Economic Aspects of the Pension Problem – Part 2

Appears Sixty Years Later

Part Two: Productivity Theory of Interest Revisited

Antal E. Fekete

In Part One I discussed the clear and present danger to pension rights: deflation as manifested by the interest rates structure that has been falling for thirty years, while most observers think that the real danger is inflation. In this second part I carry out a deeper analysis of the pension problem, looking at the marginal productivity of labor and capital and its relevance to the theory of interest.

Courtesy of Professor Fekete @ Professor Fekete.com:

Higher marginal productivity: boon or bane?

There is a lot of loose talk about productivity. Paul Krugman is expecting miracles to start happening after an increase in a mythical productivity, provided that government spending is increased to the level matching or exceeding that during World War II.

However, as Mises pointed out, productivity is a vacuous concept unless its meaning is fixed, such as that of marginal productivity of labor. Then, and only then, can one state the pension problem. According to Mises, the only means to increase permanently the wages and benefits payable to workers is to increase the per capita quota of capital invested in the methods of production, thereby raising the marginal productivity of labor. (See References, Planning for Freedom, p 6.) This is certainly true so far as it goes. It is also true that, if we project this observation to the world at large, then we can conclude that in order to have a progressive world economy and receding poverty, global capital accumulation must accelerate relative to increase in population. The greater the quantity and the better the quality of tools, the greater will be the output of the marginal worker, that is, the greater will be the marginal productivity of labor.

In reading Mises one may get the impression that an increase in marginal productivity is always beneficial to society ― as indeed it would have been under the conditions he envisaged. However, in the case of a monetary system that admits both large swings and prolonged slides in interest rates, this is no longer true. If the matter were simply increasing marginal productivity, monetary policy would be a valid means of “turning the stone into bread”. All it would take is central bank action to keep raising the rate of interest indefinitely. This would force the marginal producer whose capital produces at the marginal rate of productivity to fold tent. His marginal equipment and plants would be idled. His workers producing, as they are, at the marginal rate of productivity of labor would be laid off. Marginal productivity would increase. Indeed, the marginal productivity of both capital and labor automatically rises as a consequence of a rise in the rate of interest. However, in this case the rise in productivity, far from being a boon, is a bane to society, as it makes output and employment shrink. The trick is precisely to make marginal productivity rise along with rising output and employment.

Gold standard: a safeguard against deflation

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Economic Aspects of the Pension Problem – Part 1

As It Appears Sixty Years Later

Part One: Euthanasia of the Pension Funds

Antal E. Fekete

Sixty years ago. in 1950, Ludwig von Mises published an article with the above title. He pointed to inflation as the greatest threat to pension rights. Today an additional threat is looming large on the horizon: the threat of deflation, and a new examination of the pension problem is timely.

Courtesy of Antal E. Fekete @ ProfessorFekete.com:

Deliberate Dollar Debasement

In 1950 Mises looked at the pension problem from the point of view of the shrinking purchasing power of the dollar, a consequence of what he called the deliberate policy of currency debasement by the U.S. government. In 1950 a pension of $100 per month was a substantial allowance, he noted. Shelter could be rented for a month for less than $30 in most parts of the country. (In 2010, $100 hardly buys one night’s stay at a decent hotel.) In 1950 the Welfare Commissioner of the City of New York reported that 52 cents would buy all the food a person needed to meet his daily caloric and protein requirements. (In 2010, $100 barely buys a cup of coffee and a muffin for every day of the month.)

Of course, currency debasement does far more damage than simply eroding the purchasing power of pensions. As Mises observed, it also leads to the insufficiency of capital accumulation. Companies report phantom profits that mask losses, since depreciation quotas understate the wear and tear of productive equipment. Savings are hardly adequate to pay for capital maintenance, let alone new capital or technological improvements in production — the only source from which pensions to an increasing labor force can be paid. When young workers who now join the labor force are ready to retire, the necessary funds to pay their pensions will simply not be available.

Capital destruction due to declining interest rates

I have written extensively about the proposition, one that mainstream economists doggedly refuse to discuss, that a falling interest-rate structure has a deleterious effect on accumulated capital. Capital is destroyed across the board simultaneously and stealthily. By the time the damage is discovered, it is too late to do anything about it and firms go bankrupt in droves. The falling trend of interest rates is the unrecognized cause of the depression that is presently devastating the world economy — just as it also was 80 years ago. Nowhere is the erosion of capital caused by falling interest rates is more obvious than in the case of the capital of the pension funds. They must earn adequate return on their investments, but a falling rate of interest frustrates this effort. At the lower rate the original schedule of capital accumulation cannot be met. Continue reading

Physical Gold Shortage Worst In Over A Decade: GOFO Most Negative Since 2001

Courtesy of The Hedge:

The last time there was an systemic physical gold shortage was in July 2013. It is then that, for the first time in 5 years, the 1-month Gold forward offered rate, or GOFO, went negative. We said:

Today, something happened that has not happened since the Lehman collapse: the 1 Month Gold Forward Offered (GOFO) rate turned negative, from 0.015% to -0.065%, for the first time in nearly 5 years, or technically since just after the Lehman bankruptcy precipitated AIG bailout in November 2011. And if one looks at the 3 Month GOFO, which also turned shockingly negative overnight from 0.05% to -0.03%, one has to go back all the way to the 1999 Washington Agreement on gold, to find the last time that particular GOFO rate was negative.

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Fast forward to today, when as noted over the past week there has been a massive shortage of precious metals – most notably silver which as of this moment is indefinitely unavailable at the US Mint – as a result of the tumble in the paper price, and following 8 days of sliding and negative 1 month GOFO rates, today the physical metal shortage surged, as can be seen by not only the first negative 6 month GOFO rate since last summer’s much publicized gold shortage when China was gobbling up every piece of shiny yellow rock available for sale, but a 1 month GOFO of -0.1850%: the most negative it has been since 2001! Continue reading

Economic Entropy

DEDICATED TO THE MEMORY OF FERDINAND LIPS WHO ARDENTLY ADVOCATED THE PRESERVATION OF KNOWLEDGE HOW TO RUN A GOLD STANDARD SO THAT IT CAN BE PASSED ON TO FUTURE GENERATIONS

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Courtesy of Professor Antal E Fekete @ NASOE.org:

Social Circulating Capital

When does a river cease to be a river? At the moment it gets within sight of the sea. As the river is descending to sea level significant and conspicuous changes occur. The salinity of the water increases sharply and, with it, the ecology changes. Water molecules lose their potential energy and their kinetic energy is converted to entropy.

Similarly, the flow of myriad goods from producer to market also undergoes a remarkable metamorphosis when it gets within sight of the consumer. Adam Smith was the first to notice this interesting phenomenon. He formulated the concept of social circulating capital. By this he meant the mass of finished or semi-finished consumer goods which has reached sufficient proximity and is moving sufficiently fast to the ultimate cash-paying consumer so that its destiny of being consumed presently can no longer be in doubt.

The analogy between the flow of goods to the final consumer and the river emptying into the ocean can be profitably extended to include economic entropy. The risks and uncertainties, so characteristic of processing in the earlier stages of production, all but disappear by the time the maturing goods become part and parcel of social circulating capital and sale at the going price can be taken for granted. Speculation and other forms of risk-taking give way to the highly predictable automatic processes of distribution. In particular, established retail prices do not normally change in response to changes in demand because of the increase in economic entropy, measuring the reduction of uncertainty and risk.

Liquidity

The vanishing of uncertainty and risk, the emergence of social circulating capital, and increase in economic entropy are manifested in a most dramatic fashion through the appearance of liquidity. To Adam Smith liquidity was tantamount to the spontaneous circulation of real bills that he observed in Manchester and Lancashire\. It refers to the qualitative difference between goods carried by the trade at virtually no risk in anticipation of sale to the final consumer at established prices, and other goods carried at considerable risk in anticipation of an eventual appreciation in value. Continue reading

ECON 101 LECTURE 1

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Courtesy of Professor Fekete @ New Austrian.org:

Inaugural Lecture

AYN RAND’S HYMN TO MONEY

July 1, 2002

– Gold Money Is the Root of All Good; Paper Money Is the Root of All Evil –

– A Blueprint for a New Gold Coin Standard –

Millions of people who have read Ayn Rand’s 1957 monumental work “Atlas Shrugged” must have been impressed by an insert that could be entitled “Hymn to Money”. This insert is buried in the 1600 pages of the novel and is difficult to find. However, it is a self-contained literary masterpiece in its own right. For these reasons it may be a good idea to publish it separately.

Some remarks may be in order. Ayn Rand uses the word “money” in the sense of gold money. This may not be in line with current usage, but it is certainly correct etymologically. The English word “money” is derived from the Latin moneta, meaning”forewarner”, epithet of the goddess Juno. Her temple on the Roman Capitolium doubled as the Mint where the gold and silver coins of Rome were struck.

According to legend, during the siege of Rome by the Gauls, the sacred geese of Juno that lived around the temple forewarned the Romans with their loud cackling of the surprise attack the enemy has mounted. Under the cover of the night, the Gauls tried to scale the cliffs just below, thought to be an unassailable point of the Capitolium. The Romans, forewarned, could successfully repel the attack. In gratitude, they honored the goddess calling her Juno Moneta, or “Juno the Forewarner”. And Rome went on to great things.

Irredeemable currency, in Ayn Rand’s words “a counterfeit pile of paper”, the output of the paper mill in Manhattan, does not deserve to be called “money”. At any rate, you have been forewarned, and should be prepared for the attack of looters on your Capitol, already in progress.

We still don’t know whether the 911 forewarning of Juno Moneta about the approaching collapse of society has been in vain or, perhaps, there is enough moral rectitude left in America’s political and economic leadership to denounce globalization, and open the Mint to gold, in order to avert the coming tragedy.

Hymn to Money Ayn Rand

Must Give Value for Value

So you think that money is the root of all evil. Have you ever asked what is the root of money? Money is a tool of exchange, which can’t exist unless there are goods produced, and there are men able to produce them. Money is the material shape of the principle that men who wish to deal with one another must do so by trade, and give value for value. Money is not the tool of the moochers, who claim your product by tears, or of the looters, who take it from you by force. Money is made possible only by men who produce. Is this what you consider evil?

When you accept money in payment for your effort, you do so on the conviction that you will be able to exchange it for the products of the effort of others. It is neither the moochers nor the looters who give value to money. Neither an ocean of tears nor all the guns in the world can transform those pieces of paper in your wallet into bread you will need to survive tomorrow. Those pieces of paper, which should really be gold, are a token of honor – your claim upon the energy of the men who produce. Your wallet is your statement of hope that somewhere in the world around you there are men who will not default on the moral principle that is the root of money. Is this what you consider evil? Continue reading

The Wisdom of Adam Smith for our Own Times

Courtesy of Professor Antal E. Fekete @ Professor Fekete.com:

─ A Rejoinder ─

Let us celebrate the 291st birthday of the great Scottish economist together and let us rehabilitate his Real Bills Doctrine!

Antal E. Fekete

New Austrian School of Economics

Richard Ebeling in the June 3rd issue of the Daily Bell under the same title contributed a much needed reminder of the relevance of Adam Smith’s wisdom to our contemporary world. I am not going to speculate whether the omission of not mentioning Adam Smith’s Real Bills Doctrine was accidental or deliberate. However, it is well known that post-Mises Austrian economists have taken a disdainful view of the Real Bills Doctrine and it would have been nice to have Ebeling’s coherent articulation of their position. I can do no better than revisiting Adam Smith’s great contribution to the theory of money and credit (which, significantly, received the nihil obstat of Carl Menger a hundred years later) for the benefit of the Daily Bell’s readership.

Consumption as a source of credit

Adam Smith’s insight that consumption, next to savings, is another fundamental source of credit was one of the great discoveries of economics, comparable in importance to Carl Menger’s subsequent discovery of marginal utility as the source of value. We owe the concept of social circulating capital (SCC) to Adam Smith. By this he meant that part of the flow of consumer goods in most urgent demand that is moving sufficiently fast to the ultimate consumer so that it will be removed from the market in 91 days (the length of the seasons of the year in our temperate zone). For example, items like bread, seasonal garments and firewood in winter will unquestionably be consumed in definite quantities and do thus belong to SCC; items like grain held for speculative gains, unsold garments left over from the previous season and firewood in summer do not. Producers and distributors handling goods that form part of the SCC enjoy special privileges and have special responsibilities due to the special place their product occupies in the constellation of economic goods. They don’t have to face uncertainties and don’t have to carry risks all other producers and distributors have to face and carry. They do not finance their production under the relatively harsh terms of the interest-rate regime. They can finance it under the relatively more lenient terms of the discount-rate regime.

SCC has been compared to a great river that empties into the infinite ocean of consumption. The salinity of water undergoes important changes downstream as the river gets within earshot of the ocean. Fish habitat prospering in these waters changes. Similarly, important changes occur in the type of credit financing production and distribution of goods downstream as the ultimate consumer is getting ready to remove them from the market in less than 91 days. In particular, the gold coin need not be saved in advance of production. Financing is done retroactively with the gold coin released by the ultimate consumer. Continue reading

The Deflation Nobody Understands

Courtesy of Peter van Coppenolle @ NASOE:

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(But they will experience it first hand)

Professor Fekete has been studying and teaching the gold standard for over 40 years now. Unlike most ‘pundits’ Fekete has held a seat at the Winnipeg Commodities Exchange in order to study the gold market from every angle possible. And studying he has done so relentlessly since immigrating to Canada in 1957. He has used all his powers to educate people about gold. Part of that effort was to groom a ‘hard core’ which now, 2013, constitutes the faculty at the New Austrian School of Economics. Over the years we at the faculty have experienced the rewards that only educators can testify to: the joy when other people finally see some light. And sometimes we encounter detractors too. They are an amusing lot, put there for our entertainment, no doubt.

Professor Fekete, dissatisfied with the body of knowledge on economics, has been a writer and above all a supreme philosopher of economics. Ever since 1957, he has amassed so much old and new knowledge, that we at the faculty of NASoE have quipped that ‘if you want to understand nothing at all about the gold standard, you will have to read B. Goldwater.’ We know that is one offensive statement. But we also stand by our own insights, research and above all methodology, which is a Mengerian disequilibrium approach. Using a good compass does make a difference. The world collectively knows that traditional ‘economics science’ is (expletive) dismal, which is stronger than just ‘dismal’. It has reached the stage were this economic discipline’s own academics are mudslinging each other or hubristically refer to themselves as invincible. (E.g. Krugtron the Invincible, a neoplasm born from a bad ’80 movie.) Or in the Austrian camp, the same old boom and bust line is repeated, yet zero research has taken place, until now, either to correct for some untenable assumptions in the Austrian Business Cycle or to advance knowledge on some other aspect of credit collapse. Nor do they bother to dismiss the Quantity Theory of Money, according to which the more money is brought into circulation, the higher prices will go. “More money chasing fewer goods”, etc..

The question described in the title is the one people least understand. Perhaps I am too harsh. People who never attended or never listened to standard economics, have no problems assimilating my message. It becomes harder to grasp for those afflicted with the idea that inflation and deflation are mutually exclusive. They are not, puzzled looks and hurled insults notwithstanding. The term “hyper-deflation” was never coined nor did such a state ever occur in history and it full scope is unknown as yet. But using Mengerian disequilibrium and Aristotelian logic, I can paint the general idea.

Professor Fekete never subscribed to what he called the Quantity Theory of Money. It suffices to point to the very fact that it is possible to have a shortage of money simultaneously with the overworking of the printing presses. The reason why the QTM fails is that money is not one-dimensional. It is in fact two-dimensional. Quantity is one, and the velocity of circulation is the other dimension. Central banks control the quantity of production and the market firmly controls the circulation speed. Continue reading