Inflation-racked Argentina is preparing to issue larger-denomination banknotes to alleviate critical shortages of cash in the country. What a difference between the Argentine government and most other Western governments, which seek to crack down on the use of cash.
Yes, the headline isn’t at all shocking, but Ben Bernanke has opened his mouth and stuck his foot in it again, this time on “Audit the Fed” which is coming up for a vote in the Senate. Once more Bernanke trots out tired old canards that have been debunked time and time again. So yet again, let’s take a look at some of his arguments and see what he gets wrong.
One of the lesser-known victims of inflation is one of its smallest: the penny. At one time, the penny could actually buy you something. Many of our parents remember when a penny could buy a piece of candy. At the Federal Reserve’s creation in 1913, a penny could buy you 2/3 of a pound of potatoes. Three pennies could buy you a pound of flour. Nine pennies could buy you a quart of milk. What can nine pennies buy today? Nothing, really. Inflation has so reduced the purchasing power of the dollar that the penny is useless for commerce. Nobody wants to use them and nobody wants to accept them. It’s not uncommon to see a trail of pennies leading out of a store, as some customer would rather drop them on the ground than put them in his pocket.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
At $4.5 trillion, the Fed’s balance sheet is equivalent to about 27% of US GDP, over one quarter of the entire economic output of the United States. But it’s one thing to say that and read about it and another thing to put it into perspective.
The European Central Bank (ECB) made waves recently with its decision to lower interest rates on its deposit facility to -0.30%. That means that banks wanting to park their money at the ECB have to pay the ECB for that privilege. The supposed reason for introducing negative interest rates is to spur lending on the part of banks. Rather than being able to park their money at the ECB for free or for a small guaranteed return, the ECB wants banks to put that money to use by lending it. The idea of negative interest rates was once seen as impossible to achieve by many central bankers. But since the ECB’s decision last year to introduce negative interest rates, the concept has become increasingly accepted among central bankers, with even a few Federal Reserve officials supporting the idea of negative rates. But are negative interest rates really feasible?
India’s newest gold monetization scheme has been a colossal failure. After one month, it has netted only one kilogram (2.2 pounds avoirdupois) out of an estimated 20,000 tonnes (44 million pounds avdp) of privately-held gold. Why is that? Well, let’s look at how the program works.
- Gold-holders turn their gold over to a bank. The banks melt the metal down and provide it to the central bank to loan to jewellers.
- In exchange, the central bank provides gold accounts to the banks on behalf of the gold depositors and pays interest on those deposits.
- The interest rate on those deposits is a little over 2%, while the inflation rate in India right now is over 5%.
- The deposits are time deposits, meaning that depositors receive their principal repaid at the end of the term; short-term depositors receive gold or rupees back, while medium- and long-term depositors receive only rupees.
So you give up all your gold, get at most a -3% rate of return on your investment, and might get both your interest payments and principal paid in rupees that the government has historically devalued at up to 15% per year. And the government wonders why gold-holders aren’t flocking to offload their gold?
The Greek government has just adopted a policy requiring households with more than 15,000 euros in cash or 30,000 euros in gold, jewelry, and precious stones at home to declare those assets on their tax returns. And while the law initially affects only lawmakers, journalists, and public employees, it lays the groundwork for an eventual expansion to all Greek taxpayers. Assets inside the banking and financial system are easily taxed and controlled by governments, so governments try to sweep everything into the financial system and make transactions outside the financial system so difficult that people are forced to give in. Governments make it more difficult to hold and use cash, gold, or other non-bank forms of money. They force banks, pawnshops, coin dealers, jewelers, and others to report cash transactions above certain amounts. They place onerous taxes on the use of precious metals as money. They provide such significant advantages to banking institutions that it becomes almost impossible to do business efficiently outside the banking system, so most people capitulate and put their money in banks. But after the latest banking crises in Cyprus and Greece, who could blame the Cypriot and Greek people for wanting to keep their assets out of banks?
The ultimate aim of this new policy is to open up assets held outside the financial system to taxation and/or confiscation. Never mind that the money being held was likely already taxed, or that the jewelry or gold was purchased with money that was already taxed. Governments throughout history have treated banks as their own personal piggy banks to take money from at will. The more people keep their money and assets out of bank accounts and safe deposit boxes, the less there is for governments to tax or seize. And with a government that is in severe financial distress because of its poor fiscal policy, there is a very great likelihood that the first remedy to that situation will be to attempt to charge higher taxes. The more assets that the government knows about, the more taxes it can levy. When the US government finally realizes the dire financial shape it is in, don’t be surprised to see similar policies adopted here too.
Remember the golden rule: He who has the gold makes the rules. Governments throughout history have tried to monopolize the issuance of money, accumulating hoards of gold and silver to spend on their adventures, often by forcing debased coinage on the populace. Even though gold doesn’t play quite the monetary role that it used to, private ownership of gold is still a hedge against government devaluation of currency units. The more gold in the hands of private individuals, the less devaluation the government can get away with before people stop using government money and return to gold.
India, as one of the world’s largest consumers of gold, has a long and special relationship with the metal. In particular, Hindu shrines in India hold large amounts of the metal, brought to them by Hindu pilgrims making offerings to the gods. One temple in particular, the Sri Padmanabhaswamy temple, holds an estimated 3,000 tonnes of gold, more than all other gold-holders except for the United States and German governments. Naturally, the Indian government would like to get its hands on that gold.