Posted by: graemebird | August 5, 2007

Advice To The Reserve Bank

3 Posts from Catallaxy:

But I’ll put the third post first since its really the most important. And I want to convey the primacy of Reismans figures and terminology.

Post III

Its critical that the Reserve Bank study this young Swedish blokes PDF.

Johnsson has worked out Reismans GDR from Americas National Accounts.

He’s then split it up into what he’s calling Gross consumption and Gross Investment. But the two together make up GDR.

If you go to page 5 out of six and look at the graph (figure 2) he shows these two and shows why their was a recession in 1992 and 2001.

Because these folks were looking at consumer prices and consumer spending they screwed it up and produced two recessions.

Note how the Gross consumption trend is very smooth and barely dips in the 1992 recession.

But “Gross Investment” (Gross Domestic Revenue – Gross consumption) falls through the floor.

Now its pretty clear that the Feds screwed things up badly after that. Notice the quick upward trend to mid 1992.

And fair enough too.

Because at that point your average businesses cost-of-goods-sold would have been exceeding their revenues but for the massive amount of cash the Fed must have been flushing in to desperately restore profitability.

I’m not faulting them on that score.

But dig the trend in gross investment after that. Its up and down but the up is too steep.

It ought to have been up in such a way as they are trying to stop it being negative but only just.

Like I said you’d want that Gross investment (corresponding loosely to what Reisman calls productive expenditure or Skousen is calling Intermediate output) to grow as slowly as possible but never negative… So err on the positive side is what I’m saying.

Instead by looking at the graph we see that they have acheived this with GROSS CONSUMPTION!!!!!

I suggest that this is by design.

That the incredibly smooth gross consumption resulted from them trying to stabilize consumer prices in error leading to Gross Investment careening out of control.

Careening out of control. Growing faster then it needed to grow. But failing to stop it from falling.

And as a consequence look what happens from 1998 to 2000.
That massive upward sweep. Which signifies an unsustainable boom….. which when it comes to an end leaves everyone in the shit.

After that we see from Johnssohns notes that fractional reserve fiduciary media starts dying in the ass. It just dissappears.


Maybe now go up to figure 1. Bottom of page 4.
Here we have Gross Investment and Gross Consumption as a percentage of the total Gross Domestic Revenue.

Johnsson is plotting them from a zero start and their percentage change.
See how the percentage devoted to consumption massively increases during the recessions.

This ought to put the lie to Keynesian analysis for all time.

Its business spending that tanks in a recession. Don’t ever forget it. And don’t ever listen to the lies and ignorance of the economists that say otherwise. Or the constant Keynesian drumbeat in our financial press including the Financial Review.

But we see that in figure 2 consumer spending goes down a little bit in total dollar amounts. This is a result and not a cause of the recession. Its a measure of immense hardship.

Now its completely evident, if you are focusing on GDR and not GDP that it will do just no good at all to spend in deficit and encourage consumer spending.

This will not help end the recession in fact it will just put people in more shit.

What needs to be done is to quickly bounce-then-flatten the growth of gross investment before everyone goes broke.

Now they did the bounce in the first recession and I’m happy with that but they didn’t flatten.

The more bounce you can get WITHOUT monetary expansion the better.
You get that from slashing government spending and asking people to SAVE-NOT-SPEND. Of course reducing the piano-on-the-back of taxes to business is critical in rain or shine. But not for the purpose of deficit spending. The real solution is massive spending cuts.

This is something Hayek insisted on and no-one seems to have believed him but its really quite clear once you are looking at the right graphs. Once you are looking at the breakup of Reismans GDR in the way that Johnsson has broken it up.

You ask people to save their way out of the recession. You ask people to err on the side of lower rather then higher prices and you massively slash government expenditure.

But it is true that you want to quickly restore profitability with a burst-then-flatten effort in monetary expansion.

And you are going to be so much more successful at doing this right if you aren’t saddled with the crazy and unstable larceny of fractional reserve.

In fact the burst-then-flatten can be best acheived, under the current setup as a standing start, by a massive cash injection followed by a raising of the Reserve Asset Ratio at the first sign that the cash injection has taken effect.

But first of all we want people to be looking at the right figures and not fucking guessing.

Post I

Sometimes we skip ahead and forget that the counterfeiting will have an effect on the volume of spending and not just on price. And if the rate of counterfeiting changes then its likely that it will affect volumes of spending in individual areas first. Volumes of spending would tend to be the first effect…. price momentum would come next.

We want to look at Cantillon effects and momentum effects.
Cantillon effects are to do with the transmission of the newly created money through the economy.

Under 100% Gold this would be a very stable thing. The new Gold coming in from the mines would simply be paid to the mines suppliers and employees and it will come in like a stable flow as if you are filling up a swimming pool with a hose. No turbulence.

Just imagine the situation now. The extra money comes in via the banks and it is used to buy things that people will buy on debt. So specifically encouraging extra debt spending.

So the volumes of spending and the prices will increase on these things in the first instance and then will go on to other things increasing those volumes of spending and prices as it goes.

But what happens when it gets to consumer prices?

Well since many of the things we buy come from overseas it may not effect these prices very much even as we buy great volumes more.

This depends a lot on how investors are treating our currency.

But you can see why in the middle of a mining boom we are still running trade deficits.

And you can see also why for many years we might be able to have maybe as high as 8% monetary growth and only 3% consumer price inflation or so.

A lot of the extra spending goes into the housing market, into shares, into the expansion of Gross Domestic Revenue since this grows faster then GDP and is a better indicator of the total volume of spending.

So not only is consumer prices not the sum total of all prices that we want to be tracking…… Its actually the worst set of prices. The one least relevant to the damage we are doing with our counterfeiting.

One mental exercise you might try Z…. if in fact you are capable of such a thing. Is to seperate in your mind which consumer prices have gone up faster… out of the foreign-produced and the domestically-produced.

So we might see that bananas and milk have gone up faster then the stuff you buy from Taiwan or China in the bargain stores.

And we might find that cars haven’t gone up so much but that our domestic car manufacturers are winding up their operations.

We might find that educational services have gone up but our foreign students start staying home or going elsewhere.

We might find that houses have gone up in price as have our debt loads both foreign and domestic.

Now I will refer to a link that Mark made once to explain things further.

What we want to be doing is making sure that what Skousen is calling GROSS OUTPUT… we want that groing as slowly as possible in total nominal terms.

But more imporatantly we must not let what Skousen is calling INTERMEDIATE OUTPUT from ever surging too much or ever falling back in nominal terms.

It goes without saying that we ought to be always phasing towards 100% backing to cut down on the disinformation and turbulence that fractional reserve brings.

But while doing this its nominal INTERMEDIATE PRODUCTION that we must pay the most attention to.

Supposing a lot of money is counterfeited… goes into the loans market…. and winds up in overinvestment by firms in their intermediate production…. the flipside of which is much of the component of Reismans “productive expenditure.”

Most of their costs will go up after this frenzy of overinvestment and excess spending.

You see by always looking at consumer prices you have been deluded into thinking that prices can be sticky and insensitive to monetary expansion.

There is just no truth to this rumour at all and prices will respond immediately but it can be hard to figure out in advance WHICH PRICES.

But think of what is happening to the COST OF GOODS SOLD of the firms involved with intermediate production.

Productive expenditure…. or intermediate output…. will lead cost of goods sold. That is to say that the two measures will track together but the cost of goods sold will lag intermediate output.

If Productive expenditure or Intermediate Output peak abruptly and then falls you will get to a time period where business costs have been inflated… where their sales are suddenly dropping away… where the investment projects they have started are no longer able to be finished…..or if they are by a blowout in more borrowing and sourcing of real physical capital from overseas (the local suppliers costs have blown out)…

… But quite apart from all that their cost of goods sold will now be higher then their sales in this later period. Hence their will be ubiquitous loss-making.

So the idea is to keep intermediate production (“Productive Expenditure” is likely the better figure but its not included in Skousens link) growing as slowly as possible but definitely always positive in its growth.

That way for your average firm revenues will stay a little ahead of cost of goods sold….. speculative momentum won’t cause investments to be less sound then they otherwise would be… And generally there will never arise the need for a recession to bring things back into balance.

If intermediate production were growing 1% per quarter in nominal terms and 2% per quarter in real terms then you would have yourself a sustainable growth-deflation boom like riding a wave that you need never get off.

Notice that in none of this does consumer prices feature. Its that one part of the economy we ought to forget about with regards to monetary policy. But instead its the only part of the economy that folks are looking at.

This is a failure of analysis. And usually its macromancy and silly-buggery.

Firms don’t go to Coles…. look at the price of pencils…. and say… Jeepers. I should launch into the pencil business.

They instead look at the availability of finance……. and they look at the volume of their own sales.

With fractional reserve it will be difficult to suss out the trend in volume of sales so they will tend to carry more inventories then they would otherwise.

So what happens with a sudden monetary expansion is that its misleading them on all sides.

They think the prices of their stock are on the rise and so it makes sense not to work too hard to get their inventories down.

They see that their volumes of sales are up and at the same time their bankers are very favourable to foisting all these low interest loans on them.

They calculate that this is the time…. THIS IS THE IDEAL TIME to update all their gear to keep ahead of the pack and to hire more people and get slack with costs in the hurry to increase output.

None of this is sustainable and everything will reverse with everyones costs overblown and their cost of goods sold bigger then their sales and just at the time when they have these unfinished investment projects (they will be commisioning new machinery and working all this overtime in their other plants)…… and have all these extra debts to service.

But this need not affect consumer prices all that much while foreigners still wish to buy our currency and invest here.

You might do all sorts of damage to our manufacturers and still be patting yourself on the back that consumer price inflation is within the Reserve Banks target range.

You might dredge up some bullshit theory that it doesn’t matter the destruction to the manufacturers and that we can all flip burgers and be landscape gardeners and after all the banks have expanded so much. The kids might all become clever bankers. “Rocket Scientists” in the world of banking (I hope you are not missing the sarcasm here).

Looking at the wrong metric may leave you in a fools paradise. But the Reserve Bank ought to wake up to the fact that they have been playing golf in the dark.

Post II

Under current circumstances the bank should target nominal-intermediate-output as shown in Skousens link. But better still Reismans nominal-Productive Expenditure.

There are other things to take into account. But that would be the metric that would have you avoiding recession.

If we really must have fiat currency…. then I’d target the growth in nominal “Productive Expenditure at 1% per quarter at first….. Even though that might mean in practise that money supply growth would be up as high, or for a while even higher then 5%.

Then as we were closer and closer to 100% backing… and you could target it even better…. and people were adapting to the slightly slower monetary growth….

… well then I’d get it down to like maybe .5% per quarter.. Which probably just means trying to keep it stable but always erring on the positive side so that you don’t go negative.

But then as you gained investment momentum through other policies….. no income tax…. deregulation….. massive increases in energy production…

As you gained momentum you might let it creep up closer to 1% per quarter again.

In a high growth scenario if you really had to have fiat you might want to keep nominal-intermediate-production (nominal Productive Expenditure) at half of the growth of real-intermediate production (real Productive Expenditure).

You want to keep in that “growth-deflation” range.

But in any case you want it always positive to stop recession but only slightly positive to not have distortion and low-quality investment, outright malinvestment, or overinvestment.

Notice that nowhere do we concern ourselves with consumer prices which will take care of themselves.

I say we ought target intermediate output directly since under fractional fiat the demand for money for holding will bounce around too much for targeting money supply outright to be reliable in the medium term.

In the longer term under growth-deflation 100% backing… particularly metals backing….. targeting money supply and intermediate output would converge since the demand for money for holding will be high and stable.

I’m using the metric Intermediate output rather then Reismans Productive Expenditure only because that corresponds to the Skousen link and in the past people haven’t been able to get their head around Reismans term. And so Skousens term might speak for itself more.

But I think Reismans aggregations are the most well-worked-out ones that there are.


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