We"re Living In The Age Of Capital Consumption

Authored by Ronald-Peter Stöferle via The Mises Institute,

When capital is mentioned in the present-day political debate, the term is usually subject to a rather one-dimensional interpretation: Whether capital saved by citizens, the question of capital reserves held by pension funds, the start-up capital of young entrepreneurs or capital gains taxes on investments are discussed – in all these cases capital is equivalent to “money.” Yet capital is distinct from money, it is a largely irreversible, definite structure, composed of heterogeneous elements which can be (loosely) described as goods, knowledge, context, human beings, talents and experience. Money is “only” the simplifying aid that enables us to record the incredibly complex heterogeneous capital structure in a uniform manner. It serves as a basis for assessing the value of these diverse forms of capital.

Modern economics textbooks usually refer to capital with the letter “C”. This conceptual approach blurs the important fact that capital is not merely a single magnitude, an economic variable representing a magically self-replicating homogenous blob but a heterogeneous structure. Among the various economic schools of thought it is first and foremost the Austrian School of Economics, which stresses the heterogeneity of capital. Furthermore, Austrians have correctly recognized, that capital does not automatically grow or perpetuate itself. Capital must be actively created and maintained, through production, saving, and sensible investment.

Moreover, Austrians emphasize that one has to differentiate between two types of goods in the production process: consumer goods and capital goods. Consumer goods are used in immediate consumption – such as food. Consumer goods are a means to achieve an end directly. Thus, food helps to directly achieve the end of satisfying the basic need for nutrition. Capital goods differ from consumer goods in that they are way-stations toward the production of consumer goods which can be used to achieve ultimate ends. Capital goods therefore are means to achieve ends indirectly. A commercial oven (used for commercial purposes) is a capital good, which enables the baker to produce bread for consumers. 

Through capital formation, one creates the potential means to boost productivity. The logical precondition for this is that the production of consumer goods must be temporarily decreased or even stopped, as scarce resources are redeployed toward the production of capital goods. If current production processes generate only fewer or no consumer goods, it follows that consumption will have to be reduced by the quantity of consumer goods no longer produced. Every deepening of the production structure therefore involves taking detours.

Capital formation is therefore always an attempt to generate larger returns in the long term by adopting more roundabout methods of production. Such higher returns are by no means guaranteed though, as the roundabout methods chosen may turn out to be misguided. In the best case only those roundabout methods will ultimately be continued, which do result in greater productivity. It is therefore fair to assume that a more capital-intensive production structure will generate more output than a less capital-intensive one. The more prosperous an economic region, the more capital-intensive its production structure is. The fact that the generations currently living in our society are able to enjoy such a high standard of living is the result of decades or even centuries of both cultural and economic capital accumulation by our forebears.

Once a stock of capital has been accumulated, it is not destined to be eternal. Capital is thoroughly transitory, it wears out, it is used up in the production process, or becomes entirely obsolete. Existing capital requires regularly recurring reinvestment, which can usually be funded directly out of the return capital generates. If reinvestment is neglected because the entire output or more is consumed, the result is capital consumption.

It is not only the dwindling understanding of the nature of capital that leads us to consume it without being aware of it. It is also the framework of the real economy which unwittingly drives us to do so. In 1971 money was finally cut loose entirely from the gold anchor and we entered the “paper money era.” In retrospect, it has to be stated that cutting the last tie to gold was a fatal mistake. Among other things, it has triggered unprecedented instability in interest rates. While interest rates displayed relatively little volatility as long as money was still tied to gold, they surged dramatically after 1971, reaching a peak of approximately 16 percent in 1981 (10-year treasury yield), before beginning a nosedive that continues until today. This massive decline in interest rates over the past 35 years has gradually eroded the capital stock.

An immediately obvious effect is the decline in so-called “yield purchasing power”. The concept describes what the income from savings, or more precisely the interest return on savings, will purchase in terms of goods. The opportunity to generate interest income from savings has of course decreased quite drastically. Once zero or even negative interest rate territory is reached, the return on saved capital is obviously no longer large enough to enable one to live from it, let alone finance a reasonable standard of living. Consequently, saved capital has to be consumed in order to secure one"s survival. Capital consumption is glaringly obvious in this case.

It is beyond question that massive capital consumption is taking place nowadays, yet not all people are affected by it to the same extent. On the one hand, the policy of artificially reducing the interest as orchestrated by the central banks does negatively influence the entrepreneurs’ tasks. Investments, especially capital-intensive investments seem to be more profitable as compared to a realistic, i. e. non-interventionist level, profits are thus higher and reserves lower. These and other inflation-induced errors promote capital consumption.

On the other hand, counteracting capital consumption are technological progress and the rapid expansion of our areas of economic activity into Eastern Europe and Asia in recent decades, due to the collapse of communism and the fact that many countries belatedly caught up with the monetary and industrial revolution in its wake. Without this catching-up process it would have been necessary to restrict consumption in Western countries a long time ago already.

At the same time, the all-encompassing redistributive welfare state, which either directly through taxes or indirectly through the monetary system continually shifts and reallocates large amounts of capital, manages to paper over the effects of capital consumption to some extent. It remains to be seen how much longer this can continue. Once the stock of capital is depleted, the awakening will be rude. We are certain, that gold is an essential part of any portfolio in this stage of the economic cycle.

 

How Will The 'GREAT DEFLATION' Impact Gold & The Dollar?

By the SRSrocco Report,

The coming GREAT DEFLATION will impact the value of Gold and the Dollar much differently than what most analysts are forecasting.  Unfortunately, most analysts do not understand the true underlying value of gold or the U.S. Dollar, because they base their forecasts on information that is inaccurate, flawed or imprecise.

This is due to two faulty theories:

monetary science
supply-demand market forces

While some aspects of monetary science and supply and demand forces do impact the prices of goods and services (on a short-term basis), the most important factor, ENERGY, is totally overlooked.  You will never hear Peter Schiff include energy when he talks about the Federal Reserve, Commercial Banks, money printing or debt.  Schiff, like most analysts, is stuck on studying superficial monetary data that does not get to the ROOT OF THE PROBLEM.

Furthermore, the majority of folks who believe in the Austrian School of economics, also fail to incorporate ENERGY into their analysis.  For some strange reason, most analysts believe the world is run by the ENERGY TOOTH FAIRY (term by Louis Arnoux).  Without cheap and abundant energy, monetary science and supply-demand forces are worthless.

That being said, as the debate on whether the world will experience, inflation, hyperinflation or deflation will continue to go on and on, I guarantee we are going to experience the MOTHER of all DEFLATIONS.  Again, this will be due to the disintegrating energy sector and its inability to provide sufficent profitable net energy to the market.

The falling net energy and declining EROI - Energy Returned On Investment, are totally gutting the entire market.  This can be seen quite clearly as the U.S. added $4 of debt for each $1 of GDP growth in 2016.  According to the Zerohedge article, It Took $4 In New Debt To Create $1 In GDP:

As a reminder, according to the latest BEA revision, nominal 2016 GDP was $18.86 trillion, an increase of $632 billion from 2015; the question is how much credit had to be created to generate this growth. Well, according to the Z.1, total credit rose to a new record high $66.1 trillion. This was an increase of $2.511 trillion in the past year. It means that in 2016, it "cost" $4 in new debt to generate just $1 in new economic growth!

As we can see, adding $4 of debt to create $1 of artificially inflated GDP is not a long-term sustainable business model.  I get a laugh hearing "Conspiracy Theorists" explain how the ELITE have been planning this take-over all along and have the markets totally under control.  While conspiracies do indeed take place, the ELITE have been SHOOTING FROM THE HIP and WINGING IT just to keep the entire market from imploding.

For those who believe that the elite want to crush the market to buy assets for pennies on the Dollar, I am here to tell you...  it CHAIN"T gonna happen.  When the Ancient Roman Metropolis collapsed from a population of one million people down to 12,000, I can assure you, the majority of the ELITE were wiped out.... KAPUT.

Real Estate values and revenue streams in Ancient Rome evaporated into thin air.  There was no "RECOVERY" or "PLAN B."  Death had come to the once great Roman Empire... for good.

Regardless, the coming GREAT DEFLATION will destroy the value of most assets shown in the chart below:

Of the $369 trillion in global asset values (2015), gold and silver accounted for $3.1 trillion or 0.8%.  That"s correct, not even 1% of total global assets.  Savills Research, who put together the data shown in the chart above, recently published figures on Global Real Estate Investment:

Now, this chart does not represent total Real Estate values, but rather shows how much money is being invested in the Global Real Estate Market (minus China).  Interestingly, global real estate investment has never regained its previous peak set back in 2008.  Furthermore, the data shows that global real estate investment has rolled over and declined since the first quarter of 2016.  This is not a good sign.

This means, deflationary forces may already be taking place in the global real estate market.

How The "GREAT DEFLATION" Will Impact Gold & The Dollar

To understand how the coming GREAT DEFLATION will impact gold and the U.S. Dollar, we must throw out the window all preconceived notions about economics and money.  Any individual who continues to believe in the standard orthodox economic theory, you might as well also accept that the EARTH IS FLAT and infite GROWTH on a finite planet is possible.

Unfortunately, the U.S. educational system and alternative media continue to misinform the public about the role of MONEY.  So, the blind continue to lead the blind as Rome burns... so to speak.

The GREAT DEFLATION is coming due to the disintegration of the U.S. and global oil industry.  As I mentioned in a precious article, the top three U.S. oil companies slashed their Q1 2017 capital expenditures (CAPEX) by 40%, versus the same period last year.  Furthermore, the world only found 2.4 billion barrels of new oil in 2016 while it consumed 25 billion barrels:

I hate to be a broken record, but precious metals investors better WAKE UP.  How many new barrels of oil do you think the global oil industry will find in 2017 as they continue to slash their CAPEX spending even greater than last year??

Regardless, the Fed and Central Banks are propping up the market with more money printing and asset purchases than ever.  This will not solve our financial and economic problems, however it is a last ditch effort to postpone the inevitable.

To truly understand what will happen with the value of Gold and the U.S. Dollar, we have to grasp the data shown in the chart below:

To produce an ounce of gold in 2016 (top two gold miners - Barrick & Newmont), it took $1,113.  Thus, the top two gold miner"s total production cost was 89% of the gold market price ($1,251).  This is why gold stores wealth.  Stored wealth has always been "STORED ECONOMIC ENERGY."  Gold has been the King Monetary Metal because of its rarity in the earth"s crust and its ability not to corrode or tarnish like many other metals.

On the other hand, the U.S. Treasury Department of Engraving and Printing produced a new $100 bill for a mere 13.4 cents.  Thus, the U.S. Treasury"s $100 bill cost of production was 0.13% of its face value, versus 89% for an ounce of gold.

The production cost figures for the U.S. Federal Reserve Notes came from the U.S. Treasury Department of Engraving and Printing, shown in the table below:

It cost the U.S. Treasury $134.14 per thousand of $100 bill"s printed.  While the U.S. Treasury spent more money to produce the lower denomination bills versus their total face value, 71% of the $213 billion of Federal Reserves Notes printed in 2016 were $100 bills.

If we are able to understand the information presented above and are able to do some "CRITICAL THINKING", then it is easy to understand that the U.S. Dollar will suffer signficantlyu during the GREAT DEFLATION..... not gold.

We also must remember, a "NOTE", as in the "Federal Reserve Note", means an "OBLIGATION" or "DEBT."  Money is not supposed to be an obligation or debt.  Money is supposed to be a store of value and medium of exchange.

Thus, when the GREAT DEFLATION arrives, the value of the U.S. Dollar has a much farther way to fall versus gold.  Why?  Because the value of most things, always reverts back to their COST OF PRODUCTION.  The innate value of a $100 bill is a mere 13.4 cents.... so, its value still has room to fall 99%+.

Again... the innate value of most things are based upon their cost of production, not supply and demand.  What"s the use of being in the business of producing goods at a loss????

Here is one last example.  In 2016, total global gold mine supply was worth $103.6 billion.  This figure was based on the of 3,222 metric tons of gold mine supply (GFMS 2017 World Gold Survey), multiplied by the average spot price of $1,251.  The estimated cost to produce this gold was $92.2 billion:

Here we can see that the gold market price, was based on its cost of production.  On the other hand, the U.S. Treasury was able to print $151.7 billion in $100 bills for the total cost of $235 million ($0.235 billion).  Which means, the U.S. Treasury"s production cost was only 0.13% for the $151.7 billion of new currency (fake money) it issued last year.

People need to realize the U.S. Dollar"s value is backed by U.S. debt, which is being propped up by burning energy.  Thus, ENERGY = MONEY.  The huge increase in U.S. and Global Debt means the quality of energy that runs everything is rapidly declining.  Which means, the more debt that is added, the lower interest rates have to go.  It is a one way street.

Analysts who think interest rates need to normalize to a much higher level, have no idea about ENERGY.... ZIP, NADDA, ZILCH.  They look at the markets as if the ENERGY TOOTH FAIRIES run everything.  There are only a small handful of analysts who understand the energy dynamics.  The rest are the blind leading the blind.

The coming GREAT DEFLATION will destroy the value of most STOCKS, BONDS, REAL ESTATE and PAPER CURRENCIES.  The reason Real Estate prices will plummet below their cost of production is due to their 20-30 year financing and their inability to function during the disintegrating energy environment.  The same will be for automobiles and many other assets and items.

Investors need to understand how ENERGY and the FALLING EROI- Energy Returned On Investment, will impact the value of most assets going forward.  Most assets will collapse in value, while a few will hold or gain in value.  Gold and silver will be two of the few that will hold or gain in value during the GREAT DEFLATION.

Lastly, if you haven"t checked out our new PRECIOUS METALS INVESTING section or our new LOWEST COST PRECIOUS METALS STORAGE page, I highly recommend you do.

Check back for new articles and updates at the SRSrocco Report.

What Is This "Neutral" Interest Rate Touted By The Fed?

Submitted by Mark Spitznagel via The Mises Institute,

There’s a lot of talk these days about the so-called “neutral” (or “natural” or “terminal”) interest rate projections of the Federal Reserve. In fact, their projection of this number is a key argument in their ongoing decision to keep rates at historically very-low levels for what has been an extended period of time. (Specifically, Federal Reserve officials have argued that the neutral interest rate has sharply declined in recent years, meaning that apparently ultra-low interest rates do not really signify easy monetary policy.)

What is this neutral rate? The neutral rate, it is argued, is simply the federal funds rate at which the economy is in equilibrium or balance. If the federal funds rate were at this mysterious neutral rate level, monetary policy would be neither loose nor tight, and the economy neither too hot nor too cold, but rather just chugging along at its long-run optimal potential. The underlying theory is that loose monetary policy — where the Fed’s policy rate is set below the neutral rate — can temporarily stimulate the economy, but only by causing price inflation that exceeds the Fed’s desired target (which, by the way, eventually causes overheating and a crash). On the other hand, if the Fed is too tight and sets the policy rate above the neutral rate, then unemployment creeps higher than desired and price inflation comes in below target.

In short, the neutral interest rate is one where the central bank is not itself distorting the economy. Monetary policy would really be nonexistent, as the Fed would not be altering the interest rate resulting from a free market discovery process between borrowers and savers. (This of course raises the question, why do central planners need to fabricate something that would naturally exist in their absence?) This is near where Yellen actually thinks we are these days, hence she sees little urgency in raising rates and thus lessening what, on the face of it, looks like a very loose current monetary policy.

The Theory of the Neutral or Natural Rate 

Much of this neutral rate talk at the Fed is supposedly supported by the work of Swedish economist Knut Wicksell (1851–1926), who argued that the “natural” interest rate would express the exchange rate of present for future goods in a barter economy. If in practice the banks actually charged an interest rate below this natural rate, Wicksell argued that commodity prices would rise, whereas if the banks in practice charged an interest rate above the natural one, then commodity prices would fall. But that’s where Wicksell — often associated with the free-market Austrian school of economics — would cease to recognize his own ideas in current central bank thinking. Wicksell’s natural rate was a freely discovered market price in an economy, which reflected the implicit (real) rate of return on capital investments. For Wicksell, the natural interest rate was not a policy lever to be manipulated, in order to hit some employment or output goal. Yellen and the other Fed economists writing on this topic have conveniently (and probably unwittingly) co-opted Wicksell into their own Keynesian (and exceedingly un-Austrian) framework.

Can the Neutral Rate Be Used to Tweak the Economy? 

That’s the theoretical explanation of the neutral or natural rate. From a more practical standpoint, one must ask: How do we even know what that neutral rate is? The neutral rate is, by its current definition, inherently unobservable, as there is no discovery process in short-term interest rates (and there hasn’t been for as long as any of us have been around). Central banks calculate the neutral rate based on their formulas and identifying assumptions about output gaps and what interest rates, according to those models, will close those gaps. Here we have an immense circularity problem: Policymakers think they know the neutral rate because the assumptions of their interventionist model that they impose on the data say so, not because they have any insight that the market would actually clear at that rate, sans intervention. There is an underlying assumption that “markets, left on their own, are wrong, while our model is right.” Moreover, they are using observable data as model inputs that are the result of interventions that are already in effect. There are no controlled experiments in economics. Only market participants, acting freely in borrowing and lending at whatever interest rates make sense for that borrowing and lending, can ever discover what the neutral rate should be.

(To give a specific example: One of the key alleged pieces of evidence that the neutral rate has fallen in recent years is the sluggish growth of productivity. But suppose the ZIRP of the Fed itself has been choking off real savings and distorting credit allocation among deserving borrowers, and hence has crippled sustainable growth in output? In this case, the Fed models would conclude, “Nope, our policy rate hasn’t been too low, look at the weak productivity growth,” confusing cause and effect.)

In fact, the circular logic is such that economists are far from an agreement on the current calculation, and their admitted model estimation errors are enormous. Contrary to Yellen’s recent monetary policy ruminations, reputable estimates using two different approaches have concluded that the Fed has set policy rates below the neutral rate since 2009.

Things get worse. It’s not merely that we can’t know in real-time what the neutral rate is; we can’t even know after the fact. Suppose the Fed gradually hikes rates, and then the economy crashes. Dovish Keynesians would no doubt say, “We told you not to tighten! The neutral rate was obviously lower than the Fed realized, and they just raised the policy rate above it.” But this isn’t necessarily so. It could be that the policy rate had been below the neutral rate for years, fostering a giant asset bubble which eventually had to collapse. Both theories are consistent with the observed outcome of modest rate hikes leading to a crash.

The great Austrian economist Friedrich Hayek stressed the role of market prices in communicating information to firms and households, and the impossibility that central planners can ever effectively calculate those prices. If the Fed’s economists think they are able to estimate what the neutral interest rate is, then we can dispense with prices altogether. The Fed’s economists can estimate the “neutral wage rates” for various types of labor, the “neutral commodity prices” for various inputs, and so forth, and issue comprehensive plans for the economy, all calculated in kind.

Of course, this is absurd. The point is, in a capitalist economy, the interest rates themselves — as determined in a competitive discovery process in the bond and credit markets — are central to the coordination of the economy. To assume experts at the Fed could determine the proper, optimal interest rate, without that discovery process, is to assume away the real-world information problems that we all can agree market prices solve. Indeed, perhaps this is why our economic problems persist?