Why Do We Have to Argue the Case for Free Trade?

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I gave the following presentation at a fringe event during the Conservative conference in Birmingham.

Human Co-operation and the Universal Division of Labour

Adam Smith showed us, and it is not disputed internally within the nation, that specialisation in tasks has led to the explosion of the population and material prosperity.  One person the farmer, one the hunter, one the gatherer, one the home maker, etc., with the specialisation always geared to who is best at doing the task. This is accepted by all rational people. Ricardo showed us that what applies to the individuals in the nation should also apply to the free trade between the nations of the world.  It is always advantageous for each nation to concentrate all its efforts to produce things it is best at, even if it could produce some other lesser goods better than the next best producer. So why does this idea meet such resistance? Why do we allow crony capitalists and other vested interests to get a privileged, protected position — such as the European Union farmers when they argue for the Common Agriculture Policy (CAP) — that allows them to push up the prices of their goods and services at the expense of you and me, the consumer?

The Irrefutable Case for Free Trade

David Beckham is a super star football player, who also learned the skills of his father the gas fitter. His father, Beckham senior is a gas fitter who wanted to be a superstar football player Let’s say that David can hire a gas fitter for £20 per hour. With a little practice, he could be twice as efficient as his father. We will imagine that he could market his own gas fitting services for £40 per hour. By playing football, we will suppose that Beckham  can earn £10,000 per hour. Meanwhile, his father the gas fitter couldn’t make more than £1 an hour playing football. Beckham Jnr has a 2-to-1 advantage as a gas fitter, but a 10,000-to-1 advantage football star. If he divides his time equally between gas fitting his own house and playing football, his total output for the week can be valued at: 10 hours gas fitting  x £40 per hour = £400 10 hours football x £10,000 per hour = £100,000 Total output: £100,400 If David’s father divides his time the same way we could value his production as follows: 10 hours gas fitting  x £20 per hour = £200 10 hours football x £1 per hour = £10 Total output: £210 Between them, David and father have produced £100,610 worth of output.

The Law of Association (Mises) or the Law of Comparative Advantage (Ricardo)

Now let’s examine the situation if, as we expect, David hires his father. David’s production can now be valued at: 20 hours football x £10,000 per hour = £200,000 Total output: £200,000 And his father’s at: 20 hours gas fitting x £20 per hour = £400 Total output: £400 Their total output has risen to £200,400.

The Greatest Protectionist Block in European History: The European Union

With this case proven, our politicians should use the irrefutable law of association to call for the dismantling of fortress Europe as it price gouges its hapless taxpayers. The Taxpayers Alliance report “Food for Thought” by Dr Lee Rotherham shows us that the EU protectionist food policies costs the UK £10.3 bn per year or £400 of net disposable income per household. CAP is one aspect of the protectionism sponsored by the EU depriving us of a higher living standard; the real cost of all their interventions is many thousands of pounds per year for the EU taxpayer.

Cobden and Peel

For those interested in free trade, one of Cobden’s finest orations was delivered in the House of Commons on March 13, 1845, and described by John Morley as “probably the most powerful speech he ever made:

Men on the Tory benches whispered to one another, “Peel must answer this.” But Peel crushed in his hand the notes he had made and remarked, “Those may answer him who can.”

The Corn Laws were abolished by persuasive, clear, rational and logical argument. I hope some of the politicians here today will be able to do the same with the protectionist EU, and have that abolished.

Limited Purpose Banking?

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In April, I reviewed Jimmy Stewart is Dead by Laurence Kotlikoff. Yesterday, Jerry O’Driscoll posted a review of his own:

Chapter 1 of the book is titled “It’s a Horrible Mess,” and in it Laurence Kotlikoff, a professor of economics at Boston University, reminds the reader of the breadth, depth, and horror of the global financial crisis. It is a cure for the dispassionate observer of events, an indictment that would send all but those with ice water in their veins to sign up for the Tea Party Express. The book is a particularly well-written account of the crisis that begins in housing finance, spreads throughout the financial system, and then throughout the real economy. The crisis hit in tsunami-like waves beginning in 2007 and continued into 2009. In Kotlikoff’s words, “We thought we had well-functioning banking and insurance companies with competent directors, world-class managers, responsible regulators, and incorruptible rating companies. But overnight, we it learned it was a sham.”

O’Driscoll thinks the Achilles heel of Kotlikoff’s proposals is their reliance on a financial regulator:

Kotlikoff excels at detailing the failings of the existing regulatory structure, but does not explain why his proposed system would work any better. If the regulators at the FFA face the same incentives as do those at the SEC (and the rest of Washington’s alphabet soup panoply of regulators), then we should expect the same outcome. Government regulation, no matter the industry, typically fails for two reasons. First, there is the Hayekian knowledge problem. The information needed for effective regulation is dispersed across firms, the industry, and even the economy. There is no effective means for marshaling and centralizing the information within the agency. Second, regulators are routinely captured by the industry they regulate. Through frequent interaction with members of the industry, regulators come to identify with the industry’s interests over the public’s. The revolving door between industry and government exacerbates that problem.

Even so, he concludes:

There is a great deal to recommend this book. First, there is Kotlikoff’s recounting of the crisis itself. Second, there is sense of the manifest injustice of a system in which bad actors get to gamble with other people’s money. Third, there is the challenge to do something radical to reform a system that is radically dysfunctional.

Read the whole review.

Is there room for Austrian Ideas at the top table?

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In December 2008, Dr Anthony Evans and I wrote an article for the IEA asking, in these testing times for central banks, whether there is room for Austrian Ideas at the top table.

Historically there have been roughly three main ideas that explain macroeconomic fluctuations, and they can be demonstrated with a brief (and highly stylised) overview. The first to emerge stems from Vienna, with the works of Ludwig von Mises and Friedrich Hayek. This focuses on the communicative role played by interest rates, which signal to entrepreneurs the willingness of consumers to forgo current goods for the sake of greater future consumption. When central banks create monetary expansion this disrupts the signal and alters relative prices. Entrepreneurs invest due to low interest rates, but since this is not backed by greater savings the ‘boom’ is unsustainable. When inflationary pressures caused by the printing of money mean that interest rates rise, a recession is the inevitable consequence. The second is associated with John Maynard Keynes and his followers in Cambridge, England (such as Joan Robinson) and Cambridge, Massachusetts (such as N. Gregory Mankiw and Paul Krugman). This approach shifts attention from demand or supply shocks to emphasise the frictions within a market economy that amplify relatively minor shocks into real (i.e. output and employment) effects. Issues such as price rigidity and capital market imperfections are market frictions that require aggregate demand management to overcome. The third main idea is associated with the New Classical and real business cycle (RBC) theorists who view cyclical activity as being the outcome of random productivity shocks. Under certain assumptions supply-side shocks (such as energy prices, changes in productivity, regulations, civil unrest) alter the natural rate of output, and the economy efficiently responds. For simplicity we label these three main frameworks as ‘Vienna’, ‘Cambridge’ and ‘Chicago’, and use doughnut charts to illustrate their similarities and differences: Figure 1: Chicago vs Cambridge vs Vienna

We argue that

the neoclassical synthesis of classical (Chicago) and Keynesian (Cambridge) macroeconomics that underpins central bank philosophy is a necessary but not sufficient use of the ideas available. And as we shall see, current economic conditions are prompting a return to distinctly Austrian (Vienna) ideas across the mainstream media.

We conclude,

There seems to be an increasing acceptance amongst economic commentators that loose monetary policy has fuelled credit bubbles; a too-narrow focus on CPI has prevented central bankers from fully noticing; and the risk of a minor recession should outweigh the threat of future inflation. By providing the context for these ideas we hope this interest is extended to central bankers. In these testing times there should be an open mind for the most appropriate frameworks to influence monetary policy. There is a vacant seat at the top table, and it is time that it was filled.

We encourage you to read the whole article. [prettyfilelist type=”pdf,xls,doc,zip,ppt,img,mp3″ filestoshow=”294,” hidefilter=”true” hidesort=”true” hidesearch=”true” openinnew=”true” filesPerPage=”3″]

Assessing UK Money Supply Measures In Light Of The Credit Crunch

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[prettyfilelist type=”pdf,xls,doc,zip,ppt,img,mp3″ filestoshow=”305,” hidefilter=”true” hidesort=”true” hidesearch=”true” openinnew=”true” filesPerPage=”3″]

The Richard Dawkins Delusion

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Since the 2006 publication, by Bantam Press, of Richard Dawkins The God Delusion many commentators have critiqued it, largely for being an evangelical atheistic attack on religiosityand the mystical mind: The problem, for most commentators, seems to be the evangelical nature of Dawkins’s attack itself rather than the content of his argument. Indeed, I see more attacks on his style than I do on his argument. My contention is that Dawkins makes a categorical error in trying to apply the scientific method of the natural sciences to disprove an entirely logical phenomenon. In terms of logic I shall now attempt to disprove his theses, and to demonstrate that God does indeed exist. Dawkins is a natural scientist. His method of reasoning is firmly rooted in 20th century scientific positivism. Prior to Karl Popper’s Logic of Scientific Discovery (1959), it was assumed that a scientific proposition could only be maintained if it accorded to establishedfact. Popper pointed out that no theory could be maintained if it is refuted by some data of experience. Popper was contrasting say a mathematical proof, which is entirely in the mind (such as 2 + 2 = 4) which needs no empirical testing to prove it, with for example the fact that water will boil at a certain temperature, which needs to be empirically expressed before one believes it. The next step in the process is to declare a theory “un-scientific” if it cannot be refuted by experience. This is reasoning a posteriori dependant on experience. In applying scientific method to the question “does God exist,” the answer from Dawkins is a resounding NO! If these are the rules of the game, then we can only but agree with him. Only the data of experience will now prove to Dawkins that God exists. As we have none that seems credible, it is a matter of Faith. Faith v Science, for the Modern Mind, places most reasoning people in the camp of Science. The un-reasoning mind is therefore deemed to be the religious and mystical mind and somewhat prejudiced and backward and or primitive. Dawkins, in the name of science and what he understands as reason, proceeds to demolish some of the more wildly mystical and witch doctor interpretations and commands of religion with some aplomb. Fair play to the man for sure as they deserve to be savagely attacked by an acute mind such as his. However, as man can introspect as say a chemical or a stone, a gene or any subject of the natural science can not, we have open to us another method of acquiring knowledge, that is via reason independent of experience i.e. knowledge derived a-priori. It should also be noted at this point, that for a thoughtful introspecting human, being capable of making abstract deductions, experience is history and nothing else. It cannot tell us anything but past history, past data series. It can yield up no irrefutable truth, just very good associations, correlations etc. In fact as Dawkins points out, Darwin’s Theory of Evolution is very highly probable to be true, but it has the possibility of being refuted by other experience. As such Darwinian Theory is scientific, but we cannot say for sure, for 100% certainly, that it is true. Whilst Evolution has mounds of scientific data to support it, lots of experience, lots of history, God does not. As Dawkins admits, this does not kill God off stone dead; it just makes God very, very highly improbable whereas something like Evolution, very, very highly probable. I would disagree with Dawkins on this point, God as a scientific proposition is not a conjecture that is capable of being refuted: God is not open to proving or disapproving via experience. Indeed we have open to us introspecting beings the beauty of knowledge acquired a-priori. Subjects of the natural scientist are denied this; the subject of the Human science is not. God exists via the realm of the a-priori, independent of experience, and can never exist in the realm of the a posteriori; by the data of experience or history. What is a-priori correct reasoning? How do you correctly reason? Aristotle worked out that there were three Laws of Logic the formal explanation is as follows:

  1. A=A: The Law of Identity. A table is a table because it just is so.
  2. Not (A and not A): The Law of Non-Contradiction, if I am being boring, then it is not the case that this talk is not boring
  3. A or not A: The Law of the Excluded Middle, if you have two contradictory properties i.e. green and not green, all things are either one of the two, green or not green, and certainly not both.

Any argument that contradicts the above needs to be discarded. A great example of how you can use logic to reason correctly is in maths. For example, we all know that if 2 x X = 20, X must be 10; if you tried to argue it any other way, you would conflict with the Laws of Logic. However, any which way you turn around the equation, with a logical argument, will always lead to a truthful answer, as the premise is correct. This is very powerful because we can establish truthful propositions in logic that can only be refuted should their premise or the deductions from them fall foul of one of Aristotle’s a-priori laws of logic. Not only are the truths of mathematics rooted on the a-priori, so are the truths of the human sciences. For example; the Austrian polymath Ludwig Von Mises shows in his masterful book Human Action (1949) how all the laws of economics can be deduced from the axiom that humans act purposefully. As Mises shows, in order to be, we act purposefully. Not being, we would not act, indeed we would not exist. We act upon satisfying our most urgent needs first, then our second most urgent needs, and so on a so forth. Ranking preferences, with the most urgent needs/demands being satisfied first, the least urgent, the furthest away in time. From this hierarchy we derive the law of demand, the downward sloping demand curve, the law of diminishing marginal utility (see here for a good illustration) and on and on it goes. Lord Lionel Robbins in the masterful 1932 book, TheNature and Significance of Economic Science shows in very clear terms how all the laws of Economics are derived from the a-priori thought process. No data of experience is needed to establish that a demand curve is always downward sloping. This has real meaning in life and imparts upon how man acts in society. Experience cannot refute these laws although many modern economists will produce sets of statistical data that seem to contradict some of the Laws of Economics, but in reality, they have just got whatever they are trying to correlate wrong. A-priori knowledge contains real truths that are not just meaningless tautologies. To try to refute it, you cannot, as you act purposefully to do so. Just as Pythagoras’s Theorem is implied in the concept of a right angle triangle-and we knew about the concept of the right angle triangle before Pythagoras “discovered” his Theorem, so, to do the laws of economics flow from the one irrefutable axiom that humans act purposefully. It is a bit like saying Darwin “discovered” the Theory of Evolution, when what he actually did was articulate it and find very plausible data sets to help explain it to the sceptical mind. Evolution was always there. For all positivist science, it seems to rely on the very negative contention that the existing state of understanding is correct only because nothing has refuted it. This does not mean that what the laws that science rest on may well be truthful, full stop and unqualified. If Euclidiangeometry is tautological, as a positivist would argue, it can tell us nothing useful about the world we experience. For example, in engineering, the laws of Euclidian Geometry applied to construction. The fact that you would not want to knowingly walk on a bridge notconstructed within the confines of the laws of Euclidian geometry, as it would fall down, implies that these laws have a great benefit to our understanding of the world and are not mere tautological propositions that can deliver up no knowledge capable of being acted upon. Likewise, the Laws that govern how this paper has been written on a computer, or transmitted via the internet to someone-else will not be capable of disproving and are therefore un-scientific, they are right otherwise this would never be written and transmitted. My contention is that God exists a-priori and that Dawkins in his dismissal of the cosmological argument of Aquinas in particular, shows his lack of understanding of that argument and the distinction between a-priori and a-posteriori knowledge. Dawkins summarizes (page 77) three of the “five proofs” of Aquinas as “all involve an infinite regress — the answer to a question raises a prior question, and so on ad infinitum.” In his own words, he proceeds to list the three as follows;

  1. The Unmoved Mover. Nothing moves without a prior mover. This leads to a regress, from which the only escape is God. Something had to make the first move, and that something we call God.
  2. The Uncaused Cause. Nothing is caused by itself. Every effect has a prior cause, and again we are pushed back into regress. This has to be terminated by a first cause, which we call God.
  3. The Cosmological Argument. There must have been a time when no physical thingexisted. But, since physical things exist now, there must have been something non-physical to bring them into existence, and that something we call God.

He continues: “All three of these arguments rely upon the idea of a regress and invoke God to terminate it. They make the entirely unwarranted assumption that God himself is immune to the regress. Even if we allow the dubious luxury of arbitrarily conjuring up a terminator to an infinite regress and giving it a name, simply because we need one, there is absolutely no reason to endow that terminator with any of the properties normally ascribed to God.” So to Dawkins, it is an “unwarranted assumption that God himself is immune to the regress.” He does not say why. Why, Richard, is it unwarranted? If it is so self-evident (and needs no further explanation to his readers) that this is unwarranted, why is it not stated? I suspect it is because Dawkins does not know. In the physical universe no physical property is infinite. If this was the case, only it would exist. It does not, as you and certainly I exists along with countless other physical things. So how did we come into existence? The Unmoved Mover of Aristotle (introduced to us specifically in his Metaphysics Book VI, X1, XII and in Physics, Book VII and VIII) comes into play here. The human mind cannot conceive of anything physical without postulating another physical cause for that thing. Cause and effect are a category of the human mind: absent it, and you have no humanmind. All material things have cause and effect; one physical thing bounds another physical thing with nothing being infinite. If nothing is infinite, there simply must be a first cause. Therefore logic clearly dictates that the first cause, if it cannot be physical or material, must be immaterial. We call this God. Unless you are prepared to boot out Logic as a valid system for ascertaining truth, then you cannot escape the undeniable existence of God. Perhaps Anthony Flew, whom Dawkins questioned in his book, realised this line of logic when he converted to a belief in a Deity. An article Dawkins sites in The God Delusion says the following (from Free Inquiry magazine, Volume 25, Number 2): Flew’s Flawed Science by Victor J. Stenger “Fortunately, we can avoid an infinite regress. We can just stop at the world. There is no reason why the physical universe cannot be it’s own first cause. As we know from both everyday experience and sophisticated scientific observations, complex systems develop from simpler systems all the time in nature — with not even low intelligence required. A mist of water vapor can freeze into a snowflake. Winds can carve out great cathedrals in rock. Brontosaurs can evolve from bacteria. And our relatively complex universe could have arisen out of the entity that is the simplest and most mindless of all — the void.” I cannot see how Stenger avoids an infinite regress. The void then becomes the causeless cause, the prime mover or indeed God. Out of the causeless void comes the universe. I cannot throw out the category of my mind that only allows me to understand, or see the world in terms of cause and effect. Like Aristotle, I cannot throw out or suspend logic on this point. I may have reasoned illogically but am certainly unaware of the error. I may have misread Aristotle, but again, cannot see why. In The Ancestor’s Tale by Dawkins (page 467–468), he says, “Heredity began as a lucky initiation of an autocatalytic, or otherwise self-regenerating, process. It immediately took off and spread like a fire, eventually leading to natural selection – and all that was to follow.” So for Dawkins, the initial replicator that kicks it all off is self-causing. I postulate, like Aristotle, that this line of reasoning does not conform to the laws of logic and must therefore be discarded. God (immaterial and unmovable) is the initial cause. What its purpose is is indeed another argument. Applying the method of the physical sciences will not answer the question “is God a delusion?” Only logic will answer that and it is purely a cognitive processof logical deduction. The science of Dawkins is truly wonderful to read. He is a great teacher who unravels some of the beautiful mysteries of the world. For that I thank him. On God, I would advise him to look at the logic of Aristotle and try to refute it.

The Method of An Austrian Hedge Fund

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The most “unpalatable” distinguishing mark that separates Austrians from the mainstream economists is the use of the a priori logical analytical method as opposed to the a posterioriempirical approach to working out the problems that economics poses to us. If you can reason from self-evident propositions and not contradict the laws of logic as you reason, anything you deduce can only be true. Let me give you an example of an Austrian approach, In “The Mystery of the Money Supply Definition” written by Frank Shostak, in (Vol. 3 Num. 4) in The Quarterly Journal of Austrian Economics, the author opens by saying:

According to mainstream economics, the validity of various definitions of money can be ascertained by means of a statistical test. What determines whether money M1, M2, and the other Ms are valid definitions is how well they correlate with national income. Most economists hold that, since the early 1980s, correlations between various definitions of money and national income have broken down. The reason for this breakdown, it is held, is that financial deregulation has made the demand for money unstable. In short, the nature of financial markets has changed; consequently, past definitions of money no longer hold.

Observe that, for the mainstream, the definition of money is established through an arbitrary mixing of various liquid assets and then correlating this mixture with another dubious statistic labeled national income. In other words, any mixture of liquid assets will be classified as money as long as this mixture passes the correlation test. Now, if any mixture of liquidity is accepted, why not include retail good inventories? After all, these inventories might be as liquid as stocks or bonds. Yet, no one would consider these inventories as part of the money supply (Rothbard 1978, p. 149). In short, the mainstream will look at what comes after the fact in trying to get a definition of the money supply and not what comes before. Shostak looks to the past and the origins of money to give us a correct Austrian definition. When we have this definition water tight and under wraps we can then start building theories in economics that will have some predictive ability. The reasoning is concise and straightforward; before money there was barter, but barter was inefficient as you always required a double coincidence of wants to trade. If you did not have this unique set of circumstances, no trade happened. People chose to facilitate transactions where this set of circumstances did not arise, on commodities that were most marketable, such as gold and silver, products that most people wanted and these commodities became money. Money is thus the final commodity for which all goods trade. This is the essence of money, as it has been and as far as we know, as it always will be. It is the principle of being a medium of exchange and only because of this that secondary functions come into being, such as the role of money as a store of value. When we think of money, we must always think of it as the final commodity in exchange, we must think of it as a physical thing in itself. In the modern economy today, because we have electronic money, credit cards, e-money, and paper money all sorts of derivatives that are not just simply weights of precious metal, we should not let this cloud our thought process. The essence of money has not changed. Now that we have a working definition of money, we can now move on to defining what the supply of it is in a given economy. I will suggest to you that we need to have an accurate definition of the supply of money in order to predict currency movements, because currency movements are simply movements in the exchange rates of different national monies. To be able to count the supply of a particular money, peoples’ final commodity in exchange, you need to distinguish between a claim transaction and a credit transaction. Claim Transaction: this is when the owner of the money passes it to say a bank for safe keeping but never loses his ownership claim on it, for example in the case of current accounts. At any point in time, the owner can withdraw this money. Credit Transaction: this is when the owner contracts with a bank to relinquish immediate ownership as he or she deposits the money in a savings account, which has timed withdrawal provisions. The bank in the interim period is then free to lend out this money. As Shostak says, “credit always involves a creditor’s purchase of a future good in exchange for a present good. As a result, in a credit transaction, money is transferred from a lender to a borrower.” As long as you apply this distinction, it then becomes possible to count up the money supply of any given country. The definition of money supply that Shostak settles on is “Cash+demand deposits with commercial banks and thrift institutions+government deposits with banks and the central bank.” He then goes on to say: “This definition shows clearly that any expansion in money supply results solely from central bank injections of cash and commercial banks’ fractional reserve banking.” This is a point we will come back to later. As all economists know, if a supply of a commodity goes up, all things being equal, the price will fall. So if one can successfully define money and thus money supply, one can then see how the price of that commodity changes vis a visother money commodities and it should become possible to predict exchange rate fluctuations. This is the Holy Grail of FX traders and a big claim by me that I will attempt to justify later, but for now let’s turn to the regular theories of exchange rate determination. The Missing Supply Curve Richard G. Lipsey, Professor Emeritus and Fellow of the Canadian Institute of Advanced Research, Simon Fraser University, Vancouver, Canada, produced textbooks that we used as undergraduates at LSE. In one with K. Alec Crystal, they say the following; “The exchange rate is just a price, albeit a very important one. As with other prices, we will approach the explanation of exchange rates from the perspective of demand and supply . . . because one currency is traded for another in the foreign exchange market, it follows that a demand for foreign exchange (dollars) implies a supply of pounds, while a supply of foreign exchange (dollars) implies a demand for pounds.” They then go on in the traditional fashion to show how demand for a Pound Sterling is influenced by the demand for exports from the UK, as people need pounds to pay for the goods, how dividend income from foreign holdings will be repatriated in Sterling, how capital inflows will boost demand for Sterling, and so on and so forth. This is all fine and good, but when they seek to define what constitutes supply, they say the following; “The sources of supply of pounds in the foreign exchange market are merely the opposite side of the demand for the dollars.” Wrong. The critical error is that they have omitted to talk about the physical supply of money; they are just talking about a ratio of exchange. What the modern mainstream method is trying to determine is the price changes between . . . apples in one geographic location, say French Granny Smith’s in France and English Coxes apples in England by noting orders placed for each ones in the other respective geographic locations, then comparing the change in the ratio of demand and saying that the result of this observation will determine the price. This is all very well if the supply of each is the same, but the big error being the failure to understand, if there are only a handful of physical Granny Smiths in France and comparatively small demand in England and smaller demand for the coxes, there still will be a price rise, the value of Granny Smiths produced for consumption, however small in demand in this situation, will go up. Also note, this will only be but to a certain point as people will soon switch to Coxes as the Granny Smiths become too expensive as these are a close substitute. Physical supply matters as do substitutes, not just the demand for one commodity vis a visanother. You can see how we need a correct working definition of money to be able to determine the true definition of the money supply, to be able to count the supply of it to be able to determine its price against other monies. Two errors by the mainstream have been corrected by the Austrian understanding: We need to go back to basics and put the supply curve back into the demand and supply curve framework to get accurate price determination. We need also to resurrect the Purchasing Power Parity theory of exchange rate determination as well. Anyone in business will tell you that all commodities have a floor price and a ceiling price. For example in my industry, people, whatever the demand and or supply situation are only going to pay so much for a sirloin steak. Let us consider a hypothetical example to illustrate the point. If Mad Cow Disease hit the US in a big way and half the available cattle for slaughter were taken out of the human food chain, there would be a severe contraction in supply. With the remaining cattle, presuming consumers still remained loyal to the US beef industry, there would be half as much beef available for consumption. Certain cuts more in demand such as fillet and sirloin would command a more than double price premium, but would the consumer take this? Faced with over a doubling of prices, restaurants’ or Joe public who served or consumed these cuts would have to absorb the price and or pass it on. There is only so much one would be prepared to pay for an evening meal, before one would give up the thought of a juicy succulent steak and switch to another protein such as a chicken breast or salmon portion. This may seem obvious but it is worthwhile pointing this out, for money itself is a commodity as we have established. It is the final commodity in exchange for other commodities. When the money commodity in one geographical jurisdiction becomes too expensive, it pays for people to switch out of that commodity money and move into a cheaper one. This arbitrages away the differences over time and irons out differences in one set of purchasing power parity in one country vis a visanother country. It is quite laughable to hear economic commentators say the dollar is imminently going to fall to 30 – 50 % against the Euro. If that were the case arbitrage opportunities would become so large, as Western Europe and the USA largely consume the same things, that purchasers would switch to where it is so obviously cheap. There seems to be no consensus that the purchasing power parity theory of currencies holds, except you will get more economists saying yes it will in the long term, with a lot disputing this and very few saying it will in the short term. Our research over the last five years indicates that this process can happen, and does happen, surprisingly quickly; take a look at this graph. By simply monitoring the deviation from the quarterly trend, we can see over the many years we have been collecting data, that broadly speaking, if a currency pair is trading 5% beyond its quarterly trend line, a relatively quick re-balancing correction generally takes place. What is more, this usually comes in three spikes, one up and two down. The one up is the market testing the limits on the up phase, the two down is when the initial correction happens, traders can not believe it, they push back up, then the market goes back down and the market starts the correction process. Purchasing power parity matters here and can be very useful in providing indications as to which currencies at any point in time are overvalued re other ones. The underlying trend itself, as opposed to over-extensions beyond trend, is determined by the ongoing relative balance of the two monies in question, ie., a slow upward* moving Quarterly trend is the result of one money supply expanding faster than the other over and above changes in demand. Two potential financial products come out of this. Product 1, a strongest currency fund can be developed off the back of this understanding. For any company who trades in multiple currencies and runs cash surpluses, Product 2, a cash overlay service, applying this methodology, for the treasury departments of companies could always mean that the company remains exposed to the strongest currency only. Suffice it to say, if you know what the real physical money supply is, you can see how the various central banks around the world, intervene via the sale and purchase of bonds in turn supporting certain interest rate policies. The interest rate then has a direct and predictable effect on the determination of the exchange rate on the demand side. This is shown in the following two graphs. The Leading Composite Monetary Index that we have created incorporates among other things the percentage interest rate carry of one currency over another, in this example, the Euro over the Dollar. Actual Austrian Money Supply shows how a monetary disturbance is required to effect an interest rate change: a tightening of your monetary policy v that of another central bank will cause interest rates to go up in your jurisdiction vis a vis the other jurisdiction. Traders will exploit this arbitrage opportunity. Take notes on points A-E on the graph and then see how these points manifest themselves on the Euro Dollar exchange rate shown next. Hopefully you can get the picture as to how powerful this methodology can be regarding the prediction of medium-long term general exchange rate movements. The Moving Time Dimension Mainstream methodologies insist on placing a time dimension on the cause and effect in any given economic situation, so if X takes place then Y will take place with a time lag of A number of months. The Austrian School holds that it is unachievable to regulate actions that are determined by human choice preferences into a fail-safe mathematical model. You can see on the two graphs that points A and B both happen within the same time frame, then point C on the second graph happens some 18 months later. The point is that although the cause and effect of an increase in Austrian Money Supply and the associated effect on its purchasing power parity is certain, when it will happen depends on the subjective valuations of people. So we apply no mathematical tools to help us predict when the effect will be seen, we trade the position as and when it becomes apparent visually. To conclude, there is a role for an Austrian Hedge Fund that applies our methodology to exchange rate determination and indeed to credit spreads.

The Madness of Red Ken

/in /by

This is a tale of folly and destruction by a London socialist on the good people of London, how he imposed a distorted system of road pricing in the form of a new tax that is currently wreaking havoc on London enterprise. It is a tale that I hope never repeats itself on your side of the pond. Ken Livingston, the Mayor of London, is known as Red Ken. In the early 80s he was leader of The Greater London Council (GLC), since abolished. I remember as a child it was common for local boroughs to declare themselves “People’s Republics.” You would have the People’s Republic of Islington, Lambeth, Hammersmith and Fulham, etc. All these areas would take down their flags and lift up over the town halls the solemn red flag. Public money would regularly go to support the Irish Terrorists Sinn Fein who were running a killing campaign in London at the time, and any other left wing cause. Your area would suddenly be declared a “nuclear free zone.” Presumably, the cold war bombs would take note of this and fly off somewhere else if Armageddon ever happened. The GLC was so profligate it nearly bankrupted all local government in London. Eventually, Margaret Thatcher had enough of the “loony left” and she successfully abolished the GLC, whose base was County Hall, that fantastic building directly opposite the Houses of Parliament. It was even sold to a Japanese hotel company as a final victory for Maggie. You would think that that was the end of that, but no—these loony left types never die; they cannot do productive work so they stick around in politics like a slow-burn, malignant cancer. Many on the defunct GLC went on to become Labour Party MPs, including their leader, Ken Livingston. He became the first democratically elected Mayor of Greater London. So 20 odd years after abolishing his seat of power, he is back, and God help us. His main election pledge on becoming Mayor was that he was going to sort out London’s traffic problems. The key policy would be to introduce the Congestion Charge (for more info on the charge see www.cclondon.com), a £5.00 per day charge to all private vehicles with the exception of motorbikes, to enter what is deemed the congestion zone, which basically covers the West End and the City of London. The idea, Ken will very happily tell you, came from the Great Free Market Apostle, Milton Friedman. A secondary benefit will be that the environment will be better and people will have fresher air to breathe, giving improved health, etc. Of course, at no point in time will any jobs be affected. In fact, employment will go up as people will be able to get around quicker and do more things, and since the business environment will be far more pleasant, the centre of London will be a far more desirable place to work and be in. All well-intentioned stuff. As readers of these pages will know, however, what a lefty says and tries to do in practice invariably causes the exact opposite. Although this is not an a priori law and cannot therefore have apodictic certainty, it is however steeped in experience. I am sure that very occasionally you can produce a left winger who actually devises a policy that actually says what it does on the bottle. “C” (for congestion) day was on February 17, one month before the start of Gulf War 2. The  two very solid businesses that I have owned and developed over the last ten years, www.billfields.co.uk and www.directseafoods.ltd.uk possess, amongst other things, two depots in Central London supplying meat and fish products to the very best of the central hotels and restaurants. The Congestion Charge has instantly stopped 100,000 cars per day driving into the zone. This is hailed as a great environmental success, but my London businesses are on their knees. On the very day it was instituted, like-for-like turnover dropped by 9.86% in the meat depot and 9.15% in the fish depot. It has never recovered. This has put both of the London depots into a loss making situation. Loath to make the immediate head-count choices I should make today, we have instead gone out aggressively pitching for new business. These two London depots have expanded their customer bases on the meat side by 10.71 % and the fish side by 5.5%, but still turnover is falling, so head-count will have to take place. We will be putting 10–12 out of my 120 staff on the dole. So much for promoting good working practices in London. It is also worth noticing that I have a fleet of 45 vehicles, of which 27 of them deliver into the congestion charge zone 6 days per week. You can see the math: 27 x £5.00 x 5 days (Saturday is free, small mercies) x 52 weeks = £35,100 p.a. So Ken has successfully stolen £35,100 from me. Direct theft from my personal pocket. It seems the only way I can avoid it is by selling up or ceasing to trade. Now, I have no problem in paying for road use. In fact, in an ideal world we would all pay for road use based on consumption, just as we do for the vast majority of our goods: clearly, it is this that Milton Friedman, Ken’s new-found hero is proposing, not just a straightforward highway robbery tax. However, at present I pay for my road use once by paying road tax. Again, taking my 45 vehicles and multiplying the road tax per vehicle (£160) the cost to me is £7,200 p.a. This is not all I currently pay: I pay a second time on fuel tax and the math on this is even more alarming: we spend £21,000 per month on diesel of which a colossal 80% goes to the Chancellor of the Exchequer, or £16,800 per month  (12 months = £201,600 per year). If this were not enough, I now pay thrice for road use with the £35,100 in congestion charge. The road tax, we are told, pays for the central government’s road programme, the rest goes to the funding of the never-never land known as the welfare state. Of those 100,000 cars not coming into London, there are people like my wife who cannot now be bothered to shop in Selfridges on Oxford Street in the middle of London. Why?  Because it is in the congestion zone. Is it the £5.00 charge?  Not entirely. It is compounded by the hassle of having to phone up and pay, or log onto the internet and pay or, worse still, trying to find a shop that sells congestion charge tickets or a garage to pay for entry. Oxford Street is reporting a whopping £2m per day loss of trade since the inception of the charge every day, seven days a week. Shops and restaurants are already sacking staff and what is important to know is that this has nothing to do with the Gulf War 2. This is entirely due to congestion charging in central London introduced by Mayor Ken Livingstone, one month earlier. Westminster Council has told me that their parking meter receipts in the 1st four weeks of the congestion charge have gone down by £1m. Total revenues are £90m p.a. from the parking meters, so they are projecting revenues of £77m this year or 14.5% less income on a key line that for the council has been very static. Revenue from rubbish collection by the City of Westminster has fallen by 5% in the 1st month of the congestion charge, another good indicator of the decline of commercial activities. But what about the working man and woman? Well the working man in the congestion charge zone is being made redundant by people like me and the tens of thousands of London businessmen who employ everyone in the private sector as we have all had 10% of our customer base extinguished overnight. They are then hit again as they have to pay to get in to work. Take the case of the Smithfield Meat Market workers. They start at anytime from midnight to 3:00am  when there is no public transport to take them to work—so they come by car. They leave work after 7:00 a.m. when the Congestion charge kicks in. So you see there is no choice for these workers, any more than there is me and my businesses which work on this sort of time base. If you assume the average male working man’s earning of £24,000 p.a., “take home” pay is approximately £1,250 per month. The average month has 21.75 (Monday–Friday) working days, so that’s 21.75 x £5 = £108.75 per month—or a massive 8.7% of net disposable income. What a disgrace that night workers such as this have had a 9% tax to work nailed on them. Needless to say, what does this do to the incentive to work? Ken’s answer is for all those fat cat bosses who are earning billions and billions of pounds to pay for their staff to come to work. Oh yes, I forgot—that’s us. The problem is, Ken, you have sucked all those billions out of the London economy. So no can do. Socialists like Red Ken and his loony left co-conspirators never learn or never want to learn basic lessons of economics. If you put the price of something up and the supply stays the same, at the margin, less will be demanded as other things fall into people’s priorities. Price access to London, less people, those at the margin will not go in. They will not spend the money on all the goods and services that they usually would. This swiftly translates to lower profits, declining investment, and capital destruction. My meat businesses survived the BSE crisis in ’96 and the foot and mouth crisis of 2001. You really do not expect a fellow human being to wantonly attack your livelihood with such punishing vigour and regularity. Only a politician could do it. I sincerely hope one of Ken’s buses which have the freedom of the city runs him over and that the electors of London demand a cancellation of this wicked scheme. On an environmental note, 20 million people live within 20 miles of London in the Greater London conurbation. We have all accepted congestion and pollution as part and parcel of life and this is traded off against all the benefits one gets from living in or close to one of the greatest urban centres in the world. Why do the politicians insist on deciding what level of pollution is or is not acceptable? Ken hails the better air he has created as a huge part of the success of the charge and he wants to extend it to cover all of London. I am sure all people, whilst we like less congestion and better air, would rather have viable businesses and jobs. I used to be tongue in cheek to anyone who asked what my feelings were toward my support for the road systems. My answer was that I would rather meet highway robbers such as the infamous Dick Turpin on the highways and byways than Red Ken; at least I might have an honest conversation with a gun pointing at me, such as: “Sir, stand and deliver, your money or your life?” I actually mean it now. I fancy my chances with Dick Turpin, while with Ken and his gang it is just a straightforward £35k theft, and a wiping out of profitability within my London businesses. No weasel words with Turpin. According to his demand you still have a choice: pay up or be prepared to fight. Well then: refund our taxes, denationalize the roads. Return them to the private sector and let us pay by usage. What could be more equitable? Stop this madness.