Friday, January 9, 2009

Peter Schiff on the Fed

"As recession fears cause the nation to embrace greater state control of the economy and unimaginable federal deficits, one searches in vain for debate worthy of the moment. Where there should be an historic clash of ideas, there is only blind resignation and an amorphous queasiness that we are simply sweeping the slouching beast under the rug. ... The few who maintain free-market views have been marginalized. ... Individuals, companies or cities with heavy debt and shrinking revenues instinctively know that they must reduce their spending, tighten their belts, pay down debt and live within their means. But it is axiomatic in Keynesianism that national governments can create and sustain economic activity by injecting printed money into the financial system. In their view, absent the stimuli of the New Deal and World War II, the Depression would never have ended. ... There is a vague sense of smoke and mirrors, of something being magically created out of nothing. But economics, we are told is complicated. ... I believe these ideas hold sway because they promise happy, pain-free solutions. They are the economic equivalent of miracle weight-loss programs that require no dieting or exercise. The theories permit economists to claim mystic wisdom, governments to pretend that they have the power to dispel hardship with the whir of a printing press, and voters to believe that they can have recovery without sacrifice. As a follower of the Austrian School of economics, I believe that market forces apply equally to people and nations. ... Governments cannot create but merely redirect. When the government spends, the money has to come from somewhere. ... Something cannot be effortlessly created from nothing. ... By borrowing more than it can ever pay back, the government will guarantee higher inflation for years to come. ... We will be left with 1970s-style stagflation, only with a much sharper contraction and significantly higher inflation. The good news is that economics is not at all that complicated. The bad news is that our economy is broken and there is nothing the government can do to fix it", Peter Schiff at the WSJ, 27 December 2008.

I agree with Schiff.


Anonymous said...

Drown the Fed in a barrel of bucks...

Printfaster said...

They are all missing the fundamentals. Printing money destroys commerce by destroying real liquidity.

Let's walk through this slowly. I define liqudity as the value of the money in circulation in something immutable, say gold or average grain prices, whatever.

Let's say that we have an economy that uses gold as its method of closing debts. I incur a commercial debt, I pay in gold which in turn I either got from my customers, or a debit of gold on account.

Let's say the government steps in and starts printing gold certificates not worth anything except full faith and credit. It continually rolls over its debt so it shows no intention of paying debt in gold.

The next step is Gresham's law. Bad money drives out good.

Commerce now does not close its debts in gold, it closes them with certificates of nonsense. Those certificates are continually devalued by printing more of the counterfeit gold. Each transaction between commercial entities means a drop in the money received by the supplier.

As this proceeds, the supplier becomes poorer and poorer and can no longer afford the commodities needed to produce. He goes bankrupt. The debts that he held disappear.

But low and behold, while the debts that he had are assigned a certificate value, the true value of his debts are zero because counterfeit certificates.

That is what you have today: The disappearance of liquidity for which the value has become vanishingly small. While you think that the disappearing liquidity would make the certificates more valuable, the disappearance of debt makes the certificates more dear at the same time less valuable.

The economy is seizing up because there are no valueless certificates. The current solution is to print more valueless certificates to provide more liquidity. In the end, that will only bankrupt more suppliers and destroy the economy.

Welcome to Zimbabwe. Print faster.

Independent Accountant said...

I follow your argument to here, "Each transaction between commercial entities means a drop in the money received by the supplier". I don't know what this means. As the monetary authority creates more "Counterfeit" currency, the value of each existing unit of currency falls. This means that savings are confiscated. While "the supplier becomes poorer and poorer" this is only true if he holds currency which is counterfeited or claims to such currency, i.e., bonds. I can't follow you here.
It seems you are describing the final stage of hyperinflation just before the collapse. Monetary velocity soars, yet at the same time there is a shortage of money no matter how much is created as prices rise faster than the amount of new money created. Most estimates are that the "real value" of German currency in circulation in 1923 was about 3% of the 1918 value. Is this what you are trying to say?
I don't follow this either, "The economy is seizing up because there are no valueless certificates". Explain this. The economy is deteriorating because people now realize the demand curves for products are not what they thought they were and production factors must be redirected to give effect to the demand shifts. These "redirections" take time and reveal some production facilities are worthless as there is no demand for their potential output.

Independent Accountant said...

I think "printing money destroys commerce" by sending out false signals about relative product demand.

Printfaster said...

Let's see if we can deconstruct this:
'"Each transaction between commercial entities means a drop in the money received by the supplier". I don't know what this means.'

This is a very gradual and insidious process. Not precipitous.

Today I have a dollar. Tomorrow the government prints a counterfeit dollar. The next day my supplier is paid a dollar.

The effect of this is to reduce the value of the supplier's goods by half unless the supplier offsets the government's devaluation of his goods/services by charging me a higher price.

This process of insidious devaluation of goods and services continues for a long time. What is happening the whole time is that the value of goods and service is reduced by government debt and money printing. I will assert that government debt is money, at least counterfeit.

Hyperinflation takes place when supplier prices are raised at a rate commensurate with government money printing, and the government cannot buy goods to function. Oddly enough hyperinflation is when the value of the money in circulation bottoms to a steady value and cannot be decreased anymore by money printing. The jig is up at that point because everyone is demanding just compensation and money is destroyed instantly, essentially 100% per day.

What I am describing the leadup, a gradual erosion of the value of currency until the drop in value becomes a waterfall. Both in inflation and hyperinflation, the total value of currency in circulation drops until end stage hyperinflation when essentially is burned.

Another way to look at it is: what is the half life of currency before it decays away? Right now it has been about 5 years. Looking forward, it will be close to one year.

Instead of 1 trillion deficits, I see 2 trillion next year, 4 the next and 8 the next.

Look again and see the massive search for liquidity with BofA and Swiss bank selling Chinese bank shares because their currency does not have enough value to dispose of any property with it.

Printfaster said...

Just to clarify a bit. Government money printing does has limited effect on internal pricing until external supplies are needed -- notice the non-existent effect on US prices because the Chinese peg the renminbi, enlarging the dollar sphere.

The other place where prices start to inflate is when government starts to press on labor supply (too many government employees) or on product supply (too many trucks and building materials).

It is the need for foreign exchange and trade, unpegged of course, that triggers hyperinflation. It can be another externality of course, such as a crop failure that suddenly triggers high prices for a necessary commodity.

All of this brings an interesting point as to what happens with globalization and the ability to globalize dollar counterfeiting.

What is interesting is that unbacked currency is a bubble that builds until its value is deflated, creating price inflation.

Independent Accountant said...

The government's printing "a counterfeit dollar" does not change the "value of the supplier's goods" at all. It lets those who received the "counterfeit dollar" buy things they otherwise could not have. You write, "the value of goods and services is reduced by government debt and money printing". Again I disagree. Prices rise because the value of the "goods and services" is (relatively) constant. It is the numeraire that changes. In year one, you measure yourself. You say, "ah, I am 1.91666 yards tall". Now in year two you measure yourself, you say, "ah, I am five feet nine inches tall". What changed? Not your height, merely your unit of account. In year three you say, "ah I am 69 inches tall". What's changed? You are not 36 times as tall as you were in year one.
You write, "hyperinflation is when the value of the money in circulation bottoms to a steady value and cannot be decreased anymore by money printing". This is the terminal stage of hyperinflation just before revaluation. Money velocity increases and the real value of the money stock falls. In 1923's Germany, estimates are the real money stock was about 3% of the 1918 value. Milton Friedman calls this the "real balance effect". Since inflation is a tax on cash (and bond) balances, you can reduce the tax by reducing your cash balance.
Your comment about the "half life" of currency is significant' Keynes suggested creating "stamped money" to increase money circulation. Look into it.
Many things could trigger a dollar collapse. On 24 June 1922, Walther Rathenau, a German politician was assassinated. His death led to a crisis of confidence in Germany and the hyperinflation. A change in Chinese economic policy could collapse the dollar.
If the dollar completely collapses it may increase globalization as the world may return to pre-1914 conditions, i.e., gold.