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Archive for the ‘Federal Reserve’ Category

Although it doesn’t get nearly as much attention as it warrants, one of the greatest threats to liberty and prosperity is the potential curtailment and elimination of cash.

As I’ve previously noted, there are two reasons why statists don’t like cash and instead would prefer all of us to use digital money (under their rules, of course, not something outside their control like bitcoin).

First, tax collectors can’t easily monitor all cash transactions, so they want a system that would allow them to track and tax every possible penny of our income and purchases.

Second, Keynesian central planners would like to force us to spend more money by imposing negative interest rates (i.e., taxes) on our savings, but that can’t be done if people can hold cash.

To provide some background, a report in the Wall Street Journal looks at both government incentives to get rid of high-value bills and to abolish currency altogether.

Some economists and bankers are demanding a ban on large denomination bills as one way to fight the organized criminals and terrorists who mainly use these notes. But the desire to ditch big bills is also being fueled from unexpected quarter: central bank’s use of negative interest rates. …if a central bank drives interest rates into negative territory, it’ll struggle to manage with physical cash. When a bank balance starts being eaten away by a sub-zero interest rate, cash starts to look inviting. That’s a particular problem for an economy that issues high-denomination banknotes like the eurozone, because it’s easier for a citizen to withdraw and hoard any money they have got in the bank.

Now let’s take a closer look at what folks on the left are saying to the public. In general, they don’t talk about taxing our savings with government-imposed negative interest rates. Instead, they make it seem like their goal is to fight crime.

Larry Summers, a former Obama Administration official, writes in the Washington Post that this is the reason governments should agree on a global pact to eliminate high-denomination notes.

…analysis is totally convincing on the linkage between high denomination notes and crime. …technology is obviating whatever need there may ever have been for high denomination notes in legal commerce. …The €500 is almost six times as valuable as the $100. Some actors in Europe, notably the European Commission, have shown sympathy for the idea and European Central Bank chief Mario Draghi has shown interest as well.  If Europe moved, pressure could likely be brought on others, notably Switzerland. …Even better than unilateral measures in Europe would be a global agreement to stop issuing notes worth more than say $50 or $100.  Such an agreement would be as significant as anything else the G7 or G20 has done in years. …a global agreement to stop issuing high denomination notes would also show that the global financial groupings can stand up against “big money” and for the interests of ordinary citizens.

Summers cites a working paper by Peter Sands of the Kennedy School, so let’s look at that argument for why governments should get rid of all large-denomination currencies.

Illegal money flows pose a massive challenge to all societies, rich and poor. Tax evasion undercuts the financing of public services and distorts the economy. Financial crime fuels and facilitates criminal activities from drug trafficking and human smuggling to theft and fraud. Corruption corrodes public institutions and warps decision-making. Terrorist finance sustains organisations that spread death and fear. The scale of such illicit money flows is staggering. …Our proposal is to eliminate high denomination, high value currency notes, such as the €500 note, the $100 bill, the CHF1,000 note and the £50 note. …Without being able to use high denomination notes, those engaged in illicit activities – the “bad guys” of our title – would face higher costs and greater risks of detection. Eliminating high denomination notes would disrupt their “business models”.

Are these compelling arguments? Should law-abiding citizens be forced to give up cash in hopes of making life harder for crooks? In other words, should we trade liberty for security?

From a moral and philosophical perspective, the answer is no. Our Founders would be rolling in their graves at the mere thought.

But let’s address this issue solely from a practical, utilitarian perspective.

The first thing to understand is that the bad guys won’t really be impacted. The head the The American Anti-Corruption Institute, L. Burke Files, explains to the Financial Times why restricting cash is pointless and misguided.

Peter Sands…has claimed that removal of high-denomination bank notes will deter crime. This is nonsense. After more than 25 years of investigating fraudsters and now corrupt persons in more than 90 countries, I can tell you that only in the extreme minority of cases was cash ever used — even in corruption cases. A vast majority of the funds moved involved bank wires, or the purchase and sale of valuable items such as art, antiquities, vessels or jewellery. …Removal of high denomination bank notes is a fruitless gesture akin to curing the common cold by forbidding use of the term “cold”.

In other words, our statist friends are being disingenuous. They’re trying to exploit the populace’s desire for crime fighting as a means of achieving a policy that actually is designed for other purposes.

The good news, is that they still have a long way to go before achieving their goals. Notwithstanding agitation to get rid of “Benjamins” in the United States, that doesn’t appear to be an immediate threat. Additionally, according to SwissInfo, is that the Swiss government has little interest in getting rid of the CHF1,000 note.

The European police agency Europol, EU finance ministers and now the European Central Bank, have recently made noises about pulling the €500 note, which has been described as the “currency of choice” for criminals. …But Switzerland has no plans to follow suit. “The CHF1,000 note remains a useful tool for payment transactions and for storing value,” Swiss National Bank spokesman Walter Meier told swissinfo.ch.

This resistance is good news, and not just because we want to control rapacious government in North America and Europe.

A column for Yahoo mentions the important value of large-denomination dollars and euros in less developed nations.

Cash also has the added benefit of providing emergency reserves for people “with unstable exchange rates, repressive governments, capital controls or a history of banking collapses,” as the Financial Times noted.

Amen. Indeed, this is one of the reasons why I like bitcoin. People need options to protect themselves from the consequences of bad government policy, regardless of where they live.

By the way, if you’ll allow me a slight diversion, Bill Poole of the University of Delaware (and also a Cato Fellow) adds a very important point in a Wall Street Journal column. He warns that a fixation on monetary policy is misguided, not only because we don’t want reckless easy-money policy, but also because we don’t want our attention diverted from the reforms that actually could boost economic performance.

Negative central-bank interest rates will not create growth any more than the Federal Reserve’s near-zero interest rates did in the U.S. And it will divert attention from the structural problems that have plagued growth here, as well as in Europe and Japan, and how these problems can be solved. …Where central banks can help is by identifying the structural impediments to growth and recommending a way forward. …It is terribly important that advocates of limited government understand what is at stake. …calls for a return to near-zero or even negative interest rates…will do little in the short run to boost growth, but it will dig the federal government into a deeper fiscal hole, further damaging long-run prospects. It needs to be repeated: Monetary policy today has little to offer to raise growth in the developed world.

Let’s close by returning to the core issue of whether it is wise to allow government the sweeping powers that would accompany the elimination of physical currency.

Here are excerpts from four superb articles on the topic.

First, writing for The American Thinker, Mike Konrad argues that eliminating cash will empower government and reduce liberty.

Governments will rise to the occasion and soon will be making cash illegal.  People will be forced to put their money in banks or the market, thus rescuing the central governments and the central banks that are incestuously intertwined with them. …cash is probably the last arena of personal autonomy left. …It has power that the government cannot control; and that is why it has to go. Of course, governments will not tell us the real reasons.  …We will be told it is for our own “good,” however one defines that. …What won’t be reported will be that hacking will shoot up.  Bank fraud will skyrocket. …Going cashless may ironically streamline drug smuggling since suitcases of money weigh too much. …The real purpose of a cashless society will be total control: Absolute Total Control. The real victims will be the public who will be forced to put all their wealth in a centralized system backed up by the good faith and credit of their respective governments.  Their life savings will be eaten away yearly with negative rates. …The end result will be the loss of all autonomy.  This will be the darkest of all tyrannies.  From cradle to grave one will not only be tracked in location, but on purchases.  Liberty will be non-existent. However, it will be sold to us as expedient simplicity itself, freeing us from crime: Fascism with a friendly face.

Second, the invaluable Allister Heath of the U.K.-based Telegraph warns that the desire for Keynesian monetary policy is creating a slippery slope that eventually will give governments an excuse to try to completely banish cash.

…the fact that interest rates of -0.5pc or so are manageable doesn’t mean that interest rates of -4pc would be. At some point, the cost of holding cash in a bank account would become prohibitive: savers would eventually rediscover the virtues of stuffed mattresses (or buying equities, or housing, or anything with less of a negative rate). The problem is that this will embolden those officials who wish to abolish cash altogether, and switch entirely to electronic and digital money. If savers were forced to keep their money in the bank, the argument goes, then they would be forced to put up with even huge negative rates. …But abolishing cash wouldn’t actually work, and would come with terrible side-effects. For a start, people would begin to treat highly negative interest rates as a form of confiscatory taxation: they would be very angry indeed, especially if rates were significantly more negative than inflation. …Criminals who wished to evade tax or engage in illegal activities would still be able to bypass the system: they would start using foreign currencies, precious metals or other commodities as a means of exchange and store of value… The last thing we now need is harebrained schemes to abolish cash. It wouldn’t work, and the public rightly wouldn’t tolerate it.

The Wall Street Journal has opined on the issue as well.

…we shouldn’t be surprised that politicians and central bankers are now waging a war on cash. That’s right, policy makers in Europe and the U.S. want to make it harder for the hoi polloi to hold actual currency. …the European Central Bank would like to ban €500 notes. …Limits on cash transactions have been spreading in Europe… Italy has made it illegal to pay cash for anything worth more than €1,000 ($1,116), while France cut its limit to €1,000 from €3,000 last year. British merchants accepting more than €15,000 in cash per transaction must first register with the tax authorities. …Germany’s Deputy Finance Minister Michael Meister recently proposed a €5,000 cap on cash transactions. …The enemies of cash claim that only crooks and cranks need large-denomination bills. They want large transactions to be made electronically so government can follow them. Yet…Criminals will find a way, large bills or not. The real reason the war on cash is gearing up now is political: Politicians and central bankers fear that holders of currency could undermine their brave new monetary world of negative interest rates. …Negative rates are a tax on deposits with banks, with the goal of prodding depositors to remove their cash and spend it… But that goal will be undermined if citizens hoard cash. …So, presto, ban cash. …If the benighted peasants won’t spend on their own, well, make it that much harder for them to save money even in their own mattresses. All of which ignores the virtues of cash for law-abiding citizens. Cash allows legitimate transactions to be executed quickly, without either party paying fees to a bank or credit-card processor. Cash also lets millions of low-income people participate in the economy without maintaining a bank account, the costs of which are mounting as post-2008 regulations drop the ax on fee-free retail banking. While there’s always a risk of being mugged on the way to the store, digital transactions are subject to hacking and computer theft. …the reason gray markets exist is because high taxes and regulatory costs drive otherwise honest businesses off the books. Politicians may want to think twice about cracking down on the cash economy in a way that might destroy businesses and add millions to the jobless rolls. …it’s hard to avoid the conclusion that the politicians want to bar cash as one more infringement on economic liberty. They may go after the big bills now, but does anyone think they’d stop there? …Beware politicians trying to limit the ways you can conduct private economic business. It never turns out well.

Last, but not least, Glenn Reynolds, a law professor at the University of Tennessee, explores the downsides of banning cash in a column for USA Today.

…we need to restore the $500 and $1000 bills. And the reason is that people like Larry Summers have done a horrible job. …What is a $100 bill worth now, compared to 1969? According to the U.S. Inflation Calculator online, a $100 bill today has the equivalent purchasing power of $15.49 in 1969 dollars. …And although inflation isn’t running very high at the moment, this trend will only continue. If the next few decades are like the last few, paper money in current denominations will become basically useless. …to our ruling class this isn’t a bug, but a feature. Governments want to get rid of cash… But at a time when, almost no matter where you look in the world, the parts of it controlled by the experts and technocrats (like Larry Summers) seem to be doing badly, it seems reasonable to ask: Why give them still more control over the economy? What reason is there to think that they’ll use that control fairly, or even competently? Their track record isn’t very impressive. Cash has a lot of virtues. One of them is that it allows people to engage in voluntary transactions without the knowledge or permission of anyone else. Governments call this suspicious, but the rest of us call it something else: Freedom.

Amen. Glenn nails it.

Banning cash is a scheme concocted by politicians and bureaucrats who already have demonstrated that they are incapable of competently administering the bloated public sector that already exists.

The idea that they should be given added power to extract more of our money and manipulate our spending is absurd. Laughably absurd if you read Mark Steyn.

P.S. I actually wouldn’t mind getting rid of the government’s physical currency, but only if the result was a system that actually enhanced liberty and prosperity. Unfortunately, I don’t expect that to happen in the near future.

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I wrote yesterday that governments want to eliminate cash in order to make it easier to squeeze more money from taxpayers.

But that’s not the only reason why politicians are interested in banning paper money and coins.

They also are worried that paper money inhibits the government’s ability to “stimulate” the economy with artificially low interest rates. Simply stated, they’ve already pushed interest rates close to zero and haven’t gotten the desired effect of more growth, so the thinking in official circles is that if you could implement negative interest rates, people could be pushed to be good little Keynesians because any money they have in their accounts would be losing value.

I’m not joking.

Here’s some of what Kenneth Rogoff, a professor at Harvard and a former economist at the International Monetary Fund, wrote for the U.K.-based Financial Times.

Getting rid of physical currency and replacing it with electronic money would…eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash.

And here are some passages from an editorial that also was published in the FT.

…authorities would do well to consider the arguments for phasing out their use as another “barbarous relic”…even a little physical currency can cause a lot of distortion to the economic system. The existence of cash — a bearer instrument with a zero interest rate — limits central banks’ ability to stimulate a depressed economy.

Meanwhile, Bloomberg reports that the Willem Buiter of Citi (the same guy who endorsed military attacks on low-tax jurisdictions) supports the elimination of cash.

Citi’s Willem Buiter looks at this problem, which is known as the effective lower bound (ELB) on nominal interest rates. …the ELB only exists at all due to the existence of cash, which is a bearer instrument that pays zero nominal rates. Why have your money on deposit at a negative rate that reduces your wealth when you can have it in cash and suffer no reduction? Cash therefore gives people an easy and effective way of avoiding negative nominal rates. …Buiter’s solution to cash’s ability to allow people to avoid negative deposit rates is to abolish cash altogether.

So are they right? Should cash be abolished so central bankers and governments have more power to manipulate the economy?

There’s a lot of opposition from very sensible people, particularly in the United Kingdom where the idea of banning cash is viewed as a more serious threat.

Allister Heath of the U.K.-based Telegraph worries that governments would engage in more mischief if a nation got rid of cash.

Many of our leading figures are preparing to give up on sound money. The intervention I’m most concerned about is Bank of England chief economist Andrew Haldane’s call for a 4pc inflation target, as well as his desire to abolish cash, embrace a purely electronic currency and thus make it easier for the Bank to impose substantially negative interest rates… Imagine that banks imposed -4pc interest rates on savings today: everybody would pull cash out and stuff it under their mattresses. But if all cash were digital, they would be trapped and forced to hand over their money. …all spending would become subject to the surveillance state, dramatically eroding individual liberty. …Money is already too loose – turning on the taps would merely further fuel bubbles at home and abroad.

Also writing for the Telegraph, Matthew Lynn expresses reservations about this trend.

As for negative interest rates, do we really want those? Or have we concluded that central bankers are doing more harm than good with their attempts to manipulate the economy? …a banknote is an incredibly efficient way to handle small transactions. It is costless, immediate, flexible, no one ever needs a password, it can’t be hacked, and the system doesn’t ever crash. More importantly, cash is about freedom. There are surely limits to the control over society we wish to hand over to governments and central banks? You don’t need to be a fully paid-up libertarian to question whether…we really want the banks and the state to know every single detail of what we are spending our money on and where. It is easy to surrender that freedom – but it will be a lot harder to get back.

Merryn Somerset Webb, a business writer from the U.K., is properly concerned about the economic implications of a society with no cash.

…at the beginning of the financial crisis, there was much talk about financial repression — the ways in which policymakers would seek to control the use of our money to deal with out-of-control public debt. …We’ve seen capital controls in the periphery of the eurozone… Interest rates everywhere have been at or below inflation for seven years — and negative interest rates are now snaking their nasty way around Europe… This makes debt interest cheap for governments…and it and forces once-prudent savers to move their money into the kind of risky assets that are supposed to drive growth (and tax receipts).

Amen. She’s right that low interest rates are good news for governments and not very good news for people in the productive sector.

Last but not least, Chris Giles wrote a column for the FT and made one final point that is very much worth sharing.

Mr Haldane’s proposal to ban cash has all the hallmarks of a public official confusing what is convenient for the central bank with what is in the public interest.

Especially since the central bankers are probably undermining long-run economic prosperity with short-run tinkering.

Moreover, the option to engage in Keynesian monetary policy also gives politicians an excuse to avoid the reforms that actually would boost economic performance. Indeed, it’s quite likely that an easy-money policy exacerbates the problems caused by bad fiscal and regulatory policy.

Let’s conclude by noting that maybe the right approach isn’t to give politicians and central bankers more control over money, but rather to reduce government’s control over money. That’s one of the arguments I made in this video I narrated for the Center for Freedom and Prosperity.

P.S. By the way, Ryan McKaken at the Mises Institute identifies a third reason why politicians would prefer a cash-free society.

…the elimination of physical cash makes it easier for the state to keep track of private persons, and it assists central banks in efforts to punish saving and expand the money supply by implementing negative interest rate schemes. A third advantage of the elimination of physical cash would be to more easily control people and potential dissidents through the freezing of their bank accounts.

Excellent point. We’ve already seen how asset forfeiture allows governments to steal people’s bank accounts without any conviction of wrongdoing. Imagine the damage politicians and bureaucrats could do if they had even more control over our money.

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We’ve been suffering through the weakest recovery since the Great Depression. Labor force participation hasn’t recovered and median household income is stagnant.

So how are our benevolent and kind overseers in Washington responding?

Are they reducing the burden of spending? Nope, they just busted the spending caps (again).

Are they cutting back on red tape? No, they’re moving in the other direction.

Are they lowering taxes? With Obama in the White House, that’s not even a serious question.

But that doesn’t mean all the people in Washington is sitting on their collective hands. The folks at the Federal Reserve have been trying to goose the economy with an easy-money policy.

Unfortunately, as I argue in this recent interview, that’s not a recipe for success.

At best, an easy-money policy is ineffective, akin to “pushing on a string.” At worst, it creates bubbles and does serious damage.

Yet if you don’t like the Fed trying to manipulate the economy, you’re often perceived as a crank. And if you’re an elected official who questions the Fed’s actions, you’re often portrayed as some sort of uninformed demagogue.

I explored this issue today in The Federalist. In my column, I defended Senators Rand Paul and Ted Cruz.

Rand Paul and Ted Cruz…deserve credit for criticizing the Federal Reserve. …This irks some folks, who seem to think Fed critics are knuckle-dragging rubes and yahoos with a superstitious fealty to the gold standard.

This isn’t a debate over the gold standard, per se, but instead of fight over monetary Keynesianism vs. monetary rules.

The dispute isn’t really about a gold standard, but whether the Federal Reserve should have lots of discretionary power.  …On one side are the advocates of…the monetary component of Keynesian economics. Proponents explicitly want the Fed to fine-tune and micromanage the economy. …On the other side are folks who believe in rules to limit the Fed’s powers…because they believe discretionary power is more likely to give us bad results such as higher price inflation, volatility in output and employment, and financial instability.

And the Joint Economic Committee is on the side of rules. Here’s an excerpt from a JEC report that I cited in my article.

Well-reasoned, stable and predictable monetary policy reduces economic volatility and promotes long-term economic growth and job creation. Generally, ‘rules-based’ policies reduce uncertainties and facilitate long-term planning and investment. …Conversely, activist, interventionist, and discretionary monetary policies have been historically associated with increased economic volatility and subpar economic performance.

I then mention various rules-based methods of limiting the Fed’s discretion and conclude by commenting on the legitimacy of those who want to curtail the Federal Reserve.

Paul and Cruz may not be experts on monetary policy, just as left-wing senators doubtlessly have no understanding of the intricacies of discretionary monetary policy. But the two senators are on very solid ground, with an illustrious intellectual lineage, when they assert that it would be a good idea to constrain the Fed.

Now let’s expand on two issues. First, I mention in my article the gold standard as a potential rule to constrain the Fed. I’ve previously shared some analysis by George Selgin on this topic. He’s concluded that governments won’t ever allow its return and probably couldn’t be trusted with such a system anyway, but that doesn’t mean it doesn’t work.

Here are some excerpts from a recent article by George. Read the entire thing, but here’s the part that matters most for this discussion.

…the gold standard was hardly perfect, and gold bugs themselves sometimes make silly claims about their favorite former monetary standard. …the classical gold standard worked remarkably well (while it lasted). …it certainly did contribute both to the general abundance of goods of all sorts, to the ease with which goods and capital flowed from nation to nation, and, especially, to the sense of a state of affairs that was “normal, certain, and permanent.” The gold standard achieved these things mainly by securing a degree of price-level and exchange rate stability and predictability that has never been matched since.

And Norbert Michel of the Heritage Foundation touches on some of the same issues in a new column for Forbes.

Several candidates suggested the gold standard was a good system, and they’re all getting flak for talking about gold.

But here’s the most fascinating revelation from Norbert’s column. It turns out that even Ben Bernanke agrees with George Selgin that the classical gold standard worked very well. Norbert quotes this passage from Bernanke.

The gold standard appeared to be highly successful from about 1870 to the beginning of World War I in 1914. During the so-called “classical” gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value.

Both Norbert’s article and George’s article have lots of good (but depressing) analysis of how governments went off the gold standard because of World War I and then put in place a hopelessly weak and impractical version of a gold standard after the war (the politicians didn’t want to be constrained by an effective system).

So here’s Norbert’s bottom line, which is very similar to the conclusion in my column for The Federalist.

Many who favor the gold standard recognize that it provided a nominal anchor as opposed to the discretionary fiat system we have now. Maybe the gold standard isn’t the best way to achieve that nominal anchor, but we shouldn’t just dismiss the whole notion.

The second issue worth mentioning is that the best way to deal with bad monetary policy may be to have no monetary policy.

At least not a monetary policy from government. This video explains the merits of this approach.

Gee, maybe Friedrich Hayek was right and private markets produce better results than government monopolies.

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What’s the biggest economic fallacy on the left? What’s the defining mistake for our statist friends?

One obvious answer is that many of them hold the anti-empirical belief that the economy is  a fixed pie and that one person can’t climb the economic ladder unless another person falls a few rungs.

There’s no doubt that the fixed-pie myth is an obstacle to sound thinking, but I’m wondering whether an even bigger problem is the pervasive belief on the left that there are easy shortcuts to prosperity.

Keynesian fiscal policy, for instance, is based on the notion that more growth is just a simple question of having the government spend more money.

And Keynesian monetary policy is based on a similarly simplistic assumption that more growth is generated by having central banks create more money.

To be sure, both policies may seem to work in the short run since people suddenly perceive that they have more money. But perceptions and reality may be different, particularly if the short-run boost in the economy is an illusory bubble.

And that’s why I’m not a big fan of QE-type policies designed to “stimulate” growth with artificially low interest rates.

As I explain in this brief FBN interview, any short-run gain is offset by long-run pain.

And I’m not the only one who has a jaundiced view.

The Wall Street Journal also is not happy with the Federal Reserve, opining that the real economy has stagnated as financial assets have been propped up by easy money.

…the Fed has only itself to blame for its economic and political predicament. …One lesson here is that the Fed’s great monetary experiment since the recession ended in 2009 looks increasingly like a failure. Recall the Fed’s theory that quantitative easing (bond buying) and near-zero interest rates would lift financial assets, which in turn would lift the real economy. …But while stocks have soared, as have speculative assets like junk bonds and commercial real estate, the real economy hasn’t. This remains the worst economic recovery by far since World War II…the economic expectations of Fed Chairs Ben Bernanke and Janet Yellen have been consistently wrong. …the Fed now finds itself caught between a slowing global economy and its promise to begin normalizing rates this year. …One result has been to increase economic uncertainty and market volatility.

Another result is that easy-money policies give politicians an excuse to avoid the real reforms that would boost long-run growth.

I definitely think that’s been a problem in Europe. Politicians keep waiting for magical results from the European Central Bank when the real obstacle to prosperity is a stifling burden of taxation, spending, and regulation.

The bottom line is that politicians all over the world are exacerbating bad fiscal and regulatory policy with bad monetary policy.

To augment this analysis, here’s a video from the Fraser Institute about the insight of Friedrich Hayek, who warned that government intervention, particularly via monetary policy, caused booms and busts by distorting market signals.

Needless to say, last decade’s financial crisis is a case study showing the accuracy of Hayek’s Austrian-school analysis.

But politicians never seem to learn. Or maybe they just don’t care. They focus on the short run (i.e., the next election) and it always feels good when the bubble is expanding.

And when the government-created bubble bursts, they can simply blame greed, or rich people, or find some other scapegoat (and then repeat the same mistakes as soon as the dust settles).

P.S. For a more detailed look at Austrian economics, check out this lecture. And Austrian-school scholars also have the best analysis of the Great Depression.

P.P.S. And for a more conventional critique of easy-money policies, here are some highlights from a speech by a member of the Bank of England’s Monetary Policy Committee.

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The standard argument against an easy-money policy is that it creates distortions in an economy that lead to either rapid increases in the price level, like we endured in the 1970s, or unsustainable asset bubbles, like we experienced last decade.

Those arguments are completely valid, but they only tell part of the story.

Central banks also should be criticized because “quantitative easing” and “zero interest rate policies” create major imbalances in capital markets.

A major new study from Swiss Re quantifies the damage to savers. Here are some excerpts from a CNBC report.

The Federal Reserve’s efforts to stimulate the U.S. economy after the financial crisis ended up costing savers nearly half a trillion dollars in interest income, according to report released Thursday. Since the central bank dropped interest rates to near zero at the end of 2008, savers have labored under plain-vanilla bank accounts and money market funds that have yielded close to nothing. …In a landmark report, Swiss Re quantifies just how much savers and others have languished… The reinsurance firm put the number at $470 billion in the 2008-13 period studied, so the number is likely even higher now. …”the impact of foregone interest income for households and long-term investors has become substantial.” …Swiss Re said the “financial repression” has taken its toll not only on savers but also on some areas of investing.

Here’s a chart from the Swiss Re report. As you can see, an easy-money policy is a massive tool for redistribution, with savers being hurt and government being subsidized.

Indeed, Swiss Re actually calculates a “financial repression index.”

Financial repression reflects the ability of policymakers to direct funds to themselves that would otherwise go elsewhere.

And the level of this repression has been at record highs in recent years.

It is true that some households benefit from easy money and artificially low interest rates. Their debt expenses have been reduced and they also are enjoying higher asset values.

But those benefits may be fleeting if the end result is a bubble that bursts, as happened in 2008.

Writing for the Washington Times, my Cato colleague Richard Rahn agrees that central banks are hurting savers, but he augments this analysis by making the very important point that easy-money policies simply don’t work.

Government economic policymakers have been trying to solve a problem of too much government spending, taxing and regulation by inappropriately using monetary policy, which has not and cannot solve the fundamental problems (it is like using a hammer rather than a shovel to dig a hole). The major central banks have been holding down interest rates, which is actually a massive indirect tax levied on the world’s savers. Historically, savers would receive about 3 percent interest above the rate of inflation on their safest investments, but now interest rates often do not cover even the low inflation that is occurring in the developed countries. …Many economists expected savers to save less and consume more as a result of low or even negative interest rates… When businesses and individuals look at the world debt situation and the increased chances of another financial collapse, their rational response is to increase “precautionary” savings, even though they are not receiving interest on them.

So the bottom line is that central banks are engaging in “financial repression” today and creating risks of price instability and/or asset bubbles tomorrow.

But there’s no compensating benefit to make all these costs (and future risks) worthwhile.

That’s not a good deal.

So what’s the alternative?

In the short run, the best hope is that central bankers, including the ones at the Federal Reserve, will take their feet off the figurative gas pedal and follow some sort of monetary rule that precludes destructive intervention.

In the long run, the ideal answer would be a return to market-provided private currencies. This isn’t just silly libertarian fantasy. There actually have been countries that successfully used this “free banking” approach.

Professor Larry White has a must-read historical review of what happened before governments monopolized currency issue.

When we look into these episodes, we find a record of innovation, improvement, and success at serving money-users. As in other goods and services, competition provided the public with improved products at better prices. The least regulated systems were not only the most competitive but also by and large the least crisis-prone. …the record of these historical free banking systems, “most if not all can be considered as reasonably successful, sometimes quite remarkably so.”…Those systems of plural note issue that were panic prone, like those of pre-1913 United States and pre-1832 England, were not so because of competition but because of legal restrictions that significantly weakened banks. Where free banking was given a reasonable trial, for example in Scotland and Canada, it functioned well for the typical user of money and banking services.

The history of central banking, by contrast, is not nearly as successful. There’s been massive erosion in the value of money and central banks are largely responsible for the boom-bust cycle that has afflicted many economies.

At this point, you may be wondering why central banking triumphed over free banking if the latter is so superior.

The answer is simple. As Professor White explains, look at what’s in the best interest of the political elite.

Free banking often ended because the imposition of heavy legal restrictions or creation of a privileged central bank offered revenue advantages to politically influential interests. The legislature or the Treasury can tap a central bank for cheap credit, or (under a fiat standard) simply have the central bank pay the government’s bills by issuing new money. …Central banks primarily arose, directly or indirectly, from legislation that created privileges to promote the fiscal interests of the state or the rent-seeking interests of privileged bankers, not from market forces.

In other words, a system of competitive currencies is perfectly plausible, but it’s not in the interest of politicians (just as having no income tax is plausible, but also not in the interest of politicians).

For more information on free banking, here’s a video I narrated for the Center for Freedom and Prosperity.

Professor White also has a good video explaining why a central bank isn’t needed.

P.S. For those of you who like the gold standard, Professor George Selgin (now head of Cato’s Center for Monetary and Financial Alternatives) has some major concerns (at least if the government is in charge of it).

P.P.S. Don’t forget that the Federal Reserve also imposes a lot of costly regulation on the financial sector.

P.P.P.S. Thomas Sowell has some wise observations on why we shouldn’t grant more power to the Fed and John Stossel explains why monetary competition would be good.

P.P.P.P.S. To end with some humor, here’s the famous “Ben Bernank” video. And if that doesn’t exhaust your interest in the topic, here’s a snarky cartoon video mocking the Fed and another video with 10 reasons to dislike the Fed.

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During periods of economic weakness, governments often respond with “loose” monetary policy, which generally means that central banks will take actions that increase liquidity and artificially lower interest rates.

I’m not a big fan of this approach.

If an economy is suffering from bad fiscal policy or bad regulatory policy, why expect that an easy-money policy will be effective?

What if politicians use an easy-money policy as an excuse to postpone or avoid structural reforms that are needed to restore growth?

And shouldn’t we worry that an easy-money policy will cause economic damage by triggering systemic price hikes or bubbles?

Defenders of central banks and easy money generally respond to such questions by assuring us that QE-type policies are not a substitute or replacement for other reforms.

And they tell us the downside risk is overstated because central bankers will have the wisdom to soak up excess liquidity at the right time and raise interest rates at the right moment.

I hope they’re right, but my gut instinct is to worry that central bankers are not sufficiently vigilant about the downside risks of easy-money policies.

But not all central bankers. While I was in London last week to give a presentation to the State of the Economy conference, I got to hear a speech by Kristin Forbes, a member of the Bank of England’s Monetary Policy Committee.

She was refreshingly candid about the possible dangers of the easy-money approach, particularly with regards to artificially low interest rates.

Here is one of the charts from her presentation.

Those of us who are old enough to remember the 1970s will be concerned about her first point. And this is important. It would be terrible to let the inflation genie out of the bottle, particularly since there may not be a Ronald Reagan-type leader in the future who will do what’s needed to solve such a mess.

But today I want to focus on her second, fourth, and fifth points.

So here are some of the details from her speech, starting with some analysis of the risk of bubbles.

…when interest rates are low, investors may “search for yield” and shift funds to riskier investments that are expected to earn a higher return – from equity markets to high-yield debt markets to emerging markets. This could drive up prices in these other markets and potentially create “bubbles”. This can not only lead to an inefficient allocation of capital, but leave certain investors with more risk than they appreciate. An adjustment in asset prices can bring about losses that are difficult to manage, especially if investments were supported by higher leverage possible due to low rates. If these losses were widespread across an economy, or affected systemically-important institutions, they could create substantial economic disruption. This tendency to assume greater risk when interest rates are low for a sustained period not only occurs for investors, but also within banks, corporations, and broader credit markets. Studies have shown that during periods of monetary expansion, banks tend to soften lending standards and experience an increase in their assessed “riskiness”. There is evidence that the longer an expansion lasts, the greater these effects. Companies also take advantage of periods of low borrowing costs to increase debt issuance. If this occurs during a period of low default rates – as in the past few years – this can further compress borrowing spreads and lead to levels of debt issuance that may be difficult to support when interest rates normalize. There is a lengthy academic literature showing that low interest rates often foster credit booms, an inefficient allocation of capital, banking collapses, and financial crises. This series of risks to the financial system from a period of low interest rates should be taken seriously and carefully monitored.

Her fourth and fifth points are particularly important since they show she appreciates the Austrian-school insight that bad monetary policy can distort market signals and lead to malinvestment.

Here’s some of what she shared about the fourth point.

…is there a chance that a prolonged period of near-zero interest rates is allowing less efficient companies to survive and curtailing the “creative destruction” that is critical to support productivity growth? Or even within existing, profitable companies – could a prolonged period of low borrowing costs reduce their incentive to carefully assess and evaluate investment projects – leading to a less efficient allocation of capital within companies? …For further evidence on this capital misallocation, one could estimate the rate of “scrappage” during the crisis and the level of capital relative to its optimal, steady-state level. Recent BoE work has found tentative evidence of a “capital overhang”, an excess of capital above that judged optimal given current conditions. Usually any such capital overhang falls quickly during a recession as inefficient factories and plants are shut down and new investment slows. The slower reallocation of capital since the crisis could partly be due to low interest rates.

And here is some of what she said about the fifth point.

A fifth possible cost of low interest rates is that it could shift the sources of demand in ways which make underlying growth less balanced, less resilient, and less sustainable. This could occur through increases in consumption and debt, and decreases in savings and possibly the current account. …if these shifts are too large – or vulnerabilities related to overconsumption, overborrowing, insufficient savings, or large current account deficits continue for too long – they could create economic challenges.

In her speech, Ms. Forbes understandably focused on the current environment and speculated about possible future risks.

But the concerns about easy-money policies are not just theoretical.

Let’s look at some new research from economists at the Federal Reserve Bank of San Francisco, the University of California, and the University of Bonn.

In a study published by the National Bureau of Economic Research, they look at the connections between monetary policy and housing bubbles.

How do monetary and credit conditions affect housing booms and busts? Do low interest rates cause households to lever up on mortgages and bid up house prices, thus increasing the risk of financial crisis? And what, if anything, should central banks do about it? Can policy directed at housing and credit conditions, with monetary or macroprudential tools, lead a central bank astray and dangerously deflect it from single- or dual-mandate goals?

It appears the answer is yes.

This paper analyzes the link between monetary conditions, credit growth, and house prices using data spanning 140 years of modern economic history across 14 advanced economies. …We make three core contributions. First, we discuss long-run trends in mortgage lending, home ownership, and house prices and show that the 20th century has indeed been an era of increasing “bets on the house.” …Second, turning to the cyclical fluctuations of lending and house prices we use novel instrumental variable local projection methods to show that throughout history loose monetary conditions were closely associated with an upsurge in real estate lending and house prices. …Third, we also expose a close link between mortgage credit and house price booms on the one hand, and financial crises on the other. Over the past 140 years of modern macroeconomic history, mortgage booms and house price bubbles have been closely associated with a higher likelihood of a financial crisis. This association is more noticeable in the post-WW2 era, which was marked by the democratization of leverage through housing finance.

So what’s the bottom line?

The long-run historical evidence uncovered in this study clearly suggests that central banks have reasons to worry about the side-effects of loose monetary conditions. During the 20th century, real estate lending became the dominant business model of banks. As a result, the effects that low interest rates have on mortgage borrowing, house prices and ultimately financial instability risks have become considerably stronger. …these historical insights suggest that the potentially destabilizing byproducts of easy money must be taken seriously

In other words, we’re still dealing with some of the fallout of a housing bubble/financial crisis caused in part by the Fed’s easy-money policy last decade.

Yet we have people in Washington who haven’t learned a thing and want to repeat the mistakes that created that mess.

Even though we now have good evidence about the downside risk of easy money and bubbles!

Sort of makes you wonder whether the End-the-Fed people have a good point.

P.S. Central banks also can cause problems because of their regulatory powers.

P.P.S. Just as there are people in Washington who want to double down on failure, there are similar people in Europe who think a more-of-the-same approach is the right cure for the problems caused in part by a some-of-the-same approach.

P.P.P.S. For those interested in monetary policy, the good news is that the Cato Institute recently announced the formation of the Center for Monetary and Financial Alternatives, led by former UGA economics professor George Selgin, which will focus on development of policy recommendations that will create a more free-market monetary system.

P.P.P.P.S. If you watch this video, you’ll see that George doesn’t give the Federal Reserve a very high grade.

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It’s no secret that I’m a huge fan of Ronald Reagan.

He’s definitely the greatest president of my lifetime and, with one possible rival, he was the greatest President of the 20th century.

If his only accomplishment was ending malaise and restoring American prosperity thanks to lower tax rates and other pro-market reforms, he would be a great President.

He also restored America’s national defenses and reoriented foreign policy, both of which led to the collapse of the Soviet Empire, a stupendous achievement that makes Reagan worthy of Mount Rushmore.

But he also has another great achievement, one that doesn’t receive nearly the level of appreciation that it deserves. President Reagan demolished the economic cancer of inflation.

Even Paul Krugman has acknowledged that reining in double-digit inflation was a major positive achievement. Because of his anti-Reagan bias, though, he wants to deny the Gipper any credit.

Robert Samuelson, in a column for the Washington Post, corrects the historical record.

Krugman recently wrote a column arguing that the decline of double-digit inflation in the 1980s was the decade’s big economic event, not the cuts in tax rates usually touted by conservatives. Actually, I agree with Krugman on this. But then he asserted that Ronald Reagan had almost nothing to do with it. That’s historically incorrect. Reagan was crucial. …Krugman’s error is so glaring.

Samuelson first provides the historical context.

For those too young to remember, here’s background. From 1960 to 1980, inflation — the general rise of retail prices — marched relentlessly upward. It went from 1.4 percent in 1960 to 5.9 percent in 1969 to 13.3 percent in 1979. The higher it rose, the more unpopular it became. …Worse, government seemed powerless to defeat it. Presidents deployed complex wage and price controls and guidelines. They didn’t work. The Federal Reserve — custodian of credit policies — veered between easy money and tight money, striving both to subdue inflation and to maintain “full employment” (taken as a 4 percent to 5 percent unemployment rate). It achieved neither. From the late 1960s to the early 1980s, there were four recessions. Inflation became a monster, destabilizing the economy.

The column then explains that there was a dramatic turnaround in the early 1980s, as Fed Chairman Paul Volcker adopted a tight-money policy and inflation was squeezed out of the system much faster than almost anybody thought was possible.

But Krugman wants his readers to think that Reagan played no role in this dramatic and positive development.

Samuelson says this is nonsense. Vanquishing inflation would have been impossible without Reagan’s involvement.

What Reagan provided was political protection. The Fed’s previous failures to stifle inflation reflected its unwillingness to maintain tight-money policies long enough… Successive presidents preferred a different approach: the wage-price policies built on the pleasing (but unrealistic) premise that these could quell inflation without jeopardizing full employment. Reagan rejected this futile path. As the gruesome social costs of Volcker’s policies mounted — the monthly unemployment rate would ultimately rise to a post-World War II high of 10.8 percent — Reagan’s approval ratings plunged. In May 1981, they were at 68 percent; by January 1983, 35 percent. Still, he supported the Fed. …It’s doubtful that any other plausible presidential candidate, Republican or Democrat, would have been so forbearing.

What’s the bottom line?

What Volcker and Reagan accomplished was an economic and political triumph. Economically, ending double-digit inflation set the stage for a quarter-century of near-automatic expansion… Politically, Reagan and Volcker showed that leaders can take actions that, though initially painful and unpopular, served the country’s long-term interests. …There was no explicit bargain between them. They had what I’ve called a “compact of conviction.”

By the way, Krugman then put forth a rather lame response to Samuelson, including the rather amazing claim that “[t]he 1980s were a triumph of Keynesian economics.”

Here’s what Samuelson wrote in a follow-up column debunking Krugman.

As preached and practiced since the 1960s, Keynesian economics promised to stabilize the economy at levels of low inflation and high employment. By the early 1980s, this vision was in tatters, and many economists were fatalistic about controlling high inflation. Maybe it could be contained. It couldn’t be eliminated, because the social costs (high unemployment, lost output) would be too great. …This was a clever rationale for tolerating high inflation, and the Volcker-Reagan monetary onslaught demolished it. High inflation was not an intrinsic condition of wealthy democracies. It was the product of bad economic policies. This was the 1980s’ true lesson, not the contrived triumph of Keynesianism.

If anything, Samuelson is being too kind.

One of the key tenets of Keynesian economics is that there’s a tradeoff between inflation and unemployment (the so-called Phillips Curve).

Yet in the 1970s we had rising inflation and rising unemployment.

While in the 1980s, we had falling inflation and falling unemployment.

But if you’re Paul Krugman and you already have a very long list of mistakes (see here, here, here, here, here, here, here, here, and here for a few examples), then why not go for the gold and try to give Keynes credit for the supply-side boom of the 1980s

P.S. Since today’s topic is Reagan, it’s a good opportunity to share my favorite poll of the past five years.

P.P.S. Here are some great videos of Reagan in action. And here’s one more if you need another Reagan fix.

P.P.P.S. And let’s close with some mildly risqué Reagan humor that was sent to me by a former member of Congress.

Reagan Clinton Joke

If you want more Reagan humor, click here, here, and here.

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