Markets and Central Banks

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The financial world experienced its equivalent of a major earthquake this month when the Swiss National Bank (SNB), the central bank of Switzerland, made a dramatic and unexpected change in policy. In 2011, concerned by the rapid appreciation of the Swiss Franc and, thus, damage to Switzerland’s exporting industries and commercial banks, the SNB instigated a policy of maintaining a peg with the Euro at 1.20 Francs to the Euro. If ever the price of Euros declined against this mark then the SNB would obligate itself to sell Swiss Francs and accumulate Euros to maintain the parity. This policy therefore created a seemingly impenetrable price floor for the Euro against the Franc. Whenever the Euro declined to the 1.20 area traders could take a sure bet that they could sell Francs and use them to buy Euros (technically referred to as “shorting the Franc”), knowing that the SNB would take action to depreciate the value of the Franc and thus increase the value of the Euros that these traders now held. Indeed, that was precisely what was happening and what was expected on January 15th of this year when many traders had just opened long EUR/CHF positions as the currency pair was hovering around the 1.20 area. In recent months, however, the increasingly lax monetary position of the European Central Bank in order to ward off deflation and sluggish growth in the Eurozone – leading to a QE programme announced on January 22nd – led the SNB to maintain an increasingly expensive policy of depreciation of its own currency that risked fuelling bubbles and malinvestments within its borders. Clearly they were spooked by something as no one seemed to be prepared for the sudden announcement, on January 15th, that the SNB would, with immediate effect, abolish the peg against the Euro and the Franc would again be permitted to fluctuate freely. The market was suddenly awash with sell orders for the Euro and buy orders for the Franc that, within the space of a few minutes following the announcement, the Euro depreciated against the Swiss Franc from about 1.20 to around 0.75 – a dramatic drop of 37.5% – and eventually settling around the 1.00 mark. The movement happened so fast that any liquidity between these two points completely evaporated and anyone hoping for an entry or exit between them was pursuing a lost cause. Needless to say, anybody who owned the Euro against the Franc lost an awful lot of money, with some large institutions, such as Citibank, Barclays and Deutsche Bank, losing tens, if not hundreds, of millions of dollars. Particularly hardest hit, however, was the retail foreign exchange market, which in recent years has seen considerable growth amidst relatively lax regulation. Several of these outlets went bust while the largest, FXCM, had to be bailed out by an investment bank with $300m. Retail traders to whom these institutions cater are those who trade “on margin”, in other words, they borrow money to fund their positions. Thus their own equity amounts to only a proportion of the total cost of any trade, often as small as 0.5%. Therefore, a small movement in favour of any particular trade can lead to large profits, while a small movement in the opposite direction threatens not only to wipe out the client’s capital but to leave them owing money to their broker if the trade continues to sink and is not closed out. If this is the consequence of a small adverse movement, imagine the effects of an extremely large move such as that seen on the 15th. The movement was so sudden that stop losses, the trader’s conventional protection against risk, were useless and FXCM was particularly hard hit, being left with $225m worth of client accounts with negative equity. Needless to say, of course, there were also big winners on the other side, particularly those who were either skilful or fortunate enough to own put options on the Franc against the Euro with a strike price close to the former peg.

Standing aside from this entire calamity, what should the Austro-libertarian make of the situation? Profits and losses are supposed to be the result of superior entrepreneurial judgment in directing scarce resources available to the ends most urgently desired by consumers. Those whose judgements are more accurate than anyone else’s will walk away with profits, those who whose are not will be lumbered with losses. In financial markets, this is manifest in, say, the purchase of a stock which demonstrates the willingness to invest capital in the underlying enterprise and that the enterprise is one which will meet the ends of consumers with its trade; or a speculation in, say, the futures market is an attempt at “price discovery” and to prevent the emergence of false prices that would cause resources to be wasted1. However, the overwhelming fact that was laid bare on January 15th is that entrepreneurial fortunes are not made and lost in the financial markets through correct foresight of the desires of consumers – they are made and lost based on the whim of central banks. People are no longer rewarded for best estimating the desires of consumers but for guessing the motivations of the financial lords and masters sitting on their thrones of paper money. The stock market is no longer a place to rationally allocate resources amongst industries but a place to make bets on monetary policy. Indeed most of the significant shifts in a given stock market are made on days when the relevant central bank makes an important announcement. Those who clap their hands with glee when parasitic “gamblers” burned their hands on the day of the SNB announcement and “got what they deserved” should ask the logically prior question of why the financial markets have become such a casino in the first place. For years, central banks have maintained artificially low interests supported by monetary expansion which have made it profitable to plough funds into assets such as stocks at extraordinarily low cost – buoyed up by the, not unreasonable, belief that central banks will act to correct any dips in asset prices. Indeed with interest rates so low, borrowing money to buy assets has become an almost costless affair. Why should anyone follow other, riskier entrepreneurial ventures when this one has almost no chance of failure? Indeed, the SNB’s own commitment to maintain the peg seemed to promise free profit to anyone wishing to buy Euros and sell Francs near the peg, knowing full well that the SNB would be doing the same and hence buoying the value of the Euro against the Franc. Given that central banks have been creating fortunes for years it should come as no surprise when they take them away again, albeit in one, spectacular blow.

There is, however, a glimmer of light that has emerged from the situation – that the reputation of central banks and their pronouncements may have received lasting damage. First, the fact that the SNB reiterated, in no uncertain terms, its policy to maintain the peg a mere month before it was removed indicates that what central banks say cannot be trusted or taken as gospel. Second, the fact that it did so abandon its policy reveals the fact that these institutions do not possess the omnipotence and invincibility that they have led us to believe. In the long run, central banks cannot outwit reality and the market cannot be fought. By accumulating depreciating Euro assets at the same time as appreciating Franc liabilities the SNB was driving itself towards bankruptcy with a ludicrously expensive policy. Perhaps, therefore, the sudden realisation that the emperor has no clothes will cause bankers, economists, investors and speculators to look at central banks with a more critical and sceptical eye. May be there will then be a chance that the fatality of the pursuits of the more important central banks, such as the US Federal Reserve, will achieve widespread realisation.

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1DuncanWhitmore, Speculation,


Economic Myths #12 – The Deflation Danger


Politicians and mainstream economists have been warning us again lately of the so-called “deflation danger” – the idea that falling prices is calamitous for economic growth and that a perpetual and ceaseless price inflation is needed in order to bring us back to prosperity. With price deflation, so these sages tell us, lower prices today cause people to expect prices to be lower tomorrow so that, as a result, they put off their purchases until a later date, which causes prices to fall further and further. Hence we end up in an endless downward spiral of depression and impoverishment. Inflating prices, however, cause people to buy today so that they may insulate themselves from future price rises, thus bringing about economic growth and an increase in the standard of living. This fresh round of deflation warnings comes in the wake of the news that prices in the Eurozone were 0.2% lower than at the same time the previous year – something of an hilarious travesty when, regardless of the merits of the deflation thesis, this figure amounts to little more than a rounding error.

In basic economic theory, a price will fall as a response to the fact that demand is insufficient to meet supply at the current price. For some reason – say, as a result of the revelation of malinvestments – the demand curve for a particular asset or good shifts sharply to the left, meaning that prices now have to fall in order for the inventory to be sold to a willing level of demand. It will eventually settle at such a level. Indeed, all of the talk of “illiquid” and “toxic” assets on the balance sheet of banks following the 2008 financial crisis resulted from the unwillingness to find these lower prices and to, instead, retain assets at the old, inflated prices. Any asset, however, is surprisingly liquid when you offer a low enough price for it. However, the deflation thesis rests on the proposition that the initial fall in price, based on some exogenous factor, will then in and of itself cause a further shift in the demand curve to the left so that prices have to fall further. And then that this second price fall will cause yet another shift in the demand curve and prices will fall even further. Hence the thesis requires repeated, fresh rounds of shifting demand curves which are caused by nothing other than a previous shift in the demand curve.

However, there is no reason to suggest that prices falling as a result of a genuine, external change in valuation will, in and of themselves, cause further price falls. Indeed, every businessman will tell you that if you lower prices people will buy more and if you raise them people will buy less – precisely the opposite of the deflation thesis. More importantly, however, even if such price falls did result, there is no further reason to suggest that it would cause economic calamity. First, goods are, at the end of the day, evaluated for the ends that they meet. The fulfilment of these ends, as a result of the logic of human action, cannot be put off indefinitely and each individual will have to consume at some point. A person may simply be waiting for prices to bottom out before he purchases but there must come a time where he believes this to be. Taken to its logical extreme, the deflation thesis suggests that falling prices will cause people to simply stop acting altogether – that they cease seeking the fulfilment of ends through means. This will never happen so long as they remain human. Indeed, price deflation in entire industries – particularly in personal technology, such as computers and mobile phones – has not caused the collapse of this sector precisely because the value of owning a more expensive computer today is greater than that of waiting for a less expensive one in, say, three years. In other words, even if a person knows that a computer may cost £1000 today but only half as much in three years, he will still spend £1000 today if the benefit to be derived from the computer today is more valuable than saving £500 and waiting three years for that benefit. Second, viewed from the point of view of the satisfaction of each individual’s ends, there is no reason to suggest that artificially inflating prices, thus causing a person to buy sooner, will cause a greater fulfilment of that person’s ends compared to an economy where there is no deliberate price inflation. From that individual’s point of view, the earlier purchase may be wasteful compared to the later purchase he would have made had prices not been forcibly inflated. Third, even though the opposite of “catastrophic” deflation – namely, hyperinflation – in and of itself causes shifts in the demand curve to the right that accelerate the price rises, the motivation for this is not so much the rising prices as the realisation, on the part of the public, that the currency is worthless. Hence, a hyperinflation always ends in a flight to other currencies and stores of value. Indeed, following the recent Zimbabwean hyperinflation, the government there has gone as far as to recognise no fewer than nine foreign currencies as legal tender. No such realisation exists during falling prices and, funnily enough, people do not seem to be eager to flee to inflating currencies during a deflation! Fourth, there is no reason to suggest that falling prices will dampen business prospects. Nominal revenue will, of course, fall during a general price deflation. However, the success of a business – measured by its profit – depends not only upon the height of its revenue but also upon the height of its costs and these too are falling. Businesses would only put off purchasing and investing if revenue was predicted to remain constant while costs were predicted to fall, or fall further. If, however, falling revenue is met by falling costs then there still exists a profit motive, with every incentive to invest and trade today. Fifth, much of the deflation fear comes from the monetarist analysis of the Great Depression where, indeed, there was a monetary contraction1. However, the stagnation during that era was not due to the deflation per se but because of the widespread attempt to keep wages and prices high in spite of the monetary contraction. Had prices been allowed to fall then recovery would have been much swifter.

The real reason for the deflation scare is, of course, because perpetual inflation serves to protect the vested interests of the state and its corporate cronies and banker elites. The characteristic of any deflation is that the purchasing power of the monetary unit becomes stronger; all else being equal, therefore, assets that are merely quoted in the unit of currency and promise to pay no amount of fixed currency – such as shares, houses, precious metals, and so on – will fall in value. However, assets that are denominated in the unit of currency and promise to pay a fixed number of dollars, euros or whatever – such as bonds and debt instruments – will not lose value. Governments and banks, having benefited from borrowing cheap, printed money, used it to purchase assets that are mostly dollar quoted while their liabilities are dollar denominated2. Hence, a deflation would cripple the prices of the government’s or a bank’s assets while leaving its liabilities untouched. Hence not only large banks but entire states would be obliterated by bankruptcy. Clearly the political-banker elite cannot permit this to happen. The need for constant inflation is not, therefore, something that is necessary for economic growth and the wellbeing of the general public. Rather, it is necessitated by the asset-liability mix brought about by previous inflation which would threaten the existence of large, establishment institutions if it was to reverse. They need more cheap money, more theft of your purchasing power, in order to keep their assets rising and their liabilities from doing the same. The deflation myth, therefore, is nothing more than a part of the big statist fraud, benefitting a select few and the expense of everybody else.

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1Although the failure to overcome this was not from want of trying – see Murray Rothbard, America’s Great Depression, Part III, where he argues that the deflation was the result of factors that negated the inflationary response of the government and the Federal Reserve.

2Although mortgages, which were a heavy factor in the 2008 financial crisis, are dollar denominated, the security behind the loan – the amount the lender will receive in the event that the borrower can no longer pay – is the house that the mortgage has been used to purchase. This asset is merely dollar quoted and hence during a deflation the value of the security of a bad mortgage will dissipate and with it any chance of recovery at par for the mortgagee.

Disability and the Free Market

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Whenever faced with the opportunity to explain the benefits of the unfettered free market, the libertarian will often find himself cross-examined and required to explain how a political economic system of liberty will handle various societal ills and issues. One of these issues is disability and how disabled persons, inflicted with some kind of impairment that is (usually) no fault of their own, will be able to sustain a quality of life comparable to that of non-disabled persons. For the sake of brevity we will explore this issue here in relation to physical disabilities rather than mental.

The statist solution to disability is, typically, nothing short of rank egalitarianism. First of all, one must define a hypothetically “typical” able-bodied human being and the characteristics of that person. Anyone who does not meet this standard through either the absence of tissue (such as an arm or an organ) or damage to the same that impairs functionality to a significant degree is considered to be “disabled”. The state’s response to this, in addition to disability benefits funded by the taxpayer, is to forcibly require private providers of goods and societies to maintain equality of access for disabled citizens, including the installation of ramps, lifts, disabled spaces on transportation facilities, and so on. Tackling disability, therefore, is a plank of social justice, of redistribution not from the financially rich to the financially poor but from the physically wealthy to the physically deprived. Just like any other arm of the welfare state, one set of people is forced to fund remedies to problems that are borne by another so that the cost of disability is shifted from the disabled to the able-bodied.

A preliminary problem with this approach is defining precisely when a person will be considered to be “disabled” and which characteristics we are examining when we make such a definition. At the extreme, few people can run as close to as fast as Usain Bolt. Should we not consider Bolt and those of his calibre as able-bodied and the rest of us disabled? If Superman appeared on Earth today, wouldn’t we all appear to be chronically crippled in comparison? Shouldn’t Bolt or Superman be required to fund the rest of us with disability benefits? Clearly this would be ridiculous but when we attempt to make a similar judgment against the “typical” human being we see that we all have varying physical strengths and weaknesses compared to other people that make us either more or less suitable to certain pursuits. Indeed the very reason why we have the division of labour is because of these varying qualities, with weaknesses regarded simply as differences rather than disabilities. At what point does a weakness become a disability? While it may be possible in common parlance to state that a man without an arm is “disabled” whereas a person who has a fully functioning arm is “able-bodied”, determining a clear legal definition of disability for cases in between these two extremes will require at least a degree of arbitrariness. What, for example, should we make of a person who has an arm but cannot extend it fully in a particular direction? And if we are talking about typical characteristics, females are generally physically weaker than males – should we regard all females as “disabled” with all males required to subsidise them with disability benefits? Furthermore, simply because a person is disabled in one way does not rule out the possibility that he may excel beyond the capabilities of his able-bodied brethren in another that, in his eyes, more than makes up for any loss of functionality caused by the disability. What is also clear is that, for the most part, we have to consider a not only a “typical human” but also a “typical disability”. While any disability is capable of being “compensated” by tax-payer funded benefits, when it comes to forcing equality of access only disabilities suffered by a small but significant percentage of the population can be considered. The reason why there may be ramps and wide car park spacing for wheelchair users is because wheelchair users form such a minority. If, however, an individual suffered from a really unusual disability that could only be met through special accommodation unique to him is it likely that all businesses and public spaces in the entire country would be forced to cater for this? As with all statist solutions that lead to redistribution, defining the deserving beneficiary will always be haphazard, encompassing some of those whose ailment is little more than a minor irritation while leaving out in the cold those with significantly impacting impairments.

Leaving this consideration aside, however, and taking it as a given that we can define someone as “disabled”, the libertarian response to the statist solution must be that, however awful and debilitating one’s disability, no one possesses the right to shift the cost or the burden of that disability to another individual. Although it may not be the fault of a disabled person that he possesses a disability, neither is it the fault of anybody else and hence there can be no entitlement, enforced by the violent imposition of the state, to have other people fund a remedy or compensation. It will be the case, therefore, that disabled individuals may command lower earning power in the marketplace simply because their productivity is lower. However, this is no different from the fact that a slightly weaker man may have lower earning power than a slightly stronger man in the market for physical work; the difference between the slightly weaker man’s earning power and the disabled man’s earning power is one of degree rather than of kind. Why should the individual with the greater impairment acquire an entitlement to compensation whereas the individual with a lesser one must shoulder the burden alone? In any case, however, a physical disability does not automatically mean that a disabled individual can command lower earning power – if his mental faculties are intact then his productivity in mental tasks may exceed that of the physically able-bodied in physical tasks. Furthermore, a disabled person has no right to enforce private providers of goods and services to provide some kind of equal access to those goods and services – such as the installation of ramps, lifts, wide car parking spaces, etc. Precisely how much access a private provider grants to his goods and services is dependent upon whether the cost of doing so is less than the resulting revenue. Such questions are very broad as well as very narrow. Should, for example, the supplier set up a bricks and mortar store? If so, where should this store be sited? Should the supplier set up a website? Or would sales be maximised by sending individual salesmen round to every door with the very products in hand, ready for the purchasers there and then? All of these are questions of access. If a minority of customers with disabilities are significant enough to make increased access profitable then it will be provided, otherwise resources are diverted from ends which are more urgently desired by consumers. It is important to realise in this regard that shops, bars, restaurants and so on are not “public” premises; they are privately owned premises into which members of the public are invited to conduct trade. It is the owner’s prerogative which members of the public whom he chooses to serve – he cannot be forced to associate or disassociate with any particular customer, regardless of race, creed, or physical ability.

What, then, would be the position of disabled persons in the unhampered free market? Where a person’s earning power is markedly lower as a result of a disability, or where “access” is impeded by the same, we could suggest that private charity would exist to ameliorate the situation – something that is more likely in an economy where people are allowed to keep more of their money. Such charities could, for example, provide disability benefits to those who are disabled and fund the installation of facilities that improve accessibility. However, the essential difference between the free market and the welfare state is that the latter, in all of its guises, is preoccupied only with wealth distribution whereas the free market is the powerhouse of wealth creation. In the first place, it is only because capitalism and the free market has generated so much wealth that the existence of disabled persons in society can be funded. In impoverished past times, if a person could not work or only worked to a lesser ability than the able-bodied he may simply have starved to death, if he was not actively killed beforehand for being a burden on everyone else. Our advance in this regard is solely because even the lesser productivity of the physically disabled is, in the free market, able to afford them a comfortable standard of living, something that would continue along with increased wealth creation. Capital invested on behalf of the able-bodied is also capital invested on behalf of the disabled and the productivity of both is improved with economic growth. Second, it is not true that there would be no redistributive remedy under the free market. The whole purpose of insurance, for example, is to provide compensation for those catastrophic, but unlikely events that are no fault of the victim. Where physical disabilities are present from birth, for example, prospective parents could purchase medical insurance that will promise a certain pay out in the unfortunate event that their baby is born with a disability, compensating them for the additional costs of care and raising a disabled child. Similarly, insurance would cover the incidence of faultless accidents which leave you with a disability. It is of course the prerogative of each individual to purchase such insurance and it is entirely up to him whether he wishes to run the risk of being unfunded after an accident. But this is his choice and such a person cannot be forced to put his money towards an end that he does not deem suitably urgent enough for fulfilment. If, however, you do believe this is a valuable end then you will not left high and dry with the only option to die following an accident simply because the state is not there to lend you a crutch. Third, redistribution by the state to remedy a certain ill completely distorts the incentives that lead towards the occurrence of that ill. If one knows that a disability will be compensated by the state then, quite simply, it reduces the cost of being disabled. Disability with state compensation is relatively a more attractive proposition that disability with no such compensation. Therefore whatever steps could be taken by persons to reduce the incidence of disability will be taken to a lesser degree. Given that ability and disability is intricately linked to a person’s health overall, people will be less careful with their health; they will take more risks with their bodies; they will be involved in more accidents; indeed, even obesity is now, according to the European Court of Justice as of last month, defined as a disability – would anyone doubt that the level of obesity would be as high as it is without government funded healthcare programmes? Moreover, there will be less of an incentive for couples who possess a genetic risk of passing on a disability to a child to avoid giving birth to disabled children. There will, therefore, be more disabled children born. In short, if you confer upon people a right to be paid when they are disabled, you will, all else being equal, have more disability. Fourth, such distorted incentives also perpetuate the accommodation or compensation of physical disabilities ahead of attempting to find long term solutions that would result in their eradication. If the burden of disability is reduced it also reduces the impetus to find a cure. Disability is simply put up with instead of solved. With the free market, however, as the division of labour widens and more capital is accumulated it affords the wealth not only to increase specialist outlets and solutions that may cater specifically for disabled persons, but also it makes possible increased research and development into long term cures for physical disabilities. Imagine if a person without legs could grow new ones, or if a person who is deaf could resolve the problem simply by swallowing a pill? A truly wonderful world is not one where everybody is forced to compensate and accommodate disabled persons; it is one where we have the wealth and technology so that, to quote the prophet Isaiah, “the eyes of the blind shall be opened, and the ears of the deaf unstopped…the lame man leap as an hart, and the tongue of the dumb shall sing”. This is not to imply that there will be no attempt at achieving cures for disability under statist regimes; but with retarded wealth creation and distorted incentives the desire towards and capability of achieving it is greatly diminished. Moreover, with the free market, the point at which a person’s disability is considered a problem worth spending money finding a solution for is determined by disabled individuals and not the arbitrary decrees of the state. Let us therefore banish the statist accommodation and compensation of disability and unshackle the free market so that disabled persons, like everyone else, may enjoy not only an increased standard of living but the possibility of a complete cure for their afflictions.

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