Posts Tagged ‘government’

How are governments driving up fixed mortgage rates?

Thursday, April 23rd, 2009

Newton’s Third Law of Motion says that for every action, there is an equal and opposite reaction. Likewise, in the field of economics and finance, for every government intervention in the financial market, there is always a side-effect (some of them will be unintended).

As Marc Faber reckoned, the bull market for long-term government bonds, which started in the 1980s, has come to an end in late 2008, with a tentative rising trend of long-term government bond yields. With the private sectors all over the world de-leveraging (unwinding of debt) in an unprecedented scale from an unprecedented credit bubble, governments will be forced to fill the slack via bailouts and stimulus. As our of our concerned readers pointed out the government’s “spend, spend, spend” slogan in Can government create jobs?, government budget deficit will be a rising trend all over the world.

Consequently, government borrowings will have to increase (or taxes raised and/or money being printed). In a world where credit is scarce, government demand for credit will make it even scarcer. If the government resort to ‘printing’ money (issuing government bonds from thin air to be sold to central banks who created money from thin air to buy them), concerns about rising long-term government inflation will force long-term government bond yields to go up. As a result, this will result in a trend of rising long-term interest rates.

As fixed rate mortgages tend to follow long-term interest rates, banks will be raising their fixed mortgage rates too.

Can government create jobs?

Thursday, April 2nd, 2009

Recently, one of our readers wrote,

I recently voted against Anna Bligh who?s govt has sent QLD into some $74B debt. Her plans are to keep spending. I found it horrific. The other party reckoned they wouldn?t spend as much and would cut govt spending by 3%. Well, I?m not sure I believed it but voted against the emcumbant anyhow – along with some 40+% of other QLDers. Anna was returned though and now feels that she has a ?mandate? to spend spend spend. It?s an horrific state of affairs. Most QLDers like me wouldn?t have been aware of the extent of govt debt built in in the ?good times?.

If you notice, this “spend, spend, spend” slogan is very strong in United States, Britain, Japan, Australia and maybe China (Premier Wen recently killed off the idea of a second stimulus spending). But Europe are cool about such an idea. Particularly, France wants more regulations in the financial system and threatened to walk out of the G20 Summit if their demand is overshadowed by the “spend, spend, spend” brigade (see France is threatening G20 walkout).

Back in our Queensland, State Premier Anna Bligh promised to create 100,000 jobs over the next 3 years. The State Opposition was so motivated to keep her accountable that they set up a Jobometer web site to monitor her ‘progress’ in her promise. Politicians, in order to win elections, will promise anything and everything even if the promise is dubious in merit. Can the Bligh government really create jobs as they promised? We suppose they are going to achieve that by the slogan of “spend, spend, spend.”

We believe it is not the job of governments to create jobs. Yes, they may employ civil servants to work on the administrative bureaucracy, legal enforcement, national defence and so on. Beyond that, governments cannot produce goods and services. For example, the Federal government’s NBN project has to be contracted to the private sector. Also, governments often end up outsourcing some of their services to the private sector. Given that governments’ general track records on running business enterprises are either non-existent or abysmal, the private sector is still the one that keeps the economy alive and  dynamic, create jobs, innovate and produce goods and services far more efficiently than any governments can do.

How is the Bligh government going to create jobs?

Are they going to employ surplus civil servants for the sake of ‘creating’ jobs? No, that is not a way to keep the economy healthy. If they do that, Queensland will end up with a huge and cumbersome government sector that crowds out and stunt the private sector. A stunted private sector will retard the economy’s potential to innovate, produce goods and services and keep the economy alive and dynamic.

Or are they going to spend it on goods and services produced by the private sector? Well, if there is a structural flaw in the economy (as we said before in Are governments mad with ?stimulating??), then the initial impact of such spending will only serve to primarily bid up the wages of the sectors that receive the government spending and will not solve the root of the unemployment (plus over-employment and under-employment) problem. For example, a redundant financial engineer is not going to be civil engineer overnight to work in the government’s outsourced infrastructure project (structural unemployment). He/she may end up working as a checkout chick/bloke to serve the cashed-up civil engineer at say, Woolsworth (under-employment). The civil engineer, on the other hand, may end up being overworked from the flood of engineering service demand from the government (over-employment).

One day, government expenditure on that sector (e.g. infrastructure) will subside. What happens next? Will the government have to come up with another stimulus spending program to keep the economic jig running? In the previous recession, the Japanese government had to keep the economic ‘stimulus’ pumping to the extent that they were said to have ended up building roads to nowhere.

Thus, even if the government end up boosting employment in the short-term through their “spend, spend, spend” program, it may end up counter-productive in the long run. If “spend, spend, spend” is their only strategy, then many years from now, the government will end up with very little to show for and citizens will be wondering where have all these money been wasted on.

Why should central banks be independent from the government?

Wednesday, July 16th, 2008

Yesterday, one of our readers asked us this question:

Why is it important to keep central banks independent from the government? Wouldn’t it be better if the board of directors of a central bank are selected by the people, and therefore held accountable to the people for decisions, mistakes, and misjudgements?

At what point did central banks become concerned about targeting inflation? Before they existed, inflation was close to 0%, so surely they wouldn’t have been created with inflation targeting in mind?

The more I read, the more I feel that your ideal of a 100% reserve banking system with no central bank is the best way to control inflation (and to allow the people to understand the true cost of government projects [wars, etc] that is currently paid for through inflation). But why didn’t this work in the first place?

To answer these questions, we will turn back to history. As we explained before in A brief history of money and its breakdown- Part 2,

In the first phase, lasting from 1815 to 1914, the Western world was on a classical gold standard. Each national ?currency? was just a definition of a weight of gold. For example, the ?dollar? was defined as 1/20 of an ounce of gold. Each national currency was redeemable for gold on its pre-defined weight. Thus, if a nation were to recklessly inflate the supply of its money, it would run into danger of having its gold drained from its treasury.

Under an international gold standard, there was an automatic market mechanism to keep government from inflating the money supply and to keep each country’s balance of payment in equilibrium. Hence, the world enjoyed the benefits of only one monetary medium, which facilitated trade, investment and travel. Prices were also kept in check (see What is inflation and deflation?). During that time, there were periods of price rises (e.g. during war) followed by periods of price falls (e.g. when war ends), with relatively stable prices in between.

Why did it not work out in the end? Well, thanks to the First World War. As we all know, modern wars are terribly expensive. Under a gold standard, no country can ‘afford’ to fight any war for an extended period of time. Therefore, the only option was to go off the gold standard and resort to purely fiat paper money as it is today. You can read the rest of the monetary breakdown story at A brief history of money and its breakdown- Part 2.

Now, you know how the US is able to ‘afford’ to fight extended wars in Iraq and Afghanistan with expensive professional armies today.  A gold standard will make this truly unaffordable.

Today, the central banks of the US and Australia follows an inflation targeting policy. That is, monetary policy is set ensure that there is a consistent price rise within a target range. How did inflation targeting develop? Well, it is another long story. You can read about it straight from the RBA at Inflation Targeting: A Decade of Australian Experience.

Next, we come to the most important part: why should central banks be independent from the government?

First, we have to understand the basics. What is the purpose of money? In essence, money functions as (1) a medium of exchange, (2) unit of account and (3) a store of value. To perform these functions, money has to fulfil certain properties as described in Properties of good money and its integrity cannot be tampered with.

Now, consider the situation that we described in Recipe for hyperinflation:

… imagine you are the only person in town who has the authority to create money out of any piece of paper with your own signature. Wouldn?t this make you a pretty powerful person in town? With such power, you can acquire anything you wish at the expense of others.

Under the gold standard, gold is money that is under the control of the free market. No one or institution ‘owns’ or control the money. But today, the central bank is the only institution that has the authority to create money out of thin air. As we said in Recipe for hyperinflation,

Look at any piece of paper money today and you will find the words of a government decree (e.g. ?This Australian note is legal tender throughout Australia and its Territories?) and perhaps a signature or two.

In Australia, the signature belongs to the RBA governor.

What if we give the government (which already has executive power) the power to create money? This will give the government a deeper concentration of power! If you believe the old adage that power corrupts and absolute power absolutely corrupts, then you will not want such a deep concentration of power. As we said before in Have we escaped from the dangers of inflation?,

One final word: fiat money is only as stable as the government that enforce it, and only as safe as the stringency and integrity of the central banks who create it. Gold, on the other hand, yield to neither control nor will of any government.

That is why today, central banks are independent of the government, with complex and elaborate rules of money and credit creation (the exception will be Zimbabwe under Robert Mugabe). Our fear is that with this credit crisis worsening by the day, deflation may prove such a unthinkable threat (e.g. see How do we all pay for the bailout of Fannie Mae and Freddie Mac?) that the government will ‘roll back’ all these rules one by one in order to keep the entire financial system solvent. As the ancient Chinese saying goes, the journey of a thousand mile begins with the first step. Therefore, the journey towards a hyperinflation hell will begin with such measures (see Recipe for hyperinflation). Your belief in whether you will see hyperinflation in your lifetime will depend on your faith on the government to maintain the integrity of money.

Next, what if we let the people vote for the board of directors who control the central banks? If shareholders have trouble keeping the directors of their company honest and accountable, then it will be the same for the central bank.