Tuesday, March 20, 2012

Mr. Bernanke Scores Zero on His Term Paper, As Marked by Me

20 March 2012

To my knowledge, Mr. Bernanke has never done this before. He has laid out his delusional belief system for all to see. (Ben Bernanke, a former Princeton University professor, is the Chairman of the US Federal Reserve, a private corporation which manages money supply and interest rates in the US.)

Indeed, the emperor has no clothes.

Joe Weisenthal, an intrepid reporter with Business Insider who has a notable nose for news, summarized Mr. Bernanke's first lecture on the history of the Federal Reserve as follows. Note that Mr. Bernanke began by attacking the gold standard. That was mistake number one. Mr. Bernanke's multitudinous errors proceed from there....

In my family archives, I still have an essay written by my father on the gold standard from his college days in the late 1930s. Let me tell you, my father got it right over 70 years ago, and Mr. Bernanke has gotten it 100% wrong today. Would that my father had chaired the Federal Reserve instead of Mr. Bernanke (and before him, Mr. Greenspan).

Mr. Wiesenthal, who is indefatigable, summarized Mr. Bernanke's speech as follows:
  1. To have a gold standard, you have to go dig up gold in South Africa and put it in a basement in New York. It's nonsensical.
  2. The gold standard ends up linking everyone's currencies, causing policy in one country to transmit to another country (sort of how U.S. policy now transmits to China, because they've fixed the yuan price to the dollar). So for example, if the U.K. fixes the number of pounds to an ounce of gold, and the U.S. fixes the number of dollars to an ounce of gold, then the pound and the U.S. dollar inadvertently become linked.
  3. It creates deflation, as William Jennings Bryan noted. The meaning of the "cross of gold" speech: Because farmers had debts fixed in gold, loss of pricing power in commodities killed them.
  4. The gold standard tends to cause interest rates to rise during downturns and interest rates to fall during good times, the exact opposite of what monetary policy should be doing.
  5. The economy was far more volatile under the gold standard (all the depressions and recessions back in the pre-Fed days).
  6. The only way the gold standard works is if people are convinced that the central bank ONLY cares about maintaining the gold standard. The moment there's a hint of another priority (like falling unemployment) it all falls apart.
  7. Gold standards leave central banks open to speculative runs, since they usually don't hold all the gold.
Sadly but truly, the above summary is more or less what Mr. Bernanke had to say in his first of four lectures. From here, we can't expect much success in the subsequent lectures. How do you make a building stand when the foundation is unstable - perhaps not even there?

I replied to Mr. Weisenthal's summary as follows:

"Just to summarize, Bernanke is wrong on every point. However, this is the clearest exposition yet of his twisted logic. Others will refute this completely, so permit me to highlight a couple of the more subtle points:

1. We lock gold away because it is a real and rare substance that has real value (humans want it for many reasons, creating demand).

2. The interlinking prevents one trading partner from cheating another with bad money (as the US has done to China).

3. Deflation is the desired outcome of increasing productivity.

4. Savings are rewarded during downturns, creating income stability for the prudent, as well as future capital for business investment (also by the prudent).

5. The point about volatility is true. However, that kind of volatility (A) teaches everyone to be cautious vs reckless, and (B) prevents black swans, which emerge when volatility is suppressed by central banks while the underlying system rots.

6. It is not the job of any central bank or government to target employment. Free markets do that all my themselves.

7. Let's look at the run on the US gold hoard in the early 70s. Oh yeah, the US was running a guns and butter policy and undermining its currency. The French figured that out and took their gold. So governments that manage their budgets foolishly get punished by the free market. Hmmm. That is bad? Why was that again?

"To be clear, von Mises dealt with all of Bernanke's points half a century ago. However, knowing that Mr. Bernanke thinks this way helps me sleep more soundly at night as a gold investor. It's amazing how the smartest people can rationalize the most egregious behaviours.

"Mr. Bernanke, that will be a big round 'zero' on your term paper. Please go back to kindergarten and start over"

Read more at the Business Insider (and weep for the lost financial guardians of the US financial system).

As Mr. Bernanke pointed out, prices were unstable in the short-term under the gold standard (but stable over the long-term). How exactly has the Federal Reserve fixed that problem? See the chart below.

Since the creation of the Federal Reserve in 1913, prices are now unstable over both the short-term AND the long-term. Gee, thanks for fixing that problem, Mr. Bernanke!

Also check out this more recent article on Business Insider.

More from von Mises on the gold standard here.

30 March 2012: This is true. Paul Samuelson, the author of the world's best-selling economics textbook, "flunked" Mr. Bernanke shortly before his death in 2009. Click here.

Saturday, March 10, 2012

US Debt to GDP: Think 160% (Higher than Greece, Spain, Italy & Portugal)

10 March 2012

Bruce Krasting, a retired hedge fund manager, has recently taken a look at the off-balance sheet debt of the US government.

When you add the off-balance sheet debt (much of it high-risk loans to the public) to the $10.4 trillion in official government debt held by the public, you get a $24 trillion figure, in contrast to an annual GDP figure of $15 trillion. (That is, the above chart overlooks this $13-14 trillion off-balance sheet amount.)

This gross debt to GDP figure is actually the highest in the developed world.

Think Enron.

So exactly why are US government bonds considered a safe haven? You've got me.

My take, not that far down the road, the safe haven status of the US will be challenged by the international community. Whoever happens to be president at that juncture may have an unfortunate time with the history books.... (Not a job I would want, nor recommend!)