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The Failure of Keynesianism – Ludwig von Mises Institute Canada
The Failure of Keynesianism – Ludwig von Mises Institute Canada.
It’s hard not to agree with the old aphorism “history doesn’t repeat itself, but it does rhyme.” It’s nice to think we learn from our mistakes; yet we always seem to repeat them at some later date.
Reading the daily news, you would be hard-pressed to find mention that there is still an employment crisis unfolding in many industrialized countries. The New York Times recently reported that employers in the United States hired only 175,000 workers in February. This is apparently a cause for celebration among economists. The unemployment rate in the U.S. still remains at an historic high of 6.7%, and there appears to be no date in sight for a return of full employment, but no matter; the economy is supposedly gaining steam.
The only problem is, nobody seems to care much anymore. High unemployment is a constant reality now. Nearly six years of slagging job creation has created a cloud of apathy for most people. It’s just accepted that not everyone who wants to find work will be able to; or they will wander from low-wage job to low-wage job without any kind of security.
The current economic malaise is reminiscent of what the Great Depression was like. Persistently high unemployment with no conceivable end; massive government intervention in the marketplace; a changing industrial landscape; and even social and cultural transformation. We’re less than a century removed from the biggest economic hardship ever faced in America, and the same mishaps are unfolding in front of our eyes.
Then and now, something has remained perennial: the utter incompetence on government’s part to cure economic stagnation.
Newscasters, state officials, and academic economists all tell us government is capable of spending us into prosperity. No matter how much dough is thrown at the glob known as the “economy,” large numbers of people remain out of work. During the Depression, the glut of joblessness lasted for nearly fifteen years. Uncle Sam spent like a drunken sailor while swallowing up much of the economy in fascist scheme after fascist scheme.
The very same thing goes on today, all at the behest of Keynesian-type political actors who provide the intellectual ammunition necessary to justify government’s outstretched hand. With neatly obscure formulas and obtuse language, the apparatchik darlings of Keynes love branding themselves as deep-thinking scientists capable of engineering the perfect economy. When their policy is put to work, we get the opposite. Job creation stagnates, living standards slump, and misery spreads. The siphons of entrepreneurial growth don’t pump; they are bogged down with the grimy sludge of currency manipulation and government hubris.
After decades of constant failure, I mean this wholeheartedly: the followers of the Keynesian school don’t have a damn clue on how to fix the economy. Why my gauche phrasing? Their policy prescription is a complete and total failure. The Great Depression; the stagflation of the 1970s; the Great Recession we see today; in each instance, Washington was impotent to reverse the damage. Keynesians are either pathetically ignorant, or maliciously deceptive.
Taking rhetorical shots doesn’t mean much without some evidence. So let’s meet the Keynesians on their terms. First, economic science itself will be interpreted through the lens of positivism. That means data, in whatever form, will be used to justify whether something works or not. Of course the assumption will be made that spending is the driver of economic prosperity – not saving or investment. The same goes for boundless money printing, which is said to infuse the “animal spirits” with a rejuvenating elixir.
So what have they got for successes? Keynesians used to tout the efforts of Franklin Roosevelt (not so much Herbert Hoover, who was proto-Rooseveltian) during the Great Depression as vindication for their theory. I remember being told in no uncertain terms that Uncle Sam stepped up to save the downtrodden from excess capitalism in my American Presidency 301 class. Sure, it wasn’t an economics course; but it’s the same tale spun by economists anyway.
What does the data say? From 1931 to 1940, the unemployment rate never went south of 10%. From the onset of the Depression, Washington spending went up 97% under the Hoover Administration. According to the White House’s official statistics, the federal budget increased from $3.5 billion in 1931 to $13.6 billion in 1941, jumping in size year after year. A combination of deficit spending and tax hikes (admittedly not a Keynesian remedy) allowed for this gorge in consumption. Meanwhile, the Federal Reserve goosed the economy by first stabilizing the monetary base and increasing the supply of money after the initial contraction during the Depression’s early years. According to the Historic Statistics of the United States, the Federal Reserve increased its holding of U.S. securities from $510 million in 1929 to over $6 billion in 1942. During the same period, the central bank’s balance sheet went from about $5.5 billion to $29 billion.
That’s no small stimulus. And yet the unemployment rate failed to drop significantly during the Depression years. Most of Keynes’s disciples admit that nearly fifteen years of high unemployment leaves much to be desired on the part of muscular government. The counterfactual is then deployed that Roosevelt’s domestic efforts lightened the economic burden foisted upon America. What finally put the Depression to bed, they argue, was the incredible amount of spending during World War II.
But as economic historian Robert Higgs shows, measures of economic performance were highly skewed during wartime. Unemployment fell and production ramped up, but this was due to the draft and building of armaments. Rationing was widespread to the point where basic foodstuffs and toiletries were scarce. If a wartime economy counts as prosperity, then the homeless today are the living embodiment of luxury.
World War II is a bunk fantasy that in no way proves the Keynesian theory correct. The same goes for the fascist orgy known as the New Deal. Fast-forward to today, and the same charlatans are preaching from the gospel of government interventionism. They implore Washington to fight back against the Great Recession with the same blunted tools: spending and money printing.
When the housing bubble burst and the economy began to tank, then-Chairman of the Federal Reserve Ben Bernanke and crew nearly tripled the central bank’s balance sheet. As of right now, the Fed’s sheet stands at about $4 trillion. In 2008, it was at $800 billion. Not to be outdone, the federal government ramped up spending by running nearly-trilliondollar deficits year-after-year. Once again, all this effort has only made a slight dent in the unemployment rate.
From a strictly empirical perspective, the Keynesian theory is a disaster. Positivism wise, it’s a smoldering train wreck. You would be hard-pressed to comb through historical data and find great instances where government intervention succeeded in lowering employment without creating the conditions for another downturn further down the line.
No matter how you spin it, Keynesianism is nothing but snake oil sold to susceptible political figures. Its practitioners feign using the scientific method. But they are driven just as much by logical theory as those haughty Austrian school economists who deduce truth from self-evident axioms. The only difference is that one theory is correct. And if the Keynesians want to keep pulling up data to make their case, they are standing on awfully flimsy ground.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada. Send him mail
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Keynesian Political Economy Is Theft – Monty Pelerin’s World : Monty Pelerin’s World
Keynesian Political Economy Is Theft – Monty Pelerin’s World : Monty Pelerin’s World.
The plague of our time is Keynesian economics. It has destroyed the economics profession and enabled the political class to obtain powers never intended.
Keynesian economics provided the intellectual cover for the criminal class we politely call “government” to plunder its citizenry. In the beginning, clear-thinking, independent economists (not dependent on government largess) expressed objections to this “new economics.” There was little new in Keynes’ work and many errors that had been debunked decades before Keynes was even born. Bastiat’s parable of the “broken window” in 1850 is probably the best-known refutation, although similar arguments preceded Bastiat by a century or more.
In the 1930s leaders were desperate and willing to try anything. Keynes General Theory was published in 1936, during the middle of the greatest depression the world had ever experienced. Politicians, more so than economists, welcomed his ideas as a new approach.
The Austrian economists represented by Mises and Hayek saw the fallacies in this new approach immediately. Some of the Chicago School (Knight, Simons, Viner) did also. Ludwig von Mises, never one to mince words, described Keynesian economics in the following manner:
What he really did was to write an apology for the prevailing policies of governments.
Mises likely was one of the few who saw the full ramifications of what Keynesian economics would provide for government. Most early criticisms were in terms of the economic unsoundness of the theory.
To contrast the blatant differences between proper economics and Keynesian prescriptions, the following two prescriptions were offered early in this century:
It was proper that one of these men should have won the Nobel Prize in economics. It just happened to be the wrong one.
JAMES BUCHANAN, NOBEL LAUREATE
In 1977 James M. Buchanan and Richard E. Wagner wrote “Democracy In Deficit — The Political Legacy of Lord Keynes” (available online). It was the first comprehensive attempt to apply public-choice theory to macroeconomic theory and policy. According to Robert D. Tollison:
The central purpose of the book was to examine the simple precepts of Keynesian economics through the lens of public-choice theory. The basic discovery was that Keynesian economics had a bias toward deficits in terms of political self-interest.
From Buchanan and Wagner came this judgment regarding Keynesian economics:
The message of Keynesianism might be summarized as: What is folly in the conduct of a private family may be prudence in the conduct of the affairs of a great nation. (p. 3)
This fundamental confusion was responsible for the political acceptance of Keynesian economics. Politicians saw the potential for themselves in this new doctrine which advocated central control of the economy and fiscal irresponsibility as a necessary and patriotic thing. Giving them this gift was like providing matches and gasoline to an arsonist. (“I don’t want to spend money, but I have to otherwise the economy will tank.”)
Once government took control of the economy, they needed economists to provide the analysis and justifications for their new policies. Many in the economics profession were procured in similar fashion used with prostitutes. Money and power were heady incentives for a profession that had rightly been consigned to a section in their own ivory tower.
Justifying what government wanted to do and was doing was the only requisite. But, in order to qualify, it became necessary to convert to Keynesianism. Other branches of economics condemned government policies, at least on economic grounds.
Economists more than most understand incentives. When the payoffs increase, some men in any profession find it easy to modify ethics and integrity.
Buchanan and Wagner knew the damage that Keynesian economics had already inflicted and knew its potential was much greater. Thirty-seven years ago they commented:
What happened? Why does Camelot lay in ruin? Viet Nam and Watergate cannot explain everything forever. Intellectual error of monumental proportion has been made, and not exclusively by the ordinary politicians. Error also lies squarely with the economists. (p. 4)
They answered their own question:
The academic scribbler of the past who must bear substantial responsibility is Lord Keynes himself, whose ideas were uncritically accepted by American establishment economists. The mounting historical evidence of the effects of these ideas cannot continue to be ignored. Keynesian economics has turned the politicians loose, it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax. “Democracy in deficit” is descriptive, both of our economic plight and of the subject matter for this book. (p.4)
Now, thirty-five plus years later, one may judge the merit in this book. Prescience, while not limited to them alone, was amazing.
One must also marvel at the continuation and acceleration of the ruinous policies. Whether Buchanan and Wagner imagined things could go on for so long and to such an extent is not known. However, to appreciate these changes, this graph from Zerohedge shows the effects of Keynesianism and what it has done to governments around the world:
The deterioration in fiscal discipline was astounding and in line what they predicted.
As this false economic theology known as Keynesianism runs its course, the following conclusions are probable:
- Regardless of whether this generation escapes or not, we have impoverished our children and grandchildren.
- Politicians now control most of the economy, including what passes for acceptable economics.
- No honest economist can work for government; nor would one want to.
- The tipping point for reversing this condition has long past.
- Politicians have no incentive to stop the process underway.
- Markets (and perhaps societies and governments) will eventually collapse, ending this terrible period of economic madness.
When this flawed paradigm is finally exhausted, the world may enter a better place in terms of economics and limited government. Without this shift, poverty and misery will grow along with wars used as political diversions.
One can only hope that the world avoids an Economic Dark Age when the collapse occurs.
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Keynesian Political Economy Is Theft – Monty Pelerin's World : Monty Pelerin's World
Keynesian Political Economy Is Theft – Monty Pelerin’s World : Monty Pelerin’s World.
The plague of our time is Keynesian economics. It has destroyed the economics profession and enabled the political class to obtain powers never intended.
Keynesian economics provided the intellectual cover for the criminal class we politely call “government” to plunder its citizenry. In the beginning, clear-thinking, independent economists (not dependent on government largess) expressed objections to this “new economics.” There was little new in Keynes’ work and many errors that had been debunked decades before Keynes was even born. Bastiat’s parable of the “broken window” in 1850 is probably the best-known refutation, although similar arguments preceded Bastiat by a century or more.
In the 1930s leaders were desperate and willing to try anything. Keynes General Theory was published in 1936, during the middle of the greatest depression the world had ever experienced. Politicians, more so than economists, welcomed his ideas as a new approach.
The Austrian economists represented by Mises and Hayek saw the fallacies in this new approach immediately. Some of the Chicago School (Knight, Simons, Viner) did also. Ludwig von Mises, never one to mince words, described Keynesian economics in the following manner:
What he really did was to write an apology for the prevailing policies of governments.
Mises likely was one of the few who saw the full ramifications of what Keynesian economics would provide for government. Most early criticisms were in terms of the economic unsoundness of the theory.
To contrast the blatant differences between proper economics and Keynesian prescriptions, the following two prescriptions were offered early in this century:
It was proper that one of these men should have won the Nobel Prize in economics. It just happened to be the wrong one.
JAMES BUCHANAN, NOBEL LAUREATE
In 1977 James M. Buchanan and Richard E. Wagner wrote “Democracy In Deficit — The Political Legacy of Lord Keynes” (available online). It was the first comprehensive attempt to apply public-choice theory to macroeconomic theory and policy. According to Robert D. Tollison:
The central purpose of the book was to examine the simple precepts of Keynesian economics through the lens of public-choice theory. The basic discovery was that Keynesian economics had a bias toward deficits in terms of political self-interest.
From Buchanan and Wagner came this judgment regarding Keynesian economics:
The message of Keynesianism might be summarized as: What is folly in the conduct of a private family may be prudence in the conduct of the affairs of a great nation. (p. 3)
This fundamental confusion was responsible for the political acceptance of Keynesian economics. Politicians saw the potential for themselves in this new doctrine which advocated central control of the economy and fiscal irresponsibility as a necessary and patriotic thing. Giving them this gift was like providing matches and gasoline to an arsonist. (“I don’t want to spend money, but I have to otherwise the economy will tank.”)
Once government took control of the economy, they needed economists to provide the analysis and justifications for their new policies. Many in the economics profession were procured in similar fashion used with prostitutes. Money and power were heady incentives for a profession that had rightly been consigned to a section in their own ivory tower.
Justifying what government wanted to do and was doing was the only requisite. But, in order to qualify, it became necessary to convert to Keynesianism. Other branches of economics condemned government policies, at least on economic grounds.
Economists more than most understand incentives. When the payoffs increase, some men in any profession find it easy to modify ethics and integrity.
Buchanan and Wagner knew the damage that Keynesian economics had already inflicted and knew its potential was much greater. Thirty-seven years ago they commented:
What happened? Why does Camelot lay in ruin? Viet Nam and Watergate cannot explain everything forever. Intellectual error of monumental proportion has been made, and not exclusively by the ordinary politicians. Error also lies squarely with the economists. (p. 4)
They answered their own question:
The academic scribbler of the past who must bear substantial responsibility is Lord Keynes himself, whose ideas were uncritically accepted by American establishment economists. The mounting historical evidence of the effects of these ideas cannot continue to be ignored. Keynesian economics has turned the politicians loose, it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax. “Democracy in deficit” is descriptive, both of our economic plight and of the subject matter for this book. (p.4)
Now, thirty-five plus years later, one may judge the merit in this book. Prescience, while not limited to them alone, was amazing.
One must also marvel at the continuation and acceleration of the ruinous policies. Whether Buchanan and Wagner imagined things could go on for so long and to such an extent is not known. However, to appreciate these changes, this graph from Zerohedge shows the effects of Keynesianism and what it has done to governments around the world:
The deterioration in fiscal discipline was astounding and in line what they predicted.
As this false economic theology known as Keynesianism runs its course, the following conclusions are probable:
- Regardless of whether this generation escapes or not, we have impoverished our children and grandchildren.
- Politicians now control most of the economy, including what passes for acceptable economics.
- No honest economist can work for government; nor would one want to.
- The tipping point for reversing this condition has long past.
- Politicians have no incentive to stop the process underway.
- Markets (and perhaps societies and governments) will eventually collapse, ending this terrible period of economic madness.
When this flawed paradigm is finally exhausted, the world may enter a better place in terms of economics and limited government. Without this shift, poverty and misery will grow along with wars used as political diversions.
One can only hope that the world avoids an Economic Dark Age when the collapse occurs.
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Hayek On Keynes: “Economics Was A Sideline For Him” | Zero Hedge
Hayek On Keynes: “Economics Was A Sideline For Him” | Zero Hedge.
Keynes will be remembered as “a man with a great many ideas that knew very little economics,” Friedrich Hayek notes in this brief interview and when challenged on his ‘parochial’ knowledge of economic history he was “not sheepish in the least… he was much too self-assured.” Hayek’s perspective casts Keynes in a very different light than his fan’s apostolic adoration might suggest, “he wasutterly contemptuous of anything that had been done before.” While Hayek describes Keynes as one of the most intelligent people he had known, he perhaps sums up the man’s work in this brief phrase – “economics was just a side-line for him.” As we note below, many describe Keynesian policy as ‘dumb’, however a more appropriate word would be ‘foolish’.
Hayek On Keynes
Keynesian Policies: Not Dumb, Just Foolish (via the Ludwig von Mises Institute of Canada)
A lot of my Austrian friends refer to Keynesian policies as “idiotic,” “stupid,” etc., but that’s not really accurate. Indeed, the Keynesian policy prescriptions are so counterintuitive–they so defy common sense–that only very intelligent people with plenty of schooling could have the confidence to utter them with a straight face.
Rather than describing Keynesian policies as “dumb,” I think a more appropriate word is foolish, because the technical analyses of IS/LM curves, talk of the “liquidity trap” and so on, utterly ignore political realities. A great example of this is Matt Yglesias and his handling of Argentina. Back in May 2012–not that long ago, by any stretch–Yglesias held up Argentina as a model for the eurozone countries. He wrote:
Spain is in a complete economic crisis…But perhaps there is a way out, one suggested by the recent experience of Argentina, a nation that’s currently enjoying full employment.
…[W]hen the world economy hit a snag in 2001, trouble emerged for Argentina. Unrelated hidden risks were revealed elsewhere in the global investment landscape and everywhere people got nervous. The foreign capital began to abandon Argentina, reducing investment, employment, and incomes. This in turn sharply reduced the Argentine government’s tax revenues and led to calls for sharp budgetary consolidation…Protesters and rioters took to the streets. President Fernando de la Rua’s party took a beating at the polls. Argentina defaulted on its external debt, broke the rigid linkage between the peso and the dollar, and went back to pursuing an independent monetary policy….
Default and devaluation were hardly a party. They destroyed the country’s banking system and wiped out many Argentines’ savings. But it did work. Argentina has grown rapidly in subsequent years and its unemployment rate has fallen steadily…
So Yglesias was recommending that Spain and other troubled countries ditch the euro and default on their sovereign debts, so they could free their printing press from the shackles of Brussels. The obvious Austrian (and generally free-market) response would be to warn that debasing the currency is hardly the path to prosperity, and that “solving” a crisis in this way would merely sow the seeds of a greater problem down the road. The prosperity coming from the printing press was an illusion.
Well, the economy in Argentina is now “melting down”–Yglesias’ own term. But our fearless Keynesian pundit has nothing for which to apologize. He explains in a January 2014 post:
With Argentina’s economy melting down, I’ve gotten various queries from people asking whether I regret having praised the country’s successful 2002 devaluation and default back in 2012 as an example for Spain and Greece to emulate.
The answer is: absolutely not!
Argentina is a country that has not, historically speaking, been well-governed. In fact one reason that the 2002 default was necessary was that Argentina previously embarked on a deeply misguided currency board scheme. To say that Argentina’s 2002 default and devaluation was the right thing to do and that there are important lessons to be learned from it is not to say that all countries should always emulate Argentina in all respects.
So there you have it, folks: Countries that historically have been ill-governed should follow Argentina’s lead by defaulting on their debts and debasing their currencies, but they should stop right before the bad consequences of these actions come home to roost. Simple as pie. Sort of like giving a bottle of Jack Daniels to some frat guys and sending them to the library to study–what could possibly go wrong?
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The Limits of Stock Chart Reading – Ludwig von Mises Institute Canada
The Limits of Stock Chart Reading – Ludwig von Mises Institute Canada.
Any time people are compelled to decipher the future, strange methods and theories are sure to abound. The stock market has long been a haven of such folly. Among the diviners in that arena, there are believers in the notion that planetary movements affect share values, that stock prices move in predictable wave sequences, and that certain geometric patterns on stock charts presage a change in trend. Nor are these habits of thought restricted to tiny corners of the stock exchange. Such is the eagerness to gain a clue into the future that there’ll always be numerous takers for far-fetched prognostications.
Source: http://www.marketwatch.com/story/scary-1929-market-chart-gains-traction-2014-02-11
The latest example of this is a chart (see above) that is getting wide dissemination on Wall Street. The chart depicts two prices series, one of the Dow Jones Industrial Average between 1928-1929 and the other of that same index from mid-2012 to the present day. The two lines are strikingly similar in their undulations. Indeed, since the resemblance first caught people’s attention this past November, the correlation has persisted. What this is supposed to portend, of course, is a crash along the lines of October 1929.
Yet this presumes that patterns from the past can be reliably expected to recur in the future. It is, as Ludwig von Mises might have put it, to assume that there are constant relations in economic life — that the fact that events of type B have previously followed events of type A means that B will recur whenever A happens to arise. But there are no constant relations in human affairs. For, unlike natural objects, human beings are continually exposed to novel experiences, from which they learn and orient their actions accordingly in unforeseeable ways.
Even the original purveyor of the above chart, Tom McClellan (publisher of the McClellan Market Report), concedes that: “Every pattern analog I have ever studied breaks correlation eventually, and often at the point when I am most counting on it to continue working”. Undaunted by this realization that the past is no certain guide to the future, he nevertheless persists in warning us to be wary about the market.
The only historical pattern with any semblance of predictive significance is the proclivity of the stock market to trend in the same direction for a significant period of time. These trends are commonly known as bull and bear markets. Why these exist is actually something of a puzzle. Stock prices, being time-discounted estimates of future company dividends, ought to gyrate randomly in response to new information. To the extent one ought to expect a trend, it should be a very gently rising one mirroring the long-term rate of economic growth. The reason why this does not occur, however, is that the central bank generates booms and busts with its monetary policies, booms and busts that the stock market ends up reflecting in bull and bear markets.
All that can be usefully gleaned, then, from a stock chart is the prevailing trend. To gauge that one need not draw precise historical parallels with past price movements. A simple moving average — like a 10 month — might do. In other words, if a major index like the S&P 500 is above its 10 month moving average, the trend is up. Conversely, if the index is below the average, the trend is down. Even then, there is no guarantee that the indicated trend will continue for any specific amount of time.
Tomas Salamanca is a Canadian Scholar.
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“The ‘Recovery’ Is A Mirage” Mark Spitznagel Warns, “With As Much Monetary Distortion As In 1929” | Zero Hedge
“Today there is a tremendous amount of monetary distortion, on par with the 1929 stock market and certainly the peak of 2007, and many others,” warns Universa’s Mark Spitznagel.
At these levels, he suggests (as The Dao of Capital author previously told Maria B, “subsequent large stock market losses and even crashes become perfectly expected events.”
Post-Bernanke it will be more of the same, he adds, and investors need to know how to navigate such a world full of “monetary distortions in the economy and the creation of malinvestments.” The reality is, Spitznagel concludes that the ‘recovery is a Fed distortion-driven mirage‘ and the only way out is to let the natural homeostasis take over – “the purge that occurs after massive distortion is painful, but ultimately, it’s far better and healthier for the system.”
Via Investments & Wealth Monitor:
On the “recovery” in the United States…
Spitznagel: The somewhat improved economic activity that we’re seeing is based on a mirage—that is, the illusion created by artificial zero-interest rates.
When central banks lower interest rates in hopes of stimulating the economy, that intervention is not the same as a natural move in interest rates.
A genuine drop in interest rates is in response to an increase in savings, as consumers defer consumption now in order to consume later. In a high-savings environment, entrepreneurs put their capital to work to become more roundabout,1 layering their tools and intermediate stages of production to become increasingly productive. The time to make these investments is when consumers are saving, so that entrepreneurs can be in an even better position to make the products that consumers want, when they want them.
In an artificial rate environment, however, that’s not what’s happening. Instead of consumers saving now to spend later, they are spending now.
But because interest rates are artificially lower, entrepreneurs are being fooled into investing in something now that they will have to back out of later—building up what the Austrians call “malinvestment.” Therefore, the illusion is unsustainable, by definition. The Fed can’t keep interest rates low forever.
From an investor perspective, people are trying to extract as much as they can right now. Consider the naïve dividend investment argument: “I can’t afford to be in cash right now.” Investment managers have to provide returns today.
Whenever investors sell a low dividend-paying stock to buy a higher-dividend stock, some piece of progress is sapped from our economy. (The cash needed to pay that higher dividend isn’t going to capital investment in the company.)
This is the exact opposite of entrepreneurial thinking that advances the economy. Consider the example of Henry Ford, who didn’t care about paying dividends today. He wanted to plow as much capital as possible back into making production more efficient for the benefit of the consumer who would pay less for a higher-quality product.
In summary, a major message of my recent book, The Dao of Capital, is recognizing the distortions that come from central bank intervention. Because of the Fed’s actions, interest rates are no longer a real piece of economic information. If you treat them like they are, you will simply do the wrong thing.
After all, when the government tries to manipulate things, the inverse of what was intended usually happens. On that point, history is entirely on my side.
On The Government & Federal Reserve’s “Interventions”…
Spitznagel: The reality is, when distortion is created, the only way out is to let the natural homeostasis take over. The purge that occurs after massive distortion is painful, but ultimately, it’s far better and healthier for the system. While that may sound rather heartless, it’s actually the best and least destructive in the long run.
Look what happened in the 1930s, when the actions of the government prolonged what should have been a quick purge. Instead, the government prevented the natural rebuilding process from working, which made matters so much worse.
I draw a parallel to forest wildfires. Fire suppression prevents small, naturally occurring wildfires from error-correcting the inappropriate growth, and thus prevents the system from seeking its natural homeostatic balance—its natural temporal structure of production, if you will. Instead, everything is allowed to grow at once, as if more resources exist than actually do, and the forest actually gradually consumes itself. When fire inevitably does break out, it is catastrophic. This is a perfect analogy for the market process. We simply do not understand the great homeostasis at work in markets that are allowed to correct their mistakes.
Suppression that makes the cure that much worse than the initial ill, until exponentially more damage is done, calls to mind the wry observation made by the great Austrian economist Ludwig von Mises: “If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the [opposite] direction.”
As the Mises protégé Murray Rothbard would say, the catharsis needed to return to homeostatic balance “is the ‘recovery’ process,” and, “far from being an evil scourge, is the necessary and beneficial return” to healthier growth and “optimum efficiency.”
It is unfair to call the Austrians heartless because of these views. The Keynesians are the ones who got us into this mess in the first place—just like those who advocated for the suppression of natural forest fires are the ones who created the tinder box that puts the forest at risk.
On The Yellen Fed… (hint – no change)
Spitznagel: Post-Bernanke it will be more of the same. Therefore, investors need to know how to navigate a distorted world—and post-Bernanke the world is likely to get even more distorted—until the markets, ultimately and inevitably, flush out that distortion. This is why I rely on the Austrian school so much.
Austrian business cycle theory (ABCT) shows us what is really happening behind the curtain, so to speak, from monetary distortions in the economy and the creation of malinvestment. When the economy is subject to top-down intervention from the government and especially the central bank, investors need to read the signs in order to protect themselves—as well as still find a way to own productive assets.
People can avoid becoming trapped into chasing immediate returns along with the rest of the ill-fated crowd.
A far better approach is to wait for the return to homeostasis that will prevail even in the midst of pervasive distortion. In that way, investors can embrace roundabout investing by avoiding the distortion and, thus, have all the more resources later for opportunistic investing.
On investing (for retail inevstors)…
Another option for investors is a very simplistic, “mom-and-pop” strategy that starts with recognizing when you are in a distorted environment. For this I use what I call the Misesian stationarity index, which describes the amount of distortion in the economy.
This simple, back-of-the-envelope strategy would be to buy when the index is low and sell when it is high. In other words, people should stay out of the market when it is distorted and thus preserve their capital to deploy after the inevitable purge and correction, when productive assets become bargain-priced. Such an approach has resulted historically in an annualized 2-percent outperformance of stocks. Logically it makes sense, and when you look at it empirically, it’s incontrovertible.
Yet, admittedly, in the world of investing, sitting with one’s arms folded and not taking advantage of a rising market pumped up with distortion, is difficult—even though avoiding the enticement leads to better intermediate means for positional advantage to be exploited later.
It is difficult to do and may even feel anticlimactic. Nonetheless, the disciplined Misesian approach is healthier for one’s portfolio.
On the worst case scenario…
the Fed keeps winning and the illusion continues. The equity markets keep ripping along.
On extreme monetary distrortion and the Q-Ratio…
In simplest terms, the equity Q ratio is the total corporate equity in the United States divided by the replacement cost. Another way to think about it is the appraised value of existing capital in the United States divided by what it would cost to replace or accumulate all that capital.
This ratio has tremendous meaning from an Austrian standpoint, as it reflects what the markets are saying about the state of distortion in the economy.
This aptly illustrates Mises’s concept of “stationarity.” (In a stationary economy, in the aggregate, balance is achieved between the return and replacement costs.) The farther the ratio moves above “1,” the more monetary distortion there is in the economy. For this reason, and as a tip of the hat to the man who gave us the Austrian business cycle theory, I call this ratio the Misesian stationarity index, or MS index for short. When the MS index is high, subsequent large stock market losses and even crashes become perfectly expected events.
Today there is a tremendous amount of monetary distortion, on par with the 1929 stock market and certainly the peak of 2007, and many others (except the 2000 peak, which got a bit more ahead of itself). And all were caused by monetary distortion. As the Austrians show us, the business cycle is a Fed-induced phenomenon.
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Europe’s Future: Inflation and Wealth Taxes – Ludwig von Mises Institute Canada
Europe’s Future: Inflation and Wealth Taxes – Ludwig von Mises Institute Canada.
Tax burdens are so high that it might not be possible to pay off the high levels of indebtedness in most of the Western world. At least, that is the conclusion of a new IMF paper from Carmen Reinhart and Kenneth Rogoff.
Reinhart and Rogoff gained recent fame for their book “This Time It’s Different”, in whichthey argued that high levels of public debt have historically been associated with reduced growth opportunities.
As they now note, “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point.” Up to this point in the Eurocrisis the primary tools used to rescue profligate countries have included increased taxes, EU and IMF bailouts, and haircuts on government debt.
These bailouts have largely exacerbated the debt problems that existed five short years ago. Indeed, as Reinhart and Rogoff well note, the once fiscally sound North of Europe is now increasingly unable to continue shouldering the debts of its Southern neighbours.
General government debt (% GDP)
Source: Eurostat (2012)
Six European countries currently have a government debt to GDP ratio – a metric popularlised by Reinhart and Rogoff to signal reduced growth prospects – of over 90%. Countries that were relatively debt-free just five short years ago are now encumbered by the debt repayments necessitated by bailouts. Ireland is a case in point – as recently as 2007 its government debt to GDP ratio was below 25%. Six years later that figure stands north of 120%! “Fiscally secure” Scandinavia should keep in mind that fortunes can change quickly, as happened to the luck of the Irish.
The debt crisis to date has been mitigated in large part by tax increases and transfers from the wealthy “core” of Europe to the periphery. The problem with tax increases is that they cannot continue unabated.
Total government tax revenue (% GDP)
Source: Eurostat (2012)
Already in Europe there are seven countries where tax revenues are greater than 48% of GDP. There once was a time when only Scandinavia was chided for its high tax regimes and large public sectors. Today both Austria and France have more than half of their economies involved in the public sector and financed through taxes. (Note also that as they both run government budget deficits the actual size of their governments is greater yet.)
With high unemployment in Europe (and especially in its periphery), governments cannot raise much revenue by raising taxes – who would pay it? With already high levels of debt it is questionable how much revenue can be raised by further debt issuances, at least without increasing interest rates and imperiling already fragile government finances with higher interest charges.
Instead, Reinhart and Rogoff see two facts of life for Europe’s future: financial repression through higher inflation rates and taxes levied on savings and wealth. This time is no different than other cases of highly indebted countries in Europe’s history – just look to the post-War examples as similar cases in point. Don’t say you haven’t been warned.
David Howden is Chair of the Department of Business and Economics, and professor of economics at St. Louis University, at its 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.
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Precious Metals in 2014
“Now the New Year reviving old desires
The thoughtful Soul to Solitude retires”
Rubaiyat of Omar Khayyam
Yes folks, it’s that time of year again; but unlike old Khayyam who reflected bucolically on the continuing availability of wine, we must turn our thoughts to the dangers and opportunities of the coming year. They are considerable and multi-faceted, but instead of being drawn into the futility of making forecasts I will only offer readers the barest of basics and focus on the corruption of currencies. My conclusion is the overwhelming danger is of currency destruction and that gold is central to their downfall.
As we enter 2014 mainstream economists relying on inaccurate statistics, many of which are not even relevant to a true understanding of our economic condition, seem convinced that the crises of recent years are now laid to rest. They swallow the line that unemployment is dropping to six or seven per cent, and that price inflation is subdued; but a deeper examination, unsubtly exposed by the work of John Williams of Shadowstats.com, shows these statistics to be false.
If we objectively assess the state of the labour markets in most welfare-driven economies the truth conforms to a continuing slump; and if we take a realistic view of price increases, including capital assets, price inflation may even be in double figures. The corruption of price inflation statistics in turn makes a mockery of GDP numbers, which realistically adjusted for price inflation are contracting.
This gloomy conclusion should come as no surprise to thoughtful souls in any era. These conditions are the logical outcome of the corruption of currencies. I have no doubt that if in 1920-23 the Weimar Republic used today’s statistical methodology government economists would be peddling the same conclusions as those of today. The error is to believe that expansion of money quantities is a cure-all for economic ills, and ignore the fact that it is actually a tax on the vast majority of people reducing both their earnings and savings.
This is the effect of unsound money, and with this in mind I devised a new monetary statistic in 2013 to quantify the drift away from sound money towards an increasing possibility of monetary collapse. The Fiat Money Quantity (FMQ) is constructed by taking account of all the steps by which gold, as proxy for sound money, has been absorbed over the last 170 years from private ownership by commercial banks and then subsequently by central banks, all rights of gold ownership being replaced by currency notes and deposits. The result for the US dollar, which as the world’s reserve currency is today’s gold’s substitute, is shown in Chart 1.
The graphic similarities with expansions of currency quantities in the past that have ultimately resulted in monetary and financial destruction are striking. Since the Lehman crisis the US authorities have embarked on their monetary cure-all to an extraordinary degree. We are being encouraged to think that the Fed saved the world in 2008 by quantitative easing, when the crisis has only been concealed by currency hyper-inflation.
Are we likely to collectively recognise this error and reverse it before it is too late? So long as the primary function of central banks is to preserve the current financial system the answer has to be no. An attempt to reduce the growth rate in the FMQ by minimal tapering has already raised bond market yields considerably, threatening to derail monetary policy objectives. The effect of rising bond yields and term interest rates on the enormous sums of government and private sector debt is bound to increase the risk of bankruptcies at lower rates compared with past credit cycles, starting in the countries where the debt problem is most acute.
With banks naturally reluctant to take on more lending-risk in this environment, rising interest rates and bond yields can be expected to lead to contracting bank credit. Does the Fed stand aside and let nature take its course? Again the answer has to be no. It must accelerate its injections of raw money and grow deposits on its own balance sheet to compensate. The underlying condition that is not generally understood is actually as follows:
The assumption that the Fed is feeding excess money into the economy to stimulate it is incorrect.
Individuals, businesses and banks require increasing quantities of money just to stand still and to avoid a second debt crisis.
I have laid down the theoretical reasons why this is so by showing that welfare-driven economies, fully encumbered by debt, through false employment and price-inflation statistics are concealing a depressive slump. An unbiased and informed analysis of nearly all currency collapses shows that far from being the product of deliberate government policy, they are the result of loss of control over events, or currency inflation beyond their control. I expect this to become more obvious to markets in the coming months.
Gold’s important role
Gold has become undervalued relative to fiat currencies such as the US dollar, as shown in the chart below, which rebases gold at 100 adjusted for both the increase in above-ground gold stocks and US dollar FMQ since the month before the Lehman Crisis.
Given the continuation of the statistically-concealed economic slump, plus the increased quantity of dollar-denominated debt, and therefore since the Lehman Crisis a growing probability of a currency collapse, there is a growing case to suggest that gold should be significantly higher in corrected terms today. Instead it stands at a discount of 36%.
This undervaluation is likely to lead to two important consequences. Firstly, when the tide for gold turns it should do so very strongly, with potentially catastrophic results for uncovered paper markets. The last time this happened to my knowledge was in September 1999, when central banks led by the Bank of England and the Fed rescued the London gold market, presumably by making bullion available to distressed banks. The scale of gold’s current undervaluation and the degree to which available monetary gold has been depleted suggests that a similar rescue of the gold market cannot be mounted today.
The second consequence is to my knowledge not yet being considered at all. The speed with which fiat currencies could lose their purchasing power might be considerably more rapid than, say, the collapse of the German mark in 1920-23. The reason this may be so is that once the slide in confidence commences, there is little to slow its pace.
In his treatise “Stabilisation of the Monetary Unit – From the Viewpoint of Monetary Theory” written in January 1923, Ludwig von Mises made clear that “speculators actually provide the strongest support for the position of notes (marks) as money”. He argued that considerable quantities of marks were acquired abroad in the post-war years “precisely because a future rally in the mark’s exchange rate was expected. If these sums had not been attracted abroad they would have necessarily led to an even steeper rise in prices on the domestic market”.
At that time other currencies, particularly the US dollar, were freely exchangeable with gold, so foreign speculators were effectively selling gold to buy marks they believed to be undervalued. Today the situation is radically different, because Western speculators have sold nearly all the gold they own, and if you include the liquidation of gold paper unbacked by physical metal, in a crisis they will be net buyers of gold and sellers of currencies. Therefore it stands to reason that gold is central to a future currency crisis and that when it happens it is likely to be considerably more rapid than the Weimar experience.
I therefore come to two conclusions for 2014: that we are heading towards a second and unexpected financial and currency crisis which can happen at any time, and that the lack of gold ownership in welfare-driven economies is set to accelerate the rate at which a collapse in purchasing power may occur.
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Less Inflation, Not More – Ludwig von Mises Institute Canada
Less Inflation, Not More – Ludwig von Mises Institute Canada.
Amongst other things, inflation is a form of taxation. As prices rise the purchasing power of savings falls. As a consequence, savers are harmed while creditors gain by having to repay their debts with less valuable money than when they originally borrowed.
With this in mind it is troubling that so many within the central banking establishment are currently arguing that what the world needs is higher inflation.
Janet Yellen, President Obama’s nominee to become the new Chair at the Federal Reserve, has long argued that higher inflation is invaluable when the economy is weak. After all, as her reasoning goes, rising prices bring greater profits to businesses. Rising wages help borrowers repay their debts. And let’s not forget that inflation encourages people and businesses to borrow money to spend more than might otherwise be the case.
Harvard economist and co-author of the influential book This Time It’s Different, Kenneth Rogoff, wrote recently that inflation “should be embraced.” He goes on to explain that “moderate” inflation of 4-6% is helpful when “massively over-valued” assets, such as housing, are in danger of deflating. (I have reviewed Rogoff’s arguments in this book in the first issue of Mises Canada’s Journal of Prices and Markets.)
Such views are no longer in the minority. Indeed, a great number of commentators echo the sentiment that higher inflation is needed now more than ever to “save” the economy. Nothing could be further from the truth.
In formulating his business cycle theory that earned him his Nobel Prize in economics, Friedrich Hayek called the effects of inflation “forced savings.” Inflation induces producers to take on investments through capital expenditures that would be inherently less stable than those brought about by voluntary savings. The unsustainable nature of these investments comes from two facts.
First is that as inflation increases nominal profits, businesses are fooled into thinking that their investments are more profitable than in real (inflation-adjusted) terms. Indeed, cost-based accounting compounds this problem as depreciation allowances, for example, are based on the historical purchase price of an asset and not the higher replacement cost brought about by inflation. Consequently businesses take on investments that are less profitable on the margin than would be the case lacking inflation.
On the other hand, Hayek focused on the time structure of production. It is insufficient for a business to merely produce the amount of goods demanded by consumers. It must also structure its production processes so that its investment yields a profit at that time when consumers stop saving and start demanding goods. This is important as any production process relies on savings to sustain it until it reaches a point of payoff. This point is identified, in the terms of modern finance, as the moment that the net present value of a project turns from negative (e.g., during the initial investment stage) to positive (e.g., when the fruits of this process generate sales).
Inflation skews the structure of production and induces businesses to take on more time consuming, or roundabout, production techniques. This is so because the net present value of any investment project is interest-rate sensitive. As rates fall, as is the case in the short term in real terms as inflation rises, longer durations until payoff will be profitable compared to a lower interest rate environment.
The forced saving that Hayek focused on was the increased investment brought on by inflationary central bank policies. More to the point, his emphasis was on the fact that the investment would be of the incorrect type. Because it does not coincide with real saving preferences, longer-dated and less profitable investments will be made than would otherwise be the case.
These forced investments are not sustainable because they are inconsistent with underlying preferences. Resulting only from the illusion of profitability that low interest rates bring about, these investments will be liquidated when interest rates rise (as would be the case in the long run as higher inflation pushes up borrowing costs) or as their generally unprofitable nature is exposed.
The concerted effort to increase inflation is the same medicine that caused the current economic malaise. The world is rife with poor investments that were undertaken in the past because of inflation-induced forced saving. As central banks pursued inflationary monetary policies businesses were induced into making investments inconsistent with the sustainable needs of the economy.
Calls for further inflation are akin to demands for higher taxes. As inflation redistributes wealth of savers to investors it favours a spendthrift attitude. This has much in common with the idea that increased taxes to allow governments to continue spending will somehow miraculously cure the economy’s woes.
Unfortunately and similar to all redistribution schemes, the result is tenuous. Just as bloated public sectors are now increasingly seen as the causes of the current crisis in such basket-case countries as Greece, for example, so too should inflationary policies be seen in a similar light. By artificially altering savings preferences, inflationary policies breed the unsustainable situations that we call recessions. To the extent that they cause these problems, economists should not be advocating them as means to exit recessions as well.
David Howden is Chair of the Department of Business and Economics, and professor of economics at St. Louis University, at its 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.
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Permanence and the State – Ludwig von Mises Institute Canada
Permanence and the State – Ludwig von Mises Institute Canada.
Engraved outside the National Archives Building in Washington D.C. is the phrase: “This building holds in trust the records of our national life and symbolizes our faith in the permanency of our national institutions.” It’s an uplifting quote meant to channel the spirit of patriotism. It’s also one that is supposed to burn an imprint into the reader’s mind: the state and its behemoth bureaucracies are here to stay.
Monuments of grandeur serve a special purpose. H.L. Mencken once wrote “the average man, whatever his errors otherwise, at least sees clearly that government is something lying outside of him and outside the generality of his fellow men.” This is very much true, and large, menacing buildings such as J. Edgar Hoover Building or the Lincoln Memorial help establish this cognitive divide. By using architectural techniques dating back to ancient Rome, the designers meant to create an aura of endearing superiority for the plebes to drool over.
In a recent National Review piece, Kevin D. Williamson wrote the initial builders of Washington’s various monuments “wanted to show that this new country of free men could hold its head high in the world and stand beside the pomp of any empire.” That may very have been a driving force, but I have a different theory: government monuments are meant to be imposing. But even more than that, they are formed for the purposes of transcending the here and now. If a sense of permanence can be established in the citizenry, there is little standing in the way of perpetual domination. The use of the word “permanency” on the National Archives building is no coincidence. There is no better way to dispel resistance than to perpetuate the idea that it’s futile.
The state, as Rothbard noted, appears to many as “the supreme” and “the eternal.” But that perception is a farce. Very little makes an indelible mark on human history. People are born and die. Businesses start and end. Wealth comes and goes. And states are established and dismantled. None, except for the brightest and most convincing of thinkers, sticks around for very long.
Pulling off immortality would be a great feat for man. But alas, we are born with a set time in the material world. The state’s quest for permanency is nothing but extreme hubris displayed by the most imperialistic of empires. Governments rise and fall all the time. Currently, the regimes in both Syria and the Ukraine risk falling due to civil unrest. In Europe, governments are continually teetering on the brink. Just two decades ago, the Soviet Union collapsed, giving way for a new cronyist form of governance. It was no different from the crumbling of the empires of Rome, Ottoman, and Byzantine.
What truly achieves permanence is not lofty monuments built to worship some all-powerful dictator, but ideas. Mankind’s future is decided on mental battlefields. The very reason we have oppressive governments today is because enough have been fooled to believe that society couldn’t function without them. It’s why public schooling is mandatory in much of the Western world. Get ‘em young, pump ‘em full of tall tales of national glory, and watch ‘em recite the pledge of allegiance until they have one foot in the grave. That’s the tried-and-true formulate for institutionalizing subservience. It’s the Orwellian logic of, “he who controls the past controls the future. He who controls the present controls the past.”
By teaching that monopoly government is eternal, it becomes eternal. The lesson boxes in the thought process of impressionable fellows. It disallows them the ability to conceive of anything different from the status quo. And worse, it ingrains the idea of eternal residing in the heart of national government.
A sloppy understanding of what is really universal follows. No longer are principles seen as defining features for societal relations. Government becomes the focal point of all disputes. Order comes only from the starched-shirt bureaucrat – not from any logical precepts. Discovering the rational boundaries by which humans should live, organize, and govern their actions is the basis of natural law. It is meant to be timeless, applying universally to all humanity. The very notion of an all-encompassing order is a threat to state, which relies on unquestioned obedience. More so, it is threat to the Marxist/progressive theory of ever-evolving laws that replace and duplicate each other on a journey to the end of history.
Even some libertarians doubt the efficacy and truthfulness of permanence in teleological law. In a recent FEE.org debate, minarchist philosopher Tibor Machan wrote, “because none of us is going to live for eternity, none of us can establish anything as timelessly true.” This is the same mindset that decides slavery was once justified, state-enforced segregation was perfectly fine, and unions were a virtuous force in combating excess capitalism. In simpler words, it’s a superfluous understanding of history in relation to logic-based law. What it amounts to is a rationalization of crimes just because they happened in the past. Everything is nothing, and nothing is everything all at once.
Understanding the nature of permanence in relation to government provides insight into how fickle the state truly is. Societies have progressed from despotism to democracy to monarchy to republics. Opinions have changed, elections have occurred, and ruling bodies have been tossed out overnight. No matter how espoused, the sacredness of government eventually unravels. The people are then left staring at the truth: that their leaders are nothing but pompous tyrants.
This tenuous reality was present in the recent public execution of Jang Song-thaek in North Korea. Song-thaek, uncle to supreme dictator Kim Jong-un, was given the death treatment for angering his nephew. The Kim dynasty is supposed to be sacred. Their word is supposed to be God’s. Yet, here a second-hand man by marriage was offed like an injured race horse. In the most tyrannical country on earth, the aura of permanence saw a hole poked through it. In effect, the emperor was revealed to have no clothes, except for some rags of irrational tendencies.
The heads of the state would love nothing more than to wield the force of immortality. It’s a power-trip that pays off financially and mentally. Constructing the potemkin village of surreal authority makes for quick shock and awe. It aides in scaring the citizenry into compliance. But facades don’t last forever, no matter the marble symposiums erected as tribute.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada. Send him mail
Olduvaiblog: Musings on the coming collapse 
