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The perennial question of modern economics is simple: how are market downturns best combated? It’s a good question, if you are trying to deduce truth in matters. It also makes for good fodder to appease career-granting benefactors, i.e. the government. It was not always this way however. Economists, if true to their craft, do not make for barrels of optimism. They are supposed to be a splash of cold water on wishful thinkers.
The unholy alliance between the state and the economic profession would never last if dismal science practitioners were gadflies who swatted down every harebrained scheme that festered in the dreams of central planners. This was one of the problems encountered by classical economists. Being market-friendly, it was tough appealing to monarchs or government leaders who wanted a quick fix to economic doldrums. No head of the public wants to tell his citizens, “Sorry, I cannot help you today. You must help yourself.”
Eventually John Maynard Keynes would come along and give the economic vocation the crony justification it needed to become respectable in the eyes of the state. His The General Theory of Employment, Interest and Money was a how-to guide for pols looking to spend other people’s money. At last they had an excuse: to boost unemployment by paying laid-off workers to dig holes aimlessly.
Our friend Paul Krugman is Keynes’s most vocal disciple, and never tires of reinvoking his intellectual master’s teachings of mo’ money, mo’ debt, and no mo’ problems. In a recentinterview with the forever exhausted-looking Joe Weisenthal of Business Insider, Kruggy is perplexed by the Federal Reserve’s inability to inflate out of the ongoing economic slowdown. He snakes out a position between naysayer Larry Summers, who thinks the economy can only grow with artificial bubbles, and someone who is more optimistic about the future. On necessary bubbles, Krugman tells us:
“If we look at the evidence…and it kind of looks like…we need bubbles to grow. We’ve had one bubble after another. Long-term rise in debt, with no inflation…the economy is looking like it’s just barely managing to keep its above water with all those bubbles so…that’s the observation.”
Krugman blames the news status quo on slowing technological innovation and lower population growth. As for the United States, the Nobel Laureate is convinced the trade deficit is largely at fault. Lastly, he concedes that no one really knows why the economy must be goosed by a shot of exuberance.
That’s all true, if you forget the fact that some folks do actually understand why Krugman and his like-minded colleagues are scratching their heads over bubbles.
That the past few decades have witnessed financial bubble after financial bubble is not proof positive of a great need for them. Krugman’s assumption is that had the Fed not interfered in the marketplace to boost particular assets, the whole economy would have imploded. It’s a false assumption, but totally in line with Keynesian theory.
From the stagflation in the late 1970s to the stock market crash of 1987, forward to the failure of Long Term Capital Management in 1998, the popping of the dot-com bubble years later, and finally culminating in the housing crisis of 2007-2008, Krugman and Summers appear to have a point. All of these cases of faux prosperity were caused by the Fed’s meddling with the money supply, pushing interest rates down below their natural level. The headache after each instance was cured with the hair of the dog – meaning more inflation, more stimulus, and more central bank liquidity. The roller coaster ride of money printing has left the economy distorted and unable to find true balance again.
For the life of him, Krugman can’t seem to find any evidence of market stability without the animal spirits being thrown a liquidity bone. And yet, his go-to example of angelic prosperity – the 1950s – has all the markings of a relatively calm period of prosperity absent of central bank interference. As former Office of Management and Budget Director David Stockman points out, the heads of the Federal Reserve following World War II were less-than-enthusiastic about ginning up growth via the printing press. This was when William McChesney Martin was at the helm and President Eisenhower was reluctant to keep up the hog wild spending of his predecessor. In an interview with the American Mises Institute, Stockman comments:
Although central banking does cause moral hazards and lends itself to abuses, there have been periods in which monetary and fiscal discipline have been employed. Fed Chairman William McChesney Martin, for example, really did take the punch bowl away when the party got started because he took monetary discipline seriously. Fiscal discipline under Eisenhower and the gold standard behind Bretton Woods helped put off the day of reckoning for quite a long time.
After wartime price controls were relaxed in the late 1940s, capitalists and private investors were freed of government burden and began investing in the country yet again. Washington’s budget was cut significantly, including hundreds of billions removed from the Pentagon’s death machine expenditures. Stockman brings attention to the data: “Between 1954 and 1963, real GDP growth averaged 3.4 percent while annual CPI inflation remained subdued at 1.4 percent.”
So yes, this was the non-bubble prosperity Krugman is looking for. As Justin Raimondowrites, “[E]ight years of relative fiscal sanity under the Eisenhower presidency ushered in the greatest economic expansion in modern times.” What’s funny is that Krugman is one of the biggest cheerleaders of post-war prosperity and continually advocates going back to the Ike-era. But he wrongly attributes the golden times to pro-union labor policies and high rates of taxation.
Regardless, the takeaway from the decade of General Motors, Elvis, decent manners, and the Red threat is bubbles are not necessary for economic growth. By trying to stimulate demand, the Fed only mucks up economic calculation and capital accumulation.
Krugman’s solutions for the bubble-addicted economy are no better than his own understanding of economic theory. Widespread unemployment can be cured, in his opinion, by weaker purchasing power, a stronger welfare state, and continual government spending. In other words, by top-down central planning that attempts to tweak society “just so.” All these efforts are nothing but a shell game that take money from some and give it to another. Basically, Krugman is King Solomon with a sword, cutting everyone into parts he sees most fit.
Saying we need continuous financial bubbles to keep full employment is such a flawed conception of economics, it belongs on an island of misfit philosophies. Krugman’s incessant promotion of statism is doing more harm to the economy than good. As an opinion-molder, he is perpetuating the economic malaise of the last few years. More bubbles won’t help the recovery, just harm it more. In the middle of a grease fire, Krugman calls for more pig fat. And the rest of us are the ones left burnt.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada. Send him mail
US lawmakers reached a budget deal this week that will avert the sequester cuts and shutdowns. These fiscal “roadblocks” supposedly damaged investor confidence in 2013, although clearly no one told equity investors who’ve chased the S&P 500 up 26 percent this year. But even so the budget deal is seen by inflationists as only half the battle won, because it doesn’t deal with the pesky debt ceiling. Unsurprisingly, the old calls for a scrapping of the debt ceiling are being heard afresh.
Last week, The Week ran an opinion piece by John Aziz which argues that America (and all other nations for that matter) should keep borrowing until investors no longer want to lend to it. To this end, it is argued, the US should scrap its debt ceiling because the only debt ceiling it needs is the one imposed by the market. When the market doesn’t want to lend to you anymore, bond yields will rise to such an extent that you can no longer afford to borrow any more money. You will reach yournatural, market-determined debt ceiling. According to this line of reasoning, American bond yields are incredibly low, meaning there is no shortage of people willing to lend to Uncle Sam. So Washington should take advantage of these fantastically easy loans and leverage up.
Here’s part of the key paragraph from Aziz:
Right now interest rates are very low by historical standards, even after adjusting for inflation. This means that the government is not producing sufficient debt to satisfy the market demand. The main reason for that is the debt ceiling.
What this fails to appreciate is that interest rates are a heavily controlled price in all of today’s major economies. This is particularly true in the case of America, where the Federal Reserve controls short-term interest rates using open market operations (i.e., loaning newly printed money to banks) and manipulates long-term interest rates using quantitative easing. By injecting vast amounts of liquidity into the economy, the Fed makes it appear as though there is more savings than there really is. But US bond yields are currently no more a reflection of the market’s demand for US debt than a price ceiling on gasoline is a reflection of its booming supply. Contra the view expressed in The Week, low rates brought about by contrived zero-bound policy rates and trillions of dollars in QE can mislead the federal government into borrowing more while at the same time pushing savers and investors out of US bond markets and into riskier assets like corporate bonds, equities, exotic derivatives, emerging markets, and so on.
Greece once thought that the market was giving it the green light to “produce” more debt. Low borrowing rates for Greece were not a sign of fiscal health, however, but really just layer upon layer of false and contrived signals arising from easy ECB money, allowing Greece to hide behind Germany’s credit status. As it turned out, a legislative debt ceiling in Greece (one that was actually adhered to) would have been a far better idea than pretending this manipulated market was a fair reflection of reality. Investors were happy to absorb Greece’s debt until suddenly they weren’t.
This is the nature of sovereign debt accumulation driven by easy money and credit bubbles. It’s all going swimmingly until it’s not. And there is little reason to think this time the US is different. Except that America might be worse. The very fact of the Fed buying Treasuries with newly printed money proves Washington is producing too much debt. China even stated recently that it saw no more utility accumulating any more dollar debt assets. If the whole point of QE is to monetize impaired assets, then the Fed likely sees Treasury bonds as facing considerable impairment risk. Theory and history are clear about the reasons for and consequences of large-scale and persistent debt monetization.
Finally, it is wrong to assert that the debt ceiling is the main reason for America’s fiscal deficit reduction. The ceiling has never provided a meaningful barrier to America’s borrowing ambitions, hence the dozens of upward adjustments to the ceiling whenever it threatens to crimp the whims of Washington’s profligate classes. America’s rate of new borrowing is falling because all the money it has printed washed into the economic system and found its way back into tax revenues. Corporate profits are soaring to all-time highs on dirt cheap trade financing. Corporate high-grade debt issuance has set a new record in 2013. Companies are rolling their short-term debts, now super-cheap thanks to Bernanke’s money machine, and issuing long, into a bubbly IPO and corporate bond market. The last time corporate profits surged like they’re doing now was during the credit and housing bubble that preceded the unraveling and inevitable bust in 2008/09.
These are money and credit cycle effects. The debt ceiling has had precious little to do with it. Moreover, US debt is neither crimped nor the US Treasury Department austere. Instead, the national debt is soaring, $60,000 higher for every US family since Obama took office and rising. Add to this the fact that the US Treasury’s bond issuance schedule is actually set to rise in 2014 due to huge amounts of maturing debt needing to be rolled over next year, and the fiscal significance of the debt ceiling fades even further.
The singular brilliance of the debt ceiling however, is that it keeps reminding everyone that there is a growing national debt that never seems to shrink. That is a tremendous service to American citizens who live in the dark regarding the borrowing machinations of their political overlords. Yes, politicians keep raising the debt ceiling, but nowadays they have to bend themselves into ever twisty pretzels trying to explain why to their justifiably skeptical and cynical constituents. Most people don’t understand bond yields, quantitative easing, and Keynesian pump-a-thons too well, but they sure understand a debt ceiling.
Those who adhere to the don’t-stop-til-you-get-enough theory of sovereign borrowing, and by extension argue for a scrapping of the debt ceiling, couldn’t be more misguided. In free markets with no Fed money market distortion, interest rates can be a useful guide of the amount of real savings being made available to borrowers. When borrowers want to borrow more, real interest rates will rise, and at some point this crimps the marginal demand for borrowing, acting as a natural “debt ceiling.” But when markets are heavily distorted by central bank money printing and contrived zero-bound rates, interest rates utterly cease to serve this purpose for prolonged periods of time. What takes over is the false signals of the unsustainable business cycle which fools people into thinking there is more savings than there really is. Greece provides a recent real-world case study of this very phenomenon in action. In these cases we are likely to see low rates sustained during the increase in government borrowing, only for them to quickly reset higher and plunge a country into a debt trap which may force default or extreme money printing.
Debt monetization has a proven track record of ending badly. It is after all the implicit admission that no one but your monopoly money printer is willing to lend to you at the margin. The realization that this is unsustainable can take a while to sink in, but when it does, all it takes is an inevitable fat-tail event or crescendo of panic to topple the house of cards. If the market realizes it’s been duped into having too much before the government decides it’s had enough, a debt crisis won’t be far away.
Note: The views expressed in Daily Articles on Mises.org are not necessarily those of the Mises Institute.
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Russell Lamberti is head strategist at ETM Analytics, in charge of global and South African macroeconomic, financial market, and policy strategy within the ETM group. Follow him on Twitter. See Russell Lamberti’s article archives.
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Say what you will about Keynesian superstar Paul Krugman, he doesn’t mince words. In a recent interview with Business Insider’s Joe Weisenthal, Krugman gave his opinion that Bitcoin was in a bubble because it wasn’t backed by a tangible asset.
Perhaps sensing that this may have undercut the case for Krugman’s preferred monetary system, Krugman was quick to add thatgovernment-issued fiat money was “backed by men with guns.” (See the video for yourself.) Thus, Krugman thought that government currencies were not in a bubble, even if they weren’t backed by tangible assets, because people needed to obtain the currency in order to pay taxes.
Krugman’s analysis provides a good opportunity to explore the subtlety of Ludwig von Mises’ monetary economics. On the one hand, Mises was a “hard money” man who was a fierce opponent of government fiat money. It is also true that Mises was a classical liberal who would have opposed government coercion in the form of legal tender laws, capital gains taxes on gold and silver, and other ways that governments currently use their “guns” to solidify the present system where most people on Earth use government-issued notes as their primary form of money.
However, even though a libertarian and proponent of Misesian economics might object to government-issued fiat money because of the coercion–”men with guns”–involved, strictly speaking Mises would not agree that a currency can be backed by guns, in the way Krugman describes. To speak in this manner is a complete surrender in the face of the economist’s task of explaining money.
Mises’ grand work in this area is his The Theory of Money and Credit, for which my free study guide is available. As Mises conceived it, the central theoretical task when it comes to money is to explain why money has a particular purchasing power. Why should it be that people give up valuable goods and services for a particular item–the money commodity–according to definite exchange ratios?
Mises’ answer is that people form expectations about the future purchasing power of money, and that is what gives it purchasing power today. These expectations in turn are based on their observations of the money’s purchasing power in the past. Thus lays the groundwork for Mises’ famous “regression theorem,” in which people’s subjective valuations of money necessarily involves a historical component (unlike their subjective valuation of, say, pizza). Gold, silver, and other forms of commodity money could ultimately be traced back to the days of barter, in which they had definite exchange ratios with other goods because of their usefulness as regular commodities.
In the case of government-issued fiat currencies, Mises explained their purchasing power using the same theoretical apparatus. The only difference is that at some point in the past, the currencies (such as the dollar, pound, franc, etc.) had been explicitly linked to the precious metals, and that’s what grounded everyone’s valuations of them.
Thus, Krugman’s glib assertion that today’s government fiat monies derive their value from guns completely dodges the problem for the economist: to explain the magnitude of that value. Even if we conceded that the government could force everyone to use something–let’s say a particular type of sea shell–as money, by insisting on payment of taxes in the form of sea shells, that policy wouldn’t explain why an hour of labor should trade for 10 shells, rather than 100 or 1,000. This is especially true when we reflect that most government taxes are expressed in terms of percentages, rather than an absolute amount.
Furthermore, it’s obvious that Krugman’s “explanation” would have no way of accounting for changes in either variable. For example, in the 1970s in the United States, price inflation took off dramatically, meaning the purchasing power of the dollar fell sharply. Was this because of a reduction in taxes? Of course not. And in the 1920s, there were sharp cuts in marginal income tax rates at the federal level. Did this lead to severe price inflation, as people now didn’t need as many dollars to pay Uncle Sam? On the contrary, consumer prices were fairly stable in this period.
As these observations should demonstrate, Krugman really hasn’t offered a viable explanation for the purchasing power of money. One might be tempted to say that at best, governments can use their taxing power to dictate what the monetary unit is, even though they would still have little control over its purchasing power.
Yet even this concedes too much. Strictly speaking, if the only policy we are considering is that the government says every year, “Citizens must turn in such-and-such number of sea shells as tax payment,” that alone won’t even be sufficient to conclude that the sea shells will be the money in this society. People could still use some other commodity as the money, and then use the actual money to buy the sufficient number of sea shells each year right before paying their taxes.
UPDATE: After originally posting this, I realized there was a problem with one of my examples: In the 1920s amidst the marginal income tax rate cuts designed by Treasury Secretary Mellon, the U.S. was still on the gold standard. Thus this period is not a good refutation of Krugman’s explanation for fiat money’s exchange value. (Of course, we can simply look at other examples of governments that engaged in large-scale tax cuts even while using a fiat currency, and we don’t typically see a sharp rise in price inflation accompanying them.)
Robert P. Murphy is the author of The Politically Incorrect Guide to Capitalism, and has written for Mises.org, LewRockwell.com, and EconLib. He has taught at Hillsdale College and is currently a Senior Economist for the Institute for Energy Research. He lives in Nashville.
A paper currency system contains the seeds of its own destruction. The temptation for the monopolist money producer to increase the money supply is almost irresistible. In such a system with a constantly increasing money supply and, as a consequence, constantly increasing prices, it does not make much sense to save in cash to purchase assets later. A better strategy, given this senario, is to go into debt to purchase assets and pay back the debts later with a devalued currency. Moreover, it makes sense to purchase assets that can later be pledged as collateral to obtain further bank loans. A paper money system leads to excessive debt.
This is especially true of players that can expect that they will be bailed out with newly produced money such as big businesses, banks, and the government.
We are now in a situation that looks like a dead end for the paper money system. After the last cycle, governments have bailed out malinvestments in the private sector and boosted their public welfare spending. Deficits and debts skyrocketed. Central banks printed money to buy public debts (or accept them as collateral in loans to the banking system) in unprecedented amounts. Interest rates were cut close to zero. Deficits remain large. No substantial real growth is in sight. At the same time banking systems and other financial players sit on large piles of public debt. A public default would immediately trigger the bankruptcy of the banking sector. Raising interest rates to more realistic levels or selling the assets purchased by the central bank would put into jeopardy the solvency of the banking sector, highly indebted companies, and the government. It looks like even the slowing down of money printing (now called “QE tapering”) could trigger a bankruptcy spiral. A drastic reduction of government spending and deficits does not seem very likely either, given the incentives for politicians in democracies.
So will money printing be a constant with interest rates close to zero until people lose their confidence in the paper currencies? Can the paper money system be maintained or will we necessarily get a hyperinflation sooner or later?
There are at least seven possibilities:
1. Inflate. Governments and central banks can simply proceed on the path of inflation and print all the money necessary to bail out the banking system, governments, and other over-indebted agents. This will further increase moral hazard. This option ultimately leads into hyperinflation, thereby eradicating debts. Debtors profit, savers lose. The paper wealth that people have saved over their life time will not be able to assure such a high standard of living as envisioned.
2. Default on Entitlements. Governments can improve their financial positions by simply not fulfilling their promises. Governments may, for instance, drastically cut public pensions, social security and unemployment benefits to eliminate deficits and pay down accumulated debts. Many entitlements, that people have planned upon, will prove to be worthless.
3. Repudiate Debt. Governments can also default outright on their debts. This leads to losses for banks and insurance companies that have invested the savings of their clients in government bonds. The people see the value of their mutual funds, investment funds, and insurance plummet thereby revealing the already-occurred losses. The default of the government could lead to the collapse of the banking system. The bankruptcy spiral of overindebted agents would be an economic Armageddon. Therefore, politicians until now have done everything to prevent this option from happening.
4. Financial Repression. Another way to get out of the debt trap is financial repression. Financial repression is a way of channeling more funds to the government thereby facilitating public debt liquidation. Financial repression may consist of legislation making investment alternatives less attractive or more directly in regulation inducing investors to buy government bonds. Together with real growth and spending cuts, financial repression may work to actually reduce government debt loads.
5. Pay Off Debt. The problem of overindebtedness can also be solved through fiscal measures. The idea is to eliminate debts of governments and recapitalize banks through taxation. By reducing overindebtedness, the need for the central bank to keep interest low and to continue printing money is alleviated. The currency could be put on a sounder base again. To achieve this purpose, the government expropriates wealth on a massive scale to pay back government debts. The government simply increases existing tax rates or may employ one-time confiscatory expropriations of wealth. It uses these receipts to pay down its debts and recapitalize banks. Indeed the IMF has recently proposed a one-time 10-percent wealth tax in Europe in order to reduce the high levels of public debts. Large scale cuts in spending could also be employed to pay off debts. After WWII, the US managed to reduce its debt-to-GDP ratio from 130 percent in 1946 to 80 percent in 1952. However, it seems unlikely that such a debt reduction through spending cuts could work again. This time the US does not stand at the end of a successful war. Government spending was cut in half from $118 billion in 1945 to $58 billion in 1947, mostly through cuts in military spending. Similar spending cuts today do not seem likely without leading to massive political resistance and bankruptcies of overindebted agents depending on government spending.
6. Currency Reform. There is the option of a full-fledged currency reform including a (partial) default on government debt. This option is also very attractive if one wants to eliminate overindebtedness without engaging in a strong price inflation. It is like pressing the reset button and continuing with a paper money regime. Such a reform worked in Germany after the WWII (after the last war financial repression was not an option) when the old paper money, the Reichsmark, was substituted by a new paper money, the Deutsche Mark. In this case, savers who hold large amounts of the old currency are heavily expropriated, but debt loads for many people will decline.
7. Bail-in. There could be a bail-in amounting to a half-way currency reform. In a bail-in, such as occurred in Cyprus, bank creditors (savers) are converted into bank shareholders. Bank debts decrease and equity increases. The money supply is reduced. A bail-in recapitalizes the banking system, and eliminates bad debts at the same time. Equity may increase so much, that a partial default on government bonds would not threaten the stability of the banking system. Savers will suffer losses. For instance, people that invested in life insurances that in turn bought bank liabilities or government bonds will assume losses. As a result the overindebtedness of banks and governments is reduced.
Any of the seven options, or combinations of two or more options, may lie ahead. In any case they will reveal the losses incurred in and end the wealth illusion. Basically, taxpayers, savers, or currency users are exploited to reduce debts and put the currency on a more stable basis. A one-time wealth tax, a currency reform or a bail-in are not very popular policy options as they make losses brutally apparent at once. The first option of inflation is much more popular with governments as it hides the costs of the bail out of overindebted agents. However, there is the danger that the inflation at some point gets out of control. And the monopolist money producer does not want to spoil his privilege by a monetary meltdown. Before it gets to the point of a runaway inflation, governments will increasingly ponder the other options as these alternatives could enable a reset of the system.
Note: The views expressed in Daily Articles on Mises.org are not necessarily those of the Mises Institute.
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Philipp Bagus is an associate professor at Universidad Rey Juan Carlos. He is an associate scholar of the Ludwig von Mises Institute and was awarded the 2011 O.P. Alford III Prize in Libertarian Scholarship. He is the author of The Tragedy of the Euro and coauthor of Deep Freeze: Iceland’s Economic Collapse. The Tragedy of the Euro has so far been translated and published in German, French, Slovak, Polish, Italian, Romanian, Finnish, Spanish, Portuguese, British English, Dutch, Brazilian Portuguese, Bulgarian, and Chinese. See his website. Send him mail. Follow him on Twitter @PhilippBagus See Philipp Bagus’s article archives.
End America’s central bank because it caused the crashes of 2008, 1987, and 1929 and will blunder again.
That’s what many critics are saying about the Federal Reserve System (the Fed), which turns 100 on December 23. They note that on the Fed’s watch America has endured numerous bubbles, crashes, and inflationary cycles that have greatly devalued the dollar. The Fed, they say, has caused or aggravated several crashes.
“The Fed’s performance over the century has been abysmal, no matter how you look at it,” says Professor Joseph Salerno, a business professor and monetary expert at Pace University.
“If you say the goal of the Fed was to prevent calamities, then you have to say that it has been a failure,” says William A. Fleckenstein, a hedge fund manager and the author of Greenspan’s Bubbles.
Fleckenstein says he’s seen two bubbles over the past quarter century. He also believes that, under the Fed’s system of easy money, of interest rates of close to zero percent over the past few years that, “the Fed is once again creating a bubble.” The Fed should be abolished, he adds, because it has no accountability for its mistakes.
The length of the Fed’s charter is indefinite, said Fed sources, who would only speak on background. And that is generally the only way Fed sources will speak when asked about the bank’s current policies or historical record.
What is the Fed?
The Fed is a bank for banks that creates money. It is designed to be a lender of last resort to sick banks in times of crisis. And crisis is one reason why the United States finally returned to authorizing a central bank a century ago. (America had previously had a central bank in the 19th century, but its legislative re-authorization was vetoed by Andrew Jackson who railed against a central bank as the tool of moneyed interests.)
The Fed began with the goal of protecting the dollar. It was given the exclusive right to create money in 1913.
The Fed would “provide a means by which periodic panics which shake the American Republic, and do it enormous injury, would be stopped,” according to Robert Latham Owen, one of the authors of the original Federal Reserve Act.
Why was it given these powers?
After the Wall Street banking Panic of 1907 led numerous banks to fail, “there was a growing consensus among all Americans that a central banking authority was needed to ensure a healthy banking system and provide for an elastic currency,” according to the official Federal Reserve history.
But critics claim the Fed has made things worse. Subsequent problems were the result of Fed governors giving in to political pressure, providing elastic or “cheap money.” This is the controversial Fed policy of setting interest rates. If set too low, the rates will mislead consumers and businesses, causing them to borrow too much. And that can lead to a cycle of boom and bust.
That’s what many believe happened in 2007-2008 as millions of Americans were encouraged through cheap-money policies to use subprime loans to buy homes they couldn’t afford. But Fed critics contend that it had happened before.
For instance, interest rates were dirt cheap in 1972, which led later to an economic disaster as inflation jumped to 10 percent and interest rates went to over 20 percent in the 1970s.
“The consequence of the monetary framework of the 1970s was two bouts of double-digit inflation,” said Fed Chairman Bernard Bernanke in a recent speech entitled, “A Century of U.S. Central Banking: Goals, Framework, Accountability.” These 1970s events killed interest sensitive industries and destroyed many small businesses that couldn’t obtain credit.
These controversial money policies have lead to crashes, depressions, and recessions, including the crash of 1929 and resulting Great Depression, critics say. Some 10,000 banks failed between 1930 and 1933, according to Fed numbers.
“Tragically, the Fed failed to meet the mandate to maintain financial stability,” Bernanke said in his speech.
“Many people,” according to the official Fed history, “blamed the Fed for failing to stem speculative lending that led to the crash, and some argued that inadequate understanding of monetary economics kept the Fed from pursuing polices that could have lessened the depth of the Depression.”
One of the people blaming the Fed was economist and monetary historian Milton Friedman. He criticized Fed policies for triggering the 1929 crash and then causing a depression that lasted over a decade.
“Throughout the contraction, the System [the Fed] had ample powers to cut short the tragic process of monetary deflation and banking collapse,” according to The Great Contraction 1929-1933, by Milton Friedman and Anna Schwartz.
To Fed critics, the Great Depression of 1929 and the great inflation of the 1970s were part of a series of policy blunders that happened again in 2008.
“There never would have been a subprime mortgage crisis if the Fed had been alert,” Schwartz told the Wall Street Journal. “This is something Alan Greenspan must answer for.”
In Greenspan’s memoir, The Age of Turbulence, the former Fed chairman conceded that Fed actions leading up to the crisis were dangerous. He wrote: “I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidized home ownership initiatives distort market outcomes.” Still, Greenspan said he believes in the idea of every American having a home.
Economist Laurence Kotlikoff of Boston University says he’d give the Fed a C grade in its first century.
“It didn’t prevent the Great Depression or the Great Recession. It hasn’t fixed the core problems: opacity and leverage in the banking system,” Kotlikoff said.
“Central banking has a poor record but other methods do as well,” adds Jeffrey Gundlach, the manager of the Doubleline Total Return Bond Fund, which invests in mortgage backed securities. Gundlach has been very critical of cheap money policies of the Fed and predicted the crash of 2008. He believes the government should balance the budget first and then consider the Fed’s future.
Other critics, in reviewing the Fed’s record are harsher. They say it is time to end the Fed, in part because it favors certain banking interests.
“The Fed is an instrument of crony capitalism,” warns Hunter Lewis, a money manager and the co-founder of Cambridge Associates, an investment advisory firm.
“The Fed should be abolished because its legal monopoly of the money supply renders it an inherently inflationary institution able to create money at will and without limit,” says Salerno, noting that the value of a 1913 dollar is now five cents.
“History and current experience,” Salerno adds, “reveal to us that groups endowed with a legal monopoly over any area of the economy are prone to use it to the hilt to enrich themselves, their friends and allies.”
This past weekend I caught The Hunger Games: Catching Fire at my local theater. The movie is based on the second part of a dystopian trilogy written by Suzanne Collins. In Collins’s fictional world known as Panem, a despotic government rules over all with a violent iron fist. There is a strict separation between the political class and the rest of the populace, with the latter working in slave-like conditions to support the former. The story focuses on protagonist Katniss Everdeen and her struggle to protect her loved ones while surviving the tyranny of her brutal overlords.
Throughout Catching Fire, the subject of revolution is paramount. Since the first instalment of the series when Katniss bested her oppressive dictators in the highly-publicized, annual fight-to-the-death tournament, she has become a symbol of agitation to the people. They look to her as a chink in the government’s armor – a sign that tyranny is not immortal but can be damaged. The plebs and their desire for freedom results in riots in the streets with vicious crackdowns from Orwellian-named “peacekeepers” who maintain tranquility with the bloodied end of truncheons. At one point during Katniss’s victory tour, an older gentleman raises his hand in defiance of the regime and whistles the popularized tune of revolution. He is summarily executed on the spot while the crowd that attempts to protect him is beaten handily.
The act of violence drew a startled and winced response from the movie audience. It was a demonstration of the horribly destructive nature of tyranny. There was no question as to the evilness of Panem’s dictatorial government. The line between enemy and hero was straight and untainted.
Stories such as the Hunger Games are wonderful things because they spark what conservative statesman Edmund Burke called the “moral imagination.” In his famedReflections on the Revolution in France, Burke chided the Jacobin revolutionaries for endeavoring to paint “the decent drapery of life” and the “moral imagination” as “ridiculous, absurd, and antiquated.” Russell Kirk expanded on this phrase and defined it as the “power of ethical perception which strides beyond the barriers of private experience and momentary events.”
Whether viewers know it or not, the basic plot of the Hunger Games series is an appeal to the moral imagination that men should be free from working as servants to others. It’s not exactly a new theme when compared to other modern movies. There are a multitude of storylines where a strong-willed protagonist finds the courage within themselves to fight off an authoritarian power, not alone, but with the help of others. The narrative follows a familiar pattern: while outgunned and outmanned, good ultimately triumphs over evil not so much because of one person but rather the hope for a better life embodied within a symbol.
The engrossing message of liberty over tyranny in the Hunger Games is thought to be why the franchise is so popular. In some ways, that is correct. People tend to have the urge of rooting for the underdog. When the abuser receives his just deserts, it’s seen as a representation of justice fulfilled.
But as great as the moral imagination is, it ultimately means nothing if it does not translate into real-life behavior modification. It’s one thing to cheer on a character on screen who is risking their life for a freer world. It’s another to embody that risk yourself in a reality that is slipping towards despotism.
Anyone who claims the post-apocalyptic setting in Hunger Games bears an uncanny resemblance to state control in our time is liable to be marked as a black helicopter-type. The ridicule is the same that was aimed, and still is aimed, at Friedrich Hayek after his great work The Road to Serfdom was released. “No,” the critics say, “the existence of the large welfare-warfare state has not translated itself to one world authoritarianism.” That is certainly true for now. Still, the general public finds it fun to mock the government as an over-bearing and inefficient behemoth while relying on the beast for a bi-weekly allotment of tax subsidies.
We may not be living hand-to-mouth while being forced to labor for thuggish overlords but the modern trend is clear: the political class is consuming more and more wealth-generating capital for themselves. It can be seen in highly-unionized European countries and within the bubble of richness known as the District of Columbia. The police state is ratcheting up its already untamed authority. Economic regulation is becoming more varied and intrusive. In the West, the state as an institution has been growing by leaps and bounds for over a century. Only an imbecile would deny this mass centralization in government power.
Yet most viewers of the Hunger Games will not let that message sink into their consciousness. They will not make the connection between a story and their own lives. It’s far too discomforting. At the same time, they will revere characters in a tale who come off as heroes. These fictional thought constructs are viewed as perfectly noble persons who sacrifice for the greater good. One would think the same reverence would be shown to those individuals who engage in the same art of defiance against what is generally deemed an unjust situation. If characters in fiction can be seen as courageous, why not real-life persons who display the same type of behavior?
Edward Snowden, the now-infamous whistleblower of the National Security Agency, is still seen as a dirty, rotten traitor by much of the public. It’s a strange cognitive dissonance that while a majority are irate over their government’s spying, they see the man who clued them in as some type of mendacious plotter who hates Uncle Sam. It’s equally as strange that the same folks who hardly bat an eye when calling Snowden a scumbag will just as quickly latch on to the fighter of injustice in a movie.
Stories provide valuable insight into the limits of mankind and what constitutes good. But they are not reality in the end. There is little risk in admiring a character in fiction who stands up for the right thing. Doing so in real-life is apt to bring ridicule, and thus has a social stigma attached to it.
It takes no spine to be a warrior on paper. It also requires little brain power to bend your will with that of an author’s. The science of critical thinking demands a logical and coherent approach to viewing issues. Criticizing someone for doing the very same action that you praise in make-believe land is inconsistent and a sign of poor judgment. The borderline between the real and the imagination does not render ethics and morality capricious. A proper way to live is to be transcendent of observable examination alone.
Hunger Games contains a pertinent message to those living under big government. The heroes and villains of the story should not be unfamiliar to current events. Edward Snowden is a real life Katniss Everdeen. He defied the powers-that-be in order to do what he believed was right. But instead of receiving praise, he got condemnation from voices normally wary of statism. The irony remains that the same men and women who call Snowden a traitor should be cheering for the tyrannical government of Panem to squash the rebellion and restore its oppressive hold on society. Of course, that suggestion sounds crazy, but then so does the person who pays lip-service to freedom while cheering for the death of someone who risks their life for greater liberty. Their moral imagination is in great need of fine-tuning.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada. Send him mail
On 15 November 1923 decisive steps were taken to end the nightmare of hyperinflation in the Weimar Republic: The Reichsbank, the German central bank, stopped monetizing government debt, and a new means of exchange, the Rentenmark, was issued next to the Papermark (in German: Papiermark). These measures succeeded in halting hyperinflation, but the purchasing power of the Papermark was completely ruined. To understand how and why this could happen, one has to take a look at the time shortly before the outbreak of World War I.
Since 1871, the mark had been the official money in the Deutsches Reich. With the outbreak of World War I, the gold redeemability of the Reichsmark was suspended on 4 August 1914. The gold-backed Reichsmark (or “Goldmark,” as it was referred to from 1914) became the unbacked Papermark. Initially, the Reich financed its war outlays in large part through issuing debt. Total public debt rose from 5.2bn Papermark in 1914 to 105.3bn in 1918. In 1914, the quantity of Papermark was 5.9 billion, in 1918 it stood at 32.9 billion. From August 1914 to November 1918, wholesale prices in the Reich had risen 115 percent, and the purchasing power of the Papermark had fallen by more than half. In the same period, the exchange rate of the Papermark depreciated 84 percent against the US dollar.
The new Weimar Republic faced tremendous economic and political challenges. In 1920, industrial production was 61 percent of the level seen in 1913, and in 1923 it had fallen further to 54 percent. The land losses following the Versailles Treaty had weakened the Reich’s productive capacity substantially: the Reich lost around 13 percent of its former land mass, and around 10 percent of the German population was now living outside its borders. In addition, Germany had to make reparation payments. Most important, however, the new and fledgling democratic governments wanted to cater as best as possible to the wishes of their voters. As tax revenues were insufficient to finance these outlays, the Reichsbank started running the printing press.
From April 1920 to March 1921, the ratio of tax revenues to spending amounted to just 37 percent. Thereafter, the situation improved somewhat and in June 1922, taxes relative to total spending even reached 75 percent. Then things turned ugly. Toward the end of 1922, Germany was accused of having failed to deliver its reparation payments on time. To back their claim, French and Belgian troops invaded and occupied the Ruhrgebiet, the Reich’s industrial heartland, at the beginning of January 1923. The German government under chancellor Wilhelm Kuno called upon Ruhrgebiet workers to resist any orders from the invaders, promising the Reich would keep paying their wages. The Reichsbank began printing up new money by monetizing debt to keep the government liquid for making up tax-shortfalls and paying wages, social transfers, and subsidies.
From May 1923 on, the quantity of Papermark started spinning out of control. It rose from 8.610 billion in May to 17.340 billion in April, and further to 669.703 billion in August, reaching 400 quintillion (that is 400 x 1018) in November 1923. Wholesale prices skyrocketed to astronomical levels, rising by 1.813 percent from the end of 1919 to November 1923. At the end of World War I in 1918 you could have bought 500 billion eggs for the same money you would have to spend five years later for just one egg. Through November 1923, the price of the US dollar in terms of Papermark had risen by 8.912 percent. The Papermark had actually sunken to scrap value.
With the collapse of the currency, unemployment was on the rise. Since the end of the war, unemployment had remained fairly low — given that the Weimar governments had kept the economy going by vigorous deficit spending and money printing. At the end of 1919, the unemployment rate stood at 2.9 percent, in 1920 at 4.1 percent, 1921 at 1.6 percent and 1922 at 2.8 percent. With the dying of the Papermark, though, the unemployment rate reached 19.1 percent in October, 23.4 percent in November, and 28.2 percent in December. Hyperinflation had impoverished the great majority of the German population, especially the middle class. People suffered from food shortages and cold. Political extremism was on the rise.
The central problem for sorting out the monetary mess was the Reichsbank itself. The term of its president, Rudolf E. A. Havenstein, was for life, and he was literally unstoppable: under Havenstein, the Reichsbank kept issuing ever greater amounts of Papiermark for keeping the Reich financially afloat. Then, on 15 November 1923, the Reichsbank was made to stop monetizing government debt and issuing new money. At the same time, it was decided to make one trillion Papermark (a number with twelve zeros: 1,000,000,000,000) equal to one Rentenmark. On 20 November 1923, Havenstein died, all of a sudden, through a heart attack. That same day, Hjalmar Schacht, who would become Reichsbank president in December, took action and stabilized the Papermark against the US dollar: the Reichsbank, and through foreign exchange market interventions, made 4.2 trillion Papermark equal to one US Dollar. And as one trillion Papermark was equal to one Rentenmark, the exchange rate was 4.2 Rentenmark for one US dollar. This was exactly the exchange rate that had prevailed between the Reichsmark and the US dollar before World War I. The “miracle of the Rentenmark” marked the end of hyperinflation.
How could such a monetary disaster happen in a civilized and advanced society, leading to the total destruction of the currency? Many explanations have been put forward. It has been argued that, for instance, that reparation payments, chronic balance of payment deficits, and even the depreciation of the Papermark in the foreign exchange markets had actually caused the demise of the German currency. However, these explanations are not convincing, as the German economist Hans F. Sennholz explains: “[E]very mark was printed by Germans and issued by a central bank that was governed by Germans under a government that was purely German. It was German political parties, such as the Socialists, the Catholic Centre Party, and the Democrats, forming various coalition governments that were solely responsible for the policies they conducted. Of course, admission of responsibility for any calamity cannot be expected from any political party.” Indeed, the German hyperinflation was manmade, it was the result of a deliberate political decision to increase the quantity of money de facto without any limit.
What are the lessons to be learned from the German hyperinflation? The first lesson is that even a politically independent central bank does not provide a reliable protection against the destruction of (paper) money. The Reichsbank had been made politically independent as early as 1922; actually on behalf of the allied forces, as a service rendered in return for a temporary deferment of reparation payments. Still, the Reichsbank council decided for hyperinflating the currency. Seeing that the Reich had to increasingly rely on Reichsbank credit to stay afloat, the council of the Reichsbank decided to provide unlimited amounts of money in such an “existential political crisis.” Of course, the credit appetite of the Weimar politicians turned out to be unlimited.
The second lesson is that fiat paper money won’t work. Hjalmar Schacht, in his 1953 biography, noted: “The introduction of the banknote of state paper money was only possible as the state or the central bank promised to redeem the paper money note at any one time in gold. Ensuring the possibility for redeeming in gold at any one time must be the endeavor of all issuers of paper money.” Schacht’s words harbor a central economic insight: Unbacked paper money is political money and as such it is a disruptive element in a system of free markets. The representatives of the Austrian School of economics pointed this out a long time ago.
Paper money, produced “ex nihilo” and injected into the economy through bank credit, is not only chronically inflationary, it also causes malinvestment, “boom-and-bust” cycles, and brings about a situation of over-indebtedness. Once governments and banks in particular start faltering under their debt load and, as a result, the economy is in danger of contracting, the printing up of additional money appears all too easily to be a policy of choosing the lesser evil to escape the problems that have been caused by credit-produced paper money in the first place. Looking at the world today — in which many economies have been using credit-produced paper monies for decades and where debt loads are overwhelmingly high, the current challenges are in a sense quite similar to those prevailing in the Weimar Republic more than 90 years ago. Now as then, a reform of the monetary order is badly needed; and the sooner the challenge of monetary reform is taken on, the smaller will be the costs of adjustment.