Another classic article, brought forward. This is a speech by James Tyler to the Adam Smith Institute Next Generation Group on 6 October 2009. This speech is also available on hedgehedge.com.
I have spent the best part of the last two decades pitting my wits against the market. It’s an unforgiving game: I’ve seen ups and downs, and many of my rivals buried under an avalanche of hubris, passion, illogical thought and unchecked emotion.
I have witnessed the sheer folly of the ERM crisis, the Asian crisis, the failure of the Gods at Long Term Capital Management and the insanity of the tech boom.
I have enjoyed the ‘NICE’ decade (Non-Inflationary Constant Expansion), and scared myself silly during the credit crisis.
I am a trader.
I risk my own money and live or die by my decisions, and face the threat of personal bankruptcy every time I switch my screens on. I get no salary – indeed I turn up at the start of the month with a large office overhead – a ‘negative’ salary. I have no fancy company pension scheme, no lucrative monopoly or franchise.
I eat what I kill.
Mistakes cost me my livelihood, so, above all, my decisions have to be rooted in practical and logical decision making.
Some have called my kind parasitic, but I would have said that I bring order, efficiency, predictability, stability and deep liquidity to a crucial process: a process that makes the whole world keep ticking.
I make money work.
I make the market in interest rate derivatives: a market born out of the neo classical revolution in finance fostered in Chicago during the 1970s. I am a child of Friedman, Fisher Black, Myron Scholes and the modern international financial system.
My analysis was steeped in the neo-classical, efficient markets paradigm.
Friedman’s ideal was working. Enlightened central bankers guided the free market with gentle nudges and short term liquidity infusions, free floating currencies gently adjusted themselves to the constant flow of new information and efficient and rational markets took all in their stride.
Credit flowed, people got wealthier, economies developed and all was well.
And then the crisis struck.
Markets dried up and ceased to make sense. Price moves became highly irrational.
Then the whole market edifice began to crumble. Bear Stearns going bust tore a hole in the system and Lehman’s almost collapsed the entire financial world.
What had gone so badly wrong I asked myself? How could this have happened?
At about this time I was listening to the US presidential debates. A load of guff and hot air really – all except this fella called Ron Paul. He banged on about liberty, the constitution and the evil of the Federal Reserve. His ideas were fresh to my ears.
In particular he talked about what seemed like a loopy idea. He wanted Gold as money, and the free market to handle it.
Without central banks.
My curiosity had been piqued.
Well, what a Pandora’s box I had opened.
I had opened the door to Austrian economics. A discipline grounded in logic, human action and inevitable consequences of bureaucratic fiddling in free markets.
I discovered that we had been in this mess time and time again, and it always seemed to have the same set of circumstances surrounding it.
Every bubble, boom, bust and crisis had its origins in the extension of too much artificially created credit.
Historically this was by way of government favour and protection towards the banking industry, but in the 20th century, money was nationalised and it became explicit governmental policy.
The evidence is glaring. You name any boom and bust, and I bet I’ll be able to show you how this has been caused by expansion of the money supply.
Tulip mania, in the 1600s, was caused by the massive influx of newly discovered Gold into Amsterdam from the new world: in particular the capture of the Spanish Treasury fleet.
John Law’s Mississippi scheme was financed by the pyramiding of paper money on top of French government notes of credit.
In the US, the panics of 1797, 1819, 1837, 1857, 1873, 1893 and 1907 were all the result of banks lending out many times what they took in as deposits.
1921 and its ugly sister 1929 were both the creations of the Federal Reserve’s mismanagement of the economy, and every boom bust since then has its origins in mistakes made by central bankers.
Here’s how it works;
Firstly, you have to have fiat money. Fiat, meaning “let it be”.
In the good old days, money developed out of barter. I have a bushel of wheat, and you have a barrel of fish. You want the wheat, but what if I want to buy a horse? In a barter economy I would have to exchange my wheat for the fish, and try to find a horse owner who wanted some fish. But what if he hated fish?
What was needed was an intermediate commodity, something commonly accepted, trusted, portable and desired by all. Something that was scarce, thus held its value.
The free interaction of people, also known as the market, chose Gold.
I go to the market and sell my bushel of wheat in exchange for Gold. You sell your fish in exchange for Gold. I find another person with a horse for sale and then sell my Gold in exchange for a horse. The guy who sold me the horse sells his Gold in exchange for corn, and so on. Gold is just another commodity, but its common respect has allowed it to evolve into the higher function of a common medium of exchange, accepted and trusted by all.
Throughout most of history gold was money. The Dollar was worth 1/20th of a gold ounce, the pound was 1/4 of an ounce, and so on. In this way, foreign exchange rates were fixed, financial calculations were easy, and global trade was greatly facilitated.
Not any more.
Look at a bank note. “I promise to pay the bearer, on demand, the sum of £20”. What does that mean? Nothing. You take this note to the BoE and demand 20 pounds they will laugh at you and give you another £20 note. Today money is just pretty pieces of paper with some nice pictures on it, and this means there is no real limit on how fast the money supply can grow.
Secondly, there’s fractional reserve banking – the system whereby banks can lend out many times what they receive in deposits.
Every bank in the country is, essentially, insolvent, whilst the central bank cheers them on from the sidelines. This means the banks can effectively create money out of thin air.
This is the ‘Bankster’ system.
Thirdly, there’s our terror of falling prices. This is nothing more than a children’s scare story; the fastest growth the world had ever seen was during the 19th century – a period of falling prices.
We love falling prices when it is TV’s and computers.
But when it comes to bread and electricity prices the authorities follow the ‘progressive’ idea that we should have to pay 2% more for them each year that goes by. They then make this happen.
It is these three factors that combine to create a policy of continual inflation of the money supply, and lead to our never ending cycle of boom and bust.
It is madness, but why do it? Simple, it is a hidden tax on the nation’s savings. It allows the profligacy of government and the Bankster’s profits.
Modern monetary history is rich with stupendous bureaucrat led money failures, but I’ll just highlight a few glaringly obvious examples.
In 1987, Alan Greenspan slashed interest rates after the so called ‘great crash’ of 1987, creating the infamous ‘Greenspan Put’.
This allowed the Banksters a get out of jail free card if things went wrong, which it did, time and again. In would ride sheriff Greenspan, and save the day.
Why was there a Tech market bubble?
Could it have anything to do with the world’s central banks cutting interest rates to help save the world from the alleged catastrophe about to be unleashed by the failure of a particularly arrogant hedge fund – LTCM?
And finally: the big one.
Why did we have a crisis over the last two years?
Could it have anything at all to do with the world’s central bankers panicking after 9/11 and massively reducing interest for three long years? Could this have created the greatest property bubble the world has ever seen?
Could this have been the process that almost collapsed the world economy?
And now that the money planners have made money, essentially, free. What about that? What will be the consequence? What happens now?
Austrian economics predicted this crisis and has solutions. Austrian economics can prevent this from happening in the future. Find out about it and understand it.
It’s your responsibility. Your generation is going to pick up the bills for the morons we have in charge of us.
The massive debts my generation has amassed and the fiscal diarrhoea being sprayed upon us by the establishment. This will be paid back by you.
We are borrowing twenty five MILLION pounds an HOUR. This will be repaid by YOU. From YOUR future income.
You have a choice and a chance.
Do something about it.
I’ll leave you with a quote.
We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong somebody else can have my job. I want to see this country prosperous. I want to see people get a job….. I say after eight years of this administration we have just as much unemployment as when we started… And an enormous debt to boot!
— US Secretary of the Treasury Henry Morganthau, May 1939
“We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.”
– James Callaghan to the Labour Party Conference, 1976. It seems that the same lessons are forgotten and must be relearnt every generation. The reason they are forgotten is that Keynesianism, though wrong, is simple to understand. We must make a point of pointing out that economies do not need “stimulating”, “stimulus” makes things worse, the problem with low interest rates is not that they make the economy “overheat”, etc.
Excellent article. I’d gladly vote for, and even campaign for, a party that was publicly committed to these principles.
The panic of 1600 was caused when a great deal of gold was added to the system. The current fiasco was done entirely with fiat money. Hard currency has the effect of stabilizing prices, but apparently cannot prevent crashes and panics as such. Or am I missing something here?
Fractional reserve banking.
The Libertarian Party, in the US, is such a party publicly committed to these rpinciples. You can learn more at http://www.lp.org/. Their theme is “Smaller Government. Lower Taxes. More Freedom.” In the UK, the party can be found at http://lpuk.org/.
UK for me … for now. Thanks for the links.
James thanks you have made this really easy to understand, at last an explanation of sheer clarity. Now am i right in thinking that all this quantitative easing is shoving piles of money into the banksters coffers and they are reinvesting it in equities which is why they are going back up at such an alarming rate? I see FTSE is back over 5200 today the air is a little thin up here but all the time Gordon and his chums are Q.easing it probably won’t fall, perhaps its time for a bear put spread strategy? Or should I wait until nearer the election as George Osborne will hopefully turn off the QE tap so we can take the pain and address paying back the piles of debt. ho hum!!
again many thanks
Chris
Yes!
Tyler offers us a certain amount of sense and a degree of exaggeration.
First, his story about barter is irrelevant. Economists have this version in which primitive people traded just like us, only without money, but they actually used a lot more gift exchanges and a lot less commerce.
Yes, there were crashes on the gold standard, too, so the gold standard alone is not a guarantee of stability. All it means is the money supply is controlled by a deus ex machina — the mining of gold.
You don’t need to be an Austrian to see how the combination of loose money and over-gearing of banks set the world up for a fall. Most of all, there is no crystal ball, so to say the Austrians predicted something that others could not see is far-fetched.
Jonathan Muller
I think Tyler’s point is that money originally came from the free market rather than govt dictats. It’s therefore not irrelevant as it shows that, should the politics allow, money could go back to being a free market.
I understand that many of the crashes were created when govt suspended the gold convertability of paper money that was supposedly backed by gold (or silver), or other govt interference (eg tariffs). There is also a difference between a “crash” – ie a recession – and a general fall in prices, for example if production increases faster than gold can be dug out of the ground.
I agree that no-one has a crystal ball, but the predictions of the Austrians were in stark contrast to the mainstream economists meaning that, really, it was only the timing that was not predicted. Here are a couple of links you may find interesting:
http://mises.org/story/3128
http://mises.org/journals/scholar/Thornton6.pdf
Cheers
Sam
Except that the Austrian’s did accurately predict something that others did not. When the talking heads were yelling that no one could have ever seen this coming, there was not a single Austrian Economist in that group. Rather they were of the group that got it right. Not far-fetched, but clearly not mainstream. Could mainstream economic thinking be wrong?
Mark
Just to be clear, the Libertarian Party of the UK (http://www.lpuk.org) is nothing whatsoever to do with the US LP, although clearly you might expect some of the fundamental ideas to be similar!
We already have a Councillor and there will be some candidates standing in the 2010 general and local elections, so please check us out – we need help to get the message out there before the UK goes completely down the tubes!
Cheers
Sam
Very interesting.
Disclosures: Long gold, gold derivatives, and gold equities? Could it be?
I still don’t understand Toby’s plan:
The government printing approx £850 billion in cash and putting it in bank’s vault getting nothing in return for those £850 billion in cash.
Would you explain it in Layman terms so I can finally sleep.
You guys are too smart and know so much abstract terms that you fail to see the obvious:
1. the people lent L850b to the bank – the bank owes them L850b
2. the gov prints L850b and gives them to the people
3. the bank still owes L850b to the people
4. the government makes a law: the bank does not owe L850b to the people
5. the bank liabilities turn into bank assets. The bank now has L850b more assets.
I call this stealing people’s money, because the bank never paid back the money to the people (instead the government gifted money to the people).
The bank just kept the deposited money to itself and got L850 richer – by not paying back to the people.
It is important part to understand in Toby’s plan.
The people are not complaining that the bank stole their money and never returned it back, because the government reimbursed them for their loss.
Toby says – it is not stealing – it is turning liability into assets – it is a swap: L850b to the people – and the L850b demand deposit are gone.
However, the proper way to close the demand deposits is for the bank to pay back the money to the people. But the people already have the money from the gov. If the bank pays them back too – the people will have double the money.
6. the bank has the extra L850b that the bank did not return to depositors – the bank gives it to the government to repay debt.
At the end the government is paying the debt with the money that the bank stole from the people having demand deposits in the bank.
The money supply before the operation: cash (means the currency in circulation – the bank’s assets are part of this cash) + L850 demand deposit
The money supply after the operation: Cash (original cash + L850b(that is no longer demand deposit, but is turned into bank assets) + L850 cash that the government printed = original cash + 2xL850b
Please, don’t dismiss my brain like I am an amoeba, because I am not an economist.
Read this again and try to understand my point. It is important – if this is a real plan – it is crookery – robbery and it is inflationary.
I hope it is just a L1000 logic exercise.
The street smarts win and get the prize!