|
At the Fall Meeting,
20th October 2011.
Before addressing the consequences of today’s
macro-economic policies I want to tell you my philosophy. I support sound
money for two very good reasons:
1. Firstly, it
is a basic human right to choose to save, without our savings being debased
by the tax of monetary inflation. Those that are worst affected by this
inflation tax are not the rich, they benefit; but the poor and the barely
well-off, which is why monetary inflation undermines society and why the
right to sound money should be respected. If government gives itself a
monopoly over money, it has a duty to protect the property rights vested in
it.
2. Secondly,
it is a basic right for us to own our own money rather than have it owned by
the banks. For them to take our money and expand credit on the back of it
debases it. It is an abuse of an individual’s property rights and a
banking licence is a government licence to do so. If anyone else was to do
this, they would be guilty of fraud. Banks should be custodians of our money,
and it should not appear in their balance sheets as their property.
If we had stuck to these sound money principals,
several benefits automatically follow, some of which I will briefly summarise
for you, and I will have a little more to say about them in a moment:
1. With
sound money, governments cannot print money to fund their activities, so the
true cost of government becomes apparent to the electorate. The result is
that in a democracy the electorate votes for small government because
profligate politicians simply do not get elected. Indeed, we need sound money
for democracy to work.
2. With
sound money, governments are unable to go to war without taxpayers being
conscious of the true cost. This is a great incentive for peace and an
electorate that accepts the benefits of free markets, and therefore peaceful
trade, is less belligerent.
3. With
sound money, savings are protected. Prices tend to fall gradually over
time, reflecting improved efficiencies in production and of economic progress
generally. So the purchasing power of savings increases over the years. For a
pensioner, the purchasing power of his savings grows. He can then afford the
healthcare he increasingly requires as he ages, and he can afford to leave
something for his family when he dies. His savings work with his needs, which
is the opposite of the situation in our inflation-ridden economies. In a
sound money economy, our pensioners look after themselves and need not be a
burden on the state.
4. With
sound money, business cycles do not occur. The business cycles we are
familiar with are in fact credit-driven cycles, the result of central banks
expanding money and overseeing bank credit. They are the result of the
misconception that monetary expansion leads to growth. It doesn’t: it
merely distorts the economy by favouring a select few at the expense of the
many.
These are just some of the benefits of sound money;
benefits we can only dream about today. So long as we have unsound money we
will have difficulties that will always end in a crisis. Today, we have sunk
to the point where the answer to everything is found in more money and bank
credit instead of the genuine production of goods and services.
The long-term consequence of monetary inflation is
that voters now believe that a government always has the money to provide
everything they need. So they naturally vote for more government. They do not
question the source of government’s money. They have also been
encouraged to believe that the freedom for everyone to do what they want with
their own money, only enriches the few, when the
opposite is the case. People have become genuinely frightened by the thought
of free markets. For this reason, governments regulate most of the private
sector. Between government spending and government regulation, the private
sector is now dominated by government interference. A minimal amount of
capitalism is tolerated in economies that are otherwise socialistic; yet our
ills are blamed on the only part of the economy that actually works.
The most effective curb on political ambition is
sound money. But we don’t have sound money. So government abuses its
monopoly power over the currency to pay for its ambitions. Fiat money
gives a free rein to the ambitious politician. The First World War was made
possible by German economists, led by George Knapp, the Keynes of his day. He
showed the Kaiser the way to finance a war without
increasing taxes. In the four years from 1913 the Reichsbank increased paper
money in circulation to pay for 85% of Germany’s war expenditure for
those years. Of course, after that the script did not go to plan, and as we
all know it ended with the total collapse of the currency in 1923.
Collapse the currency, and you collapse savings.
Savings today are continually devalued by the expansion of money and credit.
Only a fool lends his money for an interest return, and savers are therefore
forced to speculate to protect themselves. The result is that there is now a
separate destabilising pool of foot-loose capital. It is used by the
financial engineers of Wall Street and the City of London to offer higher
speculative returns. It has become the feedstock for spendthrift borrowers,
particularly governments, who have no intention of ever repaying it.
The damage of unsound money to business has been
acute. Business cycles are actually credit cycles, the result of the central
banks’ monetary policies. It is easy to
understand why the expansion of money and credit drives us into cycles of
boom and bust – the exact opposite of what it is meant to achieve.
Take the example of businesses operating
with sound money. A business developing a new product or improving an
existing one has to invest its own funds, or find a lender with savings. In
either case, this takes money away from consumption, money that is
reallocated into savings and from there into the proposed investment. And because
this money is not spent on consumption, the labour and raw materials required
for any new project become available. There is a shift of resources from
consumption into savings, from savings into investment, and from there into
capital goods. A balance is maintained within the economy and there is no
boom and bust. It is a non-cyclical process, driven only by peoples’
economic needs. Business activity is inherently stable.
Now look at the situation when business
investment is financed by newly created money and bank credit instead of
savings. The process starts with the central bank lowering interest rates.
Cheap credit makes investment appear attractive, so the businessman borrows
to invest in his business. But many other businessmen are encouraged by the
same cheap credit to do the same thing at the same time.
Businesses start investing
simultaneously. The randomness has gone. But it gets worse: cheap money also
supports consumption, because saving money is less attractive due to lower
interest rates.
So our businessman has to bid up for
labour, because it hasn’t been released by lower consumption, and he is
in competition with the other businesses also taking advantage of cheap
credit. He has to pay up for raw materials, for the same reasons. The combination
of industry and consumers responding to cheap finance, in the short-term will
drive the economy better. But with no extra resources available, prices rise
due to bunched demand. And since the quantity of money in the economy has
increased, its purchasing-power also falls; exacerbating price inflation even more.
And with prices now rising strongly,
interest rates also now rise from artificially low levels. Our
businessman’s plans are totally screwed. He got the cost of labour and
raw materials completely wrong, and because interest rates have shot up, his
Return-On-Investment calculations turn out to be far too optimistic. And to
make matters worse, the deteriorating economic conditions that follow, as
surely as night follows day, forces him to accept that his sales projections
were also too optimistic.
His fellow entrepreneurs are in the same
boat. Businesses start cutting back. They act as a crowd on the way up and on
the way down.
The essential point is fake money has
created a business cycle which didn’t exist before. It is never just a
question of central banks getting their timing wrong, as many suppose.
The central bank then compounds the
problems it has created by again lowering interest rates with the downturn.
More than anything else it is scared of a fall in GDP, so it cannot allow the
distortions and false investments of the earlier round of monetary
stimulation to unwind properly.
But next time round, the businessman is
not so easily tricked. He builds greater margins into his investment calculations.
So the economy becomes slower to respond to a new, deeper round of interest
rate cuts. The central bank has to act more aggressively to create yet more
fake money, to get a result.
These credit expansions work like a
ratchet, becoming more destabilising over each credit cycle.
The businessman eventually wises up,
overcomes his patriotic instincts and moves his manufacturing to somewhere
where at least some of the factors of production are available. He needs to
plan for ten, fifteen, twenty years. He cannot afford to ride destructive
credit-driven cycles of three or four years. It is cheaper for him to build a
factory in the jungle and train up hard-working natives. It is unsound money
that has driven him abroad more than any other factor. Over a number of these
credit cycles, the economy in countries with falling savings, like the US and
UK, becomes more and more dependent on consumption, and less and less on
manufacturing.
And eventually, to encourage GDP growth,
consumers are encouraged to actually borrow to spend and abandon saving
altogether. So on every credit cycle, savings diminish and debt increases,
finally accelerating to unsustainable levels of debt. And that is where we
arrived in 2008. That marked the end of the road for the post-war Keynesian
experiment.
So understanding our economic condition from a sound
money perspective gives us a unique viewpoint. It makes it easier to see
through the fog of weak money. It also allows us to see through the problems
posed by reconciling contrary statistics. And it is here that the
establishment deludes itself as well as the rest of us.
The abuse of the GDP statistic is the most important
delusion of all, because all economic policy is directed at ensuring it
grows. But we must stop and think what it actually represents. GDP is not
economic output, it is its money-value, which is a
very different thing. It gives us no information about the relative values of
the goods and services that constitute the economy.
It is crucial to appreciate this distinction, so by
way of explanation let us again assume sound money. This is like an economy
operating with gold as money and without credit expansion. To keep it simple,
assume that trade is in balance, and there are no net capital flows to or
from other countries. Therefore, at the end of the year, there is exactly the
same amount of money, or gold, as there was at the start of the year.
What does this mean for GDP? It is exactly the same
of course, irrespective of actual economic activity. It doesn’t matter
how much people save, because those savings are reapplied into the production
of capital goods. The rest goes on consumption. It really doesn’t
matter what proportion is private sector and how much is government. But if
you start with a million ounces of gold, after a year you still have a
million ounces of gold. The only difference is what a million ounces buys.
The reconciliation between the start and the end of the year is obviously a
combination of prices and how efficiently the available gold is deployed.
In practice, human nature constantly strives for
improvement, so over a period of time in a free market the purchasing power
of sound money increases. This was borne out by the experience of Britain,
which went on the gold standard in 1821 and only went off it before the First
World War. During that time, Britain freed up her economy by dropping tariffs
and other restrictions on free trade, and we became the most powerful nation
on earth. The purchasing power of the gold sovereign increased substantially
over those ninety-odd years.
So if we look at how an economy operates in a
sound-money environment, we see that the benefits of free-markets flow to
consumers, savers and businesses. We can see that any attempt to measure
these benefits by changes in GDP are simply absurd. It therefore follows that
any change in GDP represents a change in the quantity of money in an economy
and not of the level of production.
Now, for some of us this is quite a discovery. We
are so used to thinking that GDP is the economy that government policies are
now entirely focused on boosting it, mistaking it for the economy itself. It
justifies mainstream macro-economic theory, because within that money
identity, there is no differentiation between good and bad deployment of
economic resources. This, in the minds of most economists, is why badly
targeted government spending is no different from the productive private
sector’s use of economic resources. It persuades Keynesians and
Monetarists that injecting government spending into an economy or expanding
the quantity of money in the economy is a valid route to recovery.
Understand this error and you understand why
unemployment in the United States is already at depression levels, but
according to the GDP statistic you have only just arrived at the brink of a
possible economic downturn. Understand this error, and you understand the
frantic attempts to get more money and credit into the economy rather than
address the real issues. Understand the error of confusing the condition of
an economy with its accounting identity and understand the policy mistakes
yet to be made.
So we can see that governments are doing just about
everything wrong. They have completely failed to understand the productive
difference between free markets and government intervention. They have no
knowledge of the real cost of diminishing the productive private sector, to
pay for the unproductive public sector. The activities of central banks have
encouraged boom-bust cycles that have led to the accumulation of debt in both
private and public sectors to the point where it has finally become
unsustainable. In the process, they have destroyed savings, which are the
necessary pre-requisite, the bed-rock for any sustainable recovery.
This is the background to today’s crisis.
Governments everywhere are now trying to borrow the largest amounts of money
in history, all at the same time. And to those who say that global savings
are high, I say those savings are in the hands of the Chinese and Indian
workers, who wisely are more likely to buy gold and silver than our
government debt.
Governments are now waking up to the fact that real
economic growth is disappearing far into the future and taking their
hoped-for tax revenues with it. The debt-trap has snapped firmly shut. Some
countries, such as the Eurozone members, who cannot print money to finance
themselves, are simply the first victims of the imbalance between the
financing requirements of governments and the available capital. Others, such
as the UK and US, who can print money, do so to defer funding problems and
keep their borrowing costs low; but it is only a matter of time before they
are found out.
Price inflation will put an end to these artificially
low bond yields, if markets don’t first: it has always been this way in
the past and now is no different. We already see prices measured in paper
currencies rising everywhere. Commodity prices are reflecting the increased
quantities of paper money and credit. Prices of essentials, such as food and
energy, have been rising sharply. But there are still people who think that
the risk is deflation not inflation. Presumably the Fed thinks so, since it
has stated that it expects interest rates to stay at close to zero until
mid-2013. They will be in for a shock, and here’s why.
They are about to learn the difference between sound
money and their fiat money. Real money cannot be issued by central banks.
Fiat money is an undated interest-free claim on a government whose central
bank merely tells us that it is money. The difference is important, because
in a depression, the purchasing power of real money, measured in goods,
increases. In the same depression the purchasing power of fake money falls
with the financial condition of the issuing government and with its
accelerating supply. This is the dynamic behind the rise in the price of gold
over the last decade.
The rising inflation I’ve talked about is
measured in fiat money. The rise will accelerate because when you are in a
debt trap the only way bills get paid is to issue increasing quantities of
fiat money and to borrow. And remember, in a depression tax revenues
collapse, while social security costs escalate. To defer the “Grecian
moment” we have become unhappily familiar with, both the US and the UK
will require more fiat money and bank credit than we can imagine.
So what those who worry about a depression
haven’t noticed, is that we have been in one
for some time. That comes of confusing GDP with real goods and services.
Produce enough fake money and GDP looks good. What doesn’t is the level
of unemployment. Doubtless George Knapp – remember him? The German
predecessor to Keynes? – Knapp would have felt good that German GDP
from 1920 to1923 looked fantastic. But then there was the small matter of a
collapse in the fiat money of the day, and GDP hadn’t yet been invented
anyway.
Today people are stumbling towards an awareness of
some of these problems. Most visible to everyone so far is the parlous state
of the banks. While it would be foolish to completely discount systemic risk,
we should bear in mind two things. Firstly, the central banks are now very
aware of this risk, which is different from the time of the Bear Sterns and
Lehman collapses. So you can reasonably bet that every scenario that
frightens us has been anticipated. The banks themselves are now acutely aware
of counterparty risk. Secondly, the evolution of banking over the years has
given central banks enormous control over their banking systems. It is wrong
to think that you can compare the situation today to that of the banking
crisis triggered by the collapse of Kredit Anstalt in 1931. The ECB in Europe
only has to stand by with unlimited funds when necessary. Indeed, there has
been a run on the Greek banks for at least the last eighteen months without
systemic failure. All that is required is for the ECB to make its fiat money
available in sufficient quantities.
In a few months we will enter 2012. The immediate
stresses of today will probably diminish when enough fiat money has been
thrown at them. So to my mind the two biggest headaches for next year will be
increasing price inflation, the result of too much paper money chasing too
few goods if you like, and rising interest rates. I do not expect the Fed to
keep its promise of zero rates into 2013. I do expect them to blame
unexpected stagflation.
And finally, we must understand that when it comes
to resolving our current difficulties, the order of events is bound to be
crisis first, solution second. I wish it could be the other way round, but
that is the political reality. What we must do meanwhile is get the message
home why the establishment has got its macroeconomics so wrong, and why the
only solution is to progress towards sound money.
Today I have only focused on two aspects of the
problem: the destabilising effects of credit-driven business cycles, and the
misapplication of a statistic, GDP, which should have no importance
whatsoever. There is much, much more in this sorry tale. I have touched on
the role of savings, without going into how their destruction through
monetary inflation is now bankrupting governments. I have not gone into the
fallacies surrounding trade imbalances, which are always the result of
unsound money. I have not asked how we are to feed our elderly and poor, who
have become reliant on government pensions and hand-outs, which governments
can increasingly ill-afford.
Please just accept, even if you don’t follow
my analysis, that sound money guarantees a stable yet progressive economy
where people are truly equal. It allows people to save properly for their
retirement so that they will not become a burden on the state. It leads to
democracy voting for small governments. It encourages peaceful trade and
discourages war. It is the only path, after this mess, that
leads us to long-lasting and peaceful prosperity. We really need everyone to
understand this for the sake of our future.
|
