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Money

Thoughts Inspired by Steve Forbes on Money

Last week, Steve Forbes visited The Johns Hopkins Universitycampus. After lunch at the Faculty Club, Steve, Elizabeth Ames, andI retired to the library to tape an interview for a one hourdocumentary, “In Money We Trust,” that Steve is puttingtogether. The documentary is sparked by Money (McGraw Hill, 2014), a book authored by Steve andElizabeth Ames.

My big takeaway from Money is that Steve Forbes is noJames Dean. Forbes is a rebel with a cause. Free-markets and soundmoney, please. In what follows, I will briefly mention 9 of mythoughts inspired by my reading of Money and my visit withits authors last week.

Thought #1: The dedication to AlexanderHamilton signaled right away that Money was going in theright direction. We all know that Hamilton was an extraordinary financial engineer. Among otherthings, he established a federal sinking fund to finance theRevolutionary War debt. Hamilton also engineered a large debt swap,in which the debts of individual states were assumed by the newlycreated federal government. Hamilton’s ability to solve thedebt problem established America’s financial credibility andgave the new nation a much needed positive confidence shock. We arealso aware of the fact that Hamilton was a great contributor to theFederalist Papers — a superb document. Indeed, no less thanMilton Friedman once wrote in Newsweek (June 4, 1973) thatFederalist Paper 15 “contains a more cogent analysisof the European Common Market than any I have seen from the pen ofa modern writer.”

What we do not all know, particularly many of those who espousethe sanctity of private property rights, is that Hamilton was adistinguished lawyer who took on some of the most famous propertycases in U.S. legal history. After the Revolutionary War, the stateof New York enacted harsh measures against Loyalist and Britishsubjects. These included the Confiscation Act (1779), the CitationAct (1782), and the Trespass Act (1783). All involved the seizureof property and garnered wide public support. Hamilton saw the actsas an illustration of the inherent difference between democracy andlaw. Hamilton took his views to court and successfully defended, inthe face of enormous public hostility, those who had their propertytaken under the three New York state statutes.

Thought #2: Speaking of the taking of propertyand money — right here in the USA, not the USSR — letus not forget the U.S. Congress’ abrogation of the Gold Clauses in June1933; a confiscation of property that the Supreme Court upheld in1935.

Before that abrogation, private and public bond covenantsincluded gold clauses. Under this system, bond holders receivedinterest and principal payments in dollars that contained as muchgold as the dollar contained when the bonds were issued. Well,after April 1933, the U.S. government manipulated the price of goldupward until President Roosevelt redefined the dollar in gold termsunder the Gold Reserve Act of January 1934. Overnight, the dollarbecame 41% lighter. This left gold-clause bond holders out todry.

Because of the Congress’ abrogation of the gold clauses, bondholders could only receivethe nominal dollar amounts of interest and principal, as stated ontheir bonds. They could not receive enough additional dollars tomake their payments equal in value to the amount of gold originallystipulated. In short, bondholders were stuck with new“light” dollars, not the original “heavy”ones that had been specified in the original bond covenants.

Of course Bondholders sued over this theft. But, the SupremeCourt held that the abrogation of the gold clauses for privatebonds was constitutional in 1935. The Court’s decision restedon the fallacious argument that contracts that contained the goldclauses interfered with Congress’ authority to coin money andregulate its value (Article 1, Section 8 of the U.S.Constitution).

For bonds issued by the U.S. government, the situation wasdifferent because Congress did not have the authority to repudiateobligations of the U.S. government. But, because the legal briefswere defective in proving actual damages, the plaintiffs who hadheld U.S. government bonds “protected” by gold clausescould not collect damages from the U.S. government.

In anticipation of additional gold-clause cases, Congress simplypassed a law amending the jurisdiction of federal courts, barringthem from hearing any further gold-clause cases. Every time Ireflect on this Congressional maneuver, Paul McCartney’sclassic “Back in the USSR” rings in my ears. Yes, whenit comes to money, the rule of law is rather elastic (particularlyduring National Emergencies), even in the U.S.

Thought #3: It is clear that Forbes and Ameshave taken the water in Vienna, or perhaps in Baden bei Wien.Indeed, Money contains many Austrian themes:

  • Forbes and Ames reject the closed economy model. Like BobMundell, who once said that the only closed economy is the world,Forbes and Ames embrace an open economy framework. This outlook isin sharp contrast to our last Fed Chairman Ben Bernanke. Bernankedid not even include the USD/EUR exchange rate (the most importantprice in the world) on his six-gauge dashboard.
  • Forbes and Ames junk the idea of equilibrium and economicstability.
  • Also, they embrace the central role of the entrepreneur inmarkets that are seen as a means to assemble dispersed knowledgeand information.
  • As Forbes and Ames say, “Information combined with tradeand enterprise: that says everything one really needs to know abouteconomics. Money — sound, trustworthy money — is thecrucial facilitator that brings it all together.” TotallyAustrian, indeed.

Thought #4: For a more practical and lesstheoretical view, allow me to quote from Paul Volcker’spreface to Marjorie Deane and Robert Pringle’s 1995 bookThe Central Banks. Volcker’s edifying prefacecaptures both the substance and spirit of Money:

We sometimes forget that central banking, as we know it today,is, in fact, largely an invention of the past hundred years or so,even though a few central banks can trace their ancestry back tothe early nineteenth century or before. It is a sobering fact thatthe prominence of central banks in this century has coincided witha general tendency towards more inflation, not less. By and large,if the overriding objective is price stability, we did better withthe nineteenth-century gold standard and passive central banks,with currency boards, or even with “free banking.” Thetruly unique power of a central bank, after all, is the power tocreate money, and ultimately the power to create is the power todestroy.”

Thought #5: Like Volcker, and unlike most moneyand banking professionals, Forbes and Ames are straightforward andclear, but they are puzzled:

Why then is so much writing on the subject of money soneedlessly complicated, with dense, impenetrable language andequations that make sense to only a handful of academicians? Andwhy do so many people insist that bad ideas about monetary policy,like ‘inflation is needed to increase employment,’ areas settled and unassailable as scientific principles?”

To answer that question, we need go no further than research by Larry White. He found that 74% of articles onmonetary policy published in 2002 were in Fed sponsoredpublications and authored by people on the Fed’s staff orassociated with the Fed. Fortunately, Forbes and Ames leapfrog thatFed hurdle.

Thought #6: Where does this near-monopoly ofthe professional publications lead us? Well, let’s look atthe Great Recession. Even after the resulting financial crises, weare still cursed by the central bankers’ mantra of inflationtargeting and floating exchange rates. To refresh your memories,consider the following:

  1. Former Fed Governor Ben Bernanke sounded an alarm in November2002. He claimed that the major danger facing the U.S. economy wasdeflation. It was, of course, a false alarm. Never mind.
  2. To fight the phantom deflation, the Fed pushed the federalfunds rate all the way down to 1% by July 2003, when the naturalrate was 3%-4%.
  3. With those artificially low interest rates, the Fed became thegreat enabler for the wild yield chasing, risk taking, acceleratingcarry trade, leveraging, and relative price distortions.
  4. The behavior of the CPI inflation target and other importantprices in the 2003-2008 period tell the tale: the CPI, excludingfood and energy, only increased by 12.4% during that period.Indeed, that metric increased at a steady annual rate of 2.1%-right on target. Housing prices, however, went up 45% from 2003until 2006 (Q1). Stock prices went up 66% from 2003 until 2007(Q4). Commodities zoomed 92% from 2003 until 2008 (Q2).
  5. As Prof. Gottfried Haberler put it in 1928, “The relativeposition and change of different groups of prices are not revealed,but are hidden and submerged in a general [price] index.”But, inflation targeters ignore Haberler’s observation. Inconsequence, they (read: the Fed) fly blind. Yes, going into the2008-2009 storm, the Fed was flying blind. Recall thatBernanke’s dashboard, had no exchange-rate gauges.
  6. This resulted in a disaster. Indeed, the error of 2008 was toengage in a very tight monetary policy. If Bernanke had anexchange-rate gauge, he would have seen the dollar soar against theeuro by 33% from June 2008 to late October 2008. As the USD soared,oil prices plummeted, falling by about the same percentage as theUSD appreciated against the euro. And oil prices plunged from$148/bbl to $35/bbl. Annual inflation measured by the CPI was 5.6%in July 2008. By February 2009, negative annual CPI numbers werebeing registered. So much for those alleged long and variable lagsbetween changes in monetary policy and inflation.
  7. But, we are left today with the Deputy Governor of Sweden’s Riksbank and inflationtargeting guru Lars Svensson’s words: “My view is thatthe crisis was largely caused by factors that had very little to dowith monetary policy.” What nonsense.
  8. Never mind. With the central bankers’ grip on theprofessional press, we are left with inflation targeting too.Indeed, that nostrum is even more entrenched than it was before thecrisis.

Thought #7: Foreign Exchange Comment I:

Many think current account surpluses and deficits are theproduct of misaligned exchange rates. Well, truths in economicsoften boil down to accounting principles that are as immutable asthe laws of physics. Current account deficits are, for example,equal to the sum of two quantities: the excess of privateinvestment over savings and the government deficit. Exchange rateshave little to do with current account deficits.

Thought #8: Foreign Exchange Comment II:

Forget the D.C. chatter about currency manipulation. The U.S.Treasury (UST), as well as everyone else, cannot even definecurrency manipulation. That is why the UST has neverformallybranded China a currency manipulator. Fortunately, during the1997-2004 period, the RMB/USD rate was marked by fixity. And, asthe accompanying table shows, the RMB link to the USD was very goodfor inflation and growth in China. This link was also good for theglobal economy.

Thought #9: When it comes to exchange rates,more currency unification, please. The world’s two mostimportant currencies — the dollar and the euro —should, via formal agreement, trade in a zone ($1.20 - $1.40 to theeuro, for example). The European Central Bank would be obliged tomaintain this zone of stability by defending a weak dollar viadollar purchases. Likewise, the Fed would be obliged to defend aweak euro by purchasing euros. The East Asian dollar bloc, whichwas torpedoed during the 2003 Dubai Summit, should be resurrectedwith the yuan and other Asian currencies tightly linked to thegreenback. Many other countries (Brazil and Venezuela, forexample), should adopt currency boards linked to either the dollaror euro. Or, they should simply “dollarize” by adoptinga foreign currency (like the dollar, for example) as their own.

Yes. Why not dollarize? It works. Just look at Ecuador andPanama. They are dollarized, and, based on my Misery Index, they are the two least miserablecountries in Latin America. Dollarization, like currency boards,provides discipline. This discipline leads to prosperity and lessmisery.

Iran's Economic Death Spiral -- Made in Iran by the Shah and Ayatollahs

By any measure, Iran and its economy ranks near the bottom ofthe barrel. For example, the Cato Institute’s comprehensiveHuman Freedom Index presents the state of human freedom in theworld based on a broad measure that encompasses personal, civil,and economic freedom. And in this authoritative index, Iran ranks154th out of the 159 countries covered. Not surprisingly, theIranian economy performs poorly, producing widespread poverty.

Many, both inside and outside of Iran, assert that the majorcause of Iran’s economic maladies is the cascade of primaryand secondary sanctions that the “allies” have imposed.This is a bit of a red herring.

While sanctions bite and disrupt, they are overrated as a meansof waging a war. Indeed, they are massively oversold. JohnMearsheimer, in his masterpiece, The Tragedy of Great Power Politics (W.W. Norton & Company,2001), provides more than ample evidence to show that navalblockades and strategic bombing (and I would add financialsanctions) rarely produce their desired results, and are notelixirs that win wars.

“…the populations of modern states can absorb greatamounts of pain without rising up against their governments. Thereis not a single case in the historical record in which either ablockade or a strategic bombing campaign designed to punish anenemy’s population caused significant public protests againstthe target government. If anything, it appears that‘punishment generates more public anger against the attackerthan against the target government.’”

Even though the sanctions contribute to the Iranians’misery, history suggests that a good dose of skepticism aboutwhether Iran’s theocracy will comply with the demands of theallies is in order. As Mearsheimer writes:

While blaming Iran’sdeath spiral on external enemies of the Islamic Republic might playwell in Tehran, the reality is that the Republic’s economicpolicies cause the death spiral to spin.

“…governing elites are rarely moved to quit a warbecause their populations are being brutalized. In fact, one couldargue that the more punishment that a populations suffers, the moredifficult it is for the leaders to quit the war. The basis of thisclaim, which seems counterintuitive, is that bloody defeat greatlyincreases the likelihood that after the war is over the people willseek revenge against the leaders who led them down the road todestruction. Thus, those leaders have a powerful incentive toignore the pain being inflicted on their population and fight tothe finish in the hope that they can pull out a victory and savetheir own skin.”

So, while the sanctions might be contributing to theIranians’ misery, they will probably fail to force theIslamic Republic to comply with the demands of the allies.

Iran’s economic death spiral is largely made in Iran byIranians. Sanctions imposed by foes of the Islamic Republic onlycontribute in a minor way to the spiral. Iran’s downwardspiral predates the Islamic Revolution of 1979. Recall that, beforethe last Shah was pushed off the Peacock Throne, his visions ofgrandeur had led him to embrace Soviet-type schemes, such asfive-year plans, megaprojects, rural collectivization, model towns(shahraks), and central planning. The “Soviet” Shah,who was propped up by the United States, made a mess of the economyand set the stage for Iran’s economic woes.

The theocratic regime has only further suffocated Iran’stiny private sector and caused the death spiral to spin morerapidly.

So, what should be done to push the Grim Reaper aside? Povertyis a scourge which leaves those in its grip to lead lives that arebrutish, dangerous, and short. Economic growth is a poverty elixir.From the works of the earliest economists — Richard Cantillon(1680 — 1734), Adam Smith (1723 — 1790) and JacquesTurgot (1727 — 1781) — we have learned that economicliberty is a crucial precondition for sustained economic growth,and a concomitant reduction of misery. Just what elements arenecessary to produce such a liberal economic order?

Private property and contract rights should beestablished. The following criteria should guide theestablishment of private property: universality, exclusivity andtransferability. Universality guarantees that all resources areeither owned or ownable by a private person or entity. Exclusivityguarantees that those who own property have the exclusive right touse their property as long as that it does not harm other propertyowners. And transferability guarantees that owners can freelytransfer their property rights.

Fiscal order and transparency should beestablished. To establish control over public spending andreduce waste, fraud, and corruption — governments shouldpublish national accounts that include a balance sheet of itsassets and liabilities, and an accrual-based annual operatingstatement of income and expenses. These financial statements shouldmeet international accounting standards and should be subject to anindependent audit.

Budget deficits and government spending should be keptunder control. One way to achieve control over the scopeand scale of government is to require a “supermajority” vote for important fiscal decisions: taxing,spending, and the issuance of debt.

Inflationary pressures should be kept undercontrol. To encourage economic development, inflationrates should be kept low and predictable. For many developingnations, this inflation objective can best be achieved byabolishing their central banks and replacing them with currencyboards. A currency board would issue fully convertible, stable, domesticcurrencies that is clone of an anchor currency.

The advantages of open international trade should beexploited. Liberal trade policies facilitate the efficientallocation of resources and stimulate economic growth. This isparticularly true in small economies, where real competition canonly be obtained by allowing foreign producers to compete freely indomestic markets.

Complex tax systems and excessive tax rates should beavoided. Complex tax systems coupled with excessive taxrates distort behavior, create large disincentives to economicactivity, and force that activity to go underground (read: into theblack-market).

Subsidies and tax incentives for private industry shouldbe avoided. Subsidies and tax incentives that are designedto achieve particular objectives may or may not actually assist inobtaining those goals. One thing is certain: they distort economicchoices and resource allocation, reduce fiscal discipline, andretard economic growth.

Privileges and immunities should be avoided.For example, state-created monopoly privileges and immunities forunions, such as exclusive representation, compulsory unionmembership, and immunity from antitrust laws, should be avoided.Privileges and immunities distort markets and act as a drag oneconomic growth.

Price controls should be avoided. Pricecontrols, including interest rate ceilings, cannot be justified oneconomic grounds. They tend to vitiate the signaling role thatprices play. Hence, price controls impede the movement of resourcesfrom lower-value to higher-value uses, and result in resourcemisallocation, shortages, and lower economic growth.

Market interventions and restrictions on competitionshould be avoided. Market intervention and restrictions oncompetition, such as the use of marketing boards, result in thepoliticization of economic life, inefficient enterprises, resourcemisallocation, and the retardation of economic growth.

State-owned enterprises should be privatized.State-owned enterprises are inefficient. For example, sales,adjusted profits, and productivity per employee are lower forstate-owned enterprises than they are for private firms. Sales perdollar of investment are lower, profits per dollar of assets arelower, wages and operating costs per dollar of sales are higher,sales grow at a slower rate, and, with few exceptions (petroleum),state-owned enterprises generate accounting losses that are passedon to taxpayers.

Unclear boundaries between public and private activityshould be avoided. Unclear boundaries between the publicand private sector are symptomatic of poorly defined propertyrights. Government bailouts of insolvent private firms are but oneexample of unclear boundaries between public and private activity.These Ill-defined property rights distort resource allocation andretard economic growth.

The manipulation and repression of private capitalmarkets should be avoided. The manipulation and repressionof private capital markets distort the savings and investmentprocess, retard foreign direct investment, promote capital flight,and generally act as a drag on economic growth.

For decades now, Iran has flaunted economic principles. Privateproperty and contract rights are not secure. This lack of security,particularly for foreign investors, has thrown Iran’s oil and gasdevelopment into a cocked hat. Fiscal order, transparency, andcontrol are nowhere to be found in Iran. Populist proclivities callthe budget’s tune. Price controls and subsidies are widespread.These are a deadly cocktail.

Banks are mandated to extend credit to certain favored sectorsof the economy. The specific sectors and levels of credit are laidout in Iran’s five-year development plan. Not surprisingly, creditis misallocated, and banks are zombies loaded down with mountainsof non-performing loans.

Even things like privatization are perverted in Iran. Forexample, when state-owned enterprises are privatized, the majorityof the shares are often purchased by other state-ownedentities.

While blaming Iran’s death spiral on external enemies of theIslamic Republic might play well in Tehran, the reality is that theRepublic’s economic policies cause the death spiral to spin. Theonly way to avoid more impoverishment is to remove the internallyimposed shackles on Iranians. It’s a tall order. But, just look atwhat China has accomplished since Deng’s December 1978Revolution.

Leland Yeager, R.I.P.

On Monday morning (April 23, 2018), the Grim Reaper cut down Leland Yeager—a great scholar, collaborator, and friend. I share the sentiments about Leland that have already been expressed by David Gordon, David Henderson, and George Selgin.

To fill in the picture, I will recount my first encounter with Leland, which took place in the summer of 1967. Then, I will leap ahead to the last email I received from Leland on April 5, 2018.

I first met Leland in the summer of 1967, when I attended a short course on the principles of economics at the University of Virginia. The course was offered to young faculty with an interest in free-market economics. I qualified because I had recently joined the faculty of the Colorado School of Mines. What a course it was.  The Big Guns lectured. They included: Armen Alchian, Bill Allen, Bill Breit, Jim Buchanan, Warren Nutter, Gordon Tullock, and Leland Yeager. Leland presented the lectures on international trade. I can still recall them. He arrived fully prepared and ready to go—armed with a yardstick. Yes, a yardstick, which Leland used to draw complicated trade diagrams. And, typical of Leland, he did so with great precision. Indeed, Leland is the only professor I have ever observed who could, and did, draw picture-perfect diagrams on a chalkboard. Even while lecturing, Leland was an ever-careful and precise scholar.

Fast forward 50-plus years, and we arrive at the last email I received from Leland (April 5, 2018). Our correspondence over the past few years has largely focused on a book project that we have been collaborating on. Our book’s main idea – to treat waiting as a factor of production, and its price (the interest rate) as a reminder of the opportunity cost – contributes to unifying economic theory and identifying errors.  Fortunately, our manuscript for Capital and Interest is complete, thanks largely to Leland’s work and scholarship. As I recently promised Leland, I anticipate having the manuscript cleaned and ready to go to the publisher this summer.

As our work on Capital and Interest progressed, Leland would always add what I considered to be a throw-away line about his advancing years and ill-health. I thought Leland would make it into triple digits. However, in his last email, Leland alarmingly went way beyond his usual grumblings about his age and ill-health. He wrote, “At age 93 and suffering from weakness, fatigue, various ailments, and severe pains (most recently from osteoporosis), I must admit that I am in no condition to contribute much more to the MS.”  Leland’s shot across the bow shocked me because he remained as sharp as a tack. Indeed, in his last email, Leland did what he had always done: he never stopped turning over ideas and fretting about the quality of his work. Until his dying day, Leland remained to me that precise professor who lectured with a yardstick – a master of rhetoric, blackboard economics, and much, much more.

Adding Merck to my Dividend Portfolio

News out of the imuno-oncology sector of the biotech world has hit stocks in my portfolios such as Incyte (INCY) and Nektar Therapeutics (NKTR) hard. But, I'd argue that it has left Keytruda and its owner Merck (MRK) in a measurably stronger position in the market for cancer drugs. And as they say, When the market gives you lemons, you should make lemonade.  So I'd adding Merck to my Dividend Portfolio for a buy on Monday.

Time to add China Southern Airlines to my 50 Stocks Portfolio

You might know that China Southern is the largest airline in China. But I bet you didn't know that it has the largest fleet (702 planes) of any Asian airline. I've been looking to add shares of China Southern Airlines (ZNH) to my long-term 50 Stocks ever since I saw the newest list of the world's 20 busiest airports from the Airports Council International on April 6.

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