This is not likely to be a popular post.  Just warning you.

I have a bias that modernity is more fragile than commonly believed.  One aspect of that is income/wealth distributions.  Inequality was far more pronounced in the past, and was fairly stable in being so.  So why should the last 150 or so years not be viewed as a possible aberration?

Let me give you five or so reasons why the middle class should shrink:

1) Education — middle classes in the developed world were relatively large when the education systems produced a large portion of the educated people of the world.  That is no longer so, and relative education levels have tipped against the US.  Any surprise that we fall behind?

2) Lazy choices for majors/jobs — “follow your bliss” is stupid advice if no one wants to fund your bliss.  All prosperity comes through serving the needs of others.  Follow their bliss, not yours, and you will do well.

3) Technology — some technological advances aid equality, and some aid inequality — we have been getting more of the latter lately.  If a technology aids one person to serve many at low marginal costs, it will aid inequality, unless the technology is broadly shared and used.

4) Global Conditions — Resources are scarce.  Capital is somewhat scarce.  Unskilled labor is not scarce.  Skilled labor is somewhat scarce.  For those that have not prepared themselves to be productive by having needed skills, it is a tough time.  You won’t be carried along by the prosperity of your nation, because there are many others competing against you overseas, which was not true in the 50s, 60s, and 70s.  (Nor even the 80s and 90s, in degree…)

5) Personal Ethics — Societies that tolerate many children conceived out of wedlock, and no-fault divorce create an underclass of poor women with children, and the children are far less able to compete because they have no father figure.

6) Politics won’t change things — this is yet another hard reality.  People may vote, but money/resources “vote” more.  Especially in societies where education has slumped, power gravitates to those that will better the whole, even if it means the elites get more.

Someone please send the memo to the “Occupy” crowd, and tell them that have succeeded at being the “freak show” amid changing times, but utterly irrelevant to the changes happening around the globe.  If they have jobs, get to them, if not, go find one.  You might be relevant then.

In general, my experience is that sharp moves up or down over a day or a few days proceed from investors that are reacting, not thinking.  Those moves tend to get erased by future market action.

Slower, intermediate-term moves tend to persist, and those moves don’t get the same media attention, because they aren’t dramatic.  Bear market rallies are sharp, so are Bull market panics.

That’s why I don’t make too much out of days like yesterday.  A news-driven market is over-reactive.  Days where there is no no significant news gives us a feel for how the large players are adjusting their exposure; the same is true of looking at the trend over 6-12 months, where the effect of short-term news gets washed out.

So be wary, skeptical, etc., and keep some cash on hand to buy up future bargains.

I find commentary regarding open vs. closed minds to be vapid.  For example, I saw this tweet:

Inspired_Ones Inspiration!!!

Minds are like parachutes – they only function when open. -Thomas Dewar
I responded with this:
AlephBlog David Merkel
@Inspired_Ones Minds are like castles under attack; they function well when the drawbridge is up, moat full, & the defenders are ready. 😉
I’m a value investor.  I do well partly because I am skeptical.  I implicitly trust few opinions shared over the internet, or among my acquaintances.  There are many out to bamboozle the naive.
Now, I’m not saying never believe anything.  I am saying that you should test claims that you receive from others. What is the historical evidence?  What are the biases of the writer?  Few in investing write neutrally, so analyze the angle of the writer.
But after that, once you understand the biases, read the contrary data.  They may know something that you or I don’t know.  Compare it against other opinions, and ask those that would likely disagree for their opinions.  Analyze, asking which opinion is most likely, or whether yet another opinion not yet imagined could be right.
This isn’t easy to do; it takes humility, which makes it hard for me to do, but the effort must be made.
Odd opinions must be made to jump high hurdles.  We don’t want to be like those that believe things merely because they are odd.  (I have known more than my share of those.)  For investors, in prosperous times, oddity yields bad results.  In unprosperous times, oddity yields volatile results. Some do incredibly well, and some very badly.
If someone proposes a novel investment idea to you, be wary.  Few novel ideas pay off.  This is not to say that classic ideas always do well, but the odds are skewed against novel investments.
In closing, be sensitive to your economic environment.  There are no economic environments that offer unlimited potential.  There are many that limit “normal” economic opportunities.  Don’t force an overly optimistic view on the markets, or an overly pessimistic view.
Do your “due diligence.”  Analyze your assets, and potential replacements.  Then make businesslike decisions to buy and sell, after you have analyzed the situation in entire.

One thing to search for in the markets, is what entities are being unrealistic.  We have a bevy of them now:

  • Eurozone — “We can get many nations to behave like Germans.”
  • China — “Our financial system is in great shape.  We are ready to open up our economy to global capital flows.”
  • US — “Eventually the government budget will be balanced, really!”

In the present environment, creditors are the unrealistic dreamers.  They imagine that they will be paid back at par, when they made loans that were less than creditworthy.

In most cases, the right solution is to offer no more loans, and compromise on existing loans.  The wrong solution is to extend more credit, hoping that the situation will turn, and that you will eventually be paid back at par.  The result of extending more credit is that you will take much bigger losses later.  Tough love produces better results than compassion, for all parties.

Yes, there may be more short-run pain, but there will be better recoveries after the crisis is over.  Think of Eastern Europe — those that took the “Big Bang” did better.  In this environment, creditors need to take their losses sooner, and the system will do better thereafter.  To seek full payment is unrealistic.

I wrote about the thoughts of others Wednesday as I took notes on their talks.  I don’t type that fast, so my notes gives synopses of the talks given.

Now for my own thoughts.  I have a sympathy for anyone that wants to take monetary policy out of the hands of the government, because they don’t do it well.  Some sort of hard money standard is necessary, whether gold, silver, or a commodity basket.


I have one major ideal here, and I don’t care as much how it is accomplished: get the government out of the monetary policy business.  My secondary ideal is regulating banks properly.

A gold standard could do the job, but I am not wedded to the idea.  Gold standards can be inflationary or deflationary.  It depends on the price at which you link the currency to gold.  Post-WWI, Britain pegged it too high, and got deflation.  France pegged it too low and got inflation. Getting the right level would be important.  Fortunately, we know where it trades now relative to the dollar, and that would be pretty close to the right level, if the stated gold levels of the Fed and the Treasury are accurate.


A full audit of the Fed is a minimum, as is an audit of the gold at Fort Knox.  Do it once, so that all doubts can be dispelled.

I think that bank regulation for leverage and asset-liability management is more critical than monetary policy itself. Banking crises stem from inadequate asset-liability management.  As James Grant pointed out from the historical example that he gave, deposits should back only self-liquidating assets.  Longer term assets must be backed by matching funding, or equity.

Unseasoned asset classes (i.e., asset classes for which we have no real loss statistics because they have never had failure as a group) should be disallowed as investments for banks except against surplus.  After that, risk based capital should be based off of strict actuarial studies, with a significant provision against adverse deviation, and no credit for diversification.  And, don’t allow banks to score their own riskiness, a la Basel.  That is ridiculous; the fox guards the henhouse.  If a bank has superior risk control, they will earn the results over time; they should not as a result lever up more.

Now, I really don’t care if it makes banks unprofitable, or earn less than their cost of capital.  In that case, we will get fewer banks, the margins of the remainder will rise, and you end up with a genuinely stable system with occasional bank failures that don’t threaten the system as a whole.

There was one idea that I thought could be put into practice immediately, Treasury Trust Bonds optionally backed by gold.  If nothing else, like TIPS, it would give the Fed another indicator on how credible their monetary policy is.

Conference Zeitgeist

The Taylor Rule got some respect.  Many suggested that if it had been followed, we would not have gotten into this crisis.  I’m a little less optimistic there, because bank regulation was co-opted allowing for too much risk to be taken relative to liquidity and capital.


Most felt that the Fed was the major player in causing the crisis, with the GSEs playing a lesser role.  The overpromotion of home ownership, and the constant provision of liquidity to the markets led borrowers to become reckless amid asset price inflation.

Incentives also played a role. Managerial and shareholder liability at banks would help prevent reckless behavior.  Wall Street worked better when it was a bunch of partnerships, rather than limited liability corporations.

Most thought that things are worse now than the ’70s.  The debt levels are higher, which makes demand punk, and businessman more skittish to expand and hire.  Government policy is less predictable as well.

The speakers largely expect more inflation; more debt monetization is the path of least resistance.  Politicians get what they want without a vote being taken.  On the question of where to invest, everyone was an inflationist.  Gold, silver, TBT, were trotted out.  Personally, I’ll stick with my stock investing.


Jeffrey Lacker showed courage in coming to the conference.  He made a really good point that the Fed should focus on its liability policies, and limit itself to investing in Treasuries.  The Fed gets bad press and popular dislike when it uses its assets for special lending programs and bailouts, leading to charges of favoritism.

Zoellick was a reasonable guy regarding the problems in the Eurozone.  Germany has to figure out what it wants.  To me, it boils down to this:

  1. You can have a suboptimal euro that is not a good store of value, and bail less well-disciplined governments out via the ECB sucking in their debts, or,
  2. You can have a smaller Eurozone en route to no Eurozone, or,
  3. You can have a Federal Europe, and dissolve Germany into Europe as a state of the whole, as the 13 colonies did after the Articles of Confederation.

Personally, I would choose #2, because people in Europe identify themselves with their nations, not as Europeans.  Political and economic systems must derive from cultural systems or they will not work in the long haul.

It was fun seeing my old professor, Dr. Steven Hanke.  I reminded him of nine years earlier, when he gave a talk to the (then called) Baltimore Security Analysts Society, and we discussed why we thought the Euro would have a tough time surviving.  Most of that discussion is now taking place.

Ron Paul was Ron Paul.  He doesn’t change much — that’s one of his apolitical virtues.

John A. Allison was entertaining; he argued that capital levels are too low, and regulation too high.  He thinks that you can’t expect much, and don’t get much from regulation.  Especially interesting were the discrimination in lending allegations by the regulators that BB&T fought and won twice.

Conferences like this attract cranks.  Lots of people with odd political agendas hoping to get noticed, others with odd business propositions.


As a final note, the concept of free banking and/or competitive currency issuance, I think invites more problems than it solves.  Think of it this way: people aren’t very good at evaluating financial promises.  The fewer the better, and the lower level of complexity, the better as well.  There has to be some monitoring of financial promises, some intelligent regulation of banks, or things can go badly wrong.  US history backs such an idea up, regardless of whether we have a gold-, silver-, or commodity-backed currency, or a fiat currency as we do now.

Update — thanks to Eddy Elfenbein for catching a typo/thoughtless mistake in paragraph 4.  For France, it was inflation, not deflation.


John A. Allison
Former Chairman and CEO, BB&T, and Distinguished Professor of Practice, Wake Forest University

Problems primarily caused by government policy, loose Fed policy, GSE policies.

Fed jobs: payment systems, bank regulator and monetary policy

Payment system monopoly benefits inefficient small banks.

Regulation: FDIC insurance destroys market discipline.  Financing using FDIC-insured deposits to make real estate loans.

Fed failed to oversee other regulators.

Private deposit insurance a la Bert Ely was possible. (?!)

Now-discredited study Boston Fed on discrimination in lending.  Loosened loan standards as a result.

BB&T fought it and was found not to discriminate.  Still fought it, until Republicans were elected and the investigations was dropped.  Same under Obama administration, until Republicans were elected and the investigations was dropped.

CRA eliminate redlining — banks don’t do well with low-quality lending.  Worked so long as home prices were rising, but gave the rating agencies the wrong loss factors that blew up when the bust happened.

Grossly misregulated during Bush, Jr. Administration — Privacy, Patriot Act, etc.  Only Spitzer caught.  Wasted a lot of management time which lead to less true risk control.

Would eliminate regulations before taxes. (DM: of course, taxes are easier to fuddle)

Regulators don’t catch things proactively.  No surprise, because regulators don’t act during the boom phase because everything is going well.  Describes a junky bank that BB&T passed on, until it went bankrupt.

In the bad times, regulators irrationally tighten.  BB&T no longer will make good loans that they used to.  FDIC was worse now than the early 80s & 90s.  Affects small banks most.

Price controls: no one at Fed believes in it, yet the FOMC triues to regulate interest rates.

Greenspan most regularly ran policy with negative real interest rates, helping to create a bubble, until he finally began his last tightening.  Bernanke inverted the yield curve, banks took more credit risk to compensate, worst loans were made then.

Fed held prices up in the ’20s by holding prices up when they should have been falling.  Hidden asset bubble.  Prices should have been falling in the 2000s with the addition of new labor to the capitalist system from China and India.  The process of inflating incented jobs overseas, aside from home construction jobs.

Fed policy today is destructive and lowering productivity.  Private equity guys he talked to are not changing their hurdle rates.

Current policy robs savers for borrowers.  Humiliating many older savers (DM: makes them take too much risk also).

If Congress can print money via the Fed, they will do so.

Who do enslave via regulation?

Short-term versus the long-term, we pick the short run… leading to inflation away of debts, and loss of responsibility.

Life, liberty and the pursuit of happiness… takes a dig indirectly at the gift and estate taxes… free to give it away.  (DM: perhaps it should have been pursuit of virtue, or serving Christ, but that wouldn’t have fit the Founders)

Self-esteem mainly comes from work? (?!)  An encouragement to do your best.  Welfare lowers self-worth.


Why should intervention not have occurred in the credit markets?

After making so many mistakes creating too much credit and a pseudo-boom, it was required after that. After that, the bailouts were not predictable.  The losses were not going to be so big.

Makes a mistake saying the insurance industry would not have been affected by the failure of AIG.

Disses Paulson (investment bank unsystematic), Bernanke (Academic) and Geithner.

Should bank executives have personal liability?

No. Thinks capital ratios should be 25%.

Why did they bail out Bear Stearns?

No good reason, thought it would be one-time.

Big rise in the monetary base?

Inflation, Stagflation coming.  No unemployment in a truly free economy. (?!)



Moderator: Alan Reynolds
Senior Fellow, Cato Institute

Stimulus: money away from productive uses and toward the goverment and other unproductive bits of malinvestment like autos and homes.

James Grant

Editor, Grant’s Interest Rate Observer

The cumulative effect of history

Problem in banking not a shortage of capital, but a shortage of capitalism.  Must allow banks to fail.  In old days, unlimited liability made banks more cautious.

Deutsche Bank vs JP Morgan Chase

  1. 15% capital-to-risk-weighted assets
  2. Leverage — also identical
  3. But DB 42x vs JPM 13x assets/equity
  4. 60x vs 17x — tangible assets /tangible equity
  5. JPM has less callable liabilities

1842 New Orleans — divide bank balance sheet in two; movement: self-liquidating loans and gold against deposits.  Deadweight: surplus — could invest anywhere.  Worked for a generation.

Clarity, simplicity and elegance

Kevin Dowd

Visiting Professor, Cass School of Business

Bailouts just another profit center for banks.

Liquidation would have been better than the bailouts — mentions Mellon

Low interest rates just create another bubble. DM: Hair of the dog

Confidence only comes from strong balance sheets.

Quotes Jackson regarding the Second Bank of the United States

Solution is to eliminate the Fed

Endgames: Monetize the debt, or watch interest rates rise.

Solutions? Gold standard, End Fed, personal liability for bankers.  Constitutional settlement because governments and money don’t mix.  Prohibit bailouts, and intergenerational transfer schemes.

Kurt Schuler
Senior Fellow, Center for Financial Stability

Competitive vs Monopoly issue of currency — why the shift?

Easy way for the Government to make money through seniorage.

Four places today where parallel issuance of notes goes on today: Scotland, Northern Ireland, Hong Kong, and Macau.  100% segregation of assets in reserves at the central banks, generally.

Where might issuance of competitive notes be legal?  Mostly teensy places, with the exception of the US & Japan (they aren’t sure) and the 4 mentioned above.


Raising interest rates to improve matters?  Where to invest?

Gold, silver, TBT

Currency transfer schemes talk, no question

DM: There are lots of these schemes around



Moderator: Steve H. Hanke
Professor of Economics, Johns Hopkins University

DM: Steve Hanke was a professor of mine when I went to Hopkins.

Targeting NGDP — Cato Institute — 2003 — Nominal Gross Domestic purchases or final sales

Richard H. Timberlake
Emeritus Professor of Economics, University of Georgia

Why did we go off the gold standard?

Dual Mandate is the main problem at the Fed.

Fed very different animal than at its inception.

Legal tender laws — goes back to the Civil war, 2.5x inflation afterward.  Debts paid off with depreciated greenbacks.  Tested by Supreme Court — Salmon Chase, Lincoln’s Treasury Secretary in 1864, was the Chief Justice at the time in 1869, and he changed his mind, on the ability to pay off pre-1862 debts with the greenbacks.

Rankled Grant administration — appointed 2 new justices, and a new case reversed the ruling. 1871

1884 — Congress can issue any currency it likes because it has sovereignty.

1913 — System needed a lender of last resort, thus Fed creation.

1922-1929 — Stabilized the price level, amid a gold standard…

Benjamin Strong dies, and power shifts from the NY Fed to the Board.  New leader opposes speculation; banks needing liquidity could not get it if they had been lending to the stock market. 1929-1933 huge contractions and bank failures.

FDR abandons the gold standard; devalues; collects gold; eliminates gold clauses.

Supreme Court relies on legal tender laws saying that Congress could define money as it chose.  He thinks the precedents should have been re-argued.

Judy Shelton
Author, Money Meltdown

Ruble collapse — Why back to gold standard?

Thinks all candidates should be talking about monetary reforms.

Money should be a stable unit of account and should be liquid.  It should allow us measure value well.  Convey the price signals of the market accurately.

Jefferson wanted a hard currency defined in terms of precious metals.

Offer Treasury Trust Bonds with a an optional conversion feature to gold.  Would receive par back or an ounce of gold.  Priced initially with par of an ounce of gold, no interest paid.

Argues for a balanced budget amendment.

Thinks other nations would mimic the ideas if a US Government gold bond would be issued.

Greenspan proposed this idea 40 years ago.

Lawrence H. White
Professor of Economics, George Mason University

How to go back to the gold standard?

A lot is calculating the proper initial parity with gold.

Treasury owns enough gold to re-establish a gold standard at $1600/ounce.

“At least I assume it is there, Fort Knox hasn’t been audited in a while.”

1) Eliminate excess reserve by eliminating interest paid on reserves.

2) Redeem reserves at Fed with gold.

Back M1 100% with gold — $8000/oz, Inflationary, reduction in wealth, etc.  Warehouse notes w/storage fees.

Central bank?  No monetary policy needed.  People would buy and sell gold daily.

Single mandate has not worked well for the ECB.  Inflation there running at 4% or so.

Competing private banks worked better than with central banks.

Or, the Fed could become a currency board in the short run.


Taxation of Tsy Trust Bonds?

Shelton: Would confuse some of the issues.  Just get this out there so it can be tried.

Will the gov’t take action?  Guesses as to when?

Shelton, White: No idea.

Would would trust the Treasury w/Treasury Trust bonds?

Shelton: They would be collateralized.

Why is monetary reform important?

Hanke: because the Fed ran a reckless monetary policy, and did not regulate leverage of banks well.



Robert Zoellick
President, World Bank

Questions from:

Sebastian Mallaby
Senior Fellow, Council on Foreign Relations

Asked about the EU crisis:

Missed his first point.

2) Greek debt forgiveness may come.  3) EFSF assist Italy and Spain with rollover.  4) Markets judging governments.  Slow motion run. 5) move toward political and maybe fiscal union.

All liquidity and buying time.  Emerging markets in the G20 look at the EU, and are surprised at the lack of coherence.  Zoellick doesn’t want to see the US get there.

What can Germany do?

Germany’s policies individually are reasonable, but not in aggregate. 2,3) Could provide even more in aggregate to the EFSF or IMF SDRs –> Germany: other Europeans should become more like Germany.

US underestimates Germany’s commitment to the Eurozone.  Merkel building commitment among the German electorate (?!)

What political/fiscal reforms could take place?  Uncertain.

Germany: Markets should not dominate the State (DM: Hegel?), unlike US & UK.

What else can be done?

Italy might be fixable, with a little bit of time.  Spain also.

Isn’t this just a question that reserve assets now appear to be risk assets?

Get countries to recognize the externalities inherent in their policy choices.  Get the emerging markets to move toward flexible exchange rates and independent central banks.

US Dollar will remain the main reserve currency, but may go multipolar to many reserve currencies.

Gold will judge the policies of Central Bankers.  At least Central Banks should look over their shoulder at it.


Corruption? Why not exclude those nations the Eurozone that can’t stand the rigor?

US less transparent than the World Bank.

Question comes down to cross-subsidy of the less rigorous.


Moderator: Mark A. Calabria
Director of Financial Regulation Studies, Cato Institute

Malinvestment vs capital flowing to most productive sectors of the economy.

Jeffrey M. Lacker
President, Federal Reserve Bank of Richmond

Fed’s response led to misallocation of capital.

Monetary expansion was needed to prevent a collapse.

Initial Fed lending was sterilized — equivalent to issuing Treasuries, and lending the proceeds.

Fed could have just bought Treasuries, and not MBS or other securities.  To do otherwise distorts credit incentives.  It creates an appearance of unfairness.

Many contend as a result that credit allocation should not be an aspect of Fed policy. May compromise the independence of the Fed to do so.

Cornerstone of CB independence is control of liabilities.  Assets are more open to choice.  Thus it becomes a path of least resistance in a crisis.  Creates moral hazard, and probabilities of future economic distress.  Threatens CB independence.

Contain the willingness to intervene either by CB habit or law.  Would conflict with lender of last resort, which was more a product of a commodity money era.  Not elastic credit needed but elastic currency.

CB asset policy is an unfinished aspect of Central Banking.  This should be a top priority for action.

Allan H. Meltzer
University Professor of Economics, Carnegie-Mellon University,
and Distinguished Visiting Scholar, Hoover Institution.

Bailing out Bear Stearns was a mistake, and other non-commercial banks, including AIG.  Added to uncertainty of the situation, Fed then increased supply of credit, bought MBS and long-term Treasuries.  Fed acted too soon, if they had waited, they might have been able to do less.

Speculators front-run the Fed.

Fed doesn’t care about exchange rates except in a crisis — US Dollar down 15% recently.

Operation Twist not needed because they acted too soon, economy expanding rapidly now (?!)

Fed is too short-term oriented.

Believes that things will only normalize when housing values fall to their eventual equilibrium levels.

Chart on base velocity vs LT AAA Corp Bond yields.  Current conditions consistent w/ ’20s and ’60s.  Here’s my version, really only consistent with 1932-33 at present.

Greater centralization of the Fed and US Government control over the Fed.

Thinks higher future inflation is highly likely.

Fed has done well when it has followed the Taylor Rule.  Flip-flopping from one aspect of the dual mandate to another has not worked well.

Phillips Curve does not work, and the present Fed uses it for erroneous forecasts.

Fed kept monetary policy too low for too long and created the crisis.

Fed needs to be more accountable for its actions.

George Selgin
Professor of Economics, University of Georgia

Jokes that the Federal Reserve should be done away with, or that it should be significantly modified.

Describes how monetary policy works.  Little need for a discount window a common topic before.

Fed channels liquidity through soundest counterparties — primary dealers.  But if primary dealers are impaired, they become liquidity sponges.  Happened in 2008, so they worked to rescue primary dealers, excluding Lehman. [PDCF?]

Discount window didn’t help because of stigma, and thus the TAF was created.

1) End primary dealer system.  Not needed anymore with modern technology for auctions.

2) End Treasuries only.  Original Fed was not that way; avoid monetization of US debt. Let many parties bid for credit from the FOMC.

Eventual disbanding of FOMC, let a computer do it.

Roger Garrison
Professor of Economics, Auburn University

Natural rates of Interest and Economic Growth

The Fed attempts to expand growth beyond the natural rate of growth, and accelerates it beyond, setting up the conditions for a slump.

FOMC actions every eight weeks; learns once a decade when a crisis occurs.

Taylor Rule has no concept of the natural rate of interest.

Concludes that the Fed oversupplied credit, creating a boom and then the bust we are currently in.


Opinions on Nominal GDP targeting?

Meltzer: easy to say, hard to do.  Follow Taylor Rule.  Lacker agrees.

Selgin thinks it is a much better idea.

Garrison: target a zero growth rate. Prices would fall.