Rising Prices, Falling Prices, Economic Malaise & Central Bankers

One of the reasons that central bankers are desperate for rising price levels is so that the biggest debtors, governments, will see the burden of their debt diminished. This outcome involves defrauding creditors that is also being pursued by currency devaluations/wars that may eventually lead to outright default.

As a cover story for this subterfuge, central bankers insist that indebted individuals will benefit from relentlessly rising price levels. But this claim ignores the offsetting effects of “financial repression” whereby obscenely-low interest rates punish savers, especially pensioners and other groups that live from savings.

Meanwhile, assertions of the dangerous effects of deflation overlooks the most obvious of realities. That is that after the popping of a massive asset-price “bubble” with wildly distorted prices that overshoot underlying values, prices should go down!

Meanwhile, artificially-low interest rates spawned a global glut of liquidity that has contributed to rising excess capacity in many industries that puts a lid on prices or put downward pressure on them.

At the same time, central bank policy sparked the “financialization” of the economy in that most capital is being diverted to financial instruments (bonds, etc) rather finding its way into the “real” sector where factories are built & jobs created. With few new jobs being created, it is no surprise that aggregate demand has slumped.

Virtually all of the current economic and financial problems can be traced to central bank policies that caused a proliferation of bubbles and are now responsible for the continuation of economic malaise.


China’s Devaluation: Will Real Losses Exceed Expected Gains?

After years of interventions in foreign currency markets to hold back market forces, China’s government tried to arrange an orderly retreat. It began by devaluing the Chinese Yuan on August 10, 2015 by 1.9%, the largest single-day move since 1994.

The logic behind allowing the Yuan to devalue is to boost exports and offset declines in the rate of GDP growth. (China’s annual rate of growth of real GDP dropped to 7% in Q2 of 2015 from 7.5% in Q2 of 2014 and from 8.6% in Q1 of 2012.)

While there is no evidence that currency depreciation change economic fundamentals to create sustained long-term economic growth, there is some evidence of short-term benefits.

While domestic prices and wage rates take time to adjust to changing conditions brought about by devaluation, earnings from foreign trade and tourism tend to rise more rapidly. As long as this adjustment process remains incomplete, exports tend to rise while imports tend to diminish since exporting a given amount goods buys less than before the devaluation

Eventually, as consumers and firms of the devaluating country discover they earn less for what they export and pay more for what they import; they reduce consumption.

As it is, gains from devaluations will be offset by adjustments in production and consumption based on economic realities as evidence in relative prices.

Yet even these short-run gains are likely to be illusory due to other adjustments triggered by the devaluation.

Consider the impact on China’s offshore debt market. For their part, Chinese enterprises are unlikely to hedge their offshore debts against currency fluctuations since doing so involves costs. In turn, past interventions by the People’s Bank of China in foreign-exchange markets have created a “moral hazard” that is likely to be very costly.

Bloomberg reports that the offshore debts of China’s enterprises are about $529 billion or about ¥3,235 billion before the devaluation, rising to ¥3,295 billion afterwards. This change in exchange rate caused the principle to increase by about ¥60 billion.

A Wall Street Journal report indicated that the average interest rate for offshore Chinese debt is above 8.00%. As such, the $529 billion in offshore debt owed by local enterprises requires annual interest payments of just over $42 billion.

Interest payments before the devaluation were about ¥258 billion, rising to ¥263 billion after the devaluation, so that offshore financing costs rose by 5 billion Yuan.

Meanwhile, the PBOC is now trying to curb the Yuan’s depreciation. The key factor behind pressures on the Yuan is a sharp decline in the rate of growth of exports with the annual rate of growth falling to minus 8.3% in July from 2.8% in June. In turn, China’s growth slowdown seems to have sparked capital outflows with foreign-exchange reserves down by $192 billion over the past seven months.

As evidence that no good deed goes unpunished, the initial move by the People’s Bank of China to allow market forces to determine the value of the Yuan sparked a rout. Over the five trading days after the devaluation, China’s currency fell by another 2.9% to 6.3947 per dollar.

But continued market-driven depreciation induced the People’s Bank of China to reverse course and begin intervening to “stabilize” the Yuan. Given that Chinese enterprises owe $529 billion in dollar and euro bonds and loans, the initial 1.9% devaluation will cost an additional $10 billion that will reduce China’s foreign-exchange reserves by like amount. Of course, the losses will rise if the Yuan weakens further.

On its face, this is not such bad news since China’s foreign-exchange reserves are estimated to be between $3 trillion and $3.71 trillion. But Beijing’s refusal to allow market forces is the source of economic instability and distortions along with unsustainable imbalances within its domestic economy. Continuing on this course will be increasingly costly.

Sound Papal Judgement Gives Way to Urban Myths About Market Economics

Pope Benedict XVI delivered his message for peace day that included a call for a new economic model & “ethical regulations” of markets.

His competence as a biblical scholar & his expertise on Church doctrine may be unquestioned. But one has to wonder how he missed one of the greatest shifts in the history of mankind that took place in the late 20th Century & up to now … ?

Has he not heard of the failed social experiments in the Soviet Union or in Mao’s China. And what about the moribund economies of European welfare states that threaten to underwrite the same stagnation of the US economy … ?

His comments show that he accepts the canard that the global financial crisis offers evidence of the failure of capitalism. Equally troubling, he suggested that markets do not protect the weakest members of the community.

Whatever the rhetoric of Statists that support government regulations & interventions in the name of the poor, there has been no greater friend of the poor than the recent wave of globalization that lifted 1/2 billion people out of poverty. Capitalism, NOT the welfare state, performed this miracle.

While governments may not have interfered with the spread of globalization, few saw it as the greater force for the lessening of poverty in the history of man.

In his missive, Pope Benedict also issued a condemnation of something that the world has never actually known, “unregulated capitalism”:

” … the prevalence of a selfish & individualistic mindset which also finds expression in an unregulated capitalism, various forms of terrorism & criminality.”

Ignoring the extensive web of government regulations overseen by domestic & international functionaries that prohibit or control so many aspects of life requires an amazing, perhaps willful, blindness to reality.

Why is This Man Laughing … !?!

Do you care about economic & financial stability … ?

If so, you should always shudder in horror & disbelief when central bankers use words like “unlimited” or “do whatever is necessary” … !

Should you be worried about economic & financial stability … ?

Well, the unconventional monetary policy pursued by the European Central Bank (ECB) is a cause for deep concern. For its part, the ECB has expanded monthly asset purchases to amount to €60 billion worth of bonds issued by euro area central governments, agencies and European institutions & plans to continue until at least September 2016.

Ignoring the failure of similar steps taken in the UK, Japan & the USA, the ECB added sovereign bonds to its existing private sector asset purchase program in hopes that its actions will stimulate economic growth where it failed elsewhere.

The ECB is purchasing bonds issued by euro-area governments as well as those of agencies & institutions of the EU in the secondary market using central bank money.

Although key ECB interest rates are at their lower bound, artificially-cheap credit has not induced more borrowing to expand economic activity in manufacturing or small businesses.

An underlying purpose of the ECBs asset-backed securities purchase program (ABSPP) & the covered bond purchase program (CBPP3) is to lessen the likelihood of “contagion” effects of a Grexit.

But note how these steps play out. The ECB is essentially trading pieces of paper called euros for pieces of paper called bonds. Or it is trading pieces of paper called short-term bonds for pieces of paper called long-term bonds.

You are right to be worried that Mario Draghi believes that ex nihlio creation of bit of colorful paper will be a substitute for the actions of entrepreneurs to engage in sustainable investments based on economic fundamentals.

Be afraid; be very afraid. Our economic & financial future is in the hands of MadMen.

Thomas Paine & Natural Order

“Great part of that order which reigns among mankind is not the effect of government. It has its origin in the principles of society & the natural constitution of man. It existed prior to government, & would exist if the formality of government was abolished. The mutual dependence & reciprocal interest which man has upon man, & all the parts of civilised community upon each other, create that great chain of connection which holds it together. The landholder, the farmer, the manufacturer, the merchant, the tradesman, & every occupation, prospers by the aid which each receives from the other, & from the whole. Common interest regulates their concerns, & forms their law; & the laws which common usage ordains, have a greater influence than the laws of government. In fine, society performs for itself almost everything which is ascribed to government.”

~Thomas Paine~ (“Right of Man”)

Central Banks Contribute to Unsound Banking

Modern central banks were & are justified on the grounds that they provide a means to insure economic stability by supporting “sound” money & “sound” banking practices. However, there is considerable reason to believe that central banks create “moral hazards” that undermine both “sound” money & “sound” banking.

Walter Bagehot specified the role of central banks as lender-of-last-resort in response to a liquidity crisis. According to him, they should lend “freely”, but temporarily, against sound collateral & at penalty rates. It is clear that Bagehot did not think much of the argument in insisting on such stringent limits.

But modern central banks do not take Bagehot’s case to heart. His idea of setting a penalty rate was to provide a motivation for commercial banks to pay off emergency loans once financial markets returned to normal conditions. However, central banks tend to provide liquidity at subsidized rates for periods without imposing strict limits on the duration of the loans.

In all events, the role of lend-of-last-resort seems to be made necessary when central banks hold most of the reserves of the banking system so there are few other sources of liquidity.

Concentrating reserves in one place creates a moral hazard that undermines the presumed benefits of central bank interventions to offset liquidity problems so that the banking system will be less stable. As banks scramble for liquidity after a credit crunch, they will all seek funds from a common pool of reserves that can cause the money supply to contract.

As central bankers offer relaxed collateral requirements and lend at subsidized interest rates, insolvent institutions divert resources from solvent ones. As solvent banks will be unable to lend, credit and overall economic activity will be stifled.

At the same time, deposit insurance that replaced the doctrine of “double liability” previously imposed on bank owner-shareholders undermined sound banking practices.

From the end of the Civil War to the Great Depression, stockholders of nationally-chartered banks had to place more capital if the institution was impaired or insolvent. As such, shareholder-owners of US commercial banks were held responsible both for its safety and soundness.

This “doctrine of double liability” meant that they were responsible for a portion of bank debts after insolvency, an amount up to and including the par value of their stock. Despite being contrary to the “limited liability” notion of conventional corporations, the US Supreme Court, lower federal courts and state courts upheld this arrangement.

Double liability meant that if investors engaged in risky activities for their own advantage would bear the burden if the increased risks led to losses. Since many small banks are closely held while most larger banks tend to be controlled by a bank holding company, shareholders will be more likely to be successful in controlling the risk-taking tendencies of banks.

Supporters of deposit insurance insisted that it provided better arrangements for covering risks of losses, while ignoring “moral hazard” issues arising from it as well as the loss of the beneficial effects of the “doctrine of double liability”.

Protectionism Kills … !!!

Most economists oppose government interventions that grant privileges to domestic producers, especially those that create price distortions arising from tariffs or quotas.

Despite this near-consensus, protectionist economic policies are the last domain of scoundrels, usually driven by the venality of the political class that support privilege-seeking trade unionists or industrialists.

Recent events show that these policies are not only economically irrational & counter-productive, they are also often have deadly consequences.

Turkish authorities have been using deadly means in an attempt to curb “smuggling”, an activity that is most often induced by excessive restrictions of access to certain goods or high tax rates on their consumption. A few weeks ago, 25 unaccompanied mules were shot dead by F-16s.

As it is, a more peaceful way to cope with smuggling, especially of harmless goods, is to allow free trade. For their part, Turkish villagers were quoted:

“We do not call it smuggling. “t is trade.”

Meanwhile, it has been reported that customs checks are holding up relief supplies for Nepal quake victims.

What is really at stake is government officials either refusing to relinquish some amount of power they have or their own access to revenue flows.

Protectionism is a cynical & deadly game that has real human costs & sometimes deadly consequences.

Unconventional Monetary Theory & Wealth Destruction

Many economists predicted that unconventional monetary theory, especially “quantitative easing” (QE) would lead to a dramatic rise in price levels, so-called price inflation.

A quick perusal of the normal measures of price inflation, e.g., consumer price indexes (CPI), suggest that nothing could be farther from the truth. Indeed, most central bankers are engaging in continuous handwringing over price deflation, going so far as to coin a new term, “slowflation” to depict worryingly-low changes in CPI or GDP price deflators.

It turns out there is more to all this than meets the eye.

Economists worry about the effect of excessively-loose monetary policy on rising price levels because it involves an erosion of purchasing power and a decline the value of saving. As it is, zero-interest rate policy (ZIRP) has been the cause of a massive collapse in the value of deferred consumption.

Central banks forcing of nominal interest rates ever closer to (or exceeding!) zero around the world has had the same corrosive effect on living standards as out-of-control increases in consumer prices. Collapsing yields on financial assets has much the same effect as price inflation since lower earnings on a stock of saving requires more capital or a longer time to accumulate earnings to maintain a given living standard.

Consider that you have $100 in capital assets earning 10% such that this yield allows you to consume goods worth $10 at current prices. Even if price levels remain unchanged, an impossibility in a fiat-money world, yields of .01% would require 100 years of accumulated earnings to buy $10 worth of goods. Alternatively, you would need to have $10,000 in capital.

Clearly, this is no different in effect than if there had been (hyper) inflation.

Looking back over the past 40 years, interest rates have been on a downward trend that has continuously undermined the value of saving, especially in the hands of the middle class.

Interest Rates 10yr Treasuries

Ending “financial repression” arising from ZIRP & associated central bank policies may be the most important first step to bring an end to the slow-growth recovery that has been underway since 2009.

With “friends” like this; markets do not need enemies … !!!

In a recent McKinsey report (“Harnessing the power of markets“), Martin Neil Bail supposedly speaks on behalf of how markets

Typical of mainstream economists, Baily gets the conclusion right:

The biggest opportunity for future growth is for policy makers and the citizens who elect them to take advantage of market forces.

Alas, he then mutters & mumbles through apologetics that provide ammunition for Statists & interventionists to undo all the good that he attributes to markets (NB: after a few remarks about the virtues of markets, the rest is about “market failure”!!!?!!!) …

Concerning his remarks:
1st, markets generate far more POSITIVE externalities than negative ones … market players also face incentives to find ways to mitigate negative externalities using localized information that is not available to centralized planners … .

2nd, there is ample evidence that severe recessions/depressions are not the logical outcome of markets but occur due to exogenous factors (i.e., actions taken by fiscal or monetary authorities) … as it is, markets tend to be stable due to the balancing forces of “bulls” & “bears” … the primary source of “herding” is when most market players react to the same information that eventually proves to be faulty … in terms of asset “bubbles”, this is most likely to be artificially-low interest rates conjured up by central bankers … .

3rd, recent widening of inequalities of income & wealth can be traced to “monetary central planning” whereby interest rates have been fixed at historically/hysterically-low levels creating incentives for banks to divert lending away from real sector where jobs might be created to more speculative activities that have benefited the 1% … .

In sum, this is a rather pathetic attempt to extol the beneficence of markets that becomes a paean to government intervention … !?!

Reaping the Whirlwind of Central Bank Malfeasance & Fiscal Profligacy

News that Monetary Authority of Singapore cut its benchmark interest rate sent the Singapore $ to a 4-year low against the US $.

This is another sign of the endgame of so many years of central bankers complicity with suppressing interest rates to boost the temporary feel-good effects of credit-driven growth. A plunging euro along with downdraft for currencies of many of Asia’s industrialized economies signals a skirmish in what is shaping up to be a full-blown currency war & a tit-for-tat cycle of depreciating currencies.

As it is, the “best” way for governments to repudiate debts without outright default is to trigger domestic price inflation and/or to rely on currency depreciation.

All this has come to pass due to artificially-low interest rates arising from “monetary central planning” that punished savers while allowing governments to go on excessive borrowing-and-spending binges.

Of course, America’s central bankers are the primary villain in this tale. However, most central bankers chose to set their own policies in tandem & in response to move by the FED. In turn, these choices removed the disciplining effect of international inflows & outflows that would normally accompany growing public-sector debts & the flood of liquidity sent into financial markets.

Instead of price inflation, the tsunami of credit-driven liquidity brought an endless array of “bubbles” even as central bankers pretended to be innocent of such events.

Now it will become increasingly clear that “anything that cannot go on forever, won’t” … !

Credit-driven growth will soon reach its logical end as burdens of repayment of interest obligations become unsupportable at current interest rates, likely to lead to the “Mother of All Liquidity Crunches”.

Batten down the hatches, maties … it ain’t gonna be pretty … !!!