Central Banks Don't Dictate Interest Rates

According to mainstream thinking, the central bank is the key factor in determining interest rates. By setting short-term interest rates the central bank, it is argued, through expectations about the future course of its interest rate policy influences the entire interest rate structure. (According to expectations theory (ET), the long-term rate is an average of the current and expected short-term interest rates.) Note that interest rates in this way of thinking are set by the central bank, while individuals in all of this have almost nothing to do and just mechanically form expectations about the future policy of the central bank. (Individuals here are passively responding to the possible policy of the central bank.)

Time Preference Is the Driving Force

But Carl Menger and Ludwig von Mises suggested otherwise and concluded that the driving force of interest rate determination is not the central bank, but an individual’s time preferences.

As a rule, people assign a higher valuation to present goods versus future goods. This means that present goods are valued at a premium to future goods.

This stems from the fact that a lender or an investor gives up some benefits at present. Hence the essence of the phenomenon of interest is the cost that a lender or an investor endures. On this Mises wrote in Human Action,

That which is abandoned is called the price paid for the attainment of the end sought. The value of the price paid is called cost. Costs are equal to the value attached to the satisfaction which one must forego in order to attain the end aimed at.

For instance, an individual who has just enough resources to keep himself alive is unlikely to lend or invest his paltry means. The cost of lending, or investing, to him is likely to be very high — it might even cost him his life if he were to consider lending part of his means. So under this condition he is unlikely to lend, or invest even if offered a very high interest rate.

Once his wealth starts to expand, the cost of lending — or investing — starts to diminish. Allocating some of his wealth toward lending or investment is going to undermine, to a lesser extent, our individual’s life and well being at present. From this we can infer that anything that leads to an expansion in the real wealth of individuals gives rise to a decline in the interest rate (i.e., the lowering of the premium of present goods versus future goods). Conversely, factors that undermine real wealth expansion lead to a higher rate of interest.

Time Preference and the Demand for Money

In the money economy, individuals’ time preferences are realized through the supply and the demand for money. The lowering of time preferences (i.e., lowering the premium of present goods versus future goods) on account of real wealth expansion, will become manifest in a greater eagerness to lend and invest money and thus lowering of the demand for money.

This means that for a given stock of money, there will be now a monetary surplus.

To get rid of this monetary surplus people start buying various assets and in the process raise asset prices and lower their yields. Hence, the increase in the pool of real wealth will be associated with a lowering in the interest rate structure.

The converse will take place with a fall in real wealth. People will be less eager to lend and invest, thus raising their demand for money relative to the previous situation. This, for a given money supply, reduces monetary liquidity — a decline in monetary surplus. Consequently, this lowers the demand for assets and thus lowers their prices and raises their yields.

What will happen to interest rates as a result of an increase in the money supply? An increase in the supply of money means that those individuals whose money stock has increased are now much wealthier.

Hence this sets in motion a greater willingness to invest and lend money. The increase in lending and investment means the lowering of the demand for money by the lender and by the investor. Consequently, an increase in the supply of money coupled with a fall in the demand for money leads to a monetary surplus, which in turn bids the prices of assets higher and lowers their yields.

As time goes by the rise in price inflation on account of the increase in the money supply starts to undermine the well being of individuals and this leads to a general rise in time preferences. This lowers an individuals’ tendency for investments and lending, i.e., raises the demand for money and works to lower the monetary surplus — this puts an upward pressure on interest rates.

Monetary Policy and Real Wealth

In a market economy within the framework of a central bank, the key factor that undermines the pace of real wealth expansion is the monetary policy of the central bank.

It is loose monetary policy that undermines the stock of real wealth and the purchasing power of money. We can thus conclude that a general increase in price inflation — resulting from an increase in the money supply and a consequent fall in real wealth — is a factor that sets in motion a general rise in interest rates. Meanwhile, a general fall in price inflation — in response to a fall in the money supply and a rise in real wealth — sets in motion a general fall in interest rates.

Furthermore, an increase in the growth momentum of the money supply sets in motion a temporary fall in interest rates, while a fall in the growth momentum of the money supply sets in motion a temporary increase in interest rates.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

mises.org/daily/Frank Shostak/ September 24, 2015

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Markets Brace Themselves for First Rate Hike Since 2006

The first line of The Economist's article puts it this way: "The last time the Federal Reserve raised its benchmark interest rate, there was no one to tweet about it."

That's because there was no such thing as Twitter in June 2006, when the Fed raised the Federal Funds Target rate from 5 percent to 5.25 percent. MySpace was still popular then, too, and YouTube was only 18 months old.

But, since then, the Fed has only decreased the target rate, in spite of multiple claims from the Fed that the economy is "showing signs of strength" and other euphemisms for an economy that's too fragile to endure a rate hike. The effective Fed Funds rate, of course, has been approximately zero since 2008.

So, with nine years between us and the last rate hike, it's understandable that markets may be a bit jittery about a change.

Every time the fed meets, there's speculation that it might raise rates, but this time, there's worry that it might actually happen. After all, the Fed has been threatening to raise rates since at least late last year. But, as David Stockman and others have pointed out, the window for a rate hike may have already closed.  Things may have looked strong enough to justify a hike during the summer, but with recent volatility in the stock market, and August 24's Black Monday, that time may have already passed.

But, the Fed may feel it has to raise rates, at least for a short token period, before it lowers rates again. After all, after nine years, it the Fed has to pretend that a zero rate is not permanent policy.

The consensus among cynics, however, seems to be that the Fed will raise the rates a quarter of a percent, and then quickly lower them against before engaging in fresh rounds of QE. The cynics are probably right.

But even a brief rate hike is way too much for some people. David Stockman writes that "the Keynesian Chorus has launched a full blast trilling campaign, emitting an increasingly shrill cackle of warnings against a Fed rate hike." Stockman incredulously notes that there are economists now out there claiming that the Fed "has become downright restrictive.”

Since 2006, the goal posts have been moved so much that if the Fed simply declines to open the money-creation gates only three-quarters of the way, that's "restrictive." It makes one feel downright old to know one is among those who remember there once was a time when the effective rate might rise above 5 percent. (Fortunately, I'm not ancient enough to remember rates over ten percent.)

But, nowadays, all that matters is QE. There's no need for savings, investment, capital accumulation, or all that old fashioned stuff. We just need more QE, and anything else is "downright restrictive" on the part of the central bank. All of this betrays claims of a strengthening economy of course, since, while we do indeed see numbers — such a job creation and housing starts — that point to "growth," we all know boom is intimately connected to money creation. This is a rickety apple card the Fed doesn't want to upset.

Addendum: For historical perspective, here's an additional graph that shows the target rate back to 1992, so you can see the dot-com bubble years as well. We do find that the Fed, back thebn, was not backed into the corner it is now. There were many factors at work then, including an appetite for dollars and US debt in the developing world.  But there's also reason to believe that there were better economic fundamentals at the time. In any case, there was no need for QE to achieve the levels of growth we can only wish for now.

Graphs by Ryan McMaken. Data source: https://apps.newyorkfed.org/markets/autorates/fed-funds-search-page

mises.org/blog/Ryan McMaken/ September 11, 2015

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Canada's Real Estate Bubble Turns Bust

A report from the Financial Post shows that Calgary in Alberta Canada now has 1.7 million square feet of empty office space, the most in North America with another 5.2 million under construction! After years of booming construction, the natural resource rich country is starting to feel the pinch.

CALGARY – The number of half-empty office buildings in Alberta is projected to spike, as Colliers International predicts an “ill-timed” building boom should push up vacancy rates in Calgary and Edmonton.

In a report released Tuesday, the real-estate brokerage’s chief economist Andrew Nelson said, “the fall in oil prices has had a negative impact on the energy-reliant markets (in Western Canada),” which has contributed to rising vacancy rates and falling rental prices in Alberta’s two largest cities.

Vacancy rates jumped over the course of the second quarter. In Calgary’s case, Colliers reported the downtown vacancy rate rose to 13 per cent from 10 per cent, while Edmonton’s vacancy rate increased to 11.2 per cent from 10.6 per cent.

A glut of new buildings under construction in both cities could push those numbers up even higher.

“Canada is also in the midst of an ill-timed supply surge that caused vacancy rates to rise even in markets with positive absorption in (the second quarter),” the report noted.

There are 5.2 million square feet of office space under construction in Calgary right now, which is the largest amount of new commercial space being built in any city in Canada and could further push up vacancy rates.

Edmonton, a city with a current total of 17 million square feet of office space, is in the middle of its own building boom with over 2 million square feet of space under construction.

But here comes the silver lining!

Some observers see at least a partial silver lining in the numbers.

In recent years, Calgary Chamber of Commerce director of policy and research Justin Smith said, commercial real estate costs downtown Calgary were “going through the roof” and “accelerating at a pace far beyond the Canadian average.”

He said those escalating costs made it difficult for some companies to stay in downtown Calgary and noted that even large companies like Imperial Oil Ltd. and CP Rail Ltd. moved their head offices to the suburbs.

The uptick in vacancy rates, he said, could provide some relief to smaller companies looking to do business downtown, as rental rates are projected to fall as vacancies rise.

However, the numbers in Calgary may understate how much office space is sitting empty as a result of a phenomenon called ghost vacancies, where companies that have cut staff hold onto more office space than they need.

Colliers executive vice-president and partner Jim Rea said that ghost vacancies mean that, even if employment levels rise, vacancy rates may hold steady.

“The ghost space may never come to market, but those companies that currently have excess capacity of office space, as they continue to staff up, you can’t assume that they’ll be back in the market looking for more space,” Rea said.

Weakening demand for office space in both Calgary and Edmonton has resulted in large quantities of commercial real estate coming back on the market this year.

The report showed that 1.7 million square feet of office space has become available in Calgary’s downtown core, thanks in part to thousands of layoffs in the oil patch and a decline in the need for commercial space.

That is the largest quantity of newly empty space in any downtown in North America, including Houston, an oil and gas town where 1.6 million square feet have become available this year.

 HT: RW

mises.org/blog/Mark Thornton/September 10, 2015

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Why Economics Matters

This article is a selection from a June 19 presentation at a lunchtime meeting of the Grassroot Institute in Honolulu at the Pacific Club. The talk was part of the Mises Institute’s Private Seminar series for lay audiences. To schedule your own Private Seminar with a Mises Institute speaker, please contact Kristy Holmes at the Mises Institute.

First let me say that what we today call “Austrian economics” flows from the great legacy of classical economics, with the very important modification economists now call the “marginal revolution.” Austrian economics is also a term that describes a healthy and vibrant (though often oppositional) modern school of economic thought. It originated with intellectual giants like Carl Menger and Ludwig von Mises, names I’m sure many of you are familiar with. These economists were from Austria, hence the term.

There was a landmark conference at South Royalton, Vermont in 1974, attended by the likes of Murray Rothbard and Milton Friedman, that revitalized the Austrian movement and helped it regain prominence in the latter part of the twentieth century. Milton Friedman was in attendance, and that’s when he famously remarked that “There is only good economics and bad economics.”

And of course that’s true. Schools of thought should not be rigid, or dogmatic, or too narrowly defined. But classifying various economists and theories into groups or family trees does indeed help us make sense of economics. It helps us understand how we arrived at a time and place where Ben Bernanke, Paul Krugman, Thomas Piketty, and Christine Lagarde are viewed as modern mainstream thinkers rather than the radicals they are when compared to the whole history of the field.

Image courtesy of Peter Cresswell.

We supplied some photocopies that roughly trace the history of economic thought. Notice the split in the 1930s, not coincidentally during the Great Depression, between Mises and John Maynard Keynes. Up until then, from about 1850 forward, Austrian economics was mainstream economics. But as you can see, most of today’s mainstream economists fall somewhere under the umbrella of Keynes, and they tend to focus on variants of Keynes’s ideas about aggregate demand.

But at least they focus on something!

Ignorance of Economics Is not Bliss

Which leads me to my topic today: “Why Any Economics Matters.” I say “any” because at this point the entire subject appears to be lost on the average American. Economics is not a popular topic among the general population, it would seem. When economics is discussed at all, it’s in the context of politics — and politics gives us only the blandest, safest, most meaningless platitudes about economic affairs.

Bernie Sanders or Hillary Clinton simply are not going to talk much in economic terms or present detailed economic “plans.” On the contrary, they — will assume rightly — that most Americans just don’t have any interest beyond sloganeering like “1%,” “social justice,” “greed,” “paying their fair share,” and the like.

Candidates on the Right won’t be much better. They’d prefer to talk about other subjects, but when they do broach economics they’re either outwardly protectionist like Donald Trump or deadly dull.  Who is inspired by flat tax proposals?

Americans simply aren’t much interested in the details, or even the accuracy, of the economic pronouncements of the political class. We want bread and circuses.

Consider what people talk about on Facebook: lots of posts about family. Lots of posts about celebrities, and sports. Lots of posts about food, health, and exercise. Some posts about politics, culture, race, and sex, but usually only to support one side or bash the other.

Not much, ladies and gentlemen, in the way of economics. And I submit that might be a very healthy thing. After all — we’re rich! Only a wealthy society does not have to focus on the subsistence-level concerns of adequate food and shelter, hot running water, clothing, electricity, and the like.

So let’s not be too hard on people for not spending their free time reading economics. Leisure itself is a very important activity, and represents a form of economic trade-off.

But economics matters very much, and we ignore it at our own peril. Economics is like gravity, or math, or politics — we may not understand it, or even think about it much, but it profoundly affects us whether we like it or not.

Economics as a subject has been captured by academia, and academics like Krugman are not so subtle when they imply that lay persons should leave things to the experts. It’s like team sports — we may be introduced to it when we’re young, but only the professionals do it for a living as adults.

Yet once we understand that all human action is economic action, we understand that we can’t escape or evade our responsibility to understand at least basic economics. To think otherwise is to avoid responsibility for our own lives.

While we shake our heads when twenty year olds can’t read at the college level or do simple algebra, we don’t worry much whether they never take economics. We would be alarmed if our children couldn’t perform basic math to know how much change they should get at a cash register, but we send them out into the world far more susceptible to being cheated by politicians. Why do we want our kids to learn at least basic geography, chemistry, and physics? And grammar, spelling, literature, history, and civics? We want them to know these things so they can navigate their lives properly as adults

But somehow we’ve come to believe economics should be left to academics and policy wonks. And worse yet, we don’t protest when kids grow up to become adults with little or no knowledge of economics, yet still have strong opinions about economic issues.

Ignorance of basic economics is so widespread that we ought to have a specific word for it, like we have for illiteracy or innumeracy.  

The aforementioned Murray Rothbard had this to say: 

It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a “dismal science.” But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

I’m sure we’re all familiar with this phenomenon on social media, which seems perfectly suited to vociferous unfounded opinions.

Let’s consider the minimum wage issue, as one example that’s been in the news lately:

Wages are nothing more than prices for labor services. When the price for something rises, demand drops — and you have more unemployed people than you otherwise would. Pure and simple Econ 101.

Yet what percentage of Americans today have even seen a downward sloping demand chart in a high school or college class?

It is this great and widespread ignorance of economics that plagues our ludicrous political landscape. It allows politicians to attack capitalism, and make demagogues out of entrepreneurs. It allows politicians to blame free markets for the very economic problems caused by the state and its central bank in the first place — like the dot com implosion, like the housing bubble, like the Crash of 2008, like the unsustainable equity prices commanded by US stock markets today.

In short, ignorance of economics allows some very big falsehoods to be accepted as fact by large numbers of people. And it’s only going to get worse as the presidential election of 2016 unfolds.

Read the full text here.

mises.org/mises daily/Jeff Deist/ September 3, 2015

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Stock Market Corrections are Deflationary, but There is No Inflation?

Stock market corrections are by definition deflationary events. Thefinancial press seem to understand this. They’ve even started referring to “bubbles” once again with regard to recent shocks in US and Chinese stock markets. But they never explain what caused the rapid inflationary rise in equity prices to begin with. Somehow this is a mystery, since many economists insist that QE doesn't cause inflation.

The awful truth is that the monetary base has quadrupled since the Crash of 2008. But the simple and obvious inference that adding trillions in new bank reserves to the Fed's balance sheet might cause price bubbles is dismissed as old fashioned thinking.

Here's the question we should be asking in the wake of Monday's crash: did the “wealth” represented by rising equity prices since 2009 (among publicly traded companies in the US) reflect actual increases in productivity, capital expenditures, development of new products and markets, and earnings? Or did rising prices simply reflect the Fed’s relentless increase in base money since 2008, aided by a very unholy stock buyback spree?

A comparison of the Fed’s balance sheet with the performance of US equity markets from 2009-2015 strongly suggests the latter: equity prices have risen nearly as rapidly as the supply of base money. And this rise in equity prices is every bit as much an indication of inflation as a rise in the price of milk at the grocery.

Deflation follows inflation. Anyone asking “Where’s the inflation?” caused by QE need look no further than US equity markets. Many stocks cost three or four times what they did just 6 years ago. Price inflation-- a symptom of monetary inflation-- does not occur uniformly or simultaneously across all prices in an economy. CPI is not the whole story.

The question of whether monetary expansion is benevolent or harmful goes to the heart of whether our economy is real or phony, built on productivity or a house of cards. Enduring economic prosperity requires stable commodity money, profit and loss signals, real earnings and profits, capital accumulation, and investment. There is no shortcut or substitute. 

mises.org/blog/Jeff Deist/ August 28, 2015

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Economics Is Dead, and It Is Being Killed Again

Economics is dead, and economists killed it.

What we have seen over the course of the last eighty years is a systematic dismantling of the contribution of economics to our understanding of the social world. Whatever the cause, modern economics is now not much more than formal modeling using mathematics dressed up in economics-sounding lingo. In this sense, economics is dead as a science, assuming it was ever alive. Economics in mathematical form cannot fulfill its promises and neither the scientific literature nor advanced education in the subject provide insights that are applicable to or useful in everyday life, business, or policy.

But apparently what is dead can be killed again. This, at least, appears to be the goal of the present tide of leftist critics who demand that economics be restructured from the bottom up. Why? The real reason is unlikely to be anything but the common leftist fear of what the science of economics reveals about the economy and the world. As often claimed by ideologues on the left, the science of economics “is ideology.” This is evident, we are supposed to believe, when we consult “scientific Marxism.”

The stated reason in the contemporary discussion is different, however. We need to restructure (if not do away with) economics because, we are told, it has failed. Why? Because economics could not predict the financial crisis of 2008.

These critics of economics will never let a crisis go to waste, and not only do they believe that the most recent crisis should be used to prove the Marxist dogma about the inherent contradictions in the market, but it can also be used as an ostensible reason to rethink the whole science of economics. Indeed, it is general knowledge that economists didn’t foresee the crisis, and their prescriptions to solve it quite obviously haven’t worked, either.

You have to applaud the anti-economics left for this rhetorical masterpiece. They have struggled for decades to sink the ship of economics, the generally acclaimed science that has firmly stood in the way of their anti-market and egalitarian policies, hindered the growth of big government, and raised obstacles to enact everything else that is beautiful to the anti-economics left. The financial crisis is exactly the excuse the Left has been waiting for. It is a slam dunk: government grows, Keynesianism is revived, and economics is made the culprit for all our troubles.

We see this now in education, as students demand to be taught (and professors demand permission to teach) a more “relevant” economics. Relevance, apparently, is achieved by diluting economics with a lot of the worst kinds of sociology, post modernism, and carefully structured discourse aimed to liberate us from our neoliberal bias. And, it turns out, we must also teach Keynesian ideas about how government must save the market economy.

We see this same agenda at academic research conferences, where it is now rather common to hear voices (or, as is my own experience, keynote talks) claiming that “it is time” for another paradigm: post-economics. The reason is always that economics “has failed.”

If this weren’t so serious, it would be amusing that the failure of Keynesian macro-economics (whether it is formally Keynes’s theory or post-Keynesian, new Keynesian, neo-Keynesian, monetarist, etc.) is taken as an excuse to do away with sound micro-economic theory to be replaced with Keynesian and other anti-market ideas. But it is not amusing. If most of the discussions heard are to be believed, the failures of central planning is a reason for central planning, just like socialism is a reason for socialism. The success of the market, on the other hand, is not a reason for the market.

It should not be a surprise that economics has finally become irrelevant after decades of uncalled-for mathematizing and formal modeling based on outrageous assumptions. This perverse kind of pseudo-economic analysis had it coming, really. One cannot calculate maxima for the social world; it is, as Mises showed almost a century ago, impossible. If mathematical economics is finally dead, then that is above all else an improvement.

But the death of mathematical economics should not mean economics is to be rejected. It should mean a return to proper and sound economic analysis — the state of the science prior to the “contributions” of Keynes, Samuelson, and that bunch. Mathematical economics is a failure, but economics proper is still the queen of the social sciences. And for good reason: she relies on irrefutable axioms about the real world, from which logically stringent and rigorous conclusions are derived. The object of study is the messy and sometimes ambiguous social world, but this does not require that the science is also messy and ambiguous. On the contrary, economics is unparalleled in its ability to provide proper and illuminating understanding of how the economy works. It is neither messy nor ambiguous. It brings clarity to the processes that make out the market.

This is the reason why the Left hates all that is economics. Because it points out that creating a better world through central planning, money-printing, and political manipulation is indeed impossible. The market is neither perfect nor efficient, but it is better than any available alternative. In fact, the unhampered market is the only positive-sum means available for human society. The market is indeed the only way of progress; all else is a step backward.

But the market is also uncontrollable and seems, at least to the non-economist, both unpredictable and unintuitive. This is why the Left hates it — and why the Right despises it.

The Left knows full well that they cannot beat proper economics; their ideology will always fail when put up against economic science. But they can beat mathematical economics, since it follows in the tradition of Lange-Lerner market socialism and is fundamentally flawed. They finally have. And they are using this as an excuse to kill economics again. Let’s hope for the sake of humanity that they will fail in their undertaking.

mises.org/ Per Bylund/ August 22, 2015
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

Image source: iStockphoto

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Why Government Hates Cash

In April it was announced that Greece was imposing a surcharge for all cash withdrawals from bank accounts to deter citizens from clearing out their accounts. So now the Greeks will have to pay one euro per 1,000 euros that they withdraw, which is one-tenth of a percent. It doesn’t seem very big, but the principle at work is extremely big because what they’re in effect doing is breaking the exchange rate between a unit of bank deposits and a unit of currency.

Why would they do this? Why would they want to do this? Well, it’s one of the anti-cash policies that mainstream economists have vigorously been promoting.

PAVING THE WAY FOR NEGATIVE INTEREST

To make the calculations easier, and to illustrate the effect, let’s say that the Greek “surcharge” is ten dollars for every 100 dollars withdrawn. Now, instead of being able to convert one euro in your checking account into one euro in cash, on demand, you will only be able to buy one euro in cash by spending 1.10 euros in your bank accounts. That’s a negative 10-percent rate in some sense. That is to say that you can only take out one euro from the bank if you’re willing to pay 1.10 euros. So, you would only really get ninety cents for every dollar that you wanted to withdraw and that’s very significant because this means it will be more expensive to buy an item with cash than with bank deposits.

At the same time, the Greek government made it very clear that if you deposit the cash in the banks, you don’t get 1.10 euros of bank money for every euro you deposit.

So the system is now structured to lock the money in the banks. Now, what does that allow them to do? If you lose 10 percent every time you withdraw one euro in cash, they can lower the interest rate that you get on bank deposits to negative 5 percent, or negative 6 percent. You still wouldn’t withdraw your cash from the banks even if the interest rate went negative.

What we are witnessing is a war on cash in which governments make it either illegal or inconvenient to use cash. This, in turn, allows governments the ability to spy on and regulate financial transactions more completely, while also allowing governments more leeway in manipulating the money supply.

THE ORIGINS OF THE WAR ON CASH

It all started really with the Bank Secrecy Act of 1970, passed in the US, which requires financial institutions in the United States to assist US government agencies in detecting and preventing money laundering. That was the rationale. Specifically, the act requires financial institutions to keep records of cash payments and file reports of cash purchases or negotiable instruments of more than $10,000 as a daily aggregate amount. Of course, this is all sold as a way of tracking criminals.

The US government employs other means of making war on cash also. Up until 1945, there were 500 dollar bills, 1,000 dollar bills, and 10,000 dollar bills in circulation. There was even a 100,000 dollar bill in the 1930s with which banks made clearings between one another. The US government stopped issuing these bills in 1945 and by 1969 had withdrawn all from circulation. So, in the guise of fighting organized crime and money laundering, what’s actually occurred is that they made it very inconvenient to use cash. A one hundred dollar bill today has $15.50 worth of purchasing power in 1969 dollars, when they removed the last big bills.

THE PROBLEM IS INTERNATIONAL

The war on cash in Sweden has gone probably the furthest and Scandinavian governments in general are notable for their opposition to cash. In Swedish cities, tickets for public buses no longer can be purchased for cash; they must be purchased in advance by a cell phone or text message — in other words, via bank accounts.

The deputy governor of the Swedish Central Bank gloated, before his retirement a few years back, that cash will survive “like the crocodile,” even though it may be forced to see its habitat gradually cut back.

The analogy is apt since three of the four major Swedish banks combined have more than two-thirds of their offices no longer accepting or paying out cash. These three banks want to phase out the manual handling of cash at their offices at a very rapid pace and have been doing that since 2012.

In France, opponents of cash tried to pass a law in 2012 which would restrict the use of cash from a maximum of 3,000 euros per exchange to 1,000. The law failed, but then there was the attack on Charlie Hebdo and on a Jewish supermarket, so immediately the state used this as a reason for getting the 1,000 maximum limit. They got their maximum limit. Why? Well, proponents claim that these attacks were partially financed by cash.

The terrorists used cash to purchase some of the stuff they needed. No doubt, these murderers also wore shoes and clothing and used cell phones and cars during the planning and execution of their mayhem. Why not ban these things? A naked barefoot terrorist without communications is surely less effective than the fully clothed and equipped one.

Finally, Switzerland, formerly a great bastion of economic liberty and financial privacy, has succumbed under the bare-knuckle tactics of the US government. The Swiss government has banned all cash payments of more than 100,000 francs (about $106,000), including transactions involving watches, real estate, precious metals, and cars. This was done under the threat of blacklisting by the Organization of Economic Development, with the US no doubt pushing behind the scenes. Transactions above 100,000 francs will now have to be processed through the banking system. The reason is to prevent the catch-all crime, of course, of money laundering.

Chase Bank has also recently joined the war on cash. It’s the largest bank in the US, a subsidiary of JP Morgan Chase and Co., and according to Forbes, the world’s third largest public company. It also received $25 billion in bailout loans from the US Treasury. As of March, Chase began restricting the use of cash in selected markets. The new policy restricts borrowers from using cash to make payments on credit cards, mortgages, equity lines, and auto loans.

Chase even goes as far as to prohibit the storage of cash in its safe deposit boxes. In a letter to its customers, dated April 1, 2015, pertaining to its “updated safe deposit box lease agreement,” one of the high-lighted items reads, “You agree not to store any cash or coins other than those found to have a collectible value.” Whether or not this pertains to gold and silver coins with no collectible value is not explained, but of course it does. As one observer warned, “This policy is unusual, but since Chase is the nation’s largest bank, I wouldn’t be surprised if we start seeing more of this in this era of sensitivity about funding terrorists and other illegal causes.” So, get your money out of those safe deposit boxes, your currency and probably your gold and silver.

ONLY (SUPERVISED) SPENDING IS ALLOWED

Gregory Mankiw, a prominent macroeconomist, came up with a scheme in 2009: the Fed would announce that a year from the date of the announcement, it intended to pick a numeral from 0 to 9 out of a hat. All currency with a serial number ending in that numeral, would instantly lose status as legal tender, causing the expected return on holding currency to plummet to -10 percent. This would allow the Fed to reduce interest rates below zero for a year or even more because people would happily loan money for say, -2 percent or -4 percent because that would stop them from losing 10 percent.

Now the reason given by our rulers for suppressing cash is to keep society safe from terrorists, tax evaders, money launderers, drug cartels, and other villains real or imagined. The actual aim of the flood of laws restricting or even prohibiting the use of cash is to force the public to make payments through the financial system. This enables governments to expand their ability to spy on and keep track of their citizens’ most private financial dealings, in order to milk their citizens of every last dollar of tax payments that they claim are due.

Other reasons for suppressing cash are (1) to prop up the unstable fractional reserve banking system, which is in a state of collapse all over the world, and (2) to give central banks the power to impose negative nominal interest rates. That is, to make you spend money by subtracting money from your bank account for every day you leave it in the bank account and don’t spend it.

Editor’s Note: This article was adapted from a talk delivered at the New York Area Mises Circle in Stamford, Connecticut.

mises.org(daily)/Joseph T. Salerno/August 24, 2015
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

Image source: iStockphoto

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The Fed Is Spooking the Markets Not China

Fasten your seat belts, this ride is getting interesting. Last week the Dow Jones Industrial Average was down more than 1,000 points, notching its worst weekly performance in four years. The sell-off took the Dow Jones down more than 10% from its peak valuations, thereby constituting the first official correction in four years. One third of all S&P 500 companies are already in bear market territory, having declined more than 20% from their peaks. Scarier still, the selling intensified as the week drew to a close, with the Dow losing 530 points on Friday, after falling 350 points on Thursday. The new week is even worse, with the Dow dropping almost 1,100 points near the open today before cutting its losses significantly. However, no one should expect that this selling is over. The correction may soon morph into a full-fledged bear market if the Fed makes good on its supposed intentions to raise interest rates this year. Have no illusions, while most market observers are quick to blame the sell-off on China, this market was given life by the Fed, and the Fed is the only force that will keep it alive.

The Dow has now blown through the lows from October 2014, when fears over life without quantitative easing and zero percent interest rates had caused the markets to pull back about 5%. Back then when market fear began spreading, St. Louis Fed President James Bullard publically issued a few choice words which reassured the markets that the Fed stood ready to reignite the QE engines if the economy really needed a fresh dose of stimulus. By the end of the year the Dow had rallied 10%.

 

Amid last week's carnage, Mr. Bullard was at it once again. But instead of throwing the market a much needed life preserver, he threw it an unwanted anchor. He offered that the economy was still strong enough to warrant a rate increase in September. He was careful to say, however, that the Fed is still "data dependent" and will therefore base its decision on information that will come out over the next three weeks. So after nearly seven years of zero percent interest rates, the most momentous decision the Fed has made since the Great Recession will be dictated by a few weekly data points that have yet to emerge. Haven't seven years of data provided them enough information already? What's next? Will they have to check the five-day forecast to insure that there will be no rain before they pull the trigger? 

 

As I have been saying for years, the Fed has always known that the fragile economy created through stimulus might prove unable to survive even the most marginal of rate increases. But in order to instill confidence in the markets, it has pretended that it could. Wall Street has largely played along in the charade, insisting that rate increases were justified by an apparently strengthening economy and needed to restore normalcy to the financial markets. 

 

But the recovery Wall Street had anticipated never arrived, and traders who had earlier demanded that the Fed get on with the show, have now panicked that the rate hikes are about to occur in the face of a weakening economy. As a result, we are seeing a redux of the 2013 "taper tantrum" when stocks sold off when the Fed announced that it would be winding down its QE purchases of bonds.

 

The question now is how much further the markets will have to fall before the Fed comes to the rescue by calling off any threatened rate increase? What else could pull the markets out of the current nose dive? 

 

Think about where we are. Stock valuations are extremely high and earnings are falling and the economy is clearly decelerating. The steady march upward in stock prices has been enabled by a wave of cheap financing and share buybacks. There are very few reasons to currently suspect that earnings, profits, and share prices will suddenly improve organically. This market is just about the Fed. After one of the longest uninterrupted bull runs in history, bearish investors have learned the hard way that they can't fight the Fed. So why should they now expect to win when the Fed is posturing that its about to embark on a tightening cycle?  

 

If the Fed were to do what it pretends it wants to do (embark on a tightening campaign that brings rates to about 2.0% in 18 months), and in the process ignore the carnage on Wall Street, I believe we would see a consistent sell off in which most of the gains made since 2009 would be surrendered. After all, how much of those gains came from bona fide improvements in the economy? It was all about the twin props of Quantitative Easing and zero percent interest rates. The Fed has already removed one of the props, and it's no accident that the markets have gained no ground whatsoever in the eight months since the QE program was officially wound down. 

 

As the market considers a world without the second prop, a free fall could ensue. Now that we have broken through the October 2014 lows, there is very little technical support that should come in to play. A free fall in stocks could be an existential threat to an already weak economy.  It should be clear the Janet Yellen-controlled Fed would not want to risk such a scenario. This is why I believe that if the sharp sell off in stocks continues, we will get a clear signal that rate hikes are off the table.

 

Of course, even if it does throw us that bone, the Fed will pretend that the weakness was unexpected and that it does not come from within (but is caused by external forces coming from China and Europe). Using that excuse, it will attempt to prolong the bluff that its delay is just temporary. For now at least Wall Street is happy to play along with the blame China game. This ignores the fact that China has had much bigger sell offs in recent weeks that did not lead to follow-on losses on Wall Street. I think the problems in China are the same problems confronting other emerging economies, namely the fear of a Fed tightening cycle that would weaken U.S. demand, depress commodity prices while simultaneously sucking investment capital into the United States, and away from the emerging markets, as a result of higher domestic interest rates and the strengthening dollar.  

 

But if a temporary halt in rate hike rhetoric is not enough to stem the tide, a more definitive repudiation may be needed. Such an admission should finally open some eyes on Wall Street about the true nature of the economy and the unjustified strength of the U.S. dollar. That already may be happening. The dollar index closed at 95 on Friday...down from a high of 98 two weeks prior. On Monday, the index blew through the 93.50 support level and dropped more than 3% in just one day, down to intraday low of 92.6. Who knows where it stops now? 

 

Gold is rallying in the face of the crisis and has moved quickly back to $1,160, up around $80 in just two weeks. The bounce in gold must be causing extreme angst on Wall Street. Just two weeks ago, amid widening conviction that gold would fall below $1,000, it was revealed that hedge funds, for the first time, held net short positions on gold. Those trades are not working out. With the major currencies and gold now strengthening against the dollar, the greenback has had some success against far lesser rivals like the Thai baht and the Kazakhstan tenge. But these victories against currencies largely tied to commodities may be the last fights the dollar wins for a while, especially if Janet Yellen finally comes clean about the Fed's inherent dovishness. Those currencies now falling the farthest may be the biggest gainers if the Fed shelves rate increases. 

 

Some still cling to the belief that the Fed will deliver one or two token 25 basis point rate increase before year end. But this could expose the Fed to a bigger catastrophe than doing nothing at all. If it actually raises rates, and the crisis on Wall Street intensifies, further weakening an already slowing economy, the Fed would have to quickly reverse course and cut back to zero. This would put the Fed's cluelessness and impotency into very sharp focus. From its perspective anything is better than that. If it does nothing, and the economy continues to slow, ultimately "requiring" additional stimulus, it will at least appear that its caution was justified.

 

Unfortunately for the Fed, it won't be able to get away with doing nothing for too much longer. Events may soon force it to show its hand. Then perhaps some may notice that the Fed is holding absolutely nothing and has been bluffing the entire time.

Euro Pacific Capital/Peter Schiff/August 24, 2015

 

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Central Banks and Our Dysfunctional Gold Markets

Many investors still view gold as a safe-haven investment, but there remains much confusion regarding the extent to which the gold market is vulnerable to manipulation through short-term rigged market trades, and long-arm central bank interventions. First, it remains unclear whether or not much of the gold that is being sold as shares and in certificates actually exists. Second, paper gold can theoretically be printed into infinity just like regular currency — although private-sector paper-gold sellers have considerably less leeway in this regard than central banks. Third, new electronic gold pricing — replacing, as of this past February, the traditional five-bank phone-call of the London Gold Fix in place since 1919 — has not necessarily proved a more trustworthy model. Fourth, there looms the specter of the central bank, particularly in the form of volume trading discounts that commodity exchanges offer them.

The Complex World of Gold Investments

The question of rigging has been brought to media attention in the past few months when ten banks came under investigation by the US Commodity Futures Trading Commission (CFTC) and the US Department of Justice in price-manipulation probes. Also around that time, the Swiss regulator FINMA settled a currency manipulation case in which UBS was accused of trading ahead of silver-fix orders. Then, the UK Financial Conduct Authority, which regulates derivatives, ordered Barclays to pay close to $45 million in fines against a trader who artificially suppressed the price of gold in 2012 to avoid payouts to clients. Such manipulations are not limited to the precious-metals market: in November of last year, major banks had to pay several billion dollars in fines related to the rigging of foreign-exchange benchmarks, including LIBOR and other interest-rate benchmarks.
These cases followed on the heels of a set of lawsuits in May 2014 filed in New York City in which twenty-five plaintiffs consisting of hedge funds, private citizens, and public investors (such as pension funds) sued HSBC, Barclays, Deutsche Bank, Bank Scotia, and Société Génerale (the five traditional banks of the former London Gold Fix) on charges of rigging the precious-metals and foreign-exchange markets. "A lot of conspiracy theories have turned out to be conspiracy fact," said Kevin Maher, a former gold trader in New York who filed one of the lawsuits that May, told The New York Times.

Central Banks at the Center of Gold Markets

The lawsuits were given more prominence with the introduction of the London Bullion Market Association (LBMA) on February 20, 2015. The new price-fixing body was established with seven banks: Goldman Sachs, J.P. Morgan, UBS, HSBC, Barclays, Bank Scotia and Société Génerale. (On June 16, the Bank of China announced, after months of speculation, that it would join.)
While some economists have deemed the new electronic fix a good move in contrast to behind-closed-door, phoned-in price-fixing, others beg to differ. Last year, the commodities exchange CME Group came under scrutiny for allowing volume trading discounts to central banks, raising the question of how "open" electronic pricing really is. Then, too, the LBMA is itself not a commodities exchange but an Over-The-Counter (OTC) market, and does not publish — does not have to publish — comprehensive data as to the amount of metal that is traded in the London market.
According to Ms. Ruth Crowell, the chairman of LBMA, writing in a report to that group: "Post-trade reporting is the material barrier preventing greater transparency on the bullion market." In the same report, Crowell states: "It is worth noting that the role of the central banks in the bullion market may preclude 'total' transparency, at least at the public level." To its credit, the secretive London Gold Fix (1919–2015) featured on its website tracking data of the daily net volume of bars traded and the history of gold trades, unlike current available information from the LBMA as one may see here (please scroll down for charts).

The Problem with Paper Gold

There is further the problem of what is being sold as "paper" gold. At first glance, that option seems a good one. Gold exchange-traded funds (ETFs), registered with The New York Stock Exchange, have done very well over the past decade and many cite this as proof that paper gold, rather than bars in hand, is just as sure an investment. The dollar price of gold rose more than 15.4 percent a year between 1999 and December 2012 and during that time, gold ETFs generated an annual return of 14 percent (while equities registered a loss).
As paper claims on trusts that hold gold in bank vaults, ETFs are for many, preferable to physical gold. Gold coins, for instance, can be easily faked, will lose value when scratched, and dealers take high premiums on their sale. The assaying of gold bars, meanwhile, with transport and delivery costs, is easy for banking institutions to handle, but less so for individuals. Many see them as trustworthy: ETF Securities, for example, one of the largest operators of commodity ETFs with $21 billion in assets, stores their gold in Zurich, rather than in London or Toronto. These last two cities, according to one official from that company, "could not be trusted not to go along with a confiscation order like that by Roosevelt in 1933."
Furthermore, shares in these entities represent only an indirect claim on a pile of gold. "Unless you are a big brokerage firm," writes economist William Baldwin, "you cannot take shares to a teller and get metal in exchange." ETF custodians usually consist of the likes of J.P. Morgan and UBS who are players on the wholesale market, says Baldwin, thus implying a possible conflict of interest.

Government and Gold After 1944: A Love-Hate Relationship

Still more complicated is the love-hate relationship between governments and gold. As independent gold analyst Christopher Powell put it in an address to a symposium on that metal in Sydney, October 2013: "It is because gold is a competitive national currency that, if allowed to function in a free market, will determine the value of other currencies, the level of interest rates and the value of government bonds." He continued: "Hence, central banks fight gold to defend their currencies and their bonds."
It is a relationship that has had a turbulent history since the foundation of the Bretton Woods system in 1944 and up through August 1971, when President Nixon declared the convertibility of the dollar to gold suspended. During those intervening decades, gold lived a kind of strange dual existence as a half state-controlled, half free market-driven money-commodity, a situation that Nobel Prize economist Milton Friedman called a "real versus pseudo gold standard."
The origin of this cumbersome duality was the post-war two-tiered system of gold pricing. On the one hand, there was a new monetary system that fixed gold at $35 an ounce. On the other, there was still a free market for gold. The $35 official price was ridiculously low compared to its free market variant, resulting in a situation in which IMF rules against dealing in gold at "free" prices were circumvented by banks that surreptitiously purchased gold from the London market.
The artificial gold price held steady until the end of the sixties, when the metal's price started to "deny compliance" with the dollar. Still, monetary doctrine sought to keep the price fixed and, at the same time, to influence pricing on the free market. These attempts were failures. Finally, in March 1968, the US lost more than half its reserves, falling from 25,000 to 8,100 tons. The price of other precious metals was allowed to move freely.

Gold Retreats Into the Shadows

Meawhile, private hoarding of gold was underway. According to The Financial Times of May 21, 1966, gold production was rising, but it was not going to official gold stocks. This situation, in turn, fundamentally affected the gold clauses of the IMF concerning repayments in currency only in equal value to the gold value of such at the time of borrowing. This led to a rise in "paper gold planning" as a substitution for further increases in IMF quotas. (Please see "The Paper Gold Planners — Alchemists or Conjurers?" in The Financial Analysts Journal, Nov–Dec 1966.)
By the late 1960s, Vietnam, poverty, the rise in crime and inflation were piling high atop one another. The Fed got to work doing what it does best: "Since April [1969]," wrote lawyer and economist C. Austin Barker in a January 1969 article, "The US Money Crisis," "the Fed has continually created new money at an unusually rapid rate." Economists implored the IMF to allow for a free market for gold but also to set the official price to at least $70 an ounce. What was the upshot of this silly system? That by 1969 Americans were paying for both higher taxes and inflation. The rest, as they might say, is the history of the present.
Today, there is no “official” price for gold, nor any “gold-exchange standard” competing with a semi-underground free gold market. There is, however, a material legacy of “real versus pseudo” gold that remains a terrible menace. Buyer beware of the pivotal difference between the two.

mises daily/Marcia Christoff-Kurapovna/July 23, 2015
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

Image source: iStockphoto

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