Metals Market Gets Smashed; Dr. Englehardt: Economy Beholden to Fed Interest Rate Policy

August 17, 2018

By Money Metals News Service

Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.




















Dr. Lucas Engelhardt



Mike Gleason: Well, I’m excited to have you on today because there is a lot to discuss with you. For starters I think a good place to begin is the business cycle. Now, but before we get into the misunderstandings that the Keynesians seems to have about this, explain the business cycle if you would and why it’s important in order to have a proper understanding of monetary policy.


Austrians, we definitely do not deny that this actually does work for a while. That the lower interest rate does actually encourage investment, especially in very long structures of production. The types of things that won’t pay off maybe for five, 10, or even more years. We see lots of research and development, lots of construction, these types of things happening when interest rates get pushed down.



So, we see all of these areas that expanded then start contracting, and that’s where we see the bust of the business cycle come in. We see there it’s really all centered on what the Federal Reserve in modern America is doing in interest rates.


Dr. Lucas Engelhardt: Yeah, that’s a funny question. I think, like to me, a lot of the error that’s out there is because somewhere along the lines economists, and I think people more generally have gotten into their mind that money is somehow totally different from other goods. You ask almost any economist out there, for most goods, things like shoes and shirts and whatever, they’re generally perfectly happy to have the government stay out and let the market be in charge of deciding what kinds of shoes are being produced for whom and what have you.

But, then money suddenly, even people who are relatively free market, like Milton Friedman for example, they feel like money’s different in some way and the government needs to have more of a role there. I’m not entirely sure where that comes from to be perfectly honest. It’s this odd inconsistency. But, in terms of the danger of that, I think we already described the business cycle is something we see precisely because we’ve put the central bank in charge of the money supply, and them interacting with the credit markets.

Whereas, we wouldn’t see the same type of process play out if instead we had private money producers using some kind of commodity, probably something like gold or silver historically, just producing as people want the good. Like we do with anything else. We don’t really find that to be necessarily problematic.

Honestly, I don’t have any great explanation for why most of my profession does seem to have this weird hang up when it comes to having markets in money.


Dr. Lucas Engelhardt: I think probably the best explanation of it I’ve seen of this comes from Ludwig Von Mises. The analogy that he gives is the analogy of the home builder. So you imagine that we have this home builders building this neighborhood, and they’ve been reported to them that there are a certain number of bricks available for them to use.


First, the earlier we learn that the better. So, if we’ve just laid the foundations and then we find out we don’t have as many bricks as we thought, we can salvage most of what we’ve done. On the other hand, if we get to the point where we’ve already built the first floor of every single house and then we find out we’re running out of bricks, that totally changes our plans in a way that’s much more destructive. So, the earlier we learn the better.


So then, we back up and think about in a free market economy where we don’t have manipulation of interest rates, what does the interest rate mean? Well, the interest rate then would come out of peoples willingness to save for the future. If you’re willing to save a lot then interest rates are going to generally be fairly low. We don’t have to convince people to save if they’re already will to. On the other hand, if people are not willing to save very much, then interest rates will generally be very high.


On the other hand, high interest rates send exactly the opposite signal. People are not willing to save for the far future, and that signals to investors that they won’t have the resources to complete these very long investment products. So, that’s where the signaling role of interest rates is absolutely key in getting the economy to work properly. And that’s something that we lose when we have something like the Federal Reserve in charge of determining what interest rates are going to be.

The more they manipulate interest rates; the worse things are going to be. So, the more they try to keep interest rates really, really low in order to try to stimulate the economy, the longer we’re going thinking we have more bricks than we do. Or, believing that people are willing to save up for the future when they’re not actually willing to do that, and the further we get in more and more of these investments that aren’t going to pay off.

So, the sooner we can hit that point where we’ve realized the error we have made, the smaller the error actually is. I think that’s the way it is with most things in life. The earlier we catch ourselves making a mistake, the better off we are because we can fix it before things have gotten too bad.


Dr. Lucas Engelhardt: Oh yeah. So, inflation targeting, the idea is, and this is actually something, it’s kind of an interesting idea. The first place I know that implemented this was New Zealand a few years ago, where they were having this problem where they had very high rates of price inflation. So, they decided what they were going to decrease inflation to some more reasonable level. Something like three percent. I don’t remember the exact number they were going.

They found that they actually managed to pull it off. Prices fell, they didn’t have a horrible recession as would often be the case if you tried to pull this off some other way, because people seemed to believe them. So, after this example from New Zealand, it seems to have caught on as this great idea that everybody needs to do.


Now, there are a number of errors that can show up in this index, which really anybody who takes the first semester of macroeconomics gets taught the weaknesses. It doesn’t matter who’s teaching it, you learn the weaknesses of this particular index. Things like it totally ignores relative price changes.


So, we can see all of these little changes at the micro level that people will actually make in their lives, we just don’t catch. So, the CPI is the most common way we would measure this, but it’s not the only one. There are other measures of inflation out there, and all of them have various weaknesses attached to them.

Then, the question is if we know that all of our measures are going to be mis-stating the thing that we’re actually trying to shoot for in some way or another, and it’s not always predictable which direction or how much, then what’s really the point in having a target for this thing? We won’t actually ever know if we’ve hit it. So, that to me is a rather significant problem.

Another issue is, it feels like an abusive language to me. Because, if you read the act that… I’m trying to remember the name of the most recent one that influences the Federal Reserve’s targets, I forget exactly what it was called. But, they’re supposed to aim for price stability, and bizarrely this means prices increase on the average two percent per year.

I don’t know about you, but if my height increased by two percent two year, I would not consider it to be stable. I’d say that I was actually growing. Similarly I’d say with prices if they’re going up two percent per year, that’s not stability that’s actually an increase in prices.

Mike Gleason: Right, the opposite of stability.

Dr. Lucas Engelhardt: Right, exactly. Okay, maybe they’re not flying all over the place unpredictably, but it’s still not stable. But, in any case, what does this do even if it is predictable? Well, this does change people’s behavior. If for example we have prices are increasing overtime, that changes the way we decide to hold money versus invest in riskier financial assets, for example.


That makes it very easy for people who are relatively low income, actually. You don’t have to know a lot about stocks, you don’t have to know a lot about how financial markets work. You just hold onto your gold coins until you want to use them and that’s going to work pretty well for most people. But then, when you have a system like ours where every single year, if the Fed accomplishes its goal, all the money you have has just lost two percent of its value. You don’t want to do that.


It turns out, I would suggest inflation, and I’m not the only one suggesting this, inflation does play a big role in driving things like inequality. It makes it much more difficult relatively for those with lower incomes than for those with higher incomes. Precisely because it’s taken away all of these relatively easy, relatively stable sorts of investments that were available under more stable currency.



So, say that the price of gold stabilizes at, I don’t know, $2,500 an ounce. In that case, you can go to this conversion agency, if you have $2,500 they guarantee providing you with an ounce of gold. If you provide them with an ounce of gold, they guarantee providing you with $2,500. So, in that way, the paper currency we’re all using now would become as good as gold again, because it would in fact be backed by gold.





Dr. Lucas Engelhardt: Right. Yeah, so that was Mises’s idea of how we could reconnect, the money we use now with gold. One thing I really like about Mises’s plan, is Mises was very aware of some of the difficulties that can show up with the transitions. So, you can see where the plan is designed to not necessarily be that disruptive. We’re just stopping one thing we’re doing, that is the printing of additional paper dollars, we’re letting the market stabilize, and then reacting to what the market does.


So, we know that there are however many trillion dollars nowadays of M2. There are this many ounces of gold that the fed has claim to, so there’s this many dollars per ounce of gold, that’s the price of gold. And then, if everybody rushes to hand in their paper dollars we don’t have any problem, which could be a problem potentially under Mises’s plan. When I did the math there, it turns out if we tried to back all of M2, which would be all of the paper currency, checking accounts, savings accounts, small time deposits like small certificates of deposit would be included in there as well, and money market mutual funds held by individuals… all of those would be included in that.

If we backed all of that money by gold, that would make the price of gold $54,000 per ounce. Which is a bit different from what we’re currently seeing in the market.


Dr. Lucas Engelhardt: Yeah, a touch. A touch. Now, if we wanted to do something more narrow, like M1 would basically just be paper currency plus our checking accounts, that would still be looking at $14,000 per ounce, would be required to just back that. So, we’re looking at a rather drastic change, and I suspect that would very much change things like how much are we exploring for new gold, how much are we putting into gold mining, that kind of thing. I suspect we’d see significant economic changes there. But, that would be a one-time adjustment, really.

Mike Gleason: Yeah, it certainly would be something that could finally have an effect on the out of control government spending, it just doesn’t matter who’s in power, it just continues to get bigger and bigger all the time.


Dr. Lucas Engelhardt: I feel like a few more years is asking quite a bit. The big thing that I look at, and really, this is a strange thing, while as an Austrian I’m a strange creature, yet many of the things I look at are things that other economists would look at all the time. I pay a lot of attention to the yield curve.


We’ve not seen it invert yet, but we’re looking really, really flat. And the Fed has indicated that they’re going to be pushing up interest rates, and we know that they have the most influence over short term rates. So, I would not be surprised that if say within the next two years we see some kind of recession start.

There are certain things they can try to do to delay that. Not so much the Fed – the Fed basically has interest rates, which is what they’re playing with – but we could see, say, I don’t know, Congress try to pass another tax cut or something like, which could potentially offset this for a bit. I don’t really see that we’re going to be able to put it off for long, especially given that we just had this tax cut, I don’t know that we can afford to have another one. We see government debt piling up as it is.

Mike Gleason: Yeah, they always seem to want to cut taxes, which of course is a good thing and we’re all for that, but it never seems to be accompanied by cuts in government spending.

Dr. Lucas Engelhardt: Right, exactly. It’s very much like if I decided, you know, I’ll work less and earn less money but I’m going to keep living my life as it is. You can’t do that forever. Eventually you’re going to have to adjust to get these things to line up, and that’s going to be very painful when it happens. Especially with how out of alignment we see between our revenue and our spending. We’re going to have to see big cuts in spending, or a big tax bite coming to bring that back into line.

Like, right now, at least from what I’ve seen, it seems like we’re trying to cover up most of that difference by printing money and if the Fed is increasing interest rates, they’re basically signaling they’re not willing to continue printing money to do this, so interest rates are on their way up.

And go back to the story we told at the beginning, interest rates being on the way up is what starts making those investments that looked good a couple years ago when interest rates were lower, they’re going to start looking bad and we see things turn for the worse.






