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“Inferno” and the Overpopulation Myth – Article by Jonathan Newman

“Inferno” and the Overpopulation Myth – Article by Jonathan Newman

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The New Renaissance Hat
Jonathan Newman
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Inferno is a great thriller, featuring Tom Hanks reprising his role as Professor Robert Langdon. The previous movie adaptations of Dan Brown’s books (Angels and Demons and The Da Vinci Code) were a success, and I expect Inferno will do well in theaters, too.

Langdon is a professor of symbology whose puzzle solving skills and knowledge of history come in high demand when a billionaire leaves a trail of clues based on Dante’s Inferno to a biological weapon that would halve the world’s population.

The villain, however, has good motives. As a radical Malthusian, he believes that the human race needs halving if it is to survive at all, even if through a plague. Malthus’s name is not mentioned in the movie, but his ideas are certainly there. Inferno provides us an opportunity to unpack this overpopulation fear, and see where it stands today.

Thomas Malthus (1766–1834) thought that the potential exponential growth of population was a problem. If population increases faster than the means of subsistence, then, “The superior power of population cannot be checked without producing misery or vice.”

Is overpopulation a problem?

The economics of population size tell a different, less scary, story. While it is certainly possible that some areas can become too crowded for some people’s preferences, as long as people are free to buy and sell land for a mutually agreeable price, overcrowding will fix itself.

As an introvert who enjoys nature and peace and quiet, I am certainly less willing to rent an apartment in the middle of a busy, crowded city. The prices I’m willing to pay for country living versus city living reflect my preferences. And, to the extent that others share my preferences or even have the opposite preferences, the use and construction of homes and apartments will be economized in both locations. Our demands and the profitability of the varied real estate offerings keep local populations in check.

But what about on a global scale? The Inferno villain was concerned with world population. He stressed the urgency of the situation, but I don’t see any reason to worry.

Google tells me that we could fit the entire world population in Texas and everybody would have a small, 100 square meter plot to themselves. Indeed, there are vast stretches of land across the globe with little to no human inhabitants. Malthus and his ideological followers must have a biased perspective, only looking at the crowded streets of a big city.

If it’s not land that’s a problem, what about the “means of subsistence”? Are we at risk of running out of food, medicine, or other resources because of our growing population?

No. A larger population not only means more mouths to feed, but also more heads, hands, and feet to do the producing. Also, as populations increase, so does the variety of skills available to make production even more efficient.  More people means everybody can specialize in a more specific and more productive comparative advantage and participate in a division of labor. Perhaps this question will drive the point home: Would you rather be stranded on an island with two other people or 20 other people?

Malthus wouldn’t be a Malthusian if he could see this data

The empirical evidence is compelling, too. In the graph below, we can see the sort of world Malthus saw: one in which most people were barely surviving, especially compared to our current situation. Our 21st century world tells a different story. Extreme poverty is on the decline even while world population is increasing.

world-population-in-extreme-poverty-absoluteHans Rosling, a Swedish medical doctor and “celebrity statistician,” is famous for his “Don’t Panic” message about population growth. He sees that as populations and economies grow, more have access to birth control and limit the size of their families. In this video, he shows that all countries are heading toward longer lifespans and greater standards of living.

Finally, there’s the hockey stick of human prosperity. Estimates of GDP per capita on a global, millennial scale reveal a recent dramatic turn.

rgdp-per-capita-since-1000

The inflection point coincides with the industrial revolution. Embracing the productivity of steam-powered capital goods and other technologies sparked a revolution in human well-being across the globe. Since then, new sources of energy have been harnessed and computers entered the scene. Now, computers across the world are connected through the internet and have been made small enough to fit in our pockets. Goods, services, and ideas zip across the globe, while human productivity increases beyond what anybody could have imagined just 50 years ago.

I don’t think Malthus himself would be a Malthusian if he could see the world today.

Jonathan Newman is a recent graduate of Auburn University and a Mises Institute Fellow. Contact: email

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.

The Bad Economics Behind “Monopoly” – Article by Chris Calton

The Bad Economics Behind “Monopoly” – Article by Chris Calton

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The New Renaissance Hat
Chris Calton
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In 1868, a young Henry George wrote an editorial on the nearly completed Pacific Railroad that was soon to connect his state of California with the rest of the country. This editorial, “What the Railroad Will Bring Us,” acknowledged the progress that railroads would signify in the industrializing economy of the Gilded Age, but George saw this as a boon only for the privileged few. Like many thinkers of his time, he was concerned with the “labor question,” which he referred to as one of “the riddles of a Sphinx, which not to answer is death.” Why was there poverty in an age of economic expansion?

Henry George believed that he figured out the riddle after a horseback ride in Oakland Hills, California. While stopping to give his horse a drink of water, George engaged in polite conversation with a farmer, casually asking the value of the land around him. The farmer told him of some land for sale nearby for $1,000 per acre. With this thought in mind, George concluded that land values would inevitably rise as the population grew, and speculators — that economic specter historians love to fear — could own land unproductively to profit merely off its natural increase in value. This, George decided, was the reason why there was poverty in a progressing economy.

In 1879, George published the book Progress and Poverty, formally laying out this conundrum and his answer to it. In it, he detailed for the first time his “Single Tax Plan” that proposed to tax land in proportion to its increase in value, which he believed would lead to the end of property rights in land entirely.

Apparently, George’s idea hit home with a lot of people at the time. His book outsold every book the year it was published except for the Bible, and a movement to form “Single Tax Clubs” spread throughout the country and beyond. Henry George became a Gilded Age rockstar.monopoly1

Among his followers was a woman named Elizabeth Magie. She believed that George’s land value tax plan was the solution to economic woes, and she wanted to bring this idea to as many people as she could. To do this, she developed The Landlord’s Game. This board game intended to demonstrate the horrors of land accumulation and rent, and to illustrate the benefit of George’s Single Tax Plan.

The original game, patented in 1904, closely resembles the modern game of Monopoly, that would later evolve out of it. Players started in a square that said “Labor Upon Mother Earth Produces Wages.” As the original rules state, “Each time a player goes around the board he is supposed to have performed so much labor upon Mother Earth, for which after passing the beginning-point he receives his wages, one hundred dollars, and is checked upon the tally-sheet as having been around once.”

Most of the squares look at least somewhat familiar. Many gave sale prices and rent costs, not unlike modern monopoly. This was explicitly meant to illustrate the belief that land rent transactions were involuntary, a notion that Benjamin Powell has already addressed. The railroads are also present, representing “transportation, and when a player stops upon one of these spaces he must pay five dollars to the ‘R.R.’” Less familiar squares demonstrated the horrors of private property rights by saying “No Trespassing. Go to Jail” from which the more ambiguous “Go Directly to Jail” corner would evolve in the modern game.

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In 1913, a version of the game was picked up in Britain called Brer Fox an’ Brer Rabbit, taking the name from the African fables of Brother Fox and Brother Rabbit (the native language of African slaves lacked the diphthong syllable, so the word “brother” was pronounced “br’er” when told in English). In this, the clever Br’er Rabbit represented the wily landowner earning his immoral rents. The pesky Br’er Fox was meant to represent British reform leader David Lloyd George, who was of no relation to Henry George but was a strong supporter of his land value tax. In 1909, Lloyd George came up with the “People’s Budget” which instituted a version of Henry George’s land tax and planted the seeds for the British welfare state. His face is imposed on the figure of Br’er Fox on the original cover for the British game.

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This version of the game was actually used to educate students about Henry George’s ideas in places like the University of Pennsylvania and Columbia. The Landlord’s Game and its British variant attempted to teach people the socialistic concepts that wages come from land, private property in land was immoral and destructive, and the economy is a zero-sum environment. The game evolved over time into the modern version Monopoly, whose invention is falsely credited to Charles Darrow.

Today, of course, the specifically Georgist elements have been removed from the game. There are no longer any “No Trespassing” squares, and what once was known as “The Poor House” where bankrupt players were forced to go upon running out of money is now the “Free Parking” square. The several “Absolute Necessity Taxes” across the board (perhaps the one aspect of the game’s educational commentary that libertarians could agree with) have been reduced to the Luxury and Income Tax squares. And of course, the unambiguously socialistic “Mother Earth” starting square became simply “Go.” Nonetheless, the modern variant retains the zero-sum myths of monopoly land accumulation, and in this, the legacy of Henry George is retained. If you’ve ever finished a game of monopoly with a frustrated player overturning the board and scattering the pieces, then it’s possible that Lizzie Magie accomplished her original goal.

Chris Calton is a Mises University alumnus and an economic historian. See his YouTube channel here.

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.

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

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

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The New Renaissance HatVictor Xing

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

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

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

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

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

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

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

xing3Source: Federal Reserve Board of Governors

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

xing4Source: Federal Reserve Board of Governors

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

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

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

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

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

xing5Source: Federal Reserve Board of Governors

xing6xing7

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

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

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

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

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

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

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

Why Modern Luddites Are Attacking Uber Drivers – Article by Mateusz Machaj

Why Modern Luddites Are Attacking Uber Drivers – Article by Mateusz Machaj

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The New Renaissance HatMateusz Machaj
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Earlier this year, a number of Uber cars in Poland came under attack by a group of vandals who were likely taxi drivers. In general, these types of vandalism have a long tradition in human history and have contributed to keeping populations’ general living standards at very low levels.

Attacks on Uber drivers are simply the latest chapter in a long story of efforts to intimidate and destroy innovators who are moving markets and societies in new and unfamiliar directions.

Reactions to Early Machines
For a very long time, separation of grain from the chaff was done in a very primitive manner. The process took weeks, involved hard working men, hard working women feeding them, and also children working as additional helpers. Finally, someone invented a threshing machine that allowed farmers to get rid of all this hard work: the machine could do the job much faster with less physical labor involved.

The change happened contrary to what many historical books claim: the move to threshing machines did not occur because of the patent system put in place 150 years before the change. It happened because social and political forces were too weak to stop it from happening.

Beginning in the eighteenth century in Europe, the entrepreneurial class was growing. They were a group of small profit-driven innovators interested in selling various products, and beating their competitors to markets. This “Great Change” was driven forward by many cultural, religious, political, legal, and technological factors.

At first, threshing machines were very imperfect. They didn’t always work well, and they also were expensive. There was a lot of room for improvements, and for making them better, faster, and cheaper. As they were slowly improved, it quickly became apparent the new machines were more efficient than the old manual methods. It was only a matter of time until someone would realize that steam engines could be combined with the threshing machines.

Not surprisingly, threshing machines were not welcomed by everyone. Swing Riots flared up and the Luddite movement attempted to crush technological innovation. Despite such obstacles, the entrepreneurs won out, paving the way for the future chain of market innovations, well symbolized by the modern farmer sitting in the modern air-conditioned tractor (with a good stereo system). Over the past two hundred years, agricultural workers were reduced from more than 80 percent of workers to less than 5 percent.

Economic Growth and Social Change
One of the big mysteries of human history is the question of why rapid technological and innovative growth started only around the nineteenth century. Many new ideas and technological changes were present for ages (and invented centuries before). Other cultures introduced many new innovative ideas as well.

Some steam engines were even being used in ancient times. They were applied in narrow places, however, due to social and political circumstances.

One early example of political resistance is related to us through the Roman Emperor Vespasian’s opposition to new labor saving innovations. Faced with the prospect of replacing workers with machines, Vespasian reputedly said: “You must let me feed my poor commons.”

Vespasian’s reaction is understandable; it is hard to predict what will happen in response to innovations that make certain job skills obsolete. And it’s not just the workers who fear the change. The ruling class, faced with an idle and unemployed population might also fear social upheaval.

The words of Peter Green summarize many of these concerns:

The ruling class were scared, as the Puritans said, of Satan finding work for idle hands to do. One of the great things about not developing the source of energy that did not depend on muscle power was the fear of what the muscles might get up to if they weren’t kept fully employed. The sort of inventions that were taken up and used practically were the things that needed muscle power to start with, including the Archimedean screw. On the other hand, consider that marvelous box gear of Hero’s: it was never used. That would have been a real conversion of power. What got paid for? The Lagids tended to patronize toys, fraudulent temple tricks in large quantities, and military experiments.

Naturally, human history is complicated and subject to many different factors. Nevertheless, there appears to be some truth in the argument that fixed social and political structure did not favor society open to the widespread adoption of innovation. Otherwise, it is hard to explain why so many new technical discoveries were not applied for so long, even though science and intelligence supplied them centuries before. We had to wait for the new political and social arrangements that either were tolerant of new innovations, or were unable to stop them.

Uber and Beyond
Everywhere we look, we see both the creative and destructive power of innovation. First threshing machine sellers lead to reductions in agricultural employment. Later, tractors killed the threshing machines. Telegraph and railway killed communication systems that relied on horses. Cars destroyed the horse industry. Mass production of textiles destroyed the demand for hand-crafted items. Big stores destroyed smaller shops, now discount shops (in parts of Europe) are destroying big stores. Video rentals hampered the cinema industry, now Netflix and others killed video rentals, while Napster’s success (despite its illegality) predicted a coming end to the old music industry. China’s growth and cheap efficient outsourcing reshaped traditional industries in developed countries. (From an economic perspective there is no difference between hiring cheaper labor or hiring a better machine.)

Dell smashed the traditional computer industry with eliminating many middle men. Ikea did something similar in the furniture industry. The internet destroyed regular newspapers, while Google smashed the marketing industry. Amazon destroys bookstores around the world, while Uber is doing the same with the taxi industry.

Economic progress decreases employments in one place, allows for creation of new ones, even in the service sector. During the process of liquidating employment positions, huge economic development is capable of multiplying per capita production within one generation, positively affecting all social classes.

The current state of affairs is not the end of history. Those companies, innovative today, will be endangered tomorrow. Even Jeff Bezos, creator of Amazon.com, admits Amazon won’t last forever:

Companies have short life spans. … And Amazon will be disrupted one day. I don’t worry about it ’cause I know it’s inevitable. Companies come and go. And the companies that are, you know, the shiniest and most important of any era, you wait a few decades and they’re gone.

Mateusz Machaj, PhD in economics; is a founder of the Polish Ludwig von Mises Institute. He has been a summer fellow at the Ludwig von Mises Institute. He is assistant professor at the Institute of Economic Sciences at the University of Wroclaw.

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.

Trump and Hillary Don’t Know How to Fix the Economy – Article by Justin Murray

Trump and Hillary Don’t Know How to Fix the Economy – Article by Justin Murray

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The New Renaissance HatJustin Murray
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Recently, Hillary Clinton was taped ridiculing Donald Trump for lacking a detailed plan for the American economy. The message, so it goes, is that Trump is not suited for the presidency because he doesn’t have a plan on how to turn the American economy around.

But is it really more dangerous to elect a president who makes up economic policy on the fly than one who proclaims to have a detailed plan for us?

The answer to this is no, it is not more dangerous to elect someone who makes up economic policy by the seat of his pants — as Donald Trump is prone to do — than it is to elect someone who thinks she can have the future of the economy neatly mapped out. However, this does not imply that seat-of-the-pants method is less dangerous either. The underlying problem is we have two competing people who think they can manage the American economy.

The core of why both philosophies are equally dangerous is best summarized by F.A. Hayek and the pretense of knowledge. Hayek notes in his speech in 1974:

Unlike the position that exists in the physical sciences, in economics and other disciplines that deal with essentially complex phenomena, the aspects of the events to be accounted for about which we can get quantitative data are necessarily limited and may not include the important ones … in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process … will hardly ever be fully known or measurable.

We are incapable of knowing what the future will bring. No president can come up with a detailed or air tight plan or can accumulate a sufficient stable of experts to be able to guide the behavior, wants, and needs of 320 million people.

For example, if we were to have asked George Bush and his economic experts in 2002 to develop a five year plan for cell phones, we would have built up a massive production capacity and R&D structure around miniaturizing phones as that was all the rage. If someone said in 2002 that people in the future would give up physical buttons and want larger screens, they would have been looked upon as mad. People are buying smaller and smaller phones, there’s no way they could touch the screen and get anything done! But come 2007, Apple introduces the iPhone and the older-style button phone has nearly vanished from the marketplace. Had the government decided it needed to plan the economy around smaller phones, we wouldn’t be enjoying a mobility revolution.

This extends well beyond cellular phones and into all walks of our lives. We don’t need central planning on how we consume our energy, what cars we can buy, what we charge people for borrowing money, and so forth.

All behavior is risky. Even if central planners could somehow canvass all of our wants and needs, figured out when exactly we want to satisfy those needs, and determined who gets what in a world of scarcity, the planners would still fail. This is because even we have no idea what we’ll want in the future. If we were to ask someone to write down exactly what they would buy on August 14, 2017 and put it in an envelope then open it up and compare it to what was bought on that day, there is little doubt the results would be wildly different.

The planner is going to do no better. Instead of a single individual failing to predict his own habits in a fun exercise, we’ll be malinvesting untold amounts of money into unwanted industries and imposing counterproductive and dangerous rules on businesses — the effects of which are impossible to predict. Furthermore, central planning shuts down innovation and the entrepreneurial process because it assumes to know today what is wanted tomorrow. Most innovation arises when someone produces a product we had no idea we wanted and couldn’t fathom existing.

Does Hillary Clinton’s plan for the economy make her a more qualified president than Donald Trump, who will likely create plans spontaneously? No, it makes them equally dangerous as both assume they have the ability to do what countless officials over the centuries have never managed to do — predict the future.

Justin Murray received his MBA in 2014 from the University of St. Gallen in Switzerland.

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

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

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

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The New Renaissance HatJohn Chapman

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Demagoguery vs. Data on Employment in America – Article by Tyler Watts

Demagoguery vs. Data on Employment in America – Article by Tyler Watts

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The New Renaissance Hat
Tyler Watts
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Demagogue politicians love to play on popular fears that low-wage foreigners are “stealing” good-paying American jobs by way of outsourcing and globalization. The claim is made by nativists and protectionists of all political stripes, whether leftists complaining of a “rigged economy” or rightists speaking of other countries “beating us” economically.

A sound economic analysis of the claim about job losses due to international trade should address two questions: First, is it true that the US has lost jobs due to trade (or other factors)? Second, is this phenomenon good or bad overall for the US and world economies?

On the first point, it can appear as though the US has lost jobs. For example, as Figure 1 shows, manufacturing employment in the US has declined by about 2 million from pre-Great Recession levels, and is down by over 7 million, or 37 percent, from the all-time high reached in 1979.

Figure 1: Total Manufacturing Employment, 1940–2016

watts1

The problem, though, is that by looking at manufacturing in terms of jobs, we’re missing the full picture of industrial production.

Nevertheless, the demagogues still argue that, even though high-paying service sector jobs have more than replaced lost factory jobs, “we don’t make things here anymore” and we should lament this. This oft-heard refrain is patently false. We don’t make certain things, such as garments, toys or electronics, because global free trade and technological advances tend to shift America’s output into those industries in which our comparative advantage is greatest. But Americans do indeed make things — quite valuable things.

This can be seen in Figure 2, which shows the US Industrial Production Index for the “de-industrialization” period. After the expected steep decline following the Great Recession of 2008–2009, US manufacturing has slowly bounced back and is now producing more products, in value-added terms, than ever before. Indeed, this index, which consists mainly of manufacturing, has grown by over 100 percent since the 1979 peak in manufacturing employment.

Figure 2: Industrial Production Index for the United States, 1979–2016

watts2

In other words, thanks to productivity gains, we need fewer workers to make more stuff.

From an economic perspective, nothing could be better news. US manufacturing creates 100 percent more value with 37 percent fewer workers. Creating more value with fewer workers means we’re more efficient than ever, or put another way, more productive than ever. These awesome productivity gains have many sources, especially in the form of technological advances in areas like software, robotics, and communications. Globalization and outsourcing have also played a role, as they allow American workers a greater degree of specialization in those sectors where our productivity edge is largest.

The good news gets better, though: not only have we gained jobs on net, but jobs have grown faster than the population over time. Since the 1979 peak in manufacturing employment, the US adult population grew by 53 percent, whereas employment grew by 59 percent, as shown in Figure 3.

Figure 3: Population Growth vs. Employment Growth Since 1979

watts3Source: Federal Reserve Economic Data

Despite these generally positive facts, some still contend that we’ve replaced “good” manufacturing jobs with lousy service sector jobs. Well, of course it must be true that, if we’ve lost manufacturing jobs, but gained jobs overall, then all of the job gains must have come from non-manufacturing sectors. And indeed the service sector, broadly defined, has seen employment growth of 90 percent since our 1979 benchmark. But beware of making hasty earnings assumptions about a sector that employs nearly 124 million people. To see whether the newly-created “service sector” jobs really don’t pay as well as the vaunted manufacturing jobs, we need to drill down into the employment and earnings data. What we’ll find is that a large majority of the new service sector jobs pay just as well or much better than manufacturing jobs.

Table 1 presents Bureau of Labor Statistics data on the 15 largest sectors and sub-sectors of the US economy, which together represent over 96 percent of the total net increase in payroll employment for the post-peak manufacturing jobs era (1979 to 2016). This might come as a surprise to the anti-globalization crowd: despite the loss of 7 million manufacturing jobs (and some mining, logging, and utilities sector jobs), we’ve seen a net increase of nearly 53 million total jobs. Of these net new jobs, fully 62 percent of them feature, as of January 2016, average hourly earnings equal to or greater than current average hourly manufacturing earnings. In other words, most of the 53 million new jobs pay the same or better wages than the demagogues’ benchmark “good” manufacturing jobs. So we lost 7 million good jobs, only to gain about 32 million equal or better-paying jobs, along with about 19 million lower-paying jobs (about 38 percent of net new jobs pay less than manufacturing).

Table 1: Employment Changes and Current Earnings by Sector

watts4Source: Bureau of Labor Statistics

We’ve established that, despite a major decrease in employment in the manufacturing sector, we’ve gained many more jobs than we’ve lost in the past 35 years or so, and that most of these new jobs pay better to boot. Economic changes, while painful in the short run, have brought gains in output and employment not only for the US, but for the rest of the world as well. Overall, this is good news for the US and world economies.

So, as the campaign season heats up, let’s not be misled by baseless arguments about America “losing jobs” or other countries “beating us” at trade. Trade is a positive sum game, and the benefits for both the US and world economies are, shall we say, “yuge.”

Tyler Watts earned his PhD in economics at George Mason University in 2010. He currently teaches economics at East Texas Baptist University and runs the Institute for Economic Education (see YouTube channel here), a public outreach focused on integrating economics with a Biblical worldview and providing unique teaching tools for high school and college economics students.

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.

A Conversation with My Neighbor “Sam” – Article by Mark Brandly

A Conversation with My Neighbor “Sam” – Article by Mark Brandly

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The New Renaissance HatMark Brandly
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Lately, I’ve wondered how my neighbor, Sam, affords to buy so much stuff. He appears to have an unlimited budget. When I asked him about this, Sam asked, “Do you think I’m spending too much?”

“That depends,” I said, “How much money do you make?”

“I take home $100,000 a year.”

That surprised me. I would guess that he’s spending more than that. But I tried to be encouraging, “That sounds like plenty of income. With a little planning, you should be able to budget your spending and be financially stable.”

“But my finances are a mess,” Sam replied. “I spend more than I take home. Last year I had to borrow $12,000 just to cover my spending.”

“Well maybe things will be better this year,” I said, hoping that Sam’s spending issues was a one year problem.

“No,” Sam replied. “Actually, in the first three months of this year, I’ve already spent $19,000 more than I’ve made. It looks like my budget deficit this year will be much worse than it was last year.”

Now I was starting to worry. “Have you been borrowing money to cover your spending for a long time?”

“Oh yes. I have a lot of debt. Part of the problem is that I owe myself $150,000.”

I wondered if Sam misspoke, “Wait, wait, wait, you owe yourself $150,000? Why do you think that you’re in debt to yourself?”

“Well you see, over the years I promised myself that I was going to use my paychecks to pay for a fund for my children’s education, but instead of spending $150,000 on colleges, I spent the money on other expenses. So I figure that I owe myself this money so that I can pay for my children’s college tuitions.”

Obviously Sam doesn’t understand the definition of the word “debt.”

I tried to be polite in my response: “That doesn’t make any sense. It’s true that you’ve made some horrible decisions regarding your spending, but it’s ridiculous to claim that you owe yourself money. A debt occurs when one person owes another person money. Just because you changed your mind about how to spend your paychecks doesn’t mean that you’ve borrowed money from yourself.

“So the first thing you need to do is to think clearly about the amount of debt you have. You don’t owe yourself any money. Now, forgetting about this ridiculous notion of self-debt, how much do you owe?”

“Alright, I think I see your point. Let’s just talk about the rest of my debt. I owe various banks about $420,000. This debt is more than four times my take-home income.”

Sam often lies about his income and spending issues, but he always understates his budget problem. If he’s lying now, then I can be sure that the problem is even greater than he says. I wanted more information.

“That a pretty high debt to income ratio. But that might be somewhat manageable, although unwise, if you’ve borrowed that money at low interest rates.”

“I have some good news and some bad news,” Sam said. “Interest rates are low. In fact, in the last fourteen years, my debt has more than quadrupled, but my interest payments have increased less than 50 percent. That’s because interest rates have collapsed during that time. Isn’t that good news?”

“I suppose, but do you know that interest rates are going to increase over the next several years?”

“Yes, that’s the bad news. In the past year, I only paid $7,000 of interest, but within ten years my debt will increase over 50 percent, and possibly much more, and with higher interest rates I expect to be paying at least four to five times that much in interest annually.”

“That’s a huge problem. So to be able to make your loan payments, I assume that you’ve taken out some long-term loans.”

“No, no, no. In order to take advantage of the low interest rates, most of my borrowing is short term. I rollover my loans quickly. In the past year my principal payments on these loans totaled $207,000.”

“Let me get this straight. Your loan payments, including principal and interest, are well over twice your take home pay?”

“Yes, I take home a little over $8,000 per month and my loan payments are over $17,000 per month. But it’s no problem. In the past year I borrowed $223,000 to cover everything.”

Shocked, I said “How can you say borrowing more than twice your income is not a problem?”

“I simply borrow all the money I need to make all of my loan payments. I never pay any of the loans down. I’ve been doing this for years, ever since I started spending more than I make.”

“Okay. Most of your borrowing goes to cover your increasingly large principal and interest payments. And as interest rates rise, interest payments will become a bigger percentage of your spending. When that happens, your total debt will increase faster than your income. What is your plan, say in the next ten years, to correct this situation?”

“Well I don’t have a plan for correcting anything, because I don’t see how I can cut my spending.”

“What if the banks stop loaning you money to make your payments on your loans? What happens then?”

“I guess I’m assuming that won’t happen.”

Sam’s Budget Situation in Real Numbers
If one of our neighbors budgeted in this manner, we would obviously conclude that the guy is crazy. No such plan could work. Eventually lenders would refuse to fund Sam’s spending.

However, Sam’s situation looks a lot like the federal government budget plan. Take a look at some recent federal budget information and some Congressional Budget Office projections:

  • In FY (fiscal year) 2015, the feds had a budget deficit, counting only debt held by the public, of $339 billion, which is about 10 percent of their tax revenues of $3,248 billion. The deficit has been declining the last few years, but that is now changing.
  • In fact, in the first three months of FY 2016, according to the Treasury Department, federal debt held by the public increased $548 billion. Admittedly, some of this debt was due to the fact that the feds were cooking the books in FY 2015 when they hit the debt ceiling limit. Nonetheless, the first quarter 2016 deficit is already 60 percent larger than the overall 2015 deficit.
  • The federal government claims to owe itself over $5 trillion (they call it intragovernmental debt here). This $5 trillion represents tax revenues that were earmarked for specific spending programs, such as Social Security, but were spent on other programs. Since the feds collected taxes to pay for Social Security, but spent the money on something else, they conclude that they owe it to themselves to collect those tax revenues again. That’s the essence of intragovernmental debt. We should not count this as debt. Give the Treasury Department credit for ignoring this type of “debt” in their Daily Treasury Statements and in their end of the year debt reports.
  • As of September 30, 2015, the feds had $13.1 trillion of debt owed to the public. FY 2015 tax revenues totaled $3.248 trillion. So just like Sam the government has a 4-to-1 debt-to-tax-revenue ratio.
  • In the past fourteen years, from September 30, 2001 (the start of George Bush’s first budget) to September 30, 2015 (the end of Barack Obama’s sixth budget), debt owed to the public increased from $3,339.3 billion to $13,123.8 billion. That’s an increase of 293 percent.
  • According to the Daily Treasury Statements, in the past fourteen years, interest on treasury securities increased from $162.5 billion in fiscal year 2001 to $233.1 billion in fiscal year 2015. That’s a 44 percent increase during the same period when federal debt owed to the public almost quadrupled.
  • In FY 2015, again according to the Daily Treasury Statements, the feds borrowed $7,251.4 billion (see the Public Debt Cash Issues for September 30, 2015), an average of almost $20 billion per day. They spent $6,740.3 billion of this borrowing rolling over their debt. So, Federal principal and interest payments are more than double federal tax revenues.
  • According to the Congressional Budget Office’s baseline projections, debt held by the public in 2025 should exceed $21 trillion and during that time interest rates are expected to increase. Interest rates have been kept artificially low for years. If interest rates return to a more normal level, say to the rates they were paying when George Bush took office fifteen years ago, then interest payments in 2025 will exceed $1.2 trillion. That’s over a 400 percent increase compared to the FY 2015 interest payments. I should note here that the baseline budget projections are optimistic. We should expect the debt situation in 2025 to be significantly worse than these projections.

The federal government’s debt has exploded under the Bush and Obama administrations. Low interest payments due to the low interest rates have masked their budget problems. As interest rates and the spending gap on entitlement programs such as Social Security both increase, the budget problem will compound.

The federal government’s plan is to borrow all of the money they need to pay all of their principal and interest payments and to also pay for the budget deficits in their spending programs. The question we should ask is: what’s going to happen when the world’s lenders refuse to bankroll DC’s spending schemes?

Mark Brandly is a professor of economics at Ferris State University and an adjunct scholar of the Ludwig von Mises Institute.

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 Should Stop Paying Interest on Reserves – Article by Brendan Brown

Central Banks Should Stop Paying Interest on Reserves – Article by Brendan Brown

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The New Renaissance Hat
Brendan Brown
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In 2008, the Federal Reserve began paying interest on reserve balances held on deposit at the Fed. It took more than seven decades from the US leaving the gold standard — in 1933 — for the fiat regime to do this and thus revoke a cardinal element of the old gold-based monetary system: the non-payment of any interest on base money.

The academic catalyst to this change came from Milton Friedman’s essay “The Optimum Quantity of Money” where he argued that the opportunity cost of paper money (any foregoing of interest compared to on alternative money-like instruments such as savings deposits) should be equal to its virtually-zero marginal cost of production. Opportunity cost could indeed be brought down to zero if base money (bank reserves, currency) in large part paid interest at the market rate. Under the gold standard, the opportunity cost of holding base money largely in metallic form (gold coin) was indeed typically significant. All forms of base money paid no interest. And the stream of interest income foregone in terms of present value was equal in principle to the marginal cost of gold production (this was equal to the gold price).

Interest on Reserves are Important to Controlling Markets and Imposing Negative Rates
Friedman, however, did not identify the catch-22 of his proposal. If the officials of the fiat money regime indeed take steps to close the gap between the marginal production cost and opportunity cost of base money, with both at zero, then there can be no market mechanism free of official intervention and manipulation for determining interest rates.

That is what we are now finding out in the few years since central banks in the US, Europe, and Japan started paying interest on reserves. (The ECB was authorized to do this since its launch in 1999, while the Fed and BoJ began following the 2008 financial crisis.) Central banks can now bind the invisible hand operating in the interest rate market to an extent almost unprecedented in peacetime. In some cases, central banks have even deployed a negative interest rate “tool” which would have been impossible under the prior status quo where base money paid no interest.

How We Got Here
The signing into law of the Financial Services Regulatory Relief Act in 2006 authorized the Federal Reserve to begin paying interest on reserves held by depository institutions beginning October 1, 2011. On the insistence of then Fed Chief Bernanke, that date was brought forward to October 1, 2008 by the Emergency Economic Stabilization Act. He was in the process of dispensing huge loans to troubled financial institutions but wanted nonetheless to keep interest rates at a positive level (one purpose here was to protect the money market fund industry).

Accordingly, the Federal Reserve Board amended its regulation D so that the interest rate paid on required reserves and on excess reserves would be at levels tied (according to distinct formulas at the start) to market rates. An official communiqué explained that the new procedure would eliminate the opportunity cost of holding required reserves (and thereby “deregulate”) and help to establish a lower limit for the Federal Funds rate, becoming thereby a useful tool of monetary policy.

This was useful indeed from the viewpoint of rate manipulators: by setting the rate on excess reserves the Fed could now determine the path of short-term interest rates and strongly influence longer term rates regardless of how the supply of monetary base was growing relative to trend demand. By contrast, under the gold standard and the subsequent first seven decades of the fiat money regime, interest rates in the money market were determined by forces which brought demand for base money into balance with the path of supply as set by gold mining conditions or by central bank policy decision respectively. A rise in rates meant that the public and the banks would economize on their direct or indirect holdings of base money and conversely.

Back Before the Fed Paid Interest on Reserves
Yes, under the fiat money system the central bank could effectively peg a short-term rate and supply whatever amount of base money was needed to underwrite that — but the consequential growth of supply in base money was a variable which got wide attention and remained an ostensible policy concern. Right up until the Greenspan era, the FOMC implemented policy decisions by directing the New York Fed money desk to increase or reduce the pace of reserve growth and changes in the Fed funds rate occurred ostensibly to accomplish that purpose. This old method of determining money market interest rates under a fiat regime — in which banks’ need for reserves was minute given deposit insurance, a generous lender of last resort, and too-big-to-fail — depended on the banking industry enduring what was essentially a tax on its deposit business, which was then magnified by fairly high legal reserve requirements. Thus, it is not surprising that the original impetus to paying interest on reserves, whether in the US or Europe, came from the banking lobby. There was no such burden under the gold standard even though the yellow metal earned no interest. Banks in honoring their pledge to deposit clients that their funds were convertible into gold had to visibly hold large amounts of the metal in their vaults or at hand in a reserve center. Actual and potential demand for monetary base by the public is more limited under a fiat money regime than under the gold standard as bank notes are hardly such a distinct asset as gold coin from other financial instruments.

More Problems with Friedmanite “Solutions”
Friedman, when he advocated eliminating the opportunity cost of base money under a fiat regime, hypothesized that this could occur under a long-run declining trend of prices rather than by the payment of interest. The real rate of return on base money could then be in line with the equilibrium real interest rate. This proposal for perpetually declining prices would also have been problematic, though. The interest rate would fluctuate, and in boom times be well above the rate of price decline. In any case, the rate of price decline would surely vary (sometimes into positive territory) in a well-functioning economy even when the long-run trend was constant (downward). The equilibrium real interest rate would be below the rate of price decline sometimes (for example, during business downturns), meaning that market rates even at zero would be too high. That situation did not occur often under the gold standard where prices were expected to be on a flat trend from a very long-run perspective and move pro-cyclically (falling to a low-point in the recession from which they were expected to rise in the subsequent business expansion, meaning that real interest rates would then be negative).

What Can Be Done?
So what is to be done to escape the curse? A starting point in the US would be for Congress to ban the payment of interest on bank reserves. And the US should use its financial power with respect to the IMF to argue that Japan and Europe act similarly within a spirit of G-7 coordination such as to combat monetary instability. We have seen in recent years how rate manipulation and negative rates are made possible by the payment of interest on reserves, and are potent weapons of currency warfare. Yes, the ban in the immediate would force the Federal Reserve to slim down its balance sheet so that supply and demand for base money would balance at a low positive level of interest rates. The Fed might have to swap its holdings of long-maturity debt for T-bills at the Treasury window so as to avoid any dislocation of the long-term interest rate market in consequence. That, not the Yellen-Fischer “rate lift off day and beyond,” is the road back to monetary normalcy.

Brendan Brown is an associated scholar of the Mises Institute and is author of Euro Crash: How Asset Price Inflation Destroys the Wealth of Nations and The Global Curse of the Federal Reserve: Manifesto for a Second Monetarist Revolution. See Brendan Brown’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.