Thursday, January 7, 2021

The Keynesian Multiplier is the Bigfoot of Economics—Something That Many Assume Exists But Is Rarely, If Ever, Seen

The Keynesian multiplier theory rests on the assumption that a dollar of government deficit spending can produce more than a dollar of total economic output after all secondary effects are taken into account. The multiplier is the Bigfoot of economics—something that many assume exists but is rarely, if ever, seen. The foundation of Keynesian public policy is called aggregate demand, or the total of all spending and investment in the domestic economy, excluding inventories. For example, if a worker is fired, he not only loses his income, but he also then stops spending in ways that cause others to lose income as well. The lost income and lost spending cause a drop in aggregate demand, which can feed on itself, leading more businesses to fire more employees, who then spend less, and so on in a vicious circle. Keynesian theory says that government can step in and spend money that individuals cannot or will not spend, thereby increasing aggregate demand. The government spending can reverse the slide and contribute to renewed economic growth. 

The problem with this theory of government spending to boost aggregate demand is that governments have no money of their own in the first instance. Governments have to print the money, take the money in the form of taxes or borrow the money from their citizens or from abroad. Printing money can cause nominal growth, but it can also cause inflation, so that real growth is unchanged over time. Taxing and borrowing may enable the government to spend more, but it means there is less for the private sector to spend or invest, so it is not clear how aggregate demand increases. This is where the multiplier claims to play a role. The idea of the multiplier is that one dollar of government spending will stimulate more spending by others and result in more than one dollar of increased output, and this is the justification for taking the dollar from the private sector. 

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2012), 184-185.


Wednesday, January 6, 2021

Central Banks Want to Eliminate Cash So They Can Implement Negative Real Interest Rates and Defeat Deflationary Trends

The second reason for eliminating cash is to impose negative interest rates. Central banks are in a losing battle against deflationary trends. One way to defeat deflation is to promote inflation with negative real interest rates.

A negative real rate occurs when the inflation rate is higher than the nominal interest rate on borrowings. If inflation is 4 percent, and the cost of money is 3 percent, the real interest rate is negative 1 percent ( 3 - 4 = -1). Inflation erodes the dollar’s value faster than interest accrues on the loan. The borrower gets to pay back the bank in cheaper dollars. Negative real rates are better than free money because the bank pays the borrower to borrow. Negative real rates are a powerful inducement to borrow, invest, and spend, which feeds inflationary tendencies and offsets deflation. 

How do you create negative real interest rates when inflation is near zero? Even a low nominal interest rate of 2 percent produces a positive real interest rate of 1 percent when inflation is only 1 percent (2 - 1 =1). 

The solution is to institute negative interest rates. With negative nominal rates, a negative real rate is always possible, even if inflation is low or negative. For example, if inflation is zero and nominal interest rates are negative 1 percent, then the real interest rate is also negative 1 percent (-1 - 0 = -1).

Negative interest rates are easy to implement inside a digital banking system. The banks program their computers to charge money on your balances instead of paying. If you put $100,000 on deposit and the interest rate is negative 1 percent, then at the end of one year you have $99,000 on deposit. Part of your money disappears. 

Savers can fight negative real rates by going to cash. Assume one saver pulls $100,000 out of the bank and stores the cash safely in a non-bank vault. Another saver leaves her money in the bank and “earns” an interest rate of negative 1 percent. At the end of one year, the first saver still has $100,000, the second saver has $99,000. This example shows why negative interest rates work only in a world without cash. Savers must be forced into an all-digital system before negative interest rates are imposed.

—James Rickards, The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis (New York: Portfolio / Penguin, 2016), 28-29.


Tuesday, January 5, 2021

By Overvaluing the Conversion Rate Between the Pound and Gold, The U.K. Economy Was in Depression by 1926 (NOT 1929)

Most important, nations [under the gold exchange standard] had to choose a conversion rate between their currencies and gold, then stick to that rate as the new system evolved. In view of the vast paper money supply increases that had occurred during the First World War, from 1914 to 1918, most participating nations chose a value for their currencies that was far below the prewar rates. In effect, they devalued their currencies against gold and returned to a gold standard at the new, lower exchange rate. France, Belgium, Italy, and other members of what later became known as the Gold Bloc pursued this policy. The United States had entered the war later than the European powers, and its economy was less affected by the war. The United States also received large gold inflows during the war, and as a result, it had no difficulty maintaining gold’s prewar $20.67-per-ounce exchange rate. After the Gold Bloc devaluations, and with the United States not in distress, the future success of the gold exchange standard now hinged on the determination of a conversion rate for U.K. pounds sterling.

The U.K., under the guidance of chancellor of the exchequer Winston Churchill, chose to return sterling to gold at the prewar rate equivalent to £4.86 per ounce. He did this both because he felt duty bound to honor Bank of England notes at their original value, but also for pragmatic reasons having to do with maintaining London’s position as the reliable sound money center of world finance. Given the large amount of money printed by the Bank of England to finance the war, this exchange rate greatly overvalued the pound and forced a drastic decrease in the money supply in order to return to the old parity. An exchange rate equivalent to £7.50 per ounce would have been a more realistic peg and would have put the U.K. in a competitive trading position. Instead, the overvaluation of pounds sterling hurt U.K. trade and forced deflationary wage cuts on U.K. labor in order to adjust the terms of trade; the process was similar to the structural adjustments Greece and Spain are experiencing today. As a result, the U.K. economy was in a depression by 1926, years before the conventional starting date of 1929 associated with the Great Depression and the U.S. stock market crash.

—James Rickards, The Death of Money: The Coming Collapse of the International Monetary System (New York: Portfolio / Penguin, 2017), 222-223.


Monday, January 4, 2021

“Exchange” in “Gold Exchange Standard” Means that FOREIGN EXCHANGE BALANCES Are Treated LIKE GOLD for Reserve Purposes

Yet important changes had taken place since the heyday of the classical gold standard. The United States had created a new central bank in 1913, the Federal Reserve System, with unprecedented powers to regulate interest rates and the supply of money. The interaction of gold stocks and Fed money was still an object of experimentation in the 1920s. Countries had also grown used to the convenience of issuing paper money as needed during the war years of 1914-1918, while citizens had likewise become accustomed to accepting paper money after gold coins had been withdrawn from circulation. The major powers came to the Genoa Conference with a view to reintroducing gold on a more flexible basis, more tightly controlled by the central banks themselves.

From the Genoa Conference there emerged the new gold exchange standard, which differed from the former classical gold standard in significant ways. Participating countries agreed that central bank reserves could be held not only in gold but in the currencies of other nations; the word “exchange” in “gold exchange standard” simply meant that certain foreign exchange balances would be treated like gold for reserve purposes. This outsourced the burden of the gold standard to those countries with large gold holdings such as the United States. The United States would be responsible for upholding the gold value of the dollar at the $20.67 per ounce ratio while other nations could hold dollars as a gold proxy. Under this new standard, international accounts would still be settled in gold, but a country might accumulate large balances of foreign exchange before redeeming those balances for bullion. 

In addition, gold coins and bullion no longer circulated as freely as before the war. Countries still offered to exchange paper notes for gold, but typically only in large minimum quantities, such as four-hundred-ounce bars, valued at the time at $8,268 each, equivalent today to over $110,000. This meant that gold bullion would be used only by central banks, commercial banks and the wealthy, while others would use paper notes backed by the promises of governments to maintain their gold equivalent value. Paper money would still be “as good as gold,” but the gold itself would disappear into central bank vaults. England codified these arrangements in the Gold Standard Act of 1925, intended to facilitate the new gold exchange standard.

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2012), 61-62.


Qualitative Credit Theorists Joined the Austrians in Opposing the Bank Credit Inflation of the 1920s and in Warning of Impending Depression

Various “qualitative credit” schools, however, also see the depression as inevitably generated by an inflationary boom. They agree with the Austrians, therefore, that booms should be prevented before they begin, and that the liquidation process of depression should be allowed to proceed unhampered. They differ considerably, however, on the causal analysis, and the specific ways that the boom and depression can be prevented.

The most venerable wing of qualitative credit theory is the old Banking School doctrine, prominent in the nineteenth century and indeed until the 1930s. This is the old-fashioned “sound banking” tradition, prominent in older money-and-banking textbooks, and spearheaded during the 1920s by two eminent economists: Dr. Benjamin M. Anderson of the Chase National Bank, and Dr. H. Parker Willis of the Columbia University Department of Banking, and editor of the Journal of Commerce. This school of thought, now very much in decline, holds that bank credit expansion only generates inflation when directed into the wrong lines, i.e., in assets other than self-liquidating short-term credit matched by “real goods,” loaned to borrowers of impeccable credit standing. Bank credit expansion in such assets is held not to be inflationary, since it is then allegedly responsive solely to the legitimate “needs of business,” the money supply rising with increased production, and falling again as goods are sold. All other types of loans—whether in long-term credit, real estate, stock market, or to shaky borrowers—are considered inflationary, and create a boom-bust situation, the depression being necessary to liquidate the wasteful inflation of the boom. Since the bank loans of the 1920s were extended largely in assets considered unsound by the Banking School, these theorists joined the “Austrians” in opposing the bank credit inflation of the 1920s, and in warning of impending depression.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2008), 76.


Sunday, January 3, 2021

Early in 1930 the Government Instituted a Massive EASY MONEY Program Lead by the New York Federal Reserve

Dr. Anderson records that, at the end of December, 1929, the leading Federal Reserve officials wanted to pursue a laissez-faire policy: “the disposition was to let the money market ‘sweat it out’ and reach monetary ease by the wholesome process of liquidation.” The Federal Reserve was prepared to let the money market find its own level, without providing artificial stimuli that could only prolong the crisis. But early in 1930, the government instituted a massive easy money program. . . . 

A leader in the easy money policy of late 1929 and 1930 was once more the New York Federal Reserve, headed by Governor George Harrison. The Federal Reserve, in fact, began the inflationist policy on its own. Inflation would have been greater in 1930 had not the stock market boom collapsed in the spring, and if not for the wave of bank failures in late 1930. The inflationists were not satisfied with events, and by late October, Business Week thundered denunciation of the alleged “deflationists in the saddle,” supposedly inspired by the largest commercial and investment banks.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2008), 239-241.