Wednesday, 1 April 2015

Central Banking Refuted In One Blog—–Thanks Ben!

By David Stockman

Blogger Ben’s work is already done. In his very first substantive post as a civilian he gave away all the secrets of the monetary temple. The Bernank actually refuted the case for modern central banking in one blog.
In fact, he did it in one paragraph. This one.
A similarly confused criticism often heard is that the Fed is somehow distorting financial markets and investment decisions by keeping interest rates “artificially low.” Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by “the markets.” The Fed’s actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere.
Not true, Ben.  Why not ask the author of the 1913 Federal Reserve Act and legendary financial statesman of the first third of the 20th century—–Carter Glass.
The then Chairman of the House Banking and Currency Committee did not refer to the new reserve system as a “banker’s bank” because he was old-fashioned or unschooled in finance. The term evoked the  essence of the Fed’s original mission. Namely, to passively rediscount good commercial collateral (receivables and inventory loans) brought to its window by member banks—priced at a penalty spread floating above the market rate of interest.

Continue reading the article here.

Monday, 30 March 2015

An Austrian Take on Inflation

By Alasdair Macleod

We know that today’s macroeconomists are very confused about inflation, if only because despite all experience they think they can print money and increase bank credit with a view to generating price inflation at a controlled 2% rate.

Admittedly, most of them will acknowledge there is more hope than reality about the controlled bit. Economic policy should be based on more than just hope.
It is timely therefore to see what the Austrian School had to say on the matter, but first we should define inflation: to the Austrians it is an increase in the quantity of money and credit. Inflation is not defined as rising prices; this is the long-run result of inflation in the quantity of money and bank credit. Common jargon confuses the effect for the cause.

The economist who best defined the inflation relationship was Ludwig Von Mises. Von Mises lived in Vienna during the Austrian hyperinflation of 1921-23, so he saw the problem at first hand both as a resident and as a practising economist. The Austrian government eventually succeeded in taming its hyperinflation beast, approximately ten months before the Germanpapiermark finally collapsed. What is interesting and rarely commented on is that German economists saw the collapse of their currency being played out in advance in Austria, and therefore knew with high certainty what was ahead of them, yet they were still powerless to stop German’s currency collapse.

The Aggregate Money Supply for the U.S., Eurozone and the UK Plunges Further In February

The Aggregate Money Supply for the U.S., Eurozone and the UK, as measured in US dollar terms, plunged 4.94% in February on last year according to date released by the three central banks.

This was the biggest y/y drop in the money supply since June 2010.

The decline in the aggregate money supply was again driven by a strengthening of the US dollar and a further significant fall in the UK money supply.

The Crank Report (29 March 2015)

Saturday, 28 March 2015

Yellen Just Inadvertently Admitted the US$ Is No Longer Money

Yesterday, Fed chairwoman Janet Yellen made a statement with far-reaching consequences way beyond what she probably recognises. During the Q&A following a speech she claimed that "cash is not a very convenient store of value", which
directly implies that the US dollar is not "money"! 
How come? For the simple reason that one key feature of "money" is its ability to function as a store of value. To function as a store of value, money need to at least maintain its purchasing power over time. And Yellen, the supposed "guardian" of the US dollar, just admitted the dollar lacks this very feature. A statement which of course is absolutely correct, thanks to the massive monetary expansion since the Fed was established more than 100 years ago.

Tuesday, 24 March 2015

Bubble Extraordinaire

We have long since established that the U.S. stock market has completely dislocated from many economic indicators (here's a selection). The inflationary policies, nurturing low interest rates and increased money supply, making ordinary bank savings a sure loser, have no doubt helped pushed the stock market into "I'm all in and hope for the best" territory. 

As we've seen many times throughout history, the stock market can stay overvalued much longer than one would perhaps think "rational" and "risk averse" investors would endure. Eventually however, certain basic relationships between the stock market and the economy as a whole need to revert toward more reasonable levels. 

The chart below shows the relationship between the Wilshire 4500 stock market index and the U.S. weekly leading index published by the Economic Cycle Research Institute. This leading economic index attempts to predict turns in the economy (i.e. predict the business cycle). As of 13 March, the indicator has declined on a y/y basis for 13 consecutive weeks, i.e. every week this year. Prior to this, the index increased 118 weeks in a row on a y/y basis (24 August 2012 to 21 November 2014). Currently, the index is 1.3% lower than same week last year. 

The Wilshire 4500 index on the other hand has now increased every single week on a y/y basis for 138 weeks starting 3 August 2012. The most recent reading shows a 10.5% increase compared to same week last year. Result? Since the beginning of August 2012, the stock market has increased 74.1% while the leading index for the economy has only increased 7.3%. The stock market has hence outpaced the economic index more than 10-fold during this period. But it gets worse: going back to the previous stock market peak in October 2007, the stock market has since surged 79.9% while the leading economic index has, wait for it, declined by 6.6%, leading to a 92.5% jump in the ratio between the two. 

One could argue that the above ratio reflects expectations of future improvements in the U.S. economy. The leading index, which has a reasonably good track record, is however telling us that not only is the U.S. economy weaker today than back in October 2007, but it's also weaker today than one year ago. 

With ever increasing government debt and a U.S. economy fuelled by centrally planned low interest rates and inflationary monetary policies, there are currently few good reasons to expect a progressing U.S. economy over the near to medium term. Only a falling stock market can therefore bring the above ratio down towards a more reasonable level and it might very well have to catch up with a future (sharp) fall in the leading index, too. It's just a matter of time.

The Simplicity of Economic Theory

By Fernando Herrera-González

Economic theory is the science which tries to explain economic phenomena. Just as Newton observed an apple falling from a tree and started searching for an explanation to the phenomenon, which eventually took him to the Universal Law of Gravitation, other thinkers observed the existence of a price for that apple (or the usury for loans), and looked for explanations to these other phenomena. That is the way in which economic theory started taking shape.

Unlike the fall of the apple and other natural phenomena, economic phenomena have their origin in the human individual and their actions. Absent the human being, the apple keeps falling to the ground. In contrast, absent the human being, there is no price for the apple. Economic theory does not make sense unless there are people around.

Because of this, the method for developing economic theory takes (or should take) the human being and their actions, human action, as the starting point. It is not a coincidence that Ludwig von Mises used that name for his magnum opus. The methodology derived from this is named praxeology, and it is one of the main features that differentiate the Austrian School of Economics from other economic schools.  The cornerstone on which praxeology rests is arguably the following axiom: the individual acts when they think that the state they will reach as a consequence of their action is preferable to the original state. In other words, when the ‘revenues’ they expect to obtain exceed the ‘costs’ they expect to incur. Starting from this axiom, unprovable but undisputed, theories may be developed to explain different social (not only economic) phenomena that we see around us.

Although the starting axiom may seem simple and intuitive, its application in practice is certainly complex. Firstly, the revenues and costs to which it refers are subjective. Only each concrete individual knows (or thinks they know) the costs to be incurred by carrying out a course of action, and the revenues they may attain as a consequence. However, these costs and revenues are not necessarily of a monetary nature. The motivations for most individuals, if not for all individuals in most cases, have nothing to do with receiving or spending money.

How Inexpensive Credit Spurs Recovery, according to Draghi

Speaking yesterday, ECB president Draghi put forth the following viewpoints according to Reuters,
Cheaper credit is boosting investment projects, driving up business demand for bank loans and aiding the eurozone economy, European Central Bank President Mario Draghi said. 
"As bank lending rates are being reduced, new investment projects -- previously considered unprofitable -- become attractive". "In the short run, this should sustain the demand for credit and investment."
Draghi is correct on most points. Unfortunately, none of them are sustainable long term and will only lead to the wasting  of yet more resources, the opposite of real economic growth. In fact, it is the same recipe that got the eurozone into the current financial problems in the first place. Common sense tells us that one cannot cure a problem with more of what caused it in the first place. Not so for Draghi and the other monetary cranks around the world.

Monday, 23 March 2015

Illusion of Prosperity

President Obama and Federal Reserve chair Janet Yellen have recently been crowing about improving economic conditions in the U.S.  Unemployment is down to 5.5% and economic growth in 2014 hit 2.4%.

Journalists and economists point to this improvement as proof that quantitative easing was effective. They seem to have political blinders on. The boom is artificial and has been built by adding debt on top of excessive debt.  Total household debt increased 2.5 % in 2014 – the highest level since 2010. Mortgage loans increased 1.5%, student loans jumped by 6.6%, and auto loans swelled a hefty 9.6%.  The improving auto sales are based on a bubble of sub- prime borrowers. Auto sales have been brisk because of a surge in loans to individuals with credit scores below 640. Auto loans to individuals with strong credit scores, above 720, have barely budged.

Sub-prime consumer borrowing climbed $189 billion in the first 11 months of 2014.  Excluding home mortgages, this accounted for 41% of total consumer lending. This is exactly the kind of lending that got us into trouble less than a decade ago. This trend can only end in tears.
Here’s the lingering question: is the current boom built on sound foundations? Do we have sharp increases in productivity or real wage growth?

The truth is productivity has barely budged since 2010 and real wages have flat lined, or declined for decades. From mid-2007 to mid-2014, real wages declined 4.9% for workers with a high school degree, dropped 2.5% for workers with a college degree, and sunk 0.2% for workers with an advanced degree.

So is the boom being built on broad base investment in plant and equipment?  The average age of plant and equipment in the US is currently the oldest on record.

Continue reading the article here.

The "Natural Interest Rate" Is Always Positive and Cannot Be Negative

By Thorsten Polleit

Some economists have been arguing that the “equilibrium real interest rate” (that is the “natural interest rate” or the “originary interest rate”) has become negative, as a “secular stagnation” has allegedly caused a “savings glut.”

The idea is that savings exceed investment, and that a negative real interest rate is required for bringing savings in line with investment. From the viewpoint of the Austrian school, the notion of a “negative equilibrium real interest rate” doesn’t make sense at all.

To show this, let us develop the case step by step. To start with, one should make a distinction between two types of interest rates: There is the market interest rate, and there is the originary interest rate.

The market interest rate is the outcome of the supply of and demand for savings in the market place. It can be observed, for instance, in the deposit, bond, or loan market for different maturities and credit qualities.

The originary interest rate is a category of human action, saying that acting man values goods available at present more highly than goods available in the future. In other words: Future goods trade at a price discount relative to present goods. For instance, 1 US$ available today is preferred over 1 US$ available in one year’s time.

If 1 US$ to be received in one year’s time is valued at, say, 0.909 US$, the originary rate of interest is 10 percent. (1 US$ divided by 0.909 minus 1 gives you 0.10, or 10 percent, for that matter.) 10 percent is here the originary interest rate (disregarding any other premia).