The relationship between welfare and immigration

Home comforts: Firuta Vasile's initial request for benefits had been rejected by the local council

You give immigrants a bad name

The influx of Romanian and Bulgarian immigrants expected from January 1st 2014 has lately seen Britain’s politicians running round like headless chickens trying to prevent the obvious and predictable results of their previous actions (or inactions). The idea that people from these countries might come to the UK and avail of its generous welfare system has triggered concerns about immigration. Should we not, instead, be worried about welfare?

Classical liberals and many on ‘the right’ more generally would complain if government prevented a person from Bolton taking a job in Southampton. What right would a politician have to interfere in the mutually agreed employment decision of an employee and an employer? But if this is so, why should government have any more right to prevent a person from Juarez or Lahore taking a job in Minneapolis or Sheffield?

Indeed, if the government erected capital controls such as existed in the post war period to stop people shipping their wealth abroad, many on ‘the right’ would decry an act of confiscatory socialism. But why should the freedom of movement be granted to capital and denied to labour?

Immigration is an area of public policy rarely treated coherently. ‘The left’ frequently defend the free movement of labour (recently anyway) but oppose the free movement of capital. From ‘the right’ it is often the opposite. A common opinion, in pubs and taxi cabs at any rate, is that immigrants come here to sponge off our welfare state and take our jobs, a contradictory sentiment often expressed by the same person in the same monologue.

Some immigrants do travel to the UK to gorge themselves in the trough of its lavish welfare state. I wrote last January of Firuta Vasile, a woman who has apparently done little but leech off the British taxpayer since arriving from Romania in 2008.

Indeed, stories on BBC London about the lack of affordable housing in the capital are often illustrated with an interview with an immigrant demanding that more ‘affordable housing’ be made available by the state. But there is probably no shortage of affordable accommodation wherever they came from and the high prices of London are simply a market signal saying: This place is full up.

Immigrants like Ms Vasile give a bad name to the majority who do travel to Britain wanting to work. But, besides that, they are eroding support for the welfare state itself.

For all the noble notions of a brotherhood of man it remains a fact that people, in the main, feel more empathy with those who are more like them than those who aren’t. We generally care more about people who speak our language, dress like us, worship the same God (or none), watch the same TV programmes etc, than we do about people who don’t. This is one reason why the British or American media will devote hours of coverage to the deaths of American children in Newtown but spend little if any time on the Pakistani or Afghan children killed in drone strikes.

Regrettable as it may be, it is a fact of life that our empathy decreases as our differences with the person being empathised with increase.

The effects of this for a welfare state are as obvious as the effects of throwing your doors open while laying on a banquet of benefits. While people might be quite willing to pay towards a system that they believe is going to help people like themselves they will be considerably less willing to pay towards a system that they perceive benefits people who have very little in common with them. As Stuart Soroka writes

“Immigration has the potential to raise powerful challenges to the political legitimacy of the welfare state. Immigration can unsettle the historical conceptions of community, which define those who are ‘us’, recognized members of existing networks of rights and obligation, and those who are ‘strangers’ or ‘others’ whose needs seem less compelling. According to many commentators, the growing presence of newcomers, especially ethnically distinct newcomers, may erode the sense of social solidarity on which welfare states are constructed”

Or, as Milton Freidman put it: “You cannot simultaneously have free immigration and a welfare state”. The mass immigration overseen by the Labour government which saw millions enter Britain, 371,000 of whom are claiming benefits, has been one of the major factors in the decline in support for the welfare state in Britain. It has led to the serious consideration of a contributory element to welfare.

The answer is that government has no basis in rights to interfere with migration, but neither does it have a duty to subsidise it. If people want to go and work in Britain or the United States, and they can find employment, they should not be impeded. But if they cannot find employment the government should not hand them taxpayers’ money or goods and services purchased with that money.

There is a choice between immigration and welfare. The irony is that by choosing immigration a government of the left did more to undermine the welfare state than ‘the right’ ever did.

This article originally appeared at The Commentator


Bernanke stuck in a bunker

…QE4, QE5, QE6…

At a celebration of Milton Friedman’s 90th birthday in 2002, Ben Bernanke, then a newly appointed member of the Federal Reserve Board of Governors, said “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again”

Bernanke thought Milton had been right about the Great Depression. Until the early 1960s the common interpretation of the Depression was the Keynesian one, such as that put forward by Peter Temin, where a switch in “animal spirits” had caused aggregate demand to collapse. Then, in 1963, Friedman and his colleague Anna Schwartz produced a radical new interpretation in A Monetary History of the United States, 1867 to 1960.

In this mammoth, exhaustively researched book, Friedman and Schwartz argued that far from money being “neutral”, as was thought at the time, fluctuations in the money supply were closely linked to fluctuations in output. So, if you wanted to stabilise output you had to stabilise the money supply. Monetarism was born.

But the book’s centrepiece – so much so that it was released separately as a book in itself – was that covering the onset of the Depression, “The Great Contraction”. Here, Friedman and Schwartz claimed that a common or garden down turn (brought on by the tightening of monetary policy from 1928 which, they said, had triggered the Wall Street Crash) was turned into a Depression by the Federal Reserve allowing the money supply to shrink by a third between 1929 and 1933.

This, it was argued, had increased the real debt burden of businesses and individuals. As the money supply fell so did prices, this was deflation. Anyone who had debt to service had to service debts of fixed nominal amounts which had grown in real terms as the deflation set in, with money which had shrunk in value at the same time.

Though Friedman subsequently became linked with the fight against inflation he was also concerned about deflation. Friedman argued that a money supply which neither shrank nor grew too fast was needed to bring about the monetary stability which he saw a necessary precondition for economic stability.

So while, in the 1970s, Friedman advocated slowing the increase in the money supply to tame inflation, in the early stages of the Depression, he and Schwartz argued, the Federal Reserve should have fought deflation by expanding the money supply.

That the Federal Reserve didn’t do this was, to Friedman, the cause of the Depression. It was the supposed truth of this insight that Bernanke was acknowledging in 2002.

Ben Bernanke spent his academic career studying the Depression from a Friedmanite perspective, producing a dull but worthy book on the subject. When he took over from Alan Greenspan at the Federal Reserve in February 2006 the Great Moderation was still in full swing but when the downturn came in 2008 it would have been hard to find a more qualified man to have at the helm. It was a case of cometh the man cometh the hour.

In September 2008 Lehman Brothers collapsed, banks everywhere looked vulnerable and began hoarding cash. The US broad money supply collapsed. Bernanke acted quickly to apply the lessons of the Depression he had learned from Friedman. As one reviewer of his book put it, “He is practicing today what he preached in his book: Flood the system with money to avoid a depression.”

The Fed Funds rate, which had already been reduced from 5.25 percent in early 2007 to 2 percent when Lehman tanked, was cut further to a range between 0 percent and 0.25 percent by the end of 2008 where it remains today. Still, the money supply contracted.

In November 2008 Bernanke launched QE1. Changes in the Fed Funds rate are facilitated by the buying and selling of short term dated securities to alter short term interest rates. Quantitative Easing works the same way except via the purchase of long term dated securities so as to bring down longer term interest rates.

QE1 was an unprecedented attempt to infuse tottering banks with liquidity and shore up the money supply. By the time it came to an end in March 2010 the Federal Reserve had bought $1.75 trillion of mortgage-backed securities.

But still the money supply kept falling so in November 2010 Bernanke initiated QE2 which involved the purchase of $600 billion of Treasury securities. By the time QE2 docked in June 2011 the money supply had stopped shrinking. Indeed, it had returned to fairly brisk growth. Bernanke had made the moves straight out of Friedman’s playbook and staved off deflation.

But, apart from the Federal debt, the money supply was all that was experiencing brisk growth. GDP was slowing and unemployment remained stuck over 8 percent. Bernanke, with a theory of fighting inflation, was now coming under pressure to boost growth and employment.

He took over a year to arrive at his decision but last week Bernanke rolled the dice on QE3, an open ended commitment to spend 40 billion newly created dollars a month on mortgage backed assets until, well, until something turns up.

If you are going to do a job you need the appropriate tools. QE and the mass monetary intervention executed so far by Bernanke were designed to stop the money supply contracting. Eventually it did. But the money supply is not now contracting, it is growing. QE is totally inappropriate now even on Monetarist grounds.

In desperation, with the economy stagnating and fiscal policy at its capacity, Bernanke, to the great relief of the Obama administration, is deploying a policy tool conceived and designed to achieve stability of the money stock, to boost the real variables of output and employment. Increasingly Bernanke resembles a golfer with one club. He’s stuck in a bunker and all he has is a driver.

This article originally appeared at The Commentator

More on Maggie

It was

One of the great pleasures of the internet is to see Baron Tebbit, former Chairman of the Conservative Party, saying something like “I was disappointed to read the view of viewtoday, David Simpson, Jangly Guitar Part and others…” Well, if it’s alright for Norm it’s alright for me so I thought I’d take some time to engage with some of my critics.

The thrust of my article for The Commentator last week was that when someone tells you about the party they have planned for when Margaret Thatcher pops her clogs it is generally a sign that they haven’t thought about the matter very much, at least, not in any serious or original way. There was little in the responses to indicate that this observation is wrong and much to suggest it is entirely correct.

Over on twitter @BirleyLabour saw it as an example of “Tory hate for Sheffield” despite the fact that I am from Sheffield and am not currently a member of the Conservative Party (and when I am I’m not a Tory). Still, it’s nice to see the Sheffield Labour Party’s long tradition of idiocy being upheld.

@DaveTomHodges said it was “somewhat odd to write a piece proclaiming the longeivity of Thatcher’s ideas at a time they’re most discredited economically” I asked him which ideas he meant exactly (my answer would have been monetarism, but there you go) and got in reply “why that would be the low global growth over the last 30yrs as a starter. Economic extremists on both sides are v.dangerous!”

For starters, I don’t think low economic growth was one of Thatcher’s ‘ideas’. It might have been a consequence (though I’d argue against that) but it’s not as though she thought sometime before 1979 “Hang on; what we need is lower economic growth” In fact, she is often slated for putting the pursuit of economic growth above any other considerations. The charges against Thatcher are rarely coherent.

Secondly, though, what has economic extremism one way or the other got to do with it? It doesn’t matter whether your ideas are extreme or not, it only matters whether they are right.

After that young Master Hodges drifted into the last refuge of the Thatcher Bashers, some stuff about Chile and Pinochet.

Another vocal critic on twitter was @glynsmith3. His intial response was “Thatchers achievements mmmm. no sorry she’s just an evil cow who destroyed many peoples lives #witch” which rather proved my initial point. He went on to tweet “you are one selfish dickhead. 5 million unemployed, but at least your fucking happy eh.#torywanker” (proving my point again – and it was 3 million) before tweeting “no abuse from me” He eventually asked “pray tell why Thatcher was so good. i did ask 30 messages ago” which suggests he hadn’t actually read the article which had got him so angry in the first place.

I ought to say that not all the response was bonkers. I was pleased to see a few of my fellow Sheffielders agreeing in the comments (Andrew Cadman, Chrisuk1943, and Phil).

And not all the anti responses were barking. My friend Phil, a thoughtful fellow, reflected on Facebook that “the experience of leaving school and trying to find a job in a city affected as Sheffield was circa 1982 gives me the right to dislike someone who caused that affect” This demands more of a reply.

I don’t think anyone would disagree that Sheffield in the early 1980s was a grim place to be. The question was to what extent that was Thatcher caused it. If she didn’t then celebrating her demise is pretty daft.

Thatcher was elected to tackle two problems; inflation and excessive trade union power. The tool she used to tackle inflation was the doctrine of monetarism. This diagnosed the cause of inflation as being growth in the money supply and prescribed the cure as being the slowing of this growth. However, a decline in the growth rate of the money supply would lead to higher interest rates and higher unemployment.

That is, in fact, exactly what happened under the first monetarist government Britain had; Labour in 1976. That year Jim Callaghan, Thatcher’s predecessor, was forced to ask the IMF for a bailout. One of the conditions of the IMF’s loan, not unreasonable given the inflation of 25% the previous year, was a slowing in the growth of the money supply. The Chancellor, Denis Healey, obliged (he had no choice) and unemployment quickly shot up to a post war record of 1.5 million in 1977 where it more or less stayed until Thatcher was elected. Inflation, meanwhile, fell to 8% in 1978 before Labour went on a pre election credit binge and it started heading upwards again.

So given the experiences under Callahan/Healy as well as Thatcher/Howe, we can safely say that the defeat of severe inflation means higher unemployment. There is no other way. If you believe that the inflation Britain was plagued by in the 1970s needed to be defeated you cannot hold the subsequent unemployment against Margaret Thatcher.

You might, however, think that the price was too high and that high and increasing inflation was preferable to the unemployment that was an unavoidable part of getting rid of it. Celebrating Margaret Thatcher’s death because of the unemployment she oversaw only makes sense if you believe this.

The trouble is that economic theory had come to predict and the practical experience of the 1970s had borne out that using a bit of inflation to reduce unemployment only worked for a short time (that short time getting shorter with every dose) and that each dose had to be higher than the one before*

Indeed, this insight came to Jim Callaghan before Thatcher was even elected. In 1976 he told the Labour Party conference that

“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 that 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. Higher inflation followed by higher unemployment”

That was Thatcher’s belief put as well as she ever put it herself.

Quite simply the path of ever higher inflation was the path to national ruin. Thatcher saved us from that at a dreadfully high cost. But anyone who tells you it was available cheaper is having you on.

* The reasoning behind this was that if people expected inflation of 5% they would factor it into their calculations and only nominal magnitudes (prices) would change, real ones (output, unemployment) wouldn’t. So, to spur an increase in output or employment the inflation would have to be unexpected so if 5% was the expected rate the actual rate would need to be, say, 8%.

However, once people factored in the 8% rate the next stimulus would have to be up higher, say 10%…

Barack Brewster’s Millions

Who ya gonna call in November?

Films have often been vehicles for communicating complex ideas and philosophies in coded parables. The dreary films of Marxist filmmaker Ken Loach aren’t much more fun than ploughing through all three volumes of Das Kapital but they do, at least, take less time.

When, in The Shootist, John Wayne’s character, J B Books, says “I won’t be wronged, I won’t be insulted, and I won’t be laid a hand on. I don’t do these things to other people, and I require the same from them”, he was saying roughly what it took Robert Nozick 300 pages to say in Anarchy, State, and Utopia.

But I wasn’t expecting any such heft when I sat down to watch Brewster’s Millions at the weekend. As a child of the 1980s I might have seen this film around 20 times but this time I noticed something new in it; it is a parable for Keynesian economics.

It tells the story of washed up baseball player, Montgomery Brewster (Richard Pryor), who is left $300 million by an eccentric relative. There is one catch: first he has to spend $30 million in 30 days with absolutely nothing to show for it; “you’re not allowed to own any assets. No houses, no cars, no jewelry. Nothing but the clothes on your back!”

Brewster uses a raft of tricks to spend this money, some of which will be oddly familiar to anyone who has been watching economic policy making over the last few years.

Brewster’s first act is to go on a hiring spree offering vastly inflated wages. No, not public sector employees, but a team of security guards. Later he gets into his very own crackpot environmental, or ‘green tech’, scheme when he buys an iceberg with the aim of floating it to the Middle East to bring relief to supposedly drought stricken Arabian farmers.

“What thirsty Arab farmers?” his friend Spike (John Candy) asks, “There aren’t any, because there aren’t any farmers in the desert!” If only John Candy had been on hand before Barack Obama blew $535 million on Solyndra.

Finally he hosts an expensive exhibition game between his old team, the Hackensack Bulls, and the New York Yankees. The Bulls are kitted out in new uniforms and flown in by helicopter. Brewster should, of course, have re-designated some of the major roads in New York as special lanes for his game; then he could have wasted as much money as the London Olympics.

If it sounds fanciful to see any economics in this flurry of pointless spending, consider the words of John Maynard Keynes himself:

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is”

A different attitude to wealth creation is on display in one of the classics of 1980s cinema, Ghostbusters.

Three government employees spend their days trying to seduce their students with phony experiments and running away from ghosts. When this dismal level of productivity proves too low even for the public sector they are sacked and go private, though not without misgivings.

As Ray Stanz (Dan Aykroyd) warns Peter Venkman (Bill Murray), “Personally, I liked the university. They gave us money and facilities. We didn’t have to produce anything! You’ve never been out of college. You don’t know what it’s like out there. I’ve worked in the private sector. They expect results.”

Spotting a gap in the market (“We are on the threshold of establishing the indispensable defense science of the next decade. Professional paranormal investigations and eliminations. The franchise rights alone will make us rich beyond our wildest dreams”) the three borrow some money and set up the Ghostbusters.

Soon they are raking in $5,000 a night, getting coverage from Larry King and Time magazine, and taking on a black member of staff, no affirmative action needed.

Then up pops Walter Peck of the Environmental Protection Agency. “I want to know more about what you do here” he demands. “Frankly, there have been a lot of wild stories in the media and we want to assess for any possible environmental impact from your operation, for instance, the presence of noxious, possibly hazardous waste chemicals in your basement. Now you either show me what’s down there or I come back with a court order!”

With Venkman an unlikely John Galt the government steps in, shuts down the thriving private sector enterprise, and the town is flooded with ghosts.

Where Brewster’s Millions is an object lesson in the wasteful uselessness of Keynesian economics, Ghostbusters is one of the most pro free market films ever made, a hymn to the genius of capitalism and the clumsy damage wrought by government.

Or, to quote another economist, Milton Friedman, “If you put the federal government in charge of the Sahara Desert, in five years there’d be a shortage of sand”

These differing attitudes are on display in the US Presidential election. With the American economy slowing to stall speedthe question each of the candidates must answer is “Where is the growth going to come from?”

With his background in law and ‘community organising’ it’s no surprise that Barack ‘Brewster’ Obama doesn’t know, pinning his hopes on ever more government spending of the Solyndra sort.

Mitt ‘Venkman’ Romney, by contrast, is at least paying lip service to private sector led growth of the Bain Capital sort. The difference is that Bain made money and Solyndra went bust. Do Americans want their economy run by Monty Brewster or the Ghostbusters? That will be the question this November

This article originally appeared at The Commentator

The euro – lessons from history

Dinner money

When currencies and monetary arrangements have broken down it has always been because the currency issuer can no longer fight the lure of the seigniorage to be gained by over issue of the currency. In the twentieth century this age-old impulse was allied to new theories that held that economic downturns were caused or exacerbated by a shortage of money. It followed that they could be combated by the production of money.

Based on the obvious fallacy of mistaking nominal rises in wealth for real rises in wealth, this doctrine found ready support from spendthrift politicians who were, in turn, supported by the doctrine.

Time and again over recent history we see the desire for seigniorage allied with the cry for more money to fight a downturn pushing up against the walls of the monetary architecture designed to protect the value of the currency. Time and again we see the monetary architecture crumble.

The classical gold standard

At the start of the twentieth century much of the planet and its major economic powers were on the gold standard which had evolved from the 1870s following Britain’s lead. This was based on the twin pillars of (1) convertibility between paper and gold and (2) the free export and import of gold.

With a currency convertible into gold at a fixed parity price any monetary expansion would see the value of the currency relative to gold decline which would be reflected in the market price. Thus, if there was a parity price of 1oz gold = £5 and a monetary expansion raised the market price to 1oz = £7, it would make sense to take a £5 note to the bank, swap it for an ounce of gold and sell it on the market for £7.

The same process worked in reverse against monetary contractions. A fall in the market price to 1oz = £3 would make it profitable to buy an ounce of gold, take it to the bank and swap it for £5.

In both cases the convertibility of currency into gold and vice versa would act against the monetary expansion or contraction. In the case of an expansion gold would flow out of banks forcing a contraction in the currency if banks wished to maintain their reserve ratios. Likewise a contraction would see gold flow into banks which, again, in an effort to maintain their reserve ratios, would expand their issue of currency.

The gold standard era was one of incredible monetary stability; the young John Maynard Keynes could have discussed the cost of living with Samuel Pepys without adjusting for inflation. The minimisation of inflation risk and ease of convertibility saw a massive growth in trade and long term cross border capital flows. The gold standard was a key component of the period known as the ‘First era of globalisation’.

The judgement of economic historians Kenwood and Lougheed on the gold standard was

One cannot help being impressed by the relatively smooth functioning of the nineteenth-century gold standard, more especially when we contemplate the difficulties experienced in the international monetary sphere during the present century. Despite the relatively rudimentary state of economic knowledge concerning internal and external balance and the relative ineffectiveness of government fiscal policy as a weapon for maintaining such a balance, the external adjustment mechanism of the gold standard worked with a higher degree of efficiency than that of any subsequent international monetary system

The gold exchange standard and devaluation

The First World War shattered this system. Countries printed money to fund their war efforts and convertibility and exportability were suspended. The result was a massive rise in prices.

After the war all countries wished to return to the gold standard but were faced with a problem; with an increased amount of money circulating relative to a country’s gold stock (a problem compounded in Europe by flows of gold to the United States during the war) the parity prices of gold were far below the market prices. As seen earlier, this would lead to massive outflows of gold once convertibility was re-established.

There were three paths out of this situation. The first was to shrink the amount of currency relative to gold. This option, revaluation, was that taken by Britain in 1925 when it went back onto the gold standard at the pre-war parity.

The second was that largely taken by France between 1926 and 1928. This was to accept the wartime inflation and set the new parity price at the market price.

There was also a third option. The gold stock could not be expanded beyond the rate of new discoveries. Indeed, the monetary stability which was a central part of the gold standard’s appeal rested on the fixed or slow growth of the gold stock which acted to halt or slow growth in the currency it backed. So many countries sought to do the next best thing and expand gold substitutes to alleviate a perceived shortage of gold. This gave rise to the gold exchange standard which was put forward at the League of Nations conference in Genoa in 1922.

Under this system countries would be allowed to add to their gold reserves the assets of countries whose currency was convertible into gold and issue domestic currency based on this expanded stock. In practice the convertible currencies which ‘gold short’ countries sought as reserves were sterling and dollars.

The drawbacks were obvious. The same unit of gold could now have competing claims against it. The French took repeated advantage of this to withdraw gold from Britain.

Also it depended on the Bank of England and Federal Reserve maintaining the value of sterling and the dollar. There was much doubt that Britain could maintain the high value of sterling given the dire state of its economy and the dollar was weakened when, in 1927, the Federal Reserve lowered interest rates in order to help ease pressure on a beleaguered sterling.

This gold exchange standard was also known as a ‘managed’ gold standard which, as Richard Timberlake pointed out, is an oxymoron. “The operational gold standard ended forever at the time the United States became a belligerent in World War I”, Timberlake writes.

After 1917, the movements of gold into and out of the United States no longer even approximately determined the economy’s stock of common money.

The contention that Federal Reserve policymakers were “managing” the gold standard is an oxymoron — a contradiction in terms. A “gold standard” that is being “managed” is not a gold standard. It is a standard of whoever is doing the managing. Whether gold was managed or not, the Federal Reserve Act gave the Fed Board complete statutory power to abrogate all the reserve requirement restrictions on gold that the Act specified for Federal Reserve Banks (Board of Governors 1961). If the Board had used these clearly stated powers anytime after 1929, the Fed Banks could have stopped the Contraction in its tracks, even if doing so exhausted their gold reserves entirely.

This was exacerbated in the United States by the Federal Reserve adopting the ‘real bills doctrine’ which held that credit could be created which would not be inflationary as long as it was lent against productive ‘real’ bills.

Many economists, notably Ludwig von Mises and Friedrich von Hayek, have seen the genesis of the Depression of the 1930s in the monetary architecture of the 1920s. While this remains the most debated topic in economic history there is no doubt that the Wall Street crash and its aftermath spelled the end of the gold exchange standard. When Britain was finally forced to give up its attempt to hold up sterling and devalue in 1931 other countries became worried that its devaluation, by making British exports cheaper, would give it a competitive advantage. A round of ‘beggar thy neighbour’ devaluations began. Thirty two countries had gone off gold by the end of 1932 and the practice continued through the 1930s.

Bretton Woods and its breakdown

Towards the end of World War Two economists and policymakers gathered at Bretton Woods in New Hampshire to design a framework for the post war economy. Looking back it was recognised that the competitive devaluations of the 1930s had been a driver of the shrinkage of international trade and, via its contribution to economic instability, to deadly political extremism.

Thus, the construction of a stable monetary framework was of the most utmost importance. The solution arrived at was to fix the dollar at a parity of 1oz = $35 and to fix the value of other currencies to the dollar. Under this Bretton Woods system currencies would be pegged to gold via the dollar.

For countries such as Britain this presented a problem. Any attempt to use expansionary fiscal or monetary policy to stimulate the economy as the then dominant Keynesian paradigm prescribed would eventually cause a balance of payments crisis and put downward pressure on the currency, jeopardising the dollar value of sterling. This led to so called ‘stop go’ policies in Britain where successive governments would seek to expand the economy, run into balance of payments troubles, and be forced to deflate. In extreme circumstances sterling would have to be devalued as it was in 1949 from £1 = $4.03 to £1 = $2.80 and 1967 from £1 = $2.80 to £1 = $2.40.

A similar problem eventually faced the United States. With the dollar having replaced sterling as the global reserve currency, the United States was able to issue large amounts of debt. Initially the Federal Reserve and Treasury behaved reasonably responsibly but in the mid-1960s President Lyndon Johnson decided to spend heavily on both the war in Vietnam and his Great Society welfare program. His successor, Richard Nixon, continued these policies.

As dollars poured out of the United States, investors began to lose confidence in the ability of the Federal Reserve to meet gold dollar claims. The dollar parity came under increasing pressure during the late 1960s as holders of dollar assets, notably France, sought to swap them for gold at the parity price of 1oz = $35 before what looked like an increasingly inevitable devaluation. Unwilling to consider the deflationary measures required to stabilise the dollar with an election due the following year, President Nixon closed the gold window on August 15th 1971. The Bretton Woods system was dead and so was the link between paper and gold.

Fiat money and floating exchange rates

There were attempts to restore some semblance of monetary order. In December 1971 the G10 struck the Smithsonian Agreement which sought to fix the dollar at 1oz = $38 but this broke down within a few months under the inflationary tendencies of the Federal Reserve. European countries tried to establish the ‘snake’, a band within which currencies could fluctuate. Sterling soon crashed out of even this under its own inflationary tendencies.

The cutting of any link to gold ushered in the era of fiat currency and floating exchange rates which lasts to the present day. Fiat currency gets its name because its value is given by governmental fiat, or command. The currency is not backed by anything of value but by a politicians promise.

The effect of this was quickly seen. In 1931 Keynes had written that “A preference for a gold currency is no longer more than a relic of a time when governments were less trustworthy in these matters than they are now” But, as D R Myddelton writes, “The pound’s purchasing power halved between 1945 and 1965; it halved again between 1965 and 1975; and it halved again between 1975 and 1980. Thus the historical ‘half-life’ of the pound was twenty years in 1965, ten years in 1975 and a mere five years in 1980”

In 1976 the pound fell below $2 for the first time ever. Pepys and Keynes would now have been talking at cross purposes.

Floating exchange rates marked the first public policy triumph for Milton Friedman who as long ago as 1950 had written ‘The Case for Flexible Exchange Rates’. Friedman had argued that “A flexible exchange rate need not be an unstable exchange rate” but in an era before Public Choice economics he had reckoned without the tendency of governments and central banks, absent the restraining hand of gold, to print money to finance their spending. World inflation which was 5.9% in 1971 rose to 9.6% in 1973 and over 15% in 1974.

The experience of the era of floating exchange rates has been of one currency crisis after another punctuated by various attempts at stabilisation. The attempts can involve ad hoc international cooperation such as the Plaza Accord of 1985 which sought to depreciate the dollar. This was followed by the Louvre Accord of 1987 which sought to stop the dollar depreciating any further.

They may take more organised forms. The Exchange Rate Mechanism was an attempt to peg European currencies to the relatively reliable Deutsche Mark. Britain joined in 1990 at what many thought was too high a value (shades of 1925) and when the Bundesbank raised interest rates to tackle inflation in Germany sterling crashed out of the ERM in 1992 but not before spending £3.3 billion and deepening a recession with interest rates raised to 12% in its vain effort to remain in.

Where now?

This brief look back over the monetary arrangements of the last hundred years shows that currency issuers, almost always governments, have repeatedly pushed the search for seigniorage to the maximum possible within the given monetary framework and have then demolished this framework to allow for a more ‘elastic’ currency.

Since the demise of the ERM the new vogue in monetary policy has been the independent central bank following some monetary rule, such as the Bank of England and its inflation target. Inspired by the old Bundesbank this is an attempt to take the power of money creation away from the politicians who, despite Keynes’ high hopes, have proved themselves dismally untrustworthy with it. Instead that power now lies with central bankers.

But it is not clear that handing the power of money creation from one part of government to another has been much of an improvement. For one thing we cannot say that our central bankers are truly independent. The Chairman of the Federal Reserve is nominated by the President. And when the Bank of England wavered over slashing interest rates in the wake of the credit crunch, the British government noisily questioned its continued independence and the interest rate cuts came.

Furthermore, money creation can reach dangerous levels if the central bank’s chosen monetary rule is faulty. The Federal Reserve has the awkward dual mandate of promoting employment and keeping prices stable. The Bank of England and the European Central Bank both have a mandate for price stability, but this is problematic. As Murray Rothbard and George Selgin have noted, in an economy with rising productivity, prices should be falling. Also, what ‘price level’ is there to stabilise? The economy contains countless different prices which are changing all the time; the ‘price level’ is just some arbitrarily selected bundle of these.

An extreme example, as noted by Jesús Huerta de Soto, is the euro. Here a number of governments agreed to pool their powers of money creation and invest it in the European Central Bank. The euro is now widely seen to be collapsing. So it may be, but is this, as is generally assumed, a failure of the architecture of the euro itself?

Let us remember that the purpose of erecting a monetary structure where the power to create money is removed from government is to stop the government running the printing presses to cover its spending and, in so doing, destroy the currency.

The problem facing eurozone states like Greece and Spain is presented as being that they are running up debts in a currency they cannot print at will to repay these debts. But is the problem here that these countries cannot print the money they need to pay their debts or that they are running up these debts in the first place? The solution is often offered that either these countries need to leave the euro and adopt a currency which they can expand sufficiently to pay their debts or that the ECB needs to expand the euro sufficiently for these countries to be able to pay their debts. But there is another solution, commonly called ‘austerity’, which says that these countries should just not run up these debts. As de Soto argues, the euro’s woes are really failures of fiscal policy rather than monetary policy.

It is thus possible to argue that the euro is working. By halting the expansion of currency to pay off debts and protecting its value and, by extension, preventing members from running up evermore debt, the euro is doing exactly what it was designed to do.

There is a growing clamour inside Europe and outside that ‘austerity’ alone is not the answer to the euro’s problems and that monetary policy has a role to play. The ECB itself seems to be keen to take on this role. But it is simply the age-old idea, based on the confusion between the real and the nominal, that we will get richer if we just produce more money. Germany is holding the line on the euro but history shows that far sounder currency arrangements have collapsed under the insatiable desire for a more elastic currency.


ANDERSON, B.M. 1949. Economics and the Public Welfare – A Financial and Economic History of the United States 1914-1946. North Shadeland, Indiana: Liberty Press

BAGUS, P. 2010. The Tragedy of the Euro. Auburn, Alabama: Ludwig von Mises Institute.

CAPIE, F., WOOD, G. 1994. “Money in the Economy 1870-1939.” The Economic History of Britain since 1700 vol. 2: 1860-1939. Roderick Floud and D.N. McCloskey, ed. Cambridge: Cambridge University Press, pp. 217-246.

DRUMMOND, I. 1987. The Gold Standard and the International Monetary System 1900-1939. London: Macmillan

FRIEDMAN, M. 1950. “The Case for Flexible Exchange Rates” Essays in Positive Economics. 1953. Friedman, M. Chicago: University of Chicago Press, pp. 157-203.

HOWSON, S. 1994. “Money and Monetary Policy in Britain 1945-1990.” The Economic History of Britain since 1700 vol. 3: 1939-1992. Roderick Floud and D.N. McCloskey, ed. Cambridge: Cambridge University Press, pp. 221-254.

HUERTA DE SOTO, J. 2012. “In defence of the euro: an Austrian perspective”. The Cobden Centre, May 29th

KENWOOD, A.G., LOUGHEED, A.L. 1992. The Growth of the International Economy 1820-1990. London and New York: Routledge

KINDLEBERGER, C.P. The World in Depression 1929-1939. London: Pelican

MYDDELTON, D.R. 2007. They Meant Well – Government Project Disasters. London: Institute of Economic Affairs

ROTHBARD, M. 1963. America’s Great Depression. BN Publishing

SAMUELSON, R.J. 2010. The Great Inflation and its Aftermath – The Past and Future of American Affluence. New York: Random House

SELGIN, G. 1997. Less Than Zero – The Case for a Falling Price Level in a Growing Economy. London: Institute of Economic Affairs

TIMBERLAKE, R. 2008. “The Federal Reserve’s Role in the Great Contraction and the Subprime Crisis”. Cato Journal, Vol. 28, No. 2 (Spring/Summer 2008), James A. Dorn, ed. Washington DC: Cato Institute, pp. 303-312.

VAN DER WEE, H. 1986. Prosperity and Upheaval – The World Economy 1945-1980. London: Pelican

This article originally appeared at The Cobden Centre

Monetarism: what it is and what it isn’t

Mr Monetarism

On last week’s Question Time two people in the audience angrily condemned the “monetarist” policies apparently being pursued by the British and German governments. I groaned. It seems that the only people who use the phrases ‘monetarist’ or ‘monetarism’ anymore are people who haven’t got a clue what they mean.

Monetarism was at its height around thirty years ago. With double digit inflation in Britain, the United States, and elsewhere, and the failure of Keynesian policies to deal with it (indeed, they were the cause of it) the search was on for a set of policies which would. As the chaos grew in the late 1970s many fixed on monetarism as the answer. It went where few economic theories had gone before; debated in Parliament, the front pages of national newspapers, and TV current affairs shows. Rarely has a reasonably technically involved economic concept achieved such widespread discussion among non-economists.

Though it had roots deep in the history of economic thought monetarism was popularized in the 1970s by Milton Friedman, a Nobel Prize winning economist from Chicago University. Friedman was on a roll at the time. In 1953 he had argued for floating exchange rates and in the 1970s these had come about. In 1968 he had predicted the breakdown of the Phillips Curve relationship between unemployment and inflation and, again, in the 1970s this had come about.

His theory was really very simple and was based around one of the oldest, and certainly one of the very few useful, equations in economics, the equation of exchange


Here M stands for the amount of money in an economy and V stands for velocity of circulation; how many times in a given period a unit of currency is spent. Thus, if M was, say, £50 and V was 3 then MV would equal £150 which would be the total amount of spending in that economy in that given period.

P stands for the price level, a statistical aggregate of prices in the economy like the inflation figure reported monthly in newspapers. T stands for the real value of aggregate transactions in the economy in a given period. If that sounds like a slippery concept don’t worry, Freidman swapped it for y, or income in the economy in a given period, to give a refined equation

MV = Py

So far we have a truism; an equation which is true by its very definition. It simply says that spending (MV) will equal income (Py) in the economy in the given period which, when you think about it, is obvious.

Freidman took the truism and made it into a theory by holding V and y constant. V would depend on people’s habits which would change little over the short and medium term. Y was fixed by the economy’s capacity; given a set amount of capital and labour in the economy in a given period production could not be expanded in the short and medium term.

The conclusion that followed utterly logically from this was that increases in P, the very inflation which was plaguing economies, must have been caused by increases in M. Indeed, in his mammoth 1963 book A Monetary History of the United States 1867 – 1960 (written with Anna J Schwartz) Freidman claimed to have found conclusive empirical proof of this theory.

The policy prescription that followed was equally utterly logical; if you wanted to lower and control inflation you had to lower and control increases in the money supply. Freidman argued that the aim should be for price stability, that the money supply should grow at a fixed, pre announced rate which would be calculated to match the trend growth rate of the economy.

That, and nothing else, was monetarism. Its supporters might have argued for and its practitioners might have enacted a raft of other policies such as lower taxes, lower public spending, and privatization which could crudely be labelled ‘right wing’ but these were not part of monetarism which was a narrow theory of monetary management. It would have been perfectly possible for a left wing government to have raised taxes, raised spending and nationalized and still committed itself to monetarism. Indeed, the first monetarist government in Britain was the Labour government of Jim Callaghan in 1976.

And plainly not Britain, Germany, nor anyone else today is following anything which could be called a monetarist monetary policy. Monetarism prescribed control of the money supply to control inflation; it said nothing about interest rates which it left to the market. By contrast Britain and the German controlled European Central Bank follow the monetary management method which replaced monetarism when it fell out of favour towards the end of the 1980s. Nowadays the control of interest rates is the chosen tool in the fight against inflation. It is the money supply, central to monetarism, which is left to the market.

This isn’t necessarily to praise monetarism or even to bury it. It is simply to wash off of it some of the mud thrown at other ideas.

No more Solyndras: time for the sun to go down on public spending

$535 million

Whenever I watch Dragon’s Den (Shark Tank to readers in the United States) and I see some entrepreneur waking away with £50,000 in his pocket I try and come up with my own ‘Dragon’s Den idea’.

I wonder how far I’d get if I turned up and said “I want $535 million and I’ll go bust in two years”? I might not get too far with Duncan Bannatyne, but if I was pitching to Steven Chu, Barack Obama’s Energy Secretary, I might be in with a shot.

That, briefly put, is the story behind Solyndra, a California based solar energy technology company which filed for Chapter 11 bankruptcy in August.

There are rumours that something murky went on in the approval of the loan. Perhaps, perhaps not.

But there is certainly a question mark to be raised over the willingness bordering on mania of western governments to throw taxpayers money at any business prospectus with the word ‘green’ in it.

Apparently terrified of global warming, our political leaders also harbour the hope that burying Sussex under wind turbines or covering Nevada with solar panels will boost the economy, a variation on Keynes’ old bottles full of banknotes.

But this is to miss the central lesson of Solyndra; governments aren’t much good at spending money.

In his 1980 classic, ‘Free to Choose’, Milton Friedman set out the four categories that all spending must fall into. Category I, you can spend your money on yourself; Category II, you can spend your money on someone else; Category III, you can spend someone else’s money on yourself; Category IV, you can spend someone else’s money on someone else.

Friedman gave a trip to a supermarket as an example of Category I spending, saying that “You clearly have a strong incentive both to economize and to get as much value as you can for each dollar you do spend”

Category II spending was exampled by buying presents for Christmas or birthdays. “You have the same incentive to economize as in Category I”, Friedman wrote, “but not the same incentive to get full value for money, at least as judged by the tastes of the recipient”

Friedman described Category III spending as being like lunching on an expense account. “You have no strong incentive to keep down the cost of the lunch, but you do have a strong incentive to get your money’s worth”

Category IV spending, Friedman wrote, is like paying for someone else’s lunch out of an expense account and “You have little incentive either to economize or to try to get your guest the lunch that he will value most highly”

Yet it is into this last category that all government spending falls. As D R Myddelton wrote in ‘They Meant Well’, a look at some similar examples of government profligacy in Britain, “Making a profit is the raison d’être of commercial enterprise, and company directors must account to shareholders for their success or failure in doing so. Government quasi-commercial projects may aim to make a profit, but if they fail, taxpayers have to pick up the tab”

Governments are not incentivised to get value for taxpayers’ money because they have no skin in the game. Hence debacles like Solyndra.

The obvious reply, especially given events of the last few years, is that the private sector is no better at spending its money. The multi-billion losses racked up by the likes of Merrill Lynch, JP Morgan, Citigroup, Morgan Stanley, Lloyds, Royal Bank of Scotland etc would make most governments blush.

But here’s the thing, they weren’t risking their money. When these banks saw their investments go sour they were bailed out with taxpayers cash. They were risking your money. And what’s worse, given the close relationship between Wall Street and Washington, the City and Westminster, they knew it.

None of this is capitalism despite what some might say. Capitalism is a profit and loss system with loss just as important as profit in allocating capital. Eliminate losses and you eliminate capitalism.

As has been proven from the Tanganyika ground nut fiasco to the Solyndra mess, government should leave capitalism to the capitalists.

But capitalists and government should also leave taxpayers money in taxpayers’ pockets. It is not the job of government to throw the public’s money at failing businesses or ‘green’ investment pipedreams. That is not capitalism, it is corporatism. And as the Dragons might say, I’m out.

This article originally appeared at The Commentator

The IMF: cheerleader of the rich world’s governments

If its Tuesday this must be stimulus

Ronald Reagan’s observation that “a government bureau is the nearest thing to eternal life we’ll ever see on this earth” seems to apply to supra national bodies as well.

The collapse of the Soviet Union left NATO facing an existential crisis worthy of French cinema until Slobodan Milosevic came along. So it is with the International Monetary Fund.

Established as part of the Bretton Woods system of currency management in 1944, the IMF’s job was to lend money to countries which were having balance of payments issues; who couldn’t pay their bills in other words. With their dollar exchange rates fixed, paying the bills by inflating the money supply was only allowed in the extreme circumstances of devaluation as Britain had to do under the Labour governments of Clement Atlee in 1949 and Harold Wilson in 1967.

The demise of the Bretton Woods system in 1971 rendered the IMF purposeless. Floating exchange rates replaced fixed rates so, in theory, no country should have any trouble financing its borrowing; it could just print more money, the effects being felt in internal inflation and external devaluation with the exchange rate adjusting automatically to reflect the decline in the value of the newly debauched currency.

Milton Friedman, an advocate of floating exchange rates since at least 1950, held that floating exchange rates didn’t have to mean unstable exchange rates. In practice, removed from even the questionable discipline of the Bretton Woods system, central banks around the world cranked up the printing presses and debt crises became bound up with currency/inflation crises. The IMF’s role was much as before; covering cash strapped countries while they sorted themselves out as they had to do for Britain under the Labour government of James Callaghan in 1976.

In this not-so-new role the IMF has attracted much criticism. Nobel laureate Joseph Stiglitz, among many others, has argued that the IMF’s lending conditions, generally to balance budgets, protect the currency and free up markets, are counterproductive.

In truth a country with a debt problem will have to move towards budget balance and stabilise its currency at some stage. Critics would argue that the midst of a crisis is not the appropriate time but when countries don the IMF hair shirt they have generally reached a stage where their problems cannot be solved without tackling the fiscal and monetary problems at a fundamental level. The truth is that many of the countries it has helped would have been worse off if it hadn’t been for IMF assistance.

A more serious charge against the IMF is its inconsistency. In 1997 a clutch of South East Asian countries were hit by a currency crisis and the IMF stepped in with its standard prescription of fiscal and monetary tightening with the attendant economic pain. If this was a tough sell for domestic politicians, well, that was their problem.

But when the western economies hit trouble in 2007-2008 the IMF suddenly rediscovered its dusty old copy of Keynes’ ‘General Theory’. It enthusiastically backed stimulus spending in Britain, the United States and Europe. Western politicians were given a much easier sell than their Asian counterparts had been in 1997.

The effects of the tidal wave of stimulus unleashed in 2008-2009 were subject to rapidly diminishing returns. The accumulation of vast piles of debt produced nothing beyond the short term other than higher debt. The gruesome examples of Greece and Ireland saw ‘austerity’ replace ‘stimulus’ as the economic order of the day and, again, the IMF enthusiastically backed it in Britain, the United States and Europe.

Bad economic news abounds. In Britain the service sector and manufacturing sector are struggling. The Eurozone is struggling in the face of tottering banks and battles to reign in spending. The United States economy created no net jobs in August and unemployment is stuck above 9%. Stock markets around the world have been bumping downwards.

If a second dip does emerge from all this it will no doubt enter Keynesian folklore that ‘austerity’ was the culprit. It isn’t. Economies around the world have gorged on cheap credit and are now burdened with its flipside, debt, leaving a vast overhang to be painfully deleveraged away. Further, the period of cheap credit left behind a host of malinvestments; enterprises only viable in an environment of cheap credit. Government and central bank attempts to prop these up and bail them out, soaking up much needed capital, have only delayed the economy’s move to a more sustainable basis.

The IMF may have been taken in by this burgeoning Keynesian myth. This week saw a possible switch back to the policies 2008-2009 with Christine Lagarde, new head of the IMF, calling for renewed stimulus in Europe. Keynes is reputed to have said “When the facts change, I change my mind”. The facts haven’t changed but the IMF’s stance has, repeatedly.

Ludwig von Mises wrote that Keynes’ ‘General Theory’ was “an apology for the prevailing policies of governments”. Governments may have no need of Keynes. They have the IMF in its latest role, cheerleader of the rich world’s governments.

Why mathematics and modeling should not be equated with economics and human action

A long way from the pin factory

A very intelligent friend of mine of markedly different political persuasions said the other day that he avoided “technical economic arguments” with me as I’ve just graduated with a degree in economics. I was rather sad to hear this.

The simple truth is that after doing a module called, say, ‘Introduction to Economic Principles and Policy’, you will not study very much more which will add greatly to your understanding of the subject. Beyond that, in an ‘Intermediate Microeconomics’ course for example, you are simply ladling mostly unnecessary algebra onto the subject.

Take this from a course in ‘Intermediate Macroeconomics’ for example:

This is actually some of the more accessible math involved in modern economics. Furthermore, the concepts it is dealing with, constant returns to scale and the per worker production function, are pretty straightforward. Yet many, including almost all university economics lecturers, will tell you that this is economics. It is, in fact, simply applied algebra – mathematics looking for a real world application. Economists eager to give their art the patina of science and mathematicians searching for real world relevance have combined to render economics impenetrable.

This trend also stems from the view of economics as the study of a mechanism. People may now laugh at the model of the economy A.W. Phillips built in the basement of the London School of Economics in 1949 with its gurgling pipes full of different coloured liquids representing money literally sloshing around an economy controlled by sluice gates. But it isn’t conceptually different from the computerised models that are in use today guiding research and government policy.

These models often fail. If your model is based on erroneous assumptions, such as the creation of phantom capital called Quantitative Easing actually stimulating an economy, you will get erroneous outputs; Garbage In Garbage Out as they say. But there is a more fundamental problem. There is no exogenous ‘thing’ called ‘The Economy’ which can be quantified and controlled, there is only each of us doing what we do every day. That is why Ludwig von Mises called his great treatise on economics ‘Human Action’. Or as Friedrich von Hayek rapped recently “The economy’s not a car. There’s no engine to stall. No experts can fix it. There’s no “it” at all. The economy is us”.

It is little wonder that even intelligent people feel themselves cowed and run in terror from the thicket of abstraction that shrouds modern economics. It needn’t be like this. The great works of the discipline, those of Adam Smith or Carl Menger for example, managed to lay the foundations of the subject without it.

And it is sad that people like my friend feel put off because the economy affects all of us and, to return to the point made by the rapping Hayek, it is the study of all of us. Given this we all have economic insights by virtue of being human beings, the very subject of economics itself. As von Mises wrote:

Economics must not be relegated to classrooms and statistical offices and must not be left to esoteric circles. It is the philosophy of human life and action and concerns everybody and everything. It is the pith of civilization and of man’s human existence.

Do not leave economics to the abstract eggheads. Pick up Economics in One Lesson by Henry Hazlitt, Free to Choose: A Personal Statement by Milton Friedman or even Eat the Rich: A Treatise on Economics by P.J. O’Rourke: writers who, in these books and others, passed the economist Armen Alchian’s test of whether they truly understood the subject – they could explain it to someone who doesn’t know a darn thing about it.

Economics is about you. It is your subject. Reclaim and enjoy it.

This article originally appeared at The Cobden Centre