Monetary Sources of Real Wage Stagnation

 

The left-wing Economic Policy Institute posts the chart below, which shows that real wages and productivity began to diverge in 1973, two years after President Nixon's abolition of the secondary gold standard and in the midst of a 15-year period of massive regulatory expansion, including workplace regulation such as ERISA, OSHA, and Medicaid. Before 1971 the average real hourly wage increase was .5% to 2% per year, resulting in 65% real wage growth in 50 years. That relationship began with the Jacksonian (no central bank) era or even earlier, in the colonial era, and it ended in 1971. The pre-1971 path shown on the chart (1948-1971) was characteristic of the laissez faire, Progressive, and New Deal eras.Since 1971, a period of about 47 years, there has been zero real wage growth. Although unions have declined in proportion to the work force, there was a similar level of unionization during the laissez faire era, when inflation-adjusted wages grew at .5% to 2.0%. In addition, because there were no (zero) income taxes in the laissez faire period, workers kept their wages and saved, to the tune of 30% of income in the late 19th century. The interest on that savings was higher than during the Fed era. Stock and bond market returns were, however, lower.            https://www.epi.org/publication/charting-wage-stagnation/

The Disadvantages of Trade Are Due to Federal Intervention

The federal government, not trade, is the source of social losses from the exit of manufacturing firms. Trade always results in making the parties to the trade better off. It may result in one party's being made better off to a greater degree than the other, but without both parties' being made better off they wouldn't trade.

The declining automobile industry and Chinese manufacturing illustrate separate issues. With respect to the US auto industry in the 1960s and into the 1970s, when I was in high school and after, consumer advocates talked in terms of "planned obsolescence"--that American car makers deliberately produced badly made cars so that consumers would be forced to buy new ones within a few years. That was probably an exaggeration of the Big Three's competence: They produced bad cars because their management systems were crummy, not because they consciously made bad cars. The 1979 book by John Z. DeLorean and Patrick Wright "On a Clear Day You Can See General Motors" covers GM's often laughable incompetence.

Thus, global competition has been a boon to Americans. It increased the quality of cars because of the Toyota production system invented by Taiichi Ohno and the Toyoda family. The result is that cars that once had to be junked at 100,000 miles or less now frequently last 300,000 miles.

That means every American who buys a car enjoys three times the value. Although American auto workers lost their jobs (a plight amply illustrated in Michael Moore's best work, "Roger and Me"), Americans have on balance been made better off by trade.

With respect to China, there is a combination of issues. First, labor costs are lower in China, and there is a reason to move labor-intensive plants there and to other low-wage countries. Low labor costs mean lower prices to Americans. One of the reasons we have sustained a relatively high standard of living is the inexpensive merchandise at big box stores due to low labor costs in China.

At the same time, plant relocation requires capital investment, and when capital is at its market rate, there is an impediment to making risky and costly moves. The costs of relocation have been suppressed by the federal government and the Federal Reserve Bank. By keeping interest rates artificially low, firms have been able to invest in plant relocation and make other labor-cutting capital investment at subsidized cost. There likely has been overinvestment in labor-saving technology as well as plant relocation because of suppressed capital costs.

Hence, the relocations and the loss of blue collar jobs are not entirely due to free trade. They are in part due to the federal government's subsidization of capital investment.

That's not the only way, though, that big government interventionists have hurt blue collar workers. During the same period that it subsidized plant relocations, the federal government increased all kinds of regulation, from human resources and employee benefits to OSHA, to environmental regulation, to Sarbanes-Oxley, to product liability. In addition, it raised corporate tax rates. The Democratic Party's policy mix seems designed to force manufacturing to move overseas.

Moreover, and most importantly, the federal government through its protected monopoly, the Federal Reserve Bank, has inflated the money supply while the dollar is used as the world's reserve currency. Foreign holdings of dollars limit the inflationary effect of historically low interest rates. The dollar remains relatively strong despite massive increases in the number of dollars.

In a free market trade regime, if many manufacturers exit a home country and sell their goods back to the home country, the value of the home currency will decline. That has not occurred. Rather, the dollar has retained its relative value despite the exodus of manufacturing to China. The reserve currency status of the dollar allows the Fed to subsidize privileged industries in services, government, education, and health care while it drives productive industry to China.

It is not surprising that President Trump's often-blue collar supporters have been skeptical of trade, for the managed version of it has harmed their interests. In contrast, the well-to-do beneficiaries of Fed policies, stock market investors, Wall Street, government employees, beneficiaries of government welfare plans, real estate developers, professionals like psychologists who benefit from state programs, are key constituencies of the big government economy. Notice that none of these produce much of value. America's has increasingly become a vampire economy.

The Superbubble and the Wisdom in Owning Gold

Gold Prices Since '08--An 18-Month Stagnation Mirrors the 1983-2001 Era

Money Supply M1:  Obama Meant Change

Monetary Base--Can Be Expanded Tenfold  from Here

I have been subscribing to Przemyslaw Radomski's Sunshine Profits newsletter for four or five months. One of his Kitco articles is here.  He is a capable technical analyst who is predicting a gold-price turnaround. His short-term predictions may be correct, although there’s reason  not to be surprised if there are a few years of a hiatus in gold’s movement upward (the current hiatus has lasted 1.5 years, as the top chart indicates). Even if Radomski is right and gold rallies this year, there could be a several year stale period before another epic-scale rally occurs. That's not to say to sell gold because the Federal Reserve Bank and the federal government have led America to an unstable, casino economy.  Because the US monetary system is unstable, gold is a hedge.

If fundamental political and monetary patterns don’t change, then gold can see a much larger long-term upswing than the six-fold-or-so increase that has occurred over the past 10 years.   From 1981 to 2001 there were fundamental bullish reasons to buy gold, but the Reagan, Bush I, and early Clinton years' monetary expansion caused lower commodity prices. Gold’s price fell to a low of about $250. This occurred because Federal Reserve money printing increased competition among miners as well as manufacturers.  Mining competition increased supply just as the supply of consumer goods increased, resulting in intermediate-term price depression. Also, the Chinese absorbed American inflation by demanding dollars to buy treasury bonds.   

The Chinese policy continues, and now we see a new monetary expansion under Obama that dwarfs the Reagan-Clinton-Bush expansion (see the second and third charts above).  If the Chinese policy changes, or the initial depressing effect on commodity prices from the Obama monetary expansion ends quickly, a larger bull market can occur in gold in the intermediate term than occurred from 2001 to 2011.  

The 1980s and 1990s economy was something like the 1920s, with monetary expansion funneled into stock-and-real-estate bubbles rather than price inflation.  Because the prior, 30-year monetary expansion mutes the effects of the three QEs, and the Fed added the QEs to the 30-year expansion with no reallocation or liquidation of the (distorted) real economy, in the coming years we can expect larger bubbles or larger inflation than we’ve seen in the past.  Either may augur well for gold once a shakeout in the mining sector occurs.

Let’s say natural gas fracking and shale oil cause energy price declines. The result can be a more expansive economy.  Let’s say the Fed is reluctant to withdraw the bank credit and monetary base that it has created. (The money supply –M1—has gone from $800 billion in ’08 to over 2.4 trillion now, while the monetary base has gone from a little over $800 billion in ’08 to over $2.8 trillion now, as per the two above charts.)  In that case, the monetary base can be expanded so that the money supply is up to 10 times the monetary base. That will occur in an inflationary period. In other words, the $2.8 trillion in monetary base can become $28 trillion in money supply, leading to a more than tenfold increase in the supply of money.  

That’s not all because, first, the US federal debt is currently $16 trillion, $5 trillion of which is held by foreign holders. Let's say the US economy continues to stagnate. At some point there may be a panic in US debt.  If so, there will be sales of dollars in exchange for other currencies and assets, resulting in a large inflow of dollars into the US.  Also, according to this Fedral Reserve Bank report:  “Estimates by the Federal Reserve suggest that as much as 60 percent of the $760 billion in U.S. currency outstanding at the end of 2005, or roughly $450 billion, was held outside the United States.” In the event of a run on the dollar, large dollar holdings can be repatriated through demand for exchange at banks and purchases of US assets. The result will be a dollar collapse. 

Hence, holding gold along with  other non-dollar assets such as stock has a diversification rationale.  The Fed's hyper-expansion is having the same effect on the stock market that the 1983-2000 expansion had, but the economy is much worse off in terms of misallocation of resources.  In the past, monetary bubbles and their concomitant asset bubbles and inflation were followed by contractions, but that has not occurred;  Obama and Bernanke have invented the superbubble.

Investors are no better off than they were in 2003 and 2007, and the stock market is at similar levels.  Interest rates are near zero.  Although the Fed has caused valuations of future earnings to increase to nearly infinite levels, causing the stock market to escalate, stock market prices are constrained by the availability of money to invest.  Will banks continue to pump up the stock market in a kind of Ponzi scheme whereby the Fed prints money, uses it to buy treasury bonds, and the banks then use the printed money to pump up the stock  market?  Alternatively, can foreign investors carry the US stock market to ever higher levels?   It is not at all clear that the current stock market valuation is more than one more peak in a secular bear market that began in 2000.

Another problem with the stock market is that during periods of uncertainty, there can be sharp falls in valuations.  If, for example, there is a currency collapse, the stock market might fall because of the risk.  Hence, we see the wisdom in owning gold.

In the above-linked interview (h/t Kitco),  Frank Giustra, founder of both Lion's Gate Entertainment and Goldcorp (two multi-billion dollar corporations) discusses his prognosis for the American economy's coming decades.  He concludes that there will be inflation and dollar collapse.

These would lead to a collapse in American power.  He compares the United States to 16th century Spain.  He is non-partisan.  He attributes the coming American collapse to the political system.   He suggests that it is a waste of time to try to change the political system because the incentives are too large; the politicians have zero incentive to do anything other than to inflate and cause the monetary system to collapse. 

Although he does not mention Mitt Romney, the process he describes by which inflation transfers wealth to the wealthy and destroys those who hold cash or CDs,  or earn wages,  is exemplified by Mitt Romney's career.  Making money through inflation is largely what hedge funds do. 

The best way out, according to Giustra, is to make money off the coming currency collapse.  This can be done by buying farmland, gold, or junior mining stocks (junior mining stocks are a leveraged way to invest in gold and other precious metals). 

Giustra is saying that the system is too  corrupt, and the public too misled, for political activism to make a difference at this point.

The Federal Reseve Bank Has Driven Innovation to China

I recently subscribed to Gerald Celente's Trends Journal. In the winter issue Celente makes the following point:

Innovation, once the province of the developed West, and especially the USA, is now too “Made in China.” In 2009, the Chinese processed some 600,000 patents, compared to 480,000 in the US. China plans to raise that figure to one million by 2015 and double the number of its patent examiners to 9,000, while currently in the US there are only 6,300 such examiners.

The reason innovation is now made in China is monetary. Under a market-driven monetary regime, as existed prior to 1913, if excessive numbers of manufacturing jobs were to move to China, its currency, the yuan, would rise in price. This would cause demand for Chinese goods to slow. Manufacturing would stop moving there, and move back. But the Federal Reserve Bank has not allowed that to happen. Because the dollar serves as the reserve currency around the world, the Fed has been given carte blanche to inflate the money supply without short-term consequence. This has fueled the federal deficit, consumer debt and real estate and stock speculation on Wall Street. The dollar remains firm despite the Fed's profligate monetary policy because the Chinese and other central banks hold treasury bonds as reserves. It seems cheap to manufacturers to move to China.

Thus, by voting for the Democrats and Republicans, Americans have voted to disemploy themselves. They have voted for politicians who have empowered the Fed to inflate while holding the dollar at excessive levels. Consumers have benefited, but when those consumers put on a hard hat or a white collar they have been harmed. Younger Americans have been increasingly harmed. The post-war generation consumed at the expense of boomers' jobs, and boomers consumed at the expense of gen-x's and gen-y's jobs. One of the offshoots of unlimited monetary expansion has been the expansion of government education programs, which churn out ever greater numbers of unemployed graduates who lack skills necessary to compete.

One of the offshoots of de-industrializing America is loss of innovation. Creativity results from familiarity with processes. Most advances are made by engineers and laborers familiar with specific production processes and problems who attempt to build on the status quo with respect to a particular process. Innovation is particularistic, it is not theoretical. Einstein's science, while broad, imaginative and impressive, has done little for important innovation. Tesla, who lacked theoretical breadth, had an enormous impact on human standards of living. Innovation does not generally come from theory. It comes from creative thinking about specific practice. So if practical activity moves to China, then innovation will move to China as well.

The loss of manufacturing, therefore, has graver implications than loss of jobs. It implies the loss of America's future as the Chinese replace the Americans as the world's innovators. How long will it be after that until the Chinese grow weary of holding treasury bonds that steadily decline in value? The final step in America's turning itself into a Third World nation will occur when the Chinese and other nations sell, and the dollar crashes. Then consumers will find prices increasing just as producers they have been able to find only low-wage retail jobs.

The Madness of a Lost Society

The video's description of Americans is demeaning but accurate. The fears it expresses are premature but also accurate.  Perhaps worse than the average American's capitulation to Progressivism's depredations are the greedy stupidity of global elites. Enjoy. 

Is the Ride to $3,000 Gold Going to Hit Air Pockets?

The graphs above are of the Power Shares DB Commodity Index (DBC) which tracks sweet crude oil, heating oil, RBOB Gasoline, natural gas, brent crude, gold, silver, aluminum, zinc, copper grade A, corn, wheat, soybeans, and sugar; the Power Shares DB Agricultural Index, (DBA) which tracks corn, wheat, soy beans and sugar; and GLD, the SPDR gold trust, which tracks gold.  On May 28 Smart Trend.com reported that the agricultural index is in a bearish trend.  

As you can see in the charts above, the DBC and DBA peaked in 2008 and have stayed off their peaks, while GLD, the third graph, has risen consistently.

Personally, I have no more faith in the word of the US Congress than I do in the word of a three card Monty dealer on 42nd Street.  Given the massive increases in deficits under President Obama and the even more massive increase in the monetary base in 2008 (and consistent increases in the US money supply ) there is no reason to think that gold and commodities will do anything but increase over many years. Ultimately, speculation and replacement of the dollar with gold by frenzied Americans trying to escape the government's legal tender law will push up the gold price further. 


But gold has increased almost five-fold since 2001, while other commodities have not kept place and have significantly fallen since 2008.  A general rule is to buy low and sell high.  It is possible that the gold market is more rational than other commodities because industrial demand is greater for oil, food and other metals than for gold. But it is just as possible that it is less rational because gold is subject to romance and speculation. The other commodities tell a story different from gold.

Gold is going up because of speculation in anticipation of inflation, and if there is inflation then the other commodities will go up as well.  Also, hyper-inflation might mean a two-fold increase in prices, but gold has already gone up five-fold.

I do not doubt that gold will continue to go up.  But if there were shortages in gold due to insufficient production in the 1990s, there ought to have been shortages in other commodities as well.  Hence, in the long run I wager that there will be continued speculation in gold and that when inflation takes off there will be a gold bubble. But I would think that other commodities where there is less speculation, romance and publicity are more reliable investments at this time.  When inflation starts, many will flock to gold, but the ride can be bumpy because there is speculation in the gold market. 

Let's say the Fed decides to increase interest rates.  There will likely be declines in the stock market, but gold could be even harder hit.  Over time the price will come back, but I find it hard to believe that without a concomitant increase in other commodities' prices the gold price will continue a secular increase. The reasoning for buying gold is that gold is a hedge against inflation, but so are the DBC and the DBA, and they haven't increased for two years. So if I were buying commodities now I would buy those and hold off on the gold.

According to Thoughts.com the dollar ought to be worth .7734 ounces of silver.  Today silver sells for $17.95 and gold sells for $1,207 per ounce.  Thus, the dollar is worth .0557 ounces of silver, 0.3% of the level at which the Coinage Act of 1792 defined it. If you think the decline in value was directed into the hands of the middle class, which William Greider claims in his book Secrets of the Temple, you're on drugs.  The money is created by banks who collect interest and they lend it to speculators, hedge funds, corporations and most of all, Wall Street. As well, it boosts stock prices because low interest rates increase the present value of future earnings.  Left wingers like Greider, who advocate Keynsianism, like to avoid discussing how their ideas support Wall Street and the banking lobby.

The additional money causes inflation, raising prices for everyone. Hence, it harms those who do not own stocks and real estate and are not bankers and helps those whose entire livelihood comes from stocks and real estate.  The middle class gets something back through increasing house prices, but those who save and work hard are penalized in favor of those who borrow.  Hence, it makes everyone poorer as the public learns that invention, innovation, hard work and creativity are for suckers, and borrowing to buy a condo is how to make a living.

The inflationary economy and the triumph of the left in terms of three card Monty government means that America's prospects are much worse than they've been.  A collapse of the financial and monetary system would seem to be a possibility. Hence, gold and silver are good bets. But I'm going to buy when they fall.

Will the US Hyper-Inflate?

Kitco's James Turk  cites a useful report by by Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli published as a working paper of the Bank of International Settlements. The report is entitled "The Future of Public Debt: Prospects and Implications."  The report concludes:

"Our examination of the future of public debt leads us to several important conclusions. First, fiscal problems confronting industrial economies are bigger than suggested by official debt figures that show the implications of the financial crisis and recession for fiscal balances. As frightening as it is to consider public debt increasing to more than 100% of GDP, an even greater danger arises from a rapidly ageing population. The related unfunded liabilities are large and growing, and should be a central part of today’s long-term fiscal planning.
It is essential that governments not be lulled into complacency by the ease with which they have financed their deficits thus far. In the aftermath of the financial crisis, the path of future output is likely to be permanently below where we thought it would be just several years ago. As a result, government revenues will be lower and expenditures higher, making consolidation even more difficult. But, unless action is taken to place fiscal policy on a sustainable footing, these costs could easily rise sharply and suddenly."

One may wonder whether the Obama administration, the European Union or the New World Order is capable of increasing productivity, innovation and output to cover rapidly increasing old age liabilities (including medical as well as pension benefits).  The only system that would have been capable of doing this was the laissez-faire capitalism of the 19th century.  But the Obama administration is busily placing the final nails in that system's coffin. The European Union is a form of institutionalized econo-sclerosis. And the "new world order" touted by Obama and his greedy socialist billionaire friends is dumber than a Three Stooges act.

So buy gold, my friends.  The horse is out of the stable. America is in a self-inflicted decline, motivated by greedy socialist billionaires and their media marionettes with cabezas de madera.

Happy Easter--Enjoy the Coming Economic Collapse

The Econdata site has posted the above graph of the Consumer Price Index, CPI, since 1800.  I'm not sure how they calculated it for the 19th century because the Bureau of Labor Statistics didn't start its series until the first or second decade of the twentieth century.  There were various attempts to measure inflation in the 19th century so approximations can be made.   I can't vouch for their numbers but let's assume they're correct.

Notice that most of the inflationary peaks are around wars.  There's a peak following the War of 1812, a peak right at the end of the Civil War, a peak around 1920, following World War I, and then an upswing that starts around 1940 and doesn't abate. Around 1970 (the gold standard was abolished in 1971) the inflation rate surges. It surged at a faster rate in the 1970s than during 1980 to 2010, which is probably why many Americans believed that inflation had ended in the 1980s, which it had not.  It just began increasing at a decreasing rate instead of an increasing rate.

Compare the deflation that occurred after the post-Civil War peak with the deflation that occurred during the Great Depression of the 1930s.  During the Gilded Age, from 1865 to 1910,  the deflation was proportionately greater than in the period from 1930 to 1940 (notice that the twenties, which are usually considered a boom period, also saw some deflation).  The Gilded Age was the period of greatest rates of innovation, expansion and immigration.  Fundamental inventions like the telephone, the railroad (actually pre-Civil War but largely developed post-Civil War), the automobile, radio, A/C electricity, movies, all were created in that period.  As well, there was across the board innovation in processes and methods to a far greater degree than today, despite the lip service paid to total quality management and reengineering.  Moreover, on a proportional basis there was heavy immigration, a few years reaching as high as 500,000 on a base of less than 90 million.

Yet the rapid progress occurred during the largest deflation in American history.  The deflation during the 1930s was much milder, yet the employment effects far more severe.  Yet, academic economists base their arguments on the grievous harm that deflation causes.

Here is the reason.  In the Gilded Age businessmen and Wall Street complained endlessly. The deflation created political instability because real estate investors and farmers who were anticipating real estate profits suffered losses.  But the skimpy profits led to intensification of competition.  Reducing labor costs was hardly sufficient to compete. This led to innovation.

Wall Street, the real estate investors, farmers and businesses complained about the deflation, but the average American was better off.  There was an election that emphasized this issue in 1896, and the pro-gold (but pro-tariff) McKinley defeated the pro-silver Bryan.   Despite this victory, within seventeen years in 1913, the year of JP Morgan's death, Woodrow Wilson established the Fed, which was modeled after a recommendation that Morgan's associates had previously devised.

The depression of the 1930s was accompanied by a rapid expansion of the state and by continued missteps in monetary policy (especially in the late 1930s by Mariner Eccles, the Fed chairman, who caused a second stock market collapse).  The crash of 1929 was a second leg to the correction of the 1920 inflation that the Fed had caused.  The unemployment was intensified by federal policy.  For instance, Herbert Hoover, the last Progressive president, "jaw boned" corporations into not cutting wages.  This forced a much higher layoff rate than would have otherwise occurred (see Murray Rothbard and Ronald Radosh's New History of Leviathan for information about Hoover's role and Hoover's long standing commitment to price fixing and cartelization).  Following Hoover's loss to FDR, the nation embarked on a long term socialization policy that integrated Hoover's Progressive ideas (public works and cartelization via FDR's failed National Industrial Recovery Act) as well as additional ideas that the New Deal Democrats added--regulation of wages via the Fair Labor Standards Act; Social Security; the National Labor Relations Act; and price fixing for agriculture, the Agricultural Adjustment Act, which paid farmers not to grow.  As well, the Smoot-Hawley tariff, enacted in 1930, raised tariffs to the highest levels at any time in US history save in 1828.

The period of inflation from 1940 to today has been the worst in American history for the average worker.  The claim that deflation during the 1930s caused the massive unemployment is contradicted by the fact that a larger deflation in the late nineteenth century was not accompanied by such severe unemployment. 

In other words, the Democrats used the failure of their policies to justify intensification of their policies.  They are doing it again with health care.

Happy Easter!

Stock Market Will Be Flat over Next Ten Years--Boomers Will Work 'til They Drop

The Great Depression lasted nearly ten years. The reason for depressions is that the Federal Reserve Bank creates excessive liquidity. The liquidity is used to stimulate the economy, but the stimulation is in the wrong place. For example, there may be no demand for an additional shoe store at 6% interest, but if interest rates are brought down to 4% then a new shoe store becomes viable. But the new shoe store will be sustainable only at 4% rates. If rates are kept that low, the amount of money created will exceed the value to the economy that the shoe store adds. The result is inflation. The public starts to realize that it is subsidizing businesses that cannot be reasonably justified. Everyone is paying out money through inflation so that the shoe store can stay in business. Better to make the shoemaker welfare payments and not waste so much money. The public starts to protest. The Fed then contracts the money supply, raising interest rates back to 6% or even 7%. The shoe store closes. In 1980 the prime rate was in the twenties. The higher interest rates throw more businesses out of business than were started due to the initial stimulus. A depression occurs.

What has forestalled the inflation is overseas sovereign investors' subsidization. Never before in history have other countries been willing to make themselves poorer by purchasing the additional liquidity that a country creates to keep interest rates low. This phenomenon will not last forever. It could last for 10 years, though.

Because there has been inflation in line with the past 20 years (eg., in the 3-4% range, and recently none due to credit contraction) there has been little impetus to raise interest rates. In fact they have been reduced in order to limit the effects of the bank credit contraction, which occurred for the very same reason as inflation. The Fed created excessive reserves, and mismanaged banks lent money via credit cards and mortgages that were unlikely to be repaid. When this pattern of lending had to change, there was a market collapse.

Because of these policies the country has been becoming poorer but not through inflation. Rather, the credit collapse caused people to lose jobs even though interest rates have not been raised.

Interest rates are now almost as low as they can be. If rates are raised significantly, additional businesses will be closed. If rates continue this low for long, the foreign subsidies to our economy will eventually end. The Fed has created an unsustainable system.

The period of time that this will take to clear up will be longer than the Great Depression. If you count the market decline of 2001 as part of this cycle, it already has been as long as the Great Depression. It may not be cleared up in the Boomers' lifetime.

That leads to the question of what Boomers are to do about retirement. The savings rate has been low, and few boomers have the assets to retire. A rising stock market such as existed up until 2000, ten years ago, would have subsidized the Boomers and allowed them to retire. As well, Social Security has been curtailed since their parents' day (the retirement age will be 67 or likely older), and anyway, Social Security is insufficient for retirement for all except the poor.

But the Boomers may be forced into retirement because of job losses due to the Federal Reserve Bank's being forced to raise rates. If the economy had been allowed to progress naturally there would have been better businesses, more innovation, less overseas plant transfers and a more dynamic economy. The misallocations due to the Fed would have been smaller.

If there were no Fed there would have been no problem.

In inflation-adjusted terms the stock market will not be able to advance until the misallocation of credit has been cleared up; the real estate market is stable and advancing; firms can be subsidized with additional Federal Reserve monetary creation; and inflation is stable. That is, for the stock market to begin advancing the basis for a new bubble will need to be created. This is what Jimmy Carter and Ronald Reagan did in 1979-1982 by allowing Paul Volcker to contract the amount of money and raise interest rates to very high real levels.

True reform of the American economy so that innovation is spurred in the way it was in the late 19th century will require major economic upheaval and abolition of the Federal Reserve Bank.

I doubt that either party has the courage to do this now. Hence, the stock market will not in the long term advance in real terms, although it might advance in nominal (not inflation adjusted) terms if the Fed continues to subsidize it through monetary expansion. In that case hyper-inflation with non-asset holders getting squeezed as real wages are further diminished is a real possibility.

Multiple Choice Test

1. America Needs More:

(a) Politicians
(b) Welfare Mothers
(c) Wall Street Investment Bankers
(d) Auto Mechanics
(e) All of the Above
(f) a, b and c only

2. The chief problem facing America today:

(a) There are not enough hedge fund managers
(b) There are not enough people scheming to get a handout from Uncle Sam
(c) Journalists are just too honest
(d) More than half of the nation's income is diverted into government sponsored waste

3. I fear for the future because:

(a) Wall Street may not survive
(b) Government is impoverished; private affluence public squalor
(c) George Soros says that the US debt load is too low
(d) All of the above
(e) Government is spending, spending, spending and the way they're going to pay it back is an inflation that subsidizes George Soros

You have 15 minutes to complete the test. Please do not forget to sign your name.

China Crash?

John Derbyshire of National Review.com has an interesting post (h/t Larwyn) concerning the possibility of a China crash. Derbyshire notes that two previous times in modern history have nations run up large foreign reserve balances:

>"The first time occurred in the late 1920s when, after a decade of record-beating trade and capital account surpluses, the United States had accumulated what John Maynard Keynes worriedly described as "all the bullion in the world." . . . The second time occurred in the late 1980s, when it was Japan’s turn to combine huge trade surpluses, along with more moderate surpluses on the capital account, to accumulate a stockpile of foreign reserves only a little less than the equivalent of 5-6% of global GDP"

In May 2008 I noted that a Chinese tragedy is in the making despite the major strides that the Chinese economy has made. Like the political leadership of all managed economies, the Chinese government is subject to massive errors and missteps that are far worse than would occur under laissez-faire. I wrote then:

"Tragically, the Chinese perceived the spectacular image of large-scale development and have attempted to emulate Robert Moses's approach with large construction projects, continuing to limit the intellectual and economic freedom on which economic development depends. Equally sadly, Americans lost sight of the reason for their success, and passed laws and regulations, and imposed punitive taxes, that have inhibited entrepreneurship, slowing American economic progress, even as they have increasingly provided welfare payments to incompetent bankers, real estate developers, academics and Wall Street stock jobbers who do not produce wealth.

"This country and China have squandered resources in stupid ways. The bubble will burst as all credit bubbles do. America may have enough resources to reassess its errors. The Chinese likely do not, and many there will be hurt."

Hamlet is Us

When the market is down in January, don't expect a good year. In 2008, I noticed that the market was down in January and I went ahead and invested in gold stocks anyway. I was hammered that fall. Marketwatch quotes S&P's Sam Stovall as saying that this "barometer's track record is dicey, as it often fails to identify the start of new bull markets, such as the market-turnaround years of 1982 and 2003."

At 11:01 The Street noted that gold broke 1100 (I like that kind of symmetry, 11:00, 1101, it goes with my coin flipping method of investing). I'm not convinced that gold will remain firm in the short term just yet, although I've been wrong plenty of times before. Kitco today indicates that the 30 day change in the gold price has been slightly positive.

Jon Nadler of Kitco concludes his report today with this remark:

"If you are in the short-term end of the spectrum of players, excitement will not be lacking, on an hourly basis, even. The bigger picture remains unconvincing on several levels for medium-term speculators."

Also on Kitco, Roger Wiegand has a summary of the derivatives blow up over the past ten years.

Here are some of Wiegand's points:

"USA and other nations’ central bankers pumped currencies and bonds to the moon...TARP money was stolen from taxpayers and funneled through conduit AIG to crooked, failed bankers to reliquify their balance sheets with free money. They are supposed to lend some out for growth but are holding it tight earning free interest from the government; taking no risks...Crooked bankers discovered they are “Too Big To Fail” and are doing it all over again with a tacit “no penalty” understanding. Estimated derivative balances today are $204 Trillion Dollars. No one will stop them until everything collapses in one final crashing swoon."

I have a Hamlet problem. I fear the further fall of gold and rise of dollars in light of the likelihood of dollar demand in case of a global issue such as defaults by Greece or Spain (logically that should not happen but the big investors insist on the safety of the dollar). But I also fear the long term prospects for the dollar given the fragility of the banking system and the likelihood of further inflationary movement.

Which Is Better: Strong or Weak Dollar?

My old childhood friend from Queens, Barry (actually, it goes further back because our mothers were friends in the Bronx in the 1930s and 40s), just sent me this message about the dollar on Facebook and I respond.

Barry:

>Is the "problem" with the dollar that it is too high or too low in comparison with other currencies? If the dollar falls, all of our export industries become more competitive, but we end up with a dose of inflation because our imports become more expensive. If the dollar strengthens, we keep cheap imports but have an increasingly hard time competing abroad. Which is better?

My response:

>That's one of those paradoxes, much like wages. Should an employee be paid more or less? If less, he cannot afford to pay his bills. If more, his employer may go under. Which is better? The answer is that practical human reason cannot answer that question. Rather, market forces can deliberate for us. Allowing the market to do so has the effect of allowing resources to be used most productively. If we set wages too high, there will be a reduction in demand for labor and a surfeit of supply. If we set them too low, there will be a labor shortage and the best people will start their own businesses. Rather, let us allow the market to tell us how high wages ought to be, and firms produce efficiently and fairly.

Being fair to both sides allows supply and demand, including supply and demand for labor, dollars, shoes and anything else, to fall into equilibrium. With respect to dollars, that would be done by letting them float. Firms might lose some predictability with respect to their overseas plants, but why should the public subsidize the risk aversion of big companies? Let them stay home if they wish to avoid currency risk.

In the post war period there was a peg to the dollar. But President Nixon printed too many dollars and so the peg was not sustainable. There was a run on the gold in Fort Knox as foreigners (Americans were not permitted to do this by law) cashed in their dollar bills for gold. So Nixon (a) abolished the transferability of Euro dollars into gold (that had been done for American dollars by Roosevelt in 1932) and (b) floated the dollar. Floating exchange rates, which I believe were suggested by Milton Friedman, work great in theory, but firms required long term stability to make plant decisions. To accomplish this stability, the central banks, the Chinese, Japanese, Saudis, Europeans and others have been holding onto large sums of dollar denominated bonds, informally duplicating the pegging system of the post war period. But the US has been printing more and more dollars. This makes us richer at the other countries' expense. You can cheat others once or twice, but over many decades they began to grow weary of it.

You are right that there are distributional effects of monetary policies. Under the current system the global demand for dollars is exaggerated (also exaggerated because the legal tender law increases domestic demand for dollars--we are not allowed to refuse dollars as payment for goods or services). As a result, the dollar made strong by foreign holdings makes our exports less competitive. More generally, the stability of the artificially propped up dollar has encouraged firms to move overseas. A propped up dollar benefits US manufacturing firms that have moved overseas, and so this policy has contributed to de-industrialization. Also, the Federal Reserve Bank's interest rate and monetary expansion policies have facilitated many firms' moving overseas.

The US government has thus encouraged de-industrialization, driving out manufacturers and sending them to China. China also has low labor costs, and it is difficult to say exactly how much of the move is due to the artificially high dollar and how much is due to low labor costs in China. My guess, which is completely intuitive and not rational, is 20% is due to money. So that 20% of manufacturing might come back here if the dollar were allowed to float.

The up side (besides the huge benefits to manufacturing firms and Wall Street) is that consumer goods have been cheaper.

The down side is that the system is unfair and so unstable. Winding down the dollar subsidies by the international central banks will hurt the vast majority of Americans. The dollar's purchasing power will diminish so that people will become poorer. The real cost (inflation adjusted) of all goods will go up, also guessing, 20%. Maybe a lot more, but no one knows.

So imagine a situation where there's a 20% increase in factory jobs and a 20% reduction in standards of living. Will most Americans appreciate the trade? I think there may be widespread dissatisfaction, and maybe rioting in the streets. But that extra margin (maybe 10% maybe 100%) of benefit to consumers will be lost to us.

On the one hand, the deal has been sweet for US consumers. But on the other, like all subsidies, for instance a rich heir who does not have to work, the windfall has made Americans used to an artificially high standard of living. Note that the standard of living we should be enjoying today is probably not that much higher than it was in 1971. Real (inflation adjusted) hourly wages from 1800 to 1970 increased around 2% per year. Since the abolition of the gold standard in 1971 real hourly wages have increased a total of 2% in almost 40 years. More people work two jobs now and much more families are two income, so it's not going to affect most people to the degree that they will have to give up all the consumer gains. But our standard of living, for the first time in history, probably needs to be adjusted downward by a sizable chunk. The retailing jobs that we will lose because of lower consumer demand will be replaced by manufacturing jobs.

Have Faith in the Federal Reserve Bank--Buy Lots of Gold

http://research.stlouisfed.org/publications/usfd/page3.pdf

Hey Everyone: Check out this graph of the growth of the monetary base. Then go out and put your retirement money into the following:

GLD/IAU
DBC
DBA
UDN

And maybe, if you're rich, buy a house in the Bahamas. It ain't gonna be pleasant in these here parts. No sireee.

St. Louis Fed Data Is A Scream--Needs to Be Enjoyed Nation-Wide

I just sent this message to the Webmaster at the St. Louis Fed. Take a look at the monetary base growth numbers. Wow!

http://research.stlouisfed.org/publications/mt/page3.pdf

Could you give this to me as an html file? I'd like to put it on my blog at http://www.mitchell-langbert.blogspot.com. You guys are a scream. It needs to be enjoyed nation wide.

Thanks, Mitchell Langbert.

Coming Chinese Instability

This is a tale of three nines: 1989, the year of Tiananmen Square; 1999, the year of the tech bubble; and 2009, the year of Chinese support of and complaints about the dollar.

The current global monetary regime seems to parallel the 1999 tech bubble. During the tech bubble investors believed that the stock of Drugstore.com and Cisco Systems would indefinitely escalate. Like all asset bubbles, the tech bubble came to an unhappy end. Ten years later, in 2009, the Chinese seem to think that if they keep buying dollars with yuan and threatening to withdraw the investments then in the end the investments will hold their value.

The Chinese have subsidized the dollar at the expense of their already low-wage workforce. If they keep holding up the dollar, then the Chinese people will become poorer. But if they pull out of the dollar, then their substantial dollar holdings will diminish in value, the Chinese workers will be thrown out of work and the Chinese people will become poorer because of the losses due to the dollar holdings.

Shall we conclude that the Chinese economy is headed for a rough ride?

What do we know about the stability of Chinese society? In 1989 the Tiananmen Square Protests led to hundreds of communist killings. Anyone who was conscious that year will remember the young man standing in front of the tank (see above). Since then, the Chinese have enjoyed a vibrant bubble economy based on fast money growth. But crashes inevitably follow monetarily induced bubbles.

When the Chinese economy tanks there will be alot of unhappy Wal-Mart-supplying factory workers. Perhaps the power of the Chinese state will prevent social unrest. Perhaps not.

You are Leaving Your Children the Husk: Politics, Debt Addiction and American Decline

I just had a long conversation with a friend in my neighborhood, Ulster County, New York. My friend owns a construction company that specializes in high-end residences. She advocates hyper-inflation and low taxes. The connection between her business and inflation is that debt is necessary to stimulate purchases of expensive houses. Monetary expansion is one and the same thing as debt expansion. The Federal Reserve Bank expands the money supply by increasing bank reserves (i.e., by purchasing government bonds from banks and depositing artificially created dollars in the banks). The banks lend out a multiple of the reserves, increasing the money supply. The new debt is used to build expensive houses, but the purchases of the materials for the new houses increases prices. Increasing prices spread through the economy as suppliers of suppliers face increased demand. The result is higher prices at the supermarket, and widespread wealth reduction for anyone who buys consumer goods. Inflation is thus a tax on all Americans in the interest of specific businesses and government that depend on debt. The biggest debtors are of course big, not small business. Examples are hedge funds and Wall Street. Government is the biggest debtor of all. Direct taxation "crowds out" spending on personal consumption in favor of the black hole of government waste. Inflation allocates consumption to the wealthy who can afford to borrow for expensive houses at the expense of those who buy at the supermarket check out.

The use of monetary expansion stimulates businesses that require debt at the expense of those that do not. Thus, expensive, big ticket items such as automobiles and houses are emphasized at the expense of smaller ticket items that you might purchase at a local fair, a supermarket or a boutique. Innovation of new technology that would not depend on debt for demand is replaced by real estate, investment and luxury markets. Returns to innovation become smaller in comparison with subsidized interests such as hedge funds. Income inequality results when merchandise that requires good credit is subsidized and risky innovation is discouraged. Things that people really need are not produced and instead things for which debt is available are produced. Inefficient businesses that do not reflect neutral demand but rather artificially induced demand are encouraged. Special interests accumulate that demand greater inflation. My friend, for instance, has invested in a construction company that depends on inflation. If inflation were to end, she would be ruined. Thus vested special interests that demand ever greater misallocation accumulate. Funds available for innovation diminish. The economy becomes rigidly committed to construction, real estate and automobiles, forgetting that but 15 decades ago suburbs and automobiles did not exist at all, and only came into being because of unpredictable, spontaneous innovation that social democracy has aimed to destroy since the days of Walter Weyl.

One of the effects of social democratic monetary expansion is to reduce demand for labor as debt for capital investment is made artificially available. Labor-saving machinery is made more readily available because interest rates are low. Therefore, demand for labor in capital intensive industries becomes weaker, resulting in stagnant wages. Also, expensive plant relocations to low wage nations are facilitated by low interest rates. Plant relocation is also a form of capital investment that artificially low interest rates stimulate.

There is considerable mal-investment in the American economy. My friend's construction firm is an example. Expensive house building is subsidized by low-wage consumers. The resources that could have gone into innovation and the creation of jobs to manufacture new products instead subsidizes expensive house building. There is only marginal demand for the expensive houses, so ever lower interest rates are needed to stimulate ever greater amounts of house building.

The same is true of Wall Street investments, hedge funds, and corporate takeovers. Printed money is made available to these special interests, who enjoy profits and a rising market as demand is initially stimulated through artificially low interest rates. The general public pays a tax to the wealthy via the Federal Reserve.

This system of allocation of wealth to wealthy interests is the product of the Democratic Party, specifically Woodrow Wilson, who oversaw establishment of the Federal Reserve Bank in 1913 and Franklin D. Roosevelt, who first abolished the gold standard in the early 1930s. However, the Republicans have also played an active role in establishing this system. President Richard M. Nixon abolished the gold standard in 1971 and Presidents Nixon, Reagan and Bush were aggressive inflationists.

Both parties, Democratic and Republican, are big government, interventionist parties. Both favor monetary creation to subsidize special interests. Both have favored Wall Street, commercial banking and corporate interests.

The problem with allocating wealth to special interests is that less productive investments are pursued at the expense of more productive. As less efficient firms accumulate, from Wall Street firms to real estate construction, waste becomes greater. The nation's wealth is extracted and new, innovative ways of using wealth are neglected because the rewards from innovation are diminished while the rewards of wealth extraction by banking, law and investment interests are expanded. Government work is subsidized while the work of factory supervisors and inventors is diminished. As wealth is squandered, the nation becomes poorer.

One of the ironic effects of this process is that the stimulated industries tend to be harmful to the environment. Thus, suburbs were created by Federal Reserve financed construction that far exceeded the demand that would have existed without subsidies from poorer Americans to suburban borrowers. The effect is enhanced use of the automobile, ever greater commutes and worse pollution.

As resources are squandered the technological model which utilizes them becomes exhausted. Innovation has been squelched so new technological advance does not occur. The result is national decline, stagnant or declining real hourly wages and declining opportunities for future generations.

The Federal Reserve Bank is impoverishing your children. But the interests who benefit are palpable, while the interests that are harmed, those who would benefit from unknown invention that would have occurred in the absence of the subsidies, cannot be identified. Public employees know who they are and form a powerful lobby. Beneficiaries of a yet-unknown cure for cancer or a new form of transportation are not known to themselves or anyone else.

This system is leaving future generations a husk. It is eating the corn without planting for the future. It is a reactionary, declining system.