Kept in the dark

In my last post, I shared the news that the MPC keeps no minutes of its meetings. I had pondered whether there would be any gain in trying to use the Freedom of Information Act to force the Bank to make public more information, but naturally, they’d ensured this couldn’t happen:

The Bank is designated as a public authority and falls within scope of the Act except in respect of certain excluded functions which are specified as:

• monetary policy

• financial operations intended to support financial institutions for the purposes of maintaining stability

• the provision of private banking services and related services

 

In translation, we are not allowed to know how they make decisions on monetary policy, nor are we are allowed to know about any bailouts or special arrangements made to keep banks afloat. We are being deliberately kept in the dark.

How can be keep the BoE honest if it can’t even be transparent?

What has the MPC got to hide?

News to light the fires of the paranoid and conspiracy theorists out there:

The Bank of England’s Monetary Policy Committee (MPC), the group which decides on interest rates each month, keeps no minutes of their meetings. We’ve argued on this blog that the setting of interest rates by a central body has a devastating impact on the economy – this is the view held by economists of the so-called “Austrian school”. Keynesians also acknowledge the importance of interest rates on the economy, though they argue that central banks should be setting them “correctly” to respond to market conditions. Such a key job should be done openly and transparently, rather than behind closed doors.

No only does the Federal Reserve needs auditing – so does the MPC! What do they actually base their decisions on?

 

The Bank of England must share the blame for the cost of living

Many central banks now have “inflation targets” that they are required to meet, and such targets are set by the government. For the Bank of England, this target is 2%, and is based on the Consumer Price Index (CPI). Some central banks have other legally set targets, such as employment. In the case of the BoE, it has set its own employment targets but these are not legally binding.

From the bank’s own words:

The inflation target of 2% is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI). The remit is not to achieve the lowest possible inflation rate. Inflation below the target of 2% is judged to be just as bad as inflation above the target. The inflation target is therefore symmetrical.

If the target is missed by more than 1 percentage point on either side – i.e. if the annual rate of CPI inflation is more than 3% or less than 1% – the Governor of the Bank must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank proposes to do to ensure inflation comes back to the target.

This means that the Bank is legally required to do all within its power to ensure that prices rise by 2% a year. Its important to note that this target is not that it must increase the money supply by 2% a year, but that prices must rise by 2% a year. With all the current talk of a “cost of living crisis”, we ought to examine the Bank’s role in causing that crisis. This is gradually making millions of people poorer. Pensioners, and those on fixed incomes are hardest hit. Not everyone is lucky enough to get a pay rise, and those who do often get pitiful raises that are less than CPI. Why is it the official policy of our central bank to make millions of people worse off each year?

Of course, the CPI leaves out key aspects of people’s spending – the big ones being rent and mortgage payments. RPI, which includes these, tends to be higher than CPI each year. So that 2% figure in the CPI is likely under-reporting the true rise in prices each year. Over the past decade, excepting the time of the financial crash in 2009, RPI was around 1.2 percentage points higher than CPI.

There is a persistent myth amongst Keynesians and monetarists (and clearly the BoE) that deflation is something to fear – and so we must prop up the economy with at least some inflation. One of the arguments put forward regarding the dangers of deflation is that consumers will put off purchases, waiting for tomorrow when the price will be lower. To some degree, this is true. But as consumers we do not wait forever – just witness the success of the computer industry. However, let’s accept the argument for the moment. If this is true, then we can make a similar statement about inflation. Sellers of goods will wait till tomorrow to sell, since prices will be higher – and therefore nothing will ever get sold! Again, sellers do take such things into account, but just like the consumers, sellers want to sell their goods eventually. Curiously enough, those arguing against deflation in this way never make the related argument regarding inflation.

Prices frequently fall, or even plunge in recessions, but the cause and affect needs to be established correctly. The falling prices are a symptom of the recession, not the cause. For more of my thoughts on this, I suggest reading this previous post.

Earlier in the post I asked “Why is it the official policy of our central bank to make millions of people worse off each year?”. Part is the current economic orthodoxy which fears deflation (apoplithorismosphobia for anyone who loves such daft words).

We can’t just blame economists, however. This constant inflation benefits powerful groups in society – and let’s face it, they have more leverage than most academics. As I discussed recently, low interest rates and quantitative easing help to push up share prices. Investors love it! And not just share prices – all sorts of assets not mentioned in the CPI or RPI tend to rise when central banks start easing the money supply. House prices have more than doubled in the past 10 years. And let’s not forget the politicians themselves, who are quite happy to keep the printing presses going to help pay off the massive pile of debt they ran up at our expense.

Quote of the Day

Upon observing an airplane fly, one doesn’t assume that apparently the law of gravity doesn’t apply to metal plane-shaped things. Rather, you intelligently realize instead that other forces must be in operation on the plane. Similarly, we should not assume that just because one doesn’t always see an observable, countable diminution in people employed related to the minimum wage in every specialized situation an academic looks for it, that on the margins the law of supply and demand don’t work on labor and that raising the minimum wage is costless in terms of jobs.

Reason Blog

This is just another angle on the “What is seen vs What is not seen”  that Bastiat encouraged us to see, and Henry Hazlitt expanded on in Economic in One Lesson.

The illusion of stock market prosperity

The ups and downs of the stock market is reported daily, hourly – continuously on some news channels. Stock markets are seen as indicators of the overall economy. A rising stock market means prosperity, and a falling stock market spells bad news. But is the stock market actually a good proxy for the health of the economy?

Stock markets of course only include a subset of companies in the country, and so already we are assuming the health of the largest companies is equivalent to the state of the overall economy. The FTSE 100 is quite obvious. The Dow Jones in the US only has 30 companies listed – perhaps a surprise for such a closely monitored index. For now, let’s assume that by using a variety of indices (eg NASDAQ, S&P 500 in the US) we can get a decent enough proxy in terms of the companies that are listed.

Prices act as signals of supply and demand – one reason why we should always be hesitant to control them. Prices provide information – information that you could not get easily otherwise. You may not know that bad weather has reduced the supply of oranges in Spain, but you can see that oranges have gone up in price and so you’ll buy less – reducing the pressure on the reduced supply.

In a similar way, stock prices reflect the supply and demand for shares in a particular company. Unfortunately the demand for shares is often artificially boosted by cheap money provided by central banks, and prices rise more than would be expected by the fundamentals. While inflation is supposedly under control according to the CPI, inflation in assets such as stocks and real estate is much higher. The cheap money from central banks is not going into consumers pockets, and hence CPI is not rising so much. Instead, the cheap money is lower borrowing costs for property buyers and stock market investors alike, and hence the inflation can be seen in these markets instead. If all assets were included in the inflation index, we’d see a very different picture.

Such a scenario is what took place during the 1920s, and hence what has led so many economists to reject the notion that the  crash of 1929 was caused by an inflationary boom. Where’s the inflation they ask? CPI was stable, if not falling during the 20s. Same as now, there was significant inflation in stock prices and real estate – at a time when the Federal Reserve was increasing the money supply. The new money ends up somewhere – its just that the official statistics are good at hiding it. When we look at the broader economic picture, the bubbles blown by the new money become much clearer.

So far, all very theoretical. Yet evidence for this distortion can currently be seen in the US and the UK . In both countries, stock markets are reaching new highs (beating the high prior to the financial crisis) while unemployment remains stubbornly above rates seen before the crash. There is a clear disparity between the two. Even more starkly, in Venezuela, the stock market is rising rapidly amid soaring inflation, while there are shortages of toilet paper and the government continues its attempt to defy reality by imposing price controls and seizing businesses. The rising stock market is completely detached from the real nature of the economy.

This certainly benefits anyone holding stocks, but it’s not helping anyone else. It’s another way that central banks are helping the rich at the expense of the poor. Some may believe a rising stock market brings confidence, and economic prospects will improve as a result. However, if the stock market is only reflecting the influx of cheap money rather than the reality of the economy, it fails to be a signal and instead becomes meaningless. Blowing a stock bubble will only end one way. Central banks would do well to heed the lessons of the past, and stop blowing new bubbles in order to save us from the last one that burst.

The debt limit explained

I’ve been too busy to post much recently, but this is a nice satirical look at the US debt limit:

H/T Coyote Blog

Forward guidance

One of the notably sinister traits of a central bank is the act of collaboration (read, collusion) between countries: they can’t exist for long without it. It is therefore not surprising that when Ben Bernanke issued a statement linking future monetary policy decisions to unemployment the new Governor of the Bank of England followed suit with what is called “forward guidance” (in English, guidance for the future). So what is it?

You can read the full thing here but in brief: the Bank Rate will be held at 0.5% and asset purchasing will continue, at the MPC’s discretion, while unemployment remains above 7%. This is subject to 1) expectations of inflation in two years time remaining within 0.5% above the 2% target 2) inflation during the next two years remaining “sufficiently anchored” 3) the Financial Policy Committee (in charge of deciding if something poses a systemic risk to the financial markets) deciding if monetary policy is too loose to contain.

As an aside, the guidance is revealing. It shows that the Bank admit that their monetary policy stokes inflation (despite all common sense, it is often disputed still that loose monetary policy causes inflation); that systemic risks are caused by central banks and not derivative-toting yuppies.

The recent policy changes by both the Fed and the Bank (and probably, maybe a few years from now, the ECB) harkens back to the nightmare inflation in the Weimar Republic. In Adam Ferguson’s very detailed description of the horrors of a collapse in fiat currency in When Money Dies, he describes how the printing press turned at an accelerating rate to keep employment up. Of course, it was unsustainable and it ended in a disastrous collapse in financial markets and the impoverishment of millions of people. (While enriching many of the ‘1%’ – sound familar?)

The only blessing found in forward guidance is that the Bank has partially limited the damage it can do, but this should not be a comfort. Linking money printing to unemployment rates ruined Germany and it will ruin us.

The subtle Cantillon effects of inflation

The biggest problem with increases in the money supply is not that it causes a rises in prices – that monetary inflation can cause price inflation – for this is what we would expect to happen in most cases.

Rather, the biggest problem is that monetary inflation changes different prices differently, and hence changes relative prices.  This is of course the whole point of monetary injection, for if new money increased all prices by the same amount there would be little point.

These are the so called “Cantillon effects” after the 18th century Irish-French economist Richard Cantillon.

When a king depreciated the currency by clipping the coins he received in taxes, he inflated the money supply. This allowed the king to spend this new money on goods at current prices. Only later after he had spent large sums of this new money would prices rise, forcing his subjects to pay more for the goods they needed. Which prises rises will depend on what the king buys – it is quite possible that most prices might remain unchanged. But for those things which the king demanded, prices would be higher.

In such a scenario, it is clear that the inflation benefits the king and hurts his subjects – no new wealth has been created, rather, wealth has been redistributed towards the money producer. It has allowed the king to lay claim to more goods and services than he would have been able to had there not been the monetary inflation. Though the modern economy and banking system is more complex, this key truth of the effects of money creation should be noted when economists claim that monetary inflation can actually help create economic growth.

What happens in the modern economy? The recipients of the inflation are more varied – they include the government, the commercial banks, and those closest to the new money, perhaps mortgage borrowers taking advantage of lower interest rates. When central banks buy government bonds (or do so via a commercial bank), this allows the government to draw away resources from the private sector, at the later cost of higher prices in some area of the economy. This process is much more insidious than the king above, as it fairly simple to notice the coin has been clipped – just weigh it. For us today, we may notice rising prices, but the cause is usually hidden or masked behind other market based reason for the price rise.

If you had a printing press, the effects of inflation would be quite obvious. You would be able to purchase goods and services at effectively no cost, while your neighbours would eventually notice the rising prices, as more money chases the same number of goods. The resulting price inflation is therefore nothing more than an application of the usual rules of supply and demand. Creating new money always makes prices higher than they otherwise would be.

During the 1920s, Austrian school economists have argued there was significant inflation by the Fed, and this helped cause a bubble, and subsequent 1929 stock market crash. Economists of other schools have stated this cannot be the case, as prices did not rise during the 1920s. The misses two key points -firstly, that stable or even falling prices are consistent with the above statement. Without the monetary inflation, prices would have fallen at a faster rate. Secondly, while consumer prices may have fallen, asset prices such as stocks and farmland rose considerably. This is the danger of relying on indices such as CPI. We have to look at all prices to see the effects of inflation. Even in hyper inflationary situations, not all prices rise at the same rate – it depends on what people are buying.

Economic growth requires the creation of more foods and services. All creating money does is redistribute the existing wealth towards the money producer and those closest to it. In today’s society, that means the government and the banks. All those on fixed incomes suffer. If we really believe in helping the poor, we need to recognise the impact of continuous money creation. And if we want to hurt the banks, as many do, perhaps we should stop the Fed from buying $85bn of mortgage securities a month. Let the banks stand on their own two feet.

The Myth of Democracy

This week, the US congress voted on an amendment to stop the NSA’s PRISM program which has been making headlines for the past few weeks. Unfortunately, the vote was defeated in the House of Representatives by 217-205, and so the NSA will continue to spy on the emails, phone calls and other communications of innocent people – in direct violation of the 4th amendment of the US constitution.

The debate both before and after the vote centres on the age old question of national security vs civil liberties. We are often told that without this unconstitutionally gathered data, Americans would be more vulnerable to terrorist attack, and we must sacrifice our liberty in order to be safe. (Benjamin Franklin might have something to say about that). This is a rather bitter pill to swallow, since the information the government is using as evidence of the program’s necessity is top secret. How can we judge the merits of the program?

Nonetheless, the above narrative at least shows these elected representatives in a good light. They are wrestling with difficult decisions, at a time when terror threats are known to be a serious risk. The truth, however, is rather more disturbing:

On average, House members who voted to uphold the domestic spy program received an average of $41,635 whereas those who voted to revoke authority for the program averaged $18,765. By the way, the leaders of the two “opposing” parties in the House, Boehner and Pelosi received $131,000 and $47,000, respectively, from the defense-intelligence establishment.

From Wired, where the above article was sourced:

The amendment was proposed by Rep. Justin Amash (R-Michigan), who received a fraction of the money from the defense industry compared to top earners. For example, Amash got $1,400 — ranking him in the bottom 50 for the two-year period.

As always, follow the money. Or as the Romans said, cui bono.

 

The new man at the helm

At the start of July, Mark Carney became the new Governor of the Bank of England. He appears to have taken his job at a time when there is greater optimism regarding the state of the UK economy, which has in turn changed the expectations on how he should guide UK monetary policy. Only time will tell if the optimism is warranted.

What would my recommendation be to Mr Carney? In many respects, the job is an impossible one. If the economy does indeed improve as forecasted, he will be under pressure to raise interest rates and end QE, both of which could burst any nascent bubbles the money spigot caused. If the economy falters, he might just as easily get the blame for not extending QE or lowering rates even further.

Naturally, I don’t expect Carney to fall on his sword and end the 300 year old institution that is paying him a rather handsome salary. What I do find interesting, however, is the advice from Ben Southwood at the Adam Smith Institute, who recommends Carney implements a programme of “NGDP targeting”, instead of the inflation target that is the current focus. He summarises by saying:

In general the road ahead must be one of rules and discipline, not the translucent discretion of nine unelected barons.They must keep demand steady so we can focus on improving the supply capacity of the economy, and so there is no excuse for fiscal stimulus, with all its flaws.

In many respects, this is spot on – the MPC are never going to have all the knowledge on the economy to make the right decisions, and they are not accountable in the slightest. Yet, the solution proposed is still assuming that we can centrally plan the money supply – the key tenet of monetarism. Replacing the supposedly arbitrary plans of Keynesianism and its fiscal stimulus with the apparently more disciplined monetary stimulus of the Monetarists is no solution at all. (Of course, NGDP targeting is perfectly arbitrary – who decides the NGDP rate to target? Shall we choose 3% or 4%? And there’s nothing to stop the target being changed whenever it suits.)

I have never understood why so many believers in the free market abandon these principles when it comes to money. I recognise that the ASI does not have a strict policy position in this area, and the views of the Austrian school are promoted also. But what is so different about money to any other good or service that it becomes a major exception to the workings of the market? For all the radical ideas about legalising trade in human organs, where are the radical ideas about money? The ASI needs to step out of the shadow of Milton Friedman – a great economist and libertarian – but totally flawed in his views on money.

As I explained previously, we don’t need to create new money:

In an economy with a fixed money supply, but increasing goods and services, the purchasing power of money increases – prices fall. No new money is needed to purchase the new goods. What if the population increases? No problem, the new people just trade what they produce in order to earn money, and as there are now more goods being produced, again the purchasing power of money increases – prices fall. Rather than the money supply changing, the value of money changes instead.

From my perspective, arguing about the merits of targeting inflation, employment rates, NGDP, QE and any other system for the central bank to create money is like asking how many angels can dance on the head of a pin. They all fall down in that they share the belief that inflating the money supply is necessary and beneficial to the economy. As the Austrian school tells us, any form of monetary inflation is harmful and will ultimately damage the economy in the long run.

For those who believe in small government and the free market, please question the assumptions surrounding central banking. Do we really need a central bank? If we don’t trust the state with so many things, why do we trust it with money?

Does this sound like an institution that belongs in the free market?

• it funds the government whilst punishing savers and workers
• it bailouts failing private enterprises
• it rests on monopoly privilege
• it centrally plans prices

Read Mises. Read Hayek. Bin the Bank.