Tag Archives: De Soto

Einhorn on the Fed; Lecture on Cause of Financial Crises by De Soto

Einhorn on the Fed’s Insane Policy

Editor: Mr. Einhorn recognizes the dangers of the Federal Reserves Zero (manipulative) Interest Rate Policy. Where I take a different view is that the Fed’s Zero interest rate policy hurts savers and thus capital accumulation. Less capital hurts productivity and future economic growth. Regardless, no centrally planned economy has ever worked so why expect the Fed’s manipulated price control of interest rates to not end in tears? I do agree with Einhorn’s assessment of Bernanke’s theory of lowering interest rates to increase the “wealth” effect. Only a Ph.D can lack so much common sense.

Klarman ain’t happy either: http://www.businessinsider.com/seth-klarman-goes-nuts-on-the-fed-2012-10

Those guys have been reading csinvesting or von Mises.

Dr. De Soto on the Cause of the Current Financial Crises

Jesús Huerta de Soto, author of the thought-provoking book on economics ‘Money, Bank Credit and Economic Cycles’ and Professor of Political Economy at Rey Juan Carlos University, Madrid, explains the motivations behind British Prime Minister Robert Peel’s Bank Act of 1844. Prior to this Act, the free issuance of bank notes with claims on gold bullion wasn’t limited by British law, resulting in wild economic cycles that often led to bank runs and large gold flows out of the country as foreigners sought to exchange claims on gold for actual bullion.

He discusses why Robert Peel’s Bank Act of 1844 was a failure, despite its good intentions. Although the Act placed legal limits on banks’ issuance of paper notes, its failure to place the same limits on deposits allowed banks to pyramid deposits, which ultimately led to the fractional reserve banking that we have today.

The professor also explains the problem with the practice of fractional reserve banking, and why it leads to credit expansion that ultimately results in “boom and bust” economic cycles. “Virtual money” that is created easily by banks in the process of credit expansion during the boom contracts just as easily during the bust, resulting in recession.

Furthermore, he discusses the importance of capital theory and the nexus between interest rates, savings and prices. Huerta de Soto argues that Austrian Business Cycle Theory offers the best explanation of how and why economic cycles work, and the best explanation of the pay-offs between present consumption and long-term investment.

Also, he explains how artificial credit expansion leads to a temporary economic boom, and why it inevitably results in recession. Huerta de Soto uses the example of his native Spain, and how European Central Bank credit expansion distributed unevenly around the Eurozone, resulting in housing bubbles in periphery Eurozone countries like Spain, Greece and Ireland.

He lists the six microeconomic effects that result in the crack-up boom. Crucially, credit expansion leads to over-investment in capital goods. The credit expansion leads to first rising prices and then higher interest rates, and thus lower prices for capital goods. There are not enough real savings to support the demand for the increased number of capital goods, leading to recession.

The professor questions why central banks even exist, and why there is no free market in interest rates and money supply. Huerta de Soto wonders why people are happy with socialism for the banking system, and why more people are not correctly blaming central banks and fractional reserve banking for the financial crisis.

Huerta de Soto also explains why recessions are a necessary corrective to the excesses of the boom period. Huerta de Soto argues that in his native Spain, job losses in the construction and housing sector are necessary owing to over-investment in housing during the boom. He also criticises “stupid” politicians who thought that they had abolished boom-and-bust.

He criticises those who argue that currency devaluation is a cure for the recession, and argues that his native Spain is far better off with the euro than the peseta. Huerta de Soto argues that the euro is forcing politicians and the public to make honest choices about spending and is acting, beneficially, as a kind-of gold standard.

Further he argues that the European response to the financial crisis is preferable to the wildly expansionary policies chosen by the United States. Huerta de Soto argues that for this reason, he is more optimistic about the euro than the dollar.

Huerta de Soto wraps up with three key measures needed to improve our financial system. First, Peel’s Bank Act needs to be completed which means a 100% reserve is required for demand deposits. Second, central banks need to be abolished. And lastly, the issuance of money should be privatised, leading to a free gold standard.

Bank Runs

Another Ponzi Scheme: http://www.huffingtonpost.com/2012/11/04/donald-french-ponzi-scheme-youngest-actor_n_2070515.html

The Euro Crisis Explained

“The attraction which inflation policies have for so many people grows, in part at least, out of what may be called the money illusions.” –Irving Fisher

In addition to the lectures you can watch or have watched from my last post: http://wp.me/p1PgpH-1aj you can add the one below to your education in money matters.

Jesus De Soto discusses the reasons for the European Economic crisis


A reader writes, “I found the lecture above a great way to learn about Austrian Economics and an easy way to understand the key message from the important book, Money, Bank Credit, and Economic Cycles by Jesus Huerta de Soto. His lecture sets the subject in a modern day issue, the Euro Crisis, and Prof. de Soto suggests a anti-consensual conclusion.”

Editor: Prof. De Soto said (more or less) that Americans and Westerners do not want to live under an authoritarian political system, and they have the seen the collapse of centrally planned economic systems due to constant malinvestment by bureaucrats. However, they accept without protest a monetary system that is centrally controlled.

Jesus de Soto’s great work is here: http://mises.org/document/2745/Money-Bank-Credit-and-Economic-Cycles.

His recent articles:http://mises.org/daily/author/210/


With the above book and the two below, you can become an expert on money and credit.

Man, Economy and State: http://mises.org/Books/mespm.PDF

The Theory of Money and Credit by von Mises: http://archive.mises.org/4048/theory-of-money-and-credit-pdf/

Interesting Videos and Readings

You make money on wall street by being very selective and being patient, waiting for those opportunities that are irresistible, where the percentages are very heavily in your favor.- Seth Glickenhaus

A Nose Job

Have we lost our sense of humor? A surgeon may lose his license over a commercial.


Rock Video: I will love you forever if you just got your nose done: http://www.youtube.com/watch?v=WkzTcUVTP0Q


Is Inflation about General Price Increases?  http://mises.org/daily/5953/Is-Inflation-about-General-Increases-in-Prices

The Theory of Central Banking: http://www.youtube.com/watch?v=6HAEPSt_12U. A good lecture by Robert Murphy on how central banking works.

Banking, Central Banking and the Economic Crisis by De Soto (excellent): http://www.goldmoney.com/video/huerta-de-soto-presentation.html. De Soto’s accent is heavy but he gives you a good historical perspective on fractional reserve banking.

Prison Nation going broke:http://bastiat.mises.org/2012/03/prison-nation-going-broke

Keep Track of your Investing

How To Start Keeping A Journal


The blog above is focused on trading, but the lessons apply as much to value investors. Substitute investing for the word, trading. In fact, what excuse do you have for not keeping a journal?

Make things happen


Dollar Shave Club: http://www.dollarshaveclub.com/select-blade

Investing in Banks

A Lesson in Punctuation

An English professor wrote the words, “a woman without her man is nothing” on the blackboard and directed the students to punctuate it correctly.

The men wrote: “A woman, without her man, is nothing.”

The women wrote: “A woman: without her, man is nothing.”

A reader has asked me a question about investing in banks. Unfortunately I avoid banks because I believe banks are a speculation on a bank management’s ability to make prudent, rational lending decisions combined with the whims of Federal Reserve policy. You have the risks of “bank runs” due to fractional reserve banking. (I can’t value the bank or normalize earnings or ROIC so I do what a pretty girl at a bar would do–just say, NO!) However, understanding how the banking system works is critical to understanding economic booms and busts.  My suggestion is to begin reading the books mentioned below as a starting point before venturing to banks’ financial statements.

Excellent Blog: http://variantperceptions.wordpress.com/

To learn more about banks you can read American Banker: http://www.americanbanker.com/ and S&P industry reports on banking. Also, the Wall Street Transcript has articles on banks and the banking industry here: http://www.twst.com/

The History of Banking: www.mises.org/books/historyofmoney.pdf

How banking Works: www.mises.org/books/mysteryofbanking.pdf

Money, Banking and Credit Cycles: www.mises.org/books/desoto.pdf

Warren Buffett plugs Jamie Dimon, The CEO of JP Morgan as a good banker and suggests reading his shareholder letters.

Jamie Dimon’s 2010 Letter to Shareholders: http://files.shareholder.com/downloads/ONE/1713791083x0x458384/6832cb35-0cdb-47fe-8ae4-1183aeceb7fa/2010_JPMC_AR_letter_.pdf

2009 Letter: http://files.shareholder.com/downloads/ONE/1713793272x0x362440/1ce6e503-25c6-4b7b-8c2e-8cb1df167411/2009AR_Letter_to_shareholders.pdf

A reader, generously contributed this: http://www.scribd.com/doc/83007803/Banking-101-for-Large-Cap-Banks-May-2011

A Handbook on Analyzing Banks: http://www.amazon.com/Bank-Analysts-Handbook-Conjuring-Tricks/dp/0470091185/ref=cm_cr_pr_product_top

Review of the above book:

Great introduction, some conceptual/structural flaws,October 27, 2009

By Brad Barlow (Cave City, KY) – See all my reviews

This review is from: The Bank Analyst’s Handbook: Money, Risk and Conjuring Tricks (Hardcover)

Frost’s book gets 4 stars based on its strength and accessibility as an introduction, it’s clarity (for the most part), and the breadth of topics that he covers related to banks and the banking industry.

Unfortunately, Frost’s understanding of economics is poor, leading to a relatively shallow (but certainly textbook these days) discussion of central banking and the regulatory framework in general. He, like so many other modern writers in finance and economics, would benefit greatly from actually reading a sound economic theorist, like Henry Hazlitt or Ludwig von Mises, rather than sporadically quoting JK Galbraith and Adam Smith. This lack of understanding on his part at times undermines the conceptual framework of the book, detracting from its clarity.

A few final praises and quibbles: His use of clear examples to illustrate important points is very welcome, but there are a few cases where he could give a fuller explanation (e.g., the 20-yr mortgage example). I like the diagrams showing flows of funds and parties to common transactions, but he could have picked a better font, as the small cursive script is not always easy to read. Finally, what’s with the front cover art, seriously?

Overall, I’m quite satisfied and thankful for the book. Definitely buy it if you are in the industry.

Avoid banks and seek other ideas.

You can look here: http://www.crossingwallstreet.com/buylist


The key to doing well on Wall Street is actually very simple: Buy and hold shares of outstanding companies. But too many investors never learn this valuable lesson. Or if they do learn it, they learn it the hard way. That’s where I come in. I want to help investors avoid the mistakes that separate successful investors from those who always find themselves spinning their wheels.

Without a Central Bank

A reader, Taylor, mentioned the distortions caused by central banks. What would happen if we did not have central banks?

Life without a central bank (Panama) http://mises.org/daily/2533

In this modern, post-–Bretton Woods world of “monetary order” and coordinated central-bank inflation, many who are otherwise sympathetic to the arguments against central banks believe that the elimination of central banking is an unattainable, utopian dream.

For a real-world example of how a system of market-chosen monetary policy would work in the absence of a central bank, one need not look to the past; the example exists in present-day Central America, in the Republic of Panama, a country that has lived without a central bank since its independence, with a very successful and stable macroeconomic environment.

The absence of a central bank in Panama has created a completely market-driven money supply. Panama’s market has also chosen the US dollar as its de facto currency. The country must buy or obtain their dollars by producing or exporting real goods or services; it cannot create money out of thin air. In this way, at least, the system is similar to the old gold standard. Annual inflation in the past 20 years has averaged 1% and there have been years with price deflation, as well: 1986, 1989, and 2003.

Panamanian inflation is usually between 1 and 3 points lower than US inflation; it is caused mostly by the Federal Reserve’s effect on world prices. This market-driven system has created an extremely stable macroeconomic environment. Panama is the only country in Latin America that has not experienced a financial collapse or a currency crisis since its independence.

As with most countries in the Americas, Panama’s currency in the 19th century was based on gold and silver, with a variety of silver coins and gold-based currencies in circulation. The Silver Peso was the currency of choice; however, the US greenback had also been partially in circulation, because of the isthmian railroad — the first railroad to connect the Atlantic to the Pacific — that was built by a US company in 1855. Panama originally became independent from Spain in 1826, but integrated with Colombia; however, being a small state, it was not able to immediately secede from Colombia, as Venezuela and Ecuador had done. In 1886 the Colombian government introduced several decrees forcing the acceptance of government fiat paper notes. Panama’s open economy, being based on transport and trade, plainly could not benefit from this; an 1886 editorial of its main newspaper read:

“there is no country on the globe, certainly no commercial center, in which the disastrous consequences of the introduction of an irredeemable currency would be felt as in Panama. Everything we consume here is imported. We have no products and can only send money in exchange for what is imported.”

In 1903, the country became independent, supported by the United States because of its interest in building a Canal through Panama. The citizens of the new country, in distrust of the 1886 experiment of forced fiat Colombian paper notes, decided to include article 114 in the 1904 constitution, which reads,

“There will be no forced fiat paper currency in the Republic. Thus, any individual can reject any note that he may deem untrustworthy.”

With this article, any currency in circulation would be de facto and market driven. In 1904 the Government of Panama signed a monetary agreement to allow the US dollar to become legal tender. At first, Panamanians did not accept the greenback; they viewed it with mistrust, preferring to utilize the silver peso. Gresham’s Law, however, drove the silver coins out of circulation.[1]

In 1971 the government passed a banking law that allowed for a very liberal and open banking system, without any government agency of consolidated banking supervision, and confirmed that no taxes could be exacted from interest or transactions generated in the financial system. The number of banks jumped from 23 in 1970 to 125 in 1983, most of them being international banks. The banking law promoted international lending, and because Panama has a territorial tax system, profits from loans or transactions made offshore are tax free.

This, and the presence of numerous foreign banks, allows for international integration of the system. Unlike other Latin American countries, Panama has no capital controls. Therefore, when international capital floods the system, the banks lend the excess capital offshore, avoiding the common ills, imbalances, and high inflation that other countries face when receiving huge influxes of capital.

Fiscal policy has little room to maneuver since the treasury cannot monetize its deficit. Plus, fiscal policy does not influence the money supply; if the government tries to raise the money supply during a contraction period by obtaining debt in international markets and pumping it into the system, the banks compensate and take the excess money out of circulation by sending it offshore.

Banks cannot coordinate inflation due to ample competition and the fact that (unlike even the United States banking system prior to the Federal Reserve) they do not issue bank notes. The panics and general bank runs that were so common in the US banking system in the 19th century have not occurred in Panama, and bank failures do not spread to other banks. Several banks in trouble have been bought — before any runs ensue — by larger banks, attracted by the profits that can be made from obtaining assets at a discount.

There is no deposit insurance and no lender of last resort, so banks have to act in a responsible manner. Any bad loans will be paid by the stockholders; no one will bail these banks out if they get into trouble.

After several years of accumulation of malinvestments during the booms, banks begin the necessary liquidation of bad credit. Since there is no central bank that can step in to provide cheap credit, the recession begins without any hampering by monetary policy. Banks thus create the necessary contraction by obeying market forces. Panama’s recessions commonly create deflation, which mollifies consumers and also facilitates the recovery process by reducing business costs.

Only the fact that the law does not allow for the downward flexibility of wages makes recessions longer than they would otherwise be.

Deflation happens without the terrible consequences that Keynesian economists predict; and the country, now under democratic rule, is experiencing its 4th year of market economic growth well above 7%. So the policy makers who have said that abolition of the central bank is unfeasible need only look to Panama’s macroeconomic environment, which has been favorable for over 100 years, to realize that it is, in fact, not only possible, but very beneficial. Clearly no government-forced fiat currency, no central bank, and the absence of high inflation are working quite well in this small country. Who can argue that these policies would not work in larger economies?