Posts Tagged Austrian Economics
One, perpetrated famously two years ago by Federal Reserve Chairman Ben Bernanke, is that central banks hold gold not because it’s money but because it is just an “asset” and “tradition”:
Bernanke must dearly wish that it were so. But the Bank for International Settlements confirms otherwise, that gold is “a financial instrument”:
Another disastrously false premise is that gold doesn’t pay interest. But gold pays interest just as money does — when it is lent:
In commentary posted today at Resource Investor, the financial letter writer Przemyslaw Radomski repeats another disastrously false premise — that “gold cannot be printed or manufactured.”
In fact, of course, gold can be printed to infinity thanks to “paper gold,” the issuance of claims to gold that doesn’t exist, claims against bullion banks that are never exercised and probably cannot be honored without supportive dishoarding and leasing from central bank gold reserves:
Working from this false premise, Radomski proceeds to try to answer the question “Have gold and silver stopped responding to the dollar’s price action?” without ever considering the likely price-suppressive effect of “paper gold”:
Indeed, this is the longstanding disparagement about gold in recent years — that even with its great appreciation over the last decade, the gold price has not kept pace with inflation, even as other tangibles have kept pace and even as there has been no substantial increase in gold mine production.
But somehow Radomski has managed to write a long commentary about the prospects for gold, complete with charts, without ever mentioning the involvement of the gold market’s largest participants, central banks, and their agent, the Bank for International Settlements, which appears to be trading gold, gold options, and gold derivatives on their behalf every day —
— and which even advertises secret gold market interventions as being among its services to its members:
Given such surreptitious trading and intervention, if gold, as Radomski wonders, has stopped responding to variations in the value of the U.S. dollar, the explanation is not likely to be found in his or anyone’s price charts, which are mere holograms being projected onto what only used to be markets, interpreted by what only used to be financial journalists, writers whose first principle seems to have become: Never put a critical question to the primary source.
CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.
Understanding today’s convoluted domestic and international fiat monetary system frankly requires a great deal of time and study. One must understand fractional reserve banking, and the way this system affects the money supply. One must understand the multi-step process by which banks create money out of thin air.
One must understand central bank open market operations. Internationally, one must try to understand floating exchange rates, how they are manipulated by central banks, and the resulting impact on national economies. For example, is it best for a country to drive down its exchange rate in relation to other currencies or do the opposite?
These issues are never understood by policymakers, who appear to be among the most illiterate in economic matters, so monetary policy swings to-and-fro according to which economic group has temporary control over the levers of the government, and particularly of central banks.
So Simple Even a Child Can Understand It
In a sound money environment, on the other hand, there is little confusion or controversy. Under sound money—in which money is a commodity (for discussion purposes let us assume it to be gold)—everyone, to some extent, understands monetary theory. Whether it be an individual, a family, a corporation, or a nation, either one has money or one does not. It really is as simple as that. Even children learn the nature of money. A child quickly learns that the things he wants cost money and either he has it or he does not. If he does not, he quickly grasps that there are ways to get it. He can ask his parents for an increase in his allowance. Or, he can earn the money he needs by doing chores around the house or for friends and neighbors. He might be able to borrow the money for large purchases, promising to pay back his parents either from his future allowance or from anticipated future earnings from doing extra chores. His parents can evaluate this loan request simply by considering the likelihood that his allowance and chore income are sufficient.
How is this any different when applied to adults, companies, or governments? In a sound money environment, they are the same. Individuals earn what they spend on the family and may borrow from the bank to buy a home or a new car. The lender will examine whether the person’s income is sufficient to pay back the loan. If the family hits hard times, they may ask for assistance from relatives or a charity. Companies have more means with which to fund their operations. Stockholders provide the company with its initial capital. Thereafter, when normal earnings are insufficient to fund desired expansion, the company can borrow against accounts receivables and inventories, both of which provide varying degrees of security for the lender.
So Simple Even a Politician Can Understand It
A national government’s finances, under a sound money system, are little different from either a household’s or a company’s. It needs to collect in taxes what it spends. If it suffers a budget deficit, it can cut back spending, attempt to raise taxes, or borrow in the open market. In a sound money environment, there is a limit to the amount of debt that even a government can incur, due to the need to pay back the loan from future tax revenue. If the market believes that this may not be forthcoming, the nation’s credit rating may suffer and its borrowing costs will rise, perhaps to the point that the nation is completely shut out of the credit market. But this is a good thing! The market instills practical discipline that even a politician can understand! Under sound money, one does not need a special education to understand the monetary system.
Taking the process one step further, anyone can understand international monetary theory in a sound money environment. The national currency is simply shorthand for a quantity of gold. A US dollar may be defined as one thirty-fifth of an ounce of gold, and a British pound defined as roughly one seventh of an ounce of gold. Exchange rates become mathematical ratios that do not vary. So an American purchasing English goods would exchange his dollars for pounds at a ratio of five dollars per British pound; i.e., one seventh of an ounce of gold (a pound) divided by one thirty-fifth of an ounce of gold (a dollar) equals five dollars to a pound. Through the banking system, the English exporter would demand gold from the issuer of dollars, whether it be from a central bank or private bank, at thirty-five dollars per ounce. When a currency is simply a substitute for gold, either the issuer has gold with which to redeem its currency or it does not.
Money Issuers Subject to Normal Commercial and Criminal Law
When a nation overspends internationally, its gold reserves start to dwindle. Money, which is backed one hundred percent by gold, becomes scarce domestically. Domestic prices fall, triggering a rise in foreign demand for the nation’s goods. The process of gold depletion is halted and then reversed. This is the classical “Currency School” of international monetary theory. Commercial banks present checks drawn on one another every day and the same process would exist for gold-backed currencies. If a bank issues more scrip than it can redeem for gold at the promised price, it is guilty of fraud. Its officers and directors can be sued in court for any loss incurred by those who accepted the bank’s scrip. Furthermore, the officers and director could be prosecuted for the crime of fraud. In other words, banking would be subject to normal commercial laws and bank officers and directors would be subject to normal criminal laws.
Good Money Drives Out Bad
The free market monetary system would drive bad money issuers out of the market. Plus, bad money issuers would suffer the loss of both their personal finances and, in the case of outright fraud, loss of their personal freedom. This would be a sobering incentive to deter criminals and attract only legitimate money issuers. Money would be a bailment; i.e., property held for the benefit of another, which must be surrendered upon demand for redemption. All around us exist analogous bailment examples of entrusting valuable goods to complete strangers. We leave our cars with valets at parking garages, our clothing at neighborhood cleaners, our overcoats at coat checks, our luggage to the airlines, valuable merchandise with shippers. In these cases, we fully expect that our property will be returned to us. And it almost always is! If it is not, public trust in the fraudulent outfits evaporates, and they quickly go out of business. Likewise, money issuers would thrive only when the public trusts their integrity, which would be enhanced by regular outside audits by respected firms of the existence of one-hundred-percent reserves to back the money issuer’s scrip. How different this would be from our present system in which the Fed will not allow an audit of its gold reserves even when held for the benefit of other central banks! It is clear that in a free market monetary system such a policy would drive Federal Reserve Notes out of the market through lack of demand. Even were the Fed to back its notes with its gold reserves, in a totally free market in which private banks could issue their own gold-backed scrip, the Fed would suffer from its past history of blatant money debasement and secrecy in its operations. The market would prefer the money issued by a well-respected private bank whose operations are transparent and subject to outside audit by respected accounting firms.
In a sound money environment everyone understands monetary theory. Money is like any other desired commodity, except it is not consumed. It is a medium of indirect exchange, which traders accept in order to exchange for something else at a later time. This is easily understood, whether the trader is a child, a parent, a company, or a nation. One either has money or one does not. The money can be a money substitute, a bailment, with which one can demand the redemption of the real money—gold. Money issuers must keep one-hundred-percent reserves against their money substitutes in order to abide by normal commercial and criminal law. No special agencies or monetary authorities are necessary to make the system work. The system emerges naturally and is regulated via the normal commercial and criminal legal system.
This is the system that government does not want us to have, because it provides no special favors for enhancing state power. Sound money shackles the government to the will of the people and not vice versa. As Ludwig von Mises stated in The Theory of Money and Credit:
“It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights.”
China Eclipsed the U.S. as the Biggest Trading Nation. Questions to ask from an Austrian Perspective
Last month one of the Bloomberg’s headline news was titled “China Eclipses the U.S. as Biggest Trading Nation”. There seems to be of concern China’s 2012 reported trade of $3.87 trillion surpassing the U.S. report of $3.82 trillion. For the full article click here.
The concern arises with the fact that…
China’s growing influence in global commerce threatens to disrupt regional trading blocs as it becomes the most important commercial partner for some countries. Germany may export twice as much to China by the end of the decade as it does to France, estimated Goldman Sachs Group Inc.’s Jim O’Neill.
Why worry so much about an Olympic athlete that had worked hard for many years to win the gold medal? The benefits of twenty and some years of manufacturing and producing real capital in the world are evident and well deserved. As far as Germany increasing its exports to China there should be no big surprise. Germany, one of the few productive economies left in the EU, needs to find a strong trading partner with whom to exchange goods and services. The key word is “strong”, financially strong. Who else should Germany trade with? France, Spain, Italy, Greece, countries which are literally economically insolvent?
O’Neill goes on saying that…
“For so many countries around the world, China is becoming rapidly the most important bilateral trade partner. At this kind of pace by the end of the decade many European countries will be doing more individual trade with China than with bilateral partners in Europe.”
So, what’s wrong with that? If I owned a company and found that my best consumers for my product are on another continent, I would not hesitate. In addition, knowing that my consumers are financially capable of buying my products gives me even more reasons to target that market. Why settle for local consumers heavily in debt who can’t afford my products and/or would have to acquire more debt to afford it? Competition and free markets are key components of growth and success. At this point, those European countries should pay serious attention and do whatever it takes to become competitive in the market.
Then, under the chapter U.S. Leadership, we’re finding out that…
When taking into account services, U.S. total trade amounted to $4.93 trillion in 2012, according to the U.S. Bureau of Economic Analysis. The U.S. recorded a surplus in services of $195.3 billion last year and a goods deficit of more than $700 billion, according to BEA figures released Feb. 8. China’s 2012 trade surplus, measured in goods, totaled $231.1 billion.
The U.S. economy is also double the size of China’s, according to the World Bank. In 2011, the U.S. gross domestic product reached $15 trillion while China’s totaled $7.3 trillion. China’s National Bureau of Statistics reported Jan. 18 that the country’s nominal gross domestic product in 2012 totaled 51.93 trillion yuan ($8.3 trillion).
“It is remarkable that an economy that is only a fraction of the size of the U.S. economy has a larger trading volume,” Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington, said in an e-mail. The increase isn’t all the result of an undervalued yuan fueling an export boom, as Chinese imports have grown more rapidly than exports since 2007, he said.
As far as services versus goods provided this is a clear sign that the U.S. does not provide enough goods. Goods are of two kinds. Consumer goods (those items we shop for such as cars, furniture, toys, clothing, jewelry, etc) and capital goods (which are the machinery and equipment with which consumer goods are being produced). Maybe the U.S.’s protectionist agenda, taxation, heavy unionism in conjunction with a national trend of favoring a socialist, if not fascist, economic system did not help after all. Maybe the corporate bailouts and Quantitative Easing did not in the end help the private manufacturing sector.
If I were in a position of power I would wonder – and would want to find out – how come my country with a GDP of $15 trillion has a trade deficit higher than my competition, which has a GDP half of my country’s GDP. Could it be that too much of our GDP is comprised of 1. the growing of the federal government, and 2. military exposure all over the world? Could it be that such a big economy has little to justify its big number considering its producing capacity is in a less than desirable stage? Mr. Lardy addresses such a question but he seems surprised. But the small businessman in America is hardly surprised. Why? Because it’s become very hard for the small business owner to compete with the government subsidized corporations when he has to jump government imposed barriers in form of rules and regulations, when he’s coerced with providing health insurance coverage to his employees, and when he’s faced with minimum wage restrictions. Then Mr. Lardy brings up a good point. China’s imports are now replacing its exports. The answer is: Think of the U.S. back during the 1980’s, when it was the largest manufacturer in the world and the largest creditor. There seems to be a role reversing going on.
The article goes on…
The U.S. emerged as the preeminent trading power following World War II as it spearheaded the creation of the global trade and financial architecture. Protectionist policies in the 1930s had exacerbated the global economic depression. At the same time the U.K., the leading trading nation of the 19th century, began to dismantle its colonial empire.
Wait a minute, did I read that right? It says that Protectionist policies in the 1930’s had exacerbated the Depression. Wasn’t Goldman Sachs concerned with Germany not trading locally within the E.U. territory? What Germany is doing is simply trading in a free market exchange. Why use protectionism to stifle it?
If the article referred to the U.K. as a colonial empire what makes today’s U.S.A. different than Great Britain during the beginning of the last century?
China began focusing on trade and foreign investment to boost its economy after decades of isolation under Chairman Mao Zedong, who died in 1976. Economic growth averaged 9.9 percent a year from 1978 through 2012.
After a long period of central planning and economic regression under the communist system China recognized that hard work and free markets are the answer to economic prosperity.
China became the world’s biggest exporter in 2009, while the U.S. remains the biggest importer, taking in $2.28 trillion in goods last year compared with China’s $1.82 trillion of imports. HSBC Holdings Plc forecast last year that China would overtake the U.S. as the top trading nation by 2016.
This begs the question: Is the U.S. consuming too much and producing too little?
The article continues with claims from a few banking institutions that China’s export figures could be manipulated. Maybe or maybe not. What I know is that wherever I shop in the U.S. , whether Walmart or JC Penney, I can’t help noticing the “Made in China” tags.
Eswar Prasad, a former International Monetary Fund official who is now a professor at Cornell University in Ithaca, New York, says…
“The U.S.’s bilateral trade deficit with China, which peaked in 2012, could remain a flashpoint of tension between the two countries.”
Why tension? Is it mutual from both countries, or unilateral? The question of who benefits the most out of the trading partnership at this time has not been addressed enough. What would happen to American people if Chinese goods imports would stop over night? Has the American politician explained how the lifestyle of the average American would be impacted? Has it been argued that an unemployed American may suffer drastic changes? The typical comment out there is “let’s build American”. Sure, I am all for it but with what? There is no savings to produce the capital required to produce goods. Or should we borrow more and increase our debt? Should we allow unions to force manufacturers to keep wages up? If we do, it means that we should also expect to pay double, if not triple for a product that otherwise would have cost us less if it were imported from China.
On the other side would China and its people be affected as much? Do they need the U.S. to consume its products? Maybe. But what if the Chinese renminbi is allowed to freely float? If that happens, the Chinese people’s purchasing power is increased. If their currency goes up it means their people would be able to afford more. With a population of more than 1.3 billion I would think there would be a large enough market to consume the locally manufactured products. Not to forget the rest of the countries in the region, some with affluent residents (such as Singapore) and some emerging countries with growing industries and growing wealth (Indonesia, Malaysia, Vietnam, etc).
Mr. Prasad continues…
“This trade imbalance is not representative of the amount of goods actually produced in China and exported to the U.S., but this perspective tends to get lost amidst the heated political rhetoric in the U.S.”
If it’s not indicative of the productive nature of China then what does it represent? The answer is just that. China: Large production and little consumption. U.S.A.: Little production and large consumption.
Goldman Sachs’, O’Neill, is concerned with…
“the trade figures underscore the need to draw China further into the global financial and trading architecture that the U.S. helped create. One way or another we have to get China more involved in the global organizations of today and the future despite some of their own reluctance. To not have China more symbolically and more importantly actually central to all these things is just increasingly silly.”
Why bring China to be part of the Wall Street game? So that it becomes part of the Debt web and contributes further to the global economic instability? No, it’s not silly to be sovereign. No, it’s not silly to be self-sufficient. And it’s not silly to be rewarded for hard work leading to production of real goods. Better than Goldman Sachs’ paper derivatives. Common sense, if applied, should lead us to think of this as an advance warning. Maybe it’s time America starts producing real hard assets instead of Wall Street paper assets.
By: Peter Schiff
During his testimony before Congress this week, Federal Reserve Chairman Bernanke made it a priority to dampen the growing concern that the unprecedented growth of the Fed’s balance sheet presents great risks to the economy. There has been a heightened sense even among normally complacent members of Congress that the Fed could spark a precipitous decline in the economy and the financial markets if and when it seeks to “withdraw liquidity” by selling even a minor portion of its bond portfolio (which is projected to swell to $4 trillion by year end). This is a valid concern that I have been discussing for years.
Gentle Ben soothed these fears by his novel assertion that the Fed doesn’t actually need to sell bonds to neutralize previously injected stimulus. Instead, the Fed could simply allow its bonds to mature, thereby achieving a more natural, and potentially less disruptive unwinding of its gargantuan portfolio. Although his explanation seemed to satisfy many of the Congressman (and the vast majority of the journalists who slavishly dote on Bernanke’s assurances), the idea is completely absurd.
As a result of its previous efforts during “Operation Twist” (which was conducted in order to push down long-term interest rates), the Fed has already swapped hundreds of billions of dollars of short-term securities for Treasury bonds with maturities of ten years or longer. Only a small portion of the Fed’s portfolio, then, becomes due at any given time. The average maturity of the entire portfolio is now over 10 years. There may well come a time when inflation or asset bubbles become so pronounced that aggressive withdrawal of stimulus is needed. Forceful action will only be possible through active selling, not simply by passive maturation.
However, either approach will be insufficient to tighten policy without a simultaneous cessation of buying of newly issued Treasury bonds. After all, to shrink the size of its balance sheet the Fed must stop adding to it…or at least add less than it is subtracting. Even if the Fed had the luxury of holding its bonds to maturity, such a stance would not prevent a collapse in the bond market. The Treasury does not have the cash needed to retire maturing bonds if the Fed stops rolling them over. As the government will have to sell the new bonds to other buyers, one way or another additional supply is going to hit the market.
The Federal government is projected to run trillion dollar deficits for years to come. To cover that gap, the Treasury will need to continuously sell new bonds. This need will persist regardless of the Fed’s policy priorities. For the last few years the Fed has been by far the biggest buyer of Treasuries, in recent times sucking up more than 60 percent of the total issuance. According to some reports, the Fed is expected to buy up to 90 percent of Treasuries in 2013. The only other significant buyers are foreign central banks (who buy for political reasons) and nimble hedge funds. Who does Bernanke expect will fill his shoes when he stops shopping?
To answer that question you must consider the economic environment that would compel the Fed to tighten in the first place. Presumably a period of accelerating economic growth, surging inflation, or rising interest rates would trigger asset sales. In such a situation, who in the world would want to buy low-yielding, long-term government paper while inflation is surging, the dollar is falling, and interest rates are rising? With the Fed on the sidelines, such an investment would be a guaranteed loser. Bernanke claims that the financial conditions will be soothed by an aggressive communications campaign that would let market participants know, in advance, precisely how the Fed intended to dispose of its assets. The cardinal rule in investing is that big players never telegraph their intentions. Fed “transparency” will simply mean that the hedge funds now making money by getting in front of the buying will be making even more money by getting in front of the selling! There will be no cavalry of new buyers riding to the rescue.
This means that any attempt to tighten, no matter how passive, will result in a significant drop in the price of U.S. Treasuries and mortgage-backed securities. Not only would this inflict massive losses to the value of the Fed’s balance sheet but it would exert enormous upward pressure on interest and mortgage rates that the Fed will be unable to control.
In addition to his absurd “let them mature” gambit, Bernanke also announced other novel policy tools that will supposedly help him orchestrate a successful exit strategy, most notably raising the rates paid on funds held at the Federal Reserve. Such a move is expected to deter banks from lending into a surging economy or to invest in risky assets by enticing them to park cash at the Fed. But how high must these rates go, and how much would it cost the Fed (in reality U.S. taxpayers) to do this effectively? Given how high I believe inflation will become, these payments could be truly staggering. The net result will be a substitution of large operating losses for large portfolio losses (which would have come from bond sales).
As I have said many times before, the Fed has no credible exit strategy. Its portfolio is far too large, and the economy, the housing market, the banks, and the government, are far too dependent on ultra-low interest rates to allow Bernanke any real options. In truth, his only exit strategy is to just talk about an exit strategy. Bernanke’s contention that the Fed need not sell any of its bonds is the closest thing yet to an official admission of this fact. Not too long ago Bernanke made the absurd claim that his intention to sell the bonds on the Fed’s balance sheet meant that he was not monetizing debt. How times have changed.
Bernanke is banking on the hope that his policies will jump start the economy which will then be able to motor along on its own. However, the current era of cheap money and fiscal stimulus will never create an economy that is capable of standing on its own legs. Instead, it is propping up a parasitic economy that is completely dependent on the very supports the Fed believes it can one day remove. But if the Fed does not remove them on its own, the markets eventually will.
Bernanke also defended himself against some members of Congress, particularly economically savvy New Jersey representative Scott Garrett, who pointed out the hypocrisy of Bernanke’s claims that Fed policies are responsible for the recent rise in home prices (while simultaneously absolving the Fed of any responsibility for rising home prices during the real estate bubble). To justify this claim, Bernanke made the self-serving distinction that while the Fed is currently purchasing mortgage-backed securities (in order to lower mortgages rates and boost home prices), no such actions existed prior to the 2008 financial crisis. As a result, he claims the Fed could not have been responsible for the bubble. On this point he is dead wrong.
Fed policy during the mid-years of the last decade had an enormous effect on mortgage rates and home prices. By holding short-term rates too low for too long, the Fed was responsible for the proliferation of Adjustable Rate Mortgages and the popularity of the ultra-low teaser rates without which the housing bubble never could have been inflated so large in the first place.
In other words, the Fed broke it then, but it sure can’t fix it now.
Economists who hold the popular view that expanding the money supply will provide the best medicine for our ailing economy dismiss the inflationary concerns of monetary hawks, like me, by pointing to the supposedly low inflation that has occurred during the current period of rampant Fed activism. In a recent blog post aimed specifically at me, Paul Krugman noted that the sub 2.5% increases in the Consumer Price Index (CPI) over the past few years are all that is needed to prove me wrong. In fact, Krugman and others have even suggested that the CPI itself overstates inflation and that the Fed would be better able to help the economy if less strict methodologies were used. However, there is plenty of evidence to suggest that the CPI is essentially meaningless as it woefully under reports rising prices.
Magazines and newspapers provide a good case in point. The truth has not been exposed through the economic reporting that these outlets provide, but in the prices that are permanently fixed to their covers. For instance, from 1999 to 2012 the Bureau of Labor Statistic’s (BLS) “Newspaper and Magazine Index” (a component of the CPI) increased by 37.1%. But a perusal of the cover prices of the 10 most popular newspapers and magazines (WSJ, Washington Post, Time, Sports Illustrated, U.S. News & World Report, Newsweek, People, NY Times, USA Today, and the LA Times) over the same time frame showed an average cover price increase of 131.5% (3.5 times faster than the BLS’ stats). This is not even in the same ballpark.
Some defenders of the BLS may conclude that prices were held down by the availability of free online news content or the convenience of digital delivery. But that is beside the point. Prior to the digital age, the BLS could have claimed that newspaper costs were held down by public libraries that provided free access. It’s also true that online publications deliver less value on some fronts. Not only do many people enjoy the tactile process of reading physical newspapers or magazines, but they offer the secondary value in helping to kindle fires, housebreak puppies, pack dishes, and line birdcages.
Another stunning example is found in health insurance costs, which is a major line item for most families. According to the BLS we can all breathe easy on that front because their “Health Insurance Index” increased a mere 4.3% (total) in the four years between 2008 and 2012. Interestingly, over the same time, the Kaiser Survey of Employer Sponsored Health Insurance showed that the cost of family health insurance rose 24.2% (5.5 times faster). But even if the BLS had reported higher costs, it wouldn’t have made much of a difference in the CPI itself. Believe it or not, health insurance costs are assigned a weighting of less than one percent of the overall CPI. In contrast, the Kaiser Survey revealed that in 2012 the average total cost for family health insurance coverage was $15,745, or almost one third of the median family income.
If the BLS could be so blatantly wrong in reporting the prices of newspapers and health insurance, should we believe that they are more accurate on all other sectors? If the inaccuracy of these two components were consistent with the rest of the CPI’s components, inflation could now be reported in double-digits!
Even more egregious than the manner in which prices are currently reported is the way that CPI methods have been changed over the years to insure that most increases are factored out. Since the 1970’s, the CPI formula has changed so thoroughly that it bears scant resemblance to the one used during the “malaise days” of the Carter years. Main stream economists dismiss criticism of the changes as tin hat conspiracy theories. But given the huge stakes involved, it’s hard to believe that institutional bias plays no role. Government statisticians are responsible for coming up with the formulas, and their bosses catch huge breaks if the inflation numbers come in low. Human behavior is always influenced by such incentives.
The newer CPI methodologies are designed to report not just on price movements, but on spending patterns, consumer choices, substitution bias, and product changes. In other words, the metrics have been altered to track not so much the cost of things, but the cost of living (or more accurately, the cost of surviving). But if you simply focus on price, especially on those staple commodity goods and services that haven’t radically changed in quality over the years, the under reporting of inflation becomes more apparent.
As reported in our Global Investor Newsletter, we selected BLS price changes for twenty everyday goods and services over two separate ten-year periods, and then compared those changes to the reported changes in the Consumer Price Index (CPI) over the same period. (The twenty items we selected are: eggs, new cars, milk, gasoline, bread, rent of primary residence, coffee, dental services, potatoes, electricity, sugar, airline tickets, butter, store bought beer, apples, public transportation, cereal, tires, beef, and prescription drugs.)
We know that people do not spend equal amounts on the above items, and we know their share of income devoted to them has changed over the decades. But as we are only interested in how these prices have changed relative to the CPI, those issues don’t really matter. We chose to look at the period between 1970 and 1980 and then again between 2002 and 2012, because these time frames both had big deficits and loose monetary policy, and they straddle the time in which the most significant changes to the CPI methodology took effect. And while the CPI rose much faster in the 1970’s, the degree to which the prices of our 20 items outpaced the CPI was much higher more recently.
Between 1970 and 1980 the officially reported CPI rose a whopping 112%, and prices of our basket of goods and services rose by 117%, just 5% faster. In contrast between 2002 and 2012 the CPI rose just 27.5%, but our basket increased by 44.3%, a rate that was 61% faster. And remember, this is using the BLS’ own price data, which we have already shown can grossly under-estimate the true rate of increase. The difference can be explained by how CPI is weighted and mixed. The formula used in the 1970’s effectively captured the price movements of our twenty everyday products. But in the last ten years it has been quite a different story.
If these price changes in our experiments had been fully captured, CPI could currently be high enough to severely restrict Fed action to stimulate the economy. Instead, the Fed is operating as if inflation is extremely low. As a result, they are making a huge policy mistake that will come back to haunt us. During the last decade the Fed spent many years denying the existence of a housing bubble, even as a mountain of evidence piled up to the contrary. That error caused the Fed to hold interest rates too low for too long, blowing more air into the bubble and imposing enormous negative consequences on the economy. The Fed, now similarly blind to the inflation threat, is repeating its mistake, only this time the negative consequences will be even more dire.
Apart from the statistical problems that hide inflation, there are also macroeconomic factors that have helped keep prices down despite the quantitative easing. Massive U.S. trade deficits and foreign central bank dollar accumulation mean that much of the printed money winds up in foreign bank vaults, not U.S. shopping centers. As foreign consumer goods flow in, and dollars flow out, a lid is kept on domestic prices. In effect, our inflation is exported as foreign central banks monetize our deficits and recycle their surpluses into U.S. Treasuries. The demand has pushed down bond yields which has allowed the U.S. government to borrow inexpensively. Of course, when the flows reverse, bond prices will fall, yields will climb, and a tidal wave of dollars will wash up on American shores, drowning consumers in a sea of inflation.
Unlike Krugman and the Keynesians, I would argue that it is impossible to create something from nothing. I believe that printing a dollar diminishes the value of all existing dollars by an aggregate amount equal to the purchasing power of the new dollar. The other side takes the position that the new money creates tangible economic growth and that real economic value can therefore be created by putting zeroes onto a piece of paper. I think that those making such absurd claims should bear the burden of proof. For more on the interesting topic of hidden inflation, see my video that I just posted.
By Ron Paul
The great news is the answer is not to be found in more “isms.” The answers are to be found in more liberty which cost so much less. Under these circumstances spending goes down, wealth production goes up, and the quality of life improves.
Just this recognition — especially if we move in this direction — increases optimism which in itself is beneficial. The follow through with sound policies are required which must be understood and supported by the people.
But there is good evidence that the generation coming of age at the present time is supportive of moving in the direction of more liberty and self-reliance. The more this change in direction and the solutions become known, the quicker will be the return of optimism.
Our job, for those of us who believe that a different system than the one that we have had for the last 100 years, has driven us to this unsustainable crisis, is to be more convincing that there is a wonderful, uncomplicated, and moral system that provides the answers. We had a taste of it in our early history. We need not give up on the notion of advancing this cause.
It worked, but we allowed our leaders to concentrate on the material abundance that freedom generates, while ignoring freedom itself. Now we have neither, but the door is open, out of necessity, for an answer. The answer available is based on the Constitution, individual liberty and prohibiting the use of government force to provide privileges and benefits to all special interests.
After over 100 years we face a society quite different from the one that was intended by the Founders. In many ways their efforts to protect future generations with the Constitution from this danger has failed. Skeptics, at the time the Constitution was written in 1787, warned us of today’s possible outcome. The insidious nature of the erosion of our liberties and the reassurance our great abundance gave us, allowed the process to evolve into the dangerous period in which we now live.
By Ron Paul
This neglect ushered in an age of redistribution of wealth by government kowtowing to any and all special interests, except for those who just wanted to be left alone. That is why today money in politics far surpasses money currently going into research and development and productive entrepreneurial efforts.
The material benefits became more important than the understanding and promoting the principles of liberty and a free market. It is good that material abundance is a result of liberty but if materialism is all that we care about, problems are guaranteed.
The crisis arrived because the illusion that wealth and prosperity would last forever has ended. Since it was based on debt and a pretense that debt can be papered over by an out-of-control fiat monetary system, it was doomed to fail. We have ended up with a system that doesn’t produce enough even to finance the debt and no fundamental understanding of why a free society is crucial to reversing these trends.
If this is not recognized, the recovery will linger for a long time. Bigger government, more spending, more debt, more poverty for the middle class, and a more intense scramble by the elite special interests will continue.