• The Frame of Mind of American Economic Policymakers

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    Part One.

    In his 1,200
    page History
    of Economic Analysis
    , Joseph Schumpeter mentions Gesell
    just twice and just en passant – in one instance when explaining
    that Keynes himself acknowledged in the General
    Theory of Employment, Interest and Money
    that Gesell had
    a much larger influence on him than Hobson. (Keynes called Gesell
    a “non-Marxian socialist.”)

    Keynes noted
    in the General Theory that, according to Gesell’s proposal,
    “currency notes (though it would clearly need to apply as well
    to some forms of at least bank-money) would only retain their value
    by being stamped each month, like an insurance card, with stamps
    purchased at a post office. The cost of the stamps could, of course,
    be fixed at any appropriate figure. According to my theory it should
    be roughly equal to the excess of the money-rate of interest (apart
    from the stamps) over the marginal efficiency of capital corresponding
    to a rate of new investment compatible with full employment.”
    And although Keynes found “the idea behind stamped money sound,”
    he nevertheless conceded that there would be difficulties in the
    implementation of this scheme:

    But there
    are many difficulties which Gesell did not face. In particular,
    he was unaware that money was not unique in having a liquidity-premium
    attached to it but differed only in degree from many other articles,
    deriving its importance from having a greater liquidity-premium
    than any other article. Thus if currency notes were to be deprived
    of their liquidity-premium by the stamping system, a long series
    of substitutes would step into their shoes – bank-money,
    debts at call, foreign money, jewelry and the precious metals
    generally, and so forth…there have been times when it was
    the craving for the ownership of land, independently of its yield,
    which served to keep up the rate of interest; though under Gesell’s
    system this possibility would have been eliminated by land nationalisation.
    (John Maynard Keyes, General Theory, London, 1936, Chapter

    I briefly discussed
    Gesell’s ideas because his books would make excellent bedtime
    reading for Comrade Obama. I doubt, however, that the Commissar
    can indulge in much reading time since he has embarked on micro-managing
    the economy. Also, as Keynes himself admitted, there are enormous
    problems associated with the “stamping system,” as well
    as with the “hat system” explained above by Mankiw, because
    savers would turn to other forms of “money” such as precious
    metals, non-ferrous metals, diamonds, paintings, stamps, cigarettes
    (see also below), metal coins, ecstasy pills, cocaine, prepaid cards,
    etc. But back to Mankiw!

    If all of this seems too outlandish, there is a more prosaic way
    of obtaining negative interest rates: through inflation. Suppose
    that, looking ahead, the Fed commits itself to producing significant
    inflation. In this case, while nominal interest rates could remain
    at zero, real interest rates – interest rates measured in
    purchasing power – could become negative. If people were
    confident that they could repay their zero-interest loans in devalued
    dollars, they would have significant incentive to borrow and spend…

    Yes, real interest
    rates could be strongly negative, as was the case in the 1970s,
    which generated high inflation and high nominal GDP growth rates
    but a collapse in bond prices (see Figures 1 and 2). Currently,
    Mr. Mugabe maintains in Zimbabwe by far the lowest interest rates
    in the world in real terms. But who is lending him money? What about
    capital spending and consumption in Zimbabwe? Go and look for yourself,
    Professor Mankiw! But there is no need to travel that far. After
    all, it is far too uncomfortable for an academic at Harvard. Closer
    to home – in the US – there is sufficient evidence that
    consumption as a percentage of the economy fell in the inflationary
    environment of the late 1960s and 1970s when interest rates in real
    terms were mostly negative.

    Ben S. Bernanke, Fed chairman, is the perfect person to make this
    commitment to higher inflation. [MF: I am in full agreement on
    this point.] Mr. Bernanke has long been an advocate of inflation
    targeting. In the past, advocates of inflation targeting have
    stressed the need to keep inflation from getting out of hand.
    But in the current environment, the goal could be to produce enough
    inflation to ensure that the real interest rate is sufficiently

    I have a far
    simpler solution for creating inflation (for which I should obtain
    a Nobel prize in economics) than the half-baked measures proposed
    by Gesell, Mankiw, and his students, in order to create “more
    demand for goods and services, which leads to greater employment
    for workers to meet that demand.” The government could issue
    to each US man, woman, and child free vouchers for different goods
    and services, which would have a three or six months’ expiry

    There are 310
    million Americans. The government could issue 310 million vouchers
    to be exchanged for a new car, 100 million vouchers to be exchanged
    for a $500,000 home, a billion vouchers for a visit to an amusement
    park, a trillion vouchers each for Prozac and attendance at a sporting
    event, and so on. AIG and Citigroup would be in charge of making
    a market in these vouchers, so if someone didn’t wish to buy
    a car he could exchange the car voucher for cigarette vouchers or
    any other voucher. But since these vouchers would have an expiry
    date they would unleash a huge consumption boom, which would temporarily
    lift the prices of everything and, therefore, achieve the objective
    of the US economic policymakers of creating inflation and negative
    real interest rates. (An even simpler solution would be to remove
    all taxes for two years, or simply to send each American a cheque
    for a million dollars, but the impact on spending would not be as
    powerful as with my voucher system.)

    With my voucher
    system, the current interventionist government could even target
    the bailout of some specific industries that are currently ailing.
    For instance, it could issue 310 million vouchers, each of which
    could be exchanged for the purchase of a new car; whereas it would
    not issue vouchers for goods where demand remains strong –
    namely, for guns, cocaine, ecstasy, prostitutes, and porno magazines.
    And if some protectionist flavour was desired – since this
    would really stimulate domestic capital spending and employment
    – the government could issue a disproportionately larger quantity
    of vouchers for the purchase of domestic goods than for foreign

    And who would
    pay for the vouchers that businesses would receive from consumers?
    Nobody! The Treasury Department could issue bills, notes, and bonds
    to pay businesses for the tendered vouchers, and have the Fed buy
    them all. But would nobody really pay for my voucher system? The
    objective of my voucher system would be fulfilled, which is to create
    inflation, but at the cost of a tumbling US dollar and collapsing
    bond prices, as was the case in the 1970s (see Figures 3 and 4).

    I may add that
    a collapsing dollar might lead to a “little too much inflation”–even
    for the Bernankes and Mankiws of this world! The astute reader will
    naturally ask what will happen when the economic stimulus arising
    from the vouchers ends, since they are issued with an expiry date.
    The answer is very simple: the same thing as occurred after 2007
    when the stimulus from easy monetary policies and strong debt growth
    (inflation) ended: demand collapsed.

    But that should
    be of no great concern to the Mankiws of this world. The government
    could then issue new vouchers with a higher face value and in higher
    quantities. So, whereas my initial voucher program would have issued
    310 million car vouchers with a face value of $40,000 each, the
    government could now issue 400 million car vouchers with a face
    value of $100,000 each. Now, some of my readers may think that I
    have lost my mind, but macroeconomically there is very little difference
    between my voucher program, which guarantees to stimulate demand
    and bring about inflation immediately, and the way the Treasury
    has recently expanded the fiscal deficit and the Fed has increased
    its balance sheet (see Figure 5). My vouchers stimulus runs out
    when the vouchers expire, and the Treasury’s and the Fed’s
    stimuli run out when these esteemed institutions stop increasing
    them! But my point is that if a government is determined to create
    inflation and negative real interest rates, there is really nothing
    standing in the way of its doing so.

    both voucher and money stimuli lead to enormous economic and financial
    volatility. In this respect, I urge my readers to read R.A. Radford’s
    “The Economic Organisation of a P.O.W Camp,” in Paul A.
    Samuelson, John R. Coleman, and Felicity Skidmore (eds), Readings
    in Economics
    (McGraw-Hill, 1952). (For those people who
    have little time to read, this is a superb book about economics
    and contains brief contributions by economists such as Malthus,
    Marshall, Boehm-Bawerk, Taylor, Hayek, Tobin, Friedman, Samuelson,
    Schumpeter, Ricardo, Bastiat, Rostow, Kuznets, Burns, Eckstein,
    Keynes, and Kindleberger, and many more.)

    Radford describes
    how in a prisoner’s camp during the Second World War cigarettes
    became the principal “currency” and how prices compared
    to cigarettes fluctuated widely. The Red Cross would make weekly
    deliveries of cigarettes to the P.O.W. camp and prices would subsequently
    fluctuate largely as a function of the quantity of cigarettes delivered.
    When plenty of cigarettes were delivered the prices of other goods
    would increase; conversely, when the supply of cigarettes was scarce,
    prices would deflate. Radford concluded that “the economic
    organisation described was both elaborate and smooth-working in
    the summer of 1944. Then came the August cuts [in the delivery of
    cigarettes by the Red Cross – ed. note] and deflation. Prices
    fell, rallied with deliveries of cigarette parcels in September
    and December, and fell again. In January 1945, supplies of Red Cross
    cigarettes ran out and prices slumped still further: in February
    the supplies of food parcels [to a lesser extent, food also was
    used as medium of exchange – ed. note] were exhausted and the
    depression became a blizzard. Food, itself scarce, was almost given
    away in order to meet the non-monetary demand for cigarettes.”

    Radford never
    won a Nobel prize for his observations about the economics of a
    P.O.W. camp, but they taught me far more about relative and absolute
    price movements than did economists at Ivy League schools. When
    supplies of cigarettes (money) increased relative to food items,
    prices for food rose more than for cigarettes; and when supplies
    of cigarettes fell, food prices fell more than prices of cigarettes.
    In other words, the successful P.O.W. camp hedge fund traders had
    to constantly adjust their investment position between cigarettes
    (money) and food (assets), depending on their relative supplies.
    This is the investment environment I expect for the foreseeable

    13, 2009

    Marc Faber [send him
    ] lives in Chiangmai, Thailand and is the author of Tomorrow’s

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