Archive for October 2008
Expect inflation to head skywards in the UK.
Do you want to know how I know? It’s no secret. In fact, the decision to inflate was made by Alistair Darling when he revealed the Labour government’s plans to spend its way out of the current recession.
Under Keynes’ own framework, the economy is not self-correcting and can languish for years in what is termed “underemployment equilibrium”. The economy can be “in equilibrium” with high levels of unemployment. As such, a government stimulus of sorts is needed to jump-start the economy – much like a doctor defibrulating a patient.
I won’t bother dismissing these Keynesian assertions here (I’ll leave that to the pros). I will focus on the fact that even within the Keynesian framework, Darling’s move will be inflationary.
What Darling hopes to do is stimulate spending, which will increase aggeregate demand. This is illustrated by the rightward shift of the AD curve (below). The new equilibrium will occur at a higher output (GDP) and at a higher price level (P).
So when Mr. Darling revealed his massive spending spree he announced that Britons will not only be paying off UK government borrowing, but also paying an inflation tax in the near future.
So the lesson is… when prices in Britain begin to creep upwards, it’s because of government policy, not because of anything OPEC does in the next few days.
Taking a break from economics:
Italy’s top court of appeals has barred a couple from naming their son “Friday,” castigating them for the “ridiculous” name and forcing them to call the boy Gregorio instead.
The court agreed with two previous ruling from courts in Genoa which found that the name — Venerdi in Italian — was too reminiscent of Robinson Crusoe’s servant named Friday.
The judges found that Robinson’s sidekick in the Daniel Defoe novel was associated with “subjection and inferiority.”
The child’s parents, who have battled in court for two years for the right to name their son what they want, insisted they chose Venerdi because “it was nice and sounded good” and not because of the novel.
I’ve known Irish people with much, much stranger names than “Friday”, which doesn’t seem like such a bad name to me at all. I wonder if this court battle has improved the young man’s prospects in life?
“Much of what Keynes wrote still make sense,” Mr Darling told The Sunday Telegraph. “You will see us switching our spending priorities to areas that make a difference – housing and energy are classic cases where people are feeling squeezed.”
Mr Darling said it would be “wrong” to start taking money out of the economy by cutting spending or raising taxes… The stimulus package will give departments immediate access to future years’ budgets. This is to be funded in the short term by borrowing.
Adventure capitalist Jim Rogers on CNBC discussing governmental response to the current financial meltdown.
My favorite quote:
I think they [the G7] need to go down to the bar and have a beer and leave the rest of us alone.
Well, according to this Daily Telegraph article it is not only banks, but both savers and borrowers too who benefit from the £500 billion government bailout like the one we have seen today in Britain. While it is true that the bank CEOs whose companies went bust, the depositors of those banks and current borrowers who are in debt in the banking system as a whole benefit it is certainly false to say that all banks, borrowers and savers benefit from a bailout.
What the telegraph has missed is the crucial point that Ludwig Von Mises made in ‘Human Action’ (1949) about the printing of money that the Austrian School has been repeating ad nauseum for over a century. This can be summarised as follows:
Inflation is defined as an increase in the money supply.
1. When money is printed the relative purchasing power of any unit of money already existing in the rest of the economy is decreased.
2. It is the person who receives the money first who benefits most from pre-inflationary prices and the person who receives the money last who suffers most from post-inflationary higher prices from a decrease in the purchasing power of their money.
As Peter Schiff likes to point out, Governments have no money, all they have is a printing press and the only effect they can have on an economy is a re-arrangement of who pays the debts for mal-investments.
In this case, it is clear that while the depositors of banks like Northern Rock have benefited from the fact that their deposits in the insolvent bank were not lost but guaranteed by government, all savers in other banks which had not collapsed saw an immediate decrease in the relative purchasing power of their savings. In this sense, it is precisely the savers who invested their savings in better run banks who lose out the most for they can now buy less because of this government intervention.
Furthermore, there is also the unintended and unseen consequence that this will encourage other banks to act more recklessly to maximise gain with the knowledge that if they take big enough risks and fail they will be bailed out. This is said to be why Merrill and Bank of America merged because having seen AIG get bailed out and Lehman fail they realised that the bigger you are, the more likely you will be bailed out. In other words, they wanted to be ‘too big to fail’.
Borrowers who indebted themselves before the bailout will benefit for they will now have to repay less in real terms because the value of the amount they borrowed off the bank will have decreased in the ensuing inflation from the bailout. But the borrowers who arrive after the bailout will be investing in a world where the pricing system has become utterly confused. The new money entered into the system by government will increase ten fold under the legalised fractional reserve banking system (FRB) as the banks get ‘loaned up’ which will cause another wave of mal-investments in the ensuing boom leading to the need for another bailout at a later stage. For these new borrowers it will be difficult to distinguish what is a good investment as the real value of goods will become difficult to discern from the inflation and the FRB system.
In the past, bank runs were necessary to remove poorly run and insolvent banks from the system to make way for the growth and expansion of prudent and well-run banks. Bailouts do not reward good business practice, they reward the politically connected at the expense of everyone. There is no incentive for banks to be responsible when risk is socialised amongst the population at large.
In short, only the politically connected and the indebted from before the bailout benefit from bailouts from their unique first access to the fiat produce of the Government printing press.
The prices of bread, milk, televisions, cars, tractors and factories are all set by the interaction of the supply and demand schedules of millions of individual actors. The price of credit however is set by a few men in suits in a large marble building.
As such, we have no way of knowing whether the price of credit, also known as the interest rate is equal to the price that reflects the market’s requirements.
The Central Banks of Canada, China, Sweden, Switzerland, the European Union and the United States all lowered interest rates in their respective regions today.
Central Banks are between a rock and a hard place and must decide between “injecting liquidity” into sagging financial markets and reeling in the inflation that they themselves have manufactured.
Keynesian economist and perennial Nobel Prize candidate Paul Krugman has praised the rate cuts, however claims that
We’re way past the point at which conventional monetary policy has much traction.
With the Fed’s benchmark rate now at 1.5%, the United States may be in liquidity trap territory.
Krugman may be correct in saying that coordinated rate cuts will make little difference, however he fails to present an alternative course of action. It won’t be long before Krugman and his ilk will be advocating massive public works and widescale labour market interventions to “stave off crisis”, rather than waiting for time to heal the wounds.
Another war perhaps, Mr. Krugman?
Or as Milton Friedman might say: good economics versus bad economics (I’ll let you decide which is which). This video is from 2006, when mainstream Wall Street and government economists like Art Laffer and Ben Bernanke were still of the view that the US economy was sound.