“Central bankers control the price of money and therefore indirectly influence every market in the world. Given this immense power, the ideal central banker would be humble, cautious and deferential to market signals. Instead, modern central bankers are both bold and arrogant in their efforts to bend markets to their will. Top-down central planning, dictating resource allocation and industrial output based on supposedly superior knowledge of needs and wants, is an impulse that has infected political players throughout history. It is both ironic and tragic that Western central banks have embraced central planning with gusto in the early twenty-first century, not long after the Soviet Union and Communist China abandoned it in the late twentieth. The Soviet Union and Communist China engaged in extreme central planning over the world’s two largest countries and one-third of the world’s population for more than one hundred years combined. The result was a conspicuous and dismal failure. Today’s central planners, especially the Federal Reserve, will encounter the same failure in time. The open issues are, when and at what cost to society ?” - James Rickards, The death of money: the coming collapse of the international monetary system, 2014.
Central banks have historically been born of a need to raise finance for the governments they serve. Although the Bank of England, for example, claims that its “mission is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability”, it was not set up to “promote the good of the people”. When it was established in 1694 – the same year that the Scots set in progress the first slow motion train wreck of RBS – the Bank of England was created explicitly to fund the government of the day, and that remains its primary role. The same holds for the Swedish National Bank, the Sveriges Riksbank, which was established in 1668 and which is the world’s oldest central bank.
Over time, each central bank has typically been given control over the management of its State’s currency, money supply and interest rates. In many cases they have gone on to take a supervisory and regulatory role over the commercial banking system and acted, in times of crisis, as lender of last resort to troubled banks. Both the Bank of England and the Swedish National Bank have, over the passage of time, ceded primacy in international monetary affairs to the US Federal Reserve, ‘the Fed’. Yet the Fed’s conflicted origins are murkier than either of them.
On a cold November night in 1910, a handful of financiers boarded a private railway car in conditions of extreme secrecy at the New Jersey railway station. The passengers included the Republican “whip” in the Senate and a business associate of the banker J.P. Morgan; the Assistant Secretary of the US Treasury; the president of the National City Bank of New York, the most powerful bank of the time; a senior partner of the J.P. Morgan Company; the head of J.P. Morgan’s Bankers Trust Company; and a representative of the Rothschild banking dynasty in England and France. In other words, of the six passengers, five of them were representatives of private banks.
Those financiers would go on to meet in secret at a hideaway owned by J.P. Morgan and several of his business associates, where visitors would gather in the winter to hunt ducks or deer. The name of this remote retreat: Jekyll Island.
This group met in order to tackle five pressing issues:
Perhaps most cynically of all, to address this fifth problem, the group decided to adopt the structure of a central bank and furthermore, ditch the use of the word bank altogether, in favour of a coinage that would evoke the image of the federal government instead. Three years later, after the passing of the resultant bill in Congress on December 23, 1913, the US Federal Reserve was born.
“The Federal Reserve System,” it today proudly tells us, “is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded.”
Few could deny the latter point. Rather than maintain a narrow focus on managing the money supply, the Fed is now figuratively all over the shop, its fingerprints evident everywhere across the economy. Financial author and analyst James Grant:
The Fed insists on saving us from ‘everyday low prices’ – they call it deflation. I submit that in a world of technological wonder, prices ought to be weakening: it costs less to buy things because it costs less to make them. This benign tendency the Fed resists at every turn. It wants the price level (as it defines it) to rise by two percent a year, plus or minus. In so doing, it creates redundant credit that finds its way into other things. These excess dollars do mischief. On Wall Street we call this mischief a bull market and we’re generally all in favour of it..
The Fed, in substance if not in name, is [still] engaged in a massive experiment in price control. (They don’t call it that.) But they fix the Fed Funds rate, they manipulate the yield curve.. they talk up the stock market. They have their fingers and their thumbs on the scale of finance. To change the metaphor, we all live to a degree in a valuation ‘hall of mirrors’. Who knows what value is when the Fed fixes the determining interest rate at zero ? So I said “experiment in price control” but there is no real suspense about how price control turns out. It turns out, invariably, badly.
As Robert Schuettinger and Eamonn Butler observe in their devastating history of the topic, Forty centuries of wage and price controls, which you can download for free here, government-provoked inflation is nothing new. Nor are doomed governmental attempts to control the inflationary genie once it’s out of the bottle. The Roman Emperor Nero (AD 54-68) responded to growing economic problems by devaluing the currency. The devaluation started relatively modestly but accelerated under Marcus Aurelius (AD 161-180) when the weights of coins were reduced. “These manipulations were the probable cause of a rise in prices,” wrote the historian Jean-Philippe Levy. The Emperor Commodus (AD 180-192) turned to price controls and decreed a series of maximum prices, but things deteriorated and the rise in prices became “headlong” under the Emperor Caracalla (AD 211-217).
Egypt was the imperial province most severely affected. During the fourth century, the value of the gold solidus changed from 4,000 to 180 million Egyptian drachmai. Levy also attributes the grotesque rise in prices which followed to the increase of the amount of money in circulation. The price of the same measure of wheat in Egypt rose from 6 drachmai in the first century to 200 in the third century; in AD 314, the price rose to 9,000 drachmai and in AD 334 to 78,000. Shortly after AD 344 the price had reached more than 2 million drachmai. Other provinces endured similar inflations.
In monetary affairs, ineffectual regulations were decreed to combat Gresham’s Law [bad money drives out good] and domestic speculation in the different kinds of money. It was forbidden to buy or sell coins: they had to be used for payment only. It was even forbidden to hoard them ! It was forbidden to melt them down (to extract the small amount of silver alloyed with the bronze). The punishment for all these offences was death. Controls were set up along roads and at ports, where the police searched traders and travellers. Of course, all these efforts were to no purpose.
Perhaps the most notorious attempt to control wages and prices took place under the Emperor Diocletian. Commodity prices and wages reached “unprecedented heights” shortly after he assumed the throne in AD 284. The Empire’s economic troubles have been attributed to a vast increase in the armed forces (to repel invasions by barbarian tribes); to a huge building programme of questionable value; to the consequent raising of taxes and the employment of ever more government officials; and to the use of forced labour to accomplish much of Diocletian’s public works programme.
Diocletian, on the other hand, attributed the inflation entirely to the “avarice” of merchants and speculators. (Some things never change.)
What is undeniable is that as taxes rose, the tax base shrank, and it became increasingly difficult to collect taxes, resulting in a vicious circle of rising taxation and a shrinking economy. Perhaps Boris thinks his “government” can repel the forces of history and economics.
Probably the single biggest cause of Diocletian’s inflation was his debasement of the coinage. In the early Empire, the standard Roman coin was the silver denarius. Its value had gradually been reduced in the years leading up to his reign as emperors issued tin-plated copper coins which still kept the name “denarius”. Under Gresham’s Law, silver and gold coins were hoarded and left circulation.
During the 50 years ending in AD 268, the silver content of the denarius fell to one five-thousandth of its original level. Trade was reduced to barter and economic activity stagnated. The middle class was almost obliterated. To overcome the baleful influence of his bureaucracy, Diocletian introduced a system of taxes based on payments in kind, which had the effect of destroying the freedom of the lower classes and tying them to the land. Then came currency reform, and the Edict on prices and wages. Historian Roland Kent:
Diocletian took the bull by the horns and issued a new denarius which was frankly of copper and made no pretence of being anything else; in doing this he established a new standard of value. The effect of this on prices needs no explanation; there was a readjustment upward, and very much upward. Diocletian had the option of either inflating – minting increasingly worthless denarii, or to deflate – in the form of cutting government expenditures. He chose to inflate. He also chose to fix the prices of goods and services and suspend the freedom of the people to decide what the currency was actually worth. He fixed the maximum prices at which beef, grain, eggs and clothing could be sold, and the wages that workers could receive, and prescribed the death penalty for anyone who disposed of his wares at a higher figure.
The most shocking aspect of the Diocletian inflation ? Despite imposing the death penalty on any who sold goods at higher prices than those ordained by the State, prices still rose. Less than four years after the currency reform associated with the Edict, the price of gold in terms of the denarius had risen by 250%. By AD 305 the process of currency debasement began again.
State intervention and a crushing fiscal policy made the whole empire groan under the yoke; more than once, both poor men and rich prayed that the barbarians would deliver them from it. In AD 378, the Balkan miners went over en masse to the Visigoth invaders, and just prior to AD 500 the priest Salvian expressed the universal resignation to barbarian domination.
David Meiselman, in his foreword to Forty centuries.. asks:
What, then, have price controls achieved in the recurrent struggle to restrain inflation and overcome shortages ? The historical record is a grimly uniform sequence of repeated failure. Indeed, there is not a single episode where price controls have worked to stop inflation or cure shortages. Instead of curbing inflation, price controls add other complications to the inflation disease, such as black markets and shortages that reflect the waste and misallocation of resources caused by the price controls themselves. Instead of eliminating shortages, price controls cause or worsen shortages. By giving producers and consumers the wrong signals because “low” prices to producers limit supply and “low” prices to consumers stimulate demand, price controls widen the gap between supply and demand.
Despite the clear lessons of history, many governments and public officials still hold the erroneous belief that price controls can and do control inflation. They thereby pursue monetary and fiscal policies that cause inflation, convinced that the inevitable cannot happen. When the inevitable does happen, public policy fails and hopes are dashed. Blunders mount, and faith in governments and government officials whose policies caused the mess declines. Political and economic freedoms are impaired and general civility suffers.
As the financial historian and analyst Russell Napier points out in this interview, in financial markets, it helps to recognise those occasions when the rules of the game have utterly changed. Now is such a time. While many market commentators and for that matter investors may still respect and anticipate the principles of laissez-faire and rational and efficient markets, the more sobering reality is that in 2021, in the aftermath of the Covid “pandemic”, both the Big State and the spirit of Diocletian are back with a vengeance. (Napier calls this situation ‘financial repression’ but they are one and the same thing.)
In such a situation, market efficiency counts for naught. What matters is steering precious capital away from governmental killing pens where its value will not be respected, towards those areas of freer market opportunity where it will be. Government bonds and government-issued fiat currency fall into the former category. The monetary metals, gold and silver, and the listed fruits of honest entrepreneurial endeavour trading at a discount to the broad market fall into the latter.
Diocletian could not control inflation two thousand years ago. Neither will the Fed or the Bank of England be able to, today. Inflation hedges have never been more valuable. Happily here in 2021, many of them are being given away by Mr Market. Time to get greedy with them and load up the proverbial truck.
Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: firstname.lastname@example.org.
Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and specialist managed funds.
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