the Chief Economist of Degussa (www.degussa-goldhandel.de) and Honorary Professor at the University of Bayreuth. He is the winner of the O.P. Alford III Prize in Political Economy and has been published in the Austrian Journal of Economics. His personal website is www.thorsten-polleit.com.

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.

Keeping the Bubble-Boom Going – Article by Thorsten Polleit

Keeping the Bubble-Boom Going – Article by Thorsten Polleit

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The New Renaissance HatThorsten Polleit
August 19, 2015

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The US Federal Reserve is playing with the idea of raising interest rates, possibly as early as September this year. After a six-year period of virtually zero interest rates, a ramping up of borrowing costs will certainly have tremendous consequences. It will be like taking away the punch bowl on which all the party fun rests.

Low Central Bank Rates have been Fueling Asset Price Inflation

The current situation has, of course, a history to it. Around the middle of the 1990s, the Fed’s easy monetary policy — that of Chairman Alan Greenspan — ushered in the “New Economy” boom. Generous credit and money expansion resulted in a pumping up of asset prices, in particular stock prices and their valuations.

US Federal Funds Rate in Percent and the S&P 500 Stock Market Index

A Brief History of Low Interest Rates

When this boom-bubble burst, the Fed slashed rates from 6.5 percent in January 2001 to 1 percent in June 2003. It held borrowing costs at this level until June 2004. This easy Fed policy not only halted the slowdown in bank credit and money expansion, it sowed the seeds for an unprecedented credit boom which took off as early as the middle of 2002.

When the Fed had put on the brakes by having pushed rates back up to 5.25 percent in June 2006, the credit boom was pretty much doomed. The ensuing bust grew into the most severe financial and economic meltdown seen since the late 1920s and early 1930s. It affected not only in the US, but the world economy on a grand scale.

Thanks to Austrian-school insights, we can know the real source of all this trouble. The root cause is central banks’ producing fake money out of thin air. This induces, and necessarily so, a recurrence of boom and bust, bringing great misery for many people and businesses and eventually ruining the monetary and economic system.

Central banks — in cooperation with commercial banks — create additional money through credit expansion, thereby artificially lowering the market interest rates to below the level that would prevail if there was no credit and money expansion “out of thin air.”

Such a boom will end in a bust if and when credit and money expansion dries up and interest rates go up. In For A New Liberty (1973), Murray N. Rothbard put this insight succinctly:

Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance by repeated and accelerating doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop or sharply slow down, either because the banks are getting shaky or because the public is getting restive at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, the piper must be paid, and the inevitable readjustments must liquidate the unsound over-investments of the boom and redirect the economy more toward consumer goods production. And, of course, the longer the boom is kept going, the greater the malinvestments that must be liquidated, and the more harrowing the readjustments that must be made.

To keep the credit-induced boom going, more credit and more money, provided at ever lower interest rates, are required. Somehow central bankers around the world seem to know this economic insight, as their policies have been desperately trying to encourage additional bank lending and money creation.

Why Raise Rates Now?

Why, then, do the decision makers at the Fed want to increase rates? Perhaps some think that a policy of de facto zero rates is no longer warranted, as the US economy is showing signs of returning to positive and sustainable growth, which the official statistics seem to suggest.

Others might fear that credit market investors will jump ship once they convince themselves that US interest rates will stay at rock bottom forever. Such an expectation could deal a heavy, if not deadly, blow to credit markets, making the unbacked paper money system come crashing down.

In any case, if Fed members follow up their words with deeds, they might soon learn that the ghosts they have been calling will indeed appear — and possibly won’t go away. For instance, higher US rates will suck in capital from around the word, pulling the rug out from under many emerging and developed markets.

What is more, credit and liquidity conditions around the world will tighten, giving credit-hungry governments, corporate banks, and consumers a painful awakening after having been surfing the wave of easy credit for quite some time.

China, which devalued the renminbi exchange rate against the US dollar by a total of 3.5 percent on August 11 and 12, seems to have sent the message that it doesn’t want to follow the Fed’s policy — and has by its devaluation made the Fed’s hiking plan appear as an extravagant undertaking.

A normalization of interest rates, after years of excessively low interest rates, is not possible without a likely crash in production and employment. If the Fed goes ahead with its plan to raise rates, times will get tough in the world’s economic and financial system.

To be on the safe side: It would be the right thing to do. The sooner the artificial boom comes to an end, the sooner the recession-depression sets in, which is the inevitable process of adjusting the economy and allowing an economically sound recovery to begin.

Dr. Thorsten Polleit is the Chief Economist of Degussa (www.degussa-goldhandel.de) and Honorary Professor at the University of Bayreuth. He is the winner of the O.P. Alford III Prize in Political Economy and has been published in the Austrian Journal of Economics. His personal website is www.thorsten-polleit.com.

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.

Central Banks and Our Dysfunctional Gold Markets – Article by Marcia Christoff-Kurapovna

Central Banks and Our Dysfunctional Gold Markets – Article by Marcia Christoff-Kurapovna

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The New Renaissance Hat
Marcia Christoff-Kurapovna
July 23, 2015
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Many investors still view gold as a safe-haven investment, but there remains much confusion regarding the extent to which the gold market is vulnerable to manipulation through short-term rigged market trades, and long-arm central bank interventions. First, much of the gold that is being sold as shares, in certificates, or for physical hoarding in dubious “vaults” just isn’t there. Second, paper gold can be printed into infinity just like regular currency. Third, new electronic gold pricing — replacing, as of this past February, the traditional five-bank phone-call of the London Gold Fix in place since 1919 — has not necessarily proved a more trustworthy model. Fourth, there looms the specter of the central bank, particularly in the form of volume trading discounts that commodity exchanges offer them.

The Complex World of Gold Investments

The question of rigging has been brought to media attention in the past few months when ten banks came under investigation by the US Commodity Futures Trading Commission (CFTC) and the US Department of Justice in price-manipulation probes. Also around that time, the Swiss regulator FINMA settled a currency manipulation case in which UBS was accused of trading ahead of silver-fix orders. Then, the UK Financial Conduct Authority, which regulates derivatives, ordered Barclays to pay close to $45 million in fines against a trader who artificially suppressed the price of gold in 2012 to avoid payouts to clients. Such manipulations are not limited to the precious-metals market: in November of last year, major banks had to pay several billion dollars in fines related to the rigging of foreign-exchange benchmarks, including LIBOR and other interest-rate benchmarks.These cases followed on the heels of a set of lawsuits in May 2014 filed in New York City in which twenty-five plaintiffs consisting of hedge funds, private citizens, and public investors (such as pension funds) sued HSBC, Barclays, Deutsche Bank, Bank Scotia, and Société Génerale (the five traditional banks of the former London Gold Fix) on charges of rigging the precious-metals and foreign-exchange markets. “A lot of conspiracy theories have turned out to be conspiracy fact,” said Kevin Maher, a former gold trader in New York who filed one of the lawsuits that May, told The New York Times.

Central Banks at the Center of Gold Markets

The lawsuits were given more prominence with the introduction of the London Bullion Market Association (LBMA) on February 20, 2015. The new price-fixing body was established with seven banks: Goldman Sachs, J.P. Morgan, UBS, HSBC, Barclays, Bank Scotia and Société Génerale. (On June 16, the Bank of China announced, after months of speculation, that it would join.)While some economists have deemed the new electronic fix a good move in contrast to behind-closed-door, phoned-in price-fixing, others beg to differ. Last year, the commodities exchange CME Group came under scrutiny for allowing volume trading discounts to central banks, raising the question of how “open” electronic pricing really is. Then, too, the LBMA is itself not a commodities exchange but an Over-The-Counter (OTC) market, and does not publish — does not have to publish — comprehensive data as to the amount of metal that is traded in the London market.According to Ms. Ruth Crowell, the chairman of LBMA, writing in a report to that group: “Post-trade reporting is the material barrier preventing greater transparency on the bullion market.” In the same report, Crowell states: “It is worth noting that the role of the central banks in the bullion market may preclude ‘total’ transparency, at least at the public level.” To its credit, the secretive London Gold Fix (1919–2015) featured on its website tracking data of the daily net volume of bars traded and the history of gold trades, unlike current available information from the LBMA as one may see here (please scroll down for charts).

The Problem with Paper Gold

There is further the problem of what is being sold as “paper” gold. At first glance, that option seems a good one. Gold exchange-traded funds (ETFs), registered with The New York Stock Exchange, have done very well over the past decade and many cite this as proof that paper gold, rather than bars in hand, is just as sure an investment. The dollar price of gold rose more than 15.4 percent a year between 1999 and December 2012 and during that time, gold ETFs generated an annual return of 14 percent (while equities registered a loss).As paper claims on trusts that hold gold in bank vaults, ETFs are for many, preferable to physical gold. Gold coins, for instance, can be easily faked, will lose value when scratched, and dealers take high premiums on their sale. The assaying of gold bars, meanwhile, with transport and delivery costs, is easy for banking institutions to handle, but less so for individuals. Many see them as trustworthy: ETF Securities, for example, one of the largest operators of commodity ETFs with $21 billion in assets, stores their gold in Zurich, rather than in London or Toronto. These last two cities, according to one official from that company, “could not be trusted not to go along with a confiscation order like that by Roosevelt in 1933.”Furthermore, shares in these entities represent only an indirect claim on a pile of gold. “Unless you are a big brokerage firm,” writes economist William Baldwin, “you cannot take shares to a teller and get metal in exchange.” ETF custodians usually consist of the likes of J.P. Morgan and UBS who are players on the wholesale market, says Baldwin, thus implying a possible conflict of interest.

Government and Gold After 1944: A Love-Hate Relationship

Still more complicated is the love-hate relationship between governments and gold. As independent gold analyst Christopher Powell put it in an address to a symposium on that metal in Sydney, October 2013: “It is because gold is a competitive national currency that, if allowed to function in a free market, will determine the value of other currencies, the level of interest rates and the value of government bonds.” He continued: “Hence, central banks fight gold to defend their currencies and their bonds.”It is a relationship that has had a turbulent history since the foundation of the Bretton Woods system in 1944 and up through August 1971, when President Nixon declared the convertibility of the dollar to gold suspended. During those intervening decades, gold lived a kind of strange dual existence as a half state-controlled, half free market-driven money-commodity, a situation that Nobel Prize economist Milton Friedman called a “real versus pseudo gold standard.”The origin of this cumbersome duality was the post-war two-tiered system of gold pricing. On the one hand, there was a new monetary system that fixed gold at $35 an ounce. On the other, there was still a free market for gold. The $35 official price was ridiculously low compared to its free market variant, resulting in a situation in which IMF rules against dealing in gold at “free” prices were circumvented by banks that surreptitiously purchased gold from the London market.

The artificial gold price held steady until the end of the sixties, when the metal’s price started to “deny compliance” with the dollar. Still, monetary doctrine sought to keep the price fixed and, at the same time, to influence pricing on the free market. These attempts were failures. Finally, in March 1968, the US lost more than half its reserves, falling from 25,000 to 8,100 tons. The price of other precious metals was allowed to move freely.

Gold Retreats Into the Shadows

Meawhile, private hoarding of gold was underway. According to The Financial Times of May 21, 1966, gold production was rising, but it was not going to official gold stocks. This situation, in turn, fundamentally affected the gold clauses of the IMF concerning repayments in currency only in equal value to the gold value of such at the time of borrowing. This led to a rise in “paper gold planning” as a substitution for further increases in IMF quotas. (Please see “The Paper Gold Planners — Alchemists or Conjurers?” in The Financial Analysts Journal, Nov–Dec 1966.)By the late 1960s, Vietnam, poverty, the rise in crime and inflation were piling high atop one another. The Fed got to work doing what it does best: “Since April [1969],” wrote lawyer and economist C. Austin Barker in a January 1969 article, “The US Money Crisis,” “the Fed has continually created new money at an unusually rapid rate.” Economists implored the IMF to allow for a free market for gold but also to set the official price to at least $70 an ounce. What was the upshot of this silly system? That by 1969 Americans were paying for both higher taxes and inflation. The rest, as they might say, is the history of the present.Today, there is no “official” price for gold, nor any “gold-exchange standard” competing with a semi-underground free gold market. There is, however, a material legacy of “real versus pseudo” gold that remains a terrible menace. Buyer beware of the pivotal difference between the two.

Marcia Christoff-Kurapovna is at work on the biography of a prominent European head of state and businessman.  Her work has appeared in such publications as The Wall Street Journal, The Economist and Foreign Affairs.

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.

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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The New Renaissance Hat
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.

daily july 17 350

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.