Debunking a Lie

Don Watkins of the Ayn Rand Institute wrote an article, The Myth of Banking Deregulation, to debunk a lie. The lie is that bank regulation is good. That it helped stabilize the economy in the 1930’s. And that deregulation at the end of the century destabilized the economy and caused the crisis of 2008.
As of early 2015, Dodd-Frank had imposed altogether 27,670 new restrictions, more than all other laws passed under Obama combined (that is really saying something, considering the regulatory frenzy let loose by his administration. Note: the law may have “only” 2,300 pages, but more than 10 different regulatory agencies have been producing administrative laws for six years in a row to put it into practice – and they are not finished yet. Don’t you feel safer already?

 

If deregulation is the problem, then re-regulation is the solution. So, in the wake of the crisis, Congress enacted a 2,300-page monstrosity of regulation known as Dodd-Frank.

 

Watkins does a good job describing government regulation of finance, in particular addressing the savings and loan industry. He gives an example where people commonly assume that Congress reduced regulation, the Graham-Leach-Bliley Act of 1999.

The headline is that this law reduced regulation, and allowed banks to be in the securities business. However, the truth is that it mixed in a dollop of increased regulation.

 

The economic cost of Dodd-Frank (one guess as to who is going to end up paying for this…). Note: this is not cumulative – the cumulative tally so far is a cost of $36 billion (about $310 per household!); it has so far taken 74.8 million paperwork man hours to create this monster. You will be happy to learn that the law not only makes us perfectly safe, but introduces racial and gender quotas as well. The number of final rules exceeds those generated by Sarbanes-Oxley by a factor of 30 – so far.

 

Imagined Stability

I commend him for tackling regulation and the moral hazard of deposit insurance, and calling for real deregulation. However, I must criticize his article. He says:

 

“By far the most important factor in postwar stability was not New Deal financial regulations, however, but the strength of the overall economy from the late 1940s into the 1960s, a period when interest rates were relatively stable, recessions were mild, and growth and employment were high.”

 

Here is a graph of the interest rate on the benchmark 10-year Treasury bond from 1946 through 1969.

 

10 year treasury note yield, 1946 to 1969 – stability looks different – click to enlarge.

 

Even during the initial smooth period through 1953, the rate of interest climbed 27 percent. By this point, the instability had only just begun. If “into the 1960’s” refers to the last plateau in 1965 before the rate destabilizes further, then the rate was about 4.2%.

This is about double what it had been just 15 years earlier. And at the end of the 1960’s, the interest rate had hit 7.7%, or about 3.5 times where it started.

Watkins gives us a hint that he means that the interest rate destabilized after President Nixon severed the last link to gold in 1971. He says, “…[the] U.S. government cut its remaining ties to gold in 1971. The volatile inflation and interest rates that followed…

So let’s look at the interest rate for the full period of rising rates, up to the peak hit in 1981.

 

10 year treasury note yield, 1946 – 1981 (it seems fair to assume that the market already anticipated the coming gold exchange standard default in the 50s and 60s – deficit spending and money and credit supply expansion had rendered it untenable) – click to enlarge.

 

We can see that it does indeed get worse after Nixon’s ill-conceived act. However, it is just a continuation of the same trend that had been underway since 1946. It’s a combination of rising interest rates with rising interest rate volatility. Both phenomena inflict damage on the economy.

 

The “Good Monetary Policy” Myth

Watkins claims, “Part of the credit for this [interest rate] stability goes to monetary policy.” He thus contributes — I assume unintentionally — to the myth of monetary central planning.

 

Myth: central planners were successful for decades, delivering a strong and stable economy. They can do it again. So if our present planners are not getting it right, then we just have to hire the right people.

 

If our civilization is to have a future, then this myth must come down! In recent decades, most people believed that Fed Chairmen Greenspan and Bernanke administered a strong and stable economy. They called it “the great moderation”. Of course, this view ended with a crash in 2008, along with the markets.

Watkins reinforces the myth in his subsequent discussion of regulation and the savings and loan crisis. He says that New Deal regulation, “collapsed under the pressure of bad monetary policy from the Federal Reserve…” The very phrase “bad monetary policy” implies that there is such a thing as good monetary policy.

There is no such thing as good monetary policy. There is no such thing as effective monetary policy, or monetary policy that does no harm. There are only the times when most people see no overt symptoms, when they don’t realize the damage being done.

And there are times of pain, when reality takes hold again. Since monetary policy can have lags of decades, most people do not know how to ascribe the blame properly.

 

It is actually not necessary to visit hermits atop tall mountains to find this out… the belief in a scientific monetary policy is no different than any other belief in the efficacy of central planning. It is tantamount to believing in a literal impossibility.

Cartoon by Bob Rich

 

The Quality of Economic Growth

One economic indicator that may make the postwar economy appear strong is Gross Domestic Product. GDP quadrupled from 1946 to 1969. Unfortunately, GDP is not a measure of the quality of economic activity.

A fever is not a measure of the quality your health, but merely the quantity of calories your sick body is burning. Similarly, GDP is not a measure of the quality of the economy, only the quantity of dollars turned over.

GDP should be understood to be a measure combining destruction plus production. Government waste is added to private activity. And of course, not all private activity is productive.

GDP does not distinguish between the squandering of precious capital during false booms and the genuine productive enterprise. It also includes many other wasteful activities, such as regulatory compliance. A rapidly-rising GDP does not necessarily mean the economy is healthy or stable. In fact, it was not in the postwar period.

 

What is known as gross domestic product isn’t really “gross” at all, since it ignores the bulk of the production structure.  It does however contain activities that don’t generate any wealth, and partly even destroy it. We have discussed a number of the  problems of GDP in past missives (see e.g. “The Mirage of Economic Growth”, which inter alia looks at Oskar Morgenstern’s objections to the measure).

Cartoon by Bob Rich

 

One subtle but deadly problem was described by economist Robert Triffin in 1959. Rational domestic fiscal policy was in conflict with international demand for the US dollar, used as their monetary reserve asset.

The US was obliged — and happy to oblige — to run greater and greater budget deficits. Triffin knew that a crisis was inevitable. It came under the Nixon administration.

 

The Self-Immolating Gold Standard Myth

I want to pick on a phrase that feeds — again I assume inadvertently — into the anti free market, anti gold standard myth. Watkins uses the passive voice to say that the classical gold standard “had fallen apart during World War I…”.

Most people today, if you press them, will tell you that that a free market contains the seeds of its own destruction. “Falling apart” is precisely what they fear will happen when a free market is unregulated, uncontrolled, and not centrally planned. That’s why they want regulators and central planners.

It needs to be said again and again. No. The classical gold standard did not fall apart!

It was killed by government. In 1913, the Federal Reserve was created. That altered the gold standard the way drinking a bottle of wine alters consciousness. If a drunken worker drives a bulldozer through a house, no one says that “the building had fallen apart.”

 

Ludwig von Mises noted: “[T]he gold standard is not a game, but a social institution. Its working does not depend on the preparedness of any people to observe some arbitrary rules. It is controlled by the operation of inexorable economic law.” and furthermore: “What the expansionists call the defects of the gold standard are indeed its very eminence and usefulness. It checks large-scale inflationary ventures on the part of governments. The gold standard did not fail. The governments were eager to destroy it, because they were committed to the fallacies that credit expansion is an appropriate means of lowering the rate of interest and of “improving” the balance of trade.”

Photo via mises.org

 

In addition to the Fed in the U.S., the governments of Britain and Germany and other belligerent powers suspended the gold convertibility of their currencies in 1914. Many people blithely say that the gold standard fell apart. I say, again, it did not.

After the war, the victorious countries claimed they were returning to the gold standard, but instead they created a pseudo gold standard. As everyone knows now, it didn’t work. At least one economist, Heinrich Rittershausen, knew in advance. He warned that this dysfunctional monetary system would cause great unemployment.

 

Rigorous Economic Logic and a Rational Assessment of History

We, the advocates of liberty, will only succeed if we are rigorous. We must know the facts we present in our writings, and our theories must take these facts in account. Otherwise, we may get a hosanna from the choir, but we will not persuade the mainstream. False facts will not win people who have studied the field.

Objectivism is the philosophy which reveres facts and integrates facts into theories which explain reality. The fact is that since at least 1913, we have not had capitalism (and there was not a free market in banking in 1912, or even in 1812). Instead, since 1913, we have had a central bank.

The Fed has been taking for itself more and more power over the decades. Our central bank administers the interest rate. Interest, being the price of money, affects every other price and every economic decision in the economy. Distorting interest can have terrible consequences, which can come decades later.

More importantly than deregulating — and that is very important — we need to end central planning. The collapse of the Soviet Union proved that even corn production cannot be centrally planned. Corn is a simple product. You put seeds in fertile ground, wait for sun and rain to do their thing, and then harvest it. Yet the Soviets starved.

We are smart enough to know that we can’t centrally plan corn. However, we think we can centrally plan the most complex of man’s products: credit. We must talk about this in plain language. The gold standard of a freer era did not just collapse, without cause.

Power-lusting, war-mongering governments killed it to do away with the discipline it imposed. Then, free from this constraint, they marched men off to worldwide wars twice in 30 years (no, I am not saying that the US had the same moral stature as the European belligerents).

Towards the of the second world war, the US forced the allied powers to agree to a new monetary order at Bretton Woods. The architect of this vicious scheme was Harry Dexter White, a communist and tool of the Soviet Union. Ever since then, the worldwide monetary system has been dominated by the Fed.

And the US has been abusing what Valéry Giscard d’Estaing, the French Minister of Finance in the 1960’s, called the “exorbitant privilege”. The Fed’s central planning could not possibly have delivered stability, as any rational theory tells us. The Fed’s central planning did not in fact deliver stability, as any rational reading of history shows us.

 

Charts by: Mercatus Center, American Action Forum, Monetary Metals

 

Chart and image captions by PT

 

Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

3 Responses to “The Big Myth”

  • No6:

    Well said.

    But in my view, these myths are not merely logical errors. A small group of financially connected insiders make literally millions from this fraud.

  • rodney:

    Agreed. Well said Keith.

  • wmbean:

    The big myth is that we may construct a world so that we eliminate risk. The idea that regulations will eliminate risk if only we have enough of them is a seemingly rational idea and yet the reality is one of irrationality. Playgrounds must be made safe for children when the safety of playgrounds is the reduction of liability to the owners, i.e. the state. The successful entrepreneur understands risk to a point that his efforts are rewarded. Risk assessment is about trade-offs and what-ifs. Even a gold standard involves risks. When the South African gold fields were discovered gold was in high demand. But as the world became awash in gold its sore of value declined and many miners went out of business because they could not afford the labor and machinery to mine that metal. Hence, value has a risk.

    But more to the point of regulation and of banks in particular. The risk problem is one of who protects who against who or what? If a bank provides a service then the free market should be able to keep both the banker and customer “honest”. The problem is one of competition. The few the number of banks and the greater their relative size the more the public will place its trust in government regulations to reduce their risk of dealing with these banks. Perhaps what is needed is not less regulation but smaller banks and a reduction of limited liability for those who operate them. The increased risk to a banker that he may lose everything he owns due to bad decisions is the best regulation that government could devise.

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Sovereign Bonds – Stretched to the Limit
    Anti-Vigilantes We dimly remember when Japanese government debt traded at a negative yield to maturity for the very first time. This happened at some point in the late 1990s or early 2000ds in secondary market trading (it was probably a shorter maturity than the 10-year JGB) and was considered quite a curiosity. If memory serves, it happened on just one brief occasion and it was widely held at the time that the absurd situation of a bond buyer accepting a certain loss if the bonds were...
  • Writing on the Wall
    Not Adding Up One of the more disagreeable discrepancies of American life in the 21st century is the world according to Washington’s economic bureaus and the world as it actually is.  In short, things don’t add up.  What’s more, the propaganda is so far off the mark, it is downright insulting.   Coming down from the mountain with the latest data tablet... [PT]   The Bureau of Labor Statistics (BLS) reports an unemployment rate of just 3.7 percent.  The BLS also...
  • Global Stock Markets: Danger Lies Directly Ahead
      A Global Pattern You are no doubt aware of the saying “sell in May and go away”. It is one of the best-known and oldest stock market truisms.   Mark Twain's famous saying about stock market speculation (the other one was “There are two times in a man's life when he should not speculate – when he cannot afford it, and when he can”).  From a seasonal perspective he was definitely right about September and October. [PT]   The saying is in fact justified...
  • Bond Yields in the Netherworld - Precious Metals Supply and Demand
      A Record Amount of Bonds with Negative Yields to Maturity Last week the price of gold went up $22, while the price of silver dropped ¢17. The big news last week was that the yield on all German government bond maturities is now negative. They are also all negative in Switzerland. And in Denmark, all maturities out to 20 years are negative. Interest rates are dropping rapidly in the US as well.   More than $14 trillion in bonds now trade at negative yields to maturity –...
  • Rising Stock Market Volatility – Another Warning Sign
      Bad Hair Days Are Back We recently discussed the many divergences between major US indexes, which led us to expect that a downturn in the stock market was close (see The Calm Before the Storm for details). Here is an update of the comparison chart we showed at the time:   The divergences between various indexes seem to be resolving as expected.   The next chart shows analogous divergences between the S&P 500 Index and two major foreign stock markets:   US...
  • Retail Holders Sell Their Gold - Precious Metals Supply and Demand
      A Myriad of Reasons to Buy Gold – But Small Holders are Selling Big moves occurred in the prices of the metals last week, with that of gold up $57 and silver $0.77. We have now reached a price of gold (if not silver) not seen since 2013, when it was on the way down. What is causing this sudden spike in price and renewed interest in gold?   A well-known depiction of investor emotions over a complete market cycle. Interestingly, it appears as though many retail gold holders...
  • Bitcoin – From Greed to Fear
      A Noteworthy Sentiment Change Bitcoin and other cryptocurrencies have declined quite sharply in recent days. Here is an overnight snapshot of the daily chart:   Bitcoin corrects again...   It is difficult to gauge sentiment on BTC objectively, but there is a service that tries to do just that. According to its greed & fear barometer, the recent decline seems to have triggered quite a bit of apprehension:   The BTC sentiment measure of alternative.me has...
  • Interest Rate Watch and Bond Market Curiosities
    Things To Keep An Eye On Below is an overview of important US interest rates and yield curve spreads. In view of the sharp increase in stock market volatility, yields on government debt have continued to decline in a hurry. However, the flat to inverted yield curve has not yet begun to steep – which usually happens shortly before recessions and the associated bear markets begin.   2-year note yield, 3-month t-bill yield, 10-year note yield, 10-year/2-year yield spread,...
  • Getting to a Special State of Ugly
    Suspicious Phrases There are certain phrases – like “trust me” or “I got this” – that should immediately provoke one’s suspicion.  When your slippery contractor tells you, “trust me, your kitchen renovation will be done before Christmas,” you should be wary.  There is no way it will be done before late spring.   USD-CNH (offshore yuan) exchange rate – the support/resistance level at 7 finally breaks amid escalating trade war rhetoric. [PT]   Or...
  • Tumbling Interest Rates - Precious Metals Supply and Demand
      An Era of Low Time Preference Last week the price of gold moved up another $16, and the price of silver was up $0.14.   10-year treasury note yield since 1999 – it is almost back at the multi-decade low of 2016. The only other time in history when US treasury yields were this low was in 1944-1945, when the Fed was actively suppressing yields in order to provide cheap financing for the war effort. One year later (from mid 1946 to mid 1947) the CPI jumped to more than 17%...
  • A Bubble in Complacency - Incrementum Advisory Board Discussion
      Incrementum Advisory Board Meeting of 31 July 2019 At the end of July the Advisory Board of the Incrementum Fund held its quarterly meeting (a full transcript is available for download at the end of this post). The board was joined by special guest Simon Mikhailovich, a financial market veteran who inter alia co-founded the Toqueville Bullion Reserve. The title of the transcript and this post was inspired by his remarks.   Special guest Simon Mikhailovich   We...
  • Dead Meat in Jackson Hole
      The Pointlessness of Negative Yields If there are any virtues of debt instruments with negative yields we have yet to realize them. Certainly, we understand that as bond yields fall, bond prices rise, and bond investors are rewarded with capital appreciation. But when capital is appreciating as a consequence of negative yields, we suspect there is something fundamentally wrong with the capital itself.   Not only is the stock of negative-yielding debt at a new record high...

Support Acting Man

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!