Author Archive for John P. Cochran

Leland B. Yeager: Master of the Fluttering Veil

One of the more important monetary theorists of the mid to late 1900s, Leland Yeager, Ludwig von Mises Professor of Economics, Emeritus, at Auburn University, recently turned 90. The Mises Institute last week hosted a reception his honor. Multiple tributes to Professor Yeager are available at the free banking blog.  Well worth reading to anyone interested in monetary economics.

Steve Horwitz has referred to Yeager as “one of the most underappreciated economists.” Horwitz summarizes, quite correctly, the importance of Yeager’s contributions thusly, “Everyone who finds Austrian economics valuable and wants to comment on monetary matters should not do so until they have read and digested Yeager’s work.” I would add more broadly, ANYONE, Austrian leaning or not, who wants to comment on monetary matters should not do so until they have read and digested Yeager’s insightful work. The Fluttering Veil is a great collection of Yeager’s major contributions.

For those who might be interested, Credit Creation or Financial Intermediation?: Fractional-Reserve Banking in a Growing Economy, provides a quibble with some aspects of Yeager’s work relative to ABCT.

Central Banking Distorts Markets

800px-Federal_Reserve_Bank,_Richmond,_VirginiaIn today’s Wall Street Journal, two Fed insiders Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, and John A. Weinberg, director of research of the Federal Reserve Bank of Richmond, effectively argue that central bank “actions that alter the allocation of credit … endanger the stability the Fed was designed to ensure.”  Their explicit targets for criticism are the Fed purchases of mortgage backed securities and other “actions in the recent crisis” that “bore little resemblance to the historical concept of a lender of last resort.” In my view they correctly recognize that while “these actions were intended to preserve the stability of the financial system, they may have actually promoted greater fragility.” They correctly assert “(w)hen the central bank buys private assets, it distorts markets”.

Lacker and Weinberg are late to the dance. Stanford economist John Taylor in 2009 coined the term “Mondustrial Policy” to criticize the Fed and Treasury response to the financial crisis. Taylor’s remarks are highlighted in a WSJ bolg post by Jon Hilsenrath. Hilsenrath reports that Taylor used this “unflattering term” to describe a policy environment that was “not a monetary framework. It is an intervention framework financed by money creation.”

Jeffrey Rogers Hummel in his important  “Ben Bernanke versus Milton Friedman: The Federal Reserve’s Emergence as the U.S. Economy’s Central Planner illustrates significant differences in “approaches to financial crisis” between the Bernanke/Yellen approach and a Friedman approach. In addition to exposing the theoretical foundation of the recent misguided and dangerous policy approach, Hummel provides a very detailed almost step by step use of this type of policy in response to the major events of the recent crisis. He summarizes, “those differences resulted in another Fed failure – not quite as serious as the one during the Great Depression, to be sure, yet serious enough – but they have also resulted in a dramatic transformation of the Fed’s role in the economy. Bernanke has so expanded the Fed’s discretionary actions beyond controlling the money stock that it has become a gigantic, financial central planner.”

Lacker and Weinberg see the major problem associated with this monetary central planning as “undermining central bank independence.”John Taylor sees the cause of the problem as the Fed failing to follow a rules based policy.  Research by Selgin, Lastrapes, and White (“Has the Fed Been a Failure?” points in another direction. Central banking per se may be the problem. Contra Taylor, the Great Moderation was perhaps not as great a success for monetary policy as Taylor believes. The improvement was temporary and ‘appears to be due to factors other than improved monetary policy.” Selgin, Lastrapes, and White conclude, “the real hope for a better monetary system lies in regime change.” Austrians have a strong comparative advantage in discussion of what the foundations of this regime change should look like. Reform should go much further with a goal of sound money, not a goal of stable prices.

The Fed and the Destruction of the Dollar

5856829155_3ef1df1c11_zA recent “Notable and Quotable” in the Wall Street Journal highlights insights from Steve Forbes and Elizabeth Ames’s new book Money: How the Destruction of the Dollar Threatens the Global Economy—and What We Can Do About It. There is much to like in this short excerpt.

Echoing Roger Garrison on the housing crisis, Forbes and Ames point out, “For example, few connected the housing bubble of the mid-2000s with the Fed’s weak dollar.” They add, “The weak dollar was not the only factor, but there would have been no bubble without the Fed’s flooding of the subprime mortgage market with cheap dollars.” They point out other factors often blamed for the crisis, regulatory factors, greed, affordable housing laws and the role of the government-created mortgage enterprises were in effect through much of the nineties without creating “housing mania” and correctly surmise that Fed credit creation was the factor that, to borrow a phrase from Roger, “turbo charged” a policy distorted market eventually generating the boom-bust, the Great Recession, and setting the stage for the now prolonged stagnation. Too bad Bernanke, Yellen, Krugman, and Blinder continue to ignore this fundamental truth which  Garrison summarizes nicely:

Had the Fed provided no fuel for the boom, federal housing policy, though perverse, would not have been unsustainable. The mortgage market would have had to compete with all other markets for the funds that savers provided. There would have been a continuing bias in favor of the mortgage market, and the ongoing rate of foreclosures would have been higher. House prices would have been higher (because houses and mortgage loans are complements), but they would not have been high and rising.

Forbes and Aims go wrong when they fail to recognize that the Fed policy was loose in the 1990s. They ask, “Why did it (housing crisis) happen in the 2000s and not in the previous decade?” They respond, “The answer is that the 1990s was not a period of loose money.” Like John B. Taylor, who yearns for a rules based policy and a return to the “Great Moderation”, Forbes and Aims fail to recognize Fed policy was amiss during the late 1990s as well. The both downplay or ignore the boom-bust and the less severe recession of the early 2000s. The significance of this first cycle for the role of monetary policy was perhaps missed because it occurred at the end of the relatively long period of growth and stability known as the “Great Moderation.” This period was a time of better—at least compared to monetary policy of the 1960s and 1970s—but not necessarily good policy

Garrison again is right on target:

The dot-com crisis of the 1990s occurred because a credit expansion took place during a time when technological innovations associated with the digital revolutions created a strong demand for investment funds in that sector. The housing crisis in 2008 occurred because a credit expansion took place during a time when the federal government was pushing hard for increased home ownership for low-income families. We understandably identify these different cyclical episodes (the dot-com crisis, the housing crisis) with “what was going on at the time.” The common denominator, however, is the Fed’s propensity to expand credit.

Garrison provides a suggestion for the use of bubble and boom terminology that should be more widely adopted.

The terms boom and bubble are often used interchangeably in the literature on business cycles. It may be preferable, however, to use boom—or more specifically artificial boom—to refer to the credit-induced simultaneous expansion to various degrees of different interest sensitive sectors of the economy and to use bubble to refer to the artificial boom’s most dramatic manifestation. Which sector reveals itself as the bubble depends on the circumstances in which the credit expansion occurs. As indicated earlier, artificial booms entail a turbo charging of whatever else is going on at the time.

For a longer discussion of these back to back boom-bust see  my “Hayek and the 21st Century Boom-Bust and Recession-Recovery.”

The Fed at One Hundred: A Critical View on the Federal Reserve System

fedbookSome great contributors. This might even be worth the high price:

Including contributions from David Howden, Guido Hulsmann, Thomas DiLorenzo, Thomas Woods, Robert Murphy, Shawn Ritenour, Jeffrey Herbener, Mark Thornton, William Barnett, Peter Klein, Lucas Engelhardt, and Douglas French.

The book was edited by David Howden and Joseph Salerno, and includes a forward by Hunter Lewis.

Joe Salerno discussed the book at the most recent Austrian Economics Research Conference.

Prohibition Not Appetite is the Problem

1280px-Panama_clashes_1989Don Boudreaux  at Café Hayek highlighted yesterday’s Wall Street Journal article by Mary Anastasia O’Grady where she asks “What Really Drove the Children North”? Her answer, “Our appetite for drugs caused the violence that made life unbearable in much of Central America.” O’Grady, through Marine Corps Gen. John Kelly who now heads the U.S. military’s Southern Command, identifies the root the problem as “our appetite for drugs”. Both fail to see that the violence is the result, not of the demand for drugs, but or drug prohibition─the war on drugs.

Thus while O’Grady concludes:

Gen. Kelly writes that the children are “a leading indicator of the negative second- and third-order impacts on our national interests.” Whether the problem can be solved by working harder to bottle up supply, as the general suggests, or requires rethinking prohibition, this crisis was born of American self-indulgence. Solving it starts with taking responsibility for the demand for drugs that fuels criminality.

While it is a step in the right direction for the mainstream press to at least mention the possibility of ‘rethinking prohibition’, actually ending the war on drugs, not thinking about it is the only long term solution. Thus for better analysis developed prior to O’Grady which provides a strong case for an actual solution, readers should refer all who are concerned with this ‘crisis’ to Mark Thornton’s excellent and to the point Mises Daily, “How the Drug War Drives Child Migrants to the US Border.” Thronton’s  no holds barred conclusion:

When you try to make sense of parents sending their children on such a dangerous undertaking, just remember it is just another despicable result of the war on drugs with few solutions.

The Economist recommends the repeal of the war on drugs and the legalization of drugs globally as the solution. Its second best solution is for the United States to finance an effort to rebuild the institutions (i.e., police, courts, prisons, etc.) and infrastructure (i.e., military, transportation, and education systems) in the countries of Central America:

Such schemes will not, however, solve the fundamental problem: that as long as drugs that people want to consume are prohibited, and therefore provided by criminals, driving the trade out of one bloodstained area will only push it into some other godforsaken place. But unless and until drugs are legalised, that is the best Central America can hope to do.

In other words, ending the war on drugs is the only solution.

Regime Uncertainty: Washington’s Attack on Property Rights

1280px-UnitedstatesreportsWithout mentioning it, Michael Boskin provides supports Robert Higgs’s contention the Regime Uncertainty is a, if not the, major contributing factor to the current stagnating economy. Per Higgs, regime uncertainty is a “pervasive lack of confidence among investors in their ability to foresee the extent to which future government actions will alter their private-property rights.” Michael Boskin in “How Washington Whittles Away Property Rights” makes a similar argument. He states what should be obvious, but is too often neglected in Washington and state capitals, “Property rights and the rule of law are essential foundations for a vibrant economy. When they are threatened, or uncertain, the result is inefficiency, rent-seeking, a larger underground economy and capital flight.”

Boskin then provides ample reasons for why worried investors would eliminate, postpone, or reduce investments necessary for recovery and sustained prosperity creating economic growth such as:

1. A Supreme Court decision which “gutted the Constitution’s “public use” restriction on eminent domain (Kelo v. City of New London, 2005), allowing local governments to take the property of some individuals for the benefit of others, especially private developers.”

2. President Obama’s decision to trample “the legal rights of secured Chrysler bondholders to transfer billions of dollars to unions.”

3. EPA wetlands compliance freezing land use.

4. With the “biggest future threat” coming from unfunded entitlements coupled with massive government spending which places the right to “the fruits of one’s labor” at great risk.

5. “Taxes explicitly designed for redistribution—instead of revenue”… .

He then argues, “Ultimately, behind this and other attacks on property rights is the notion that the government owns all income, leaving to you only what it doesn’t demand.”

I argued elsewhere, even before it was apparent that the stagnation would stretch over 5 years, the correct road to a “free and prosperous commonwealth” would include a return to sound money, competitive markets, and the rule of law with a total level of government spending and tax burden that, as suggested by Gwartney, Holcombe, and Lawson (The Scope of Government and the Wealth of Nations) is no more than 15% of GDP.  Mises would most likely go even lower. As Adam Smith put it many years ago in a 1755 paper,

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about the natural course of things. All governments which thwart this natural course, which force things into another channel or which endeavor to arrest the progress of society at a particular point, are unnatural, and to support themselves are obliged to be oppressive and tyrannical.

Rizzo on Cochrane

Mario Rizzo

Mario Rizzo

Several days ago I highlighted John H. Cochrane’s critique of modern macroeconomics.

In today’s Wall Street Journal Austrian Economist Mario J. Rizzo provides an excellent comment on Cochrane’s defense of modern modeling techiniques.

“Mr. Cochrane’s excessive scientism is on display when he pooh-poohs Paul Krugman’s critique regarding the “haze of equations” that has become standard in this field. Apparently Mr. Cochrane is worried that economics might become “ephemeral” like philosophy. I would welcome the ephemerality of Plato, Aristotle, Aquinas, Hume, Kant, Wittgenstein and so on.”

Prof. Mario J. Rizzo

New York University

New York

Bubbles Everywhere: Krugman Wrong Again; Austrians and the BIS Are Correct

BankIntZahlungsausgleichPaul Krugman is at it again – distorting or misinterpreting work by other economists to attack critics of  today’s central bank driven low interest rate environment and to defend policy status quo or to push for even more stimulus. This time the economist is Knut Wicksell whose work in both monetary theory and capital theory was part of foundation for Mises’s development of Austrian business cycle theory (ABCT). Krugman’s rant is in response to Neil Irwin’s  commentary on booms and bubbles in asset prices driven by central bank policy and his target is Austrian influenced economists and Wall Street analysts and pundits with a pointed jab at recent work from the Bank for International Settlements (BIS).  From Krugman:

The proximate cause is obvious: policy interest rates are very low, and expected to remain low, so money is pouring into alternative assets, driving their yields down too. The question is what you think about this situation.

Quite a few people — including a lot of people on Wall Street, at the BIS, and so on — look at this and say that it’s terrible: the Fed is keeping interest rates “artificially low” and thereby distorting asset prices across the board, and it will all end in grief.

But for Krugman there is no reason to panic, rates are not too low and there are no asset price bubbles:

Mainly, though, there simply isn’t any macroeconomic case for claiming that interest rates are wildly depressed relative to fundamentals, and not much reason to believe that assets in general are overvalued.

Robert Murphy at Mises Canada exposes the fallacy of Krugman’s argument:

Krugman is supposed to be a technical wizard who throws up an impressive array of mathematical models to justify his policy conclusions. Well, in this case he tries to get his readers to accept first derivatives in place of levels. Nope: However you slice it, central banks have pushed interest rates artificially low. That’s why their balance sheets have exploded. It is astonishing that Krugman is trying to justify this outcome as “natural.”

What I find interesting here is Krugman’s explicit attempt to discredit the recent BIS warning, based on the work of Mises and Hayek, of Central bank excesses. As reported by the Wall Street Journal, (“Stop Us before We Kill Again”):

The Bank for International Settlements issued a report warning that global monetary policies are reaching their useful limit and may be contributing to financial excesses that could turn out badly if central bankers aren’t careful.

“Financial markets are euphoric, in the grip of an aggressive search for yield,” Claudio Borio, head of the monetary and economic department at the BIS in Basel, Switzerland, said as the club issued its annual report. “And yet investment in the real economy remains weak while the macroeconomic and geopolitical outlook is still highly uncertain.”

Austrian influenced work by current BIS economist Claudio Borio and former Head of Monetary and Economic Department of the BIS, William R. White is highlighted here. As a side note, I would like to think work by Fred Glahe and I perhaps planted a seed for some of this work as White often cites our Keynes-Hayek Debate when he introduces Hayek.  A more detailed list and discussion of recent mainstream work on ABCT is developed Nicolas Cachanosky can be accessed from links provided here.

Andreas Hoffmann, co-winner of the 2014 Lawrence W. Fertig Prize in Austrian Economics for Monetary Nationalism and International Economic Instability, has had his paper “Zero-Interest Rate Policy and Unintended Consequences in Emerging Markets” has been accepted for publication in The World Economy (pdf upon request). The abstract:

 Since 2009, central banks in the major advanced economies have held interest rates at very low levels to stabilize financial markets and support the recovery of their economies. This paper outlines the unintended consequences of the prolonged period of very low world funding interest rates in emerging markets. The paper is informed by a Mises-Hayek-BIS view on credit booms and Mises’ law of unintended consequences. Consistent with the presented credit boom view, the paper shows that the period of low world funding interest rates is associated with a rise in volatile capital flows and asset market bubbles in fast-growing emerging markets. As suggested by Mises’ law, the unintended consequences give rise to a new wave of interventionism as policymakers in emerging markets increasingly reintroduce financially repressive measures to isolate the economies from foreign capital inflows.

Interesting addition illustrating the renewed influence of Hayek and Mises is the reference to this increasingly influential emphasis on credit booms as Mises-Hayek-BIS view.

Remedy for The Failure of Macroeceonomics: Austrian Economics

The ‘grumpy’ John H. Cochrane provides some interesting commentary on the “The failure of macroeconomics” in today’s WSJ. Missing – recognition of Higgs’s important ‘regime uncertainty’ and the Mises-Hayek-BIS view of credit-booms recently highlighted here and here in warnings from the Bank of International Settlements of central bank excesses. Dave Howden comments here.

Per Cochrane:

Where macroeconomists differ, sharply, is on the causes of the post-recession slump and which policies might cure it. Broadly speaking, is the slump a lack of “demand,” which monetary or fiscal stimulus can address, or one of structural sand-in-the gears that stimulus won’t fix?

Cochrane provides blistering commentary on the “demand –side” view, as argued by the likes of Larry Summers, Brad DeLong, Paul Krugman. He states, “this diagnosis and these policy predictions are fragile.” And “None [of the New Keynesian models] produces our steady low-inflation slump as a ‘demand’ failure.” As a result, “The reaction in policy circles to these problems is instead a full-on retreat, not just from the admirable rigor of New Keynesian modeling, but from the attempt to make economics scientific at all.”

749px-Paul_Krugman_BBF_2010_Shankbone-300x239Cochrane provides added commentary here. Note especially his graph at the beginning of his commentary.

The alternative explanations of the Bush-Obama-Fed Great Stagnation Cochrane provides; John Taylor’s “uncertainty induced by seat-of-the-pants policy” which stifles investment and hiring, Ed Prescott’s distorting taxes and stifling regulation, or Casey Mulligan’s “unintended disincentives of social programs”, all of which stifle growth and innovation, are better than the “the … new [demand side] thinking which “is largely old thinking: traditional Keynesian ideas of the 1930s to 1960s.” These alternative explanations at least point toward reforms that might improve economic conditions and facilitate recovery. They are however, inferior to a capital-structure based macroeconomic understanding of recession and recovery supplemented by Robert Higgs’s Regime Uncertainty. Even better suggestions for a sustainable recovery can be found here.

Productivity Declines, Fewer Startups, and Regime Uncertainty

8393213472_24d08168b0_zIn today’s Wall Street Journal, Edward C. Prescott and Lee E. Ohanian provide some important commentary on the causes of continuing slow recovery, the Bush-Obama-Fed Great Stagnation. Their conclusion:

Surveys of small-business owners clearly indicate that changes in economic policy are required to reverse this trend. Chamber of Commerce surveys show that roughly 80% of small-business owners believe that the U.S. economy is on the wrong track and that Washington is a major problem. Surveys by John Dearie and Courtney Gerduldig, authors of “Where the Jobs Are: Entrepreneurship and the Soul of the American Economy” (2013), show that entrepreneurs report being hamstrung by difficulties in finding skilled workers, by a complex tax code that penalizes small business, by regulations that raise the costs of doing business, and by difficulties in obtaining financing that have worsened since 2008.

There are clear solutions to these problems. Immigration reform that increases the pool of skilled workers and potential new entrepreneurs. Tax reform that reduces and equalizes marginal tax rates on capital income, including reducing the corporate income tax, which currently exceeds 40% in some states. Reforming Dodd-Frank to make it easier and cheaper for small business to obtain loans. Reducing the regulatory burden on all businesses.

In the absence of these reforms, there is little reason to believe that the depressed rate of new business creation will reverse itself. And if the trend is not reversed, then the current shortfall of $1 trillion per year in lost output due to lost productivity will continue.

Conspicuously absent from the list of culprits─The Federal Reserve’s zero interest rate policy (ZIRP) and quantitative easing. Salerno (A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis, p. 38) explains:

The rise in the natural interest rate that overcomes the pandemic demoralization among capitalists and entrepreneurs and sparks the recovery is reflected in the credit markets. For recovery to begin again, there needs to be a steep rise in the “real,” or inflation-adjusted, interest rate observed in financial markets. High interest rates do not stifle the recovery but are the sure sign that the readjustment of relative prices required to realign the production structure with economic reality is proceeding apace. The mislabeled “secondary deflation,” whether or not it is accompanied by an incidental monetary contraction, is thus an integral part of the adjustment process. It is the prerequisite for the renewal of entrepreneurial boldness and the restoration of confidence in monetary calculation. Decisions by banks and capitalist-entrepreneurs to temporarily hold rather than lend or invest a portion of accumulated savings in employing the factors of production and the corresponding rise of the loan and natural rates above some estimated “true” time preference rate does not impede but speeds up the recovery. This implies, of course, that any political attempt to arrest or reverse the decline in factor and asset prices through monetary manipulations or fiscal stimulus programs will retard or derail the recession-adjustment process.

For another argument on the adverse effects of ZIRP see Robert Higgs, The Fed’s Immiseration of People Who Live on Interest Earnings.

Also unspoken; Stagnation is the direct result of an economy suffering from Regime Uncertainty. Prescott and Ohanian highlight that which is seen. “Behind the productivity plunge: fewer startups.” They fail to highlight the unseen. Behind the fewer start ups: “Regime Uncertainty.”

Ohanian’s empirical work often supports Austrian interpretations of economic history. It should be remembered that other work has provided significant empirical research that bolsters Rothbard’s argument of how what should have been a garden variety recession developed into the Great Depression (see here), and supports both Vedder and Gallaway’s work and Robert Higgs’s “Regime Uncertainty” argument relative to the 1937 recession within a depression (see here and here ).

The Real Elephant in the Room

4882451572_1827973b1c_mMark Skousen has been the leading advocate for better measures of economic activity ─ measures that better reflect an Austrian-Say based perspective of how an economy actually works ─ measures that better reflects the importance of production and investment in driving the economy and employment. His preference, gross domestic expenditure (GDE), as highlighted in his The Structure of Production. With a strong nudge from Mark, such a measure, gross output (GO), which is not quite as comprehensive as GDE, has recently become available as highlighted here.

Steve Hanke reports on the development here. Per Hanke, “The announcement went virtually unnoticed and unreported─an unfortunate but not uncommon, oversight on the part of the financial press.

He adds, “Yes, GO [emphasis added] represents a significant breakthrough” and “GO is a big deal.”

The new data offers Austrians and fellow travelers who have emphasized the importance of production and investment; business planning to best meet consumer demands, both now and in the future, as the prime mover of the economy better data to support their historical analysis.

Hanke’s conclusion:

Even though the always clever Keynes temporarily buried J.-B. Say, the great Say is back. With that, the relative importance of consumption and government expenditures withers away (see the accompanying bar charts). And, yes, the alleged importance of fiscal policy withers away, too.

Contrary to what the standard textbooks have taught us and what that pundits repeat ad nauseam, consumption is not the big elephant in the room. The elephant is business expenditures.

It’s time to not only tout, but time to take advantage of this new data set to better advance and support the insights of a capital-structure based macroeconomics (See Capital in Disequilibrium: Understanding the “Great Recession” and the Potential for Recovery).

HT to Mark Skousen.

The Great Rebuild

The Mises Institute is currently undertaking a major website rebuild. Peter Klein recently shared a link to an early version of the website. Brought back memories of how important resources have been over many years in my teaching efforts to make Austrian and libertarian/classical liberal readings available to undergraduate students and to encourage self-learning. What an advance the website was, even in its infant forms, over getting access to hard copies and then making photocopies for distribution. The changes on site are in many ways as dramatic as the improvement in basic computing technology from the days when I began teaching. I wrote my dissertation on a Columbia portable PC with 56 K memory. I used wordstar, which came on two 5 and ¼ floppy discs, to do the drafting. Printing was done by a dot matrix printer. Whole set up cost me around $3K. Cut and pasting required removing disc 1 and inserting disc 2.

To make access to all the important resources even easier for the next generation of professors, scholars, students and motivated self-learners, do as I have done and Help Build the New Mises Website.

Two Monetary Policies in One

10547392033_9accff5c59_zTwo Monetary Policies in One

A summary from The Denver Post  of  Federal Reserve Chairwoman Janet Yellen’s report Wednesday May 7 to Congress:

  1. The U.S. economy is improving but the job market remains “far from satisfactory” and inflation is still below the Fed’s target rate.
  2. Yellen said that as a result, she expects low borrowing rates will continue to be needed for a “considerable time.”
  3. Yellen’s comments echo signals that the Fed has no intention of acting soon to raise its key target for short-term interest rates even though the job market has strengthened and growth is poised to rebound.

See no evil, hear no evil, speak no evil.

A more realistic assessment of policy since the initial deer in the headlight response by the Bernanke Fed was provided yesterday in the Wall Street Journal by Allan H. Meltzer; How the Fed Fuels the Coming Inflation.

Some highlights:

The U.S. Department of Agriculture forecasts that food prices will rise as much as 3.5% this year, the biggest annual increase in three years. Over the past 12 months from March, the consumer-price index increased 1.5% before seasonal adjustment. These are warnings. Never in history has a country that financed big budget deficits with large amounts of central-bank money avoided inflation. Yet the U.S. has been printing money—and in a reckless fashion—for years.

Of the 6.7 trillion in Bush-Obama deficits:

The Federal Reserve financed almost $3 trillion of these deficits by purchasing Treasury bonds and notes. The Fed has also purchased massive amounts of mortgage-backed securities. Today, with more than $2.5 trillion of idle reserves on bank balance sheets, there is enormous fuel for greater inflation once lending and money growth rises.

On the result of QE and the continuing low interest rate environment:

The Fed’s unprecedented quantitative easing since 2008 failed to lead to a robust recovery. The unemployment rate has gradually declined, but the main reason is that workers have withdrawn from the labor force. The stock market boomed, bringing support from traders, but the rise in asset prices of equities didn’t stimulate growth by inducing investment in new capital. Investment continues to be sluggish.

Echoing but not mentioning Robert Higgs’s rational for the slow recovery; Regime Uncertainty:

Most of all the Fed years ago should have recognized that the country’s economic problems weren’t arising from monetary factors. Instead of keeping interest rates low to finance deficits, the Fed should have explained that costly regulation, increased health-care costs, wasteful spending and repeated threats to raise tax rates were holding back the recovery.

Despite the much hyped tapering of QE, the Fed balance sheet, bank excess reserves, and the monetary base have continued to expand since the Yellen ascension. Based on data from the St. Louis Fed FRED, excess reserves, after being relatively flat from November 2013 to January 2014, increased nearly 6.6 percent January-April 2014; expanding from $2.42 trillion to $2.58 trillion. The monetary base exhibits a similar pattern with a 6.2% increase; 3.73 trillion to 3.96 trillion.

While those benefiting from the illusory wealth enhancing aspects of  Fed policy continue to cheer, others should be rightly concerned about future prospects for the economy. Meltzer ends with an appropriate reminder of the effects when the Phillips Curve last dominated Fed policy:

We are now left with the overhang. Inflation is in our future. Food prices are leading off, as they did in the mid-1960s before the “stagflation” of the 1970s. Other prices will follow.

Image Credit. 

Twaddle or Scholarship?

6736Thomas Piketty’s Capital in the Twenty-First Century has drawn raves from the many uncritical pundits and academics on the left. For the meddlers, the book is about the ‘right’ topic, inequality, at the right time. Never mind that the question is wrong (here, here, and here).  Hunter Lewis and Peter Klein in recent Mises dailies have effectively illustrated the foundational weakness of the work (here, and here).

The Economist has recently joined the discussion with a short review in is Capitalism and its critics” column of May 3-9 (pp 12-14) and gets the basic flaws mostly right.

Some highlights:

Thomas Piketty’s blockbuster book is a great piece of scholarship, but a poor guide to policy [While the latter is correct, the former is debatable at best].

But if Mr Piketty does set the tone of debate on inequality, the world will be the poorer for it.

Here “Capital” drifts to the left and loses credibility. Mr Piketty asserts rather than explains why tempering wealth concentration should be the priority (as opposed to, say, boosting growth). He barely acknowledges any trade-offs or costs to his redistributionist agenda.

Mr Piketty’s focus on soaking the rich smacks of socialist ideology, not scholarship [emphasis added]. That may explain why “Capital” is a bestseller. But it is a poor blueprint for action.

Note by the end of the review, the Economist, has effectively retracted its initial praise of Piketty’s scholarship. Because the book has taken on such importance, it is important that serious scholars should continue to address, critique, and correct many false impressions embedded in the book. The work is better described as dangerous twaddle or balderdash not insightful scholarship with useful policy prescriptions.

Liberty Advances in Colorado: Not

More “good news” on how regulation protects consumers while advancing welfare: Marijuana testing labs barred from taking individual samples:

Don’t Blame the Whole Housing Bubble on CRA: Part II

800px-MarlboroNJMcMansionsA follow up to Ryan’s excellent post.

Roger Garrison is at his best here balancing Fed policy and housing policy  including CRA and their relative impact of the latest boom-bust. An excellent example of  historical interpretation and “variations of the theme” of ABCT.

From his Alchemy Leveraged: The Federal Reserve and Modern Finance:

Unsound as these policies were, they were not the principal cause of the financial crisis. Again, Dowd and Hutchinson are right in identifying the expansion-prone Federal Reserve as the principal institutional cause. Had the Fed provided no fuel for the boom, federal housing policy, though perverse, would not have been unsustainable. The mortgage market would have had to compete with all other markets for the funds that savers provided. There would have been a continuing bias in favor of the mortgage market, and the ongoing rate of foreclosures would have been higher. House prices would have been higher (because houses and mortgage loans are complements), but they would not have been high and rising. Practitioners of modern finance would have paid due attention to the higher VaR, which would have reflected the expectation of an ongoing higher foreclosure rate. Conversely, had the federal government not enacted legislation and created institutions that rigged mortgage markets so as to increase home ownership, credit expansion by the Fed would nonetheless have created an artificial boom, which inevitably would have ended in a bust.


Although Fannie, Freddie, and related federal legislation are not the principal cause of the crisis, they do account for the particular character of the preceding boom and hence for the particular character of the subsequent bust. The terms boom and bubble are often used interchangeably in the literature on business cycles. It may be preferable, however, to use boom—or more specifically artificial boom—to refer to the credit-induced simultaneous expansion to various degrees of different interestsensitive sectors of the economy and to use bubble to refer to the artificial boom’s most dramatic manifestation. Which sector reveals itself as the bubble depends on the circumstances in which the credit expansion occurs. As indicated earlier, artificial booms entail a turbocharging of whatever else is going on at the time.

The problem is poverty. The solution is liberty.

Ryan McMaken provides an excellent response to the current the inequality is the root of evil nonsense.

It is amazing how many on the left choose not celebrate the tremendous success of liberal institutions that support markets in generating prosperity. The evidence of the success of these classical liberal institutions; markets, property rights, and the rule of law: poverty was turned on its head. Areas adopting such institutions flipped the world wide long term norm of a 90-95 percent real poverty with 5-10 percent relatively better off but living actually in much less pleasant conditions than typical middle class in a modern market oriented economy to a 90-95 percent well off with 5-10 percent poor in a relative but even most of these living above absolute poverty norm which still exists in many non-developed, non-market economies. Instead they argue for abandonment of these institutions for their failure to raise that 5-10 percent even further.

An absurd outcome of a focus on inequality rather than poverty and an abandonment of quest begun by A. Smith to understand the nature and cause of the wealth of nations.

Accounting and The Rise and Fall of Firms and Nations

41-Me49saYL._SY344_BO1,204,203,200_Accounting and The Rise and Fall of Firms and Nations

James Grant, presenter of the Henry Hazlitt Memorial Lecture at this year’s AERC, reviews The Reckoning. Success and failure of institutions and states raise and fall with the integrity of their balance sheets. As Grant observes, “successful societies—while they last—are those that properly cast their figures. They confront their liabilities as well as their assets. In their enterprise and politics, accountability is the watchword …”

Amazon summarizes the arguments of the book thusly:

Basic accounting tools such as auditing and double-entry bookkeeping form the basis of modern capitalism and the nation-state. Yet our appreciation for accounting and its formative role throughout history remains minimal at best—and we remain ignorant at our peril. The 2008 financial crisis is only the most recent example of how poor or risky practices can shake, and even bring down, entire societies.

Readers of The West Grew Rich: The Economic Transformation Of The Industrial World, a excellent book that I used as a foundation source when in taught economic history would not be surprised at this assessment of the importance of double entry bookkeeping. The authors, in addition to pointing out correctly that the living standard norm world-wide, pre-industrial revolution, was poverty provide an excellent list of “institutions favorable to commerce”. Included among these essential institutions was double entry bookkeeping.

Mr. Solis work puts heavy emphasis on this institution. Grant summarizes, “Mr. Soll’s story largely concerns the technique of double-entry bookkeeping, with its elegantly counterbalanced assets and liabilities. It is a system that almost forces managerial attention not only on profit and loss but also on debt, net worth and solvency. As Mr. Soll hustles through history, he stops to ask whether a particular society employs the double-entry method or not.” Successful institutions rely on sound accounting.

Grant next asks a very penetrating question:

His grand thesis is another matter. Is good accounting a cause of the wealth of nations or is it an effect of the virtues—individual liberty and the rule of law, to name two—that foster financial and political truth-telling? Does careful reckoning implant these essential moral qualities or do honest people count straight and true whatever the state of their knowledge about generally accepted accounting principles?

Deirdre Nansen McCloskey’s The Bourgeois Virtues: Ethics for an Age of Commerce would tilt the answer in Grant’s direction.

Grant ends the review with penetrating commentary relevant to meaningful discussion banking reform.

Mr. Soll, though a keen proponent of accountability, misses a bet when he fails to mention the convention of “double liability.” In America before the coming of the Federal Deposit Insurance Corp., the stockholders of a bank were responsible for the solvency of the institution in which they owned a fractional interest. In the event of impairment or insolvency, they—not the taxpayers—were required to stump up the funds with which to pay the creditors.

The 21st-century reader will rub his eyes. Were most banks not limited-liability corporations? They were. And is the liability of the stockholder of such a corporation not, well, limited? Indeed it was and is. Banks were the exception. Between the Civil War and the Depression, the stockholders of a failed bank got a capital call from the receiver. They were liable for an amount up to and including the par value of their shares.

They got the dividends in good times. They owned the problem in bad times. In short, they were accountable.

Consumption Does Not Drive the Macroeconomy

DCUSA.Gallery11.BB&BBlackFriday.WikipediaMark Skousen, through his Economic Logic and The Structure of Production, has been leading the fight for years for a measurement of economic activity that more closely aligns with a capital structure based macroeconomics. GDP is truly a Keynesian–based view of the economy; a data set that often hampers rather than helps advance Austrian macroeconomics. Misguided use of the data set encourages counterproductive active management of aggregate demand.

Both Hayek and Rothbard highlighted the inadequacies of national product measures of the  economy. From a Hayekian perspective, investment as measured by product and income accounts, greatly understates the role of capital or future-oriented expenditures in the economy. Hayek raised the point in his criticism of Foster and Catchings’s misguided underconsumption approach to fluctuations.  Expenditures on “raw materials, semi-finished products and other means of production” greatly exceed the value of consumption goods that are simultaneously offered in the markets for consumption goods. According to Rothbard, “It is certainly legitimate and often useful to consider net incomes and net savings, but not always illuminating, and its use has been extremely misleading in present-day economics.” Consumption spending is overemphasized and investment and saving is dwarfed relative to their overall importance in maintaining and expanding the structure of production.

Fortunately Mark Skousen stayed diligent in pressing for a better data set. Now what started as windmill jousting has ended in a minor victory for those who desire a better understanding of how an economy works. Mark explains more in today’s Wall Street Journal in his commentary, “At Last a Better Measure of Economic Activity.”


In many ways, gross output is a supply-side statistic, a measure of the production side of the economy. GDP, on the other hand, measures the “use” economy, the value of all “final” or finished goods and services used by consumers, business and government.

GDP is a useful measure of a country’s standard of living and economic growth. But its focus on final output omits intermediate production and as a result creates much mischief in our understanding of how the economy works.

In particular, it has led to the misguided Keynesian notion that consumer and government spending drive the economy rather than saving, business investment, technology and entrepreneurship.

The critical importance of business activity is clear when you look at employment statistics and leading economic indicators. Employees in the consumer side of the economy (retail outlets and leisure businesses) account for about 20% of the labor force, and another 15% work for various levels of government. Yet the vast majority of employees, 65%, work in mining, manufacturing and the service industries.

Finally, as a broader measure of economic activity, gross output is more consistent with economic-growth theory. Studies by Robert Solow at MIT and Robert Barro at Harvard have shown that economic growth comes largely from the supply side—increased technology, entrepreneurship, capital formation and productive savings and investment. Higher consumption is the effect, not the cause, of prosperity [emphasis added].

The new measure: Gross Output, while not perfect, is a marked improvement that should enable more and better historical analysis of the economy from an Austrian perspective. What an opportunity for the growing ranks of Austrian influenced scholars.

Fed Liquidity and the World Economy

404px-Currency_Exchange.svgNoah, commenting on “For More Jobs and Stability, Set the Economy Free”, points to second  important observation in the linked commentary by Kevin Warsh – the spillover effect of Fed Policy, with significantly negative long run consequences, on the world economy. From his comment:

The piece by Kevin Warsh that was linked in the article (“Finding Out Where Janet Yellen Stands”) included this important observation:

“The Fed makes domestic decisions for the domestic economy. Yes, but the U.S. is the linchpin of an integrated global economy. Fed-induced liquidity spreads to the rest of the world through trade and banking channels, capital and investment flows, and financial-market arbitrage. Aggressive easing by the Fed can be contagious, inclining other central banks to ease as well to stay competitive. The privilege of having the dollar as the world’s reserve currency demands a broad view of global economic and financial-market developments. Otherwise, this privilege could be squandered.”

The Fed is not just picking winners and losers domestically, it is doing so globally. While the winners fill their pockets, the losers get increasingly restless and increasing aware that the screwing they are getting is not random but has a very definite source.

As is often the case, Austrian influenced economists have been on the leading edge. Those wonkish types interested  more detail first see the Fertig Prize winning article Monetary Nationalism and International Economic Stability by Andreas Hoffmann and Gunther Schnabl. The abstract:

ABSTRACT: This paper describes the international transmission of boom-and-bust cycles to small periphery economies as the outcome of excessive liquidity supply in large center economies, based on the credit cycle theories of Hayek, Mises, and Minsky. We show how too-expansionary monetary policies can cause overinvestment cycles and distortions in the economic structure on both the national and the international level. Feedback effects of crises in periphery countries on center countries trigger new rounds of monetary expansion in center countries, which bring about new credit booms and international distortions. Crisis and contagion in globalized goods and financial markets indicate the limits of purely national monetary policies in countries, which provide the asymmetric world monetary system with an international currency. This makes the case for a monetary policy in large countries that takes responsibility for its long-term effects on goods and financial markets in both the center and the periphery countries of the world monetary system.

Other good work on the topic is by Metro State’s Nicolas Cachanosky:

The effects of US monetary policy on Colombia and Panama (2002-2007)


  • Studies international      effects on two small economies with different forex regimes.
  • Studies how these two      economies react to US monetary policy.
  • Relative capital      intensive sectors are more sensitive to US monetary policy.
  • This common      characteristic can explain business cycle co-movements.


U. S. Monetary Policy’s Impact on Latin America’s Structure of Production (1960-2010)” which extends ABCT and capital-based macroeconomics in the international arena, especially as it applies to the ‘periphery’.

The abstract:

I study the effects of U.S. monetary policy on Latin America’s structure of production prior to two recent economic crises. I find that changes in the Federal Funds rate produced uneven effects across economic sectors. Those industries that are more capital intensive and relative long-term projects are more sensitive to changes in the Federal Funds rate than projects that are less capital intensive and relative short-term in duration. Therefore, periods of loose monetary policy resulted in a misallocation of resources that has been costly to correct during the bust. This result finds a particular pattern of economic distortion during an unsustainable boom.

Also by Andreas Hoffmann’s “Zero Interest Rate Policy and the Unintended Consequences on Emerging Markets.

The abstract:

In response to the subprime crisis and Great Recession central banks in advanced economies have cut interest rates towards zero and increased monetary accommodation to step-up domestic growth. In this paper I attempt to describe the unintended consequences of the low interest rate policies in emerging markets. I argue based on the Mises-Hayek business cycle theory that the current low interest rate policy in advanced economies may have planted the seeds for new bubbles and gave rise to interventionist cycles in emerging markets. I show that capital flows to high-yielding emerging markets translate into monetary expansion in emerging markets. In the face of buoyant capital inflows fear of floating forces emerging markets to follow the interest rate policy of advanced economies. The monetary expansion triggers mal-investment and over-borrowing. To stem against arising inflationary pressure and kill-off speculative capital inflows empirical evidence suggests that emerging market governments increasingly repress financial markets. International financial markets disintegrate. I conclude that the monetary policy of the large advanced economies is incompatible with financial integration and globalization