What is the greatest wealth of all? Mr. Stolyarov explains that the greatest wealth is the fact that one is alive right now. This reinforces the imperative to support indefinite life extension and to develop improved means to combat the forces of ruin.
A week from now, the Federal Reserve System will celebrate the 100th anniversary of its founding. Resulting from secret negotiations between bankers and politicians at Jekyll Island, the Fed’s creation established a banking cartel and a board of federal-government overseers that has grown ever stronger through the years. One would think this anniversary would elicit some sort of public recognition of the Fed’s growth from a quasi-agent of the Treasury Department intended to provide an elastic currency, to a de facto independent institution that has taken complete control of the economy through its central monetary planning. But just like the Fed’s creation, its 100th anniversary may come and go with only a few passing mentions.
Like many other horrible and unconstitutional pieces of legislation, the bill which created the Fed, the Federal Reserve Act, was passed under great pressure on December 23, 1913, in the waning moments before Congress recessed for Christmas with many Members already absent from those final votes. This underhanded method of pressuring Congress with such a deadline to pass the Federal Reserve Act would provide a foreshadowing of the Fed’s insidious effects on the US economy—with actions performed without transparency.
Ostensibly formed with the goal of preventing financial crises such as the Panic of 1907, the Fed has become increasingly powerful over the years. Rather than preventing financial crises, however, the Fed has constantly caused new ones. Barely a few years after its inception, the Fed’s inflationary monetary policy to help fund World War I led to the Depression of 1920. After the economy bounced back from that episode, a further injection of easy money and credit by the Fed led to the Roaring Twenties and to the Great Depression, the worst economic crisis in American history.
But even though the Fed continued to make the same mistakes over and over again, no one in Washington ever questioned the wisdom of having a central bank. Instead, after each episode the Fed was given more and more power over the economy. Even though the Fed had brought about the stagflation of the 1970s, Congress decided to formally task the Federal Reserve in 1978 with maintaining full employment and stable prices, combined with constantly adding horrendously harmful regulations. Talk about putting the inmates in charge of the asylum!
Now we are reaping the noxious effects of a century of loose monetary policy, as our economy remains mired in mediocrity and utterly dependent on a stream of easy money from the central bank. A century ago, politicians failed to understand that the financial panics of the 19th century were caused by collusion between government and the banking sector. The federal government’s growing monopoly on money creation, high barriers to entry into banking to protect politically favored incumbents, and favored treatment for government debt combined to create a rickety, panic-prone banking system. Had legislators known then what we know now, we could hope that they never would have established the Federal Reserve System.
Today, however, we do know better. We know that the Federal Reserve continues to strengthen the collusion between banks and politicians. We know that the Fed’s inflationary monetary policy continues to reap profits for Wall Street while impoverishing Main Street. And we know that the current monetary regime is teetering on a precipice. One hundred years is long enough. End the Fed.
Ron Paul, MD, is a former three-time Republican candidate for U. S. President and Congressman from Texas.
This article is reprinted with permission from the Ron Paul Institute for Peace and Prosperity.
Today, anyone who talks about hyperinflation is treated like the shepherd boy who cried wolf. When the wolf actually does show up, though, belated warnings will do little to keep the flock safe.
The current Federal Reserve strategy is apparently to wait for significant price inflation to show up in the consumer price index before tapering. Yet history tells us that you treat inflation like a sunburn. You don’t wait for your skin to turn red to take action. You protect yourself before leaving home. Once inflation really picks up steam, it becomes almost impossible to control as the politics and economics of the situation combine to make the urge to print irresistible.
The hyperinflation of 1790s France illustrates one way in which inflationary monetary policy becomes unmanageable in an environment of economic stagnation and debt, and in the face of special interests who benefit from, and demand, easy money.
In 1789, France found itself in a situation of heavy debt and serious deficits. At the time, France had the strongest and shrewdest financial minds of the time. They were keenly aware of the risks of printing fiat currency since they had experienced just decades earlier the disastrous Mississippi Bubble under the guidance of John Law.
France had learned how easy it is to issue paper money and nearly impossible to keep it in check. Thus, the debate over the first issuance of the paper money, known as assignats, in April 1790 was heated, and only passed because the new currency (paying 3 percent interest to the holder) was collateralized by the land stolen from the church and fugitive aristocracy. This land constituted almost a third of France and was located in the best places.
Once the assignats were issued, business activity picked up, but within five months the French government was again in financial trouble. The first issuance was considered a rousing success, just like the first issuance of paper money under John Law. However, the debate over the second issuance during the month of September 1790 was even more chaotic since many remembered the slippery slope to hyperinflation. Additional constraints were added to satisfy the naysayers. For example, once land was purchased by French citizens, the payment in currency was to be destroyed to take the new paper currency out of circulation.
The second issuance caused an even greater depreciation of the currency but new complaints arose that not enough money was circulating to conduct transactions. Also, the overflowing government coffers resulting from all this new paper money led to demands for a slew of new government programs, wise or foolish, for the “good of the people.” The promise to take paper money out of circulation was quickly abandoned, and different districts in France independently started to issue their own assignats.
Prices started to rise and cries for more circulating medium became deafening. Although the first two issuances almost failed, additional issuances became easier and easier.
Many Frenchmen soon became eternal optimists claiming that inflation was prosperity, like the drunk forgetting the inevitable hangover. Although every new issuance initially boosted economic activity, the improved business conditions became shorter and shorter after each new issuance. Commercial activity soon became spasmodic: one manufacturer after another closed shop. Money was losing its store-of-value function, making business decisions extremely difficult in an environment of uncertainty. Foreigners were blamed and heavy taxes were levied against foreign goods. The great manufacturing centers of Normandy closed down and the rest of France speedily followed, throwing vast numbers of workers into bread lines. The collapse of manufacturing and commerce was quick, and occurred only a few months after the second issuance of assignats and followed the same path as Austria, Russia, America, and all other countries that had previously tried to gain prosperity on a mountain of paper.
Social norms also changed dramatically with the French turning to speculation and gambling. Vast fortunes were built speculating and gambling on borrowed money. A vast debtor class emerged located mostly in the largest cities.
To purchase government land, only a small down payment was necessary with the rest to be paid in fixed installments. These debtors quickly saw the benefit of a depreciating currency. Inflation erodes the real value of any fixed payment. Why work for a living and take the risk of building a business when speculating on stocks or land can bring wealth instantaneously and with almost no effort? This growing segment of nouveau riche quickly used its newfound wealth to gain political power to ensure that the printing presses never stopped. They soon took control and corruption became rampant.
Of course, blame for the ensuing inflation was assigned to everything but the real cause. Shopkeepers and merchants were blamed for higher prices. In 1793, 200 stores in Paris were looted and one French politician proclaimed “shopkeepers were only giving back to the people what they had hitherto robbed them of.” Price controls (the “law of the maximum”) were ultimately imposed, and shortages soon abounded everywhere. Ration tickets were issued on necessities such as bread, sugar, soap, wood, or coal. Shopkeepers risked their heads if they hinted at a price higher than the official price. The daily ledger of those executed with the guillotine included many small business owners who violated the law of the maximum. To detect goods concealed by farmers and shopkeepers, a spy system was established with the informant receiving 1/3 of the goods recovered. A farmer could see his crop seized if he did not bring it to market, and was lucky to escape with his life.
Everything was enormously inflated in price except the wages for labor. As manufacturers closed, wages collapsed. Those who did not have the means, foresight, or skill to transfer their worthless paper into real assets were driven into poverty. By 1797, most of the currency was in the hands of the working class and the poor. The entire episode was a massive transfer of real wealth from the poor to the rich, similar to what we are experiencing in Western societies today.
The French government tried to issue a new currency called the mandat, but by May 1797 both currencies were virtually worthless. Once the dike was broken, the money poured through and the currency was swollen beyond control. As Voltaire once said, “Paper money eventually returns to its intrinsic value — zero.” In France, it took nearly 40 years to bring capital, industry, commerce, and credit back up to the level attained in 1789.
Frank Hollenbeck, PhD, teaches at the International University of Geneva. See Frank Hollenbeck’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.
On Monday, former Fed official Andrew Huszar publicly apologized to the American public for his seminal role in executing the Quantitative Easing (QE) program, a program he characterizes as “the greatest backdoor Wall Street bailout of all time,” and “the largest financial-markets intervention by any government in world history.” While this is a momentous admission from an insider (Mr. Huszar is also a former Wall Street banker), perhaps Mr. Huszar’s most revealing statement concerned the results of QE’s “relentlessly pumping money into the financial markets during the past five years.” He referred to the spectacular rally in financial markets and expressed agreement with the growing belief among expert observers that market conditions had become “bubble-like.”
In a paper just released by the American Enterprise Institute, another former policymaker, resident fellow Desmond Lachman, formerly deputy director of the International Monetary Fund’s Policy Development and Review Department, warns that QE and other “unorthodox monetary policies” are having “unintended consequences.” Among other consequences, Lachman sees signs of incipient bubbles forming throughout the world:
An important aim of the QE policies pursued in the United States, the United Kingdom, and Japan has been to encourage risk taking and to raise asset prices as the means to stimulate aggregate demand. The question that now needs to be asked is whether these policies may have given rise to excessive risk taking, overleveraging, and bubbles in asset and credit markets. In this context, one has to wonder whether historically low yields on junk bonds in the industrialized countries now understate the risk of owning those bonds. . . . One also has to wonder whether yields on sovereign bonds in the European periphery have become disassociated from those countries’ underlying economic fundamentals and whether global equity valuations have not become excessively rich.
The markets for gems and for collectibles have also become very frothy of late. Yesterday, new records were set for a gemstone and for an Andy Warhol piece of art sold at auction. The “Pink Dream,” is a 59.60 carat vivid pink diamond, which is the highest color grade for diamonds, and the purity of its crystals is ranked among the top 2 percent in the world. The record setting price was $83 million. Not coincidentally, the DJIA set an intraday record shortly before the auction. The new record price for the Andy Warhol piece was $105.4 million. The auction’s combined $199.5 million in revenues was also a record for Sotheby’s. During Sotheby’s Geneva fall auction season, records were also set for the prices of an orange diamond and a Rolex Daytona watch.
While the Austrian insight that super-accommodative Fed monetary policy may be causing a recurrence of asset bubbles is making headway in policy circles, it has not yet dawned on Janet Yellen. Nor is such an epiphany likely. Ms. Yellen wears the intellectual blinders of the mainstream macroeconomist which force her to focus narrowly on arbitrary and increasingly irrelevant statistical averages and aggregates like the CPI, the unemployment rate, and GDP and to ignore what is going on around her in real markets.
This was clearly revealed in remarks prepared for her confirmation hearing released yesterday. Ms. Yellen noted that the rate of increase in the CPI index was less than the Fed target of 2.00 percent and that the labor market and the economy were performing far short of their potential (based on the meaningless concept of “potential GDP”). She thus reiterated her commitment to continuing monetary accommodation and “unconventional policy tools such as asset purchases.” It is true that in her testimony before the Senate committee on Thursday she did concede that it is “important for the Fed to attempt to detect asset bubbles when they are forming.” However, she blithely dismissed concerns that recent record highs in asset markets reflected “bubble-like conditions.” With Ms. Yellen’s confirmation highly likely, we can look forward to the Fed blindly fueling asset bubbles to a fare-thee-well. With the financial system still on shaky ground, this will lead to another financial meltdown and a U.S. government takeover of the financial system, the likes of which will make the last Wall Street bailout appear to be a minor intervention.
Joseph Salerno is academic vice president of the Mises Institute, professor of economics at Pace University, and editor of the Quarterly Journal of Austrian Economics. He has been interviewed in the Austrian Economics Newsletter and on Mises.org. Send him mail. See Joseph T. Salerno’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.
Last Thursday the Senate Banking Committee held hearings on Janet Yellen’s nomination as Federal Reserve Board Chairman. As expected, Ms. Yellen indicated that she would continue the Fed’s “quantitative easing” (QE) polices, despite QE’s failure to improve the economy. Coincidentally, two days before the Yellen hearings, Andrew Huszar, an ex-Fed official, publicly apologized to the American people for his role in QE. Mr. Huszar called QE “the greatest backdoor Wall Street bailout of all time.”
As recently as five years ago, it would have been unheard of for a Wall Street insider and former Fed official to speak so bluntly about how the Fed acts as a reverse Robin Hood. But a quick glance at the latest unemployment numbers shows that QE is not benefiting the average American. It is increasingly obvious that the Fed’s post-2008 policies of bailouts, money printing, and bond buying benefited the big banks and the politically-connected investment firms. QE is such a blatant example of crony capitalism that it makes Solyndra look like a shining example of a pure free market!
It would be a mistake to think that QE is the first time the Fed’s policies have benefited the well-to-do at the expense of the average American. The Fed’s polices have always benefited crony capitalists and big spending politicians at the expense of the average American.
By manipulating the money supply and the interest rate, Federal Reserve polices create inflation and thereby erode the value of the currency. Since the Federal Reserve opened its doors one hundred years ago, the dollar has lost over 95 percent of its purchasing power —that’s right, today you need $23.70 to buy what one dollar bought in 1913!
As pointed out by the economists of the Austrian School, the creation of new money does not impact everyone equally. The well-connected benefit from inflation, as they receive the newly-created money first, before general price increases have spread through the economy. It is obvious, then, that middle- and working-class Americans are hardest hit by the rising level of prices.
Congress also benefits from the devaluation of the currency, as it allows them to increase welfare- and warfare-spending without directly taxing the people. Instead, the increase is only felt via the hidden “inflation tax.” I have often said that the inflation tax is one of the worst taxes because it is hidden and because it is regressive. Of course, there is a limit to how long the Fed can facilitate big federal spending without causing an economic crisis.
Far from promoting a sound economy for all, the Federal Reserve is the main cause of the boom-and-bust economy, as well as the leading facilitator of big government and crony capitalism. Fortunately, in recent years more Americans have become aware of how the Fed is impacting their lives. These Americans have joined efforts to educate their fellow citizens on the dangers of the Federal Reserve and have joined efforts to bring transparency to the Federal Reserve by passing the Audit the Fed bill.
Auditing the Fed is an excellent first step toward restoring a monetary policy that works for the benefit of the American people, not the special interests. Another important step is to repeal legal tender laws that restrict the ability of the people to use the currency of their choice. This would allow Americans to protect themselves from the effects of the Fed’s polices. Auditing and ending the Fed, and allowing Americans to use the currency of their choice, must be a priority for anyone serious about restoring peace, prosperity, and liberty.
Ron Paul, MD, is a former three-time Republican candidate for U. S. President and Congressman from Texas.
This article is reprinted with permission from the Ron Paul Institute for Peace and Prosperity.
No two countries’ responses have polarized commentators over the past five years more than the contrasting post-crisis policies in Iceland and Ireland.
In a paper published in Economic Affairs (available here as a PDF) I contrast the policies enacted by Iceland and Ireland, perhaps the two countries most affected by the liquidity freeze of 2008. A common conclusion has been that one country did everything right and the other did everything wrong, however, I take a more pragmatic approach. There are some positive aspects in each case, and other aspects we can do without.
At the risk of over-simplifying their situations, the key policy differences are:
The evidence is mixed as to which solution was more effective. Iceland seems to have softened the immediate blow of its recession, but present growth in Ireland is stronger. In a similar way, unemployment in Iceland was less and still remains lower today.
For our purposes here, I want to focus just on the effects of their respective monetary policies, and how the short-term gains from Iceland’s inflationary response now pale in comparison to Ireland’s more subdued response.
Figure 1: Nominal GDP (2008 = 100) Source: Federal Reserve Bank of St. Louis
Figure 1 shows the common story. Iceland’s inflationary policy stimulated exports, papered over some bad debts, and in general allowed it to exit the storm relatively unscathed. In contrast, Ireland is languishing in slow growth and five years later the country’s income is still 10 percent below its pre-bust peak.
Such an analysis neglects the pernicious effects of inflation on the Icelandic economy. This policy increased the money supply by almost 20 percent in 2008 alone, and lead to an immediate increase in prices.
Figure 2: Real GDP (2008 = 100) Source: Federal Reserve Bank of St. Louis
In figure 2 we get a better feel for how the situation felt to the average Icelander or Irishman. As the Central Bank of Iceland inflated the money supply, price inflation raged. Icelanders continually felt their financial security worsen as their purchasing power collapsed. This was not apparent to the rest of the world, fixated as it was on the nominal prices the Icelandic economy posted. By its nadir in late 2010, inflation-adjusted income in Iceland was down over 35 percent.
In Ireland this decline was muted because of price deflation. As domestic prices fell it became easier for Irish citizens to make their declining nominal incomes go further. At its worst, the Irish economy collapsed less than 10 percent in real terms.
This seems to suggest that Ireland had the better solution by not pursuing an inflationary monetary policy. Some will note, however, that Iceland’s recovery since 2010 has been quite strong.
Indeed, if we look at the drop in the employment rate for both countries most probably feel more sympathy for the masses of unemployed Irishmen.
Figure 3: Employment rate (2008 = 1) Source: Federal Reserve Bank of St. Louis
Digging deeper, however, we find that not all is as it seems. Many Icelanders work two jobs to make ends meet. This effect was increasingly pronounced through the recession as inflation made it more difficult to get by with one salary. As a consequence, many Icelanders lost one job during the recession but the unemployment statistics did not reflect this as they were still employed elsewhere. This is notably not the case in Ireland, where not only is one job per worker the norm, but falling prices made it easier for an employed person to make ends meet as the recession continued.
A better way to gauge the employment situation is to look at changes in the hours worked.
Figure 4: Annual hours worked (2008 = 100) Source: Federal Reserve Bank of St. Louis
Here we can see the situation is reversed. By the recession’s trough in 2010 the number of hours worked by the average Icelander had fallen 6 percent while in Ireland the corresponding drop was only 3.5 percent — almost half as much.
Both countries still have problems. Iceland’s monetary controls are notably stifling needed investment, while Ireland is left with a large debt from bailing out its banks, and this is stalling growth. One thing is clear though — the effects of monetary policy are stark and the proclaimed benefits of Iceland’s inflationary policy were counteracted by the price inflation that ensued.
Don’t let a good crisis go to waste; learn something from it. As the tale of these two countries demonstrates, inflating one’s currency may give the appearance of recovery, but the truth is somewhat less rosy.
David Howden is Chair of the Department of Business and Economics and professor of economics at St. Louis University’s Madrid Campus, Academic Vice President of the Ludwig von Mises Institute of Canada, and winner of the Mises Institute’s Douglas E. French Prize. Send him mail. See David Howden’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.
The banking industry is unstable. Banks are regularly going bankrupt. Crises in the banking industry have occurred in three distinct time periods during the twentieth century—during the Great Depression of the 1930s, during the Savings and Loan crisis of the 1980s and 1990s, and during the Great Recession from 2007 to present.
Why the banking industry is so vulnerable to bankruptcies and what can be done to correct this problem?
Debt to assets, or leverage, ratios vary significantly from industry to industry. They are typically under ten percent in most high tech industries and go up to forty percent for public utilities. Average debt ratios in the banking and financial services industry are in the fifty to seventy percent range, however, and many banks have much higher leverage ratios.
Firms attempt to minimize their total financing costs or Working Average Cost of Capital (WACC). The component costs of capital (cost of debt and cost of equity) are determined by investors’ perceptions of the risk and return possibilities associated with buying debt or equity in a given company or individual.
A credit card loan has a higher interest rate than a home loan because the credit card loan is riskier—i.e. there are no assets to seize if the money is not paid back. Similarly, a high-risk company normally pays a higher interest rate on its debt than a lower-risk company and increasing leverage is normally associated with increasing risk. Due to deposit insurance, however, this isn’t the case with banks.
Moral Hazard
The Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 in the United States. Most of the European countries (including Cyprus) have similar organizations that insure deposits up to 100,000 EUR. (See Deposit Insurance.)
Since depositors believe that their bank accounts are insured by governments, they do not generally know or care how much risk banks incur when they invest their depositors’ money. This creates a moral hazard problem with very little oversight by depositors of a bank’s management of their assets. Bank managers can take a lot of risk and, if they make profits, they keep the money. If they lose money, the taxpayers pay for the losses. In theory, this moral hazard problem is mitigated by subordinated debt, investors with deposits over the deposit insurance limit, and banking regulations. But these approaches are clearly not working.
In a series of agreements called the Basel Accords, the Basel Committee on Bank Supervision (BCBS) provides certain recommendations on banking regulations in regards to capital risk, market risk and operational risk. The purpose of these accords is to ensure financial institutions have enough capital to meet their obligations. The Tier I and Tier II capital controls of the Basel Agreements are supposed to prevent banks from taking too much risk with depositors’ assets. Tier 1 capital consists largely of shareholders’ equity. Tier 2 capital comprises undisclosed reserves, revaluation reserves, general provisions, hybrid instruments and subordinated debt.
The capital ratios are:
To be well-capitalized under federal bank regulatory definitions, a bank holding company must have a Tier 1 capital ratio of at least six percent, a total capital ratio of at least ten percent, and a leverage ratio of at least five percent (Capital).
The leverage ratios allowed under the Basel agreements are far higher than the typical leverag ratios in most industries and are far higher than would exist in a free-market financial system. Under a free-market system, depositors would not put their money in overly-leveraged banks and banks would be forced to decrease their leverage ratios and behave more like mutual or money market funds. Banks would be less likely to use short-term liabilities (deposits) to fund long-term assets (loans).
The S&L Crisis
Massive bank leverage would not create as much instability if the money supply was stable as in the 1800s under the gold standard. Under the current debt-is-money system, inflation and interest rates can vary wildly from year to year. The Savings and Loan Associations (S&Ls) made many low interest 30-year fixed rate home loans when inflation was low in the 1960s—five percent interest rate loans were typical. As inflation increased, the S&Ls still had these long-term home loans on their books, but the market now demanded higher interest rates on deposits (eighteen percent at times). The interest rates that many savings and loans were receiving on their assets (30-year fixed rate loans) were much lower than the interest rates the same S&Ls were paying on their liabilities (deposits). This duration mismatch resulted in the mass insolvency of the Savings and Loan Industry and a bailout of the S&Ls by the American tax payers exceeding $100 billion.
The Great Recession
The banking defaults of the Great Recession (2007 to present) were also caused by unstable interest rates combined with high leverage. The Federal Reserve lowered rates in the early 2000s to stimulate the economy after the bursting of the dot.com bubble. This resulted in many people borrowing money at very low interest rates to buy homes. Then the Federal Reserve raised interest rates and many people were no longer able to make their home payments. Again the result was massive bank insolvency and a substantial decrease in home values. Another huge taxpayer -funded bailout of the banking system followed, and the Federal Reserve has been printing money ever since, trying to stimulate the economy in the wake of yet another bubble it created. The disbursements associated with placing into conservatorship government-sponsored enterprises Fannie Mae and Freddie Mac by the U.S. Treasury, the Troubled Asset Relief Program (TARP), and the Federal Reserve’s Maiden Lane Transactions are probably around $400 billion. How much of these disbursements will be paid back is currently unclear.
During the recent crises in Cyprus, proposals were seriously considered to ignore the 100,000 EUR deposit insurance and seize a fraction of even small depositors’ money. Most depositors lost access to their accounts for over a week and large depositors are still likely to lose a large fraction of their assets. This crisis has made some depositors more likely to pay attention to the solvency of their banks, but most depositors still believe that deposit insurance will cover any possible losses. If banks are to become more stable, the amount of equity relative to debt in the banking system must be drastically increased to something resembling what it would be without government deposit insurance, central bank subsidies, and treasury bailouts. Given the lobbying power of bankers in Washington, DC and around the word, such is unlikely to occur. The boom-bust cycle of banking bubbles followed by banking crises will most surely continue.
For further reading on this topic see this from The Freeman.
Kirby R. Cundiff, Ph.D. is an Associate Professor of Finance at the Rochester Institute of Technology. He is a Chartered Financial Analyst and a CERTIFIED FINANCIAL PLANNERTM Professional.
The news that Janet Yellen was nominated to become the next Chairman of the Board of Governors of the Federal Reserve System was greeted with joy by financial markets and the financial press. Wall Street saw Yellen’s nomination as a harbinger of continued easy money. Contrast this with the hand-wringing that took place when Larry Summers’ name was still in the running. Pundits worried that Summers would be too cautious, too hawkish on inflation, or too close to big banks.
The reality is that there wouldn’t have been a dime’s worth of difference between Yellen’s and Summers’ monetary policy. No matter who is at the top, the conduct of monetary policy will be largely unchanged: large-scale money printing to bail out big banks. There may be some fiddling around the edges, but any monetary policy changes will be in style only, not in substance.
Yellen, like Bernanke, Summers, and everyone else within the Fed’s orbit, believes in Keynesian economics. To economists of Yellen’s persuasion, the solution to recession is to stimulate spending by creating more money. Wall Street need not worry about tapering of the Fed’s massive program of quantitative easing under Yellen’s reign. If anything, the Fed’s trillion dollars of yearly money creation may even increase.
What is obvious to most people not captured by the system is that the Fed’s loose monetary policy was the root cause of the current financial crisis. Just like the Great Depression, the stagflation of the 1970s, and every other recession of the past century, the current crisis resulted from the creation of money and credit by the Federal Reserve, which led to unsustainable economic booms.
Rather than allowing the malinvestments and bad debts caused by its money creation to liquidate, the Fed continually tries to prop them up. It pumps more and more money into the system, piling debt on top of debt on top of debt. Yellen will continue along those lines, and she might even end up being Ben Bernanke on steroids.
To Yellen, the booms and bust of the business cycle are random, unforeseen events that take place just because. The possibility that the Fed itself could be responsible for the booms and busts of the business cycle would never enter her head. Nor would such thoughts cross the minds of the hundreds of economists employed by the Fed. They will continue to think the same way they have for decades, interpreting economic data and market performance through the same distorted Keynesian lens, and advocating for the same flawed policies over and over.
As a result, the American people will continue to suffer decreases in the purchasing power of the dollar and a diminished standard of living. The phony recovery we find ourselves in is only due to the Fed’s easy money policies. But the Fed cannot continue to purchase trillions of dollars of assets forever. Quantitative easing must end sometime, and at that point the economy will face the prospect of rising interest rates, mountains of bad debt and malinvested resources, and a Federal Reserve which holds several trillion dollars of worthless bonds.
The future of the US economy with Chairman Yellen at the helm is grim indeed, which provides all the more reason to end our system of central economic planning by getting rid of the Federal Reserve entirely. Ripping off the bandage may hurt some in the short run, but in the long term everyone will be better off. Anyway, most of this pain will be borne by the politicians, big banks, and other special interests who profit from the current system. Ending this current system of crony capitalism and moving to sound money and free markets is the only way to return to economic prosperity and a vibrant middle class.
Ron Paul, MD, is a former three-time Republican candidate for U. S. President and Congressman from Texas.
This article is reprinted with permission from the Ron Paul Institute for Peace and Prosperity.
Paul Krugman has recently been critical of Friedman (and Phelps), the Phillips curve, and the Natural Unemployment Rate (NUR) theory in the process of arguing that due to the recent Great Recession, the accompanying financial crisis, and Bush-Obama-Fed Great Stagnation, Friedman has vanished from the policy front. Krugman makes this claim despite the fact there is an on-going vigorous debate on rules versus discretion with at least some attention to Friedman’s plucking model. While maligning Friedman’s contributions, Krugman manages a slap at Austrians and claims a renewed practical relevance for Keynes:
What I think is really interesting is the way Friedman has virtually vanished from policy discourse. Keynes is very much back, even if that fact drives some economists crazy; Hayek is back in some sense, even if one has the suspicion that many self-proclaimed Austrians bring little to the table but the notion that fiat money is the root of all evil — a deeply anti-Friedmanian position. But Friedman is pretty much absent.
The Friedman-Phelps hypothesis was the heart of the policy effectiveness debate of the 1970s and early 80s. The empirical evidence developed during the debate over the policy implications of the NUR model, at least temporally, discredited active Keynesian discretionary policy as an effective tool to reduce unemployment in the long run. One result of the debate: monetary policy appeared to improve, especially compared to the Fed’s dismal record in the late 1920s and 1930s and the mid 1960s to the late 1970s. Central banks, à la Friedman, focused on rules-based policy and inflation targeting resulting in what many, following John B. Taylor, call the Great Moderation of the early 1980s to the early 2000s.
Krugman does recognize the “stagflation (of the 1970s) led to a major rethinking of macroeconomics, all across the board; even staunch Keynesians conceded that Friedman/Phelps had been right (indeed, they may have conceded too much [emphasis added]), and the vertical long-run Phillips curve became part of every textbook.”
My early work on Hayek and Keynes (see here and here) argued that this development was important, but misleading. The then current business cycle research and its newer variants could benefit from re-examining the issues at the heart of the Hayek-Keynes debate.
Money, banking, finance, and capital structure were, and still are, for the most part ignored in much of the new (post-Friedman-Phelps) macroeconomics including the new–Keynesian approaches. In this regard, Hayek (and Mises) had then, and has now, more to offer than Keynes.
Recent papers by respected mainstream economists are beginning to recognize that attention to Hayek and Mises can be useful. Guillermo Calvo of Columbia University, in a recent paper [PDF], has even gone so far as to argue, “the Austrian school of the trade cycle was on the right track” and that the Austrian School offered valuable insights and noting that:
There is a growing empirical literature purporting to show that financial crises are preceded by credit booms including Mendoza and Terrones (2008), Schularik and Taylor (2012), Agosin and Huaita (2012), and Borio (2012).
Calvo adds “[t]his was a central theme in the Austrian School of Economics.”
Claudio Borio highlights what Austrians have long argued is a key flaw in inflation-targeting or stable-money policy regimes such as many central banks either adopted or emulated during the 1980-2008 period. This flaw contributed to back-to-back boom-busts of the late 1990s and 2000s:
A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply-side developments, such as those associated with the globalisation of the real side of the economy, provide plenty of fuel for financial booms.
Borio thus recognizes that a time to mitigate a bust is (contra-Keynes) during the boom:
In the case of monetary policy, it is necessary to adopt strategies that allow central banks to tighten so as to lean against the build-up of financial imbalances even if near-term inflation remains subdued.
William R. White, another economist who has worked at the Bank of International Settlements (BIS) and has been influenced by Hayek, has come to similar conclusions as does Calvo, who argues “Hayek’s theory is very subtle and shows that even a central bank that follows a stable monetary policy may not be able to prevent business cycles and, occasionally, major boom-bust episodes.”
In the current environment, many, including Krugman, have argued for a higher inflation target or a higher nominal GDP target to jump start the current sluggish recovery.
Austrian business cycle theory on the other hand, as recognized by Borio and Calvo, provides analysis on why such a policy may be ineffective and if temporarily effective in the short run, harmful if not destructive, in the long run. (See here and here for more.)
An easy money and credit policy impedes necessary re-structuring of the economy and new credit creation begins a new round of misdirection of production leading to an “unfinished recession.” Calvo expounds:
Whatever one thinks of the power of the Hayek/Mises mix as a positive theory of the business cycle, an insight from the theory is that once credit over-expansion hits the real sector, rolling back credit is unlikely to be able to put “Humpty-Dumpty together again.”
It is too bad it took back-to-back harmful boom-bust cycles for the profession at large to begin to again examine Austrian insights, but it does illustrate how foolish Krugman is when he argues Austrians have nothing to bring to the table.
John P. Cochran is emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He is also a senior scholar for the Mises Institute and serves on the editorial board of the Quarterly Journal of Austrian Economics. Send him mail. See John P. Cochran’s article archives.
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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.
Understanding Bitcoin requires that we understand the limits of our ability to imagine the future that the market can create for us.
Thirty years ago, for example, if someone had said that electronic text—digits flying through the air and landing in personalized inboxes owned by us all that we check at will at any time of the day or night—would eventually displace first class mail, you might have said it was impossible.
After all, not even the Jetsons cartoon imagined email. Elroy brought notes home from his teacher on pieces of paper. Still, email has largely displaced first-class mail, just as texting, social networking, private messaging, and even digital vmail via voice-over-Internet are replacing the traditional telephone.
It turns out that the future is really hard to imagine, especially when entrepreneurs specialize in surprising us with innovations. The markets are always outsmarting even the most wild-eyed dreamers, and they are certainly smarter than the intellectual who keeps saying: such and such cannot happen.
It’s the same today. What if I suggested that digital money could eventually come to replace government paper money? Heaven knows we need a replacement.
Money started in modern times as gold and silver, and it was controlled by its owners and users. Then the politicians got hold of it—a controlling interest in half of every transaction—and look what they did. Today money is rooted in nothing at all and its value is subject to the whims of central planners, politicians, and monetary bureaucrats. This system is not very modern when we consider a world in which the market is driving innovations in other aspects of our daily lives.
Maybe it was just a matter of time. The practicality is impossible to deny: Gamers needed tokens they could trade. Digital real estate needed to be bought and sold. Money was also becoming more and more notional, with wire transfers, bank computer systems, and card networks serving to move “money” around. The whole world was gradually migrating to the digital sphere, but conventional money was attached to the ground, to vaults owned or controlled by governments.
The geeks went to work on it in the 1990s and developed a number of prototypes—Ecash, bit gold, RPOW, b-money—but they all faltered for the same reason: their supply could not be limited and no one could figure out how to make them impossible to double and triple spend. Normally, reproducibility is a wonderful thing. You can send me an image and still keep it. You can send me a song and not lose control of yours. The Internet made possible infinite copying, which is a great thing for media and texts and—with 3-D printing—even objects. But reproducibility is not a feature that benefits a medium of exchange.
After all, a currency is useless unless it is scarce and its replication is carefully controlled. Think of the gold standard. There is a fixed amount of gold in the world, and it enters into economic life only through hard work and real expenditure. Gold has to be mined. All gold is interchangeable with all other gold, but when I own an ounce, you can’t own it at the same time. How can such a system be replicated in the digital sphere? How can you assign titles to a fungible digital good and makes sure that these titles are absolutely sticky to the property in question?
Finally it happened. In 2008, a person called “Satoshi Nakamoto” created Bitcoin. He wasn’t the first to solve the problem of double spending. A currency called e-gold did that, but the flaw was that there was a central entity in charge that users had to trust. Bitcoin removed this central point of failure, enabling miners themselves constantly to validate the transaction record. He had each user download the full ledger of all existing Bitcoins so that each could be checked for its title and not used more than once at the same time. With his system, every coin had an owner, and the system could not be gamed.
Further, Nakamoto built in a system of mining that attempts to replicate the experience of the gold standard. The math equations you have to solve get harder over time. The early creators had it easy, just like the early miners of gold could pan it out of the river, though later they had to dig into the mountain. Nakamoto put a limit on the number of coins that can be mined (21 million by 2140). (A new coin is currently mined every 20 seconds or so, and a transaction occurs every second.)
He made his code completely open-source and available to all so that it could be trusted. And the payment system used the most advanced form of encryption, with public keys visible to all and a scrambling system that makes its connection to the private key impossible to discover.
No one would be in charge of the system; everyone would be in charge of the system. This is what it means to be open source, and it’s the same dynamic that has made WordPress a powerhouse in the software community. There would be no need for an Audit Bitcoin movement. Trust, anonymity, speed, strict property rights, and the possibility that applications could be built on top of the infrastructure made it perfect.
Bitcoin went live on November 1, 2008. To really appreciate why this matters, consider the times. The entire political and financial establishment was in full-scale panic meltdown. The real estate markets had collapsed, pulling down the balance sheets of the major banks. The investment banks were unloading mortgage-backed securities at an unprecedented pace. Boats delivering goods couldn’t leave shore because they could find no backers for their insurance bonds. For a moment, it seemed like the world was ending. The Republicans held the White House, but the unthinkable still happened: Government and the central banks decided to attempt a full-scale rescue of the whole system, spending and creating trillions in new paper tickets to fill bank vaults.
Clearly government paper was failing. A digital alternative had to exist. But what gave Bitcoin its value? There were several factors. It was not fixed to any existing currency, so it could float according to human valuation. It was made from real stuff: the very 1s and 0s that were driving forward the global market economy. And while 1s and 0s can be reproduced unto infinity, the new coins could not, thanks to a system in which the coin and its public key were strictly controlled and the ledger updated for every transaction. Its soundness could be checked constantly through instantaneous conversion to other currencies as well as to goods and services. The model seemed impenetrable, the first digital currency that really addressed all the problems that had doomed previous attempts.
Let’s fast forward in time to March 2013. I had become the proud owner of my first Bitcoin. My wallet lived on my smartphone. Only three years ago, some wonderful applications had already developed around the currency unit. Although I’m a bit techy, I’m not a rocket scientist and I’m quite certain that I would have been out of my league. But this is how digital institutions develop to become ever more user friendly. At the same event at which I became a Bitcoin owner, I also used a Bitcoin ATM. I put in the green stuff, held my digital wallet up to the scanner, and then I felt the buzz on my smartphone. Physical became digital. Beautiful.
But still I wondered what exactly I could do with these things. That’s when the consumer world of Bitcoin products appeared before me. We aren’t just talking about the Silk Road—a website that became notorious for enabling the easy, anonymous buying and selling of drugs. There are Bitcoin stores everywhere. And there are services in which you can buy from any website with a Bitcoin interface. There was growing talk of Bitcoin futures markets. Some companies were rumored to be going public with Bitcoins, and thereby bypassing the whole of the Securities and Exchange Commission. The implications are mind-blowing.
Still, I’m a tactile kind of guy. I need to experience things. So I went to one of these sites. I brought the first product I saw (why, I do not know). It was a pair of pliers for crimping electric cables. I put in my shipping address and up came a note that said it was time to pay. This was the moment I had been waiting for. A QR code—that funny square design that looks like a 3-D bar code—popped up onscreen. I held up my “wallet” and scanned. In less than 2 seconds, the deed was done. It was easier than Amazon’s one-click ordering system. My heart raced. I jumped out of my chair and did a quick song and dance around the room. Somehow I had seen it thoroughly for the first time: this is the future.
The pliers arrived two days later, and even though I have no use for them, I still treasure them.
Bitcoin had already taken off when the surprising Cyprus crisis hit in a big way. The government was talking about seizing bank deposits as a way of bailing out the whole system. During this period, Bitcoin essentially doubled in value. Press reports said that people were pulling out government currency and converting it, not only in Cyprus but also in Spain and Italy and elsewhere. The price of Bitcoin in terms of dollars soared. Another way to put this is that the price of goods and services in terms of Bitcoin was going down. Yes, this is the much-dreaded system that mainstream economists decry as “deflation.” The famed Keynesian Paul Krugman has even gone so far as to say that the worst thing about Bitcoin is that people hoard them instead of spending them, thereby replicating the feature of the gold standard that he hates the most! He might as well have given a ringing endorsement, as far as I’m concerned.
My own experience with Bitcoin during this time intensified. I began to call friends on Skype and scan their QR codes and trade currencies. I began to rope other people into the obsession based on my experience: you have to own to believe. After one full day of buying, selling, and using Bitcoins, I had the strange experience of resenting that I had to pay a cab fare in plain old U.S. dollars.
How do you obtain Bitcoins? This process can be a bit tricky. You can look up localbitcoins.com and find a local person to meet you to trade cash for Bitcoins. Usually, this exchange takes place at high premiums of anywhere from 10 percent to 50 percent depending on how competitive the local market is. It is understandable why people are reluctant to do this, no matter how safe it is. There is just something that seems sketchy about meeting a stranger in an all-night cafe to do some unusual digital currency exchange.
A more conventional route is to go to one of many online sellers and link up your bank account and buy. This process can take a few days. And then when you set out to transfer the funds, you might be surprised at the limits in the market that exist these days. Sites are rationing Bitcoin selling based on availability, just given the high demand. It could be 10 days or more to go from non-owner to real owner. But once you have them, you are off to the races. Sending and receiving money has never been easier.
As of this writing, a Bitcoin is trading for $88.249. Just three years ago, it hovered at 0.14 cents. Many people look at the current market and think, surely this is a speculative bubble. That could be true, but it might not be. People are exchanging an unstable, fiat paper for something with a real title that cannot be duplicated. Everyone knows precisely how many Bitcoins exist at any time. Anyone can observe the transactions taking place in real time. A Bitcoin’s price can go up and down, and that’s fine, but there is no real speculation going on here that is endogenous to the Bitcoin market itself.
Is it a pyramid scheme? The defining mark of a pyramid scheme is that more than one person has an equal claim on the same money or good. This is physically impossible with Bitcoin. The way the program is set up, it is a strict property rights regime with no exceptions. In fact, in early March, there was a brief hiccup in the system when some new coins were approved by one group of developers but not approved by another. A “fork” appeared in the system. The price began to fall. Developers worked fast to resolve the dispute and eventually the system—and the price—returned to normal. This is the advantage of the open-source system.
But what about the vague sense some people have that a handful of coders cannot, on their own, cause a new currency to come in existence? Well, if you look back at what Austrian monetary theorist Carl Menger says, he points out that a similar process is precisely how gold became money. Every new currency is not at first used by everyone. It is at first used only “by the most discerning and most capable economizing individuals.” Their successful behaviors are then emulated by others. In other words, the emergence of money involves entrepreneurship—that is, being alert to opportunities to discover and provide something new.
But what about a government crackdown? No doubt that attempt will be made. Already, some national government agencies are expressing some degree of annoyance at what could be. But governments haven’t been able to control the cash economy. It would be infinitely more difficult to control a virtual currency with no central bank, with encryption, and with millions of users per day. Controlling that would be unthinkable.
There was a time when the idea that ebooks would replace physical books was an absurd notion. When I first took a look at the early generation of ereaders, I laughed and scoffed. It will never happen. Now I find myself looking for a home for my physical books and loading up on ebooks by the hundreds. Such is the way markets surprise us. Technology without central planners makes dreams come true.
It’s possible that Bitcoin will flop. Maybe it is just the first generation. Maybe thousands of people will lose their shirts in this first go-round. But is the digitization of money coming? Absolutely. Will there always be skeptics out there? Absolutely. But in this case, they are not in charge. Markets will do what they do, building the future whether we approve or understand it fully or not. The future will not be stopped.
This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.