The Drug War

"It is so easy to be wrong—and to persist in being wrong—when the costs of being wrong are paid by others."

Thomas Sowell

As a child you are told that once you grow up you'll be able to make your own decisions and live life the way you wish. The so called do-gooder's within society have other ideas, becoming your adult paternal replacement in whats known as the 'nanny state'. "You can't eat this, drink that, you should recycle this, don't smoke that", and so on. The machinations of the modern state have become the new religion, giving directives as a set of commandments for how people should live their lives. The war on drugs has been an ongoing crusade for decades for such people, it can never be won and is a prime example of the destruction caused by the nanny state. Rather than doing good, in typical Government fashion it is in fact crippling society. Every drug should be made legal just like alcohol or tobacco for all to use and consume.

Prohibition of Alcohol in 1920's America was a disaster. It lasted just over a decade and acomplished none its objectives. Rather than 'solve' the social ills associated with drink it caused more problems. It was a boom time for Organised Crime creating one of the most infamous Gangsters of all time, Al Capone, who prospered from Prohibition. Corruption was endemic across law enforcement. Alchol was still readily available and was further glamorised by its outlawed image. The American Government backtracked and repealed the law during the 1930's, allowing market forces once more to supply it freely.

The 'War on Drugs' is a repetition of histories mistakes, a war that can not be won and like all wars causes more issues than it seeks to solve. If we allowed the market to supply drugs today it would eradicate many social difficulties. 

The problem with sending products people wish to buy underground is their price inevitably rises. The demand doesn't go away and results in smuggling to get around the authorities. Production can not be ramped up the same way due to the limitations placed on distribution channels. Competition is stiffled as drug barons and cartels can restrict supply much easier and "strangle" competitors out of the business. Prices are just half the problem, you then have the end product and with drugs it becomes a danger to public health. When the government makes drugs illegal they are in fact the ones who cause far more innocent deaths than would happen if it were legal. Alchol is a drug, and a very dangerous one at that. Most of us know the dangers and thousands die every year. Yet due to its legal status we all know (or should know) our limits and what we can drink. This is due to the free market to ensure consistent product quality thereby enabling consumers to drink in relative safety. The problem happens when drugs are made illegal the product quality is driven down. All sorts of pollutants end up in the mix, dangerous substances that makes its way to the consumer. Needless deaths are caused with such reckless product control with the quantity of units also hard to determine, the consumer is never sure what they are taking. You are never quite sure of how potent the portion of drug will be. With alcohol or tobacco there is no such problem, the user is always aware.

The high price of illegal drugs usually lead to many users resorting to crime. These crimes are committed on innocent members of the public, that could be avoided if market forces were allowed to bring down costs. The Government throws more state resources to "solve" the ills diverting police resources to investigate such "wrongdoings". Turf wars within communities erupt caused by the restriction of free trade. Politicians don't live in such areas so are disconnected from such realities but the people who do live in such places are generally unaware that the Government is creating such problems by inciting the fictitious "War on Drugs".

Meanwhile end users continue to use drugs freely, despite having to play roulette on product quality. Teenagers go to clubs and don't even have to ask to find who is selling. Despite being in my late twenties its still the same as when I was a teenager, people asking me do I want any 'gear' (I've even been asked if I was selling which I found amusing). Anyone who has been to University knows someone who did weed, not just once or twice, but every day (possibly multiple times). Just like the old Soviet Bloc outlawing denim jeans people still bought them away from Government eyes. 

So what would a world look like where all drugs were made legal? Wouldn't we all be addicts, our children would all end up in prison and the fabric of society would fall at the seams? Hardly. There would probably be more drug users. There may even be more overdose deaths, but these outcomes would be determined by the action of the individuals themselves and would not effect innocent third parties. Smoking, drinking, eating fast food, joining the Army, doing skydiving, driving a car; all of these activities put an individuals health at risk however the individual knows the risks associated with their actions. There would be no innocent community torn apart from Drug related crimes. No innocent victim caught up in gang crossfire. Organised crimes influence would be greatly reduced to intimidate members of the public. Addicts could be helped more openly and not cast aside by society. The glamour of drugs would loose its appeal to young naive users.

Professional drug companies would take on production and units (like we have in alcohol) could inform the user how much of a substance is safe to use. Product quality would be assured through open competition and prices would be driven down substantially, so low income users would not resort to petty crimes to fund their addictions. This would stop wasting societies resources with repeat offenders (quite often drug related) being sent to prison. Developing Countries could have a legitimate product to sell overseas which assists people out of poverty.

Some people who believe in legalisation also state that it could raise additional Government revenue through taxation. This is where I disagree and think there should be no taxation on any drug (I've already stated that I think the state and tax will one day be obsolete so I think you could guess that anyway). Current Taxation on alcohol and tobacco is amoral. The people who pay the price are generally innocent children who have low income parents who smoke or drink. To make these products it costs next to nothing, however the Government artificially raises prices dictating that its for our own good. It never is. One of my partners Grandmothers smokes around 50-60 a day. She's been doing this for years and like many others the raising of the price due to higher taxes has never slowed her consumption down. In most cases this can lead families to avoid spending money on the children in the family. How can they buy books when they wish to smoke or drink? All essentials become that much harder to fit in when the alcohol price rises. There's only so much people can drink or smoke and generally they will do it regardless of price. The recent phenomenon is continuing to drink the same but at home before they go to the pub (or to drink harder substances). Rather than buy cigarettes it has become more common to buy roll-ups and bags of tobacco, again continuing consumption. The government like to claim they look after you, in reality they are punishing the most vulnerable in society.

So what do we have to fear from making drugs legal? Nothing. We should always give individuals full autonomy over their lives, making things illegal doesn't stop this. Of course if someone were to infringe on someone else's liberty and rights then this not acceptable but how would allowing people to take drugs be an infringement on others. We already allow open use of alcohol and tobacco, why not other drugs? I myself am not a drug user. I don't smoke and only drink the odd Guinness here and there. However I believe people should be free to choose, if not for their own sake but for all of our well-being.

The Children's Budget

"I shake my head in despair. As the Chancellor faces a terrible fiscal position no one outside the Treasury will believe the forecasts. When I saw the public spending plans I nearly fell off my chair"
Michael Saunders, chief UK economist at Citigroup

"The increase in debt servicing costs alone will be between £35bn and £47bn per year in 2008 money. That is more than the annual transport budget. It is about the same as the entire annual defence budget, and about half the annual education budget."
Danny Gabay, head of Fathom Consulting


In 1909 David Lloyd George, Chancellor of the Exchequer, delivered what became known as the Peoples Budget. It's primary aim was to raise taxes on the rich in an attempt to redistribute wealth within society, which in its day was a historical and radical set of measures. One Hundred years later, Alistair Darling delivered another historic budget, however it was under quite different circumstances. With finances spiralling out of control and a country heading for the worst post war recession, there was no room for social justice. Again a Labour government had spent too much. History will judge it as the Children's Budget.

The repetition of all the budgets figures are not required here, suffice to say the numbers are truly horrendous given the optimistic forecasts the government has used. Some of the areas of worry are:

Future Economic Growth
We are in the midst of the worst recession any living person would have experienced. Looking back at history when events like this happen, economies take years or a decade or more to recover from these credit excesses. The growth projections given yesterday were lies. Not even Mr Darling believed them. The idea that the economy will grow at the end of the year, and be in the thick of a new boom within a couple of years is nonsense. The economy will continue its decline for this year and the next. If there is any recovery after - which this author does not believe - it will be weak at best. Not 3.5% growth. The IMF have recently projected -4.1% and -0.6% growth for the next two years, however they are still playing catch up and their projections have always been wrong. Expect further revisions to these numbers.

Peaking of Debt levels
The government claims that debt will peak at around 80% and again it is more lies, and the markets know it too. It will go much higher. For readers of this blog you will also be aware that this is only the official debt figure. There's many off book debts to come, just at the time they claim debt will peak.

Deficits turning to surpluses?
In order to try and pay the debt back the government needs to be running budget surpluses. Estimates again, state that the deficit will drop below the £100B mark around 2013/2014 with the admission that it may take a decade to balance the books - to just break even. Then we get to the point where we need to be running surpluses to pay for all this debt. We can let our children worry about that. Whose going to fund all this? Isn't global capital low, with the high saving nations in Asia enacting their own stimulus plans? The main buyers of Government bonds have been foreign buyers but for how long?

All of the above is based on government estimates. Estimates that will prove to be as wrong as the estimates of 2008, or the ones in 2007 and so on. There were no proposals to try and balance these figures, which is to be expected as the election looms with unpopular decisions being put back. However the longer the government postpone action, the worse the hardship will be. By not creating a credible framework for balancing the books the risk of further gilt strikes are inevitable. David Cameron again had no polices that would attempt to rectify the perilous position as he follows the focus group discussions not wishing to disturb his poll leads, sending signals to investors that Britain has no intention of paying its creditors back.

The budget was full of contradictions. We had the various environment measures for wind power and then there were incentives to build more Coal power plants along with tax breaks for Oil and Gas. They announced they will pay people to buy new cars, which is in effect throwing money away. We may as well employ some people to dig holes and another set of people to fill them in, rather than subsidise car purchases - at least it will keep the unemployment figures down. If double glazing sales start dropping is the government going to pay people to smash windows in order to create artificial demand? There was extra money for the Job Centre network, when the job market is shrinking. A scheme to back mortgage backed securities, dead assets, further preventing liquidation that is needed in order to bring about the recovery Darling mentions. However the biggest move was an introduction of a new high income tax.

The 50% rate of tax was welcomed by many - "get the rich, they got us in this mess" as many will say. However readers of this blog will be aware it is government that got us in this mess. Unsound money, central planning price stability created huge distortions in the economy. However this tax increase is just a foot in the door. We will all be paying much more in tax in the coming years like I have previously mentioned - crushing any recovery for a generation or more. It was the increase in income tax by Herbert Hoover and then Franklin Roosevelt that assisted in the prolongation of the great depression. By hitting wealth we are also sending a signal to the rest of the world, that if you work hard in the UK we will confiscate your earnings. Suggestions of a brain drain has begun before any of the real hardship has even started. Before our boomers begin to retire. Before we run out of cheap energy. Before printing money has had its full ruiness effects and so on. It also marks a further nail in the coffin for the city of London as a financial center of the world.

With the above there is no hope of retaining quick growth again. By taxing the entrepreneurs who create jobs and wealth for us all we are further impoverishing ourselves. Then there's the point will they pay? There could be a negative effect with more people looking to avoid the tax. Tax revenues could actually fall, as less jobs are created as successful business leaders and entrepreneurs wonder what will happen next. The IFS has recently supported this claim, however I don't think they appreciate the full damage of a policy such as this.

Healy or Howe?

There were discussions about if the increase in income taxes represents a return to Old Labour, or if the cuts to come in spending represent a return to Thatcherite economics. We are a long way from Old Labour 83% high tax brackets, but we are heading in the same dangerous direction. Then there's the myth of the supposed Thatcher Monetarism economics that prevailed during the eighties. Government spending barely moved during her time as prime minister. Standing at around 42.5% in 1977/78, it was 41.7% ten years later. She actually spent more than Ted Heath and Harold Wilson as spending on government rose 32% in real terms through the eighties credit boom. Thatcher kept this fact quiet as she prided herself on the illusion of getting government out of the way, controlling the money supply, the Milton Friedman philosophy. In Milton Friedman's later life he would be critical of the governments and central banks who inflated in his name, rejecting his original ideas that they could be trusted to control the money supply. The Austrian Economists always told him governments could never be trusted. Nevertheless taxes and unprecedented public spending cuts will be required - both of which we have never experienced in tandem. We will need more substantial cuts then just "savings efficiencies" to balance the books and tax rises that can actually make an impact on the deficit.

The government are also starting to admit they may have to take losses on the bank bailouts they carried out, rather than the profit many believed. As I have said before I will be happy to get half the money back. Wait until the losses really start stacking up. There will be an incredible strain in the gilts market for years to come, with further money printing to cover the shortfall as investors appetite for our debt wanes. Indeed questions of Britain's AAA rating has become mainstream news now, as a ten year old could do the sums and realise they don't add up.

Green Shoots?
Before the budget there had been more discussions of green shoots of recovery or the bottom of this and that. These green shoots will be mentioned for years to come as I have mentioned before, many will be fooled by the bull moves in this bear market we find ourselves in. I started this blog around this time last year and everyone was saying the same. The 'worst is behind us', 'the credit crunch won't effect us', 'the UK has sound fundamentals' with everyone having an almost religious belief in the state of the economy. There is plenty more pain to come. Mistakes of history are being repeated which are once again impoverishing society. Unemployment has only just begun its climb. The next bubble, government debt has yet to pop and cause havoc. Energy prices and commodities are historically low. Retirement has yet to set in. As the year goes on the FTSE will hit new lows possibly hitting levels around the mid 1990's in a best case situation.

So the Children's Budget has been announced. A decade of deficits, and a generation of hardship. These were the debts I have been talking about. The debts I knew were in the system, waiting to hatch out and there's much more to come. The debts that are now staring my generation and future generations in the face. Many Western Governments will find themselves in a similar situation, but Britain has managed to come up with the largest deficits of the developed world, even without the substantial stimulus packages other nations are putting in place. The greatest asset we have is a long history of democracy and peoples individual rights, but we have a government that is continuing along the path towards bankruptcy. It's all unsustainable and must be stopped, immediately, if not for our sake then for future generations sake.

The Fallacies of Deflation

It seems every authoritative figure has begun warning about the dangers of deflation. With Britain's Monetary committee making a case for printing money, we are told that this is to ward off the 'dangers' of a falling money supply, and we need to inject more cash into the system to get the economy moving again. The Keynesian's, the governments economic cheerleaders, are proposing that inflation is needed in order to combat deflation and the new money can ensure increased consumption in order to drive the economy forward. Deflation is one of the most misconceived economic terms, used as a scapegoat by the above institutions portrayed that it can somehow cripple an economy. Yet Deflation should always be embraced as it is a sign of a healthy free market economy. If our economic system was truly free, we would never get inflation. We would always have deflation in the modern sense of falling prices. However Banks and Governments always prosper with inflation. Throughout history this has been demonstrated with the costs borne by the rest of us. I felt this post was needed as I have become weary of these statements that deflation is some how a terrible event that should be avoided at all costs, used to try and justify printing money. Nothing can ever justify printing money or inflation and this post attempts to tackle these common misconceptions that have been indoctrinated onto the public, either by officials and economists that prosper from such policies or are incompetent to see what is happening.

Credit Expansion, Banks and Governments

Governments worship inflation. It funds their expensive welfare programs. It funds their wasteful consumption. It funds their political ideologies, their Utopian society they promise the public who elect them. Permanent inflation, like the one we have in our monetary system would never occur in a stable and free market monetary system. It can only occur by the continual expansion of our money supply. Markets always reduce the costs of goods ensuring greater productivity efficiencies as capital is used to enhance the way we make products. The debasement occurs with the co-operation between the banks and the state, similar to what we are seeing now. There is no conspiracy behind this as there is a long history of governments encouraging reckless credit expansion from the banks. A credit boom, like the one we have just come out of, creates huge amounts of credit which is spent during the boom. Most of this money does not exist as fractional reserve lending allows banks to lend far more money than they hold on deposit (money that actually exists). The government allows this privilege to banks as it inflates the currency, expanding the amount of money in the system. Despite the huge deflation we have had over the past 10 years in, computers, mobile phones, holidays, with all these items coming down in price, we have still had continual inflation. That inflation was a credit boom created by the private banks orchestrated by the central banks who prop up this credit expansion process, ensuring it goes on for far longer then would occur in a free market system.

At some point this process breaks down (a credit crunch), usually by previous investments turning bad (sub prime was the trigger recently) thus wiping out what little reserves the banks have. The banks reach a point where they can no longer inflate and central banks become the lender of last resort propping up these banks, and essentially printing money to replace the credit being destroyed. This is the current time frame we find ourselves in. Deflation, as in a contracting money supply is happening, thus the government and institutions step in to inflate. Since the credit crunch began true deflation has not actually occurred. Instead the money supply (Broad Money, M3, M4) is still growing as the governments resort to running huge budget deficits, that will be paid by printing money. We are told that this is necessary, as our economy needs the credit in order for it to operate. This however is not the case.

It doesn't matter how much money you have in the economy, so long as it is stable and divisible enough to price goods and services. Zimbabwe has huge amounts of money, yet they are no better off than traditional hard money countries such as Switzerland. In other words our prosperity does not depend on how much money there is, only that it be a commodity that can retain its value. If we allowed our money supply to drop, as markets are currently indicating, prices would just fall to a new equilibrium. If our money supply fell 50% then prices would generally fall 50%. This is the way to get out of the economic hardship we find ourselves in. This ensures a healthy liquidation process runs its course and cleans out these excessive speculative debts, those of the wasteful businesses and individuals. It would also stop government spending, and these unpayable deficits that we now see. It would be painful, depending on your circumstances, but it was brought about by the excessive credit expansion of the previous boom. The market is simply trying to get rid of these excesses. The worst thing we can do is try to re-inflate like we are currently doing. History has always shown this, and economic theory proves it.

Deflation is Compatible with Economic Growth

The recent credit bubble has now morphed into a violent contraction as the credit expansion process has turned into a credit contraction. This is not to be confused with normal market deflation (constantly falling prices), rather a by product of the elasticity of our money. In a free market that did not permit excess credit creation (ideally none), used sound money and removed the monopoly our governments hold on our money, deflation would be a normal occurrence. As history has shown, economies that have undergone deflation, have performed better than economies that have experienced inflation. Milton Friedman, who in fact believed in price stability therefore inflation, concluded that America during the period from 1865 to 1879 experienced huge economic growth despite having no inflation. On the contrary the U.S. was experiencing deflation.

"[T]he price level fell to half its initial level in the course of less than fifteen years and, at the same time, economic growth proceeded at a rapid rate. . . . [T]heir coincidence casts serious doubts on the validity of the now widely held view that secular price deflation and rapid economic growth are incompatible."
Milton Friedman and Anna J. Schwartz, A Monetary History of the United States 1867–1960

Around this time Germany also experienced rapid price declines, yet had the best economic growth in the whole of Europe as they became a world superpower that challenged Britain's status at the start of the twentieth century.

These false justifications to create more credit will ruin market forces for years to come. Credit merely channels societies resources. If we have less credit then prices drop to their new equilibrium. Just because credit contracts, doesn't mean we suddenly loose all our infrastructure, our skills, our resources? They are still there, and will just be re-priced accordingly. The competent, people and businesses who did not overextend themselves during the credit boom, did not make wasteful purchases, will take over from the people who were overextended and have been liquidated, who could not manage societies scarce resources.

'Price Stability'

So why do we have this catastrophic credit expansion that creates all the issues we now have? Governments and Central banks use a concept of price stability. Many of you would have heard of it before. In the UK for example we have a composite index that represents typical consumer goods, called the CPI (Consumer Prices Index). The government (Central Bank) try to keep this target in a range of 2-3%. Around the turn of the Twentieth Century a proponent of this concept was an economist called Irving Fischer (an early day monetarist). The concept goes that this will somehow ensure greater economic productivity and planning. Another economist at the time, Friedrich Hayek, indicated that this proposal was doomed from the start. In order to stabilise prices in a free market where prices were continually falling, the stabilisation would inevitably take the form of a credit expansion, which would provoke a boom. This boom would be unsustainable and would result in these artificial credit distortions eventually unwinding with a bust.

These polices were used during the 1920's in America, with the Federal Chairman Benjamin Strong, ensuring 'price stability' by crediting a huge credit bubble in the stock market. Irving Fischer, who supported such polices said in 1929;

"Stocks have reached what looks like a permanently high plateau."

He also made statements for the continuing years that stock prices seem to have stabilised, even as they continued to decline until 1933. Meanwhile in 1928/1929 Friedrich Hayek, had wrote that a great depression was coming. Price Stability was a form of central planning, targeting fixed metrics that were incompatible with market forces. It was central planning intervention, interference with markets just like Communist Russia. At the time he was laughed at, people were saying it could never happen, this was the "Global Economy", the "New Economy". However the disaster was always on the cards, it was just a matter of time. Governments and Central Banks subsequently use 'Price Stability' to legitimise this expansion of the money supply that always brings about the boom and bust process we are currently seeing.

Price Indexes

Then we come to the point of the price index (CPI, RPI etc). How do we determine the algorithm to use? In a free society how do we decide what people spend their money on? Well one cost would be living costs, as we all have to live somewhere. Not in CPI. CPI, the preferred measure the government uses doesn't even include typically peoples biggest cost, their roof over their head. So how can they target 'price stability' when we don't include house costs. Quite simply they can't and its all an illusion. All the inflation went into houses - trillions of it, now its all spilling out as the governments try and replace the bad loans that were lent on these assets. It's a similar story with stock markets, they are also not included in any measure. The indexes they use from the start are flawed. Its all deliberate, to give people the illusion of prosperity i.e. rising asset prices to ensure continual inflation, debasement of our money. These are the justifications they now use for printing money, flawed centrally planned metrics which is just the same as any Communist centrally planned ethos. All monopolies are doomed to fail and impoverish the people. This is no different.

The amusing thing with CPI in the UK, is it hasn't even fallen in it's targeted range and yet the government are already wanting to print money, even before true falling prices have actually met their bounds that they use.

Arguments against deflation

There are many common horror stories with deflation, a fear is installed in people with various doomsday scenarios that will occur, and all of them incorrect.

The first one, is no one will buy anything. People will stop consuming and we will all have no jobs. So when mobile phones, computers, televisions, holidays, cars etc have all been falling, did people prospone their consumption? Of course they didn't, people have a time preference to enjoy their life now. Everyone knew these goods would most probably fall in price over the past 10 years yet everyone kept buying them at record levels for the enjoyment of these products now. People buy mobile phones every year, despite them continually falling in value. Common sense says people always spend money. We always need goods. People use these justifications for houses, if prices keep falling then no one will buy them. People will always buy houses regardless, as its a home, and people will always pay for the enjoyment of 'their' home. If peoples past expectation during the housing bubble was rising appreciation, then these attitudes need to change. A house is a home and historically has been a poor investment. When the credit crunch began people stopped buying homes not because they thought they would fall, but because the banks stopped reckless lending. Now people are not even sure if they will have a job, so buying a home suddenly seems like a liability.

Second, it would be harder to service our debts. Sure, if you have a million pound house with an income on minimum wage and a 125% mortgage. This only occurs in the extreme case we find ourselves in now, that is caused not by deflation, but the excessive credit expansion of the preceding years, all in the name of 'price stability'. Even in our current situation, people who have over extended themselves get liquidated. The people who have been prudent and competent take over these assets. Governments cut their wasteful spending, and don't rob the people through inflation allowing the competent private sector companies to take over - not the government like we are seeing now. An attempt to re-inflate will only result in further struggles to pay debts as the new money ends up in food, energy etc meanwhile production is distorted and hampered by these re-inflationary tactics.

Third, we will get a deflationary collapse like Japan in the nineties. It wasn't the deflation that killed Japan, as in a monetary trap, it was the government, a structural trap. It continued with further inflation. The government expanded its involvement, tried to prop up prices and didn't allow liquidation. The funny thing is U.S. Treasury Secretary Timothy Geithner now states that Japan did not inflate enough and that's why their economy never recovered. Talk about clown school economics. I couldn't believe what I was hearing. It was like Robert Mugabe stating that Zimbabwe's economy is in such a bad state, because he didn't print enough money.

Deflation allows all sections of society to prosper. It distributes lower priced goods and services to all income groups, regardless of social standing or what assets they hold. Inflation enriches the wealthy at the expense of the poor. It puts a break on social mobility. Banks and Governments are always the winners as they receive the money first. As the money moves out, prices rise and the last to get it suffer. As long as the government holds a monopoly on our money they will always inflate, regardless of the consequences. Regardless of robbing the very people they are elected to represent. The only way to prevent this is by giving production of money back to the people - to the market. Just like any other good, Chicken, Shoes, Phones, all are provided by the market and money is no different. It is merely a convenient commodity to exchange our more cumbersome goods. Britain had free market money around the turn of the nineteenth century, as it rose to become the economic superpower of the world. Government intervention outlawed it, as there was no benefit for them subsequently creating the modern money monopoly they still hold. One day, I hope we will look back at inflation as an ancient cult, extinct, with deflation a permanent feature in our economic landscape, discriminating against no social group and ensuring everyone can enjoy the fruits of a true free market.

"Today everybody is prepared to consider a rise in his nominal or monetary income as an improvement to his material well being. People’s attention is directed more toward the rise in nominal wage rates and the money equivalent of wealth than to the increase in the supply of commodities. In a world of rising purchasing power for the monetary unit they would concern themselves more with the fall in living costs. This would bring into clearer relief the fact that economic progress consists primarily in making the amenities of life more easily accessible."
Ludwig Von Mises, Human Action

Interest Rates and Capital

“Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.”
Mahatma Gandhi

“The highest use of capital is not to make more money, but to make money do more for the betterment of life.”
Henry Ford

"This weak republic throws its pieces of paper about wildly in order to enable its main party functionaries ... to feed at the trough"
Adolf Hitler


The use of paper money has become ubiquitous in modern times and with the introduction of computers in the past few decades, society has become accustomed to the further abstraction of money in the form of pixels, a series of 0's and 1's to represent money. We all use our nations currency either the paper or electronic form, and have complete trust and faith in what it represents and it's intrinsic value. Is this blind faith in pieces of paper justified? As we have only grown up in a society whose main medium of exchange is the use of government currency, should we place an almost religious belief that it will always retain its value? We have recently had a meeting between the G20 countries, to co-ordinate agreements towards a global fiscal stimulus package. The Bank of England cut rates by 1.5% with the base rate now at 3%. The Federal Reserve is down to 1%, with other nations Central Banks following the trend. However if we go back 6 years, weren't the low interest rates the main cause of the monetary problems we are now facing? Why do politicians always seek lower interest rates and why do we have central banks that try and impose a broad monetary policy on all financial institutions in our economy? We have become accustomed to Central Banks, almost conditioned, into the fact that their very presence is essential for a functioning modern economy. Contrary to what Central Bank are supposed to do, that is fight inflation, they are actually a huge inflationary mechanism that create the moral hazard we are now seeing and continually told about.

Central Banks are the Moral Hazard

When Mervin King the Governor of the Bank of England makes statements regarding moral hazards towards banks, its like a drug dealer giving a lecture on drug abuse to a drug addict. Central Banks amplify the effects of the boom, by flooding private banks with cheep money at the beginning of the boom. When the boom turns to bust, Central Banks begin a program of propping up private banks as the private banks always know they can turn to the Central Bank when the bust materialises. If you can't picture a modern economy without a Central Bank, then America had no central bank from the 1830's right up until 1913, just as it was becoming the industrial power of the world. The current central bank is the third America has had in its short history as a nation and is owned and controlled primarily by private banks. It was set up with the intention not in ensuring financial stability but for the purpose of increased profits for the banks, so they could load up even more with peoples debts with less need for capital. In a true free market there wouldn't be need for a Central Bank. Private banks would obtain capital and lend on their own accords. The setting of interest rates is just the supply and demand mechanism banks use in order to encourage people to either save with them, or borrow from them. If a bank has a lot of money in reserve then it lowers interest rates to increase demand for loans. If they have low reserves then they raise interest rates in order to encourage people to save and increase their capital base.

These aggressive cuts that we are witnessing bear no relation to the above supply demand dynamics detailed above. Many countries, in particular western nations, have pitiful low capital levels and huge levels of debts. What needs to be done is at least a stabilisation in interest rates, however an increase is required in order to incentivize people to save thus allowing banks to re-capitalise, capital based on human labour that has already been done. Debt is the modern Political-Monetary illusion of wealth, however its all a magic act with the money being taken from future human labour. Having a Central bank trying to set interest rates for the whole financial system is an crude instrument for influencing private institutions monetary policy, similar to the communist state planned centralised economy. It will always be inefficient.

Marx on Capitalism

Karl Marx, the most famous anti-Capitalist symbol in history, stated that sooner or later Capitalism would drown its markets in goods. It could only survive by continually cutting prices and real wages of the workers to below the point of subsistence. With markets ever expanding the Europeans would eventually branch into Asia, with ever more goods being produced but eventually the people of the world would revolt under these conditions and the global socialist system would emerge. So why has this not happened yet? One of the main flaws of a centralised state planned economy is its neglect of a suitable pricing mechanism.

The Capitalist Pricing Mechanism

Free market economics uses the basic premise of supply and demand to drive markets. This creates a pricing mechanism that is used to divert capital and labour to the required sectors of the economy in order to obtain economic efficiency. I'm not saying that capitalism is a fine tuned, super efficient economic model, far from it, I'm sure there is some economic model that has yet to be invented that is far more socially responsible. However for this reason a free market, operating under the direction of individuals and capital obtained from labour that has already been performed, induces a system of great productivity and material gains. This whole system relies on no monopoly and no centralised institution controlling a specific sector. Central Banks are a monopoly that prevent these very market forces. They prevent capital being used wisely and labour being re-deployed and used efficiently. Interest rates should always be driven by private institutions all in competition with one another, all responsible for their business actions, with no inflationary engine waiting in the background to bail them out or other businesses for their irresponsible decisions. Accountability has all but been ignored within finance recently as the bonuses were rewarded for short term decisions that were never beneficial to the bank and society.

Without a sufficient pricing mechanism Eastern Europe's Communist block collapsed as the planned state economy could not allocate resources efficiently. After the early illusionary productive gains obtained under the Stalinist Regime with the use of forced labour (the infamous Gulag camps) the economy began to collapse. The 1980's saw Mikhail Gorbachev introduce Perestroika, a policy to try and introduce a more efficient pricing mechanism, however it was too late as inflation and product shortages had become widespread.

The Capital of Asia

The IMF have recently begun to show the strain and how little capital they have. A world body that is supposed to ensure stability and provide capital for nations in need of it has now begun turning to the Japanese for money. They are increasingly seeking funds not from Western nations, but from Asian Nation states. The reality of the current situation in the global economy is the G7 and the IMF have very little capital. The real countries that hold the capital are now in Asia. An assumption that the West are the rich is simply not true the way things stand. Asian countries with savings rates of anything between 20% and 40% are now the people with capital, the west with negative savings rates are the ones who are now in poverty, relying on the external capital flows from Asia. It's only our high levels of debt, our old infrastructure that gives the illusion of wealth. Why do you think people were given 125% mortgages? Why do you think everything was on credit with no one saving? Why did you think people could buy a whole street of houses, with no money down, just the supposed capital gains of previous acquisitions? It wasn't because we had entered a new frontier of Western superiority. Asians were giving us their Capital. Capital that they obtained by expending human effort to produce goods for us to consume. They gave us more capital so that we could continue loading up with more debt and buy more goods from them and they further increased their capital reserves, buying bigger stakes in our economies. Now the global downturn has come, Asian economies are being hit more and more, and this 'agreement' above is beginning to break down. Capital, instead of going West is now in retreat back to China or Japan. This is what happens when you rely too much on foreign capital to fund your consumption. This is why in particular the US and the UK need savings. Tomorrow always comes and with it real problems.

Sterling Collapse?

One such country who was greatly reliant on external capital was Britain. It tapped foreigners for their capital and used London as the driver for this financial utopia. Britain has the second largest external liabilities behind the US. Recently the Shadow Chancellor George Osbourne has come out and said a future sterling collapse could occur due to the unfunded borrowing of the Labour government. What became interesting was the reaction his comments evoked. Rather than dismiss it, opposition politicians have labelled it as "irresponsible" or "dangerous". I thought our politicians were supposed to challenge and offer conflicting views. If there is a run on the pound, there will be a run on the pound not because of what one man said, but because of fundamentals relating to the UK economy. If they continue with inflationary policies, deficits continue rising with little internal savings as foreigners sell their pounds then a run seems likely.

Helicopter Ben

Ben Bernanke the current Chairman of Americas Central Bank has dedicated an academic life to the study on the causes of the Great Depression. Two of his economic heroes are Milton Friedman and the latters wife, Anna Schwartz, who some four decades ago co-authored a landmark book entitled "A Monetary History of the United States", on which he based a lot of his ideas regarding the Great Depression. In a recent interview that Anna Schwartz gave she said Ben Bernanke was getting Fed policy wrong and the problem does not lie with liquidity or money supply. It lies with the toxic securities that Wall Street has created. Her comments regarding these were,

"Because you cannot sell them, you don't know what they're worth, your balance sheet is not credible, and the whole market seizes up."

She went on and said that Paulson and Bernanke have now prolonged the crisis,

"They should not be recapitalizing firms that should be shut down ... Firms that made wrong decisions should fail."

Central Banks are just a monopoly, and just like any other monopoly are desperately inefficient. They create huge distortions during the boom and prolong the bust, punishing the prudent among us and propping up institutions that should be liquidated to create a more efficient economy. Capitalism's "Creative Destruction" has been replaced with "Monetary Creation". He still believes we had the Great Depression because the Central Bank didn't print enough money. The reason we had the Great Depression are the reasons given in the quotes above.

Weimar Germany

"I do not believe a word of the silly stories that the German Government could be so bold or so mad as to engineer on purpose what will in the end be a great catastrophe for their own people."

The most recent example in modern Western history of a nation experiencing serious inflation and its destructive effects was Weimar Germany just after the First World War. After incurring substantial debts during the war and the imposition of further debts by the victor nations, the Reichbank pursued inflationary policies through persistent trade and budget deficits and the increase of government spending. All the European countries incurred substantial debts during the First World War, Britain had debts amounting to 136% of GDP but Britain avoided hyperinflation. Inflation was high, running at around 22% but nothing like Germany which witnessed people wheelbarrowing worthless Marks to burn as a source of fuel. The currency was destroyed by irresponsible fiscal and monetary policies, Britain chose debt service, while Germany ramped up the printing presses. Just before hyperinflation became evident Germany experienced deflation, with inflation dropping to 2% with the Mark rallying, just before its spectacular collapse. I warned in one of my previous posts that the media and institutions would begin warning about the misconceived notion of the dangers of deflation, and we are beginning to hear more about it with Gordon Brown now mentioning it. Deflation is a natural function of a free market. We are not going to get a true deflationary bust that would happen in a truly free market as governments and Central Banks are now pursuing inflationist policies similar to the above, with economies that ill equipped to weather the storm.

One of the main causes for the rise of National Socialism and Adolf Hitler was the hyperinflation caused by Weimar Republic contrary to the conventional emphasis placed towards anti-semitism and First World War grievances. It destroyed peoples savings, capital that people had laboured for their whole life vanished in a matter of months. Whether any Western nation will experience hyperinflation remains to be seen and one hopes not, but as economies shrink, debt increases, trade collapses, deficits rise and more people claim benefits, we have the conditions for at best, mild inflation.

The quote given above is a comment made by economist John Maynard Keynes in November 1921, who was an advisor and influential figure towards German economic policy during those fateful post war years. A person whose inflationary economic theories have become biblical in recent decades.

The Last Bubble?

Western Government Bonds are shaping up to be the next bubble in a very long line of bubbles, from the Dot Com Stock Market bubble, to the Real Estate bubble now government debt is beginning its exponential climb upwards. However if this does become a bubble and bursts, its effects will be felt very quickly and violently in the nations it occurs in. If there are no buyers for government debt, then interest rate will have to rise in order to attract capital, how high it all depends on if investors think the government is solvent. For years the US has abused the Dollars status of world reserve currency, building up many enemies throughout the world through its Imperialist policies. From the teachings of Sun Tzu in China, to the chess culture of Russia, they are all waiting for their opponent to self destruct or make continued mistakes.

A Sound Currency

Money is not a new concept, it has been around for millennium used as a means of exchange between people, a store of human labour or something people value. Empires have come and gone along with currencies too, but there is one that has withstood the test of time. Gold. In our modern western culture it has been associated with extravagance with no intrinsic value, however when we step outside our conditioned frame of mind that has been shaped by the environment we have grown up in it becomes something different. If you took an ounce of gold a thousand years ago, to an ounce of gold now its purchasing power would be more or less the same. Gold is a rare metal that can't be printed out of thin air like banknotes can. That's why it has always held its value throughout time, throughout the world. Older generations always remark that a penny today isn't worth what it was 50 years ago, however people don't seem to realise that this is due to the inflationist policies of the people who regulate our currencies. The reason why we have more money then we did at any other time in history, is not due to the fact that everyone has become richer, its because more of it has been printed. This is why we always experience inflationary periods throughout life, market forces are always deflationary as economic efficiencies are made from capital that is re-invested. Its politically popular to increase the money supply, to give a short term illusion of wealth or to try and pay off excessive debts. People make statements asking why value is placed in an archaic metal such as Gold or Silver, but never ask the right question, why a set value is placed in a piece of paper with pictures on it. History has always shown precious metals to uphold their value as a store of human labour. All modern fiat currencies have shown persistent devaluation over time, especially when debt is as high as now.

Will it Work?

The favourite phrase in the media over the past year has been "Will it Work?". New policies are implemented with the same question repeated over and over again, now with interest rates falling we are told this is the latest silver bullet. The real question should be what are we trying to solve? The Credit Crunch isn't the problem, its the cure. Its brought about an end to reckless lending, a recapitalisation of banks, a break on consumption, the re-balancing of the economy, yet "remedies" to the credit crunch are formulated as though it is the problem. The patient is sick and just as the doctor was about to administer the medicine the "I know better" parent with no medical training stepped in to provide the "real cure". By delaying the treatment the patient becomes worse, until eventually the patient is no longer ill but becomes terminally ill, beyond help. The pricing mechanism for capital has been distorted by the Central Banks and Governments. The end result could be disaster for nations with little or no capital.