How does it know?

IMF Says China’s Currency No Longer Undervalued

The International Monetary Fund announced on Tuesday that for the first time in over a decade China’s currency is no longer undervalued (SCMP). U.S. policymakers have long criticized China’s artificial weakening of the renminbi, and the issue of currency manipulation has been at the center of deliberations over trade deals in the U.S. Congress.

With currency markets rigged everywhere and central banks intervening either to support or devalue their currencies according to the politics of the day, there is no free currency market. Only free markets deliver real prices; therefore, in a free market no good is ever undervalued or overvalued. There is only the latest price at which buyers and sellers agreed to an exchange.

Pat Barron

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US inflation up 47.1% and real GDP down 21.4% since 2011!

Alasdair Macleod compares the Chapwood Index to the official CPI

Government has been lying to everyone, including itself, about the rate of inflation. The government claims that cumulative inflation since 2011 is 7.2%; whereas, the Chapwood Index claims that real prices of the top 500 items purchased by Americans in America’s 50 largest cities have risen a cumulative 47.1%.
The Chapwood Index also challenges the government’s claim that nominal GDP has grown by 18.1% since 2011, which would mean that real GDP is up by 10.9% (the difference between nominal GDP of 18.1% and inflation of 7.2%). But Chapwood claims that real GDP has FALLEN by 21.4%!
Patrick Barron
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My letter to the NY Times re: Why laid off Americans can’t find jobs

Re: The Perils of Globalization

Dear Sirs:
I believe that Binyamin Appelbaum may have unwittingly answered his own question about why American workers who lose their jobs–as illustrated by the former Maytag employees in Galesburg, Illinois–have such a difficult time finding alternative employment of the same standard. Mr.Applebaum reports that America is trying to negotiate international trade agreements that would build a “shield against globalization that would move closer to American standards for environmental protection, worker rights and intellectual property.” These very policies are the cause of America’s economic problems, and our trading partners would be foolish to adopt them. They are more likely to adopt the common sense policy of gradually incorporating these standards over time on a cooperative rather than an adversarial basis, in full knowledge that adopting them too early would create a barrier to economic growth. These standards are the consequences of economic growth. In effect, economic growth pays for them. The adverse consequences for believing otherwise are there for all to see in the US and Western Europe–a falling labor participation rate and out of control government debt to pay so-called welfare entitlements.
Patrick Barron
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Greeks get Mercedes and BMW’s; Germans get depreciating euros

Re: Where Greeks Are Stashing Their Cash

Ludwig von Mises characterized the third and final stage of a currency’s collapse, where people are desperate to exchange their currency for almost anything of real value, as a “crack up boom”. Notice the “boom” part. The German automobile industry is booming, because Greeks (and others) are converting their depreciating euros into real goods. Apparently Greek pharmacies cannot get drugs, because they or their government do not pay their bills. But luxury cars are still available and Germans are happy to sell them. OK, now the Germans have euros instead of cars. What can they do with these depreciating euros? Well, for one thing, these euros are stacking up as credits at the Bundesbank’s TARGET2 account at the European Central Bank. Unlike other clearing systems run by central banks, which require member banks to fund their deficit clearing accounts with real assets on a daily basis, the ECB allows its national central bank members to run overdrafts. A close look at the latest TARGET2 accounts reveals that Germany and Luxembourg are running significant positive balances; whereas, Spain, Italy, and Greece are running significant negative balances. The other ECB members carry somewhat less significant positive (Finland, the Netherlands) or negative (Ireland, France, Portugal) TARGET2 balances. Another way of looking at this is that Germany and Luxembourg are not getting paid for the goods and services that their hard working population provides to Spain, Italy, and Greece. It’s all funny money. Germany, especially, carries a huge positive balance of around a half trillion euros.
ECB president Mario Draghi is determined to drive down the value of the euro vis a vis other world currencies and generate positive inflation in the euro zone. So Germany’s TARGET2 balance is officially under attack. Draghi is a fool for believing that his bank can peg inflation to a low number once inflation gets a good hold on the people’s psyche.
Germany should get out of this monetary loony bin forthwith, reinstate the Deutsche Mark, and treat its euro credit at the ECB as a bad debt. One of the rules of debt collection is to stop lending the debtor more money! A strong Deutsche Mark exchange rate vis a vis what’s left of the euro and especially vis a vis a reinstated Greek Drachma and/or Italian Lira would reveal that Germany in effect has been giving its products away for almost nothing. This used to be called slavery.

 

Pat Barron

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The problem isn’t overproduction; it’s malinvestment

Mr. Max Ehrendfreund, writing in the Washington Post’s Wonkblog, believes that he has discovered something new: that the world is producing too much and doesn’t know what to do with it. His solution, of course, is to confiscate the overproduced products, such as oil and cotton, from its rightful owners and give it to the people who need it. This phony problem and its statist solution goes back at least as far at the 1930’s socialist calls for “production for use” vs. the hated capitalist concept of “production for profit“.

 

Mr. Ehrenfreund commiserates that a “surplus…challenges some basic principles of conventional economics…”. Ah, now we see why Mr. Ehrenfreund has a problem; he understands only “conventional economics”. Austrians have no such problem understanding why many commodities are currently in surplus. Our understanding of Austrian business cycle theory tells us that years of interest rate suppression by monetary authorities worldwide has disrupted the time structure of production; i.e., that artificially low interest rates have led entrepreneurs and their business partners to believe that sufficient resources exist for the profitable completion of longer term projects, such as increasing investment in oil and cotton production. Austrians do not contend that there cannot be a surplus of some goods. Of course, there can! But we know that a surplus of some goods means that there is a scarcity of others. Resources were “malinvested” in some projects instead of those more urgently desired by the public.

 

Here’s a rather humorous example.  A good friend was teaching in West Germany during the age of Tito, when he and his wife decided to vacation along Yugoslavia’s beautiful Adriatic coast. While there they tried in vain to find swimming accessories, like fins and masks, but shop after shop sold only one product. That one product? Panama hats! True story. So here is a good example of zero demand for Panama hats and a scarcity of swimming accessories in one of the most beautiful seaside vacation spots in the world. But these surpluses and scarcities are not always so obviously related. A surplus of oil and cotton may mean that there is a scarcity of millions of other goods that could otherwise have been produced.

 

The socialist dogma, to which Mr. Ehrenfeund seems to be enamored, blinds him to the concept that a successful economy does not need centralized control. In fact a successful economy needs no guidance at all, except the rational decisions of the owners of the means of production to put their resources to the most desired use. How do they know what that “most desired use” is? The price system tells them! A dynamic economy is controlled by millions upon millions of people making billions upon billions of decisions that are in constant flux. Manipulating the price of any factor of production, such as cotton prices, will cause disruptions. But our governments have done much worse than manipulate the price of a few major factors o f production; they have manipulated the price of money itself, the medium of exchange that is the lubricating and knowledge transmission device for ALL economic decisions.

 

So, Mr. Ehrendreund, brush up on your Mises, Rothbard, Hayek, Habeler, and Garrison. Your confusion will disappear to be replaced, no doubt, by exasperation that you ever could have harbored such silly notions as those you espouse in your article.

Patrick Barron

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Give the free market a chance!

Re: US jobs relapse raises fresh doubts on Fed tightening

This link to a recent Telegraph (of London) Ambrose Evans-Pritchard (AEP) report is typical of the trap that Keynesians have built for themselves. AEP well articulates their dilemma, stating:
“…the developed world has yet to shake off the legacy of the Lehman crisis, is struggling with record debt ratios and has already used up most of its fiscal and monetary ammunition.”
The Keynesian tools of choice for escaping a recession are increased government spending and monetary stimulus. It must work, they believe, because their models tell them so. But when governments spend themselves to unsustainable debt levels and central banks expand base money and drive down the interest rate and STILL the economy refuses to budge, these Keynesians are trapped. And like all trapped animals, they are dangerous. But their conundrum is a mental trap only and one that is easily conquered, if only they have the courage to admit it and take appropriate action. The cure is simplicity itself. They must give the free market a chance. Governments must CUT spending, and central banks must STOP EXPANDING base money. This means that governments must tell their citizens that the welfare/warfare state is ending. And central banks must tell their governments that they will no longer monetize debt or intervene in any way to influence the interest rate. The resulting recession, perhaps even depression, is the necessary and inevitable workings of the free market to shed itself of what must now be massive malinvestment. It is the market working to realign the structure of production to economic reality. This will take time, but there is no other way.
Patrick Barron
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My letter to the NY Times re: Rattle those bones, blow that smoke, and bleed the patient until he recovers!

Re: Is 2% Inflation enough?

Dear Sirs:
As you note, the Fed has held “its benchmark rate near zero…since December 2008″, but without the result promised by econometric models. Therefore, those Keynesian economists you quote want even more money printing. They sound like witch doctors who have stood over a patient for six years, rattling bones and blowing smoke to no avail. Now they are consulting Colonial era specialists, who advocate bleeding the patient until he recovers. I recommend that they advance at least one hundred years to the era of the marginalist revolution of the Austrian school and stop money printing all together. Money is a medium of exchange and nothing more. Its uses as a means to settle accounts and as a store of value derive from this foundational utility. Printing more money simply reduces each unit’s usefulness, what Austrians call its “diminishing marginal utility”. The witch doctor and Colonial era physicians are going to drive the dollars marginal usefulness to zero, and America will experience the same wonderful benefits of cheap money as did the Germans of the Wiemar Republic and more recent Zimbabweans.
Patrick Barron
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My letter to the NY Times re: Statism vs. Liberty

Re: In Japan, Bid to Stifle Criticism Is Working

Dear Sir:
In your chilling report of the Abe government’s efforts to limit Japan’s free press, you use the terms “right-leaning” and “conservative” to describe his government. May I suggest that a better term is “statist” vs. one of “liberty”. The right/left and conservative/liberal descriptions do not convey real differences. An extreme example would be the usual references to Nazi Germany as right-leaning and conservative and Stalinist Russia as left leaning and liberal; whereas, both were statist regimes intent on grinding their citizens under the boot heal of government repression. Nobel Laureate F. A. Hayek characterized both regimes as two sides of the same coin in Road to Serfdom. The alternative to a statist regime is one dedicated to liberty, in which the individual is allowed complete freedom of expression.
Patrick Barron
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My letter to the WSJ re: Austrians understand why there is a commodity glut

Re: Glut of Capital and Labor Challenge Policy Makers

Dear Sirs:
The worldwide commodity glut is not a surprise to Austrian school economists. It is a wonderful example of the adverse consequences of monetary repression to drive the interest rate below the natural rate. Longer term projects, such as expansion of mineral extraction, appear to become profitable. But such is not the case for the simple reason that printing money does not represent an increase in real, saved resources. Eventually it will be clear that capital has been wasted, what Austrian school economists call “malinvested”. No amount of further monetary repression can cure this problem, although I am certain that the Keynesian school economists in charge of central banks and governments all over the world will give it a good try. Akin to bleeding the patient until he recovers, we may not survive this Keynesian medicine.
Patrick Barron
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Critiquing a Monetary Reform for Iceland

The Prime Minister of Iceland recently commissioned a report by Frosti Sigurjonsson (henceforth referred to as “Mr. S”) to recommend a better money and banking system for Iceland. (I’m sorry, but isn’t Frosti a great first name for someone from Iceland!) The recently released report recaps Iceland’s sorry history of money and banking disasters and lays the majority of the blame for the 2008 collapse on the institution of fractional reserve banking, which caused an out of control increase in the money supply. Mr. S recommends its abolition. For this I applaud Mr. S and hope that the prime minister accepts the report and urges the Icelandic legislature to act upon it.

 

My endorsement of the report’s primary recommendation does not mean that I believe that Mr. S fully understands money and banking from an Austrian perspective. Nevertheless, his recommendation, limited as it is, is a huge step in the right direction. To this extent it is compatible with my recommendations, delivered at the recent Mises Canada’s “Prices and Markets” conference, that called for the abolition of fractional reserve banking, the separation of deposit and loan services, and an end to deposit insurance. Mr. S recommends the same for Iceland.

 

Mr. S is correct that the central bank lost control of the money supply in the years leading up to 2008 as the banks leveraged their excess reserves into new loans, which created new deposit money out of thin air. Sounding very much like Weimar Republic and Zimbabwean central bankers, he states that it was the duty of the Central Bank of Iceland (CBI) to “provide banks with reserves as needed in order to not lose control of interest rates or even trigger a liquidity crisis between banks.” He accuses the banks of lending for speculative rather than worthwhile purposes, whereas he has no such concern over government control over this powerful economic lever. He is confident that the central bank would expand and contract the money supply in a fashion that would be beneficial to all society and that government would spend new monies only for purposes that would benefit the nation. Whew!

 

The resultant monetary regime in Iceland would be very similar to that of America during our Civil War (1861-65), when the North introduced fiat paper money. The Greenbacks–so named due to their color on one side–were pure irredeemable fiat monies issued by the Treasury Department. At that time America had no central bank, thanks to the foresight and courage of President Andrew Jackson, who was able to block the renewal of the charter of the Second Bank of the United States in 1837. When the North won the war, it did eventually buy back the Greenbacks for gold. The lesson here is clear–one of the main reasons that governments debase money is to fight wars. The North found it impossible to finance the war with taxes and honest debt, so it resorted to confiscation via the monetary printing press. Are Iceland’s leaders any different? They may not want to fight a war, although they did get into a naval shoving match with Great  Britain in the 1950s through 1970s over fishing rights, the so-called “Cod Wars“. So one never knows.

 

Mr. S believes that government needs the power to introduce new money to meet the needs of an expanding economy and that the central bank and government will do so for the good of the nation as a whole and not for private purposes. At a minimum he believes that the money supply must expand in order for the economy to expand. In this regard he is a full-fledged Friedmanite, who little understands the adverse impact of even a low level of money growth on the structure of production. On the contrary, he sees money growth as necessary for economic growth and has full confidence that government will spend any newly created money only for good. It is obvious that either he’s never heard of public choice theory or does not subscribe to its conclusions. Really, who today believes that government, which after all is manned by some of the most fallible humans in society, can (1) be completely altruistic in its spending decisions and (2) would know what is best anyway? I refer Mr. S. to F. A. Hayek’s wonderful Nobel speech in which he clearly articulates his theory of the pretence of knowledge.

 

Mr. S concludes his proposal with a call for what he terms the “sovereign money system”. Right away we know that he is not an Austrian when he states “The CBI will create enough money to promote the non-inflationary growth of the economy.” He would separate money creation from money allocation. A money creation committee would decide how much money to create and then the parliament would decide how to spend it. New money would serve five purposes–fund new government spending, reduce taxes, pay off the public debt, provide a citizen bonus, and increase lending to business. Money would not be backed by debt, but would be a sovereign asset created at will. The proposal does remove the ability of banks to increase the money supply through the lending process. All to the good so far. But it transfers this power to government. It allows government to spend what it wishes, as long as the money creation committee goes along, by counterfeiting whatever amount is desired. Government would not be required to increase taxes or issue new debt. Halleluja! A counterfeiter’s dream! Also a government dream. Somehow I have little confidence that the money creation committee will not go along with whatever spending plans the parliament desires, a sure path to hyperinflation.

 

Be that as it may, I hope that Iceland implements that aspect of Mr. S’s proposal that requires banks to maintain one hundred percent fiat reserves on checking accounts. Then separating deposit banking from loan banking would negate the need for deposit insurance. Perhaps Iceland’s central bank and government will exercise their money printing power with discretion long enough for the rest of the world to see the benefits of abolishing fractional reserve banking and moving to a one hundred percent fiat reserve system. After that we can fight the next battle–prohibiting central banks from expanding the fiat money supply and then finally tying money to specie at a legally enforceable ratio. At that point money production can be turned over completely to private hands and the central bank abolished.

Patrick Barron

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