The Origin of Money

Markets are true democracies. The allocation of resources, capital and labour is achieved through the mechanism of spending, and so based on spending preferences. As money flows through the economy the popular grows and the unpopular shrinks.  Producers receive a signal to produce more or less based on spending preferences. Markets distribute power according to demand and productivity; the more you earn, the more power you accumulate to allocate resources, capital and labour. As the power to allocate resources (i.e. money) is widely desired, markets encourage the development of skills, talents and ideas.

Planned economies have a track record of failure, in my view because they do not have this democratic dimension. The state may claim to be “scientific”, but as Hayek conclusively illustrated, the lack of any real feedback mechanism has always led planned economies into hideous misallocations of resources, the most egregious example being the collectivisation of agriculture in both Maoist China and Soviet Russia that led to mass starvation and millions of deaths. The market’s resource allocation system is a complex, multi-dimensional process that blends together the skills, knowledge, and ideas of society, and for which there is no substitute. Socialism might claim to represent the wider interests of society, but in adopting a system based on economic planning, the wider interests and desires of society and the democratic market process are ignored.

This complex process begins with the designation of money, which is why the choice of the monetary medium is critical.

Like all democracies, markets can be corrupted.

Whoever creates the money holds a position of great power — the choice of how to allocate resources is in their hands. They choose who gets the money, and for what, and when. And they do this again and again and again.

Who should create the monetary medium? Today, money is designated by a central bank and allocated through the financial system via credit creation. Historically, in the days of commodity-money, money was initially allocated by digging it up out of the ground. Anyone with a shovel or a gold pan could create money. In the days of barter, a monetary medium was created even more simply, through producing things others were happy to swap or credit.

While central banks might claim that they have the nation’s best democratic interests at heart, evidence shows that since the world exited the gold exchange standard in 1971 (thus giving banks a monopoly over the allocation of money and credit), bank assets as a percentage of GDP have exploded (this data is from the United Kingdom, but there is a similar pattern around the world).

Clearly, some pigs are more equal than others:

Giving banks a monopoly over the allocation of capital has dramatically enriched banking interests. It is also correlated with a dramatic fall in total factor productivity, and a dramatic increase in income inequality.

Very simply, I believe that the present system is inherently undemocratic. Giving banks a monopoly over the initial allocation of credit and money enriches the banks at the expense of society. Banks and bankers — who produce nothing — allocate resources to their interests. The rest of society — including all the productive sectors — get crumbs from the table. The market mechanism is perverted, and bent in favour of the financial system. The financial system can subsidise incompetence and ineptitude through bailouts and helicopter drops.

Such a system is unsustainable. The subsidisation of incompetence breeds more incompetence, and weakens the system, whether it is government handing off corporate welfare to inept corporations, or whether it is the central bank bailing out inept financial institutions. The financial system never learned the lessons of 2008; MF Global and the London Whale illustrate that. Printing money to save broken systems just makes these systems more fragile and prone to collapse. Ignoring the market mechanism, and the interests of the wider society to subsidise the financial sector and well-connected corporations just makes society angry and disaffected.

Our monopoly will eventually discredit itself through the subsidisation of graft and incompetence. It is just a matter of time.

We’re All Nixonians Now

People have got to know whether their President is a crook

Richard M. Nixon

I often wonder who is worse: George W. Bush — the man who turned a projected trillion dollar surplus into the greatest deficits in world history, who bailed out the profligate Wall Street algos and arbitrageurs, who proceeded with two needless, pointless and absurdly costly military occupations (even though he had initially campaigned on the promise of a humble foreign policy), who ignored Michael Scheuer’s warnings about al-Qaeda previous to 9/11, who signed the Constitution-trashing PATRIOT Act  (etc etc ad infinitum) or his successor Barack Obama, the man who retained and expanded the PATRIOT Act powers under the NDAA (2011), who claimed the right to extrajudicially kill American citizens using predator drones, who expanded Bush’s expensive and pointless occupations (all the while having run on a promise to close the Guantanamo Bay detention centre and reverse Bush’s civil liberties incursions), who proceeded with Paulson’s Wall Street bailouts, authorised the NSA to record all phone calls and internet activity, and continued the destructive War on Drugs (even though he had in the past been a drug user).

The answer, by the way, is Richard Nixon. For almost forty years after that man’s resignation, it is arguable that almost every single administration (with the possible exception of  Carter as well as Reagan’s first year in office) — but especially that of Bush and Obama — has been cut from his cloth. It was Richard Nixon who inaugurated the War on Drugs — that despicable policy that has empowered the drug gangs and obliterated much of Latin America. It was Richard Nixon who so brazenly corrupted the White House and tarnished the office of the Presidency through the Watergate wiretapping scandal.  It was Nixon’s administration that created the culture of government surveillance that led directly to the PATRIOT Act. It was Nixon who internationalised the fiat dollar, so trampling George Washington’s warnings about not entangling alliances, and of course setting the stage for the gradual destruction of American industry that continued apace under NAFTA and into the present day, where America runs the greatest trade deficits in human history. It was Richard Nixon who set the precedent of pointless, stupid, blowback-inducing militarism, by continuing and expanding the Vietnam war. It was Richard Nixon whose administration authorised the use of chemical weapons (or as George W. Bush might have put it, “weapons of mass destruction”) against the Vietcong.

Presidents since have followed — to a greater or lesser extent — in his mould. This is particularly acute this election cycle; you vote for Obama and you get Richard Nixon, or you vote for Romney and you get Richard Nixon. Nixon’s words: “we’re all Keynesians now” have a powerful resonance; not only has every administration since Nixon retained the petrodollar standard and spent like a drunken sailor in pursuit of Keynesian multipliers, but every President since has followed in the Nixonian tradition on civil liberties, on trade, on foreign policy. Henry Kissinger — the true architect of many Nixonian policies, and Obama’s only real competition for most bizarre Nobel Peace Prize recipient — has to some degree counselled each and every President since.

It is hard to overstate the magnitude of Nixon’s actions. The demonetisation of  gold ended a 5,000 year long tradition. It was a moment of conjuring, a moment of trickery; that instead of producing the goods, and giving up her gold hoard to pay for her consumption habits (specifically, her consumption of foreign energy), America would give the finger to the world, and print money to pay her debts, while retaining her (substantial) gold hoard. The obvious result of this policy has been that America now prints more and more money, and produces less and less of her consumption. She has printed so much that $5 trillion floats around Asia, while the American industrial belt rusts. Industrial production in America is where it was ten years ago, yet America’s debt exposure has ballooned.

America has had not one but two Vietnams in the past ten years.

First, Afghanistan, in the pursuit of the elusive Osama bin Laden (or, “in the name of liberating women”, presumably via blowing their legs off in drone strikes), where young Western soldiers continue to die (for what?), even after bin Laden’s supposed death in a Pakistani compound last year.

Then, Iraq, presumably in the interests of preventing Saddam Hussein from using non-existent Weapons of Mass Destruction, or liberating more women by blowing their legs off (or as Tom Friedman  put it: “SUCK! ON! THIS!”).

Like Nixon’s Presidency, the Nixonian political system is highly fragile. Debt is fragility, because it enforces the inflexibility of repayment, and the Nixonian political system has created staggering debt, much of it now offshore. The Nixonian economic policy has gutted American industry, leaving America uncompetitive and dependent on foreign productivity and resources. The Nixonian foreign policy has created a world that is deeply antipathetic to America and American interests, which has meant that America has become less and less capable of achieving imperatives via diplomacy.

Future historians may finger George W. Bush as the worst President in history, and the one who broke the American empire. But smarter scholars will pinpoint Nixon. True, the seeds of destruction were sown much earlier with the institution of permanent limited liability corporations. This allowed for the evolution of a permanent corporate aristocracy which eventually bought out the political echelon, and turned the Federal government into an instrument of crony capitalism, military Keynesianism and corporate welfare. Nixonianism has been the corporate aristocracy’s crowning achievement. And to some extent, this period of free lunch economics was a banquet, even for middle class Americans. The masses were kept fat and happy. But now the game is up — like Nixon’s Presidency — its days are numbered.

Price Stability?

Yeah.

Breaking the Banks

Simon Johnson at the New York Times takes Ron Paul seriously:

Mr. Paul  has a clearly articulated view on the American banking system, laid out forcefully in his 2009 book, “End the Fed.” This book and its bottom-line recommendation that the United States should return to the gold standard – and abolish the Federal Reserve System – tend to be dismissed out of hand by many. That’s a mistake, because Mr. Paul makes many sensible and well-informed points.

But there is a curious disconnect between his diagnosis and his proposed cure, and this disconnect tells us a great deal about why this version of populism from the right is unlikely to make much progress in its current form.

There is much that is thoughtful in Mr. Paul’s book, including statements like this (on Page 18):

“Just so that we are clear: the modern system of money and banking is not a free-market system. It is a system that is half socialized – propped up by the government – and one that could never be sustained as it is in a clean market environment.”

Mr. Paul is also broadly correct that the Federal Reserve has become, in part, a key mechanism through which large banks are rescued from their own folly, so that their management gets the upside when things go well and the realization of any downside risks is shoved onto other people.

But Mr. Paul’s book also acknowledges the imbalance of power within the financial system that prevailed at the end of the 19th century. Wall Street financiers, like J.P. Morgan, were among the most powerful Americans of their day. In the crisis of 1907, it was Morgan who essentially decided which financial institutions would be saved and who must go to the wolves.

Would abolishing the Fed really create a paradise for entrepreneurial banking start-ups, enabling them to challenge and overthrow the megabanks?

Or would it just concentrate even more power in the hands of the largest financial players?

Important questions, no doubt — but also something of a contradiction.

Absolute power — who gets bailed out, who gets access to a lender of last resort, who gets access to money at next-to-zero rates, who gets stimulus funds — is today concentrated in the hands of the largest financial players— the US government, and the Federal Reserve system.

And the US government is susceptible (understatement is an art!) to the activities of lobbyists.

Here’s the NYT on that issue:

The financial industry has spent more than $100 million so far this year [2011] to court regulators and lawmakers, who are finalizing new regulations for lending, trading and debit card fees. During the second quarter, Wall Street spent $50.3 million on lobbying, a small dip from the prior period, according to an analysis by the Center for Responsive Politics.

 Big banks are among the most prolific spenders. JPMorgan Chase‘s team of in-house lobbyists spent $3.3 million, a slight uptick over last year. The biggest war chest among organizations focused primarily on Dodd-Frank belongs to the American Bankers Association, which so far spent $4.6 million on lobbying. The organization wrestled the top spending spot from the Financial Services Roundtable, a fellow trade group that represents 100 of the nation’s largest financial firms.

And the Federal Reserve itself is much worse still. Its stock is owned by private banking interests:

The 12 regional Federal Reserve Banks  issue shares of stock to member banks. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.

The banking industry effectively writes much of its own regulation, because it is enmeshed into the governmental-bureaucratic superstructure:

Frankly, I don’t think that power could get any more concentrated.

So surely only the naive would be surprised that the banking industry — through their benefactors at the Fed — bailed themselves out of the last crisis to the tune of $29 trillion.

And that is not just unfair; it’s unhealthy.

As I wrote in November:

Bailing out failed and failing financial institutions creates a zombie economy. Why?

In nature, ideas and schemes that work are rewarded — and ideas and schemes that don’t work are punished. Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish.

These bailouts have tried to turn nature on its head — bailed out bankers have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure.

So it should be no surprise that financial institutions have continued making exactly the same mistakes that created the crisis in 2008.

So while it is all very well debate the various schemes to end the problem of too-big-to-fail, it is important to remember that the problem will ultimately solve itself — a system that rewards failures and creates zombies is fundamentally unsustainable.

Ron Paul does not need to end the Fed. By bailing out a system shot with fragility, leverage junkies and counter-party risk — by attempting to sustain a system that is fundamentally unsustainable — the Fed is quietly abolishing itself, or at very least strongly endangering the status quo.

Income Inequality, Aggregate Demand & the Gold Standard

Paul Krugman presents a graph that I think is pretty relevant to the state of America:

During 1947-73 (for all but two of those years America had a gold standard where the unit of exchange was tied to gold at a fixed rate) average family income increased at a greater rate than that of the top 1%. From 1979-2007 (years without a gold standard) the top 1% did much, much better than the average family.

As we have seen with the quantitative easing program, the newly-printed money is directed to the rich. The Keynesian response to that might be that income growth inequality can be solved (or at least remedied) by making sure that helicopter drops of new money are done over the entire economy rather than directed solely to Wall Street megabanks.

But I think there is a deeper problem here. My hypothesis is that leaving the gold standard was a free lunch: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by pumping money into the system and assuming that this would have a positive effect on the economy as a whole. After all — say the Keynesians — “aggregate demand” (i.e. money circulation) “is the state of the economy”.

But in reality “higher GDP” and “higher aggregate demand” just mean more money circulating. It’s perfectly possible for more money to circulate while the real economy (productivity, labour, technology, infrastructure, etc) deteriorates. In fact, in many respects this is exactly what happened during the Bush administration, where trillions of dollars of productive capital was burnt up on military adventurism.

So — in effect — I hypothesise that fixed money acted as a check on irrational exuberance. GDP growth could not be conjured up via money printing (and resulting credit expansion) but instead had to be earned slowly and laboriously through real development. It also made investors and financial institutions significantly more cautious — they could not lose it all playing at the derivatives casino, and then enjoy a recapitalisation from newly printed money.

Most importantly, governments could not run up and monetise absurd deficits on spending in the name of military adventurism and maintaining the petrodollar standard. Government spending had to be of real, palpable benefit to the nation — infrastructure, medicine, education, technology, defence (clue for George W. Bush & Barack Obama: “defence” does not mean “attack”) etc. The bare necessities.

The trick here is that the only difference between gold and paper is that gold is naturally limited, and governments can’t just conjure large quantities of it out of thin air at will in the name of largesse, or saving the world from non-existent weapons of mass destruction, or whatever takes the central planners’ fancy.

In theory a fiat system could work so long as in the long run (when we are all dead) governments are willing to practise the discipline to save in the fat years, and spend in the lean ones.

The problem is that such self-discipline has never been maintained in the long run. In fact, governments (in Britain, the Eurozone, and America) seem to misunderstand that concept altogether, running huge deficits in the fat years, and then trying to undertake austerity programs in the lean years — exactly the opposite of what Keynes intended.

Which suggests to me that as a society we are not yet mature enough to leave the haven of fixed money, for when we do, we wreck everything.

A Keynesian or Krugmanite perspective would be welcome, of course.

Obama: Class Warfare Against the Poor

Obama claims that his administration and his tax policy is not class warfare against the rich.

From CBS:

Taking a defiant tone against Republicans unwilling to raise taxes in order to close the deficit, President Obama today unveiled a $3 trillion long-term deficit reduction plan that relies heavily on raising taxes on the wealthiest Americans.

“This is not class warfare — it’s math,” Mr. Obama said from the White House Rose Garden, addressing GOP critiques of his plan head on.

“The money has to come from some place,” he continued. “If we’re not willing to ask those who’ve done extraordinarily well to help America close the deficit… the math says everybody else has to do a whole lot more, we’ve got to put the entire burden on the middle class and the poor.”

The policies of his administration are not class warfare against the rich. They’re class warfare by the Obama administration, the establishment, and the military-industrial complex against everyone else.

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America Priced in Gold

Let’s imagine that the gold standard was not abolished in 1971, and was instead maintained — or, alternatively, assume that only gold is money and that other things are merely paper intermediaries. What would be the shape of economic data under that paradigm? Here’s retail gasoline:

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