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Prophets of Gold – Part 6 – Economic fear mongering

Posted by Don McLenaghen on January 29, 2012

Okay, we have thrashed out all the arguments the prophets put forward to support their golden view…they seem lacking at best and fictional at worse; but what about the current economic meltdown?

There is a major problem with the world’s economy…the US economy. The US did not spend enough to get itself out of the recession. Most economists now think[1] if the US had doubled or more its stimulus spending, the economy would be back to a healthy state. You ask “what about the downgrade in the US’s credit rating?” Well that had NOTHING to do with the American debt; the US economy, dollar and treasury bill are still considered the safest investment on the planet (safer than gold?).  The downgrade occurred because of political manipulation of a political minority (the GOP)…S&P stated it was the political instability NOT economic that prompted it to downgrade. The prophets feed into this hysteria to capitalize on the public fear to promote their radical change (I would recommend reading “Shock Doctrine” by Naomi Klein). It has never been cheaper for the US to raise money that now.

Now, the debt is a long-term issue; I am not saying that it is not but I am also saying that it is not the time to worry about it. Reasonable and effective stimulus via spending is more important than debt reduction (and tax cuts do NOT effectively stimulate). Those who follow the prophets, SHOULD insist that when the economy has recovered the government must resist demand to cut taxes but should instead increase them and pay down the deficit when times are good and to place the nation in a position so as to be able to take on the next economic downturn.

“But what about THIS recession? Was it not caused by fiat money? By a high debt?” No!

The current troubles were not caused by government manipulation of the currency nor the debt. Almost every economist (left and right including the infamous Greenspan) blames lack of regulation for the current debacle. The prophets (when not praising gold) staunchly support the laissez faire approach to the economy… a completely free and unregulated market. They say this in spite of the fact that the current crash is directly the result of under-regulation…that in no point in history has unregulated markets led to stable economics. History has shown that deregulation always leads to short term instability and long term monopolistic markets (near absence of competition).

“What about Greece, Italy…they have fiat money and are about to default on their debt; explain that!”

Loss of options

None of the problems had anything to do with the type of (fiat) currency these countries had. In fact, the trouble they currently have is because they cannot just print money. The Euro is not in the control of Greece or Italy…it’s in the control of the European Central Bank. They do have a problem with ‘bonds’ and the need to secure new bonds to keep paying the bills and pay off old bonds that have come due. A countries credit rating is intended to provide lenders a guideline as to the likelihood a nation might default on its loans; this then determines the interest rate lenders can ask.

For a company, a lender would renegotiate the loan – better to take a small loss and let the company recover to repay then lose it all by forcing a bankruptcy. However, in the case of a nation…a nation with the backing of the Euro, there is no chance it will go bankrupt…or default (long term at least) on its debt; there is no incentive for the creditors to ‘work with Greece’ to help its economy recover. To make its bond payments, Greece is forced to reduce its spending because it cannot ‘print more money’…the Euro for Greece is like a fixed currency…the economy goes into recession leading to less tax income so less money to pay lenders and the cycle continues.

Huff and Puff!

The current holders of Greek debt are hedge funds which bought the Greek bonds from other less speculative lenders at a discount; they then turned around and purchased insurance on the debt. The speculators have no interest in helping Greece recover its economy but only to see how much money it can squeeze out of the Greeks. It is true Greece put itself into this bind but we are seeing that the interdependence of a fixed currency can cause financial repercussions over the whole global economy.  The speculators know eventually the European Central Bank or the International Monetary Fund will step in; make good on the loans and turn Greece into a third world country…they will then repeat the process in Spain, Portugal, Italy…if it takes the rest of

The dark side of finance.

Europe down, speculators can still invest in China. The main point in our context is none of this would have been avoided by the gold standard in fact because relative to Greece, the Euro is a fixed currency; it shows that the gold standard would have made no difference and caused the same economic crisis Greece et al are now experiencing in the Euro Zone. In fact it provided a counter-factual because if the Greek’s had their own fiat money, it may have provided Greece a way out of its bond crisis (although still at a price).

“Okay, but more than Greece has experienced a drop in its credit rating…admit it, it’s their debt that caused this problem!”

Now, Greece and more importantly France (among others) have experienced a downgrade in their borrowing grade NOT because they have too large a debt (although for Greece that is part of it) but because they are trying to reduce the debt through austerity measures. There has been a complete misstep that politicians around the globe (reflecting the neo-liberal/neo-conservative revolution that has occurred in the last couple of decades) have become obsessed with reducing the size of government, the deficit and a removal of government regulations on ‘the market’.  As mentioned earlier it was deregulation that was at the heart of the current financial crisis however those who have profited from this ‘unfettered capitalism’ do not want regulations to return so the blame for the economic debacle has been laid at the feet of the debt. The only way the pro-corporate right wing governments[2] see to reduce the debt is to reduce government size and government spending. So, countries like Britain and France have been imposing austerity measures in the false hope they will ‘stimulate the economy’ from the current recession. This is like inflicting deeper cuts on a person who is bleeding to death; it will only hasten death.

"It shall collapsing under the weight of its own contradictions" Marx

In one of those twists, the rating agencies are beginning to acknowledge that government spending in times of recession is good…that failure to do so will make an nation a greater credit risk; thus France is downgraded. I say twist because it is those very same credit rating agencies that graded the toxic Credit Default Swaps from bad housing loans as Grade A that started this current bust cycle. The problems the current nations are experiencing are not universally safer because some nations are willing to spend more to (at least) reduce the decline into recession or attempt to recover. If all nations were locked into the gold standard then the global economy would not be teetering on the edge for a couple of years, it very well have slammed head into a decade’s long depression like we experience a century ago…while on the gold standard!

[2] Sadly, in the ‘new left’ which has replaced the ‘socialist left’ are corporate ponds. The Labour of the UK is not pro-union but pro-business as its actions have shown. This is seen in the US with the difference between the Dems and the GOP being how much and how far they are willing to go in lowering taxes and cutting spending.

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Prophets of Gold – Part 5 – Hyper-active over hyper-inflation

Posted by Don McLenaghen on January 27, 2012

Last time we discussed how fractional reserve banking can inflate the amount of money in an economy…the prophets hate inflated money.

Old fears renewed

The underlying premise of the previous planks of the prophet’s gilded construct is the idea of inflation. This actually has two parts, first is the inability to buy stuff because it becomes too expensive (classic inflation) and the devaluation of fixed assets (depreciation).

Now, it is true that fiat currency can experience hyper-inflation. It happened in Germany, Zimbabwe and other places…surprisingly a lot of ‘small’ nations have experienced hyper-inflations with little long-term detriments. The normal course of action is for a ‘revaluation’ of the currency. This has the harmful effect of wiping out ‘old money’; however for the majority of the populations (at least of these countries) poverty minimized this loss. Fixed assets are also safe for once a revaluation occurs these assets (property) are valued at the new stable currency maintaining an equivalent value prior to the hyper-inflation. That is why; those who fear hyper-inflation the most and thus preach the stability of the gold standard are those with large ‘savings’…the 1% types…those who have little real assets and thus must defend their (ironically) paper fortunes.

I am not saying hyper-inflation is always a minor and temporary event in people lives. We have all seen the wheel-barrows of money Germans needed to buy a loaf of bread.  In Germany’s case, we did have a major economy hitting the wall where simple revaluation did not seem to work. Of course Germany could not simply adopt a gold standard for most of its reserves were being paid out as reparations to ‘the victors of WW1’; it eventually recovered in small steps from 1923 to 1925. Germany did end up with a gold backed mark but this ‘saviour’ became the gate way to the depression for Germany less than 5 years later.

Why did it become the gate way to depression? The one thing the prophets of the gold standard mention the most is the one thing that is the biggest asset of ‘fiat money’ – the ability of the government to control the economy. Most prophets have an extreme fear of governments and thus see anything they do as innately wrong and to be eliminated or minimized. One of the realities of the capitalist system is the boom/bust cycle. The prophets believe that the gold standard will ensure stability by prevent the government from interfering in the ‘free market’; that historically gold has had a stable price and thus countries on the gold standard do not experience (large) boom or bust cycles. Historically this is pure fantasy.

Gold-flation, the instability of Gold

Whenever a government NEEDED money, it would just drop the gold standard, print what it needed and then return to the standard when it was convenient. The prophets have an existential fear of government and somehow think that the gold standard will miraculously prevent them from interfering in the national monetary system; this too has been proven to be pure fantasy. The USA alone has been effectively on and off the gold standard three times.

Using the USA, as an example, they have experienced dozens of recessions/depressions during the 19th century. Most were quite severe because under a fixed currency there is no way for the government to ‘push back’ against the economic tsunami that ‘bust’ begets. As everyone starts to suffer, spending goes down, leading to drops in demand, businesses close or go bankrupt leading to more suffering and even less spending…what is needed is ‘push back’ to restore economic equilibrium; this is when fiat money becomes a necessity. Let us remember that is was the USA’s attempt (and Germany and others) to maintain the gold standard that pushed a recession into the worst depression in modern times. That when a government was freed from the demands of the gold standard only then could they stimulate their economy by ‘printing money’; only then did the depression end. As mentioned earlier, a direct correlation between abandoning the gold standard and recovery can be found[1].

Governments can both stimulate economies, in a measured and controlled way, by increasing debt via the printing of money. This stimulus creates jobs, which creates demand, which creates more jobs. As the cost of goods rise, so too do wages. When an economy becomes ‘too hot’, the government reduces spending, pulls money out of the economy via increasing taxes (which should be used to reduce the debt incurred during the stimulus phase) there will be less money in the economy, meaning less will be bought, things will become more expensive, even less will be bought and the economy gently slows down. The role of the Bank of Canada, the Federal Reserve or any central bank is to balance the money supply to ensure limited and sustainable grown while avoiding boom or bust; for the last 80yrs it has worked well. Not perfect I admit but it has done well to smooth out the peaks and valleys of the capitalist system.

Now this does require some fiscal responsibility for governments to not go overboard, however it is in the long-term interest of governments to resist; the memory of Weimar Germany shows how quickly an undisciplined printing press can lead to ruin. Lessons learnt by the major economies as can be witnessed that since the 1930’s no major depression has occurred, no major currency had experienced hyper-inflation. One of the ways that has helped prevent ‘abuse’ by politicians is that in most (all?) modern governments, there is a separation between the government and the central bank. In Canada, the Bank of Canada is technically part of the government but is administered at arm’s length by an independent governor; the same is more evident in the USA were the Federal Reserve[2] is a private entity governed by presidential appointees

Now, you might say “what about now? The USA’s credit rating has been downgraded, Greece et al are about to default on loans, the Euro is about to crash! What about that?” Nothing to do with the gold standard but before we move on to these sexy issues lets deal with the other way inflation frightens the prophets of gold.

As mentioned there are two aspects to inflation; we have covered the supply/demand for currency and how it affects boom/bust cycles; the other is how long-term inflation can erode the value of fixed assets. In a world of ever increasing inequality, depreciation of assets is very important to the 1% (to single them out again). Inflation not only makes things more expensive but it also has the effect of eroding the value of fixed assets like property, savings, or overseas investments. If you buy a house for $100,000 at time X then sell it for 150,000 at time Y, you might think you have made 50,000; however if you factor in inflation of let’s say 10%, you only made 40,000…if its high inflation of 100% from time X to Y, you actually lost 50,000. That is why prophets of the gold standard, who constantly preach stability, have a vested interest in ensuring inflation is as close to zero as possible. The gold standard protects there ‘paper profits’ and zero inflation protects their luxury homes…their ‘comfort profits’. Now, I understand that a lot of the 99% have accepted the mantra put forward by the prophets; I am not saying that all those who want the gold standard are the 1%, but I would argue they have been duped by them. The myth of the gold standard is simple and convenient; the prophets promise in one simple move we can solve all our nation’s problems…who would not be tempted by that.

[1] Bernanke, Ben (March 2, 2004). “Remarks by Governor Ben S. Bernanke: Money, Gold and the Great Depression”. At the H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia

[2] The Fed, although governed by publicly appointed governors, is private banks. It’s in their vested interest to ensure the government does not induce major, let alone hyper, inflation. They would lose the value of their primary asset – money.

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A taxing issue

Posted by Don McLenaghen on November 17, 2010

In the shadow of the elections victories of the Tea Party in the US election and the recent announcement of our own Campbell government here in BC to both cut income taxes while implementing a user fee for hospital stays, I thought it would be educational to take a sceptical look at taxes and in particular tax breaks.

Taxes have been a widely used tool by governments to punish ‘sin’ (in the form of alcohol and tobacco taxes) and to promote investment (in the form of tax holidays or credits like the capital gains tax). I am not going to get too partisan here. There are valid arguments on all sides about what are appropriate taxes and at what level those taxes should be – that is a discussion for a different day and perhaps a different show. What I would like to investigate here are two things: first that cutting taxes increases tax revenue (this was called Voodoo economics by G. Bush Sr., trickle-down economics by others but economist refer to this broadly as supply-side economics) and second that tax cuts are always good.

I shall address the former first. For those of us who had access to an US media source (or those who can remember any recent political campaign) every politician was promising to cut taxes; when asked how they would pay for these tax cuts, they would either respond by saying tax cuts cost nothing or they said they will reduce spending…when asked what spending, they would say something like “that fat in the system” or “improved efficiencies” – IE they would not cut anything. For example they often say they will cut “ear-marks’, but this only accounts for $3 billion out of a budget of $3.6+ trillion (with a deficit of $1.7 trillion)…or 0.08% of budget (0.17%  of deficit).

It seems popular among voters across the political spectrum. However, the recent dual announcements of our local government show the reality of the situation. Campbell announces a popular across the board tax cut of 15%. This applies to rich and poor alike (although not equally, but again that’s a different show*). This equates to a loss of over half a billion dollars a year. That is money the government will not have to provide services…like hospital beds. The government also recently announced a user fee on hospital rooms amounting to over $200 a week. Who is going to make up for the loss in tax revenues? The sick.

Environics Poll 2007

Now don’t get me wrong, maybe we are all happy with that, but most people when asked the question do they want to cut public spending (especially healthcare), they say no…in fact it is one of the few areas people show an innate socialist tendency.

Just to put the two into perspective, the median family will save about $350 a year in taxes.  The average hospital stay for an individual is 3-10 days (depending largely on age)…that’s a fee cost of $87 to $290 (and for those of you who say “well most people will not be in hospital that long” just remember that makes the fee even more onerous because it WILL effect most those who are suffering most and likely least like to afford it).

Okay, my math may be a little dodgy (mainly due to the lack of accurate numbers for ‘average hospital’ stay or the myriad of different income/fee/taxes an individual will pay) but the point should still be obvious. The hospital fee was not to pay for the tax cut but add in the added cost of medical insurance premiums[1], camping fees[2], transit fees[3], licence fees[4], tuition[5] and so on you will get there. (for those of us old enough, we remember when ‘user fee’ was a dirty word and the fees that did exist were token…not any more).

Cost of Bush's tax cuts

The point I am getting at, is if we want social services we have to pay for them as a society. That means when someone yells “tax cuts” remember they are also saying “cut services”. Maybe something you are comfortable with…maybe not but that is the reality of it. I was going to go on to talk about the wisdom of providing robust social services but that would be straying perhaps outside the bound of a sceptic podcast so we shall stop here and address the second point.

Many have claimed, largely Republicans and Monetarists, that cutting taxes increases tax revenue. On the surface this sounds paradoxical; however there is a shred of logic to be found. The idea, goes that if you cut taxes, those who have more money will invest in the economy, the economy grows, from this larger tax base you collect more absolute dollars even though the rate is lower. The idea works in reverse as well; increasing the tax rate will cause a contraction of the economy and a reduction in absolute dollars.

Often the example of the Reagan Revolution is used to prove this point…i.e. that it works in practice. However this is a flawed claim. As many modern economists have shown[6], including noble prize winner Paul Klugmen, the Reagan tax cuts did not improve the US economy and actually made government finances worse.

It is true the US economy grew fast from 1983-89 however this is in contrast to the miasma of the severe recession of 81-2. Capitalist markets are cyclical, and this was not an unusual recovery. Private savings, something supply-side economics assumes from the masses to provide the capital for investment, continues to decline throughout the decade (7.8->4.8%). Meaning, the money for the recovery, as it was, came from spending savings and increasing personal debt. Finally, this trend is echoed in the US budget; when Reagan came to office the US debt as a % of GDP was 32.5%, when Bush Sr. left it was 66.1%. Clinton, who raised taxes, brought the rate down to 56.4%. The same happened in Canada, when we increased taxes in the 90’s and went from the ‘basket-case’ nation to arguably the country with the most stable finances.

Lastly, the multiplier effect. Not all tax cuts are equal. Tax cuts cost money; those who claim that it is not should ‘not’ collect their next pay-check and see if it costs them money. So, the current desire of governments everywhere is stimulus. When the government (or anyone really) spends money it has what is called, a multiplier effect on the economy; that is for every “Y” dollars spent it generates Y*x (or Y’) in the economy. So, if I give you a dollar and you burn it, which generates no activity in the economy, in fact it removes the dollar from circulation so has a negative multiplier effect. Now most people will spend it or ‘invest’ it (be it real investments or just in your bank account) and they have a positive effect; that is they generate more than a dollars worth of economic activity. The best way to think about this is if you spend the dollar, the merchant sells more, can now hire a new employee, and we will in turn make more dollars and spend them; the new employee generates the new value. An economist could spin a better story, but I think you get the gist of it – the one dollar generates more than a dollar of economic activity.

Relative stimulus effect

Having given the background, how do tax cuts fair as stimulus[7]? In general, every dollar of tax cuts generates $1.30 of economic activity compared to a dollar spent on increasing UI benefits would generate $1.62 or increasing food stamps generates $1.74. There is also the issue of WHO to give the cut to. Lower income people spend (out of necessity) every penny they make so a cut in their taxes (thanks to HST we ALL pay taxes even the poorest) will generate the most activity but they latterly also have the least money (the bottom 50% of household control about 3% of Canadian wealth). As you move to the other extreme, the very wealthy often ‘invest’ most of their tax cuts (earning more than they need), so less activity generated but because they make more money a big bang (the top 10% own around 58.2% of the nation’s wealth[8] in the USA its 1% owning 35%). However, in a global world, it is most likely their investments will be ‘trans-national’ or outside ‘our’ economy and thus lost completely to the system – complete fizzle.

Society, of course, is not only extremes but a lopsided slope of ‘everything-in-between’ (note percentages of wealth ownership mentioned earlier) otherwise it would be easy to define tax policy; the trick is to determine both purpose (stimulate consumption, promote manufacturing, decrease inflation) and effectiveness. History has given us lessons to learn from and one a sceptical economist should be able to apply.

<From Episode #88 of Radio Free Thinker>

[1]British Columbia Medical Services Plan Premium Increase Notice
[2]BC April fee increases
[4]BC Gov 2010 fee increase
[5]BC Gov tuition increases
[6]Supply-Side Economics Debunked – TYT
[7] Recovery Ac
[8] Inequality in Canada

* By this i mean 15% of $100k = $18k while 15% of roughly the median income, $50k = $7.5k. So, the tax applies the same but the benefit is very unequal.

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