Considering Investment Advice Today

Someone who I have gotten to know and respect on-line recently recommended a book of investment advice. Certainly, there are people who understand investments better than others and can clearly explain that understanding. I have no reason to doubt the usefulness of the book if my friend thought it was good.

I did have a problem, however. The advise offered in the book came from decades ago. What about today? Certainly the principles of economics haven’t changed, ever. But the economic and legal context for investment could have.

What isn’t in these books, not the one suggested by my friend (which I haven’t read but he did not mention the subject) nor any of the others I have looked at, is a discussion of their assumptions. I am not referring to their metaphysics or epistemology. I am assuming a basic I mode for these people, otherwise there would be no hope that the investment advise would or could work. Further, I am not referring to the economics fundamentals of how markets work or the ethics of investment. No, I am referring to what you might call the range of decision making within the economy.

One way to open up what I am trying to consider is to ask these questions: Where would the advise in the book work? We know it wouldn’t work in Cuba. How about Venazula? Egypt? Mexico? Sudan? Turkey? Saudi Arabia? Obama America?

I am not just looking at the legal system in these examples, or even the safety of the investment (against nationalization or another kind of thief). I am wondering about the legal ability of the business manager, the people who will ultimately determine if a business succeeds or fails, to understand the conditions and make the decisions and execute those decisions.

For example, in Europe and the U.S., there has been a drive since the last financial crisis to add additional layers of regulation and regulators to the financial services industry. Many of the areas that major banks were relying upon for profits and growth are being eliminated or curtailed. This process is ongoing. The major law expanding banking regulation in the U.S., Dodds-Frank, has something over 350 new areas of regulation. As of last week according to a recent news article, the government and the various agencies have missed 63% of the deadlines stipulated in the act. Many of those new regulations have yet to be finalized. Further, there are another 36% of the act which the government has yet to address. Five years after the crisis and three after the passage of Dodds-Frank, the industry is still uncertain as to what is going to happen. Whatever the results, the banks are all going to have to function in the same, regulatory approved method, about which no one has any real world experience. Expect stuff to go wrong in many different ways. Expect the banking system to function less efficiently, and investment decisions to be less reliable.

Then there is the larger size of the Federal Government in the economy. Its annual deficit and demand for funds has been soaking up the capital of the country. This astonishing level of spending is expected to continue, regardless of the activity or lack there of in the real economy.

There is the continuous effort by the Federal Reserve Board to manipulate the economy into growth by completely destroying any meaning to the pricing of capital. Interest rates mean almost nothing now for the business decision maker. He has no tool to determine if his capital project is going to be profitable or if the capital he needs is actually there.

A business decision maker might also be concerned with the changes in the level of new money being introduced into the market. He might be concerned about the lack of stability in what the Fed and the rest of the government is doing or can be expected to do. He has no idea or source to understand what is going to happen. But to him, the difference between 2.5% and 3% interest on loans is not as significant. You can readily see that since 2009, there has been no rush to borrow and invest as interest rates were lowered and have remained at historic lows.

I have seen commentators and business people point out that current profits are from cost cutting, not from new investments coming on line. They point out that there is only a limited amount of costs that can be cut and that point is being reached. There is a certain amount of growth through merger and acquisition, which isn’t economic growth, but still cost cutting. There may be some investment due to the need to replace plant and equipment. But there is little growth.

None of this is similar to the economic context in the U.S. since the end of WWII. Except for the inflation years ending in 1982, business has had sufficient confidence in the future to invest and grow. That isn’t the case today or for the last five years.

Could confidence return and get us going again? I don’t think we can know until the situation calms down and the government stops tinkering. It is possible that the government won’t stop. It is possible that the restrictions on action will overcome the American businessman. That will happen at some point. We just don’t know.

But we do know that the situation is sufficiently different today so as to make application of successful personal investment policies from the 80s and 90s uncertain. The context has changed. That is a major deal. If you are serious about your investments, you have to recognize the underlying premises about how the economy functions.

When I read some of the economic analysis offered by people with mainstream approaches, I see that they treat all non-communist economies the same, regardless of the level of government intrusion. In their mind an economy will continue going along somehow. They believe that the government’s impact is necessarily either minor or for the good of the economy. That is the same attitude of the standard works on investment: the economy is not going to change significantly when the government acts. But that is not true. You need to recognize that there is a point in which the government’s actions are making normal economic activity too difficult. That has been happening now. It might be temporary, I am not going to rationalistically say that we have reached the point of no return. Nor am I going to say that the current situation may calm down and people can work within the levels of controls we will have. But, it will happen. Don’t ignore it.

From Bernanke's Lips

While I do have one bone to pick with John Allison, I have found his book, The Financial Crisis and the Free Market Cure, to be a source for many insights into our economy and how it works. One point he made just popped into my head as I was reading another silly article.

The article, “Loose Lips Sink Euro Bond Markets in Crisis: Cutting Research,” cites “research” about the effect of 25,000 news releases by eruo-zone governments on the sovereign bond markets. They did a statistical analysis on the words and content of all of those news releases. Real science, right? They found that positive announcements tended to have a positive affect and that negative, confusing, or conflicting announcements tended to have adverse affects on the market, i.e., interest rates went higher. Like I said, real science! There was no indication in the news article if the study considered the effect of lies or self-serving political announcements.

Mr. Allison’s point was that every time the Federal Reserve Board made an economic prediction, it was wrong, significantly wrong. That’s right, Mr. Allison points our that the Fed has a perfect record of understanding what was going to happen. Always, 100% wrong. They have no idea what is going to be the results of their policies.

Think of Bernanke’s pronouncements from 2005 to 2008. He was asked how things were. He said, “Fine.” When housing prices skyrocketed, Bernanke said everything was “Fine.” When it was noticed that subprime mortgages began to fail, he said that the economy was “Fine.” When Lehman Brothers failed, Bernanke said that everything was “Fine.” When the economy went into crisis, businesses failed, people lost their incomes, and asset values collapsed, Bernanke claimed that he saved the world.

So today, everyone is hanging on every word that Bernanke says and the market is going up and down like a yo-yo. People are ignoring that there is little to zero investment occurring that would expand production, that there is little growth in employment (of any kind, let alone highly productive ones) to put the millions who lost their jobs back to work, that government debt is swamping our ability to cover current expenses, or that expanded regulation is close to choking our economy.

Why are people paying so much attention to Bernanke? Well, he does have a lot of power. Speaks well of us U.S. voters, doesn’t it. It is also true that today the government, including the Fed, is a major force, if not the major force, in the economy. That’s not good either.

What are we going to do to change it?

But, also important to anyone living in the U.S. or in some way dependent upon the condition of the U.S. economy (nearly everyone alive, right?): you best remember Bernanke’s track record. If he says that were heading into a drought, you better be ready for a flood and our ships won’t float either

Inflation Update: First Quarter, 2012

I have been writing this since the turn of the year. It has been subdivided already several times. A couple parts have appeared as other posts and several pages are just sitting around in this file, orphaned! I have again divided it so that I can get something out and the length will not evoke cursing. This section is my inflation update. Maybe some of the rest will appear in the future.

I realized recently that my most “favorite” group that constantly announced the coming of hyperinflation has only made one such announcement in the last several months, and that one was somewhat less frantic than normal. (Recently, they have been touting stocks.) In their last prophascy of doom, they did touch on issues that are important, but since they have only one economic note, hyperinflation, they don’t consider other, equally nasty, potentials, of which there are several. But apparently, hyperinflation is not the immediate threat they have often claimed. They haven’t said why they have changed their tune.

Yet, there is plenty of good reasons to be concerned about inflation in the next few years. For the fun of it, let’s divide up the issue into two separate (but certainly related) questions:

If by inflation you are asking about the money supply and its impact on asset prices and the economy: just look at the stock market! There is plenty of made up money sitting around that comes out and bids up assets when given even a glimmer of hope. True, company profits are healthy. My question is about the source of those profits. Is it just savings from leaner operations, or is it return on growing business. I fear that it is the former, which means little for future economic improvement. What reasons do we have to suggest that businesses are investing in the anticipation of growth?

There is new, made-up money floating around, for example, our balance of payments for last year was again a large deficit, perhaps smaller that in 2007, but still large. That means that a lot of electronic dollars left the country, billions of them ($110B in the third quarter, 2011; $124.7B in the second quarter, 2011), and didn’t return, won’t return (for those dollars to come back other currencies would have to be better than the dollar, and that isn’t happening). At the same time, notice that our money supply did not shrink by hundreds of billions. Think about this. We sent over $400B dollars out of the country last year, and didn’t notice it. Where did it come from? (Hint: International trade is done entirely on credit!)

The money supply within the country, in the broad measure that I use, MZM, shows the resumption in the upward trend continuing. The graph available, and widely used, is hard to read and the current trend is still only a few of months old. So what it means is unclear. What appears to be the situation at this point is that the increase is on the same growth line as before the meltdown. But since the base is larger, the growth will have less impact. Think of the difference it means to you to have a $10,000 raise when your income was $30,000 vs. $200,000. So, an additional $100B means more when the money supply was $1T in the 80s vs. today’s nearly $11T. The rate of growth in the money supply would need to be a lot steeper to be really important. The growth we see isn’t good, mind you, just not frightening.

Another important measure of the money supply is new loans made by banks. This is the method by which the Fed puts money into the economy. The Fed has been trying to push new made-up money into the economy since 2007 with little success. Recently, however, loans are beginning to increase again. Just new loans would not be an issue. After all, business needs credit, and amount would fluctuate over time. Further, with the deep recession, the amount of loans would have declined. A healthy economy would need credit to grow. If that new credit reflected new savings we would be seeing real growth soon. Of course, it doesn’t. Savings is being sucked into the Federal deficit. So, the growth of bank loans tends to indicate new made-up money being pumped into the economy, which could lead to another round of asset price inflation. The recent upward trend of new bank loans is worrisome, and needs to be watched. Again, the graph is too small to give good detail, but the slant of the upward movement isn’t too steep.

We are still sitting on a time bomb. If you look at the reserves (deposits) of banks who are members of the Federal Reserve (nearly all banks), you see that the amount of reserves they have is amazingly high. This is the Bernanke plan. Notice the last big jump to about $1.8T. That was QE2. That is to say that much of the massive amounts of money that Bernanke and his gang pushed into the economy is actually just still sitting at the Fed. It really didn’t do much except keep interest rates at stupidly low levels. It did help push commodity prices up, which is another type of asset boom. Does anyone believe that the interest rates actually reflect any element of the real economy? Low interest rates have not sparked new investment. They have merely given an unearned bonus to holders of federal debt and kept BO thinking that his deficits don’t really cost anything.

The time bomb will be the consequence when banks begin to think that they should move those reserves to their banks and expand their loan portfolios. Then we have a real inflation as the money supply explodes (once put into the economy, under current rules, each dollar moved from the reserve could become ten, or the $1.8T of excess reserves could become an additional $18T (our current money supply using MZM is almost $11T). The Fed actually knows that is a bad thing. When they first expanded the reserves with QE1 in 2008, there was a lot of talk about what they would do to sop up the excess reserves, which were then about $1T. That talk has completely disappeared as the economy failed to improve. But the problem remains and has gotten bigger. If the economy begins to grow the Fed will have to do something. Any action the Fed takes to sop up that money will raise interest rates, perhaps dramatically, and that would put a lid on the economy. That would also send interest rates up around the world and make things in Europe much worse. So ignored everywhere right now is this time bomb that will go off if the economy does begin to grow.

If you are thinking of prices as an indication of your cost of living (quality of products is often forgotten), the news is mixed. For example, the costs of health care and health care insurance is going to continue to skyrocket, especially if the quality of care is considered. (This increase in cost is only partly due to ObamaCare. Wait until that really begins to kick in!) Government interference in healthcare has never lowered cost or improved care. It has only made people feel like they were getting something for nothing.

Gas prices have risen, and will remain at higher levels until various international issues have been resolved. The last few years the pressure on prices has been due to new demand from countries that actually were developing. The current problem is due to the threatened supply because of Iran’s level of irrationality, Iran being a major oil producer. Again, the West’s willingness to allow its technology and industriousness to be hijacked by local warlords and savages becomes the source of economic shocks.

(The problems with higher food commodity prices that we had a while ago have abated, mostly due to higher crop results, e.g., the end of the draught in Russia. There are countries that are still seeing lower supply and thus more expensive food supplies. Most of these countries have governments who are controlling the markets. I can’t help but wonder if their problems are due to their governments inability to continue to subsidize food distribution.)

Reports from some U.S. food processors report that they have had to raise their prices from between 5% and 7% in the last year. No doubt we will see some upward movement in prices and no upward movement is good. Even price inflation rates of 2% are damaging. But there is no indication on the horizon that we are moving toward hyperinflation.

I just read another of Peter Schiff’s monologues. Among other things, he claims that price inflation is running at 10% (He just said inflation, but I assume he meant prices, in his writing he often switches back and forth.). He and others have constantly asserted that the CPI has been politically corrupted and that actual prices increases have run much higher. I do think that the CPI has been manipulated in many ways, and a lot of it was politically motivated, at least implicitly. But I have a problem with rates of price increases much higher than a few percent. Why? Let’s say that prices were going up at the rate of 7% a year, which is in the ballpark of many such claims. That would mean that prices today would be double what they were ten years ago (rule of 72, see below). Is that your experience? It isn’t mine. Some have argued with some justification that the quality level in many products has improved at the same or nearly the same price and that lots of technology prices have dropped. As I suggest in my review and comments of his books, I think Schiff often shoots from the hip, which I don’t find admirable. He has been right on some important things, but I’m not sure that it was because of good insight or just accident.

I did say that the situation is mixed, didn’t I. What I meant is that the news is that mixed in with the reports that prices are generally drifting upward are some reports of some really bad spots. In December, I would have said that foodstuff commodities prices had dropped, but the thinking that loosening of credit in China and Europe was going to stimulate demand has run them back up a little.

As I see it, the problem that could most affect us immediately is a financial crisis brought about by the European governments. The finance ministers in Europe are saying that they aren’t sure that this bailout will succeed. The Greeks have shown that they fail to live up to their promises, and curse others when that is pointed out. The other tottering European economies are very dependent upon low interest rates and the availability of massive amounts of made-up money. Remember, the euro zone’s long-term plan is a “fire wall” of several hundred billion euros. Where is that money going to come from?

So, my expectations for the next year or so is that our economy will continue to totter along. If unemployment moves up, or people become to understand the figures that are before them, we could see a big pull back in equities and consumption slow. That would lead to QE3 and more of a mess.

Prices will continue to inch up. Commodities will continue to have upward pressure. Basically, we will have more of the same.

There are two other considerations to watch for: The implimentation of the new rules for banks and derivatives and the actions that BO might take in anticipation of the election latter this year. Neither of these will be good for us and will be inflationary.

Having said that I should also say how reliable I regard my expectations. (Do you notice that nearly all of today’s prognosticators never look at how they did in the past?) Reliability of economic predictions is dependent upon two separate issues: One – how reality oriented is the analysis; Two – lack of omniscience. There is also one other point to keep in mind, good economic events require rationality, at least to some extent, and productivity. As good economic events are in short supply, for obvious reasons, the question is then how far off on the down side are my comments. I noted the areas that I thought that we could have major problems. There could be problems coming that I, or anyone, has not noticed. The most recent example, aside from people missing what is under their noses (the residential real mortgage meltdown), is 9/11. Another major terrorist strike could upset everything, and we would have a hard time recovering, too. So, I have tried to cover the economic bases that I can spot. But there could be others. Just keep on your toes.



P.S. I just read an article about investments in Turkish companies by venture capitalists, Now I don’t know how true the article was, although it did make Turkey sound like a much better place than I would have imagined. What I thought was so amazing about the article was that it didn’t mention the Turkish government or nationalized companies once! (Except to imply that the government wasn’t an issue!)

A Real Warning

Many people have been saying that the U.S. government debt level is too high. Even people that the government sometimes listens to, such as Helicopter Ben (Bernanke), although he doesn’t really make a good case and is a horrible example. But they have been ignored. Certainly, policy makers and legislators have ignored anyone who starts off with an appeal to reality. The only real voice that the government types will listen to are those who can sway the voters. That is the politician’s only “reality”, the voters, i.e., those people who keep the politician in office, in power. If the voter can remain blind to the real situation, today’s politician doesn’t care.

Or at least that was what many of us were thinking. But we forgot some actors on the national scene who can upset the politician’s applecart. There are people connected with the bond markets who can shake up things in Washington, by shaking up their spending source. One of the underlying premises of the “plans” being proposed by both the Dems and the Repubs is that interest rates stay low. It has been so long since the interest rate on government debt was above 5% that I am sure that most of those people have forgotten that rates can actually rise that high. But they can, and dimly, the politicians remember that somehow it isn’t good for them if interest rates do rise.

One set of actors with a voice that can influence markets are the companies that evaluate the credit worthiness of debt. Events in the last few years have led some to regard the credit evaluators as less than useful. Standard & Poor (S&P) and the others did a very poor job, almost to the point of committing fraud, in evaluating the mortgage-backed securities. They tended to let their cozy connections with the government and outfits like Fanny Mae cloud their professional judgment. As with the bankers, I am sure that there were significant elements in the management of those businesses who were appalled at what their company had done. I suspect, as with the bankers, that they are attempting to regain their self-regard as professionals. Today, when they see a spade they intent to call it a spade, errr, bad debt is bad debt, even when the debt is that of the U.S. government.

So, S&P says that they have judged that the credit worthiness of U.S. government debt is deteriorating (surprise) and the people in charge (and the opposition Republicans) aren’t going to do anything about it. So they, S&P, spoke up. Washington, on the other hand, firmly believes both that the real world does not pertain to their activities, so they are merrily playing S&P’s announcement to suit their own political agendas, and that no good deed goes unpunished. I’m sure that the Dems are plotting revenge on S&P. The only people who really paid any attention (as far as we can see at this point) were those who already thought that things were out of control. The Dow lost some ground for a day, but has since hit new highs in the current market. It will be interesting to see if S&P sticks to their guns and lowers the rating for U.S. government debt in the future.

Then, a day or two later, the IMF (International Monetary Fund), of all people, popped up and declared that Washington has no credible plan to return to fiscal rationality (my paraphrase). (Note that the IMF would be happy if the debt was just not increasing so fast. Its standards for “rationality” are somewhat low.) I’m not sure if the IMF is talking from a principled conclusion or just using the opportunity to take a potshot at Washington. Either way, their observation happens to be true. Neither the Dems nor the Repubs have any clue how to deal with the situation. It should not be a surprise that they have no creditable plan. It is a surprise that someone mentioned it out loud.

Then there is the poll released this week that shows the American public doesn’t want to give up their entitlements. Whatever solution there might be to the debt, the American public is apparently saying, they don’t want to give up what is causing the problem. And here we have the fundamental problem. They think they have a choice. The American public is just as confused and deluded as the Greeks, the Irish, and the populations of the other Western mixed economies. They all think that they have a choice as to having their wonderful “safety nets” or “social programs” and the altruistic, state controlled economies. They don’t. No choice. Reality is coming and it is all going to fall down and go BOOM.

Certainly the leaders and even some of the followers of the movement supporting the funding of the entitlements are doing so because they are sworn to altruism without regard to the consequences. It will be reality they curse when their programs fail. But there are many, perhaps a majority, of the supporters of entitlements in America, whose support is founded on altruism (in some form), but who do not want the country to self-destruct. Our way out of this mess is to bring the reality of the situation to these people. We must remove their delusions and confusions.

Actually, it is easier than you might think. We don’t have to provide some argument founded on what might appear as a convoluted, discarded economics, i.e., capitalism. We can merely point to the coming tsunami of retiring baby boomers and the catastrophe of funding Medicare and Social Security. We can’t really fund them now. It shouldn’t be hard to communicate the rest, the whys and the alternatives.

What really bothers me is that from what I can see, few of my fellow Objectivists seem to have figured all of this out. There was tremendous energy during the days of the ObamaCare fight. But, the coming depression seems to be as insignificant and unreal to them as it is to most of the country. Really people, if we don’t get something done on this in the next few years, the depression will be unavoidable. And it will be a depression that will make the 1930’s look like a picnic. The consequences for capitalism and freedom will be catastrophic.

MAKING CLAIMS ABOUT THE MONEY SUPPLY

The concept of the money supply is central to understanding events and prospects in modern, mixed economies. What the money supply is doing, and what the manipulators of the money supply are doing, are key indicators of immediate and intermediate economic events. In my blog, I refer to the money supply often. Analysts and writers who are influenced by the Austrian school of economics, and here, as always, I am referring to von Mises and his predecessors, will refer to the money supply in understanding business cycles in modern, mixed economies. So, how do we know what is happening with the money supply?

From the U.S. government we have several measurements of the money supply, called M1, M2, and M3 (no longer published). There is also MZM, my preference generally. There are also indicators such as the balance of payments, for indications of the outflow of money. Another important tool to keep in mind is the changing level of bank loans. The past two asset price inflation events have both been created by bank loans. Finally, there are some private measurements available at various websites.

As with any measurement, it is absolutely necessary to clearly understand what is being measured, how, and how those measured elements relate to your conceptual framework. You must also know how the measurement in question performed in the past, i.e., what the results meant and how the economy performed.

All too often, what I see when reading other authors is that they have chosen tools that reinforce their own expectations. They ignore other tools that currently are pointing in other directions. That is especially true of the people who are expecting hyperinflation in today’s world. I certainly sympathize with the hyperinflationists. There is reason to be concerned, from what I can see. But I do not accept their knee jerk approach.

My approach is to look at all of the indicators that I have identified and try to make sense of them and what is happening in the economy.

One indicator can also be the interest rate set by the Federal Reserve Board. One influential online group recently used the argument that since the Fed had set the Reserve rate at zero, there had been billions of dollars created. In other words, it was automatic. If the interest rate is set well below a market rate, then money will be created. This same reasoning occurs when the Fed creates reserves. For example, in 2008, the Fed created nearly $1T in member bank reserves. People immediately said that the Fed had created billions of dollars in the economy. But, there is a difference here. Lowering the interest rate and creating reserves are not the same as actually printing money. Printing money and shoving it into people’s hands through government handouts or expenditures or payrolls put money into circulation immediately. That money is in play.

But the actions of the Fed are different. The Fed can create reserves and lower interest rates, but the Fed depends upon the banks and businesses to actually put the money into play. If the banks do not lend (which requires a borrower) then nothing happens. That is what we have seen over the last two years. The Fed has tried to put more money into play, but the banks have not cooperated. The Fed’s influence is not automatic. The claim that low interest rates have created massive amounts of money is not substantiated by the level of bank loans and other indicators, e.g., MZM. It is important to objectively understand how this stuff works.

I saw an argument that claimed that it is wrong to argue if the money supply has expanded or not. According to this person, looking at the facts was not thinking in principles. Instead, he said that we should state that the Fed is, “The reality is that money has been created out of nothing and it therefore will alter behavior (otherwise why do it?). … that this money has created price increases in several sectors, commodities and oil among them, despite the ‘we haven't really increased the money supply’ theory.” Somehow, for this person, thinking in principles does not include relating one’s ideas to the real world nor having a sound, fact based argument for our position. We merely sate that the government has made money that raised prices without being able to even demonstrate it, not to mention, prove it. It does not include looking at the present, specific situation and making sense of it or presenting your position in the context of the crisis we actually face. I do not know how this person thinks that we can be convincing or persuasive.

Some will then point out that the Fed has recently been buying Treasuries from the Government directly, thus putting newly made money directly into the economy. That is true. That step leads directly to expanding the money supply and to affects in the economy, generally, to increases in consumer prices. However, given the size of the economy vs. the amount of purchases the Fed has made, the effect is not particularly significant. We would have to see closer to $1T of Fed direct purchases from the Treasury for the Fed to trigger consumer price rises.

Potentially more significant would be the return of sizable amounts of the dollars held overseas via Treasury Bond purchases. With a $1.7T deficit, if $1T was financed from overseas, we would see a mammoth flooding of dollars flooding our markets. This returning money, often as much as $500B in the past few years, has been a source of some of our price inflation. Higher amounts would put more pressure on prices.

Yet another recent argument that I have seen implies that in today’s world, real market forces (as opposed to governmental influences) have no impact on prices. The field of play, this person held, is controlled completely by governments. Again, there was no attempt to demonstrate how this is so. The position was presented as necessarily following from the fact that governments act and have bad influences, there were bad events happening (the raising of oil prices), therefore, it was completely because of government intervention. No facts about the current situation were necessary.

Thus, it is important to look at the various moving parts of the make up of the money supply and their impact. Then, it is imperative that your understanding relates these different measuring tools to the real world in an objective manner. For example, look at M2 http://research.stlouisfed.org/fred2/series/M2?cid=29 , the simple view would be that inflation is rampant and that prices should be going through the roof. But have they? I just saw an observer on PJTV who kept track of his expenditures of a few items over the last year. His personal stats did show across the board significant price increases. What is your experience? Mine has been that there has been little change for some time, with some bigger increases just recently. Even if prices are going up, does that mean that the hyperinflationists are correct in saying that general, average price increases of 20% or more (hyperinflation) are beginning soon? That is a big jump.

Some argue that because certain prices went up, there is inflation. Most recently, these are the prices of gold, oil, and food commodities. But prices go up and down for various reasons. That is especially true in a “mixed economy”, where government actions have hidden, unforeseen, and often weird, effects. You have to be careful when attributing reasons for price movements, which means actually finding a cause and effect. For example, the decades old efforts by governments around the world to control oil discovery and production in many different ways means that there are restrictions on production and supply. The result is an artificial shortage of oil. Supply shortages would mean higher prices, given level demand. In our situation today, and for the last several years, demand is actually growing. So you have three different factors pushing the price of oil upward, including whatever inflationary pressure there might be. But the price would be going up anyway. When discussing the price of oil, you cannot objectively leave out the supply restrictions and all of the reasons for increases in demand.

Turning back to the analysis of the money supply, my overall point is that many things are happening within an economy that will affect whatever actions governments take to manipulate the money supply. How it plays out and what the ultimate effect will be depends upon those factors. To accurately explain events, you need to have identified the actual causal connections and explained other details that may seem to be contrary to your conclusion. A site or writer who ignores those contrary elements only means that they are pushing their pet theory without actually relating it fully to reality. Economics is a difficult science, but it is a science. Economics is about the real world, and one’s standard of truth must be consistency with reality.

Bernanke's Confirmation: No! Err... Well....Okay

Ben S. Bernanke, the Chairman of the Federal Reserve Board, is facing some opposition in winning a confirmation for his second term as Chair. As a man who is nearly universally proclaimed as the savior of the American economy from a deep depression, it seems amazing. The mainstream press has been a cheerleader and books have been written extolling his heroics. What is happening?



My own view of the man is spread throughout this blog, especially in my comments on his speech on January 2nd. He practices a science that is tailor made to not learn of causal relationships. He gives the impression of being non-political. He appears to be the ultimate academic bureaucrat.


Bernanke always appears poised and rock solid in his pronouncements and prognostications. This is his view of how a Fed Chair should be. Unfortunately, he appears rock solid regardless of the veracity or wisdom of his statements. Here are some examples: He appeared poised and rock solid when he said that there was no problem with the rise in housing prices a couple years ago. He appeared the same when he said that the problems with foreclosures would have no impact on the economy. He appeared the same when he said that Fannie Mae and Freddy Mac were in excellent financial health. He appeared the same when he and the Treasury nationalized the failing Fannie Mae and Freddy Mac a few days later. He appeared the same when he began nationalizing banks and put a couple trillion dollars into the economy. He appeared the same when he said that events that coincided with injections of money were coincidences. He appeared the same when he said that the probable cause of the foreclosure problem was the use of risky mortgages offered to substandard credit borrowers, even though he knew that the Fed had pushed with the rest of the Federal government for lowering credit standards for mortgages for years. The guy has an appearance that does not connect to the real world.


I also think that any man who accepts the chair of the Fed has to be regarded as having a questionable psychology. This is one of the most powerful, political positions in the world. Anyone willing to accept that much power over his fellow man has problems.


At this point, there is very little suggestion in the mainstream press that the Fed is responsible for the house price bubble. As I mentioned, there is nearly universal acclaim for his leadership in keeping the U.S. economy from depression. Why then is his confirmation being opposed by several Democrats?


The good news is that several democrats are criticizing Bernanke for the bailouts. The bad news is that they are criticizing the bailouts primarily because these politicians think the companies bailed out are unpopular. It is a play of the class warfare card.


It is okay, they think for the Fed to have pumped a trillion or two into the economy. It is okay for him to have wielded the power he has, along with the Treasury.


One set of criticisms of Bernanke is that he gave too much money to AIG and did not add conditions. These criticisms aren’t that Bernanke bailed out AIG, but that he didn’t do it in a certain fashion. Somehow, in his headlong dash to dole out all the money he could create, Bernanke was suppose to make sure that the money wasn’t suppose to be used for AIG’s actual business, which, in this case, was to insure certain investments tied to mortgage backed securities. If AIG failed to meet its contractual obligations, those companies would suffer sever difficulties and many would fail. What was AIG suppose to do with the money? These congressional critics are all for the use of government money as a means of manipulating the economy, confiscate assets, and generally extend the government’s reach, but they are outraged that the money was used for contracted, normal business activities. It is just another example of the attitude of the political climate that the importance of contract is ignored and denied. The worthiness of attacking a person because their actions inadvertently helped a company that can be attacked for political gain.


One criticism that I have heard only a little is that he has lied at several stages of the bail-out. He lied to BoA on the financial health of Merrill Lynch, and then when they found out the depth of the problem he threatened the Bank’s leadership and implied that he would put someone in their place who would do what he, Bernanke, wanted. The man feels as though he may do as he pleases with his power. He lied about the AIG deal and his representatives at the New York Fed told AIG to keep quite (for which the AIG officials are blamed with the suggestion that AIG instigated the deceit, when it was obviously the Fed). He has lied about the role of the Fed in the lowering of credit standards for sub-prime mortgages, implying that it was the nefarious and evil mortgage brokers, who had only their jobs and businesses to loose. The man apparently feels that any statement he makes is acceptable because he is “saving” the country from depression. He must “do all it takes”, which means forcing people to do what is not in their best interest. At best, Bernanke believes in sacrificing others for the sake of “the greater good”. Not to psychologize, but it is just as possible that he just likes the power.


I have seen that many people are happy that Bernanke may be rejected. They are joining the chorus, albeit a small one at the moment, in calling for his confirmation to fail. Bernanke should be fired, at the very least. He should not continue in a post that he doesn’t understand and mishandled so badly. I cannot deny that I too would feel good about the Senate sending him home. But. But! BUT! There is a small, okay, a big problem.


If Bernanke, the lying, self-deluded, power craving, freedom destroying, bureaucrat loses his job on Sunday. What happens? Obama gets to appoint a new Fed Chairman. Obama. Obama gets to appoint the person who is quite possibly the most powerful person in the world economy. Obama.


I am afraid. The prospect of Obama placing a person in the Fed Chair frightens me more than Bernanke does.


I have not kept track of Obama’s appointments. But from what I can tell, his people are radical, anti-freedom socialists and fascists. I am not aware of a single competent person. The guy at the Treasury is the one who forced through much of the current economic plan as head of the New York Fed. He came to the government from Goldman Sacks, and he turns out to be a pragmatist of the first order, willing to use government power to control and manipulate. He is not a capitalist. If there are people in Obama’s administration who do not want to actively expand government power, they haven’t made an impact.


So, what can we expect from an Obama appointment that could get through the Senate confirmation process? Anyone who has paid their taxes, including their nannies taxes, who will use the Fed as the means to further corrupt, undermine, and destroy what little remains of our freedom and capitalistic system. Is that better than Bernanke? Bernanke’s one little bitty redeeming piece of character is that he is an academic, as corrupt and pragmatic as that is. He is not overtly political. He is certainly not a supporter of capitalism, and he has shown no willingness to oppose any of Obama’s drive to fascism. Nor will his policies help stabilize and strengthen the economy. But, he is not going to act as Obama’s pawn or tool in the manner that Obama’s own selection would. It is a small difference, but sufficient that I am willing to argue for Bernanke’s return for another term.


If you want to argue that putting Obama’s person into the Fed will make our current situation much worse and that people will rebel against Obama and the destruction of our freedom I am willing to listen. But, I think that it is too early for us to do that. People don’t know any more about freedom and capitalism than they did three years ago. It is still too soon. I think that we can use more time in a slowly deteriorating situation to further our efforts to save our freedom and the United States of America. I want more time.

Inflation Watch: Early 2010

It is kind of interesting now. Aside from the very important fight to prevent the federal government from expanding their control over medicine, not much is happening. It is a lull. It is the eye of the storm. It is waiting for the other shoe to drop (and it could be a big shoe). It is the calm before…..well you get it.


If this were nearly any other time after WW2, we would be seeing business activity picking up, profits being made, people being hired. Instead, people are waiting. Sure the equity markets have moved up some. Obama has spent a lot, okay, he has spent a lot of a lot. He is going to be spending even more, even if the healthcare bill fails. But, banks are still not making loans. The last report on consumer credit showed a decline. The money supply quantity has been level for a while – it is a reverse hockey stick. The dollar, the price of gold, oil prices, and house prices are staying in a pretty narrow range. Of course, when the supports of house prices disappear, we may see something different. The Fed keeps talking about having to soak up all of the excess reserves they created, but a lot of people don’t think that they have the backbone, let alone the ability, to do it. What we are all doing is waiting. Waiting for the shoe to drop. We’re afraid that it will hit us on the head, hard.

There is some talk about production beginning to come back on line, about corporate profits growing and banks regaining their strength. Then, following FDR’s example, Obama says something that scares everyone (like the tax on banks to “recover” the TARP junk money), except his loyal followers, and decision makers, the wise ones, sit on their hands again. So, this period is one of uncertainty and pause.
We can be certain that everything that Obama has done and wants to do and what the Fed has done and will probably do are bad for us. The corrections that are needed because of the house price bubble have only partially occurred, at best. There is still a lot that could happen besides a house price decline. We could easily see more unemployment, and certainly see more non-employment, as Obama continues to take money out of the economy to fund non-productive, make-work jobs. It would take a lot of study to determine which was worse, unemployment insurance or Obama make work jobs. Not only are these people not producing which would move our economy toward prosperity, but money is being taken out of the economy to pay the unemployed not to produce. At least with unemployment insurance there is no pretense.

Even though the money supply numbers are coming up flat for the last several months, since production has fallen off, but prices have not, we are experiencing price inflation, at least enough to maintain prices. There may be some asset boom in the price level of stocks and gold, but not a lot. There is a lot of money sitting on the sidelines. There is talk of the “carry trade” in international asset markets. I am sure that there is something happening there. How big it is I don’t think anyone knows.
Since banks aren’t lending, added money is coming from direct government spending. Obama’s spending feeds directly into the consumer markets, therefore, to the extent that the money is being pumped, we will see pressure on prices. The direct spending is coming through the increased government payroll and things like non-employment programs and mortgage support. This spending is money that winds up in individual’s pockets and does not impact any specific set of prices. As general government spending continues to ramp up, the result will be more like “stagflation”, much like the 70’s where we had a stalled economy and rising prices. This will confound the “economists”, especially the Fed’s people. They are depending upon businesses being able to ramp up their production to meet the levels of money wondering around the economy. Businesses aren’t ramping. Banks aren’t lending, which is a really reasonable, business wise, good decision.

The Fed will be amazed that their magic wand, really low interest rates, doesn’t provide the wonderful result their models predict. We will be back in 30’s, or the 70’s take your unhappy pick.  (When you hear "low interest rates" from the Fed, always think: creating made-up money.)
The money for the government spending is coming from some U.S. “investors” who are frightened and think that federal bonds are safe. A lot is coming from foreigners, mainly central banks, who have trillions of dollars sitting there with nowhere to go except U.S. government debt. If the Fed does start mopping up money out of bank reserves, we will see short-term interest rates rise, which may affect the long-term bond rates. It depends on the conclusions reached by investors. If they think that the Fed is acting with some determination and will finish the task of taking nearly a $ T out of member bank deposits (this is the money that banks are forced to have on deposit with the Fed;  in government speak, it is called a reserve, but it isn't), then long-term bond rates may stay fairly flat, with the inflation premium pretty small. If investors think that the Fed is not serious or lacks the will to do the job, long-term rates will rise, and today’s buyers will suffer.

Maybe it would be worthwhile to talk about what makes up interest rates. As von Mises would say, the basic decision a person has to make is his preference for current consumption or future consumption, today’s goods vs. future goods. What does it take to get you to put off consumption? The classical answer that I have seen is something like 1 ½ to 2 %, that is, you would want an interest rate of return of say 2% a year to put off consumption, all things being equal. That is a wonderful saying by economists, isn’t it? “All things being equal”, because all things aren’t equal in a mixed economy. There are two added factors: inflation and taxes. (This is why government bonds have always been a bad deal, because after inflation and taxes they generate a net loss, guaranteed.)

What is your expectation for inflation? Up until 2007, the average for 10 to 15 years had been around 2%, using the CPI (don’t shout at me, this is only an example). Let’s say that your tax rate (federal only) is 33%. Using the basic, “natural” interest rate of 2%, you would want a nominal rate of return of 6% on your bond, i.e., after the tax of 33%, you had 4%, then minus the rate of inflation, you had 2% left. Today the 10-year bond is under 4%. In 2008, the social security people decided seniors should get an indexed increase of 5.6%. That tells you where things were headed, doesn’t it.

What is your inflation expectation of 2011 and beyond? More than 2%? Mine is. Taxes aren’t going down either (I will pause while you laugh.)………

If long-term bond prices go up, BO will have to spend more money financing his spending (doesn’t that make sense?), and he won’t be happy. He will point his finger at the Fed. Our hero, Bernanke, will…. And the story continues.

Back to my inflation watch, I am trying to avoid guessing or jumping to conclusions, here. I don’t see much hope. I think the question is how severe will things get. If they get more severe, will people demand that the government and the Fed do something different, like get there hands off the economy and also stop making money? We shall see.



To let you know that I am keeping my eyes as open as possible, I want to report that one of the standard indicators of the 20C suggests that we will not see more downturn. Hemlines have pretty much stayed where they were. Yes, for most of the 20C, when recession or depression hit, hemlines went down, adding to the personal sense of depression. However, either this indicator has lost its connection to the economy, or things will be fine, or at least the level of depression in the population will be a little lighter.



(Please give me some feedback if any part of this was not as clear as you want. I want to be sure that I am deciding to publish what an intelligent person will understand. Thank you. C.W.)

Speech by Ben S. Bernanke, Commentary

Monetary Policy and the Housing Bubble
At the Annual Meeting of the American Economic Association

January 2, 2010

This is a speech in front of an association of economists, and, consequently, Bernanke can talk freely in his “native language”. He can use the reasoning and terms with which he is most comfortable, keeping in mind that it is in public and the speech will be reported. This speech is his personal, professional statement of what he considers to be the consequences of his actions as a government official.

First, Bernanke’s comments make clear that in his opinion, the range of options that he faced or would not consider appropriate do not extend to letting interest rates rise to the market level. Those who argue the rates were too low, he says, meant that he should have done something different, not leave his hands off. As he was reported to have said in the book In Fed We Trust (p. 21), he was unpersuaded by arguments that the market can be effective by itself. In addition, he says that he was afraid of an unwelcomed decline in inflation. He was afraid of deflation, referring to Japan as an example of what can happen if prices fall.

“…the FOMC’s policy response also reflected concerns about a possible unwelcome decline in inflation. Taking note of the painful experience of Japan, policymakers worried that the United States might sink into deflation and that, as one consequence, the FOMC’s target interest rate might hit its zero lower bound, limiting the scope for further monetary accommodation.”

That he has no evidence that deflation in the U.S. was happening, or that it would have been bad is not considered. What he is actually saying is that falling prices is a bad thing for any economy. Falling prices are to be avoided at all costs. Falling prices, plus the potential for large scale problems in the financial sector world wide meant probable depression.

Bernanke has established himself as an expert on the Great Depression. His take on the depression is that it could have been avoided if the Fed had flooded the market with money in 1931 and 1932. This is his perspective. If something goes wrong in the economy, lower the interest rates.

Bernanke’s speech begins with discussion of the level of the overnight federal funds interest rate between 2002 and 2006. The question is whether it was appropriate in the face of the critics. He thus says that he will begin with a discussion of “simple rules” that have been offered to determine the proper rate, and talks about one, only one. And with the conclusion of this discussion, he simply dismisses the issue of the interest rate levels by saying that it appears that the Fed followed the correct policy.

The “simple rule” is a formula suggested by an academic that includes the actual rate of inflation, the desired rate of inflation, and the deviation from the optimum level of production. Bernanke quibbles about some of these terms, and ends by declaring that, even if the final result, after he has tinkered with the terms, is close to what the short-term interest rate goals that the Fed actually achieved, it is still too restrictive to be used. Sound strange? It is. I don’t recommend reading that section (or any of them, really; what’s that fun saying that some media types are using, “I read it so that you don’t have to”). (I am sorry. This section of the speech, about 25% of the text, is just not easily translated.)

He also uses only the level of prices, consumer prices as the subject matter of inflation. If prices rise there is inflation. If prices fall there is deflation. He is not willing to suggest that there is any other set of issues. Money supply is not an issue. It is not mentioned during the speech. Other causes for price rises, such as restrictions on oil production and thus higher oil prices, which tend to make other prices are not considered, at least in this speech. (He would probably like this suggestion, since it would be yet another explanation of “inflation” in which the central bank played no part.)

As you would expect, the concrete-bound detail and triviality of his remarks make this extremely tedious to read, as, I am sure, to hear by his listeners. Of course, they were mostly mainstream economists and government people and are used to hearing this kind of speech.

He then asks “can monetary policy have made an impact on housing prices?”

“With respect to the magnitude of house-price increases: Economists who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade can be attributed to the stance of U.S. monetary policy. This conclusion has been reached using both econometric models and purely statistical analyses that make no use of economic theory.”

Bernanke’s answer is founded in statistical analysis. He doesn’t use cause and effect, but looks for correlations. These techniques also depends upon focusing on the interest rate at the time and price inflation. What they ignore entirely is how low interest rates are achieved. He pretends that the fed declares low interest rates and they come about. But what happens is that to keep interest rates low, even the short-term rates, the Fed must supply funds. It must make up money. It must keep making money (this is electronic money) as long as it wants to keep the interest rates below what the market would set. Every time there is a move upward, the Fed makes up more money. Where does this money go? In the period in question, much of it went into mortgages. But Bernanke does not think that looking at this money makes any sense. He ignores it as if it doesn’t exist. But it does, or did until the liquidation of mortgage-backed securities became necessary because of so many defaults, which was the liquidation of the mortgages.

His entire speech demonstrates that the epistemological methods used in today’s mainstream economics is designed to avoid looking at reality and to obfuscate cause and effect.

He slips in the suggestion that the availability of ARMs and other special mortgage types is a “key” explanation of the rise in house prices.

“Clearly, for lenders and borrowers focused on minimizing the initial payment, the choice of mortgage type was far more important than the level of short- term interest rates. The availability of these alternative mortgage products proved to be quite important and, as many have recognized, is likely a key explanation of the housing bubble.”

At this point the level of evasion of responsibility becomes obvious, since the Fed, as well as every other imaginable government agency had pushed home ownership and the lowering of credit standards for years. (see Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas Woods, p. 15ff)

“As you can see, the use of these nonstandard features increased rapidly from early in the decade through 2005 or 2006. Because such features are presumably not appropriate for many borrowers, Slide 8 is evidence of a protracted deterioration in mortgage underwriting standards, which was further exacerbated by practices such as the use of no-documentation loans. The picture that emerges is consistent with many accounts of the period: At some point, both lenders and borrowers became convinced that house prices would only go up. Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term. They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ultimately, further appreciation could not be sustained and house prices collapsed.”

To further support his position that the Fed is blameless, he considers the rise of house prices internationally. Bernanke uses the same statistical method of comparing monetary policy, as represented by a statistical analysis of the central bank short-term rates compared to the rise of house prices in separate countries. He finds no correlation. So the central bank of the U.S., the Fed, did not cause the rise in house prices. QED! The guy is a wizard! And, it is entirely nonsense. He has no concept of the role of cause and effect in economics. That is where we are, and why he and his brothers are completely mystified as to why people want to shut them down.

So what explains it, in Bernanke’s opinion: savings glut, especially in developing countries. It seems that the people who feed off of money loaned or “invested” in developing countries turn around and put the money in the U.S. Since this money is usually dollars and it isn’t actually U.S. savings, but made-up money, it is U.S. inflation anyway. But that is far too long of a chain for Bernanke to accept or even consider. Yet, here we are, foreign savings sent to the U.S. has driven up American house prices.

Step back and consider our house prices dependency on foreign money for a second. With Bernanke is keeping American interest rates low, why would anyone send us money. Well maybe, if your own country’s currency is even less stable, the U.S. is a fine place to put your money, or maybe you have so many dollars you need someplace to put them.

Somehow Bernanke can keep track of the money coming into the U.S., he says (actually, he is suggesting it, cause and effect is something that he is avoiding), but he can’t or won’t consider what is being done with the money the Fed is creating to keep the interest rates low in the first place. There is a parallel, Bernanke admitted in front of Congress that he doesn’t know what happened to the money that he loaned/gave to foreign central banks as part of the stabilization after September, 2008. He doesn’t watch it, except for that money that came from developing countries that drove up house prices in the U.S.

“In previous remarks I have pointed out that capital inflows from emerging markets to industrial countries can help to explain asset price appreciation and low long-term real interest rates in the countries receiving the funds -- the so-called global savings glut hypothesis (Bernanke, 2005, 2007).”

In his argument that central bank short-term interest rate policies are not responsible for the increase in house prices, Bernanke’s approach shows that there is a very significant methodological issue here. Bernanke felt that all he needed to do was create charts comparing the central bank interest rates with the house prices. He didn’t feel it was important to consider the actual money market in each country, or credit standards, if credit is used, type of mortgages, income levels of house purchasers, laws, or any feature that might or might not make each county a relevant candidate for comparison with the U.S. situation. No, all that is needed in Bernanke’s world is a look for the correlation. I have watched reactions to Bernanke’s speech and I have seen no reaction at all to his analytical methods. I suspect that the standard journalist is intimidated by what passes as Bernanke’s science. I saw one comment on a critic’s article saying that he thought Bernanke was smarter than the author of the article and so would continue to believe Bernanke. That is part of the problem, a lack of understanding of simple methodology.

And, therefore, after his analysis of the appropriateness of his low short-term interest rate policy and the possibility of Fed responsibility for the rise in house prices, both of which Bernanke resolved in his own favor, the cash payout, the conclusion, the recommendation is, wait for it, what do you think, you get three answers and the first two don’t count, what do you think it could be….(consider this all said in a high voice with a drum roll)…… it is, to da, MORE REGULATON!!!! SURPRISE!!!

Sorry, I couldn’t resist.

“What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk- management practices without necessarily having had to make a judgment about the sustainability of house price increases.

“The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble.

“The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by- institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country’s overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.”

The nicest thing that can be said is the he must be well insulated. The push to expand home ownership and lower credit standards by the government was a very big effort. To ignore that takes a heap of mental effort. The other problems I have touched upon.

But, the basic modus operandi of a government regulator is well established by excellent writers, Ayn Rand, Ludwig von Mises, and many more. When something goes wrong in the economy you are regulating always blame it on free enterprise and never yourself. And demand, loudly and often, more controls and power and less freedom.

(Bernanke's speech    http://www.federalreserve.gov/newsevents/speech/bernanke20100103a.htm)

Learn About Capitalism

Capitalism is a major value for a rational person. It is the political system of freedom. It requires property rights and thus the individual rights that are necessary for man to live as a man and pursue happiness. Without rights and capitalism, man is a miserable, sacrificial animal.

Not known until the last century, and the writings of Ayn Rand, capitalism is the only moral economic/political system. It is the only such system that is consistent with man’s need to make decisions based upon his own judgment and create values. In our current world that is flooded with pleas, demands, and commands to be altruistic, to be a human sacrifice, the morality of capitalism is truly unknown. This knowledge, the reality of the moral purity of capitalism, needs to be broadcast loudly and constantly.

Yet, I have found that those who know of the moral stature of capitalism often have less knowledge of how capitalism works. They do not know the issues of trade, finance, money, and business. They do not know how the nuts and bolts fit together.

I think that it is vital that the supporters of capitalism know the economics of capitalism, for the same reasons.

You see, unfortunately, the rest of the population doesn’t know either.

The effort to deny the moral stature of capitalism also has succeeded in hiding the efficaciousness of capitalism as well.

People in general do not know that capitalism works.

People in general believe that capitalism leads to boom and bust, to keeping the poor poor, to the exploitation of the under privileged, to overproduction, to producing things that will fall apart, to destroying the Earth. They do not know anything, or at least very little, about what capitalism actually does for mankind.

I think that this lack of knowledge extends to just about everyone, including “economics professor”. Certainly, almost no journalist, few blogger, no commentator, and few TV talking heads have an idea of how capitalism works. I wouldn’t put the “pro-business” conservative or Republican in the category of the pro-capitalist, since most of them would be terrified of the idea of doing away with any of the New Deal restrictions on business. Capitalism is fine, they think, as long as it isn’t allowed to go full bore.

It isn’t just that capitalism is the unknown ideal, capitalism as a system is literally unknown, too (even among many who support it). If you sit down and argue capitalism’s moral worth, you could easily get the answer, “Okay, it may be moral, but it doesn’t work!”

I have read and heard surprise that people are ready to discard this wonderful system that has brought about our unprecedented standard of living. But people do not know that capitalism is responsible. They see the health care industry failing, for example. It seems that the market is failing. They do not know that capital is required for production. They do not actually know what capital is. They do not know how money works, or finance, or markets. Their ignorance is amazing until you realize that there is no source in our educational system to learn about capitalism.

So, if you want to argue for capitalism, you need to be able to explain what it is, that it is moral, that it works (and how), and, I am sorry to say, how and why what is currently going on is so bad for America. This last point is like having to look deeply into very shameful, evil, and often, boring issues. But it is necessary. I do mean necessary. If we are going to beat this thing, we need to root it out and kill it. And we have got to know our enemy to succeed.

Our biggest enemy today, the one with the most impact on our daily lives and that undercuts our prosperity is the Federal Reserve Board. There are very few who have a clue as to what it is and how it works. Start there. Read Meltdown by Thomas Woods. (I just finished it and will have a review here shortly.)

Read the business section of your newspaper. Read The Capitalist Manifesto. Read Ludwig von Mises. Read the Fed website. Read the few blogs dedicated to capitalist economics.

Learn how the Fed manipulates the money supply and how much it has done. Pick an industry and learn how it is manipulated and regulated. Learn how pervasive federal, state, and local governments are in every area of our daily lives. You will become a fountain of knowledge and moral condemnation.

I know that this sounds like a lot to do. Economics texts tend to be big and filled with jargon. If you took economics in college you may be scared for life! But knowing how capitalism works is important. You know, if you actually lived in a capitalist economy, you would want and need that knowledge. The more you knew about the rational world you lived in, the better off you would be. The same is true in this context. Speaking about your personal situation, the more you know about what is happening, especially when it is bad, the better off you will be. So there are two excellent reasons to follow up.

The Federal Reserve Board and the Money Supply, Part 2

The Fed has this toy, the deposits of 10% of the country’s banks’ checking deposits. By law, the Fed can do two things with that toy. It can change the percentage of deposits required. If there is a limit on the percentage I haven’t found it. If there is a legal limit, it has no practical significance. We are really left with the Fed being able to set the percentage of demand deposits required by law with just the Fed’s “good judgment”!

The Fed also has the right to change the amount of money that is in a bank’s Fed deposit. The Fed can add money or it can take money away. So there are two parties who can change the bank’s deposits: the bank and the Fed. Now the bank is limited in how it can adjust its deposit. It must be close to the correct percentage. The amount of demand deposits the bank has is figured every week and it must reconcile the percentage at that time. It can borrow to cover a shortfall in its deposits. It can borrow from a bank that has a surplus or from the Fed (called the “discount window” and thus the “discount rate” that we hear so much about).

We are now at the key to the expansion of the money supply. Watch this. When the Fed adds money to a bank’s Fed deposit, the bank can consider the larger deposit as “found money”, and regard the new total deposits as the 10% (again, the current percentage requirement) the bank must meet. Since the size of the bank’s Fed deposit is now larger than it was, the bank may turnaround and expand the demand deposits held by the bank to the extent of the new proportion, 10 to 1, 10 parts demand deposits, 1 part Fed deposit. The bank expands its demand deposits by offering loans. Hospokus, we have credit expansion!

Let’s look at an example. Bank XYZ has $100M in demand deposits. From this, it has placed $10M at the Fed, and keeps, let’s say, $30M as actual reserves (I have no idea what banks currently believe is a reasonable, actual reserve, these numbers are made up by me). The Fed, acting upon its good judgment, puts $1M into XYZ’s Fed deposit, raising it to $11M, and whamo, the bank can expand its demand deposits to $110M. ZYX Bank can now loan out $10M more and be completely legal. (What percentage banks actually loan out is not really relevant. The Fed would just keep adding money to the deposits on hand until they reached their target of credit expansion.).

Whamo, we have now witnessed the expansion of the money supply by way of bank credit expansion.

The Fed uses a certain technique to add or subtract money from banks’ Fed deposits. The Fed buys and sells Federal Treasury Bonds on the open market. What it does, when it buys a bond, it buys it through a bank, and places the payment for the bond in the bank’s reserve. So, in the above example, it bought $1M worth of bonds through XYZ bank, and paid XYZ bank via the bank’s Fed deposit. If it wants to contract bank credit, the Fed buys bonds on the open market, and takes the payment from the Fed deposit.
The open market operation of the Fed is carried out by the, wait for it, Open Market Committee, which meets in the New York Branch of the Federal Reserve System. This Committee makes the open market policy and thus determines the rate of credit expansion. The credit expansion in turn causes an increase in the money supply, which may result in higher consumer prices. The credit expansion may also cause booms in stock prices, residential real estate prices, commercial real estate prices, and many other things. It also finances our export of dollars by way of our trade deficit. Credit expansion is handy for all sorts of things.

The Federal Reserve Board and the Money Supply, Part 1

The reason for spending valuable time on the Fed is that it plays an inordinate role in our lives. Interestingly, it is not so much the role that we are use to seeing in the papers. Periodically, during the year the Board of the FRS gets together and sets some policies. The one policy that everyone pays attention to is the setting of the “discount rate”. Few people know what it is discounting, but they know that it has something to do with interest rates. Everyone, it seems, wants the rate to be low.

No, the role the Fed plays in our lives has to do with money, i.e., the amount of money. The Fed is the primary source for the enormous growth in money floating around in our economy. It is my intention here to try and explain how that happens.

The Fed has been in existence since 1913. As far as I can tell, nothing significant has changed in its structure or purpose since then. It has been doing harm for 96 years nearly unchecked. To learn about its early years form a free market oriented historian, read Economics and the Public Welfare by Benjamin McAlester Anderson. It is an excellent history of the U.S. economy from before WW1 to after WW2. I picked up that book from NBI in 1969 and have had a pretty good understanding of what was happening ever since.

In this first part of my explanation I will talk about “reserves”. In part two, I explain what the Fed does with them.

Okay, reserves. This is the “reserves” in “The Federal Reserve System”. For once, here is a government name that gives you a key as to what is what. Yet, in spite of my last statement, “reserves” is also a misnomer. It is an anti-concept. It is also there to mislead you.

When you think of a reserve you think of something that is there when you need it. As these are bank reserves, you may think that this may be good because banks need reserves. They need reserves against unexpected demands for cash, changes in the economic climate, loan failures, and any number of reasons. So reserves are good, right.

However, the reserves at the Fed are not available to the bank. When a bank places their legally required reserves at the Fed that money is there to stay. The bank can’t get at it or use it. The money is actually a deposit. That is what I will call them, deposits. I think that “deposit” makes the whole thing clearer.

So, a federally chartered bank is required to deposit part of its demand deposits at the Fed. (I am not going to discuss why a bank would be federally chartered. There are benefits and requirements.) What is a “demand deposit”? “Demand deposit” is a fancy name for a checking account. Money deposited in a checking account may be demanded at any time the bank is open, without notice. As opposed, for example, to a savings account, which does require you to give notice. Yes, I know, you never have. But if you read the fine print in your savings account agreement with your bank you will see that the bank has the right to require you to give notice, at the banks discretion. So, a checking account is a demand deposit.

The federally chartered bank, which is nearly all banks, certainly all of the big banks, must place a portion of its demand deposits with the Fed. There are different percentages, depending upon the size and location of the bank, but almost all of the total dollar demand deposits in the country have the same percentage and that percentage is the only one I’ll use here. When I checked last in May, 2009, the percentage was 10%. Historically, that is pretty low.

Therefore, the Fed has about 10% of all checking account deposits in the country in its accounts. What a toy!