Monday, June 8, 2009

Treasury Yields and Currency

At the moment there is a great deal of talk about the falling prices of treasuries. The explanation for this appears to fall into two camps; one explanation is that there is perception that the worst of the crisis is over (meaning that investors are willing to abandon the 'safe haven' of treasuries), and the other is that markets are being spooked by government deficits and quantitative easing (QE - money printing) of the Federal Reserve. Without being a market insider, it is difficult to judge the relative importance of either factor.

One of the errors on this blog has been to overestimate the collective intelligence of the markets, which means that the former explanation is quite plausible. However, the critical factor in the US treasuries market are the rate of QE and the continued confidence of overseas buyers (in particular China). I will return to this, which is a well worn theme of the blog.

The really curious part in this is that any 'recovery' that might involve a move out of treasuries is quite simply impossible. The US is on course for a deficit of $1.84 trillion, which represents about 13% of GDP, and the 'recovery' therefore must be financed through treasuries. If there is any concerted move out of treasuries into other assets, what will be funding the deficit? During the early part of the crisis there was a 'flight to safety' into treasuries, which has inevitably held yields down on bonds, and allowed the growing deficits to be financed. If at any point this process sees any significant reversal, then funding the deficit will become increasingly difficult.

Quite simply, aside from the fact that a failure to fund the deficit would be catastrophic, what kind of 'recovery' is it, if it is being financed by borrowing 13% of GDP?

A long time ago, I made an analogy with a household to explain the absurdity of this notion. A household has been racking up huge debts due to too much expenditure on the 'good things in life', but continues spending. All the time the family's debt is increasing, and then the bad news comes. The wife's job is under threat, and the husband's working hours are being reduced. Their income is declining, but the cost and size of the debt is increasing. They are in deep financial trouble, and are borrowing more and more money in order to keep their lifestyle and also to make payments on previous debt.

It looks like the household is in crisis, and they will soon go bankrupt if they continue their profligate spending. Fortunately, so it seems to our irresponsible family, a visitor comes to their house from 'Dodgy Loan Corporation' and offers them a further and much bigger new loan. They look at the figures, and it appears that, if they accept the loan, the family will be able to continue to live the same lifestyle as they had before. A massive weight lifts off their shoulders, and they live happily ever after.....

We can all (I hope) see the problem in the happy ending. I have not mentioned the prospects for the family's income increasing in the future, and without a massive increase in income, bankruptcy will just be delayed. Sadly, for the family, there is no identifiable prospect of such a massive increase in income in the future, and they are just hoping that 'something will turn up'.

As such, when there is talk of recovery, it is necessary to ask how much of the 'recovery' is simply the massive amount of new borrowing appearing in economic activity. Whilst the money may allow, for a short while, a perception that all is OK, spending is simply exceeding income on an ever greater scale. The debts are just getting bigger, and the prospects of ever repaying are diminishing.

The underlying problem that arises is that the equivalent of the 'Dodgy Loan Corporation' is China, and China is less and less willing to lend. The problem for China is that they have already lent huge amounts, and bankruptcy will mean a loss on their previous lending. The next problem that China has is that the 'family' refuses to rein in their spending, and is continuing to spend more than they earn. In the event of bankruptcy, they lose it all, but if they continue there is no prospects of repayment of the new debt. They are faced with the problem of whether they too might believe that 'something will turn up', or whether they cut their losses.

I have, for months now, been highlighting the many articles in which China has been sounding warnings to the US about their profligacy, and will not repeat the same points I have made many times before. The important point is that China is losing patience, and certainly does not believe that the US policy is sustainable. The best expression of the doubts about the prospects for the US in China was not from official channels, but through the laughter from Chinese students in response to a speech by Geithner in China. He had proposed that the Chinese $US assets were 'very safe'.

The problem for the US is that China does represent the 'Dodgy Loan Corporation', and without their ongoing financial support, the US is bankrupt.

This returns to the question of the bond markets, and the impossibility of a 'recovery' in which money moves out of treasuries into other assets. The only way any movement of money out of treasuries into other assets might be sustained is if China steps up to the plate as the Dodgy Loan Corporation, and actually makes up for the shortfall that will arise. In other words, if other creditors are withdrawing support (for whatever reason), somebody has to enter the market in their place.

It looks very unlikely that China is going to play this role.

The question then arises as to how this problem might play out. I would like to give a firm answer, but must speculate. The problem is that it is impossible to forecast how markets might shift in a situation of an impossible dilemma. If the markets move out of treasuries into other assets, then increasing doubts about the viability of the US state will arise. At the same time, many other indices will tick up, apparently suggesting that recovery is around the corner. In other words the signals will contradict one another. If recovery is around the corner, then perhaps the US state is viable after all. If recovery occurs, then the state will be able to repay the borrowing.

The problem is that the recovery is not a 'recovery'. It is an upswing that is resultant in further expansion in borrowing.

I have to assume that the collective intelligence of the market is not very high, as indications over the last year suggest that they have a limited ability to adapt to new circumstances. Whilst they must eventually adapt, they are slow to do so. In the end, markets will shift towards acceptance of reality, but the process is delayed by clinging on to old paradigms.

In the interim, it is very likely that there are going to be wild swings in sentiment, and what appear to be contradictory indicators appearing all over the news.

These problems are not restricted to the US.

As many of the readers will be aware, there are significant problems in many of the traditionally rich countries - in the Euro area, the UK and in Japan. Each of these economies has a range of problems, similar solutions such as government stimuli and QE, and varying degrees of underlying economic problems. The key question that many investors will be asking in this situation is not which is the best bet as an investment, but which is least worst. I have recently written an article for TFR, in which I outline the underlying problems for investors - determining which currency might be 'safe'.

In the article, I ask why Sterling rose despite the negative watch on the currency from S&P. I will not repeat the article (you can read it here), but the underlying point is that all of the traditionally wealthy economies are looking 'ugly'. As a result, as has happened recently with Sterling, currencies will shift on any news - whether good or bad (e.g. the decline in Sterling as a result of the troubles of Gordon Brown).

What I am trying to do here is paint a picture of the potential for extreme volatility in the coming months. In particular, there are many contradictory forces within individual economies, and uncertainties about the relative health of the traditionally wealthy economies, when one is compared to another. There is, therefore, going to a period of considerable uncertainty as the underlying economic changes start to work through markets, and as investors flee from one high risk into another high risk.

The certainties in this scenario is that the economic shape will eventually shift to reflect the underlying shift in wealth, which is the shift from the traditionally wealthy countries to the 'emerging' markets, and that the economies of countries like the UK and US will be left in tatters.

It is also increasingly probable, but still not certain, that China is going to emerge as the dominant economic power.

In other words, what we are seeing is the final process of the shift of the world into the new economic shape. The only questions that remain are how the process will actually play out, over what timescale, and the level of drama with which the change happens.

Note 1: I have long been discussing the prospects of the RMB as the new reserve currency. I pointed out long ago that the Chinese government would never openly declare such an intention, but that they would rather use proxies. A recent article in the Telegraph reports a continuation of this process:

Guo Shuqing, the chairman of state-controlled China Construction Bank (CCB), also said he is exploring the possibility of issuing loans to trading companies in yuan, allowing Chinese and foreign companies to settle their bills in yuan rather than in dollars.

Mr Guo said the issuing of yuan bonds in Hong Kong and Shanghai would help to develop the debt markets in China and promote the yuan as a major international currency.

The reality is that Mr. Guo would never say such a thing without approval of the government. However, the government is still in a position where they can deny any such intentions, and deny any plan to make the RMB the reserve currency. In the interim, the IMF has suggested that their SDR might be the new reserve currency, following the line of the head of the Chinese central bank. Perhaps they do not realise that this proposal from China was simply a method of indirectly attacking the $US, as an early step in manouvering the RMB in to position as the replacement?

Note 2: Some replies to comments on the last article:

Lord Sidcup: I would like to reply to your 'bafflement', and might do so in the future. However, that is a complete post rather than a reply to a comment. I hope to answer your question at some stage.

Luke Skywalker: Some interesting ideas, which again need a long answer. I would hope though that I have answered many of them throughout the blog.

Matt: I have previously discussed the land tax idea I believe (following another commentator pointing it out), so I would guess that you can find my thoughts in the archive. If I remember correctly, my main worry was how the tax might be assessed. However, it is a long while ago. Overall I remained unconvinced, and will therefore apologise for not revisiting the subject.

Tiberius: Your quote seems to sum up the nature of the process of accepting reality and is relevant to this post, so I will requote here:
"All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."
- Arthur Schopenhauer
Lord Keynes: Thank you for your many links, and well researched comments. I have previously read (and commented on, I believe) 'The Roving Cavaliers of Credit', which was linked to by a previous commentator. Like many such articles, it is very clever, but I believe misses the real basics of economics. If you increase the money supply, eventually it must lead to inflation. However you look at it, if you have 100 units of output, and 100 units of money, if you increase the units of money without increasing output, there is more money per unit of output. That, in the end, must lead to inflation. It is just a question of time....whether output can expand faster than the impact of the increase in supply.

Note 3: I am a bit short of time for replies, so apologies for the brevity and not including replies to all the comments. I wanted to take time to highlight a little discussion I had on the Von Mises Institute (Austrian Economics) comments section. I have argued in this blog for a fixed 'fiat' money supply, and posted a brief suggestion to that effect. I was rather surprised by the response. I am not certain that my idea is sound, and am open to positive or negative comments. However, I was a little surprised at the dogmatism of the responses from (presumably) Austrian economists. I have copied one of the replies below:
  • Cynicus Economicus,

    "regarding the origin of money, I do not believe this is an issue."

    You vastly underestimate the importance of this issue. Money can only originate in the processes of the market. In other words, the best money is chosen by the market. Moneys that don't originate on the market are not good moneys. So the system you're advocating would entail bad money because it cannot originate in the processes of the market.

    "Electronic money is the obvious answer, not paper money"

    Electronic money cannot originate in the processes of the market. The money commodity must have prior barter value before it can originate on the market. Electronic money doesn't have prior barter value. Furthermore, electronic money does not possess an important characteristic of good money: scarcity.

    To be blunt, the system you suggest has no promise.

This was a bad example, but I did feel that they did not address the points that I made. I am not sure that I was very eloquent, but even so...I seem to recall MattinShanghai identifying the Austrian school as dogmatic, and feel I have to agree. This is a pity, as I do like their arguments against Keynesianism. Am I being unfair to them - was my argument addressed? Or was it just poorly expressed, or completely unsound. Comments welcomed.....

28 comments:

  1. Mark,

    Told you that the Austrians were nut cases ;-) Eloquent perhaps, but still insane. If you're into punishment, try commenting on some Trotskist web sites...

    Best regards
    Matt

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  2. Always a pleasure to read your blog. Running a similar macro blog in French language just on the other side of the Channel, I found it was a pleasure to discover I share most of your views on global economics, finance and monetary issues.

    May I say however that I seriously doubt that China is ready for international prime monetary status. Chinese finance has an history of extremely low financial returns. The creditors, whatever their status, from saver to bank, are on a bad trip.

    Their money is currently being invested at negative return rates into the local economy. Money flows are severely controlled. That may even increase for a while until some kind of aggiornamento takes place.

    I certainly do not discount China's extremely brilliant economic run. But it comes at a cost, relatively low work revenues and definitely low capital revenues as well. Hardly solid ground for a reserve currency.

    The yuan is an instrument of the Chinese miracle but certainly not in the way the mark was one for Germany. China misses the solid economic teaching of a Rueff or a Roepke.

    Keynes, Friedman or Bernanke are certainly no decent alternative to the few robust schools of monetary thinking.

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  3. Mark,

    My previous comment seems to have been lost by the proxy server I was using today, so here it is again.

    I had a look at the article and discussion on mises.org. I told you that these people are nutcases. Your mistake was to try to engage in a discussion with them, without realizing that they are not in the least interested in any ideas you might have. They simply KNOW what the truth is. It was interesting to see commentator after commentator trot out the same quotes from Rothbard and Mises, to "prove" the idiocy of your views. These people are the Taliban of the economics world. "There is no God but Mises, and Rothbard is his Prophet", pretty much sums up their beliefs. It is pointless discussing anything with them, regardless of how eloquent they may seem.

    As far as your actual arguments are concerned, it is difficult for me to comment on them, since (as you probably know) my thinking on the subject of money tends to go along different lines from yours, and secondly, my knowledge of the subject is not deep enough to engage in any fruitful discussion. All I can say is that your arguments in that discussion were clearly stated, and rejected out of hand by everybody because some of them violated basic Misesian dogma.

    All the best
    Matt

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  4. About the "Austrian school," I hope you differentiate between the economists and professors and "amateurs" among those who comment on the posts and in the forums. I think I can say that if they are really agitated about something, it is the free market.

    About your arguments, I think most of them were well addressed philosophically, but not as thought experiments. Kris' answer to your-
    --
    "As is identified, money only has value in exchange...provided that the quantity of issue is absolutely fixed?"
    --
    though somewhat brusque, was the right one. The Austrians, particularly Mises and his followers, believe in Mises' "regression theorem" - money always originates in commodity form; there is a time when money has value not as a medium of exchange but as a commodity. Once it is certain that money has emerged on the market, I guess the "dogmatic" answer would be that the government has no business coercing people to accept pieces of paper - fiat currency. People would not accept that if it weren't for coercion and even then only when it is first linked to an existing form of "commodity money." And history is on the side of the free marketeers on this one whichever way you look at it.

    Mises does write about fiat money in TMC-
    --
    "A piece of paper that is specially characterized as money by the imprint of some authority is in no way different, technologically considered, from another piece of paper that has received a similar imprint from an unauthorized person, just as a genuine five-franc piece does not differ technologically from a 'genuine replica'. The only difference lies in the law that regulates the manufacture of such coins and makes it impossible without authority.
    --

    Now there is nothing "wrong" with fiat money regardless of whether it is fixed or not as long as the government does not force anyone to use it, nor does it prevent any competition. You do submit to this
    --
    "Under this system, there is no reason to make it the exclusive legal tender...It will be every bit as real as a lump of gold, and will work perfectly well in that role."
    --
    though I disagree with the whole concept and the supposed outcome. And I believe Hayek proposes something similar - competing paper currencies - in his "Denationalization of Money."


    On your statement
    --
    "However, regarding the origin of money, I do not believe this is an issue...I am guessing that we can all agree that inflation of the money supply is not a positive process, and might even be described as theft/or stealth taxation or redistribution."
    --
    I think you should grant that there is a fundamental problem, a philosophical one, with government interference in the monetary system and the "origin" question is very important to the Austrians - it is an issue.

    On inflation, there is a difference between inflation of a "forced" fiat currency, and inflation of "commodity money" - gold, silver, tobacco, whatever. The difference is coercion. On the free market, no one is coerced into adopting tobacco as a means of exchange, or gold. And none of them can be inflated at "zero" cost, unlike paper money. So inflation is a very important problem, but it is a secondary one. And so is every other problem with "commodity money." The primary one shall always remain coercion, as far as those who believe in the free market are concerned.

    You might want to read Prof. Walter Block's paper critiquing the various arguments against the gold standard, and even talk to him if you have some queries. I don't think I will be able to contribute anything else of note. My primary interest being the philosophy of liberty, I haven't yet managed to read many of the economics texts I refer to here, particularly the one by Mises. I just thought I should comment because I don't want people to think that the Austrians are some kind of dogmatic kooks, especially when the real dogmatic kooks are writing for the NYT.

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  5. Mark,

    I've succumbed to the temptation of engaging in a discussion with you regarding monetary issues. You've talked a lot about the dangers of hyperinflation resulting from the uncontrolled printing of money by central governments. I have to admit that I'm quite confused about the whole subject, and reading numerous opinions published both by "experts" and amateurs, does not help. On the one hand, there are voices saying that we are on the road to Wiemar-style hyper inflation. Others say that the destruction of paper wealth in real estate and the stock markets, collapse of the markets for securities which underwrote many of issued loans, bankruptcy of financial institutions etc. have "shrunk" the money supply so much, that no amount of central bank money printing can fill the "black hole" and avert deflation.

    I suppose that my natural reaction in the face of this is simply to suspend judgment and adopt a "wait and see" position. But I also do seem to have some fundamental problems with supposedly "uncontroversial" aspects (at least in mainstream economics) of money theory. I wonder if you or any of your readers can enlighten me on the subject and point out where I'm wrong.

    The only uncontroversial statement about inflation seems to be that inflation is caused by excessive money supply. We have all seen pictures from 1920s Germany of people carting wheelbarrows full of paper currency to go shopping. I have no doubt that there is clearly too much money about, if you need a wheelbarrow to carry it around. But is this extreme example helpful in understanding money phenomena in "normal" times?

    Economics students are introduced to a famous formula, which is supposed to "capture" the essence of money circulation. One of its forms is:

    Mv = Pn

    Where 'M' is the total supply of money, 'P' is the "average" price of commodities traded, 'n' is the number of transactions in a given period, and 'v' is the "velocity" of money. This formula is then related to the real world by saying something like: "if the quantity of money 'M' in an economy doubles, and the velocity and the number of transactions stay the same, then the average price will double. This is then taken as "proof" that increasing the money supply "leads" to inflation.

    Now, to put it bluntly, the formula and the "deductions" made from it are so incredibly stupid, that I'm amazed that they have made it into academic textbooks written by Nobel prize laureates. To anyone willing to spend a little time looking at it, the problem with this formula becomes obvious. Unlike the average price 'P' and the number of transactions 'n' (and for the sake of argument the money supply 'M') which are physical, observable quantities, the velocity 'v' is a "fudge factor" used simply to balance the equation. It is not an observable quantity. The entire formula is just a meaningless arithmetical identity, without any relation to the real world. I can generate any number of similar formulas. Here's one:

    Wm = lM

    'Wm' are Matt's lottery winnings for the week. 'M' is the amount of money, Matt has used to buy lottery tickets, 'l' is the weekly "luck coefficient". If Matt doubles the amount of money wagered 'M' and the "luck coefficient" stays the same, he will double his winnings (or losses); if his winnings are the same, this means that the 'luck coefficient' has halved. If he wins double the money with half the wagered amount - his "luck coefficient" has quadrupled. Does this tell us anything about the real world? I think not...

    But it gets worse. Take the money supply 'M'. What is it? Is it just the sum of notes and coins in circulation? What about money stored in jars buried in gardens? Does this count? How about credit card limits? Savings accounts? Private debts? Cheques "in the post"? Questions and more questions...

    TBC...

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  6. (Continued from previous post)

    Going back from reality into the world of textbook examples, let us see if our formula can shed any light on something simpler than anything resembling a real economy.

    Let's assume a poker game. Each player has a certain number of chips. The game consists in the "purchase" of "pots" by the participants. In an hour, a certain number of hands are played, and a corresponding number of pots is "purchased". In this model, the money supply corresponds to the total value of chips belonging to all the players, the average price of a pot is just the sum total of the value of all pots won divided by the number of hands played and the "velocity" is the fudge factor needed to balance the equation. If we vary the "money supply" in this scenario, can our formula give us any insight into what will happen?

    Assume that the casino owner is celebrating tonight, and in a generous mood says that he will double the value of the chips each player holds.The "money supply" has just increased by a factor of 2. How will this affect 'P', the average price of a pot? Well, it's hard to say. Perhaps some players will use this event as an excuse to pocket their "winnings" and leave the game, thus reducing the price of subsequent pots. Perhaps some players will feel more confident gambling with what is in effect somebody else's money, and the average price of a pot will rise. Perhaps nothing will change, only the game will last longer. What does seem clear, is that our formula is of no use in predicting the outcome.

    Other scenarios can be explored (such as what will happen if Bill Gates joins the game, doubling the money supply), with similar conclusions.

    Now if orthodox, microeconomic models are incapable of explaining or predicting even the simplest phenomena, what chance do they have when "scaled" up to macroeconomic levels?

    Once again, maybe I'm missing something fundamental here. If anyone can enlighten me, I'd be most grateful

    Best Regards
    Matt

    P.S. I recommend an entertaining foray into "economic model building" here:

    http://www.atimes.com/atimes/Global_Economy/KE30Dj02.html

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  7. The Misesians are certainly distrustful of government! I happen to share that distrust.

    As a sensible compromise, I favor gold and silver -backed electronic currencies. These seem to solve the want of convenience together with the need for stability.

    Whilst gold continues to be mined causing a little inflation, I can't see any other common sense alternative that should satisfy the majority of reasonable people.

    In fact, the 'market' is already working in this direction, goldgrams: http://bit.ly/k8ZQg

    Whilst Russia are considering coining palladium rubles:
    http://english.pravda.ru/business/finance/05-06-2009/107730-ruble_palladium-0

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  8. Cynicus,

    re: The Austrian School.

    I agree with MattInShanghai's analysis that these people are dogmatic, and idealogical.

    To test what people are saying on something I don't know much about (and my monetary theory is, well, crap), I always litmus paper their views on a subject on which I am more knowledgeable: so I typed 'Chomsky' into the search engine to see what came up....

    Chomsky's Economics

    A laughably critique on what purports to be Chomsky's economics (note: Chomsky has never outlined any plans in detail, and always resists calls to do so). It includes an attempt to debunk syndicalism by placing it within an overall capitalist system and seeing how it stand up: failing to capture that essence of syndicalist ideas that the economic system would be placed in the framework a truly democratic system.

    It also has the irony of an American writer placing libertarian in quotation marks - as if Chomsky where somehow mistaken in the etymology of that word.

    Chomsky on Libertarianism. Nonsense?

    A veritable feast of half-truths, misunderstandings, and pure nonsense. My personal highlight/lowlight is the assertion by 'sicsempertyrannis' that: "Actually, if I recall in the 90s he advocated carpet bombing of Serbia. Anti-war my foot..."

    *shakes head*

    So yeah, 'economic Taliban' covers it pretty well.

    More specifically, with regards to Rothbard's “anarcho-capitalism”: as the name would suggest, I agree with about half of what he says and think that, like Marx, he combines an astute analysis of the problem with some horrendous proposals for the solution.

    Regarding your own divergence from the Austrian School: this gap comes, I believe, from your own reluctance to admit that the game is inherently rigged. All regulatory systems are eventually co-opted by the very institutions they are supposed to monitor, and there is no reason to assume that, whatever safeguards you propose, the monetary system should not suffer a similar fate.

    I think this is a mistake on your part, but I claim no expertise.

    What separates myself from the Austrian school/American libertarians is what I consider to be their lack of faith in humanity (including what I take to be their mistaken beliefs regarding 'human nature').

    For me, the Austrian school fails because it can only explain people's behaviours and motivations by the very tools they are provided with by the current system: “People under capitalist society and self-serving, atomised, selfish, etc. ergo people are naturally self-serving, atomised, selfish, etc.” - it's nonsense - but, in a society such as ours, seductive nonsense.

    Without wishing to stray too far into the poetic, I think that, for the most part, theirs is not a failure of logic, but rather a failure of imagination; they lack heart rather than mind.

    As for the general tone of their delivery: you are talking to people who have an ideological commitment to being anti-social - and I think this is reflected in their dialogue!

    All the best,

    T.

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  9. The money we use in the real economy is always recorded somewhere on the liability side of the balance sheet of a bank, be it central or commercial.

    So a simple way of looking at money supply is to know that it is the total of all the commercial banks balance sheet liabilities plus the central banks liabilities.

    So to reduce money supply these 'credits' have to be reduced. How can this be done?

    Does a fall in asset prices do it? No because this does not affect the liability side of the balance sheet.

    The only way of decreasing money supply by significant amounts is to let banks go bust so the credits they owe (i.e money) are never honored and simply disappear. This is true deflation, where depositors lose everything, and this has not and will not be allowed to happen.

    Therefore we will continue to have an inflating money supply, which, as cynicys says, in the long run always results in rising prices.

    Another effect of this constantly inflating supply will be much more volatility because it only takes a small % of the very large, and increasing, amount of money in the system to cause a bubble or other painful effects in the real economy (witness oil prices in previous years).

    I would guess that the eventual outcome of this 'sloshing about' of excess money will be to destablise and collapse the system completely when it moves into something that has a profound effect on the real economy of a major player.

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  10. Tiberius,
    The "Austrians" are no different from any other ideologues who have a model of the world they religiously stick by. The same applies in churches and to atheists, to Marxists and Free-Marketeers alike, to Labour and Tories, to Democrat and Republicans and to Mac and PC users (except mac users are obviously a superior product!).

    Adam said...
    The Misesians are certainly distrustful of government! I happen to share that distrust This is a false premise. Just as mystical as if you wrote The Marxists are certainly distrustful of big business! I happen to share that distrust
    What group or institution are inherently trustworthy? Corporations? Academics? Lawyers? Bloggers? Regulators? The media? "The rationality of markets? Investors? Voters? None of the above.

    The capacity for any group or institution to do irrational, stupid, destructive things is infinite (as perhaps is the inverse). This is not a function of government itself, but the fact these institutions are are created by human minds which, as we increasingly, see are dangerously imperfect and perhaps unsuited to the environment we have created.

    If there is a silver-lining to this crisis I think the overall collapse in trust in human belief systems is it. The deep problem is not what people do or don't belive it's the structure of beleif itself.

    Many of the problems of the world, in my view are caused by the human preference for creating and working with abstractions and models of the world, rather than reality itself. These then becomes more real than reality for their exponents.

    We see examples of it on this blog: CE is at his most excellent when describing reality and creating arguments on empirical analysis etc, however the quality takes a nosedive (in my opinion of course) when he invokes Adam Smith and we can detect the outlines of his political/economic - which was broadly inherited from his parents ) if he is like most people on the planet).

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  11. @MattInShanghai

    Really enjoyed your analogies!

    You are right: these economic models bear no relation to reality – and they probably never have. They are just there to provide intellectual cover to unpopular government policies, and to justify university grants to economic professors who've probably never done a day's work in their lives!

    Once you go beyond observing a couple of factors under experimental conditions, the world is too complex a place to successfully model – just too many darned variables! So these 'economic theories' are essentially just projections – they tell us more far more about their proponents (and hangers-on) then they do about the real world.

    PS, thanks for your reply on my blog. As always, your comments have caused me reassessed my own 'working model of reality' (which is a good thing!) - once I've done that I'll get back to you!

    @Lord Sidcup

    re “Many of the problems of the world, in my view are caused by the human preference for creating and working with abstractions and models of the world, rather than reality itself. These then becomes more real than reality for their exponents.”

    I kind of agree. The abstractions/models people employ are both a gift and a curse: they are the source of our imagination and creativity, but also our delusions and destructiveness.

    I think the pertinent question though is where does this “human preference” come from? Are you suggesting it is innate – were our cave-dwelling ancestors the philosophical types? Is it universal – do the Amazonian tribes and Kalahari bushmen suffer from them? Are they cultural – have we become more abstract over the years as our young minds a filled with scientific formulae and mathematical equations? Is there an agenda at work – is it politically expedient to have populations living in a kind of 'hyper-reality' of images and ideas to keep them separated from their own predicaments? Or maybe it is a cause for hope – should we not be more worried by a poverty of thought and a dull acceptance of a present reality?

    And yes I am aware of the irony in talking about abstractions in such abstract terms!

    re “We see examples of it on this blog: CE is at his most excellent when describing reality and creating arguments on empirical analysis etc, however the quality takes a nosedive (in my opinion of course) when he invokes Adam Smith and we can detect the outlines of his political/economic - which was broadly inherited from his parents ) if he is like most people on the planet).”

    I agree that CE's dissections of economic reality are excellent, but I disagree that this quality drops when the discussions are more theoretical. Though I don't share his perspective, I think CE explains his positions well and it helps to stimulate lively, thought-provoking discussions like this one. Long may it continue!

    T.

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  12. More on why it is unlikely that hyperinflation will happen any time soon:

    http://www.counterpunch.org/whitney06092009.html

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  13. "What group or institution are inherently trustworthy? Corporations? Academics? Lawyers? Bloggers? Regulators? The media? "The rationality of markets? Investors? Voters? None of the above."

    I generally trust free markets as in FREE markets of FREE people to decide amongst themselves FREELY.

    What do you mean by 'mystical', Lord Sidcup? Does agreeing with points made by the Misesians make one automatically 'mystical'?

    "People under capitalist society and self-serving, atomised, selfish, etc. ergo people are naturally self-serving, atomised, selfish, etc."

    I haven't noticed this view from the Misesians. Surely the Misesians would debate that what we have is a state-capitalist system rife with various government interventions in what might otherwise be free markets. “Capitalism” is short for free-market capitalism, not rigged-market, state-capitalism.

    "Those special people under a state-capitalist society who are given certain 'protections' from competition by government ARE self-serving, atomised, selfish, etc.”

    People are people everywhere, with the same capacity of selfishness and selflessness. The point is that they should decide which of their numerous capacities is best employed for the current circumstance. The way to judge an economic system is in the degree that it gets in the way of people to wishing to deploy their physical, intellectual and emotional resources, either as individuals or as collectives. We each make these choices many times a day, without the need to label them in each instance.

    On groups being discredited because they're "dogmatic" and "ideological", yeah — and? We all have our comforting ideas. Being ideological is surely a matter of degree, rather than an absolute. If we can see past the defences ideologues erect simply because they feel marginalised by people lazily labelling them ideologues, we may learn something of value. If calling someone an ideologue automatically shuts them off from public discourse, we are all in a very sorry shape indeed.

    In my pursuit of common sense economics, I simply can't afford to let human folly (ideology) and insecurity (dogmatism) get in the way of my learning. I continue to read Paul Krugman even though I find him ideological and dogmatic, but his views help me widen my understanding and appreciate the still healing scars of old debates. This week it'll be the importance of the velocity of money, for instance.

    http://krugman.blogs.nytimes.com/2009/06/03/the-stagflation-myth/

    Please, let's not get all troll-like on the one blog that seeks understanding above showing off.

    I mean, what's more dogmatic than naming yourself Lord Keynes? Though, let me be clear, I've learnt an enormous amount from this particular commenter, perhaps not always directly. My point is this: are we not tolerant of “ideologues” on this blog? Can we not look past their "dogmatism" to see the worthy and important points they're making? Can we not make up our own minds, freely, without joining one tribe or another?

    (My apologies to Lord Keynes for using his chosen handle to make this point.)

    Back to this idea of a fixed money supply that somehow arises from agreement in the free market...

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  14. Tiberius

    Am not arguing that CE’s arguments are weak when abstract, rather that there is a clear difference in quality between the conclusions he has empirically worked out for himself – rather than the ones he accepts / repeats without showing evidence of having scrutinized them with his usual rigour.

    If for the sake of this argument we accept that CE’s arguments broadly relate to Adam Smith, I think its fair to examine them in light of Smith’s statement. “by pursuing his own interest, [the individual] frequently promotes that of the society more effectually than when he intends to promote it.” “ Adam Smith, Wealth of Nations, 1776.

    “ “The answer to Lemming’s question, and perhaps the questions of others, is that there is no basic problem in economic growth, and no real problem in a system built around consumption . . .in other words, the underlying system works.” “ Cynicus Economicus, Capitalism and Consumption

    Although Adam Smith’s views have been distorted, misunderstood and misquoted by free-marketeers etc the two belief-sets quoted above have been linked for hundreds of years. I say that this link is false or at best unverified and therefore in the realm of mysticism. So, as I find the core model of reality CE SEEMS to use highly suspect, when I see it inform CE’s views it renders these views highly suspect. On the surface it might seem plausible, I don’t see any provable, casual link between pursuit of self-interest and the good of a society.

    Adam Smith understood a Newtonian mechanical universe that was rational and therefore knowable and controllable, reality is a lot more messy ( Look at the huge consequence an ebb in “animal spirits” can have ). Economic-decision theory assumes that people know the probability of future events, which we don’t and cannot.

    Behavioral Economics / Evolutionary psychology seem to offer real hope that humans will accept and deal with our psychological limitations as successfully as we have overcome our physical limitations.

    I *believe* that many of our psychological biases are hardwired and evolved to be beneficial in environments we no longer face. If we put Kalahari bushmen within a wall street type system of incentives etc we could expect similar results.

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  15. @ Adam

    re “I haven't noticed this view from the Misesians.”

    It's implied. If you think that a free-market system is the most efficient one, then, by definition, you must believe that is the one in which human beings perform best. Ergo, humans are 'naturally' capitalists.

    Re “Surely the Misesians would debate that what we have is a state-capitalist system rife with various government interventions in what might otherwise be free markets.”

    You're right, they probably would (and I think they'd be wrong – see below), but your point is a non sequitur as far I can make out.

    Re “ “Capitalism” is short for free-market capitalism, not rigged-market, state-capitalism.”

    Unfortunately, capitalism as you define it does not exist in the western world, and never has (see here for my take if interested). So it becomes a matter of faith/ideology to think it will benefit us - mistaken in my opinion.

    re “The way to judge an economic system is in the degree that it gets in the way of people to wishing to deploy their physical, intellectual and emotional resources, either as individuals or as collectives.”

    Agreed, and by this definition capitalism(the real version, not the idealic Misesian version that doesn't exist) fails.

    re “If calling someone an ideologue automatically shuts them off from public discourse, we are all in a very sorry shape indeed.”

    Yes, but if people hold positions as a matter of faith then there is little point in entering into a debate with them. I would not try an convince a Christian that there their belief in God was illogical, as it is their a priori way of viewing the world.

    Likewise, I wouldn't try and convince a Misesian on their mistakes re free-market capitalism.

    re “Please, let's not get all troll-like on the one blog that seeks understanding above showing off.”

    I agree that there is no sense in falling out with one another over these things.

    @ Lord Sidcup

    re “ I find the core model of reality CE SEEMS to use highly suspect”

    Agreed.

    “I don’t see any provable, casual link between pursuit of self-interest and the good of a society.”

    Agreed.

    “Economic-decision theory assumes that people know the probability of future events, which we don’t and cannot.”

    Agreed.

    “Behavioral Economics / Evolutionary psychology seem to offer real hope that humans will accept and deal with our psychological limitations as successfully as we have overcome our physical limitations.”

    Definitely not agreed.

    “I *believe* that many of our psychological biases are hardwired and evolved to be beneficial in environments we no longer face. If we put Kalahari bushmen within a wall street type system of incentives etc we could expect similar results.”

    Half agree.

    I think there is an interesting discussion to be had here but it doesn't really relate to what CE has posted. I will post some thought on my blog in the near future and welcome your take.

    T.

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  16. Dear Cynicus,

    I really enjoy reading your blog, thank you for widening the lense of on this financial crisis.

    I want to alert you to a great new book on the matter:

    lootingofamerica.com

    One of the best accounts I've read so far on the crises.

    Thanks.

    Stacy Filgen

    ReplyDelete
  17. Dear Cynicus,

    I really enjoy reading your blog, thank you for widening the lense of on this financial crisis.

    I want to alert you to a great new book on the matter:

    lootingofamerica.com

    One of the best accounts I've read so far on the crises.

    Thanks.

    Stacy Filgen

    ReplyDelete
  18. @ Adam

    "My point is this: are we not tolerant of “ideologues” on this blog? Can we not look past their "dogmatism" to see the worthy and important points they're making? Can we not make up our own minds, freely, without joining one tribe or another?"

    I think your fears are not justified. I have been following this blog for many months now, and despite the wide spectrum of political/economic beliefs among the commentators, I have found the (sometimes heated) discussions here to be extremely courteous, with very little flaming or showing off. Perhaps this is one of the reasons for the popularity of this blog. Let's try to keep it that way.

    My admittedly hostile characterization of the Austrian school was triggered by the arrogant and rude responses which our host received as a result of posting on one of their sites. My advice to avoid engaging with them concerned posts "in the lair of the beast" such as mises.org, where you will be eaten alive for even the slightest deviation from established truth, not "neutral ground" like this site.

    I do actually know a lot about Austrian economics, and have no problem discussing the subject with anyone on this forum.

    "I generally trust free markets as in FREE markets of FREE people to decide amongst themselves FREELY."

    This is all very nice, and I'm sure most people would agree with you. The problems start when you begin to inquire into the meaning of FREE. Is a FREE, but penniless person, FREE to decide in a FREE market? What do you mean by freedom. Is it freedom to do something (e.g. own a gun) or freedom from something (e.g. the freedom of not having to sell your daughter to a brothel in order to avoid starvation). You must be more specific than that if you want to engage in a meaningful discussion.

    TBC

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  19. (Continued from previous post)

    "Surely the Misesians would debate that what we have is a state-capitalist system rife with various government interventions in what might otherwise be free markets. “Capitalism” is short for free-market capitalism, not rigged-market, state-capitalism."

    They would say that, wouldn't they? This is exactly what the Marxists said after the collapse of Soviet Communism. The fact is that a Misesian society never existed, and no one knows if it would actually work or not. In fact, we did have something similar to a libertarian/anarchist system in our distant past. It was called "the jungle". Thankfully we moved on from that...

    "Being ideological is surely a matter of degree, rather than an absolute. If we can see past the defences ideologues erect simply because they feel marginalised by people lazily labelling them ideologues, we may learn something of value. If calling someone an ideologue automatically shuts them off from public discourse, we are all in a very sorry shape indeed."

    If the term "ideologue" is used as a form of abuse, then I agree that it is not helpful in discussion. My understanding of the term "ideologue" is more specific. An ideologue is someone committed to an ideology (and yes, the degree of commitment may vary). An ideology is a self-contained set of beliefs about the world, usually expressed in a canonical body of writings and interpreted by a formal or informal group of "guardians". This definition may not be perfect, but it serves my purpose. By this token, various strands of Marxism (Leninism, Trotskyism, Maoism), Freudian psychoanalysis, Objectivism, the Henry George "single-tax" movement, and Austrian economics, qualify as ideologies. Neoliberalism, Keynsianism, socialism, the trade union movement, do not.

    The problem with ideologies (and ideologues) is that they are seldom open to discussion, especially discussion which might question their fundamental beliefs. That's why they are called "dogmatic". I would say that it is they who shut themselves out from debate with the wider world. This is what CE found out the hard way. I do not mean to say that they have nothing to contribute to the world of ideas. For example, scholastic theology, probably as dogmatic an ideology as can be, had great influence on the development of modern logic.

    Best Regards
    Matt

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  20. The correct critique of fiat money is one of political economics. Can you trust the government to which you've granted the power to regulate money not to later game the rules in the name of political expediency? This sort of behavior typifies state action. Your fiat money would only be as sound as the principled understanding and commitment of the politicians administering it, imagine that.

    Its a pipe dream anyway; a fiat system of the sort you suggest is politically unpalatable for the same reasons it would later be gradually abandoned if it somehow ever were adopted. Pols want a money press, and people want raises.

    The current shape of fiat money isn't an accident, its the result of repeated efforts, over time, to solve political problems. Your system would ultimately be shaped by the same incentives.

    Kudos on your triumph over the deflation bugbear, btw

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  21. I just spent about an hour composing a treatise (well, writing a comment) on how the Invisible Hand (TM) can never work when it comes to children's education, but then I found this article which says it so much better:

    http://www.thefreemanonline.org/featured/classical-libertarian-compromises-on-state-education/

    Any views Mark? If you were truly consistent on the free market you would surely prefer a world without education provided, mandated or regulated by the state.

    But if, as is clear, the Invisible Hand doesn't work with children's education, why are we so sure it works with everything else?

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  22. I now realise that my previous comment was somewhat off-topic. Forgive me, but it was the progression of others' comments that led me astray.

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  23. Swine Flu will be the Kibosh...

    The sting out of left-field...

    The crack that will break the Dam.

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  24. Observations on the Fiat Money Debate


    I have read the debate on a fixed fiat money supply at the von Mises blog. There responses are unimpressive, though I myself don’t agree that the fiat money system should be fixed.

    Here are some responses below:

    Reply to Anonymous on Fiat Money

    You say:


    Can you trust the government to which you've granted the power to regulate money not to later game the rules in the name of political expediency? This sort of behavior typifies state action. Your fiat money would only be as sound as the principled understanding and commitment of the politicians administering it, imagine that.


    You fail to see that this very same argument can be used against commodity money!!
    Can you seriously believe that a government will adhere to a gold standard under economic collapse and political pressure? It is just as easy to abolish a gold standard and institute a fiat money system as it is to abolish a fixed fiat money system and expand the money supply.
    There is not one shred of evidence that politicians under a gold standard will not abandon that system when it is politically expedient.
    In short, your argument (if taken seriously) means that no money system at all is legitimate, simply because there is the possibility that it could be changed by an unscrupulous government.

    The fact that the gold standard was universally abandoned in the 1930s gives the lie to the idea that it is somehow a stronger system or one more difficult for a government to change.

    Reply to Aristotlethegreek

    On inflation, there is a difference between inflation of a "forced" fiat currency, and inflation of "commodity money" - gold, silver, tobacco, whatever. The difference is coercion. On the free market, no one is coerced into adopting tobacco as a means of exchange, or gold.

    And yet a commodity money system can easily suffer high inflation if new amounts of the commodity are brought onto the market. Under the gold standard system in the 19th century, there were inflationary periods when new deposits are added to the existing money supply. How is this process not forced by a narrow group of private interests mining the gold and bringing it onto the market? There is an element of private coercion here as well! In 1896 when the West suffered continued inflation for years because of gold rushes, did everyone, say, in the UK give their explicit agreement to having the money supply increased by new gold deposits?
    Of course they did not, people who disagreed would have suffered just as much coercion as people under a fiat money system.

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  25. Red

    About the bird/swine flu thing. Should the state be co-ordinating a response to it, or should the free markets be trusted to do it?

    Maybe the Invisible Hand would already have spontaneously produced isolation wards around the country, and implored people to people to stay away from work if they felt a bit unwell.

    Or maybe it would already know that the virus will definitely not mutate into a nasty form, thereby cleverly saving all the costs associated with a co-ordinated response.

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  26. Excellent article on a possible "Black Swan" event happening from a run on the US$ and its effect on treasuries and debt.

    http://zerohedge.blogspot.com/2009/06/thinking-unthinkable-treasury-black.html

    I cannot find a link to the original article quoted, but it is by Eugenio Aleman of Wells Fargo, and not the usual doomsters.

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  27. In short, your argument (if taken seriously) means that no money system at all is legitimate, simply because there is the possibility that it could be changed by an unscrupulous government.

    This is a good insight, but not one new to me. I never advocated a government gold standard as more resistant to political pressure, or even advocated one at all, so your response seems a bit of a strawman.

    Fiat and gold government money aren't equivalent, though, in that abandonment of a gold standard is highly public, while inflation of fiat money would happen more quietly. This is potentially an important accountability difference, but your general point stands.

    Decentralized government and encouragement of money provided by the market itself both suggest themselves.

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  28. Keynes,

    # "And yet a commodity money system can easily suffer high inflation..."
    It can and it will - I don't deny it. Its simple logic - an increase in the quantity of "money" will result in a reduction in its purchasing power, other things remaining the same. But there is a limit to such inflation, unlike fiat money. I don't know of any case where the pure gold standard has resulted in hyperinflation.

    # "Under the gold standard system in the 19th century, there were inflationary periods...coercion as people under a fiat money system."
    Coercion is making me do something against my will. Taking advantage of my "bad" decisions - risks - is not coercion. Think negative liberty.
    On a free market, "money" is "free." People voluntarily choose some commodity, generally gold or silver, to serve as a medium of exchange. They should be aware of the possibility of a sudden surge in the supply of gold, or to take an outlandish example, that of someone having discovered the philosopher's stone and churning out gold in huge quantities.
    A "stable" - frozen - price level is a mirage. No monetary system can achieve it.

    ---

    By the "gold standard" free-marketeers mean any standard that arises freely on the market. Unlike fiat money, or a "gold standard" wherein the government controls money, no one is forced to adopt it. They can still trade in cowrie shells, or barter, or create their own monetary authority issuing stamped pieces of paper. They are free to protect their wealth and trade in whatever manner they wish without the government coercing them. This issue, a political one, lies at the root of it all. The "what is the 'best' standard" argument is, at best, a technical one. Finally, it is a matter of choice, and whether we are allowed to exercise it.

    ReplyDelete

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