Government Money, Taxes, and War

Struggle for Empire: Kingship and Conflict Under Louis the German, 817 – 876, by Eric J. Goldberg.

One key source of income for Louis the German was the collection of tribute – for example, collected from the Danes and various Slavic people.  I find this of little noteworthy interest in and of itself; what is noteworthy is the amount – and what that amount represented:

…Louis could demand some 335 pounds of silver annually from the Slavs and the Danes….Of course, frequent rebellions made it likely that Louis often received only half the owed tribute in a given year.  Nevertheless, the estimate suggests an annual income of some 170 pounds of silver.

Call it $55,000 at today’s price of silver (I am not going to get into pure silver per ounce, troy or otherwise, etc.).

To put the sum in perspective, this amount was enough wealth for the king to reward sixty-eight young noblemen with a complete set of military equipment – a horse, coat of armor, helmet, sword, shield, and spear – every year.

This is about $800 per young nobleman.

I can think of a dozen points that must be examined before I feel I fully understand the meaning of this calculation; I do not intend to examine any of these points.  Instead, I offer two observations:

First, the total sum collected from the entirety of Louis’ non-Saxon tributes is $55,000 in today’s value of silver.  That’s it.

Second, the fighting men of Louis’ time required only $800 worth of equipment to turn them into the most destructive fighting force of Europe at the time.

Times have certainly changed, on both points.

Professor Fekete at The Daily Bell

Professor Fekete: The Rothbardian and Misesian prognostications are rooted in the Quantity Theory of Money (QTM), according to which, if it were correct, we would have inflation instead of deflation following the miraculous proliferation of money, credit and debt.

BM: Two thoughts.  First, there is inflation – using the professor’s own definition (and I will come to this shortly).  Second, the professor seems to be describing only one side of the QTM equation and then attributing this definition to the Austrians associated with Mises and Rothbard. 

Hans Hoppe defines the quantity theory of money: “whenever the quantity of money is increased while the demand for money to be held in cash reserve on hand is unchanged, the purchasing power of money will fall.”

Hoppe has read and studied far more Mises and Rothbard than I have, so I will take his word for this.  In any case, this more complete definition by Hoppe seems reasonable.

Professor Fekete: I recognize only one kind of deflation, namely the deflation of assets.

BM: It is interesting; the professor defines “deflation” in the price of assets.  Would it not follow that he would define “inflation” the same way, in the price of assets?  Yet he does not recognize today’s asset price inflation as inflation – see his quote at the top of my comment.

Using Fekete’s own definitions, Mises and Rothbard are correct, yet the professor chides them for this.

But why is there an expectation of a deflation of assets?  It can only be due to an artificially induced and maintained inflation in assets.  And why would this be?  Might it have something to do with the quantity theory of money and where / how that quantity was deployed?

Professor Fekete: A gold standard cum real bills is the right medicine to the moribund world economy.

BM: Unless it is advocacy for the free market, I get nervous when someone proclaims “the right medicine” for economic ills (aren’t we operating under the “professorial standard” today?) although I find no reason to disagree with “a gold standard cum real bills” as a possibility in a market of freely developed and accepted money and credit instruments.

A Weak Currency is Good for the Economy…Not!

Volume 2,475,623.  (Not really, but...well, you know.)

Apparently corporate bankruptcies are up in Japan; the bankrupt companies blame the weak yen:

Corporate bankruptcies linked to the yen’s slide hit a new record in November, highlighting the strains on small and midsize companies…

Small and midsize companies – no mention of large companies?

While some small firms are struggling to pass on higher costs of imported materials to customers, large exporters are reporting higher profits…

So the big guys are doing OK.

Forty-two of the companies that failed in November cited the weakened currency as a contributing cause, bringing total bankruptcies associated with the yen so far this year to 301, almost triple that of the same period in 2013…

Triple.  Ambrose Evans-Pritchard, are you paying any attention?

The story goes that a weak currency is good for exports.  Lower labor costs and all that.  But what about all of the stuff that needs to be purchased – at global prices – in order to thereafter produce?

It said surging costs of imported food, metals and construction materials are squeezing small companies.

Yes, that is my point.  Once inventory acquired by the stronger currency unit is depleted, it must be replenished via the purchasing power of a weaker currency unit. 

But at least the labor is cheaper – this has to help exports on net, doesn’t it?  I guess you might make a case that it helps exporters of products with a high labor content and a low bill-of-material content – in other words, exporters based in countries with un-developed and low division-of-labor economies (but even here, I doubt it) – for sure not Japan (or the US, or the EU, or the UK, etc.).

Besides the large exporters benefitting with increased exports, consider that a weak currency policy also wipes out the competition for the home market; take out the small and medium sized suppliers, and guess what happens?

Three constituencies benefit, at least to some extent, from a weak currency policy – and even these three are, to a good degree, overlapping:

1)      Large exporters

2)      Multi-nationals

3)      Executives with financial-performance based compensation (options / equity / bonuses)

I have touched on the benefit to the large exporters.  What of the multi-nationals?  Such companies have aligned production more-or-less with the location of sales – in other words, they have neutralized currency fluctuations naturally.  While this may not be a benefit, it certainly minimizes the cost.  How many small to medium sized businesses are structured in a similar manner?

Finally, the executives: large exporters and multi-nationals based in Japan report their revenue earnings in Yen.  For the large exporter, this results in an increase in reported results even if actual performance doesn’t change a bit.  For the multi-national, producing and selling in several jurisdictions world-wide, the result is similar.

For the small- to mid-sized company?  All they see is higher prices for their purchases.  For the average citizen, the same thing.  To say nothing of the value of savings being diminished.

Once again, policies developed for the connected at the expense of most of the rest of us.

The QE Will Continue Until Inflation Improves

Ambrose Evans-Pritchard has nailed this one, hit it out of the park.  I am not kidding.  He has written a piece entitled “World economy so damaged it may need permanent QE.” 

Combined tightening by the United States and China has done its worst. Global liquidity is evaporating.

What looked liked [sic] a gentle tap on the brakes by the two monetary superpowers has proved too much for a fragile world economy, still locked in "secular stagnation".

I don’t want to get into a debate about the concept of “tightening”; I accept that to people like AEP a slowing of monetary pumping is the same as tightening.

There is no growth; there is no recovery. 

If this growth scare presages the end of the cycle, the consequences will be hideous for France, Italy, Spain, Holland, Portugal, Greece, Bulgaria, and others already in deflation, or close to it.

Forward-looking credit swaps already suggest that the US Federal Reserve will not be able to raise interest rates next year, or the year after, or ever, one might say.

He is correct; other than a feeble attempt here or there, the Fed cannot.

Ambrose offers a point that would not be considered news to an Austrian:

It is starting to look as if the withdrawal of $85bn of bond purchases each month is already tantamount to a normal cycle of rate rises, enough in itself to trigger a downturn.

I believe it is consistent with Austrian theory about money and credit to suggest that even a slowdown in the rate of expansion will lead to the bust.  A stop or even a reversal is not necessary.  Perhaps instead of mocking Austrians, Ambrose might pay some attention.

Put another way, it is possible that the world economy is so damaged that it needs permanent QE just to keep the show on the road.

Ambrose is right, at least for the foreseeable future.  But it can’t last forever; just ask Mises:

Inflation can be pursued only so long as the public still does not believe it will continue. Once the people generally realize that the inflation will be continued on and on and that the value of the monetary unit will decline more and more, then the fate of the money is sealed. Only the belief, that the inflation will come to a stop, maintains the value of the notes.

Ambrose should also listen to another point by Mises:

Continued inflation inevitably leads to catastrophe.

What do I think will happen?  Take it from Ambrose’s piece:

Traders are taking bets on capitulation by the Fed as it tries to find new excuses to delay rate rises, this time by talking down the dollar. "Talk of 'QE4' and renewed bond buying is doing the rounds," said Kit Juckes from Societe Generale.

I see no reason for money printing to stop until consumer price increases become politically intolerable.  This is the “inflation” that the “people” in Mises’ statement are watching (I know it is not the “inflation” to which Mises refers).  Of course, they are watching the wrong walnut shell, but it is the one they are watching.

Central banks might try to slow it down or stop for a time, but I suspect they will reverse course when markets start to fall.

Eventually the Fed will have to stop, as eventually, I suspect, consumer price inflation will show signs of life.  But if consumer price inflation doesn’t show such signs, or for as long as it doesn’t, what would prompt the credit expansionists to quit their game?

But if they wait that long, will it be too late?  Will too many have lost faith in the inflated currency such that, as Mises suggests “Once the people generally realize that the inflation will be continued on and on and that the value of the monetary unit will decline more and more, then the fate of the money is sealed.”

My guess the pumping will continue until the Fed (and other major central banks) faces mass consumer price inflation – “mass” being subjectively defined as that level which is politically unpalatable.

The Fed will then take actions to end it – and a central bank will have the tools to end it, painful as the implementation of those tools might be to most of us.  If necessary, they will even tie the currency to gold (a phony standard, of course) to protect the currency – at a value not easily comprehended today, perhaps, but tie it they will (as a last resort).

This is when asset prices will finally find the level that they have been attempting to find since around 1982.

If the consequence is mass-inflation heading toward hyper-inflation, the central banks will protect their currency.  Asset prices (and the impact to those of us who live in the general economy) be damned.

So Much Wrong About Inflation

Austrians are more and more noticed in the mainstream.  You don’t get much more mainstream than Paul Krugman; he has written a short blog post (HT EPJ) critical of Austrians and their supposedly creative use of the term “inflation.”  Referencing a Noah Smith post, Krugman writes:

Noah Smith has a funny piece on the hermetic system that is Austrian economics, with its multilayered defenses against any kind of criticism. What gets me in particular, because I’ve noticed it a lot lately, is this:

3. “Inflation” doesn’t mean “a rise in the general level of consumer prices,” it means “an increase in the monetary base”, so QE is inflation by definition.

So when Austrians were predicting runaway inflation, they didn’t actually mean consumer prices?

Insisting that the term “inflation” means something else in your private language is just pathetic.

… [Austrians] could have called a general rise in the CPI a banana. Were they predicting a banana? Of course they were. And they were wrong.

In order to avoid confusion through the remainder of this post, I will use the following definitions (to which Krugman will disagree, but I expect to be proven correct):

Banana = price inflation

Inflation = an increase in the monetary base

To the extent some Austrians and others have predicted runaway- and even hyper-banana to occur, so far they have been wrong.  One might debate the actual increase in consumer prices, but runaway or hyper-banana would be overtly noticed via protests on the street.  No such protests have materialized.

A Dose of Reality (Yes, Krugman is Pathetically Wrong…Again)

What of Krugman’s charge (and he goes somewhat beyond Smith in this) that Austrians have invented the definition of inflation out of whole cloth?  It took me all of one minute to find a source that Krugman could not so easily disparage, The Federal Reserve Bank of Cleveland: On the Origin and Evolution of the Word Inflation, by Michael F. Bryan. 

Unlike Krugman, Bryan actually considers history:

Inflation is the process of making addition to currencies not based on a commensurate increase in the production of goods.

Federal Reserve Bulletin (1919)

This idea of “a commensurate increase in the production of goods” can be found in the original Federal Reserve Act, regarding the discounting of commercial paper:

Upon the indorsement of any of its member banks, with a waiver of demand, notice and protest by such bank, any Federal reserve bank may discount notes, drafts, and bills of exchange arising out of actual commercial transactions; that is, notes, drafts, and bills of exchange issued or drawn for agricultural, industrial, or commercial purposes…. (P. 263, emphasis added)

Inflation was a term used to describe the relationship of currencies to goods – something backing the currency; it had nothing to do with prices.  Just ask the Cleveland Fed and Bryan:

For many years, the word inflation was not a statement about prices but a condition of paper money – a specific description of a monetary policy.  Today, inflation is synonymous with a rise in prices, and its connection to money is often overlooked.

Certainly overlooked by Krugman.

This Economic Commentary considers the origin and uses of the word inflation and argues that its definition was a casualty in the theoretical battle over the connection between money growth and the general price level.  What was once a word that described a monetary cause now describes a price outcome.  

It was a purposeful casualty – macro-economists don’t want you to look at the cause; they only want to direct your gaze to the effect of their choosing.

Bryan offers some history; apparently the term “inflation” (in its original sense) began to gain traction about two centuries ago:

One More Wealth-Skimming Consequence of Boom-Bust

When it comes to inflation – the monopoly-enabled money-printing / credit-creating type – there are many benefits to those receiving on the front end (politicians, bankers, crony-capitalists, etc.), and many costs to those receiving on the back end…wait, that didn’t come out right…although it paints the proper picture.  I think you get my meaning.

I will comment on an aspect that gets little, if any, attention – at least within the universe of what I have read on the topic: the tax benefits to the state.  I will take this in two forms – one somewhat more obvious, and another that may not be so.

First, to the more obvious (and at least somewhat more commented on): inflation stimulates (or attempts to stimulate) economic activity more than otherwise would occur.  On the back of this false, boom activity rides tax receipts – real wealth taken from the productive sector to the government sector.  That this will be partially offset (and certainly reduced) in the subsequent and certain bust is somewhat irrelevant; all politicians in elected democracies live for today.

Second, perhaps the less obvious: tax-loss carry-forwards in various forms.  Some examples and definitions will help:

Tax Loss Carry-Forward:

A tax loss carryforward takes place where a business or individual reports losses on a tax return up to seven years after the loss occurred. Frequently the logic behind this is to reduce tax liability during a year where the income or profits are high if losses were experienced previously. The tax loss carryforward reduces the overall tax liability during the high-earning year by incorporating the earlier loss as a reduction to taxable income.

In the boom, artificially high profits were earned.  Tax is paid on these in the immediate year earned.  In the bust, lower profits and, inherently, losses are incurred.  These losses do not result in a refund of prior years’ taxes paid (paid due to the boom that will always result in the bust); the losses do not result in a payment from the treasury to the taxpayer at the marginal (negative) tax rate in the current year.  Instead, the taxpayer must carry-forward the loss, helpful only in future years and only if a profit is achieved in the future.  So, on a timing basis, the treasury comes out ahead.

Consider; the boom ensures a subsequent bust: condition precedent is the boom; condition subsequent is the bust.  But the logic of the tax code is the opposite: the losses associated with the bust cannot be retroactively applied to the taxes paid during the preceding (and causing) boom.  Instead, they must be carried forward – to a boom not associated with the current bust.

Of course, if the business goes bankrupt in the bust, there is no profit in the future against which to apply the loss.  The treasury comes out net ahead.

Net Operating Loss:

A period in which a company's allowable tax deductions are greater than its taxable income, resulting in a negative taxable income. This generally occurs when a company has incurred more expenses than revenues during the period.

The net operating loss for the company can generally be used to recover past tax payments or reduce future tax payments.

The terms of the tax relief and how it can be applied varies by jurisdiction but usually the NOL can be applied to the past few years (two to three) and much more to the future (seven to 10) years.

Similar in concept to a tax-loss carry-forward.  Note that the retroactive period is much shorter than the prospective period.  I often hear of businesses that carry as an asset a tax loss.  This suggests that the prior 2-3 years where not useful in recovery, and that the hope is for the future ten years to offer the possibility of application.

Once again, the treasury is paid taxes on income, while the taxpayer has to wait to gain benefit from losses.

Writing off Investment Losses.  Note: this is taken from an article at the end of 2008 – a year of significant investment losses for many, and a bust period following a significant boom (similar to the dot-com bust several years earlier):

The IRS allows a taxpayer to use up to $3,000 in net capital losses to offset ordinary income. Capital losses of more than $3,000 ($1,500 if married, filing separately) must be carried over to the next year, though they can be carried over indefinitely.

Take the example of someone with $500,000 in capital gains and $1 million in capital losses. After subtracting the gains from losses, he has $500,000 in excess capital loss. He can use only $3,000 of that loss to offset ordinary income, such as salary, that year.

The taxpayer, having previously enjoyed the gains from the boom (and paid taxes for the privilege), now faces substantial capital losses due to the inevitable bust following the preceding boom.  Can he go back to the returns of the boom years and apply these losses to the earlier periods?  No.  They can only be applied to future years, and only up to the amount of the future capital gains plus $3000 per year.

So, the poor sap in the above example must either dive back into the market and hope for the best (the next boom), or wait 167 years to recover.

These are just a few examples.  Different jurisdictions have different rules.  Sometimes the losses can survive a bankruptcy, sometimes not.  But most, if not all, tax laws are skewed in favor of the treasury – leveraging the inevitable bust following the boom to the benefit of the state.

To summarize: the bust is tied to the preceding boom, yet the tax benefits (if you will) of the bust must wait for the next boom (if any benefits are even realized; often, the benefits can die unused for various reasons) – the treasury is always one cycle (if not permanently) ahead.