With the Republican presidential primaries coming soon, the race for the Republican nomination is heating up.  There is one particular question that should be asked to all of the candidates.  A lot of libertarians want to know the answer.  Democrats should be asking the question to show the hypocrisy of most of the Republican candidates.

It is unlikely that this question will be asked in any of the debates.  If it is asked, most of the candidates will not answer the question.  Their hands should be forced to answer the question or else look really bad.  The question is this:

What specifically would you cut from the federal budget to balance the budget for the first budget year that you would be responsible for as president?

I do not recall hearing any of the candidates saying that they would not balance the budget.  This question would force them to admit this.  It is true that Congress is responsible for spending, but that is 535 people.  The president is one person who can veto spending bills.  The Congress needs a supermajority to override a presidential veto.  In addition, the president can influence the American people, and thus Congress, when it comes to spending cuts.

Here is the problem for the Republican presidential candidates.  They say they want a balanced budget.  They say they will not raise taxes.  Yet, it would be impossible to balance the budget unless you significantly cut military spending or cut Medicare and Social Security.  Cutting military spending would mean ending wars and bringing troops home.  Cutting Medicare and Social Security would mean severely cutting benefits for those already collecting.

Of course, there are a lot of departments that can and should be cut from the federal budget.  But even if all of the unconstitutional departments and programs were cut, it would still fall short.  But the candidates are not proposing this anyway, except for one person.

Ron Paul (and Gary Johnson to a much lesser extent) is the only candidate who is serious about making deep and significant cuts.  Ron Paul has said that he would end the wars currently going on.  They would end almost immediately on his watch.  He would like to get rid of all of the unconstitutional departments.  He would like to end foreign aid.

Ron Paul is the only candidate who has been specific enough to come anywhere close to a balanced budget. In fact, Ron Paul should be asking this question to the other candidates.  It would show that the other candidates are closer to Obama than they want to admit.  They have no plan for a balanced budget.

Balancing the budget it just one of the major issues of this campaign.  But most people know where the candidates stand on the other issues.  It is obvious that Ron Paul ( and again, Gary Johnson to a much lesser extent) is the only anti-war candidate in the race.  But when it comes to spending, the Republicans are trying to have their cake and eat it too.  There is simply no way to balance the budget without big cuts in military spending or entitlement spending.

Today is July 4, otherwise known as Independence Day to Americans.  Americans celebrate by barbecuing, going to the beach, and lighting off fireworks, among other things.  While I am hopeful that at least a majority of Americans understand that July 4 is a celebration of the American colonists declaring independence from the British Crown, I don’t think that most Americans realize that the colonists, in effect, seceded.

The labor theory of value, as stated by Wikipedia, is a theory which argues that the value of a commodity is related to the labor needed to produce or obtain the commodity.  This has been refuted by Eugen von Bohm-Bawerk and the Austrian school of economics.  Austrians believe in the subjective theory of value.

Basically, the subjective theory of value says that things are valued based on the opinions of people.  This whole thing has always kind of puzzled me.  You’re telling me that it took hundreds of years of theorizing to come to this conclusion and even now it is still debated?

For anyone who works in an office, you should know that the labor theory of value is not true.  You might observe someone who sits at his desk all day and seems to work hard.  He may even work overtime.  And yet that person may not be the most productive person in the office.  It can even be the case that there are some people who seem to be hard workers and yet are some of the least productive people.  Bottom line is, productivity is not determined just by how hard someone works.

Of course, there can be a relationship between labor and productivity.  If someone doesn’t work at all, he is not going to produce something of value.  But even for someone who is seemingly productive, it doesn’t mean that what he is producing is of value to anyone else.  That is for other people to determine.

I think the one important thing to take away from the subjective theory of value is that consumers dictate prices.  It doesn’t mean that costs don’t matter.  It doesn’t mean that the labor spent on things doesn’t matter.  But, ultimately, what matters the most is how much consumers are willing to pay.

When a business takes on higher costs (let’s say because of a government regulation or tax), we often hear people say that the business will just pass the cost on to the consumer.  Sometimes this is true.  The business will certainly try to charge more if it thinks it can get more.  But it doesn’t always work this way.  The consumer may not be willing to pay more.  The consumer might find a replacement product or just decide that it is not a necessary item to have.

If oil prices go up, food may or may not go up in price due to higher transportation costs.  If Coke and Pepsi get hit with a new corporate tax or accounting rule that drives up their costs, the price of their products may or may not go up because of this.  There are a lot of things that can contribute to prices, including costs and competition.  However, ultimately, it is the consumer who decides the price by how much they are willing to pay.

Today, June 30, 2011, officially marks the end of QE2.  You can look at the adjusted monetary base to see what happened.  It is up around $600 billion, just as the Fed had said it would be.  There was actually a slight retreat in the last week.

You can also see the excess reserves held by commercial banks.  They have gone up with the monetary base.  That last line up is QE2.  This means that all of this new money is being held by the banks.  The banks are parking this money at the Fed to earn .25%, which is close enough to zero.  I don’t think it is a quarter percent of interest that is keeping this money tied up.  I think a more logical conclusion is that the banks see more trouble down the road and are building up reserves to deal with those problems.  I have read that much of QE2 went into European banks.  The speculation is that the Fed was helping to capitalize these banks because of the threat of defaults by Greece and other European countries.

It looked like the stock market was in for a major correction, but things reversed quickly this week.  Meanwhile, gold retreated to just below $1,500 per ounce the other day.  Gold has been going down slightly over the last couple of weeks, but it isn’t anything big.  I still think a good strategy for speculation is to have some gold assets and to short the stock market (to a lesser extent).

I just cannot picture a scenario right now where the stock market will go up and make new highs while gold goes down or even stays flat.  If there is not a big correction in stocks, then I see gold going much higher.  I think low interest rates and loose money is the primary reason for the stock market moving higher.  These conditions, along with huge deficits, should be even more positive for gold.

The big question remains: what will the Fed do next?  My guess is that it will keep the monetary base stable for a while.  It could keep buying government debt and not actually announce QE3, but I don’t think this is likely.  If we see more major signs of a downturn (stock market crash or higher unemployment figures), then many people on Wall Street will start demanding another round of digital money printing.  Then we can expect QE3.

It is likely that we will continue to see a roller coaster ride.  Gold has been very quiet lately, so I would not be surprised to see it start moving fast in one direction or the other.  This is a tough environment for investing.  The name of the game right now is to keep what you have, including its purchasing power.

I have already given my perspective of Herman Cain, a best friend to bankers.  Since Michele Bachmann is moving up in the polls, it is now time to take a look at her from a libertarian point of view.

Bachmann has only been in Congress since January 2007.  She is from Minnesota and is considered a supporter of the Tea Party movement.  Some libertarians are sympathetic towards her and her views.

She may actually be the worst of all worlds for libertarians.  The problem is that she has some libertarian rhetoric and she sounds like she is a supporter of capitalism most of the time.  She even throws in states’ rights on some economic issues.  The problem will come if she is elected to the presidency.  Just like George W. Bush and Ronald Reagan, I am fairly convinced that her policies would not reflect her rhetoric.

When she favors special interests and big business and she does nothing substantial to help the average American who is being choked by big government, then capitalism will get the blame.  We hear it now with previous presidents.  We can even go back to the 1920’s and 1930’s and people talk about Herbert Hoover as if he was a big supporter of the free market when it is just about the opposite.

Bachmann sounds just good enough to appeal to conservatives (and even some libertarians).  I have heard her say that she wants to get rid of the Department of Education.  I don’t hear her say it often though.  But why should we believe her?  She is part of the Republican establishment.  If she gets the Republican nomination, she will be surrounded by insiders (if she isn’t already).  Just how the Republican revolution in 1994 turned out to be nothing, so will Michele Bachmann.

The Republicans tinkered around the edges after their major victory in 1994.  They were less disastrous than other congressional periods before and after.  But overall, there was no significant change that took place in the direction of liberty.

The last debate on CNN was horrible.  The candidates were only given 30 seconds to answer the questions, which is not a lot of time for someone wanting to become President of the United States.  But all of the candidates talked about cutting taxes and cutting spending.  Other than Ron Paul talking about the military, none of the candidates offered anything specific of substance.

That is the question I want posed to Michele Bachmann.  How will you balance the budget?  Where specifically will you cut $1.5 trillion from the federal budget.  In fact, every candidate should be asked that question.  It is impossible to balance the budget unless you cut military spending and/or so-called entitlement spending.

Of course, when it comes to foreign policy, Bachmann is a nightmare for libertarians.  She is a typical pro-war Christian who wants to bomb the Middle East and spread democracy throughout the world.  She doesn’t quite put it in those terms, but you can certainly tell that she will not be ending any major wars any time soon.  She never seems to explain how she will spend trillions on military spending and yet remain a fiscal conservative.

Libertarians, beware of Michele Bachmann.  With Obama in the Oval Office, it is easy to see what he stands for (bigger government).  It is a little trickier with Bachmann, which makes her more dangerous.  Do not mistake her for a friend of liberty.

The velocity of money is a huge factor in our economy and yet many investors do not understand it or even know what it is.  I find that even many libertarians and followers of Austrian economics do not understand velocity.

The velocity of money is the demand for money.  It is how quickly money is changing hands.  If there is a high demand for money, then velocity is low.  This means that people are not spending as much.  Therefore, money is changing hands less frequently.  This has the same effect as monetary deflation.  With everything else being equal, a reduction in velocity will push prices down.

The opposite is true for high velocity.  There is a low demand for money and money is changing hands quickly.  This pushes prices up.  The most extreme example of high velocity is during a period of hyperinflation.  People get their paycheck and they run to the store and hurry up and spend it before prices are even higher.  When overall prices are rising every day, this is extreme hyperinflation and it means that the money being used will be worth nothing soon.

Velocity is determined by the attitudes of the people.  Right now in the U.S., velocity seems to be quite low.  It is almost impossible to measure, but you can usually take a good guess based on other factors.  With the economy down, unemployment high, and uncertainty high, people are afraid of the future.  They have cut back on their spending and are trying to pay down debt.  They are trying to save for a rainy day, or in this case a rainier day.

The adjusted monetary base has approximately tripled since 2008.  But consumer price inflation has been relatively mild.  I attribute this to two things.  First, the excess reserves held by commercial banks have dramatically increased.  Second, the velocity of money has been low.  The two of these things are even related in a way.  Banks are not lending due to fear and people are not spending due to fear.  This has kept us from having massive price inflation.

For some reason, people still run to the U.S. dollar in times of uncertainty.  I think is beginning to change and will continue to change.  Eventually, people will start running away from the dollar and will run to hard assets like gold and silver.

Because of velocity, it is possible to have rising prices without monetary inflation.  It is not likely, but it is possible.  If everyone became an Austro-libertarian tomorrow and knew that everyone else did too, then people might start dumping their dollars for hard assets.  High velocity alone could kill a currency.  If people no longer have faith in their money, it won’t matter what the government does.  It will quickly become worthless.

Although it is impossible to measure velocity, it is important to keep it in mind when examining the economy and prices in general.  Human behavior plays a big role in our economy.  If velocity turns higher one day, we should watch out for big price inflation.  Then the Fed will have to decide if it wants to save the dollar.

There is an article (linked via Drudge) that discusses China’s role with Europe.  The Chinese premier, Wen Jiabao, is visiting Europe.  With all of the problems with Greece and the other “PIIGS”, the euro is in some trouble, but China is saying that it will support the euro.

The article quotes the Chinese premier as saying, “China is a long term investor in Europe’s sovereign debt market.”  He goes on to say, ” In recent years we have increased by quite a big margin our holdings of government bonds.  We will consistently continue to support Europe and the euro.”

Assuming this did not get translated incorrectly and assuming he means what he is saying, this man is an imbecile.  The Chinese government is still labeled communist.  I’m not sure if that is true anymore when it comes to economics, but it is still mercantilist.

China has made wonderful improvements over the last 3 decades.  When you are starting from just about the lowest point possible, it is not hard.  Economically speaking, China is not really communist anymore.  In some ways, China is more free economically than the U.S. (although still much poorer).  There are less regulations on business in China.

Although China has improved, it is still being centrally planned by a bunch of morons.  They continue to invest in currencies like the euro and the U.S. dollar.  There is little doubt that there will be some form of default with both in the future.  If there is not an outright default, the Chinese will be paid back with money that has been devalued considerably.

Why does the Chinese government have to “invest” all of this money?  Why can’t they allow the citizens of China to have this capital?  It would lower their consumer prices.  It would help their standard of living.  Instead, these complete idiots prefer to subsidize Americans (and apparently Europeans too).  It may help their export sector, but they are hurting themselves far more by making things more expensive within China than they otherwise would have been.  Instead, rich Americans get cheaper products at the expense of the poor Chinese.

The people of China tend to be huge savers.  Even with relatively small incomes, they save a high percentage of their earnings.  The same cannot be said for Americans.  But the Chinese people are not reaping all of the rewards they should be from their frugality.  Their stupid government continues to squander part of their savings.  Of course, the same thing could be said for Americans who don’t save as much (relatively speaking), but still have a government that spends huge amounts.

China will be experiencing huge problems in the near future.  The central bank inflated like crazy.  There is a huge real estate bubble.  There are cities there that are practically empty.  China cannot escape the Austrian business cycle theory.  They will have a bust.  It is too bad.  If the Chinese government would get out of the way and keep a stable monetary system, the Chinese people would become rich very quickly with their high savings rates.

Last month, I posted a piece on bank excess reserves and the federal funds rate.  I was basically saying that the Fed was not really holding down the fed funds rate.  It makes this announcement after every FOMC meeting that it is keeping the rate at between zero and .25 percent.  This has been going on for a couple of years.  But because the banks have massive amounts of excess reserves, there is very little need for overnight lending.  Therefore, this keeps the federal funds rate low and the Federal Reserve’s monetary expansions or contractions have little to do with their target rate right now.

In my piece, I also cited an article by Kel Kelly.  In his article, he says that the only way that the Fed can raise rates is by paying the banks significantly higher rates on their excess reserves and that this is unlikely because it would lead to a recession.

I received a comment in response to my post.  The comment says, “The Fed can [lower] rates only by paying banks interest on reserves.  In your article, you addressed it as ‘raising’ rates, which is not the case.”

I understand this comment, but I maintain what I said in my post and that Kel Kelly is correct in his article.  It is a bit counter intuitive, so let’s go through it.

If the banks had virtually no excess reserves, as was common before 2008, then the Fed could more easily control its target rate.  Therefore, the commenter is right in one sense that if the Fed put a negative interest rate on excess reserves (charged banks for holding money instead of lending it), then this would force down the excess reserves.

But it does go the other way too.  The reason that the Fed started paying interest on excess reserves was so that it had more manipulation power.  It is no coincidence that the rate paid on excess reserves right now is a paltry .25%.  Let’s say that the Fed raised this to 5% tomorrow morning.  What would happen?  The banks would tie up their money in excess reserves and there would be very little money there for banks to lend overnight.  This would actually increase the Fed’s target rate.

Ben Bernanke himself is quoted as saying, “In principle, the interest rate the Fed pays on bank reserves should set a floor on the overnight interest rate, as banks should be unwilling to lend reserves at a rate lower than they can receive from the Fed.  In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime, and other factors.  However, as excess reserves decline, financial conditions normalize, and banks adapt to the new regime, we expect the interest rate paid on reserves to become an effective instrument for controlling the federal funds rate.”

The rate paid on excess reserves actually puts a floor on the federal funds rate.  It is not an exact science as even Bernanke struggled with this when the tool became available.  The Fed did not know exactly where to set the rate on excess reserves and it was throwing off their target rate.  So if the Fed announced a significant increase in the rate paid on excess reserves, this would in fact raise the fed funds rate.

So the Fed can control the federal funds rate, but it is unlikely to do so right now.  If it raises the rate on excess reserves, this would really hamper lending and it would likely lead to a quick and sharp recession.  If the Fed puts a negative interest rate on excess reserves (charges a fee), then banks will start to lend out their reserves and we will see massive price inflation very quickly.

The Fed will keep walking a tight rope between recession and inflation.  It will eventually run out of room and we will probably get both at the same time, if we don’t already.

With all of the economic problems we face today, there are a lot of myths out there.  These myths are promoted by the media and politicians and even some so-called economists.  They are Keynesians.  One of the biggest myths of all is that spending drives our economy.  When you think about it, this is really childish and yet many people believe this nonsense.  It is a mix up of cause and effect.

An economy grows because of production.  We get increased production from savings, capital investment, and increased technology.  An economy is not more productive because of consumer demand.  We can have all of the consumer demand we want, but it doesn’t make things appear out of thin air.  I’m sure that people living in third world countries would like to have ipods, flat screen televisions, and be able to dine out at fancy restaurants.  But they simply don’t have the wealth accumulation to have these things.  They can demand these things all they want, but they won’t appear until there is production.

There is more consumption in a place like America as opposed to a place like Ethiopia because there is more to consume.  There is more to consume because America is wealthier.  There is more wealth because of the prior savings and investment that has taken place.  This is because of stronger property rights and freer markets.

Remember that you can’t consume that which isn’t produced.  The excessive consumption of Americans in the last decade does not exactly mean that people consumed future goods.  It means that they consumed more in place of saving.  Due to the lack of savings, it will hurt future production.  We are beginning to pay for that now as we can see with the economy.  Unfortunately, the government continues to exacerbate the problem.

Look at this from an individual standpoint.  Let’s say that you have saved up $100,000 over the last several years.  You earned more than you spent each year and the difference was put into savings.  Now you decide to take an extravagant vacation.  You rent out your own private island for a month and get the best service available.  You have a great vacation, but you squander all of your savings of $100,000. Now you are left with nothing, except for your job.

This doesn’t mean that you will starve.  You still have the income from your job.  But your lifestyle will have to take a hit from your one month vacation.  You will have to go back to work and live within your means again.  If you want to save money again for the future, you will have to live below your means.

There is nothing wrong with consumption from an individual perspective.  We need some consumption on a daily basis just to survive.  But most people realize that we can’t always live for just today.  We do have to plan for the future.  This means saving money.  This allows capital investment, which increases future production.  It means we can have a higher standard of living in the future than what is possible today.

Government spending does not stimulate an economy any more than the person taking an extravagant vacation.  It might appear that your standard of living has increased, but in reality you are substituting savings for consumption.  You are simply living for today and not worrying about tomorrow.  The problem is, tomorrow is here now for Americans and for governments here and around the world.

The Federal Reserve met yesterday and today and Ben Bernanke held a press conference, which is a new gig designed to fight off Fed critics.  The FOMC said that it is keeping rates the same.  Of course, this is in reference to the Fed funds rate, which is almost at zero.  But the Fed is not really controlling that rate right now anyway because most of the banks do not need to borrow overnight money because they have a massive pile of excess reserves from all of the quantitative easing.

Other than some little changes in their forecasts for growth and inflation, there was not much new coming from the Fed.  Bernanke is saying that the Fed will continue to reinvest expiring bonds.  This means that the money supply should remain stable with the ending of QE2.  He did not make any promises for a QE3 and that is probably the reason that the stock market pulled back today.

It should not matter what one man says or does.  It should not matter what one small committee does.  Unfortunately, because they control the money supply of the money that is used in the largest economy on the planet, every little word by Bernanke has an effect.  It shouldn’t be this way, but it is.  Therefore, as investors, even if we don’t like the central bank, we still have to pay close attention to what it is doing.

It is impossible to predict what the Fed will do next.  If I had to guess, I think the most likely scenario is that they keep the monetary base steady for the next few months.  When the stock market does poorly, the economy continues to struggle, and unemployment doesn’t get any better, then the Fed will have an excuse to go forward with QE3.

Meanwhile, we have to continue to monitor all of the variables in our world.  There is continuing war, there are revolutions going on in the Middle East, there is a disaster still going on in Japan, there is the good possibility of default by Greece and other European countries, and there is the health of the economy in the U.S.  There are a lot of things that could go wrong right now and any one thing could trigger a financial panic.  Continue to play it safe with your money.  Playing it safe means putting a good chunk of money in the permanent portfolio and the rest in cash, gold, and silver (or equivalents).

We will also continue to monitor the adjusted monetary base and the excess reserves held by banks.  This will clue us in if we should expect serious price inflation in the next several months.