Gold is Money

keep-calm-buy-gold

“Gold is money. Everything else is credit” — J.P. Morgan testifying to Congress in 1912.

Let’s acknowledge that although the terms money and currency are often used interchangeably, they actually have distinct meanings.

Currency has value because it has been deemed so by the government in power in that jurisdiction. Why has a piece of paper with Queen Elizabeth’s face on it considered to have value within the UK? Because that government has decreed it so. There is no intrinsic value in that piece of paper. It is only valuable because the UK government defends its value through control of its printing and severe suppression of its counterfeiting. That rectangle of paper has no practical use and only holds value because of the projection of force by the British government. That force is a two sided sword. If wielded with integrity, it staunchly defends that paper’s value.

If it is abused (and boy is it currently being abused), it is fighting a losing battle with reality. This is the major failure of fiat currency. Through the cancer of Quantitative Easing (QE), the value of the currency is being constantly diminished. The amount of currency in circulation in the UK, if properly protected, should be increased by the Bank of England roughly in line with the rise in UK GDP.

These last five years this has not been the case. QE has run way ahead of GDP, and the only reason we have not yet seen hyperinflation is because this excess currency has been diverted through the crony banking system in order to build up their depleted capital reserves (depleted because of their utter incompetence in the last property boom/bust). Everything in excess of this reserve has been diverted via the bank’s investment arm into the grossly over inflated stock market.

I’m not picking on Sterling in particular; USD, EUR and YEN are all being similarly manipulated.

Which brings us to money. The quote above from 1912 succinctly differentiates money from credit.

Note, credit not currency.

Back in J.P.Morgan’s time currency was freely exchangeable for gold at a set rate that had barely changed for 150 years since the formation of the United States. The “dollar a day” set wage for a day labourer had held steady since before the revolution. There was practically no inflation for all that time.

JPM was of course testifying against the formation of the Federal Reserve.

It went ahead anyway.

Since then, the dollar has lost over 95% of its value through systemic devaluation of the dollar. What JPM warned against has happened. Currency has been converted from money to credit.

There have been three steps to this.

The first was the creation of the Federal Reserve in 1913. Although this sounds like it is a government entity, it is not, it is in fact a private corporation owned by a conglomerate of private banks with a government monopoly to create dollar bills, to manipulate the national interest rate, and recently it has taken upon itself the right to create money out of thin air using the QE mechanism.

The next step was the confiscation of physical gold held by private American citizens by President Roosevelt in 1933 with Executive order 6102

The final step was the dropping of the gold standard by President Nixon in 1971. Prior to this anyone could go to the Fed and demand physical gold for $35 per ounce. This became unsustainable because investors lost faith in the US governments’ ability to deliver on this promise because of the over-extension of spending.

And so, what J.P.Morgan warned against has indeed come about. Currency has lost its connection to gold money and has in fact been turned into credit. That is, the currency has been turned into debt through the action of the FED.

What caused this over-spending? The ongoing Vietnam War and the financial commitments of the ‘Great Society’ introduced by President Lyndon B Johnson.

All of these steps replaced a regime of dollar value fixed to an immovable quantity of gold, with one of an ephemeral number of printed dollars printed at the discretion of a privately owned banking cartel under the influence of a political structure using it to support short term political expediency.

What could possibly go wrong?

The future of education

There is a quiet revolution in academia underway that is growing exponentially and will decimate ‘The Anointed’ class very soon. It is called Massively Open Online Courses (MOOC). Two examples that I have personally used are Coursera and the excellent Khan Academy (See the TED talk by Sal Khan in the video above. A very worthwhile use of your next 20 min) . A single inspired teacher can give the lecture once, put it online and it never has to be done again. Or as Sal puts it, “If Isaac Newton had bothered to put his ideas up on YouTube, I wouldn’t have to”.

Now subjects like Chemistry, Medicine and Engineering will always require lab time to make the principles stick.

Comparative Gender Studies, not so much.

With the accelerating deflation of the Higher Education bubble in the US and the introduction of £9,000 tuition fees in the UK, more and more students will forego traditional universities for MOOCs.

Imagine an 18 year old student considering doing Economics at the LSE. The tuition fees over 3 years will come to £27,000 and accommodation and expenses near the same again. The online Distance Learning option costs £3,807 with invigilation fees and books maybe £1,200 more.

So do you choose to go to college for 3 years and come out £50k in debt, or spend maybe 4 years to do the exact same course, while holding down an entry level job and come out at the end debt free with exactly the same degree? The lack of a £50k noose around your neck will give you a lot more options to buy your first rung on the property ladder.

As Joseph Schumpeter put it: – “The process of Creative Destruction is the essential fact about capitalism”.

Money given to banks is a LOAN

loan application

There has been a lot of controversy recently with the ‘Bail-in’ of the Cyprus banks. What this entailed was any deposits under €100,000 were fully protected, everything over this amount was discounted by 47.5% (for now), all shareholders and junior depositors were wiped out and all senior bond holders (i.e. French and German banks) were compensated 100%. This procedure was financed by a €10 Billion loan to the Cypriot government, to be repaid by the Cypriot people at roughly €12,500 for every man, woman and child in the country plus ongoing interest.

Now the fact is that this is an inversion of the internationally accepted hierarchy of rights on the insolvency of banks. In this agreed model the hierarchy should be as follows:-

  1. Depositors under €100,000 (to be made whole by a national deposit insurance scheme if capital remaining is insufficent)
  2. If any capital remains, deposits over €100,00 in proportion as to what is left in equity
  3. If any capital remains, Senior bond holders in proportion
  4. If any capital remains, Junior bond holders in proportion
  5. If any capital remains, other creditors in proportion
  6. If any capital remains, shareholders in proportion

The third place in the hierarchy has been pushed to the top and has taken all the remaining equity in the insolvent banks leaving ECB loans to cover both their shortfall and that of the under €100k depositors, partially cover the above €100k depositors and screw the rest, all at the expense of the Cypriot taxpayer, who will be paying off this loan for at least the next 20 years.

It is obvious that this deal was hammered out and forced down the throat of the Cypriot government by the ECB under severe pressure from the indebted French and German banks who engaged their wholly-in-the-pocket national politicians to lobby for them at the European level.

So national politicians, perceiving their self-interest in keeping this creeping Euro financial disaster from their own doorsteps by supporting their national banks, have forced a reversal of the standard norms in order to fully compensate their own banks at the expense of the Cypriot depositors and taxpayers.

This ‘bail-in’ model with reversed hierarchy has been quietly adopted by national governments around the world with no media scrutiny and zero public awareness.

So expect the Cyprus deal to be repeated in a country near you in the near future.

Now in My Ideal World™ the original hierarchy should prevail and the public should be fully informed of the actual position of their deposits at their local banks. Deposits are a loan to the bank as has been established in law for two centuries. If you put your money in a bank and expect interest, you have to accept some level of risk because there can be no profit without risk. Your bank is only able to pay you interest because it loans out your money to businesses and house buyers at a higher rate, keeping the difference as its profit. There is an inherent risk in this, as we have found out over the last five years.

Senior bond holders need to accept their place in this heirarchy and not  try to skew the system in their favor by lobbying through their in-house politicians, and the public need to inform themselves of the facts of the situation so that they are not bamboozeled by their bought-and-paid-for political class.

If you put your money in a sealed container and bury it at the end of the garden you will have no bank risk and you will also earn no interest, in fact your stash will lose value over time due to inflation.

Now, if it were up to me, I would create a higher level in the above hierarchy with level 0

0.  Current account holders who earn no interest and pay an annual fee for banking services

These top level customers should have the highest priority above all others, as they get no interest (in fact they pay for their banking services), and should, in turn, face the least risk.

Bottom line is that bank customers need to make themselves aware of the inherent risk they take on by LOANING their money to a bank, and divide their money between current and deposit accounts and multiple banks in order to mitigate their risk. This is not super-complicated and anyone with over the €100,000 savings level should be financially sophisticated enough to take on this relatively simple task.

Debt or Deficit?

Debt or Deficit?

There is a lot of confusion in the public mind between these two terms and this ignorance is deliberately exploited by politicians on both sides in order to underplay the problem we face.

But it really is very simple.

Debt is the amount of money currently owed by the government to the bond markets. The bond market is simply the forum for private investors, insurance companies, banks etc. to lend money to the government at an interest rate set by supply and demand. It has long been regarded as the safest option for investment by people and institutions with a low risk appetite, the proverbial Widows and Orphens market. So much so that the interest rate so derived is known as the ‘risk free rate of return’.

The mechanics of this system are very straight-forward. Every few weeks a government will offer to the bond market, X million of debt denominated in its own currency over a fixed term of anything from three months to thirty years. The treasury will make the following proposition: I am offering a bond which will pay back £100, (let’s say) one year from now and I want £98 for it today. So the lender pays £98 today and in exactly one year he gets back £100, so he gets £2 interest on a £98 loan which is an implied interest rate of (2/98)x100 or 2.04%. If the government has done its sums right, there will be more money offered by the market than is required from this particular bond issue and the bond sale is described as ‘oversubscribed’ and each bidder gets a percentage of the amount of bonds they bid for at the price offered.

The reverse is also possible. If the government offers a rate that the bond market thinks is insufficient the bid will be undersubscribed and there will be only a partial sale of the bonds on offer. This is hugely embarrassing for the treasury so they work very hard to get their sums right to avoid this.

Previously issued bonds are constantly traded on the bond market so that for any given maturity date, there is a clearing price set by supply and demand in the market. The treasury sets its prices to align with the spot price in the open market so that an undersubscribed issue is extremely rare. Bonds are constantly being rolled over so as one bond issue expires and the principle needs to be returned to investors, a similar amount is being raised through a new bond issue to pay it back.

If the government is not overspending, that is, if its income from tax receipts is in line with what it is spending then the total debt can remain static with the annual interest to the bond market becomes just one more line item of expenditure. If the GDP rises and the debt is static then Debt/GDP ratio actually reduces. However if the amount of debt increases faster than GDP then this Debt/GDP also rises. This is where most governments are currently.

Deficits arise when the amount of money being spent by the government exceeds the amount coming in by way of taxes. The difference has to come from the bond market and the amount of this excess adds each year to the total pool of debt.

The Deficit is the amount by which the Debt increases each year.

And this is where the sleight of hand is played. Politicians deliberately use the term deficit where the audience are led to believe that it is the debt that is being discussed. See the video above for recent examples. So a politician can say, truthfully, that the deficits are being reduced, but by mixing up the two words he can lead the audience to believe that is the debt that is being reduced.

It is not.

The debt is just increasing by slightly less than last year, but it is still increasing. So the statement is technically true but by flustering his words, with plausible deniability, he can leave the audience with a false impression.

This deceit is deliberate.

But you already know that politicians are professional dissemblers, right?

After the money’s gone

 

You may ask yourself, what is that beautiful house?
You may ask yourself, where does that highway go to?
You may ask yourself, am I right, am I wrong?
You may say to yourself, my God, what have I done?
 -David Byrne-

When trying to explain the mess we are currently in, the left will decry the greedy ‘Banksters’ and declare a failure of capitalism and the right will point to the Community Reinvestment Act and blame it on government interference.

Both are half right.

To see how we got to where we are it is necessary to start back in 1945 and bring together a number of different threads. After the end of WWII, the industrial base of Europe and Japan lay in smoking ruins and the USA reigned supreme as a military and industrial power. Its industry had ramped up to wartime production while being unaffected by aerial bombing due to the lack of range of bomber aircraft of the time. All of the Industrial countries (by which I mean North America, Western Europe and Japan) took on huge debts to finance the war. Europe began a massive reconstruction program to rebuild its industrial capacity, financed by the Marshall Plan to the tune of $12.7 billion ($152B in todays money) and a similar plan for Asia of $5.9 billion ($70B ITM). The US did this through a mixture of altruism and self interest in that it provided a bulwark to an expansionist Soviet Union, a growing market for its own exports, successful democratic allies rather than permanently subdued and resentful vassal states and in many cases, the money was provided in the form of loans which were repaid. Hard and soft power allowed the US to reshape international trade in a form more to its liking with freer trade with lower tariffs.

Wartime Debt

We can see from the graph above that this was hugely successful with most of the wartime opponents undergoing a ‘post war miracle’ that allowed them, by the mid 1970’s to bring their wartime debts to below 50% of GDP.

The 1970’s saw a number of post war effects come to a head. The baby boomers reached their 20’s and began demanding political influence and a more socialist economic system, through a combination of youthful enthusiasm and Soviet manipulation. This was the time of the communist radicals, the Vietnam War protesters, the 68ers of Paris and the various left wing terrorist groups financed by the Soviets and Libya. While the terrorists mostly failed in their objectives, the political centre ground lurched to the left and more and more social programs and entitlements were demanded and enacted. At first, this was financed through ever higher taxes until it was found that there was a limit to how much you can tax an economy before it began to have a negative effect on growth.

The back slope of the Laffer Curve had been reached.

So tax rates were lowered by Regan in the US and Thatcher in the UK and following their success, by many others worldwide. The public, however, still demanded ever increasing entitlement spending, so the difference had to be found somewhere. This is when national debt rates began to rise again throughout the western world as governments looked to the bond markets to fund the entitlement spending that the public demanded but were unwilling to pay for through taxes. The media, the voters, the political class and academia cheered them on.

While Thatcher’s legacy as a fiscal conservative is secure, having brought Debt to GDP down from 45% to 25% during her tenure while greatly improving economic growth, Regan’s is more mixed. He did reduce taxes and increase economic growth, but he also embarked on an arms race with the Soviet Union rather than use the savings to reduce debt. It can be argued that eliminating the threat of nuclear Armageddon was worth the price, but the fact remains that that debt increased from 30% to 50% during his time. The upward trend continued under Bush Sr who had a gulf war to pay for. Clinton during his two terms reversed the deficit and reduced the debt, but Bush Jr and Obama significantly increased it again.

All of them however, failed to tackle the ticking time bomb of demographic changes that would mean that as the baby boomers reached retirement age, there would be significantly fewer younger workers to pay for their retirement. The baby boomers embraced feminism which brought vast numbers of working age women out of the kitchen and into the workforce. This had a number of long term economic effects. Firstly, working women with newly available birth control, decided to have fewer children in order to better balance home and work life. Two income families bid up the price of property to way beyond what could be afforded by a single salary, forcing more women into the workforce in an ever increasing property price arms race. Rapidly increasing home prices gave an illusion of increased wealth and people began to view the family home as an ATM machine to borrow against for current consumption.

During the last 20 years, an apparent increase in wealth has convinced more and more school leavers to go to university. In the US and to a lesser extent the UK, this has seen them enter the workforce already massively in debt. Young couples, already in debt are putting off having their first child till their mother’s early thirties when fertility rapidly declines and the time available to have subsequent children is greatly reduced. As a huge phalanx of baby boomers rapidly comes to retirement age, this process is now about to create the perfect storm.

The children of the Baby Boomers begat the echo boom of those born in the 70s and 80s, who have had to delay forming families due to their educational indebtedness, their wives’ reluctance to begin childbirth without financial security and the lack of available housing at reasonable cost due to their parent’s generation reluctance to sell up and downsize at a price less than they think their properties are worth due to a fallback after a lifetime of booming prices. This now middle aged generation have produced far fewer offspring than their parents.

It is normal, in the western world, for someone with three or four siblings to have one or two children themselves. Thus a falling population is a mathematical certainty. The retirement system was set up sixty years ago when every couple could expect to have four children and sixteen grandchildren, each earning wages and paying taxes back to the previous generation with a comfortable surplus. This model fell apart in the 90’s and the number of workers per retiree is rapidly dropping to an unsustainable level, i.e. the falling number of new workers can no longer sustain the increasing numbers of retirees.

This demographic problem has been obvious for decades and has been criminally ignored by the political class that preferred to spend now and forget about paying later because it would be someone else’s problem. And the public have only themselves to blame for ignoring the problem and failing to hold their politicians to account while believing the pretty lies. Instead of creating a “You get out what you paid in” system as was put in place in Chile when they took on board this problem decades ago, and as was half attempted in the US with the 401(k) scheme, the political class, with the acquiescence of the people, chose to ignore the problem and will soon have to face it straight on, without a backup.

This will not end well.

Letting the days go by, let the water hold me down
Letting the days go by, water flowing underground
Into the blue again, after the money’s gone

David Byrne

Shame on you!

shame-on-you

“Shame on you!

They spit the words into your face. Every hard case that arises must, of course, be solved immediately by state intervention with a new bureaucracy with sufficient staffing and a generous budget. Anything else would be ‘unfair’. And if you don’t agree, you should be ashamed of yourself. Never mind what it costs, we’ll make the rich pay for it. Anyone who has ever delved into the comments section of the Guardian or the New York Times will recognise the narrative. The effectiveness of this approach is that it completely bypasses logic and goes straight to emotion for its impact.

And you know what? We should be ashamed.

We have created in the last fifty years a multi-generation underclass that has never worked and will never acquire the habits of work. We used to have a proud working class where self sufficiency was prized, where dependency was considered pitiful by your peers, where personal advancement and education and community were valued, where the first member of the family to enter university was a source of enormous pride for the entire family….

Until the dead hand of the state got involved.

In the 1970’s, the new generation of baby boomers, in their hubris, voted for and many of them administered a vast new program of welfare in order to improve the conditions of the working class. In attempting to remove want, they decided that they, as only intellectuals could, were best placed to run the little people’s lives for them. Instead they removed all responsibility and turned adults into children. What they actually achieved was the decimation of the working class and the huge expansion of the underclass. Now we have the second and third generation of useless parasites that survive by a combination of welfare and petty crime. They destroy everything around them, make the lives of their working neighbours miserable through their defiant and unchecked antisocial behaviour, ruin the schools and fill the prisons. The self regulating communities that kept this misbehaviour in check has been displaced by a careerist, self interested and self perpetuating bureaucracy on full pay with generous benefits.

You want thanks for the trillions that have been spent on them over the decades? London riots last year and flash mobs in Walmarts. There’s your thanks.

Their anger has been encouraged by legions of grievance-mongers who absolve them of all personal responsibility and deflect the blame to ‘Society’. They have a white hot visceral hatred for you, (the poor working stiff who has to pay for this through ever increasing taxes) because deep down they recognise the dependant squalor they have been reduced to and they blame you for it.

And as those 70’s radicals reach retirement age after a long and securely paid career with good pension benefits paid for by the (actually) working class, do they look back on their life’s work and reflect on the destruction their conceit has wrought? The hell they do.

Where is the shame?

The number of people on disability in the US has grown from 3m in 1990 to 9m now; in the UK it has grown from 0.4m to over 2m in the same period. Has there been an epidemic of work accidents these last 23 years that we all missed? No, of course not, with the move away from heavy industry to the service economy, most workers’ biggest physical risk is a nasty paper cut. It’s abundantly clear that politicians on both sides have cynically facilitated the transfer of the unemployed from dole to disability for their own ends. Those on the right did it to hide the embarrassingly large unemployment figures, while those on the left were more than happy to create a constituency of dependants who will forever vote in their interests to keep the welfare money coming.

Look also at the breakdown of type of disability. The percentage with either back pain or mental illness went from 18% (of a then much smaller number) in 1961 to 53% in 2011. It is no coincidence that vague back pain or depression are the easiest ailments to fake.  So Mary does the rounds between doctors until she finds some doddery old fool who will sign off on her sub-Oscar performance of depression or her pantomime of back pain, and now she is set up for life to doze in front of the TV while the cheques roll in.

Where is the shame?

Since the Lehman’s debacle in 2007 the banking system worldwide has been on life support. True capitalism has two sides, those companies that provide genuine value to their customers should flourish and those that fail to do so should disappear. On this point, Occupy Wall Street are absolutely right, those banks that have singularly failed in their duties should go bankrupt. But no, the zombie banks that deserved to fail because of their mismanagement are kept alive by their bought and paid for politicians at the taxpayer’s expense. This is not the free market, it’s not true capitalism, it’s crony capitalism. We reward incompetence and put the taxpayer in hock to pay for the failures of the politically connected.

Where is the shame?

We are constantly inveigled by the mainstream media and the political class that the answer to all our economic problems is ever increasing amounts of stimulus spending in order to boost the economy. Classic Kenseynism, though we of course failed to build up the necessary reserves during the good times.

But where is the money to come from? We didn’t create a rainy day fund during the boom times. We tried austerity, by reducing government spending, but the push-back from the public sector unions was too strong. We tried raising taxes, but the private sector started squealing and the tax take actually reduced with higher rates as the free economy was squeezed and we found the downslope of the Laffer Curve. We tried going back to the bond market, but they took a jaundiced view of our willingness or ability to ever pay it back, so they balked.

Which left us in limbo and so we took the coward’s way out with Quantitative Easing (QE). Let us be very clear what QE is, it is the Central Banks around the western world creating new money out of thin air and using it to purchase treasury bonds from their own bond markets. The basic economic law of supply and demand means that increased (artificial) demand increases the price of these bonds, which in turn, reduces their interest yield. This has the added benefit for governments that the reduced bond yield (i.e. interest rate), means that they can roll over their expiring bonds at reduced interest rates.

But, you say, surely we can’t keep adding printed money to the system without unleashing hyperinflation? And here we get to the crux of it, no we can’t, the coming hyperinflation will decimate the savings of the prudent, reduce the debt load of the indebted, so those who caused the problem will be, again, bailed out by government action and those who were prudent and had nothing to do with the problem will again be shafted.

Where is the shame?

We have become immune to the shaming language of the statists. Their remedies have failed and failed again.

They’re the ones who should be ashamed.

It’s only fair

office

Next!

Good morning Sir, how can I help?…

Your wages have been halved you say, well let’s take a look at your file. Ahh yes, I see here that the new approved wage rate for your work category has been set at a new level…

Yes, it’s half what it was before…

No, I don’t know how you can feed your family on that amount…

Well you wouldn’t want to go back to the bad old days when footballers (hhhaaaach, spit), sorry, when footballers earned hundreds of times what a nurse earned, now would you? Under the new order, it’s been decided that footballers should earn one hundred pounds a week plus an orange at half time, which is less than what a nurse now earns, which is only fair, no?…

Your wife is a nurse you say, and now she earns one hundred and ten pounds a week…

She gets a free orange every week doesn’t she?…

Well yes, there are two oranges in my lunch box right there, but we government workers do a very important job and it’s only fair that we get extra oran…I mean…recognition…

Yes it is very good work if you can get it…

You want to work here you say? A very good choice Sir. Ahh, well I see here on your file that you were noted as holding um…unorthodox views, so no, you can’t apply for government work.

Next!

No more Crony Capitalism

Crony capitalism

Every western government now owns a plethora of nationalised banks. How hard is it to pick one, make it an ultra-safe National Bank, ban it from being involved in stock market or derivative trading and demand that it maintain a massive capital adequacy ratio. Given its ultra conservative nature, it could offer the safest borrowers the best terms, its depositors the safest haven and offer the most secure, though not the most exciting, returns to shareholders. It would be a boring and stodgy but secure investment opportunity that would be very welcome to investors in the current volatile market. Most banks used to be like this a generation ago.

In the future, any bank that fails can have its serviced loans and any remaining deposits folded into the National Bank, as the FDIC does so efficiently in the U.S. currently. When the crisis is over, slowly divest the government’s shares in the National Bank to the widows and orphans investment market.

Anyone who wants better returns is free to go to the open market to find it, but should expect no government backed bailout. If you want easier credit terms, the market offers plenty of choice, but at significantly higher interest rates to cover the extra risk. If the deposit interest rates on offer are too dull, you’re free to put your money elsewhere on the understanding that you stand to lose every penny if your bank implodes. If the stock price gain and dividend is a big yawn, you’re free to go to the lightly regulated banks, but be fully aware that you could lose it all. Don’t come crying to the taxpayer via the government if it all goes tits up.

If any other bank wants to compete with the national leader and avail of government deposit insurance, and some building societies and credit unions may well do, no problem, so long as they are prepared to submit to the much higher capital ratios and more restrictive rules required for a National Bank. Leave the market open for any banks to do whatever they want, but make sure that its depositors, bondholders, shareholders and counterparties are fully aware that they are on their own if the bank implodes through mismanagement and that none of the losses will be covered by the taxpayer.

Make every single bondholder, depositor and shareholder, read and sign a clear simple one page statement in plain English and large text that they understand this before their money can be accepted.

Let’s have a proper free market and not the crony capitalism we have now. Let investors diversify their investments according to their own risk appetite and not expect some other sucker to come in and bail out their bad decisions. It would be a salutary lesson in hubris and it’s consequences every decade or so.

Let’s finally be rid of the cancer of the too big to fail banks.

Where’s the wealth fund?

KvH

John Maynard Keynes was an English economist and academic who lived from 1883 to 1946. He was hugely influential in the foundation of modern macroeconomics. This is the study of economics on a national and international level, as opposed to microeconomics which is the study of interactions between individuals or companies. His theories have given rise to the ‘Keynesian school’, one of the main schools of economics, though there are other competing ones such as the Chicago school and the Austrian school.

It is important to understand that, despite the fact that economists use highly intricate mathematical models and theories, theirs is not really a mechanistic science in the way that physics or chemistry is. People are not like machines where a given input equates to a predictable output. If there is one thing that we all know is that people are capricious. At times we move like great shoals of fish, seamlessly and in unison, and at other times it’s like trying to herd cats. We are given to extremes of emotion. We sometimes fall into a mania of overconfidence and greed and at other times we are paralyzed by fear and disillusion. Economics is really a social science, in that it describes both the initial actions of human beings and their reactions to economic incentives. At least, it tries to describe it and given the difficulty in doing so, a number of different theories have grown up around the study of these unpredictable creatures.

The Keynesian school is one of these theories. It follows Keynes’ theory of how to best understand it. His principal idea was that aggregate demand should be moderated by government action. Aggregate demand is an economist’s way of describing the economic cycle. When the economy is booming, it has high demand and when it is in recession it has low demand. Keynesian theory says that it’s a duty of government to act as a counter-cyclical agent to the economic cycle, so when the economy is booming, the government should draw down liquidity from the economy, meaning it should spend less than it receives in taxes and put the surplus aside into a rainy day fund. In practical terms this means that it should use the tax surplus to pay down national debt and once a reasonably small debt is left to facilitate the national pension fund market, say 20% of GDP, it should begin to create a sovereign wealth fund to put aside the surplus to invest abroad. At the same time, this drawing down of liquidity should moderate the boom.

The economic cycle will of course inevitably turn to recession. Then the government can make use of the surpluses it put aside during the good times. It can now draw down the money it had previously saved in order to stimulate the economy during the bad times. Given that the debt to GDP is at an ultralow level, there is plenty of room to maneuver, by raising debt, if required. It can now use this cash to, for instance, support the construction industry through a program of investment in infrastructure. It can build roads, bridges, hospitals and schools which provide direct and immediate employment to an under-utilized construction sector, while at the same time producing assets that have a positive value to the nation. This also has the positive effect of injecting much needed liquidity into the economy.

The problem is that the economy tends to run on a six to ten year cycle, but politics runs on a four or five year cycle. They are misaligned. A politician’s principle incentive is to get re-elected. So if during his tenure, the economy is booming, he damages his chances of re-election by ignoring calls to use the current surplus to spend on new social programs and new entitlements. It is very difficult politically to ignore calls for more spending on this or that new initiative while the national coffers are overflowing. ”It’s only fair”, his constituency and his opponent in the next election will say. A brave and principled politician would explain that the surplus needs to be set aside for the inevitable future downturn and should not be frittered away.

When was the last time you encountered a brave and principled politician?

So we now find ourselves where we are. No politician dared to put money aside during the good times because he was constantly watching his back, watching for his re-election chances. And thus no surplus was created. So now we hear the current crop of politicians saying, “Well, Keynes said we should be stimulating the economy during the downturn”.

True, but where’s the money you should have put aside in the good times to pay for this?

Keynesian economics is a two way proposition. You only have the right to call for deficit spending in the bad times if you had the balls to resist the call to overspend during the good times.

Wheres the wealth fund you should have created?

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Update: Click on the image above to view a cool video on the difference between the Keynsian School and the Austrian School of economics.

Pick your poison

PYP

When you put yourself into the position that many of the western central banks have done with massive unsustainable national debt near, at, or well past 100% debt to GDP, you leave yourself vulnerable to any shocks that come along. And believe me, there are many shocks in the pipeline.

The main problem here is that central banks throughout the western world are dependent on private capital, via the bond market, to make up the difference between tax receipts and day to day spending. They have all been doing this for decades, so the annual deficit has each year added to the national debt which has grown relentlessly. This is why the debt levels are so high. The patience of the bond market has been sorely tested and will soon reach a breaking point. When this breaking point arrives, few will be prepared to buy any more treasury bonds and their prices will plummet. The interest rate, its corollary, will soar. The central banks will then find themselves in a bind.

There are three, and only three, ways out of this bind.

1/ An individual, who finds himself in debt, can do the responsible thing which is, try to reduce his spending, raise his earnings and accept the fact that he will have to grind through this for many years in order to repay his freely accepted debts. On a national level this means raising taxes, reducing entitlement spending and biting the bullet, accepting that things will be tight for years until the debt is down to a manageable level. All the while begging the forebearance of your creditors to allow you the few years breathing room needed to bring tax receipts and spending in line. This is the path that Ireland has chosen. The absence of demonstrations or riots in the streets of Dublin shows that the Irish people have accepted this grim burden.

2/ Another individual may say “There is no way I can pay this, I’m filing for bankruptcy”. On a national level this means defaulting on the debt, saying to your bond holders that they have to accept pennies on the dollar, or nothing at all. Take it or leave it. Along with shafting their bond holders, they are now in a position that they can no longer go to the bond market in order to finance their deficit (the difference between what the government spends each year and what it receives in tax revenues) which means they have to suddenly bring their spending and tax revenues in line so that they do not need to go to the bond market to make up the difference. This means that tax rates soar, entitlement spending plummets and no national consensus is there to accept this new reality. Hence, riots on the streets and stories of extreme hardship abound. This is what Greece has done.

3/ The final option is monetisation. This option is not available to individuals, only to sovereign governments with control of their own currency, so not Ireland or Greece, being tied to the Euro as they are. Monetisation is basically printing as much money as the government needs and ignoring the need to get spending in line with tax receipts. This is the most dangerous choice as it inevitably leads to hyperinflation as the market is swamped with currency with no actual value to back it up. I’m looking at you America.

So there are the three choices, pay the debt, repudiate the debt or inflate the debt away. There are no good choices, only varying degrees of bad.

Pick your poison.



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