Monday, February 23, 2009

Boom!

Expansion of the money supply through spurious paper currency is always attended by a loss to the laboring classes."
-- Andrew Jackson
"Government is the only agency that can take a useful commodity like paper, slap some ink on it, and make it totally worthless."
-- Ludwig Von Mises
"There is no subtler nor surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
-- John Maynard Keynes
At lunch once some colleagues and I were discussing the financial crisis and one asked the question why the government doesnt just print more money to cover what everyone needs -- print money backed by government reassurances and give it to people for example. Ive heard this remark in other variations and from people Ive talked with from all walks of life, from the college graduate to the tambay, and Ive been struck by the ignorance most people have about how the economy works. Im no expert -- far from it -- but my economics class in third year high school taught me that if supply exceeds demand, the prices of commodities fall, so increasing the supply of money would result in the fall in its value, raising the price of goods and services. I also have a keen bullshit detector, and reading the pronouncements by the leading economic experts of the day has made my bullshit detector go berserk. In that particular lunchtime kwentuhan I was talking about, the question was asked by a graduate of one of our better universities. Such has been our training I suppose that when the economy is in trouble, the government should step in and do something. That's the way it's always been done, the fact that it hasnt worked, that booms and busts still occur, hardly figures in the assessment. The government has to do something. In fact, the present economic crisis is being blamed on the free market. Nothing could be further from the truth. In the present economic paradigm used by governments, the free market is a myth, so in effect, the blame is placed in some mythical creature that doesnt exist. That's because governments want more control of our lives and by blaming the market and not itself, they can have more reason to seize control while the people cheer them on.

In the Keynesian economic paradigm in vogue right now among government planners and academia, government has an active role in the economy. The economy is looked at as some kind of wild, bucking bronco that the government must tame: Inflation is caused by excessive spending, so the government steps in and imposes measures for people to spend less, such as higher taxes; economic depressions occur because people dont want to spend so they impose measures for people to spend more, or take on the act of spending itself. There is something inherently Marxist in the approach to the economy, especially how it views the business cycle and the solution. ("Centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly," Marx urged.) Marx, observing that the business cycle emerged only after the Industrial Revolution, concluded that the cycles of booms and busts were inherent in the free market economy, never mind that classical economic theories from David Ricardo and David Hume identified the cause of the boom-bust cycle on the artificial expansion of bank credit. Keynesians like Paul Krugman admit that booms and busts happen but they dont have a theory as to why. They just happen. Lack of consumer spending? Sure, but why?

In a free economy, some kind of natural selection takes place. Entrepreneurs that can forecast future demand and meet them survive, while entrepreneurs who arent good at it fail. This is normal. But what happens during a bust is that businessmen seem to be making errors in projection at the same time, and even the most astute entrepreneurs arent immune. What gives?

Booms are caused when the government, through its central bank, expands credit by increasing the money supply. This lowers the interest rates, since more money available for credit will tend to lower the cost of money. Ideally, in a market free from government intervention, the source of credit is people preferring to save money, hold them as cash balance, or lend money out as investment, that is, people preferring to spend their money on goods in the future rather than now. Cheaper credit will for instance make investment in production of capital goods more attractive to the businessmen, so investment in factories building capital goods will expand. This is the boom phase. People have jobs and can spend on consumer goods and businesses selling these goods flourish. However, the increase in the money supply was artificial. The money available for credit didnt come from people saving money or preferring to keep them to use them at some future time. This skews the business forecasts of entrepreneurs. They base their business decisions on their ability to forecast future demand, and an increase in the supply of credit makes them think that people have money to spend in the future, but this money doesnt exist. Plus the increase in the money supply has greatly reduced the value of the money people hold. The artifically created credit made businesses invest in factories that would create goods for their perceived increase in demand, but this demand doesnt exist in the particular price that the businessmen are willing to sell them for to make a profit. The bust has begun. If the market were truly free, it will correct itself. Wasteful malinvestment will be liquidated and the money put to better use, however government interferes to keep inflating the bubble, injecting more money and credit into the economy, allowing more malinvestment to take place while at the same time destroying the value of their paper money, setting the economy up for a major crash that just needs a trigger to set off. In short, an artificial increase in the money supply fosters disproportionate malinvestment in one sector or another, whether in new factories or new houses.

University-trained economic 'experts' Ive encountered online are an exasperating lot probably trained in the Keynesian model in which government has to step in to pick up the slack in spending if the consumers won't. In fact I wonder whether other economic paradigms are taught in Philippine universities such as Milton Friedman's Monetarist school or Ludwig Von Mises's and Friedrich Hayek's Austrian school. One of the online 'experts' Ive encountered in fact accepts fractional reserve banking as a matter of course, even thinking it is a boon, instead of calling it the government-backed fraud that it is. (For Keynesians, savers and lenders are entirely different people: Savings “leak” money out of the consumption-spending stream while investments come in from some other phase of spending. The task of government in a depression is to stimulate investments and discourage savings, so that total spendings increase. Classical economists on the other hand treat savings and investments as closely-linked if not practically the same thing. Investment can come from no other source but from savings aside of course from the fraudulent and dangerous government expansion of credit out of nothing.) For this expert, the banks have an absolute right to the money deposited with them to do with as they please because they pay the depositors interest. He could not seem to conceive of banking without the fraudulent fractional reserve system. Such are the people universities are churning out.

The solution to prevent the boom-bust cycle is simple, and not so simple: stop inflating. It's not so simple because the government wants to inflate. It doesnt produce anything so to get funds, it seizes private property in the form of taxes, or it inflates. Raising taxes has political repercussions so it would rather inflate while promoting the myth that inflations just happen. Inflation in fact is just a subtler and more insidious form of taxation where the value of our property is systematically reduced through the creation of central bank issued counterfeit money, where wealth and property from the poor and the middle class goes to the government and its cabal of oligarchs. Therefore to prevent government from inflating, we have to get rid of central banking. Government invented central banking so that it could centralize inflation, that is, it orchestrates the banks in such a way that they inflate at the same time, and this is facilitated by the government edict that only central bank notes are allowed to circulate as money. Without central banking, banks would check each other and prevent the widespread circulation of inflated currency. It goes like this: suppose Bank A decides to issue paper not backed by anything, sooner or later, this inflated currency is going to end up in other banks who will then redeem these papers. If Bank A can't cover the papers, it will trigger a bank run, and without the government and central bank to cover its ass, it'll go down into liquidation. Whatever artificial boom Bank A created will be limited in scope and will be easily corrected.

Another thing to do to prevent the boom-bust cycle is to return to a gold standard, an actual physical standard to which the value of money is to be based. For example, we could peg the peso to 1/10,000th a gram of gold. That of course means that the banks will have to build up its gold reserves from the mines in Masbate and Davao and elsewhere, as well as purchase gold or gold certificates or as a last resort hold reserves in foreign currency tied to the gold standard. In short, we must actually have the stuff before we can mint coins or issue paper notes backed by the stuff. Gold is the ideal stuff because it has been chosen by the free market as the medium of exchange. Citizens should be able to redeem notes they hold for the real stuff from the banks that issued the notes.

These ideas shouldnt be radical. This was the way civilized societies traded before central banks and government-sponsored counterfeiting were invented. It's just that we are in the position Thomas Jefferson was in when he contemplated slavery. He knew it was wrong, but the economy was based in no small part on slave labor so he couldnt imagine giving it up even though he was wracked by guilt about it. Our economy now is based on a similar slavery but this time we are the slaves. It's time we got rid of that slavery as well and be truly free.

References:
Murray N. Rothbard, America's Great Depression, first published 1963
Murray N. Rothbard, What has Government Done with our Money? 1991.

Both are downloadable from the net. Google is your friend. If youre a Keynesian or a Paul Krugman fan, the books represent a paradigm-shift in your view of things, so try to relax while reading them and dont throw a fit.

Update 18 March: In the comment section, I mentioned to R.O. , "Keynes dreamed of a worldwide central bank with one currency and that is closer now than ever before." Guess what? 
The International Monetary Fund is poised to embark on what analysts have described as "global quantitative easing" by printing billions of dollars worth of a global "super-currency" in an unprecedented new effort to address the economic crisis.
Let's hope that this is just a trial balloon to gauge public reaction as this has disaster written all over it. As the linked article points out:
However, economists warned that the scheme could cause a major swell of inflation around the world as the newly-created money filters through the system.


18 comments:

cvj said...

God in heaven and Gold here on earth. If life were so simple...

Jego said...

Not the same. I can see gold, I can touch gold, I can buy and sell gold. I can even wear gold. I can give you gold and you wouldnt doubt it's value. It's not that difficult to believe in gold (or silver, or other tradeable metals). The comparison isnt God and gold. The choice is who do you trust more? Gold or paper; market or government. It's that choice that defines how we view the economy.

But yes, life isnt simple.

R.O. said...

Nice, eye-opening lecture. SO you don't buy the we're-all-socialists-now line, eh?

What do you think of the French model, economically speaking?

Jego said...

I completely buy it. It's the direction the governments are taking us. They won't give up total control now when it's all within their grasp. Keynes dreamed of a worldwide central bank with one currency and that is closer now than ever before. (I sometimes feel like there are just a few of us in The Matrix who knows how deep the rabbit hole goes. But Im not a Morpheus or a Neo. Im just an average Joe. :-D )

Im not familiar with the French model though. I'll try to look it up.

WillyJ said...

Hi Jego,
I'm an economics grad but all I remember right now is the concept of laissez-faire. not much else. On the other hand, one of the lessons of the Great Depression was that the inherently self-interested tendencies of human nature challenged secular liberalism and the Social Gospellers. The "brutalities of the conflict of power", as Niehbur saw it,naturally gives rise to social conflicts and the depression.
I have read some comments about Obama's stimulus plan as bound to matters worse in the long run. not encouraging healthy competition and bailing out the inefficient, something like that. I am not a fan of the guy, but I hope he's
right on track.

Jego said...

No kidding, Willy? We learned laissez-faire in high school. (Teka, do they still teach economics in high school today? Dati it's part of the DECS curriculum.) In any case, laissez-faire doesnt exist anymore. The government doesnt want competition in the embezzlement racket. :-D

The stimulus plan is part of the Keynesian playbook, that is, if consumers won't spend, government has to pick up the slack (by borrowing money from the Fed who then creates more money). It's like treating a heroin addict by giving him more heroin.

The Monetarists recommend lowering interest rates. The Austrian school recommends laissez-faire, letting companies liquidate and freeing the market to revalue stuff including labor (there will be an oversupply of labor so the price of labor will drop). This way, they said, the depression will be over in a year or so, not the 15 to 20 years it took for the Great Depression which only ended after the war. Keynesian and Monetarist solutions have been tried and have been failures. But theyll keep trying to do the same thing over and over and over again. Government and its oligarchs arent affected by economic downturn (counterfeit money benefits the counterfeiters) so why should they care? They have a pretty good gig.

WillyJ said...

No wonder laissez-faire doesn't exist anymore. It was once thought that by simply pursuing ones self-interests, one contributed to the common good. The Depression and today's crisis disprove that. Seems like a self-defeating philosophy, actually encouraging social conditions where the majority lives in want under the economic tyranny of a few.

"But they'll keep trying to do the same thing over and over and over again"

That doesn't inspire us much: if you do what you always did, you get what you always got. :-(

stuart-santiago said...

hey jego, you talk / write more economic sense than most economists i've read. more please ;)

Jego said...

Thanks, angela. The ideas arent mine though. I stole them from economists and libertarians like Murray Rothbard, Llewelyn Rockwell, Peter Schiff, Ron Paul, and bloggers who didnt trigger my bs detector. :-)

(Im still unclear about how to shift from fiat currency to hard currency though. For example, does our central bank have enough gold? The Americans, Russians, and South Africans probably do.)

GabbyD said...

hey, jeg... nice blog!

question, according to the austrian theory:

... when investors increase investments as interest rates fall, shouldn't the money come from savers?

but as interest rates fall, don't savers save less?

in macro 101 there is a simple identity:
Y=C+I+G, (lets say there are no exports).

Y-C-G=I or S=I.

so if savings and investment go up together.

in your formulation, when I goes up, what does S do?

Jego said...

Hi Gabby. Nice of you to drop by. And such great timing. I don't get to access this blog as often now that Im in China.

but as interest rates fall, don't savers save less?

I dont know whether or not this is from the Austrian school but savers save because they dont want to spend yet, no matter what the interest rate is. They can keep it in a safe deposit box or under their kutson. For example, I have money for an iPod but I know that the prices of iPods will fall in the future. That means I won't buy the iPod now and keep my money as cash balance til the prices fall. If prices show a trend toward rising however, the incentive to save disappears. People will want to spend their money now.

You'd have to elaborate on what all those letters mean, though. My only economics courses were in high school with all those equilibrium graphs.

GabbyD said...

thats just GDP is the sum of consumption, investment.... etc..

its an identity...

all it says is that savings must equal investment.

so if investment is going up saving is also.

so in your story, if investment is going up, savings must be going up too.

but why/how? interest rates affect both savings and investment, ala supply and demand (i.e. savings is the supply of investment funds).

GabbyD said...

thats just GDP is the sum of consumption, investment.... etc..

its an identity...

all it says is that savings must equal investment.

so if investment is going up saving is also.

so in your story, if investment is going up, savings must be going up too.

but why/how? interest rates affect both savings and investment, ala supply and demand (i.e. savings is the supply of investment funds).

Jego said...

What we have here are two things: time preference and money utility or demand for money. Time preference determines the proportion between consumption and savings and investment (present consumption vs. future consumption), and money utility determines the proportion of income one wishes to 'hoard', that is, not consume or not invest. These two are unrelated. But investment should only come from savings. Keynesian doctrine assumes that any increase in hoards will be matched by a corresponding fall in invested funds. This is not so. And in my previous comment, I showed that the decision to hold off on consumption is unrelated to the interest rate.

Did I answer your question? Sorry. Can you elaborate? Im really interested in your little equation.

GabbyD said...

Here is my question:

when investment increases, the money must come from SOMEWHERE.

the question is where?

... when investors increase investments as interest rates fall, the money must come from savers.

Y is GDP
C is consumption
I is investment

Y=C+I by construction.

Y-C=I which is just S=I. here i assume that there are no exports or imports.i don't think this is material to your story, but do tell me if it actually is.

this 'little equation' appears in any college macro book. check one out!

Now, this is an IDENTITY. i has to be true, regardless of what your beliefs are about the determinants of saving. Btw, there is evidence of the importance of the interest rate to savings decisions.

so basically, back to the question. if Investment is rising for some reason (i'm not sure why yet), then savings must match it.

how?

i get time preference. i get (liquidity) demand for money. in a modern economy though most money will be in banks, so the demand for currency for transactions purposes cant be very high.

your latest comment makes me wonder:
" Keynesian doctrine assumes that any increase in hoards will be matched by a corresponding fall in invested funds. This is not so."

why not? if no one is lending, how can investment get started? i think you are describing a liquidity trap, where nominal interest rates are so low, they don't care if they are holding money or an interest rate earning asset.

what happens to S=I identity? it holds.

but at a lower value of S and I.

Jego said...

when investment increases, the money must come from SOMEWHERE.

Ok, Im with you so far...

Y=C+I by construction.

Y-C=I which is just S=I.


No need to check out a macro textbook (=yawn=). I trust you.

Your question is: If Investment is rising for some reason (i'm not sure why yet), then savings must match it. How?

If it's an identity, then the point is moot. Maybe that's why I dont get the question. If theyre the same thing, then if savings rises, investment also rises. Investment must come from no other source. If there are no savings, where else can investment come from? I think your question is upside-down. There can be no rise in investment unless there is savings. At least that's how it ought to be. In the real world run by economists mostly directly or indirectly on the government payroll, investments can rise even without the rise in savings.

so the demand for currency for transactions purposes cant be very high.

I meant demand for money as money. To keep for future use: future consumption, investment, whatever.

why not? if no one is lending, how can investment get started?

Does someone really have to lend for investments to get started? Why can't I use my own money which I saved? Why can't I get a group of us to co-own a business using money we saved and not have to go to some bank and borrow money? Why can't I sell stock in a company?

I get a feeling that we're talking past each other, probably because of a difference in paradigm. I think economic 'growth', the kind that stems from lending from artificially created bank credit and government spending, is not necessarily a good thing. I think governments and people should live within their means and not borrow from future generations who have no say on the matter of how we screw up their future for them.

You seem to know a good deal about the topic, Gabby. Why not start a blog?

***

Btw, there is evidence of the importance of the interest rate to savings decisions.

Im sure there are. But to what extent does the interest rate being offered by a bank figure in the decision to save? Why do we save, and do we here on the ground away from academia, check out the interest rates first before we decide to save? Methinks inflation rates figure more than interest rates banks offer. That is, an ordinary person will save if that person calculates that the losses he will incur due to inflation is acceptable if he decides to spend money in the future rather than now. If it is not acceptable, a person would rather spend now than incur greater losses. (By inflating currency, the government steals money from savers, the very people they need to help the economy.)

GabbyD said...

i was curious about the implication of the story in your original blog post... austrian econ confuses me. i thought since u had read it, you can provide me with insight...

i remember from basic macro that S=I but if I goes up, S must go up too. but it seems from your original story that S doesnt change at all (i.e. there is a mismatch between S and I, according to the austrian story).

anyways, thanks for taking the time...

Jego said...

Im hardly an expert in Austrian economics, or any other economics for that matter. Im approaching this from a skeptic's point of view, and I think mainstream economists deserve every bit of skepticism they get. It is easy to see that the Keynesian orthodoxy has failed, but it is in government's best interests to keep propping it up as it has been very lucrative for them and their oligarchs at the expense of the rest of us.

i remember from basic macro that S=I but if I goes up, S must go up too. but it seems from your original story that S doesnt change at all (i.e. there is a mismatch between S and I, according to the austrian story).

Sorry if I gave that impression. Austrian theory does state that (S) and (I) are so intertwined, theyre practically the same thing, only I get the impression that (I) can only rise if (S) rises, not the other way around, as in your basic macro class.