Day of the Doorknobs

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–Before we get into how to turn Australia into post-war Germany with the soundest currency in the world and a healthy manufacturing sector, let us remind you that it’s Wednesday. That means you should go check out Murray’s latest Slipstream Trader market update on his YouTube channel. If you haven’t done so yet, you have no idea what you’re missing.

–Now, back to markets. Have you noticed that every time someone from the US Federal Reserve opens his mouth, he creates more instability? Unsound money leads to monetary instability. Monetary instability creates economic instability. And economic instability makes people really uncomfortable. And cranky.

–Yet the president of the Federal Reserve Bank of Chicago, Charles Evans, wants even more unsound money! Evans got on CNBC last night and told the world, “I would favour more accommodation…I am in favour of some of the most aggressive policy actions of anyone on the [Fed’s policy making] committee.”

–Just what “more accommodation” is intended to accomplish is unclear. More wealth destruction? About all that’s clear so far is that when you tell people you’re going to keep interest rates low for the next two-and-half years, they speculate. And when you tell them your intention is to effectively devalue your currency, they buy real money.

The Aussie gold price up 21.61% in 60 days

The Aussie gold price up 21.61% in 60 days

–December gold futures in the US gained 2% after Evans opened his big mouth. We suppose if you’re a gold bull, you don’t mind this sort of thing. But after a day or two of ceasefire, the global currency war is back on again with some feeling. Even Treasurer Wayne Swan is getting in on the act.

–Swan is on his way to China to talk over the terms of Australia’s gradual surrender of economic sovereignty to the Chinese over the next 50 years.

–Wait. Just kidding. He’s over there to talk business. But while he’s at it, he’s had an early go at China’s currency peg. He told reporters:

“Australia is a very strong believer in a floating currency and one of the structural reforms that we require in the global economy, particularly from large developing countries, is for them to boost domestic demand and move to more market-based exchange rates…That’s part of dealing with the global financial imbalances, the global financial imbalances that cause the global financial crisis and then the global recession.”

–He’s referring to some of the structural imbalances we wrote about yesterday. He’s especially referring to the strong Australian dollar. The same dollar that’s decimating the manufacturing industry. He must have read yesterday’s Daily Reckoning and saw what’s in store for an entire segment of the economy that can’t compete.

–Don’t expect any sympathy from Reserve Bank of Australia governor Glenn Stevens. He reckons that the strong dollar is here to stay and it’s going to cause unavoidable wreckage in some parts of the Australian economy. In public remarks, Stevens said:

“Some parts of the economy will shrink while others grow. I wish I could say we had a way of avoiding that; I don’t think we do . . . We don’t have an instrument that can prevent these shifts in the structure of the economy from occurring. I’m sorry but that is just the reality.”

–Ah. But is it true the decimation of Australian manufacturing is an inevitable result of the structural changes in the global economy? Maybe not. But to avoid said decimation, Australian regulators and politicians might have to put down their meddlesome policy tools and pick up a German history book.

–If they find such a book and turn to one specific date in German history, they’ll find a blueprint for how to make Australia more competitive and increase productivity. We’d also humbly suggest that fully employed people with sound money in their pockets are happier people. But we’ll get back to that in a second.

–In late June of 1948, US, French, and British troops discretely distributed over 23,000 wooden crates across Germany. The crates were labelled “doorknobs”. But there weren’t any doorknobs inside.

–Inside the crates were over 10.7 billion new currency units, or Deutschmarks. The Deutschmark replaced the Reichmark, which had been invalidated by the currency reform law passed by the Allied Powers. On Sunday, 20 June 1948, every German citizen received 40 new Deutschmarks. A month later they received 20 more.

dollar image

Source: http://www.numismondo.com/pm/gdr/


–Reichsmarks could be traded in for new D-marks at an exchange rate of 10-1. And when you first think about that, you realise that the issuing of a new currency had the effect of wiping out the savings of millions of Germans in one fell swoop. So why did this one key move become the foundation for Germany’s post-war economic recovery?

–The introduction of a new currency reduced the amount of money in circulation in Germany. It reintroduced sound money into the German economy by strictly limiting money supply growth. Sound money means monetary stability. And monetary stability makes normal economic activity and planning possible (and worthwhile) again.

–The new currency was encouraged by German economist, Ludwig Erhard. Erhard then went beyond what the Allied occupation authorities had in mind when, in one fell swoop, he removed price controls and rationing in the German economy. The effect was dramatic.

–Price controls virtually guarantee scarcity. Producers hold back goods and services because they are forced to sell them below their market value. The black market flourishes. Shelves are empty and barter replaces normal commerce.

–But with sound money back in the economy, and price controls gone from the economy, sellers and producers in Germany no longer hoarded goods and services. The shelves filled up. And the incentive to resume economic production returned quickly.

–It’s hard to imagine how complete the change must have been to Germans shuffling through the rubble of the post-war reconstruction. Frenchman, Jacques Rueff – who later famously pointed out the “exorbitant privilege” the US enjoys issuing debts in the same currency it prints – captured the effect of the currency reform on German society:

“The black market suddenly disappeared. Shop windows were full of goods; factory chimneys were smoking; and the streets swarmed with lorries. Everywhere the noise of new buildings going up replaced the deathly silence of the ruins. If the state of recovery was a surprise, its swiftness was even more so. In all sectors of economic life it began as the clocks struck on the day of currency reform. Only an eye-witness can give an account of the sudden effect which currency reform had on the size of stocks and the wealth of goods on display. Shops filled up with goods from one day to the next; the factories began to work. On the eve of currency reform the Germans were aimlessly wandering about their towns in search of a few additional items of food. A day later they thought of nothing but producing them. One day apathy was mirrored on their faces while on the next a whole nation looked hopefully into the future.”

Sound money creates the incentives for production. Erhard ended money printing. He understood all too clearly that accommodative monetary policy doesn’t create wealth. It prolongs instability. But he did not stop there.

–He dismissed most of the public service in Bavaria and said his goal was to replace a bureaucratic culture with an entrepreneurial culture. He also gave people an incentive to work. He abolished taxation on all income tax on hours worked over 40 hours.

–Exporters paid fewer taxes on profits. The top rate of Germany’s so-called progressive income tax was lowered from 80% in 1948 to 55% by 1950. Productive industries were given tax deductions for capital investment. And high depreciation allowances were introduced for almost all capital investment.

–Now, we’re certain that the progressive collectivist socialist types will howl at the last suggestions. Higher depreciation allowances effectively allow a business to lower its tax liability. Instead of writing off the cost of a capital asset over 10 years, gradually, you do it quickly and subtract it from your tax bill. That lowers government tax takings.

–Assuming you’ve fired a good deal of the bureaucracy, this shouldn’t be a problem. The government’s bills will be lower. It will get out of the way of the entrepreneur and do what it ought to do in the first place: ensure the conditions for a stable legal and monetary environment (although even this role is debatable).

–The big benefit to allowing faster depreciation is that you encourage capital investment by “de-risking” it. Businesses are much more likely to invest in capital goods if they can expense them quickly and turn a profit sooner. That profit is ploughed back into new investment, higher wages, and greater production.

–There are two reasons Australia will never encourage flat taxes, sound money, and accelerated depreciation of capital assets. The first is that it doesn’t benefit the financial and banking industries. We have a money system and an economic system that directs all the benefits of unsound money to a very small group of money shufflers at the top.

–Bankers get to create money at no cost and loan it out for interest. They also get first use of the money, before the expansion of the money supply decreases purchasing power and erodes savings through inflation. They have no interest in a structural change to the financial system that encourages capital investment; the kind of investment that would lead to higher-wage jobs, production, and create a bigger market for skilled labour.

–And if the objections of the financial industry are not enough to prevent sound money, flat taxes, and capital investment, you always have the central planners and bureaucrats to deal with. Under the current system, the government gets to take money from one group in order to bail out another group that cannot compete because of unsound money and stupid tax laws.

–For example, the government (the ‘steal’ industry) would rather tax the resources industry to subsidise the steel industry. This arrangement suits the government perfectly because it makes its agents necessary and ensures their power. They get to decide who to punish with higher taxes and who to reward with hand outs. It’s no wonder power-hungry politicians would relish their place in this system.

–Of course under this system the government creates no value at all. In fact it prevents wealth being created. All it can do is take money from one group and give it to the next. It’s pure wealth redistribution. And aside from being intellectually unimaginative, it caters to the vanity and lust for power of people in politics. It’s disgusting and immoral the more you think about it.

–Far more ethical, just, fair, and prosperous is a combination of sound money, low taxes, a stable rule of law (just as important as stable money), and conditions under which private enterprise can thrive because people know the wealth they create will be theirs to keep. At least, that seems better to us.

–To be fair to Australia’s current money masters, the unsound money they are dealing with is a global problem. It originates with the fact that the world’s reserve currency, the US dollar, is as unsound as it gets. Everything linked to it rots by association.

–This brings us back to yesterday’s closing question. The structural imbalances in the world economy are nearing the breaking point. But what will break first? China’s currency peg? Europe’s monetary union? Or America’s distorted consumption-based economy?

–Our answer? All of it will break at about the same time!

–As analyst Jim Rickard has written, there are four alternatives to the current currency regime: multiple reserve currencies, IMF special drawing rights (SDRs), gold, and chaos. The first two results would come from an orderly retreat from the dollar. The second two would come from a disorderly exit. Entropy being the way of the world, we’re going for accelerating disorder before the emergence of a new currency standard.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. LAX is the US gateway engine for imports from Asia, it reflects mainly high value imports but also top up where lower value consumer imports normally moved by ocean don’t meet inventory demand.

    http://www.bloomberg.com/news/2011-08-31/los-angeles-airport-july-cargo-statistics-summary-table-.html?cmpid=yhoo

    Reply
  2. Why not simply take a leaf from China’s book and peg our currency to the Yuan (making sure the AUD cheap for the Chinese). This would make our commodities cheaper for them and reduce imports which would increase manufacturing in Australia. We may even steal a bit of their $3 trillion in reserves

    The USD/AUD could then be determined through the law of transitivity. We peg the AUD to the YUAN and the Chinese peg the Yuan to the USD so we can calculate AUD to USD

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  3. Dan,
    Like you, I argue for smaller government. But I also argue for localisation in our living arrangements, with long distance and international trade being a smaller part of life than it currently is. I think bioregion self reliance needs to be increased, with all the diversity this demands.
    The problem with a view that says “let the market sort it out” in an environment that views globalisation as good is that this results in the replacement of manufacturing with useless consumer dependant services jobs. If you’re going to support globablisation, some form of govt interference is also usually needed.
    Globalisation is only possible due to cheap energy. But I’ll put that aside for a moment. What if Australia looked to domestic production for it’s needs wherever possible, and looked to export high value products rather than simply digging up resources and selling them overseas? We have the majority of the world’s proven uranium deposits. So why don’t we produce our electricity via Nuclear power? As George Monbiot so competently articulates, this is proven as far safer for human life than coal mining. Australia could immediately halt raw resource exportation and live animal exportation, instead processing to a finished product and service. If we delivered managed power generation as a service to domestic and international markets, we’d retain the value of our uranium. Example, we don’t export uranium, we send an expert team of nuclear power station construction engineers to Japan (or anywhere), we build the station using Aussie steel, we run the station, we import the waste material back to Australia for safe permanent underground storage in the middle of the desert. We sell the service for x years with agreed SLAs and scaled pricing. That’s a globalists dream!
    We stop exporting coking coal and iron ore to china. We process it all domestically in regional towns like Newcastle, Whyalla etc, then we export finished steel products or even better, we supply buildings, factories and structures. Since we have most of the world’s coking coal and iron ore, we could control the steel industry globally.
    This falls down today because large foreign owned (or partially foreign owned) mining companies have short term views on chasing massive profits for just digging and selling. BHP sold off their steel manufacturing, and now we have One Steel decreasing their steel manufacturing to expand into mining. This is going the wrong way.

    We could stop export of rare earth metals. We could manufacture hi tech goods domestically. We could relax our immigration laws to allow for influx of nuclear scientists and electronics design engineers.

    How do we get from here to there without some form of govt interference?

    Of course, when cheap energy vanishes, so will globalisation and this will force people to get inventive locally anyway. But isn’t it better to begin this transition in a planned and orderly manner ahead of the day when we’re forced to?

    Nathan Chattaway
    September 1, 2011
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  4. GB, making our exports to China cheaper wouldn’t increase manufacturing in Australia under the current dig and sell model. It would make the problem worse!
    Manufacturing in Australia is suffering because we can’t compete with cheap Chinese manufacturing (which uses Australian resources). If the resources are cheaper in China, they will boost their manufacturing and our mining industries and put the final nail in the coffin of Australian manufacturing.

    Nathan Chattaway
    September 1, 2011
    Reply
  5. I don’t understand the bit in the article which says “There are two reasons Australia will never encourage flat taxes, sound money, and accelerated depreciation of capital assets. The first is that it doesn’t benefit the financial and banking industries. We have a money system and an economic system that directs all the benefits of unsound money to a very small group of money shufflers at the top.”

    How does the current progressive tax system benefit those at the top?

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  6. I have 2 questions from reading this piece (which I generally agree with from a laymans point of view).

    1. Do you imply government is a waste of resource? While I agree it should be less intrusive, isn’t there a valid role for government to play in a social system as large and complex as ours? Issues of basic infrastructure (water, electricity), emergency services, just to name a few – aren’t they best left in the hands of someone not interested in making a profit rather than someone would gouge the maximum from the service, at the expense of some who would go without?

    2. How do you correlate capital investment with higher wages? While I agree the capital investment would be stimulated, isn’t it always the case an employer is looking to minimise the wages they pay? I don’t recall ever seeing or hearing about an industry where on making a greater profit, the operators said ‘We have more money! Let’s pay our workers more!’.

    Just two points that stood out which I questioned. Otherwise I like your reasoning. It is a pity the greedy and powerful cling tightly to their vices and are blind to a greater good…

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  7. I like the cut of your jib. (Economic principles anyway).

    I do however believe that the true cost of shipping something from distant point A to consumption point B should not be subsidised as ‘Globalisation’.

    It is not good for the World environment for stuff to travel half way around the World to be made into something and then travel all the way back again to be sold. The true cost of this practice is not reflected in the product cost and it is unforgiveable.

    If we are to have a carbon emission mitigating policy, it has to make exporting manufacturing nations bear the cost of the transportation of the raw materials and the finished product.

    If this is done (with a shipping levvy) then it will make localised manufacturing competitive. It is not environmentally sustainable to have China making everything and our economic World has to be taught this.

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  8. Nathan
    You forget that our cheaper currency means chinese goods become more expensive to us, so china can buy our iron cheaper but the price of a chinese toaster that we buy back off them goes up too, and when the price of the toaster increases our manufacturers can compete with higher prices

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  9. GB,

    that is the worst idea i’ve ever heard – sell more of our iron ore, just so that we can buy it back more expensive from the chinese.

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  10. Mike,
    its called a weaker currency – our exports do well so we SELL heaps of stuff and imports become expensive so we MAKE lots of stuff

    if you dont think it works that way then go to China and tell them to shut down their factories because its the worst idea ever

    i wasn’t even talking about imports/exports anyway, i was talking about pegging our currency to the yuan like the yuan is to the USD, then america would tax currency exchanges and so trade flows balance out, i.e. we end up with a surplus from china and that surplus then goes to the US via a tax and then flows to china through their currency peg. Its a workable solution as the only other solution is for china to float its currency

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  11. I think our currency should be backed by gold or silver and not floated or pegged to any other international currency.
    My earlier post regarding globalisation and govt control was from the point of view that if you’re going to participate in a global trade economy, it’s hard to do well without corresponding govt policy to ensure we don’t become the world’s quarry.

    My view is that we should greatly reduce our dependance on global trade in any case, and greatly scale back our level of government.

    Dan, you’re not going local enough in your perspective. I would agree that while we have large centralised “grid” services provided to happy suburban sprawlites, you don’t want these being run by massive corporations with a monopoly. But, the solution isn’t to give up and nationalise everything while the government grows ever larger. It’s to dismantle the centralised services. Every household should provide its own water, power and basic fresh produce food requirements and we shouldn’t expect some central planning and maintenance bureau to spoon feed us. Don’t outsource provision of basic needs of life or you run the risk of becoming unviable at a personal and eventually national level.

    Nathan Chattaway
    September 2, 2011
    Reply
  12. My father grew up in postwar Germany and at the time the current saying went something like, if a German is hardworking they will be dead before they’re 30.

    Having worked themselves to death of course.

    And this was true.

    Needless to say my father fled the country as soon as he could!

    Not only did they have sound economic fundamentals, they also worked themselves to death, and that SECOND part of the equation is what made Germany great. Hard work and more hard work until the point of death. Patriotic duty for the prosperity of the nation. Prosperity rules.

    Look no further than the productive developing nations compared to US, UK and even Australia. Here in Australia we get paid top dollar for doing nothing. And we think this is sustainable long term?

    We all need to take a 50% pay cut, and build a few sweatshops then we’re talking.

    The Chinese copied our model and became successful and powerful. Why don’t we copy theirs now?

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  13. It’s plainly obvious if you leave people on a planet they’ll bitch over property, default on their debts, lie to, steal from and murder each other.
    It’s plainly obvious when people decide they need a government to sort their problems that the government is immediately if not eventually made up of people also…who bitch over property, default on debts, lie to, steal from and wage war on other nations.
    Granted the American Ron Paul is human too, though he has slain his own demons and has proven he will behave differently. It seems his life would be easier if he quit the crusade but no. He marches to a different drumbeat than the zombies around him. Australia has a sea of zombies at the helm, God help us.

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  14. I guess there is no end to the quarrel about how we should run the show for the collective good…is what brought that thought on.

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  15. gold policy of CB V Vietnam ,gold bond can be alternative via death invest @
    risk of old roller-coaster ride.In my opinion,Gold price is not stable and stay at top floor ,there are 2 effects of Gold both are negative for recovery global economy and ecology also ruin by gold mining..The super elite can make $$$$$$$$$$$$$ but people who buying gold to avoid risky their saving currencies papers.The Breton wood @gold back up policy was terminated to became recovery US D inflation,35USD/ounce was almost stable in the world ,US could not enough gold reserved to balance printing amount of USD in 1970s.it was likely to be 2011 after End of BW system 1970 Nixon Era.But I worry for this time ,may be shocking and shaking , collapsing asia pacific ,by hyper quicke epicenter on NY&DC.

    zaw myo naing
    September 6, 2011
    Reply

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