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Home > Authors > Antal E. Fekete > Page 4

Premature Obituaries for the U.S. Dollar

February 8, 2012 by The Gold Standard Institute International

DeathUsDollar700300

http://professorfekete.com/articles%5CAEFPrematureObituaries.pdf

It is open season for wild monetary prognostications. More premature obituaries on the dollar have been posted on the Internet. For example, see Jim Willie’s The US Dollar Paper Tiger (Financial Sense, January 11) with epitaphs like “the U.S. dollar rising to the cemetery”, or “dollar death dance”. Or see another article, Jeff Nielsen’s entitled Maximum Fraud in U.S. Treasuries (Gold-Eagle, January 3). It betrays maximum misunderstanding about keeping the dollar on a life-support system. It assumes that the Fed and the U.S. Treasury are fighting tooth and nail to keep the value of government debt high lest it collapse in want of support from Japan, China, and other countries.

These views hang the picture upside down. In actual fact, the Fed and the U.S. Treasury desperately want to beat down the value of the dollar. The greatest obstacle frustrating their effort is the stubbornly high and still increasing value of U.S. Treasuries. Captains of the world’s monetary system are yanking levers and twisting throttles which are no longer connected to anything. The captains are no longer in control. Yet they continue to wave their batons feverishly and pretend that the orchestra is paying attention. They want Jim Willie, Jeff Nielsen and everyone else to believe that the falling interest-rate structure is the outcome of their deliberate monetary policy. In fact, the Fed and the U.S. Treasury are trying to stop the rate of interest from falling further. They instinctively realize the threat of falling interest rates brings deflation and depression in its train. The dollar is much too strong, contrary to the wishes of policy-makers. It is not so easy to beat down the value of the dollar as suggested by Keynesian textbooks, even if you have the key to print shop where the presses are running. The dollar’s strength prevails in spite of the withdrawal of Chinese and Japanese support of the U.S. bond market, and in spite of the destructive monetary policies of the American guardians of the dollar.

This observation reveals the prevailing profound misunderstanding about the nature of this financial crisis. To set the matter right, in this article I shall recapitulate the argument that I have been presenting on the Internet for the past ten years.

Where Keynes Went Wrong

At the heart of my theory is speculation, the main driving force of the huge oscillating money flows between the commodity market and the bond market. It can, and often does, overrule official monetary policy.

It is well-known that Keynes had a poor understanding of speculation. His occasional excursions to the pits resulted in significant financial losses for him. No more successful was he as a theorist. For example, he introduced the concept of normal backwardation as the main underlying feature of the futures market. He insisted that in buying futures contracts speculators demand ? and receive ? compensation for their services as ‘insurers’ in return for carrying the price risk that owners of physical commodities and first order financial assets are unable or unwilling to carry. First order financial assets such as stocks, bonds, foreign exchange, mortgages must be carefully distinguished from higher-order financial assets such as futures and options on first order financial assets, options on futures, options on options on futures, and so on and so forth ad libitum. Keynes did not live to see the rise of higher order financial assets. He called the insurance premium speculators pocket when their contracts mature ‘normal backwardation’.

Backwardation is the name for the market condition under which futures are offered at a discount relative to physicals. Keynes is putting things upside down. The futures market, far from being an insurance-operation, is in fact a market for warehousing services. The warehouseman buys the physicals and sells the futures as a matter of arbitrage. But he can do that only if the future price is at a premium over the cash price. This condition is known as contango, which is the exact opposite of backwardation. For example, at harvest time cash wheat is plentiful and contango is robust. The elevator operator, our warehouseman, is buying cash wheat against selling wheat futures. In doing so he performs a useful service to society: that of warehousing and rationing the wheat supply until the next crop comes around a year later. The premium, the difference between the futures price and the cash price is his fee for the service. To create this arbitrage opportunity was the main justification for starting futures trading in wheat and in other agricultural commodities in the 19th century, when the monetary unit was a positive rather than a negative value. Notice that nature is responsible for the fluctuation in the price of agricultural commodities: weather, unforeseen natural disasters, climes and other things over which man has no control.

All this has changed when, at the behest of Keynes, governments exiled gold from the monetary system and embraced a negative value, debt, as the monetary unit. As an immediate consequence a lot of new futures markets sprang up, chief among them the futures market for foreign exchange and the bond market. In these the cause of fluctuation was no longer nature. Instead of nature-created risks, here futures trading addressed artificial risks created by man. Keynes blithely assumed that futures trading would have the same stabilizing effect on the price of these financial assets as it did in on the price of agricultural commodities. This was his worst blunder. When man or a committee of men rather than nature calls the shots,speculation becomes destabilizing. The nature of speculation has changed beyond recognition. In the first scenario when nature alone calls the odds all speculators start with equal chances. No combination of bets is capable of changing the odds. This is no longer the case when risks are man-made. In this case speculation assumes the character of gambling. Here speculators (gamblers) are matching their wits against that of the house. Here, given a bottomless purse, a combination of bets can indeed change the odds. The gamblers can even beat the house. We have seen it happen time and again: speculators in foreign exchange or bonds won and the government or the banks had to take huge losses.

It would be more reasonable to talk about normal contango than about normal backwardation, the obsession of Keynes. Backwardation in many ways is an anomaly. If and when it occurs, it indicates scarcity. In case of scarcity there is no need for warehousing. Keynes got it all wrong.

The problem of warehousing applies to gold par excellence, which owes its status as the monetary commodity (independently of the wishes of governments and banks) to the size of stocks which are large relative to flows which are meager. The stocks-to-flows ratio of gold is a high multiple, in contrast with that of copper, for example, which is a small fraction for reasons of its fast declining marginal utility.

If gold is forcibly divorced from money by order of the government, or to say it differently, if a negative value such as debt is foisted upon society as the new monetary unit, then the price of gold will fluctuate inviting speculation and gold futures trading. The gold futures market, if it is to function at all, must be a contango market. Otherwise it would give an opportunity to speculators to make risk free profits (they would buy cash gold at a discount and sell futures at a profit). That would immediately eliminate the discount on gold futures (making a mockery of Keynes’ normal backwardation.) However, in the case when gold is scarce as a result of flight from paper currencies, permanent backwardation of gold puts in an appearance. This sounds the death knell of the regime of irredeemable currencies.

Not only did Keynes misunderstand speculation, but he also completely misconstrued the God-ordained role of gold in society. He did not see that variable foreign exchange rates would ultimately undermine paper currencies and bond values due to gold hoarding. Moreover, vanishing confidence in foreign exchange rates and bond values could be directly measured in terms of vanishing contango. Ultimately, all monetary gold would be driven into hiding. The biblical writing on the wall “Mene tekel upharsin” (you have been put on the scale and found wanting) would become reality in a literal sense.

Ever since gold futures markets started trading in the early 1970’s, they were subject to the Law of Vanishing Contango. It was never properly understood by the so-called experts or by anyone else. While nobody could predict when contango would go into permanent backwardation, it is certain that when this ominous event happens, the music stops and the game of musical chairs is up. Mainstream economists ignore the problem of permanent backwardation in gold. They do it at their own peril. Keynesian/Friedmanite economics is going to be shipwrecked on the reef of permanent backwardation. Irredeemable paper currencies which they have spawned will be ignominiously wiped off the face of the earth.

Economic Resonance

When at the behest of Keynes foreign exchange rates were deliberately destabilized, a couple of other ominous things happened. Most importantly, interest rates were also destabilized that made an old phenomenon, the Kondratieff long wave cycle self-boosting, leading to runaway-vibration. As may be recalled, this rather rare physical phenomenon caused the Tacoma suspension bridge in Washington state plunge into the river in 1940. Parcels of energy bombarding the bridge in gusting winds resonated with one of the characteristic harmonic frequencies of the bridge. As a result total energy, rather than dissipating harmlessly, kept piling up. It ultimately overwhelmed the statics of the bridge. Engineers have forgotten to take runaway resonance into account when the bridge still existed only as a blueprint. Likewise, designers of the regime of irredeemable currency have failed to consider economic resonance. Runaway vibration exists in economics whether recognized or not. It can destroy currency and bond values just as it can destroy bridges.

I describe the present economic crisis in terms of economic resonance. The economy experiences oscillating money-flows between the commodity market and the bond market. When money flows from the bond market to the commodity market, we witness the inflationary phase of the cycle. Inevitably, rising interest rates accompany this phase. At the top of the cycle the money-flow will reverse itself and will go from the commodity market to the bond market. This is the deflationary phase of the long-wave cycle that, no less inevitably, is accompanied by falling interest rates. These huge money-flows are driven by speculation. There is a linkage between the price level and that of interest rates compelling them to move in the same direction (always subject to leads and lags). Furthermore, the two resonate. It is altogether too naïve to suggest that the government is equipped to control the phenomenon of economic resonance. As the story of King Canute shows, tides of the sea cannot be turned back by royal proclamation.

For centuries the Kondratieff cycle has been kept on a leash. Resonance was always damped so that vibration could never reach runaway levels. Neither prices nor interest rates were allowed to grow indefinitely. At one point the policeman would stop their march and turn them back. The policeman was none other than the gold standard.

The regime of irredeemable currency fired the policeman and resonance has become self-boosting. Runaway vibration is in the making. When the energy level of the self-boosting system overwhelms centripetal forces, the system snaps like a broken chain, releasing the surplus energy most destructively. This is the substance of every crack-up boom. Like Mises, I also object to the use of the word hyperinflation, albeit for a different reason. It suggests that the phenomenon is linear and follows the laws of the Quantity Theory of Money. The more money is printed, the higher do prices go. However, we are here facing highly non-linear phenomena. Our economy is torn to pieces by runaway vibration. We are victimized by the self-destruction of the monetary system subjected to oscillating money-flows boosted by the resonance of fluctuating interest rates resonating with fluctuating prices.

The Vampire of Risk Free Bond Speculation

Another ominous thing happened when, at the behest of Keynes, foreign exchange rates were deliberately destabilized. Monetary policy has become counterproductive. When the central bank intervenes in the market to control the rise of interest rates, it inadvertently makes prices fall; and when it intervenes to stop prices from falling, it inadvertently makes interest rates rise. The upshot is that the central bank intervention, rather than tempering movements, aggravates them.

Once more, the source of the trouble is Keynes’ poor understanding of the dynamics of speculation. Whether combatting inflation or whether combatting deflation, the central bank has only one policy tool, namely, printing more money. Keynesian economics pretends that the central bank operates in vacuo. It can assume away any and all side effects. But there is one side effect it certainly cannot wish away, and that is bond speculation that follows the central bank like the shadow follows the thief. The bond market is huge, exceeding the equity market in size more than ten-fold. Equally huge is its speculative following.

When the central bank wants to control rising interest rates, then it goes into the open market to be a net buyer of Treasury bonds. Inevitably, speculators want to preempt the central bank. They strive to buy the bonds first, dumping them into the lap of the central bank at a higher price afterwards. Speculators are making risk free profits. The central bank is helpless. It has to pay the speculators’ price.

Likewise, when the central bank wants to control falling prices, it goes into the open market to be a net buyer of Treasury bonds. Speculators will gratefully take the new money so created. Of course, the central bank wants them to buy commodities to prevent prices from falling. However, speculators have a better idea. They go to the bond market where the fun is. Commodities are too risky for their taste, especially when they can make risk free profits in bonds. The risk free profits speculators make are made possible by Keynesian monetary policy.

This is the fundamental flaw of Keynesian economics. At the present junction the Fed is buying bonds to combat deflation. Bond speculators know this, will buy the bonds first driving down interest rates in the process. The result is more deflation, not less. The Keynes-inspired central bank action is counterproductive. Policy-makers are blind and don’t see this. They stick to their self defeating monetary policy. They actually become the quartermaster general of the depression they are trying to avoid. As if cursed by a particular kind of madness, policy makers saddle society with the vampire of risk-free speculation. They turn the constructive energy of stabilizing speculation into a most destructive kind of energy: destabilizing speculation. The problem cannot be cured because bond speculation cannot be eliminated. It should be clear that as long as the world does not succumb to a military conflagration such as a world war destroying supplies of goods and production facilities, the danger is not inflation as predicted by the Quantity Theory of Money. The danger is deflation due to risk free-profits with which Keynesian economics inadvertently tickles speculators.

It is suggested that the world is facing an imminent inflationary collapse of the dollar for reasons of over-issue. But what the world is getting is a deflationary collapse of the economy, as a result of the obtuseness of academic economists and policy-makers sold on Keynesian economics. They fail to see in the collapse of the rate of interest the inherent destruction of capital. Businessmen are lethargic. They know that making new investments while interest rates keep falling is suicidal. No matter how low interest rates may go, their competitors who invest later will have the advantage of investing at lower rates still.

Destruction of the Wage Fund

The German economist Heinrich Rittershausen (1898-1984) predicted the horrendous unemployment that was to hit the world economy in the 1930’s in terms of the destruction of the wage fund. He pointed to the failure after World War I to rehabilitate the real bill market. The victors in their conceitedness ignored the fact that the wage fund, out of which workers could be paid up to 91 days in advance of the sale of merchandise they are producing, was part of the volume of circulating real bills. When the bill market was destroyed in consequence of the deliberate decision not to allow real bill circulation to return after hostilities ended, the wage fund was destroyed along with it. There was no one to advance the funds out of which wages could be paid for labor whose product has not been and may not be sold for up to 91 days. But workers could not wait 91 days to buy food, clothes and shelter for themselves and for their offspring. In the absence of a wage fund employers had no choice but to lay off their employees.

Rittershausen was ignored by economists in the Anglo-Saxon countries. His message is still being ignored in the world today. But make no mistake about it, unless gold bill trading is rehabilitated soon, the world will face a new wave of unemployment far worse than that of the 1930’s. This also confirms the deflationary diagnosis for the present crisis.

The majority of hard-money analysts call for a hyperinflationary collapse of the dollar. Their analysis is faulty. Like a cornered rat, the dollar is capable of putting up a vicious fight for survival. In the words of Mark Twain, all the obituaries on the dollar are premature. The dollar is not a push-over. A yen-yuan coalition (or any other combination of existing or yet to-be-invented fiat currencies) cannot send it into oblivion.

To say that the dollar is strong is not the same as saying that is also healthy. In fact the irredeemable dollar is terminally ill. The reason for this is its departure from constitutional money. The Constitution mandates a metallic monetary system for the United States. Nothing shows the bad conscience of our monetary leadership more clearly than the fact that they could never muster up enough moral courage to propose a Constitutional amendment giving the federal government the power to establish a monetary unit based on negative values such as debt. Cheerleaders for fiat money in academic circles, in the media, and in financial journalism will not be able to live down the shame that will be their lot when the world economy collapses. The excruciating economic pain that people will suffer as a consequence will be their responsibility. The break-down in law and order will be their fault. As history and logic conclusively prove, fiat money is not a viable monetary system. It is prone to succumb to the sudden death syndrome. Whether caused by inflation or whether caused by deflation, sudden death is assured.

It should not be beyond the wit of human intelligence to see this coming and fend off the disaster by making a timely return to sound money, based on a monetary unit of a positive value as mandated by the American Constitution.

________________

ANNOUNCEMENT

New Austrian School of Economics

Course Four Munich, Germany

from March 24 – April 2, 2012

Title of the course:

The Austrian Theory of Money, Credit, and Banking

This is the fourth in a four-course series on Austrian Economics, a branch of economic science based on the work of Carl Menger (1840-1921). It is meant for those, including beginners, who are interested in the theory of money, credit, and banking, with special emphasis on the current financial and economic crisis. The complete program consists of four courses (10 days, 20 lectures each). Completion of each course will earn one credit. Participants who have accumulated four credits get a diploma signed by Professor Fekete. Course One that was given in 2010 and courses Two and Three that were given in 2011 are not a prerequisite. All three are available on DVD for purchase.

For further information or in order to register for the course you can get in contact with the organizers Ludwig Karl and Wilhelm Rabenstein via mail ( nasoe@kt-solutions.de ) or phone ( +49 – 170 – 380 39 48 , before calling please consider a possible time lag).

http://www.professorfekete.com/

Filed Under: Antal E. Fekete, Gold and Silver, Popular Economics

A Tale of Two Schools

February 2, 2012 by The Gold Standard Institute International

MengerAmerica700300

http://professorfekete.com/articles%5CAEFATaleOfTwoSchools.pdf

The New Austrian School of Economics (NASE) will celebrate its tenth anniversary this year. Under different names in different locations it has attracted many a student from all parts of the world. Its next session will take place from March 24 to April 2, 2012. It looks like NASE has found its permanent home in Munich, the capital of Bavaria where it will offer two ten-day (twenty-lecture) sessions twice a year, in the Spring and in late Summer. The first Ph.D. degree will be awarded at the coming Spring Session.

Why two Austrian Schools?

I have never addressed this question in public before. NASE goes back to the fountainhead of Carl Menger. This fountain is still gushing forth in its original purity and splendor while our tragedy, the most devastating credit collapse in world history that Menger foresaw is unfolding. While admiring Ludwig von Mises as the greatest economist of the 20th century, it has not been possible for me to analyze some of the notions of Mises deviating from Menger’s original vision in the cultist atmosphere of the American Austrian establishment for reasons of their intolerance. These deviations have mostly to do with the theory of interest. In my view the dogmatic theory of Mises is not in the spirit of Menger. Unlike his teacher, Mises embraced the Quantity Theory of Money without carefully delineating the extremely narrow limits of its validity. Moreover, Mises categorically rejected the idea of interest as a market phenomenon. Not only is his intransigence contradicted by empirical facts, but it also represents a deviation from Menger’s own methodology.

The evolution of interest

Interest is not a matter for postulating apodictic truths. Rather interest, as money itself is the result of a long evolution. In the case of money we are looking at the evolution of direct exchange, culminating in the indirect exchange of goods. In the case of interest we are looking at the evolution of direct conversion of income into wealth and wealth into income through hoarding and dishoarding, culminating in the indirect conversion through exchanging rent-charges, bonds, and other similar instruments.

But beyond the taboo on reading Mises critically, I have found that the approach of the American Austrians is far too superficial. Take for example the burning problem of the collapse of the international monetary system staring us in the face. It should be obvious that the problem cannot be solved without Adam Smith’s Real Bills Doctrine (RBD). Like them or hate them, real bills will start circulating spontaneously in want of other media of exchange. Gold will be unavailable as it will have gone into hiding, and it will be a painfully slow process to coax it out.

The Real Bills Doctrine

American Austrians refuse to accept the wisdom of Adam Smith’s RBD. They believe that there is enough monetary gold to go around to finance the myriad of transactions of our complex, many-faceted world economy. Even if there was, gold would be a fetter upon technological progress as it hampered the further refinement of division of labor. To avoid this deflationary bias, it will be necessary in the future, as it has been in the past to augment the stack of monetary gold by granting limited and ephemeral monetary privileges to the next best thing to gold, namely real bills – relying, as they do on self-liquidating credit. Real bills mature into gold coins in 91 days or less (91 days being the length of the seasons at the end of which demand for consumer goods changes). They are paid out of the proceeds of the sale of consumer goods in most urgent demand using the gold coins released by the consumer. They are not inflationary because real bills arise simultaneously with and in consequence of the production of new goods most urgently demanded by the consumer. Moreover, they expire as these goods are removed from the market by the final consumer.

A most recent restatement of the position of the American Austrians on RBD can be found in The Daily Bell interview with Dr. Joseph Salerno of Pace University (July 3, 2011). Salerno vigorously rejects the “age-old fallacy” (mark the fact that he shies away from mentioning Adam Smith by name) according to which regardless whether a bank provides mortgage finance or whether it discounts a real bill, it must increase its demand deposit liabilities. In doing so it increases the money supply and puts upward pressure on prices. Yet, in spite of Salerno’s sweeping equalization of these two banking activities, there is still a difference. Money provided for mortgage finance has been sunk into bricks and mortar which are among the most illiquid assets of all. By contrast, money from the proceeds of discounting real bills is financing the movement of goods in most urgently demand from the producers to the ultimate gold-paying consumers. The liquidity of these bills is second only to that of gold itself and, better still, they are an earning asset in virtually unlimited demand by banks and others in need of a quick asset. Note that the concept of liquidity (marketability by another name) is quintessential Menger. This has apparently escaped the attention of Salerno, as before him it escaped that of Mises himself. NASE puts marketability at the very heart of its inquiry. It has refined the concept further by distinguishing between marketability in the small (a.k.a. hoardability), and marketability in the large (a.k.a. salability). As it turns out, silver is the most hoardable and gold is the most salable good of all.

According to an aphorism on Lombard Street of old, long since forgotten, there is no easier profession in the world than that of the banker, as long as he can tell a real bill and a mortgage apart. Detractors of RBD may do well to brush up their knowledge of the principles governing pre-1936 banking theory, especially the part on self-liquidating credit (a phrase Mises never used except to ridicule it, in calling it Deus ex machina).

Interest rate versus discount rate

Salerno also believes with Mises that there is no substantial difference between the rate of interest and the discount rate. He says that if banks persisted in maintaining the rate at which they discounted real bills below the natural rate of interest, then they would generate a torrent of real bills for discounting, that would cause an inflationary spiral of money-creation and piece increases.

Despite these beliefs, the difference of the discount rate from the rate of interest is fundamental, all declarations to the contrary notwithstanding. Mises considered the former to be a short-term interest rate with interest payment collected at the beginning of the loan period rather than at the end. However, the fundamental difference is far more important than this technicality. The concept, the sources and the formation of the two rates are very different.

Interest is paid by the debtor to the creditor on loans. Discount is paid by the lower to the higher-order producer of the maturing consumer good. No loan is involved in discounting. Neither one of the two producers is subordinate to the other. They are like the two blades of a scissor. Take away either one — no cutting is possible. At any rate, it is ridiculous to suggest that the lower-order producer is in debt to the higher-order producer. The former handles merchandise that is one step closer to the consumer. For this reason alone it commands a higher marketability. The dependence of the latter on the former is obvious.

The confusion of the two rates gives rise to a long string of serious errors. The rate of interest takes its origin in the propensity to save; the discount rate takes its in the propensity to consume. The propensity in either case varies inversely with the rate itself. Consumer demand is satiated through the very act of consumption. This means that consumption causes the discount rate to rise, rather than to fall — as Salerno would have us believe. The banks have no mythical power over the discount rate; they must follow the wishes of the sovereign consumer. Thus, by definition, there can be no torrent of real bills triggering an inflationary spiral and price increases. Salerno’s analysis is shallow without any redeeming features.

The mission of NASE is to go back to the unpolluted sources: to Carl Menger’s theory of the origin of money; to his all-important concept of marketability; and to his consistent application of marginalism. For example we at NASE talk about the principle of marginal time preference. It asserts that, when confronted with falling interest rates, the marginal bondholder will sell the bond (a future good) and with the proceeds will buy gold (a present good). This gold/bond arbitrage of the savers is anathema to Mises-worshippers because they think that Scrooge, the Prodigal Son, and everybody else have exactly the same time preference. The truth, however, is that there is a whole spectrum of different time preferences from that of Scrooge to that of the Prodigal Son. The critical one, the time preference of the marginal bondholder is decisive. It has a crucial role to play in preventing the rate of interest from falling through the floor. The mechanism through which it does that is the bond market. After all is said and done, interest is a market phenomenon.

Furthermore, according to Mises paper promises to pay gold to bearer, nay, even fiat money promising to pay nothing, is a present good. He explicitly stated that a gold certificate, if its security cannot be doubted, is just as much a present good as the gold coin itself. Heck no, it isn’t, and the marginal bondholder knows it. If he accepted such a promise, however secure, in exchange for his bond, he would be jumping from the frying pan right into the fire. He would be worse off than if he held on to his bond. The bond at least pays interest at a positive rate, however low it may be. By contrast, paper promises of gold such as a gold certificate pay interest exactly at zero percent. The bondholder’s avowed protest against low interest rates would be counter-productive. The conclusion is that the principle of time preference as formulated by Mises is utterly inadequate. It is a paper tiger having no effect whatsoever on the condition it is supposed to rectify. It leaves all the victims of Bernanke’s ZRP helpless.

But as those who have eyes to see can see, even in the fast-degrading monetary system of ours marginal time preference — as opposed to the time preference of Mises which is hardly more than a pious wish — is live and kicking. Savers, from individuals to pension funds to central banks and governments are selling their bonds in a panic and rush to buy gold with the proceeds. This is marginal time preference in action.

We may conclude that the American Austrian establishment is badly in need of a critic. NASE has volunteeed to serve as one, but the offer was rejected. It is regrettable that American Austrians are deaf to criticism of any kind. Mises was a modest man. He never thought that his had to be the last word. He severely castigated those who were ready to settle arguments by calling names. I sincerely hope that we can have a conference where arguments on both sides can be presented without fear and favor, and let the best argument win. So far, any suggestion of this kind was refused out of hand. I would be personally very happy to have a public debate with Dr. Salerno.

This is no time for fratricidal bickering. The survival of our civilization is at stake.

Filed Under: Antal E. Fekete, Gold and Silver, Popular Economics

Mainstream Economists’ Monetary Insanity

December 21, 2011 by The Gold Standard Institute International

CircusClown700300

http://professorfekete.com/articles%5CAEFKrugmansMonetaryMadness.pdf

Paul Krugman’s article in the December 15 issue of The New York Times under the title G.O.P. Monetary Madness takes G.O.P. presidential candidate Dr. Ron Paul to task for his ‘ideological’ stand on money. For excellent reasons, not all of which had to do with fear of a Zimbabwe-style hyperinflation, the Constitution explicitly prohibited manipulation of the dollar such as Bernanke’s threefold increase of the monetary base in three years. Krugman ruefully reports that the ‘hard money doctrine and the paranoia about inflation’ took over the G.O.P. that has, up until now, meekly followed Keynesian precepts about pump priming and turning the stone into bread through pushing interest rates all the way down to zero.According to Krugman, in spite of the ‘false alarm’ sounded by the Austrian economists over the debasement of the dollar, inflation is still only 1.5 percent. ‘Who could have predicted that so much money printing would cause so little inflation?’ he asks rhetorically. ‘Well, I could, and I did’, he boasts, ‘because I understand (the) Keynesian economics that Mr. Paul reviles.’

In the event, unknown to Krugman, I also predicted the same thing. Unlike Krugman I did more than simply predicting that inflation was not the danger. I warned that Keynesianism would lead to deflation and depression. Money-printing has become counterproductive. Krugman doesn’t understand that it will boomerang. I stated that, unwittingly, Bernanke is the Quartermaster General of the Great Depression II (see: Front-Running the Fed, www.professorfekete.com, February 9, 2010). He doesn’t understand the monstrous mistakes prophet Keynes made concerning the role of speculation in the money-creation magic. The fact is that central bank buying makes speculation risk free in the bond market. In comparison, speculative risks in the commodity market appear forbidding. All the speculator has to do in order to reap risk-free profits is to preempt the Fed. He buys the bonds before the Fed has a chance. Then he turns around and dumps them into the lap of the Fed at a profit. The Fed is helpless: it must buy at the higher price. Keynes completely misrepresented the ability of the central bank to stay in charge, given its compulsive drive to suppress interest rates when confronted with a profit- hungry pack of bond speculators.

Friedman’s analysis of the Great Depression couldn’t be more wrong. In 1933 deflation was brought about not by the gold standard  but, au contraire, by abolishing it. Here is what actually happened. Roosevelt has removed the only competition government bonds have, gold. The most conservative investors saw their gold confiscated and, willy-nilly, they were forced into the next most conservative instrument, Treasury bonds. Speculators became emboldened and bid bond prices sky high for risk free profits. Had gold been still available, bondholders would have severely punished the speculators for their daredevilry. They would have sold the overpriced bond and stayed invested in gold until bond prices came back to earth from outer space. Then they would have bought their bonds back at a profit.

In the absence of gold, speculators made interest rates go into a tailspin. That caused (the) dominoes in the commodity market (to) fall. Prices collapsed one after another. Pieces on the chessboard started falling as well, symbolizing serial bankruptcies of productive enterprises. Breadwinners of families lost their jobs in droves as money flowed from the commodity market to the bond market in the wake of speculators selling commodities short while buying bonds hand over fist. All the while Keynes was rubbing his hands together behind the scenes exactly like Mephistopheles had in the famous paper money scene of Göthe’s Faust (Part Two).

The same thing is happening all over again. When a central bank increases the monetary base three-fold in three years, this is a clear invitation for bond speculators to move in and make a killing. But what the central bank utterly fails to understand is that, contrary to its hopes, new money is not going to the commodity market. Speculative risks there are far too great. Instead, new money is going to the bond market where the fun is. Bond speculation is risk-free. Speculators know which side the bread is buttered. Krugman doesn’t.

Dr. Paul is the conscience not just of the G.O.P., but of the entire nation. Through inflation or through deflation, the mad orgy of money creation that makes mockery of the Constitution will finish the Keynesian agenda of ruining the nation and the world economy.

Krugman’s joy over the supposed defeat of Austrian economics is premature. Bernanke’s Fed in blissful ignorance is still putting money in the hands of speculators which they use to place bets on the further fall of interest rates and commodity prices. The day of reckoning comes when falling interest rates destroy capital and, together with it, destroy budding job opportunities. The lethargy of businessmen will continue. They will not start hiring as long as the interest-rate structure is in falling mode.

Welcome to the world of Keynes-inspired Great Depression.

Filed Under: Antal E. Fekete, Gold and Silver, Popular Economics

You Can’t Eat Gold. But Can You Eat Real Bills?

July 12, 2011 by The Gold Standard Institute International

Chaplin

http://www.professorfekete.com/articles%5CAEFYouCantEatGold.pdf

I have received the following letter from a reader.

Professor:

I have been reading your essays on real bills for several years with great interest. If there were any contemporary examples of such credit in circulation, it would be easier to understand how real bills work. Also, have you considered editing the real bill entry on Wikipedia, to give it a less pejorative sense?

Paul Dadford

Seattle

Here is my answer:

Hello Paul:

I am not responsible for the real bill entry on Wikipedia. I understand it was written by Mike Sproul, the author of the pamphlet There’s No Such Thing as Fiat Money .

I shall give you more than what you have asked me for: I give you a futuristic example of real bills in action and how you can put them in circulation. I hope it won’t come to that, but if we find out that the dollar has no dispensation from heaven exempting it from being fiat money and, hence, it can lose all its purchasing power as has every other fiat money in history within a generation, then my epistle may come handy some day.

Suppose for the sake of argument that the U.S. dollar has already lost all its purchasing power. (My apologies to Mike Sproul, but I was in Germany on August 15, 1971, the very day the dollar was declared fiat money. In trying to check out of my hotel, the cashier declined my Federal Reserve notes. He sent me to a bank across the street to change my money. At the bank I found a long line of other people with the same problem waiting for their turn. The teller was on the phone nonstop, waiting for the latest instructions from headquarters. To put it mildly, the bank did not welcome the opportunity to do business with us wanting to sell dollars, and we were treated accordingly: you were asked to produce 3 picture ID’s, provide your address and phone number, the name and address of your employer, your mother’s maiden name, your next destination, etc.)

Going back to our futuristic story, we have assumed that the dollar has died. It would be outrageous to assume also that the American people, and people of other countries where the dollar used to circulate, would now have one great death wish: they would all want to die along with the dollar in sympathy. No, they would want to eat, to get clad, shod, and to keep themselves warm in winter as before. Admittedly they have a problem. Here is what they will do.

Let’s say you are the maker of some consumer good (say, a small whisky dispenser that can be attached to any cell-phone) that you are selling through Macy’s Department Stores; and your brother is producing some semi-finished goods (say, cigarette lighters to be built into cell-phones) that he is selling through Walmart. As neither Macy’s nor Walmart is accepting dollar bills from their customers, they won’t try to pass off dollar bills to you. Macy’s offers you two choices (the procedure at Walmart is very similar):

(1) you can have Macy-vouchers in any combination that you can use in store as cash, or

(2) you can bill Macy’s for the goods delivered.

A bit suspicious, you take the second choice. Then the clerk at Macy’s gives you a form to fill out, indicating date, quantity and quality of goods delivered, and your instruction that they pay the bill at their chief cashier’s office ‘in legal money’ no later than 91 days to you or to whomever you may transfer the title through endorsing in the meantime. The receiving department takes your bill, stamps it on the other side with the legend “I accept” over the signature of the receiving clerk, date, address and phone number of Macy’s. Then the bill is returned to you.

Congratulations: you have just drawn your first real bill!

The receiving clerk apologizes for the inconvenience and gives you a flyer suggesting supermarkets and clothes outlets in the neighborhood that will accept your bill drawn on Macy’s as cash in payment for your purchases.

He also gives you another flyer listing those firms, including Walmart, whose bills (i.e., bills drawn on them) are received as cash at all the cashiers in any Macy’s store. This means that if your brother endorses his bill drawn on Walmart, then you can use it as cash at Macy’s.

As you leave Macy’s, you get a terrible toothache. You go the dentist’s office nearby where you are informed by the receptionist that the doctor no longer accepts dollar bills in payment. She gives you a flyer listing supermarkets and department stores whose bills the doctor will take. Luckily, Macy’s is on that list and you are on your way to the dentist’s chair. The professional charges are lower than your bill drawn on Macy’s so the receptionist offers you change in the form of a bill drawn on the dentist that you can use to pay for further professional services of his, but is also receivable by hundreds of medical offices nearby, as well as by many retail outlets including Macy’s.

Congratulations: you have just put your first real bill into circulation!

Incidentally, all the banks have by then closed their doors for reasons of insolvency. Nobody feels sorry for them. They got such a bad name during the death-throes of the dollar that the few of them that tried to re-open for business were avoided by the people like they avoid the plague. According to the latest report some succeeded, but their officers shun the name ‘banker’. They call themselves ‘bill mongers’. Sounds much more honorable.

Real bills are second only to gold. But sometimes they are safer. When you try to eat them, for example. True, it is a hassle trying to eat your real bill. But when you try to eat your gold, you may get killed for it!

Detractors of real bills, beware! One day your life may depend on them!

Yours, etc.,

Professorfekete

Come to Munich, the capital of Bavaria, for the next ten-day course of the New Austrian School of Economics, from August 20-29, 2011, where I shall answer any questions you may have on the origin of money, origin of interest, hoardability of monetary metals, opening the Mint to silver. Also on hand will be Sandeep Jaitly to tell you about the gold mine of the silver basis, and about the last contango in Washington. For details, consult: See also my website:

Also on the drawing board we have a Seminar in Hong Kong, as well as one in Auckland, NZ, coming up in November. Stay tuned for details.

Filed Under: Antal E. Fekete, Gold and Silver, Popular Economics

“You Have Never Ever Seen An Elephant Fly”

July 4, 2011 by The Gold Standard Institute International

ElephantPilot

http://www.professorfekete.com/articles%5CAEFRealBillsAndMortgages.pdf

In the 19th century a saying was current on Lombard Street that went like this: “There is nothing easier in the world than the banker’s profession – provided that he can tell a real bill and a mortgage apart.”

I would like to engage Dr. Joseph Salerno in a friendly debate on this maxim. In his interview with the Daily Bell published July 3, 2011, he sees nothing wrong with people drawing bills of exchange, or accepting them in payment, as these instruments are completely consistent with a society based on free contract. I heartily welcome this statement of his. It should be much more widely known. After the death of the dollar people in the United States, and in other countries wherever the dollar also circulates, will not want to die along with the currency. They will still want to eat, get clad, shod, and keep themselves warm in winter. In order to be able do so they will just have to draw bills on retail merchants and other producers whom they supply with finished or semi-finished goods. These bills will serve as cash with which to buy food, clothes, shoes, fuel. We may expect that banks, central or otherwise, will have earned themselves such a bad name by then that nobody will want to be known as a ‘banker’. ‘Bill-monger’ will sound much more honorable.

Dr. Salerno adds: What I vigorously reject is the age-old fallacy known as the ‘real bills doctrine’ asserting that when a bank issues currency or creates a bank deposit in discounting a bill of exchange, it is not causing inflation . In the next sentence he clarifies his position further when he suggests that whether a fractional-reserve bank buys a mortgage, or whether it discounts a real bill, it comes to the same thing: the bank increases its demand deposit liabilities to finance the expansion of assets.

While this is true, it does not prove that the bank is guilty of causing inflation when discounting a real bill. The difference is this, and in ignoring it Dr. Salerno dodges the real issue here: when the bank discounts a real bill, it withdraws from the market an instrument that circulates as money. Ephemeral, to be sure, but money nevertheless. Ludwig von Mises, no friend of the real bills doctrine, admits that bills of exchange have circulated as a means of payment among spinners, weavers and other tradesmen dealing in cotton products in Lancashire before the Bank of England opened its branch in Manchester.

There was a time not too many years ago when it was strictly against the rules for a commercial bank to put a mortgage in its portfolio of assets. You have never ever seen a mortgage, or an elephant for that matter, fly. Real bills, by contrast, can and do circulate on their own wings and under their own steam as currency. The present Great Financial Crisis started with commercial banks overloading their portfolio with mortgages disguised as ‘securitized equity’. Yet no one is inquiring whether the violation of the old time-tested rules has caused the crisis in the first place.

In discounting a real bill the banker only substitutes his own credit that has a higher name-recognition. The potent ingredient of the credit is that of the weaver, even though it has a lower name-recognition. The searching question to ask therefore is this: does the weaver really cause inflation when he passes along the bill he has drawn on the fabric merchant to the spinner in payment for the yarn?

I hope Dr. Salerno agrees with my answer: no, the weaver causes no inflation. It is true that he puts a purchasing medium, his bill drawn on the fabric merchant into circulation, but it is matched by the cloth, a new merchandise of the same value he offers for sale. The bill and the cloth appear simultaneously and will disappear simultaneously. The former disappears when it matures, and the latter disappears when it is purchased by the ultimate consumer. An increase in purchasing media that is matched by an increase of merchandise in urgent consumer demand is not inflationary.

Bankers of old on Lombard Street expressed this by saying that the credit embodied by a real bill is self-liquidating as it is extinguished by virtue of the sale of underlying merchandise on which it is drawn. By contrast, the credit embodied by a mortgage is not self-liquidating as it is not normally extinguished out of the proceeds of the sale of the underlying property.

Dr. Salerno also makes a comment on the suppression of the rate of interest, allegedly caused by bankers in discounting real bills at a discount rate lower than the rate of interest. This suppression, he suggests, generates an unlimited supply of bills to discount, causing an inflationary spiral of money-creation and price increases.

Mises explicitly stated that the discount rate is just another name for a short-term interest rate with interest taken out of the proceeds of the loan up front. However, this description is mistaken, as pointed out by several authors, among others John Fullarton and Charles Rist. The nature and origin of the discount rate are entirely different from that of the rate of interest. The two rates are completely independent of one another. The rate of interest is determined by the propensity to save ; the discount rate by the propensity to consume . In either case the relationship is inverse: the greater the propensity, the lower the rate, and conversely.

When the spinner delivers yarn to the weaver and is offered payment in the form of a bill drawn on the fabric merchant, he will accept it but will apply a discount to the face value. The question is how the two tradesmen can come to an agreement what rate to apply. There can be only one answer to this question: a lower discount rate will be acceptable to the spinner if the market is brisk; however, a higher discount rate will be insisted on if the market is lethargic. Thus the discount rate is determined by the condition of the consumer goods market, and not by the availability of savings. It reflects the propensity to consume (with apologies to Keynes). There is no loan involved in discounting , so the rate of interest is irrelevant. Tradesmen processing semi-finished goods hardly ever pay cash for supplies to their suppliers. The prices they are quoted are not cash prices. They are “90 days net”. The credit is part of the deal: you need not even ask for it. On the rare occasion when you don’t need the credit you pre-pay your bill, having applied the discount to its face value.

Filed Under: Antal E. Fekete, Gold and Silver, Popular Economics

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