Empire of Debt

Empire of Debt is a book by Bill Bonner and Addison Wiggin. It was written in 2005 and published in 2006 and it talks about the history of empires and the current American empire. It talks about how empires rise and come down and most of all, it describes perfectly the conditions that led to the economic crisis and it predicts precisely the events that we are going through today. This is the book that gave me a lot of answers, sent me searching for more and eventually led me to discover Austrian economics. I want to share one of my favorite excerpts from this book:

     "Things that are unusual usually return to normal. If they did not, there would be no "norma" to return to. That is why you can expect stocks to become more expensive when they are cheap and cheaper when they are expensive. Stocks today are expensive - they trade for an average of about 20 times earnings. Usually, they trade for only 12 to 15 times earnings, so you can expect them to get cheaper.
     Houses are expensive too. They usually go up at a rate roughly equal to the rate of inflation, income, or GDP growth - no more. For the past 10 years, however, they've gone up three to five times as fast. House prices cannot grow faster than income for very long; people have to be able to pay the prices in order to live in them.  So, you can expect houses to revert to their mean too. Prices will fall... or else stop rising. 
     These simple reversions to mean are hardly controversial. We don't know when they will happen or how, but that they will come about is practically guaranteed.
     More interesting to us are the reversions to other, bigger means. An empire itself is a rare thing. It is normal, but unusual. Nature abhors a monopoly. An empire is a monopoly on force. Nature will tolerate it for a while, but sooner or later, the imperial people must revert to being normal people, and the preposterous beliefs that the imperial people cherish, also must pass away. They must go up to a kind of humbug heaven, where absurd ideas and idle flatteries strut around while the gods point, snicker, and collapse into mirth, rolling around clutching their stomachs as if the humor of it was going to kill them.
     The dollar is an extraordinary thing too. Do you know what the long term mean value of paper currency is? Well, it is zero. That is what the average paper currency is worth most of the time... and it is the black hole into which all paper currencies in the past have gone. There could be something magic about the dollar that makes it unlike any paper currency in the past - this is, something that makes it non-mean reverting. But if anyone knows what it is he is not working on this book. For the last hundred years, the dollar has lost value faster than the decline of the roman-era Dinarius after the reign of Nero. This is not surprising. Roman coins had silver or gold in them. In order to make the coins less valuable, they had to reduce the precious metal content. People didn't like it. The dollar, by contrast, contains no precious metal. Not even any base metal. It is just paper. It has no inherent value. There is nothing to take out, because there was never anything there in the first place. Over time, the dollar is almost certain to revert to its real value - which is as empty as deep space. 


It's an excellent book, pick it up if you have a chance. And if you don't, the authors also have a blog called The Daily Reckoning. It's a good read.

The Social Contract

The justification for a democratic social order is often based on the so called social contract, whereby citizens give their consent, pay taxes and pledge their obedience to their elected overlords in exchange for protection, justice, a civil society, order and all the rest of it. This creates a sort of a balance. The men of elevated justice take on the monstrous task of creating a social order, while the masses pay taxes and obey the rule(r)s. Also, there are checks. The men in power amass all the guns so as to make sure people obey their commands, while the people, on the other hand, have the right to vote the bums out of office every 4 to 5 years and vote in – new bums who take over the guns from the old bums along with the rights to tell everyone what to do. So far, so good.

There is one problem, however – no one has ever seen this contract. If it were a super hero, it would be the invisible man. It's the 10th planet of our solar system and the third twin baby. It would be the Bigfoot of contracts except there have actually been reported sightings of Bigfoot. There have, on the other hand, been no reported sightings of the social contract. At least none that I know of.

But since we are all driven to obey this mysterious contract, it would certainly behoove us to learn a little bit about the wording of it, would it not? Now again, I have not myself seen or signed it (drunk Fridays don't count), so I cannot testify to its contents first hand. Nonetheless, observing the world around me, I can imagine it looks a bit like this:

This is a contract between the governing people

and

The governed

1. The governing people shall henceforth be allowed to

·      Write any law that shall direct and prescribe behavior of the governed and command obedience

·      Write any number of nearly incomprehensible laws, of which ignorance and inability to comprehend them shall not exempt the governed of being guilty of violating them

·      Be the final arbiter and judge in any case of disagreement or conflict between the subjects of the governed or between the governed and the governing people themselves

·      Write different classes of laws, one class applying to the governed and another applying to themselves - the governing people

·      Take possession of all firearms and disallow possession of them by the governed – for their own safety

·      Demand payment from the governed in any size and from any sources deemed fit and appropriate by the governing people and assume debt which will have to be paid by the governed and their scions; these payments and debt can be changed at any time, subject to the governing people's discretion

·      Spend the collected money according to their discretion

·      Use force in case of non obedience by the governed

·      Inspect, regulate, license, control, survey, register, restrict, punish, label and supervise conduct of the governed to ensure compliance with the laws they have written

·      Change any of the above at any time and in any way deemed necessary or appropriate by the governing people

2. The governed people shall henceforth be allowed to

·      Have a 1/N (N = the number of voters) chance of replacing the governing people with new governing people who shall remain in control of all the powers listed in point 1. and be allowed to change them at will.

Would you sign this contract? Apparently we already have. It's a strange thing this collective amnesia thing. I have to go ask my neighbor if he remembers signing it...

If Only Tobacco Had a Voice

There are many differences between tobacco and a government. Tobacco never lies, deceives or robs people. It does not tax or regulate and it cannot fight as well. It does not shoot at people and it doesn't insult anyone. It cannot protect and defend itself and it has no means of having anyone do that job for it. What a shame!

And why should you care? If tobacco is so defenseless, it's obvious then that we should stand up for it and defend it with all honor, for it is being attacked all them time. Government keeps throwing around ugly images about what tobacco does to us all the time. We see pictures of black lungs, they try to frighten us about what tobacco will do to us with photographs of yellow teeth and fingernails. We find dire warnings on cigarette packs and billboards. Something must be done to stop these atrocities tobacco is committing, the government warns us! Likewise, the government forces bar and club owners to ban tobacco from being used on their premises. Even the World Health Organization tells us that "[t]obacco caused 100 million deaths in the 20th century". How on earth tobacco managed to kill all these people when it cannot even pick up a gun is a bit of a stretch for my reasoning. But whatever, my aim is not do dispute this number. Quite the contrary, I believe it likely to be accurate. I do not smoke myself and obviously, if you are going to be a smoker, you are increasing your chances of slashing a few years off your to-do list. I just want to put this number into perspective.

I cannot be perfectly sure, but if tobacco had a voice, I think it would wish to tell us these two things:

1.     I don’t kill people. Some people seem to have higher time preferences than others. They want to enjoy the present and are not too much worried about increasing their chance of an early death in the distant future. It is their choice to roll me up in paper and set me on fire, and who is anyone else to be the final and objective judge on what is right or wrong with that.

2.     I may have indirectly caused the death of 100 million people in the 20^th century, but governments around the world, who are constantly trying to warn you abut me, have very directly murdered 262 million people in the same 20^th century. And this is just in times of “peace”. In wartime, an additional 34 million perished at the hands of government sponsored wars. In the 20^th century alone then, governments around the world gave a blood bath to nearly 300 million people. This is the entire population of the USA completely wiped out, off the face of this planet.

If you’ve managed to read this whole piece, you probably either feel better about smoking or worse about your government. I wish it wasn’t the former.

Hi Policeman, Would You Like To Have Some New Powers Today?

I've said many times that most people will not protest the loss of liberty and will be quite complacent about it, so long as Internet and Facebook in particular remain relatively free. Well, apparently, and predictably, this also is about to change. In a rather fascist statement, the British prime minister David Cameron made it blatantly clear today that the powers that be will stand for no loss of control and will indeed take any chance to expand it:

"Mr Speaker, everyone watching these horrific actions will be stuck by how they were organised via social media. Free flow of information can be used for good. But it can also be used for ill. And when people are using social media for violence we need to stop them. So we are working with the Police, the intelligence services and industry to look at whether it would be right to stop people communicating via these websites and services when we know [emphasis added] they are plotting violence, disorder and criminality."

How exactly the government would come to know someone is plotting violence, ho does, to the best of my knowledge, not explain. Also, once they usurp these powers, the line between knowing and thinking will gradually diminish. Moreover, the term "plotting violence" can have more definitions than Angelina Jolie has children. He then goes on to assure us that our rights don't really matter that much:

"I have also asked the police if they need any other new powers. Specifically on facemasks, currently they can only remove these in a specific geographical location and for a limited time. So I can announce today that we are going to give the police the discretion to remove face coverings under any circumstances where there is reasonable suspicion that they are related to criminal activity. And on dealing with crowds, we are also looking at the use of existing dispersal powers and whether any wider power of curfew is necessary. Mr Speaker, whenever the police face a new threat – they must have the freedom and the confidence to change tactics. This government will make sure they always have that. The fight back has well and truly begun."

Notice how "knowing" swiftly changes into "reasonable suspicion". Reasonable, also, is a flexible term. Like a steak. Beat it enough and it soon covers half of your kitchen. I wonder, though, what they'll do if the swine flu returns and everyone is wearing masks... "Remove that mask, sir, oh no wait, hang on... oh... Harry, good ol' chap, I say, what to do with all these powers if you shan't use them... Take your trousers off instead!" But back to serious matters, the bottom line is, when I step on your toe and you complain, the best way to silence you is to bash you over the head. The complaints, of course, must be evil, for I have every right to step on that toe. And how do you know that? Well, I've written a law about it, haven't you heard?

Switzerland Joins the Band Wagon

The Swiss National Bank (SNB) announced recently that it will devalue the Swiss Franc. This can in no plausible way end well. The only way they can of course devalue the Franc is through inflation. And the way the modern banking system is designed, it can only do so through the banking system in the form credit expansion. It means more debt will be taken on and since banks make money through loans, this measure will lower the interest rate and lure businesses into investing. Now since this lowering of the interest rate will not come through an increase in savings by the people but rather by monetary expansion, it is by definition necessary that all these investments will not be completed. People are spending the same or more, saving the same or less, and yet more investment is being undertaken. This cannot be, it is unsustainable. At a certain point, some of these investments will have to stop. Businesses will need to fail and the banks that fund them will be in trouble. Sound familiar?

At this point, the government can do two things. It can either let the recession and liquidation process run its course and let the economy heal or it can bail out the banks, create more credit and inflation. And we all know how that story ends...

Another myth out there is that the strengthening Franc is somehow bad for the Swiss economy. Is it really? Let's look and see. When a currency strengthens, it means it has more purchasing power. It means you get more for the same amount of money. So on the face of it, it would seem at least weird to claim that it is bad for the Swiss to have their money buy more stuff. Truth be told, there are some sectors of the Swiss economy that might be having some trouble, such as exports, but it is not specifically because the Franc is rising, that's just a corollary and I'll get to that in a minute. First, you have to remember what the Franc is gauged against, which is always another currency. So if the Franc is going up, by necessity, another, and in this case, most (or all) other currencies are losing value. And this is the true underlying trend. It's not so much that the Franc is gaining, rather the value of other currencies like the Euro and the US dollar is plummeting. Compare the Franc to the New Zealand dollar and it is not anywhere near as bad, the Franc is flat to slightly rising. Compare it to gold and you will see the Franc flat to falling, depending on which time horizon you are looking at. So it might be that exporters are having a tough time (though I'm not entirely convinced) but importers on the other hand are positively thrilled. Their imports are getting cheaper and cheaper as the Franc is gaining value. And to the extent that the exporters are in trouble, it is because the rest of the world is losing its purchasing power, not specifically because of the Franc. Besides, it's a more or less open world for trading, Switzerland imports as much as it exports (their trade surplus is less than 0.5% of the GDP), so every single exporting business in Switzerland is enjoying the benefits of a strengthening Franc as much as it is lamenting the downsides. Also, as the Franc has been going up during the past 5 years, so has the Swiss trade surplus! On the other side of the pond, the US has been devaluing its dollar for decades and the last time they had a trade surplus was in... um... hang on... well, the chart I have only goes back to 1992. It's not that you can prove or disprove a point by pointing at statistical data, but it lends some illumination nevertheless.

Now let's examine what will happen to the Franc and the Swiss businesses after the Swiss central bank starts devaluing. Inflation will cause rising prices in Switzerland and stop (or else slow down) its strengthening against other currencies. Foreign goods and services will also start rising in price just like they are for the rest of the world – US dollar denominated commodity prices have doubled (!) in the last two and a half years – and if the Franc stops outpacing the USD, imports will get more expensive and this will start squeezing the profits of  the exporters. Now of course, if the Swiss businesses want to drop their profit margins, they can do so at any moment. They need only to lower their prices and voila, there it is (I wonder why they don't do that?). I have a hunch they will not be happy with lower profits or losses. They will have to raise prices and the problem reemerges. On top of that they will have rising domestic consumer prices, an ailing economy and a wave of bad investments ready to spoil whatever is left of the party.

This is not, however, an unexpected turn of events. If one has an exclusive right to print money, it's impossible to expect them not to take advantage of it and inflate. The only question in my mind is how they were able to resist it thus far, as much as they did. Either way, at long last, as if any further proof was needed, we find that all politicians are red under the skin and wicked to boot, even the Swiss.

Why the Depression Just Won't Go Away

The US just lost its AAA credit rating, stocks are plummeting, the European states are drowning in debt and the economy is in the toilet...

Many people around the world find themselves wondering why the economic downturn we are enduring keeps persisting so relentlessly and are at a loss for an explanation. Thinking that you, dear reader, might be one of them, I have set before me the all but impossible task of shedding some light on this issue. It's not something you can learn in 2 minutes, but fear not, it doesn't require a lifetime either. On the contrary, everything is very logical and you don't have to be a trained economist to grasp it. In fact, it might even help you, since your mind has most probably not been clouded with all the political economy nonsense that is floating around these days.

I also want to throw in a word about economic literacy and why it is important. It is vitally important because you are inevitably going to make decisions in your life that reflect what you think about the economy. If you think that recovery is around the corner, you are invariably going to make different decisions than if you think the retardation is going to persist. If you know the weather, you might spare yourself getting caught wet and cold. If you know economics, you might be able to spare yourself being caught penniless in the coming economic hail. You will be able to translate the near incomprehensible lingo of Keynesian economists, such as »we must increase aggregate demand to stimulate economic output« into what they are really saying, which is »we must print money so that our friends in the government and banking sector might increase their income at the expense of everyone else.«

Back to the subject at hand. Our current recession is a part of what economists call a business cycle, whereby the economy goes through cyclical, recurring changes in the amount of goods and services the economy produces. It keeps switching between expansion or economic boom and contraction, also known as the bust, recession etc. This is why it is also called the boom and bust cycle, or the trade cycle. Its history starts roughly in the mid 18th century and this peculiar phenomenon has boggled the minds of countless economists ever since. There were economic depressions before that but not this cyclical and lacking an apparent cause. Numerous theories have been developed as to the root of this menace, but only one of them has been able to both predict and explain the cycle to the full extent. Ever since Ludwig von Mises and Friedrich A. von Hayek have developed the »Austrian« theory of the business cycle in the 1920s and 1930s, the cause of the cycle is no longer a mystery (when I say Austrian, it doesn't have much to do with Austria; it is called Austrian because it is based on a school of thought whose founders mainly came from Austria).

A correct and full explanation of the trade cycle must answer two vital questions. Firstly, why do many or most entrepreneurs suddenly find themselves producing losses all at the same time. Entrepreneurs tend to be great forecasters. If they are not, the market weeds them out and they go out of business fairly quickly. So why do all these entrepreneurs, trained to forecast future demand, make all these losses all at the same time? Secondly, why are capital goods industries hit much harder than consumer goods industries. Why is, for instance, construction and manufacturing hit much harder than retail. In every recession, case after case, you have these two phenomenon and the Austrian theory of the business cycle is the only one that answers both of these questions and many more.

So let me then try and put forth the Austrian theory of the business cycle in a nutshell as best I can. This theory holds that interest rates, much like any other price in the economy, actually have a meaning and that they should be determined by the market, not by a central planning institution, such as the central bank. Central planning of prices has been tried many, many times in the history of human kind and every time it is implemented, it wreaks havoc to the economy. It so happens that prices convey information about relative scarcity (how much of something there is available) and when they are artificially set, they put a blindfold on people’s eyes so that they can no longer make informed decisions. Interest rates then play the function of allocating credit to the most eligible borrowers that are most credit worthy and will use the borrowed funds most productively.

First, let us examine the process of saving and lending in a free market where a central bank does not exist. In this case interest rates in general will be determined by the supply and demand for loanable resources (saved money). While the demand for them will be set by different variables, such as technological advances and tendencies to take risk, the supply of loanable funds (credit) will always be determined by people's time preferences – how much of their income they wish to consume and how much of it they wish to save and invest for future consumption. Thus, when people's time preferences fall, the level of savings in the economy increases and this lowers the interest rate. This provides a powerful incentive for entrepreneurs and businesses to borrow. Since there are now more resources available to invest at a lower cost, businesses engage in new projects and new investments. Also, since long term projects are more interest rate sensitive (if you are borrowing for 30 years, the interest payments represent a much higher cost than if you are borrowing for 3 years), it follows that businesses will also engage in more long term investments that are higher in the stages of production, i.e. investments that are further removed from consumer products (investments into buildings and machinery as opposed to investment into computers). The increased pool of saved resources by the public will provide the supply of physical resources to see all these new projects through to completion, which is why they can be carried out profitably. Upon the completion of these projects, the invested businesses can now repay the loans to their borrowers (this being the public who initially saved) in the form of consumer products that they can now produce with a higher rate of productivity because of the new capital they have invested in (more and better equipment and machinery etc.). This is the way economies grow and have grown since the day man invented his first tools that we now call capital and there is no way around it. Only sufficient saved funds will provide the resources for investment and an unhampered free market will be needed to guide these resources to their most efficient uses. This is the process by which we have been able to come to enjoy the standards of living that we do today.

By contrast, when the central bank intervenes in the market interest rate, usually by lowering it, this gives businesses the false illusion that there are now more loanable funds available for borrowing and investing. The effects are the same, the interest rate drops, even though no one is saving more. The money supply increases but the pool of real resources (the real material stuff out there) needed to fund these investments stays the same. Just because a central banker decides to lower the interest rate, this doesn't release any new resources into the economy. As we have seen, the supply of saved funds is determined by people's time preferences (apportioning income between consumption and saving) and an artificial lowering of the interest rate does not cause people to spend less and save more. If anything, people will spend even more since saving has now been rendered less rewarding by a lowering of the interest rate. The economy is now being stretched apart in an unsustainable way and is »overheating«. Businesses have received new loans due to an increase in the money supply and now an increased number of enterprises is competing for the unchanged pool of physical resources, an unchanged pool of the factors of production, investing them in all the wrong places (eg. tech companies in the 1990s, housing in the 2000s) and most importantly, bidding up their prices. Since entrepreneurs were not calculating with these price increases, they now need new borrowed funds, new credit, to carry out their projects to completion. This causes a surge in the demand for credit, which in turn causes the interest rate to rise again. All those projects that seemed profitable and were started just because of the artificial lowering of the interest rate will now reveal their true nature and show to be unprofitable again because the public has not saved enough to fund them and the return to the market interest rate indicates precisely that. The projects will either not be completed or there will not be enough consumer demand (spending) to make them profitable. What needs to happen then is for these malinvestments, as they are called, to get liquidated. Some investments can be restructured and be put to new use, while others will have to be abandoned altogether. The investments were being made by an artificial boom in credit and were not allocated according to consumer demands.

Knowing this, what then is the best way to “treat” the recession? The shortest way out of it is for the government to step out of the way and let the market work. At a higher rate of interest, the public will automatically increase their savings to provide funding for profitable investments and a reallocation of invested resources to their proper productive use. In other words, the recession is not to be fought, but rather let to run its course and correct the mistakes of the boom since it is the only way back to prosperity. The worst thing a central bank can do is to lower the interest rate yet again, since that will only cause a new wave of malinvestments that will need to be liquidated later on in a longer and more painful period of restructuring, once the credit expansion cycle is over. If the central bank keeps lowering its rates and increasing its money supply in perpetuity, it will eventually and inevitably lead to hyperinflation. If it raises its rates, a recession will ensue but there is no third way. And the sooner the recession, the better, since there will be less malinvestments to liquidate. As Ludwig von Mises puts it in his opus magnum Human Action, »[t]he wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.« Get rid of the central bank and the problem disappears.

Read Austrian economics and learn more about this stuff, I could not encourage you more, for as Murray Rothbard and Mises put it, economics is far too important to leave it to the economists. If you are interested in this subject, here are some helpful links:

Introductory:

Tom Woods on the business cycle and why the 1920 depression was over very quickly: Why You've Never Heard of the Great Depression of 1920 (video)

Tom Woods: An 8 min part of the same lecture where he speaks only about the business cycle theory (video)

Ron Paul, US congressman: Ron Paul and the Austrian Theory of the Business Cycle (video)

Intermediate:

Roger Garrison: Austrian Theory of the Trade Cycle (video)

Advanced:

Murray Rothbard: America's Great Depression (pdf book)