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Britain and European Union – Partly Cloudy With Scattered Showers

Mendip Skies

Mendip Skies

It only rains twice a year in Britain, from January to June and from August to December.

Anonymous (joke)

Partly Cloudy With Scattered Showers

I don’t care what anyone says, I love the weather in Britain. I live in Somerset, one of the wettest counties in England, but also one of the sunniest (unlike Lancashire, which is just wet… and wet). That’s why we grow apples and make cider and hang out in muddy fields around Glastonbury.

Muddy Man

Muddy Man

What does “partly cloudy with scattered showers” mean exactly? That’s the meteorological equivalent of “I’ve got no *!&?ing idea what’s coming”. As the boys around here say, “noo point listenin’ to them forrrrecast son, you just look at them Mendips an’ she tell you al’ you need know”. My house sits on the edge of a village perched on the Somerset Mendip Hills, it looks over fields and forest but beyond that rolling green horizon, it drops down to the West coast of the Britain. Next stop New York. So the weather comes in from the Atlantic un-filtered, unrestrained and variable, very variable. But it makes for an interesting life. Today I meant to mow the lawn, but it was raining. Looking over the hills I knew it didn’t have legs and that we’d get some sunshine in the afternoon so, instead I stayed inside to write this post and mowed the lawn after lunch. See? Life could be worse.

But on this lowly, rainy island there are clouds gathering on the political horizon. It’s about Europe… and its “ever-closer” political union. Just like the British weather, it’s proving remarkably difficult to call. So I’m ditching the forecasters, the pollster, the media commentators and the politics of the situation and I’m just looking at the hills. In the skies of an EU referendum, from my house in Somerset, this is what I see; raw, untamed, without the complex political analysis or deep philosophy.

Most of you will wonder what has happened. One minute I’m talking about monetary inflation and the next European politics. But they’re related, of course. Wayward economic policies of the twentieth century were a precursor to the devastation of war. After WWII, Europe, devastated, came together at last and vowed never to let it happen again. They signed the Treaty of Brussels in 1948 and the Treaty of Paris in 1951, both of them could be summed up in one sentence “let’s stop spending all our energy making weapons to annihilate each other and try and do something productive for all of us”. And so the European Project began. Historically, the European union (with a small “u”) can be seen as an accumulation of treaties between European countries. So, you see, the economic predicament of Europe in the 1900’s has everything to do with the EU referendum. I just haven’t got enough time in the day to tie the two stories together articulately. Sorry…

BREXIT Tailwinds

A few short years ago the idea of Britain Exiting the EU, the “BREXIT” idea was a speck on the political landscape. A tiny piece of cloud, a wisp of stratocumulus drifting aimlessly, helplessly in the North Atlantic destined to be burnt out by the omnipresent heat of the sun. Somehow, between then and now, conditions aligned and it gathered energy, force and mass and now resembles something of a geopolitical hurricane with a path predicted to hit Western coast of Europe with great violence next month. So what happened? How did this come about? I’m examining the tailwinds to the BREXIT idea and how this wisp of a cloud managed to garner so much political energy.

On the face of it the likelihood of BREXIT seems absurdly low. The official manifesto of the Conservative Party, or Tories, in Europe is pro-EU, indeed, David Cameron has pretty much staked his job on it. But also the second, third and fourth most powerful parties (Labour, Scottish National Party and Liberal Democrats) are distinctly pro-EU. That leaves only the, very poorly-represented (and diminishing), UK Independence Party and a few Tory back-bencher dissidents feebly holding up the BREXIT campaign. To add to this, the UK voters are generally quite conservative bunch, who grumble and groan but generally only vote for change when the stress has stretched to palpably painful proportions. If life is OK, don’t bother changing it.

This is a non-issue right? The “RemaIN” campaign will win hands down, it’ll be a wash-out. Why are we and the markets even contemplating the notion of a BREXIT? What happened? I’m setting out on a voyage of discovery to find the answer to this question, and it starts exactly two years to the day, May 22nd 2014.

Why the BREXIT Campaign has gained traction in the UK

Reason 1 – political incohesion

The pro-EU juggernaut in Britain has a much more powerful political army and a bigger arsenal than the Eurosceptics. Perhaps the most famous “Vote Leave” campaigner, and London Mayor, Boris Johnson is right, this is a David versus Goliath match up. In choosing to part from Goliath (and his Prime Minister and party leader, David Cameron) Boris Johnson too has staked his career on the EU referendum.

But, let’s leave Barack Obama, the European leaders and all the large corporations aside for the minute and examine just the domestic political landscape in the simplest terms. With the four most powerful domestic parties in the UK all wanting the same thing (RemaIN) you’d think they’d come together to deliver a powerful and meaningful message together, in unity, in solidarity. I’ve been waiting for this to happen. But so far it has not. At times it’s as though incumbent politicians here are so vehemently against agreeing with anything the “opposition” party has to say that, even on the things they agree on, they choose not to be even in the same room as one another. Perhaps they are saving this moment of union until the eleventh hour when the campaign will suddenly explode into life… but they are running out of time, it is now the eleventh hour and the 58th minute.

On the flip side, the political minnows on the Eurosceptic side (officially the “Vote Leave” campaign) of the fence seem to be delivering clear, succinct messages and are focussing, at least temporarily, on their commonality rather than their differences. There is nothing to corroborate this subjective, cloudy argument. It’s just my opinion. But, if the logic of causality is not there, the results certainly are, because in May of 2014 something quite strange happened.

 

Reason 2 – poor turnout

On May 22nd 2014 Britain went into Local Elections but also, concurrently European Elections, which are held every 5 years around Europe. What is characteristic of both Britain and, indeed, the whole of Europe, was that turnout to European elections is woefully poor. Not only is it poor, it’s getting poorer and has been getting poorer for generation after generation of voter. As the allegedly independent EU media broadcasting site EurActiv informed its readers in a piece, It’s official – last EU elections had its lowest ever turnout:

The updated numbers, published on the Parliament website, show that turnout struggled to reach 42.54% in 2014, well below the 43.1% initially announced.

Diplomatic pencils will be being snapped in despair at the lowest public enthusiasm for an EU poll since 1979, when elections were first held.

Turnout is seen as a litmus for the EU Parliament’s democratic legitimacy by many but it has fallen steadily, from 62% in 1979 to 43% in the 2009 election.

Worryingly for europhiles, the new low will call into in question the legislative credibility of the European Parliament. Guy Verhofstadt, the lead candidate for the liberals and a convinced federalist had initially hailed the marginally-higher turnout estimate, saying the new Parliament “will be more representative than the previous one”.

However you quibble the numbers, the trend in the charts is apparent; even in the “Pillars of Europe” – countries like Germany, France and Italy. Lower turnouts mean that radical parties, both to the right and left tend to get higher representation. Eurosceptic parties are often to be found in the politically peripheral tranches within European states.

But this bears another, perhaps more worrying predicament to the European project, something which the Eurosceptics have been quick to pounce on. Europeans, all Europeans, not just the British, are simply disengaged from the political process and the politics of the European project. Why is this? Is it just too boring? Is it too complicated? Is it by design or by accident? What is unquestionable is that, while over the decades the power of the European Union has increased, public participation in that power has waned. This is a structural shift in the fundamentals of European democracy and it’s easy to see how a Eurosceptic would be quick to jump on this argument as indication of something more sinister beneath the surface.

 

Reason 3 – the mechanics of the voting system

On May 22nd 2016 a party which only has only one seat in the House of Commons (one seat out of 650 seats) rose victorious at the European Elections and triggered a political earthquake in Britain. An earthquake whose aftershocks would be felt on the other side of the Globe for years to come. The party was called the UK Independence Party or UKIP. No prizes for guessing what their agenda was towards Europe – the clue is in the name!

There’s a little quirk in the European voting mechanism that basically states that, provided proportional representation is used to determine the European parliamentary seats, it does not matter which method, specifically, is used.

Firstly, the point about proportional representation. Britain doesn’t have it. Not for general elections at least. We have a First Past The Post (FPTP) system. Take a simplistic and crude example: imagine you have a country with 100 constituencies representing 100 seats in parliament. Imagine you have two parties; Party A and Party B. If in every single one of the 100 constituencies Party A just eeks ahead of Party B by the skin of its teeth, then Party A ends up with ALL the seats in parliament. Not one single seat is attributed to Party B despite the fact it may have won 49% of the votes, proportionally. As far as seats, and thus legislative power is concerned, Party A has a 100% majority, Party B has absolutely nothing. This method has its advantages – favouring two-party systems and thus simplifying or adding clarity to the public political debate and it suppresses destructive extremism. However the main criticism of FPTP is that huge numbers of votes are often thrown away, wasted, ignored and thus it is not a true representation of public opinion or feeling.

The Economist Blog has a good graphical representation of this (the solid blocks representing real seats, the hollow blocks representing voting proportion not allocated as parliamentary seats). It is undeniable that FPTP favours larger parties and suppresses the votes of smaller (allegedly more radical) parties. The pros and cons of voting mechanics is not up for debate in this piece. All that concerns us is the fact that the British are not used to electing powerful governing bodies by proportional representation. But in European elections member states are required to use proportional representation and Britain opted to use a method known as D’Hondt method, named after the Belgian Mathematician and creator Victor D’Hondt. The D’Hondt method is a, rather beautifully simple, mathematical method of counting votes. Like a Blackjack dealer flinging cards across the table, seats are sprayed across the parties by a sort of round robin method based computationally on voting share. I won’t go into too much detail, only to say that this BBC explanation is pretty good.

In May of 2014, the tiny UKIP party stormed to victory due, in part, because the mechanics of the voting process favoured smaller, more radical parties. Of course, UKIP voters would suggest that, actually, it is the current British Parliamentary voting system that is flawed, not proportional representation – the method by which they claimed victory. In the last election the Labour required 34,244 votes per seat in The House of Commons. The Conservatives could feel slightly aggrieved, they required 40,290 votes per seat. A full 6,000 votes more than Labour. UKIP’s ratio was 3.9 million votes per seat. Ironically, while UKIP voters would argue vehemently that proportional representation is actually a fairer way to vote in Europe, it is a case they may not wish to argue too passionately for – after all it was the Big Bad EU that enforced proportional representation on EU voting – thus giving them a voice in Britain in the first place! But let’s face it, proportional representation helps the BREXIT case and there is nothing more proportional than a referendum.

 

Reason 4 – immigration rhetoric

There is no question that the immigration crisis has helped campaign Vote Leave and the BREXIT folk. As Der Spiegel, reports – handling of the immigration crisis has even cost the Great Merkel a great deal of her power. There is a nationalistic element of the Vote Leave campaign which has jumped onto the immigration bandwagon as vindication of how the EU system “simply doesn’t work” and will not ever work for the British nation. But this is not solely nationalistic, there is the antagonistic element that simply points to this as a demonstration of bureaucratic incompetence and political arrogance. That said, the timing of the immigration crisis is unfortunate for the RemaIN cause and will be a thorn in their side right up until election day.

 

I think these are the main reasons why the BREXIT campaign has gained traction over the last few years in Britain. There are of course other reasons; Vote Leave would point to the billions of tax dollars which Britain has exported to the continent as the “cost of membership” but this is balanced by the obvious argument of the economic benefits that have come with free trade, liquid labour and enablement of a “common passport”. I’m not getting dragged into this and other, quite valid, arguments at this stage, only to say that this referendum may be closer than it appears on paper for a variety of reasons.

 

New Romantics

You could thus far describe my post as describing simply the headwinds to the RemaIN campaign. It’s quite one-sided in this respect. But I believe both sides of the arguments have weak points, Achilles heels, which has rendered a strange sort of political stalemate and rhetoric which gives excessive focus on immigration and bizarrely contorted stand-off positions over the philosophy or culture of the European Union as a political establishment.

Hold tight now, dear reader, this is where I offend everyone and show my political naivety. My simple brain buckets UK EU referendum voters into a number of categories ranging from vehement Union-haters to roaring pro-Union fundamentalists.

  • Nationalist-leaning (ANTI EU – Vote Leave). A romantic notion of UK independence from Europe. We never wanted to be part of the European Union never mind an “ever-closer union” going forward. We want to preserve 100% of British sovereignty. The European project is fundamentally broken and always will be – we don’t want to be any part of it. Embodied by, Nigel Farage of UKIP.
  • Libertarian-leaning (ANTI EU – Vote Leave). A romantic notion the best way to affect European policy is to vote to walk away from the status quo. We like the idea of a closer Europe facilitating trade, but the European Union is simply not working and it places too much power in the hands of the governing bodies in Europe. It has to change and the only way we feel our voice will be heard is by voting to exit until suitable reform is made. Embodied by, Boris Johnson of Conservative Party.
  • Moderate Right (PRO EU – Vote RemaIN). A romantic notion that we can change the EU once we’re in it. We are EU reformists, we think the European Union is flawed, perhaps fundamentally so, but we have to be IN the Union to reform it and ensure that reformations are favourable to the British people. Embodied by, Prime Minister David Cameron of Conservative Party.
  • Moderate Left (PRO EU – Vote RemaIN). A romantic notion that the EU is roughly on the right track. Yes there are political and structural flaws to every political system but it’s a complicated challenge. Europe needs to change, but the European project is a long game easily derailed by political short-termism. We’re in and we’re willing to do our part and collaborate with European members. Embodied by, Jeremy Corbyn of the Labour Party.
  • Pro-Euro Activists (PRO or ANTI ???). Arguably the biggest romantics of all, calling for immediacy over European political harmony. Ever-closer-union is good but it’s not happening quickly enough with the EU. I want the Social Democratic United States of Europe and, enough already – get on with it, I want it now!

The final category of people who are so pro European integration that they simply don’t think Europe is moving quickly enough is a hard category to define. I’m not sure who they are or even if they exist, perhaps the younger voters? It’s a wild card. But both sides have Achilles heels which they’re trying desperately to conceal. What I think is interesting about this category is that they are so much in favour of European integration that they may actually be democratic puritans and could conceivably be pushed into an anti-EU stance… that’s the bit that makes us come full circle on the EU debate.

 

Achilles Heel of Vote Leave

Vote Leave actually has two Achilles Heels, one of which is within their control.

The first is the immigration rhetoric. Immigration has become a strong part of the argument, but, as the heat turns up its in danger of turning too nationalistic and they risk losing the moderate Libertarians and will lose all hope of taking Moderate swing voters. This is why I think, ultimately, the RemaIN will win. There are simply not enough Nationalists and Libertarians to get across the line, even with proportional representation. Part of me feels that it’s only a matter of time before a desperate and delinquent member of the Vote Leave campaign says something obnoxious about immigration which turns the Moderates off.

The other Achilles Heel for the Vote Leave campaign is so subtle it barely exists. It concerns the lack of an alternative plan towards a pro-Europe initiative. Because I believe some Vote Leave campaigners are actually pro-European integration of some form. It’s just that they are against the EU, specifically, as the mechanism to achieve this integration. Let’s face it, this is, specifically, an EU referendum, not a necessarily a pro-European integration referendum per se. But this faction of Vote Leave simply cannot present an alternative to European integration as it would be political suicide. They would lose their nationalist core and open themselves to the same criticism they are venting towards the RemaIN candidates, picking holes in the fabric of an inherently complicated political integration plan.

So the tactic is to deliver forceful, yet carefully measured rhetoric on immigration policies of the EU while simply saying that the “EU isn’t working” without ever suggesting a viable pro-European alternative. Putting the onus on the RemaIN campaign to respond.

 

Achilles Heel of Vote RemaIN

The Vote RemaIN campaign have one leading Achilles Heel. Simplifying greatly (as I always do), it basically concerns the answer they must give to the BREXIT slogan “the EU isn’t working”. No doubt, cross-border trade has been liberated, transport and travel has been lubricated along with the positives of a liquid labour force. But, let’s face it, while Europe can claim some of the credit for closing out the Cold War, most of the growth over the last 30 years has been from a rising tide of globalisation lifting all boats. By this measure Europe, crippled by chronic Eurosclerosis, has fallen woefully behind the US and other First World counterparts (including the UK, in isolation) on a relative basis. Of course, the economy isn’t everything, but from an economic perspective, it’s hard to fight the Vote Leave toe-to-toe that the EU is actually working.

But the “EU isn’t working” is a shrewd double-edged sword that the Vote Leave campaign is wielding. Because there is a structural argument about the democracy of the European experiment. In order to answer this question the RemaIN campaign cannot simply say “no, you’re wrong the EU does work”, because they know exactly what the follow up question will be. They must explain how it works, the very fabric of European democracy under the EU vessel. This is wonkish, it’s complicated, it’s not a topic to be taken into open and public debate. So the tactic is, rather than answer this head-on, to grin and bear it as the Vote Leave campaign ask the question again and again, knowing that each silent response adds volume to the Vote Leave thunder cloud. Instead the focus from RemaIN is on the economic credibility of the Vote Leave campaign, citing the potential economic turmoil that could result from an isolationist Britain.

 

It’s a funny sort of dance our politicians do. But, if anything I think this corroborates that a simple YES/NO vote does not mean a simple political debate. Anything but…

 

But I’m going to try and address the question of “how the EU works as a democracy” head on… that’s for another post.

 

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The Nuclear Option: Turbo-Printing

Hyperinflation2      Hyperinflation1 

Quote of the Day

By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

John Maynard Keynes

From Claim-Check Money to Paper Currency

That’s not waste in the wheelbarrow. Each and every one of those bricks is made up of pieces of paper and every piece of paper in every brick in that barrow is a bank note. Real, tangible, fungible, legal tender. Those men must be rich, you must be thinking… except they aren’t. In fact it is the picture of poor men. For these men live in Germany, the Weimar Republic, during a time of the great hyperinflation. Those children playing with blocks of money are not the offspring of uber-rich, profligate parents. Nay, dear reader, they too are the poor children of the Weimar Republic’s inflationary calamity. They have all the currency in the world, and not a shred of money to buy anything with.

How did Germany get to this place? Well, it seems fitting on the Queen’s 90th birthday to talk about one of her relatives: cousin Wilhelm (first cousin, once removed). Aka Emperor Wilhelm II and leader of the German Reich. I’ve told the story of how we got from Anne, the Queen of Great Britain to cousin Wilhelm II, so let me tell you we get from Wilhelm II to that wheelbarrow full of trash… err, sorry, I mean currency.

You remember previously how we said Lydia’s caveman economists were able to derive a new transaction method. Rather than carrying precious (but heavy) metals like gold and silver with them they could transact receipts or “claim-checks” for the metal. There was no risk of the Pebble Hyperinflation of 100,000 BC because the notes were directly linked to (exchangeable for) the precious metal, which had only limited supply.

It’s hard to be a virtuous monetary authority under constant political pressure (as all monetary authorities are). The short-termist remedy to print away one’s political pain is apparently a temptation too alluring for even the most saintly and righteous. And so, right up through the centuries this claim-check-to-precious-metal principle was regarded a good method to control the wayward monetarists our dear Mr Milton Keynes was referring to in our quote of the day.  It did not matter what the paper currency was pegged to, so long as it satisfied the definition of Money: portable, fungible, divisible, durable, store of value. In practice, Gold was used nearly every time. Paper monies which were a claim-check on a tangible amount of gold were said to be on the “Gold Standard”.

 

The Birth of the Weimar Republic

Really, Germany’s* economic problems began when Queen Victoria’s eldest grandson, Wilhelm II. abandoned the Gold Standard to the Deutsche Mark. When Wilhelm’s friend Archduke Franz Ferdinand of Austria was assassinated in Sarajevo by secretive Serbian military forces called The Black Hand, Wilhelm’s German Empire, along with the rest of Europe was, seemingly incredulously, sucked into a massive conflict which (even more incredulously) cascaded into a global war.

When WW1 broke out in 1914, much to the disgust of many prominent German economists at the time, Emperor Wilhelm II decided he would print-and-borrow his way into the war. In economic terms, at least, he was effectively “betting the farm”, “throwing the kitchen sink in” or “swinging for the fences” – choose your metaphor. That is, he was gambling everything, the fabric of the entire economy, on winning the war. Perhaps Wilhelm was uber-confident of the imperious German Navy he had, so attentively, nurtured and invested in. Either way, chips in.

Thus, by the year 1918, following defeat in The Great War, Germany was in a shambolic state, deep in the throes of what would be called “The German Revolution”. This was precipitated by the armed forces themselves – most famously Wilhelm’s beloved German Navy, described in the Kiel Mutiny. The sailors simply refused to battle to the death on the whim of some aloof and distant royalist. It emerged that they had no faith in this Prussian autocratic despotism and it was a mood that swept the country.

Wilhelm was ousted (fled and abdicated) and thus a democratic state (a republic) was elected and brought to govern. Because public anger was so volatile in Berlin (which still had royalist connections), the new-state-forming process was held in a little-known town two or three hundred kilometres South West of Berlin, called Weimar. The newly formed democratic government under the Weimar Constitution thus became known as the Weimar Republic.

 

The Disintegration of the Prussian Empire

But this did little to ease tensions within Germany. The country was teetering on the edge of dissolution and complete disintegration.  The Bavarians tried to create an independent state, The Bavarian Soviet Republic.  They failed, of course, but it highlighted how the fractious fever was creating a mess of what was once a unified empire. A mess compounded by a humiliating punishment the Allies, in particular Britain and France, were imposing in the form of steep reparations (money, capital, land-seizures Germany had to pay) signed by the Treaty of Versailles. As an interesting sidebar, keeping our Austrian angle here for a minute, a heavy majority in both Austria and Weimar Germany wished for Austria and Germany to be reunited as a single state, but, of course, this was strictly forbidden by the other European states in one of the key articles under the Treaty of Versailles.

Tensions in Germany grew to boiling point as Germans felt that their economy simply could not pay the reparations without plunging large swathes of the population into poverty or decades of servitude. Just like our famous Roman Emperor, Diocletian, did with his asset requisitions after Nero had inflated the Denarius to near worthlessness, the Germans too resorted to paying repatriations in basic materials such as steel and wood and coal. It’s funny how, when the going gets tough with currencies, even great, sophisticated economies revert back to the exchange of tangible assets or, what caveman economists such as our dear Lydia would call; real money.

But German workers saw their hard-earned money ending up in the hands of their foreign neighbours who they were only recently at war with. The Belgian and French Occupation of Ruhr, was possibly the final straw. Ruhr was the heartbeat of an industrialized Prussia, and therefore of the German Empire, and the consequential outrage of the occupation was now palpable. The link above shows the ominous translated quote from German Newspaper, Deutsche Allgemeine Zeitung, at the time:

France herself has smashed the dictates of Versailles. But Paris must not think that the German fury is an apparition that belongs to the past so completely as the French imagine, or that it needs guns or bayonets to appear once more on the scene. Any great nation that has been driven to despair has always found the ways and means for its revenge.

Germany took the only power it felt within its grasp at the time: it simply stopped turning up to work in what became an official stance of “passive resistance”, but what was actually politically-sponsored brinkmanship in an orchestrated full-blown general strike. The German economy ground to a halt and was now becoming short of manufactured goods as well as money.

This very simple 4 minute video (love the dramatic music!) shows the rise and fall of the Prussian Empire. While it may be unfair to say that all Prussia’s problems were entirely economic, I think it is accurate to say that the decision to slip off the inherent regulation of a Gold Standard to favour the infinitely printable “Flying Fiat Paper” coincidentally demarked the peak of the Prussian Empire almost to the day. How much causality there is between the two, I’ll leave you to make an intelligent judgement. But after dropping the accountability to Gold, it was an immediate and continuous decline to complete annihilation which ultimately dragged with it the newly-formed Weimar Republic.

 

The Onset of Hyperinflation

Without the regulatory control of money supply, strategic economic blunders were now coming in thick and fast. In a desperate attempt to reassure the striking Ruhr workers, the German government promised to pay workers using the same method it was using to pay repatriations. It was going to simply print more currency… LOADS more currency. The printers were on turbo-drive producing the new currency. A currency which was now a fiat currency, not a ‘claim check’ on anything real with tangible supply.

While the Allies were, obviously, not prepared to take Deutsche Marks for payment. Germany still had to print more and more Deutsche Marks in order to purchase real, hard currency to pay the repatriations. As they printed, the currency would devalue and as it devalued they would have to print more in order to purchase the same hard currency. This cycle was running out of control and fuelling a hyper-inflationary circumstance within the country. What happened next was quite spectacular.

It started out relatively benign: 1 US Dollar was equivalent to 4.2 German Papiermark. I’m not sure what a dollar would have bought our stereotypical housewife, Frau Schmidt, those days – perhaps a bag of groceries, some eggs and bread and a few vegetables. But then, out of nowhere, the same bag of groceries was costing 5 Papiermarks. Before you knew it, the grocery shopping was costing her 10 Papiermarks. Then things started to get absurd, Frau Schmidt’s grocery shop which used to cost just 4.2 Papiermarks was costing 100 Papiermarks, then 1000 Papiermarks before you knew it she was taking money out of the bank, then sprinting to the market store and just chucking handfuls of trash cash, to the tune of millions, at the store owner just to get her eggs and bread. The exchange rate went from 4.2 Papiermark to 4.2 TRILLION Papiermark to the Dollar. You think I’m making this up? Wikipedia does a lovely illustration of how the notes evolved, see here. By the end, the Germans were issuing 100 Trillion Papiermark notes!

Hyperinflation5

I love this article in Germany’s leading news magazine Der Speigel. I quote:

Few people understood what had happened. Even today, three generations later, much of it sounds pretty incredible.

Take for example the family that sold its house to emigrate to America. On arrival at the port of Hamburg, they found that the money wasn’t enough to pay for their crossing — in fact, it didn’t even pay for their tickets back home. Then there was the man who drank two cups of coffee at 5,000 marks each, only to be presented with a bill for 14,000. When he asked why this was he was told he should have ordered the coffees at the same time because the price had gone up in between. And then there’s the story about the couple that took a few hundred million marks to the theater box office hoping to see a show, but discovered it wasn’t nearly enough. Tickets were now a billion marks each.

At the height of the crisis, the inflation rate was in the tens of thousands — per month, that is. And this in the era before the invention of the pocket calculator.

Hyperinflation3            Hyperinflation4

People were taking banknotes and burning them to keep warm because its intrinsic value as plain paper had exceeded its monetary value. Kids were playing with piles of cash on the pavements. Cash became litter, which had to be swept off the street. The fiat currency simply wasn’t worth anything. Banks were taking deposits by the ton only to recycle the paper back into pulp. And once again, people began resorting to tangible caveman capital to transact, as Der Speigel accounts.

Many doctors insisted on being paid not in cash but sausages, eggs, coal, and the like. Because of the constant increase in prices, shops stopped displaying them in their windows. And when the Prussian authorities forced them to do so nonetheless, it drove prices even higher because traders simply took prospective increases into account.

This all sounds rather amusing in hindsight but it was not. It completely levelled the German economy and, in my opinion, was the fault of the over-meddling monetarists. It had to be, nobody else controlled the money supply or its standards. The frustrating thing was, the goods and produce was all there in good supply, there just was no credible money to transact with! To quote again.

Bizarrely enough, goods were no longer in short supply. There was simply no stable currency to buy them with. As the later Chancellor Hans Luther noted in 1923, Germany threatened to “starve with full barns.”

This great Economist article sums up the destructive effect of inflation quite neatly.

HYPERINFLATION is among the worst catastrophes that can befall an economy. It can destroy output and destabilise societies. The hoarding of real assets, such as property and precious metals, wrecks business and financial investment in countries afflicted by it. Business costs soar, as wages and prices have to be increased on an hourly basis, reducing productivity. Foreign investment evaporates as the financial risks of doing business rise. The sudden redistribution of wealth from creditors to debtors can eat at civil society and discredit political institutions. John Maynard Keynes, as early as 1919, recognised the threat inflation posed to modern capitalist societies:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency… [he] was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

 

More importantly, the impact was taken by everyday “Main Street” consumers. Ordinary people took the hit, and they were hit HARD. What was even more demoralising was that hard workers and diligent earners who sought to pay down debts and save nest eggs were obliterated – their savings simply disintegrated. They suffered more than those with massive debt obligations – who fortuitously saw their debts evaporate into thin air. The hyperinflation simply levelled everything and everyone –  it left the economic equivalent of a nuclear holocaust. This was a shock that would be etched into German psyche to this day. Is it any wonder that the German public does not like the ECBs “QE to infinity” which is, effectively money printing on a massive scale? In Weimar Germany, the parabolic rise in consumer prices was accompanied, inevitably, by the fall in living standards with diligent, productive workers and savers hit the hardest. The same Der Spiegel article doesn’t hold back in attributing the rise of Nazism in Germany to the hyperinflationary catastrophe. I quote:

It’s no coincidence that Adolf Hitler’s inexorable rise to power began in November 1923, the highpoint of Germany’s inflation, when he organized the abortive Beer Hall Putsch in Munich.

So, admittedly, the first sentence of this post was incorrect. It was waste in the wheelbarrow. And this is what uncontrolled fiat currency inflation can do to a country.

The rest, as they say, is history…

 

*I use Germany and German Reich/Empire interchangeably – you’ll have to forgive, me dear reader but, frankly, it’s hard to know when to use which. This is where having a more knowledgeable person write your articles will help! But, hopefully, you’ll get the general gist from a financial perspective – which is what I think matters most.

 

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The Real Game of Thrones

Quote of the Day

A Lannister always pays his debts.

A Lannister always pays his debts, that is the motto of the House of Lannister in the fantasy drama; Game of Thrones. Now I think I’ve figured out that this program is fictional, but isn’t it funny how reference to one’s creditworthiness can guarantee so much power?

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Having just returned from a skiing trip in Austria I am completely in awe. The Austrian Alps are a thing of jaw-dropping beauty. The Austrians are friendly and warm-hearted people, even when clumsy Brits are cutting across their skis on snowboards (apparently – I didn’t stop to see the aftermath). I am filled with joy and gay abandon whenever I wake up in the morning to this view of snowy mountain tops and stark rocky crags. I now know what Julie Andrews must have felt like each day. Irrespective of how much Apres Ski had been indulged in the night before, the sheer drama of the topographic backdrop makes one yearn to put on an appropriate frock and frolic in the fields; gaily bounding from one sweetly scented meadow to another yodelling of how the hills were… alive, yes, alive with the sound of music. But, alas, the terrain was steep and covered in snow and, besides, the cold wind would have got up my skirt.

And yet, for every euphoric morning and every exhilarating piste-run, my heart could not help but be thrust into an uncontrollable swirling vortex of sorrow as I found my mind drifting from the sugar-glazed heavens into a dark and melancholy memory-pit of monetary massacre. A magazine rack, pictured below, at Innsbruck airport jolted me back in time to a place when this Germanic outcrop realised that Geld ist nicht alles – Money Is Not Everything. Or, now that we know the difference, I should more accurately say: Currency is not everything it is made out to be. Interesting how the German for Money, “Geld”, looks very much like the word “Gold”, huh?

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You see, this part of the World provided us with perhaps the most audacious money-printing experiment in modern history. It would make even the Flying Money specialist, Kublai Khan, tut in his grave. It didn’t end well … for anybody.

 

The Real Game of Thrones

I quit history at school by the time I was 13 years old. I never really paid any attention during the lessons at school, perhaps I should have. If only someone had told me; when you truly look into it, it was thrilling and as full of incest, violence, nudity and public beheadings as Game of Thrones – only without the dragons [spoiler alert]. But I’ll make an attempt to cover the history (at least from a British angle) leading up to the Weimar Republic in as few paragraphs as possible. Apologies to all who take the subject more seriously (especially my old history teacher) as I will undoubtedly butcher the subject, but here goes…

It starts, rather bizarrely, back in Britain with a rather sad and sorrowful story of a girl, born in 1665 who would become queen. The Brits often joke about how The Royal Family are more German than most Germans, but it’s closer to the truth than most Brits would care to admit. One thing for sure, religion and monarchy have indeed been hugely influential on Europe’s rich and complicated history.

The girl is Anne, and her story is a truly sad one which, like all good tragedies, starts much happier than it ends. It starts with Oliver Cromwell; known to some as the heroic revolutionary and father of British democracy and to others as a genocidal war criminal. But we won’t get into this.

King Charles II            MilliVanilli

Only to note that after his death in 1658, royalist rule had resumed and Anne’s uncle, King Charles II was perching his well-fed rump on the throne of Britain. Nice hair-do mate, but so far no significant German connection to the British royals other than the fact his hair does make him look like the third member of the awesome German 80’s pop duo Milli Vanilli (ahem). Uncle Charles II was your stereotypical hedonistic king who basically drank, ate and shagged anything that moved but, critically, failed to produce any legitimate children. This meant he was succeeded by Anne and Mary’s father, James, who consequently became King James II of England. He was a different man altogether. He had an agenda, outside binge drinking and shagging.

This did mean, however, that Anne and her sister, Mary, were in line to the throne. I have three girls, I simply cannot tell you how many princess costumes I have bought over the last 8 years. Being a princess is surely the dream of every young girl (indeed some young boys) let alone becoming a queen. When Anne was 15 years old her second cousin, a chap called George I Louis von Braunschweig-Luneburg, aka Georg Ludwig of Hanover (no prizes for guessing that he was German not English) visited her for 3 months. While the chattering classes speculated over rumours of marriage, for whatever reason, things didn’t work out that way. This for me is the inflexion point where Anne’s story takes a solemn turn.

Queen Anne of Great Britain

Queen Anne of Great Britain

 

History Skinny – The Last Stuart

It was a time of religious apartheid which divided the country, even families. While Anne and Mary had a protestant upbringing, away from the king and queen, their father, King James II of England was catholic and was moving catholic officials into senior positions in establishment. There was palpable unrest between the ruling establishment and both the protestant elite and public at large.

As they grew older, Anne’s sister, Mary, married a protestant Dutch chap by the name of William of Orange and moved to Holland – almost as if to escape what she may have regarded as the suffocating encroachment of Catholicism. Anne could not attend the wedding as she was bedridden with small pox – a disease that would come to haunt her in later life. But, while Mary was across the sea from Anne, she was never really inert from the politicking in Britain.

Tensions between the ruling British families and elite classes eventually drew Mary’s Dutchman, William, to invade and overthrow hers and Anne’s own father, James II, and dismantle the allegedly predominantly catholic leadership in England in what became known as the Glorious Revolution. Not only did the revolution perceive to triumph protestant faith over the so-called fear of creeping catholic tyranny, more importantly, it swung the pendulum back towards the succession of parliamentary power over family feudalism and autocratic dictation of the monarchy. King William III of Orange took to the English throne with Queen Mary (Anne’s sister) at his side and he was crowned not only King of England, Ireland and Scotland but also the saviour of the protestant faith.

But King William and Queen Mary’s longest lasting legacy had nothing to do with religion or royalty. Sometimes, you see, necessity is the mother of invention. Because, after the English invasion, King William, always wary of the French Navy, wanted most of all to build a powerful navy of his own. But he’d run out of money, the coffers were empty. He needed a massive loan of £1.2 million to achieve such a task so, in order to inspire faith and credibility to the loan, he established an intermediary institution called the Bank of England to effectively syndicate the loan. This was an establishment that took credits and issued notes, but, more importantly managed the Government’s accounts and acted as the banker to the state with a degree of objectivity and independence. The money for his navy was raised almost instantly. Ominously though, William III of Orange, was also the first person to introduce the notion of massive national debt to Britain (as a percentage of GDP).

When Anne’s sister Mary and her husband William died, she was appointed as Anne, the Queen of Great Britain. Like so many monarch rulers before her, her ascent to the throne came by default and as the result of rather inglorious Game-of-Throne-esque culmination of death, sickness, violence and betrayal. Never-the-less the public seemed to warm to her work-ethic, kind demeanour and genuineness.

Alas, Queen Anne’s personal life would be filled with pain, mourning and mental torture. Desperate in her attempts to produce a rightful heir to the throne, she miraculously survived 17 pregnancies but produced no child to take the throne. Conception was not a problem – after marrying, she soon became pregnant but unfortunately had a still birth. However, she gave birth to two daughters soon after. But in a horrific turn of events, in 1687 she miscarried again, her husband caught smallpox and their two young daughters caught it too and died tragically of the same disease. It was documented how heavily she took their deaths, weeping and mourning with her husband as she lay nursing her sick husband. I think that would have broken many women but she continued to try for a child only to suffer another still birth that same year.

The rest of her life seems to lurch desperately from one tragedy to another. I’m frankly amazed this woman lived as long as she did. To quote Wikipedia:

Anne’s final pregnancy ended on 25 January 1700, when she miscarried a stillborn son. She had been pregnant at least seventeen times over as many years, and had miscarried or given birth to stillborn children at least twelve times. Of her five live-born children, four died before reaching the age of two. Anne suffered from bouts of “gout”, pains in her limbs and eventually stomach and head, from at least 1698. Based on her foetal losses and physical symptoms, she may have had disseminated lupus erythematosus, or Hughes syndrome. Alternatively, pelvic inflammatory disease could explain why the onset of her symptoms roughly coincided with her penultimate pregnancy. Other suggested causes of her failed pregnancies are listeriosis, diabetes, intrauterine growth retardation, and rhesus incompatibility.

Anne’s sole surviving child, the Duke of Gloucester, died at the age of eleven on 30 July 1700. She and her husband were “overwhelmed with grief”.

Remarkably, despite all this, Anne, continued to play a very active role in governance and matters of state and some would say it was the continuous work stress, not her own personal hardship, that eventually killed her. Anne, the Queen of England died alone and widowed, in pain, lame and crippled and mentally exhausted. One of her doctors wrote: “I believe sleep was never more welcome to a weary traveller than death was to her”. This was the sorrowful tale of a weeping queen who had a childhood eye-condition causing excessive watering – as though she were continually crying. She was the last of the Tudors to sit on Britain’s throne.

 

Queen Victoria

Queen Victoria

 

History Skinny – The Last Hanover

After Queen Anne of England died heirless in 1714, rather than crown an unwanted (catholic) successor, the monarchy deliberately turned to a familiar face. It was the same bloke that visited but never married Anne all those years ago. Georg Ludwig of Hanover, or King George I, as he became to be known. And so began the House of Hanover. Britain’s royals were effectively a German family right up until the final Hanover – a certain dowdy old dear called Queen Victoria. Now, Queen Vic married a bloke by the name of Prince Albert of Saxe-Coburg and Gotha (no prizes on guessing that he also was German, not British). It’s interesting to note that, in sympathy with rising tensions between Germany and Britain in the early twentieth century, The Royal Family changed their name from the Germanic-sounding Saxe-Coburg and Gotha to that of their favourite English castle: Windsor. Yet to this day the Queen and The Royal Family still open their Christmas presents on Christmas Eve, not Christmas Day – as is the German custom.

Why am I telling you all this, dear reader? It doesn’t pay to switch context so violently between posts does it? One minute I’m talking to you about hyperinflation, fiat currency and Chinese Flying Paper Money and the next I’m spewing forth on our Anglo-German history. With the impending EU referendum looming in the UK, perhaps it seems relevant to revisit some of our intertwined history. But the real reason is that the two stories of hyperinflation and our Anglo-German past are in fact linked, literally by blood.

You see, Queen Victoria’s eldest child (Victoria, The Princess Royal) married German Emperor Frederick III and became the German Empress and Queen of Prussia. The best way to think of Prussia at the time was as the largest, most powerful state in the German Empire (aka the German Reich). The German Empire the was pretty big and powerful by size and even more powerful by GDP prowess. The landmass consumed Germany and most of what we now know of as Poland, for example, and even parts of what is now France. Importantly, it was the mighty, industrial heartland of Europe, capable of producing machinery, goods and, most notably, weapons at a furious rate.

 

Wilhelm II

Wilhelm II

History Skinny – The Last German Emperor

Queen Victoria’s daughter, the now English-Prussian Empress did have children. Most notably, her first son and heir was a chap called Wilhelm II. He rose to rule over the Germanic Empire. But, of course, he had British roots (which were, in fact German roots, which were in fact British roots etc etc). In particular, he shared Grandmother Victoria’s fondness of the Great British Navy, widely regarded as the most powerful fleet of naval vessels in the World, and sought to build his own imperious army of the seas.

But it was his imperious nature and his great navy that would eventually be his downfall. Like the Roman Empire and the Mongol Empire before it, the German Empire’s fate was sealed as much by the weight of its own economic folly as it was by the sword of military combat.

 

 

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From Treasure Money to Fiat Currency

Sparrow

 

Quote of the Day

If you put together all the Christians in the world, with their Emperors and their Kings, the whole of these Christians, – aye, and throw in the Saracens to boot, – would not have such power, or be able to do so much as this Kublai, who is Lord of all the Tartars in the world.

Marco Polo on Kublai Khan (Grandson of Genghis Khan)

 

The Grandson of Genghis Khan

Remember the story of that guy, Temujin, who came to be known as Great Ruler, or Genghis Khan? As a Mongol warrior, the bought the trust of a rival warlord (his father’s blood brother) by offering him the only money at his disposal: a rare animal fur. He then went on to slay his own blood brother, who had defected to become his fiercest rival, and set out slay anyone who stood in the way of him becoming the ruler of the World. Let’s face it, he probably got the closest any single human being has every gotten to achieving that feat.

Well, sable furs are one thing, but in the space of just two generations in China, currency innovation would take a leap that The West would take centuries to orchestrate. By the time Genghis Khan was the Great Ruler of the Greater Middle Kingdom, “flying cash” was flying all over the place and was already well entrenched as the standard money-form. Genghis Khan was wise to accept and adopt this sophisticated economy with its efficient transaction mechanism.

But, Genghis Khan would not live forever. Later, his Grandson, Kublai Khan, took to power as the first Emperor of the Yuan Dynasty and he decided to experiment a little more with the notion of flying cash. “Why did the currency have to be backed by anything with a limited supply, like gold or silver?“, he thought. Money was just paper. Why couldn’t he simply just print money whenever he needed it and ignore the notion of supply and stability? Kublai Khan began to simply print paper without any anchor to tangible money, such as gold or silver. Kublai Khan was seemingly creating wealth by magic, he was printing without the inherent discipline a currency with finite supply enforces. His theory would be to encourage people to use the paper money always and thus avoid any onset of Gresham’s Law by using an ancient technique he’d learnt from this Grandfather… paper money was law and he would chop the head off any person he found not using it. Et, voila! Backed by thin air and threat, the world’s first fiat currency was born.

 

Pirates and Travellers

To this day, when we think of “treasure” we think of gold and silver, pearls and emeralds. Sparkly things that would be of just as much value today as they would have been a thousand years ago. We do not think of a chest full of extinct paper fiat currency. If you’re a pirate and you have paper currency, you spend it. If you are a pirate and have jewels, you put it in a chest and bury it on a tiny island in the middle of the Pacific, leaving one copy of a badly drawn map in the possession of another pirate who can immediately identify the coordinates to the inch (despite the fact it could be anywhere and looks like a 3 year old drew it with a crayon). Everybody knows this – it’s a scientific fact, it’s a mutation of Gresham’s Law.

Well, back in the West (Europe) we had a few “educated travellers” who made it their mission to scamper East to find treasures of their own while miraculously avoided being slaughtered by pirates. In the 14th century Europe had an educated traveller out of Italy by the name of Marco Polo, a man who would be the inspiration for the great discoverer, Christopher Columbus. Marco Polo decided to see what this Asian revolution was all about. He travelled through the Greater Middle Kingdom where he mingled with Kublai Khan and the Mongol elite and made some interesting observations of his own, albeit through slightly rose-tinted spectacles.

 

The Archives of an Educated Traveller

The beauty of what Marco Polo did was, just like Genghis Khan, he was smart enough to carefully document and archive his observations. Incidentally, while many-an-Italian will be quick to tell you that Marco Polo did not introduce pasta to Italy, most will agree that the Chinese were eating pasta-like food as early as 3000 BC. A full 4000 years before any Italian saw a plate full of linguine. But I digress. As an educated traveller with a diligence for recording observations, one could argue that the biggest treasure Mr Polo brought back was INFORMATION. After all, it was eloquent Captain Jack Sparrow himself who said: “not all treasure is silver and gold, mate“. Marco Polo’s written word was indeed a great treasure, his works are publicised in many languages and still read frequently even today. Now, I’m going to be lazy and simply quote someone else’s passage from Marco Polo on the Mongol State, because what Marco Polo observed of the new “flying fiat currency” of China is something to behold.

Currency Manipulation

It will not surprise Austrian economists to hear that the biggest state monopoly concerned the money supply itself. During an era in which Europe’s rulers could do no better than clip coins, the Mongols had succeeded in instituting fiat currency across much of their empire. As Ron Paul puts it, “The emperor, like the vast majority of politicians, found the lure of paper money irresistible”. Polo remarks that the Great Khan’s mint “is so organized that you might well say that he has mastered the art of alchemy”. Indeed, whereas alchemists never did discover the secret of transforming base matter into gold, Polo notes that the Khan’s procedure of issuing paper money “is as formal and as authoritative as if they were made of pure gold or silver”. The state not only turned worthless paper into money but also profited from the wear and tear of the bills: “when these papers have been so long in circulation that they are growing torn and frayed, they are brought to the mint and changed for new and fresh ones at a discount of 3 per cent”.

 

Get a load of this. Not only was Kublai Khan printing his own wealth, he was accepting old notes and issuing crisp, clean new notes for a fee of 3% – the cheeky devil!! Janet Yellen, Haruhiko Kuroda, Mario Draghi you still have so much to learn!

But can you imagine the productivity, the efficiency, the sheer velocity of this new Chinese economy? The autocrats controlled and enforced the money supply and liquidity was vast; trade was booming. If the state or rulers needed more money, they would simply print wealth into existence. Had Kublai Khan, as Marco Polo inferred, conjured the magic of economic alchemy?

For a while the fantasy persisted. But, alas, utopia is not a place where authoritarians print wealth into existence. The wheels began to fall off the cart, the emperor was wearing no clothes… and many more appropriate metaphors as well. I quote again (because I’m lazy). This time a partial excerpt from A History of Money in Ancient Countries.

Population and trade had greatly increased, but the emissions of paper notes were suffered to largely outrun both, and the inevitable consequence was depreciation. All the beneficial effects of a currency which is allowed to expand with the growth of population and trade were now turned into those evil effects that flow from a currency emitted in excess of such growth.

These effects were not slow to develop themselves.cessive and too rapid augmentation of the currency, resulted in an entire subversion of the old order of society. The best families in the empire were ruined, a new set of men came into the control of public affairs, and the country became the scene of internecine warfare and confusion.

… and the same literature goes on to quote…

During the last days of the Mongol dynasty^ in 1351, an effort was made to reform the currency; but by this time the evil lay too deep for remedy; for many kinds of paper money were in circulation ” government, provincial, and private ” besides many counterfeits; and the government was powerless to limit the circulation. The notes therefore continued to depreciate.

The Chinese, once again, were millennia ahead of their time – not only with pasta, but with fiat currency too.  Where it took the Romans centuries to truly obliterate their currency the Chinese succeeded in just a couple of decades. But, while, the flying cash crashed and burn down to Earth at the first bump of turbulence, China had set a precedent. A precedent for systemic financial control, via a currency which could be magically created by the few to be consumed by the many.


 

*Little sidebar. Marco Polo was so intertwined with the Mongol Rulers in particularly Kublai Khan. Given that the Mongolians were admired for their amazing horsemanship in particular a game called “Polo” or The Game of Genghis Khan, it’s natural to draw the conclusion that the name polo is derived from the great explorer Marco Polo. Actually, it is thought that the name for the sport comes from a Tibetan word “pulu” which means “ball”.

 

 

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Legitimacy of Currency

PigOrigami

Quote of the Day

It’s Legal Tender. It’s legitimate currency.

An American man apparently going by the name of ‘Bacon Moose’ who tried to pay for a parking ticket at a Police Station with 137 neatly folded Origami Pigs in a Dunkin Donuts box. Bless him!

 

Gresham’s Law

And so, under the economic weight of its own expanded empire coupled with the abrasion of its self-inflicted inflation, Rome slowly crumbled, like a sandcastle on the beach. Nero tried to reinforce confidence in the currency by declaring it tender for taxes but, alas, the damage was done. The Denarius debasement rendered the currency in the throes of Gresham’s Law.

Gresham’s Law is quite simple: only “trash cash” is pushed into circulation, valuable money is taken out of circulation. Simple experiment: if someone gave you two coins both of the same legal value of 50 cents, but one coin had pot value (once you’d melted it down) of 25 cents and the other had pot value of only 2.5 cents. Which one would you use to pay for your bagel? Because they have the same legal value of 50 cents and despite the fact that neither coin had an intrinsic value equal to 50 cents, everybody would choose to give the shopkeeper the coin with the lowest intrinsic value, the 2.5 cent coin and keep the 25 cent coin. It is thus the trash which finds itself in circulation.

Diocletian came in to reform Rome’s profligacy-induced Gresham Spiral with a heavy hand and had success in parts. But by now Rome was on a slippery slope to financial ruin. Wikipedia’s comment on Diocletian’s draconian taxation techniques did get a wry smile [emphasis mine]:

In the early empire (30 BC – AD 235) the Roman government paid for what it needed in gold and silver. The coinage was stable. Requisition, forced purchase, was used to supply armies on the march. During the third century crisis (235–285), the government resorted to requisition rather than payment in debased coinage, since it could never be sure of the value of money. Requisition was nothing more or less than seizure.

Because the Denarius had been systematically delegitimised, the Romans had to resort to what was effectively a form of Neanderthal Economics, the exchange of physical goods without the existence of a transaction “money”. For centuries after, great economists of great nations were eager to learn lessons from Rome’s fiscal and monetary recklessness, but also to innovate.

One millennium after the collapse of Rome (give or take a century of two) people started to wonder if there were more efficient ways to transact than lumbering around with pockets stuffed with metal, albeit precious metal. By now stories of Lydia, the first great banker, were a thing of myth and legend. But they remembered how Lydia’s investment bank permitted surplus money holders (savers) to invest in private organisations, called “companies”, using Lydia’s process of exchanging certificates for loans and shares in a market place. In Asia’s Middle Kingdom, it gave financial engineers of the 11th century another fantastic idea. What if they stopped using metal coinage itself and just kept the copper/silver/gold securely “in the bank” and transacted only with the paper certificates?

 

Chinese Flying Money

What if, just like Lydia’s certificates for investment, one could merely possess a “claim-check” certificate for the precious metal one kept safely in the bank? These receipts or “claim-checks” on the precious metal acted as a record of ownership or entitlement or record of account. So long as a record of account was kept, many of the transactions could occur without the physical effort of transporting metal in bulk. Of course, the claim-checks, just like the bond and share certificates, have no intrinsic value.

The example often given is that when one hands one’s suit to the dry-cleaners one receives a ticket or receipt which acts as a “claim-check” on that suit. The dry-cleaning ticket has no intrinsic value, it’s a worthless piece of paper, but it’s a claim on the real asset (the suit at the dry-cleaners). Likewise, these claim-checks on real, hard, metal assets in the bank could be just as easily used as money. In fact, it could be made even more efficient, with different claim checks (banknotes) for different quantities of precious metal. People transacting in the market place could simply present these claim-checks in place of metal coinage as they were backed by a true, valued physical asset, the copper/silver/gold piled up in the money bank. Furthermore, because the banks were an integral part of the system money could still be loaned into existence, as we’ve touched on before.

The Chinese were the next great civilisation to take the concept of financial engineering to new heights. They issued money in the form of paper which they called “flying cash” because it could literally fly from your hands. Chinese flying cash was, in fact, backed by real tangible silver and gold… well… initially.

This flying cash was a “currency”, meaning that it was not necessarily money per se. For example, some regard money as an intangible concept, where currency is just the physical thing that represents money in the real World. Remember also Lydia’s Law, rule 5, from my piece, “The Birth of Money”, which stated that money must be a store of value. A claim-check on a pile of precious metal is a store of value. A currency which can, theoretically, be printed ad infinitum and therefore out of existence can be currency, but doesn’t quite fit with Lydia’s definition of money. Hey, just ask Diocletian.

 

SpidermanMoney

Legalisation of Currency

Rome’s financial hardship hadn’t completely gone to waste. In Rome’s attempt to revive the Denarius some interesting observations could be made and applied to the then modern era. For example, if the governing bodies* set the laws of the land; then, by declaring it permissible to pay all debts by the new paper money without risk of the debtor being sued makes them “legal tender”†. Secondly, if the government controls all taxes and levies; the paper notes could also be permitted to be used to pay taxes back to the government.

These were crafty moves for a couple of reasons. Firstly, they intended to give authority and thus confidence to the paper – after all, it’s just a piece of paper, right? Secondly, because the governing body is the essential party in these arrangements it gives the governing body much more economic power and financial control. Of course, we all know that Spider Man’s dad once said… “with great power comes great responsibility”.

The paper currency was indeed flying around. But as flying cash became entrenched, one wondered whether it was the state and monetary powers giving credibility to the ubiquitous paper currency or the ubiquitous paper currency giving power to the monetary powers. Perhaps it did not matter… or perhaps this is another story for another time…

What is interesting in all this is the consistent relationship currency has with debt and the governing bodies. Indeed, if you are bored enough to read the US Coinage Act of 1965 you will note that, I quote [emphasis mine], “United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues”. You see – cash and taxes are unequivocally joined at the hip… it’s the law.

Dollar bills have the words “This note is Legal Tender for all debts, public and private” imprinted on each note. Other, modern notes such as British Pounds and Hong Kong Dollars bear strange language such as; “I promise to pay the bearer the sum of [insert monetary amount here]”. I suppose you knew this, after all, we handle these notes every day, I expect there are some flying cash notes in your pocket right now, dear reader. But why does somebody have to “promise to pay” anybody anything? I have the cash in my hand – I don’t need a promise of anything because it’s right here!? Well, the Bank of England has an official explanation far more succinct than mine:

What is the Bank’s “Promise to Pay”?
The words “I promise to pay the bearer on demand the sum of five [ten/twenty/fifty] pounds” date from long ago when our notes represented deposits of gold. At that time, a member of the public could exchange one of our banknotes for gold to the same value. For example, a £5 note could be exchanged for five gold coins, called sovereigns. But the value of the pound has not been linked to gold for many years, so the meaning of the promise to pay has changed. Exchange into gold is no longer possible and Bank of England notes can only be exchanged for other Bank of England notes of the same face value. Public trust in the pound is now maintained by the operation of monetary policy, the objective of which is price stability.

There you have it. That last sentence says it all. Currency used to be claim-checks on money or Flying Cash backed by physical assets such as Gold and Silver. But the currency of today is backed by some sort of faith-based system and “trust” in the governing bodies to maintain stable prices and thus stable supplies of cash in the system.  That is the ONLY thing preserving the value of your cash and ultimately your livelihood. This is worth emphasising because it has direct consequent to what is happening right now, today, under our very noses.

 


*I refuse to use the term “The Government” or “The State” because we’re prone to relate such bodies to the current affairs and thus politicise the argument. But, in the modern world of finance, the governing bodies could also be a Central Bank or even large, privately-owned financial institutions (commercial and investment banks, insurers etc) which, of course, act independently from the government (so we are led to believe). Note, if you want the “whacky version” there are some conspiracy theorists who think the central banks are a figurehead for some sort of clandestine group of elites or Financial Illuminati, who want to control the world. What is perhaps more believable (or just more boring) is that the true ownership of the Fed is a little bit of a grey area which the Federal Reserve itself doesn’t do a great job of explaining to the public.

†Legal tender for coinage is a quirky little thing. For, example did you realise you could go into a shop and pay for a £10,000 home theatre in ten thousand one pound coins but if, in the very same shop you bought a piece of candy for £0.22 (22 pence) and paid with 2 pence coins the shop would have the right to refuse the eleven 2 pence coins as legal tender? This is cited clearly in The Royal Mint’s legal tender guidelines (or, for you nerds, Coinage Act of 1971, c.24 section 2 (1A)). By the way, for those of you trying to get too clever, don’t do what Mr. Norris of Wichita Falls, Texas did and get yourself for trying to pay his taxes in dollar bills which were so tightly folded it “required tax office personnel approximately six minutes to unfold each bill”.

 

 

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The Bastards of Money

Colossus of Nero

Quote of the Day:

Pol Pot killed 1.7 million people, we can’t even deal with that. I think, y’ know. I think, we think:

  • [that if] somebody kills someone, that’s murder you go to prison.
  • you kill 10 people, you go to Texas, they hit you with a brick… that’s what they do.
  • 20 people you go to a hospital, they look through a small window at you forever…

… and over that, we can’t deal with it, y’ know. Someone who’s killed 100,000 people and we’re almost going… “Well done! Well done. You killed 100,000 people? You must get up very early in the morning”.

Eddie Izzard’s interpretation of how bastards get away with things.

Lydia’s Law

Last post, we saw a fictitious Cavewoman “Lydia”, whose name came from the place where coinage was invented. By the end of her life our little experimental cave village was the fastest economic microcosm on the planet.

Decades, Centuries and Millennia would pass, great civilisations would come and go and none of them would be quite able to match (never mind improve on) Lydia’s economic prowess or the purity of her financial ideology. You see, firstly, the villagers respected debt as a “bond” which held the debtor in servitude or, well, bondage. Just google* “financial bondage” and your search will be awash with religious sites diagnosing financial bondage as existing when: “there is excessive debt or a preoccupation with wealth or misuse of it.” Secondly, Lydia’s financial planners saw the value in efficiencies of coinage and even paper which was backed by real tangible assets, but never strayed from the principles of tangible assets and hard money – whose supply was limited and whose value inspired confidence and credibility. Lydia’s currency regime was born out of the harsh lesson during the dramatic pebble-hyperinflation of 10,000 BC.

It was so beautifully transparent. Follow one simple rule, Lydia’s Law: MONEY MUST BE CREDIBLE. Meaning, primarily, its supply must be stable and transparent and thus its value. If an economic system has this, then other things seem to fall into place. The monetary authorities find it much easier to establish credibility of their own and thus pursue policies targeting investment in long term growth. Even during times of stress, the financial system converges toward stability after a setback. The Banks become safer and and more trustworthy and bad loans, bad banks, bad governments and systemic corruption find it harder to propagate.

 

Chinese Whispers

Of course, over time, people upgraded from copper to even rarer, more precious, metals such as gold and silver. Lydia’s descendants tried their best to stick to the principles the Great Woman laid down, but somehow, as the centuries ticked by, like some historic game of Chinese Whispers, the message got watered down. I use this phrase almost literally, where money is concerned.

You see, the fact that Lydia’s “companies” and “investors” used paper contracts, such as shares or bonds certificates, to move and transact capital or investments led some people to the obvious conclusion that there should also be “paper money” or money which was backed by “real money” such as gold.

You could say the process of monetary de-coupling and then de-basement probably started in magnitude with the two most invincible superpowers of their time (Roman Empire around 2000 years ago and the Chinese Empire about 1000 years ago). These were, if you like, the first global superpowers, but they met their demise by doing what all superpowers eventually end up doing… overreaching, overextending and ultimately overburdening their financial obligations with a budget they could not support and books they could not balance. But they were invincible powers who “owned everything”. What does a superpower do when they need more money? Simple, right? The monetary authorities own the financial system, they own the money… just make more money!

By now Lydia would be turning in her grave. Her first rule of Finance and Economics: MONEY MUST BE CREDIBLE, was being dangerously tested.

 

Emperor Nero: The Bastardisation of Money

The Roman’s had a huge empire and brought civilisation, and with it modern economics, to the World on a massive scale. They had a financial infrastructure and monetary system to boot. Civilians across the empire were required to pay taxes to a centralized body/government and received public works, safety and peace in return. It was a good deal for all. For a long time…

Until an emperor named Nero came to power. To say this guy had an ego was a bit of an understatement. He was an egocentric, megalomaniac of (literally) monumental proportions. If you look up the word narcissist in the Oxford English Dictionary it should simply say: Nero. This dude murdered his mother, then his first wife and was rumoured to have popped off his second wife too. Even by Roman Emperor standards, this was quite a busy schedule. As Eddie Izzard comically quips, murdering megalomaniac rulers have a habit of getting away with behaving like bastards.

The Colosseum, regarded as one of the most magnificent and technologically advanced pieces of civil engineering in history, got its name, not from its own magnificent physical presence, but after the colossal statue Nero had erected of himself, which stood next to it, The Colossus Neronis. Yeh, the figure was approximately the same height as The Statue of Liberty – remember, this was nearly 2000 years ago! Vain perhaps? This is a chap that would make Kanye West look meek and humble.

 

The Fall of the Great Roman Empire

Well Rome burned under Nero (literally, he torched the place). But more important than this, he burnt a massive hole in the budget. Unsurprisingly, Nero had a habit of writing and spending cheques his colossal butt couldn’t cash (mainly on incompetent management and vain projects like his Golden Palace). So the Romans, unable to pay their bills, tried cheating. They broke “Lydia’s Law” and began clipping coins, officially debasing their currency to produce more of it in the hope that nobody would notice the demise in credibility that came with it… indeed, I wrote a couple of pieces about this:

The Denarius was a gold and silver coin which was introduced a couple of centuries before Christ and was the Roman currency and the empire’s equivalent of a global reserve currency. However, in the centuries after Christ, starting around the second century AD, it was systematically debased to pay for Roman fiscal mismanagement and the unsustainable obligations of a far-reaching superpower. In fact one can pin-point the beginning of the decline of The Roman Empire to the decade starting, coincidentally, with the commencement of the debasement of the Denarius. Romans simply kept shaving precious metals out of the coin and replacing the incorruptible silver and gold with a more “faith-based” system of ubiquitous scrap metal + “golden promises” toward a “strong Denarius policy” (heard that one before?). Saving a very brief flirtation by Diocletian to bring back a heavier gold and silver standard, this practice continued until it tarnished the lustre of loyalty; The Roman Empire had no faith, no purchasing power, no wealth and, eventually, no purpose.

As I alluded to, people often look at gold currency in the wrong context; just because the Roman system, and successful monetary systems thereafter, were based off a Gold Standard does not mean that this should necessarily be the currency-base of choice in a modern world. Currency debasement may be more of a symptom of a failing faith-based economy than a cause. Indeed, an interesting observation is that the debasement of the currency not only marked the peak of The Roman Empire, but also that, once momentum against the Roman currency was entrenched, attempts by Diocletian to revert back to a gold standard were a complete failure – if anything further fuelling the inflationary fire.

As the phrase goes for the great narcissistic monument: “As long as the Colossus stands, Rome will stand, when the Colossus falls, Rome will also fall”. Ironic then, that, after debasing the currency, both the fall of the empire and the infamous statue resulted in scenes of “thieves” scavenging the statue for the bronze metal or what they may have regarded as “real money”, in other words.

Spectacular though this seems through the gaze of historic record, the rise and subsequence collapse of The Roman Empire took centuries to play out – it was at glacial pace, comparatively. Superpowers could get away with quite a lot of economic mismanagement back then. This was at a time when there simply was not effective communication between Rome and the outer reaches of the empire nor were there abundant socio-economic alternatives. The demise of The Roman Empire would not even compare to the spectacular collapses which proceeded it. But the Romans had set a precedent for monetary meddling on a macro scale. Future civilizations would extrapolate (Tim Price thinks “extrapolate” is the most dangerous word in investment) Lydia’s concepts of asset-backed paper receipts to new heights and inevitable new lows. The next chapter of this sordid historic tale continues with an even greater civilisation. A civilisation which covered over 3 times as much land mass as The Roman Empire, forged from what they called the Middle Kingdom, or Zhongguo/Zhonghua… otherwise known as China.

 

*Note the small “g” the verb “to google” is now an official word in the Oxford English Dictionary – see, my grammar isn’t crap all the time!?

 

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The Innocence of Debt

 

 

Cash Wave

Quote of the Day

The process by which Money is created is so simple, it repels the mind.

John Kenneth Galbraith (one of the World’s most famous economists)

 

Making Money Out of Thin Air

In the Caveman Capital piece, I challenged the notion that money doesn’t grow on trees. One could make the argument to say it does – it’s just that fruit and wood are just a particularly bad form of money. Similarly, every child has heard their dad say at least once: “what, you think money comes out of thin air?” The answer any child should give to this intended rhetorical question is: “unquestionably, YES, dear father… now, allow me to relieve you of your ignorance…

In my last “Neanderthal Economics” piece (Banking on the Future) we spoke about the World’s first financial entrepreneur – a Cavewoman called Lydia. Lydia had created a form of money out of metal discs, or coins, as they became to be known. She’d also designed a privately-owned institution which could heap or “bank” them up and lend the coins back out again for profit margin.

The model was simple, but it revolutionised productivity because money could be loaned into existence, even by an independent, privately-operating, institution. This is perhaps one of the most fundamental concepts of finance, but it’s one of those things which you need to repeat over to yourself a couple of times before the penny (sorry for the pun) drops. John Kenneth Galbraith’s quote is succinctly interpreted by Chris Martenson’s Crash Course 7th Chapter. In this 4 minute clip, Martenson also goes on to talk about Fractional Reserve Banking. But we won’t cover this yet – it’s coming but it’s another story for another time.

 

Debt Doesn’t Kill Business, People Kill Business

What is important to understand here is that debt is not evil, per se, indeed it is the fabric of an efficiently functioning economy. The Cave People respected the credit lines extended to them. They understood that credit, the word derived from “credo” meaning “trust”, meant that when you took out a loan, you had entered into a “bond” with the creditor. The priority and focus was to pay the creditor back, in full… with interest and with honour.

FAST-FORWARD to today.

While debt and credit extension can be a great enabler, or even prerequisite, to an efficiently functioning modern economy, one cannot simply create a good economy by encouraging (forcing) more indebtedness in society. Japan found this out rather painfully with a quarter-century-long debt-deflation spiral, the US (and all of us) found out that prolonged credit extension has some pretty major drawbacks and Europe, and Sweden in particular, is finding today that even taxing cash with NIRP (negative interest rates policy) only seems to produce destructive asset bubbles and, potentially, a dangerous revolt. For example, the blogosphere has recently lit up with speculation that the Bavarian Bankers Association has advised banks to start stockpiling physical cash in their vaults (nice picture of ‘Fiddy’ there). Ever get that feeling things are going back to the Stone Age? Storing piles of currency in vaults is not too far off Lydia’s first, rudimentary, banking model. Don’t even get me started on China’s potential NPL (non-performing loan monster).

Back to the real Stone Age. This new credit-extending mechanism provided by Lydia’s bank meant that; just because money was deposited in a bank, it did not mean that the cash had to disappear from the economy. Copper money which simply vanishes can no longer be active and this would limit economic activity. Stagnant, dormant money is inherently deflationary and deflation is inherently recessionary. No, with the presence of the bank, the copper deposits could be re-injected back into the economy via the creation of debt (by simply lending it back out again). That is, another Cave-person could take a loan at the bank and receive copper cash to spend freely in the economy with immediate effect. Another way of saying this is that Cave People with ideas, conviction and credibility (and possibly collateral) could be extended credit (loans) to cover their costs before the returns on investment had been fully realised.

 

The Banker and the Wheel Maker

The new idea of credit extension allowed entrepreneurial Cave People (like the bloke working on circular pieces of wood he called “wheels”) to work on ideas which were previously inaccessible. They could invest in the idea before it could be monetized because the bank was investing in their enterprise and, ultimately, in their time and labour. Previously, you see, the wheel-maker could not work on his wheel engineering without starving to death. But, with a loan, he could afford to use the copper to buy food while he worked on his idea, even before the wheels of his enterprise were in motion and the fruits of his labour could be exercised. Credit-extension was almost like temporarily traveling through time in order to front-run costs before the investment returns were realised. The important thing to realise about the wheel-maker was that debt was not the only essential part of the mechanism; so too was risk. Debt and risk go hand-in-hand. The wheel-maker was taking risk, therefore the bank loaning him the money was too. Again, there is nothing inherently evil with this type of debt or this type of risk. Debt is good, risk is good. It’s an integral part of any efficient modern economy. But this is not the same as saying (more) debt and (more) risk inevitably create a sounder economy.

But what an efficient financial system Lydia had orchestrated! Now, Cave-people were travelling from the far and wide to ask Lydia to supplement their deposits with investment advice. Well, Lydia had a gift for them too. A new type of investment was born because, just as a deposit was a liability to the bank (an asset to the depositor), a loan represented an asset to the bank (or, indeed, any other creditor). The bank did not have to keep this loan asset, it could offer the asset to other “private investors” who wanted to invest in the activity of the borrower and also earn interest. A system of ownership was needed so, with the introduction of Papyrus, and writing tools* special certificates of ownership were created. These certificates could be exchanged for copper cash and these “transactions” could be done freely and publicly between private groups and individuals – without the need for a central intermediary such as a savings and loans bank or governing body. Behold… the beginning of the “bond market”, “broking“, “investment banking” and the “free market economy”.

 

The Mammoth Hunter Company and the Activist Investors

A consortium called The Big Mammoth Hunters wanted in on the action. Mammoth meat, wool and tusks were a rich commodity, especially during the harsh winter months, but Mammoths were hard to come by. The Big Mammoth Hunters needed copper money to invest in capital, spears, food and to pay their huntsmen. Most of all, they needed a solid “group of warrior-hunters” or a collection of soldiers or what the French called a compagnie or a “company”. But mammoth hunting was a risky business and lumpy too; a 2 month expedition could quite easily yield nothing. The ever-creative Lydia created a new type of financing vehicle for them. Investors wanting a more risky / higher return investment could invest in a particular “hunting company” for a particular expedition. But there was no obligation for The Big Mammoth Hunters to repay the investors and make them whole. Instead they agreed to share the dividends of their hunt pro-rata with the other investors. If an investor owned 25% of the “shares”, as they became to be known, then the investor would receive 25% of the bounty. If the expedition returned with nothing, the shareholders received nothing. Some shares traded with different classifications, for example, some had voting rights – where the holders could vote on with direction or which hunting routes to take, or, indeed, who should lead the expedition. Some investors were quite aggressive in casting their voting power, they would look for areas where they saw weak or misdirected ownership and swoop in to take large voting ownership stakes in a bid to influence decisions or even the management of hunting parties. They were called activist investors.

 

Companies, Convertibles and Corporate Finance

One private individual, ran a business called Spearhead – it made weapons like clubs, spears, daggers and axes. He had a good business and had invested a lot of his wealth by accumulating shares in the next Big Mammoth hunting expedition at a price of around 10 coppers per share. The problem was, he needed a loan but he thought there was at least another 20% rise in the value of the hunt shares. He was working on a new harpoon, which he thought could fell a fully-grown mammoth with one projectile. Lydia’s commercial bank was offering a loan but the interest was too high and Lydia thought the public investors would share the same sentiment… but Lydia had a brainwave. She asked her investment bank if they could structure a loan which would give the investors a smaller interest, but also, as a sweetener offered the option to convert loan into shares of The Big Mammoth Hunters’ next hunting expedition at a rate of 15 coppers per share. If the shares of the hunt traded up to 30 coppers the investors could convert their bonds into hunt shares and sell those shares in the open market for a healthy clip! Aha! Our first Stone Age Convertible Bond. In fact, because the underlying shares of the conversion property (Mammoth Hunt) were exchangeable into a different company to the original loan-seeking company (Spearhead), this was known as a Convertible Exchangeable Bond.

Lydia went one stage further and set up another bank whose sole remit was to connect investors with private entrepreneurial groups or business collectives (now known simply as “companies”). This special bank did not even have to take the loans on the books in the first place. By staying in close contact with investors, the bank could simply arrange the loans for the companies and distribute the packaged certificates to investors without having to dip into copper assets in the bank’s balance (leverage the bank’s balance sheet). Obviously, the bank took a fee for such a service – it wasn’t a charity! But because investors knew this bank had special relationships with many companies it attracted a great many investors, because companies knew that this bank was servicing many investors it meant they were more likely to get efficient pricing for their loan and so it attracted even more companies. Behold, Lydia had corporate finance division … and had inadvertently created the world’s first investment bank.

*Appreciate the (pre)historic credibility of my allegoric story-spinning is starting to fray at the edges here!

 

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