Tuesday, 24 July 2007

Reserve Bank's foul ups: PC's four-point remedy.

I'm stunned. A commenter here says he's been keeping up with my comments on the Reserve Bank's ongoing and losing battle with inflation and the exchange rate, but he then says he assumes I'd want the Reserve Bank to inflate the currency!

What on earth has he been reading? It surely can't be anything I've written here. I've said several times that there's no magic level for the money supply; what's important is that the money supply itself remains stable so that price information is real market information, and so that governments aren't stealing our wealth by means of inflating the currency.

Just for the record then (and to answer my questioner), here's PC's Four-Point Plan to fix the foul up. (Click on Inflation or Reserve Bank tags to see all the posts I've produced on the cause of the foul ups.)
  1. Slash government spending to the bone. it's govt spending more than consumer spending that's keeping up price inflation: slash it to the bone, and give people back their own money to invest. That's money that will be invested to going to grow the economy, not to buy elections. (But won't tax cuts be inflationary? No, we've answered that one before. Several times. And doesn't "too fast growth" cause inflation? No, that's another myth put out by economic morons.)
  2. Consign the Resource Management Act to the flames. If there's one thing that's increased the price of housing more than any other, it's the power the RMA has given the ill-named "planners" to restrict the growth of housing supply to meet rampaging housing demand. Time to consign this egregious piece of drek to the flames and free up housing supply. As a minimum, abolish immediately the Metropolitan Urban Limits the so called planners have applied around our cities like a noose, and prohibit them introducing these restrictive constraints again.
  3. Leave the Official Cash Rate to the market. Even Reserve Bank boosters admit that the best the Bank can do with the Official Cash Rate is to set it at something approaching the natural interest rate. Why the bureaucratic middle man? Having either bureaucrats or politicians meddling with something they clearly know nothing about, (and which they say at best simply emulates the natural workings of the market) is a recipe for disaster, especially when the market is working contrary to the failed economic theories of the bureaucrats and politicians. Leave the OCR to the market, and begin working to disestablish the Reserve Bank itself.
  4. Prohibit the Reserve Bank from inflating the currency. The money supply has increased by roughly fifteen percent year on year for the past few years, this more than anything else has contributed to any across-the-board price inflation that does exist. While the Reserve Bank still does exist, I would prohibit it from inflating the currency.
In my view, those are four things that should be done immediately. Long term, what I'd like to see applied is the prescription called for by economist Larry Sechrest in the latest Free Radical: free banking. What we're after from the banking system in this context is not the illusory idea of "price stability" (in whose pursuit the wealth of all of us is being sacrificed) but monetary equilibrium. As Sechrest points out in the Free Radical, "as long as there is continuous monetary equilibrium, all other desirable monetary goals become superfluous."
In addition, it is important to recognize that the demand for free bank-created, “inside” money represents an act of short-term voluntary savings by consumers. The supply of inside money represents an act of investment in that new inside money comes into being via the process of creating loans and deposits. Under free banking, saving and investment move together, as do the supply of and demand for credit. Therefore, the market rate of interest remains equal to the natural rate of interest. Since departures of the market rate from the natural rate are the cause of most if not all business cycles, then free banking is likely to avoid all such economic disruptions.

By contrast, in a fiat money, central banking system liquidity is a “common pool”. Costs have been socialized---spread across all citizens. That is, the monopoly issuer of currency and lender of last resort (the central bank) itself faces essentially zero marginal costs. It can increase the supply of money at will. So damaging expansions of money and credit are to be expected from central banks.

Mark this well. Central banks are the source of both inflation and business cycles. Tragically, many people seem to believe that both inflation and boom-bust cycles are somehow an intrinsic part of a market economy. They thus turn to the central bank to solve the problems that the central bank itself created. I might add that the very existence of a central bank introduces into all markets pervasive “regulatory risk” that would not otherwise exist. That is, market participants expend real resources in an attempt to forecast---and then cope with---the manipulations of money, credit, prices, and interest rates undertaken by the central bank. It all sounds frighteningly familiar.
That's the long-term solution then: Remove the Reserve Bank's monopoly powers, and cut the govt's apron strings from the currency.


  1. Interesting, and yet, I am still unsure as to what you require the Reserve Bank, considering that in reality it still exists, to do.

    You assume that the reserve bank is a monopoly, but this is not true. Anybody can start up their own currency - it's literally just an IOU note for goods and services on behalf of the issuer. The reason the Blair Mulholland Peso does not get off the ground is that the NZ$ has better branding. That's all.

    Thus, point #3 is bizarre - the RBNZ is part of the money market - not the sole provider. It is selling New Zealand Dollars, which is merely one measure of the value of goods and services. The main problem is that, like other goverment owned enterprises, it doesn't set prices according to pure market principles. It believes that by printing money it can stimulate the economy, whereas any good libertarian knows this is bollocks. Its only restraint is an attempt to control inflation. What it should be doing is maximising returns from its currency, which would actually, by default, control inflation anyway. That's why I want Bollard to raise the cash rate. At the moment he is below the threshold whereby banks will, by and large, find it cheaper to seek offshore credit. If he raises the cash rate enough he will find that threshold - just like any other organisation selling a product or service. And New Zealand will be better off for it.

    Point #4 is equally, if not more so bizarre - what do you think inflates the currency?! The entire purpose of the cash rate is selling money that doesn't hitherto exist! That's what creates inflation! Bollard raises the cash rate precisely because at a higher rate he will "print" less money, because supply and demand will decrease at a higher rate.

    Your answer to my question of whether the OCR should be higher or lower was neither, but again, you don't have that choice. It's either one or the other. If you believe the RBNZ should be keeping the currency "stable", or at the same value, then that's just silly. Our currency grows with our economy.

    What bothers me is not that you dislike the RBNZ and want it abolished (bring it on!) but that you think that raising the OCR is somehow wrong - that making the currency more expensive is wrong, that printing less money as a consequence is wrong, that the goal of lowering inflation and preventing savings from devaluing is wrong... seriously it's confused! You should be cheering Bollard on with every rate hike! Every rate hike means less fake money in our economy. Every rate hike means more international investment. Every rate hike makes us wealthier than we were before.

    I don't comprehend your point of view. On one hand you want less money printed, but then you criticise Bollard for taking actions which does exactly that! Make up your mind.

  2. Blair wrote: "The reason the Blair Mulholland Peso does not get off the ground is that the NZ$ has better branding. That's all."

    Wrong. The NZ currency is legal tender. Among other things NZ law makes it illegal for me or anyone else to refuse to accept it to transact. In some cases it is illegal for me to transact at all unless I use NZ currency.

    Hey there, why not try paying your tax in non-legal-tender Blair Mulholland currency and see what occurs?

    Best to be rid of the Reserve Bank altogether. There is no need for it. A government monopoly with special priviledges such as this one will never get it right. The necessary result is he impoverishment of those who have no choice but to exist under its auspices.

    For example, your call to increase the cash rate will damage those who invested in houses and real estate developmment projects. It will hurt those who purchased machinery and equipment under a finance agreement. And all for what purpose exactly? To prop up a shakey unbacked fiat currency...

    These guys got everyone into the troublesome and vexatious situation in the first place, best to exterminate them and their powers altigether. Bollard should swing alongside Cullen.


  3. Banker, that's just nonsense!

    I or anyone else can accept anything I want as payment for goods and services. There's no law stopping me buying a car with three goats if I want.

    You are confusing "illegal" with entities' right to choose what they will accept as payment. Nobody is forced to buy or sell anything. Terms are negotiated to the benefit of both parties in any transaction, otherwise the transaction does not occur. The exception, as you point out, is tax, but for the NZ Government to only accept its own IOU notes just seems logical.

    God, why are people so confused about this? In one paragraph you call for the RBNZ to be abolished, then the next you don't want them raising the OCR at all!!!!!! Well do you want them to stop printing money or not?!!!! Make up your mind. As I keep pointing out - and it seems to fall on deaf ears - if the OCR was at 50%, that's effectively as good as abolishing the RBNZ anyway, because nobody would borrow off them. Alternative credit would take over.

  4. Blair, can I suggest you go to the Reserve Bank site and read up on how the OCR works, and why ignoring it would be difficult if not impossible. There are a few confusions evident in your reply, but that's the most easily fixed.

    But back to printing money and interest rates. Asking what they SHOULD be is asking what rates the market would have them in a free banking regime. What would those rates be? I don't know and I can't know, and the point here is that neither do you or Alan Bollard know. We can't. In the absence of a real market, no one can know.

    It's markets that set prices, and without a real market there's no way of knowing what the price for money would be.

    That's not the only problem with the RB.

    As long as the Reserve Bank system is there, a system based on flawed economic reasoning, then difficult monetary conditions and severe regulatory restrictions on supply will both show up those flaws, and remove any possibility of rational action to redeem the situation without a crisis. That's what we're seeing at the moment.

    As Larry Sechrest says in his article on free banking, the system first creates the problems and then by its very existence makes the solution for the problem all but impossible.

    By the way, the process of setting the OCR and printing money happens in reverse to that which it works in a free market (like the Keynesian theory on which the RB system is based, it works AGAINST causality, or tries to). In a free market, natural interest rates will tend to reflect the amount of credit available from the "pool of funding" that is created by real savings and genuine investment (ie., from the quantity of goods available in an economy to support future production). That's how things happen in genuine free markets.

    Whereas with the RB system, interest rates are set for whatever political end is chosen (they're currently set so as to maintain the illusion of price stability), and then currency is created to maintain that rate. You see, it happens in reverse of how it should.

    What I want from the RB as long as it exists is for it just to leave the goddamn currency alone ( ie, to neither inflate or contract it), and to let the market itself set interest rates based on the level of our genuine funding pool. What I don't want them to do is think that they can create that funding pool out of thin air, or to encourage excessive malinvestment by acting as a magnet for the carry trade and acting to hike exchange rates.

  5. Let me summarise, just in case it's still unclear.

    "Interesting, and yet, I am still unsure as to what you require the Reserve Bank, considering that in reality it still exists, to do."

    The answer in a word is this: Nothing. EXACTLY nothing. Think about it.

  6. Blair

    You're the one who is utterly confused. I suggest you take a deep breath and hold it while someone who has had the benefit of decades of experience working in finance and banking explain something important to you.

    Firstly, you've conceded the point already. Tax must be paid in legal tender. My point is made. Thank you.

    Consider the consequences of that regulation. It results in a guaranteed demand for NZ currency as all taxable NZ residents require it to satisfy the law of the land. They must acquire it in order to pay it. They must calculate all income, value, asset, debt, liability, cost etc. etc. etc and measure all of it in the legal standard. That is NZ dollars. Despite what you may like to write, tax is not an exceptional example by any means.

    Secondly, aside from the tax example, already admitted, there are other transactions that are controlled in such a way that NZ legal tender must be employed as the means of transaction. You can't get away from it, as no-one is allowed to contract outside of the law. The government prevents certain transactions from occurring unless legal tender is the means of enablement of the transaction. For example, it is illegal for the financial institution I work at to refuse to accept payment in NZ dollars. If someone offers it, we are obliged to accept it in settlement of a debt, even if we do not want it. Same goes for the owner of a retail shop such as a dairy.

    What I am endevouring to point out to you is that the NZ dollar and the bank that issues it have special monopoly priviledge granted by government. Not only is it difficult to compete against it, it is prohibited to.

    Next issue is with this piece of misleading deception, "In one paragraph you call for the RBNZ to be abolished, then the next you don't want them raising the OCR at all!!!!!!"

    No, son. That's not what I did. What I was explaining to you is that it is the existence of the reserve bank and its special priviledges that causes much of the economic troubles we are concerned about in the first instance. Therefore the best thing to do is abolish the reserve bank, hence removing a causal agent at source.

    I wrote that the reserve bank can't get it right. No matter what they do they necessarily impoverish those they prey upon (that is, the rest of us).

    To your call for increased OCR I responded that such an action would cause destruction of wealth (and a lot of destruction would indeed occur) and mentioned two important sectors as examples. This is the main point. There is nothing the reserve bank can do which will solve the impoverishment that it causes. It necessarily will continue to impoverish and make things worse. Your suggestion for increased OCR illustrates this harm well.

    You are trying to tie respondents to your postings to two options only, namely
    A. reserve Bank increases OCR
    B. reserve bank decreases OCR

    These are not the only options available to chose from. There are other options. Among them is this. Eliminate the Reserve Bank altogether.

    You wrote, "Well do you want them to stop printing money or not?!!!!" To which I have already answered that they should be eliminated. Therefore there would be no Reserve Bank to print ANYTHING at all.

    In the absence of a Reserve Bank you concede that "alternatigve credit would take over." Good point. Bravo. It would be best were it to be with fully backed currency and no special government mandated special monopoly priviledge. Well, on that, at least, I hope we understand each other.

    Must get back to work now. Lots of Japanese institutions getting ready to pull Bollards panties off.


  7. Excellent points, Banker.

    On the Reserve Bank's monopoly you said, "Tax must be paid in legal tender. My point is made. Thank you."

    I wonder if Blair and other readers might ponder a suggestion made by George Reisman. What do they think would happen if a government were to announce that payments to government may be made both with the RB's paper money, and in notes backed by gold or precious metals?

  8. "Tragically, many people seem to believe that both inflation and boom-bust cycles are somehow an intrinsic part of a market economy."

    Indeed. Merely because economic history shows this and all decent mathematic models of the economy (ie any with decent predictive power) show this, some idiots believe it.

    What tragedy!

  9. Uh, and when you say "what's important is that the money supply remains stable" - what makes you think the money supply is stable in a libertarian paradise?

    Which money supply? The number of bits physical bits of currency in circulation? What the hell makes you think the money supply would remain stable in absence of the RB?

    Haven't you noticed that use of exotic instruments by trading banks has been boosting various money supplies world-wide?

    A universal gold standard doesn't give you a fixed money supply either. Not in any useful sense of the term "money supply".

  10. One point to consider. A big point.

    Money is debt. It is has no value. It is not a medium of exchange. It is debt. If everyone paid off their debts, including the government, there would be no money left in circulation. None.

    People don't realize this fact. If they did, there would be outrage. In the days of old, money was a promissory note that could be exchanged for something real. In fact the term pound originated when a pound note could be exchanged for one pound of silver.

    If you had no silver you could not issue the money. Thus inflation was almost non existant.

    Compare that to the current system. The reserve bank takes an IOU from the govt to print money, for which the govt agrees to pay interest at the rate set down by the reserve bank. In a closed system that would mean that there was a ever diminishing pool of currency in existence.

    How does the system keeps going because of taxation on the citizens, which keeps the pool of money afloat. When the reserve bank raises the interest rate, it is another form of taxation on people.

    At the same time the government is printing money hand over fist, inflating the currency and secretly taxing the populace through inflation.

    Last year the government via the reserve bank printed 15% more money. That translated into an inflation rate of close to 10%.

    The NZ situation is not an isolated one. All currencies are inflating at huge rates. I believe that the global economy is on the edge of global hyperinflation a la the weimar republic of the 1930's.

    From where I sit, the world is balanced on the edge of the knife... Anybody got gold????


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