Tagged: Credit

The Austrian Prescription

At the start of the year it has become wearily traditional for us pundits to offer one of two genres of prediction.

The first takes the form of a genuine—if ultimately foredoomed—attempt to lift a ragged corner of those thick shrouds of unknowability which separate today from tomorrow. The second combines such futility with a certain arch attempt to make one’s name in the event one chances upon what can afterwards be trumpeted as the inspired prediction of what the consensus presently regards as a highly unlikely event. Continue reading

Broken Down

First published as ‘If it’s Broke, Don’t Fix it!’, 12th August, 2011

The only part of the so-called national wealth that actually enters into the collective possessions of modern peoples is their national debt. Hence, as a necessary consequence, the modern doctrine that a nation becomes the richer the more deeply it is in debt. Public credit becomes the credo of capital. And with the rise of national debt-making, want of faith in the national debt takes the place of the blasphemy against the Holy Ghost, which may not be forgiven…

Modern fiscality, whose pivot is formed by taxes on the most necessary means of subsistence (thereby increasing their price), thus contains within itself the germ of automatic progression. Overtaxation is not an incident, but rather a principle… The destructive influence that it exercises on the condition of the wage labourer concerns us less however, here, than the forcible expropriation, resulting from it, of peasants, artisans, and in a word, all elements of the lower middle class. On this there are not two opinions, even among the bourgeois economists.

Karl Marx, ‘Das Kapital’, Vol I, Ch 31

In Elgin Groseclose’s magisterial ‘Money and Man’, the following, eerily contemporary quote appears in his chapter on paper money:-

The administration of the finances appears to have practised a subtle and ingenious tactic… [and] by modifications in the monetary unit, attempted to influence economic phenomena. Changes… were made to prepare for the issue of loans or to audit the circulation of the treasury notes, or to regulate exchange, to modify the balance of trade… to effect a redistribution of wealth, to influence the price level of commodities, perhaps to attenuate economic crises and famines…”

So, we are told, wrote Albert Despaux of the practices of the French regime under Louis XIV during the final, disastrous twenty-five years of his reign. Indeed, upon first examining the accounts, after seven decades of chronic warfare and costly ritual, the incoming administration was to discover that matters were even more dire than they had originally been led to believe – even without a helpful Wall St. broker-dealer to help anyone cook the books beforehand.

As the Duc de Noailles – the new chief of the Council of Finance– wrote to the dead king’s chief concubine, in the autumn of 1715:

We have found matters in a more terrible state than can be described; both the king [i.e., the ‘public sector’] and his subjects ruined; nothing paid for several years; confidence entirely gone. Hardly ever has the monarchy been in such a condition, though it has several times been near its ruin.”

Plus ça change, one cannot refrain from remarking.

Though we must factor a larger margin of error into his accounts than we must apply to even our own governments’ dubious estimates, it seems that the sunset of le Roi Soleil was accompanied by an annual expenditure of the order of 236 million livres – of which some 86 million was interest payable on the debt – against which revenues of only some 150 million livres could be found. Total debt amounted to perhaps 3 billion livres, implying an average interest rate just south of 3% which is, ironically, much the same as that enjoyed by Uncle Sam today.

The annual deficit, therefore, amounted to some 43% of revenue, or 30% of outlays – still below the Bernholz accelerating inflation threshold of 66% and 40%, respectively, even if not exactly a testimony of rude fiscal health. Things had been deteriorating for quite some time before this, so that, overall, the grand Bourbon’s debt rose twentyfold in thirty years. By way of comparison, the imperial presidency in Washington has allowed its own count of obligations to climb a not wholly incomparable fifteenfold in a like period of time.

It is of note, then, that the abject financial state to which Louis’ vainglory had reduced his realm compares fairly favourably with that produced by a similar threescore years-and-ten of military welfarism in his successors’ populist republic, where the latest €150bln deficit represents 54% of receipts and 35% of expenditures – and the old satyr‘s performance looks even more attractive beside the newly ex-AAA United States’ tally of 60% and 38%.

Moreover, whereas the currency doctoring of which Despaux so disapproved was the culmination of a 66-year process during which the livre was devalued 40% in terms of gold and 35% in terms of silver (for a mean inflation rate of 0.8%!), that same proportionate loss of gold value has occurred to the livre’s paper descendants in just the last sixteen-eighteen months – much less the last six-seven decades. Moreover, in the same, two-generation period up to the present, the US dollar has lost 98% of its gold and over 99% of its silver value, with the franc putting up an even poorer showing beside it.

Even in CPI terms, the US dollar buys only 8% of what it did in 1945, a 3.8% annualized drop whose overall extent it has taken successive French governments something of the order of fifty years to accomplish at the compounded 4.7% rate prevailing in l’Hexagone.

The consequences of the penury of the early eighteenth-century French state are well known to students of human folly, for these were the all-too familiar circumstances in which the regent, the personally extravagant Duc d’Orleans – eschewing both politically unpalatable alternatives of swingeing austerity or outright default – turned to the twisted, Scots genius of John Law, that patron saint of underconsumptionist currency quacks and the honorary founding-father of latter-day central banking.

The broad thrust of the insanity and wastefulness unleashed by this pecuniary Pandora are perhaps too well known to bear overmuch repetition here, but what should be emphasised is that Law – like Bernanke – at first tried to argue that he was not some crude inflationist, but that he was merely arranging an asset-swap of paper money for mortgages. He also held, like all of his ilk who have succeeded him, that the panacea for a nation groaning under an insupportable burden of debt and famished for a lack of productive capital was the emission of more and more money.

This age old error of confusing the medium of exchange with the object of exchange is one we continue to commit. It as if a man’s thirst can be slaked by giving him a box of drinking straws or his appetite sated by kitting him out with a shopping basket.

Soon, enough, for all his astuteness, the malign side-effects of Law’s scheme made themselves felt, not the least of them, the distress occasioned to the ordinary household by the rising price of necessities in a world simultaneously subject to the blatant vulgarities of the rising mob of instant, speculative ‘millionaires’ (as the new phrase had it). Just as we have learned all over again, such disadvantages came rapidly to overwhelm the largely incidental fillip the inflation accorded to genuine economic activity.

Unabashed, our Caledonian conjuror could only plunge ever further into a maze of bewildering – and often contradictory – expedients of his own construction. In a flurry of on-the-hoof policy-making of the kind so eagerly practiced today, he unavailingly sought to remedy his earlier mistakes by blurring the lines between state debt and public equity, between common stock and bank money; by banning, then re-instating the use of gold and silver and altering their official parities with mind-numbing speed until all trust in his System – its specious virtues so recently extolled to the heavens – collapsed and France lay broken alongside it.

So, too, do we – the voluntary legatees of John Law – face a world which is seemingly broken, in its turn.

Sauve qui peut!

With the PR-man’s trained ear for a catchy phrase, that emptiest of empty suits, UK PM David Cameron declared, in the aftermath of this week’s appalling display of mass barbarism, that society in the unhappy land over which he shakily exercises power was ‘broken’ – to the ill-concealed schadenfreude of much of the continental press, many of whose own cities still bear the scars of similar irruptions of the Noble Savages whom their Provider States have so successfully reared in the moral wasteland of their sprawling favelas and seething bainlieues.

Painted in oscillating shades of red and green on our dealing screens, we can also see the full, epileptic frenzy of our broken financial markets, no longer evidence of the rational allocation of hard-spared capital to the enriching process of patient and diligent entrepreneurship, but a wild, computer-driven video arena where countless billions swarm into and out of the sea of tickers from one micro-second to the next, with each successive ebb and flow of this leveraged flood further reducing the informational content of the associated prices and so defeating the very purpose of the capital market itself.

Many disparate classes of ‘assets’ had spent eight months trading ever more closely bound to one another on the wave of Bernanke’s last, fatuous, Rooseveltian ‘experiment’ of QEII. So it was that the expiry of that nakedly cynical programme, at a time when the underlying macro-data had rather predictably started to turn sour, left a vacuum behind the broken-record promises of the stock promoters. Unfortunately, much like Nature herself, the milling Herd in charge of Other People’s Money – to whose members the projectors exist solely to whisper their blandishments –– absolutely abhors a vacuum.

A long time ago, we first wrote about what we had come to recognise as the bipolar tendency of financial orthodoxy to undergo opposing, Kuhnian revolutions of its Groupthink every six to twelve months, or so.

Typically, the players first persuade themselves of the validity of an often arbitrary, but usually bullish, scenario which, by dint of constant repetition and uncritical mimicry comes not only to serve as a dogma, but one which each believer professes to have discovered for himself. Along the way, all objective data and governmental statistics which can possibly be construed to support this scenario are talked up and re-transmitted in confirmation of the first idea: those which cannot be so re-interpreted are simply ignored as ‘outliers’ by all except the small cluster of much-derided contrarians and habitual Cassandras.

Eventually, as the trend matures and its espousal becomes near universal, it begins to lose its onward momentum. Now, for the first time, the dissonant evidence, which has long been accumulating, begins to excite a certain uneasiness in the Jungian mass consciousness.

Finally, the trend turns – sometimes to, but often absent, the accompaniment of some unanimously-recognised trigger event – and the first losses start to be taken by those latecomers caught in the reversal. As each successively lesser, Greater Fool sells out, cursing himself that he always buys the top, as he does, he encourages another of this time’s Smart(er) Money men to quit while he’s ahead, too. So, each initial trickle dislodges more and more of those clinging precariously to the edges of a now-vertiginous slope below, until the first, trivial setback snowballs its way into a screaming avalanche of head-in-the-hands liquidation.

Now, at this point of maximum dislocation and mental discomfort, all those inconvenient developments which should have long since called the move into question are suddenly rediscovered and – lo! – they crystallise instantly into the foundational themes of a counter-trend of equal and opposite conviction.

Sadly for them, the earlier naysayers will find no belated applause for being right, being despised for their pusillanimous refusal to play the game if they say, ‘I told you so’ and being anyway doomed to seeing their premature insights co-opted shamelessly – and without the slightest attribution – by the post hoc rationalisations of a consensus-hugging crowd soon avidly blowing themselves an anti-bubble to replace the inflated soapskin of ill-starred hope which has just imploded all around them.

So it has been here, too, with the Shock! Horror! Hoocoodanode? of the downwardly-revised US GDP numbers; the farce of the WWE Smackdown which was the Federal budget dispute; and the ritual slaying of the sacred cow of that nation’s

undeserved prime credit rating.

Up until that point even the yawning cracks opening up around the foundations of the Eurozone could largely be ignored in the eagerness to buy a small section of Blue Sky, but, once sufficient self-doubt was ignited in some corner of that Gordian tangle of correlated and cross-margined trade in which the near-free leverage of QE-II had enmeshed everyone, that ongoing turmoil also became one of the defining features of the new bearishness and its expression in market pricing became violently intensified as a result.

So the first sparks of panic were struck to find a ready kindling among the garish paraphernalia of illusion piled high behind the flats and tableaus which comprised the backstage clutter in the Theatre of the Absurd where the ‘Great Global Recovery’ play had been enjoying its unbroken, 15-month run.

In time-honoured fashion, a mad rush for the exits soon followed.

The Wasteland

So, here we stand, exactly eighty years on from the collapse of CreditAnstalt, the run on the Danat bank, and the disastrous abrogation of Britain of sterling’s gold standard status which turned an earlier stock market setback into an enervating slough of Depression.

Here, we stand, almost forty years to the day from Nixon’s abandonment of the dollar’s pivotal membership of the bastardized gold-exchange standard and the horrifying decade of rampant inflation which followed.

And here we stand, a week shy of four years after the Fed’s first, tentative response to the looming CDO/wholesale funding disaster which would threaten to sweep away not just those hocked up to the eyeballs in America’s grotesque sub-prime bubble itself, but feckless borrowers and risk-insensitive lenders – both public and private – right around the globe.

So let us take stock of what exactly we have wrought in the meanwhile by following mainstream economic exhortations to emulate what we think the hallowed FDR may have enacted or the venerable Keynes may have ordained, were these two leading lights of cynical expedience and wilful interventionism each alive today.

With over $2 trillion in excess reserves parked with the Fed, the ECB, and the BoE; with unsecured, interbank loans for anything other than the shortest of terms all but impossible to obtain; with the thirst for security sporadically driving rates on T-bills, general collateral – even deposits – below zero; with the benchmark LIBOR rates increasingly inoperative and their replacement OIS rates barely standardised – with the spread between the two varying widely and with the latter diverging from supposedly stable official base rates which thy are supposed to reflect – it is clear that the money market is broken.

With even short-date basis swaps between the major currencies wandering far, far from their near-zero, normal levels; with countries like Brazil attracting peer group interest for imposing taxes on inflows into and bets on the appreciation of its currency; with the Swiss trying to stem a 7.8 sigma, one-in-300-trillion, two-week move in the currency by aiming to swell sight deposits by 10% of GDP and by showering hapless East European carry-traders with precious francs; with EUR-USD risk reversals at their most extreme ever, both in absolute terms and as a percentage of underlying volatility – what can we say but that the FX market is broken?

With the DAX – for example – undergoing its own, 6.3 sigma, 7-in-a-billion chance, two-week move – one only exceeded in its compressed magnitude during the Crash of ’87; with the peak five days of frantic selling seeing record volume, thanks in part to the less-than-benign influence of the high-frequency trading which hummed along the fibre-optic cabling at triple the normal rate and accounted for up to 75% of overall trades, according to the Nasdaq’s biggest execution broker, it is no wonder the VIX doubled in only four days, a jump only exceeded by last May’s HFT-led ‘flash crash’. No wonder either that several European and Asian authorities saw fit to intervene, either to prop up prices or to outlaw short selling, or both. The only inference to be had – the equity market is broken

With the ECB being forced to take drastic – and arguably illegitimate – action to cap the 3-month, 225bps rise in the Spanish-Bund and the concomitant 270bps rise in the Italy-Bund spread; with US Treasury bonds plunging amid the rout to record low nominal and negative implied real yields, all the way out to 10-years; with record low mortgage rates forcing duration-hungry investors and hedgers to receive long-dated swaps at minus-40bps; with record levels of junk issuance having been conducted at record low yields, before a frozen market saw spreads explode a 5.6sigma, 218bps to stand 50bps wider in just ten days – to cite just a few instances of a widespread disruption – it is fairly evident that the bond market is also broken.

With the ratio between the two main oil benchmarks – WTI and Brent – having crashed from its well-behaved, long-term, pre-crisis ratio of 1.07:1 +/-0.2, to hit 0.79:1; with gold trading to a 5% premium to platinum for only the second time in at least the past quarter-century; with base metals showing less and less correlation between price, curve shape, and visible inventory as funding games and warehouse manipulations distort trading patterns; with industrial commodities being driven more by CB inflationary-‘Risk On’ considerations than by the specifics of usage and production – perhaps we must admit that the commodity market is broken, too.

With the widespread frustration of the masses spilling out onto the streets of the Maghreb, Egypt, the Levant, the Gulf, Spain, Greece, Eastern Africa, Bangladesh, Chile, and others; with even the mighty Chinese Communist Party quailing before the popular wrath excited by the divisive symbolism of the high-speed rail crash; with 80% of surveyed US voters saying the country is ‘heading down the wrong track’; with the widespread unease in Germany at the executive’s dismissal of the citizens’ understandable reluctance to bankroll the wider EU; with the emerging realisation that three generations of an ever-encroaching, ‘tutelary deity’ welfarism have not only sapped the vitality out of the economic organism, but have bred out all vestige of responsibility and self-restraint from the teeming, unweanable mass of perennial dole-puppies it has whelped – it is therefore undeniable that politics-as-usual is broken, too.

With the glaring failure to predict even the possibility – much less the circumstance – of the recent Crash and with the even more foreseeable failure of its tired old, rehashed nostrums of ending the slump by means of an inequitable programme of corporate welfare, inflationary ‘unorthodoxy’, and the unleashing of the debt-spewing monster of the state to gorge itself upon such things as individuals and private concerns no longer care to consume, it should hardly be controversial to assert that mainstream macroeconomics – and the reputations of the many panderers to power who practice it – are equally broken.

Breaking the mould

Whatever our individual pre-occupations with the specifics of this collapse, we must bear in mind that, amid all the wreckage, there are countless millions of hard–pressed souls, each trying to earn an honest living by first identifying and then satisfying the needs of their fellow men in the best, most cost–effective manner they can accomplish. In the attempt to do so, the overwhelming majority of these strivers cannot fail to provide a living to others, too – whether by employing their labour directly in their own factories and offices, or indirectly, by buying in the goods and services these latter work to supply at the workbenches and computer docks of other hirers of their effort.

In their constant struggle to peer into an uncertain future so as to estimate whether anyone will buy their output and, if so, at what price; and then to decide what they can afford to pay in turn for the necessary means to meet this potential market, they cannot in any way be assisted by the ramifications of all the multiple breakages outlined above.

If they cannot trust the signals being sent to them about the cost of inputs or the acceptable charge for outputs; if they cannot assume a certain stability in the rent and availability of working capital, or rely on the calculus of securing longer term funding; if they and everyone with whom they deal are being subject to wild swings in currency rates and commodity prices; if there is no clarity about the framework of regulation, the structure of legislation, or the outlook for taxation – but only a well-founded pessimism that none of these are likely to change for the better; if they begin to see themselves as the targets both of material expropriation and Pharisaic condemnation – are they then likely to give full reign to their innate spirit of enterprise, to fully express their characteristic get-up-and-go and, by so doing, give the rest of us a greater opportunity to sell our wares in the marketplace for skill and sweat?

Hardly and therein lies the rub. For if we are to pull ourselves out of the quagmire into which we have stumbled, it will be to little purpose to take three short, backward steps before hurling ourselves deeper into the morass, not just with renewed energy, but while carrying the growing weight of mud which clings to our clothes as the result of each previous failed attempt.

Debt cannot be the cure for over indebtedness, nor a more rapidly debased currency the antidote to its ongoing debasement. We must forgo the intellectual conceit that we can impose some higher order on the seeming chaos of the world and instead we must simply smooth the way so that its own emergent properties can seek out a better constellation of interconnections, all by itself.

We must recognise that there are no workable macroeconomic solutions which can be laid down: that everything is a matter of functioning microeconomics building things up; that the diamond takes on its lustrous geometry, atom by atom; that the masterpiece hanging in the Louvre came into being brushstroke by painstaking brushstroke.

Only get the microeconomics right and all else will follow.

Make labour once more affordable and its terms no longer an indentured servitude for the employer. Ensure that entrepreneurship is no more risky than it has to be and that it reaps the full fruits of its success – as well as seeing that it bears the full responsibility for its failure – by clarifying law, minimising red tape, and, once this is achieved, by resisting the bureaucratic urge to tinker any further. Set prices free to perform their function, insist that markets are able to clear, and see to it that titles to property are both secure and simple to transfer.

Under such conditions, we will each help to build a lasting recovery for the other, one job and one company at a time, much more certain of our success – however much patience will be required in its achievement – than if we were to heed the thundering decree of some sweeping, Collectivist Five-Year Plan emanating from the mouths of the tin gods who frequent the Platonic centres of world power.

Financial markets may be broken, politics and mainstream economics may be broken, but, fortunately the economy of men is a robust, highly redundant network, furnished with its own immune system and self-repair mechanism, consisting of unhampered entrepreneurial search and action.

As Adam Smith famously remarked, ‘there’s a lot of ruin in a country’ – though, contrary to what our present rulers seem to believe, he was not issuing a challenge to them to seek to quantify its limits.

If we are to avoid that final ruin, if we are to properly rectify much of what is broken and not merely smother it in an inflationary balm and patch it over with a plaster of false accounting for a further, brief, electoral half-life, there are three things which we could and should usefully add to the list of the downcast and destroyed.

These are, namely: that unsound money which is truly the root of all evil; the unfunded mountains of government debt with which such bad money engages in a poisonous symbiosis of executive tyranny and political corruption; the duty-free but rights-encrusted, all-pervading Provider State which waxes fat on that unholy alliance of illusory finance and which not only robs Peter piecemeal to pay Paul, but empowers Pericles to oversee the theft, and so suffuses the commonwealth with a miasma of perverse incentives, ethical degeneracy, and irreconcilable conflicts of interest.

What lies broken, we can surely fix, but only if we break in turn the habits of mind and the tyranny of the man-made institutions which we first allowed to break the things we value – our freedom of association, our independence of action, and our individual chance of prosperity.

Flawed Fractions

First published 5th July, 2013 as ‘Free, Fractioned & Flawed’  by the Cobden Centre

It is unsound to distinguish between circulating and idle money. It is no less faulty to distinguish between circulating money and hoarded money. What is called hoarding is a height of cash holding which–according to the personal opinion of an observer–exceeds what is deemed normal and adequate. However, hoarding is cash holding. Hoarded money is still money and it serves in the hoards the same purposes which it serves in cash holdings called normal. He who hoards money believes that some special conditions make it expedient to accumulate a cash holding which exceeds the amount he himself would keep under different conditions, or other people keep, or an economist censuring his action considers appropriate. That he acts in this way influences the configuration of the demand for money in the same way in which every “normal” demand influences it.

Ludwig von Mises, ‘Human Action’, 1949

Of late, there has been a vigorous renewal of the old debate regarding the advisability or otherwise of allowing free banking institutions – otherwise unanimously preferred to that ubiquitous, illiberal cartel which operates with enormous legal and political privilege under central-bank tutelage – the right to issue their own ‘inside money’ in the form of ‘fiduciary media’ which have less than a 100% backing in whatever form of ‘outside money’ (e.g., precious metal bullion or specie) has come to form the fundamental basis for the currency.

Recasting this question in less esoteric terms, the argument is one of whether free banks should be allowed to increase their stock of demand liabilities (their ‘inside’ or self-created money) – namely, deposit book entries subject to cheque or immediate electronic transfer and their own proprietary issue of bank-notes and E-cards – beyond the sums representative of the stores of – let us say, for the sake of example – silver residing in their vaults (their share of ‘outside’ or exogenously-arisen money).

Though the Fractional Free Bankers (hereafter, the FFBs) generally concede that the stock of outside (or, as we might say, ‘hard’) money should be fixed so as to limit the generation of an undesirable degree of instability in the economy, they have no such scruples about permitting the sum of ‘inside’ monies from varying to a degree determined only by the narrow, actuarial calculus of the individual free bank.

Anything else, they say, is not only an unwarranted intrusion into the voluntary relations conducted between each free bank and its customers – who should have the right to agree even to a contract which the 100% reservists unwaveringly argue is logically inadmissible – but it is actually a sub-optimal economic solution, too.

The reasoning they apply goes something like the following. The ideal money is one whose use does not impair economic calculation because of changes emanating from the money ‘side’ rather than from the goods ‘side’ of each transaction undertaken with it.

Implicit in this asymmetry is the idea that while variations in people’s expressed valuation of a single good – as reflected in its price – send useful, specific packets of information about that one good’s relative scarcity (loosely, the balance between its available supply and the demand it experiences from all those aiming to buy it) and hence about the expense and effort to which people should go in making more of it, money changes affect all goods indiscriminately (since money, the generally accepted medium of exchange has no price of its own, per se) and hence these latter sow as much confusion as they bring disruption into the marketplace.

Running through this discussion are two intertwined sub-debates: firstly, whether money is a good in its own right, or whether it is itself merely a token, a ‘place-holder’, or accounting entry which records some prior contribution to production and, secondly, whether there exists a genuine distinction between that saving which is accomplished by a co-incident act of passing the saved command over present goods to another (i.e., investing it, for however short a time) and that brought about by that simple abstention usually scorned as ‘hoarding’ (which we shall hereafter refer to as the much less emotively-charged business of ‘sparing’).

In fact, one of the arguments the FFB team frequently advances is that since money is indeed ‘just another good’, there are no grounds for erecting a hindrance to entrepreneurs – i.e., fractional free-bankers – if they seek to meet evidence for an increased demand for it with a suitably increased supply.

Yet, this line itself entails both a paradox and something of a non sequitur. The first arises from the fact that, as we were earlier assured, changes deemed to emanate from a differently expressed demand for money were not supposed to be equivalent to those emanating from fluctuations on the goods’ side (perhaps, in this context, we should say the other goods’ side), which somewhat belies this opposing and treacherously bland denial of money’s special role in the economy.

The second failure of logic is the bound up with the idea that if money is just another good then presumably its multiplication cannot be as nearly costless to accomplish as one continues to suspect its grant to be, notwithstanding the FFB advocates’ rhetoric about the burden of such intangibles as establishing and maintaining the issuing bank’s reputation, or of protecting its liquidity, in addition to the firm’s further outlays on buildings, labour, equipment, and marketing, all means by which it promotes public acceptance of its brand and hence earns its lucrative contribution to the overall supply of money. Even if we do concede the fact that the replication of such monies is not completely free, they certainly are among the most easily reproduced of all goods, at least within a wide range of successive, marginal additions to the stock of fractionally-uncovered, ‘inside’ money.

The FFB school further suggests that, absent today’s statist interventions, each bank would not only be stopped from growing disproportionately to its peers – for fear of being presented with more net claims than it can redeem in outside money – but that banks collectively would still be precluded from expanding in concert because the width of the illiquid tail in the distribution of their mutual clearings would grow faster than the height of its expected zero-net mean and hence the costs of prudence would eventually outstrip the benefits of enlargement.

Even if we accept this rather arcane statistical hypothesis, this in itself, however, would still seem to rest largely upon the implicit assumption that a bank caught in that position would not have either formal or informal borrowing arrangements with its peers upon which to fall back in the event of such a statistical misfortune befalling it.

Although we must be of course exercise care in appealing too closely to a system which is perverted by the presence of fiat money, a central bank, state-subsidized deposit insurance, and the moral hazard of ‘Too Big To Fail’, it is nonetheless hard to say that banks have felt unduly cognisant of their basic liquidity needs during these past two decades of reckless hypertrophy. Much as often happened in Victorian banking crises, modern financial institutions – at least prior to 2008’s little embarrassment – came to rely upon the market itself to keep them out of difficulty – banking upon being covered by the highly efficient clearing house, stock lending, and securities repo markets which carry out some $1.5 quadrillion’s worth of annual transactions (some with a 99% netting success rate, in the US alone).

Lulled into a false sense of security by this mirage of systemic liquidity, leverage grew alarmingly, even without counting the mountainous contingent liabilities each bank tried to conceal among the footnotes to its quarterly reports.

Nor can one argue that they spent much time restricting one another’s activities too much by refusing each other credit or dealing lines. In fact, a glance at their aggregate balance sheet shows that, even now, as mistrust has grown and the potential capital costs of the new Basle III regime loom large in their calculations, two-thirds of the entries are made up of bank-bank transactions while in the enormous, off-balance sheet, derivative iceberg which lurks treacherously in the financial shipping lane, more than 90% of the more than half-quadrillion dollars of notionals outstanding involves another financial counterpart.

Be that as it may, the FFB’s reasoning is then often reinforced with an approach which openly relies upon the opposite interpretation of the nature of money – which is to say that it is no more than a datum of economic input, comprised of the counters which some all-seeing recording angel transfers to each individual’s credit whenever he or she sells something they have made, practices their skills, expends their sweat, or lends out their property for use by another.

Now, the argument runs, when a man is struck with a suddenly elevated sense of risk he sells but does not buy – when he ‘spares’ and does not invest what he thereby saves – he has ‘deactivated’ his small share of the medium of exchange and has thus served to make it unreasonably difficult for all his fellows to trade their goods and services with one another, in their turn.

Passing by the implicit aggregatism of much of what follows, we are told that, by not passing the money he has earned immediately back to another he is acting to reduce the ‘carrying capacity’ of the economic network much as if he were selfishly tapping into the electricity grid and draining off much-needed kilowatts simply to charge up his precautionary stack of batteries.

However, this argument only really holds if we also hew to the idea that to avoid a cascade of harmful side-effects, the quantity of utilised ‘money capital’ must correspond one-for-one with the actual physical goods available for purchase (especially where these are destined for purposes of reproductive, rather than exhaustive, consumption) and that it must do so at broadly unchanged prices, into the bargain.

To be fair to our FFB friends, we can perhaps resolve some of this inherent contradiction by an appeal to the overriding importance of the subjective over the concrete in much economic analysis, that is to say, by a much more accurate definition of what we mean by that very overworked, but often ill-defined term, ‘capital’.

As Richard Strigl (among others) made very plain, the mental image we usually conjure up when we hear the phrase is that of some actual capital good – usually a piece of long-lived machinery, but also a tool, a component, a building, and so forth – but it is crucial to realise that this explicitly physical entity only comprises actual economic capital to the extent that it is properly integrated into the structure of and participates in the processes inherent to ongoing production – a test it will meet by routinely generating sufficient net income to maintain itself in operation.

Indeed, the prevalent fetishism attached to such substantial forms and the corresponding lack of attention paid to the manner of their current or prospective employment is a major source of error in matters, not just economic, but investment-related, too.

Similarly, ‘spared’ money – if kept back as a precautionary reserve – may still, therefore, be a good, but it may no longer be considered a capital good. Its withdrawal – or we might better say, its reclassification – may, of course, have wider consequences, much as would a similar alteration in the status or employment of any other entity, since capital formation and, alas, capital consumption are part and parcel of any dynamic economy.

Bah! Humbug!

That having hopefully been clarified, let us look at the alleged difference between saving-investing and sparing to see if we can discover any irrefutable reason why we should favour – indeed, facilitate – the one and yet fight to neutralise the other.

If I save, the first thing I do is abstain from immediate (exhaustive) consumption and, in seeking a home for my increased funds, I may well transfer my potential command over the foregone goods to a third party, via the purchase of a financial claim. Regardless of whether this investment is conducted in the ‘primary’ (or fund raising) or the ‘secondary’ (title transfer) market, it will serve to furnish the claim’s seller with a ready means of purchase in my place.

Alternatively, I may simply leave the balance on deposit at the bank (or at one of that bank’s regular correspondents) which had earlier granted a loan to the man for the very purpose of buying whatever it was I sold to him in order to raise this money. Effectively, via the intermediation of the bank, I have unconsciously lent my customer the means to enjoy current goods which he previously did not possess.

Hopefully, but not necessarily, the man who takes them off the market will transform them into capital – i.e., as discussed above, he will put them to use in a productive act which is intended to bring a net material addition (and an increment of value) into being in compensation for the effort and outlay involved.

Another way I may save is by using my sale proceeds to discharge an outstanding debt. If this debt was part of a book credit offered me by some non-bank entity, it is easy to see that my delivery of money to my creditor similarly promotes him to into my place as a likely customer of someone else.

If I owe the sum instead to the bank, it is true that to pay this back potentially shrinks the outstanding stock of money, though the often overlooked corollary is that this presumably liberates the lending or securities buying capacity of a bank which may now feel it has more reserves, or more capital, than is optimal. Even if the bank decides that an increase in its own prudential ratios is in fact warranted – and so does not seek to replace me as its obligor – far better to allow me to do this voluntarily than for the bank to withdraw its facilities in a summary fashion from some other whose livelihood is still reliant upon them.

However, what I might also do is take delivery of a sum of ‘outside’ money – say a quantity of silver coins – and commit them to safe keeping, whether at home or in a safe deposit box – or I may simply leave untouched the pre-existing demand deposit balance made over to my name in settlement of my unmatched sale of goods, a deposit against which the bank, of course already holds some asset and so which remains similarly passive.

Now, by ‘sparing’, I clearly make no such direct, onward provision for another to take my place in the queue for the checkout desk but – to the extent that whatever goods of my habitual uptake I chose not to consume fall in price on that account (or whatever other goods so decline because their demand was predicated upon my usual vendor’s subsequent use of his receipts from me) I still transfer real purchasing power to all other present holders of money.

Now if, as is often the case, my decision to ‘spare’ has come about because my perception of the degree of economic uncertainty has increased and if this angst is mirrored by others, it is likely that the next most eager buyer of the goods after me may also be chary of offering any lasting lien over the success of his enterprise or the strength of his balance sheet as part of their acquisition. Alternatively, the typical lender or equity investor to whom they might turn might be similarly reluctant to accommodate even those who are not so discouraged.

But if a substitute buyer does now emerge who has decided that, at this newly lowered price, the goods in question cross both the threshold of his list of subjective wants and fall within the limits of his available monetary means, he may be relieved of the need to borrow from me, or anyone else, and the one-off nature of the cost incurred in their purchase (as opposed to the ongoing, riskier one entailed in either selling a stake in his business or giving someone a continuing first charge over its earnings) may make him correspondingly more eager to proceed.

But, in either case, the fact that the goods can now be had without having to give any deeper a commitment than to hazard a diminution in his cash holding, may make their purchase all the more likely and may thus prove a swift and effective counter to any supposed ‘blockage’ in the circulation of goods and services which my actions may have caused.

The only real caveat here is that the good’s seller, disappointed at my lack of custom will not reduce them sufficiently for them to be sold to anyone else; that he resists marking them down to their new clearing price. As W. H Hutt took great pains to elucidate such a process of ‘withholding’ – whether of goods or labour or whatever – is the real cause of economic constipation, not my simple refusal to spend.

The more readily the withholder can persuade himself that some deus ex machina of the credit market will somehow provide him with a better price for his wares, the more likely he is to resist liquidating them. This leads straight to the inference that, once again, the knowledge that money may be manipulated in one’s favour only enhances the natural temptation to shy away from the immediate realisation of a loss and so, often, traps one into suffering a greater one in future. We shall return to this theme later.

To the argument that this is cold comfort to the man whose cashflow I have so callously reduced (or a similarly chilly one for those who depend on subsequent disbursements of the same), all that can be said is that such a disappointment may have occurred even had I save-invested and not spared, or paid down a bank debt since no-one in the world shares my uniquely individual, subjective, ordinal listing of wants and so, by that token, no-one is likely to be an exact replacement for me as a consumer of specific goods, in any case.

Thus, the truth is that even if I had pressed my money into the hands of the next man I bumped into in the street and bidden him to spend it, my favourite bar, or the shop where I regularly buy my groceries would still have been at risk of a drop in their takings. The economic ‘data’ – to use Mises’ somewhat dry terminology – have changed and if someone has been over-reliant on me not contributing to that change, well, they have my sympathies, but do not arouse in me any feeling of guilt, nor to they have me clamouring that either an all-knowing central bank, nor a purportedly more sensitive network of FFBs should immediately step in to compensate for my sudden lack of appetite.

Nor is it entirely clear how ‘hoarding’ money – to give it its full, pejorative flavour – is altogether different to ‘hoarding’ something else of wide-ranging economic significance like petrol or potash. The first ‘hoarder’ of these may also trigger other, precautionary acts of ‘hoarding’; this will increase the scarcity of the ‘hoarded’ entity in a manner few had foreseen; this will bring about economic disruption, plan failures, and a winnowing out of the weak and under-capitalised across the economic structure.

But, ultimately, just like money, the ‘hoarder(s)’ cannot live on fuel or fertilizer alone: they must realize some of their stockpile – albeit, on better terms than before they started (at least at first). Soon, however, it is likely to be the case that they will face the same problems in first maintaining, then liquidating their ‘corner’ that many have experienced before them, viz., that they will have (a) destroyed some of the demand for their product; (b) promoted a discovery process which may reveal a permanent means of economising on its use; (c) stimulated supply (about which more in a moment); and (d) confounded themselves with the challenge of not driving down the exchange value of their inventory, perhaps even more violently than they first elevated it.

To Catch a Falling Safe

FFB supporters will tell us that all this could be avoided if we simply cut to stage (c) by allowing their banks to increase the quantity of money smoothly, proportionately, and on a semi-automatic basis. This is where we both encounter a distinct sense of unease and fall prey to suspicions that the story is just a little too – well – Just So.

The disquiet comes because we insist that for it to be as ‘hard’ as we feel is ideal (in order to avoid the wasteful hysteresis of the business cycle) money must be a good with a cost of production at least commensurate with that of other goods. So, as Mises unequivocally proposed, let people go out and dig more metal from the ground if they really must (so as to provide us with more ‘outside’ money), but let us not allow a narrow community the power to create it with the stroke of a pen or the click of a keyboard.

Nor should we introduce a controversial means of money multiplication – with all its latent dangers of abuse during the upswing – by assuming that this virtuous elasticity will spare us the traumas of the dreaded ‘secondary depression’ and so be well worth the risk. Two aspects of this contention need a closer examination than they usually receive from the FFBers: will their banks actually do what they think they should and expand their unreserved demand liabilities at the height of a money panic rather than scrambling themselves after liquidity and so aggravating the crisis; and, absent a prior, fractionally-pyramided, money and credit bubble to over-extend men’s means, can there even be such a generalized sauve qui peut as is herein imagined?

As for the first of these, let us reiterate that, for its promulgated mechanism to work, the FFB circle implicitly assumes that at this, the point of maximum fear, the bank will quickly recognise my deposit’s likely inertia and will chance its arm to increase its earning assets by supplementing my dormant holding with a newly-created other, something it can only do by extending a new loan or buying a longer term financial claim whose rather more unquestioned marketability during the boom had gilded it with a thin sheen of ‘moneyness’ now cruelly revealed as a sham, with drastic implications for its pricing, here in the bust. Twenty-five years in both the practice and the study of financial markets persuades your author that bankers – famously known as men who offer you the use of an umbrella only when it is not raining – would ever proceed in this manner!

Turning to the second question, we confess to a feeling that if money were really ‘hard’ – and so, for us, 100% reserved and difficult of increase – the amount of credit erected upon its durable foundations would be less prone to a dangerous and even reckless top-heaviness; that the extinction of credit could not itself reduce the supply of money (as the imploding fractional process would do) and so prevent the ‘real balance’ effect from eventually stabilizing prices; and that the acquired understanding of how a hard money system works – complete with its benign, productivity-led, secular fall in prices – would bring about a gradual shift towards an ever greater reliance on equity finance and an equal-and-opposite withdrawal from our endemic inflationary gaming by which we routinely incurring ever more debt to dress up returns, to flatter our income, and to falsely bolster ‘growth’ – and Miller-Modigliani be damned!

Even if we set aside these objections and accept the FFB view, a further difficulty quickly arises regarding the implementation of any stabilization policy – i.e., one aimed at preventing a feedback between the ‘real’ and the money side of the economy whereby the decline in one exacerbates that being suffered in the other – whether this offset is centrally-directed from above or spontaneously-emergent from below.

The centrally-planned solution that we all now have to endure suffers most obviously from the classic Hayekian ‘knowledge problem’ of being ignorant of what signs to monitor, in how timely a fashion they must be gathered and interpreted, and what actions they should then induce as a corrective.

This is too big a topic with which to deal fully here – indeed, it has, in one form or another, comprised the core of the author’s commentaries over the past decade and a half! Suffice to say that many of the more enlightened (if not all the Austrian-inclined) analyses tend to converge on the idea of wondering whether we might stabilise nominal income by an appeal to the tautologous ‘equation of exchange’, MV=PT – that is, that the volume of money turned over in a given period (the product of its supply, M, with its ‘velocity’ V) necessarily equals all money transactions taking place within the economy (exchanges of physical goods, T, weighted by their money price, P).

The first thing to say is that idea of maintaining the volume or even the flux of monetary circulation should not – as some have suggested – be confused with targeting nominal GDP since this clumsy statistical artefact is far too biased towards final, exhaustive consumption (and, worse, to government spending of a fundamentally uncertain value) and to end up promoting excess exhaustive consumption in a bust is only to increase, not to diminish, the destruction of capital, a harsh truth rarely grasped by your average, pull-push hydraulics, mainstream macromancer.

But, even if we widen this to the aim of stabilising a more soundly-based measure of nominal transactions (i.e. of including all those significantly larger, intermediate exchanges largely netted out of the GDP arithmetic)– most easily proxied by non-financial business sales – there is a further caveat that what looks like a ‘hoarding’-led decline in velocity (the rate of money turnover) may, in fact, be a reflection of a monetary surplus brought about by the removal of many higher-order stages in what is, by definition, an overly-extended, far too ‘roundabout’ economic organization.

To see this, imagine that a firm which once bought the grain, milled it, baked it, and retailed it all under one roof only pays its workers and its suppliers of one input and only sells to one set of customers, requiring many fewer monetary interchanges than if each of these stages were hived off into a separate, specialist enterprise. As the over-stretched and under-capitalized layout of the boom economy snaps back into a more sustainable configuration, many such stages, erroneously laid out during the misleadingly easy money conditions of the boom, will be eliminated, reducing the number of sales and purchases as it does. Though many of these will involve only credit, there will inevitably be an extra call on money involved as well

Thus, if velocity falls – something the FFB bank is mooted to register and then counter-balance because of the palpable reduction in the clearings it must undertake – it may not be just because money is becoming immobilized in ‘hoards’ but because actual transactions volume is shrinking as it must if the adjustment is to be allowed to run on unhindered.

Conversely, if many of the boom’s dealings were undertaken outside of the banks – i.e., on the securities markets, or via the direct extension of intercompany trade credit – there may actually be a dash to make avail of those same backstop lines of credit which the fee-hungry banks typically insist its capital and money market customers take up when the skies are cloudless and their utilisation is likely to be scant, indeed.

Thus, the hypothetical negative feedback of lowered money transmission and lesser bank clearings leading to an equilibrating expansion in money liabilities may prove a chimera, since the link between the first and second may not only be broken, but rewired with an opposite polarity.

All in all, we hope we shown that we have sufficient reservations – both in theory and practice – not to cast our lot in with the FFBers on this issue.

No Compensation

Perhaps we should give the last word on the foregoing not to Mises and Rothbard – who were, of course, just as vehemently opposed to fractionalism as they were avidly in favour of free banking – nor to such ‘stabilizers’ as Roepke, or the more Wieserian Hayek (who seemed to become ever more woolly-minded and impractical on this issue as time went on) but to Richard Strigl, a less well-known member of the Pantheon, but one who provided us with one of the most detailed and clearly-worded expositions of the structure of production, the nature of capital, and the business cycle in his 1934 work, fittingly – if unimaginatively – entitled, ‘Capital and Production’.

It is true that in the relevant Chapter 3, section 3, Strigl deals with the standard framework, i.e., one which is dominated by a central bank, but nonetheless his unequivocal distinction between what might happen and what will happen if we attempt to offset hoarding remains, I think, decisive, even when we relax that constraint.

Firstly he makes a case which I think today’s primary FFBers such as George Selgin and Steven Horwitz would share as to why such a move might be desirable.

“… An elasticity in the volume of credit can be demanded without the adaptability of the money supply [thanks to ‘hoarding’], thereby leading to an interference of money in the structure of roundabout methods of production… If the central bank could completely oversee the conditions which require the expansion or the contraction of credit from the point of view of the ‘neutrality’ of money… it could [do so].”

“’Additional credit’ that the central bank grants in order to compensate for the effects of hoarding are not ‘genuine additional credit’, but ‘compensatory credit’ and [ditto] restrictions… However, the central bank has no reliable indicator for such a policy; there is nothing in the economy that can directly inform [it] whether the supply of credit is greater or smaller than the supply of ‘real savings capital’.”

In the money and credit economy there is no market on which the ‘artificial’ influencing of the supply of credit would immediately lead to a disruption. Here, the rule holds that the influence on the capital market from the side of money can only be recognised by the effects which [genuine] expansions or… restrictions have.”

“…As a consequence, an ideal functioning of money in the sense of a neutral money can probably never be expected.”

Our contention, argued above, is that this lack of what Strigl terms an ‘omniscient institution’ cannot just be assumed to be made good by its substitution with a multiplicity of FFBs, each concerned only with maximising profit under the constraints holding of the lowest possible reserve consistent with statistical safety, as indicated by their expectations of likely clearing conditions.

Strigl further goes on to warn explicitly of the purely theoretical validity of this business of a neutral money, pointing out in a footnote to the above that:-

“… In the stationary economy, monetary influences lead to ‘disturbances’; hence there is a question under which circumstances these… do not occur, i.e., that money is ‘neutral’. Here the question regarding the neutrality of money is hence a question regarding the monetary conditions of the stationary course of a money economy.’

The crucial point here is that the concept of a ‘stationary economy’ is an abstraction of the economist’s mind, adopted so as to hold at least a few of the ceterises briefly paribus in a way that the real world denies him the chance to do. Strigl is thus making clear that what seems logically unimpeachable in this Gedanken experiment should not imply a prescription for how to order matters amid the messy dynamism of the real world.

Strigl further questions the practicality of such measures in a lengthy appendix, ‘On the Problems of Business Cycles’. After dealing here in more detail with the progression of the downturn, we reach the point where “…a withdrawal of money capital from the circulatory flow of the turnover of capital” – our accursed itch to hoard – takes place, implying that “a compensation without damage” – such as the FFBers presuppose – “would seem conceivable here”

But, says Strigl convincingly, this will be just the point where the only ones willing to take up this newly-available credit will be those who, otherwise, “…are forced to liquidate, to make emergency sales or to cease production due to a lack of capital…” for whom “…any credit means at least the monetary avoidance of losses and perhaps even the potential for later improvements.”

However,” he goes on, “satisfying this demand implies delaying the liquidation of the crisis, lengthening and strengthening it. For it is essential that a significant demand for credit by those who would like to work towards continuing the boom, that is, an ‘unhealthy’ demand for credit, exists along wit a significantly reduced demand for new, sound investments.”

Here we are back to Hutt’ s insights on how voluntary ‘withholding’ – which we could even term, speculative denial – means Say’s Law breaks down and markets no longer clear, perpetuating and propagating the misery of the bust.

To be sure,” Strigl continues, “ these explanations are highly schematic. However, they can show that the chance of a compensating expansion of credit in the recessive phase of the cycle is in practice very small; that there is hardly any chance of financing production processes which can be lastingly continued: and that the danger, instead, that additional credit prolongs and makes the crisis more severe is very large.”

As for that other canard of modern ‘re-inflation’, i.e., boosting consumer expenditures, our sage is also very forthright about its malign effects:-

“…a cycle policy is also conceivable which, by enlarging consumption would try to avoid those effects of ‘decapitalization’ which consist of the loss of demand for consumer goods. Here, additional money would function such that it would replace the money withdrawn from circulation and would demand consumer goods for pure consumption in its place. The movement of goods would thus be the same as if the money withdrawn… had served consumption.”

We have already pointed out that withdrawing money from investment and using it for consumption is the same as consuming capital” – a quantity of which, you will recall, the higher orders we are trying to prop up is already suffering a desperate lack.

In addition, some effect on relationships for cost prices must also surface in the form of support for cost prices…” – are you watching, Mr. Bernanke? – “Thus, the policy of financing consumption must in the end cause the emergence of price relationships that make an improvement in the potential for new investments more difficult… The ‘artificially’ created demand for consumer goods will ultimately also create an increased need of for operating capital (sort-term investments) and will make these… increasingly profitable. This, too, must serve to weaken the forces that work in the direction of removing the obstacles which stand between short-term investments and long-term capital markets.”

In conclusion, let it be said that a guideline for determining the extent of credit that should operate in this way does not exist.”

We insist that neither does it exist when Fractional Free Bankers, rather than the central bank, are doling out that credit, even if we stretch our credulity to believe they would be so inclined to do, just at the moment when the economic prospects were at their bleakest and the cause of their own survival was therefore paramount.

So, in banking, by all means give us freedom, but also give us freedom from fractions, for we believe that the benefits of their permitting their use within an otherwise demonstrably superior framework to be too largely illusory and their potential drawbacks all too threatening to make the experiment of their introduction a rational one to conduct.


Hurricane Cassandra

First published 8th August, 2008

When the music stops, in terms of liquidity, things will get complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Citigroup CEO Chuck Prince, FT Interview, July 2007

How things have changed in the short space of a month.

For, right up to the second half of July, world equity markets were still raging ahead in utter denial of the spreading cracks in the credit boom, with both the S&P and the emerging markets indices making new highs in that time .

This was despite the fact that all the technicals were signalling the need for caution – elevated sentiment readings; record high margin longs on the NYSE; record low mutual fund liquid asset percentage holdings; a turn in the breadth of the market (that for the Nasdaq has, indeed, since hit multi-year new lows); volatility indices climbing with – rather than against – the rise in stocks.

More crucially, there was still an attempt to downplay the magnitude of the problems finally coming to boil in what has arguably been the most spectacular mass hysteria in the whole sorry history of financial market manias – the multi-trillion Ponzi scheme of credit we have created since the collapse of the Technology frenzy.

We have long told anyone arguing that commodities have occasionally displayed bubble-like behaviour that they were no more susceptible to this kind of infection than any of a number of other asset classes – both conventional and ‘alternative’ – and that this was unlikely to pass until the we had removed the cause of all this mischief, namely, the credit bubble which had continuously been inflating prices everywhere you looked (though, ironically, everywhere the central banks were choosing not to look, at the same time).

The real bubble, we maintained, was in credit: all others – whether in lead futures, LBO targets, Patek Philippe watches, or Modernist daubings – were ancillary to what the woefully uncomprehending ex-Fed Chairman once called a ‘conundrum’, but which was, in reality, all too understandable a phenomenon.

In saying this, we would be assailed on the one side by starry-eyed mining promoters (many of whom had increasingly only come across a ‘mine’ in the reference section of the Harvard library) who would insist on telling us that our caution was misplaced; that we ‘didn’t get it’ because we didn’t understand China’s influence on the supply:demand dynamics of the metals concerned (sic!).

On the other hand, we have been haughtily dismissed by institutional investors who could very well scoff that, say, nickel might be overstretched in the near term, but who were still perfectly content to buy yet another gallimaufry of dubious, rag-tag credits from their over-eager investment bank account managers, each secure in the belief that the hocus-pocus which purported to value these baskets afforded him a wide margin of safety.

As the events of the past few weeks have begun to reveal, however, this last presumption has proved just as fatal as all of its many less-than-illustrious predecessors in the perpetration of mathematical hubris.

Indeed, it is a compelling testimony to our capacity for pseudo-rational self-delusion that so many could still cling to the idea that something as intensely self-reinforcing as the financial markets – institutions in which those highly non-linear and inherently unquantifiable actors known as ‘human beings’ are at play (and largely with Other People’s Money, at that) – can ever yield to the same statistical calculus as a laboratory vessel full of inanimate gas particles.

Without delving into the wide chasm between ‘risk’ (a realm where models can be made to work) and ‘uncertainty’ (one where they decidedly can not), without drawing upon the insights of Austrian epistemology, without citing Nicholas Taleb’s famous metaphor of the ‘Black Swans’, did no-one stop to think that if their model was supposed to be so hot, then so, in all likelihood, was everyone else’s?

Had they done so, they would have realised that not only must buying assumptions have become claustrophobically crowded (i.e. very efficiently irrational!), but that – far worse in its implications – once the market turned, all these blessed computers would be revealed to be disastrously mispriced in one horrible unison.

After all, if everyone was running much the same CDO-analytical version of Deep Blue, did no one ever ask themselves whether they were really enough Gary Kasparov’s out there on whom to unload the junk once the models all began to flash, “Sell!”, at the same time?

Obviously not. And yet, even now there is a current of denial still insidiously at work in the minds of people who don’t wish to acknowledge that their own deeds, as members of the undiscerning Herd, have given rise to what they insist on misconstruing as just one more ‘six sigma event’.

Apart from “the problem is fully contained” school of hopeless little Dutch boys and the usual crowd of “buy the dips (preferably from me)” chancers, the air is filled with the dreary strains of that eternal Chorus intoning “the economic fundamentals are sound”, even as all manner of high-falutin’ investment schemes implode around us.

Have you ever remarked upon the strange fact that when asset prices are rising, their ascent is the inescapable consequence of a solid ‘fundamental’ underpinning – no matter how unrealistic have become the valuations of the assets the pundit himself is touting. The market is, after all, a ‘discounting mechanism’, don’t you know?

Now, contrast this with the reaction once that same market suffers one of its periodic bouts of vertigo. Far from being an unbiased reflection of disembodied knowledge, the reversal can now only be ascribed to an access of the vapours on the part of a few ill-informed neurotics!

What is more, this asymmetrical mental ratchet effect (in part, the sort of ‘model arrogance’ discussed above; in part, wishful thinking; in part, cynical salesmanship) misses the fact that just as financial market conditions exert a clear and undeniable influence on the real economy in the upswing (we do mostly direct our efforts toward the prospect of monetary gain, remember), they can hardly fail to do so in the downleg as well.

To those who would here interject that this is all irrelevant because ‘”for every loser there is a winner”, we would point out another glaring asymmetry – not that which exists between sellers and buyers, so much as that between assets and liabilities in our highly-interconnected world.

To aver that the gains made by the man who sold a since-fallen stock at the top constitute a zero sum with the losses of the man to whom he sold is a statement which only holds at an immediate and individual level: at the systemic one, the truth is never so reassuringly self-correcting.

For a start, our self-congratulatory high-seller will probably have plunged straight back into the market and bought some other claim on Dame Fortune with his gains. Being still exposed, therefore, he may well see his notional profit eroded as his new holdings are, in turn, pulled lower – perhaps as a direct consequence of his original counterparty’s distress.

More importantly, the top of the market for this particular asset was unlikely to have been reached thanks to a calm shifting of a greater proportion of a finite pool of money preferentially from its alternative outlets: alternatives which therefore had to cheapen both relatively and absolutely and whose countervailing decline must, accordingly, have exerted a genuine, intrinsic mechanism of restraint on the game.

Instead, the system in which we must operate is inherently unstable, like the moisture-laden, summer air over the warm tropical ocean.

Only let a share, or a group of bonds, or a new-fangled class of derivative instruments puff up, lazily, into the view of speculators and their avid lenders and, before you can say “the ghost of John Law”, the hot winds of credit are filling it and driving it higher and higher into the troposphere – an ascent which not only induces more and stronger currents of air to lift it yet further, but which catches all other asset classes willy-nilly along with it in its swelling updraught.

In this regard, what we have lived through, these past few years, is nothing less than the genesis of a Category Five, super-cyclone – one whose terrifying eyewall is a screaming vortex of collateral-debt-derivative feedback.

Once such a storm breaks, our asset-liability bind will be seen to be the critical weakness, the Mississippi levee whose failure could well swamp us all.

Granted, it is the case that every debit has somewhere a corresponding credit, but this also means that everyman’s fate is intimately bound up with that of his neighbour.

As Fritz Machlup pointed out in the 1930s, if A lends to B who lends to C, who in turn lends to A, it is indeed the case that – at the aggregate level – everything seems to match up, but this does not mean that it also cancels out. If C encounters difficulties and informs B he is broke, B will default on A and A will then be unable to meet C’s call for the cash with which he hopes to disembarrass himself. All will be ruined together.

Therefore, even if we personally have not been knowingly playing the ragged edges of the credit game, the fact that the mighty hurricane which looms above us made its first landfall in the sprawling, plasterboard suburbs of sub-prime is no reason for complacency for, as is just beginning to be glimpsed, sub-prime is itself no more than a particularly indefensible subset of the far more widespread dangers we all now face.

No, the world is not going to go into a tailspin because of the travails of fifty-odd thousand poor fools whose painful desire to make a fast buck flipping condos met a none-too-choosy lender with similarly short-sighted motives.

The plain fact is, however, that Hurricane Cassandra (so named because no one would heed the many warnings given, instead of carrying on frenetically dancing the Chuck Prince Charleston) never limited herself to such a low-rent corner of the world.

Rather, the whole colourful motley of hedge fund gunslingers, private equity barons, bond insurers, CDO traders and fixed-income investors – the whole, out-of-control business of M&A, of vast share buybacks, and hence of main market equity outperformance, as well as emerging market re-rating – the whole self-aggrandizing swagger of the Bulge Bracket bonus bonanza – all of it – every last red cent of it – has been, in turn, cause and effect of the build-up of the storm system which now threatens to sweep this Big Easy of false prosperity away, leaving little but the matchwood of shattered dreams and disabused expectations in its wake.

If all of the foregoing doesn’t strike a cautionary enough note to give you pause, Dear Reader, when you hear the Siren whispers telling you to dive back in now that things are ‘cheap’, there is one last sobering question to contemplate.

In our Austrian vision of the world, the business cycle IS the credit cycle. Overeasy credit encourages too much investment in too many false projects. Financiers become reckless and entrepreneurs are mislead en masse to see real opportunity where there is only the shimmering mirage given off by hot money.

What is more, the cycle tends to manifest itself in a lengthening of the productive structure, in undertaking investments increasingly removed from the immediate provision of consumer goods, and especially of consumer staples. Another crushing asymmetry comes to bear here, as a result.

This lies in the fact that it is far easier to lengthen the structure – to use easy money and expensive shares to build plant, lay pipelines, and fill the factory with banks of gleaming, new, highly-specialized machinery – than it ever is to shorten it again – retooling the assembly line for a different use, bringing a different ore out of the mineshaft, even breaking the equipment profitably up for scrap – when the premises on which these bold steps were taken prove to be mere falsehoods spun amid the prevailing mood of financial incontinence.

If, therefore, the credit cycle really has turned here – and this is surely the best candidate for marking that decisive change of phase we have had for some years – we cannot fail to reckon with serious, real world implications as the squeeze progresses, as returns on investment falter, as orders are cancelled and jobs begin to be lost.

Accordingly, as we try to extricate ourselves under from the falling masonry of financial foolhardiness, what we must be asking ourselves is which company (or, indeed, which resource) has received the greatest short term boost from the recent asset inflation and has therefore become the most over-extended and vulnerable to its subsequent evaporation.

Conversely, we must also try to identify those who have been conservative enough, or who will hence react sufficiently rapidly (or for which resource we will still find the matching of physical supply to genuine, end demand a considerable challenge) and who or what will therefore best weather the onrushing tempest, offering real, long term value, no matter how beaten down the traded price becomes in the interim.

Answers on a postcard please, but we suggest you draw the lesson from sub-prime and start by looking for the corporate equivalents of those who took out – as well as those who looked like geniuses for extending – larger and larger chunks of ‘NINJA’ loans (‘No Income, No Job or Assets’), even as the ship was visibly heading for the rocks.

If you do, you’re sure to find more than enough candidates to keep you out of mischief for some good while to come.

MMM Approach

At root, MMM is based on the belief that the Credit Cycle is the Business Cycle; that fluctuations in money and credit are what give rise to instabilities in economies. It is our lot to live in a period where the checks and balances on such turbulence are much less robust than ever before; one where the deliberate violation of such restraint as does remain has become the very goal of active policy. To try to understand the interplay between money, asset markets, and the real world is the crux of what we do.

There is not much here that is a dull repetition of the mainstream economics practised so widely today. It may be a strange confession for the author of a publication called ‘Money, Macro & Markets’, but we like to start thinking about things from the individual perspective before working upwards to the collective – from micro to macro as it were. No spurious pseudo-science, just the rigorous application of logic tempered in the forge of experience.

For more detail, please download the Intro:-

16-04-28 MMM Approach

MMM Archive

Regular readers will know that the articles published here are but a small subset of the detailed work I undertake to analyse economic and political developments and their effects on markets. In order to give some idea of the scope of this, presented below is an archive of past issues of the Austrian School-informed, in-depth monthly publication, ‘Money, Macro & Markets’ in addition to which I compile twice monthly updates as the ‘Midweek Macro Musings’ which are also made available on a complimentary basis to subscribers to the former letter.

September 2016 – US equity (over)valuation: Eurozone policy overkill: Japan’s dire fiscal status

16-09-29 MMM Sept Issue

July 2016 – Liquidity traps: Post-Brexit UK: Chinese credit

16-07-20 MMM July Issue

June 2016 – US Labour Market: Productivity Unpuzzled

16-06-20 MMM June Issue

May 2016 – IMF Ship of Fools: China the Next Sucker

16-05-12 MMM May-Issue

April 2016 – UK deficit – Fred Karney’s Circus: China’s Drain: US – All in Order

16-04-11 MMM Apr Issue

March 2016 – ECB Overkill: The Farm Patch goes Oil Patch: Beijing Fingers in the Dam: Drilling Down

16-03-10 MMM Mar Issue

February 2016 – China Hopium Wars: USA Top-end Teetering: Saudi’s Empty Quarters: Is Cheap Oil Good?

16-02-10 MMM Feb Issue

January 2016 – China promises reform (again): The Fed finally does it: Carney sees no signal: ECB running out of debtors

16-01-12 MMM Jan Issue

November 2015 – Hocus Pocus: UK Sells the Family Silver to Europe: USA ABCT: China JIitters

15-11-11 MMM Nov Issue

October 2015 – Against Stupidity: Tail-chasing at the Fed: Lipstick on the Chinese Pig: Stocks (& Bonds) for the Long Run

15-10-12 MMM Oct Issue

September 2015 – Mississippi Bubble Chinese-style: Reserves & Repos Cheatsheet: Shuddup, already!

15-09-01 MMM Sep Issue

August 2015 – China’s Fake Boom: FRB Wash, Spin, Repeat: UK World per capita Deficit Champs: Euro Money Explosion: Real Commodities still not cheap

15-07-30 MMM Aug Issue

July 2015 – China & the Water(ed) Margin: Spending the Swiss Hoards: Behind the Fed Curve: CPI Mania goes Global: US Equity Valuations

15-07-30 MMM July Issue

June 2015 – China Running to Stand Still: USA Fewer Grasshoppers per Ant: UK New Regime, Old problems: Europe’s Rational(ized) Bubble

15-07-30 MMM June Issue

For subscription details, please refer to the HindeSight Letters page.

Money, Macro & Markets – The Archive

Regular readers will know that the articles published here are but a small subset of the detailed work I undertake to analyse economic and political developments and their effects on markets. In order to give some idea of the scope of this, presented below is an archive of past issues of the Austrian School-informed, in-depth monthly publication, ‘Money, Macro & Markets’ in addition to which I compile twice monthly updates as the ‘Midweek Macro Musings’ which are also made available on a complimentary basis to subscribers to the former letter.

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The Road to Canossa

That the artificial interest rates in evidence in our hugely distorted capital and money markets can be made negative in nominal as well as in real terms is, alas, the curse of the modern age. Though entirely at odds with natural order – as we have repeatedly tried to make plain – they are also a curse that we are unlikely to have lifted any time soon, especially not in a Europe where there is no effective restraint to be had upon the exercise of his awful powers by the likes of a fanatic like Draghi.

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Thoughts on Gold

A brief, pictorial essay seeking to illustrate a few salient features of today’s gold market, such as what underlying factors drive the gold price? How ‘cheap’ or ‘expensive’ is gold on a relative and historical basis? Gold or gold miners, that is the question. How is the gold market positioned? What do the technicals say about gold’s possible future direction?
Read the thoughts of the author of ‘Money, Macro & Markets‘ courtesy of HindeSight Letters

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Viennese Primer

The original of the following, somewhat edited statement was first posted on the Mises Institute website all of 10 years ago but, despite the somewhat archaic corporate references (and we have, of course, had many bigger and badder examples of misadventure since then), it still provides a useful frame of reference to the school of thought to which I belong.


As often in the wake of an episode of financial meltdown, the cosy complacency of the economic world has been shattered and reformed among more factional lines. For their part, the failure-of-capitalism school have shaken off a VERY brief interlude of introspection to come back, red in tooth and claw, to blame all the ills of the times on the mythical beast of ‘market fundamentalism’ rather than on the disastrous crony corporatism which had been engaged in by their hallowed public sector on the one hand and a motley crowd of strutting CEOs and Old Boy Network oligarchs on the other.

In reaction, those who are wholly unconvinced by the tendentious – but oh, so opportune – scribblings of a Piketty or who are infuriated by the daily ravings of that intellectual charlatan his opponents refer to as the ‘former economist’ Paul Krugman have been casting about once more for an opposing  banner under which to muster.

Many of the more vocal among them – especially when they have a fund to sell you, or a column to promote – have positioned themselves in the media as ‘Austrians’, even though their views are often little more than a precious metal, prepper-mentality parody of the School’s thinking. Because there is no trademark on the name, and since the Mises Institute issues no Seal of Austrian Approval, our only real hope is that these good people take time off from talking to the press, or trying to part you from your hard-earned cash, and spend more time reading instead.

If they do, they will find that Man, Economy, and State by Rothbard, and Human Action by Mises, are both online, but that the opportunity costs of such deep study are high. The same is true of the expansive Austrian Study Guide posted on Mises.org. There is a quiz to help, and 20,000 have taken it—all to the good. But even the quiz and audio content may prove too much to handle in our times of 140-character commentary and Instagram exegesis.

So in the interests of broad public understanding, I here present an admittedly imperfect Austrian Economics in one short article:

Philosophically, the idea is that Man is a rational actor insofar as he tries to increase his well-being, or to decrease his “unease,” through purposive Action.

However, each man’s individual motivation in Acting—his pleasure/pain scale, if you will—is wholly different to that of his neighbour’s and it is an ordinal one—with little scope for quantitative measurement and certainly none for aggregation.

In this focus on the subjective elements of a man’s choice, all value – and, hence, all utility—originates. These are constructs of the human mind and explicitly not some derived property of the physical world.

Value is thus a specific, not a generic, quality and varies according to time, place, and circumstance—e.g., a thirsty man in the desert is glad to exchange gold for water, while a visitor shivering in the rain at the English seaside may be willing to pay good money to be spared having to endure any greater supply of the stuff.

Developing this idea, Austrians were in the forefront of the Marginalist revolution; an advance which realized that choices are made (and hence valuations formed) “at the margin.” This alone was enough to correct errors which had long confounded both classicists and Marxists.

By marginalist, Austrians mean that a person makes an exchange only after making a favourable, subjective mental comparison of the cost of forgoing the most willingly surrendered (the most “marginal”) tradable quantum of his existing property with the benefit he expects to enjoy from the corresponding, first quantum of goods offered for it by his counterparty, as well as with those which might accrue from trading for another’s, different, goods instead, should this be an option.

Austrians know better than to believe in the sterile, zero-sum games of some schools, since exchange, though conducted at a single price, does not therefore preclude the derivation of mutual benefit from the act.

More emphatically, the very fact that there may exist an overlap between the two counterparties’ subjective valuation scales is what allows for the emergence of mutual benefit and so motivates the process of exchange itself.

This clearly refutes Marx’s crude exploitation theories by revealing that the costs which went into providing a good can have no influence on its subsequent circumstantial valuation and hence on the price these goods can command on the free market.

Indeed, it is the entrepreneur’s particular skill—as well as his essential service to society—that he has an enhanced ability to put temporarily underpriced combinations of resources to a more nearly optimal use than can other men.

These insights are said to be made a priori and Austrian reasoning is thus deductive, not inductive, or empirical. Economics is, then, evidently a discipline where mathematical abstraction can play little part.

Politically, Austrians are classic Manchester liberals, firmly behind a policy of laissez-faire and many today thus shade into Misesian minarchism or even what Rothbard proudly called anarcho-capitalism.

Mises himself single-handedly destroyed any attempts to construct a socialist rationale in the famous “calculation debate,” showing that, without private property and an unhindered price mechanism, production can never be properly coordinated to allocate scarce resources to their best and most urgent uses.

Hayek joined Mises in showing that there can be no room for compromise, that a “mixed” economy inevitably leads to an erosion of freedom and the growth of the state to the detriment of all those not in, or patronized by, the ruling classes (of whatever caste, creed, or form).

Menger and Boehm-Bawerk, et al, derived the most satisfying theory of the origins of interest—the so-called natural rate being, essentially, a measure of mortal man’s inherent impatience with any delay in the gratification of his wants and needs. This is greatly influenced by the degree of plenty and comfort which he already enjoys.

In turn, this implies that capital-rich economies with bounteous productive capabilities tend to have higher levels of present satisfaction and so lesser impatience, more saving, and hence lower natural rates of interest.

Therefore, the Austrian realizes that low interest rates naturally arise amid abundance—an abundance based upon a wide division of labor and a capital-rich layering of specialized productive means.

He also knows that abundance can never be entrained merely through forcing money market interest rates lower by fiat.

Austrians know something cannot be had for nothing, nor can the element of time be ignored—Bastiat’s fable of the “broken window” is often cited as a starting point for argument.

Hazlitt, developing this theme, wrote that the “One Lesson” of economics is that there is no such thing as a free lunch and that we must always look beyond the immediate results of an action to see its hidden and indirect influences before we pronounce it a success or a failure.

Mises developed a comprehensive “Theory of Money and Credit” which irrefutably showed that inflation always leads to ill effects and, together with Rothbard, campaigned for a system based on free-banking, meaning no FDIC, no Fed, no fiat, and – for some proponents of 100% commodity reserve, to boot – absolutely no fractional reserves, either!

Out of this arose the Austrian Theory of the Business Cycle which discusses in detail how an inflationary infusion distorts price signals—particularly intertemporal ones.

By lowering market rates below the natural one, credit expansion severs them from that which is compatible with the availability of real capital and with the concomitant willingness to save while more “roundabout”—slower amortizing, but potentially more productive—methods are employed.

Thus, the builders of plants and the makers of equipment base their return calculations on low rates, but are blinded to the fact that these do not signal the necessary limitation of end-consumer competition for the factors of production which they, or those downstream from them, will need to secure the required return on their efforts.

At some point these factors will be bid away to other, more urgent uses, more compatible with consumers’ time preferences—which may in fact have been increased (their demand for goods enhanced)—by the same lower rates which entrepreneurs have implicitly taken as meaning that such an appetite has diminished.

These distortions will lead to bottlenecks in skills, staff, resources, equipment. They will mean a consistent price path from high-order to consumer goods will not be possible. It will mean losses and the revelation of widespread “malinvestment”—not necessarily “over-investment,” but misdirected and sub-marginal investment, e.g. Global Crossing, Nortel, AT&T and many others in this past cycle! [Add whomsoever you like here – housebuilders and shipping lines, commodity producers, and half of China, perhaps, to illustrate the same phenomenon at work in the subsequent cycles]

Credit expansion will therefore sow the seeds of its own destruction as soon as any initial slack in the system is taken up and as soon as the rate of inflation (a monetary addition revealed to be in excess of people’s willingness to absorb it into their everyday holdings) ceases even to accelerate (a process needed to keep the producer borrowers surfing ever ahead of the breaking wave of the faulty price/preference matrix in the economy).

Developed in the earlier part of the century, the standard exposition implicitly assumes that most large scale borrowing is done by producers, not consumers—the former thus got the first, most beneficial use of the inflationary influx (spending the money before prices rose) and they could bid resources away from the latter as a result of this legalized fraud.

This has had to be modified somewhat to take account of today’s institutional framework where the consumer is a major borrowing force also and where a soft-budget Leviathan has grown ever more bloated, but the underlying principles have nonetheless not been challenged by this expanded scenario.

Again, modern expositions of the theory have to take into account the sweeping internationalization of the economy and recognize that Asian savers, for example, can substitute for US ones, for so long as they are willing to do it or, conversely, that an inflationary excess in, say, China, can induce a wave of malinvestment half way around the globe.

As part of this, unlike almost all opposing strains of opinion, Austrians have no irrational fear of gently falling prices – of ‘deflation’ as this blissful state is regrettably misnamed in the common usage – not where such a raising of real living standards arises from advances in productive technique, from the practice of well-founded entrepreneurship, or from the wider division of labour.

In contrast, in the aftermath of the recurrent historical misfortunes that befall us as a result of the interplay bad economics, flawed institutions, and irredeemably venal politics, it may just be acceptable for those eternal agents of our misfortune, the central banks, to act so as to arrest a self-fuelling destruction of values when the earlier, unsustainable, and thoroughly unnatural boomtime pathology to which they gave rise transmutates suddenly into its polar opposite, the ‘secondary depression’. Even this concession is highly contentious among real Austrians, many of whom credibly fear to encourage such a rescue’s subsequent abuse, as well as being chary of the demoralizing effect of knowing in advance that this is likely to be the response.

What no-one of the Austrian persuasion will ever endorse, however, is that it should be any part of subsequent policy to make the attempt to ‘unwind’ this genuine example of a money-driven ‘deflation’. As Mises pithily put it, you cannot help the subject of a traffic accident by reversing the car back over his prostrate form.

Austrians are thus typically lampooned as ‘bitter end liquidationists’ when all they want is for the rules of contract to be applied without exception, for all failures to be recognised swiftly – so minimizing the duration of economic pain as well as serving to visit it principally on those who have contributed to such failure and not on the community of their uninvolved neighbours – and for a cynical exploitation of our natural human compassion for our fellows in trouble not to hinder a rapid and necessary triage of the casualties.

Better a swift bankruptcy, a cleared market, and a leg-up into a new opportunity for those displaced than a wearisome period of ‘Fauxterity’ (i.e., of the strangulation of sharply higher taxes but rarely reduced state outlays), the mass Zombification of enterprise and of its lenders, and the pernicious victimisation – indeed, the creeping criminalisation – of those whose savings, property, and income may have survived the initial cataclysm.

Having viewed the sorry track record of the last six years’ denial of this prescription, can anyone honestly argue to the contrary?

Austrian theory is thus subjective, not objective; dynamic, not static; logical, not empirical; individualistic, not aggregative; libertarian, not statist; it does not confuse money with wealth; it knows that production delivers prosperity, not consumption.

It recognizes consumer sovereignty, places prime importance on the capital structure of the economy, apotheosizes the entrepreneur, despairs of government, and utterly disdains Marxists, Keynesians, Chicagoites, and all other Positivists, Historicists, and wannabe Natural Scientists.

In their ignorance, these latter, naturally, return the compliment and since these schools can all be used by the State as an excuse for its ever-widening interference in our lives—whereas Austrians demand the minimum possible intrusion upon private property and personal liberty, for solidly economic, as well as for ethical grounds – guess who gets most of the air time?


Sean Corrigan aka Wild Goose