Clear, Simple and Wrong

The reason opinions are so cheap is that everyone has one and nobody wants to buy anyone else’s. I’m no different.

I’m not going to try to sell you mine. I would like to present you with some ideas to think about before you overpay for someone else’s though.

Jon commented on a recent post of mine and, guessing I’d be interested, directed me to a fascinating opinion piece by Mark Gilbert on Bloomberg covering a range of current economic issues. I suggest you read it now. It’s ok, I’ll wait.

Right, some pretty compelling points are made there. I disagree with many of them, but they are pretty compelling at first read. Here’s my rebuttal to those I’ve heard discussed most commonly in recent times (typically with head nodding all around).

Gold is not the answer to all our currency problems

All of a sudden it’s popular to talk about how fiat currencies are not worth the paper they’re printed on, how it’s a scam, how we’d be better off with a metal-backed currency. They’re wrong. This is a complex area so I’ll only touch on the points rather than try to explain each of them in detail.

Broken promises and speculator spectacles

A metal-backed currency is only as good as the government’s promise to stick to the standard. History shows this promise has been broken regularly. By attempting to stick to a standard, it’s like waving a red, pheromone-doused flag to an amorous bull (a.k.a. currency speculators. The Bank of England was hit by this in the 1930s and again, albeit with a different kind of peg, in the early 1990s by Soros).

Shackling monetary policy can cause recessions

The gold standard contributed to the Great Depression through the restrictions on monetary policy and the enforced coordination of monetary policy around the world. (Research it, even Milton Friedman, often brought into these conversations as a support of these views on inflation, understands how the gold standard exacerbated the Great Depression.) The liquidity trap that Paul Krugman fears we may be entering is the same as a fundamental cause of the Great Depression. Ben Bernanke understands this only too well, as his speech from 2004 shows (read the whole thing, it’s worth it). The hikes in interest rates that happened around the world at different times of the Great Depression were responses to pressure on the gold standard. Imagine increasing interest rates with deflationary prices and plummeting employment and GDP?

Deflation and liquidity traps

With a gold standard, the world’s money supply is dictated by the supply of gold. This has two important impacts. Firstly, it’s like that the price of gold would need to increase sharply in order to be used internationally as a currency with all the economic havoc and redistribution that would follow. Secondly, since the expansion in the money supply would relate to the speed at which we can get it out of the ground, we would most likely have persistent deflation with prices decreasing over time. Deflation is toxic to the economy as it encourages people to sit on their money rather than spend or invest it elsewhere. Why spend your money today when it will be worth more tomorrow, just sitting under your mattress.

To be very clear, the gold standard is not the answer to our problems.

Treasury bills were never the right asset for a pensioner to be invested in

If you retire at age 65 today, you should still have a significant portion of your wealth in risky, inflation beating instruments such as equities and property. Throw some index-linked bonds into the mix to reduce the risk profile, and an amount in fixed interest instruments and cash to provide income and decrease risk in the short term. You’re going to be living for 20 to 35 more years, it’s not time to be invested in zero-risk-guaranteed-not-to-keep-pace-with inflation T-Bills.

Pension funds will be just fine if the correct political decisions are taken around retirement age

Yes, life expectancy is up. Yes, fertility is down and the populations of developed countries are ageing. This doesn’t automatically mean that social security is bankrupt. Increase in life expectancy has brought with it the ability to work productively way past normal retirement age in some countries of 60 to 65.

In Greece, some employees can reach “normal retirement age” with full benefits at age 50 for women and 55 for men. Apart from the astonishingly young age of retirement, on what planet does it make sense for women to retire before men given that they will outlive men on average?

The average retirement age in Greece is 61, the lowest in Europe. So state pension in Greece are problematic because of daft (but politically popular) decisions around retirement age. This has nothing to do with monetary policy, gold or the global credit crisis. This reflects bad decisions made every year for the past couple decades.

There are other sensitive political decisions that need to be understood around ownership of assets. The ageing populations of the developed countries have accumulated enormous wealth. They will need to sell these assets to pay for goods

Stimulus and Keynesianism are only inflationary when the economy is near full employment

Everyone is concerned about inflation it seems.  Well, everyone except those putting their money with their collectives mouths are.  Bond yields, even long-bond yields, are down sharply. Investors are stashing money away for 10 years at less than 3%. Not exactly a sign of hyperinflation coming around is it?

Why is this, with low interest rates, quantitative easing and central banks doing (ok, stopped now with short-sighted austerity measures) everything in their power to increase the money supply?

The money supply is created in part by central banks but in much larger part by commercial and retail banks through lending. Lending has dried up massively since 2008, with a result massive decrease in liquidity available to the economy. Private borrowing has disappeared, almost but not quite entirely replaced by government borrowing. With high unemployment, there is no pressure to increase prices when production volumes can so easily be increased without straining factors of production.

This is the very widely accepted position of Keynesianism with Aggregate Demand far away from Aggregate Supply. These models are also still working, but some have chosen to ignore them now because they don’t feel right.

Inflation measures aren’t lies because you don’t like the numbers

Inflation, typically measured through the chain-linked change in price of a basket of goods defined in some way, is low everywhere. In spite of low interest rates and the crows crowing about inflation fears, inflation is low.

I recall a true story told during our previous low inflation cycle. A lady (I think she was old, but I don’t see that it matters except for age-inspired gumption) somehow got hold Sean Summers at Pick n Pay. I don’t know whether she had his number on speed dial or whether she knew someone who knew someone, or whether her query was passed through to him internally. She was complaining that although the government said inflation was so low, the prices of the goods she purchased had been going up at a much faster rate. Sean (or one of his underlings) called up her purchase history going back a few years (linked to a credit card number I believe – fantastic data resources these clued-up retailers have…) and showed her that the inflation she was personally experiencing was actually below of  overall Consumer Price Inflation.

There is a huge difference between what we feel and what we experience through our human interactions with the world and what the hard, measurable reality is when the numbers are crunched. This goes to the same point about bond yields I mentioned previously.

Where does that leave us?

I don’t pretend to have convinced you with this drag-race through some fundamental economic issues. If I’ve persuaded you that maybe there is more to these issues than the charismatic gut feel story and encourage you to reader further, well I consider that a success.

I’ll finish with an excerpt from that same speech by Ben Bernanke covering the Great Depression and the role of monetary policy and the gold standard:

Some important lessons emerge from the story. One lesson is that ideas are critical. The gold standard orthodoxy, the adherence of some Federal Reserve policymakers to the liquidationist thesis, and the incorrect view that low nominal interest rates necessarily signaled monetary ease, all led policymakers astray, with disastrous consequences. We should not underestimate the need for careful research and analysis in guiding policy.

Today, more than ever, we seem to be in need or careful research and analysis to save us from the hell that is waiting for us if we follow  ideas that are compelling, dangerous and wrong.

One last quote:

For every complex problem there is an answer that is clear, simple, and wrong.
H. L. Mencken

Published by David Kirk

The opinions expressed on this site are those of the author and other commenters and are not necessarily those of his employer or any other organisation. David Kirk runs Milliman’s actuarial consulting practice in Africa. He is an actuary and is the creator of New Business Margin on Revenue. He specialises in risk and capital management, regulatory change and insurance strategy . He also has extensive experience in embedded value reporting, insurance-related IFRS and share option valuation.

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