We have no Solutions Yet

"Don't be fooled. Don't fall into the government's trap. Lenders and debtors will sit at the same table, having agreed to skin the people alive."

Aleka Papariga, Greek Communist Party Leader

The ECB and IMF have yet again decided to lend Greece more money in order to 'avoid' contagion which would lead to a tsunami of defaults across the financial world. The Greeks can't pay but who cares, I don't think any Western Government can. 

'Tough talking' British Prime Minister Cameron told Ed Milliband during this weeks PMQ's Punch and Judy show that if Labour were in power, then we would have a Greek crisis. Yet what is the current Governments approach? Inflation is rising. The BoE have now admitted they don't give a monkeys about Inflation. Despite it being more than double their official target they have stated that more QE (money printing) may be 'required'. The rate of inflation is now predicted to stay above target for the next two years. Of course, what they don't say is they plan for it to stay around for the whole decade.

David Cameron is a showman, all talk and no action, a modern day Ted Heath, as I previously said before he came to power. He has been in power for over a year, yet the Government continues to spend more money, 

"During April and May, the first two months of this fiscal year, the Government borrowed £27.4bn according to figures released last week, up from £25.9bn during the same months in 2010."

The majority of people are wrong that Cameron will solve our problems. A valuable lesson in life is that people are not able to see trends. They see the current time-frame, and extrapolate. When Cameron talks of 'austerity' and 'cuts' the public believes we will be back to boom times again soon. Cameron is no Thatcher. The Governments loose monetary policy may inflate tax receipts, but spending will rise as costs always catch up. Thatcher raised rates, lowered spending and let business go to the wall. Until this happens, then the current rhetoric is all fluff.

History is repeating itself again. Britain in the 1970's had some of the highest inflation in the developed world. Fast forward 40 years and its the same again, we are world leaders in the Western inflation league table. Germany meanwhile has less than half our inflation rate, and their earnings, unlike ours, are rising in real terms,

"Real earnings, that is, the price-adjusted gross monthly earnings of full-time employees, rose by an average 2.0% in the first quarter of 2011 on the same quarter of 2010. As also reported by the Federal Statistical Office (Destatis), nominal earnings increased by 4.1% in the first quarter of 2011 compared with the first quarter of 2010. Consumer prices were up 2.1% in the same period. The increase in real earnings was the second highest since the beginning of the time series in 2008, while that in nominal earnings was stronger than ever before in the given period."

Yet Germany imports every drop of oil, and the majority of food, just like the UK. UK wages in real terms continue to decline,

"Average pay rose at an annual rate of just 1.8% a year in April, according to the Office for National Statistics (ONS), while the consumer prices index was running at 4.5%."

Inflation is a monetary phenomenon. Keynesian's will point to the symptoms of Inflation and tell the public that these are the causes, for example increases in workers wages. Government friendly economists state that if wages do not rise, then inflation should be subdued. It doesn't take an economist to work out this is just plain illogical thinking. The above clearly disproves the theory. German wages are rising twice as fast, but the inflation rate is half as much. By any scientific measure this Keynesian law wouldn't even hold at primary level education. 

Now is a time to reign in loose monetary policy, but not for the UK, its time to print more. If history is a guide the UK will have negative wage growth and high inflation for a long time, just like in the seventies. Worse still, we will accept it. Its a culture thing. Similar to the Greeks, as the quote at the top of this article reads, believing their problems are inflicted by others, when in reality it is all their own reckless doing. They wasted money for years.

The rise of union strikes have also become more prominent. So rather than lacing up our boots to go work, like the Germans, we decide not to turn up to work, compounding inflationary pressures, eroding our global market competitiveness and lowering real term wage growth. Marvelous! I believe people are free to do as they please. Strikes however are always a waste of time and do not raise peoples living standards. It seems to me that their living standards are already quite cushy compared with many,

"The calculations show that a mid-ranking teacher on £32,000 a year will receive a final salary pension that is the equivalent of having built up a £500,000 pension pot. This is 20 times higher than the average private sector scheme, according to figures from the Office for National Statistics."

Rather than sulk, how about they spare a thought for future generations. State pensions will be non existent, despite the fact we pay National Insurance, the greatest ponzi scheme in existence and the new pension standard is to be put on a private contributory scheme (if you are lucky) that is no where near as previous non-defined schemes. 

Previous generations fought a war, underwent rationing during the 1940's and 1950's, left school at 15, worked for 40-50 years and got a paltry state pension, if they lived that long. Meanwhile many boomer's were the first generation that got a free University education, gained greatly from credit booms from substantial asset inflation in items such as houses and to top it off were given gold plated pensions. A generalisation, of course, my mum left school at 15, never went to University and won't have a gold plated pension, but for many of her generation this was not the case. However this is how economies should work, the next generation has it better.

Subsequent generations now have to pay for their University education. They will never see their state pension as it keeps riding on further into the sunset. Private pensions are minimal in comparison. This is not how the next generation should have to live. But hey, that's governments, they take money from the future to buy off present day votes.

Circumstances will improve, the free market will see to that. As the Government creates more problems the only way to solve them will be to expand the price system and allow free markets further reign over the economy. It always happens. The end of this current age of stagflation will result in further moves towards free markets. Just like the last stagflation. In the current climate I see no solutions yet, just more compounding of our current problems. The solutions will come, just not quite yet.

BoE 'Inflation, Thats Our Job'

"The MPC's chosen approach has been to accept a temporary period of above-target inflation, rather than seeking to hold inflation as close to the 2 per cent target as possible at all times."

Charlie Bean, Member of the BoE Committee

News it may be to many, but for readers here this is not news. This is how Governments work. Goalposts move. Targets change. Inflation is always present. People looking for action on Inflation from Central Banks are looking in the wrong direction. These people create inflation, not control it. With private and public debt out of control they are 'secretly' creating inflation.

When I have mentioned previously of interest rates going to double digits during the decade this may seem scary in the current time-frame. But by that time  debts will have been drastically erroded by the damaging effects of inflation over the years to come. Negative interest rates, where inflation out paces the savings rate is here to stay for some time. When interest rates hit 10%, expect inflation to be at least twice that rate.

The central banks primary function is not to fight inflation, or to sustain economic growth. Its job is to prop up the whole fragile fractional reserve banking system. Its aim is to ensure financial collapse does not occur. This means re-leveraging the system back up and and trying to inflate their troubles away. It takes a while for people to become sick of inflation. Britain had terrible inflation for over a decade during the seventies. No one did anything as the public didn't feel strongly enough over the issue for some time. Its going to be the same again. Inflation is here, 4.5%, double the targeted rate, but no one in the public wants to do anything about it. Most people are so heavily in debt, they want it.

The Bank of England's comments will worry no one. The words may even reassure people. The deflationists are wrong, as they have always been since the post war era. With Central Bankers running a monopoly on the printing press, how can we ever have deflation?

Where is the deflation?

"The Chinese government is expecting its economy to expand around 8% of gross domestic product in 2011, same as in recent years, but it has raised its inflation target to around 4%, indicating Beijing isn't willing to sacrifice growth even though fighting inflation is a top priority.

State television reported the new numbers Tuesday, citing Zhang Ping, the head of the National Development and Reform Commission. Next year's inflation target is a full percentage point higher than this year's target of 3%."

News that China will raise its Inflation target

If you were to believe the experts it is deflation we have to fear. Its just round the corner. Its a battle we must win. A depression must be avoided which apparently is caused by deflation. In the real world people are seeing costs rising all the time. Not just in the West but in emerging economies also. The Chinese authorities have raised their inflation targeting metrics in order to keep their bubble, sorry growth, moving up. A rule of life is governments always bend the rules. Its sets them. Free markets allow people as individuals to set the rules. Participants mutually trade with one another under an amicable agreement. The state takes at will and by force. Inflation is one such example, it benefits no one in society in the long run, only the government over the short term.

The fact that the target has been moved upwards should not be a surprise. This is what's going to happen everywhere, across the globe. Here in the UK our Inflation has risen yet again. Its now been above the target for over a year now and what are the "inflation fighters" (that is Mervyn King and his MPC comrades) doing about it, Nada. Zilch. They have already raised their inflation targets, they just haven't told the unsuspecting public. There's more price increases in the pipeline:

The increase in VAT from 17.5% to 20% that will come into effect next month will be used to "mask" more extensive price rises according to accountants at KPMG.

They claim almost two thirds of retailers and consumer product manufacturers plan to increase their prices by more than the planned VAT hike in January.

Martin Scott from KPMG told the BBC why he believed retailers would raise prices by more than just the VAT hike next month.

All this inflation is causing Government bond prices to stay high. Well I say high, but we haven't seen anything yet. They will go double digit over the course of this state induced disaster. Double Digit may seem high in today's environment buts that's what you would have thought when Interest Rates were single digit back in the seventies. In the US they eventually went above 20%. Ouch!

Well at least the banks are ok now. They were small fry. We have moved on to more impressive bailouts like, err, countries? Ireland, Portugal - what about when Italy and Spain need assistance? They in turn get bailed out by Germany or France or even the UK. Hang on, aren't we bust also? Yep. Fractional reserve banking, fiat state monopoly money, you have to admire it. The Governments legalised ponzi scheme. No one has the money for any of these bailouts. Deflation will never happen because Governments know this would be the end and a collapse of the system. Therefore they will print money. They will raise inflation targets. They won't even tell people they are doing this. Oil is at record high once more. Just like with any unwarranted inflation, peoples living standards are falling. Prices rise and real wages don't keep pace. 

Through all the bailouts and enlightened interventions, nothing has been solved. Its worse than before the crunch. Its the quiet before the storm, just like prior to the market collapse of 2008. Everything was fine until it happened. That's the problem with economic collapse caused by government mismanagement. You can't predict it, you just know it will come. And when it comes its always too late to act. We won't hit bottom until the market is allowed to cleanse itself, but that isn't going to occur. Until then, just know that inflation will always be there, always rising, even when it may seem its not. Deflation is just the Governments smoke screen.

Inflation - The Governments Free Lunch

"While our case has been aggravated by the illegal sanctions imposed by the Western powers, rising food prices are a world phenomenon because of the use of biofuel"

Zimbabwe's Finance Minister, Samuel Mumbengegwi 

Recent figures for inflation have been released for the UK yesterday and it doesn't make pretty reading for the Government. CPI up to an annualised rate of 3.7% with RPI standing at 5.3%. Again Mervyn King blames the increase on VAT, the fall in the pound or the rise in oil prices. Hate to break it to him but these are just symptoms not causes. The causes can be laid directly at the Governments monetary policy, that is printing money, record peacetime deficits and artificially low interest rates. Thats what he should have told the new Chancellor George Osbourne. Scepticism amongst the city seemed to be the other part of the story, that is they are not buying the above reasons anymore. How long will it be before the general public cottons on that inflation is going to be a real problem going forward. The only way inflation is going to come down, as the Governer would have us believe, is if the government stops printing money, hikes interest rates and gets their books in order. But none of this will occur.

Continued debates regarding which algorithm to use have resurfaced. RPI-X, RPI, RPI-Y? What about using a tool we all know works, the free market. Supply and Demand. Prices. But that would be all too easy. The Keynesian witch doctors couldn't promote their economic religion of the 20th Century. 

There are a lot of common myths surrounding inflation in most instances, the symptoms are portrayed as the causes. Symptoms such as unions, 'overheating', OPEC, speculators - the list goes on. In a nutshell inflation is actually created by making more money, its that simple. Zimbabwe hasn't got inflation because of their stock market or the Unions or OPEC, its got price problems because Robert Mugabe ran out of money and turned to a printing press instead of balancing the books. Of course he lists the same reasons as all governments do. Zimbabwe shut down their stock market recently by stating it was helping to cause runaway inflation. The best stock market in the world is there, along with the best housing market, gains we could only dream of. However there is a catch. The Zimbabwe dollar, in which these assets are valued, is worthless. Same policy as our current Governments are pursuing only with more moderation.

Excess Capacity? Now theres something Zimababwe knows about. But yet the well versed lines we are told is that we can't get inflation because of this excess capacity. People can't demand pay rises, again a symptom, because of this fact. When in history did a country sucumb to high rates on inflation when their economy was strong? Excess Capacity exacerbates inflation, it doesn't dampen it. So while the deflationist scream 'excess capacity', I say 'look at history' (Remember Stagflation?). Incorrect lessons are learnt, fallacies are drawn from history. By the same logic, Zimbabwe should have solved their inflation problem. I have been tracking events there from around 2006 when their inflation stood at a 'mere' 1,000-2,000%, and continuously there has been more and more slack in the economy but yet inflation has gone through the roof, it can't even be measured anymore. People stopped turning up to work because the price of the bus fare was more than they got paid at work. People get confused that the unemployment caused during Thatchers Policies in the early eighties helped dampen inflation when in fact all she stopped doing is spending money the Government didn't have and buying her way out of trouble like previous Governments had. She let market forces take over which lowed consumer prices, and let inefficient state entities fail. It wasn't excess capacity, it was a combination of market forces and the relative restraint of money creation.

Oil keeps going up and up. It does in Zimbabwe. So much so that they put price controls in place. Mugabe blamed oil speculators or OPEC, again the symptoms. It was caused in exactly the same manner as we have now, excessive monetary expansion. Supply and demand issues will occur at some point in the future as we hit peak, but not now. Global demand is weak and people are struggling to buy as much of it. So that price of £1.22 a litre in the UK, we can thank our MPC and our government. Not the oil companies as the Government would have you believe.

Unions or the lack of them. We won't get inflation because we don't have unions due to the wage price spiral they cause, again its a symptom. As more money gets created the publics demand for money becomes greater as it takes more money to buy the same goods and services. However pay demands can equally occur in the free market, for example people move jobs similar to India where they have greater inflation expectations as their Government is weak thus creates too much money. People can just as easily drive up their own wages. We will see more unions and strikes in the future, but don't confuse this with a cause of inflation. I disagree with the concept of unions but there is one point I agree with them, they don't cause inflation, they just play catch up to rising prices caused by weak incompetent Governments. Suggestions of public sector pay freezes does not bode well for future industrial relations, when inflation is on the rise.

In 1997 when Labour granted 'independence' to the BoE for controlling interest rates this was hailed in the city and by many economists, but I disagree. Their targets are still set by the Government. It's laughable that the BoE is independent with it's main remit to target inflation however this figure is now nearly twice as high as what they target, it's not even within their bounds. The 'recovery' or 'it will subside' are reasons given to not take action, but the bank doesn't have a remit on these issues. Its aim is to take steps once inflation goes outside its bounds of 1-3% that the Government dictates. So while Mervyn King and Co. sit on their hands it won't be long before the creditability of the central bank is called into question. A year ago the bank predicted that inflation would now be 0.7%. A 3% margin or error is quite large if you ask me. The record reads quite clearly - it didn't take until 2011 for inflation to rise above 1.2%.

Frustrated savers sit and wait, questioning the policies officials take. Of course its one great moral hazard and the Central Banks are masters at setting up future disasters. The reason savings rates are so low is because commercial banks can lend from central banks for virtually nothing. Unlike genuine savings (capital) this is just pure inflation, so why pay retail savers with real capital more than the central banks rate? The commercial banks can then take this money and lend it for the long term, a common trade is to borrow short term at 0.5% and take this money to buy long dated bonds, say 10 year gilts, which have a higher return (inflating the bond bubble). The difference becomes the profit, money for nothing. Of course the problem occurs when Central Banks have to raise rates. How will the banks deal with this sudden shock to funding? Bailout Mark II? Private Banks then lend to the public and the Government at higher rates because of inflation and default risks in the future. So unless the Government and Central Banks step into the place of private banks then they will never ultimately set market interest rates. 

Media types will have you believe that this is not a plan, that is to inflate away the debts, and its Central Banks believing that inflation will subside. Don't believe everything you read in the news, like I mentioned above there is a remit on the bank which they are quite clearly ignoring. Much damage will be done by trying to inflate, its not just a case that the prudent among society are punished to bailout the irresponsible. The prudent peoples savings erode, incentives are lost to save and capital begins to flee, into foreign assets or Precious Metals. Keynesian's would have you believe we have a liquidity problem, when it fact its a capital deficiency issue. If you have a printing press liquidity is never an issue, so by inflating all officials are doing is adding gasoline to the fire. It compounds the problem. I think people are aware something is not quite right with the monetary system, printing money, giving away free money, people are asking "isn't this what Banana Republics do?".

I warned that we can't devalue our way out of trouble, making the point that prices always catch up with you. The UK is now beginning to find this out. Companies and individuals get lazy but when prices come back to bite, suddenly that purchasing power has gone. Capital gets eroded, saving rates come under pressure as people's demand for money rises to buy the same goods for more - two building blocks for prosperity. Peoples inflation expectations grow. Capital becomes harder to form as prices rise and people struggle to forgo consumption. Company profit margins come under pressure. A vicious cycle can occur without action from a strong Government. Could we have a fall in inflation? In the short term I don't dispute this, when cuts are enacted we could have some slowdown but we won't go the distance and take our full dose. If we couldn't take the pain in 2008 why do you think our leaders will take it going forward with the economy in worse shape. 

There is only one trend and that is expect more inflation, but not the relative calm inflation we have seen over the previous decade. Over the new decade inflation will get out of control, the policy makers will go to far. With the same deflationary market forces relatively subdued it's going to get messy. Inflation, its historically the Government great free lunch.

"Inflationism, however, is not an isolated phenomenon. It is only one piece in the total framework of politico-economic and socio-philosophical ideas of our time. Just as the sound money policy of gold standard advocates went hand in hand with liberalism, free trade, capitalism and peace, so is inflationism part and parcel of imperialism, militarism, protectionism, statism and socialism."

Ludwig Von Mises

Britain, the Canary down the Western Coal Mine

"We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step."

Jim Callaghan - Speech at the Labour Party Conference, 28 September 1976

Gold prices had been on the rise for weeks, then all of a sudden fell back with a thud as we were told that only 11,000 jobs were lost in the US during November. Another Brown bounce in the polls left Cameron backtracking, austerity is so last month, instead 'growth' by government spending is now acceptable as policy is dictated by focus groups. The Middle Easts version of Las Vegas got a helping hand which was good news for many UK banks, however only a mere $80 Billion would have been at stake. Years ago it would have meant something, not today with Trillion dollar bailouts. China's vice governor at the peoples bank declared 'We must watch out for bubbles forming on certain assets, and be careful in those areas' referring to golds recent upward trajectory. Nice try, that deceit may wash with CNBC but those of us in the loop know full well that China would love to transfer much of their paper assets into hard assets such as Gold.

It's sometimes easy to forget what the average person thinks in relation to financial matters. Articles posted here are certainly not consistent with mainstream thinking. People are still on the same broken record, 'Buy a house now while prices are cheap before you get priced out', 'We are past the worst now and good times are ahead', 'The government will make a good profit for the taxpayers with the bank bailouts'. Ask people who read the financial sections of broadsheet newspapers about gold and you get told 'The price can go up as well as down' as though this is a unique quality that does not apply to other assets such as bonds, real estate or stocks. Indeed it is important to remember just what people are thinking, because you don't want to be on the same page as them. 'Repeat after me, Gold is a bubble, Central Banks can 'tame' markets, the sustainable recovery is here and there is no inflation! There is no spoon!' There's no analysis of the thunderstorm that is brewing in the distance.

So what about this Gold bubble then? People are right, however they are 5, 10, 15 years too early in calling it. People are buying the stuff because one day it will be a bubble as the Worlds Central Banks are busy blowing the next bubbles as I write. The currency and Government Bond bubbles will eventually burst causing mass inflation and creating the next bubble, commodities and precious metals. As Bernanke and Company try to assess how best to deal with bubbles, they fool the public as though these events are some mystical force that no one can control. I have a simple solution, how about stop printing so much money. We instead move from bubble to bubble, the Centrals banks policy after one pops is to inject further easy money into the system. Like some drunk who throws up after a bottle of vodka, 'I best have another to sort myself out'.

Could the US unemployment figures signal the turn with people getting back to work? Maybe in the short term, but I don't think this will be a long term trend. You have to remember governments everywhere are printing huge amounts of money and this is bound to give the so called 'prosperity' effect in the short term but it won't last, the free market hasn't healed. During the coming stagflation a lot of conventional indicators will seem to be healing when in fact the underlying fundamentals are deteriorating. For ten years after the credit crunch in 1973/74 the unemployment rate in the UK kept rising.

It didn't move up in a straight line, with periods of consolidation and even movements to the downside. When the correct path was taken it took years to fall. Numbered estimates in the news are useless, three million, four million, all have been given as figures for the short term, however no one can say for certain, all we do know is that history says it will keep rising over the long term.

For a developed country the British people sure do love their inflation. While many other nations inflation indices have plummeting like many a British Banks shares, the UK's inflation rate has remained remarkably 'sticky'. Whether its the appreciation of our assets, our rising incomes, our increased levels of debt or the fallacy that we believe the weak pound is good, we really do want to beat other nations in the race to the bottom. The yanks scream 'bloody murder' watching their beloved dollars debasement from the powers that be, not realising that one hundred years ago a British pound used to be worth $5. Anything you can do across the pond, we can do it much worse. Over the next decade I'm sure we will show the developed world what not to do. The problem I see is that British people want inflation. We want to see rising prices, we believe that this is a healthy state of affairs and will thus allow a greater level of leniency towards our policymakers compared with other nations when it comes to expansive monetary policy.

Will the BoE raise interest rates when the market forces their hand? Contrary to what people believe it is the market that controls long term interest rates. We may like to think of central banks under a paternalistic viewpoint, our saviours there to insulate us from financial destruction and chaos, to solve economic issues should they arise. Central bankers are just like their Communist Central Planning counterparts, eventually market forces get the better of them where eventually they follow the market, not set the tempo as they would have us all believe.

In order to understand how markets dictate prices such as interest rates its easier to compare the lowering of interest rates to say lowering the price of bread. If the government declared rather than liquidity not been easily accessible that the issue was now high bread prices, they therefore set forth a policy to fix the price lowering it below the market one. As suppliers begin making losses they shut down production, at the same time people consume more as they can purchase more of the product. Eventually the country runs out of bread with all stocks depleted. Rather than bite the bullet immediately the government would in all probability resort to rationing rather than admit the error of their ways with bread queues becoming a common occurrence. A black market may appear as people under their free will and against the governments law begin selling bread to one another for a price set by people, the marketplace. If however the government wishes to fix the state of affairs they must liberate the price once more, allowing the market to determine the price of production. As suppliers closed down long ago abandoning their supply networks it takes a short while for supply to meet demand once more. During this period the price of bread goes into the stratosphere as people bid up the cost of the present scarce bread. Eventually market forces will drive the cost down over time to a point of equilibrium.

How does bread relate to interest rates? Its the same principle. Governments can set the price low but eventually the market will force its hand to raise the price, with the price going into the stratosphere. This is why we had 18% interest rates when Thatcher tried to put things right, or when Paul Volker put US rates above 20%. The policy makers were just chasing the market, trying to reign in inflation which was driving the free markets interest rates haywire. During the 1973/74 credit crunch Central Banks had the same idea as now, that is they lowered interest rates in response to the recession, but the longer and lower you try to hold down these prices the higher and sharper they have to eventually rise as many an older reader will painfully remember.

The BoE could be forced to raise interest rates under a number of scenarios. They may have to raise rates if there is a currency crisis with the pound falling as investors flee. Like the bread situation above, they will put off the price liberation, instead they will put currency controls or limits on capital (like bread rationing) in order to try and provide a short term fix. Eventually the market beats them and they have to hike rates as over the long run a lack of foreign investment creates a less dynamic economy and higher inflation.

It could be forced to raise rates if inflation got out of hand with the free market demanding increased real rates of return to negate the depreciation of the currency. Even if central banks keep buying government debt at artificially low rates, private banks still lend to all of us, with this mortgage rates could rise for example. Its similar to what we see now, despite base rates at near zero average mortgage rates are far higher as the free market realises there are inflation risks over the medium to long term. They are also hedging against their potential losses as the government props them up.

However they could do none of the above. They could keep rates low, spurring on more inflation as the government can no longer afford increased rates on the ever expanding debt. They by pass the market and lend to individuals themselves at these rates. They print money directly to cover the shortfall in the various government payrolls. Currency collapse is ensured at this point as it becomes clear to all that its time to pack your suitcase. Marc Faber believes this is the conundrum America will face at some point in which its policymakers will not rise to challenge, instead they will shirk away from the correct action to take, opting for runaway inflation. At some point the stock market of such a country would be a screaming buy, just at the depths of the seemingly never ending hyperinflation when the average person has lost all confidence.

Could the UK be the Canary down the Western coal mine? There are many other nations with serious issues that have faced or will face issues sooner, but I wouldn't put them in the same tier as Britain, a nation who still has a recent innovative and industrious past. She could however, be the warning signal for many other Western nations that mass inflation and/or interest rate rises are just around the corner. Either option ain't pretty.

Interest Rates are Prices

A while back I posted on Interest Rates and Capital using explanations of supply and demand. It was to my astonishment that I noticed an article published by a popular newspaper. Rather then heap praise on the recent lowering of interest rates and accepting at face value what the central bankers were saying, it actually challenged these concepts and the so called 'wise men'. There is no logic to having a centralised committee setting prices such as interest rates. Rather than determined by the market these prices are adjusted by these central institutions. Despite all the propaganda that central banks are now 'Independent' its still the same as when politicians have control over interest rates. They always try to keep them as low as possible for as long as possible. Creating inflationary booms is the best weapon politicians have at creating artificial prosperity. Until the public balks at the inflation or the scale of malinvestment becomes too large, then these prices are risen by the powers that be.

A good question would be, how should interest rates be set? Who would set them if Central Banks were not in control? That simple micro-economic concept called supply and demand would set it. The great Austrian economist Eugen von Bohm-Bawerk noted that the setting of interest rates is a time preference, peoples preference to get money upfront in the current time frame. Many sections of society view making money off money as immoral, historic notions of Usury, the reason why Jewish people have been casted outside society due to their role in money lending. Karl Marx in his critique of Capitalism stated that charging interest was 'exploitation' of the workers (everything he wrote was one big exploitation, his Communist Manifesto is heavy on that concept) with no inherent purpose. Of course Bohm-Bawerk's time preference explained this concept. If I saved then I have produced more than I have consumed during that time period. I may give this to a bank who I charge interest, as they may wish to make use of these savings. The bank in turn may lend it out to a business at a slightly higher rate as they may have immediate plans to hire more people to expand their business in the current time frame however they do not have sufficient capital to do so. They are therefore paying for this privilege. Time preference also applies to entrepreneurs and labor. Labor was not exploited, again as Marx falsely assumed. Labor gets paid upfront for what it does. I go to work and I don't risk my capital, my time - I get paid for what I produce, regardless of what happens in the market. Entrepreneurs don't. They risk their capital, their time and in the end they may not earn a penny. Again time preference explains this, do you want to get paid upfront for less, or potentially earn more later down the line if you succeed.

So how would interest rates fit in with the above example. Interest rates are set based on peoples time preference. If no one saved and lots of people wished to borrow for the current time frame, then interest rates would go up as a shortage of genuine capital would be evident. Similarly if there were lots of savers and few borrowers, interest rates would fall, deterring saving and spurring consumption or investment. The above is just a supply and demand concept, one that Governments always like to abuse.

Once the above is understood the whole economic crisis becomes quite simple to explain. It was the setting of these prices, outside of the markets control, that caused all sorts of industries to exist that were never sustainable in the long term. It's the reason why unemployment is on the rise, why businesses are failing in mass. Many economists are still blinded by such simplicities. BBC's Robert Preston drones on about regulatory structures, but its akin to a doctor putting a plaster on a cancer patient, its the wrong diagnosis. The free market interest rate article sums up this process:

"This illusion creates waste, because it makes people overestimate the available resources. Ventures that would have been unprofitable if interest rates were not artificially low are now embarked upon, drawing scarce resources away from better uses. According to Friedrich von Hayek and other advocates of the Austrian theory of the business cycle, it is this interference with interest rates and the money supply that causes an unsustainable combination of consumption and investment — a boom that inevitably leads to a bust."

We got into this mess because of low interest rates and expansive monetary policy. So how do we try and navigate out of the current situation? By using exactly the same policies as before. Putting another plaster over the other plaster of the cancer patient. A similar re-run of the seventies, more inflation to try and solve the previous inflation. Recession after recession.

This is of course a great magic act that Governments have. Through the inflationary boom, all the 'robust' growth is down to the Governments policies. During the bust it's suddenly the free markets fault, it peoples 'psychology', speculators and so on, but never the government. Blame the banks if you will, but the majority just play this game knowing the rules, profits in the boom, bailouts in the bust (we could also go into the practice of fractional reserve banking - again governments rules, banks just playing the game).

Bubble China

The most recent example of a Government creating an artificial inflationary boom is China as I write. Rather than causing the economy to readjust painfully due to the lack of Western or Japanese demand for their export products, the government have begun on a program of recklessly expanding the money supply, around 30% per annum. This is causing all sorts of incorrect investments may it be the stock market, real estate or certain sectors. The end game? They can't put off their depression merely buy time and make it much worse when it arrives. China's Banks are now copying the Wests - reckless lending fueled by cheap money and their economy will suffer eventually. The Communist party is scared that the depression would be so bad that its people would begin asking for democratic change like I mentioned in my Building Bridges post. We will have to see when.

As bad as the dollar is, where's the alternative? Governments are all bad, its just some are worse than others. There is nothing good I can see around the world right now. We are in a classic bear stock market rally all over the world at the moment. It doesn't matter what the news is, it just goes up. Japans Nikkei after 1990 rallied on numerous occasions, sometimes rallying as high as 70%, but where did it go? Right back down hitting new lows (its real lows we may have to watch, not the nominal price). The sign of a long term great bear market is the size of the rallies, so in my opinion this is truly a great bear market we are in. Lost decade? Only this time global?

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

Purchasing Power is Wealth - Not Money

Today, more than ever people are obsessed with money. It has become a key driver of the employment people choose, how we view individuals and one of the measures that helps form class structures. Yet money today, is one of the causes that has disrupted and distorted our financial systems and ultimately, that affects our prosperity. Sound money it seems, always evaded society, instead a continual debasement of currencies is the preferred approach. Yet it doesn't have to be like this. We could implement sound money, thus abolishing the periodic economic disasters we have become indoctrinated to accept. Unsound monetary expansion that occurs when banks expand credit in concert with the support of a Central bank and government, always leads to a loss in purchasing power of the money we have saved, the preferred commodity we use to store our labour. Our paper notes that we assume always have the ability to store wealth, don't. It is constantly debased, inflated, to pay for government programs, the invisible taxation. I think an historic, hypothetical example is required in order to explain this simple process.

The King who acquires money, without taxation

Let me explain the title above. It's no magic act, just monetary trickery. Lets say our King lives in the Kingdom of Hyper, and decides he needs money for his own consumption, in order to buy a new castle and land and chooses debasement to pay for his pet project. He announces to his people to call in of all of the gold coins in the kingdom to be re-minted with the kings face on the new coins. Currently each coin within the kingdom contains 10 grams of gold, and these are used to pay for goods, the unit is called the Crown. During this process however the King decides to readjust the amount of gold in the Crown, and only puts 5 grams of Gold in each Crown, using the excess Gold to create new coins for himself to use. The people don't really notice the weight as it is the unit, the crown, that they use to purchase goods not the gold content. However the money supply, to pay for the Kings extravagant life style, has increased 100 percent. With more Crowns in circulation and the same goods and services, the effect is that prices rise as the the money supply has increased, thus distorting the previous price equilibrium. The King benefits the most as he is the first to use the new crowns thus has the purchasing power he requires to pay for his consumption, but as the money moves through the Kingdom it effects the prices of goods and leads to inflation.

Other common historic forms of debasement was the alloying of Gold and Silver coins with more common forms of metal, thus giving the illusion of the coins having the same weight but they would now contain less Gold or Silver. The effect was the same. More Coins were minted and it lead to the inflation of prices.

So how does the above example link into the modern financial system we live in today? Well in modern times all a government had to do was print more paper money, they didn't even need to re mint coins. Today it has become even easier, in fact far to easy with the use of computers. They can just digitalise the extra monetary units without the need for deforestation and paper printing. This is what is happening now as this post is been written. Governments are now deploying "Quantitative Easing" in order to "Stimulate" the economy. In other words taxing all of us, ensuring our currencies have less purchasing power. Rather than all of us enjoying the fruits of prices falling in a free market system, we instead have to continually witness the decline of our wealth we have built up, for those of us who are prudent enough to save - which is a crucial function in any developed economy. Savings pay for increased productive efficiency.

We can see Debasement directly in our own currencies

Ever wondered why a unit of pound Sterling is called a pound? Well a pound used to be worth a pound of silver, or 16 ounces of silver. Now a pound is worth around, well, not even 1 ounce of silver. Rather it now takes around £8 to buy an ounce of silver. I'll leave the reader to do the arithmetic, as this shows the complete loss of purchasing power Sterling has had and most of it within the past century. Sovereigns, a common bullion coin that are still traded today used to represent a pound and contain 1/4 ounce of gold. That same coin today is now worth around £137. These were still used in the later years of the 19th Century, which shows how much inflating our governments have done. Ever look at your coins and wonder what they are made of? Very cheap metal, however the debasement has got so serious that even these more common metals used in the 1p and 2p coins are now being melted down as the metal is worth more than the coins. The new editions however are just copper plated steel - it makes you wonder whats next. We might as well start using monopoly money.

When we had currencies backed by gold or silver, our notes used to read redeemable in gold or silver, whichever metal was the preferred backing chosen. Now they just have empty promise statements, meaningless in terms of future purchasing power and value. One of the reasons that the US had to abandon Bretton Woods in 1971 and consequently loose ties the Dollar had with gold, was due to the printing during the sixties, that paid for Vietnam, President Johnson's Social spending programs and NASA's space adventures along with various other deficit spending policies. When the French and British got wise, they started trading some of their Dollars for physical gold. With a run on Fort Knox Nixon had to act, thus removed the Dollar from Gold convertibility. It was quite simple - the currency was being debased, just like the King of Hyper above.

So why are goods still so cheap?

Simple - The Free Market. Through technological advance, the reinvestment of capital to increase productive capacity and the relocation of production to low cost destinations (recently China), this has all created the mirage for a seemingly stable purchasing power. However we should have all basked in the falling prices of the free market more than we have. Perpetual inflation means we have to work until we are 70 and not 50. It means we have to speculate on investments, in order that inflation does not destroy the value of our money we save for the future. Investments that are based on rising capital gains caused by inflation, rather than dividend payments from solid business models. These investments where main street looses, while Wall Street gains. Just like a casino, the players (public), don't stand a chance. DVD players for £20 - more like 10 pence if our currency had retained value. We have China to thank for the gain in purchasing power we have received as they began industrialising, along with artificially pegging the Yuan lower, in order to achieve spectacular export growth. Their huge productive capacity has flooded our markets with goods - we haven't increased our production - they have provided the illusion. I don't care if I have £1,000 or £1,000,000 - I care about how much that money may be worth in the future. Money that has in all likelihood been gained by the use of my labour.

We mistake wealth for money when real wealth is the labour and goods that we produce - its stuff. Money is mearly the preferred mechanism we use to exchange these goods and services between one another, a contractual agreement. In order for these contracts to be valid, it is vital that money is a stable store of value. This, however, as history has shown, and economic theory can prove, is not the case.

"To put it another way: a continuing, sustained inflation — that is, a persistent rise in overall prices — can either be the result of a persistent, continuing fall in the supply of most or all goods and services, or of a continuing rise in the supply of money. Since we know that in today's world the supply of most goods and services rises rather than falls each year, and since we know, also, that the money supply keeps rising substantially every year, then it should be crystal clear that increases in the supply of money, not any sort of problems from the supply side, are the fundamental cause of our chronic and accelerating problem of inflation. Despite the currently fashionable supply-side economists, inflation is a demand-side (more specifically monetary or money supply) rather than a supply-side problem. Prices are continually being pulled up by increases in the quantity of money and hence of the monetary demand for products."
Murray Rothbard, The Mystery of Banking

The Descent of Niall Ferguson?

We came close to financial collapse, Wall Streets big Investment banks went bankrupt or were merged into other banks, the IMF bailed out various countries from monetary implosion, Sterling plunged, Governments turned to Socialist solutions, the myth of houses being a 'safe investment' was derailed. In all the turmoil with every asset in sight heading south, historian Niall Ferguson was on our screens again, this time with a series titled "The Ascent of Money" to promote his new book. A six part series that looked at the historical impact of finance within human society and how it has evolved, into the modern system we now use in our economies. I personally enjoy reading Niall Ferguson's books and there are some interesting titles to his name, my favourite being Empire: How Britain Made the Modern World. After the last episode there was an open web chat in which he answered peoples questions, which can be found here. Like the television series, Prof Ferguson seemed to have flawed analysis of economic matters, such as deflation and inflation which I wish to explain briefly here. Inflation and deflation is strictly a monetary phenomenon, it is caused by an increase in paper money compared with the goods and services in an economy. This shows up as rising prices, however the goods do not rise in price from market forces, but from monetary expansion. For the sake of this article, I may refer to deflation as falling prices, but technically it is a falling money supply. However I will use this definition to elaborate on Prof Ferguson points in question. I have selected some of the quotes he made in the online discussion that I found interesting.


"Well, right now Ben Bernanke is more worried about deflation than about inflation. But if he's successful we can soon revert to worrying about inflation. As I said in an earlier post, central banks today do not want 0% inflation (i.e. price stability). It limits the room for monetary policy too much. Are we going to see a big surge in inflation after this crisis is over? I frankly doubt it. The Fed can mop up a lot of this excess liquidity quite easily, as the Bank of Japan did after the end of quantitative easing."

The above analysis is flawed, in many aspects. First of all, that we are suddenly worried about deflation. This is a myth, as the past couple of decades have been deflationary. As I've said before market forces are always deflationary, people reinvest capital to increase productive capacity, thus reducing the cost of goods and services. Prof. Ferguson confuses general deflation, with the aspect of deflation that Ben Bernanke is worried about, that is asset price deflation - houses and stocks. As the US and UK have consumption debt based economies, where the 'wealth' is based on the price of the above assets, when these are falling in value then the economy contracts. This is what the Western Central Banks are worried about, as our whole economy revolves around these assets. They will inflate these assets at all costs, hence why they want to print money. History has always shown governments will do this as people want the government to take action. Prof. Ferguson does not mention any of this which is a big omission. He also doesn't mention it in the television series.

Apart from the first episode there is no great mention about inflation. Inflation is a purely monetary phenomenon, which amazingly he doesn't seem to explain in great depth. In order to obtain the 'price stability' he references above, central banks must constantly inflate the currency as the prices of goods and services continue to fall. Achieving price stability is a path to periodic financial crisis. Price stability helped cause the Great Depression, as the FED had to inflate during the 1920's in order to ensure inflation was ticking along, fighting against the deflationary forces of industialisation. Then when the bust came in, they tried to inflate to keep inflation up (i.e. keep wages, agriculture and stock market prices high), however they were beaten in the end by the gold convertibility so deflation won in the end. Rather than the economy resuming normal operation it stagnated for years due to the huge inflation in the proceeding years, accompanied by the draconian measures that were introduced as the government constantly interfered during the bust. It wasn't deflation that made the great depression, it was the inflation in the stock market. Then there was the stagflationary seventies. All currencies were off gold, therefore governments this time could inflate so inflation reached as high as 25% in Britain. Again the result was the same - economic hardship for years. It was inflation again in the 50's and 60's into asset prices that caused this as central banks looked for 'price stability'. Yet again, we are following the same foolhardy decisions, as price stability causes financial instability.

When Dr Ferguson mentions this price stability he says it limits the room for monetary policy. Does he really understand what he is saying here? The only thing it limits is the economies ability to re-deploy its resources efficiently and effectively. It has helped cause the stock market bubbles and the housing bubbles with the recent one, being one of the prime reasons we find ourselves in this mess as Greenspan and Co decided we had to pump cheap money in the system to ensure 'Price Stability' to combat these deflationary forces. They expanded the money supply so much that the West quite simply misallocated its resources in the wrong areas, hence the major correction we are now going into. Capital should always be scarce despite what people say, as it tries to direct a scarce amount of resources in the real economy into the required productive channels.

Then we come onto his other comment regarding if we going to see a big surge in inflation, in which he doubts we will. His reasoning is that we will be able to mop up any excesses like Japan. Like Japan did? As I have mentioned before, and unfortunately our governments have begun implementing this policy, Japan cut interest rates to 0% and tried to inflate to cure their downturn in the 90's but all it did was kill the economy. They also tried the new buzz word in the media "Quantitative Easing" which is effectively printing money, as I have earlier warned about. The reason Japan didn't experience inflation domestically, was that they exported this excess money to the world. Japan exported inflation to the world. You have probably heard of the Yen Carry trade well this is what it was in effect, people buying up huge amounts of Yen at cheap rates and putting the money to use in other countries where the returns were higher. It was also the reason for the Yens surge this year, and the deleveraging we saw in the autumn and winter of 2008 as these returns evaporated and the Yen increased in value against all currencies - people had to sell to cover these loses. This is also one of the causes of our asset booms in the stock market and housing. If it wasn't for this and the fact Japan is a huge creditor nation who have a trade surplus, they would have experienced huge inflation. So then we ask the question, how will the West mop up this excess money if the majority of the worlds economies are doing it? Quite simply, they can't, once this money is in the system along with less goods and services (which is what is happening at the moment as businesses won't invest) inflation is inevitable. The only way to stop it is by raising interest rates to double digits, a policy politicians don't particularly like, as Margaret Thatcher found when she became a demonised figure. Our economy is based around debt, so they are not going to be doing this for some time.


"Don't know the book. But people are always writing things like that. My favourite is William Rees Mogg's Great Depression of the 1990s, which never materialized (rather the reverse). Usually the predicted event doesn't happen. Sometimes it does -- though by 2010 I suspect we'll be out of this hole and Harrison's book will be out of print."

The comments above are in regards to Fred Harrison's book, Boom Bust: House Prices, Banking and the Depression of 2010, this is also a book I have read. Yet if Prof. Ferguson had done sufficient research and indeed read the book before passing judgement, he would have discovered that there is a very set pattern for the gap between each housing boom, specifically 18 years which Fred Harrison shows in his book. The book was also written in 2005, just as the housing market was slowing down and many thought it would collapse, however Fred stated that it would carry on for another two years, the period he terms as the "winners curse". He also said it would carry on with double digit rises, when everyone said it would slow to more moderate growth, as he claimed hysteria would grip the market once more. He also wrote a book back in the early eighties, The Power in the Land, in which he predicted the recession of the early nineties, so this is not a one off.

The assumption that we will be over the worst by 2010 is wrong and sounds like he has been listening to the Labour Government. This stagnation will go on for years in the West. 2009 will be even worse, with more bank failures, huge unemployment, and rising debt. Government finances will be in a hideous state and 2010 will be a grim year too, with in all probability the beginning of what will be years of inflation, as 2009 winds down.

"No, we are in a very different situation from the world in 1929, although the potential was certainly there for a Great Depression 2.0. The key difference is that the Federal Reserve System and the U.S. Treasury are doing everything in their power to combat the collapse of the banking system. And so far they've done a pretty good job. I find it hard to believe that this time next year will be so worried about deflation and depression. The conversation may even have switched to inflation and the need to reverse some of the stimulus that was injected."

The final sentence of the above comment concurs with the first statement in this article, however it is his comments regarding the authorities' interventions that I wish to tackle, as he quite clearly has a incorrect interpretation of history. As I have shown in a previous post the Great Depression was caused by government intervention, the Federal Reserve slashed interest rates from 6% to 1.2% and took all sorts of financial instruments from the banks to prop them up. Prof Ferguson seems to place a belief that they have done a good job, however President Hoover was saying exactly the same at the end of 1930. It wasn't until the second half of 1931 when things really were desperate, and the previous measures had quite clearly had no effect. Governments make the situation worse, which I will dedicate a post at a later date to fully explain why free markets should never be interfered with, even during a bust. He's right in once aspect that later in 2009 we shouldn't be worried about deflation, the monetary expansion along with the depletion of goods should ensure a resurgence in inflation again. We are facing a depression, even if the authorities never admit it, but it will be an inflationary depression.


These were just three of the comments he made in the web chat, I didn't feel the need to choose anymore comments as the post would have been too long. There were some good points regarding the Socialist Chilean President Salvador Allende from various posters and from Prof. Ferguson himself. His successor, General Pinochet was a tyrant and an oppressor of personal liberty, but Allende would not have been the Socialist Utopian alternative, as so many among the left like to believe. Before the coup, Chile was already showing signs of Totalitarianism, along with the classic hallmark of Socialist overspend resulting in the escalation in inflation. There was quite an extensive debate on this subject matter, with some emotions running high.

One of the terms coined in the series is that of "Chimerica", or the union of China and America in recent times. Ferguson paints a rosy picture of this relationship, although he does mention the possibility of a Third World War between the two without the mention of possible alliances. In one of his books "Colossus: The Rise and Fall of the American Empire", he evidently can see that America is on its way out as the worlds superpower, displaying signs of overstretch and faltering economic growth, similar to Britain's decline, decline that I suspect we will see over the coming decades (as empires always decline in over a long period of time). In the book he doesn't use the term Chimerica but acknowledges the China effect and the deficits that America is running with the rest of the world. This is one point he doesn't make an issue of in the series, which in my view is a major point. Britain, when it began its decline, was a large creditor nation with assets all over the world. America, on the other hand, is a huge debtor nation the largest in history with very little in terms of overseas assets. America, is in a far worse state than Britain was during its decline. Yet Ferguson seems to believe that America will be the main economic powerhouse for years to come. I disagree, and think he has overlooked this fact, or forgot to mention this historic parallel. The globalisation of today is far different to the one before the first world war. He mentions British trade with China, however the Chinese were very restrictive back then, only allowing European merchants to trade at key ports. They had no access to mainland China, and shifted their goods through the local merchants. In this recent revisit of Globalisation, the situation is very different. China now produces and exports huge amounts of goods to the West, and have modern economic capabilities. They are becoming self sufficient, while the West now relies on their productive facilities to make goods. This is why this time it is more experimental, as the West slowly loses its status as the economic center of the world.

In the final series Prof. Ferguson detailed the various financial events of the past two decades, from the Savings and Loans Crisis, the Asian financial crisis, the Russian Government Default, LTCM collapse, the dot com bubble, Enron then finally the housing bubble. Yet he didn't link into what caused these events, and how they kept reoccurring. Again the Federal Reserve has fostered these, and persistently distorted the market causing the major downturn we are now seeing today. All the above is created by Greenspan and Co who kept bailing the markets out. People were amazed that Lehman Brothers went bust last year, but half of those US investment banks should have gone bust 10 years ago, along with LTCM at the time. He instead pins the mistakes on human behaviour and markets. This is not true, as the market would have corrected these excesses long ago, instead the Central Banks kept bailing out everyone. In other words they took the risk out of the free market. The free market therefore did not price risk, which is a reason why the banks have so many issues we see today. This omission was fatal, as it explains the bust we are going into is not a product of the true free market, or the product of Capitalism (as many anti-capitalists have begun prophesying its downfall) but the product of Central Bank intervention. The market would have corrected all the above long before, thus we would have never had house values escalate as high as they did and an economy orientated so heavily towards these asset prices. These banks would have gone bust long before and along with it more sensible lending standards, with a more balanced economy.

After viewing the series I don't think I will be buying the book, and will probably wait until it becomes available at my local library. I was also disappointed that the series did not go into the details of fractional reserve banking, Central Banks and the artificial market forces that China have been exerting in recent years in order to grow their economy quicker. There was also a lack of history towards recent financial events, which would explain more clearly the predicament we find ourselves in. However, Prof. Ferguson is an academic, not an economist. His book Cash Nexus, another book that I have read, he declares gold as an old relic with comments such as "Gold has a future, of course, but mainly as jewelry". This was in 1999, around the bottom in Golds price, since which Gold has increased around 400%-500% in Sterling a decade since these comments. Other recent comments such as "Money is trust, not metal", is true with our modern fiat currency, however only metal ever keeps its value over history. Another historical point Prof. Ferguson misses.

Alan Greenspan, who helped cause the current issues we see, understood the damage central banks and a fiat monetary system can cause. Back in 2002 Ron Paul asked him about Gold and Economic Freedom, an essay he wrote (in which I have taken an extract from), and if he still believed it to be true and valid for today. He responded with "I wouldn't change a single word". It's a shame many mainstream commentators such as Prof. Ferguson can't see the flaws in our current system. Greenspan could.

"But prior to World War I, the banking system in the United States (and in most of the world) was based on gold and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion ... In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value."
Alan Greenspan, Gold and Economic Freedom, 1967
Note: The Federal Reserve was established in 1913