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Sunday, October 21, 2012


A)Beware Of The Fake Gold Floating Around

If you are a precious metals investor, the recent news of fake gold bars  showing up in Manhattan should be of interest. News of the existence of tungsten-filled "gold" bars is certainly not new. They have been found in other parts of the world as well. But when people are successfully selling fake gold bars to reputable and knowledgeable gold dealers in the United States, it is time for U.S. based investors to be especially careful with their purchases.
Here are a few things to keep in mind when purchasing physical precious metals:
First, stay small. There is less economic incentive to fake a gold coin as opposed to a gold bar. It doesn't mean there aren't fake gold coins floating around (there are). But if you stick with a reputable dealer, and you know what a real coin looks like, you are less likely to get scammed than you might be when purchasing a gold bar. Moreover, if you are nervous about buying a fake gold coin, you can always choose to purchase coins that dealers have purchased directly from the U.S. or Canadian Mints.
The American Precious Metals Exchange (APMEX) has a program called MintDirect, which allows investors to purchase unopened tubes of gold and silver coins that came in "Monster Boxes" direct from the U.S. and Canadian Mints. In terms of gold, the 1 ounce American Eagles come in tubes of 20 coins, and the 1 ounce Canadian Maple Leafs come in tubes of 10 coins. Regarding silver, the 1 ounce American Eagles come in tubes of 20 coins, and the 1 ounce Canadian Maple Leafs come in tubes of 25 coins.
Additionally, if you are worried about fake silver coins, you could consider purchasing some of the older 90%, 40%, or 35% silver coins that used to be in circulation. These include silver dollars, half-dollars, quarters, dimes, and nickels. There would far less economic incentive to fake these coins. Although, again, it does not mean that fakes don't exist.
Furthermore, regarding silver bars: if you want to purchase physical bars and think you can avoid fakes by turning to silver, be aware that silver bars stuffed with lead are known to exist.
In terms of finding a dealer with whom to do business, the U.S. Mint has a "Coin Dealer Database" on its website that allows you to search for dealers by state. But be aware that the Mint includes the following disclaimer regarding the database: "The companies that appear on this list are neither affiliated with, nor are they official dealers of the United States Mint."
Also, if your exposure to physical precious metals comes through exchange-traded funds such as GLD, SLV, IAU, or PPLT, you should at least think through the potential for those funds to be backed by fake gold, silver, or platinum. One question to consider is what would happen if an audit of these funds' holdings actually did turn up fake precious metals. What do you think the chances are that investors would actually find out?
Finally, if the possibility of purchasing fake precious metals is a worry with which you do not want to concern yourself, you could always purchase the miners as a means of gaining exposure to precious metals. One of the more popular ways of diversifying exposure to the miners is through the Market Vectors Gold Miners ETF (GDX).

SOURCE   http://seekingalpha.com/


The term "gold standard" signifies a paper money economy in which the
government is contractually bound to convert a unit of its circulating paper
money into an inter temporally constant amount of a real commodity, usually
a precious metal because of the relative transactional convenience of such
conversion payments. Whether or not a country is on a gold standard has
substantial effects on the welfare of its people.
The gold standard first appeared in China during an early-ninth-century
renaissance in ancient Chinese religion and effective democracy and was
consistently maintained there in some form throughout China's lengthy golden
age of technological and economic expansion until the standard, and the
extended renaissance, was finally brought to an end in 1620 with the maturation
of China's unfortunately durable reversion to philosopher  authoritarianism.
Although the idea of the gold Standard was introduced to the West at the end
of the thirteenth century by Marco Polo  who was greatly impressed by the
convertible certificates of the initially silver-rich Mongol Emperors, not until
four centuries later did the gold standard begin an independent life-cycle of its
own in the West.

1. The Rise and Fall of the Gold Standard in the West
Economic folklore attributes the evolution of the gold standard in the  West to the development of a fractional gold­reserve system by seventeenth  century English goldsmiths who lent out a fraction of their idle gold reserves  in exchange for promissory notes that they used to back private
issues of negotiable paper debt, i.e., paper money. But similar private banking
institutions had already developed much earlier without special comment in
medieval Florence and Venice.
The true innovators were the governmental leaders of England's new  democracy following her "Glorious Revolution" of 1688. This path breaking   democratic revolution, while providing a legal and philosophical ("rights-of  man") commitment to compensate the citizen-Soldiers of  the huge new armies   of rifle-equipped Englishmen for their large wartime personal sacrifices, did  nothing to prevent the new democracy from subsequently repealing its debts to  those who had made large wartime financial sacrifices. Yet such Financial   sacrifices had been necessary for the survival of the fledgling democracy  because, as we shall see, military leaders cannot defend a democracy unless
they can override the self-defeating , but narrowly rational -- appeasement response to potential aggressors that characterizes any democratic legislature.
The governmental invention of the gold standard, by solving this critical  problem in defense  finance for the newly forming democratic nations of the West, cleared the path to modernity.
The evolution of the gold standard in the West was thus begun by the  newly established Bank of England during the formative years of what was to  become our first successful national democracy. Then, almost a century  later. after a failed Swedish experiment to establish a national democracy
supported by a cumbersome copper­ standard (1719-1772), a second viable  precíous­ metal standard was adopted in   by the newly formed Bank of the  United States in what was to become our second successful national   democracy.
Then, due largely to the remarkable success of these two nations relative to their neighbors, the standard -- usually accompanied by substantial   democratization -- spread to Continental Europe, Latin America and Japan  during the nineteenth century. The restructured countries similarly enjoyed eras  of remarkably successful national defense and exceptionally high, albeit fitful,overall economic growth. Eventually, in the early-mid 1930s, based largely  upon the cumulative impact of  the "Cambridge School" of  economics led by the  increasingly influential  John Maynard Keynes, each European nation separately  abandoned its gold standard in order to give its central bank greater flexibility   in fighting the unemployment characterizing the Great Depression.

Only the U.S. remained on a gold standard, albeit one with harsh curbs imposed on the export and possession of gold. And only the U.S. could finance  the military defense of the democracies during WWII.
After the end of WWII, an international "gold exchange standard" was  set up. This was achieved by executing a 1944 agreement developed in an  international monetary conference at Breton Woods, New Hampshire, in which  financial representatives of  the democratic nations of Europe all agreed to
work to make their countries' paper currencies convertible into the U.S. dollar  as long as the U.S. maintained a  conversion rate of the dollar into gold in  exchanges with foreign central banks. This internationally cooperative kind of   gold standard effectively served the emergency military requirements of the   recovering European democracies, and in the same  recession- producing way that the internationally individualistic gold  standard had served prior to the early 1930s. Then, upon the completion of a   U .S.­ centered nuclear defense system for the democratic nations of  the West
during the late 1960-5, this last remnant of  the gold standard was quickly phased  out and finally eliminated when the U.S. closed the gold window on 15 August,197l .
Since that date, no government has made a viable claim of convertibility  of its paper money into a real asset of any kind.

2. Business Cycles and the Gold Standard
Because, during periods of free commercialise of paper money into  a real asset, the public is free to exchange idle real commodity stocks for   paper money, or vice verse, the total demand for this convertible paper  completely determines its supply. Governmental monetary authorities then
have no direct control over the money supply. The correspondingly passive  money supply has been generally understood by political economists to be  a property of a classical gold standard since the writings of Adam Smith, as reflected in the policy­  oriented writings of Thomas Tooke and the
English "Banking School" in the 1840s, of J. Laurence Laughlin and the  U.S. "sound money school“ of  the 1890s, and of  the early supporters of the Federal Reserve Act of 1913. All of these authors saw great benefits in the  system's ability to automatically expand and contract its peace time paper
money supply in response to "the needs of trade" without affecting prices  to any significant degree.
Such benefits are absent during periods of suspended or non-existent convertibility. During such periods, independent governments, such as the  contemporary U.S. government, are free to tix their paper money supplies  "exogenously", i.e., without regard to legal commitments. Thus` with
observed governmental monetary authorities unwilling to Surrender their discretionary control to an automatic mechanism, sudden expansions or   contractions in the demand for ìnconvertible paper money have regularly raised or depressed commodity prices and correspondingly generated
avoidable business cycles. This has been well-recognized since the early  days of classical economics, as reflected in Henry Thortons famous  analysis of  the effects of a monetary shock on prices and interest rates  during periods of suspended gold payments. The analysis was placed in
a somewhat more explicit, mini ­general­  equilibrium-type, setting for  permanently in convertible,  money economics in the late 1930s  by Keynes and John R. Hicks and survives today as what is commonly  called "neo-Keynesian macroeconomics".

Examples of such business cycles, and correspondingly of the social value of a passive money supply, are easily supplied. At the time  of this writing,  the last two U.S. recessions provide almost
identical examples of how sudden fluctuations in the demand for a fiat money create
modem business cycles that would have been automatically avoided if we  had adopted a suitable gold standard. The suddenly higher demands for  U.S. paper money, the medium for the payment of U.S. taxes, 'Following  both the mid-1982 and mid-1990 Presidential announcements of near-
future tax-rate increases immediately precipitated almost identical  economic declines rather than immediate increases in the stock of paper  money. In contrast, these recessions would have been automatically  avoided if our paper money supply ,had been freely convertible (into a real asset whose relative price were unaffected by the tax-rate) and therefore automatically expanded part
pasu with the tax needs of trade.
However, a gold-standard produces its own unique brand of  business cycle. In particular, gold-standard depressions occur when, and  only when, there are shocks that increase the equilibrium value of the conversion commodity relative to other commodities, thereby decreasing
the general price level by the Same percentage. A correspondingly severe  gold-standard depression induces a percentage reduction in the endogenous money supply approximately equal to the percentage  reduction in the price of ordinary goods relative to the fixed-price  conversion commodity. In sharp contrast, the same relative demand  shock would occasion no systematic change in the overall price level or  aggregate output if there were an exogenous  currency stock. The
gold ­standard government's inability to so  fix  the paper money supply, and thereby avoid the severe depressions caused by shocks that  significantly increase the relative demand for the conversion commodity,is by far the main disadvantage of a gold standard.
Moreover  such business cycles, including the Great Depression occurred regularly under the gold standard  And  despite the relative ease with which they could be -- and actually were -- predicted by financial  experts, the cycles in real output under the gold standard were of much  greater amplitude and duration than those observed under our recent, in convertible, governmental managed, monetary systems. Viewed solely from the standpoint of the economic costs of  the business cycle, the gold
standard was, therefore, probably, on net, socially disadvantageous.

3. Emergency Finance and the Gold Standard
However, as already noted, by far the main advantage of a gold standard to an adopting country was its historically unique ability to facilitate the financing of large-scale military emergencies. The underlying reason for this ability is that a wartime suspension of a governmental conversion promise is widely regarded as a temporary force majeure, an excusable but temporary supply interruption in an otherwise inviolable contract between a powerful government and an innocent individual citizen,
the latter being conceived of as requiring the substantial protection of the  law. Post-emergency law courts and legislatures therefore typically  enforced depression-producing resumptions of pre-war gold conversion  payments on their paper monies, although usually only after several years
of extended legislative debate during which time suitable revenue-increasing measures could be devised in order to finance the retirement of  the large issues of wartime paper.
Before the nuclear age, when emergency national defense was a  prolonged and expensive affair, this financial advantage had been necessary  for the military survival of national democracies. Theoretically, this  financial sine qua non of pre-nuclear modern democracy arises because
there is a time-inconsistent, overly appeasing, response of any narrowly  rational collection of voters to each in a series of broadly rational threats of  all­  out-war by external aggressors demanding individually small favors. A democratic nation whose leaders are unable to overcome this legislative
appeasement   problem by independently Financing its military defense would, sooner or
later, be subjugated by external aggressors.
More specifically, the late seventeenth century founders of  the Bank  of England were acutely aware both of the historical reluctance of  independent parliaments to supply funds necessary for emergency military  defense and of the recent military failure of neighboring Holland's  pioneering, but short-lived, national democracy. These perceptive British  bankers, along with their new Dutch King, William iii, saw that Holland's  failure was due to the disastrous legal inability of  the Bank of Amsterdam  to expand her innovative paper money supply in a defensive emergency (the  War of 1672). This unfortunate infeasibility was due to a rule in the banks  constitution limiting its issue of paper money to its effective gold reserve.
In any case, the war-troubled William III, his pragmatic English  bankers and a Scottish banking promoter, William Paterson, worked to  create a national paper currency that would flexibly expand during military  emergencies, and do so without creating proportionate increases in the price
level. Under a gold standard, extra paper money could be created and spent  during the defensive emergencies, although convertibility would have to be  temporarily suspended to prevent a  of  the paper money back to the Bank. (The first formal suspension of gold payments thus occurred in
1695, barely one year after the money was first issued; and the suspension lasted only the two additional years that William required to impressively defeat the formidable France of Louis IVX.) The suspension-induced  expansion of the paper money supply would in turn cause some wartime
inflation. But since the new paper money represented a durable contract  between the individual money-holder and the government meant that  English  judges would likely attempt to enforce an eventual resumption of  gold payments at the original conversion rate as a matter of common law.
Parliament , unwilling to risk yet another constitutional crisis and civil war predictably ordered the resumption of gold payments at the old conversion rate -- and continued to do so until 1931  despite the need for both a real post-war tax increase the finance the payments and a depressionary return to
the pre-War price trend  was the very expectation of this post-war  depression by the financial comm unity that allowed the wartime expansion in governmental purchasing, power that was in tum required for the survival of the democracy.
Then, early in the eighteenth century, after a couple of such wars  widespread parliamentary support arose for large wartime issues of long-term national debt. For such borrowing served as a convenient substitute  for wartime monetary  expansion. Although moderate interest would be due
on such borrowing, repayment could be delayed to dates that would  officially distribute the inter  generational burden of the war in a more  politically acceptable fashion or moderate the social costs of the anticipated  post-war deflation. War finance in countries with mature gold standards
was therefore typically marked by substantial issues of legislatively  approved, long-term, governmental debt as well as by Suspension-induced  monetary expansions. The resulting appearance of a simple willingness on  the part of  the democratic legislatures of gold standard nations to support
defensive warfare with substantial domestic issues of long-term debt has   obscured, for
even the most astute of contemporary economic observers, the basic  problem that the gold standard was solving.
In any case  without the gold standard, emergency finance would  have doubtless remained in the hands of clubs of wealthy noblemen,bankers, and guild aristocrats, groups,,whose peacetime compensation for  their extensive wartime sacrifices depended on maintaining highly elitist
religions and philosophies, anti­modern (although currently re emergent) value systems deserving their countries by exaggerating the personal  wisdom and benevolence of appropriately educated aristocrats.
Indeed, before the nuclear age, no independent nation evolved  aristocracy to a surviving national democracy without the aid of a gold  Standard.

4. Mainstream Macroeconomics and the Gold Standard
This major advantage of a gold standard, although never a  recognized part of mainstream economics, has been particularly obscured  to modern economists by an error in basic Keynesian economics leading to  the theoretical conclusion that a permanent increase in a fiat money supply
lowers interest rates. This theoretical error, the source of a major  unresolved empirical paradox in Keynesian theory called the Gibson  paradox   led Keynes and subsequent generations of economists, to a  dangerously false belief. This was the misbelief that emergency expansions
in a  money supply  which were correctly understood to be permanent  increases in the money supply  would be partially hoarded. Such induced  hoarding would occur because of  the theoretically induced decreases in the  foregone-interest cost of holding money. The increases in commodity
prices during  emergencies would then be proportionately less than the  corresponding money-supply increases. If this is true, then the permanent money-supply increases occurring during a wartime emergency in a flat money economy would produce unambiguous increases in  emergency  governmental purchasing power, just as had occurred for the  temporary monetary expansions that had been induced by national emergencies under the classical gold standard. A correction of this
theoretical error leads to the opposite theoretical prediction. A permanent  increase in a flat money supply in a capital-theoretically correct macro-model, by unambiguously increasing the marginal productivity of capital and leaving the rationally expected inflation rate constant, leads to an  increase in interest rates and therefore an increase in the opportunity cost  of holding money- Dis hoarding, not hoarding, is induced. Such a monetary  expansion thus results in percentage increases in prices that  the  percentage increases in money supplies.

Besides freeing us from the Gibson paradox, this theoretical  correction leads us to understand why democratic Europe was so uncharacteristically weak in its response to Fascist aggression in the late
1930s. It also enables us to understand why the U.S., the only country that  did not abandon the gold standard, at least in international transactions, was  able to generate uniquely large increases in emergency governmental  purchasing power and, as part of the same process, maintain exceptionally
low interest rates throughout WWII.
Democratic Europe's intellectually  fashionable abandonment of the gold standard in the early 1930s in order  to forestall further depression therefore appears to have been a serious policy error. The fashionable abandonment left democratic Europe wide-open to the threat of all-out attack by rationally selected military fanatics, who then naturally emerged in the mid­late 1930s. The only democratic  nation that was sufficiently resistant to intellectual fashion to remain on the
gold standard, the U.S., was therefore the only nation able to finance a wartime defense effort adequate to the task of "defending the world for  democracy".
Although it may appear peculiar, the mainstream literature on the gold standard has traditionally avoided the important political-economic issues discussed above in favor of narrower and more speculative discussions dealing with the dynamics of international price adjustment.

The latter include: (I) David  seminal discussion of the laissez  faire gold-flows, and corresponding price-level changes, occurring between nations in a suddenly disequillibrated hypothetical world whose only money  consists of full-bodied gold coins; (2) the famous "currency school" versus
"banking school" debate leading to Peel's Bank Charter Act of l 844, which  enshrined Hume's view of the natural adjustment process, except that the Central Bank could respond to a shock inducing continual gold drains by  Bank borrowing (ie. by raising the Banks discount rate) serving to raise
the domestic relative price of gold and thereby hasten the final laissez faire  price adjustment while at the same time preventing a costly overshooting  of gold flows during the adjustment period; and (3) the increasingly  acrimonious post-WWI discussions of the negative short-term employment
effects on other nations of the above,  borrowing  policies (or restrictive short­term trade policies) and the corresponding  international disapproval of gold-hoarding (perennially by France and, in
the critical I929-32 period1 by the United States) to the point that such   borrowing policies were condemned as "not playing according to the rules" of an imaginary international game. The international sensitivity of these dynamical effects is probably what best accounts for the fact that the most  influential authors in the field have traditionally been specialists in  intellectual diplomacy and strategically sophisticated communication.

5. The Broad Price Trends Observed Under the Gold Standard
To describe the basic workings of the gold standard with added  precision, it is help full to assume a zero "transaction­  costs"perfectly   competitive, equilibrium in all markets. Then, multiplying the
governments fixed, inter temporally constant, money price of gold by the  perfectly competitive equilibrium price of any other commodity relative to gold, we can immediately determine the my price of that commodity.
Since this can be done for all commodities, and without reference to the  passively determined money supply, equilibrium relative prices in a perfectly competitive money economy can be determined independently of  the monetary sector. The resulting "classical dichotomy" between the real
and monetary sectors of an economy., which was implicit in most of classical and early neoclassical economics, greatly facilitates the  quantitative analysis of the economy.
In a perfectly competitive economy with a gold standard, idle Stocks  of gold (called "monetary gold" when they are held by financial  institutions), like any other currently non-productive asset„ must be
expected to appreciate at a rate equal to the real rate of  return to holding  currently productive assets. Thus, issuers of gold-convertible paper money  need not pay direct interest on their monies. Indeed, Convertible banknotes  bore no direct interest while money prices in gold-standard economies
generally fell slightly during` peacetime, reflecting the slightly positive real  interest rate on alternative investment goods.
During wartime, when gold standard economies generated large  increases in the money supply and suspensions of gold payments, there were typically substantial releases of monetary gold to the public, roughly  constant money prices of gold, and therefore increases in the nominal prices
of most other goods. Nevertheless, the rational expectation of postwar resumptions of gold conversion payments, and corresponding postwar  reductions in commodity prices implied higher-than-normal rates of return  to holding paper money relative to goods during the wartime emergencies.
Increases in the governments  wartime purchasing power therefore accompanied wartime increases in the governments nominal issue of paper  money. This powerful financial weapon provided a gold­standard  government with a potential wartime increase in zero-interest purchasing power limited only by the government's ability to repay the zero-interest  loan after the war by suitably raising postwar taxes to finance future  conversion payments. The increase in the rationally expected deflation rate  also generated, after the Brie` learning period of 1695-1725, nominal
interest rates that typically remained low (below 5%) during major Wars throughout the gold-standard era despite the obvious wartime increases in both real interest rates and default risks.

But this main advantage of  the gold standard also implied postwar depressions as monetary gold was gradually re accumulated by the central banks which correspondingly increased the value of gold relative to other  commodities. Repetitive innovations economizing on gold conversion
during these resumption periods  first by including silver as a conversion  metal, then by limiting conversion to bullion, then by allowing conversion  into another country‘s convertible currency, then by outlawing the private   hoarding of gold, and finally by restricting gold payments to conversion payments made by a single country to foreign central banks , beneficially  served to mitigate these consistently depressionary resumption costs and create a long-term trend of money prices in the West that was roughly constant throughout the entire quarter-millennial era of its classical gold standard, 1694-1944.
The demise of the international gold exchange standard in the quarter-century following WWII followed closely behind the development of an international system of nuclear defense, because, as already noted, a well—equipped nuclear power does not require large increases in cumulative  expenditures during a defense emergency. As the underlying advantage of the gold-standard was thus becoming increasingly obsolete, the number of real experiences of the emergency financial benefits provided by the gold standard correspondingly diminished. And as the main disadvantage in the form of potential cyclical instability obviously remained  most imminently in the form of a potential worldwide recession if the US,were to attempt a resumption of gold payments that had been suspended since 1968 -- the international political support for a gold standard by practical people rapidly eroded.

6. Emergency Finance After the Gold Standard
Nevertheless, smaller, non-nuclear armed, nations, while likely to be living under a larger nation's "nuclear umbrella", still have been facing substantial emergency financial demands to cover domestic political uprisings. Such countries, even after the abandonment of the BrettonWoods agreement, have typically attempted, quite rationally, to unilaterally keep their currencies convertible into the fiat currency of a large foreign country in order to maintain the financial advantages of a gold standard.However, the repetitive hyperinflation of the 1970s proved that the legal systems of these nations did not treat a domestic government promise to convert a unit of its currency into a fixed amount of an in convertible paper currency of a foreign nation anything like a promise to convert into gold.
The 1980-5 and early 1990s have thus been a period in which these  countries have enlisted the aid of foreign governments, usually through international economic organizations set up at Bretton Woods and  somehow surviving the collapse of the original agreement. to commit themselves to a more durably fixed exchange rate. These recent attempts,although much more successful in controlling the secular inflation rates of small countries, and correspondingly in achieving domestic political stability, have also produced a series of small-country, post-emergency depressions quite analogous to the large-country depressions occurring under the gold standard. Finally, looking to the future, the problem of emergency finance in large Democratic nations has not permanently disappeared. For one thing,the continuing growth of governmental indebtedness beginning about 35 years ago is steadily diminishing the abilities of governmental authorities to finance future emergencies, including domestic emergencies, with ordinary borrowing. There is therefore an increasing need for large democracies to provide mechanisms that will finance future emergencies.But prospective democratic legislatures cannot be expected to adopt  mechanisms that will burden their future economies with post-emergency depressions anything like those observed under the classical gold standard. It follows that if new, depression-resistant, mechanisms of emergency finance are not adopted, and pre- l8th century history and recent trends are any guide, the increasing emergency usefulness of wealthy individuals  relative to ordinary civilians will inevitably lead to a tortuous degeneration  of our effective democracies back into elitist aristocracies such as those that had dominated our governments prior to the rise of the gold standard.

By Earl A- Thonipsori

SOURCE    http://www.econ.ucla.edu


Thursday, October 11, 2012


2.3 The Link Between Deflation and Depression 
Given the above discussion and evidence, it seems reasonable to accept the
idea that the worldwide deflation of the early 1930s was the result of a monetary

contraction transmitted through the international gold standard. But this 

raises the more difficult question of what precisely were the channels linking

deflation (falling prices) and depression (falling output). This section takes a

preliminary look at some suggested mechanisms. We first introduce here two

principal channels emphasized in recent research, then discuss the alternative

of induced financial crisis.

1.Real wages. If wages possess some degree of nominal rigidity, then falling
output prices will raise real wages and lower labor demand. Downward

stickiness of wages (or of other input costs) will also lower profitability, potentially

reducing investment. This channel is stressed by Eichengreen and Sachs

(see in particular their 1986 paper) and has also been emphasized by Newell

and Symons (1988).

Some evidence on the behavior of real wages during the Depression is presented

in table 2.5, which is similar in format to tables 2.2-2.4. Note that

table 2.5 uses the wholesale price index (the most widely available price index)

as the wage deflator. According to this table, there were indeed large real

wage increases in most countries in 1930 and 1931. After 1931, countries

leaving the gold standard experienced a mild decline in real wages, while real

wages in gold standard countries exhibited a mild increase. These findings are

similar to those of Eichengreen and Sachs (1985).

The reliance on nominal wage stickiness to explain the real effects of the

deflation is consistent with the Keynesian tradition, but is nevertheless somewhat

troubling in this context. Given (i) the severity of the unemployment that

was experienced during that time; (ii) the relative absence of long-term contracts

and the weakness of unions; and (iii) the presumption that the general

public was aware that prices, and hence the cost of living, were falling, it is

hard to understand how nominal wages could have been so unresponsive.

Wages had fallen quickly in many countries in the contraction of 1921-22. In

the United States, nominal wages were maintained until the fall of 1931 (possibly

by an agreement among large corporations; see O'Brien 1989), but fell

sharply after that; in Germany, the government actually tried to depress wages

early in the Depression. Why then do we see these large real wage increases  
in the data?

One possibility is measurement problems. There are a number of issues,

such as changes in skill and industrial composition, that make measuring the

cyclical movement in real wages difficult even today. Bernanke (1986) has

argued, in the U.S. context, that because of sharp reductions in workweeks

and the presence of hoarded labor, the measure real wage may have been a

poor measure of the marginal cost of labor.

Also in the category of measurement issues, Eichengreen and Hatton

(1987) correctly point out that nominal wages should be deflated by the relevant

product prices, not a general price index. Their table of product wage

indices (nominal wages relative to manufacturing prices) is reproduced for

1929-38 and for the five countries for which data are available as our table 
2.6. Like table 2.5, this table also shows real wages increasing in the early

1930s, but overall the correlation of real wage increases and depression does

not appear particularly good. Note that Germany, which had probably the

worst unemployment problem of any major country, has almost no increase in

real wages; 10  

the United Kingdom, which began to recover in 1932, has real
wages increasing on a fairly steady trend during its recovery period; and the

United States has only a small dip in real wages at the beginning of its recovery,

followed by more real wage growth. The case for nominal wage stickiness

as a transmission mechanism thus seems, at this point, somewhat mixed.

2.Real interest rates. In a standard IS-LM macro model, a monetary contraction
depresses output by shifting the LM curve leftwards, raising real interest

rates, and thus reducing spending. However, as Temin (1976) pointed

out in his original critique of Friedman and Schwartz, it is real rather than

nominal money balances that affect the LM curve; and since prices were falling

sharply, real money balances fell little or even rose during the contraction.

Even if real money balances are essentially unchanged, however, there is

another means by which deflation can raise ex ante real interest rates: Since

cash pays zero nominal interest, in equilibrium no asset can bear a nominal

interest rate that is lower than its liquidity and risk premia relative to cash.

Thus an expected deflation of 10% will impose a real rate of at least 10% on

the economy, even with perfectly flexible prices and wages. In an IS-LM diagram

drawn with the nominal interest rate on the vertical axis, an increase in

expected deflation amounts to a leftward shift of the IS curve.

Whether the deflation of the early 1930s was anticipated has been extensively

debated (although almost entirely in the United States context). We will

add here two points in favor of the view that the extent of the worldwide

deflation was less than fully anticipated.

First, there is the question of whether the nominal interest rate floor was in

fact binding in the deflating countries (as it should have been if this mechanism

was to operate). Although interest rates on government debt in the

United States often approximated zero in the 1930s, it is less clear that this
was true for other countries. The yield on French treasury bills, for example,

rose from a low of 0.75% in 1932 to 2.06% in 1933, 2.25% in 1934, and

3.38% in 1935; during 1933-35 the nominal yield on French treasury bills

exceeded that of British treasury bills by several hundred basis points on average."

Second, the view that deflation was largely anticipated must contend with

the fact that nominal returns on safe assets were very similar whether countries

abandoned or stayed on gold. If continuing deflation was anticipated in

the gold standard countries, while inflation was expected in countries leaving

gold, the similarity of nominal returns would have implied large expected

differences in real returns. Such differences are possible in equilibrium, if they

are counterbalanced by expected real exchange rate changes; nevertheless,

differences in expected real returns between countries on and off gold on the

order of 11-12% (the realized difference in returns between the two blocs in

1932) seem unlikely.12
3.Financial crisis. A third mechanism by which deflation can induce
depression, not considered in the recent literature, works through deflation's

effect on the operation of the financial system. The source of the nonneutrality

is simply that debt instruments (including deposits) are typically set

in money terms. Deflation thus weakens the financial positions of borrowers,

both nonfinancial firms and financial intermediaries.

Consider first the case of intermediaries (banks).13
Bank liabilities (primarily   
deposits) are fixed almost entirely in nominal terms. On the asset side,

depending on the type of banking system (see below), banks hold either primarily

debt instruments or combinations of debt and equity. Ownership of

debt and equity is essentially equivalent to direct ownership of capital; in this

case, therefore, the bank's liabilities are nominal and its assets are real, so that

an unanticipated deflation begins to squeeze the bank's capital position immediately.

When only debt is held as an asset, the effect of deflation is for a

while neutral or mildly beneficial to the bank. However, when borrowers'

equity cushions are exhausted, the bank becomes the owner of its borrowers'

real assets, so eventually this type of bank will also be squeezed by deflation.

As pressure on the bank's capital grows, according to this argument, its

normal functioning will be impeded; for example, it may have to call in loans

or refuse new ones. Eventually, impending exhaustion of bank capital leads to

a depositors' run, which eliminates the bank or drastically curtails its operation.

The final result is usually a government takeover of the intermediation

process. For example, a common scenario during the Depression was for the

government to finance an acquisition of a failing bank by issuing its own debt;

this debt was held (directly or indirectly) by consumers, in lieu of (vanishing)

commercial bank deposits. Thus, effectively, government agencies became

part of the intermediation chain.14
Although the problems of the banks were perhaps the more dramatic in the

Depression, the same type of non-neutrality potentially affects nonfinancial
firms and other borrowers. The process of "debt deflation", that is, the increase

in the real value of nominal debt obligations brought about by falling

prices, erodes the net worth position of borrowers. A weakening financial

position affects the borrower's actions (e.g., the firm may try to conserve financial

capital by laying off workers or cutting back on investment) and also,

by worsening the agency problems in the borrower-lender relationship, impairs

access to new credit. Thus, as discussed in detail in Bernanke and Gertler

(1990), "financial distress" (such as that induced by debt deflation) can in

principle impose deadweight losses on an economy, even if firms do not

undergo liquidation.

Before trying to assess the quantitative impact of these and other channels

on output, we briefly discuss the international incidence of financial crisis

during the Depression. 
Author: Ben Bemanke, Harold JamesConference Date: March 22-24,1990

Ben Bemanke is professor of economics and public affairs at Princeton University and a research
associate of the National Bureau of Economic Research. Harold James is assistant professor
of history at Princeton University.

The authors thank
David Fernandez, Mark Griffiths, and Holger Wolf for invaluable research
assistance. Support was provided by the National Bureau of Economic Research and the National
Science Foundation.


10. However, it must be mentioned that recent exponents of the real wage explanation
of German unemployment invoke it to account for high levels of unemployment
throughout the mid and late 1920s, and not just for the period after 1929 (Borchardt  1979).
11. In the French case, however, there may have been some fear of government
default, given the large deficits that were being run; conceivably, this could explain the
higher rate on French bills.
12. A possible response to this point is that fear of devaluation added a risk premium
to assets in gold standard countries. This point can be checked by looking at
forward rates for foreign exchange, available in Einzig (1937). The forward premia on
gold standard currencies are generally small, except immediately before devaluations.
In particular, the three-month premium on dollars versus the pound in 1932 had a
maximum value of about 4.5% (at an annual rate) during the first week of June, but for
most of the year was considerably less than that.
13. The effect of deflation on banks, and the relationship between deflation and
bank runs, has been analyzed in a theoretical model by Flood and Garber (1981).
14. An important issue, which we cannot resolve here, is whether government takeovers
of banks resulted in some restoration of intermediary services, or if, instead, the
government functioned primarily as a liquidation agent.

B)Why the U.S. Has Launched a New Financial World War -- and How the Rest of the World Will Fight Back

For thousands of years tribute was extracted by conquering land and looting silver and gold, as in the sacking of Constantinople in 1204, or Incan Peru and Aztec Mexico three centuries later. But who needs a military war when the same objective can be won financially? Today’s preferred mode of warfare is financial. Victory in today’s monetary warfare promises to go to whatever economy’s banking system can create the most credit. Computer keyboards are today’s army appropriating the world’s resources.
The key to victory is to persuade foreign central banks to accept this electronic credit, bringing pressure to bear via the International Monetary Fund, meeting this last  weekend. The aim is nothing as blatant as extracting overt tribute by military occupation. Who needs an army when you can obtain the usual objective (monetary wealth and asset appropriation) simply by financial means? All that is required is for central banks to accept dollar credit of depreciating international value in payment for local assets.
But the world has seen the Plaza Accord derail Japan’s economy by obliging its currency to appreciate while lowering interest rates by flooding its economy with enough credit to inflate a real estate bubble. The alternative to a new currency war “getting completely out of control,” the bank lobbyist suggested, is “to try and reach some broad understandings about where currencies should move.” However, IMF managing director Dominique Strauss-Kahn, was more realistic. “I’m not sure the mood is to have a new Plaza or Louvre accord,” he said at a press briefing. “We are in a different time today.” On the eve of the Washington IMF meetings he added: “The idea that there is an absolute need in a globalised world to work together may lose some steam.” (Alan Beattie Chris Giles and Michiyo Nakamoto, “Currency war fears dominate IMF talks,” Financial Times, October 9, 2010, and Alex Frangos, “Easy Money Churns Emerging Markets,” Wall Street Journal, October 8, 2010.)
Quite the contrary, he added: “We can understand that some element of capital controls [need to] be put in place.”
The great question in global finance today is thus how long other nations will continue to succumb as the cumulative costs rise into the financial stratosphere? The world is being forced to choose between financial anarchy and subordination to a new U.S. economic nationalism. This is what is prompting nations to create an alternative financial system altogether.
The global financial system already has seen one long and unsuccessful experiment in quantitative easing in Japan’s carry trade that sprouted in the wake of Japan’s financial bubble bursting after 1990. Bank of Japan liquidity enabled the banks to lend yen credit to arbitrageurs at a low interest rate to buy higher-yielding securities. Iceland, for example, was paying 15 per cent. So Japanese yen were converted into foreign currencies, pushing down its exchange rate.
It was Japan that refined the “carry trade” in its present-day form. After its financial and property bubble burst in 1990, the Bank of Japan sought to enable its banks to “earn their way out of negative equity” by supplying them with low-interest credit for them to lend out. Japan’s recession left little demand at home, so its banks developed the carry trade: lending at a low interest rate to arbitrageurs at home and abroad, to lend to countries offering the highest returns. Yen were borrowed to convert into dollars, euros, Icelandic kroner and Chinese renminbi to buy government bonds, private-sector bonds, stocks, currency options and other financial intermediation. This “carry trade” was capped by foreign arbitrage in bonds of countries such as Iceland, paying 15 per cent. Not much of this funding was used to finance new capital formation. It was purely financial in character – extractive, not productive.
By 2006 the United States and Europe were experiencing a Japan-style financial and real estate bubble. After it burst in 2008, they did what Japan’s banks did after 1990. Seeking to help U.S. banks work their way out of negative equity, the Federal Reserve flooded the economy with credit. The aim was to provide banks with more liquidity, in the hope that they would lend more to domestic borrowers. The economy would “borrow its way out of debt,” re-inflating asset prices real estate, stocks and bonds so as to deter home foreclosures and the ensuing wipeout of the collateral on bank balance sheets.
This is occurring today as U.S. liquidity spills over to foreign economies, increasing their exchange rates. Joseph Stiglitz recently explained that instead of helping the global recovery, the “flood of liquidity” from the Federal Reserve and the European Central Bank is causing “chaos” in foreign exchange markets. “The irony is that the Fed is creating all this liquidity with the hope that it will revive the American economy. … It’s doing nothing for the American economy, but it’s causing chaos over the rest of the world.” (Walter Brandimarte, “Fed, ECB throwing world into chaos: Stiglitz,” Reuters, Oct. 5, 2010, reporting on a talk by Prof. Stiglitz at Colombia University. )
Dirk Bezemer and Geoffrey Gardiner,  in their paper “Quantitative Easing is Pushing on a String” , prepared for the Boeckler Conference, Berlin, October 29-30, 2010, make clear that “QE provides bank customers, not banks, with loanable funds. Central Banks can supply commercial banks with liquidity that facilitates interbank payments and payments by customers and banks to the government, but what banks lend is their own debt, not that of the central bank. Whether the funds are lent for useful purposes will depend, not on the adequacy of the supply of fund, but on whether the environment is encouraging to real investment.” 
Quantitative easing subsidizes U.S. capital flight, pushing up non-dollar currency exchange rates
Federal Reserve Chairman Ben Bernanke’s quantitative easing may not have set out to disrupt the global trade and financial system or start a round of currency speculation that is forcing other countries to defend their economies by rejecting the dollar as a pariah currency. But that is the result of the Fed’s decision in 2008 to keep unpayably high debts from defaulting by re-inflating U.S. real estate and financial markets. The aim is to pull home ownership out of negative equity, rescuing the banking system’s balance sheets and thus saving the government from having to indulge in a Tarp II, which looks politically impossible given the mood of most Americans.
The announced objective is not materializing. The Fed’s new credit creation is not increasing bank loans to real estate, consumers or businesses. Banks are not lending – at home, that is. They are collecting on past loans. This is why the U.S. savings rate is jumping. The “saving” that is reported (up from zero to 3 per cent of GDP) is taking the form of paying down debt, not building up liquid funds on which to draw. Just as hoarding diverts revenue away from being spent on goods and services, so debt repayment shrinks spendable income.
So  Bernanke created $2 trillion in new Federal Reserve credit. And now (October 2010) the Fed is proposing to increase the Fed’s money creation by another $1 trillion over the coming year. This is what has led gold prices to surge and investors to move out of weakening “paper currencies” since early September – and prompted other nations to protect their own economies accordingly.
It is hardly surprising that banks are not lending to an economy being shrunk by debt deflation. The entire quantitative easing has been sent abroad, mainly to the BRIC countries: Brazil, Russia, India and China. “Recent research at the International Monetary Fund has shown conclusively that G4 monetary easing has in the past transferred itself almost completely to the emerging economies … since 1995, the stance of monetary policy in Asia has been almost entirely determined by the monetary stance of the G4 – the US, eurozone, Japan and China – led by the Fed.” According to the IMF, “equity prices in Asia and Latin America generally rise when excess liquidity is transferred from the G4 to the emerging economies.”
Borrowing unprecedented amounts from U.S., Japanese and British banks to buy bonds, stocks and currencies in the BRIC and Third World countries is a self-feeding expansion. Speculative inflows into these countries are pushing up their currencies as well as their asset prices, but. Their central banks settle these transactions in dollars, whose value falls as measured in their own local currencies.

Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) and Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy . He can be reached via his website, mh@michael-hudson.com