The ECB Targets 1752 (Part 3)

(New Gold Supra-Theory Salon des Refusés – Post 3)
In the discussion thread of this post I think we clarified some important issues around the theory about the adjustment mechanism for household consumption-driven imbalances in the Eurozone. In the course of the discussion it became obvious that gold had no role to play in the operation of this mechanism in the Euro currency zone. The Euro can and does get the job done.

This isn't the end of the story. My view hasn’t changed that the probability of gold being a key part of a new international monetary and financial system has such a high probability that it approaches inevitability. Determining the limits of the role of gold in this new system is a valid line of enquiry too. If gold is making a comeback let’s not be right for the wrong reasons.

Kudos (in alphabetical order) to DP, Piripi Peterson and Victor The Cleaner for engaging in the discussion and presenting their perspectives. We clarified some issues about the composition of the HICP Eurostat inflation index that I want to share with you here in the Salon des Refusés. This is where theories that don’t make the cut for the New Gold Supra-Theory will reside. We also discussed a circuit theory approach to understanding the TARGET2 balances that has identified one of the potential roles for gold in the Eurosystem.

Let’s briefly recap on the theory about the consumption circuit and incorporate some of the input from the discussion about the first two parts of this post. I presented the theory that the fathers of the Euro incorporated a modified version of the classical economists “price>specie>flow” mechanism into the design of the Eurosystem. I style this mechanism as prices+>money>flow for a currency zone but it should be rendered as prices+>Euro>flow in the EMU single currency zone.

The adjustment mechanism in the consumption circuit allows the ECB to target it’s two (2) per cent average annual inflation rate with feedback from the Eurostat HICP consumer price index (CPI). On their web pages discussing the HICP the ECB says here: “Key priorities for the coming years are the treatment of owner-occupied housing (currently excluded)....”

If they are including new housing consumption in their index and excluding land already then we will argue that they should Stop right there! The HICP is already capturing the only useful data on owner-occupied housing (OOH) that a consumption index can utilize. If Eurostat isn’t including any part of the consumption associated with new OOH then we propose an approach that will solve three statistical analysis problems associated with OOH that bedevil other CPIs around the world. These problems are: volatile land prices, resales of existing homes and rent (housing services).

If data on house prices that separates land prices is gathered in your region it should be clear that the replacement cost of a house closely tracks increases in the general price level.  Armed with this data it also becomes obvious that it’s the land component of housing that experiences these boom-bust cycles. (One bonus in excluding land from your CPI is that you reduce the volatility in your index.) It is self-evident that houses deteriorate over time unless they are maintained. This is the consumption component of OOH. (There are question marks over the correct treatment of depreciation, repairs and maintenance so I’m going to put these issues aside for now. It's not a deal breaker however you treat them!)

You can also record the purchase of a new house (minus the land component) as a single consumption event in the year in which it occurs. Here’s why: let’s say this new house has a life of 40 years. The first owner has purchased 40 years of house consumption. Even if the house is sold every 10 years each of the 4 owners only “consumes” one quarter of that initial consumption item over the ‘working’ life of that house. So you can exclude resales from your CPI as well.

In the comment thread here Victor The Cleaner offered the analogy of a new car purchase to explain this principal: “If you purchase a new car and then sell it after a year, the value added that you have consumed is only the difference of the prices. Same for the next owner in line after you, and so on, until the car is eventually scrapped. So in effect, the purchase price of a single new car needs to be counted once.” This analogy also deals neatly with the depreciation issue.

You solve the rent/housing services problem by not treating OOH as a form of quasi-income. Occupying a house may be a cost saving if it’s owned outright but an avoided cost isn’t income. If you want to test this out wander past a Ferrari showroom and decide not to buy one and then check your bank balance to see if you are any wealthier. If one of our 4 owner-occupiers in the example above is replaced by a tenant for 10 of those 40 years it’s still part of the consumption life cycle of the house that began with the original purchase.

Rent on a house can be equated to an interest-only private loan. The landlord has invested in an asset. The tenants have an overhead that reduces their disposable income – the income available for consumption. The rent paid by the tenant could result in an increase in the disposable income and consumption of the landlord's household which would be detected by the HICP anyway. This is a transfer of purchasing power rather than a type consumption.

Kudos to Eurostat for not using a “typical household” approach to gauge consumption spending and thereby resolving the classical economists reservations about indexes. They seek to gather statistics on actual household consumption spending across the Eurozone. It appears that Eurostat have finally created an accurate inflation indicator based on prices.

The TARGET2 system also discussed in this series provides a very low friction ‘plumbing’ system allowing the prices+>Euro>flow mechanism to correct imbalances across the Eurozone. In the process optimizing the benefits of free trade and a single currency zone as the classical economists Hume, Ricardo et al said it would.

Next we’ll explore a circuit theory approach to understanding the TARGET2 balances in order to determine if gold has a role to play in correcting imbalances in this part of the Eurosystem.


Warren James said...

[ fwiw: Retail cost of electricity (have been researching) is an interesting rising cost not in line with CPI (in fact exceeding it, in Australia anyway). Since I was born, the average retail price of kilowatt/hour in Australia has gone up 1,000 percent, with about half of that in the last 10 years or so. Neat. ] rgds.

costata said...

Hi Warren,

IMO it's instructive that governments here are so focused on increasing people's incomes (which they tax) and unwilling to discuss the expenses they impose on our incomes.

AdvocatusDiaboli said...

This stupid talk of the HICP reminds me of something else going on around the times of 1752 in the earlier eurozone:

"Qu'ils mangent de la brioche" (wrongly) attributed to Marie Antoinette

Or to put it into english and in place of the article and modern times of this HICP talk:
"if they cant have bread, let them eat mud-cookies, at least this fixes out inflation rate publication problem forever." (probably accordingly) attributed to some EUro-lunatic-fanboy
Greets, AD

costata said...

Hi AD,

Long time no see.


AdvocatusDiaboli said...

Hi Costata,

"You can also record the purchase of a new house (minus the land component) as a single consumption event in the year in which it occurs. Here’s why..."

Sorry, but here's why this is bullshit, at least in Europe/Germany (where you dont live, and I am still amazed about your confirmation bias into something without any background information):

Consumption on the individual level, when you want to measure the nominal consumer price level, can only include items that are bought from your net money. I know, today we have credit cards, but still your personal debt ceiling of such credit in a functioning economy is choosen either by you or others at a decent appropriate level.
Now about housing in this context: In the EUro area the housing market is a completely etatist planning field. Housing prices depend exclusively on the centralistic planning of the state and banking sector and does not reflect ANY free market.
To give you an example from Germany: You can have a partial mortage for private housing purchase at a rate of 1.9x% fixed for 10 years. Remember that's a loan for consumption!!!! But if I want to take out a loan for my company for investment with perfect rating (as an experiment, I even offered to deposit the same amount in cash at the bank as collateral!!!) I pay >=5%!!!
Why? Because no bank gives you 1.9% for consumption fixed 10yrs in a free market, it is the state bank KFW that subsidizes those loans differences in their pet projects.
and in the meantime the government even subsidizes social welfare housing...

I like the term "credibility inflation" :) So if we dont have voluntary credibility inflation any longer, we just simply try to enforce it by central planning to desperately blow another serial bubble (and if this does not work, Mr.Draghi disappointedly says "the transmission mechanism does not work, yet".)

Do you now see the problem of including realestate prices into the CPI, while having such EUro planning?
Greets, AD

costata said...

Hi AD,

If you want to have a conversation with me here then leave out words like "bullshit". Prosimians are excitable creatures and we have to be aware of the rabies issue.

The kind of subsidies for housing purchases that you describe capitalize into land prices when there are restrictions on land supply and zoning through planning legislation. The brake on the price increases in the built component of a dwelling (house and land) is the replacement cost of the building.

I would view those subsidies you describe as transfers by government policy. FWIW I don't agree with governments interfering in markets in this way. It distorts markets and tends to inflate the cost of acquiring a home. This is not a problem that is unique to Germany. It costs half a million Aus dollars to buy a crappy house in Sydney these days because of this kind of bad government policy.

I'm not going to invest much time in discussing these issues. The HICP appears to have solved a longstanding problem in measuring inflation by monitoring prices. If you disagree then we'll have to agree to disagree.

The main objective of this post was to explore whether there's any role for gold in this part of the Eurozone monetary system and I think it's quite clear that there isn't one. My next post will explore another circuit in that system in order to try to determine if there is any role for gold there.


AdvocatusDiaboli said...

Hi Costata,

as you might have noticed, I didnt interrupt any of your articles concerning your "new monetary system", reading curiously where you wanna guide us :)
But: "The HICP appears to have solved a longstanding problem in measuring inflation by monitoring prices."
I simply dont get how you insist continuesly that the current HICP monitors anything of the real prices. The housing discussion shows that interventionism distorts prices todays and in the future, okay looks like we agree on that one.
The other post you didnt adress at all: If the economy runs out of bread (and bread prices are skyrocketing or simply disappear) and people turn to mud pies, those central planners simply say, null problemo, just look at the HCIP, our monetary policy seems to be perfect, no reason to bitch about us. Because let's face it: monetary policy is state interventionism at its best.
Other examples? Energy prices in Germany are skyrocketing. 600000 households are without electricity due to outstanding bills, I wonder how you replace electricity in the HICP...
Fuel has been skyrocketing over the past ten years, okay dont worry about the HICP, people will stay at home and instead play with their chinese toys, hopefully being dumped down by the state propaganda TV, good thing is, therefore we dont need to fix the roads...
Gas and oil for heating have been skyrocketing over the past ten years, people therefore turn to wood (taking it out of the woods by themself, but now also wood starts to skyrocket). But the HICP is just fine....come on, how much more absurd can it one of the leading industrial nations of the world with one of the lowest unemployment numbers!!!
Greets, AD

costata said...

Hi AD,

If you can discredit the HICP as a measure of inflation go for it. I'll happily do a post summarizing the key arguments you put forward.

Your main thrust seems to be that HICP doesn't capture actual cost of living increases. Why doesn't the HICP reflect your experience of price increases in Germany?

Are the prices of fuel and electricity in Germany rising much faster than they are in other parts of the Eurozone? If not, what consumption items are being excluded from the HICP?

AdvocatusDiaboli said...

"If not, what consumption items are being excluded from the HICP?"
No items are excluded, but their weighing is chosen.
How is it chosen? The official version is: According to the amount of consumption of a particular good. Already this shows the flaw in the thinking, because if goods get too pricy like bread, the consumer is forced to turn to mud pies. To say: "oh look, nobody or much few are buying bread any longer, therefore we can put more weighing on the newly demanded super popular mud pies, instead on bread" is just simply lunatic.

So far the already flawed theory, but in reality the weighing is chosen at random by the very same central planers, to whom the HICP is supposed to be their grading. How crazy is that?

Inflation is the expansion of money supply by its very own definition, and the numbers are all out there, no reason to have a HICP at all.

When you want to have a measure for price increases, just look at the prices. The german static department had onces an interactive graph, on which you could do your own weighing. Guess what, as soon as you switched off all the "chinese platic toys", price increases turned to average annually +5%. OOps, magically that's the very same speed of the technical "money printing" in the EU of ~5.6%/yr over the last ten years, maybe that's a coincident, maybe not.

But one thing is for sure, dont fall for any bullshit measure of the money printers themself, regardless on how they set it up, simple as that.
Greets, AD

IMHO If you still looking for some "official" numbers and dont want to argue on the weighing, just take numbers of very complex products of people that know how to calculate real costs professionally rather than faking their own numbers out of thin air: insurances. car, medical, household, building... The risks itself does not change much, but it reflects a huge variety of underlying costs for replacements.

IMHO The value of money when being measured exclusively by itself, is the interest. Since this is centrally controlled, all other measures start to become useless anyway.

DP said...

Inflation is the expansion of money supply by its very own definition

Disagree. There is more to price inflation than simply the stock of money in the system.

AdvocatusDiaboli said...

Hi DP,
lets be accurate in economical wording from the theoretical view point: Inflation is the expansion of money supply, deflation is contraction of money supply. Prices (<="the human moneyness";-) might or might not follow more or less to those technical actions, yes?
Greets, AD

DP said...

I would say what people choose to hold their excess in has a rather significant bearing on the matter.

In fact, with a goal of price stability, I might be drawn to believe any expansion/contraction of the money stock would be largely determined by that factor.

AdvocatusDiaboli said...

maybe this is something to watch for you?
Any freegolder will probably hate such consideration ;)
SCNR, Greets, AD

DP said...

Yes, any Freegolder hates Hard Money Socialist considerations.

These people fundamentally misunderstand the nature of money (Unit of Account and Medium of Exchange). They think it should be an enduring Store of Value, that the State will protect the (LDO, rising - because they should be rewarded for hoarding money so others cannot have as much!) value of their savings that they choose to keep in money.

That is why they struggle to accept the majority position on "elastic money", and incessantly beat their skulls on any brick wall that gives the appearance it might listen.

They are wasting their time, and everyone else's. In this case almost an hour, if one cared to actually watch his drivel to the end. Fortunately for me, I've seen it all before. But he still keeps saying the same bullshit, over and over.

AdvocatusDiaboli said...

I used the word "consideration" intentionally ;) Because, when getting older, you start to wonder if there is a right or wrong. MMT, Freegold and HMS advocates, what does it actually mean? It means somebody thinks that he is smarter than the other and therefore knows what is best for the majority.
Me personally thinks, I really dont care any longer, just important to know enough not to be the sucker at the table.
When it comes to "what is money" it easily gets into the discussion "what should be money".

MMT=whatever we print for whatever we think is needed for spending or compensation of the stacking of money by the evil savers


HMS=fixed/constant base money supply, credit is determined from there by the owners of the money.

I think the most important perspectives are made in FOFOAs "Moneyness" + "Moneyness 2.0". From there everybody can determine for himself "what should be money". FOFOA comes to his conclusion that money is credit in itself, with the consequence that everything is fine like it is, because refusing seperation of money and credit in exchange of establishing a useless "StoreOfValue".
I personally find this idea sick (but thats up to everybody for himself), because it leaves you with the question of "who determines to give the credit" is the key: The collectiv political system or the individual holder of money who earnt it. Besides the moral aspect it means, who is economically wiser? The hungry collective or the economically succesful?
Just my 2cents, @costata: sorry for getting OT, hope you dont mind.
Greets, AD

costata said...

Hi AD,

No need to apologise. When you engage with the arguments of your opponents I'm happy to spend the time reading your comments.

You may find this attempt to build out a New Gold Supra-Theory interesting. I won't be drawing on the Freegold A/FOA/FOFOA reasoning except where it fits into a conventional frame of reference. If I can present a sound, coherent theory that doesn't rely on the A/FOA legacy for authenticity it may provide an alternative pathway for people to take that still leads to conclude that a new gold-based international monetary and financial system is the highest probability.

Re: HICP - I think that attempting to capture actual household consumption is a much better approach than using a "typical household" model like other consumer price indexes.

If the reality is that people are spending most of their money on "chinese plastic toys" then so be it. Record the numbers as they come. That said I'll keep copies of your comments and the discussions you get into and compile a list for a future post that argues that the HICP is skewed and under-records inflation in the Eurozone.

I'm going to pick up on the inflation-deflation issues you were discussing with DP in a comment to him next.


costata said...

Hi DP,

Spending time with the classical economists has given me the opportunity to take a fresh look at some of the original work on theories such as the quantity theory of money. I think some of the later work on this theory took it in directions they never intended.

Basically their argument was that if the supply of goods and services is fixed and you double the money supply it will double the prices of those goods and services overall. They were also cognizant of velocity. They understood that money changes hands faster at a village fair compared to transactions with, say, a travelling seller (tinkers etc).

The classical QTM is pretty banal in retrospect but it was revalatory in its time. Throughout the renaissance inflation period of around 150 years the strongly held belief was that the observed price "inflation" indicated a shortage of money.

I think Milton Friedman overdid QTM when he helped to justify targeting of monetary aggregates by central banks. That seemed to work OK for a while when conditions favoured that approach. Ultimately it failed and the CBs moved on to the next fad - inflation targeting. I'm hoping this fad dies a natural death along with CBs meddling with interest rates. But that's just my 0.02!

To me the HICP is less important than the TARGET2 payments system and relatively free trade within the Eurozone. I think this structure is doing most of the heavy lifting in currency management.

IMHO the real problems in the Eurozone are in fiscal policy - government policy - not monetary policy and the banking system. Same deal here in Australia.

AdvocatusDiaboli said...

Hi costata,

"IMHO the real problems in the Eurozone are in fiscal policy - government policy - not monetary policy and the banking system. Same deal here in Australia."

That's not just an opinion, thats the simple ugly fact!!!111 Any kind of money system that includes debit/credit is influenced by the debtors. And since the productivity of the the government has a tendency against zero (sometimes even taken negative signs, just thing of CashForClunkers) the debt value has a tendency against zero as well. Now if you have a state expenditure quota (allocation of goods and services) passing 50%, how on earth does somebody expect that the involved monetary system can keep up with that in logical mathematical terms? Ugly truth is, it cant, therefore just breaking the rule-of-law at random and fiddling around in the monetary system (EUro is probably the best example of breaking any kind of rules in the open day light).
Greets, AD