–Before we get into how to turn Australia into post-war Germany with the soundest currency in the world and a healthy manufacturing sector, let us remind you that it’s Wednesday. That means you should go check out Murray’s latest Slipstream Trader market update on his YouTube channel. If you haven’t done so yet, you have no idea what you’re missing.
–Now, back to markets. Have you noticed that every time someone from the US Federal Reserve opens his mouth, he creates more instability? Unsound money leads to monetary instability. Monetary instability creates economic instability. And economic instability makes people really uncomfortable. And cranky.
–Yet the president of the Federal Reserve Bank of Chicago, Charles Evans, wants even more unsound money! Evans got on CNBC last night and told the world, “I would favour more accommodation…I am in favour of some of the most aggressive policy actions of anyone on the [Fed’s policy making] committee.”
–Just what “more accommodation” is intended to accomplish is unclear. More wealth destruction? About all that’s clear so far is that when you tell people you’re going to keep interest rates low for the next two-and-half years, they speculate. And when you tell them your intention is to effectively devalue your currency, they buy real money.
–December gold futures in the US gained 2% after Evans opened his big mouth. We suppose if you’re a gold bull, you don’t mind this sort of thing. But after a day or two of ceasefire, the global currency war is back on again with some feeling. Even Treasurer Wayne Swan is getting in on the act.
–Swan is on his way to China to talk over the terms of Australia’s gradual surrender of economic sovereignty to the Chinese over the next 50 years.
–Wait. Just kidding. He’s over there to talk business. But while he’s at it, he’s had an early go at China’s currency peg. He told reporters:
“Australia is a very strong believer in a floating currency and one of the structural reforms that we require in the global economy, particularly from large developing countries, is for them to boost domestic demand and move to more market-based exchange rates…That’s part of dealing with the global financial imbalances, the global financial imbalances that cause the global financial crisis and then the global recession.”
–He’s referring to some of the structural imbalances we wrote about yesterday. He’s especially referring to the strong Australian dollar. The same dollar that’s decimating the manufacturing industry. He must have read yesterday’s Markets and Money and saw what’s in store for an entire segment of the economy that can’t compete.
–Don’t expect any sympathy from Reserve Bank of Australia governor Glenn Stevens. He reckons that the strong dollar is here to stay and it’s going to cause unavoidable wreckage in some parts of the Australian economy. In public remarks, Stevens said:
“Some parts of the economy will shrink while others grow. I wish I could say we had a way of avoiding that; I don’t think we do . . . We don’t have an instrument that can prevent these shifts in the structure of the economy from occurring. I’m sorry but that is just the reality.”
–Ah. But is it true the decimation of Australian manufacturing is an inevitable result of the structural changes in the global economy? Maybe not. But to avoid said decimation, Australian regulators and politicians might have to put down their meddlesome policy tools and pick up a German history book.
–If they find such a book and turn to one specific date in German history, they’ll find a blueprint for how to make Australia more competitive and increase productivity. We’d also humbly suggest that fully employed people with sound money in their pockets are happier people. But we’ll get back to that in a second.
–In late June of 1948, US, French, and British troops discretely distributed over 23,000 wooden crates across Germany. The crates were labelled “doorknobs”. But there weren’t any doorknobs inside.
–Inside the crates were over 10.7 billion new currency units, or Deutschmarks. The Deutschmark replaced the Reichmark, which had been invalidated by the currency reform law passed by the Allied Powers. On Sunday, 20 June 1948, every German citizen received 40 new Deutschmarks. A month later they received 20 more.
–Reichsmarks could be traded in for new D-marks at an exchange rate of 10-1. And when you first think about that, you realise that the issuing of a new currency had the effect of wiping out the savings of millions of Germans in one fell swoop. So why did this one key move become the foundation for Germany’s post-war economic recovery?
–The introduction of a new currency reduced the amount of money in circulation in Germany. It reintroduced sound money into the German economy by strictly limiting money supply growth. Sound money means monetary stability. And monetary stability makes normal economic activity and planning possible (and worthwhile) again.
–The new currency was encouraged by German economist, Ludwig Erhard. Erhard then went beyond what the Allied occupation authorities had in mind when, in one fell swoop, he removed price controls and rationing in the German economy. The effect was dramatic.
–Price controls virtually guarantee scarcity. Producers hold back goods and services because they are forced to sell them below their market value. The black market flourishes. Shelves are empty and barter replaces normal commerce.
–But with sound money back in the economy, and price controls gone from the economy, sellers and producers in Germany no longer hoarded goods and services. The shelves filled up. And the incentive to resume economic production returned quickly.
–It’s hard to imagine how complete the change must have been to Germans shuffling through the rubble of the post-war reconstruction. Frenchman, Jacques Rueff – who later famously pointed out the “exorbitant privilege” the US enjoys issuing debts in the same currency it prints – captured the effect of the currency reform on German society:
“The black market suddenly disappeared. Shop windows were full of goods; factory chimneys were smoking; and the streets swarmed with lorries. Everywhere the noise of new buildings going up replaced the deathly silence of the ruins. If the state of recovery was a surprise, its swiftness was even more so. In all sectors of economic life it began as the clocks struck on the day of currency reform. Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display. Shops filled up with goods from one day to the next; the factories began to work. On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food. A day later they thought of nothing but producing them. One day apathy was mirrored on their faces while on the next a whole nation looked hopefully into the future.”
—Sound money creates the incentives for production. Erhard ended money printing. He understood all too clearly that accommodative monetary policy doesn’t create wealth. It prolongs instability. But he did not stop there.
–He dismissed most of the public service in Bavaria and said his goal was to replace a bureaucratic culture with an entrepreneurial culture. He also gave people an incentive to work. He abolished taxation on all income tax on hours worked over 40 hours.
–Exporters paid fewer taxes on profits. The top rate of Germany’s so-called progressive income tax was lowered from 80% in 1948 to 55% by 1950. Productive industries were given tax deductions for capital investment. And high depreciation allowances were introduced for almost all capital investment.
–Now, we’re certain that the progressive collectivist socialist types will howl at the last suggestions. Higher depreciation allowances effectively allow a business to lower its tax liability. Instead of writing off the cost of a capital asset over 10 years, gradually, you do it quickly and subtract it from your tax bill. That lowers government tax takings.
–Assuming you’ve fired a good deal of the bureaucracy, this shouldn’t be a problem. The government’s bills will be lower. It will get out of the way of the entrepreneur and do what it ought to do in the first place: ensure the conditions for a stable legal and monetary environment (although even this role is debatable).
–The big benefit to allowing faster depreciation is that you encourage capital investment by “de-risking” it. Businesses are much more likely to invest in capital goods if they can expense them quickly and turn a profit sooner. That profit is ploughed back into new investment, higher wages, and greater production.
–There are two reasons Australia will never encourage flat taxes, sound money, and accelerated depreciation of capital assets. The first is that it doesn’t benefit the financial and banking industries. We have a money system and an economic system that directs all the benefits of unsound money to a very small group of money shufflers at the top.
–Bankers get to create money at no cost and loan it out for interest. They also get first use of the money, before the expansion of the money supply decreases purchasing power and erodes savings through inflation. They have no interest in a structural change to the financial system that encourages capital investment; the kind of investment that would lead to higher-wage jobs, production, and create a bigger market for skilled labour.
–And if the objections of the financial industry are not enough to prevent sound money, flat taxes, and capital investment, you always have the central planners and bureaucrats to deal with. Under the current system, the government gets to take money from one group in order to bail out another group that cannot compete because of unsound money and stupid tax laws.
–For example, the government (the ‘steal’ industry) would rather tax the resources industry to subsidise the steel industry. This arrangement suits the government perfectly because it makes its agents necessary and ensures their power. They get to decide who to punish with higher taxes and who to reward with hand outs. It’s no wonder power-hungry politicians would relish their place in this system.
–Of course under this system the government creates no value at all. In fact it prevents wealth being created. All it can do is take money from one group and give it to the next. It’s pure wealth redistribution. And aside from being intellectually unimaginative, it caters to the vanity and lust for power of people in politics. It’s disgusting and immoral the more you think about it.
–Far more ethical, just, fair, and prosperous is a combination of sound money, low taxes, a stable rule of law (just as important as stable money), and conditions under which private enterprise can thrive because people know the wealth they create will be theirs to keep. At least, that seems better to us.
–To be fair to Australia’s current money masters, the unsound money they are dealing with is a global problem. It originates with the fact that the world’s reserve currency, the US dollar, is as unsound as it gets. Everything linked to it rots by association.
–This brings us back to yesterday’s closing question. The structural imbalances in the world economy are nearing the breaking point. But what will break first? China’s currency peg? Europe’s monetary union? Or America’s distorted consumption-based economy?
–Our answer? All of it will break at about the same time!
–As analyst Jim Rickard has written, there are four alternatives to the current currency regime: multiple reserve currencies, IMF special drawing rights (SDRs), gold, and chaos. The first two results would come from an orderly retreat from the dollar. The second two would come from a disorderly exit. Entropy being the way of the world, we’re going for accelerating disorder before the emergence of a new currency standard.
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