Don't Believe Your Lying Eyes: Gold Does Not Offer a Safe Harbor Against Financial Crises

"Gold has worked down from Alexander's time... When something holds good for two thousand years I do not believe it can be so because of prejudice or mistaken theory."

Bernard Baruch


"After we came out of the church, we stood talking for some time together of Bishop Berkeley's ingenious sophistry to prove the nonexistence of matter, and that every thing in the universe is merely ideal.

I observed, that though we are satisfied his doctrine is not true, it is impossible to refute it.

I never shall forget the alacrity with which Johnson answered, striking his foot with mighty force against a large stone, till he rebounded from it--

"I refute it, thus!"

Boswell, Life of Samuel Johnson


"For centuries, gold had a profound impact on history, as a symbol and a storehouse of wealth accepted universally around the world. Gold functions as a medium of exchange, particularly in areas where currencies are distrusted.

Yet gold has not been without controversy. The influential economist, John Maynard Keynes, referred to gold as a 'barbarous relic.' Later in the 20th century, former Chairman of the Federal Reserve’s Board of Governors, William McChesney Martin, praised gold as 'a beautiful and noble metal. What is barbarous,' Martin said, 'is man’s enslavement to gold for monetary purposes.' Clearly, this precious metal has aroused great passion. It undoubtedly will continue to do so long into the future."

New York Federal Reserve


"The commerce and industry of the country, however, it must be acknowledged,though they may be somewhat augmented, cannot be altogether so secure, when they are thus, as it were, suspended upon the Daedalian wings of paper money, as when they travel about upon the solid ground of gold and silver.

Over and above the accidents to which they are exposed from the unskilfulness of the conductors of this paper money, they are liable to several others, from which no prudence or skill of those conductors can guard them."

Adam Smith, Wealth of Nations

Gold has moved in price from $250 in the year 2000 to roughly $1,350 today. In other currencies the move has been much more pronounced.

The period of 1996-2000 is a good time to pick a start for this monetary episode, because this is when the global monetary regime, which had been in place since the end of WW II with a significant change made by fiat in 1971, began to change, substantially in the most proper sense of the word. 

Some like to cherry pick a study of recent gold performance from the prior top of $1,900, but that says more about them and their intentions than it does about gold.  They know that all bull markets climb a wall of worry and can offer significant retracements from new highs while remaining intact.

And given the structure of global supply and demand, and the vast movements in the global economy, it is likely to go much higher, unless it becomes a fixed asset in a global monetary system once again and its price becomes set by fiat.

More likely it will become a floating asset with a more 'official' status than it has today when some central bankers will hardly recognize its existence in public, although they own it, and worry over it in private.

As shown in the second last quote above from the NY Fed, which unfortunately is no longer found on their web site, some central bankers find the attractive, and yet restraining, qualities of gold as a standard to be cloying, because it restrains their degrees of freedom to act as they would like.

And even when it is not a standard it does tend to utter some 'unpleasant truths.' But there is no denying its role as a refuge during periods of monetary instability, especially for those who are not currently holding the financial power.

And gold is certainly not the only hedge, and only safe harbor available.  But that is a far cry from saying it has not served many people very well during serious financial crises, and worked exceptionally to retain its value during a currency crisis and reissue/reflation.  Even a cursory look at historical crises show that.   The value is to study the nature of crises, and to understand the situation one has, not the one you wish you had, or even worse, the one that serves your mistaken point of view.

By the way, I am not advocating a gold standard as a cure for our ills. What our financial system requires is genuine reform from top to bottom. It is capable of corrupting, for at least a protracted period of time, virtually any single solution that one can imagine.  Look what they have done to the civic impulse for genuine change that became that industry-born frankenstein, Dodd-Frank.

They create a desert, and whimsically call it the 'new normal.'

So let us then consider this paper below, titled Gold Has Never Been a Great Hedge Against Bad Economic Times.

Not meaning to be rude, but there are some telling flaws in this paper.  But even then I would not have been moved to respond to it, if they had not had the cheek to use the word 'never' in the title, and to employ such sloppy criteria in their hypothesis as 'bad economic times' and 'major macroeconomic declines,' which they tend to confute with stock market performance.

And that is not to say that any very broad sweep of data over time, without sufficient attention to the particular character and context of the various situations described within, can easily be misleading, or be used to 'prove' something else when using it to draw broad and poorly defined conclusions.

What kind of crisis was it?  Was it a crisis period or not?  What caused it, what policy actions helped to precipitate it, if any, and what were the policy responses?  How are you measuring the asset? Was the change uniform, or different across areas and economies, and what were those differences?

In the Weimar inflation, for example, gold among other assets was a spectacular hedge in a financial crisis, but so were some stocks.   So one can see that using the 'stock market' as your defining variable of a macroeconomic disaster might not be effective.  This is not a quibble.  It is calling out some very fuzzy thinking which characterizes this analysis, that does not support such a sweeping hypothesis.

It may surprise you, but not all crises are the same. And I do not hold gold to be a panacea, not at all. Nor do I consider it to be a outlier or aberration, which is the converse of this, that some others seem to do. 'Gold has never been a hedge against bad economic times.' The use of the word 'never' is a deep tell about their mindset and predisposition.

What variables do tend to have a correlation with gold over periods of crisis?  I have found in my own research that they tend to be risk spreads in bonds, the growth in the broadest money supply, other risk factors, and of course the relative strength of the currency in which you are expressing gold's value.   But even this is not uniform over time, especially in non-crisis or managed price periods, such as when gold is fixed as a 'standard.'

Most assets will smooth out over a long period of time, unless they are artificial constructs,like some stock indices, which are altered by throwing losers out and putting winners in to achieve a semblance of growth.

There is an ebb and flow in everything.

It takes someone with the time and ability and most importantly the open, inquisitive mind not bound by some school of thought or orthodoxy to go into the various situations where something has happened, and happened with a particular cause and effect that was widely acknowledged, in order to really understand the mechanisms and nature of a thing.

When I first began studying money as a practical consequence of my international business dealings, and later with first hand experience to the Russian currency crisis, I could have given two hoots about gold or silver.  They were never even mentioned in any of my business or economic courses.  But later as I continued to study this as an avocation, their role in the history of money and current events could not be ignored.

But never mind what is happening all around you.  Don't buy any gold, and don't like it. Laugh at the rest of the world which is buying it.  Tell them to eat trillion dollar platinum coins because you say so.  It doesn't matter. Keep believing, believe in memes and quaint canards and slogans like the 'efficient market theory' and 'printing money endlessly doesn't matter.' Keep applying top down monetary stimulus and ignoring the results of your serial policy errors and asset bubbles.

So called experts have their noses stuck so deeply into 'what everyone in their profession knows' as an accepted orthodoxy that they can understandably fail to see the forest for the trees. They miss the big changes, the 'sea-changes.'  They are well trained for a world that is changing all around them, using inflexible models too often based on deeply flawed assumptions.

In 2006, the central banks of the world became net buyers of gold bullion for the first time in 30 years, and are continuing to do so in a very big way. Gold has been moving en masse to the emerging economies of Asia, the biggest beneficiaries of 'globalisation.'

And there is a reason for this, that is not based in some quirk or personal idiosyncrasy.

But arguments based on faulty hypotheses such as this paper, or even worse, on almost nonsensical or ad hominem arguments, seem to poke their heads up every so often, either when the banks, or some other major players, get their panties in a bunch because of their exposure to bad bets in the metals markets, or when some central banks start to feel nervous about their ability to manage the markets in their currencies to achieve their financial engineering goals.

Those economic policy goals get in trouble, by the way, because the policy itself is quite possibly running against the markets, and is also misdirected in addition to being ineffective.  We have certainly had enough first hand experience in this for the the past twenty years or so.

But at the end of the day, people may say what they will, but money talks. The real economy has a message to tell for those who will listen to it.   Or not.

There will be those who will continue to say, 'this is not happening' even while a tsunami of change rolls over them.   That is their prerogative.

The time for warnings was then.  This is now.

And events are underway that will have something like the character of a force of nature.

GOLD HAS NEVER BEEN A GREAT HEDGE AGAINST BAD ECONOMIC TIMES: Evidence from decades of US and global data

Gold has not served very well as a hedge against bad macroeconomic and stock market outcomes. That is the central conclusion of research by Professors Robert Barro and Sanjay Misra, published in the August 2016 issue of the Economic Journal. Their study draws on evidence from long-term US data on gold returns, as well as gold returns during some of the worst macroeconomic disasters experienced across the world.

Gold has historically played a prominent role in transactions among financial institutions even in modern systems that rely on paper money. What’s more, many observers think that gold provides a hedge against major macroeconomic declines. But after assessing long-term US data on gold returns, the new research finds that gold has not served consistently as a hedge against large declines in real GDP or real stock prices.

From 1836 to 2011, gold delivered low average real price appreciation and experienced high average volatility. The mean real rate of price change was 1.1% per year, close to the 1% average real rate of return on three-month US Treasury Bills and comparable assets. The standard deviation of annual gold returns was 13.7%, almost as high as the 16.7% on the US stock market...

Royal Economic Society, Gold Has Never Been a Great Hedge Against Bad Economic Times

The Fed In December

For Whom Are the Japanese Leaders Kuroda and Abe Making Their Monetary and Fiscal Policy?

The expansion of the BOJ asset purchase program was timed to start with the end of the Fed's asset purchase program.  I mean, come on.  Could it have been any more obvious?

There is no big question that the Bank of Japan has been acting in concert with the Fed for the better part of this century at least.  And politically, Japan is a client state of the US.

One of the great difficulties in recovering from the long period of Japanese economic stagnation since the collapse of their great real estate and stock market bubble has been the inability to clean up their interlocking financial system dominated by industrial combines called keiretsus and a closely associated political system run by a surprisingly well connected minority of insiders.

Beyond that I wondered why was Japan pursuing the purchase not only of domestic equities and non-sovereign paper, but foreign equities as well with their very large pension fund?  Are these intended as 'investments?'  Or are they a form of cross subsidies in support of a more global agenda?

It makes me wonder if the policy being pursued by the BOJ is not designed to help the people of Japan now, so much as to support the requests of the international banking concerns, more specifically the US Federal Reserve.

This made me wonder if Kuroda is pursuing the same type of trickle down stimulus in buying large amounts of financial paper by printing money, rather than engaging in policy actions to stimulate aggregate demand.

And there is that nasty consumption tax hike in April which tends to have a regressive effect on lower income households.  A weak yen is good for the exporters and multinationals, but is hard on small businesses and consumers. 

Although the Japanese GINI coefficient for economic equality is lower than that of the US, in terms of power Japan is a very top heavy, insider dominated society.   Their incorporation of University pedigrees into the success ladder would make the Ivy League envious.

Here is a thoughtful discussion of Japanese quantitative easing from just a few weeks ago from Sober Look.   As you can see, the consensus was running heavily against an expansion, making the surprise from BOJ the day after the Fed taper even more of a surprise.

"With wage growth remaining sluggish (particularly for non-union workers), rising import costs could undermine consumer demand - particularly in the face of higher consumption taxes. Given these headwinds, there may be sufficient political pressure to put the BoJ into a holding pattern."

I am not sure of all the specifics of what is happening in Japan, but I am becoming increasingly persuaded that the Anglo-American financial cartel and some of its client states are engaging in an intensifying currency war with regard to the international dominance of the dollar.

This extends not only to the dollar as the primary benchmark for international valuations, but also to the more compelling power that such an instrument, in the hands of a single governmentally affiliated entity, provides to those who wield it to set international and domestic policies that go far beyond mere terms of trade. 

 

So I think it is fair to ask for whom the Bank of Japan and their political leadership are making some of their policy decisions.  And further, it is incredibly naïve not to ask the same questions about the Federal Reserve and the political leadership of the US.

Money power is political power, in every sense of the word. 

Employment In Japan

It has been quite some time since I have been doing business in Japan, and I was curious to know if the culture of the 'salary man' had changed.  What is the employment picture in Japan really like for the average person?   What are things like behind the statistics put forward in the international press?

While unemployment in Japan is very low at 3.6% or so and the Labor Participation Rate is still fairly high, it looks like 'underemployment' might be something worth looking at given the slack in wage growth.  Certainly Japan is experiencing deflation, but is that a 'cause' or an effect as part of some other economic feedback loop? 

What happened to the NAIRU non-accelerating inflation rate of unemployment theory?  It is the theory put forward by Friedman and the monetarists that refers to a level of unemployment below which inflation must rise due to wage pressures.   Personally I think the growth of monopolies, the globalization of markets, and the relative political weakness of labor has knocked another dodgy economic theory into a cocked hat.

Places like the old South might have had nearly full employment, but I don't think slavery was adding seriously to wage pressures. Quite the contrary. But it may have put pressure on selective prices, like transport, whips, and chains for repression.  But this is just my opinion and I could be wrong.

Sometimes it is not always easy to find things because people tend to be very positive about their country, especially when speaking with others.  And I dislike looking at OECD statistics and other compendiums because they tend to lose quite a bit with time lag and a lack of insight past government statistics which, and I know this is hard to believe, tend to paint a pretty picture.

But I did get this in from a long time friend in Japan.

"It is difficult for many young people who are part-time or temporary, particularly the men. It is hard for them to "attract" a mate. Many couples are both employed but when they have children there is pressure to find a nursery and often times the wife cannot return to her former job. This obviously complicates the demographic conundrum. Although I do not have figures, this sort of conversation comes up even on the TV.

This is from JIJI dot com. Sorry but Japanese.

The chart shows average monthly salary after subtracting inflation for 2013 having dropped 0.5%.

According to the latest government statistics there are 33.1 million "full time employed" (seiki shain) and 20.4 million "part-time" (hi-seiki shain).

This means that the hi-seiki  非正規 or part-time/temporary account for 38% of the work force.

You can see the numbers I quote "3311" and "2042" in the second line of the page linked below.

Japanese Internal Affairs and Communication Ministry

Note:  Hi-seiki refers to any type of employment other than full-benefit employee of a company. I have also seen figures that suggest 40% of those employed earn an average of less than 3 million yen  (about $26,710 per year at current exchange rates).

Jesse's Note:

There is an English tab on the site, but unfortunately the tab goes to a different site and does not 'match up' with the Japanese page.

Here is a google translation of the relevant line on the page. 

Heisei "regular staff and employees" of the October time year 24 33,110,000 people, "non-regular staff and employees" is 20,420,007 thousand (Excel: 2985KB)

 

Comparing One Dimension of the Policy Responses of the ECB and the Federal Reserve

Here is a chart comparing the Balance Sheet Assets of the Fed and the European Central Bank.

It is important to recall that the Fed has been providing extensive funding to non-US, largely European, multinational Banks through their US subsidiaries.

This also does not compare the sovereign debt of the two regions, but rather just one measure of their Central Banks policy responses.  It does not indicate how those assets are being used, by whom, and to what effect.

Nevertheless there seems to be a clear divergence between the two policy responses.

 

Ben Bernanke On Money and the Sophistry of Modern Monetary Theory

soph·is·try (s f -str ). n. pl. soph·is·tries. 1. Plausible but fallacious argumentation. 2. A plausible but misleading or fallacious argument.

I see the Cullen Roche is back at it again, telling us all about the wonders of modern money. The Biggest Myths in Economics

I will take these myths, and comment on them one by one.  Some things make sense, and others, not so much.  But perhaps the discussion will help to shed some light.

I am going to try to do it simply and in straightforward language, because that is often the best antidote to sophistry.

1) The government “prints money”.

The government really doesn’t 'print money' in any meaningful sense. Most of the money in our monetary system exists because banks created it through the loan creation process. The only money the government really creates is due to the process of notes and coin creation. These forms of money, however, exist to facilitate the use of bank accounts.

This is the 'I didn't do it, because the guys who are working for me did it' argument.

As you might recall, the banks in the US, and most other places, operated under a license and regulation of the government. The banks are part of the Federal Reserve System. They create money under the supervision and regulation of the Federal Reserve Bank, which in turn is answerable to the government.

Most of the time the money is created, organically if you will, through economic activity. The Fed exercises quite a bit of direct and indirect control over this process as both actor in the markets and a regulator. This is the very basis of the Federal Reserve.

At other times, the Fed is able to create money on its own volition, by expanding its Balance Sheet. It can create money at will, and uses it to enact its policy objectives. Whether you say 'print' or 'create' money is a matter of usage, as they are both essentially the same in this context unless you are given to splitting hairs.

You want to know the difference here?  If some bank or person started 'printing' its own money apart from the Federal Reserve system or the rules of the government over commercial paper they would shut them down in a Manhattan minute.  Just ask the Liberty coins guy.  The almighty dollar is a jealous god.

There were times in the past when the 'currency of the US' was created by private parties and circulated.   That is not the case now, except in the fevered minds of creative imaginations.

2)  Banks “lend reserves”
  
This myth derives from the concept of the money multiplier, which we all learn in any basic econ course.  It implies that banks who have $100 in reserves will then “multiply” this money 10X or whatever.  This was a big cause of the many hyperinflation predictions back in 2009 after QE started and reserve balances at banks exploded due to the Fed’s balance sheet expansion.  But banks don’t make lending decisions based on the quantity of reserves they hold.

Banks lend to creditworthy customers who have demand for loans. If there’s no demand for loans it really doesn’t matter whether the bank wants to make loans.

This one gets definitionally tricky, because it involves the terminology of bank accounting and its own particular jargon. But let us cut to the heart of it by saying that banks make loans with some regards to their assets. A person cannot just stand up with no money in their pockets and say, I am a bank and am going to start making loans. They need to be licensed by the government, and must adhere to certain requirements from their books.   Those nasty things like leverage, risk, etc.

As for Banks being in the business of making loans, that is nonsense. Banks are in the business of making money, and we should never forget that.  Sitting idly on what in another business would be called working capital does not do them much good. And people tend to mistake 'working capital' for 'reserves' and that's where we go off into the jargon wilderness.

What is a creditworthy loan? This is not some black and white threshold, good or bad, but more like better or worse, an analog measurement of risk and reward. Anyone who has ever funded competing projects in corporations understand this. It is intimately tied to risk return and competing opportunities.

I would certainly think that most people understand that making commercial loans for some meager basis points in return over the long haul is boring stuff compared to the opportunities to be had in gaming hot money markets for outsized gains and large bonuses tied to short term results.

And that is the heart of much of the problems in the financial system today. Speculation is crowding out investment from the commercial banking system due to the repeal of Glass-Steagall, and the laxity of regulating the abusive practices of large and powerful players in the markets.

3) The US government is running out of money and must pay back the national debt.

There seems to be this strange belief that a nation with a printing press whose debt is denominated in the currency it can print, can become insolvent. There are many people who complain about the government 'printing money' while also worrying about government solvency. It’s a very strange contradiction...

As I’ve described before, the US government is a contingent currency issuer and could always create the money needed to fund its own operations. Now, that doesn’t mean that this won’t contribute to high inflation or currency debasement, but solvency (not having access to money) is not the same thing as inflation (issuing too much money).

This is a nice piece of sophistry because while it knocks down a thesis, it does not prove its antithesis.

Because the US government is NOT running out of money, and it does NOT have to pay back the national debt, that does not mean that the national debt has no limit. It just means that we have not yet reached it, whatever that may be.

At some point you have to get off the theoretical merry-go-round and try to exchange some of that money which you declare that you have for real goods. And the perspective of the counterparty weighs in heavily on that transaction I daresay. One only has to look at the many, many failed currencies throughout history, from 'contingent currency issuers,' in order to understand the fallacy of this argument.

Certainly you can force your own citizens to adhere to your commands, as the MMT crowd are often wont to imply.  But it is still a larger world out there, and absent one world government, there are some degrees of freedom in determining currency valuations.

4) The national debt is a burden that will ruin our children’s futures.

The national debt is often portrayed as something that must be “paid back”. As if we are all born with a bill attached to our feet that we have to pay back to the government over the course of our lives. Of course, that’s not true at all. In fact, the national debt has been expanding since the dawn of the USA and has grown as the needs of US citizens have expanded over time. There’s really no such thing as “paying back” the national debt unless you think the government should be entirely eliminated (which I think most of us would agree is a pretty unrealistic view of the world).

This one is almost the same as myth number 3. The national debt is something that will always exist in a debt based system. The pricing of debt in a marketplace is how the Federal Reserve system and Treasury are theoretically restrained from the excessive creation of money.

The very money in your pocket is itself is a 'note' of obligation on the Balance Sheet of the Fed, and overall a debt obligation of the Treasury.  The 'full faith and credit' of the United States if you will.

But that does not mean that the debt cannot become a burden on our children. If the debt is misspent and squandered and allowed to outgrow the capacity to manage it, it can become a very real burden.

But I find that those who make this argument are typically those who have already grabbed a good portion of the money from some financial bubble, and now seek to hold their gains.   Debt must be managed.

To this point Cullen says "All government spending isn’t necessarily bad just like all private sector spending isn’t necessarily good." And I agree with this completely.

5) QE is inflationary 'money printing' and/or 'debt monetization'

Quantitative Easing (QE) is a form of monetary policy that involves the Fed expanding its balance sheet in order to alter the composition of the private sector’s balance sheet. This means the Fed is creating new money and buying private sector assets like MBS or T-bonds.

When the Fed buys these assets it is technically 'printing' new money, but it is also effectively 'unprinting' the T-bond or MBS from the private sector. When people call QE 'money printing' they imply that there is magically more money in the private sector which will chase more goods which will lead to higher inflation. But since QE doesn’t change the private sector’s net worth (because it’s a simple swap) the operation is actually a lot more like changing a savings account into a checking account. This isn’t 'money printing' in the sense that some imply.

Well yeah, it is money printing, although I agree it is not magical. The Fed simply expands its Balance Sheet and creates, or prints if you will, Federal Reserve notes of zero duration, also known as dollars, and exchanges them for assets of various durations and quality at non-market based prices. It is not limited to Treasury debt, but can include almost anything really according to the Fed, whether it be toxic debt mortgages, or common stocks, etc.  

And the Fed is not 'unprinting' anything, until it either writes off the debt, or return it to its issuer.  The Fed is a private corporation.  You can say that the Fed withdraws the liquidity from the market place by keeping it relativelhy inactive because the Fed does not purchase many things, but even that is no longer the case.  The Fed has grown into quite the organization, with its own police force.  It merely surrenders any 'profits' remaining after all its discretionary expenses back to the Treasury.

If this was such a simple and benign swap why else would they do it? It is one of the primary levers the Fed uses to influence monetary policy.

They are increasing and changing the character of the money supply in the course of managing it. It is what they do for God's sake, besides riding herd on their banks who normally create the money for them, but occasionally get derailed by some financial bubble of their own creation.

7) Government spending drives up interest rates and bond vigilantes control interest rates.

Many economists believe that government spending 'crowds out' private investment by forcing the private sector to compete for bonds in the mythical 'loanable funds market.' The last 5 years blew huge holes in this concept. As the US government’s spending and deficits rose interest rates continue to drop like a rock. Clearly, government spending doesn’t necessarily drive up interest rates.

And in fact, the Fed could theoretically control the entire yield curve of US government debt if it merely targeted a rate. All it would have to do is declare a rate and challenge any bond trader to compete at higher rates with the Fed’s bottomless barrel of reserves. Obviously, the Fed would win in setting the price because it is the reserve monopolist. So, the government could actually spend gazillions of dollars and set its rates at 0% permanently (which might cause high inflation, but you get the message).

It is not government spending that drives up interest rates, but that does not mean government spending cannot drive up interest rates. It sure as hell can. 

And I would hope to think that bond vigilantes can help to control interest rates, otherwise the entire Federal Reserve system and the US dollar is based on a fallacy. See what Mr. Bernanke has to say below. This is the confidence on which the dollar rests.

In fact the Fed COULD exercise reserve monopolist powers and print all the money it wishes at zero rates. And the 'vigilantes' could respond by shifting their wealth into other non-dollar instruments, en masse.

What is somewhat confusing is that the relationship is not straightforward, but is a somewhat non-linear dynamic with a lag. You can get away with quite a bit of economic behavior in the short term. But eventually you can reach a tipping point, if there remain enough agents who are free to dissent from the dictates of a central authority that has fallen into error, aka 'vigilantes.'

8) The Fed was created by a secret cabal of bankers to wreck the US economy.

The Fed is a very confusing and sophisticated entity. The Fed catches a lot of flak because it doesn’t always execute monetary policy effectively. But monetary policy is not the reason why the Fed was created. The Fed was created to help stabilize the US payments system and provide a clearinghouse where banks could meet to help settle interbank payments.
...So yes, the Fed exists to support banks. And yes, the Fed often makes mistakes executing policies. But its design and structure is actually quite logical and its creation is not nearly as conspiratorial or malicious as many make it out to be.

This is reductio ad absurdam. The Fed is not a monster or inherently evil. But that does not make it good.

The Fed was created in somewhat extraordinary circumstances, wrapped in political secrecy in the aftermath of a banking crisis.  And it was driven by a small group of powerful men who united to promote a common purpose.  I will not speak to their motives.

There is a long controversy about the proper role of a central bank in the US, going back to its very founding, and this treatment makes light of that.

It is a great power to create and distribute money, that can be used for good or ill. And therefore it must be constrained, and subject to oversight. And history shows that this power is frequently abused.

9) Fallacy of composition.

The biggest mistake in modern macroeconomics is probably the fallacy of composition. This is taking a concept that applies to an individual and applying it to everyone.

Could not agree more, especially if you extend it to anecdotal information. But I would tend to refer to it as the fallacy of reasoning from the particular to the general.  But I would not call it 'the biggest.'

One of the most perennial myths is that a skill in making money, especially through financial speculation, is the sign of wisdom in other things.  Some of the best traders I have known are borderline savants and white collar criminals, whom I would hardly trust to handle my family's future. 

Alas, wealth and beauty are not always companions of virtue in this world.  They become accustomed to obsequiousness, and lose site of their common humanity.  And there is nothing sadder or more tedious than a man who has become wealthy, who decides to grace the public with his wisdom, bad haircut and all. 

I think a more pernicious and prevalent economic myth is the notion that economics can dictate public policy through some appeal to economic laws as if they were physical laws like gravity. Public policy is best decided by determining goals and priorities and then allowing many things, including economics, to shape the implementation of that policy.

But economics has been elevated to a position in our societies which is wholly inappropriate and a source of great mischief, especially when the truly dangerous myths like 'naturally efficient markets' become the basis for policy decisions without proper regard for their effects. The 'austerity for the sake of the public while sustaining corrupt practices' myth is perhaps the most cruel and appalling.

10) Economics is a science.

Economics is often thought of as a science when the reality is that most of economics is just politics masquerading as operational facts.

Economics is a social science, and not a physical science. There are plenty of facts, and somewhat ironically Mr. Cullen has just leaned heavily on quite of few of the ones he tends to favor, whether they are right or not.  

The worst of it is when economics is used by those who claim an 'authority' from it to promote policies that are quackery, as we have seen all too much in the past twenty years in particular with regard to the natural goodness of the power of 'the Market.'

What concerns me though is the follow on to this declaration of  the myth of economics as science. It is that extreme resort of relativism which holds that since economics is all bullshit, why not use it, and shamelessly, to promote a particular point of view, wrapping it in as much jargon and intimidating hoo hah as you can manage?  Since there is no science, there are no necessary consequences, and we may do as we please.  And that is a sophistry of the first order.

And this view is being promoted by the economists themselves, those few members of a 'disgraced profession' like accountants and regulators, who were willing to say and do almost anything for the promise of money, favors, and political connections.

And this deterioration in professional standards has long been my objection to much that has been said and is being said about money by these most modern of thinkers, caught up in the will to power, who believe that since there is no god of consequences, then everything is lawful.  

They lose their grounding in the reality of commerce and risk, and start throwing around harebrained notions like 'platinum coins.'  They bring the childish politics of their academic departments to weigh in on serious policy decisions with serious real world consequences.

Even a few faux Nobel laureates have been seen to join in this Dionysian dance, a filigree of modern monetary contrivance.  Skip the coin, default, and be damned if you will, but a old fish wrapped in silk is still a dead and stinking fish.

Speaking about money, It is worth reading what Mr. Bernanke has written about money in this essay below.  It speaks volumes. 

"What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.

By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior). Normally, money is injected into the economy through asset purchases by the Federal Reserve.

To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys.

Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic.

One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it.

If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation."

Ben S. Bernanke, Deflation: Making Sure 'It' Doesn't Happen Here

Pictures of an Exhibition in Policy Error - Without Oath or Honor

The growth in money supply is very strong, both in M2 and MZM, both broad measures of overall supply, each with a differing emphasis on duration.  Both are growing at around 7 percent year over year.   This is certainly in excess of the GDP, and the growth of consumer loans and bank credit, which is only growing at 2.5 percent year over year.

What is particularly disturbing is that the growth rate of real disposable income at this late stage of The Recovery™ is sub one percent, even as corporate profits, cash levels, and executive pay return to stratospheric levels for the large multinationals with large cadres of lobbyists and significant political influence through the revolving door.

I am not saying this is solely a Federal Reserve driven policy error.  Not at all.

Quite a bit of it is being driven by fiscal policy, and specifically by the Congress and a Wall Street friendly Administration.  This is not a New Deal, it is the Raw Deal.

But the failure of the Fed to act aggressively in conjunction with other regulatory agencies to reform the financial system, given the additional powers as regulator which they actively sought in the aftermath of the financial crisis for which they were a primary contributor, makes them equally culpable for the folly of this 'trickle down' approach.  And the 'hands off, see no evil' approach to widespread financial fraud and abuse that continues even today.

There is a credibility trap at work, that prevents those in leadership positions from addressing the real problems frankly and honestly. They will attempt to shift the blame and the pain to the people, but with the pay and privilege of leadership comes responsibilities and obligations, what at another time would have been lumped together as 'honor.'  

Oaths and the highest principles of the land are just pieces of paper, not allowed to stand in the way of the personal god of the day, gettin' paid.

And I think that the ruling elite have lost all sight and sense of the consequences of this in a frenzy of personal advancement and enrichment.

This is neither sustainable nor decent, and will not end well.

 

"I believe we have a crisis of values that is extremely deep, because the regulations and the legal structures need reform. But I meet a lot of these people on Wall Street on a regular basis right now. I'm going to put it very bluntly. I regard the moral environment as pathological. And I'm talking about the human interactions that I have. I've not seen anything like this, not felt it so palpably.

These people are out to make billions of dollars, and [think] nothing should stop them from that. They have no responsibility to pay taxes, they have no responsibility to their clients, they have no responsibility to people [or] counterparties in transactions.

They are tough, greedy, aggressive, and feel absolutely out of control, in a quite literal sense. And they have gamed the system to a remarkable extent and they have a docile president, a docile White House and a docile regulatory system that absolutely can't find its voice. It's terrified of these companies.

If you look at the campaign contributions, which I happened to do yesterday for another purpose, the financial markets are the number one campaign contributors in the U.S. system now. We have a corrupt politics to the core, I'm afraid to say... both parties are up to their necks in this.

...But what it has led to is a sense of impunity that is really stunning, and you feel it on the individual level right now. And it's very very unhealthy. I have waited for four years, five years now, to see one figure on Wall Street speak in a moral language.

And I've have not seen it once. And that is shocking to me. And if they won't, I've waited for a judge, for our president, for somebody, and it hasn't happened. And by the way it's not going to happen any time soon, it seems."

Jeffrey Sachs, Address By Video to a Conference At the Philadelphia Fed, April 2013

Eisenbeis: What's A Central Bank To Do Besides Printing Money (And Pursue A Hidden Agenda?)

I thought this was a fairly nice thumbnail sketch of the problem facing the world's central banks vis à vis the US dollar as reserve currency and globalization. I have to add that this current impasse was not unforeseen.

I suggest you take a look at a very brief description of Triffin's Dilemma.

The Triffin dilemma is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. This dilemma was first identified by Belgian-American economist Robert Triffin in the 1960s, who pointed out that the country whose currency foreign nations wish to hold (i.e. the global reserve currency) must be willing to supply the world with an extra supply of its currency to fulfil world demand for this 'reserve' currency (foreign exchange reserves) and thus cause a trade deficit.

The use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars in to the United States. Currency inflows and outflows of equal magnitudes cannot both happen at once.

The Triffin dilemma is usually used to articulate the problems with the US dollar's role as the reserve currency under the Bretton Woods system, or more generally of using any national currency as an international reserve currency.

The problems with any domestic currency operating as the world's reserve currency are well known, and yet the United States decided to pursue this after Nixon closed the gold window. Perhaps that is because the risks to the many were outweighed by the benefits to a few.

I enjoyed the author's flat out statement that "it is undeniable that the world's central banks collectively have flooded world financial markets with liquidity by printing money."

If someone tells you that central banks, in a fiat regime, cannot create money out of nothing, then they simply do not know what they are talking about, no matter how many rhetorical flourishes and convoluted rationales they may produce. They can do it, they are doing it, and they will keep doing it until they reach what they consider to be a sustainable equilibrium, or they exhaust their ability to print based on the limits I have previously described.

The problem is that none of the equilibria they have produced in the last twenty years have been sustainable, except for a few years, and the half life of the monetary bubbles appears to be contracting.

The US dollar is at the end of its rope as the reserve currency for the world. Nothing could be more clear.   What will be done about this is another matter.  The Anglo-American banking cartel will enter the next phase of the evolution of money resisting change every step of the way.  What they most desire is to maintain and extend their control of a worldwide fiat currency, not even in the interests of their own people, but for the benefit of a few.

Institutional Risk Analyst
What's a Central Bank to Do?
By Bob Eisenbeis, Cumberland Advisors
April 25, 2011

Faced with largely the same set of facts when it comes to their inflation outlook, some of the world's major central banks have come to markedly different conclusions about the appropriate policy.

The ECB began to exit from its accommodative policy by increasing its policy rate by 25 basis points to 1.25% on April 7. The ECB noted that growth was improving moderately, but inflation had increased to 2.6% and was up from 2.45% the previous month. The rise was largely due to increases in energy, food, and commodity prices. The concern was the potential second round effects and that these increases could become embedded in inflation expectations.

The same day, the Bank of England kept its policy rate at 0.5%, despite the fact that inflation had been running well above its target rate of 2% for more than a year and was likely to remain so through 2011. Again, the Committee noted that the near term path for inflation was higher due to energy, imported commodities and other goods. Concern was also expressed about inflation expectations having risen in the UK, the US and the euro area relative to what they had been before the financial crisis. Finally the UK real economy was softer than that of the EU generally with output having declined by 0.5% in the fourth quarter of 2010.

While the FOMC will meet this week, Fed Chairman Ben Bernanke and Vice-Chair Janet Yellen have already signaled that they view the recent increases in commodity, energy and food prices as transitory. Governor Yellen in particular provided an extremely thorough and detailed dissection of the inflation data and her views on the real economy and employment in her April 11th speech in New York. She indicated clearly that the causes of the run-up in food, energy and commodity prices were rooted in increases in global demand, combined with energy supply shocks and uncertainty about oil flow from the Middle East. Like the Chairman, she expressed the view that the increases were transitory.

Most notably she attempted to debunk the widely discussed view that accommodative policies in the US were the cause of the increase in global prices. She was very clear that the main concern was for the US expansion and employment situation, that the current stance of policy was appropriate, and that QE II would be completed as scheduled. So we don't expect any notable news coming from this week's FOMC meeting.

These three views on the appropriate stance of policy and how individual-country central banks may think about policy shows a growing disconnect between traditional approaches to monetary policy and globalization. For example, the US economy historically has been largely isolated from the rest of the world. International markets were not particularly significant (exports and imports were roughly balanced and accounted for less than 13% of GDP). Inflation was largely a domestic issue and could be directly affected by changes in US policy rates. From the 50s through 70s, the main channel for monetary policy was through housing: when interest rates exceeded the Reg Q ceilings that banks and thrifts could pay for funds, the supply of funding to housing was cut off. Then construction declined and the effects rippled through the rest of the economy. Most of the economic models have that structure and international isolation embedded within them. Yet this is not the world that policy makers are now dealing with, as the above descriptions of the causes of the current inflation aptly illustrate.

If the major causes of inflation are external to an economy, and policy makers have domestic tools and targets for inflation and local employment, either explicitly or implicitly, then how should they respond to externally generated causes of inflation? What is the link between the central bank's domestic policy interest rate tool and the external causes of price increases? These key questions are not currently addressed within contemporary policy frameworks employed by the FOMC, the ECB, or the Bank of England, as best one can determine.

In the current inflation environment, one can justify any one of three alternatives, and some of these are clearly being adopted. Furthermore, all can be mostly right or mostly wrong.

First, a policy maker could attempt, as the US did during the 1970s oil crisis, to insulate the real domestic economy from the contraction supply shock by keeping rates low. This policy seemed appropriate and was politically acceptable, especially since the price increases were viewed as temporary. But it clearly failed, and we paid the cost with higher inflation.

Second, if one believes that the energy, food and commodities price increases are transitory, then no response is called for; and this can justify focusing on domestic employment, as is currently being done in both the US and UK. Even if the increases are permanent, doing nothing may be the appropriate policy. Permanent increases in energy, commodity, and food prices will shift these prices relative to other goods and services and generate substitution and accommodative responses by business and consumers. We may, for example, drive less and adopt more hybrid transportation alternatives -- moves that are already beginning to take place -- than we would if the energy price increases were viewed as being temporary.

But doing nothing also has its own risks. Maintaining an accommodative policy too long risk overheating an economy and fueling both an increase in domestically-produced goods and services prices and passing along the increased prices of external goods and energy prices as second round effects. As always, timing is everything when it comes to exiting from an accommodative policy.

Third, a central bank can move to increase its policy rate to choke off inflation, as the ECB has begun to do. But this policy has certain risks associated with it. If the causes of the inflation are external to the economy, then one would not expect those prices to be responsive to a policy move by a domestic central bank. But the increase in rates will clearly impact those domestic and non-international activities that are affected by rising interest rates. Economic activity in those areas will contract, including production, employment, and prices. So the impact of responding to an external inflation source is to force a decline in an aggregate price index by contracting domestic economic activity. This seems a risky path indeed. Right now it may appear less so because policy, as ECB President Trichet stated, is still viewed as being extremely accommodative.

So what is a central bank to do, especially when policy is overly accommodative? While Vice-Chair Yellen may argue that the increase in world prices is not our fault, it is undeniable that the world's central banks collectively have flooded world financial markets with liquidity by printing money.

This situation is likely to become even worse in the near term if Japan resorts to inflation as a means to finance the cleanup and rebuilding necessitated by the recent earthquake, tsunami, and nuclear disasters. When domestic economies are no longer insulated from international markets and forces, individual central banks can no longer go-it-alone with their policy decisions. In such a world, perhaps the best policy is to remove the distortions cause by current policies, and then attempt to avoid extremes. Unfortunately, how to get from here to there in a non-disruptive way is not at all obvious, as the ECB may soon find out..

What this means for investors is that market uncertainty is likely to remain high for some time to come, and attempting to play in international markets carries with it huge foreign-exchange and real risks that need to be hedged.

Although I may say uncomplimentary things occasionally about Messrs. Bernanke and Greenspan and their colleagues on Wall Street and in government, I most definitely do not think they are fools, or naive, or uncomprehending of what they are doing. Therefore I find their actions difficult to square with a sincere fulfillment of their stated objectives, and the oaths of their offices, unless there is another dimension to their plans which has not been disclosed, and which I do not yet understand.

"And some of us who have already begun to break the silence of the night have found that the calling to speak is often a vocation of agony, but we must speak. We must speak with all the humility that is appropriate to our limited vision, but we must speak...Perhaps a new spirit is rising among us. If it is, let us trace its movements and pray that our own inner being may be sensitive to its guidance, for we are deeply in need of a new way beyond the darkness that seems so close around us."

Martin Luther King

Fiscal Union Is Implied if Not Required by a Monetary Union

In 1991 during a visit to Brussels for a discussion of the EU '92 event with some of the bureaucrats engaged in planning there, my old economics professor predicted that no matter what they said, a monetary union implies a fiscal union, greater than the targets and harmonisation which they would admit, men being the creatures that they are.

It makes sense when one understands monetary policy and its theory, and the implications it has in restricting the freedom to save or spend as one may wish to pursue as a fact of fiscal policy.

Here is a story below in which France and Germany discuss their moves to bring more uniformity to their fiscal policies. Quite frankly I am surprised that it has taken this long for it to happen. With the financial crisis tearing down the facades, the extend and pretend policies of the EU have collapsed, and the cheating behind their targets have been exposed for the farce that they are.

And by extension, if one's monetary and fiscal policies are no longer their own, but shared with another and intimately bound by a common currency, then a greater political union and independent governance is a moot point.

This is what my old professor predicted in 1991. And on the train ride back to Paris he said, "Watch what happens if there is a move to establish a single world currency that is a sovereign instrument, and not merely a reference to a basket of currencies and commodities. And then he quoted the famous observation from Mayer Rothschild: "Give me control of a nation's money and I care not who makes the laws."

It has been many years since we have spoken. He was tottering towards his retirement then, and I suspect that he is smiling at all these developments from some better and kinder vantage now, as I know he would be even if it was a profane preference. It was always his first joy to probe the subtle mysteries of money, and how they related to the political follies of men. It was he who first infused me with an interest in the study of money, an aspect of macroeconomics which bordered on his obsession. And it opened a new world to me, and an endless fascination with what is difficult, but so wonderfully, and often subtlety vast.

"Much have I travell’d in the realms of gold,
And many goodly states and kingdoms seen;
Round many western islands have I been
Which bards in fealty to Apollo hold.
Oft of one wide expanse had I been told
That deep-brow’d Homer ruled as his demesne;
Yet did I never breathe its pure serene
Till I heard Chapman speak out loud and bold:
Then felt I like some watcher of the skies
When a new planet swims into his ken;
Or like stout Cortez when with eagle eyes
He star'd at the Pacific--and all his men
Look'd at each other with a wild surmise--
Silent, upon a peak in Darien."

John Keats, On First Looking Into Chapman's Homer

LesEchos.fr
France
et Allemagne s'attaquent à l'harmonisation de leur fiscalité

La bonne gouvernance européenne implique, notamment, l'harmonisation des politiques fiscales. Paris et Berlin en font leur credo, qui ont fait un pas ce mercredi vers une convergence de leurs systèmes fiscaux, à l'occasion de l'invitation au Conseil des ministres français du ministre allemand de l'Economie et des Finances Wolfgang Schäuble.

L'objectif est que « nos deux gouvernements soient ensemble en mesure de prendre des décisions pour aller vers la nécessaire convergence fiscale, tant dans le domaine de la fiscalité des entreprises que dans celui de la fiscalité des particuliers », a annoncé l'Elysée dans un communiqué. « La convergence entre nos systèmes fiscaux est un élément essentiel de notre intégration économique et de l'approfondissement du marché intérieur en Europe », a estimé Nicolas Sarkozy. La première étape de cette convergence devrait passer par un état des lieux des deux systèmes. La Cour des comptes s'en chargerait, côté français, un organisme équivalent s'y attelant outre-Rhin.

Le plan de rigueur allemand est soumis à des risques d'exécution

Le rapprochement franco-allemand en matière de fiscalité ressemble fort, côté français, à une volonté d'aligner le système fiscal sur le modèle allemand. Le poids des prélèvements obligatoires sur l'économie est globalement inférieur chez les deux plus proches partenaires de l'UE (42,8% du PIB en France et de 39,5% en Allemagne en 2008, selon les données énoncées par Nicolas Sarkozy ce mercredi), et leur répartition y est sensiblement différente (moins d'impôt direct, mais TVA plus forte
outre-Rhin)...