Monthly Archives: January 2013

Signature:1aa0edd3f00ecb0adc8aa215f572f8061f81f2bd7ee14d34f53c48d50acdcb69Those who have the weakest connection to our economy and the least understanding of how a market economy actually works and grows seem to think of production, wealth and income as a zero sum game.  “You do not have enough because somebody else has too much” is a popular socialist/populist refrain.  For example, most politicians and governments appear to view taxes in this way.  If the resulting deficit from current government spending and entitlements is too large, simply reduce it by raising tax rates (capital gains, payroll taxes, and push up income tax rates on the “wealthy”).  Surely, if we do this, more tax revenue will be collected and the deficit will shrink without forcing hard spending decisions on subsidies and entitlements.  After all, incumbent politicians view subsidies and entitlements as necessary rewards and bribes to the constituencies that elected them.

The problem is that economies are dynamic, growing and behavioral.  Thus, when tax rates are selectively raised, there is no assurance that individuals will not simply alter their behavior in order to avoid those rate increases as far as possible—in exactly the same way that if a popular restaurant doubled its prices, it would be naïve to assume the same number of customers would choose to eat there.  Two major budgetary harms can befall a government that simply raises tax rates to deal with the problem of a rising current and future debt burden.  First, the rise in tax rates may simply result in a disappointingly small increase or even a reduction in tax revenue actually collected (the traditional “supply-side” argument, often ridiculed but not refuted).  Second, the growth path of the economy may be damaged by tax increases paid out of private funds that would otherwise have been productively invested.  Private funds invested in capital could have resulted in the future growth of output, prosperity and employment.  Since, this growth trajectory will never be observed after a tax increase, it is sadly impossible to know exactly what opportunity we will have lost.  What is true for taxes, of course, is also true for debt or inflation-financed government spending as well.   When discussing the government budget, we have pointed out previously that the ratio of government spending to output (G/Y) is the one to watch.

As of January 10, 2013, the stock of government interest-bearing debt had risen to just over 100 percent of GDP.  This was highest level of that ratio within most of our memories and it resulted from bailouts, entitlement spending growth and new government programs following the credit collapse of 2008.  However, going back in history to a previous real emergency, the peak stock of federal debt in U.S. history actually reached its high point of 120 percent of GDP (  The high water mark was the result of debt financing of the armed forces and war material required for the allied victory during WWII.

How did we extricate ourselves from such a mess at that point in time?  Did we courageously cut federal expenditures and programs to the bone in order to rapidly pay down the stock of government debt?  Largely, we did nothing.  Of course, the spending in the defense sector immediately declined following peace, though it was still large and growing during the “Cold War” period.  The budget and debt problem was solved much less dramatically because, on average, during the 25 years following 1945, the growth of the U.S. economy exceeded the growth rate of the stock of debt—of the cumulative government deficits.  Simple economic growth forgives many sins. 

Politicians would do well to remember that.  Cold courage is not required of them.  Outright expenditure cuts and program elimination is not necessary to get the government’s financial house in order (although we would love to see it).  A much wimpier solution is possible.  If our government could simply restrain its greed to allowing existing government programs and cumulative expenditure to simply grow only by 1% to 2% per year, while the economy is growing at 3%, then the debt problem will be cured within a generation.  Then the politicians can take unearned credit and pat themselves on the back for political courage and good, hard-nosed management.  Will this slower-relative-growth solution happen?  Well it happened before, but in today’s political climate we shouldn’t be too hopeful.  After all, sustained slower growth of the government sector makes politicians less relevant to a robust market economy—the spoils system would be devalued.

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Recently the U.S. government raised the long-term capital gains tax rate from 15% to 20%.  Think for a second what this means.  Think what a “capital gains tax” really is in a fiat money economy.   It may be the perfect tax for targeting and destroying what remains of private ownership and freedom.  Why?

When a government or central bank prints worthless fiat currency, such as our Fed does, it steals real output from the private sector by issuing a currency that is steadily shrinking in value in exchange for real goods and services.  This is what is referred to as an “inflation” tax.  It can be collected by counterfeiters and especially the largest counterfeiters of all—central banks.

Now simple logic tells us that the more a government abuses its monopoly of printing new money, the higher the inflation tax will be.  Therefore, the higher will be the appreciation of all real goods and assets measured in terms of fiat currency.  So when these goods and assets are traded, the higher, therefore, will be the realized “capital gain.”  Talk about gaming a rigged system.  The government will get you coming and going.  First, with the inflation tax and then with the arbitrary capital gains tax collected in terms of an increasing value of real goods and assets measured in terms of its weakening currency.  It’s a perfect example of the government having its cake and eating it too.  Practiced to an extreme, it’s perhaps the ultimate scheme for destroying private property.

Now consider how such a “tax” would work in a world using capital as money.

Of course, “capital gains” taxes would not be collected on appreciation of broad productive capital because, as money, capital would be the numeraire good in which all other goods and services were valued.  That is, by definition the value of a unit of broad productive capital in terms of itself would always simply be just 1—as the value of a single unit of any money is always just a unit of itself.  Therefore, on average, there would be no “capital gains” tax on productive capital.

If such an insidious tax persisted, it would largely be de-fanged because it would only be collected on extraordinary gains of other single goods and assets relative to the average value of the money or valuation good.  Since the value of broad capital would be growing at rate over time equal to the sustained rate of growth of the economy (for a more detailed explanation see  our book Capital as Money), you would not expect to see a large set of goods or assets whose rate of return would steadily exceed that.

This is why the ownership of broad productive capital seems to us the compelling choice for money.  Imagine an asset used for exchange and valuation whose own value steadily grows over time in terms of consumption goods and services.  What a recipe for peaceful sleep by money holders!  What an antidote for a weary world historically on the wrong end of the traditional government/central bank inflation game.  In fact, “inflation” would be an alien and odd concept in such a world.  It is the primary logic for choosing capital as money.

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Most who have studied basic courses in economics or finance are familiar with the concept of the “Capital Market Line,” which attempts to show the theoretical relationship between expected rates of return and risk. Look at the graph shown below, where risk is measured on the horizontal axis and expected return on the vertical scale.  Risky securities are those whose returns display greater variation about their averages over time, formally measured as the standard deviation of returns.   In the graph, point B represents a riskier investment in comparison to security A. The greater the standard deviation, or risk, the greater should be the expected rate of return.

capital market line

We have no argument with this appealing intuitive concept—higher risk is commensurate with a higher reward or expected rate of return.  Rather our argument is with the idea that the left end of this line is, or should be, anchored by the short-term rate of return (represented by RFR, for risk-free rate) to cash or very short maturity assets (e.g. Treasury bills).  Really?

Let’s think about that proposition for a moment.  What is “low risk” about fiat cash, or for that matter a Treasury bill?  The money supply is abused by greedy or desperate central banks trying to impose an inflation tax upon the private sector or seeking to monetize previously issued government debt.  In fact, inflationary financing is the covert means, denied to the rest of us, by which a government can actually default on its real debt obligations.   Even were that not the case, the supply of fiat money is also subject to the lending vagaries of private banks as they seek to maximize profits and make loans with “excess reserves.”  The double “ponzi” scheme of both these processes makes the “return” to holding cash very uncertain.  With its value at risk, fiat currency even held over the short term cannot be viewed as a “risk-free” asset.  Nor can Treasury bills, whose return is paid in a fixed quantity of fiat currency.  Moreover, the rate of return to cash and cash equivalents is typically vigorously manipulated by the policy of the Central bank.  Consider the recent period when the nominal yield on T-bills is close to zero and the real return is negative.  It makes no sense to believe these rates are market determined, as rational investors should not enthusiastically choose to lock in negative real rates of return.  How investing in a T-bill earning a negative real rate of return could be viewed as “risk-free” is beyond us.  Bob Rathbone, a Boise area financial advisor, aptly refers to the investment in such as the “paradox of security.” The “paradox” is that, seeking security, investors are willing to accept a guaranteed loss after the effects of taxes and inflation are accounted for.  What is risk free about that?  Perhaps we should ask those who have lived through a hyper-inflation or the recent Russian fiat money meltdown, or even a vigorous and variable period of inflation such as the 1970’s in the U.S., if they think the holding of money or Treasury debt was risk free. 

The sad truth is that there is no “risk-free” asset class.  At rock bottom, there is a base level of uncertainty that is an inescapable characteristic of the natural world.  Sadly, men and their institutions have often added mightily to this.  One might be tempted to think of a particular commodity, such as a precious metal, as a good candidate to be called a “risk-free” investment.  The problem is that the price of any single asset can vary due to market conditions—as holders of individual commodities over a period of time can testify.  Worse, outside of speculative price movements, holders of commodities typically derive no rate of return.  This gives their holders a tremendous disadvantage over time relative to real income-producing assets.   If there is no “risk-free” rate of return, what is an appropriate standard rate of return to which all others can appropriately be compared?  In Capital as Money, our suggestion for a yardstick is the broad rate of return to productive capital.

In a capital-as-money economy, the benchmark return would be that of a tradeable share of a broad index of capital.  Such an asset could be used as a store of value, a medium of exchange, and the good in which all other goods are conveniently priced.  Because it is a real asset, sustained inflation, typical of fiat money economies, would be logically eliminated.  With appropriate capital-deepening (see Capital as Money), there is good reason to suppose that the real rate of return to broad productive capital would converge to the long-term average growth rate of the economy (of course the real and nominal rate of return would be same in the absence of fiat money and, therefore, inflation).  This return would be available to all simply by holding index shares of the capital market or “money balances.”  Would higher rates of return be available?  Of course, on those assets whose risk was perceived to be greater.

It is to the broad, sustained rate of return to productive capital that other available rates ought to be logically compared.  Isn’t the real rate of return to the broad capital market, itself, highly variable and uncertain?  We would argue that much of that variability is due to the marginal product of capital being viewed and valued in a fiat-money world.  Fiat money shocks, in turn generating shocks in interest rates, inflation, employment, credit and output, are the prime cause of short-term variability of the rate of return to broad capital.  Remove the central bank, fiat currency and the fractional-reserve banking system and you might be surprised at how stable the average marginal product of capital (which is also capital’s return) really is.  What about government bonds?  It might not be attractive in a capital-as-money economy for a government to engage too strenuously in bond-financing.  First, it would have to pay bond holders a rate of return that would compare favorably to the average rate of return to capital in order to encourage investors to buy its bonds.  Second, principal and interest payments would have to paid in terms of units of real productive capital, which is “money.”  Third, there would be no convenient fiat-money escape hatch to allow for covert stealing and devaluation of government debt.  Politicians would be brought back to the hard reality of real tax financing of government expenditure, unpopular to the public, but politically more honest because it makes all of us aware of the ratio of government spending to real GDP (that is, of what the government is really expropriating from its citizens).

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Last week Nobel-prize-winning economist Paul Krugman argued for the Treasury Dept. to manufacture a trillion-dollar coin to address the nation’s debt issue.  (This raises rather serious questions about how the Nobel-prize in economics is being awarded, but that is not the topic of this blog.)  Our focus is on the wisdom of the trillion-dollar coin idea.

As background information, we note that in 1913 the Federal Reserve was created, and was given the authority to print money.  In general the U.S. Treasury cannot print money, but there is a loophole in the law that allows the Treasury to coinsmanufacture coins. And, thus the brainstorm:  Print a trillion-dollar coin and use that to take care of the government’s debt problem.

Crazy as the trillion-dollar coin idea sounds, it really isn’t that different than what is happening anyway.  After all, presently the Treasury prints up bonds and then sells them to the Federal Reserve.  And where does the Federal Reserve get the money to buy the bonds?  It creates it out of thin air!  After the Federal Reserve has made new money and bought the bonds, the U.S. government then owes the Fed.  But there is a catch—when the bonds mature, the Fed must remit its profits back to the Treasury.  After all this back and forth occurs, the end result is that new money is created to finance government spending, just as surely as if the Treasury mints trillion dollar coins. So, what the heck—since money is simply being created either way, maybe the Treasury should go ahead and crank up operations down at the mint.   Since the government has had recent success at stealing output through money creation, they might as well double down on the counterfeiting operation.

How can such nonsense be stopped?  We need Capital as Money.

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person carrying signRecently, we have been treated to the spectacle of protests, chaos and decline within the EU.  A country or a national economy can be likened to the simple analogy of a wagon.  Those who ride on the wagon are living off of more than they produce.  They are the net beneficiaries of government largesse—of the modern welfare state.  These programs were designed and implemented by their elected politicians as “bread and circuses” to cobble together winning coalitions and maintain incumbency.  In various places in our national media, the term “euro-trash” has even been employed to describe the lost generation of young Europeans who aged 20 to 40 are either chronically unemployed or underemployed.  They are the aimless beneficiaries of mature, cradle to grave, enabling, and incentive-destroying national welfare systems.  When a large portion of a nation’s population in their prime productivity years is withdrawn from producing real output and wealth, the patient is indeed gravely ill.  Those who are not on the wagon are, of course, pushing it. The pushers are the producers of real output and wealth, and it is they who pay for it all.  If they grow weary, or there are too few of them, or if they finally defect to become riders, then we are past the tipping point.  The wagon ceases to move and the welfare state must collapse without its source of funding.  It is bankrupt.  Witness Greece.

This example is disturbing in light of the just-passed U.S. national election.  A successful constituency was apparently cobbled together and incumbency retained by appealing to a general national need or yearning for dependency.  What has been offered to wagon riders?  “Free” national health care, forgiveness and subsidies to stressed homeowners, larger and more extensive continuing unemployment benefits, continuing social security, more freebies for favored businesses and corporations, greater access to student loans (or student gifts), greater access to all manner of programs that defer the tough decision of actually going back to work.  In a difficult economy, who could be against such comfort and largesse?  Only those who realize that the government actually pays for nothing.  Who does?  Taxpayers (the wagon-pushers), government bond purchasers, and all of us who are hit by the hidden tax as our fiat currency is inflated to take the pressure off government bonds by monetizing them.  In fact what has happened in our country is that the large pool of toxic private debt has largely been assumed by the federal government.   This has hemorrhaged the national deficits and the stock of government debt.  Now we are all (as taxpayers) responsible for it.  Who is now lending?  Not the deer-in-the-headlight, heavily regulated banks, at least not without federal threats and prodding.  Rather, our government has become the lender of last resort and, believe us, the criteria for its lending is not economic efficiency.  Rather it is the political agenda of pandering to the needs of an increasingly dependent economic constituency.

What has happened to our older American values of free markets, individual freedom, minimal government, and individual responsibility?  Are they anachronistic and dead?  Is there no spirit of individual achievement and economic success?  Actually no, they are alive and well in some places such as the recently liberated economies and countries of Eastern Europe.  They are also still held by a large number of Americans, but, unfortunately apparently only a very sizable minority of Americans.  Perhaps the country has become a greater Scandinavia as exemplified by a recent comedy series targeted at Portland (Oregon) called “Portlandia.”  In it Portland is described as a place where the dreams of the nineties are still alive, where Al Gore and global warming still loom large, and where the young can go to retire.  Let’s hope that this is an unfair stereotype of Portland and its fine citizens and also an inaccurate description of where America is headed.  Perhaps our 20 to 40 year olds will return to the values, not of their parents, but of their grandparents.  We shall see.

Of course a major part of the sickness of our economy lies in enabling the covert government financing of expenditure through the creation of fiat money and monetization of the federal debt.  Further contributing to our economy’s ills is the overhang of a ballooning pyramid of questionable credit enabled by the tired anachronism of fractional-reserve banking.  Also there is the inefficiency of a credit market that has come to be driven less and less by the criteria of economic efficiency.  It is these issues and what to do about them that are the core of our recent book, Capital as Money.  You should read it.

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cartoon person relaxing in chairIn  August of 2012 the U.S. labor force participation rate sank to 63.5 percent, the lowest mark recorded in the past 30 years.  The declining labor force participation rate is occurring at the same time the unemployment rate is dropping; the rate of unemployment has fallen from 10 percent in October 2009 to 7.8 percent in December 2012.

 How are the falling unemployment and labor force participation rates related? To answer this question it is useful to examine what it means to be in the labor force, and also what it means to be unemployed.  According to the definitions of the Bureau of Labor Statistics, to be in the labor force somebody must either be employed or unemployed. This seems straightforward, but we also need to understand that being “unemployed” does not simply mean not having a job.  To be considered “unemployed” a person must not only be out of work, but also must be willing and able to work.  A person is not counted as being in the labor force or as being unemployed if he decides he no longer has any desire to find a job.   As a result, when a person without a job decides he is no longer interested in looking for work, then both the labor force participation rate and the unemployment rate will simultaneously fall.

 An examination of the data reveals that labor force participation rates have declined most dramatically for young adults.  According to the Bureau of Labor Statistics (, labor force participation rates for the cohort ages 16 to 24 have declined from 65.4 percent in 2000 to 55.2 percent in 2010. 

 One explanation for the recent drop in labor force participation is that job-seekers have become discouraged, and therefore simply quit looking for work.  But, we think there may be another, greater force at work here.  In the case of young adults, the decline in labor force participation is very sharp.  Many observers believe this may be a consequence of an increase in the number of students attending college—a full-time student is not part of the labor force if he/she is not interested in working while going to school.

 Not coincidently, at the same time young people are exiting the labor force the amount of student loan debt has skyrocketed.  Student loan debt is increasingly owed to the federal government, as private lenders are unable to compete with the attractive loan repayment plans offered by Uncle Sam.  In fact, the U.S. Department of Education encourages students to eschew private lenders, and promotes their own their own taxpayer-financed loans instead.    Quoting from the Department of Education’s website (, “when it comes to paying for college, career school, or graduate school, federal student loans offer several advantages over private student loans.”  The Department of Education lists many of the benefits of federal student loans when compared to private loans.  For example, the Dept. notes that private loans may require a credit check, whereas “you don’t need to get a credit check for most federal student loans.” Another so-called advantage of federal loans is that  “you may be eligible to have some portion of your loans forgiven if you work in public service.  Learn about our loan forgiveness programs.” (Read, don’t worry too much about whether or not you can pay back the loan—taxpayers have you covered).

 Is it any wonder the growth rate in GDP is miserable? The U.S. government and its money-creating ally (the Federal Reserve) are great at finding ways to encourage people to avoid productive employment.  Going to school through student loans, which may never have to be repaid, is a big deterrent to entering the labor force.  But, there are many other ways to get some cash without breaking a sweat.  For instance, part of the deal that was cut to resolve the “Fiscal Cliff” involved maintaining the availability of “extended” unemployment benefits.  Simple economic logic suggests increasing the duration of unemployment benefits does little to encourage people to accept less-than-desirable work.  Instead, like Eddie in the movie Christmas Vacation, it is better to hold out for a “management position.”

Will our economy ever again experience robust growth?  It may, but only if the federal government stops distorting incentives and discouraging productive people from working.  Printing money and throwing it around willy-nilly isn’t the way to promote a healthy economy.  Private markets should determine who gets student loans and who doesn’t.   And, the hurdle rate on student loans should be high—at least as high as what could be earned by owning a diversified portfolio of capital assets.  In such a world, a potential borrower would have to carefully weigh the costs and benefits of the borrowing decision.  Ultimately, things get properly balanced only when we get government out of the lending business, and also out of the money-printing business. Read Capital as Money!

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Capital as Money

Capital as Money is now available as a paperback, or as an e-book.  Either one can be purchased by visiting

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In our December 20th blog we suggested that any last minute deal to resolve the Fiscal Cliff was unlikely to produce a meaningful change in the size or scope of the federal government.  To quote our earlier blog:

“So, let’s get back to the fiscal cliff. Why do we hope a deal isn’t reached? Simply because of the automatic spending cuts that are scheduled to occur if there is no deal! We’d like to see government spending decline as a percentage of GDP. In fact for the long-term health of the U.S. economy we think a federal spending decline is imperative. Any other sort of deal that is struck between the President and Congress is likely to involve a few symbolic gestures such as a higher tax rate on ‘rich’ people, while diverting attention away from the one real concern, which is the size of the overall bite the federal government is stealing from the GDP pie.”

Sad Face

Contrary to our hope, in the past two days a deal was struck.  And, unfortunately, our prediction of what the deal might look like was spot on.  (We should not boast about our forecasting prowess, as anyone who has been watching Congress could see it coming.)  The details of the deal involve a few tax hikes targeted at the wealthy.  Namely, the tax rate on those individuals making over $400,000 is increased from 35 percent to 39.6 percent, and the capital gains tax rate is increased from 15 percent to 20 percent. Also the payroll tax rate will go up by 2 percent (on everyone, not just on “rich” people).

OK, so that is the outcome on the tax side of the picture.  But what about those automatic spending cuts which were scheduled to occur?  Well, the decision was to postpone those.  Rather than letting the automatic cuts happen, Congress will wait 60 days and then get to work on the spending side of the equation (yeah, right).

Bottom line:  The federal government is going to continue to run enormous budget deficits, financed by monetization of the debt by the Federal Reserve.  As long as the government can postpone any spending cuts through the printing of new fiat money, any real progress on lowering the national debt is unlikely.  Printing new fiat currency is the way out (at this point perhaps the only way out) for an enormous, past-the “tipping-point,” rapidly growing government sector. Only by switching to a “money” whose value depends on something real (i.e. physical capital) could this process be reversed (read Capital as Money).  Meanwhile we can make another no-brainer forecast, given that converting debt to currency is the last refuge for the financing of out-of control government expenditure, the prudent might batten down the hatches in expectation of rising inflation during the next few years.

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