Cyprus may or may not prove to be a ‘watershed’ for the European crisis but what we can say for now (tempting fate outrageously as we do) is that, for all the dire warnings that this ‘confiscation’ will provoke a Continent-wide bank run, the initial reaction of the wider populace has been to treat the matter as something of ‘a quarrel in a far away country between people of whom we know nothing’.

That said, there is a wider issue at stake, beyond the inequity or otherwise of penalising small depositors, or the opportunism of imposing a haircut on those stock music hall villains, the Russian oligarchs, whose holding companies populate the corporate register of this otherwise economically–insignificant little island.

This is, namely, that however much we might express our contempt for a European elite which has so far exhibited a mix of pusillanimity and shameless political calculation in trying to avoid havingtheir constituents face up to the cost of either their caprice or credulousness during the boom, the Cypriot ‘tax’ – in reality a haircut – must serve as a necessary, if horribly belated, reminder to all of what it is exactly that modern-day banking entails.

It is high time that the Man on the Clapham Omnibus realised that his banker is nothing more than his, the depositor’s, creditor – and not a very reliable one, at that. Nor will it do our Everyman any harm to be shown once more that, for all the marbled halls and pseudo-classical gravitas of the banker’s typical premises, his profession is nothing more than a highly-leveraged, actuarial gamble, largely reliant not so much on the shrewdness of the banker himself as upon his cynical awareness that he can stretch to almost no enormity of bad judgement or abused trust such that it will pierce the carapace of privilege and protection with which he is furnished by a venal political class itself hopelessly in hock to the lenders of the counterfeit monies with which it buys the votes necessary to keep its members in the enjoyment of the many perks of office. A further lesson might be drawn from this last assertion which is that, far from being the soundest of borrowers, sovereign entities throughout history have been the worst, zero risk-weighting and mandatory ‘liquidity’ holdings notwithstanding.

Though there has been much expression of outrage at this ‘assault upon private property’, the sorry truth is that this is only the most recent – if also the most blatant – of the many transfers of wealth from the populace at large to the balance sheets of their bankers. Should you need any convincing of this, I am sure the poor, put-upon Irish could quote you chapter and verse about the miseries of the debt slavery imposed upon them by their overlords in Frankfurt, while it is beyond human wit to reckon the number of the prudent and thrifty now being denied a due return on their hard-won savings by the arrogance of the central bankers to whose crass, ’reflationary’ redistributionism they are now subject.

It should also be emphasised that it is no more than just that the owners and creditors of a failed institution share proportionately in its ruin, or conversely contribute in due measure to its rescue – though, naturally, the choice between these alternatives should lie with them as individuals. That the institution in question is a purveyor of banking services, rather than of beauty products or bed linen is totally beside the point. As the latest of several heavyweight commentators (such as members of the Chapter 14 group or Richard Fisher of the Dallas Fed in the US), Willem Buiter endorses this view in his latest piece where, he says, it is high time we ‘resolved’ our commercial banks à outrance, relying on the near limitless power of the central bank to maintain the basic stock of money and to staunch any systemic haemorrhage as and where needed. After all, if we are to be saddled with the institutional evil of a central bank, we may as well enlist its baleful power in a good cause for once.

That the powers-that-be, having driven the masses through the drip-drip torment of ‘Fauxterity’ in the attempt to save their own banks, have only now dared to try to implement such a process of ‘bail-in’ in a small , politically-impotent country such as Cyprus certainly reeks of hypocrisy and double standards. Nor is it exactly a matter of justice that the admittedly nugatory exposures of the banks’ stock and bond holders have again gone unscathed, or that even depositors of healthy banks (assuming there are any) are being compelled to pay for the sins of their less sanitary peers. Nevertheless, as we have said several times before, the lesson that must be taught when dealing with bankers, as with any other recipient of one’s funds, is Caveat commodator! Let the lender beware

Slowly, slowly, amid all this chaos, the commentariat is coming around to espouse several key tenets of our Austrian creed. Five years too late for many of the downtrodden victims of the crash, alas, and with nary a nod of recognition to the fact that their beloved Keynes is an idol with feet of clay, but at least they themselves are beginning to inch tentatively along the road to Damascus-am-Donau.

The first of these contentions is that the crisis itself is always the result of an inflation of money and credit – whether this is unleashed as a deliberate act of commission before, or supinely accommodated by the monetary authority after, the fact. The danger here is not so much that consumer goods prices rise as the money and its substitutes swell in availability, but is rather that the inflation distorts, if not entirely suppresses, the critical signals sent about relative scarcities and the subjective human preferences which set these. Especially problematic are those least directly observable signals which act across time and which are therefore transmitted by interest rates in particular and by asset pricing in general. In scrambling these, inflation progressively fixes too much precious capital into the wrong, ultimately barren foundations and leads too many people to exert their limited human energies in pursuing foredoomed endeavours.

The second Austrian lemma is that when the boom turns to bust, the wisest course, that is to say the one which will involve the least long-run hardship and impose the lowest threat of a widespread descent into lingering hopelessness, is not one that will involve the exercise of either misplaced compassion (if we are charitable) or of naked, political short-termism (if we are not). The answer, when the bust threatens to push the economy beyond its self-regulating ‘corridors’ is to widen them as much as possible by pursuing an Auflockerung – a lifting of the man-made impediments to swift adjustment – and to eschew all attempts at propping up as much of the Boom’s inherently unsound and demonstrably unremunerative superstructure as is possible by a crude and usually fruitless macro-manoeuvring.

The dispelling of the boom-time enchantment typically leaves many saddled with ill-advised levels of obligation which they cannot now honour in the easy manner formerly envisaged. It reveals that many of those in command of economic assets have woefully misapplied and mismanaged them, even where this has not been deliberately fraudulent. It shows that large numbers of people have imagined themselves more prosperous than they really were and have therefore spent and borrowed according to a perniciously false scale of values.

Once this mass deception becomes known, it would be folly to assume that the ‘undeserving’ can be spared any and all suffering in the ensuing bust. It is also clear that there will be far greater numbers of the plaintive than the pleased when the Wheel of Fortune starts on its inevitable downward course. But nothing in this implies that any purpose is served by indulging in a denial of the gravity of the circumstance. It is a further grave misstep to trust that a ‘socialization’ of the problem will somehow help, or to expect genuine benefits to accrue from a wilful attempt to further confuse the accounts – which is essentially what the unholy concert of the fiscal and monetary authorities usually seek to do. To the contrary, to act to deaden the pain through a policy of obfuscation, procrastination, and the dispersion of responsibility is not only to prolong the suffering in the here and now but to make a future recurrence much more likely.

All of the misconceptions fostered in the easy money boom require for their remedy a forthright and fearless recognition of what can hardly fail to be unpalatable facts. Like a patient confronted with the news that his ailment is at once more serious and more advanced than he had been given to suspect, or like the general who discovers to his horror that his previously quiescent foe is even now marching in strength upon his flanks, this is no time for palliatives, or for futile ’If Only’s’. It is time for corrective action: for harsh treatment if necessary; for a rapid re-arrangement of one’s dispositions and for an immediate abandonment of one’s earlier illusions.

The more rapidly that a misguided lender and his now discomfited borrower can renegotiate their arrangement, the more resolutely they can each own up to their disappointments, and the more determinedly they can avoid the sunk cost fallacies of regret, the quicker each can disencumber himself of his past errors of judgement and so the earlier each may begin to re-establish what he has lost by acting henceforth in a manner more suited to the changed situation in which he and most of his fellows now find they must go about their business.

It is far preferable to undergo a timely, strategic withdrawal, the better to prepare both the recovery of lost ground and hopefully the advance beyond it, than to become trapped in a personal Stalingrad where a combination of an unwillingness to recognise the scale of the reverse suffered and a naïve hope in a rescue miraculously being effected from above condemns one both to an unavailing struggle and to a final reckoning of loss far more shattering than what was initially required.

One of the most insidious ways to postpone this catharsis is for the central bank to slash interest rates and to flood the world with liquidity, goading the populace into repeating that very falsification of price of assets and of the discount between today and tomorrow which led its members to their present state of ruin.

If we recognise that our savings have been wasted, that our investments have gone sour, that our wealth has been reduced, then the price of what must be a more scarce endowment of productive capital should reflect this. Rates should be higher, not lower. Moreover, with yesterday’s attempts at providing for our present needs having been led so far astray, we will all have to put more emphasis on securing current rather than future provision. Again, rates should be higher, not lower. With the sorry lesson fresh in our minds that any chancer can start a business when credit replaces capital and when its rent is set artificially low, we should all be more choosy about whom we are to entrust with our savings. A third time, rates should be higher, not lower

To clarify this last point, it should be obvious that we should never be overly willing to see funds placed, willy-nilly, at the disposal of men who, however praiseworthy their initiative, are sufficiently foolhardy as to want to undertake projects of such a marginal nature that they will fold at the first whiff of adversity – at the merest uptick of interest rates, the first drop in sales or hike in costs, at the smallest fluctuation of exchange rates. Instead we should look for men whose product is really likely to satisfy consumer demand, men whose entrepreneurial antennae have unearthed a reasonably durable arbitrage between input and output prices, and men whose confidence in the schedule of prospective returns to their efforts does not require a vanishingly small rate of interest for its maintenance. If this is true of start-up companies in the upswing, it is doubly true of those stranded on the beach when the flood tide of the boom recedes.

But what do we get instead? We get the present, abominable, inverted Bagehotism of lending on no very good security at all, to all and sundry, and at a highly subsidised rate of interest. By this perverse means we attempt to perpetuate people in the errors of the boom, to succour the weak at the expense of the strong, and to practice Aufhalterung – a gumming up of the system – in place of Auflockerung.

Miracle of miracles, there are those who are beginning to recognise this, whether from the ranks of Britain’s recovery professionals at R3, or in the shape of well-known UK investor John Moulton, who severally risk much ill-informed opprobrium by daring to bemoan the policy of allowing zombie companies to hoard resources, manpower, and space on overburdened bank balance sheets. On another tack, Ronald McKinnon and his Stanford University colleague John Taylor (he of ‘Rule’ fame) argue correctly that ZIRP discourages much lending – whether direct or disintermediated – since risk palpably outweighs a return which is deliberately ’repressed’ to or even, in real terms, below zero.

In Axel Leijonhufvud’s pithy characterisation, when depressions occur, we are made captives of the past while inflations act to preclude us from mapping out our course into the future. He also suggests that, in the former case, monetary policy may be less effective than might be thought because once it has percolated, as it inevitably will, from the wallets of the income-poor to the pockets of the income-sufficient, the latter may have little incentive to re-employ it – whether they seek to hold it as a backstop amid economic uncertainty, or from a Ricardian-equivalence foreboding about higher taxes, or again because an elevated appraisal of risk seems vastly to outweigh a purposefully scanty reward. If prices, moreover, are not allowed to fall out of an irrational fear of ‘deflation’, the real value of their reserve will not increase and so gently encourage them to transmute a portion of it back into a medium of exchange: the Pigou effect will not come into play and so another means of self-equilibration will be denied us.

Can we really say that such is not the fate to which Ben Bernanke will consign us, strive though he will to dissolve our contractual ties in the acid of inflation instead?

Recently by Sean Corrigan: The Great Wave

Cyprus may or may not prove to be a u2018watershed' for the European crisis but what we can say for now (tempting fate outrageously as we do) is that, for all the dire warnings that this u2018confiscation' will provoke a Continent-wide bank run, the initial reaction of the wider populace has been to treat the matter as something of u2018a quarrel in a far away country between people of whom we know nothing'.

That said, there is a wider issue at stake, beyond the inequity or otherwise of penalising small depositors, or the opportunism of imposing a haircut on those stock music hall villains, the Russian oligarchs, whose holding companies populate the corporate register of this otherwise economically–insignificant little island.

This is, namely, that however much we might express our contempt for a European elite which has so far exhibited a mix of pusillanimity and shameless political calculation in trying to avoid having their constituents face up to the cost of either their caprice or credulousness during the boom, the Cypriot u2018tax' – in reality a haircut – must serve as a necessary, if horribly belated, reminder to all of what it is exactly that modern-day banking entails.

It is high time that the Man on the Clapham Omnibus realised that his banker is nothing more than his, the depositor's, creditor – and not a very reliable one, at that. Nor will it do our Everyman any harm to be shown once more that, for all the marbled halls and pseudo-classical gravitas of the banker's typical premises, his profession is nothing more than a highly-leveraged, actuarial gamble, largely reliant not so much on the shrewdness of the banker himself as upon his cynical awareness that he can stretch to almost no enormity of bad judgement or abused trust such that it will pierce the carapace of privilege and protection with which he is furnished by a venal political class itself hopelessly in hock to the lenders of the counterfeit monies with which it buys the votes necessary to keep its members in the enjoyment of the many perks of office. A further lesson might be drawn from this last assertion which is that, far from being the soundest of borrowers, sovereign entities throughout history have been the worst, zero risk-weighting and mandatory u2018liquidity' holdings notwithstanding.

Though there has been much expression of outrage at this u2018assault upon private property', the sorry truth is that this is only the most recent – if also the most blatant – of the many transfers of wealth from the populace at large to the balance sheets of their bankers. Should you need any convincing of this, I am sure the poor, put-upon Irish could quote you chapter and verse about the miseries of the debt slavery imposed upon them by their overlords in Frankfurt, while it is beyond human wit to reckon the number of the prudent and thrifty now being denied a due return on their hard-won savings by the arrogance of the central bankers to whose crass, 'reflationary' redistributionism they are now subject.

It should also be emphasised that it is no more than just that the owners and creditors of a failed institution share proportionately in its ruin, or conversely contribute in due measure to its rescue – though, naturally, the choice between these alternatives should lie with them as individuals. That the institution in question is a purveyor of banking services, rather than of beauty products or bed linen is totally beside the point. As the latest of several heavyweight commentators (such as members of the Chapter 14 group or Richard Fisher of the Dallas Fed in the US), Willem Buiter endorses this view in his latest piece where, he says, it is high time we u2018resolved' our commercial banks outrance, relying on the near limitless power of the central bank to maintain the basic stock of money and to staunch any systemic haemorrhage as and where needed. After all, if we are to be saddled with the institutional evil of a central bank, we may as well enlist its baleful power in a good cause for once.

That the powers-that-be, having driven the masses through the drip-drip torment of u2018Fauxterity' in the attempt to save their own banks, have only now dared to try to implement such a process of u2018bail-in' in a small , politically-impotent country such as Cyprus certainly reeks of hypocrisy and double standards. Nor is it exactly a matter of justice that the admittedly nugatory exposures of the banks' stock and bond holders have again gone unscathed, or that even depositors of healthy banks (assuming there are any) are being compelled to pay for the sins of their less sanitary peers. Nevertheless, as we have said several times before, the lesson that must be taught when dealing with bankers, as with any other recipient of one's funds, is Caveat commodator! Let the lender beware

Slowly, slowly, amid all this chaos, the commentariat is coming around to espouse several key tenets of our Austrian creed. Five years too late for many of the downtrodden victims of the crash, alas, and with nary a nod of recognition to the fact that their beloved Keynes is an idol with feet of clay, but at least they themselves are beginning to inch tentatively along the road to Damascus-am-Donau.

The first of these contentions is that the crisis itself is always the result of an inflation of money and credit – whether this is unleashed as a deliberate act of commission before, or supinely accommodated by the monetary authority after, the fact. The danger here is not so much that consumer goods prices rise as the money and its substitutes swell in availability, but is rather that the inflation distorts, if not entirely suppresses, the critical signals sent about relative scarcities and the subjective human preferences which set these. Especially problematic are those least directly observable signals which act across time and which are therefore transmitted by interest rates in particular and by asset pricing in general. In scrambling these, inflation progressively fixes too much precious capital into the wrong, ultimately barren foundations and leads too many people to exert their limited human energies in pursuing foredoomed endeavours.

The second Austrian lemma is that when the boom turns to bust, the wisest course, that is to say the one which will involve the least long-run hardship and impose the lowest threat of a widespread descent into lingering hopelessness, is not one that will involve the exercise of either misplaced compassion (if we are charitable) or of naked, political short-termism (if we are not). The answer, when the bust threatens to push the economy beyond its self-regulating u2018corridors' is to widen them as much as possible by pursuing an Auflockerung – a lifting of the man-made impediments to swift adjustment – and to eschew all attempts at propping up as much of the Boom's inherently unsound and demonstrably unremunerative superstructure as is possible by a crude and usually fruitless macro-manoeuvring.

The dispelling of the boom-time enchantment typically leaves many saddled with ill-advised levels of obligation which they cannot now honour in the easy manner formerly envisaged. It reveals that many of those in command of economic assets have woefully misapplied and mismanaged them, even where this has not been deliberately fraudulent. It shows that large numbers of people have imagined themselves more prosperous than they really were and have therefore spent and borrowed according to a perniciously false scale of values.

Once this mass deception becomes known, it would be folly to assume that the u2018undeserving' can be spared any and all suffering in the ensuing bust. It is also clear that there will be far greater numbers of the plaintive than the pleased when the Wheel of Fortune starts on its inevitable downward course. But nothing in this implies that any purpose is served by indulging in a denial of the gravity of the circumstance. It is a further grave misstep to trust that a u2018socialization' of the problem will somehow help, or to expect genuine benefits to accrue from a wilful attempt to further confuse the accounts – which is essentially what the unholy concert of the fiscal and monetary authorities usually seek to do. To the contrary, to act to deaden the pain through a policy of obfuscation, procrastination, and the dispersion of responsibility is not only to prolong the suffering in the here and now but to make a future recurrence much more likely.

All of the misconceptions fostered in the easy money boom require for their remedy a forthright and fearless recognition of what can hardly fail to be unpalatable facts. Like a patient confronted with the news that his ailment is at once more serious and more advanced than he had been given to suspect, or like the general who discovers to his horror that his previously quiescent foe is even now marching in strength upon his flanks, this is no time for palliatives, or for futile 'If Only's'. It is time for corrective action: for harsh treatment if necessary; for a rapid re-arrangement of one's dispositions and for an immediate abandonment of one's earlier illusions.

The more rapidly that a misguided lender and his now discomfited borrower can renegotiate their arrangement, the more resolutely they can each own up to their disappointments, and the more determinedly they can avoid the sunk cost fallacies of regret, the quicker each can disencumber himself of his past errors of judgement and so the earlier each may begin to re-establish what he has lost by acting henceforth in a manner more suited to the changed situation in which he and most of his fellows now find they must go about their business.

It is far preferable to undergo a timely, strategic withdrawal, the better to prepare both the recovery of lost ground and hopefully the advance beyond it, than to become trapped in a personal Stalingrad where a combination of an unwillingness to recognise the scale of the reverse suffered and a nave hope in a rescue miraculously being effected from above condemns one both to an unavailing struggle and to a final reckoning of loss far more shattering than what was initially required.

One of the most insidious ways to postpone this catharsis is for the central bank to slash interest rates and to flood the world with liquidity, goading the populace into repeating that very falsification of price of assets and of the discount between today and tomorrow which led its members to their present state of ruin.

If we recognise that our savings have been wasted, that our investments have gone sour, that our wealth has been reduced, then the price of what must be a more scarce endowment of productive capital should reflect this. Rates should be higher, not lower. Moreover, with yesterday's attempts at providing for our present needs having been led so far astray, we will all have to put more emphasis on securing current rather than future provision. Again, rates should be higher, not lower. With the sorry lesson fresh in our minds that any chancer can start a business when credit replaces capital and when its rent is set artificially low, we should all be more choosy about whom we are to entrust with our savings. A third time, rates should be higher, not lower

To clarify this last point, it should be obvious that we should never be overly willing to see funds placed, willy-nilly, at the disposal of men who, however praiseworthy their initiative, are sufficiently foolhardy as to want to undertake projects of such a marginal nature that they will fold at the first whiff of adversity – at the merest uptick of interest rates, the first drop in sales or hike in costs, at the smallest fluctuation of exchange rates. Instead we should look for men whose product is really likely to satisfy consumer demand, men whose entrepreneurial antennae have unearthed a reasonably durable arbitrage between input and output prices, and men whose confidence in the schedule of prospective returns to their efforts does not require a vanishingly small rate of interest for its maintenance. If this is true of start-up companies in the upswing, it is doubly true of those stranded on the beach when the flood tide of the boom recedes.

But what do we get instead? We get the present, abominable, inverted Bagehotism of lending on no very good security at all, to all and sundry, and at a highly subsidised rate of interest. By this perverse means we attempt to perpetuate people in the errors of the boom, to succour the weak at the expense of the strong, and to practice Aufhalterung – a gumming up of the system – in place of Auflockerung.

Miracle of miracles, there are those who are beginning to recognise this, whether from the ranks of Britain's recovery professionals at R3, or in the shape of well-known UK investor John Moulton, who severally risk much ill-informed opprobrium by daring to bemoan the policy of allowing zombie companies to hoard resources, manpower, and space on overburdened bank balance sheets. On another tack, Ronald McKinnon and his Stanford University colleague John Taylor (he of u2018Rule' fame) argue correctly that ZIRP discourages much lending – whether direct or disintermediated – since risk palpably outweighs a return which is deliberately 'repressed' to or even, in real terms, below zero.

In Axel Leijonhufvud's pithy characterisation, when depressions occur, we are made captives of the past while inflations act to preclude us from mapping out our course into the future. He also suggests that, in the former case, monetary policy may be less effective than might be thought because once it has percolated, as it inevitably will, from the wallets of the income-poor to the pockets of the income-sufficient, the latter may have little incentive to re-employ it – whether they seek to hold it as a backstop amid economic uncertainty, or from a Ricardian-equivalence foreboding about higher taxes, or again because an elevated appraisal of risk seems vastly to outweigh a purposefully scanty reward. If prices, moreover, are not allowed to fall out of an irrational fear of u2018deflation', the real value of their reserve will not increase and so gently encourage them to transmute a portion of it back into a medium of exchange: the Pigou effect will not come into play and so another means of self-equilibration will be denied us.

Can we really say that such is not the fate to which Ben Bernanke will consign us, strive though he will to dissolve our contractual ties in the acid of inflation instead?

NB: The mischievous thought arises that since what Blackhawk Ben and his acolytes really seek is for us all to lose faith in our money as a store of value, so that we go out and spend it as fast as we can, they should be cheering the Cyprus experiment to the rafters!

Sean Corrigan [send him mail] writes from Switzerland.

Sean Corrigan Archives

Rather than pretending to a level of insight into the scale of Japan’s problems which neither we nor anyone else truly possesses at this stage of the disaster, we think it might be worthwhile instead to run through some general considerations of what ramifications might be felt in its aftermath.

Before we do, however, we cannot abstain from expressing our utter contempt for the many idiots who have already begun parroting the standard Keynesian nonsense that this calamity will ultimately ‘prove positive for GDP ’, or that the rebuilding efforts can only redound to the nation’s well-being to the extent that they shake it out of its ongoing u2018deflation’.

As is their wont, such imbecile Cargo Culters are once again making a fetish of a coarse-grained statistic which is supposed – however imperfectly – to offer a rough measure of material progress being made in the real economy and not the converse, leading them to lose all focus on what is actually happening to people’s living standards and wealth accumulation.

Japan has been stricken with a huge loss of productive capital – as well as an appalling toll of human suffering – and this cannot do anything other than to leave the nation discernibly poorer and, by extension, to curtail its ability to make people across the world better off than they otherwise would be by offering them valuable goods and services as part of that beneficent mutual enrichment which is the international division of labour, conducted under conditions of free(ish) exchange.

Contrary to popular belief, the Japanese have not, in fact, been trapped in a deflationary slough of stagnation these past two decades as both the real and nominal supply of money have risen throughout his period (with the exception of the worst months of the GFC itself), while real per capita national income has also increased modestly, especially on a PPP, or TWI-adjusted basis. Granted, the consumer price basket has trended lower at a rate of less than 1% a year, but this is something which is presumably no more than a reflection of ongoing productivity gains – ones delivered, to boot, in a country formerly marvelled at for the extreme levels of its domestic pricing.

But, even were we to subscribe to this myth of secular slump, the idea that to eradicate a large quantum of people’s possessions or to evaporate a sizeable fraction of their nest-eggs would be to contribute to their prosperity is to reckon that in futilely striving to heft his rock up the hill for all eternity, Sisyphus was the most tireless ‘engine of growth’ for Hades at large.

If you go to the trouble of cooking yourself a dinner, only for the dog to snatch it from the sill where you placed it to cool, do you congratulate yourself on your own good fortune as you troop back to the larder to begin again? If a sudden hailstorm strips bare the groaning ears of your wheat crop the day before you were due to harvest it, do you cheerily go about preparing the field for replanting, content in the knowledge that your doubled labour is being duly recorded in the plus column by a mindless government data-gatherer?

After all, if the awful spectacle of vast swathes of land littered with shattered buildings and crumpled vehicles – or the concern that they suffer the invisible hazards of radioactive contamination – offers such grand opportunities for advancement, why stop there?

Why wait for the vagaries of the climate, or the tortured creaking of continental plates to bring about such a u2018stimulus’ to growth? Why not declare war on ourselves and unleash our titanic arsenals of destruction on our own towns and cities, and rain down hellfire upon our own farms and gardens, razing the first to the ground and sowing the last with salt, until we make a self-inflicted Carthage of them, one in whose midst we can hope to become rapidly richer than our neighbours as, shivering and starving, we pick our way among the debris of our former civilisation to the nearest construction site?

This is all such arrant nonsense that you should banish from your consideration, henceforth and forever, all of the jejune scribblings of the fool whom you once catch propounding it!

But enough of this! The real crux of the matter is to look at the two sides of Japan, Inc. – both as a user (and end-consumer) of certain goods and as a provider of often highly-valued and not easily replicated material inputs to the world economy in exchange.

All else being equal, the country will be consuming some goods (e.g., lumber, steel, copper wire, concrete, fossil fuel) far more directly in the near future and, moreover, consuming them with little onward production of value from their use.

The first order effect of this would be expected to push up preferentially the prices of both the materials they will be absorbing and those whose production by them is temporarily being reduced.

Conversely, the consumption patterns of the ordinary Japanese will also suffer a compositional shift away from the enjoyment of certain goods and services and, ceteris paribus, the prices of these should be less well supported as a consequence.

Where they no longer supply goods to the market – initially being completely unable to do so, perhaps, and, later, devoting selectively less resources to that production as they first tackle the problems of rebuilding – there is certainly scope for their competitors to prosper, but also significant dangers that the partial or total absence of such goods will disrupt production in factories and fab plants elsewhere, too. [Incidentally, the possible fall in the external surplus this comprises is one offset for the fabled yen ‘repatriation’ flows which the market so fears]

In short, where Japan’s goods are competing for sales, others may benefit at her expense: where they are complementary to them, they will equally share in her ruin. In the counter-weighting of these two factors will be decided the first question of whether output suffers beyond her shores and of what impetus is given to what prices.

Read the rest of the article

Sean Corrigan [send him mail] writes from Switzerland.

Sean Corrigan Archives

[Government] is apprehended, not as a committee of citizens chosen to carry on the communal business of the whole population, but as a separate and autonomous corporation, mainly devoted to exploiting the population for the benefit of its own members… The intelligent man, when he pays taxes, certainly does not feel he is making a prudent investment of his money; on the contrary, he feels he is being mulcted in an excessive amount for services that, in the main, are useless to him, and that, in substantial part, are downright inimical to him"

~ H.L. Mencken, "More of the Same," American Mercury 1925

Imagine a country unfortunate enough to have succumbed in conflict to a foreign enemy and now subject to a thorough-going military occupation by the forces of their victorious foes.

Young men, who have been conscripted in a vast profusion, are marched in to pacify the vanquished nation’s populace, to patrol its streets, watch over its borders and constantly to patrol its coastlines — though, in truth, much of their activity soon palls into a dull routine, being merely work for work’s sake, meant to deny the devil too many idle hands for mischief, rather than because the doing of it fulfils any useful purpose of itself.

Some of these warders of the conquered realm are barracked in camps where their basic material needs are catered to in large, centralized facilities specially built for the purpose, while others are billeted on civilian householders in their homes — whether or not these latter show any willingness to have their property used, their provisions divided, and their privacy violated in this way.

Aside from the fighting force itself, there is an even larger host of administrators, technicians, and other support staff abroad in the land, many of its members busy overseeing the activities of the conquered — issuing requisitions to the factory owners; commandeering resources; ordering farmers what to grow and where; and generally re-organizing a significant part of the people’s economic lives in order to serve the needs of their new masters in place of those of their own.

War, after all, had best be made to pay for war and all those martial souls need to be fed, shod, clad, sheltered, and even re-armed if they are to maintain their military effectiveness.

Finally, however, the glad day dawns when the war is ended and blessed peace takes its place. Bested on some far distant battlefield, the invader negotiates a peace, its armies meekly surrender their arms and the erstwhile Hectors and Horatios shuffle apprehensively off to wire-strung detention centres, there to await their fate. Meanwhile, the bells ring out in carillons of joy and young and old alike take to dancing in the streets in a great celebration of regained liberty.

As it soon transpires, large numbers of the former garrison have no wish to return to a homeland many can scarcely still remember. Besides, they have grown to love their new surroundings and many of them have found wives and sweethearts there, to boot. They plead to be allowed to stay and — at first with reluctance, but gradually with a laudable hope for reconciliation (for this occupation, while not without its share of accompanying evils, was not marked by wholesale rapine or blemished with overmuch outright atrocity) — the authorities accede to more and more of these very human requests.

Even amid the rejoicing, however, there are one or two grumblings to be heard. Will all these former soldiers not still be have to fed and clothed at our expense, some ask or — worse to some — finding productive work at last, will they not represent a drug on the market for labour, depressing the wages of us, the long-suffering natives?

Not so, reply the wiser heads. For we should see them not as a surplus, but rather as a vital human resource and each, eager to earn his keep and ply again a peaceful trade, will have to give as much value as he gets in future if he is to earn the goods he formerly took simply by merit of his uniform. This can only be to the benefit of all.

There are others, too, whose feelings of relief are decidedly mixed — the sutlers and the swordsmiths, the bar-keepers and the bawds, the munitions-makers and the mule-breeders — for all those who supplied the enemy have lost the greater part of their custom, even though their conscience must have told them that their living was being made at the final expense of those unconsenting fellow citizens whose wealth and income were being tapped to make up the soldiers’ pay and quartermasters’ drafts.

At length, they, too, still their complaints and resign themselves to seeking out another kind of clientele; to producing ploughshares not poniards or pikestaffs, all the while consoling themselves that, now the exactions of war have been stopped, the majority will have more money in their pockets and that, in the general hunger for the things long denied them during the grim, grey years of subjection, trade and industry will soon be booming once more and commerce will again flourish.

Some good while may pass before they see it this way, but certainly, no-one among even those who flourished most — or languished least — will so rue his temporary loss of business that he will advocate striking up a quarrel with some other likely nation, in order to capitulate as abjectly as possible and so to refill the deserted camps and cantonments with another batch of loose-pursed intruders!

So far, the verdict here seems indisputable. The end of the occupation — though occasioning a measurable difficulty for the few, as well as a by no means trivial challenge of readjustment for the many — will overwhelmingly redound to the common weal: a truth which will be instinctively recognized in an intuition of good to come which almost everyone will later find to have been a correct one.

A Continuation of Policy by Other Means

If all the foregoing seems unobjectionable — and we fully trust that it will — then consider how little the argument changes if there is no foreign occupation, but instead the imposition of martial law by those in power domestically.

We still have the same diminution of the private sphere; still the same tyranny over people’s lives, however softly velveted is the mailed fist which holds the nation down. We still have the same forcible redirection of employment and still the same sequestration of income and arbitrary denial of property as we did when the perpetrators spoke a foreign tongue — and, on that account, we will be just as glad to be rid of all their impositions when the laws are at length repealed or the regime is toppled in the dust of despots past.

Finally, even where the intent is in no way overtly malign — where the nation has been put on a purely defensive war-footing in order to deter the aggression of a hostile neighbour — the very same conditions will apply and the very same relief will be felt when the Dogs of War are finally put back on their slips and "Havoc!" no longer cried.

So, if you are with me this far, tell me why it is any different when the Home Army carries few actual arms and when most of those who fill its ranks wear no obvious uniform, or bear no fluttering pennons, but whose stormtroopers and Sonderkommandos none the less boss us and direct us; telling us what we can and cannot do; relieving us of a good portion of our income to pay their keep and to enact their schemes of domination; and hemming in our natural rights to property with rules and regulations which we ourselves pay for them to conjure up and to impose upon us?

What if this occupying army is in service to — nay, if it actually constitutes — the government itself? What if comprises a host grown fat and bloated and officious as it siphons off the best milk from our herds and swipes the choicest fruit from our orchards in order to satiate its vast, pestilential, multi-million array — its troops of tax-gatherers and health-and-safety tinpots; its platoons of permit peddlers and planning panjandrums; its ranks of red-tapers, rubber-stampers, and rubbish-recycling bin-riflers; its columns of closed-circuit televoyeurs and carbon credit con-men; its divisions of dole deceivers and disability dissemblers; its junta of jobsworths, Jacks-in-Office, and gender outreach counsellors; its cohorts of Cultural Marxist commissars, and clipboard commandants; its echelons of egalitarian engineers, its squadrons of subsidy-suckers — and all the other plunderers who make up this Legion of the Damnable?

A Set of Lies Agreed Upon

Why, then, should we listen to the hand-wringing of the punditocracy when they tell us that to disband even the most ineffective and ill-disciplined section of this rapacious army of permanent occupation is somehow to condemn ourselves to ruin?

Why should we heed the brow-beating of the leader writers when they insist that to reduce even some of the country’s unsustainable deficit — not even, you will note, to try to eradicate the whole of the annual shortfall, much less to address the noxious legacy of debt accumulated over long years of easy profligacy — is for the Emperor to condemn all of us to his former nakedness if foregoes his customary non-attire (one cut by his charlatan couturiers from the virtual cloth of spending what he routinely does not earn) and dons, in its place, a debilitating hair shirt of "austerity"?

No! Better that we stop our ears to the insidious wheedlings of all the Philosopher Kings — the Stiglitzes and Soroses, the Krugmans and Kaletskys and all the other intellectual Vichy who would perpetuate our subjugation— and press on with the attempt to demobilize as many of these battalions of bad husbandry as possible.

Nor should we be persuaded that, without the reckless dollops of Other People’s Money which the vote-buying minions of the State dish out in all their counter-productive billions, the real economy will crumble and blow away in the wind: that shops will empty and factories shutter; that the lights of enterprise will dim, and flicker, and fade — any more than they would if a foreign conqueror were to relinquish his pitiless hold upon those who own them and allow them to take charge, once more, of their own destinies.

Rather, we should steel ourselves for the challenge ahead in a frame of resolute self-reliance and, to show our true intent, we should first make plain our utter rejection of the doom-mongers’ vision of a people grown too servile and enervated under the heels of the horde which strangles their growth and saps their strength that they dare not greet their own liberation with the utmost, unqualified, clarion jubilation.

Otherwise, this will be a long, protracted war, and, as Sun Tzu himself noted all those centuries ago, no country has ever benefited from such a calamity – to which aphorism, we might add, all too few have emerged with even their money, much less their wealth, intact, either. It may also be true that ‘there’s a great deal of ruin in a nation,’ but keep in mind that when Adam Smith penned those words, at a bleak moment in British history, he was making an observation, not a policy recommendation.

Sean Corrigan [send him mail] writes from Switzerland.

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While the headlines of the day are filled with the story of Congress’ rescue of Fannie and Freddie (in a bill which seems to have been stuffed with more of what the Americans call "pork" than a sausage factory), for this observer the most exquisite testimony to the sorry depths to which the modern interventionist government has fallen came in an op-ed for the New York Times, penned by former Fed Vice-Chairman and all-round policy "wonk," Alan Blinder.

Entitled, "Cash for Clunkers" our learned friend there set out — with what, to this reader, seemed to contain not the slightest, mitigating trace of irony — a hare-brained scheme which promised to conflate the worst elements of corporate welfare, crassly redistributionist politics, and the promotion of one of those hot-button issues so beloved of our latter-day Guardians — so-called "global warming."

The gist of this truly Swiftian contrivance — for those not given a hint by familiarity with the American vernacular — is for the State to offer a premium to buy up the oldest, most clapped-out cars on the roads (the "clunkers"), subject to some upper income limit on those who own them (to ensure that only the deserving poor can benefit from this injection of Other People’s Money), and then to scrap every last rusting jalopy this largesse brings in.

According to Professor Blinder’s own breathless characterization, such a tawdry piece of populism would constitute “the best stimulus idea you’ve never heard of” (sic) because it would “address today’s concerns over stimulus, inequality, and greenhouse gases, as well as an ageing vehicle fleet.”

But why stop at cars?

Can "poor" people not be allowed to trade in their old sneakers, too, so they don’t embarrass themselves with their lack of fashionability the next time they take the bus down to the strangely deserted shopping mall?

Is it any more equitable that the man on less than the median income is expected to make do with only a 32-inch-screen TV in each of his six bedrooms while he waits for the foreclosure proceedings on his house to reach their tragic culmination?

Should the beneficent Shepherd of the State not also protect the lower orders from the social stigma and the crushing assault on self-esteem which arise from no longer being able to tap a line of credit in order to buy the latest iPhone?

What the good Professor Blinder is utterly able to recognize, of course, is that both Joe Six-Pack and his supposed elders and betters in the ivy-clad halls of Princeton have got themselves into their current parlous state by spending too much, not too little, in gratifying their momentary whims. Handing them cheques and exhorting them to spend again, is therefore not the remedy most likely to effect a lasting cure for their affliction, though it may, of course, buy a few more X’s for some wannabe-Il Duce in the next political beauty contest.

As one of the more vocal apologists for the Federal Reserve, Prof. Blinder is also precluded from the realization that this endemic imprudence has been encouraged to reach such an Olympian scale only because of the long years an interfering and intrusive political class has spent eroding individual thrift and personal responsibility. Nor is he exactly the bookie’s favourite to confess that this has been worsened by the burden of having to grapple with the false signals and perverse incentives given off by the inherently unstable monetary system of state-sanctioned, fractional reserve banking from which that same governing elite draws it sustenance.

As we have tried to point out, on any number of occasions over the course of the last year, none of what is taking place has to do with either a failure of (if you are currently exulting from the Red end of the political spectrum), or a betrayal of (if you are instead donning sackcloth and ashes from the Blue) anything which remotely resembles "free market capitalism."

Inflationary state corporatism is what has "failed" — or, rather, is what has reached yet another, all-too-frequent low point — and the legally-privileged nonsense of our monetary arrangements are what have, once again, swept us all up to have our wealth consumed in the maw of their own internal contradictions.

But, alas, such protestations are wholly futile, for the Orwellian programming to which we have long been subjected means that we no longer insist upon that proper definition and rigorous use of words which are indispensable to clear thinking.

Thus, we are taught that a quasi-private mongrel of a mortgage company, spawned (along with so much other persistent social evil) during the dark decade of the 1930s — an entity able to shower the riches of Croesus on members of an executive board often unable to produce a viable set of accounts — a set-up making its ostensible profits, not via a process of genuine entrepreneurialism, but through the cynical moral arbitrage of pretending to accomplish a warm-glow mission of "promoting the American Dream" at its sponsoring politicians’ vote-grubbing behest — this ill-bred chimera, we are told, somehow epitomizes the "unacceptable face of capitalism," red in tooth and claw!

As Gustav Stolper put it in his 1942 book, This Age of Fable:

“Hardly ever do the advocates of free capitalism realize how utterly their ideal was frustrated at the moment the state assumed control of the monetary system. A "free" capitalism with government responsibility for money and credit has lost its innocence. From that point on it is no longer a matter of principle but one of expediency how far one wishes or permits governmental interference to go. Money control is the supreme and most comprehensive of all government controls short of expropriation.”

We would all do well to remember that, the next time we start blaming "capitalism" for our woes.

Sean Corrigan [send him mail] writes from Switzerland.

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As the financial system totters around Samson’s sightless head, we can all feel good blaming the post-Lapsarian evils of what we have been brainwashed into believing in some way represents "free market capitalism." We can huddle together and sing the Internationale in atonement at the shrine of the saintly FDR, stopping a moment to pay an undue reverence to the sanitized half-memory of the rag-bag of charlatans, vote-grubbers, and fellow travellers who rode his coat-tails to power.

Ah well. Amid the unseasonable chill and lashing rain which besets us, this bleak, solar minimum July, such a mass outbreak of comradely curmudgeonliness would make a rare divertimento from the relentless persecution of poor, old "carbon."

If it does, however, it might not entirely please Sir David King — former chief witchdoctor (sorry, scientific advisor) to the British government. In a wonderful example of utterly misplaced climate battiness from a serial alarmist, he used an Observer op-ed last weekend to suggest a radical new opportunity for unwarranted state intrusion in our lives — not entirely whimsically, either, one suspects.

No more tilting for windmills for this Green Knight: instead he has in mind a radical new role for the Bank of England — you know, the institution which has proven s-o-o successful in discharging its existing mandate of keeping down inflation and of preserving financial stability; the one whose former governor, it should not be forgotten, was a fervent advocate of the policy of stimulating the turkey-breeding mess of the housing bubble and the fiscal blow-out in order to compensate for the chicken-farm collapse of TMT, which also happened during his watch.

In place of mundane monetary manipulation, Sir David would like the Bank to be henceforth entrusted with the job of reducing economy-wide CO2u201A emissions (no, honestly!), presumably complete with the requirement that if a wet litmus paper turns too vibrant a pink when waved in the air, the Governor would have to dash off one of those confounded apologia to the Chancellor and adopt a polar bear as penance!

Suspect science, bad economics, and poor politics all in one remit. That’s quite an achievement, even for a career bureaucrat!

On second thoughts, why not? Then, when the perversely-incentivised bankers next land themselves in difficulty — compounding up from cap-and-trade to continent-wide crash in a flurry of crazed financial creativity, no doubt — we can presume the Old Lady will stand ready with a "special facility" to swap the noxious flatulence they give off for a steady puff at the collective oxygen tank.

After all, the ordinary working man will never realise just who is responsible for the fall in air quality he will be asked to suffer as a consequence and, besides, what better way to be Green than to collapse the modern industrial economy amid the ringing approbation of the anti-capitalist mob?

Sean Corrigan [send him mail] writes from Switzerland.

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The end of the law is not to abolish or restrain, but to preserve and enlarge freedom. For in all the states of created beings capable of laws, where there is no law, there is no freedom. For liberty is to be free from restraint and violence from others; which cannot be where there is no law: and is not, as we are told, a liberty for every man to do what he lists.

~ Second Treatise on Government, John Locke (1690)

With a certain weary inevitability, the cries of pain emanating from those seeing their aspirations ground to dust amid the current upheaval in financial markets have been interspersed with the shrill descant of those all too eager to proclaim a "crisis of capitalism."

The implication that it is now time for those far-seeing, disinterested Solons in government to step forward once more and to put right what mere "market forces" have again so woefully failed to correct.

High finance, we are told, has become a business of "privatizing profit and socializing losses," a thoroughly inequitable mechanism which the state now has a duty to redress by erecting a whole new framework of Do’s and Don’ts in order to rein in the 21st century’s version of the Robber Barons.

With a breathtaking degree of effrontery, we are even being asked to take seriously the idea that the very institution which has been one of the most culpable in laying the groundwork for the disaster — the Federal Reserve of pre-ordained, baby-step rate rises and skyscraper-ledge rate reductions — should, henceforth, be accorded unparalleled powers of oversight and direction over every facet of our everyday business!

While the initial diagnosis is fairly unexceptionable — since the game of "heads-I-win-tails-you-lose" is precisely what financial market institutions have long been conditioned to play — the corollary is not. Nor is this just because politically opportune Witchfinders General tend to be more guilty of fighting the last war than even the most hidebound of generals; nor because the analogy is decidedly unfair to the original Robber Barons, many of whom grew rich by creating genuine wealth and not simply by living, often obscenely high on the hog, off that generated by others.

No, the whole concept of a "market failure" is a hoary old canard which it is vitally important to dispel for fear that an eager Leviathan will again exploit its subjects’ understandable present anxieties in order permanently to increase its power over their lives and liberties.

If the basic tenets of free-market "capitalism" include the full recognition of property rights, the sanctity of voluntary contract, and the relegation of government to a minimalist role as arbiter — and, reluctantly, as enforcer — of last resort, it can hardly be argued that we have ever actually lived under such a regime.

Indeed, the roots of today’s woes — as of those suffered innumerable times in the past — lie not in whether this or that regulation was sufficiently well-crafted or implemented, but rather go deeper into the issue of whether banking as currently instituted is — in any way, shape, or form — an activity consonant with such principles.

If the very act of asking such a question sounds insupportably radical to modern ears, we would say, in our defence, that we are only following in an honourable, republican tradition which stretches all the way from Jefferson and Jackson to Ron Paul.

Firstly, the ability of banks to create money simply by making a book entry in favour of a borrower, without first asking whether anyone else would be willing to place their previously earned cash at the latter’s disposal, is nothing other than a legalized act of counterfeiting or, if you prefer, an act of "watering" the stock of claims upon the totality of private property; of diluting the existing "shareholders" rights to the social product without their prior consent.

That such a practice of issuing monetary substitutes willy-nilly is the fons et origo of inflation (at least in countries where similarly forcing government liabilities into circulation does not predominate) should need little explanation. What might bear emphasis, though, is that if one considers the state’s indulgence in such crude coin-clipping as a "tax" — i.e., as a legal, if unethical (and often unconstitutional), act of expropriation, one is forced to conclude that the banking equivalent is nothing less than an unauthorised expropriation — in other words, a theft.

Such a crime is no less worthy of outrage simply because it has long been officially sanctioned, even encouraged. Nor is it pardonable because there is no one, single, identifiable victim, for the truth is that we all suffer from such depredations — or, at least, all of us excluding the initial borrower (able to spend the new money before the rest of us realize it should buy fewer goods than it does) and the issuing bankers themselves.

Secondly, the fact that depositors are led to believe that they do not relinquish any rights over the funds they entrust to the banks — when, in fact, they are no more than the unsecured creditors of a commingled holding — leads to the reprehensible business of promising demand account customers instant access to "their" cash, while being fully aware that such a promise is wholly fraudulent since the bulk of this "cash" will be rapidly deployed to "fund" any number of the long term, potentially illiquid ventures being undertaken by the bank’s lending department.

That this "cash" can therefore only be repaid by luring other dupes into the scheme means that the whole businesses has its foundations in a further falsehood, one which seeks to make profit from what is little more than a typically lucrative, if undeclared, actuarial subterfuge.

The fact is that, by some twisted thread of history, banks have been accorded the unjust privilege of being allowed to ignore the absolutely crucial lines of demarcation between four, wholly beneficial, but utterly distinct, roles.

Monies given into their possession in their guise as "giro," or transmission, agents, or as the custodians of what are, today, largely virtual safety deposit-boxes, are one thing: quite another are the resources entrusted to them in their equally laudable function as asset managers whose job is profitably to invest their customers’ term deposits in a range of what are presumed to be creditworthy ventures.

A third — individually irreproachable — business is that of facilitating the raising and transfer of capital between customers; mobilizing savings, large and small, in order to fund entrepreneurial attempts at wealth creation, whether through arranging trade finance or by bringing issues to the bond and stock markets.

Finally, there is no intrinsic demerit to bankers speculating either with their own capital or, indeed, with that of those clients who are fully cognizant of the fact that their money will be used to bankroll an attempt to outguess other traders and to pre-empt changes in the valuation of securities, currencies, or commodities.

The underlying problem is that banks have been granted the right indiscriminately to mix all four of these often incompatible activities. This gives rise to an unhealthy promiscuity, corrupting their fiduciary duties, introducing irreconcilable conflicts of interest, and opening up countless opportunities for a wholly legal embezzlement which has a small, but significant, chance of going horribly awry — as today’s events have once more forcibly brought home.

Moreover, this is a world in which banking "capital" is a veritable Cheshire Cat of insubstantiality (since banks are unique in having little but their own debauched "money" on both sides of the balance sheet). That "capital" is most easily increased by means of the notional profit booked on a deal — a profit which is often no more than a deliberately optimistic, upfront reckoning of many future years’ prospective income and, so, is one which is subject to a whole array of possibly unjustified, "modelling" assumptions.

As ethereal as this gain might turn out to be, the fact is that, for as long as this fiction can be maintained, it strongly induces banks to lend and re-lend against the collateral afforded by the very same assets which have most appreciated under the influence of their original loans, thus ensuring that they re-attain the maximum permissible degree of leverage and hence most flatter their returns on equity.

This powerful positive feedback — one whose underlying fuel is the banks’ unnatural ability to create money, simply by granting loans — means that they are rewarded (at least while things are in the upswing) for reinforcing any resulting instabilities. Thus, they frequently find themselves turning the most innocuous of convective puffs into a raging hurricane of wasteful malinvestment.

What this implies is that fractional reserve banking not only gives rise to a fall in the value of money, per se, but it is also the well-spring of that thoroughly avoidable and widely destructive bipolar disorder we know as the business cycle — i.e., the boom and the bust itself — and so gives the main impulse to those periodic, lemming-like waves of folly which so mar the history of material progress.

While this indictment would seem to suggest that — as those now waving pitchforks and mattocks on the intersections of Wall St. are noisily demanding — banks should be subject to an unusually strict scrutiny in place of the rather lax regime prevalent of late, the truth is that no special rules whatsoever are necessary: on the contrary, all that is needed is for the same basic principles of law to apply to banks as to any other commercial enterprise, in a manner that they have never done heretofore.

Those who would deny the validity of this last contention might reflect upon the fact that the very existence of legal tender laws, government-administered deposit insurance schemes, and — a fortiori — public sector "lenders of last resort" reveals the inherent invalidity of the banks’ logical, economic, and jurisprudential position, despite centuries of positivist legal precedent and state-sanctioned privilege.

It should be obvious by now that none of this has anything to do with "capitalism," properly defined, but rather is something more common to the practice of rent-seeking despots — whether those of the ancien rgime, or of our modern elective dictatorships.

Without the honest money which presupposes a system of 100% specie reserve, free banking with no second recourse — should bankruptcy still occur — to its victims’ property via forced taxpayer restitution or compensatory central bank inflation, there can be no truly free market and hence no "capitalism" to let us down so badly. Instead, what we are suffering is yet another demonstration of the perils of state intrusion into the sphere of private relations, with all the perverse disincentives it entails and with all the faulty signals it gives off to businessmen and consumers alike.

In fine, what we are having to endure is the latest example of the many crises brought on by financial corporatism — a sorry situation which will neither be remedied nor prevented from re-occurring in future by succumbing to the panic and taking measures which will only serve to strengthen the stranglehold already exerted upon our lives by a voracious, interventionist bureaucracy; measures which would only come at the expense of that genuine freeing of the economic realm which would most rapidly heal our present hurts and so assure our continuing prosperity.

Sean Corrigan [send him mail] writes from Switzerland.

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Often has it crossed my fancy, that the city loves to deal
With the very best and noblest members of her commonweal,
Just as with our ancient coinage and the newly-minted gold.
Yea for these, our sterling pieces all of pure Athenian mould,
All of perfect die and metal, all the fairest of the fair,
All of workmanship unequalled, proved and valued everywhere
Both amongst our own Hellenes and Barbarians far away,
These we use not: but the worthless, pinchbeck coins of yesterday,
Vilest die and basest metal, now we always use instead.

Aristophanes, The Frogs

For the past 2 millennia, the Lydian king Croesus has been a byword for fabulous wealth, the prime beneficiary of vast riches accumulated partly by the trading skills of his subjects and partly as a result of the copious alluvial deposits of electrum — a naturally-occurring alloy of gold, silver, and copper — which were to be found in the country’s rivers (placed there when the even more legendary Midas washed away the curse of his golden touch, we are told).

Indeed, it was here in Lydia that the first stamped and standardised coins began to circulate, at the turn of the 6th century BC; a development which allowed for a wider monetization of trade and hence unleashed what some historians have called a "commercial revolution" across the Ancient world.

The idea that financial innovation can provide a stimulus to real activity — warranted or otherwise — is one with which we should all be very familiar, but there is a slightly darker parallel at the core of Croesus’ extreme affluence: namely, that the official Lydian coins show a suspiciously low 50—60% gold content, in sharp contrast to the 80% and higher constituency to be found in the unadulterated local alloy.

The strong implication is that, not content with earning a modest degree of seignorage from the royal mint and too impatient to wait for genuine economic growth to add to his storied pile, Croesus greatly enhanced his status as the prototypical ber-High Net Worth individual by practising the world’s first recorded instance of surreptitious currency debasement and by profiting all the more from the ensuing inflation.

The Lydian trite

The analogy goes further, for Croesus, professing himself alarmed at the rise of Persian power on his borders, decided to spend some of his immense hoard in launching a pre-emptive strike on his neighbours’ upwardly-mobile ruler Cyrus (does this all sound horribly familiar?), having been bolstered in his aggression by a quintessentially Delphic prophecy that if he crossed over the border into hostile territory he would bring down a great empire.

Alas! Our Pre-o-Neocon plutocrat forgot to ask the Pythia just which empire she meant exactly and nearly paid the ultimate price for "sexing up" the intelligence in this manner when, shortly thereafter, he found himself at Cyrus’ mercy, having been delivered into his conqueror’s hands during the sack of the Lydian capital, Sardis.

Even if we can’t link Croesus’ inflationary policies directly to his subsequent military humiliation, we can share Hemingway’s sour observation that for such "political and economic opportunists" as he, the "first panacea for a mismanaged nation is inflation of the currency; the second is war" and that while "both bring a temporary prosperity," they also both lead to "permanent ruin."

The role of gold today

Morality tales aside, however, does this have any relevance to the role of gold in one’s portfolio today? We think the answer is, yes.

But, before expanding upon this assertion, the first thing we have to make clear is that — however ardently the Goldbugs may wish it were — gold is no longer, in any sense, a "money," that is, it does not function as the present good par excellence, the medium of exchange, the one thing universally accepted, on demand and at par, for all the other goods and services one wishes to buy with it.

In short, you can’t easily settle your bar bill with a bar of bullion, nor — under current political circumstances — are you ever likely to be able to, no matter how much better off we all might be were the yellow metal to be reinstated in its rightful place at the heart of economic life.

Accordingly, the fact that gold is no longer money means we have to turn its historic function upside down and accept that it is no longer able to provide protection during those rare periods when money itself becomes painfully scarce — i.e., during a deflation (properly defined).

In microcosm, we can see an example of this axiom at work whenever we suffer that lesser species of contraction which is a margin-driven liquidation of market positions — hence gold’s ~7% decline when the credit crunch first began to bite in August of this year.

Conversely, ever since this uniquely liquid, highly fungible, easily storable, durable, scarce, real asset has been denied its monetary birthright by virtue of its intrinsic lack of compatibility with the workings of populist-democracy welfare states, it has had to be thought of as a kind of anti-money: one largely to be held during periods of inflation, when the impaired currency we actually use is in a dangerous overabundance.

Gold’s late run has therefore come about since the Bernanke Fed was first panicked into cutting the discount rate, since the ECB abandoned its stance of "strong vigilance" to send the Eurocopters flying over its shaky banks, and since the Old Lady begrudgingly bailed out Northern Rock (and hence all its counterparts) under explicit government duress.

The arguments may still be raging about exactly who, or what, was responsible for the recent financial turmoil, or to what extent it will come to affect the wider economy, but one unavoidable conclusion can already be reached: namely, that the sustained inflation of money and credit has become such an integral part of our modern way of life that our rulers fervently believe that it must never be allowed to slow (much less reverse) for fear of toppling over the whole, precarious house of cards which we have so painstakingly built about ourselves.

During the past few months, the stark truth is that our central bankers have once more revealed — both in word and deed — that, as Charles Goodhart explicitly put it a few years back, "deflation is a policy choice": the unspoken corollary to which is that "inflation is, and always will be, the preferred policy choice."

u2018…towards carrying on the War against France’

The prudent investor cannot afford to ignore the implications of this doctrine. He must realise that the money which he holds in his hands — and in which he routinely calculates both his profit and loss and his overall wealth — is not to be trusted: that it is doomed to lose value — now at a slower, now at a faster, rate — but always diminishing in worth.

Not only must he contend with this broad, underlying current of depreciation, but he must also be aware that the quickening and slowing of its stream, as well as the twists and turns which make up its course, give rise to the business cycle itself and so make the longer-term preservation of capital an all the more difficult task to accomplish.

Forget all the fine words about containing "inflation expectations" or "preserving price stability." From their very first incarnations in 17th century Sweden and England, central banks have been purposeful mechanisms for shoring up profligate governments (whether these are buying guns or butter without properly funding the purchase) while serving as a backstop to the inherently flawed and highly unstable practice of fractional reserve banking.

Thus, at the first sign that a crisis is about to erupt in a financial system which could only have become so perilously over-extended because of a prolonged episode of central bank laxity, the first priority will invariably be to rescue the principal culprits by dousing the wildfires raging about them with exactly the same brand of flammable liquid which was used to fuel them in the first place.

In running true to form at this particular juncture, we can only underline that we feel the price risks being run by the central banks are extraordinary. Not the least of these is the danger that the US will provoke the fourth great reserve currency crisis in a century — the previous three being the abandonment of the gold standard during the Great War, the collapse of the gold exchange standard during the Great Depression, and the break-up of Bretton Woods at the start of the Great Inflation.

Since this is a chronicle of the successive adulteration of money and of the serial acceptance of a more bastardized replacement when the burdens of the previous one become too much for political expediency to bear, we can expect profound consequences to follow — social and political, as well as purely financial — if the ailing dollar does, indeed, end up being widely forsaken by its anxious sponsors.

A flight to real values might well be unleashed in such a pass, potentially boosting the price of our anti-money, gold, to unheard of heights along the way.

At the same time, the full panoply of protectionism, export bans, income support, wage freezes, and the direct administration of prices — already surfacing in several countries around the world — could devastate entrepreneurial activity and usher in a nasty and protracted recession.

Should this transpire, the thing to bear in mind is that, in the two years from the first quarter of 1973, annualised, quarterly real GDP in the US plunged from 10.6% to —4.7%, yet the price of gold tripled, that of oil quadrupled, and wheat’s gain to the monthly peak was 160%.

Nor was this an isolated incident, for worse was to come, just five years later, during the two years from the second quarter of 1978, when US GDP underwent an even more remarkable swoop from +16.7% to —7.8%. That time, wheat rose 70%; the price of a barrel of crude was well on its way to tripling; and the number of rapidly shrinking dollars needed to buy an ounce of gold quintupled.

Along the way, the world painfully re-learned the truth that inflation and recession were not mutually exclusive. Perhaps the lesson is about to be repeated for a generation which has again forgotten the rudiments of proper, pre-Keynesian economics.

Solon’s New Deal Athens

Back in 6th century BC Lydia, Cyrus’ first impulse was to have his captured enemy, Croesus, burnt at the stake. However, soon after the faggots were lit, his royal victim could be heard plaintively uttering the name of Solon. Piqued by this, the Persian ordered the flames to be doused and inquired of his erstwhile foe what he had meant, only to be told that the famous Athenian law-giver had once warned Croesus that fortune was so fickle that it was impossible to say which man was truly fortunate until his life had finally ended and a full account of it rendered.

Recognising true wisdom when he heard it, Cyrus immediately ordered Croesus to be spared and, indeed, went so far in his reconciliation as to make him a senior member of his council — a far-sighted piece of clemency well beyond the ken of the present era’s serial regime changers.

As for Solon, well he, too, would have been fully at home today.

A well-known establishment figure who was appointed to the archonship amid the severe credit crisis which was mowing down broad swathes of woefully over-mortgaged smallholders, he first absolved the sad, deluded "condo flippers" of his day of all responsibility for the unpayable debts imposed upon them by oligarchic "predatory lenders." Next, he attempted to counteract the deflationary affects of this officially sanctioned mass default by means of a 37% devaluation of the drachma — moves which laid him open to charges that he had allowed certain of his acquaintances (later branded the Repudiators) into the secret ahead of time, so enabling them to profit inordinately from the eventual rescue plan.

Plus ça change, for today we see Treasury Secretary Henry Paulson scrambling to prevent the contemporary mortgage crisis from worsening, while the Fed has cut rates in the face of a dollar declining at an annualized pace not that far removed from Solon’s one-off parity change.

With almost preternatural resonance, Chairman Bernanke has also been reviled for navely sounding out the opinions of the good and great immediately before he started cutting rates, while Paulson, for his part, has been accused of tipping off the members of his notorious Working Group early enough for them to take a lucrative advantage of the imminent policy easing. Neither charge, however unfounded it might be, has done much to restore confidence in either the credit system or the ailing dollar.

Scarcity v Abundance

So, where for a gold price which has already had a spectacular — if, so far, brief — run to well beyond what (unsurprisingly) proved the largely illusory "barrier" of $800/oz?

Well, in the short run, caution must be exercised as the speculative throng on the main COMEX exchange have built up an unprecedented long position of up to 240,000 contracts. To put that into perspective, the size of the bet works out at about 745 tonnes equivalent, roughly equivalent to a four months’ mined supply of metal. With so much hot money having been brought to the party in so short a time, it is little wonder that the recent price action has been so savage.

Looking beyond this, however, consider that, over the past two years alone, broad money in the US, the UK, the Eurozone, and the BRIC quartet (of Brazil, Russia, India, and China) has risen a combined $11.5 trillion — equivalent to around $70,000 for every ounce of newly mined gold wrested from anything down to 4 kilometres deep in the Earth’s crust in that same period.

Bear in mind also that the outstanding notional stock of derivatives has soared to more than $1/2 quadrillion over this horizon, representing an extra $1.7 million haystack in which to search for the poisoned needle of mathematically-abstruse, systemic risk for each and every, readily-valued, new ounce of metal brought laboriously up from the Stygian gloom and into the broad light of day.

Such are the risks and so great is the disproportion entailed in this orgy of overtrading and speculation that a clamour has arisen on both sides of the Atlantic for the central banks to undertake yet more inflation in order to stave off a potentially damaging aftermath.

You see, no matter how big the inflationary bubble, an offsetting deflation is merely a policy choice to be avoided in its wake. No cold turkey will be endured here — no emetic will be taken to purge the poison — only a stiff hair of the dog administered to spare the drunk the worst of his pain.

In light of this — and with gold still some 60—65% off its CPI-adjusted peaks in dollars, deutschemarks, and in terms of US average wages — we can confidently argue that while the metal may have undergone an impressive degree of reassessment already in this young century, it has hardly exhausted all its strength in this latest round of its multi-millennium struggle against the endemic evil of inflation — an inference that is likely to hold even if a misguided American electorate fails to give Ron Paul the chance to restore both the long-lost Jeffersonian Republic and the sound money, based on a true gold standard, so essential to its future maintenance .

A version of this article appeared in the November issue of the Hedge Fund Journal.

Sean Corrigan [send him mail] writes from Switzerland.

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In testimony before the House Committee on Financial Services, Robert Kuttner of the American Prospect, this week delivered a searing Philippic on the topic of the current excesses.

Like many from his part of the political spectrum, however, he missed the essential cause of the disease and so recommended the wrong treatment, as the following open letter to him tries to explain:

Mr. Kuttner,

Leftists often analyse history and highlight institutional conflicts better than purblind Rightists (after all, the whole doctrine of the former is about the clash of class interests competing for economic control), but they always fail at the juncture of true cause and effective remedy.

Though nearly all of what you have to say regarding the marrow-deep corruption of the present era is true, what you give no hint of understanding is that government itself brought this about, not a market which is therefore decidedly not a ‘free’ one.

Government allowed deposit banks to function as "fraudulent warehouses" in the first place. Government extended them and other corporate bodies the privileged protection of limited liability for doing wrong. Government forced its subjects to accept its IOUs as money. Government founded the Fed. Government went off gold. Government favoured debt over equity (both via preferential tax treatment and perpetual inflation). Government set up agencies to over-promote home ownership. Government instituted the next great office of "moral hazard" with the FDIC of which you so approve. Government routinely bails out and reinflates all failures which repeatedly shake the gimcrack system which has been its result.

So, no, Mr Kuttner, we will not remove all conflicts and enhance stability by a return to the Depression-extending, soft tyranny of your beloved, Mussolini-inspired New Deal, but only by a return to sound money and the strict and consistent rule of law.

Banking and money are themselves the intrinsic problem. The question of whether or not the rules and regulations of the day are doing a good enough job of covering up the flaws inherent in banking’s anomalous legal and economic framework is merely a post hoc diversion from a much more fundamental issue.

Taking but a few of the present evils to which you allude, if banks were forced to obey the rules applied to all other custodians of property — and if, additionally, money were hard and therefore potentially subject to the same consequences of scarcity as any other good — highly-leveraged, destabilising speculation would be well nigh impossible (or, at worst, it would be confined to a kind of specialized, self-contained, private gambling club); inflationary booms would be precluded, and capital would be both unblinkingly supervised — lessening "agency problems at source" — and scrupulously invested in genuine enterprise, not in the kind of destructive and debauched financial trickery you so correctly denounce.

Oh, and as hugely beneficial side effect, overweaning government — the true bane of our existence, as well as the "bankster’s" sword and shield — would perforce become rigorously constitutional, minutely accountable, a great deal smaller, and far less intrusive and arrogant into the bargain!

The cause of both liberty and prosperity would be enormously advanced as a consequence and artificial layers of cloying, stable-door bolting "regulation" could be safely relaxed, with only the effective oversight of a watchful and self-reliant citizenry needed to restrict malfeasance and to see that malefactors receive their just desserts.

You never know, Mr. Kuttner, but if enough of your fellow Americans come both to endorse your indictment and to yet to reject your prescriptions, we might be afforded the chance to put the above assertions to the test. I say this, for the inescapable conclusion is that, in all good conscience, your compatriots could only then vote for the one true alternative to the yelping pack of statist, unimaginative, self-serving political jackals vying to secure their own four years as Ozymandias in your upcoming Presidential elections — namely the estimable Ron Paul.

~ Sean Corrigan

Sean Corrigan [send him mail] writes from Switzerland.

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"When the music stops, in terms of liquidity, things will get complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

~ Citigroup CEO Chuck Prince, FT Interview, July 2007

How things have changed in the short space of a month.

For, right up to the second half of July, world equity markets were still raging ahead in utter denial of the spreading cracks in the credit boom, with both the S&P and the emerging markets indices making new highs in that time.

This was despite the fact that all the technicals were signalling the need for caution — elevated sentiment readings; record-high margin longs on the NYSE; record-low mutual fund liquid asset percentage holdings; a turn in the breadth of the market (that for the Nasdaq has, indeed, since hit multi-year new lows); volatility indices climbing with — rather than against — the rise in stocks.

More crucially, there was still an attempt to downplay the magnitude of the problems finally coming to boil in what has arguably been the most spectacular mass hysteria in the whole sorry history of financial market manias — the multi-trillion Ponzi scheme of credit we have created since the collapse of the Technology frenzy.

We have long told anyone arguing that commodities have occasionally displayed bubble-like behaviour that they were no more susceptible to this kind of infection than any of a number of other asset classes — both conventional and "alternative" — and that this was unlikely to pass until we had removed the cause of all this mischief, namely, the credit bubble which had continuously been inflating prices everywhere you looked (though, ironically, everywhere the central banks were choosing not to look, at the same time).

The real bubble, we maintained, was in credit: all others — whether in lead futures, LBO targets, Patek Philippe watches, or Modernist daubings — were ancillary to what the woefully uncomprehending ex-Fed Chairman once called a "conundrum," but which was, in reality, all too understandable a phenomenon.

In saying this, we would be assailed on the one side by starry-eyed mining promoters (many of whom had increasingly only come across a "mine" in the reference section of the Harvard library) who would insist on telling us that our caution was misplaced; that we "didn’t get it" because we didn’t understand China’s influence on the supply:demand dynamics of the metals concerned (sic!).

On the other hand, we have been haughtily dismissed by institutional investors who could very well scoff that, say, nickel might be overstretched in the near term, but who were still perfectly content to buy yet another gallimaufry of dubious, rag-tag credits from their over-eager investment bank account managers, each secure in the belief that the hocus-pocus which purported to value these baskets afforded him a wide margin of safety.

As the events of the past few weeks have begun to reveal, however, this last presumption has proved just as fatal as all of its many less-than-illustrious predecessors in the perpetration of mathematical hubris.

Indeed, it is a compelling testimony to our capacity for pseudo-rational self-delusion that so many could still cling to the idea that something as intensely self-reinforcing as the financial markets — institutions in which those highly non-linear and inherently unquantifiable actors known as "human beings" are at play (and largely with Other People’s Money, at that) — can ever yield to the same statistical calculus as a laboratory vessel full of inanimate gas particles.

Without delving into the wide chasm between "risk" (a realm where models can be made to work) and "uncertainty" (one where they decidedly can not), without drawing upon the insights of Austrian epistemology, without citing Nicholas Taleb’s famous metaphor of the "Black Swans," did no-one stop to think that if their model was supposed to be so hot, then so, in all likelihood, was everyone else’s?

Had they done so, they would have realised that not only must buying assumptions have become claustrophobically crowded (i.e. very efficiently irrational!), but that — far worse in its implications — once the market turned, all these blessed computers would be revealed to be disastrously mispriced in one horrible unison.

After all, if everyone was running much the same CDO-analytical version of Deep Blue, did no one ever ask themselves whether there were really enough Gary Kasparov’s out there on whom to unload the junk once the models all began to flash, "Sell!," at the same time?

Obviously not. And yet, even now there is a current of denial still insidiously at work in the minds of people who don’t wish to acknowledge that their own deeds, as members of the undiscerning Herd, have given rise to what they insist on misconstruing as just one more "six sigma event."

Apart from "the problem is fully contained" school of hopeless little Dutch boys and the usual crowd of "buy the dips (preferably from me)" chancers, the air is filled with the dreary strains of that eternal Chorus intoning "the economic fundamentals are sound," even as all manner of high-falutin’ investment schemes implode around us.

Have you ever remarked upon the strange fact that when asset prices are rising, their ascent is the inescapable consequence of a solid "fundamental" underpinning — no matter how unrealistic have become the valuations of the assets the pundit himself is touting. The market is, after all, a "discounting mechanism," don’t you know?

Now, contrast this with the reaction once that same market suffers one of its periodic bouts of vertigo. Far from being an unbiased reflection of disembodied knowledge, the reversal can now only be ascribed to an access of the vapours on the part of a few ill-informed neurotics!

What is more, this asymmetrical mental ratchet effect (in part, the sort of "model arrogance" discussed above; in part, wishful thinking; in part, cynical salesmanship) misses the fact that just as financial market conditions exert a clear and undeniable influence on the real economy in the upswing (we do mostly direct our efforts toward the prospect of monetary gain, remember), they can hardly fail to do so in the downleg as well.

To those who would here interject that this is all irrelevant because "for every loser there is a winner," we would point out another glaring asymmetry — not that which exists between sellers and buyers, so much as that between assets and liabilities in our highly-interconnected world.

To aver that the gains made by the man who sold a since-fallen stock at the top constitute a zero sum with the losses of the man to whom he sold is a statement which only holds at an immediate and individual level: at the systemic one, the truth is never so reassuringly self-correcting.

For a start, our self-congratulatory high-seller will probably have plunged straight back into the market and bought some other claim on Dame Fortune with his gains. Being still exposed, therefore, he may well see his notional profit eroded as his new holdings are, in turn, pulled lower — perhaps as a direct consequence of his original counterparty’s distress.

More importantly, the top of the market for this particular asset was unlikely to have been reached thanks to a calm shifting of a greater proportion of a finite pool of money preferentially from its alternative outlets: alternatives which therefore had to cheapen both relatively and absolutely and whose countervailing decline must, accordingly, have exerted a genuine, intrinsic mechanism of restraint on the game.

Instead, the system in which we must operate is inherently unstable, like the moisture-laden, summer air over the warm tropical ocean.

Only let a share, or a group of bonds, or a new-fangled class of derivative instruments puff up, lazily, into the view of speculators and their avid lenders and, before you can say "the ghost of John Law," the hot winds of credit are filling it and driving it higher and higher into the troposphere — an ascent which not only induces more and stronger currents of air to lift it yet further, but which catches all other asset classes willy-nilly along with it in its swelling updraught.

In this regard, what we have lived through, these past few years, is nothing less than the genesis of a Category Five, super-cyclone — one whose terrifying eyewall is a screaming vortex of collateral-debt-derivative feedback.

Once such a storm breaks, our asset-liability bind will be seen to be the critical weakness, the Mississippi levee whose failure could well swamp us all.

Granted, it is the case that every debit has somewhere a corresponding credit, but this also means that everyman’s fate is intimately bound up with that of his neighbour.

As Fritz Machlup pointed out in the 1930s, if A lends to B who lends to C, who in turn lends to A, it is indeed the case that — at the aggregate level — everything seems to match up, but this does not mean that it also cancels out. If C encounters difficulties and informs B he is broke, B will default on A and A will then be unable to meet C’s call for the cash with which he hopes to disembarrass himself. All will be ruined together.

Therefore, even if we personally have not been knowingly playing the ragged edges of the credit game, the fact that the mighty hurricane which looms above us made its first landfall in the sprawling, plasterboard suburbs of sub-prime is no reason for complacency for, as is just beginning to be glimpsed, sub-prime is itself no more than a particularly indefensible subset of the far more widespread dangers we all now face.

No, the world is not going to go into a tailspin because of the travails of fifty-odd thousand poor fools whose painful desire to make a fast buck flipping condos met a none-too-choosy lender with similarly short-sighted motives.

The plain fact is, however, that Hurricane Cassandra (so named because no one would heed the many warnings given, instead of carrying on frenetically dancing the Chuck Prince Charleston) never limited herself to such a low-rent corner of the world.

Rather, the whole colourful motley of hedge fund gunslingers, private equity barons, bond insurers, CDO traders and fixed-income investors — the whole, out-of-control business of M&A, of vast share buybacks, and hence of main market equity outperformance, as well as emerging market re-rating — the whole self-aggrandizing swagger of the Bulge Bracket bonus bonanza — all of it — every last red cent of it — has been, in turn, cause and effect of the build-up of the storm system which now threatens to sweep this Big Easy of false prosperity away, leaving little but the matchwood of shattered dreams and disabused expectations in its wake.

If all of the foregoing doesn’t strike a cautionary enough note to give you pause, Dear Reader, when you hear the Siren whispers telling you to dive back in now that things are "cheap," there is one last sobering question to contemplate.

In our Austrian vision of the world, the business cycle IS the credit cycle. Overeasy credit encourages too much investment in too many false projects. Financiers become reckless and entrepreneurs are mislead en masse to see real opportunity where there is only the shimmering mirage given off by hot money.

What is more, the cycle tends to manifest itself in a lengthening of the productive structure, in undertaking investments increasingly removed from the immediate provision of consumer goods, and especially of consumer — staples. Another crushing asymmetry comes to bear here, as a result.

This lies in the fact that it is far easier to lengthen the structure — to use easy money and expensive shares to build plant, lay pipelines, and fill the factory with banks of gleaming, new, highly-specialized machinery — than it ever is to shorten it again — retooling the assembly line for a different use, bringing a different ore out of the mineshaft, even breaking the equipment profitably up for scrap — when the premises on which these bold steps were taken prove to be mere falsehoods spun amid the prevailing mood of financial incontinence.

If, therefore, the credit cycle really has turned here — and this is surely the best candidate for marking that decisive change of phase we have had for some years — we cannot fail to reckon with serious, real world implications as the squeeze progresses, as returns on investment falter, as orders are cancelled and jobs begin to be lost.

Accordingly, as we try to extricate ourselves under from the falling masonry of financial foolhardiness, what we must be asking ourselves is which company (or, indeed, which resource) has received the greatest short-term boost from the recent asset inflation and has therefore become the most over-extended and vulnerable to its subsequent evaporation.

Conversely, we must also try to identify those who have been conservative enough, or who will hence react sufficiently rapidly (or for which resource we will still find the matching of physical supply to genuine, end demand a considerable challenge) and who or what will therefore best weather the onrushing tempest, offering real, long-term value, no matter how beaten down the traded price becomes in the interim.

Answers on a postcard please, but we suggest you draw the lesson from sub-prime and start by looking for the corporate equivalents of those who took out — as well as those who looked like geniuses for extending — larger and larger chunks of "NINJA" loans ("No Income, No Job or Assets"), even as the ship was visibly heading for the rocks.

If you do, you’re sure to find more than enough candidates to keep you out of mischief for some good while to come.

Sean Corrigan [send him mail] writes from Switzerland.

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Whenever I’m asked to express a view upon the prevailing investment climate, I tend to show a series of three schematic demand graphs depicting, in turn:

• a rising straight line to represent the steady secular upswing occasioned by the contemporary industrialisation and urbanisation of a large part of the world’s population;
• a sine wave to show the cyclical fluctuations around this which we Austrians believe to arise from the instabilities inherent in our system of credit;
• and, finally, an ECG plot to mimic the manic-depressive overlay of financial market hyperactivity — a dance of dervishes which certainly draws some of its rhythm from the so-called "fundamentals," but which is often no more than the hallucinatory frenzy induced by the narcotic vapours of too much leverage.

Though much of the daily grind involves making assessments of the noisier, latter pairing, the first retains a key role in the decision process and, though the least volatile of the three, it is not a wholly trivial task to gauge its vitality and strength.

Naturally, once the conviction arises that what we are witnessing is the unfolding of a major socio-economic phenomenon, this is not a judgement which lends itself to short-term revision. Still, this is not to say that risks to this trend do not, in fact, exist.

That these are mainly political, rather than economic, in nature means that while often a matter of unforeseeable electoral caprice, they may yet remain true to the march of history — which, today, can be too readily seen as a creeping, but inexorable, anabasis away from the republic of individual liberty and on toward the Reich of intrusive collectivism.

Thus, the present, widespread resurgence of a petulant and suspicious nationalism is one development which may yet divert the locomotive of emancipation and enrichment off the main line and into the barbed-wire sidings of the gulag, helping beat ploughshares back into swords as it goes. This primitive xenophobia applies not just to the import of goods, but also to that of people and even of capital from abroad.

Indeed, it is all too characteristic of the prevailing tide of distrust that foreigners’ money is only grudgingly welcomed by the usual inveterate debtor nations if it takes the form of a passive (and preferably a sovereign) loan and, even then, only to the extent that the obligation is not prevented from slipping through the lender’s hands by way of a steady depreciation of the currency in which the loan was contracted.

Added to this has been a worrisome rise in the expropriation of private property, especially where it consists of one of the more immobile pools of capital — archetypally mine sites and oil fields.

Here, we should not confine ourselves to a consideration of the rough, political banditry being practiced in the likes of Venezuela and Bolivia. Rather, before we shy too many stones at the surrounding glazing, we should note that these are only extreme cases of a rapacity which has seen the imposition of retrospective taxes and ramped-up royalties, the forced "re-negotiation" of commercial leases, and the insidious extortion of "social responsibility" bribes (ostensible "good works" which are actually demanded either to buy votes for the local nomenklatura or to further the insidious cause of the Platonic One-World guardian class).

We should harbour no illusions about the supposedly high-minded egalitarianism in which these last are meant to be rooted. These are all policies enacted for the sole benefit of the venal ruling classes. They work to the detriment of the owner-shareholders of the businesses so gouged and are thus both an infringement of freedom and a destruction of capital, no matter how willingly the preening CEO in charge engages himself as an accomplice in this theft.

Accordingly, they are acts all the more reprehensible when the afflicted companies are based in those Anglo-Saxon nations which most pride themselves on their supposed commitment to the cause of the free market and the rule of law.

A combination of the above dangers is also to be recognised in the Listian promotion of "national champions" by the likes of Messrs. Sarkozy and Putin (though we can perhaps temper our criticism of the latter by noting that he is neither so narrowly mercantilist as his Euro-bashing French counterpart, nor is it always so clear that ownership of the corporations for whose control he is contending was honestly acquired or is responsibly being discharged).

Next, we can point to the ongoing disgrace of that impenetrable thicket of farm subsidy, tariff barrier, and naked trade restriction which is often dressed up today with the meretricious verbal garlands of "energy independence" or "consumer protection" (not to mention the even more Orwellian abuse of the term "free trade").

When we consider all the harm this does, especially to the poorer producers and consumers of the goods affected, we can only aver that if the Bono’s of this world really wanted to do some good, they could start by learning a little economics before spouting off between sets.

They might then realise that they would be far better employed in arguing the case for the aspiring third-world entrepreneur to have unhampered access to the world market instead of propounding another dreary round of statist charity-mongering (i.e. invidious tax redistribution mixed with market-stultifying surplus dumping) every time they step out of their gleaming limos and onto the awaiting red carpet.

A further danger is that posed to a senescent world order when its existing hegemon is growing tired and irascible and where the weight of his mailed fist is becoming resented far more than the soft stroke of his ensheathing velvet glove is appreciated.

By exaggerating and exploiting the perils emanating from new ideologies while reinvoking the faded demons of an expired one, the Hegelian ratchet of action and reaction, of belligerence and blowback, is surely aggravating all the antagonisms discussed above: a policy which may well end with the horrid doors of the temple of Janus Quirinus being thrown fully open once more.

Finally, we can hardly overlook the obstacles to genuine material advance which issue from the dismal oracles of that eschatological and profoundly anti-human cult of Gaia worship known as "environmentalism" — a leitmotiv which so informs our present political rhetoric that it has become little more than the liturgy of a state-sponsored religion which handily bathes all of the inquisitor’s cowl, the commissar’s cosh, and the tax gatherer’s claw in a falsely-reassuring, panda-friendly, green glow.

Sadly, little resistance to this is ever heard from among the grandees of the managerial class — the self-enriching CEOs who give true capitalism and genuine entrepreneurialism a bad name among the less discerning. These asymmetrically-rewarded plutocrats, champions of the corporatist state, are all too ready to play along with this humbug (as they are with most other governmental intrusions), happy that there are sufficient incentives to comply being offered in the form of taxpayer subventions, the suppression of competitors, or the personal approbation they can expect from the regime and from its pet intellectual apologists — carbohypocrites, every man jack of them!

Amid this gloom, the hope we must cling to is that, despite the uncomprehending prejudices regularly and cynically stirred up in the masses by the insufferable presumption of their leaders, the "spontaneous order" which characterises our economic organism will continue to provide it with a powerful and constantly-adapting system of repair and recovery. We must not forget that this is a self-organising principle which asserts itself exclusively through the courageous exercise of entrepreneurship in utilizing the previously-harvested fruits of thrift and stewardship — each of them institutions in whose defence we must therefore be untiring.

Among us six and a half billion human cellules there are, regrettably, any number of pathogens, parasites, and cancer precursors to plague us and yet the "invisible hand" of our shared immune system usually manages to overcome all but the worst of their onslaughts, so allowing the rest of us the chance to develop and grow to somewhere near our true potential.

For as long as that precarious advantage is maintained, the secular trend to a resource-intensive deepening of the global capital structure will also persist, allowing us to put aside for now our darker forebodings and to focus on the more concrete (though, presumably less existential) cyclical disturbances which we face in the here and now, retaining a certain faith that material progress can still be achieved — and some measure of liberty retained — in spite of whatever unnecessary disruptions they may meanwhile entail.

Sean Corrigan [send him mail] writes from Switzerland.

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As we began the vaporetto journey across her lagoon, u201CLa Serenissimau201D — the Most Serene Republic — was coyly shrouding her splendours in the thick sea fog she had drawn about her, frustrating the search for the landmarks so familiar from a thousand cheap reproductions of Canaletto’s work on postcards and placemats.

Disembarking directly to the hotel foyer, our first order of business was to pay a brief homage to the gravestone of the father of modern central banking, John Law, who was re-interred in the adjacent Chiesa di San Moise by a descendant who governed the city after its capitulation to Bonaparte’s armies in 1797, a catastrophe which finally extinguished the maritime oligarchy’s 1100 years of sovereignty.

Law — gambler, duellist, womaniser, and monetary theorist — was that very Lucifer of finance who briefly outshone all others when his attempts to rescue France from the Sun King’s ruinous legacy flared into the white heat of speculative excess and chicanery which became known as the Mississippi Bubble.

Fleeing the country in the wake of its implosion — and frustrated in his attempts to persuade his former patron, the dissolute Duc d’Orleans, to recall him when the hue and cry had subsided a little — Law died in Venice in what some claim was relative penury: a necessary coda to this classic tale of hubris and nemesis which is somewhat spoiled by suggestions that he and his common-law spouse actually set up home on the lagoon accompanied by the eighty-odd crates stuffed full of valuable artworks which they had smuggled out before absconding.

In fact, Law’s very modern story was to provide the hook for the brief address which I gave at the private conference my company, Diapason, was hosting in the city: a gathering held in order to celebrate the firm’s three years in business as a leading independent asset manager, dedicated wholly to commodities.

I could do this because Law’s "System" had all the elements of the storm we see around us today — starting with a debt-for-equity swap into an IPO privatisation vehicle with an emerging market theme; proceeding with the building of this enterprise into a "national champion" conglomerate; ensuring its successful launch and paving the way for secondary offerings with a manipulation of the share price through clever financial engineering; and — of course — unleashing a torrent of inflationary paper money and security credit, Shanghai banking-style, with which to pay for it all.

But if today’s ill-recognised inflation is one side of our contemporary investment equation, the splendours of Venice remind us of the other, for these were built upon the proceeds of what for long periods amounted to her dominance of the flow of commodities, both from East to West and from North to South.

Spices, silks and silver, furs and fabrics all came under the influence of the Republic — especially so when, in 1203, having craftily diverted the chain-mailed hooligans of the Fourth Crusade into settling a little private business on his behalf, the blind Doge Enrico Dandolo took part in the Franks’ sack of the city state’s greatest commercial and political rival, mighty Constantinople itself.

Basing her trade on her naval might — and using that trade, in turn, to finance her navy’s construction at what was then the largest industrial complex in the world, the mighty dar-es-sina’ah, or Arsenal — Venice’s three centuries of glory were not entirely a miracle of the free market, just as the US economy today relies more than it likes to admit upon McDonnell-Douglas rather than upon McDonald’s, or upon the Sixth Fleet as well as upon Silicon Valley.

Yet, it has to be granted that however great the role of armed might in exerting her influence, Venice’s unique position was also due in no small part to her aptitude for encouraging entrepreneurs — including those housed in the ex-pat conclave we know as the Ghetto. From this sprang her ability to accumulate capital and to re-employ it fruitfully in order to finance both a further expansion of trade and the acquisition of sources of production themselves.

Perhaps the best example of the latter was the wealth generated by one of her leading families when they married one of their daughters off to James II of Cyprus in the 1470s.

Poor James barely survived his nuptials (portraits of Queen Caterina show he may not have been as unlucky as he seems!), while his posthumously-born son expired shortly after Caterina was confirmed as regent, so it comes as no surprise to discover that the rival Neapolitan faction was soon spreading rumours that the cause of neither death was entirely natural.

Whatever the merits of the charge, as a result of astute diplomatic manoeuvring, the Venetians were soon in undisputed command of the island and Cyprus was transformed from being the last remaining Crusader state (ruled by the heirs of The Kingdom of Heaven’s boo-hiss baddie, Guy de Lusignan) and became instead an economic colony of the Republic, the site of the most important plantations, mills, and refineries it devoted to production of that white gold of the Middle Ages — sugar.

Though some dictionaries provide a more prosaic and much later etymology, Fernand Braudel suggests that the effective sugar monopoly which resulted was so lucrative that the Queen’s relations, the Cornaro, or Cornero, clan, gave rise to our modern expression "to corner the market."

In a setting where every winding alleyway and each of the profusion of footbridges we walked simply oozed a living history, it was hard not to succumb to the obvious metaphor and think of ourselves, at Diapason, as latter-day Merchants of Venice, and to hope that, like Antonio, our "ventures are not in one bottom trusted, nor to one place, nor is [our] whole estate upon the fortune of this present year.u201D

With that, the water taxi arrived to ferry us back to our waiting flight to the mundane world of city streets and traffic jams, leaving Venice floating impassively on her shining sea of memory, gently serenaded by the sublime Adagio emanating from the ghostly strings of Albinoni’s smiling shade.

Sean Corrigan [send him mail] writes from Switzerland.

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For the better part of four years now, commodity prices have been rising as the unexpectedly rapid pace of urbanisation of Asia, running in a not-entirely unrelated concurrence with the deepening industrialisation taking place in Eastern Europe, Latin America, the Gulf, the FSU — and even parts of Africa — has boosted demand to levels totally unforeseen during the resource industry’s Pharaonic famine of the 1990s.

Given both the scale of the increase and its longevity to date — and taking account of Wall St’s predilection for memorable marketing tags — some pundits have gone so far as to call this episode a "Supercycle."

Others are not so sure and point out that such reasoning smacks rather too much of the cries of "it’s different this time" which eventually accompany any boom — and whose increasing stridency usually signal its imminent demise.

After all, one of the underlying tenets of economics is that the emergence of a greater scarcity of some resource is made known in a higher price and that this, in turn, induces consumers to be more sparing in its use — or to seek for substitutions — while it also alerts producers to the fact that there are extra profits to be made either by supplying more of the good, or by finding ways to make what we do have go a lot further.

So basic is this that at least one highly vocal critic has used this concept — if only by way of a kind of extrapolation-squared — to predict that, because base metals prices are currently so far above what he sees as their marginal cost of production, the market will soon be shivering through a "nuclear winter" of shrinking demand and long-term over-supply.

In passing, we should note that this same marginal cost seems to be escalating rapidly (e.g., BHP Billiton’s recently announced 64% budget blowout at its Ravensthorpe nickel project or the IEA’s admission that 95 in $1 of extra energy E&P spending has been eaten up in inflation, these past five years) and that it is dangerous to attach too much significance to one, fairly static datum in a dynamic world of rapidly shifting variables.

More generally, the idea that the higher prices which result from greater scarcity will entrain their own solution may be all very good in theory, but the hard practical experience is that a solution will not be achieved automatically, even given the entrepreneurial will and the supply of ready capital with which to make the attempt.

Let us take a few examples of what may go wrong, here from the world of mining.

Zinc giants Teck Cominco recently told us that third quarter sales of the metal would be reduced by 28%, or 50,000 tonnes, thanks to a burst of unseasonably cold and foggy weather which hampered the firm’s ability to ship concentrate from its Red Dog mine in Alaska. A convenient excuse for management failings, perhaps, but, nonetheless, testimony to the problems encountered in an industry running absolutely flat out

Nickel major Inco, for its part, not only had to cope with a long-lasting industrial dispute at their Voisey’s Bay property, but also had to endure a veritable attack of the gremlins, as listed in their third quarter report:

"… repairs to an electric furnace damaged by fire… took longer than originally anticipated… a motor failure on one of the oxygen plants in July 2006 [led to a] long lead-time to purchase and install a replacement motor… a production incident… damage to the furnace and a converter and has led to the temporary suspension of the operation of one of the two smelter furnaces…"

The result of all this? At a time of record prices and insistent end-demand, the company’s nickel production fell 12% below target and copper missed by close to 20%.

BHP, of course, made the wrong sort of headlines thanks to the labour dispute at its signature Escondida copper mine in Chile, an event which was enough to lower output by up to 40% over the course of several fraught weeks.

Meanwhile, top gold miner, Newmont owned up to a 300,000-ounce shortfall in gold output, citing a wide range of mishaps. As Exploration Vice President Steve Enders told a Denver audience — echoing the views of many of his peers — the main worry, though, remains reserve replacement.

"Newmont and the rest of the industry are really behind in greenfields and generative exploration," he said, noting that, at the same time, "the 14.5% escalation in drilling costs in one year… is killing us."

Then there is another bogie to beat for, as David Humpreys of Norilsk Nickel told us last month, the company will invest "the better part of $1 billion" in each of the next four years with the main result, not of delivering appreciably more metal to the market, but merely of "serving to avert what would otherwise have been a significant reduction in production resulting from declining ore grades."

Ahh! Costs! Equipment backlogs! Skill shortages! Delays! Depletion and overdue maintenance!

Add to this litany of woe the likely cartelisation and hidden inefficiencies involved in the current wave of both horizontal and vertical integration being driven partly by Wall St short-termism and partly by executive hubris.

Notice the political banditry inherent in the creeping nationalisation being enacted, whether covertly via permitting issues, by the insistence on allowing national champions into what were previously private ventures, or through post-hoc demands for confiscatory levels of royalties and the imposition of "windfall" taxes.

Lastly, consider the affliction of that anthrophobic, anti-capitalistic and wholly irrational environmentalism, whether exemplified by cuddly panda(r) pressure groups or in the compulsory purchase of those contemporary green indulgences which masquerade as carbon permits.

This last may be the most pernicious of all since it serves so many disparate, destructive interests all at once.

Big business can enjoy it — as it does all regulatory blankets — as a means of disadvantaging smaller, would-be competitors. Boardroom egoists can bask in the vainglory of the eco-plaudits they can win from both kings and credulous crowds, while disregarding their primary duty to maximise shareholder returns.

Union leaders relish it, because it allows them to dress their selfish restrictionism up in the colours of compassion. "No!" they cry, "You mustn’t move the factory to China — they pollute too much! Here at home, we may be relatively expensive, but at least we’re clean. Pay us more for the sake of your children!…"

Messianic political leaders — each lustful of his precious "legacy" — Jacobin fanatics, and the kind of frustrated dirigistes who secretly bemoan the fall of the Berlin Wall can all exploit Green scaremongering to order their twisted Dystopias, to impose whole new rafts of taxes upon their electors, and to interfere ever more closely with individual liberties as they do.

National Security Strangeloves have a certain coincidence of interests here, too, for not only can they hope that the adoption of the Cult will inhibit the economic ascent of any potential rivals to their own Hegelian deity, but they can easily substitute the militarists’ hallowed concept of "autarky" whenever they encounter the nauseating buzzword, "sustainability."

Then there are whole faculty buildings packed with hack scientists whose uninspired work promises to deliver neither fundamental insight nor commercial usefulness, but who can enhance the importance of their pronouncements — and better harvest public funding — by uncritically endorsing the new atmospheric atavism.

Next up we have the unwashed hordes of woad-painted New Age warriors — dole-devouring, didgeridoo-droning addle-heads — all convinced that if they throw a few brickbats outside a WTO meeting they will soon usher in the kind of faux-Celtic fantasy world best restricted to the escapist realms of the RPG addict.

In contrast, we have an entire concours d’elegance of those fad-ridden fortysomethings who are the latest designer-labelled devotees of the Earth Goddess, their Kensington mews coffee tables groaning under the forest-felling weight of the pretty picture books issued as holy writ by Gaia’s own High Priest of the Britons, the Attenborough.

Finally, we have the same hoi polloi-hating coterie of Michelin-munching, silk-suited Platonic elitists — of the kind so mercilessly exposed in John Carey’s seminal work, The Intellectuals and the Masses.

These sanctimonious, self-appointed meddlers can usually be found advocating higher taxes for budget holidaymakers while hypocritically flying first class from one five-star NGO summit to another. These are the Davos Dominicans — mendicants who nonetheless manage to live high on the hog as they seek to impose their narrow and stifling orthodoxy on all us poor, toiling peasants, while wielding Bell, Book, and Biofuel in the attempt to exorcise us of that most diabolical of fiends, the dreadful demon, Carbon.

Given all of the above, we can perhaps begin to see why the supply-demand issue for commodities is not exactly guaranteed to meet as smoothly and predictably as the crossed lines on an economist’s chart.

Therefore, while not wanting to give any credence whatsoever to the Peak Oilers’ and Climate Catastrophists’ dismal Malthusianism by claiming that mineral and energy resources are in any meaningful sense "finite," what we must recognise is that the world’s diggers, drillers, dairyman and dirt farmers will have to spend ever more prodigious amounts of capital, while employing ever more sophisticated techniques, in seeking to exploit finds in ever more remote, physically extreme, and politically uncertain regions, if they are to meet the basic needs of this, the ongoing, second industrial revolution.

Sean Corrigan [send him mail] writes from Switzerland.

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Though the secular force of globalization and the urbanization of large parts of the world in what some have called a u2018second industrial revolution’ seems set fair to continue issuing its increasing call on the basic raw materials needed to build the necessary infrastructure, those calling for a largely uninterrupted rise in raw materials prices are overlooking the fact that our present day financial structure is almost guaranteed to introduce a significant cyclical element into their trajectory.

This instability is fundamentally rooted in the artificial stimulus to growth which originates in credit expansion and which results in that alternation of booms and busts we call the business cycle.

Despite the long passage of time since the pathology of this affliction was first teased out by the great Austrians, the phenomenon is still widely misunderstood, its causes misidentified, and its progression mischaracterised, so another treatise on this virulent, if entirely self-inflicted, the disease is perhaps warranted.

Blackhawk down!

At its most basic, the foundation of all the associated woes were first explained by Richard Cantillon — the father of modern economics and one of history’s great traders — nearly three centuries ago when he was making his own, considerable fortune amid the twin manias of the Mississippi and South Sea bubbles.

His exegesis relied, at root, on the insight that the process of money creation can never be u2018neutral’ since somebody, somewhere has to have the new money first. In other words, the famous Friedmanite-Bernankean u2018money helicopter’ is not some indiscriminate crop-duster, but a Hellfire-spitting Apache with very specific targets in its sights.

Once he has had his bank account credited, the fortunate, early recipient of the new monies can immediately exercise claims upon existing resources far beyond those he has earned through his prior productive contribution — just like the quartermaster of an occupying army can fill his supply train simply by issuing the expropriated locals with requisition chits, rather than having to render them honest payment in exchange.

In this way, a borrower can hope to buy now, on the cheap — before his counterparty realizes the tendered money has just been debauched — while potentially reselling more expensively later, enjoying windfall gains, once the effects of the dilution have begun to manifest themselves.

Whatever the majority of today’s policy makers may think, even if output simultaneously rises, or people make after-the-fact savings out of this extra money, so that prices in general remain unchanged, this cannot fail to distort and gradually to weaken the economic structure, while merely transferring — rather than increasing — wealth, in a manner that is both unfair and unsustainable, to boot.

In fact, Albert Hahn once referred to this phenomenon of u2018inflation without inflation’ as being the most dangerous type of all, since it was almost guaranteed to lull policy makers and financiers into the most enormous of errors.

But, of course, despite the fundamental lack of equity involved, the masses have been taught to clamour ceaselessly for a regime of easy money, for this gives rise to the illusion of u2018making bread from stones’ — as Keynes, the most persuasive modern advocate of this fateful ruse, once put it.

Easy money is popular because it fosters a period of feverish economic activity through lowering the rate of interest well below the level which would serve to match the supply of genuine savings to the demands arising from the most compelling entrepreneurial investment schemes in strict sequence of their merit.

A measure of the seductiveness of this prospect can be seen in the fact that even Hayek, in his early days, once dismissed the idea of halting credit expansion so as not to have to forego a more rapid rate of achieving technological progress. Needless to say, he spent the rest of his long and intellectually prosperous life demonstrating the full extent of this youthful error.

When money is easy, many more undertakings can be launched than are strictly warranted by the resources available.

This gives rise to the intoxication of a boom for so long as we can defer the crucial question of how all this will be funded — that is, supplied with the necessary real resources — as opposed to merely being financed; that is, furnished with the extra, fraudulent credit needed to contend for an unaugmented pool of such scarce resources.

Live now, pay later

A great part of the appeal is that, with no-one having to undergo the rigours of conscious abstinence today in order to provide for a greater plenty tomorrow, inflation is a means of burning the candle at both ends — of living a gloriously indulgent Rake’s Progress.

Inevitably, what is consumed in the flames which illuminate the revelry is nothing less than hard-won capital. It is only later, when the taper gutters and goes out, that the true extent of the impoverishment which has paid for such a Bacchanal is fully revealed.

Frustratingly, the date of that day of reckoning cannot ever be predetermined — a fact which makes Cassandras of those of us who tend to fret about its inevitability.

Late in life, Hayek himself regretted that he had tended to underestimate the ability of the great institutional change to universally elastic credit and floating currencies to add greatly to the longevity of the upswing.

However, the fact that we humans cannot predict the date of our own demise makes its arrival no less fore-ordained. Similarly, the discontinuities which accompany such a boom must one day come to threaten its very continuance, even if we cannot say when or even exactly how.

Whenever this juncture does arrive, however, the central banks will finally be forced to face the dilemma inherent in their whole flawed policy, for they will now be confronted by the stark choice that to belatedly jam on the brakes is to instantly derail the runaway train, while to shovel even more paper money into its firebox will only delay the wreck, not avert it.

If they do choose the first course — never smart, politically, since it is one option for which the blame can hardly be deflected — it will primarily hit those businesses whose false profitability has come to depend only on the continuation of inflation (and perhaps on its intensification, if the process comes to be better and better anticipated by buyers and sellers).

Those disrupted in this manner will find their margins suffer horribly at the moment the credit expansion begins to decelerate. Then, as their own income falls, their suppliers (especially those of deferrable investment goods), creditors, shareholders, and workers will, in turn, have the squeeze transmitted to them.

Additionally, the economic frictions inherent in the struggle for scarce resources will become progressively unresponsive to the lubrication of inflation. So-called u2018bottlenecks’ will appear in many areas, severely limiting the smooth flow of goods and services wherever they do and thus occasioning losses to those consequently unable to meet deadlines or to deliver on budget.

Moreover, though those urgently-needed workers and owners fortunate enough to be the subject of a bidding war will enjoy a sizeable (if temporary) windfall, this will not do much to mitigate the wider pain if their — or their would-be competitors’ — efforts to increase supply are either protracted, or even precluded absolutely.

Once a fire breaks out in a crowded tenement, the man who has a hose to rent may be paid far more than he could ever have foreseen for its use, but, if the conflagration spreads too rapidly and attacks too many different points at once, this will not spare either his customers, or even him, personally, from suffering the resulting agonies.

Inverted logic

In passing, it is this combination of a scramble for the necessary co-factors to one’s own output (many of which may lie well downstream) and the associated dwindling of cash flow which tends to push up real short-term interest rates at the same time that the strident disharmonies in the structure discourage or disable longer-term investments and so lessen the relative pressure on long rates.

This is why an inverted yield often presages a crisis, since the exigent demand for money which twists time rates in this fashion is, in effect, a signal of a generalized scarcity of present goods: to borrow a term from commodity markets, it is akin to a widespread u2018backwardation’ of circulating capital, of a dire lack of the needed complements to all too many misconceived productive plans.

Thus, contrary to the many who rely, not upon a theory as to why this should be so, but only upon a happenstance of the statistical record, it is also why such an occurrence should be disregarded when, as today, it is not accompanied by elevated real short rates, falling profits, rising risk premia, and direct evidence of credit restriction.

No, sir, today’s inverted curve can in no way be construed as a characteristic sign that extraordinary numbers of producers are forlornly trying to salvage something from the wreckage of their plans even as the financial system has finally become more wary of accommodating them in the attempt.

Rather, the present inversion is only an artefact of three, highly idiosyncratic influences, namely, those of:

1. the prodigious, leveraged purchases of longer-dated securities which are being conducted by the speculative horde — conducted, moreover and in good part, by using the lowest cost global currency to the purpose in a manner which begs the entire question of whether the u2018global’ yield curve (if we can allow ourselves such a loose description) is effectively negative at all;
2. the vast, concerted, governmental programme of foreign exchange intervention, enacted through the same medium of the bond market, but in a largely price-insensitive fashion;
3. the post-Tech Bubble shift in the regulatory environment for pension funds, et al, which has conveniently given these supposed stewards of the small man’s savings a perverse incentive to devote an increasing share of them, not to viable long-term wealth creation, but to finance the present squanderings of the welfare-warfare state by buying its longest dated bonds, regardless of the vanishingly small real yields which they offer.

To sum up, as Hayek again put it, the truly ominous aspect of a negative yield curve is that which arises in a situation where u2018investment raises the demand for capital’ and not when inflation itself — properly defined — is boosting the price of riskier financial assets and thus suppressing long bond yields in a highly artificial manner.

E&P or M&A?

To return to our theme, despite all the inescapably malign side-effects of credit expansion we have detailed above, it is nevertheless true that, while the Pan pipes still play, all manner of businesses can appear to thrive. The rising incomes of those who work for, or speculate in, such concerns will therefore tend to boost all manner of spurious economic activity until the music finally stops.

The political attractions of all this are not to be underestimated, especially since there are, these days, no dynasties to be preserved through the ages, only the briefest of incumbencies to be exploited as shamelessly as possible by each succeeding crop of elected dictators.

In the boom, not only is tallow burned to light the merry makers’ wild carousing, but concrete is poured, copper is wound, chrome is plated, and thrifty sub-compacts are traded in, en masse, for thirsty SUVs.

As this happens, it is of little immediate consequence to the producer of the commodity being more rapidly used up than it otherwise might whether it is contributing to a self-regulating, mutually consistent upswing — one built on the careful deployment of voluntary savings — or whether it is helping construct yet another grand architectural folly; a monument to those recurrent episodes of human credulity which are all too readily financed with paper money and lax lending.

Indeed, to the extent that the producer suspects that things are running just a little too well — and so resists taking a full participation in the boom — such a period of heightened appetite may well not elicit much at all in the way of a supply response.

Instead, he may forego the hard slog of finding and developing his own reserves in favour of using his newly-buoyant share price and his lately-enhanced creditworthiness to try to gain control over those of his peers.

The flipside of this is that, in order to lessen the chances that he will himself become the target of an unwanted bid, he will be tempted to apportion a sizeable proportion of his swollen income stream not to delivering more material to the market, but to putting more cash in his shareholders’ pockets — cash which may well, of course, serve only to further excite the demand for his product when it is finally spent.

Even if he does finally succumb to the urge to expand, he may well find that most of his peers have reached the same decision along with him, meaning our man will soon be confronted by the very same forces of overstretch on which his own forecasts are based — forces which we have highlighted as a major feature of every boom.

If so, he will find that such matters as a shortage of truck tyres; a lack of specialist steels; waiting lists for capital equipment; rising energy costs; the income retardant of a differential strengthening of the u2018commodity currency’ in which he pays his bills; an ageing workforce lacking replacement cadres with suitable skill and experience — and many more such operational difficulties — may greatly limit his own ability to react.

Far from being an academic construct, these very phases of caution giving way to cupidity should be familiar to anyone who has been following the boardroom manoeuvrings of the miners and drillers through the course of this cycle. Each of them has, in its different way, served only to intensify the impact of the secular upswing on the prices of the resources involved.

A promenade down rue Quincampoix

Meanwhile, it must always be borne in mind that the creation of extra purchasing power — in the form of unsaved credit — is a business which involves essentially no cost of production.

Patently, the same cannot be said for the real resources on which those funds may be spent, meaning they are always likely to boast a rising scarcity premium amid a sea of financial super-abundance.

Put at its briefest, this excess of easy money can give the post-hoc appearance of too many savings chasing too few outlets — a u2018global savings glut’, as our esteemed Fed Chairman fatuously termed it, early last year.

Risk premia fall; multiples expand; a u2018search for yield’ begins; leverage rises; a credit-collateral vortex starts to form, and analysts go back to the old Amazon/Google game of making headlines, not through any dispassionate reckoning, but by competing to be the most raucous cheer leader of the boom and issuing ludicrously ascending u2018targets’, like roosters bragging on a dunghill.

In such a phase — like the one witnessed as recently as this spring — it almost doesn’t matter which asset you borrow money to buy, it’s almost guaranteed to go up — pro tem — and the greater the relative weight of money pouring into any individual market, clearly, the more dramatic the results to be expected from the influx.

Conversely, of course, the greater the superstructure of unstable positions which have been built up, the more violent the downdraft when the margin calls can no longer be met, as anyone familiar with this year’s debacle in the natural gas market can attest.

Taken together, all of these malign monetary influences mean that one must always temper one’s enthusiasm for the so-called u2018fundamental’ reasons why commodity prices should tend to rise for some time yet. To recap, these are the ones we adduced above: viz., that producers — themselves victims of an earlier entrepreneurial error of underinvestment — are struggling to catch up to the largely unforeseen and immensely magnified demands of an industrializing world.

However, u2018fundamentals’ alone are never sufficient in an investment process, for this is another realm where subjectivity reigns. We must realize that, just as the humble shopper, in expressing her preferences down at the mall, casts a vote with every lowly dollar she spends which helps determine the fate of commercial empires, vast beyond her ken, so consumer sovereignty is no less absolute in financial markets and that here it is the investor himself, in all his folie d’amour, who comprises the consumer who matters.

Thus, however solidly-grounded we may believe the secular trend to be (u2018More’ will almost certainly be required: that same u2018More’ may not easily be forthcoming), the more transient manifestation of periods of significant decline can never be ruled out, particularly when a previous outbreak of financial market euphoria evaporates, or when a cyclical overextension in the real economy intrudes and a period of recuperation and rebalancing has to ensue.

It is hardly a novel concept that, amid such turmoil, the canny investor’s task is to try to identify and thence to exploit such oscillations — and not to act so as to magnify their amplitude by blindly following a peer group often bereft of any real intellectual understanding of the forces at work in the market, but whose every member implicitly trusts in his individual ability to jump off his log raft just before the stream’s momentum carries him over the cataract with all the others.

What may be a less commonplace observation is one which rests on the propositions we have tried to advance in the course of this article; namely, that the speculator who wants to stand out from the Herd will be greatly assisted in his quest if he conducts his own, entrepreneurial-style assessment of the opportunities and uncertainties which face him resolutely and exclusively from within the correct — and uniquely Austrian — framework.

Sean Corrigan [send him mail] writes from Switzerland.

Indeed, as press reports on either side of the Pond have breathlessly revealed, Wall St’s $21.5 bln in bonuses, added to the $13 bio ‘trousered’ in London’s Square Mile, takes the rocket scientists, vulture capitalists, and assorted structured-product salesmen up to $35 bln in extra moolah in just these two main temples of Mammon.

For allowing my jaw to fall unrestrainedly open at the mention of such sums, I was taken to task as an ante-diluvian moralist and an unmitigated smokestack worshipper by a friend of mine who just happens to work in the bond market (summa cum bonus an non!).

In my defence, I pointed out that one could not quibble that speculation should not be seen an evil, per se; nor could one pretend that the old-style banker who shepherded a man’s savings toward productive investment — using specialist knowledge and economies of scale of which the individual could not dispose — was inherently a malign influence.

I even put aside forebodings about that $350 trillion sword of Damocles which is the derivatives market to allow that such instruments are a baleful presence by dint of their extraordinary scale and not because of their intrinsic properties.

Indeed, I went so far as to admit that, in their primary function of exchanging economic risk between actors with complementary needs — e.g., between farmers and millers — they are an unqualified plus, as they are when they perform the role of genuine insurance contracts drawn up between informed and consenting adults.

But when financiers and traders get paid well enough to make Croesus kvetch for taking wholly asymmetric risks with phantom capital — risks underwritten by government institutions like the Fed and the FDIC; risks constrained by limited-liability partnership, or corporate status — this is not exactly a fair card game.

When arbitrageurs and junk-bond jugglers receive kings’ ransoms for indulging in manic, fiat money-fuelled churning — a hyperactivity which reached $1 quadrillion at the DTCC alone in 2004!! — thus financing illiberal and corrupt governments at home and abroad, and so distorting prices that economic calculation is rendered well-nigh impossible for producers and consumers alike, this is a different ball game altogether.

When the buy-out merchants and private equity partnerships can borrow what are effectively limitless sums of cheap, tax-advantaged debt with which to buy out corporate shareholders (not all of them willing sellers, remember); when they can then proceed to ruin the target business’ balance sheet in a flash, by ordering payment of special dividends and by weighing it down with junk debt, in order to return their funds at the earliest juncture; when their pecuniary motives are mollified by so little pretence of undertaking any genuine entrepreneurial restructuring with which to enhance economic efficiency; when they can rake in an even greater haul of loot by selling the firm smartly back to the next debt-swollen suckers in line (probably into the little man’s sagging pension funds via the inevitable, well-hyped IPO); when they can scatter fees and commissions (and often political ‘contributions’) liberally along the way — then we’re clearly well past the point of reason or endorsement.

Just to see the scale of things here, let us consult the US Dept of Commerce’s quarterly reports on business profits and see how long it would have taken Main St. and Commercial Rd. to make the same $35 billion as did Wall St. and Canary Wharf’s favourite sons and daughters.

$35 billion — even in today’s high-priced world — is no trivial sum.

In fact, it is roughly equal to 15 months’ worth of combined profits at ALL of the US wholesale trade business. It represents close to a whole year of the American mining industry’s after-tax income. It matches 8 months’ earnings made by both the computers & electronics industry and by the nation’s retailers.

It would take almost six months for the entire US chemical industry to ring up the same number of dollars and — perhaps most tellingly of all — even at $60 and north for a barrel of crude and after a three-year doubling per tonne of anthracite, it is comparable to 35% of the annual take of every one of those supposedly villainous price-gougers who comprise Big Oil & Coal.

For any members of the Fourth International out there who still cling to the discredited dogma of the labour theory of value and who are sick of all this talk of profits, they may wish to hear instead that the arch-exploiters’ and rentiers’ $35 billion bonuses would also meet five weeks of payrolls for all of the Stakhanovite production workers left tenuously clinging to the rump of America’s dwindling manufacturing industry.

Now, it is true that, according to Bloomberg News, Exxon’s outgoing boss Lee Raymond was paid $38 million last year — mostly through stock awards — and that this seems to have been pretty much what Henry Paulson of Goldman, Sachs garnered in emoluments, too.

You may well think that Mr. Raymond may actually be worth that sum, or that he may not; likewise Mr. Paulson — but I think I know who created most real value and who had the much harder job to do.

So, who wants to spend weary years of bone-sapping practice learning to be a concert pianist? Who dreams of a Nobel Prize for Medicine for ridding Mankind of one of the many scourges which plague the human condition?

What sane would-be innovator-businessman would aspire to be the next Bill Gates, or Steve Jobs?

Who would think about a job drilling for gas in the wind-swept wastes of Kazakhstan, or digging for minerals in the fly-blown wilderness of Kalgoorlie?

With today’s outrageously skewed reward system — and the twisted monetary backdrop which makes it all possible — why would anyone waste their considerable analytical brainpower to deliver such less controversial benefits to humanity?

As it does to everything else, inflation greatly misdirects human resources, too, and it impoverishes us all thereby.

Why train to be a farmer or a pharmacologist, when you can join Merrill Lynch and become a millionaire in your mid-20s, using someone else’s ‘capital’ and benefiting from being an insider in the great Ponzi scheme in which we live.

Though one should never be a fetishist for such tangible endeavours as manufacturing, ultimately, one must also recognise that all material human needs are met by industry; by the application and transformation of capital goods, resources, labour, etc., into products.

In contrast, no City-slicker exotic options trader (or Zurich gnome!) is going to put food on your table or a flame in your furnace, no matter how quickfire his mind and steely his nerves.

Indeed, if more honest money and thus a less fevered and hypertrophic financial sector meant there were a few less of us and a few more mechanical engineers, private-sector scientists, and process managers — all guided by real-world entrepreneurs and not led by paper money pirates — the MTV-muddleheads’ dreams of “Ending Poverty Now” would be a great deal nearer being translated from a forlorn slogan on their modish, rubberised bangles and into a measurable alleviation of our lot in life.

But, as things stand, it is far, far more lucrative to don a silk shirt, polish up the shoe buckles, and to spend one’s day buying and selling electronic blips on a multi-coloured screen, using a bottomless supply of faux monetary tokens, at what must be the ultimate embodiment of one of Mssrs Gave and Kaletsky’s u2018platform’ companies.

Sadly, such pursuits hold out a much more tantalising prospect of gain; it is far easier to play the tables in a fiat market than it is to make them in a free one.

And that is why the bonuses on Wall St. and in the city are a matter for shame, even if they should not be cause for envy.

Sean Corrigan [send him mail] writes from Switzerland.

by Sean Corrigan by Sean Corrigan

Though darkling realm oppresses all, Its overlord a titan cold, With ruthless stars and ice-shards crowned, His hoaréd orb our night-girt globe, Yet, at his triumph’s very blare, His boreal trumpets’ wind-blasts cease. Astounded he, who sought to bind Our puny race with frost-wrought chains, As ragged tapestries of weave, That chill, not sheltered, keep his Hall, Are kindled in a new struck spark, A youngling flame of Life and Hope.

For eastward, eastward gleams the Child As solstice’ turn brings in His birth And, though we languish in despond, Will Infant grown reconquer Earth, Full-manned in panoply of gold, His blazing sword our Foe’s confound. His fiery scutcheon day star set, Our vital warmth its heavenly round.

From fields ashimmer, boughs weighed down, Will thence come harvest to sustain, But, zenith o’er, His reign shall pass, His kingdom ebb, His power wane. But rue not majesty which fades, Nor fear the shadows’ onward creep. Eternal is the measure tripped, Unfathomed is our wellspring’s deep. Unending is the round we sing: “Our King of Light lies nobly dead– Long live our deathless King!”

Sean Corrigan [send him mail] writes from Switzerland.

Firstly, we must ask whether it could be wholly a coincidence that, just as we are to read the obsequies over our beloved aggregate in March 2006, Iran (if not yet "wiped off the map" by the Imperial legions or their auxilia) is due to open its long-heralded oil bourse; an exchange where trading will be conducted — horror of horrors! — in Euros, not USD.

Now, if this were to spark a reserve shift and/or a more general flight from a dollar currently back in vogue with the leveraged crowd — a switch perhaps aided by moves from those other energy kings, Mssrs. Chavez and Putin — dear old Ben Bernanke would probably be compelled to help American banks monetize much more of Uncle Sam’s debt, in order to keep domestic bond yields from soaring.

Though the mere fact of opening another financial casino might not, of itself, seem to pose much of a threat to the u2018exorbitant privilege’ of the pax Americana, it could, in fact be the crack in the levee which allows the dollar’s unsteady hegemony to be swept away in an ensuing deluge of fear.

For one, America’s main creditors — the Asian central banks — are undeniably nervous about the $2.7 trillion Faustian bargain they have struck with their most importunate customer, as HK Monetary Authority chief, Joseph Yam, reminded an audience only this week, when he told his listeners:

“Whether we like it or not, we now find ourselves in the unenviable position of holding a substantial part of our savings in the financial liabilities of an economy that does not save, fearing that a diversification of a small part of such holdings might lead to a sharp fall in the value of the rest, thus shooting ourselves in the foot."

"We also find ourselves somewhat stuck with recycling a large part of our savings through the developed markets back into the region in a much more volatile form, occasionally creating havoc in our monetary and financial systems.”

Moreover, though the participants have understandably been chary of divulging any specifics of the scheme thus far, the six oil-rich members of the Gulf Co-operation Council are aiming to “reach agreement on the principles of a monetary union by 2006″ and “to press ahead with preparations for a single currency along the lines of the euro” — under the guidance of none other than the European Central Bank itself.

At present, all these candidate currencies are pegged to the almighty dollar, but it would hardly stretch credibility to imagine that the Arabs’ European advisers might see fit to hint that a broader basket of reference currencies — to include those of their other, major trading partners — might be more suited to the purpose.

With the IMF estimating that, as a group, the world’s oil exporters will enjoy cumulative current account surpluses of no less than $900 billion this year and next — and with the Gulf inevitably bound to reap the lion’s share of that enormous bounty — the question of the ultimate fate of this mountain of petrodollars is hardly a trivial one.

It should be obvious that, given the potential sums involved, even a proportionately minor shift, on the part of the oil producers, in favour of a wholly sensible reserve diversification, could have profound implications for markets in the chronically over-borrowed and acutely over-stretched US of A.

Furthermore, if the Bank of Japan can shake off the snarling pack of political dogs who are threatening to legislate against its operational independence in the event it should actually choose to exercise that same privilege, the close of the current fiscal year — March, 31, 2006 — might also be an opportune moment for it to commence the delicate task of weaning its recovering economy off the drug of its u2018quantitative easing’ policy and to begin edging interest rates up from their present, wholly unnatural, zero setting.

Then, absent the multi-billion, one-way bet which relies on further copious BOJ largesse, both local Japanese investors and the hordes of greedy gaijin — who finance a great deal of their speculative trades almost for free, by borrowing Yen and then selling it for dollars — could find it expedient either to liquidate their positions outright, or to finance them directly in dollars — so pressuring asset prices and interest rates in the US, in turn.

Bernanke’s putative problem could be further exacerbated next Spring by dint of the fact that last year’s soggy stock market is not likely to produce much of an April tax windfall in 2006 and so bad deficit headlines will once again be in prospect just as the Administration will want to be ladling out extra dollops of vote-winning pork ahead of the mid-term Congressional elections.

A similar rational would come into play if, by then, any of the following, homegrown exigencies arise:

• the finally-exhausted US consumer finds herself in need of a little Rooseveltian assistance from the public purse;
• the impending pensions bust intensifies (post GM?) to the point where a new Resolution trust is deemed necessary;
• any of the mortgage, M&A, or LBO bubbles begin to produce a few shockers for the financial sector

(Timing here, however, is necessarily much less exact.)

Finally, who knows what retaliatory action — or even unintended consequences — might redound if those Solons of virtue and wisdom, Senators Charles Schumer and Lindsey Graham, at last succeed, by the March 26 procedural deadline, in raising a punitive tariff on Chinese imports and so inscribe their names in the roll of economic history, right next to their illustrious predecessors, Senator Reed Smoot and Representative Willis C. Hawley.

Ergo, if, in order to deal with any of the above, a heliborne rescue mission of the accelerated monetization of government debt were seen to be needed next March, the simultaneous suppression of the M3 data would usefully serve to obscure the extent of the US banks’ role in the scheme by no longer revealing — as one of the aggregate’s particular components — what would then be the banks’ rapidly swelling repurchase agreement liabilities (all of them held against USTs & government Agency bonds).

Thus, the abandonment of M3 could disguise this Reichsbank-like response to America’s hypothetical future ills for some little while thence, delaying market fears of a hyperinflationary outcome, and so keeping "Blackhawk" Bernanke hovering over the scene of the emergency for a little longer than might otherwise be the case.

As with all good conspiracy theories, we hope this sounds just credible enough to keep you wondering whether it might even be true, even though, at this juncture, we have to emphasise that it represents nothing more than the rankest of rank speculations.

After all, it would surely be simpler to assume that the new Chairman might just have taken pity on the poor, overworked public servants — toiling selflessly away in the dreary depths of the Marriner S. Eccles building — and that he has therefore decided to lighten the drudgery entailed in crunching the same, weary old set of numbers they have routinely had to process for each of the past 47 years.

Only time will tell.

Sean Corrigan [send him mail] writes from Switzerland.

Dear Mr. Corrigan:

Something I feel a need to be enlightened on: falling prices.

I was watching a regular TV program that is run by three economists — with occasional guests — here (in Istanbul, on a national channel), and they answered the fax of a viewer on the problem of “falling prices."

Naturally, they being neo-Keynesians, quickly pointed out that it’s the worst of all economic evils.

Their reasoning went: if prices start to fall, consumers stop consuming as they give into an expectation to wait for lower and lower prices.

For example, even though I may be starving, I don’t buy bread at $1 today, which was $1.10 two days ago, since, if I fast for another week or so, I may purchase it for 90c. And who knows, if I break Bobby Sands’ record, in 54 days or so, I may even get the darned thing for free.

Seriously, though, this “psychology of expectations” — and the accompanying “conceit of low expectations from non-inflationary markets” — is a difficult trick to deal with.

In fact, I could bet my boots that three issues are what helps these guys pull fast ones at every opportunity: (i) liquidity — what will poor investors do if they can’t make a fast buck by selling their speculative holdings to some ever greater fool? (ii) consumption — what will poor investors do if other people don’t spend everything on their chosen company’s products, even if they are simultaneously consuming their seed-corn to do so? (iii) u2018deflation’ — what will poor investors do if their company cannot post ever higher monetary profits, thanks to the deceit of a debased currency?

I was wondering if you might say a few words about this “nightmare” scenario of falling prices?

Well, for the hunger-striker gag alone, I thought this merited a considered reply, and — for what it’s worth — I thought I’d share it with readers, here.

As you say, Sir, what nonsense!

Clearly, we all know that iPods will be cheaper next year and cheaper again the year after that; we all know that this season’s must-have shoes will be 50% off, come the Spring; we know that, when the barely-discernibly different new model arrives, the perfectly functional car sitting on the garage forecourt today will be 10, 20, 30% cheaper than its near exact replacement; we all know that the presents we buy for our kids at Christmas will be practically given away by the stores on Boxing Day and — to adapt your marvellous bread analogy (which I will certainly plagiarize!) — we know that if we buy a loaf on the way home from work, rather than on the way to work, it can be had for a song — yet, still, many of us are compelled to buy the dearer product, precisely because we want it NOW!!!!!!

All Keynesians and all under-consumptionists should be compelled to spend several weekends escorting their five-year-old nephews and nieces around the shops, in the run-up to the little treasures’ birthdays — let them see how much psychic pain is really attached to the matter of deferring the instant gratification of wants!

As you also say, we live in a world so engrained with the effects of inflation that it is hard to envisage how things could be other than they are — much as a fearfully scourged galley slave would find it impossible to comprehend the voluntarism inherent in an Oxbridge rowing eight.

Yes, in a world run on debt and dissaving, where instant credit means one never has to wait for anything and where assets are supposed magically to appreciate every year to offset the debt incurred by one’s unceasing improvidence, generally falling prices would prove a formidable — if a temporary and wholly beneficial —hardship, indeed. But, even Heracles must have gotten his sandals wet when he cleaned the Augean stables!

What everyone also forgets is that, in an unhampered market, as prices fall, costs are also likely to fall and that producers may therefore count on earning one of: (i) the same nominal profit per item; (ii) failing that, the same real profit per item; or (iii) a lower unit profit which is compensated for by the higher unit sales which a cheaper price usually occasions!

What everyone also forgets is that as the money we hold and the wages we earn go further and further in the shops, we are therefore becoming materially richer and, therefore, we are likely to become increasingly less, not more, reluctant to consume.

What they also forget is that because we can satisfy our existing consumption needs with less outlay today, we can provide for tomorrow’s consumption needs more richly — i.e. we can save and invest more in an even more materially favoured, lower cost, more prosperous future and so we can begin to reinforce this wholly virtuous circle!

Thank the Gods that Keynes only arrived to plague us at the very tail end of our antiquity! Can you imagine how it would be had he been borne a thousand years earlier? For surely, the authorities would have seen to it that, in their struggle to plaster over and otherwise deface the rich tapestry of technological progress and entrepreneurial innovation with the ragged scraps of their ever more debauched money, the real price of cakes would hardly have fallen from the one they commanded when King Alfred himself was burning them, even as their nominal price would have soared beyond all possibility of calculation!

Sean Corrigan [send him mail] writes from Switzerland.

In fact, on a rough calculation and under the somewhat unrealistic assumption that NONE of the Republikudan war outlays were offset by taxes, but were all funded at the prevailing 3-month T-bill rate and that principal & interest was successively compounded at this rate from the end of the quarter in which the charge was incurred up to end Sept 05…. this would put their contribution alone to around $11.25 trillion — more than a whole year’s current private sector GDP!

For the record, Clinton’s two terms are sufficient to add another $3.8 trillion to the tab, so with the kinder, gentler bomber included we’d be getting close to 2 × all current debt outstanding, and more than twice the increment over the period in question.

Nothing like borrowing to build up a little useful productive capital for the nation’s old age!

Sean Corrigan [send him mail] writes from Switzerland.

This time though, not only are the truly extraordinary mental contortions of the Feketians on display but methinks their inflationist mask has slipped just a little more than they intended.

I quote:

"To start with, Rothbardians have not adequately researched history [sic!] because they believe so deeply in the rationalist myth that truth can be discerned solely through the spinning out of deductive logic [sic]. Consequently they have confused the Financial Bills Doctrine of central government banking with the Real Bills Doctrine of Adam Smith."

"They misunderstand the nature of credit, for they perceive it as monolithic, rather than dual. They misunderstand interest, believing that there is no difference in the interest rate and the discount rate [and what would THAT be, precisely?]. They fail to grasp the difference between the propensity to save and the propensity to consume [You mean, there IS one?]. They think the distribution of consumer goods can be financed like the production of fixed capital assets through borrowing and lending [Can't it? Shouldn't it?]. They presume in their ivory tower world of deductive logic that gold will easily adjust prices down to accommodate expanded productivity [Check out the period from about 1873 until the Gold discoveries of the late 1880s, for a real example of this supposed impossibility]."

"As a result of these misperceptions [sic], they fail to see that under a 100% gold system we would have to endure a much lower standard of living because the trillions of dollars of credit necessary for the production and distribution of consumer goods would have to be taken out of savings, i.e., gold reserves, and thus could not be used to finance factories, technology, plant and equipment, etc. This makes their 100% gold paradigm unworkable for any society that wishes to achieve modern levels of capital accumulation." [emphases mine]

Here, having hopefully condemned them out of their own mouths, I could rest my case, but a subsequent blog session showed that, once again, the Feketians have managed to generate just enough smoke from their furious inflationist friction to befuddle the senses of some of those who find it hard to believe that all their effort and verbiage really does constitute just one more empty philosophical space.

So, it’s back to the lists, once more!

Firstly, those becoming exhausted by this debate should recognise that the Feketians have no concept of capital, to the point they never even mention it.

Since the theory of capital is perhaps the first pillar of the Austrian Temple, even as a profound understanding of the auxiliary role of money and credit is the second, the Feketians therefore have no need of a Rothbardian Samson to pull such an unstable structure as theirs down around their own ears.

Next, look at the confusions here, from Hultberg’s last:

"…real bills, though not backed by previously-saved final goods, are backed by already-produced goods that are urgently needed and in the pipeline. This negates any price inflation…"

Precisely NOT, for money is a PRESENT good, and the fact that the bill is issued against an "already-produced [higher order] good" provides absolutely no guard against inflation. This is because it allows the fiduciary money so generated to be offered forthwith in exchange, without having to wait for the consummation of the yet-to-be-produced present (final consumer) good to which the bill’s corresponding consignment of material might, after further, lengthy subjection to the productive process, one day give rise.

In truth, it is bad enough for the purposes of entrepreneurial calculation to allow money to grow in strict lockstep with the volumetric availability of even final goods — herein lie the pitfalls of Irving Fischer, et al. — instead of allowing benign, supply-side price falls, where necessary, to signal costs and prices accurately, all along the cone of production.

But what is worse, as the Feketians blithely propound, is to assume that no ill can come of increasing the number of demand claims on final goods — as constituted here, now, today — against a promise of final goods to come, a week next Wednesday!

This temporal difference is utterly crucial and herein lies the crux of the dispute, for the Austrian would hold that any bill (or any other form of credit) is totally unobjectionable when it is funded by saving (waiting), or when it is paid for, prior to maturity, in gold — in which latter case it represents a temporary transfer of purchasing power from some willing other (probably with the intermediation of an honest bank) and thus it does not produce multiple, simultaneous claims to the same stock of scarce final (present) goods — a phenomenon which constitutes the disruptive fraud of inflation!

OK. Now consider the next few lines:

"…In addition when real bills are discounted by the banks, the notes issued to do so are backed 100% by bank reserves of gold and real bills that mature into gold within 90 days…"

This is a wholly misleading assertion. Bank money is either 100% backed by money proper (ideally, until we find a better substitute, gold), or it is not.

Substituting a credit instrument for this backing, and so not according one man instantly-exercisable purchasing power only after the voluntary abnegation of this right by another, is as fundamental an error as you can make and one that leads to all our subsequent logical confusions, not to mention the considerable practical harm it perpetrates in the real world.

"… In a truly free-market banking system that prohibited fraud (such as borrowing short to loan [sic] long)…"

As an aside, is this act a fraud? True, a man taking such a chance will need to secure a series of consecutive short-term loans until his longer-term project matures, and thus he runs the risk of being caught illiquid — if not necessarily insolvent. But, nonetheless, he has still attempted to fund himself with savings, even if the single-span bridge of a matched-term loan would be a more certain means of crossing Time’s turbulent river than the slippery succession of short-term stepping-stones he instead chooses to attempt.

But, we digress. Let’s return to the main point of contention with the vexatious Mr. H:

"… The real bills are as good as gold because they can be sold in the bill market for gold at any time by a banker to meet any demands from depositors for specie redemption…"

But isn’t this precisely the point where all fractional reserve banking fails? Just who will appear to sell the Feketian bank this gold in its hour of need, unless that person fortuitously decides to save, (i.e. to forego the act of immediate consumption) post hoc et deus ex machina, so rescuing the bank from its counterfeiter’s nightmare — namely, that too many of its depositors will want their money back, all at the same time?

Historically, the answer to such straits has been suspension (i.e. a total violation of contract) and/or the interjection of the state. Historically, whether u2018real bills’ have been held against its notes or not, such banks have tumbled their innocent depositors down in the rubble of their own crushing ruin.

Such evil is the inescapable consequence of allowing banks to connive at having more than one person lay claim to an as-yet unaugmented stock of present goods (as opposed to goods-in-progress) — and of aiding and abetting the act of cheating the genuine money holder of his due; a crime committed, however unknowingly, by the man clutching the duplicate claim represented by the bank’s fiduciary (unbacked) notes.

Ultimately, what the Feketians cannot comprehend is that it is likely to prove cold comfort indeed to find that, when you shout at your banker that you want your rightful money back to buy a hamburger, NOW!, all he can offer you is the u2018real’ bill he has discounted — and that, at best, you can only use this instrument of holy Feketian veneration to lay immediate claim to the phial full of bull semen against which it was drawn!

Sean Corrigan [send him mail] writes from Switzerland.

However, the latest blast from Mr. Hultberg was notable for the fact that, far from continuing to press his case on its economic merits, it constituted nothing more than a farcically overblown assault on the libertarian credentials of Murray Rothbard — he, of all men!

Thus, we read that:

"Rothbardians will have to become government interventionists in order to implement their 100% gold monetary system. They must interject government into the free interaction of entrepreneurs and customers to dictate what form of trade they may partake in."

"…The issue is who is to make the choice between these… forms of banking — the government or the people? Are we to have the choice dictated to us by politicians and their armed police, or are we going to be allowed to freely decide for ourselves in the marketplace?"

"Because they declare fractional-reserve banking to be fraud, Rothbardians must opt for state dictates and armed police to decide."

Clearly, to respond to this hysterical bromide with a line-by-line rebuttal would truly be to accord it a much greater dignity than it should command.

That said, it does occasion just a little mirth that our antagonist has seen fit to raise the spectre of the marbled banking halls of a Misesian Dystopia being subject to frequent assault by squads of brutish Austrian storm-troopers, all so that the account books could be delivered up to the instant scrutiny of a Rothbardian Torquemada — a foaming zealot all too eager to carry out an auto-da-f on any inflationist heretics he can unearth!

More to the point, the casting of this lurid vision does lead one to wonder whether the Feketians have at last realised the paucity of their economic justification and have therefore chosen this noisy, but wholly specious, shift of direction, in order to cover the confusion of their retreat.

Among the litany of fundamental mistakes of logic and fact which comprises Mr. Hultberg’s invective, one of the most startling is that a man who so readily adopts the posture of a bristling anti-statist could allow himself to confound a most fundamental issue of liberty.

For, in calling hellfire down upon the Austrians, he seems to be ignorant of the principle that a true system of law can only arise by an appeal to natural rights — and must develop thereafter among private actors as a way of facilitating Man’s crowded life in a co-operative society.

Categorically, we must not fall for the pretence that the Law — rather than mere legalism — is instead that endlessly-expanding catalogue of injunctions and prescriptions which are continually being handed down by the grovelling officers of the State, so as to favour its supporters, disadvantage its foes, and visit its prejudices forcibly upon the rest of us.

For, it is only by assuming the latter that the positivist (i.e. state-determined) legal privilege — which is an absolute sine qua non for the maintenance of the dangerous and flawed workings of fractional reserve banking — can be applied to such bankers, alone among men, in place of subjecting them to the otherwise universal application of an adherence to open and voluntary contracts.

Were it just a matter of our detractors’ lurid name-calling, however, this would not warrant further mention.

However, the persistence of this whole phoney argument and the attention which that stale porridge of u2018real bills doctrine’ has lately drawn does show that a fundamental misperception exists about monetary matters — one which it might be worth yet one more effort to dispel.

Ironically enough, not the least of those seemingly in the thrall of such a misconstruction are to be found among the wide constituency of Gold Bugs, many of whom seem uncritically keen to fill their websites with the Feketians’ submissions — whether these take the form of the founder’s alchemical maunderings, or his apostles’ self-righteous thunderings.

Do the Gold Bugs not realize that u2018real bills’ doctrine is absolutely inimical to their cause?

Do they not understand that the practice of this pernicious creed served to discredit and ultimately to destroy the metallic system they so esteem?

Don’t they realize that the Federal Reserve — the monetary Antichrist of their particular Revelation — itself adheres to a thinly-disguised version of this cant?

Perhaps not: but the Gold Bugs are not alone in succumbing to this spurious programme. Indeed, it may be that the credence which monetary cranks are all too frequently accorded has its roots in two different, but mutually reinforcing, phenomena.

The first is a deep-seated — but often unarticulated — feeling that the history of money is largely a tale of wholly avoidable tragedy. This then becomes conflated with the fear that our own ever-uncertain future looks even more ominous than it need do because of the flaws inherent in the monetary system under which we still labour today.

One can feel a certain sympathy with such sentiments, for they undeniably contain more than a kernel of truth.

However, where this leads the disquieted layman astray is that he has never been taught to fix his bearings fast upon the mental beacon which is the truth that money is a mere cipher, a medium by means of which goods and services are exchanged, and nothing more.

Thus misdirected, he focuses only on the shadows cast on the walls of his pecuniary Plato’s cave, and so, he is highly prone to becoming seduced by each reformatory scheme in turn, as it is promulgated by any of a long succession of wild-eyed prophets, impractical idealists, and cynical charlatans.

In the attempt to avoid this obfuscation and simultaneously to exorcise the whining ghost of the u2018real bills’ doctrine, perhaps we should best approach this using that stalwart aid to clear thinking, Crusoe economics.

So, please join us in imagining that, rather than just having Friday with him on his island home, Crusoe also enjoys the company of a second man, Thursday.

At first, they all three eke out a bare subsistence, with Crusoe hunting the shoreline for crabs and shellfish, Friday hunting for goats, and Thursday shinning up the swaying palms in search of coconuts and other tropical fruits.

But, one fine day, Crusoe decides that, between the three of them, a much more efficient method of production could be put in place; one which would lift them out of their barebones struggle and into a life of enhanced security, more comfort, and even greater variety.

The trick, he explains, will be to save a requisite portion of their daily haul of food and then gradually to organise themselves in order to take full advantage of each man’s specialist skills.

Thursday, he declares, with his knowledge of the forest, will collect timber, hemp, and tinder which, once gathered, he will then give up to Friday.

The latter, being good with his hands — as well as having mastered the rudimentary pastoral skills needed to look after his goats — will use these raw materials, plus the skin of one of his flock, to fashion an outrigger canoe, and a net and he will surrender these, in turn, to Crusoe — the experienced mariner and accomplished fisherman.

Suitably equipped, Crusoe will then be able to venture out as far as the surf pounding the outer reef of their island refuge and will thus bring in a greatly improved haul of fish each day, according them all a much greater degree of certainty that their bellies will be regularly filled than the three of them had previously been able to enjoy.

As he reckons it, this will require the prior saving of three full days’ rations.

This having been achieved — not without some effort of will and grumbling of stomachs at making sufficient savings out of such a poor diet — the project goes ahead.

On the first day, one of the saved rations will be used to feed Thursday after his initial spell of foraging for raw materials in the forest, while Friday and Crusoe will keep on about their normal routine and so continue to satisfy their own needs (however poorly) as before.

On the second day, Friday, will also now abandon his old round and instead will take Thursday’s inputs and use them to make the boat and net. That evening, another ration will be taken to feed Friday since he will not be directly able to provide for himself out of his substitute occupation.

Simultaneously, the third and final portion of savings will be consumed to keep Thursday in sustenance, as he repeats his task of the previous day and so maintains the onward flow of goods-in-progress.

Crusoe, meanwhile, will attend to his primitive search among the rock-pools and will eat the exiguous proceeds of his own labours later that night for what he sincerely hopes will be the last time ever.

Finally, on the third day, the rearrangement of production will reach its fruition when Crusoe paddles out through the light swell of the lagoon to spend an active but exhilarating day setting lines and casting his net.

Triumphantly, he will, at length return to shore, laden with the bounty of the seas, for the shared enjoyment of all the castaways.

As he has fished, Thursday and Friday will have gone on about performing their newer tasks, as they did during their previous day’s labour, in order to keep the continuity of their novel chain of production intact.

Now — to add a decidedly anachronistic set of modern financial concepts to this glowingly successful display of mutual co-operation, we can treat the three days’ rations, initially saved to u2018fund’ the process, as u2018capital’.

In essence, Friday — who needs only one day’s support — can save enough on his own (his is a self-funded business), but while Thursday can save one unit of capital himself, he must also borrow another unit from Crusoe who will have need of none himself, since he will work the old way and earn his keep without interruption until the very last, unlike his two colleagues.

Having established this, next let us keep track of who owes what to whom throughout the process by having them draw bills of exchange (You-owe-me’s, rather than IOU’s) upon one another.

At the end of the first day, as Thursday hands over his product to Friday, he will draw upon him a bill (effectively invoicing him), for value two calendar days hence, to the sum of one unit of goods (to avoid confusion, we shall here defer all questions of money, units of account and interest. Neither should it be thought that we are endorsing a labour theory of value through this simplification!).

At the end of the second day, Friday, having added his labour and materials to the batch, will deliver a canoe to Crusoe, drawing upon him his own bill. This one will be for two units’ worth of goods and will fall due for final payment one day hence.

Though it is not germane to what follows, bear in mind that as part of the ongoing stream of goods now repeatedly working its way through what is, in effect, a sequentially-outsourced, mass production line, Friday will also now take delivery of another batch of materials — perhaps repairs, spares, or an upgrade — from Thursday, for which a second two-day bill of one unit’s worth will be drawn upon him.

Finally, at the end of the third day, Crusoe will wearily drag his canoe up the strand and will discharge the debt recorded by the bill drawn upon him (and so redeem it) by paying Friday two units of fish, leaving one for his own profit. Friday, in turn, will redeem Thursday’s claim upon him, by paying out one unit to the latter.

(As above, the third day will also see Friday delivering more goods to Crusoe and drawing his second bill upon him. Again, Friday will also take delivery of a third batch of materials from Thursday, these to be accompanied by another bill drawn upon him)

It will be seen that this basic schema contains several levels of simplification — not the least of which is that we have set the increment of value produced at each stage equal to that arising at the next.

Out in the real world, the relative valuations between them would rather be determined by the market according to what the matrix of competing demands for such goods and services throughout the whole economy would come to imply for their prices.

The other major omission is that we have not introduced any rates of discount or interest (each identical by definition, whatever the Feketians absurdly try to insinuate); nor have we mentioned profit or time preference.

As a first step to remedy this omission, we can act on the assumption that, in the innocent little world we have presented — blessedly absent the distortions of banking and high finance, much less the baneful interference of government — these will all harmoniously equalize in that theoretical, if never-to-be-realized Eden of equilibrium, the u2018steady state’.

Thus, setting both the simple discount rate and the required rate of return on capital at the (ludicrously high) level of 10% per diem and assigning each day’s product the value of 100 arbitrary units (with 100 in value added, therefore, at each stage of processing), we can derive the pro forma accounts shown in the table below.

-

Thursday

Friday

Crusoe

Discount rate

10.0%

10.0%

10.0%

Revenues

120

220

300

Cost of Sales

0

100

200

Equivalent Interest Paid

-

20

20

Net Income

120

100

80

Cost of/ (Earnings on) Invested Capital

20

0

(20)

Final Income

100

100

100

Here we see that Friday took 100 units of goods from Thursday which — working backwards at 10% per diem for two days — meant the bill was drawn for a face value of 120 units. Crusoe took 200 units at 10% for one day which was thus drawn for 220 units. Additionally, Thursday owes Crusoe for two days’ use of 100 units of capital.1

So far, there should be nothing controversial in any of this — though we do have to emphasise most strongly that the existence of the bills per se has had nothing to do with the matter of whether our three castaways were able to effect this transformation of the productive structure in the first place.

The bills have only functioned as a score-keeper — a tally of who contributed what and when — and, yes, they have been able to do this as voluntarily agreed instruments of credit, and all without the necessity of them possessing any of the attributes of a u2018money’ whatsoever.

No. What has been needed is capital — by which we mean not yet another form of financial instrument, but the availability of material savings for deployment towards an envisioned productive use. This capital was the sole, necessary and sufficient, tangible pre-requisite for our heroes’ progress toward the establishment of a divided — and probably a more fruitful — mode of labour.

That this has not come up in all the bad-tempered to and fro between the u2018real bills’ advocates and us Austrians should be no occasion for surprise.

This is because the Feketians have nothing whatsoever to offer on this matter, since, like the vast majority of other would-be monetary meddlers, they exhibit an utter lack of any concept of the primary need for capital and hence of its irreplaceable role as a temporal bridge between the present — when u2018roundabout’ methods of work are begun — and the future — when their consummation will hopefully result in an array of useful final consumer goods.

But where the Feketians do intrude — and intrude mischievously and detrimentally, at that — is that they would herein introduce an institution which they would gladly allow — indeed, which they would urge — to run that pyramid scam, that Ponzi scheme, that legal embezzlement which goes by the name of u2018fractional reserve banking’.

The only limit they would set on this institution’s reign of deception is that it should only be able to work its dark sorcery upon those bills of exchange demonstrably raised as invoices for the transfer of ownership of physical goods. They also stipulate that these are to be redeemed after the passage of a maximum of a numerologically pleasing ninety days.2

We have raised objections to the blithe assumptions of the enforceability of this supposed restraint before, so here we will let it pass without protest.

What we would like to do, however, is to illustrate just how detrimental such an unnecessary and artificial system is to the process of dividing and specializing labour in the manner outlined, and, hence, how much of a curse the Feketians’ supposed blessing really represents to Man’s prospects of material improvement.

To do this, let’s step back a touch and suppose that the vital three days’ store of savings are being kept in a warehouse on the shore and that each has been separated into a crate fastened with its own unique padlock.

Friday — by dint of having saved one of the units out of his own entitlements, naturally has the key to the corresponding lock. Ditto, Thursday who, furthermore, has been given the key to the third by its owner, Crusoe, in exchange for a share of his eventual earnings.

So, at the end of the first day, Thursday unlocks the first crate and eats his evening meal, as a just return for his labours.

In the normal course of events, at the end of the second day, Thursday would use his remaining key and Friday would likewise utilize his own, so granting both men their due bodily satisfaction.

However, on the morning of the second day, after Thursday has handed his previous day’s products over to Friday and has drawn a bill of exchange upon him to record this deed — a bill which is not due until two day’s hence, you will recall — let us suppose that our Feketian Real Bills Banker pops up from nowhere and offers to issue Thursday with a skeleton key in exchange for his bill.

Now Thursday need not be so abstemious. He can run straight to the magazine and help himself to a large and unforeseen breakfast from the contents of Friday’s box, only sparing a fraction of it to accord the Banker a small share of the loot.

Alas and alack! Come the end of that second day and there must be a fearful falling out, for, then, Friday and Thursday will both repair to the locker room, only for the first to find that he must now go hungry since the second has already made off with the provisions he, Friday, had laid down for his own use, while the culprit, Thursday, still retains the sole key to the last remaining portion.3

Not only will this discovery give rise to suspicion and social strife — dissipating the spirit of willing collaboration which had hitherto promised so much — but it must also stop the chain of production in its tracks, for Friday will now be in danger of succumbing to his inanition.

He may, therefore, be unable to continue to work on the morrow. Alternatively, his hunger may cause him to abandon his place in Crusoe’s novel set-up and revert back to the job of feeding himself directly, if inefficiently, as he did before.

Either way, he will cause a rupture in the painstakingly constructed chain of production and it will not be long before both the visionary Crusoe and the incontinent Thursday are also forced back to the same low-level subsistence methods they had employed before their grand experiment took place.

Again, even if Friday is strong enough simply to tighten his belt and carry on, this will not be an end of it for, when Crusoe does land his first prodigious catch, it will be Thursday who now finds himself short of provender, having earlier ceded his rightful claim upon a share to his Real Bills Banker.

This latter, you will note, has done nothing to facilitate the actual productive flow, but rather has sought to live parasitically off the cupidity and intemperance of Thursday, all the while sowing discord among the three men whose interest should be indissolubly linked together.

In all of this, we have not had to appeal to arcane arguments about inflation; nor to the intricacies of the entrepreneurial effects of disrupted price signals: nor have we dwelt upon the perverse and conflicting incentives offered to the owners of factors of production (including labourers) by the hosts of financiers and coin-clippers who live by bamboozling them.

However, this toy example should still suffice to demonstrate beyond reasonable doubt what happens when temporally-extended credit is diabolically transmuted into instantly-expendable money — which is, after all, the very purpose of a system of u2018real bills’ wedded to fractional reserve banking — and we should also be able to see that the now-monetized bills’ infinitesimal capacity for doing incidental good is utterly overwhelmed by their near infinite capacity for doing purposeful harm!

To restate the issue: we must always concentrate exclusively on analyzing the material requirements of production and not allow ourselves to be befuddled by the vapour trails of their monetary familiars.

As we do, let us first lay a Feketian calumny to rest, for no Austrian is concerned to preclude the issue of bills — or of any other instrument of private credit — for, indeed, he is aware that this may constitute a great and laudable convenience and is, in any case, a matter for sovereign individuals to decide.

But, what the Austrian also forcefully avers is that the moment we allow the legally-favoured bankers to issue fiduciary media (by which we mean bank-created money entirely unbacked by previously-saved final goods) against such credit, we are doomed to end up with too many instantly-payable claims on the stock of goods currently in existence.

This circumstance can have only one effect — and an unmitigatedly malign one at that — namely, to complicate, if not completely to frustrate, the business of calling more such goods into being in future, as our tale of Crusoe and his partners was intended to illustrate.

It is therefore absolutely imperative — not just on high-flown, ethical grounds of equity, the sanctity of contract, and ultimately of liberty itself, but also due to more prosaic, pragmatical considerations of productive efficacy — that the granting of credit cannot be permitted to create multiple, on-demand claims to the same stock of final goods.

Instead, all such credit as is given must be matched by creditor forbearance until such time as those goods realize their existence, at which point the debtor can discharge his obligations by forbearing, in his turn, from playing any part in their consumption.

No less than we must trust our obligors to pay up promptly when the loan comes due, it must be incumbent upon us obligees to act only in the knowledge that we cannot both have our cake and eat it, too.

It must, then, be impressed upon the creditor that a term loan (or a u2018real bill’) is exactly that — a contract which insists that, for an agreed period of time, he must wait until he indulges himself; that it is a pledge of future goods and future goods alone — and that it cannot, at a whim, be transubstantiated by a fractional reserve banker into a duplicate (we might say, a counterfeit) claim upon the same present goods whose enjoyment has supposedly been uniquely transferred, pro tempore, to the debtor.

It is precisely the evil of fractional reserve banking that it violates this stipulation and no amount of window-dressing by limiting its scope to one particular instrument of credit, or to the one tenor over which this may run, can mitigate the harm it will do as a consequence.

Nor can any such tinkering ever be enough to extend the operation of such a palpably ruinous system beyond the speedy collapse it would otherwise endure were it not underwritten by the terms of that tyrannical Devil’s bargain of the kind most famously drawn up between the corrupt Whig financiers of the u2018Glorious’ Revolution and their importunate, invited overlord, William of Orange, for the "better prosecution of the war with France".

At the risk of blurring the weight of this conclusion — and in anticipation of receiving another heap of opprobrium from the Faithful — I cannot resist closing with the puckish suggestion that the Feketians should forthwith hold some sort of Council of Nicea to settle upon a consistent body of dogma, before they have the temerity to carry on their attempts to proselytize the rest of us.

I say this because it is notable that one wing of this church offers soothing assurances that we need have no fears about the implications of their schemes, since, they blithely assert, u2018real bills’ possess an impeccable pedigree, having successfully been in place all through the long, drowsy days of a supposed Victorian summer of u2018price stability’.

Yet, sitting in the pews on the opposite side of the aisle, there are others who are somewhat embarrassed by the actual historical record of wild booms and crushing busts, of rapid inflation and plunging deflation, which characterized much of that turbulent period.

Not to be discouraged either by reason or experience, however, these good souls roundly declare that u2018real bills’ have never been given a true test, having always been adulterated by the prolific rediscounting of all sorts of other, less worthy bills — a crime perpetrated, of course, by exactly the same coterie of foolish and greedy bankers that the Feketians want to foist upon the ideal future Commonwealth of their promises!

To the first group of schismatics, we can only say that to make a fuss about the fact that u2018price levels’ at either end of the 19th century were more or less equal — and to disregard the vertiginous topography they mapped out within it — is to say that because America’s sea level is the same on its Atlantic coast as at its Pacific one, one can safely fly between the two at an altitude of fifty feet!

To the second group, we can only confess that they seem most like the hapless plague doctors of Pepys’ London; quacks who well recognise the symptoms of the disease, but who are unable to identify its root cause — in our case, fractional reserve bankers, rather than the equally pestilential rats and fleas! — and instead opt for a truly Hermetic mysticism in treating it.

So, we are left to wonder just how that Feketian Pietist, Mr. Hultberg, proposes to prevent the fractional reserve bankers he so ardently defends from once again debauching his new Jerusalem of u2018real bills’ and from inexorably transforming it into an inflationary Sodom and a speculative Gomorrah of monetized credit instruments — whether finance or accommodation bills, promissory notes, securities credit, asset-backeds, etc. — without himself having to resort to an appeal to the same violence of authority which he falsely supposes his opponents to endorse.

But, enough banter.

Simply banish the bankers and insist upon an honest money (one likely to be firmly based upon a rigorous gold specie standard), Mr. Hultberg, and you can issue all the bills you wish, for then they’ll be unable to do much harm to the rest of us — and that means we shan’t ever be tempted to call in the Rothbardian monetary Sonderkommando of your unrestrained imaginings!

Notes

1. To forestall a storm of irrelevant protest from the anachronists of the ‘real bills’ cult, it will be freely admitted that the historical drawer of a bill of exchange did NOT habitually think forward in this way, adding a premium on, but that he tended to work backwards, deducting a discount instead.
   However, though the accounting treatment would thereby be rather inconsequentially altered, that this makes not the slightest economic difference should be apparent by the observation that such discounted bills have largely been superseded, in the modern world, by the use of interest-bearing instruments.
   On these grounds, we are fully entitled to regard Thursday’s 20 units’ of earned discount, without caveat, as the equivalent of interest paid. Similarly, as laid out in our table, Crusoe took 200 units from Friday for one day @ 10% per diem, so, in anticipation, the corresponding bill will have been drawn for redemption at a value of 220 units. Finally, Crusoe has capitalized half of Thursday’s initial endeavours and so requires 100 x 10% x 2 days = 20 units of dividend payments as recompense for his investment.
2. Attentive readers may have noticed a small hitch here, for, in our example, Thursday’s bills run for twice the time that Friday’s do. Though we arbitrarily set the elapsed instalments of time to one and two days, there is nothing to say that these could not last for thirty and sixty — or, indeed, ninety and one-hundred-and-eighty days — or any other number, without any prejudice whatsoever to the process. What, then, apart from a piece of cod historicism, is so special about the Feketians’ ninety days alone?
3. If it is objected that the principle of the total fungibility of deposits in an actual bank became an unfortunate matter of legal precedent in the early 19th Century and that, therefore, the parallel should be that each man draws rations from a common pile, rather than from a separated and identifiable box, this makes little difference, save that it means that either the first man to the store will exhaust its contents, or that, arriving together, both will have to be content with half, since each will be clutching an otherwise identical claim to the whole.

Sean Corrigan [send him mail] writes from Switzerland.

~ James E. Thorold Rogers
Six Centuries of Work and Wages, London 1901

In line with the above definition of futility, I shall not spend time re-re-rebutting all the false lines of argument and logical errors in the latest blast from the Feketians, but there are one or two points worth making, nonetheless.

Ever sensitive to the "unscholarly" tactics of the Unbelievers and quick to wail about u2018ad hominems’, while peppering their own bromides generously with the same, one might take the Devotees’ complaints a little more seriously were they themselves not steeped in the sophistic techniques of the high school debating society.

For example, consider the following paragraph:

“The first mistake made by Corrigan and Blumen is their Rothbardian conception of what inflation is. They rigidly define inflation as any excess of money and credit over gold and silver reserves. They believe that all such monetary inflation is dangerous because it will always bring about price inflation. This, of course, is not true as all credible economists understand….”

But, Mr. Hultberg should not presume so much when he puts words in my mouth. I cannot speak for Mr. Blumen, but I do not now, nor ever never have, defined inflation in this way, nor have any of the Austrian masters, to my knowledge. (As an aside, I’m not sure I’ve ever been known to pay much attention to silver, either.)

“Inflation,” i.e., unwarranted credit expansion, comes about when new monetary substitutes (“fiduciary media” to use Mises’ phrase, as well as outright fiat money) are brought into existence and so disturb a prevailing state of adjustment between the "real" economy and the prior total of (A) genuine commodity money (including 100%-backed money certificates) and (B) any already-issued fiduciary (and fiat) money.

Here, then, it is not the presence or absence of unbacked money which matters, but rather a question of whether that which was previously conjured up has been allowed to work out all its effects, and of how easily and to what extent it can be further increased and so occasion future disruptions.

Accordingly, to advocate the adoption of a 100% gold-standard is a step not aimed at indirectly defining “inflation” as being a stock of money equal to, rather than in excess of, a set amount of specie, but at taking a practical, institutional stance on how best to limit the further progress of the disease which so besets us.

Additionally, we must recognise that a given credit expansion’s effects can never be predetermined, for it just may be that much of this new money will simply find an outlet in voluntarily-increased, post hoc saving (as is the case in China today, for example) and that this precludes, or mitigates, any wholesale change in prices.

Even so, it still cannot fail to alter the matrix of economic data, by changing the relative prices between the increased amount of goods being sought by the newly-empowered spender-borrowers and those wares whose incremental uptake is abstained from by the spenders’ counterparts, the new savers, in their turn.

Indeed, Austrians have spent a good deal of time debunking the mechanistic quantity theory of money implied by Mr. Hultberg’s words, which leads us to wonder whether he has actually read — or having read, truly understood — the work of those whom he is deriding.

No! Not for us an invariable mathematical relationship between that aggregative fiction known as the price level and the quantity of money. Like all other economic goods, we hold that the value of money is set subjectively, and at the margin, by the actions of millions upon millions of individuals going about their daily lives and entering into free exchange with one another.

Therefore, only convince people that extra money will not necessarily mean higher prices and they may just hold onto enough of the additional medium to make your weasel words hold true for a while: why else do central banks expend so much hot air on boasts about their “credibility,” and why do they also fret so much about the temperature of their precious “inflationary expectations”?

Conversely, let the populace come to doubt its money’s ability to retain its value (or, more realistically, let people fear it will lose its value at an even faster pace than at present) and then, in the self-defeating rush to be rid of it ahead of this expected calamity, prices can still rise for a time, even if the volume of money is held constant, or is even falling.

Anyone who doubts these contentions, has never read anything of the course of events during the great European hyperinflations of the last century

To set Mr Hultberg straight, then, we should inform him that "inflation" is an increase in the quantity of money above and beyond people’s desire to hold it, rather than spend it: gold and silver do not enter into the discussion, save as a functional means to make inflation as difficult as possible to promote, to the benefit of all.

With that hopefully put to rest, it is perhaps now the time to deal with one other insidious tactic which the Feketian camp regularly employs in its assault on reason and to state categorically that, for all the sound and fury surrounding it, the monotonously invoked concept of "clearing" is nothing more than a side issue in all this, for clearing is only a contractual arrangement which economises on money use and is thus wholly unobjectionable of and in itself.

Indeed, we could almost be cheeky and say that the appearance of private clearing systems undercuts one of the fundamental premises upon which Real Bills and other inflationary doctrines are built; namely that, under a 100% gold specie standard, money would somehow become too “scarce” as the economy grew and hence that some form of phantom substitute must be introduced to allow economic progress without living in peril of a “deflation" occurring (another phenomenon also wholly misdefined by our opponents).

But, even if the u2018needs of trade’ mean we come to exchange ever more IOUs among one another — in the form of bills, as but one example — the only important thing is that these must NOT be allowed to form a “money” themselves: a transformation which they are only likely to achieve if we accord property-infringing privileges on bankers, whether or not backed up functionally, as well as legally, by the State.

Contrary to Mr. Hultberg’s strictures, there is nothing in here which violates any libertarian code. Quite the converse: to continue to allow banks and the state this pernicious opt-out from the common law of contract is to throw all private property into jeopardy, as well as to threaten liberty and to hamper the smooth course of material progress.

But this point somehow evades our protagonist and so he waxes sarcastic, at this juncture:

"If Rothbardians wish to prohibit the issuance of real bills by producers, distributors and retailers, and their subsequent discounting by banks, then they will have to circumvent the very FREE market they profess to espouse."

Again, here, our author either perpetrates a calumny or falls prey to a grave misapprehension, for Rothbardians (and others) don’t wish to prohibit the issue of bills, at all. What they do wholeheartedly demand is that the ordinary laws of contract apply both to Leviathan and to the banks, as to all other private entities.

If this were granted, any statues of intervention would be as unnecessary as they are unconscionable; for then banks, subject to the automatic restraints of a true gold standard, would not reckon it in their interest to run the embezzler’s actuarial risk of committing what is today a wholly legal fraud: namely, that of issuing more claims on final goods, ostensibly payable at par on demand, than they possess in their vaults.

Of course we don’t want to "prohibit" bills, bonds, mortgages, debentures, letters of credit, asset-backed loans, pawn tickets, IOUs, accounts receivable, or any other of any of the vast fauna of such voluntary contractual arrangements, at all.

All we want to ensure is that the claims to which these arrangements give rise cannot simply be stamped by a legally-indemnified bank and then given back to its favourite customer in place of a cloakroom ticket, so that she can leave the play early, wrapped in the fur coast which really belongs to some other, poor soul who still sits, all unsuspectingly, in the theatre, believing her property still to be safe and awaiting her future disposal.

So long as we do preserve this distinction between that ultimate final good — money — and those promises of future goods — credit — the trumped-up conflict of clearing and the use of credit instruments with a Rothbardian, gold-based system disappears.

This is because, under a gold standard as opposed to a Real Bills fiddle, the bill I choose to accept in return for the sale of my non-final goods automatically represents a saving I have made, for I can only now liquidate this bill ahead of time (and so consume exhaustively before my work has added to the supply of such consumables) by persuading another, a holder of genuine, cash money, to swap his currency for my claim: i.e. I must get him to save in my place.

Of course, I may instead want to consume productively, once more (i.e. to buy in some extra materials or components to my factory), ahead of my last batch of goods being transformed into final goods and settled for the cash which will partly redeem the bill I hold.

But, even here, it makes no difference whether I assign the existing bill (first drawn upon my own customer) to my supplier, or whether I allow him to draw a new bill upon me directly. In either case, he is also temporarily forgoing payment in cash, and thus the ability to buy consumer goods on demand: hence, he is now saving alongside me and so funding (as opposed merely to financing) our increased productive efforts.

Indeed, to root out another misperception, an increase in credit is always likely to accompany an increase in the vertical scope of the Cone of Production since this implies more specialists are setting up to add extra, more roundabout stages to the industrial process and that these higher-order goods makers will need more funding and — mirabile dictu — possibly even the issue of more bills!

(Incidentally, this is something which again bewilders not just the RBD dogmatists, but quantity theorists everywhere, for the latter routinely confuse the flawed concept of the final consumption-heavy GDP measure with the true sum of productive activity and so generate much spurious variation in their measures of monetary "velocity" when they divide an increased credit into a more slowly rising "output.")

What only counts here is not the increase in credit per se, but the extent to which this increase is funded with new saving and that to which it is financed through means of inflationary credit expansion, Real Bills included.

The crux, then, is not that it is the sum of gold which ultimately signifies, but the amount of saving — i.e., the available stock of set-aside consumable goods which is needed to see a productive process through to its consummation in the replenishment (and, one hopes, the augmentation) of that same stock.

However, gold is not the thing itself: we have succumbed to no fetish in our insistence upon its playing a primary role in our particular vision of a reformed world. Gold is only the least bad proxy we can devise to keep track of a man’s earned right to a portion of that consumable mass from which we can draw this critical stock of saving.

Gold thus furnishes the basis for the least bad accounting method for entrepreneurial calculation and, hence, for the generation of those genuine profits which arise from the delivery of a tangible economic advance and which give rise to both the preservation and the proliferation of capital and so to the material advance of Man.

To sum up, then: u2018clearing’ itself cannot give rise to a business cycle ,except, perhaps, under the extreme condition where it is suddenly implemented for the first time on a grand enough scale to disrupt the pre-existing patterns of exchange, such as historically seems to have happened in the Tulipomania, for example; or in the manner in which more recent innovations have come to play so significant a role in the governmentally-underwritten, financial asset insanities of the modern era.

It must also be re-emphasised that the issue of bills, or any other credit instrument, will in no way be detrimental, much less antithetical, to the workings of a free market, as long as these cannot be turned into money substitutes at whim via fractional reserve banking practices such as those countenanced by the cult of Real Bills (or through inflationary discounting and note issue at the central bank itself).

In conclusion, one cannot help but entertain the suspicion that the Feketians have either deliberately set up a straw man in order to confuse ordinary businessmen and women, who can’t see why we Austrians seem to be objecting to every financial innovation of the past half-millennium (we are not!), or they are themselves hopelessly lost as to the underlying economics of what is at work, or perhaps their error is a mixture of both.

In any case, they are not to be given any credence, whatsoever. Passion — however sincere — is no substitute for cool economic reasoning.

Sean Corrigan [send him mail] writes from Switzerland.

But, hey! I’m a big boy, able to take a few verbal brickbats and it was rather heartening to note that green ink and bile was all these virtual Assassins could muster, for nary a one actually advanced any counter argument to the piece.

Among the more civil and sensible mails was one which summed up the tone of those who wondered bemusedly quite what all the fuss was about.

"I’ve been reading with interest the debate between the proponents and opponents of RBD… and have to admit being confused," my correspondent wrote. "It seems to me the Real Bills are nothing more than vendor financing, which is currently widespread in industry. As long as these transactions are voluntary (not mandated by government), what’s the problem?"

"It seems that the actual transaction, when a vendor accepts a u2018real bill’ in lieu of payment, is that the vendor is taking what would have been his cash payment, and investing in a promissory note from his customer… Furthermore, selling these promissory notes for yet another discount is mirrored by the common practice of banks u2018factoring’; that is, buying companies’ accounts receivable for a… discount."

"I would appreciate you explaining where I’ve screwed up… because, to me, this seems like yet another (senseless?) intramural cat fight between liberty minded people."

Ouch!

Well, he does have a point. Quite why this has become such a matter for contention must be a trifle difficult for the educated layman to fathom out. It must, after all, have an air of one of those apocryphal Scholastic arguments about the number of angels able to sit on the head of a pin.

However, I do think it does bear one further (brief!) examination in order to try to show, once and for all, why this truly is of some significance.

"Sir," I replied (well, he was polite enough to me), "as you so rightly say, the use of bills as a commercial finance tool is so unexceptional as not to be worth a sentence on any body’s weblog (hardly a scarce economic good!) — and, yes, vendor finance and asset-backeds are effectively new versions of this hoary old instrument."

"However, the issue with the Feketians is that they think poor old gold is somehow too scarce to allow it to form the basis of an honest money system (not that we’ll ever have one of those in our bankster- and career politician-dominated real world). So, what they insist we need is ever more commercial credit to finance growth as the world progresses."

"Indeed, this last is unexceptionable enough, given one very important caveat which the Feketians, of course, do not recognise, as I will elaborate upon, below."

"Now no sensible gold advocate (I hope that’s not an oxymoron!) thinks you have to insist on paying over hard metal every single time you undertake a transaction (despite Fekete’s gross misrepresentation of the Austrian position). Moreover, as you rightly say, the voluntary extension of credit between consenting adults is nobody else’s business whatsoever."

"But the crucial point is that such credit is not and cannot ever be allowed to become ‘money’, in an honest world."

"Yet, the RBD cranks think that it is in fact perfectly acceptable for credit to be turned into money by fractional reserve banks through discounting, as long as the credit is somehow attached to a physical pile of Chinese cereal-box inserts sitting in Long Beach harbour, or is pinned to the shipping documents of a container-load of US scrap paper bound for Beijing in return, and for as long as the loan lasts for no more than their arbitrary and mystical 90-days (there goes the option ARM!)."

"Now, anyone aware of trends in modern finance should know to what abuses this can lead — even assuming we could, or should, discriminate between physical goods and less tangible, but no less valuable, commercial services."

"Also, anyone with the mental faculties of an inebriated lugworm (or a West Coast real estate flipper) can see there’s precious little to stop credits being successively rolled and rolled and rolled under their crackpot scheme, so controverting the 90-day limit entirely — and without even having to look Andy Fastow up on the Rolodex."

"In fact, as the u2018Fool’s Gold’ article briefly shows, all the above parts of the folly were effectively dismissed in the early 19th century. QED, over and out!"

"What the article perhaps did not bring out strongly enough is that RBD offers no real improvement on what we have today, since, tacitly, every central bank effectively adheres to it already."

To see this, ask yourself on what it is that policy is mandated, other than on the belief that if ‘growth’ is occurring in the economy, not only is there no harm in providing extra credit to correspond to this, but that if the CB doesn’t do this, the ‘price level’ (whatever that genuinely means) will not continue to rise in the supposedly acceptable — and totally arbitrary — fashion which the Solons have previously determined that it should."

"Then, Whammo!! The next thing you know ole’ Colonel Kilgore Bernanke will be blasting out the Wagner and napalming us with more funny money lest we suffer the imaginary catastrophe of supply-driven (and, therefore, wholly benign) u2018deflation’!"

"So, if we’re to rule out chronic and endemic inflation totally, when a commercial bank discounts a bill (or makes any other kind of loan), it cannot be allowed to credit the seller’s account with new ‘money’ instantly created by the bank itself for the purpose — and this is where the Feketians slip up so badly."

"Instead, the discounting bank should only be able to buy the bill with a sum of money already in existence in the form of gold itself, or of 100% gold-backed, instantly-convertible notes or account entries on its books."

"This money must, in turn, have come from one of two sources: from among those of the bank’s own depositors who have agreed to forego the use of the funds — and therefore any ability to buy material goods or services — for the full term of the bill’s tenure in a savings or time deposit account; or, by the employment of the bank’s own fully paid-up capital."

"If we break this rule at all, we’re back to square one: if we abide by it the bills can be as ‘real’ or ‘unreal’ as you wish, we won’t ever have inflation."

"Again, this is a verity categorically denied by the Feketians — just like it is by Keynesians and Monetarists, by the Greenspan’s, the King’s, Trichet’s, and Fukui’s and all their ilk at the overmany central banks of the world."

"It is this denial, pure and simple, which immediately disqualifies any of them a place among the counsels of the wise."

"That aside, the other great failing of the RBD pod people — as it is of 99.999% of standard economists everywhere — is the one I tried to make clear in the second (and in many ways more important) half of the piece: credit is no substitute for capital, i.e. for those savings which are devoted to productive and reproductive use."

"For, no matter how hard they struggle to decipher the runes in the spell-book, by trying to make up for any shortfall of such savings by the issue of a swathe of inflationary credits, these sorcerer’s apprentices will never succeed in building a vertically-specialized, divided labour, integrated, self-compatible, sustainable economic structure."

"Instead, the use of such in inflationary means — long, short, real or imaginary —will only condemn us to the dreary round of the business cycle, ensuring we end up being afflicted in turn with an endless succession of New (Newer, Newest?) Deals, ‘depression-ending wars’, and all manner of other execrable collectivist intrusions upon our freedoms."

"So, if these other ‘liberty-minded’ folks are genuinely sincere in wanting a better world — rather than running around gratifying their own false prophet’s ego — the sooner they rid themselves of this tired, old mental affliction and start campaigning for the only true remedy — a 100% gold specie reserve standard based on free banking (for my taste, with unlimited liability, to boot) — the better."

"That way — instead of trying to sell us the same old, past-its-sell-by-date, monetary snake oil; or communing with advanced alien civilizations; or getting in touch with their inner children; or agonising over the esoterica contained in the da Vinci code; or whatever other mumbo-jumbo it is which pre-occupies them when they sit as supplicants before their sage — that way, if they gave us a little more Ludwig von Mises and a little less L. Ron Hubbard, they might actually end up doing something of use."

"Now, I don’t think that qualifies as ‘yet another senseless, intramural cat fight’. Do you?"

Discuss all this in The Austrian Forum.

Sean Corrigan [send him mail] writes from Switzerland.

"Is the attempt to guide the people on the right road not hopeless, especially when we recognize that men like John Maynard Keynes, Bertrand Russell, Harold Laski and Albert Einstein could not comprehend economic problems?"

Indeed, we have to agree.

In fact, it would provide fertile ground for a doctoral thesis in that Just-So-Story u2018discipline’ of evolutionary psychology to speculate on whether there is something hard-wired into our atavistic, hunter-gatherer brains which does this.

Did all those years — supposedly spent on the sun-baked Savannah — mean we have been stubbornly tuned to the instant gratification of the kill and to the visible apportionment of its spoils among the familiar and ever-present members of our band?

If so, is this what makes it such a struggle to attain a full grasp of the phenomena associated with divided labour, indirect exchange, and u2018roundabout’ methods of production?

We’re sorely tempted to answer in the affirmative, for the idea of Keynes’ own frontal lobes consisting of little more than an economic "barbarous relic" is an irony almost too delicious to resist!

Thus, the job of eradicating economic errors often seems, as Mises’ lament implies, a Sisyphean task.

Picture the poor Austrian, doomed to the eternal task of heaving his rock of enlightenment up the hill of ignorance — only to have it slide from his sweaty grasp, to the diabolical glee of the Inflationist ghoul inevitably supervising his torment.

For example, there is presently a series of polemics rattling around the websites normally frequented by Armageddonist gold bugs and millenary financial doomsters, all emanating from the pen of Antal Fekete — professor emeritus (in Mathematics and Statistics) of the Memorial University of Newfoundland — and his acolytes.

In this, they have been dressing up that ugly sister of the 19th century Banking School — the Real Bills Doctrine (RBD) — in a racy new ball gown, while simultaneously disparaging us Austrian Cinderella’s as "enemies of freedom" for our stubborn adherence to the 100% gold standard in the face of their more sophisticated alternative.

One may acquire a hint of the sheer perversity of the clique’s argument when one knows that among the many enormities Prof. Fekete propounds is one in which he contends that the rate of interest is to be treated separately from the rate of discount, the first being "governed by the propensity to save" and the latter by the purportedly distinct "propensity to consume"!

But, leaving such evident contortions aside, RBD is subject to any number of pernicious flaws, not least that it rests on a u2018reverse engineering’ of one of the ideas — and an extension of yet another — framed by that egregious Scottish gambler, John Law, in his Money and Trade Considered; the first being that:

"…trade depends on money: a greater quantity employs more people than a lesser… nor can more people be set to work without more money to circulate so as to pay the wages of a greater number…"

— and the second on the widely held belief that, so long as money is rooted in u2018the needs of trade’, its increase can occasion no possible harm, thus:

"…the (note-issuing) commission giving out what sums are demanded and taking back what sums are offered to be returned, this paper money will keep its value and there will always be as much money as there is occasion or employment for, and no more…"

Here, Law — like many subsequent inflationists and real bills advocates — has overlooked one crucial flaw; that, absent the physical limitations of the scarcity of a hard specie standard to provide a restraint, this system tangles itself in not so much a Gordian, as a Gödelian knot.

The nature of this hangman’s bootstrap is that, as any California real estate speculator or Nasdaq day-trader will tell you, the u2018needs of trade’ are hardly independent of the quantity of credit available to finance them.

It seems to escape the RBD cultists that the sum one u2018needs’ to borrow in order to buy an asset — with which the loan will be collateralized — is self-referentially dependent upon the quantity of similar credits both already extended and currently competing for similar purposes, thanks to these credits’ crucial role in determining the asset’s prevailing market price.

As Henry Thornton — that giant of the Currency School — succinctly put it, two hundred years since:

"[Law] forgot that there might be no bounds to the demand for paper; that the increasing quantity would contribute to the rise of commodities and the rise of commodities require — and seem to justify — a still further increase"

Thornton’s near contemporary, Joplin, was equally quick to spot the error:

"Bankers, indeed, have the idea that their issues are always called forth by the natural wants of the country, and that it is high prices that cause a demand for their notes, and not their issues which create high prices, and vice versa. The principle is absurd, but it is the natural inference to be deduced from their local experience. They find themselves contracted in their issues, by laws which they do not understand, and are consequently led to attribute the artificial movements of the currency to the hidden operations of nature, which they term the wants of the country"

But, even were we to overlook these fundamental objections and to allow the Feketians their head, they nowhere explain to us how we are to determine the u2018reality’ of a given bill in today’s complex economy.

How are we to gauge the value of, say, the provision of legal services in a patent dispute, rather than that of a VLCC cruising the high seas? Or how might the act of contracting the WPP Group for an advertising campaign differ from laying claim to the very tangible cargo of iron ore nestling in the hold of a 1,000-ft carrier plying the waterways of the Great Lakes?

One might even maliciously wonder whether a margin loan on the NYSE is not at least a cousin to a u2018real’ bill, since it helps finance the purchase of a direct claim upon the net productive assets — the stock — of a private corporation. And what about a repurchase agreement used to finance a holding of that same corporate’s debt and hence to maintain a prior lien on a share of its income stream?

There is also a deafening silence on how the good Prof. Fekete might propose to prohibit the issue of finance (“pig on pork”), or accommodation bills (glorified promissory notes) — and lest the reader thinks we are here arguing about the niceties of some Victorian anachronism, he should be aware that the traditional bill’s latter day equivalents in this area, asset-backed securities, are a quintessential feature of the modern credit landscape, comprising a $1.8 trillion market in the US alone.

In failing to address these points, Prof. Fekete not only overlooks the sporadic bill-”kiting” crises which dogged Industrial Britain throughout what he supposes to be an untarnished golden age, he also fails to recognise that it would be only too trivial to disguise such bastard children as the u2018real’ thing in today’s Andersen-Enron-Money Center Bank, financially-engineered, smoke-and-mirrors economy.

However, erratum longum, vita brevis, so, rather than picking our way through each of the many mistakes which litter Prof. Fekete’s diatribe, there is one matter whose exegesis might furnish us with a more lasting reward than the simple pleasure of puffing air at his inflationist house of cards — namely, that related to the cone of production, to the importance of the concept of gross, not net, product (as Professor Reisman has taken great pains to elucidate), and to the true function of saving.

Here we must allow Professor Fekete the liberty of hoisting himself on his own petard and quote him at some length:

"… it is not possible to finance all of society’s circulating capital out of savings. It would put inordinate demand on savings that simply could not be met. Consider a hypothetical production cycle [of] 91 days, with as many as 90 firms participating, so that the sojourn of the semi-finished product at every one of the 90 stops takes one day. The ultimate consumer is willing to pay $100 for [it] while the producer of the 90th order good has paid $11 for raw materials. We shall also assume that the value added to the maturing product at every stop is $1. Now if you want to finance the movement of one [unit]… through the various stages of production… you have to withdraw savings in the amount of… $4995, almost 50 times retail value"

Put this way, the idea does seem ludicrous — exactly the effect Fekete intends by deploying this clearly exaggerated, 90-stage process as an attempted reductio ad absurdum.

But is this actually as risible as it sounds?

Actually, it’s not — but, rather than going through the argument line-by line here, the sceptical reader is invited to consult the working paper for a full rehearsal of the logic.

The rest of you will just have to take it on trust that what the arithmetic finally shows is that it will require 4,095 units of final goods output selling for $4,095 (at $1 a piece) to equalize the real income of all participating 4,095 u2018workers’ arranged in a 90 step triangle of 1-2-3… …88-89-90 u2018workers’.

The calculations also reveal that $125,580 in revenues will be generated with every complete productive cycle which gives rise to the same $4,095 of consumer goods, in what is a perfect match for the 125,580 units of final and intermediate goods which we shall be transporting down the chain at each turn.

But, though our model shows that this natural correspondence jumps straight out of the simple logic at work, the seemingly large monetary disproportion between $4,095 rattling into the retailers’ tills and the $125,580 circulating throughout the value chain still causes our bill-wielding maths professor to utter howls of derision at the idea of using so much u2018scarce’ money to effect such a low rate of conversion of total effort into final goods.

But, in fact, there is another important truth to be revealed here.

For what Fekete labours under is a GDP-style obsession with the value of these final goods alone to his consequent — and logically fatal — neglect of the importance of all the intermediate products to which each cycle gives rise. This misleads him into scorning matters that are, in fact, critical to the means by which genuine capitalism (not inflationary corporatism) showers us with its bounteous material riches — a sin no true Austrian would knowingly commit.

Now, narrowly, it can be admitted that a clearing instrument (CI), a bill (real or otherwise) could greatly facilitate the movement of the stream of products which emanates from our highly vertically-divided arrangement of labour. However, we must acknowledge that the income — if not necessarily the intermediate revenues — must be settled only in gold dollars — in money — in order to avoid entraining an inflationary outcome from this.

Thus, in our recasting of Fekete, we could get by with $4,095 in gold and supplement its use with roughly 30 times its value, or $121,485 in CI’s.

Alternatively, there is no fundamental reason why we could not use the same physical sum of gold for both tasks (it is highly divisible and completely fungible, after all), dispensing with these CI’s entirely and allowing prices to fall wherever they must so as to reflect the sizeable output of goods taking place across all stages of production (a concept which Fekete totally misses in his characteristic inflationist’s haste to use a putative shortage of money as an argument for his wild schemes).

One key point here, however, is that, even if they should be used for convenience, the clearing instruments are not themselves money in that they cannot automatically be used for final settlement pari passu for final goods, certainly not on demand and not at full face value.

In fact, even this proviso may provide little enough protection against excess, if the issue of bills (or other credit) becomes swollen with regard to the money stock. This most easily occurs under a system where inherently fraudulent, fractional-reserve banks are lulled into the false security of having a lender of last resort behind them or, indeed, in cases where that (typically state-privileged) lender itself is over ready to rediscount their acceptances and to expand credit.

Here, as Law’s sometime confederate, Richard Cantillon, remarked in his marvellous u2018Essai’, the ultimate check was usually imposed when the winners of any ensuing investment mania tried to leave the casino:

"In 1720, the capital of public stock and of Bubbles — which were snares and enterprises of private companies at London — rose to the value of 800 millions sterling, yet the purchases and sales of such pestilential stocks were carried on without difficulty through the quantity of notes of all kinds which were issued, while the same paper money was accepted in payment of interest. But as soon as the idea of great fortunes induced many individuals to increase their expenses, to buy carriages, foreign linen and silk, cash was needed for all that… and this broke up all the systems."

Naturally, today’s South Sea Bubbles and Mississippi Schemes call into play instead what the market argot terms the u2018Greenspan Put’, for they are now watched over by a coterie of central banks, collectively untrammelled in the exercise of their peculiar brand of RBD and ever-ready to abandon even the pretence of sound conduct in a crisis, by invoking the necessity of maintaining the u2018financial stability’ of their multi-trillion dollar Ship of Fools.

But, even setting aside the case of such effusions of wild optimism and their ensuing outbreaks of despair, it remains to emphasize that one of the most insidious dangers of the RBD is precisely that it allows such u2018clearing instruments’ to be converted into — indeed, to form the basis of the issue of — money and thus it begins to disrupt all-important relative price signals, both between factors of production and across time itself which perverts economic activity and so triggers the highly wasteful cycle of repeated Boom-and-Bust.

More important still, however, is that Fekete, in his ambition to be seen as a monetary Messiah, shares the all too common trait of inflationists from Law to Gesell to Keynes, and on to Bernanke; viz., that he has lost sight of the inescapable truth that it decidedly does take genuine net savings to build out our triangle in the first place.

What all such monetary manipulators overlook is that, while physical equipment is being assembled, land cleared, buildings constructed, workers trained and hired, there inevitably arises exactly so much excess of the demand for the sustenance for the workers involved over their ability simultaneously to provide for its supply themselves.

Moreover, there must necessarily be a suitable degree of diversion of scarce physical resources away from the provision of final goods and into the creation of the new, higher order ones, for the whole duration of such an undertaking.

Here, if we think of the Hayekian triangle, not so much as a stylized economy, but as a factory assembly line, it becomes easier to visualize the situation wherein, once a firm decides to revamp its production arrangements, it is highly likely that the existing output of its products will suffer while the re-organisation takes place.

Thus, the company will have to build up an inventory to tide it over if it wishes to keep its customers happy — i.e. it will have to have saved pre-emptively before the revamp of its factory.

If not, then the burden will fall instead upon the consumers of the firm’s products — individuals who, of course, play a dual role as the producers of the other goods which the firm and its workers need in their turn and for which they ultimately aim to exchange their wares.

In the case where the firm has not saved by laying in inventory ahead of time — perhaps because the owners have managed to issue a u2018real’ bill! — the good souls who are its customers will temporarily be compelled to forego the consumption to which they have otherwise earned the right by producing their own marketable goods.

So, assuming they do not simply retire to the beach, while the retooling is being completed, these customers will have to save concurrently with the reorganization’s undertaking.

(Without diverging too far from our theme at this juncture, it is this outcome which, when engendered by producer-centric monetary manipulation, comes under the vexed Keynesian rubric of u2018forced saving’).

But how much saving is needed to accomplish this task? In what proportion to the ongoing division of labour must consumption be foregone?

We can again look at this schematically, using nothing more than straightforward arithmetic, but rather than burden the reader with the details here, it is suggested that he again consults the working paper on the Mises Institute website.

There he will find that to order everyone most efficiently into Fekete’s 90-stage process will require a minimum of 30 2/3 days of savings — or 125,580 units of the goods which were previously being churned out at the rate of 4,095 per day — in order to accomplish his task.

At this stage, the observant reader may have noticed that the requisite quantity of savings of consumer goods needed to divide labour vertically in this manner is arithmetically equivalent to the revenue flow which will comprise one full turn of the completed, triangularized structure!

So much for the laughter with which Professor Fekete greeted the idea that rather than using the wholly insubstantial backing of one of his supposedly u2018real’ pieces of paper, circulating capital must actually take the form of high multiples of the saved output of final goods.

For what we discover is that circulating capital, no less than fixed, must be funded — i.e. it must be built out of a store of saved consumption goods or else accompanied by foregone consumption opportunity — and that no amount of monetary legerdemain can avoid this restriction.

It should also be noted that, even with the simplifications already imposed, we have still only accounted for the maintenance of the human element of what were actually composite capital-plus-labour u2018workers’ and so we have looked only at how many final goods need to be saved.

The reality is that we may well need to divert an over-proportionate amount of scarce physical resources — such as fuel, raw materials, land, and even some of the remaining machinery — away from the reduced, interim production of such goods and into our new building process, as well.

This will especially be the case since our composite u2018workers’ are implicitly assumed to take their capital with them when they move up the order, whereas — in the real world — much of this capital will not be so readily interchangeable in function, but will have to be largely fashioned anew.

Thus, even the seemingly high multiples which our simple heuristics have generated are likely to be seriously understated.

No wonder that while Soviet Russia could routinely announce new pig iron production records, its people were left craving a few ounces of butter and had to queue long hours in the hope of securing a few heads of fresh cabbage!

So, faced with this realisation, are we to conclude that matters are indeed hopeless — that the division of labour cannot be achieved without the whips of Collectivist coercion and the scorpions of inflationary finance?

Not a bit of it!

For what all the forgoing excludes is any consideration of the essential purpose behind all this endeavour to increase u2018roundaboutness’ and to bring about an increasing specialization of function — namely, the very real increase in productivity and efficacy which such an advance almost invariably brings forth (see, for example, The Positive Theory of Capital, Bk II, Ch II.19, n13, Böhm-Bawerk).

As an example, look what the industrial genius of the real Henry Ford managed to achieve and how the principals he laid down have immeasurably enriched our lives ever since.

Yes, we must certainly struggle and scrimp to save and nurture a very great deal of capital, indeed, if we are sustainably to lengthen the structure of production; but the effort to do so usually brings about its own reward!

As the apex of the cone of production is shifted to a more remote location from the store front, as extra tiers of specialists are included on the notional assembly line, so its mouth may also be widened — giving rise to more goods per cycle; it may be improved — giving rise to better goods; and it may be accelerated — giving us more cycles per unit of time.

If we are truly fortunate, all three will occur — though, at first, it may only be available in whatever colour you like, so long as it’s black!

Out of this, of course, comes the possibility of successively generating ever more future savings ever more easily, which all means that the magic of compounding applies not just to monetary interest, but also to real, productive capital.

This means that, on the road to general prosperity, saving, directed by entrepreneurial foresight into a greater division of labour, quickly enlists the "most powerful force in the universe," as Einstein reputedly called it, in what was possibly this proto-socialist’s only correct pronouncement in the field ever.

So, in finally dispensing with the good Professor Fekete’s contumely, we find he has, in fact, rendered us a service, for he has forcefully pointed out what an effort capital accumulation is and so he has implicitly charged us to beware of anything which threatens this act: be they threats to private property; the risk of civil disorder; legal and contractual uncertainty; the clouding of entrepreneurial calculation; or the frustration of the market process.

On this reckoning, his own wild dreams of resurrecting the age-old follies — and his unintended effect of reinforcing the present-day incarnation — of the irretrievably-flawed Real Bills Doctrine poses perhaps the single greatest concentration of all these dangers — in complete contrast to the protections which would be afforded by the institution of a free banking system, securely bound by the ordinary laws of contract and girded tightly about with a 100% gold coin reserve standard.

Sean Corrigan [send him mail] writes from Switzerland.

For example, whenever we are obliged to determine the net asset value of our fund for the purpose of reporting to our shareholders, we take the last price bid for each security on the last day of the month; we multiply this by the size of our holding; we repeat the process for each security in turn; we add up the results and — lo! — we have an aggregate total.

Though this methodology is standard throughout the industry, by virtue of its simplicity and transparency, we really ought not to forget that the price of the last traded fraction of the company’s stock is not logically applicable to the value of the whole. Here is the reason behind this assertion.

“Dad, we are thirsty!”

Imagine you are walking a baking hot stretch of beach, trailing your two restive and annoyingly insistent kids, each of them moaning that they are thirsty.

Just ahead is the only kiosk visible for a mile or more in either direction so, gritting your, teeth you drag your little darlings over the last few hundred yards of scorching sand and there you happily part with $5 to get them a couple of small bottles of soda.

Now, those two particular bottles, in that particular time and place, clearly seemed well worth $2.50 apiece in your hour of need. But, by the same token, you’d have been increasingly less keen pay such a premium for a third, a fourth, or a fifth bottle of what you’d soon have come to regard not so much as a welcome liquid pacifier, but as a fairly meager container of overpriced, sugary acid.

Similarly, you’d also be a trifle reluctant to fork over that same $2.50 a pop when you’re cruising — thankfully child-free — along the beverages aisle of your local, air-conditioned supermarket — your shopping cart sandwiched between two long, closely-stacked ranks of competing wares.

Again, at the neighborhood cash and carry, you may well be offered this same soda by the crateful. But, since you’ll have more urgent things to acquire with your last few bucks of housekeeping money than to buy three weeks’ advance supply of soda, it will have to be pretty steeply discounted to tempt you into making such a large purchase upfront.

Taking this to an extreme, you’d be positively dismissive — even if you had the required wherewithal — if Coke itself tried to get you to take a whole year’s production from them at an equivalent price to the one being asked by that damnable seaside “gouger” (actually a man who is not so much a rip-off artist as an astute entrepreneur with a keen sense of what the local market will bear).

So, we should quickly be able to deduce from this that it doesn’t makes sense to calculate the whole of Coke’s annual sales by taking the product of the waterfront kiosk’s circumstantially specific $2.50-a-bottle and the company’s 475 million bottles of worldwide shipments.

But, if this is the case, we should realize it makes no more sense either to fall into the analogous trap of valuing all of Coke’s shares, en bloc, by taking the $42 where the last 4,000 lot changed hands and multiplying it by the whole 2.4 billion shares the company has in issue, to arrive at a market cap of $100.8 billion.

The crucial point to grasp is that any individual trade reflects the monetary overlap in preferences of the most insistent buyer and the most willing seller at the point of exchange.

It should be obvious that each individual will be influenced in where he ranks on that scale of mutual eagerness by plain circumstance. This is exactly in the manner that our two very insistent minors combined with the presence of only one nearby seller to make for a highly skewed deal at the seaside!

Further, it is self-evident that as we begin to satisfy our appetite for what the other fellow has to offer, this quickly changes the relative attractiveness of the trade as we gain more of what we want — soda — and are therefore left with less of what we have to give up — money (and therefore the chance to buy, say, a candy bar for Mom, or a beer for Dad instead).

Theoretically, the converse would apply to our vendor, who would gradually raise the price of each successive soda sold, were it not that he has no other, more pressing needs to satisfy with the money he earns and that he suffers severe constraints of time in shifting his stock-in-trade.

Arguments along these lines were among those which revolutionized economic understanding in the 19th century under the guidance of the so-called “marginal utility” school, which included such Austrian luminaries Wieser, Menger, and Bhm-Bawerk.

Churn and burn

But, as well as this somewhat theoretical objection, there is a more practical aspect to the tyranny of the regular pricing mechanism to which we are subject.

This is that most of these marginal buyers — the I-want-it-now, $2.50-a-bottle guys who effectively set the price for our snapshot of net asset value — are buying now, only to sell a moment later and they are doing this largely with borrowed money, into the bargain.

To give some idea of the incredible rate of churn between specialists, brokers, and clients, consider that NYSE dollar volume has averaged $55 billion a day in 2005, while overall securities trading in the US topped $1 quadrillion (a one followed by fifteen zeroes!) in 2004.

For equities themselves, however, data from the National Securities Clearing Corporation shows that, on any given day, typically as little as 2—3% of that sizeable notional sum actually goes to cash settlement — with the balance being netted out between all those frenzied intraday buyers and sellers, winners and losers.

Thus, in a market dominated by players with the most restricted of short term horizons — who battle it out literally tic-by-tic for the scraps to be made between the brackets effectively set by the less frequent entry of punters taking a longer view — we can see that considerations of the actual fundamental value of any given enterprise are the furthest from the minds of the majority of those likely to set our reference price.

What is a stock worth to these guys? Hopefully, a couple of tenths more than when they bought it two minutes ago.

Moreover, even the longer-term players who impart the underlying momentum to the market — those who, as it were, provide the ocean current, rather than the tide which is superimposed upon it — may well be executing trades based on a whole host of disparate factors: technical analysis, “relative value,” “sector rotation,” “index arbitrage,” “asset allocation,” derivative or convertible arbitrage, and “black box” trading. The list of such blind, mechanistic, model-based approaches seems endless.

As a particular case in point, on average, more than half — and anything up to three-quarters — of NYSE volume is now accounted for solely by program trading (Goldman, Sachs alone accounted in this way for 1.2 out of the total 8.8 billion of recorded volume in the week of June 24th).

Yet another facet of this commoditization and temporal foreshortening of the market is the rise of the exchange-traded funds, or ETFs — quasi-mutual funds which “trade just like stocks.” As the latest hot thing to hit the Street, last year the assets incorporated in these entities soared by nearly one half, reaching $222 billion as everyone sought to cash in on the speculative fever of the times.

Are these savings vehicles or tools of speculation? Are they a means to “grow the world economy by furthering the development of low-cost, efficient capital” (as the DTCC motto laughably proclaims) or merely another fancy way for respectable folks to do a little gambling with their nest-eggs?

You tell us. But again, note that most of the people involved in trading this way — and so in setting a price on all the relevant securities — would be hard pushed to name the CEOs of the constituent companies, or their main line of business, or a single key product, much less tell you anything about their balance sheets or income statements.

It should be apparent that the motivations of the overwhelming majority of “price-setters” are thus wholly different to the ones which drive us as we try to discharge our duty to our shareholders.

In our work, what we are firstly seeking to avoid are costly mistakes of over-enthusiasm — of buying when the market is clearly overpricing a business. We try not to buy soda for $2.50, no matter how much the kids might whine at having to drink water instead.

Conversely, we always try to recognize and take advantage of those times when the market underprices claims on valuable, well-managed, wealth-creating assets. 50 cents a litre? Yes, please. Do you deliver?

By now it should be apparent that on both these counts — both the theoretical and the practical — that to focus too much on price, especially in the short term, is to commit what logicians call a “category error”: instantaneous market price and long-term value are decidedly not the same animal!

Discounting the future

But if a stock is not always “worth” the price, what factors should we consider in valuing a company?

Here, many fall back on something called the “dividend discount” model, which effectively assumes a near infinite flow of dividend payments and discounts them back to a price payable today, using some readily observable long-term interest rate — usually, if highly inappropriately, in our view — the US Treasury 10-year note yield.

This simplistic calculation, however, poses a number of problems, namely:

• the dividend payments are inherently uncertain (unlike those contractually set by a fixed income instrument) and will certainly be variable;
• the company may choose to return shareholders’ funds through buybacks instead of dividends (whether or not financed by borrowing);
• it may chose not to return them at all;
• from the other side of the equation, the T-Note yield is itself intimately subject to market whim and is therefore by no means an objective yardstick;
• being technically “riskless” (a rather empty guarantee related to the surety with which a government can always print enough local currency — however worthless — to redeem the bond) it is not really suitable for gauging a “risky” asset like a common stock, in the first place.

For our part, to the extent we pay any attention at all to this concept, we sometimes compare the market’s earnings yield to that applicable to 30-year BAA-rated corporate bonds — which, unlike US Treasuries, therefore theoretically discount for real yields, implied inflationary erosion, and corporate credit risk. This leaves us with a broad measure of expected real, long-term earnings growth. This, in turn, can be loosely benchmarked against observed or expected rates of change in gross domestic product with which, intuitively, it should be correlated over the long run.

We should caution, however, that the only purpose for doing this is to judge how “cheap” stocks — as a group — may or may not be, relative to bonds, and not whether they — much less any individual components of the index they comprise — hold any absolute appeal whatsoever.

Through the looking glass

But what of the vexed issue of why anyone other than one of our market-timer friends would ever wish to buy a non-dividend bearing stock? What we can say here is as follows.

A non-dividend paying, non-liquidated, still-independent stock derives its worth from a gauge of the company’s ability (a) to generate real income (over some uncertain, but broadly-estimated time horizon) and (b) to maintain and hopefully to extend that income generation capability in the course of its operations (i.e. to preserve and accumulate ‘wealth’).

Essentially, this ‘worth’ reflects the fractional ownership of the firm’s productive assets, its claims on resources; its inventories of finished goods; its stock of work-in-progress; and any other titles to property it holds, as well as to more ephemeral entities such as brand and reputation.

Above all this, though, the stock has value as a vehicle through which to devote one’s savings to a participation in that epitome of wealth generation — entrepreneurial activity, especially that of a kind in which one either is technically, or perhaps, financially unable to engage, alone and unaided.

Granted, ownership of the stock must eventually release some of the income or the capital to its proprietors whether through dividends, buy-backs, spin-offs, liquidation, transfer sale, or take-over or there would be little purpose in owning it, beyond vanity.

However, so long as one regards the potential for such deferred remuneration as reasonable and as long as one possesses the suitably low degree of time preference to wait, one need not demand such a disbursement in the here and now before considering the stock worthy of purchase today (particularly if one holds a realistically dark view of the process of the chronic monetary depreciation endemic to our modern system).

To illustrate this, we ask you, would you have wanted Microsoft to have paid a dividend in the early, and rapid expansion days (at the possible cost of slowing its advance to profitable, global dominance)? Would you consider a share in the title to an undeveloped (and so, financially ‘inert’) gold-bearing ore as “worthless”?

Moreover, for so long as the firm is deemed to be growing its shareholder equity better than any alternative is likely to do for a given degree of uncertainty which is a purely subjective matter, no dividends rationally should be paid; for to do so would actually be to squander and possibly to prejudice entirely the ultimately realizable worth of the company.

Vive la différence

To recap our earlier theme, it is critically important to try to maintain the distinction between this process of consciously and painstakingly estimating the true going-concern worth of a viable business enterprise and the one derived by a glib (and wholly non-marginalist!) extrapolation from the prices posted, second-by-second in the stock market, at which a handful of its shares are passing from largely instantaneous sellers to equally short-term buyers, the majority of whom are engaged in a frantic game of musical chairs, often after having borrowed the money for the entrance fee.

As the example of Mr. Buffett, among others, underlines, significant returns can be had, often at relatively low risk, if one realizes that the two sums can diverge significantly — and can stay divergent for a considerable period of time.

Indeed, the knack of recognizing this kind of disparity is what makes a great investor simply another form of entrepreneur (if a vicarious one) that is to say, a man who is constantly seeking to exploit the arbitrage between what he feels is the unduly depressed price of resources being made available to him and the total real income he will ultimately derive from their use.

So, what is a stock worth? The answer — different things to different people — is not as trivial as it sounds, for in that very difference lies a world of opportunity for those of us who know the only way to protect our clients’ existing wealth — and then to nurture it — is by redeploying it at the most propitious moment so that it can share in and help foster the creation of wealth anew by others.

Sean Corrigan [send him mail] is an executive of Sage Capital Zrich AG and strategist for the Edelweiss Fund.

Sean
Corrigan Archives

Hatshepsut the Mendacious of Thebes, Junior Minister for Sport and Culture, told the convened members of the press corps that, thanks mainly to the inspired last minute intervention of His Most Excellent Pharaonic Majesty Khufu the Great — may the eternal light of Ra the Magnificent shine upon him — the Lower Kingdom had beaten off intense competition from the rival Hyskos and the Assyrians to be chosen as the venue for the 2512 BC u201CWonder of the Ancient Worldu201D contest.

Ignoring complaints that the monuments would cost the Kingdom much of its annual tribute and that small farmers, up and down the Nile, would find more of their grain taken in taxes to fund the project, Hatshepsut assured her audience that they could look forward to great benefits in future.

u201CThe Giza plateau has been a scene of social exclusion and low self-esteem for too long,u201D she said. u201CJust think of the possibilities for regeneration this project will bring to a deprived area — why, we could even end up making this into a UN World Heritage Site.u201D

Pointing out that the benefits to the local economy would be immeasurable, Hatshepsut noted that, according to official calculations from the statistics office at Karnak, u201Ctens of thousandsu201D of Hebrew slaves would be given a livelihood building the edifice, while the permanent revenues forecast to come from future tourism would amount to a u201Ca tidy sum, indeed.u201D

Hatshepsut further rejected criticism that the government had a poor record at managing such public projects and that the experience of previous winners such as Babylon, Olympia, and Halicarnassus was that cost overruns would be substantial and that long-term benefits would prove elusive.

u201CThere is a culture of u2018knocking’ in this country. We’ve learned from the mistakes of all the other empires,u201D she assured reporters. u201CThis is a time to stop carping from the sidelines and to get involved. We held a musical procession to eliminate poverty all over the Nubian desert. We’re tackling the man-made rise in Nile inundations by means of our tax on bullock dung fuel. Now we’re ready to put Giza on the map!u201D

Private economists at the Jordan Bank agreed with her prognosis.

u201CThe impact on growth could be significant. Fifteen billion talents of silver will be spent in the next 10 years. These are the sorts of events that boost consumer confidence!u201D said one.

Others focused more on the social consequences. Luxor social worker Ahmose the Corpulent told the media that she thought this would u201Creally make a difference to people’s lives — especially those of our youth communityu201D

u201CLots of us have never been involved in pyramid building due to years of institutional prejudice and a shocking lack of public investment. But now you’re going to find urchins from all over the Giza being inspired by their heroes to get involved in stone masonry and slave-driving.u201D

As a carefully-orchestrated rejoicing broke out across the land at this fulfilment of the Royal Will, word from the palace was that His Most Excellent Pharaonic Majesty Khufu the Great — may the eternal light of Ra the Magnificent shine upon him — told a member of his noble household that if it wasn’t all a roaring success, they could "bury him in the middle of the pyramid in a stone sarcophagus and blessed after-life, sailing through the starry heavens in a sacred reed-boat, be damned!"

See also Sean Corrigan’s previous articles on the Olympics, here and here.

Sean Corrigan [send him mail] writes from Switzerland.

Sean
Corrigan Archives

He
cursed softly to himself as he became aware, once more, of the stiffness in his
hamstrings which had been brought on by the long hours of trying to keep his balance
on the shifting sandy bottom, as he had stood, waist-deep in the surf, dragging
his self-made fishing net again and again through the water.

But,
no matter, he thought. The catch had been just sufficient to afford him a light
supper and also to feed the new man on the island, Friday, fortifying the latter
while he busied himself about the tasks Crusoe had set him, making extra hunting
traps and then digging out a makeshift food larder in the cool soil at the edge
of the forest.

Though
his shoulders still smarted where the merciless midday sun and the stinging salt
had combined to blister the skin off them — and though his stomach rumbled
in protest at the sparing evening meal which his shared haul had left him —
Crusoe was content enough, for he knew that his sacrifice would mean more for
both men in the future as they combined their labour to increase the tools and
equipment with which they could better exploit their fertile tropical environment.

Canadian
retail sales unexpectedly rose to a record high in April as debt-loving consumers
like Randy Mickevicius provided the lift.

Retailers
rang up $30.9 billion in business, up 1.5% from March, Statistics Canada reported
yesterday.

Mr.
Mickevicius confessed to having been on a credit-fuelled spending spree over the
past 10 months.

After
buying a house with his partner Karen Bogo last summer, he has turned to a 17-month
interest-free payment plan, a line of credit, or his credit card to buy everything
from a big-screen TV to a washer and dryer. He has also been renovating their
basement, and, most recently, put another $1,100 on plastic for two round-trip
plane tickets to Vancouver.

"It’s
scary, but such is life," says the 32-year-old manager of an upscale Italian
restaurant in Toronto. "We are not going to shut ourselves off from enjoying
anything in life because we are in debt."

Downing
the last of his geneva, Piet van der Eyck, clapped the tankard back on the table
and grubbed in his purse for a few coins.

It
was time he was on his way, he thought, or he’d have to walk the last few miles
in the darkness and — in these wild and fevered times — it was not always
so safe to be abroad in the twilight hour before the night watchmen began their
rounds.

It used
not to be a concern, but a strange madness had overtaken the good burghers of
the stadt lately, loosening their morals and dissolving the restraints of common
decency.

Piet
himself was not blameless in this regard, for he too had succumbed to the sin
of avarice as he had scrambled to find a down payment for one of the bulbs which
had been separated from a particularly fine, variegated specimen.

Once
or twice, he had said sharp things to his neighbours; once or twice he had indulged
in sharper practices, in his greed for a few guilders’ deposit.

He
had even come, albeit briefly, to regard his own, sweet wife as his enemy —
especially that time when Elvira, her sturdy Flemish farmers’ arms firmly crossed
and her reddish brows knitted in stern disapproval, had tried to prevent him from
spending next year’s seed corn money on yet another of those accursed flowers.

u201CI
wouldn’t expect a woman to understand,u201D he was ashamed to recall he’d told her.
u201CInvesting is a man’s work. So you busy yourself about your needlework, dame,
and I’ll look to acquiring us some riches and the better station they will afford.u201D

But Piet was,
at heart too honest and straightforward a man to be led astray for long.

Increasingly
as the mania wore on, he had been nagged by an inner voice — whether his
conscience or his own native wisdom, he could never say. But what he did know
was that he began more and more to doubt the sanity of what he was doing.

All
of the family’s hard-saved cash — including Elvira’s handsome dowry —
had been handed over to the fidgety, sharp-nosed bulb brokers in the main town.
He had even borrowed a sum from the drover who usually bought his surplus cattle,
promising the man a share of his profits later.

However,
Piet had felt uneasy at the thought that a man could get rich by doing no more
than buying and selling — and selling something of so little underlying utility,
to boot.

What
good, after all was a tulip? You couldn’t eat it. You couldn’t make fibre from
it. You couldn’t even extract those vibrant, but short-lived colours and sell
them as pigment to one of the many artists who nowadays flourished in the back
streets of the city, catering to the tastes of the many new rich who had so suddenly
sprung up.

No,
at last Piet had seen sense and so, that very day, he had travelled up to Amsterdam
to sell his prize possession.

The
man he visited had been very eager to have it, though he grumbled long and loud
at Piet’s insistence that he be paid there and then, in full and in good solid
gold, not in promissory notes.

u201CYou
pig-rearers are all the same,u201D the man had fumed. u201CYou always want to get your
grubby peasants’ hands on cash. Don’t you people understand that the world moves
along on credit, these days?u201D

u201CImagine
where we’d all be if we had to pay the full price of everything in gold? How would
anyone get started in this business? How could a man make a profit, if he wasn’t
able to pay five percent down and the rest to come?u201D

Finally,
Piet had offered a small reduction in his selling price and the man had instantly
agreed and had rushed to unlock his money box and weigh out the balance due.

In
fact, Piet suspected that the man would have been more than pleased to have paid
his original price entire and that he thought Piet was a bucolic fool who could
not fully appreciate the value of the flower he was offering.

But
Piet was happy. He had finally quit the tulip madness and he had already marked
out the field he would buy with the proceeds and even some of the kine he would
soon fatten up on its lush water-meadow grass.

Soon,
with God’s good grace and a favourable hay harvest, the extra income would allow
him to settle his debts with the drover and to pay back the whole of Elvira’s
dowry. Then he could put most of the surplus back to work, providing income for
future years.

Once
he’d taken care of that necessity, he might even have enough to get his wife a
little gift as a way of thanking her for her forbearance.

He’d
better not buy her flowers, though, he chuckled to himself.

Toronto-Dominion
Bank economist Eric Lascelles pointed out that sales grew fastest for products
usually bought on credit — cars, furniture, household electronics and building
supplies — and that Canadians are increasingly reliant on credit as their
personal savings rate erodes.

But
Mr. Lascelles also said there are several reasons a so-called negative savings
rate — that is, spending more than you are earning in income — "does
not spell imminent doom."

The
first is that the calculation of the rate excludes the income people earn from
the appreciation of assets they own.

"So
if you’re becoming richer because your house is more valuable and your stocks
are more valuable, that’s not reflected in your income. You could say people simply
didn’t need to save by conventional means."

This
article originally appeared on the Sage
Capital Weblog.

June
24, 2005

Sean
Corrigan [send him mail] is the
Investment Strategist at Sage Capital Zurich
AG. The views expressed are, of course, his own.

Sean
Corrigan Archives

These overproduction/underconsumption doom-mongers constantly fret that the prodigies of Asian industrialization will permanently suppress finished goods prices (and thus their businesses will also ultimately collapse into idleness), while we Sybarites in the developed world will, one day soon, either max out on our credit cards, or else we will succumb to a bout of real estate revulsion, and so compound the woes of the world, in a dark spiral of recession — even depression.

What the pessimists miss in all this is that — where not temporarily suspended by government interference and funny money — Say’s Law still holds good and so the Asian suppliers can always buy in proportion to what they sell and thus bring about their own demand; a demand they can always exercise personally if their debt-ridden customers are eventually forced to take a breather.

In this context, we’ve already twitted the bond gurus at PIMCO for their contention that “it’s different this time”, but now we find that perennial Cassandra, Steven Roach of Morgan Stanley, has also fallen back on this most insubstantial of mental crutches.

We say this, for Roach — who is at least a thoughtful Keynesian — actually stooped to citing the fabled powers of the cyber-revolution as a factor in his reluctant endorsement of the instant orthodoxy of a bond bullish view.

Throwing in the towel on his call for higher Treasury yields, in his latest circular, he reasoned that:

"Nor do I view [my] concerns as purely cyclical. The ever-powerful IT-enabled forces of globalization — now spreading from tradables to once-sacrosanct non-tradables — seem to be imposing new limits on pricing leverage that our traditional inflation models are simply not equipped to handle." [Emphasis added]

But, faulty logic aside, Roach is not alone in his rush to clamber aboard the bond-market bandwagon.

Indeed, so many commentators have recently found a pretext to issue encomiums for the lowest real yields since the Great Inflation stole every widows’ mite in the 70′s, that you could almost start to get suspicious about just how spontaneous this chorus of approval really is.

Be that as it may, the biscuit was surely taken by the latest comments of Dallas Fed President Richard Fisher — a gentleman who seems to have surpassed even his egregious predecessor, Bob McTeer, for farcical pronouncements on economics.

Giving an interview to (whom else?) CNBC, this worthy added a little “coup de whiskey” to the bond market rally by opining that:

“We’re clearly in the eighth inning of a tightening cycle — we have the ninth inning coming up at the end of June… There is room to tighten a little bit further. Then we will see how we are standing against inflation.”

(Answer: even compared to the Fed’s own “haute con job” figures, still at or below zero, for what will soon be a foolhardy fourth year running!)

So how did Mr Fisher view the bond market’s current euphoria? As barely worth the trouble of explanation.

The 10-year Treasury note yield, he vouched, was “less of a conundrum” but was simply “an expression of confidence in the way the FOMC has conducted its policy.”

Moving on from this laughable display of misplaced conceit, Mr. Fisher next expressed incredulity at the thought that the best use for one’s hard-earned “savings” might not be to place it at the tender mercies of those wise and disinterested philosopher-kings in Washington.

“What we have in this country is a $12 trillion economy growing at between 3 and 4 per cent,” he said. “We have constitutional unity [A snide dig at Europe?]. Where [else] are people going to put their money?”

As if this was not fatuous enough, Mr. Fisher went on to show that he is another member of the school [possibly the only one he's ever attended] which holds that Western overindulgence is the height of philanthropy and that if we spendthrifts — we latter day Bertrand de Mandevilles — are to be criticized for anything, it is that we are still not doing enough to devour the “global glut of savings.”

“Where would the world be,” Fisher smugly, if rhetorically, asked, “if Americans did not live out their proclivity to consume everything that looks good, feels good, tastes good?”

With a man like this voting on how rapidly your money should be depreciated, are you really wise to lend it to an incontinent, irresponsible and unanswerable government for twentysome-odd years at a measly 4½%, before tax and price rises?

Sean Corrigan [send him mail] is an investment analyst in Switzerland.

Surely, none can doubt that such a display of democracy at its finest will shame all those Third World mobsters who are the object of our scorn and the target of our covert operations!!

Given that Labour has increased public sector payrolls since 1997 by a cool one million, to take the balance to over 7.4 million (and not counting all the hordes of extra corporatist "contractors" who now make a living by doing the Treasury’s bidding) — it certainly looks as though a good number of the ingrates who are somehow in his pocket through work, much less those dependent upon him for benefits (such as the 11 million pensioners), could not stomach the prospect of voting again for this hysterical charlatan.

However, assuming the rump of 23 undeclared seats is distributed pro rata, this slimmest of "mandates" will nonetheless prove to be enough to secure him 56.7% of the seats in the Commons and, thus, 100% of the dictatorial royal prerogative we in Britain endure thereby.

It should also be noted that, thanks to assiduous gerrymandering during its stay in office (coupled with the effects of the first-past-the-post system), it took only around 25,400 votes to give Labour a seat, versus 41,900 for the Tories, 90,500 for the Lib Dems, and 168,800 for the "Other" parties.

For the marginalists among us, Labour’s 795,000 votes beyond the Tory total were enough to give it up to 163 more seats, or 1 whole seat for every 4,900 in the surplus (less than 0.01% of the population per pro) — even worse than the 11,682 per seat they needed at the margin vis–vis the Lib Dems.

Though we are now stretching the logic, if not the maths itself, this means that just 216,000 marginal crosses on the ballot paper in favour of Labour, rather than Tory, effectively decided the election — well within the margin for error, or fraud among the c.6.5 million postal votes (of which between one-third and one-half are still unaccounted for) issued, for the first time in a national election, under a system which a High Court judge recently thundered would “put a banana republic to shame”!

Did somebody say “One man, one vote”?

Sean Corrigan [send him mail] is an investment analyst in Switzerland.

Indeed, things have become so frenetic that Economy Minister Serhiy Teryokhin had to urge reporters:

“Don’t succumb to panic — it won’t get worse.”

This didn’t mollify Nestor Shufrych, a member of the opposition Social Democratic Party, who gave vent to fierce criticism of the central bank’s action, saying that Ukraine’s currency was “floating in the air, with no ground to support it.”

But what heinous monetary crime was the National Bank accused of?

Why! On Thursday, it suddenly and arbitrarily set the hryvna’s exchange rate against the dollar 4% higher, at UAH5.05 to $1, compared to the UAH5.25 which prevailed a day earlier.

Yes, Dear Reader, you read that aright: the bank is being lambasted for taking the (admittedly all-too rare) step of making its people’s money buy more abroad!

But, how can this be a threat to savers, you ask?

Because the Ukrainians, it seems, have become so used to the rampant inflation which bedevils them at home that they keep most of their savings in dollars, officially or otherwise!

As the Russian press reported (seemingly with a straight face), the good citizens of Kiev “called the currency move outright theft, and exporters complained that it could drive them into bankruptcy.”

Unrepentant, National Bank head Volodymyr Stelmakh defended the new exchange rate before a parliamentary session, telling lawmakers that “strengthening the national currency is only for the welfare of the Ukrainian people.”

Stelmakh is correct in espousing this v-e-r-y unfashionable view, of course, though he might have figured that encouraging the money supply to triple in just the past three years, and to rise tenfold in the past 6 1/2, was hardly guaranteed to bring about this laudable aim.

Showing that economics is not the strong suit among the populace of the latest EU aspirant and NATO-wannabe, this modest rise in the parity has set the citizens grumbling anew, adding to complaints about “rising meat and gasoline prices since the new government came to power” — increases obviously not exactly unrelated to the hryvna’s former weakness!

All in all, this leaves us with a vision of a truly Swiftian world where, not content with instantly taking to the streets — complete with supporting rock-bands and miraculously-appearing tent cities — every time some ex-Soviet crook wins or loses an election contest with another ex-Soviet crook, the NGO-sponsored Chromatic Revolutionaries will now protest currency movements — or maybe stock prices, or credit spreads — in such a “direct” fashion, too.

“What do we want? A lower dollar! When do we want it? Now!”

“Power to the Peso! Death to the Koruna!”

“2-4-6-8. Why won’t the Yuan appreciate!”

Lenin must be spinning in his grave fast enough to melt the wax!

Incidentally, Ukraine’s present Prime Minister and sometime gas oligarch, “Red” Julia Timoshenko, has addressed the petrol price problem the old-fashioned mafiyah way — by using the explicit threat of state violence to subvert the market.

As Kommersant reports, she recently summoned TNK-BP, among others of the country’s larger energy suppliers, to a meeting at which she demanded it cap prices at the pump.

Serendipitously, her negotiating position was enhanced by the simultaneous appearance of a fabricated press release suggesting her ministry was about to launch a major investigation of the firm’s 2000 takeover of state assets (the joint leader of the “Orange” party would know all about these sorts of shenanigans, you may be aware, since she herself is currently the subject of an arrest warrant issued by the Russian tax authorities for her rôle there, during the Yeltsin era).

Had a government leader in Ukraine’s eastern neighbour pulled a similar stunt with a partly-owned Western company, we can only imagine the headlines.

But, then, the newest “democracy” in the former-USSR can clearly expect to be spared any opprobrium, since the fact of its pleasing little people’s coup has surely lent an unquestioned legitimacy to all the government’s subsequent actions.

Any thoughts, M de Tocqueville?

This article first appeared on Sage Capital’s Weblog.

Sean Corrigan [send him mail] is an investment analyst in Switzerland.