On January 8, 1912 the National Monetary Commission established by the Aldrich-Vreeland Act issued its final report. The Aldrich-Vreeland Act had been passed in 1908 in response to the Panic of 1907. The act established a monetary commission that studied the banking systems of England, France, Germany, Switzerland, Canada, and other countries, and issued a series of documents during its existence. The Commission’s final report contained suggestions for a National Reserve Association to further nationalize the banking system, centralize reserves, and respond to combat financial panics. The ideas and language in that final report formed the basis for the eventual creation of the Federal Reserve System. Some advocates of sound money have advocated the creation of a new monetary commission, the Centennial Monetary Commission, which would examine the Federal Reserve’s performance over the past century and put forth proposals for a potential overhaul of the American financial system.
Today is the anniversary of the death of Austrian School economist Murray Rothbard in 1995. Along with Ludwig von Mises and others, Rothbard was one of the men most responsible for popularizing the Austrian School of Economics in the United States. Following in the vein of Carl Menger, the founder of the Austrian School, Rothbard made important contributions to economics as well as economic and monetary history, and gave penetrating insights into the public policy impacts of monetary policy. For those wishing to begin reading Rothbard’s work on money and banking, his short book “What Has Government Done to Our Money?” and the longer “The Mystery of Banking” are great introductions to and explanations of the workings of the American banking and monetary system.
With a new year come new opportunities as well as new issues to take into consideration. Here are the five most important issues to keep an eye on in 2017.
1. Trump Presidency
The most important issue facing monetary policy, at least in the United States, will be the incoming Trump Administration. The Federal Reserve Board of Governors is currently operating with two vacancies and has been for quite a while. With majorities in both the House and Senate, it is highly likely that President Trump will be able to successfully nominate two candidates to the Board. Depending on who he picks, that could put additional pressure on Chairman Janet Yellen to continue to raise the federal funds target rate throughout 2017.
2. Ongoing Weakness in Europe
The PIIGS are returning. The Greek debt crisis is still unresolved, the Italian banking sector is weakening with Monte dei Paschi likely facing a bailout this year, and Portugal is showing signs of a weakening banking sector. Add to that the difficulties continuing to face Deutsche Bank and 2017 could be a perfect storm facing the Eurozone banking sector. The big question then would be to what extent bank failures and bailouts in Europe would cause spillover effects in the United States and worldwide.
3. China Is Still a Wild Card
While the yuan continues its march towards becoming a global reserve currency, the Chinese economy faces continued difficulty and slowing growth. Private sector debt loads are high, the insurance and banking sectors are built on matchsticks, and the government is beginning to sell off some of its foreign exchange reserves to defend the yuan. 2017 could be a very interesting year for China, and for the rest of us if a Chinese collapse spills over to the West.
4. The Relentless War on Cash
As India’s demonetization demonstrated, the war on cash is ramping up around the world. While there likely won’t be major moves towards eliminating high-denomination bills in the United States or Europe, there will be continued actions that chip away at the use of cash and the financial privacy that cash affords. Expect more legislative and regulatory action against cash transactions under the guise of fighting against money laundering, terrorist financing, and tax havens as governments continue to try to squeeze as much money as possible from taxpayers.
5. A Coming Financial Crisis
The most important thing to watch for in 2017 is the possibility of another financial crisis. With the trillions of dollars of new money pushed into the financial system over the past several years by central banks around the world, financial bubbles growing, popping, and leading to financial crises are inevitable. Contrary to the thinking of Ben Bernanke and others of his mindset, it doesn’t take a central bank actively removing liquidity from the financial system to pop bubbles or create financial crises. All that is required is for the central bank to stop or slow its monetary easing and the effects of the newly created money will soon be evident.
As the reality sets in that massive amounts of resources have been malinvested in unproductive sectors of the economy, the bubbles that were blown will inevitably burst. While monetary policies around the world remain historically loose, the Federal Reserve’s raising of its federal funds rate target has been accompanied by talk in other countries about raising interest rates. Given the anemic recovery in the aftermath of the 2008 financial crisis and continued low interest rates, central banks don’t have much room to maneuver when the next crisis hits. It’s always tricky trying to predict when a crisis will occur, but given economic data in various sectors that show similarities to the last crisis, it’s not out of the realm of possibility for 2017 to be the year of the next crisis.
According to Austrian Business Cycle Theory, injections of money and credit by central banks lead to artificially low interest rates, incentivizing investment into longer-term, more capital-intensive projects that wouldn’t be profitable at higher interest rates. When those projects are completed the realization comes that there is insufficient demand for them. Resources have been malinvested, put to use in producing goods not demanded by the market. Companies are forced to lower prices, liquidate assets, and lay off workers in order to put their malinvested resources back to productive use.
Similar things happen on a smaller scale in households. As money flows into the economy and salaries rise, people feel flush with cash and begin to increase their discretionary spending. Expectations about the future increase too, leading people to believe that the good times will never end. As the bubbles burst, however, and the layoffs begin, people begin to realize what is coming and pull back on their spending. Dining out is replaced by dinners at home, cars and houses may be downsized, and spending on frills and luxuries is curtailed.
It’s been a while since we’ve put together a bubble watch post, so here is a little compendium of some news items from the past few months that might be indicators of bubbles. While it isn’t always possible to identify which bubbles are going to burst and when, nor how important such bubbles bursting may be, smaller bubbles can serve as leading indicators of overall bubble creation or point to even larger bubbles in the overall economy. The skyscraper index is a well-known example of a smaller bubble indicator, but it’s not the only one.
The South Korean government is preparing to move to a cashless society as the Bank of Korea plans to phase out all coinage by 2020. Apparently not all governments are proceeding as quickly as the Indian government. South Korea’s government hopes to get its citizenry to deposit their coinage onto electronic travel passes that are widely accepted throughout the country. The Bank of Korea will undoubtedly watch to see how smoothly the phaseout of coinage proceeds in order to set a deadline further in the future for the eventual phaseout of paper notes. Since only 20 percent of South Korea’s purchases use cash, the phaseout will likely be less severe than it would be in countries more dependent on cash, such as Germany, India, or the United States. Still, even though there are advantages in certain situations to using non-cash means of payment, an all-electronic payments system is fraught with danger. The BOK’s decision shows us that the war on cash is a worldwide phenomenon that governments are undertaking under a variety of different pretenses. This particular decision demonstrates the roadmap that will most likely be used by most governments: gradual phaseouts of coinage, followed in the future by eventual phaseouts of paper notes. Unless this creeping gradualism is able to be stopped, the war on cash may result in victory for governments and defeat for consumers and their financial privacy.
By Ron Paul
Former Dallas Federal Reserve Bank President Richard Fisher recently gave a speech identifying the Federal Reserve’s easy money/low interest rate policies as a source of the public anger that propelled Donald Trump into the White House. Mr. Fisher is certainly correct that the Fed’s policies have “skewered” the middle class. However, the problem is not specific Fed policies, but the very system of fiat currency managed by a secretive central bank.
Federal Reserve-generated increases in money supply cause economic inequality. This is because, when the Fed acts to increase the money supply, well-to-do investors and other crony capitalists are the first recipients of the new money. These economic elites enjoy an increase in purchasing power before the Fed’s inflationary policies lead to mass price increases. This gives them a boost in their standard of living.
By the time the increased money supply trickles down to middle- and working-class Americans, the economy is already beset by inflation. So most average Americans see their standard of living decline as a result of Fed-engendered money supply increases.
Some Fed defenders claim that inflation doesn’t negatively affect anyone’s standard of living because price increases are matched by wage increases. This claim ignores the fact that the effects of the Fed’s actions depend on how individuals react to the Fed’s actions.
Historically, an increase in money supply does not just cause a general rise in prices. It also causes money to flow into specific sectors, creating a bubble that provides investors and workers in those areas a (temporary) increase in their incomes. Meanwhile, workers and investors in sectors not affected by the Fed-generated boom will still see a decline in their purchasing power and thus their standard of living.
Adoption of a “rules-based” monetary policy will not eliminate the problem of Fed-created bubbles, booms, and busts, since Congress cannot set a rule dictating how individuals react to Fed policies. The only way to eliminate the boom-and-bust cycle is to remove the Fed’s power to increase the money supply and manipulate interest rates.
Because the Fed’s actions distort the view of economic conditions among investors, businesses, and workers, the booms created by the Fed are unsustainable. Eventually reality sets in, the bubble bursts, and the economy falls into recession.
When the crash occurs the best thing for Congress and the Fed to do is allow the recession to run its course. Recessions are the economy’s way of cleaning out the Fed-created distortions. Of course, Congress and the Fed refuse to do that. Instead, they begin the whole business cycle over again with another round of money creation, increased stimulus spending, and corporate bailouts.
Some progressive economists acknowledge how the Fed causes economic inequality and harms average Americans. These progressives support perpetual low interest rates and money creation. These so-called working class champions ignore how the very act of money creation causes economic inequality. Longer periods of easy money also mean longer, and more painful, recessions.
President-elect Donald Trump has acknowledged that, while his business benefits from lower interest rates, the Fed’s policies hurt most Americans. During the campaign, Mr. Trump also promised to make audit the fed part of his first 100 days agenda. Unfortunately, since the election, President-elect Trump has not made any statements regarding monetary policy or the audit the fed legislation. Those of us who understand that changing monetary policy is the key to making America great again must redouble our efforts to convince Congress and the new president to audit, then end, the Federal Reserve.
The Indian government last week demonetized its 500- and 1000-rupee notes. Overnight, the 500-rupee ($7.36) note and the 1000-rupee ($14.73) note were banned from use in commerce. Those holding the notes were allowed to exchange their notes for smaller denominations, but only to a total sum of Rs 4000, and only one time. That sum has now been reduced to Rs 2000. The alleged reason for the demonetization of the notes was to crack down on corruption, tax evasion, and black markets. The results of the demonetization, as should have been easily predicted, were horrendous.
ATMs throughout India began running out of cash, tourists found themselves stranded, and long lines formed at banks around the country. Many Indians turned their notes in to black market currency traders or purchased gold so as not to have to deal with the banks or with the authorities. More than 85 percent of the bills in circulation in the country were Rs 500 and Rs 1000 notes, so the effects of this demonetization are widespread. Although the government has introduced new Rs 500 and Rs 2000 notes to replace the demonetized notes, that doesn’t do much good for those who may have had significant amounts of savings held in cash, and the delays in provision of the new notes have caused further difficulties.
In an unsurprising decision, the Federal Open Market Committee (FOMC) decided today once again to keep its target federal funds rate steady at 0.25-0.50%. It was widely speculated that the FOMC would hold rates steady at today’s meeting due to concerns about influencing next week’s Presidential election. Expectations now are that the Fed, if it decides to raise rates, will do so at next month’s FOMC meeting.
There were no significant changes in the language of the statement from September’s meeting. Household spending was described as “rising moderately” rather than growing strongly, price inflation and measures of inflation expectations have risen but still remain lower than what the Fed would like to see, and the case for raising rates has continued to strengthen. Voting against today’s action were Esther George from Kansas City and Loretta Mester from Cleveland, both of whom wanted to raise the target federal funds rate to 0.50-0.75%. Eric Rosengren, who voted against September’s FOMC action, switched this month to supporting the most recent FOMC action.
It remains to be seen when the Fed might raise rates, as it seems that central banks are waiting to see what the other central banks are going to do before they make their own decision. The Fed, the Bank of Japan, the European Central Bank, and others are playing a game of chicken. They are like cars heading full-speed towards a volcanic crater, soon to plunge into the chasm and assured of destruction. Yet none of them want to be the first to hike rates. That would be tantamount to admitting error, or at least admitting defeat, and would be a tremendous blow to their pride. And so meeting after meeting we see central bank after central bank holding steady.
Some of them like to talk a good game, jawboning markets into thinking that more easing might be on the way (BOJ, ECB) or that rate hikes are just around the corner (Federal Reserve), but they never back up their tough talk with action. Watching central banks nowadays is like watching a game of poker in which each player has a horrible hand, tries to bluff, and is unwilling to show his hand. And so it goes again today. Even if the Fed were to raise rates next month, it would likely only be to 0.50-0.75%, still an abnormally low figure. Given that the Fed spent all year talking about raising rates and not doing anything, it would be safe to say that rates won’t even approach 1% until December of 2017. Don’t expect full “normalization” to be reached until 2020 at the earliest, assuming the economy doesn’t go down the toilet before then, which is very likely given the huge asset bubbles that easy money policies have inflated all across the world.
The following is the prepared version of a speech delivered at the Ron Paul Institute Conference in Sterling, VA.
I am here today to talk about one of the most important, but also most overlooked, issues of our day: the relationship between central banking and total war. When you focus on central banking and the problems that result from it, it’s very easy to see how central banks enable larger, more centralized, and more pervasive governments. But it isn’t always easy for those who oppose war to see how central banks enable war. So I’ll go ahead and give you kind of the 10,000 foot view of the symbiotic relationship between central banking and war.
One of the primary activities that states engage in is fighting wars. But wars cost money. Armies march on their stomachs, and someone has to buy the necessary food and transport it. Weapons and armament cost money too, all of which has to be paid for. So where have kings and governments historically gotten that money from, particularly when their own treasuries ran out? As Willie Sutton could have told them – banks.
Banks developed initially as a means for merchants to store their funds safely and securely. But eventually those banks took in so much money that they got the idea to loan out some of those funds, hoping that they could juggle loans and receive enough payment on outstanding loans to satisfy demands for redemption by depositors. Thus was born fractional reserve banking and the recourse to banks as lenders of money. Sure, kings could expropriate money from banks, but that only went so far. If you continued to rob banks outright, they would eventually either hide their money or disappear from the kingdom and the king was left with no money to fight his wars. So what developed was a relationship that has developed over time and become ever closer and more symbiotic over the course of time between banks and governments.
45 years ago today, on August 15, 1971, President Richard Nixon officially closed the gold window. While US citizens had been forbidden from owning gold or from redeeming their gold certificates for gold coins since the early 1930s, foreign governments still had the privilege of redeeming their dollars for gold. Due to the Federal Reserve’s inflationary monetary policy during the 1960s, foreign governments began to redeem more and more dollars for gold. Attempts to encourage other governments (especially France) not to redeem their dollar holdings were unsuccessful, and there was a very real threat that US gold holdings might eventually be exhausted. So President Nixon decided to close the gold window, thus severing the final link between the US dollar and gold. The removal of the restraint of gold redemption freed the Federal Reserve to engage in more inflationary monetary policy than ever. The effects of that on money supply and official price inflation figures are readily apparent.
The demonetization of silver in the Coinage Act of 1873 was widely assailed by its critics as the “Crime of ’73.” Isn’t it about time that Nixon’s closing of the gold window be known as the Crime of ’71?