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The Divisia Monetary Indicator and the Money Supply Definition

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Published : November 25th, 2021
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By most commentators, since the early 1980s, correlations between various definitions of money and national income have broken down. The reason for this breakdown, it is held, is financial deregulation that made the demand for money unstable. Because of financial deregulation the nature of financial markets has changed; consequently, past definitions of money no longer hold.

As a result, it is held the usefulness of money as a predictor of economic events has significantly diminished. Note that according to popular thinking the definition of money is not something permanent but of a flexible nature. Sometimes it could be M1 and at another time, it could be M2. What dictates whether M1, M2 or some other M will be labelled as money is the correlation with national income.

Note again that according to popular thinking, the validity of various definitions of money can be ascertained by means of quantitative methods. What determines whether money M1, M2, and the other Ms are valid definitions is how well they correlate with various key economic data such as the gross domestic product.

Some commentators are of the view that a major factor behind the breakdown in the correlation between money supply and national income is not so much financial deregulation but rather an unsound methodology of measuring the monetary aggregates.

On this way of thinking the monetary aggregates presented by the Fed is a sum of its monetary components in which the components are assigned the same weight. For instance, the components of the money supply definition M2 comprises of cash, checking deposits, savings deposits, money market securities, mutual funds, and other time deposits.

It is however argued that such a summation does not weigh components in a way that properly summarizes the services of each monetary component of money. On this way of thinking, conventional money-supply measures do not account for differences in the degree to which various assets actually serve as money.

The Divisia indicator, named after the early 20th-century French economist, Francois Divisia, makes adjustments for differences in the degree to which various components of the monetary aggregate serve as money. This in turn it is held offers a more accurate picture of what is really happening to money supply. 

The primary Divisia monetary data for the US is money M4. It is a broad aggregate, which includes negotiable money-market securities, such as commercial paper, negotiable CDs, and T-bills. By assigning variable rather than equal weights to the money supply components, it is held, that one could remedy the issue of an unstable money demand. By assigning suitable weights by means of quantitative methods, it is held that one is likely to improve the correlation between the weighted monetary gauge and various economic indicators. Consequently, one could employ this monetary measure to ascertain the future course of key economic indicators.1

However, does it all make sense?

Defining What Money Is

No definition can be established by means of a correlation. The purpose of a definition is to present the essence the distinguishing characteristic of the subject we are trying to identify. The definition is expected to tell us what the fundamentals of a particular entity are.

To establish the definition of money we have to ascertain how a money-using economy came about. Money emerged as a result of the fact that barter could not support the market economy. A butcher who wanted to exchange his meat for fruit might have difficulties to find a fruit farmer who wanted his meat, while the fruit farmer who wanted to exchange his fruit for shoes might not been able to find a shoemaker who wanted his fruit. The distinguishing characteristic of money is that it is the general medium of exchange. It has evolved from the most marketable commodity.

On this Mises wrote in The Theory of Money and Credit,

There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money. 

Observe money is that for which all other goods and services are traded. This fundamental characteristic of money must be contrasted with those of other goods. For instance, food supplies the necessary energy to human beings, while capital goods permit the expansion of infrastructure that in turn permits the production of a larger quantity of goods and services.

Through an ongoing selection process over thousands of years, people have settled on gold as money. Gold served as the standard money. In today’s monetary system, the money supply is no longer gold but coins and notes issued by the government and the central bank. Consequently, coins and notes constitute the standard money, known as cash that is employed in transactions. Goods and services are bought and sold for cash. Note again that the essence of money is that for which all other goods and services are traded. Also, note that the essence of money remains the same irrespective of financial deregulations.

Distinction Between Claim and Credit Transactions

At any point in time, an individual can keep his money in his wallet, at home or deposit the money with a bank. In depositing his money, an individual never relinquishes his ownership over the money. No one else is expected to make use of it.

When Joe deposits his money with a bank, he continues to have an unlimited claim against it and is entitled to take charge of it at any time. Consequently, these deposits, labelled demand deposits, are part of money. At any point in time if in an economy individuals hold $10,000 in cash, we would say that the money supply in this economy is $10,000.

Now, if some individuals have stored $2,000 in demand deposits, the total money supply will still remain $10,000: $8,000 in cash and $2,000 in demand deposits—that is, $2,000 cash is stored in bank demand deposits. Finally, if individuals deposit their entire stock of cash, the total money supply will remain $10,000, all of it in demand deposits.

This must be contrasted with a credit transaction, in which the lender of money relinquishes his claim over the money for the duration of the loan. As a result, in a credit transaction, money is transferred from a lender to a borrower.

Credit transaction does not alter the amount of money. If Bob lends $1,000 to Joe, the money is transferred from Bob’s demand deposit or from Bob’s wallet to the Joe’s possession.

Why Various Popular Definitions of Money Are Questionable

Consider the money M2 definition. This definition includes money market securities, mutual funds and other time deposits. However, investing in a mutual fund is in fact an investment in various money market instruments. The quantity of money is not altered as a result of this investment; only the ownership of money has temporarily changed.

Thus, if Joe invests $1,000 with a mutual fund, the overall amount of money in the economy will not change as a result of this transaction. Money will move from Joe's demand deposit account to the demand deposit account of the mutual fund with a bank. To incorporate the $1,000 invested with the mutual fund into the definition of money would amount to double counting. Again, the investment of $1000 in the mutual fund did not generate additional money that should be included in the money definition.

We suggest that the money of zero maturity (MZM) definition also does not help identifying what money is. The essence of the MZM is that it encompasses financial assets with zero maturity. Assets included in the MZM are redeemable at par on demand. This definition excludes all securities, which are subject to risk of capital loss, and time deposits, which carry penalties for early withdrawal. 

The MZM includes all types of financial instruments that can be easily converted into money without penalty or risk of capital loss.2 Observe that MZM includes assets that can be easily converted into money. This is precisely what is wrong with this definition, since it does not identify money but rather various assets that can be easily converted into money. It does not tell us what money actually is. This is what a definition of money is supposed to do. 

Observe that the Divisia monetary gauge is not of much help either in establishing what money is. Please note that this indicator was designed to strengthen the correlation between monetary aggregates such as M4 and other M’s with an economic activity indicator. In fact, by this logic the change in weights of various components of money as a result of financial innovations can lead to an ongoing change of the definition of what money is. In this sense, the construction of the Divisia gauge is an exercise in curve fitting. 

We suggest that by replacing the equal weights components of the popular money supply definitions with variable weights one does not establish the essence of what money is.

Again, the Divisia M4 or the Divisia of other M’s are employed with the view that it will enable a reliable forecast of some key economic data. The Divisia of various M’s such as the Divisia M4 does not address the double counting of money issue.

Note again that the M4 is a broad aggregate, which includes cash plus negotiable money-market securities, such as commercial paper, negotiable CDs, and T-bills. What we have here is a mixture of claim and credit transactions i.e. a double counting of money. This generates a misleading picture of what money truly is. Applying various weights to the components of money cannot make the definition of money valid if the definition comprises of erroneous components.

The current practice of including various assets into the definition of money because of their liquidity is questionable. In some cases, inventories of retail goods might be as liquid as stocks or bonds. However, no one would consider these inventories as part of the money supply. In fact, they are other goods that sold for money in the market. Observe, that liquid assets like stocks and bonds in similarity to other goods and services are exchanged for money i.e., other goods are not exchanged for these assets.

We hold that once it is established that the definition of money is sound one must stick to it regardless of whether it is well correlated with some other economic data or not. Thus regardless of the correlation we can say that an increase in money supply sets in motion an exchange of nothing for something. This in turn results in the diversion of wealth from wealth generators towards non-wealth generating activities. In the process, this sets in motion the menace of the boom-bust cycle. Hence, by observing the correctly defined money supply an analyst can establish an important economic information.

The introduction of electronic money has supposedly introduced another confusion regarding the definition of what money is. It is held that the electronic money is likely to make the current money i.e. cash redundant. We suggest that the various forms of electronic moneys do not have a “life of their own.” Electronic money can function as money as long as individuals know that they can obtain cash on demand. Various financial innovations do not generate a new form of money, but rather the new ways of employing existing money in transactions. Regardless of these financial innovations, the nature of money does not change. It is that for which all other goods and services are traded for. 

Thanksgiving plays an important role in Americans’ views of ourselves and our heritage. The mere fact that it is time off from work and school cannot by itself explain how many travel to be with those they care about to celebrate. But our understanding does not extend very deep, because the Pilgrims started from a communal or communist system, and only moved to a private property-rights based system that many, even in this woke time, now celebrate, because they were starving.

That change gave us now far more to celebrate now than the pilgrims did then, because private-property based systems prohibit violations of one anothers’ rights, and enable the greatest area for competitive advancements.

In excellent way to review the essential contributors to the bounty Americans’ now celebrate (even in hard times for many) is to consider an excerpt from Leonard Read’s traditional opening address at Foundation for Economic Education seminars, first given 60 years ago.

The American people are becoming more and more afraid of, and are running away from, their own revolution.

Our Pilgrim Fathers at Plymouth Rock…began the practice of…from each according to ability, to each according to need--and by force! [But] these communalistic or communistic practices were discontinued…because the members of the Pilgrim colony were starving and dying.

During the third winter Governor Bradford got together with the remaining members of the colony and said to them, in effect…“We are going to try the idea of ‘to each according to merit,’”…the private property principle…nothing more nor less than each individual having a right to the fruits of his own labor…Governor Bradford records that “Any generall wante or famine hath not been amongst them since to this day.”

This private property principle…[led] to what I refer to as the real American revolution…The real American revolution was a novel concept or idea which broke with the whole political history of the world.

Up until 1776 men had been contesting with each other, killing each other by the millions, over the age-old question of which of the numerous forms of authoritarianism--that is, man-made authority--should preside as sovereign over man. And then, in 1776…the new idea…“that all men are created equal; that they are endowed by their Creator with certain unalienable Rights; that among these are Life, Liberty, and the Pursuit of Happiness”…This is the essence of Americanism. This is the rock upon which the whole “American miracle” was founded.

It…[denied] that the state is the endower of man’s rights, thus declaring that the state is not sovereign.

It is one thing to state such a revolutionary concept as this; it’s quite another thing to implement it--to put it into practice. To accomplish this, our Founding Fathers added two political instruments--the Constitution and the Bill of Rights. These two instruments were essentially a set of prohibitions; prohibitions not against the people but against the thing the people…had learned to fear, namely, over-extended government.

[America] more severely limited government than government had ever before been limited in the history of the world. And there were benefits that flowed from this severe limitation of the state.

There wasn’t a single person who turned to the government for security, welfare, or prosperity because government was so limited that it had nothing on hand to dispense, nor did it then have the power to take from some that it might give to others. To what or to whom do people turn if they cannot turn to government for security, welfare, or prosperity?...to themselves.

All over the world the American people gained the reputation of being self-reliant.

When government is limited to the inhibition of the destructive actions of men--that is, when it is limited to inhibiting fraud and depredation, violence and misrepresentation, when it is limited to invoking a common justice--then there is no organized force standing against the productive or creative actions of citizens. As a consequence of this limitation on government, there occurred a freeing, a releasing, of creative human energy, on an unprecedented scale.

This was the combination mainly responsible for the “American miracle,” founded on the belief that the Creator, not the state, is the endower of man’s rights.

This manifested itself…as individual freedom of choice. People had freedom of choice as to how they employed themselves. They had freedom of choice as to what they did with the fruits of their own labor.

But something happened to this remarkable idea of ours, this revolutionary concept…the people we placed in government office as our agents…discovered that the force which inheres in government, which the people had delegated to them in order to inhibit the destructive actions of man, this monopoly of force could be used to invade the productive and creative areas in society.

The extent to which government in America has departed from the original design of inhibiting the destructive actions of man and invoking a common justice; the extent to which government has invaded the productive and creative areas; the extent to which the government in this country has assumed the responsibility for the security, welfare, and prosperity of our people is a measure of the extent to which socialism and communism have developed here in this land of ours.

There was a time, about…[1840], when the average citizen had somewhere between 95 and 98 percent freedom of choice with each of his income dollars. That was because the tax take of the government--federal, state, and local--was between 2 and 5 percent of the earned income of the people. But, as the emphasis shifted from this earlier design, as government began to move in to invade the productive and creative areas and to assume the responsibility for the security, welfare, and prosperity of the people, the percentage of the take of the people’s earned income increased. The percentage of the take kept going up and up and up.

Has there ever been an instance, historically, when a country has been on this toboggan and succeeded in reversing itself?...The only significant one took place in England after the Napoleonic Wars.

England’s debt, in relation to her resources, was larger than ours [in 1961]; her taxation was confiscatory; restrictions on the exchanges of goods and services were numerous, and there were strong controls on production and prices. Had it not been for the smugglers, many people would have starved!

There were in England such men as John Bright and Richard Cobden, men who understood the principle of freedom of exchange. Over in France, there was a politician by the name of Chevalier, and an economist named Frederic Bastiat.

Bastiat was feeding his brilliant ideas to Cobden and Bright, and these men were preaching the merits of freedom of exchange. Members of Parliament listened and, as a consequence, there began the greatest reform movement in British history.

Parliament repealed the Corn Laws, which here would be like repealing subsidies to farmers. They repealed the Poor Laws, which here would be like repealing Social Security. And fortunately for them they had a monarch…who relaxed the authority that the English people themselves believed to be implicit in her office. She gave them…a permissive kind of freedom…Englishmen, as a result, roamed all over the world achieving unparalleled prosperity and building an enlightened empire.

This development continued until just before World War I. Then the same old political disease set in again…It has many popular names…such as socialism, communism, state interventionism, and welfare statism. It has other names such as fascism and Nazism. It has some local names like New Deal, Fair Deal, New Republicanism, New Frontier, and the like.

If you will take a careful look at these so-called “progressive ideologies,” you will discover that each of them has a characteristic common to all the rest. This common characteristic is…a rapidly growing belief in the use of organized force--government--not to carry out its original function of inhibiting the destructive actions of men and invoking a common justice, but to control the productive and creative activity of citizens in society.

As this belief in the use of force as a means of creative accomplishment increases, the belief in free men--that is, men acting freely, competitively, cooperatively, voluntarily--correspondingly diminishes. Increase compulsion and freedom declines. Therefore, the solution to this problem, if there be one, must take a positive form, namely, the restoration of a faith in what free men can accomplish…either you accept the idea of the Creator as the endower of man’s rights, or you submit to the idea that the state is the endower of man’s rights…We have forgotten the real source of our rights…the free market, private property, limited government philosophy with its moral and spiritual antecedents.

The real problem is developing a leadership for this philosophy.

[It] requires that an individual achieve that degree of understanding which makes it utterly impossible for him to have any hand in supporting or giving any encouragement to any socialistic activities…however disguised. People reject socialism in name, but once any socialistic activity has been Americanized, nearly everybody thinks it’s all right.

Read the ten points of the Communist Manifesto and see how close we have come to achieving them right here in America.

The philosophy of freedom is at the very pinnacle of the hierarchy of values; and if you wish to further the cause of freedom, you must use methods that are consonant with your objective. This means relying on the power of attraction.

Freedom is an ore that lies much deeper than most of us realize…A great effort is required to dig up this ore that will save America.

We will find these miners of the freedom ore among those who love this country.

I just came across and article which reminded me that this November 16 was the 15th anniversary of the death of Milton Friedman, one of the past century’s greatest advocates of freedom. As someone who has followed his writing for most of my adult life, I can barely believe he has been gone that long. On the other hand, the abyss between the freedom he advocated and the world we now inhabit is so vast, I can barely believe he has only been gone that long.

That great gap makes me believe that now would be a good time to think back to some of Friedman’s insightful words. But his prolific output makes it hard to choose (rather than Free to Choose) among them when faced with limited space. How much further we have moved along what Friedrich Hayek called The Road to Serfdom since then, however, suggests one good source—Friedman’s “Introduction” to the University of Chicago Press’s 50th Anniversary edition of the book.

The promotion of collectivism is combined with the profession of individualist values.

Individualism…can be achieved only in a liberal order in which government activity is limited primarily to establishing the framework within which individuals are free to pursue their own objectives.

The free market is the only mechanism that has ever been discovering for achieving participatory democracy.

Unfortunately, the relation between the ends and the means remains widely misunderstood. Many of those who profess the most individualistic objectives support collectivist means without recognizing the contradiction.

To understand why it is that “good” men in positions of power will produce evil, while the ordinary many without power but able to engage in voluntary cooperation with his neighbors will produce good, requires analysis and thought, subordinating the emotions to the rational faculty.

The argument for collectivism is simple, if false; it is an immediate emotional argument. The argument for individualism is subtle and sophisticated; it is an indirect rational argument.

Experience…has strongly confirmed Hayek’s central insight--that coordination of men’s activities through central direction and through voluntary cooperation are roads going in very different directions: the first to serfdom, the second to freedom. That experience has also strongly reinforced a secondary theme--central direction is also a road to poverty for the ordinary man; voluntary cooperation, a road to plenty.

The battle for freedom must be won over and over again. The socialists in all parties to whom Hayek dedicated his book must once again be persuaded or defeated if they and we are to remain free men.

The bulk of the intellectual community almost automatically favors any expansion of government power so long as it is advertised as a way to protect individuals from big bad corporations, relieve poverty, protect the environment, or promote “equality.”

It is only a little overstated to say that we preach individualism and competitive capitalism, and practice socialism.

It is amazing how dead-on both Friedrich Hayek’s The Road to Serfdom and Milton Friedman’s appreciative and insightful “Introduction” remain about Americans’ current situation, unfortunately moving back down the wrong road in many ways. But I find the last two quotations particularly ominous. Many today have moved to the point, in their confused understanding, that they want to not only practice socialism, particularly when they think its selective application will benefit them, but preach it as well. But that “progressive” regression into utopian thinking which actually produces dystopian results also means that the benefits from renewed attention to the lessons for liberty to both Hayek and Friedman are greater, as well. 

For months the battle over the Federal Reserve has been playing out within the financial press. On one side, the Warren wing of the Democrat Party trying to make institutional gains within the central bank. On the other, allies of Janet Yellen have promoted Jerome Powell as a fellow traveler. Today, Joe Biden was finally provided with a script naming Powell as the victor.

The real question is whether the battle will end there. 

As we have already seen, what Joe Biden’s handlers want is not always what Joe Biden’s handlers get. High-profile nominees like would-be OBM director Neera Tanden and would-be ATF director David Chipman have already been defeated. An obvious calculation in the renomination of Jay Powell is the belief that Republicans will cross over and make up for predictable defections from the more progressive Democrats in the Senate.

The question now is how many Republicans are willing to own the Powell Fed?

As the Mises Wire noted during his original nomination, Powell’s selection by Donald Trump reflected one of the most significant areas where the Swamp won over the rhetoric of Trump’s campaign. While Powell was quick to become a target of Trump’s wrath, the resulting monetary policy was predictable. The current pandemic of inflation doesn’t reflect some radical break from mainstream monetary policy, but rather is a direct product of the technocratic status quo.

Since 2010, however, the failings of the status quo have required a more advanced lens to appreciation. Corporate consolidation, Cantillon effects, the regressive nature of financialization—all have resulted from the monetary hedonism of the radical nature of post-2008 central banking, but none of these is as apparent as a more expensive Thanksgiving dinner. Or rising gas prices.

While the Republican Senate Caucus is the institution where Bush-era conservatives continue to have the most power, the question is how many senators are willing to go on record in support of the current state of the dollar. Additionally, will rising populist outlets make them pay for doing so?

Tucker Carlson, for example, has established himself as one of the greatest threats to Republican politicians. While your average Republican may be able to fundraise off a nasty article from the New York Times or being made a punchline from Stephen Colbert, a monologue from Tucker can ruin a career. Will the populist Right recognize the importance of Murray Rothbard asking, “What has government done to our money?

With enough pushback, Republicans in the Senate would be right to join with Warren/Sanders-style Democrats in rejecting Jerome Powell. This would not, however, require them to embrace the more partisan Lael Brainard or the radicalism of modern monetary theory. While it is not likely to see the Biden administration ever nominate a serious thinker to head America’s central bank, Republicans could succeed in taking a scalp against those who are the face of the monetary malpractice the Fed is guilty of. Substituting Powell for, say, a Raphael Bostic, would do nothing to improve the Federal Reserve System—but it would provide some small symbolic demonstration of accountability.

Rejecting a Federal Reserve nomination would be a historically significant vote of no confidence.

Does the Senate GOP have the courage to act?

Any day now President Biden will nominate his choice candidate for the role of Chair of the Federal Reserve. If Jerome Powell doesn’t get reappointed then Biden will likely go with progressive Democrat Lael Brainard. Everyone has a take, some more opinionated than others.

The editorial board of the Wall Street Journal made no attempt to soften their thoughts on Powell in the onion piece entitled Tweedledum and Tweedledee at the Fed, calling Powell’s tenure “historic failure:”

Mr. Powell’s credibility has been damaged with his persistent refrain, until recently, that inflation is “transitory.” His new monetary policy framework of average-inflation targeting, unveiled in August 2020, has been a bust.

They conclude that given the choice between two, there isn’t much of a difference and that he’ll have to “own inflation even more than he already does.”

CNBC provided an array of opinions last week, including a chief strategist from State Street who also didn’t have much faith in a Powell re-nomination:

The odds and probabilities seem to be falling. The higher-than-expected inflation readings hurt, the trading scandals hurt, and the fact he’s a Trump appointee makes him an easy scapegoat for the administration.

A chief economist at Grant Thornton made an attempt to compare the two, CNBC quoting:

The biggest difference between her and Powell is she might be faster on climate change, though Powell was pretty quick on the uptake. The other issue is she’s much more open to cryptocurrency for the Fed, and that’s the biggest difference I know between them.

Still somewhat of a difference, if Brainard is “more open” to cryptocurrency, that certainly wouldn’t be a bad thing for the country. While being “faster on climate change” sounds more contentious as the effectiveness of inflating the money supply or suppressing interest rates could have little effect on making the world a greener place.

Perhaps it was an investment manager at Morgan Stanley who said it best:

It’s not like either one would be dramatically different from the other… It’s not like you’re going from a hawk to a dove. You’re changing leadership, not changing philosophy.

Isn’t that the truth?

For all that can be said, the difference between Brainard and Powell is more superficial than skin-deep. Certainly, every Fed Chair brings their own experience, outlook and maybe even leadership qualities. But their ethos, whether it’s the dual mandate or the desire to use the central bank’s powers to intervene in the free market, still stands.

Any notion of freedom, liberty or understanding the dangers of increasing the money supply will likely continue to go unnoticed. Whether Powell or Brainard, however the next four years goes, unless a dramatic change sweeps the country or the Federal Reserve, which demands an end to this pseudo-mainstream/make-it-up-as-you-go economics, there really isn’t much to look forward to regarding who will helm America’s central bank.

By 1982, Mexico had nationalized 85 percent of its economy. The eighties did not treat Mexico kindly and supposed attempts at neoliberalization took over Mexico in the late eighties and nineties. But as the stupidity of government ventures fades from our collective memory, old methods get reintroduced. Despite a history of failure, the Mexican government, led by President Andrés Manuel López Obrador, seems fixated on repeating such failures.

Case in point, as a part of his attempt to “organize” the energy sector, Mexico will create a new state-owned company to be in charge of the nation’s lithium. As El Financiero noted, “The head of the Ministry of Energy, Rocío Nahle, confirmed that the exploration and exploitation of the mineral will require the creation of a State company.” When asked about this move, Nahle harkened back to Mexico’s expropriation of the oil companies in 1938, a move Nahle praised, saying, “[F]or eight decades, [the oil expropriation] gave us wealth, schools, hospitals, roads…. Lithium will be the same, without a doubt, and I think it will be faster, such a strategic mineral that today is a raw material for the manufacture of batteries.”

This appeal to PEMEX, the state-owned oil company that was the result of the 1938 expropriation, is, quite frankly, hilarious. Indeed, on the same day that El Financiero ran the article, they also ran an article stating that the Mexican government is going to cover PEMEX’s debts (which total roughly $36 billion) that expire in 2024. A state-owned company run so well that the cronyist veil must be dropped so that the state can save its corporatist child is the proposed model for this new lithium company! How grand.

As previously explained, Ludwig von Mises and Murray N. Rothbard made it abundantly clear that there is nothing the Mexican government can do that will benefit the Mexican people. It is apodictically impossible for state action to be in pursuance of the common good. This power grab by the elites in Mexico City will only benefit them and those connected to them. It seems too obvious to even write, but monopolizing lithium production cannot make Mexicans richer. It did not work with oil, it did not work with banks, and it will not work with lithium. Even if this new company were able to bring the price of batteries and other lithium products below the current market price, it would be infantile to claim victory. If the Mexican government decided to spend the entire nation’s GDP on creating the most powerful computer known to man, I do not doubt a powerful computer would be created. But what would the cost be? Starvation for the entire country. The same applies here. Even if the state successfully reduces the price of lithium, this will not create wealth; it will only cause a redistribution of resources. This redistribution would lead resources away from the desires and needs of the people, impoverishing the society. What good are cheaper batteries if food prices go up? It cannot be reiterated enough—the state cannot create. The state only steals and redistributes. It only disrupts. It cannot benefit society in any way, even if it takes control of lithium. Only saving and investment, fueled by a respect for markets, will make Mexicans richer. State interference will only get in the way.

The latest quarterly filing statement of the Swiss National Bank (SNB) has been issued. Switzerland’s publicly traded central bank had a decrease in the value of its US stock holdings by around $5 billion in Q3 of 2021, ending the quarter with a value of $157 billion. SNB currently has a profit of over $40 billion for the 9 months ended in the year. Perhaps subjective, it looks like a banner year for an entity who turns a profit through currency manipulation.

As for other affairs the central bank has been concerned with since last quarter; how about climate change?

Several weeks ago the question was asked to board member Andrea Maechler, whether the bank should use its money to “influence companies” linked to climate change initiatives. According to Reuters, the board member responded that it wasn’t the SNB’s job:

We don't have the goal to make the world greener. That's not our mandate.

A bold statement, and something one would be hard pressed to hear coming from a central banker on this side of the Atlantic.

But then the following week happened. On November 3 Reuters reports:

The Swiss National Bank reiterated its commitment to tackling climate change on Wednesday, saying it would take environmental factors into consideration in its macroeconomic modeling and monetary policy analysis.

The SNB bought “green bonds and excluded companies that systemically cause severe environmental damage.” Mining companies are also excluded from their purchases, which is ironic since green technology like electric vehicles rely heavily on the mining industry.

Despite Ms. Maechler comment, the SNB is using some of its power to invest in the green economy. To what ends remains anyone’s guess.

She was again in the news last week, reiterating their ongoing currency intervention strategy, also to ends which no one knows:

The reality is, we continue to have a safe-haven currency… It is something that we do continue to monitor, and we will continue to do so.

Ensuring the currency doesn’t become too strong is the stated reason behind SNB’s money creation scheme, one of the outcomes being the buying and selling of US stocks.

There are almost 200 national currencies in the world. If history is any indication of the past, and if one can reasonably predict the future, it's likely there will only be a handful of safe-haven currencies in the world at any given time. Even if all national currencies continue to decline into inflationary oblivion, there will always be the best of the worst currencies. The US dollar, the Japanese yen and Swiss franc are a few of a handful of such winners.

For all the concern over the risk of the franc becoming too strong, they should be concerned with the franc becoming too weak. Undoubtedly, the SNB will never want to lose the franc’s status as a safe-haven currency. So they're looking to find a level where the franc is weaker than some, or all other safe-haven currencies, but strong enough to maintain safe-currency status.

Like central bank investments into the green economy, no measurement, calculation nor logic will suffice to explain just how weak the franc should be. But with just a little more money creation, maybe one day, their objective can be met.

The Biden administration has certainly made the most misguided nomination for Comptroller of the Currency in history with its nominee, Saule Omarova. Professor Omarova has published proposals displaying deep ideological commitments which make her obviously unacceptable for this key responsibility in the banking system. Even after this has become apparent, the Biden administration has very surprisingly not withdrawn her name and a Senate Banking Committee hearing on the nomination has been scheduled for this week, November 18.

Concerning this hearing, every Democratic senator on the Banking Committee should be asked in public:

  • Do you subscribe to the proposals published by Professor Omarova?
  • Do you support taking all deposits away from private banks?
  • Do you support making the Federal Reserve in charge of "economy-wide credit allocation"? Do you support making the Federal Reserve a deposit monopoly?
  • Do you support having the New York Federal Reserve Bank short investments it [somehow] decides are too expensive and buy to boost the price of investments it [somehow] decides are too cheap?
  • Do you support giving the government seats on privately owned companies' boards of directors, with the government having "disproportionate voting power"?

All these remarkably unwise and naive proposals are explicitly made in her published articles.

Honorable Senators: If you support these proposals, you should stand up and say so out loud, so everybody can hear you. If you don't support them, you should obviously vote No on this nomination.

Originally published at RealClearMarkets.

I just received an intriguing email. The author suggests that Ayn Rand's novel Atlas Shrugged features Ludwig von Mises in one of the secondary roles (yet still as a hero). I had not at all seen the point that my correspondent raises, but I think he is right. When I wrote the Mises biography, I did not take the time to look up Atlas Shrugged again (I had read it in the mid-1990s), otherwise I might have noticed. Anyway, here is the message:

Dear Prof.,

I'm going through your profound "The Last Knight of Liberalism". It made me pause a couple of times, just to be able to read entire books before I continue (e.g. "Critique of Interventionism", "Bureaucracy"), and there were several fine points of Mises' thinking that I had overlooked or misunderstood - your brief summaries of deep ideas are invaluable for making such errors apparent.

So, first of all, thank you for the amazing work. Plus your lectures, of which I've watched a few. (I think that there was a list of lectures, following the book, which I watched before reading the book, but now I can't find, do they still exist somewhere?).

Though this message is not to express my gratitude, but rather, to ask you whether you made the same connection or not. I recently read Atlas Shrugged, and years ago I finished Human Action (which itself took years...). In your book, at some point you say: 

Mises was not a man to attach too much importance to material things. He once told Margit that, if she was after riches, she had married the wrong man. But neither was he the type of intellectual that Ayn Rand depicted in her novel Atlas Shrugged: the libertarian philosopher who in dire straits would descend stoically from his chair at the university to work behind the counter of a small-town burger joint. Had Mises ended up flipping hamburgers, his heart would have broken.

I'm dying from curiosity to know whether you spent a minute pondering about the name of that professor in "Atlas Shrugged", which was: Hugh Akston. What are the chances that this was a coincidence? Hugh Akston? Really?

Isn't this an "obvious" easter egg, hidden in plain sight, paying tribute to nothing other than Mises' Human Action? (I checked online, nobody seems to have noticed this).

Though I seem to recall that Ayn was not particularly impressed or appreciative by the first part of the book, i.e. praxeology, where the title comes from, but maybe she had a different opinion when she wrote the book, who knows.

Best, D.A.

In an era where entrepreneurs feel compelled to be agents of social change displaying deep commitments to social causes can yield immense admiration. Therefore, Corporate Social Responsibility (CSR) has become a seminal topic in the arsenal of entrepreneurship research. Often researchers divulge the pros and cons of CSR, though few consider the impacts of social obligations on entrepreneurship at the community level.

Large businesses are resourced to fund social activities, however prioritizing social obligations pertaining to family and community can hamper business growth. Unlike the narrative of CSR, social obligations are embedded in micro-structures operating at the family or communal level. The former is a call for companies to curate transcendental goals that comply with socially progressive causes. Yet there is an appreciation that companies can only fund social causes when they are prosperous.

Although some dispute the efficacy of CSR at least advocates accept that businesses are better situated to accommodate social demands when they are financially successful. However, the norm of social obligation in a communal setting is a different affair. In the context of social obligation, responsibilities are foisted on entrepreneurs because of the perception of prosperity. Social obligations are more relevant in collectivist societies where people are pressured to satisfy the interests of the group to the detriment of individual achievement.

Shedding light on the norm of social obligation can plausibly explain variations in high-growth entrepreneurship across regions. The potential for growth is stifled when a small business owner is expected to cover the expenses of family members and friends, due to the speculation that “he is rich.” Unfortunately, for the entrepreneur dismissing the solicitations of associates could result in him being depicted as selfish, so to avert this image, he may indulgence costly demands.

Using Africa as a case study researchers illuminate the adverse effects of committing to social obligations: “The kinship system in Africa exerts pressure on individuals to provide for the needs and obligations of other kin members. In East Africa, demands from one’s social relations, particularly kin, may include financial contributions to community projects, paying school fees or medical expenses, and providing for financial expenses of social events like weddings and dowry payment.” People usually comply with these burdensome requests to prevent social exclusion: “Because of fear of consequences of non-conformity to the kinship normative value “ “sharing without reckoning,” for instance losing legitimacy, status, and a following, entrepreneurs are forced to comply with demands from their social relations.”

Such developments exist because of the mistaken belief prevalent in some quarters that entrepreneurship ought to serve a social agenda. Similar beliefs are less pervasive in individualistic cultures, where people value autonomy, achievement, and self-actualization than group solidarity. Since individualistic societies, emphasize personal achievements entrepreneurs in these societies are more likely to perceive entrepreneurship as a tool to attain success by creating value.

In contrast, the constraints of social obligations levied on small entrepreneurs in a collectivist setting diverts attention from business expansion when scarce resources are directed to social obligations. By nature, the process of entrepreneurship aims to procure value for society. Hence jobs and the capacity to assist family members are merely the consequences of producing value. When one becomes an enabler of social requests, he is no longer managing a business, but existing to serve a social agenda.

Accordingly, Khayesi and George (2011) argue that high levels of communal orientation increase the acquisition of resources due to compliance with unreasonable social obligations and demands from kinship ties. Another recurring problem in these settings is that entrepreneurs might feel obliged to employ family members as a noble gesture. Yet, as research shows this can be a great error considering that the distribution of skills possessed by relatives could be narrow thereby limiting the scope of talent available for business expansion.

Moreover, neither is it cheap to maintain a network of dependents. In fact, researchers describe social payments to dependents as a solidarity tax, since failure to comply with demands will result in the isolation of entrepreneurs. Furthermore, beneficiaries of the entrepreneur’s benevolence often develop an entitled mindset motivating them to believe that the entrepreneur is permanently obligated to service their desires. This automatically slows growth by reducing resources available for capital expansion. However, in the long-term, beneficiaries are also victims.

By succumbing to their requests, the entrepreneur has ensured that they remain mendicants and this could deter them from acquiring the skills required to compete in an economy. On a broader scale, the negativities associated with excessive communal involvement often lead to declining profitability, negative firm growth, and ultimately financial demise. In hindsight, it is evident that unnecessary social obligations also impede the actualization of other businesses that could have been created with greater capital. Similarly, expending resources on social projects would have also depleted investments available for retooling.

However, the most pernicious effect of this arrangement is the perpetuation of the narrative that entrepreneurs exist to serve a social agenda. Without altering cognitive styles future generations will mature to embark on similar ventures, even to the extent of prioritizing social obligations before job performance.

To remedy the problem policymakers in developing countries where the situation is most dire ought to focus on reorienting cognitive perceptions of entrepreneurship. Entrepreneurship must be conceptualized as a medium to create value and not a tool to pursue social agendas.

We must reduce government power to a bare minimum, or the next threat to our security will lead to an even greater loss of individual freedoms.

In life, we are constantly making trade-offs between life, liberty, and property. When we take our car out for a ride, we trade life for liberty: walking is safer than driving. When we take our car to work, we trade life for liberty and property. The minute we get out of bed, we make these trade-offs, and we do it so often that most times we don’t even realize we are making them: Indeed, our entire lives are a series of continuous trade-offs. However, for this pandemic, politicians decided they knew the best trade-off for everyone, and like sheep we should blindly accept these government edicts. They even tried to "infantilize" their populations (e.g. most COVID propaganda used child-like cartoons) to quash any dissent.

 The general rationale for such government dictates is that individual decisions on life, liberty, and property do not consider the externalities on the life, liberty, and property of others. Not wearing a mask may spread the disease, affecting the lives and liberties of others. Individuals are said to be flawed and selfish.

Yet, the government is an association of individuals, so doesn't that also make the government flawed and selfish? Or do we have leaders who are flawless and altruistic individuals? How do we ensure these individuals are in power at the right moment? Also, is a unique strategy optimal for everybody and how do we determine this optimality with no comparison strategies? (See here and here.)

John Stuart Mill’s arguments in On Liberty (1859, Chapter III), said:

The spirit of improvement is not always a spirit of liberty, for it may aim at forcing improvements on an unwilling people… but the only unfailing and permanent source of improvement is liberty, since by it there are as many possible independent centers of improvement as there are individuals.

Mill argues individuals make different trade-offs and pursue different paths to individual strategies. This tatonnement process of trial and error based on imperfect information will ultimately lead to an overall strategy or strategies adopted voluntarily by others. This is a market-like process (mutually beneficial voluntary actions) and will be more popular and accepted than the one-size-fits-all strategy currently being enforced by virtually all governments.

France closed all its ski resorts during the winter of 2020-21, violating owners’ property rights. Switzerland was open for skiing, but with added restrictions on liberty and property. Which strategy was better? Before responding, why are we forced to choose between two strategies instead of many? Individual resort owners could have made those decisions and others about the use of their property. Where is the outrage over these restrictions on fundamental liberties? Do you own property if you cannot dispose of it as you wish? Of course, letting everyone find a strategy is judged as chaotic, and our benevolent government leaders cannot conceivably allow such a solution. Yet, just like a competitive market process is Pareto efficiency, this semblance of chaos would have led to a more accepted social outcome.

This pandemic has taught us a multitude of lessons about liberty and government.

First, democracy is no guarantee of freedom nor of protection from despotism. The advantage of democracy is that it is more likely to ensure peace since we have a peaceful transfer of power from one majority to another. However, democracy can be as despotic as any other form of government. People forget Hitler was elected democratically, and many Germans knew of the holocaustduring the war.1 Democracy must have a rulebook to protect minorities from the majority. For the USA, that is supposedly the Constitution. But those rules need to be explicit and binding. Today, no one is batting an eye about taxing billionaires to pay for social programs. These billionaires are a minute minority (700 in this case), but nonetheless with fundamental freedoms of life, liberty, and property. Voting to limit the freedoms of others or minorities is a risky business, since tables can turn as many Jews discovered even before WW II.

Second, the police can rapidly be turned into an instrument of despotism. Today in France, the police will stop you if you cross a street in an open market because you are not wearing a mask. To enter many businesses, you must be vaccinated. Yet, one of the fundamental pillars of liberty, developed by John Locke and others, is a natural immutable right over one’s own body. 

Third, we can identify which politicians, from governor to dog catcher, respected and valued individual liberties, and those who saw individual liberties as an obstacle to their vision of right and wrong.

Many individuals, even those who do not classify themselves as libertarians, understand that fundamental freedoms were lost over these last two years. A way to turn the pendulum back is to have a serious debate and draft legislation to limit the scope of government actions. As Bastiat made clear (here) in his seminal work, the only or exclusive role of government is the defense of an individual's life, liberty, and property, and nothing else.

We must stop idolizing plunderers, and demand that the power of government be used to protect, and not plunder life, liberty, and property.

Source : mises.org
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Frank Shostak's consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies.
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