Category Archives: Austrian Economics

Austrian Economics

Kleines Lesebuch über den Freihandel

Kleines Lesebuch über den Freihandel. Ebook von Detmar Doering.

Editor: Detmar Doering,
Vorwort: Otto Graf Lambsdorff

“Der Freihandel, eine der grössten Segnungen, die eine Regierung einem Volk erweisen kann, ist dennoch in fast jedem Lande unpopulär”. Von dem britischen Historiker Thomas Babington Macaulay stammt dieser Stoßseufzer aus dem Jahre 1824. Viele Verfechter des freien Welthandels können ihn nachempfinden. Anscheinend erhalten die Theorien, die den Freihandel stützen, so manche Wahrheit, die tief im menschlichen Geist verwurzelten Vorurteilen und Instinkten widerspricht. Viele Menschen können sich zum Beispiel anscheinend nicht vorstellen, dass ein freier und offener Welthandel den ärmsten und schwächsten Völkern dieser Welt nutzt. Dabei ist in Wirklichkeit gerade der Freihandel das beste Instrument der wirtschaftlichen Entwicklung für die Benachteiligten dieser Welt, das wir kennen. Dort, wo wirtschaftliche Unfreiheit herrscht, ist auch die Armut am größten. Die Wahrheit ist: Kaum eine ökonomische Doktrin ist so sehr durch Theorie und Praxis bestätigt worden wie die des Freihandels …

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Vernon Smith Prize 2016: Winners announced

Vernon Smith Prize 2016 Call for Papers
Vernon Smith Prize 2016: Direct Democracy versus Representative Democracy …

1. Prize: Karol Zdybel (Warsaw, Poland)

2. Prize: Alan Futerman (Rosario, Argentina)

3. Prize: Mark O’Kane (Lancashire, UK)

Essays had been judged by an international jury. They will be posted after their defense at the ‘International Vernon Smith Prize Ceremony’ on February 6, 2017 in Vaduz, Principality of Liechtenstein.

The 9th International Vernon Smith Prize for the Advancement of Austrian Economics was an essay competition sponsored and organized by ECAEF European Center of Austrian Economics Foundation, Vaduz (Principality of Liechtenstein). Topic: ‘Direct Democracy versus Representative Democracy. Cost and Benefit of the Citizenry’.

Although, democracy is fundamentally a method for preserving individual liberty and civil rights, this almost narcotic term has become so powerful today that all essential limitations on governmental power are breaking down before it. By deteriorating into a scheme of legitimizing the regime of coalitions of organized interests, representative democracies gradually transform into oligarchies. While it is assumed that governments always have the people’s best interests in mind, for the most part they seem to act in their own behalf. In direct democratic systems, however citizens have more controlling devices at their disposal and can propose, decide, or profoundly modify their governing laws, and even secede from the republic. Are direct democracies more cost effective and beneficial for the citizenry?

1st Prize EUR 4,000 – 2nd Prize EUR 3,000 – 3rd Prize EUR 2,000

ECAEF invited papers on this topic which needed to meet several requirements, such as:

Entries may be submitted by individuals of up to 30 years (in 2016).

Entries may not exceed 12 pages; 1.5 spacing; left/right margins no less then 1 inch; full bibliography and a 1/2 page summary (abstract) must be included.

Entries had to be submitted in English in electronic form (PDF) including an abbreviated CV. Entry deadline was November 11, 2016.

The End of Milton Friedman’s Monetarism

by Dr. Emanuele Canegrati and Dr. Keith Weiner*

According to the latest data released by the European Central Bank on September 2, the outstanding amount of the central bank’s outright operations touched nearly €1.3T, with the lion’s share going to the public sector purchase program (nearly €1T). Table 1 shows the outstanding amount for every instrument used by the ECB (source: ECB website).

Instrument:  Reference date – Outstanding amount
Covered bond purchase programme:  2 Sep. 2016 – 16,412 mn
Securities market programme:  2 Sep. 2016 – 108,404 mn
Covered bond purchase programme 2:  2 Sep. 2016 – 7,442 mn
Covered bond purchase programme 3:  2 Sep. 2016 – 190,735 mn
Asset-backed securities purchase programme: 2 Sep. 2016 – 20,142 mn
Public sector purchase programme:  2 Sep. 2016 – 1,001,947 mn
Corporate sector purchase programme:  2 Sep. 2016 – 20,497 mn

In governor Draghi’s view, the biggest injection of euros in the ECB history, associated with the negative interest rate policy undertaken by the central bank, should have brought Eurozone inflation back to the ECB 2% policy target. Many times, Draghi’s rhetoric inflamed investors. “We have shown we are not short on ammunition”, he swore last March, when the ECB cut the deposit rate by 10 basis points to a historic low of -0.4% and stepped up the pace of its quantitative easing program from €60bn to €80bn a month. Results? Quite disappointing.
The latest figures released by Frankfurt showed that the Eurozone inflation rate was only equal to +0.2% in August, unchanged from July and at only 1/10 of ECB target rate. A failure for the central bank. Figure 1 shows the monthly increase of ECB balance sheet (assets for Euro Area) compared to the Eurozone Harmonized Index of Consumer Prices (HICP) over time. Looking at these two trends, one may hardly say that a positive correlation exists.
Let’s consider another example: the quantitative easing program by the U.S. Federal Reserve. Since 2008, there has been a massive increase in the money supply. M0 has increased from about $875B to $4.07T in 2014 (all time high); M1 surged from $1.4T to $3.2T in July 2016 (all time high), or 2X and M2 sky rocked from $7.8T to $12.9 in July 2016 (all time high), or about 1.5X. But prices haven’t followed the same trend. The Bloomberg Commodity Index fell from about 175 to 83 on September 6, while the rate of inflation, as calculated using the Consumer Price Index, published monthly by the Bureau of Labor Statistics, was +0.8% in July 2016 and the average rate for 2015 was a meager +0.1%.
Finally, Japan. Last August Bank of Japan Governor Haruhiko Kuroda stated the bank will approve more quantitative easing or lower negative interest rates “without hesitation,” and that he felt that between quantitative easing and negative interest rates, the bank has an “extremely powerful policy scheme” and “will act decisively as we move on” in order to raise inflation to 2% policy target. And yet, notwithstanding the ¥80T ($733B) in government bond purchases per year, the Japanese inflation rate was -0.4% last July and the Tokyo’s secular decline in prices is far from being abandoned.
This international evidence is useful to demonstrate, amongst other things, the fallacy of the monetarist’s quantitative theory of money, which hypothesizes the existence of a positive (linear) relation between money supply growth and prices. According to this theory, if money supply increases by 1% prices should increase by approximately the same percentage, as monetarists believe that the excess of money supply in the economic system transforms to rising prices. “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”, wrote Milton Friedman, one of the biggest promoters of monetarism, in The Counter-Revolution in Monetary Theory (1970).
Contrary to Milton Friedman’s prediction, ECB and FED excessive expansion of the money supply did not drive prices up. Evidence also showed that the current deflationary spiral cannot be attributed to the reverse effect of a failure of central banks to increase the money supply during a liquidity crunch. Would Milton Friedman ever have written his theory in modern times with these data available? We can only wonder. Friedman had insisted upon the strong relationship between changes in the monetary aggregates and movements in the overall level of prices by observing statistics during the heyday of monetarism for many economies and for many time periods. And, for many years, evidence seemed to be by his side. But, after the Great Financial Crisis, the situation and data have changed and Friedman’s theory seems not to hold anymore.
Having not much faith in monetarism, Friederich von Hayek maintained that monetary expansions disrupt the market process, causing resources to be misallocated. It is not difficult to find evidence of Hayek’s prediction in the ECB’s quantitative easing program. The recent commitment by Frankfurt to extend the buying program to corporate bonds generated a rapid increase in the issuance of these securities. In just the month of August, traditionally a very calm one, the total issuance was €49.7B (€833.4B year-to-date). U.S. corporates switched to euro-denominated issuance, with very high-yield issuers amongst the most active in this rush, taking advantage from the higher risk appetite by investors for risky assets. Exactly what von Hayek defined with the term “malinvestments”, or investments undertaken by investors as a consequence of artificially low interest rates decided by central banks. The origin of bubble and financial crisis.

*Dr. Emanuele Canegrati is a PhD at Catholic University of Milan, economist at Department of Treasury, Head Market Analyst at BlackPearlFX and Fellow of the Liechtenstein Academy Foundation.

Dr. Keith Weiner is president of the Gold Standard Institute USA in Phoenix, AZ, and CEO of gold investment company Monetary Metals. He speaks and writes about free markets, money, credit, and gold.

Consequences of faulty central bank policies

Essay by Dr. Tillmann C. Lauk; presentated at the ECAEF Workshop, in Bratislava on September 8, 2016 

Since the GFC1 of 2008 all central banks of the Triade are pursuing the same monetary policies. All central banks of the advanced-/over-indebted economies stick to this recipe. The main tools are QE2, ZIRP3 and NIRP4 and possibly in the future „helicopter money“ and a ban of cash. All tools have in common that they are highly repressive, malicious for the economy (mal investments), they stealthy expropriate savers, and massively hurt retirees. What the tool-kit of central banks is targeting at:

• Quantitative Easing means buying assets from the commercial banking system which in return gives cash to the private banking sector. The money required for those purchases is simply „printed out of thin air“.

• 1st Rationale: increase credit to the economy in order to stimulate aggregate demand = what is supposed to spur productive investment and employment.

• 2nd rationale: create a wealth effect through raising asset prices = equities and other (financial) assets.

• 3rd rationale: through this increase of the money supply try to create controlled inflation and to devalue currencies in the hope to stimulate exports.

• 4th rationale: ZIRP or even NIRP aim at (a) bringing down the debt service obligations of the ever increasing sovereign debt and (b) forcing savers to spend.

Now, let’s check whether data support that statement …

Continue reading -> Download PDF: “Consequences of faulty central bank policies”

The Central Banks’ problem with the profitability of banks

by Dr Emanuele Canegrati*, Rome

   During the press conference, which followed the 21st July’s meeting of the ECB Governing Council held in Frankfurt, Governor Mario Draghi declared that the European banking system currently has a “future profitability problem” rather than a “solvency problem”. He related profitability imbalances afflicting European banks with the high amount of non-performing loans (NPLs) in banks’ assets but he also said that he felt “confident that strong supervision and robust regulation, and better communication, indeed, by the supervisory authorities, the EBA and all this, will still improve the situation and the perception in the rest of the world’s eyes”.

   If we look at some stylized facts, we realize that the profitability problem of banks is serious indeed, not only in Europe but everywhere. The Wall Street Journal recently wrote of “the big-bank bloodbath”, estimating the total losses of the 20 biggest world banks (J.P. Morgan Chase & Co. Wells Fargo & Co., Bank of America Corp., Citigroup Inc., Goldman Sachs Group, Morgan Stanley, Royal Bank of Scotland PLC, HSBC Holdings, Barclays PLC, Standard Chartered PLC, UBS Group AG, Credit Suisse Group AG, BNP Paribas SA, Credit Agricole SA, Société Générale SA, UniCredit SpA, Deutsche Bank AG, Banco Santander SA, Industrial and Commercial Bank of China Ltd. and Mitsubishi UFJ Financial Group Inc.) near half a trillion dollars, as plunging share prices in the first half of 2016 have erased a quarter of their combined market capitalization, according to FactSet data. The following FactSet chart shows losses for each of the twenty observed banks:


   On effectiveness (or ineffectiveness) of the ultra-expansionary monetary policies undertaken by central banks, especially the Fed, BOE, BOJ and ECB much has been written and continues to be written. Positions, amongst economists, are not aligned at all. While Keynesian economists see the monetary easing as the only possible remedy to heal the world economies hit by the crisis and stimulate consumers’ demand (George Cooper’s “pre-emptive Keynesianism”), the Austrian School of Economic has always condemned this type of stimuli, focusing on the perverse effects they generate on the real economy.

   In the recent 12th Gottfried von Haberler Conference, organized by and held in Vaduz (May 2016), Prof. John B. Taylor (Stanford University, USA) defined the actual world monetary environment as a “rule-free zone”, while historian Johan Norberg (Stockholm, S) described the actual financial crisis as a consequence of the “corrupting effects of easy money”. When the Euro was created, short-term interest rate decreased for peripheral countries like Spain and Ireland, whose economies ended in huge, inflated housing bubbles. Norberg reminded us as the average Spanish mortgage rate had collapsed from 18 to around 5 percent after the introduction of the single currency, and debt in proportion to income doubled for the average Spaniard between 1997 and 2006. At its peak, Spain built more than Germany, France and Italy combined. After the burst of the housing bubble, building companies collapsed and banks as well, being packed by NPLs in their balance sheets. Those same NPLs which governor Draghi accused of being the cause of the current troubles of the European banking system, without considering that the ECB is one of the architects which create this moral hazard problem in the peripheral economies.

   The creation of a gigantic financial bubble is not the only consequence of the “easy money” policy undertaken by the ECB. A recent empirical paper by Borio et al. (2015)1 published by the Bank for International Settlement accelerated the existence of a correlation between the interest rate structure and banks’ net interest income and discovered that, over time, unusual low interest rates and flat term structure erode bank profitability.

    In order to comprehend this second point, it’s useful to remind that the lion share of a bank’s profit comes from the interests that the bank charges for its services and the interest that it earns on its assets. The figure below depicts the average net interest margin for all U.S. banks since 1984 compared to the one-year constant maturity yield on U.S. Treasury securities, a proxy for the general level of short-term market interest rates.

Net interest margins (red) and one-year Constant maturity yield on U.S. Treasury securities (blue)
Net interest margins (red) and 1-year Constant maturity yield on US Treasury securities (blue)

    To understand the relationship between market interest rates and net interest margins (NIMs) one has to consider that the optimal asset-liabilities management for a bank is synthetized by “lend long and borrow short.” This happens when the average maturity of the banks’ loans exceeds the average maturity of deposits and other type of debt. Hence, when market interest rates fall, banks’ funding costs usually fall more quickly than their interest income. As a result, NIMs rise. Over time, however, as banks repay or renew loans at lower interest rates, NIMs reduce. Thus, in the medium-to-long term, NIMs are largely unrelated to the general level of market interest rates. The point is that all this happens only under normal conditions. From 2010 something of abnormal happened, as NIMs have continued to fall while the yield on one-year Treasury securities and other market rates has been relatively stable at historically low levels, as a consequence of the ultra-expansionary monetary policies. Over this period we can observe that bank-funding costs have been exceptionally low, while the average rates of return on bank assets have fallen at a more sustained pace. If before the crisis banks underwrote loans at relatively high interest rates, during the crisis they have been obliged to underwrite new loans at lower interest rates.

   In conclusion, the extraordinarily loosen monetary policy undertaken by central banks, such as the zero interest rate policy (ZIRP) associated with Quantitative Easing programs has put downward pressure on banks’ NIMs. Figure 1 shows how, over the past 32 years, banks’ NIMs have fallen by nearly -11,5%. The decline of this indicator at large banks is driven by two main factors always linked to the ZIRP environment. The first factor is due to banks’ liabilities, as funding costs at small banks strongly decreased, and accounts for the majority of the gap in the behavior of NIMs between large and small banks. The second factor comes from the other side of banks’ balance sheet. Specifically, over the last years large banks have been hit by bigger decline in the interest income that they earn on “other” assets, such as assets held for trading purposes.


*Dr. Emanuele Canegrati is a PhD at Catholic University of Milan, economist at Department of Treasury, Head Market Analyst at BlackPearlFX and Fellow of the Liechtenstein Academy Foundation.