There is constant talk about unemployment, and for good reason.  The unemployment rate is high right now.  It is officially at 8.3%.  If we counted those who have given up looking for work and those who are working part time (who want to be full time), then the unemployment rate would be over 15%, and this is a conservative number.

This is, of course, highly significant for individuals and families who have been directly affected.  Times are tough enough with a steady income.  It is incredibly hard for those who have lost their job and cannot find another job that pays a comparable salary.  In discussing the economics of this issue, it in no way is attempting to show a lack of empathy for people who have faced unemployment.

The problem with the subject of unemployment is that employment itself seems to become the goal.  This is reinforced by the media, by politicians, and by bad economists (which is the majority of economists).

Low rates of unemployment is not the ultimate goal.  If we didn’t live in a world with scarce goods, then employment wouldn’t be necessary.  If we could have robots do all of our work, then we would not need to work.  If robots could provide all of our food, clothing, and housing, along with luxury goods and services, why would we need to work?  Everything would be handed to us.

The reality is that we don’t have robots to do everything.  We certainly have more advanced technology than in the past, but it is still necessary for humans to work to satisfy our wants and needs.

When we discuss employment as an end instead of a means, then we lose focus and we get bad economics.  The key to making a society richer is by having greater productivity.  That is the main problem with high unemployment.  There are people who are willing and capable of working who are not working.  They are producing nothing.  (I’m not including things they may do at home for their families.)  They are not contributing to society.  It’s not that anyone has an obligation to contribute to society, but having people wanting to work and contribute in order to improve their own lives is a benefit to everyone in society, as long as it is done honestly.

There are many reasons for the high unemployment numbers and most of them have to do with government.  I have discussed some of these things before.  And now we have people suggesting things that will only do further damage.

This thinking leads people to say things like, “we can’t stop this war or there will be defense contractors who will have to let people go and we will have even higher unemployment.”  Aside from this being possible war propaganda, it is also really bad economics.  If productivity is going needlessly to a defense contractor, then it should not be sustained.  Those resources need to be reallocated to better meet the needs and wants of consumers.

If getting people employed were all that mattered, then we could simply get people to dig ditches and fill the ditches back in with dirt.  But someone would have to pay them.  It is easy to see that this does not lead to any net wealth for society.  It may redistribute some wealth, but it does nothing to create any.

Employment should not be the ultimate goal.  Employment is a means to get more productivity.  With higher productivity, a society has a larger amount of wealth in the form of goods and services.  It means a higher standard of living.  So we should want people to get back to work who want to work, but it should not just be for the sake of working.  It should be for the sake of productivity to meet consumer wants and needs.

In my last two posts, I discussed the factors of price inflation and the possibility of price inflation with excess reserves remaining high.  I wrote that price inflation is primarily determined by the supply and demand of money.

There is another factor in price inflation and that is productivity.  While this would not usually cause significant price swings in the short run like the supply and demand of money can, productivity does have an effect, especially over the long run.

To be clear, this has little to do with the pricing of individual products.  Prices of certain goods and services can go up and down based on the supply and demand.  For instance, if there are really cold temperatures in Florida which cause orange trees to be destroyed, we would expect for orange prices to go up because of a lower supply.

For this discussion, the focus is on the overall general price level.  For the sake of discussion, let’s assume that the supply and demand for money remains constant and we have a free market economy.

It is obvious that a farmer using a tractor can and will be more productive than a farmer using hand tools to do all of the work.  If country A has many farmers who use tractors and country B has farmers that mostly use hand tools, then we can expect food production to be higher in country A.  If not, then country B would be expending a lot more resources in the form of labor to match the food production of country B.  Either way, we can expect food prices to be lower in country A.

This is because of capital investment and technology.  Some farmers have tractors to use because they have prior savings that could be used to buy a tractor.  The savings do not even necessarily have to be from the farmer.  He may borrow money that someone else saved and promise to pay back the loan with the food he is able to produce with the use of his tractor.

The point is that you need capital investment and increases in technology in most cases to significantly increase production.  This will happen to a higher degree in a more free market economy.  If there are productivity gains throughout a society, it will actually lead to noticeably lower prices.  If the same amount of money is chasing a larger number of goods, then prices will go down.

We can see this in the electronics industry where computers and televisions get cheaper every year.  If they don’t get cheaper, then you are getting more for you money in terms of chip speed, storage space, quality, etc.  This is in spite of the Fed’s monetary inflation and an overall positive CPI.  If only healthcare and education could be more like the electronics industry, where we see things getting constantly better and cheaper at the same time.

Price deflation is not a bad thing if it is due to an increase in productivity.  There is nothing to fear in that case.  It is a good thing.  It means that our standard of living is increasing.  It means that we can purchase more goods and services with the money we have.

While we don’t want to see deflationary situations due to failing banks and boom and bust cycles caused by the Fed, we shouldn’t let that scare us about having falling prices.  We should cheer on falling prices that are due to productivity gains and increasing technology.  We should be thankful that we still have a free enough economy that some sectors see productivity gains.

In my last post, I discussed the different factors of price inflation.  These factors are the money supply, the demand for money (also known as velocity), and fractional reserve lending.  Even this third thing really fits into one of the first two categories.

(It should be noted that production also has an effect on prices in the long run.  If there are increases in production, it can actually lead to a decrease in prices.  For the sake of this discussion, we are assuming that productivity and technology remain constant.)

While some Austrian school economists predicted the housing bubble, many have not been as accurate with their prediction of price inflation, or at least not yet.  This is the danger of making predictions.  It gives a little ammunition to people like Paul Krugman.  The ironic thing is that Austrian (free market) economics should make us careful in making bold predictions.  Austrian economics teaches that economics is really the study of human action and human action cannot be predicted with certainty.

So what has happened with price inflation?  While many claim that it is understated in the government statistics and they may have a valid claim, it is obvious that price inflation has not been severe.  We are not anywhere near the 1970’s, or at least not yet.

Milton Friedman said that inflation is always and everywhere a monetary phenomenon.  This is essentially correct with a long-term view.  However, in the short term, it is more than just monetary policy that dictates consumer price inflation.

One thing that is important to note is that inflation is not uniform.  Monetary inflation can cause pockets of high price inflation and it doesn’t just have to be in consumer goods.  It can also be in stocks, bonds, gold, or any number of other things.

There are basically three things that will affect overall consumer prices.  One is the money supply.  Two is velocity, or the demand for money.  Three is fractional reserve lending.

Actually, number three really fits in with the first two.  Velocity can drive the degree of fractional reserve lending and the degree of fractional reserve lending affects the money supply, at least in a sense.  While the actual supply of money doesn’t increase with fractional reserve lending, it gives multiple people the claim on the same money.  Therefore, the actual digital bank accounts of people and companies are higher than they would be without fractional reserve banking.

I say that velocity affects fractional reserve lending and we can see that with the current situation.  The commercial banks have built up massive excess reserves over the last 4 years and it is not because their reserve requirements have gone up.  Due to the hard economic times, there is more demand for money. In other words, velocity has slowed down considerably.  People are scared and are trying to build up cash reserves and pay down debt.  The same goes with businesses.  The banks are also scared of making bad loans and would rather sit on the money than risk lending it out.  So the overall recession and the scary economic times have slowed velocity and built up excess reserves.

This is what was missed by people who predicted imminent and severe price inflation.  The Federal Reserve has tripled the adjusted monetary base since the fall of 2008, yet we have not seen a corresponding increase in overall prices.  I believe this is due to the high excess reserves, which prevented another de facto increase in the money supply from fractional reserve lending and I believe it is also due to the low velocity.

When there is a higher demand for money, this is the equivalent of lowering the money supply.  Therefore, an increase in the money supply can be offset by a higher demand for money.  The Fed can control the money supply.  It has a certain amount of control over excess reserves with its policies.  The Fed has far less control over the demand for money.  However, I won’t say that the Fed can’t affect the demand for money at all, because it could if it went crazy enough with money creation.  The Fed could also cause velocity to drop even more if it stopped buying government debt.

Unemployment is high and people are still spooked from 2008 and rightly so.  Therefore, they are paying down debt and trying to build up cash (or the equivalent of cash in their bank accounts).  This means that they are spending less.  This means they are not bidding up prices as much.  It means that the higher money supply is being offset by a higher demand for money.

This is the reason that we have not seen high price inflation.  It is possible that it could continue and it is possible that it could reverse quickly.

In my next post, I will discuss the possibilities of price inflation with excess reserves remaining high.

This presidential election gives us Willard Mitt Romney against Barack Obama (supposedly known as Barry Soetoro as a child).  Since the Ron Paul news has quieted down, I haven’t spent as much time on presidential politics.  For today’s post, I am going to discuss the possible implications of either one of these two winning the presidency.

First, unless there is some major event, it will be one of these two men.  I know that Romney isn’t officially the Republican nominee yet.  I know that people like Gary Johnson are running on a third-party ticket.  However, barring something huge, there is no way that someone like Johnson is going to come anywhere close to winning.

Most Republicans are absolutely terrified of Obama.  While I somewhat concur, I don’t find him any more terrifying than most others running for that office.  Obama probably really does have Marxist roots.  He truly believes in big government.  He believes that government is the primary reason for prosperity in our society.

With that said, Obama is a politician first.  He rarely let’s his philosophy interfere with his political calculations.  He did overstep his bounds when he said that if you have a business that you didn’t build it; that someone else did.  He let his true philosophy slip out of his mouth.  It wasn’t a good political calculation.  But when it comes to policy, Obama probably isn’t even the one making the decisions.  It is his advisors around him.  It is the establishment telling him what to do.

Many Republicans fear that if Obama is given a second term that he will be out of control.  They believe that if he doesn’t have to worry about another election, that he will do whatever he wants.  The problem with that theory is that it simply hasn’t been true in the past.  Bill Clinton, at least domestically speaking, was actually probably better in his second term.  That was when the budget actually came close to being balanced.  (It was really borrowing from the Social Security fund, so there wasn’t truly a surplus, but it was still much better than we have seen since.)

If Reagan was really a great conservative who believed in small government, then why didn’t he act that way in his second term?  Government spending and deficits were still obscene in Reagan’s second term.

I doubt that Obama will be out of control in a second term.  He will probably do less.  Also, if there is a Republican majority in Congress, then we will actually have some opposition to big government, even if just in rhetoric.  While I don’t expect a Republican Congress to control spending any better than it is doing now, we wouldn’t see any more disasters like Obamacare.

While Obama has been bad on foreign policy, he hasn’t been as bad as he could be.  While he has continued Bush’s wars and started some smaller ones, at least he hasn’t directly attacked Iran.  I’m not saying it can’t still happen under Obama, but I would hate to see what the world might look like if John McCain had been elected 4 years ago.

That brings us to Romney.  I have no idea what Romney’s foreign policy will look like.  He sounds belligerent now.  He just visited Israel to show his support there.  He seems like a war hawk.  Again, it is impossible to say what he will be like in office.  Because of that, I would give a slight edge to Obama on foreign policy in terms of liberty.

Now you would think that Romney would at least be much better on economics than Obama.  But I don’t think this is the case at all.  He may have been successful in business, but he doesn’t understand free market economics at all (unless he is a complete liar).

I heard Romney on Sean Hannity’s radio show today.  Hannity asked him about cutting spending.  The only thing Romney said was that he favors entitlement reform in the form of means testing.  In other words, he wants to deny Social Security checks (or reduce them) to rich people.  Regardless of whether this is right or wrong, it is a drop in the bucket.  I hate to break it to you conservatives out there, but even if he got through that reform, we would still have trillion dollar budget deficits.  Romney has not offered one other specific cut that is anything of significance.  He has not called for the elimination of any departments.  How could he when he hasn’t even called for any cuts in them?

The other thing I heard Romney say is that China is not playing fair.  I remember him saying this multiple times during debates.  This means that Romney is a Keynesian.  He is not a monetarist in the mold of Milton Friedman.  He is a Keynesian in the mold of Keynes.  He does not understand free market economics at all (again, unless he is lying).  Either way, Romney is sounding like a mercantilist. Does he think that China’s currency is harming Americans?  Does he think that having the Chinese sell inexpensive products to Americans is harmful?  Does he not understand that this is beneficial to the American consumer?

If Romney is saying these things now, I can only imagine what his policies will look like.  If a candidate is already talking like a lover of big government before he gets into office, then it isn’t going to get much better when he is elected.

So for economics, I can’t even say that Romney will be better than Obama.  If Romney is president, then we lose all opposition to big government in Congress, just as we saw during the Bush years.

In conclusion, if you love liberty, there is no way you should vote for either one of these two.  If I were absolutely forced to pick between the lesser of two evils, I think Obama may actually be the lesser of the two evils.  At least we know what we are getting.

The Federal Open Market Committee (FOMC) released its statement today regarding the economy.  It stated that information received since June “suggests that economic activity decelerated somewhat over the first half of this year.”  With that said, there was no announcement of a new quantitative easing (QE) or any other kind of major stimulus.  The stock market was only down slightly on the news.

The statement said, “The Committee anticipates that inflation over the medium term will run at or below the rate it judges most consistent with its dual mandate.”  I find it hard to believe that they believe this.  If inflation is expected to be at or below its dual mandate and the economy is still showing weakness, then why wouldn’t the Fed inflate more?

As I have discussed recently, the Fed is holding back right now on purpose.  The monetary base has been flat for over a year now.  They are walking on a tightrope right now and they would prefer a controlled liquidation over any of the other options.  The Fed is saving any additional QEs for something more major than a minor stock market downturn or 8% unemployment (at least based on the government’s statistics).  In addition, as I recently discussed, the Fed does not care about re-electing Obama.

The Fed will buy more government debt to keep rates low and to keep the big banks afloat.  Right now, rates are at or near all-time lows and the banks are still technically solvent.  Therefore, the Fed will wait for something more major before creating more new money out of thin air.

The FOMC statement said, “To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate more consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.  In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

This means that the federal funds rate will be near zero for at least 6 years.  That is unprecedented.  However, it is misleading for the FOMC to say that it is being highly accommodative by keeping rates so low.  While the original Fed monetary inflation contributed to the situation, it is not really the Fed that is holding rates low now.  The federal funds rate is near zero because the banks have built up massive excess reserves.

The FOMC decision was almost unanimous, with one person dissenting because he “preferred to omit the description of the time period over which economic conditions are likely to warrant an exceptionally low level of the federal funds rate.”

Yes, these are the people controlling our economic future right now.  It is not consoling.  The good news is that I don’t think the Fed/ FOMC will go to hyperinflation.  I see that with their actions now.  If I see anything new that changes my mind, I will be sure to write something about it.  But for now, the Fed is sitting tight and we should too.

I am a big proponent of the permanent portfolio as described by Harry Browne in his book Fail-Safe Investing.  I believe you should have a majority of your investments in a setup like the permanent portfolio.  For more conservative investors, it should be closer to 100% of your investments (not counting any investment real estate).

The one thing that scares many people, particularly libertarians, is the bond portion.  You are supposed to invest 25% in long-term government bonds.  Many libertarians (and others) are convinced that rates will be going up.  This would drive down the value of the bonds.  Ironically, I have heard this for many years now, even about 7 or 8 years ago when Harry Browne was alive.  Yet, bonds have done quite well over this period of time.

I understand the fear that people have of government bonds.  You shouldn’t be afraid of an outright default, as we see coming in Europe.  I’m not saying it isn’t possible, but I think we still have quite a bit of time before the U.S. government considers an outright default.  The main threat is rising interest rates.  If we hit a period of higher price inflation and the Fed is forced to stop buying government debt, then higher interest rates will probably occur.

The problem here is that the future is unpredictable.  Japan has really high debt and yet interest rates have stayed very low there for decades.  The bond portion of the permanent portfolio is designed to keep the portfolio performing well in the face of a deflation/ depression.  It actually kept the portfolio from falling too dramatically in the fall of 2008 when stocks and gold tumbled down.

So I have come up with a compromise for those interested in the permanent portfolio, yet too scared to put such a big portion in bonds.

Earlier this year, I wrote a special report titled, “Should You Pay Down Your Mortgage?“.  It is available on kindle for just 99 cents and can be read in less than an hour.  I have mixed opinions on this subject and I laid out the pros and cons of paying down or paying off your home mortgage.

One thing I mention is that paying down your mortgage is somewhat of a hedge against deflation.  While actually selling your house might be a better hedge, that isn’t a realistic option for many people.  Some people don’t want to rent.  Plus, it wouldn’t make much sense to sell your house in anticipation of deflation when you can’t be certain of the future.  If the deflation doesn’t come, then it was a bad decision to sell.

So here is my proposal, assuming you have a mortgage and assuming you have money to invest.

Instead of investing 25% in bonds, take half of that portion and make a payment towards the principal balance on your home mortgage.  In other words, let’s say that you have $20,000 to invest.  You will take $5,000 and buy gold or gold investments.  You will take $5,000 and buy a broad stock market index.  You will take $5,000 and put it in some kind of a money market fund.  For the remaining $5,000, you will take $2,500 of it and put it in long-term government bonds and you will take the other $2,500 and pay down the principal on your mortgage.

Assuming you have an interest rate of 4% on your home loan, you will get the equivalent of a 4% return on this money.  You will essentially be locking in that return with compounding interest, so it will benefit you if interest rates go lower. In other words, it is somewhat of a hedge against deflation.  If you have trouble thinking of it this way, just think that having a big mortgage is a hedge against inflation.  You can pay off your mortgage in depreciating money as time goes on.

With that said, I wouldn’t recommend taking the full 25% and paying down your mortgage.  You have more leverage with the bonds.  In addition, paying down your mortgage makes that money illiquid.  If there is a deflationary depression, you need to be able to rebalance your portfolio.  That’s why you should still leave a portion in bonds in your permanent portfolio, even if it is a smaller amount.

This is not an exact science, but neither is the permanent portfolio.  It is just a suggestion for those of you who are really scared of buying bonds with rates so low.  If you have a mortgage, then you can hedge against deflation by paying that down.

There seems to be an assumption that is held by a large number of people that the Federal Reserve tampers with its monetary policy prior to an election in order to juice the economy.  I have heard people say that they don’t expect a crash until after the election because the Fed won’t let it happen.

While I can’t say for certain that this hasn’t happened in the past, I don’t believe it is necessarily true.  Making this assumption could really guide someone the wrong way.

The Federal Reserve is a political organization.  Its website ends in “.gov”.  While the Fed is certainly there to benefit the big banks, it is also there to benefit big government and deficit spending.  It has a monopoly on the production of dollars, which we must use in many cases because of the legal tender laws.  In addition to all of this, the Fed chairman is nominated by the President and confirmed by the Senate.

While the Fed is a political organization, I’m not sure why people would think that it has to favor the incumbent.  The Fed is in bed with the establishment, not any one particular party or incumbent.  Why would Bernanke and the Fed care about saving Obama for re-election when the alternative is Romney? Does is really make any difference?  If anything, the establishment might actually prefer Romney at this point.  Obama seems to be overplaying his hand lately with comments about businessmen not really building their own business.  Obama is so philosophically wedded to big government, he is giving it a bad reputation.  The establishment might prefer someone like Romney who talks about capitalism and entrepreneurship, because they know his policies will still favor the establishment.

Now, if Ron Paul were the Republican nominee, then certainly Bernanke and company would be doing everything in their power to get Obama re-elected.  If they had to triple the money supply again just to get things looking good before the election, they would do it.  But since that is not the scenario, the Fed and the banking establishment don’t really care about Obama.

The current Fed policy proves that they don’t care about Obama winning again.  The adjusted monetary base has been flat for over a year now, since QE2 ended in June 2011.  If the Fed really wanted to cause an artificial boom prior to the election, they aren’t doing a very good job of it now.

I think another interesting point in all of this is to look at the past.  Paul Volcker came in as Fed chairman in 1979 and threw the hammer down.  He stopped the printing presses and let interest rates rise well into the double digits.  This sealed the deal for Jimmy Carter.  Volcker’s policy brought about a deep recession.  He was not concerned about Carter winning his re-election.  He was concerned about saving the dollar.  This was in spite of the fact that Carter nominated Volcker to his position.  It just shows that not even the president is really running the show.

I would not time your investments based on the election.  If you think there will be a stock market crash, I wouldn’t wait until after the November election to sell.  There is a lot of concern building that higher taxes will really hurt the economy in 2013.  These are expiring tax cuts and new ones from Obamacare.  When you couple this with the flat monetary base, there is certainly reason to be concerned about trouble in the short term.  Regardless, I wouldn’t count on the Fed going to QE3 just because Obama needs a boost.  They might do it for other reasons, but it won’t be for Obama.

I received this comment/ question recently:

The Wall Street Journal ran an article earlier this week about who invented the internet.  The author says it is an urban legend that the government launched it.  The article describes a brief history of some of the individuals and companies (like Xerox) that helped bring about what we have today.

I have always thought it was a ridiculous claim by statists to point out the internet as an example of something in which the government created or helped innovate.  The internet itself would be nothing if not for all of the contributing individuals and companies in the free marketplace.  How could anyone seriously ever compare the government to Google, Apple, Amazon, Ebay, or Yahoo when it comes to innovation?

The other thing that has always annoyed me about this claim that the government invented the internet is that it completely ignores what Bastiat taught.  A good economist should not just look at the things we can see, but consider all of the unseen things that never came about.  Government at all levels in the U.S. takes almost half of our income.  With that much money, it is actually surprising that the government can’t innovate more and invent more, especially with help from private companies.

If I had a trillion dollars per year at my disposal, I would think that I could hire enough people that I could at least cure a few diseases each year and invent some great new gadgets.  You could do a lot with even just 1% of that.  With 10 billion dollars per year, you could probably come up with some great things.

If the government hadn’t been taking all of this wealth out of society and misallocating it for the last several decades, it is hard to imagine what luxuries we would enjoy now.  Twenty, or even ten, years ago, nobody could have imagined an iPad because there was no such thing at that time.

The other interesting thing to note about this article is a fact that is missed on most people.  It was hard for the author of the article to pinpoint who exactly invented the internet.  It is hard to get it down to one company and even harder to get it down to one name.  That is because most things are not really invented by one person.

Most of the great things we have in our lives today were not invented by one person or even one company.  People are constantly building off of the works of others.  Chip speed and storage are getting better exponentially.  Yet, how many people could explain why?  How many techies do you know who could actually give you a coherent explanation as to why this is occurring?  A few might be able to tell you something, but they will probably just be blowing smoke.

There is nobody who knows how to make a car from scratch.  There is nobody who knows how to make a computer from scratch.  As Leonard Read told us in I Pencil, nobody even knows how to make a pencil.

This is the way civilization works.  We are constantly building off of the ideas and works of others.  This is how society can progress at such a rapid rate.  Most people specialize in one small thing.  They cannot tell you how all of the other parts work in the process.  They don’t need to.  It somehow all comes together.

In truth, nobody invented the internet.  It was millions of people who contributed.  Some people were more important than others, but it still would have happened if any one person had not existed.  It is rare that you have someone like Steve Jobs who makes such big contributions.  But even if Jobs had never existed, we would still have many great gadgets today.  It is hard to say if we would have iPads, but I’m guessing we would have other things similar.

Just imagine if the government ever got out of the way and all of the bright minds in this world were allowed to flourish.  Technology could grow even faster than it is today.  We can only imagine what might exist in another ten years.