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Wednesday, April 01, 2015 5:50 AM

Iceland Ponders Radical Money Plan Including Elimination of Fractional Reserve Lending and Deposit Insurance

I have long railed against fractional reserve lending, duration mismatches (e.g. banks issuing 2-year CDs and lending money for 15-year mortgages), bank's ability to lend money into existence, and deposit insurance. 

Fractional reserve lending allows banks to lend out a near infinite amount of credit with essentially no backing. Money inevitable creates asset bubbles, but as long as the bubbles are expanding it appears the system is solvent.

Money that depositors believe is available on demand in their checking accounts is not actually present at all. And banks are not required to hold any reserves on savings accounts at all.

Deposit insurance is the epitome of moral hazard. It guarantees money will flow to banks offering the highest yield. Of course, banks offering the highest yields on deposits need to take the highest risks to be able to pay that interest. Depositors do not care because the deposits are insured.

Iceland Ponders Radical Money Plan

I am somewhat surprised by this development, but Iceland is investigating a banking system that will eliminate all of the above flaws.

The Telegraph reports Iceland Looks at Ending Boom and Bust with Radical Money Plan.

Iceland's government is considering a revolutionary monetary proposal - removing the power of commercial banks to create money and handing it to the central bank.

The proposal, which would be a turnaround in the history of modern finance, was part of a report written by a lawmaker from the ruling centrist Progress Party, Frosti Sigurjonsson, entitled "A better monetary system for Iceland".

"The findings will be an important contribution to the upcoming discussion, here and elsewhere, on money creation and monetary policy," Prime Minister Sigmundur David Gunnlaugsson said.

The report, commissioned by the premier, is aimed at putting an end to a monetary system in place through a slew of financial crises, including the latest one in 2008.

According to a study by four central bankers, the country has had "over 20 instances of financial crises of different types" since 1875, with "six serious multiple financial crisis episodes occurring every 15 years on average".

Mr Sigurjonsson said the problem each time arose from ballooning credit during a strong economic cycle.
The Proposal

The proposal is a 110 page PDF called Monetary Reform - A Better Monetary System for Iceland

The proposal describes in detail the problems of deposit insurance, fractional reserve lending, and various moral hazards in a way that is easy to understand. I encourage everyone to read the document as it debunks many widely-held beliefs such as the money-multiplier theory of how money is actually created.

The money-multiplier theory is widely taught and widely believed but totally wrong as I have discussed many times.

Unfortunately, the proposal has a major flaw. It hands responsibility for the creation of money to a panel. The document discusses that flaw in sections 9.5.3 and 9.5.4.
9.5.3 What if the money creation committee makes mistakes?

It has been pointed out that the money creation committee may not possess all the information necessary for creating the optimal amount of money for the economy. The concern is that wrong decisions by the committee may lead to either inflation or the economy failing to reach its potential.

It would be unrealistic to demand or expect perfect decisions on money creation under a sovereign money system. But it would also hard to believe that a committee tasked with creating the proper amount of money for the economy would consistently create money to similar excess as the commercial banks have done in the past.

9.5.4 Fear of government creating money to fund its policies

Concerns exist that if governments are allowed to create money directly, they will get carried away and create excessive amounts of money to pay for vote-winning projects.

Under Sovereign Money, however, the government is not allowed to create money directly. The decision to create money would be made by a money creation committee, independent of government, on the basis of what is appropriate for the economy as a whole. The committee will not have the power to decide who benefits from its money creation or what new money will be used for. The allocation of new money will be decided democratically by parliament.
What is the Proper Supply of Money?

The obvious flaw is there is no all-knowing panel that has any idea what the money supply should be.

Three Questions

  1. Would a panel be any better than the Fed? 
  2. Would it be politicized?
  3. What increase in the amount of money is necessary for growth?

I do not know the answer to the first two questions although it's likely that the panel would be at least as good as the Fed, at least initially, if for no other reason than the proposal corrects many of the flaws in the existing monetary system.

I can answer question number three. The answer is zero. No growth in money supply is needed to have a growing economy.

Please consider a snip from the eBook What has Government Done to Our Money? by Murray Rothbard.
What “should” the supply of money be? All sorts of criteria have been put forward: that money should move in accordance with population, with the “volume of trade,” with the “amounts of goods produced,” so as to keep the “price level” constant, etc. Few indeed have suggested leaving the decision to the market. But money differs from other commodities in one essential fact. And grasping this difference furnishes a key to understanding monetary matters. When the supply of any other good increases, this increase confers a social benefit; it is a matter for general rejoicing. More consumer goods mean a higher standard of living for the public; more capital goods mean sustained and increased living standards in the future. The discovery of new, fertile land or natural resources also promises to add to living standards, present and future. But what about money? Does an addition to the money supply also benefit the public at large?

We may ask ourselves what would happen if, overnight, some good fairy slipped into pockets, purses, and bank vaults, and doubled our supply of money. In our example, she magically doubled our supply of gold. Would we be twice as rich? Obviously not. What makes us rich is an abundance of goods, and what limits that abundance is a scarcity of resources: namely land, labor, and capital. Multiplying coin will not whisk these resources into being.

We may feel twice as rich for the moment, but clearly all we are doing is diluting the money supply. As the public rushes out to spend its new-found wealth, prices will, very roughly, double — or at least rise until the demand is satisfied, and money no longer bids against itself for the existing goods.

An increase in the money supply, then, only dilutes the effectiveness of each gold ounce; on the other hand, a fall in the supply of money raises the power of each gold ounce to do its work. We come to the startling truth that it doesn’t matter what the supply of money is. Any supply will do as well as any other supply. The free market will simply adjust by changing the purchasing power, or effectiveness of the gold-unit. There is no need to tamper with the market in order to alter the money supply that it determines.
Aside from the errors regarding the amount of money and who is in control of creating money, the proposal is an excellent starting point for addressing many of the flaws inherent in the existing fatally-flawed fiat currency scheme.

Mike "Mish" Shedlock

Tuesday, March 31, 2015 8:01 PM

If It Ain't Broken, Don't Fix It: Religious Freedom Act Take II

Religious Freedom Act Take II

I received a number of emails in response to Indiana Legalizes Discrimination on Grounds of "Religious Freedom".

The bill, signed by Indiana Governor Mike Pence openly encourages discrimination based on sexual preference although Pence incredulously denies that claim. Pence now recognizes the need to "clarify" the legislation.

One of the better email responses came from reader Mark who wrote ...

The Constitution plainly states "Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof."

The Constitutional guarantee of religious freedom is sacrosanct. The only restrictions placed on religious freedom are those religious practices that harm others.

And I would say “Yes” if you wanted to post a “No Catholics” or “No Jews” sign on the front door of your business. I would also warn, in the same breath, that you may find your business surrounded by protestors and boycotted the very next day. That is the market forces at work. Even though I am neither a Catholic nor a Jew, I would not do business with someone that had that sign on their front door. That is my choice, too.

If It Ain't Broken, Don't Fix It

I replied ...

"Why was there a need then to pass any bill? Pence now says the bill needs to be 'clarified'. If the bill needs 'clarification' then something in it is wrong. At best, the law was political stupidity. At worst, the legislation provides explicit and open encouragement of discrimination."

By the way, the problem with allowing a sign "Blacks Not Welcome" or "Jews Not Welcome" would be the massive protests that would undoubtedly disrupt neighboring establishments, all of which whose business would suffer while the sign was up.

In fact, it is likely the entire neighborhood of an establishment posting such as sign would be torched, with considerable and perhaps permanent damage to the property owner.

For similar reasons, freedom of speech does not allow someone to yell "fire" in a movie theater.

Otherwise, Mark is totally on target with the constitutional idea.

Acting Man Chimes In

I bounced my response off Pater Tenebrarum, a confirmed Libertarian, to see what he thought. Pater replied ...
In principle, the libertarian stance would be that I can decide on my private property, and if my body, time, equipment, etc. are concerned, who I want to let on my premises, and whom I wish to serve in some commercial capacity, or talk to, or otherwise interact with.

So if the law means something like "if you (for whatever reason) dislike gays or any other group of people, you cannot be forced by law to e.g. act as a photographer at their wedding", then it would be consistent with libertarian views - since obviously government coercion would otherwise be involved (saying "no" to someone is not tantamount to coercion, but not being allowed to say so is).

I personally think religious zealots of this sort are detestable, but as you can see, most businesses are voicing their opposition to discriminating conduct and social pressure (boycotts etc.) is already exerted as well (which again is perfectly legitimate).

Thus, there should be no need for the state to intervene at all. Anyway, it seems rather selective if it is introduced solely on "religious grounds". Any other reason than religious conviction should be just as admissible. For instance, it should suffice if one is merely a racist or homophobic jerk. I really don't get why it requires a law.
Real Purpose of the Bill

Pater is precisely correct. There is no need for the state to act.

It follows that the only conceivable purpose of the law is to make it clear that discrimination against gays on "religious" grounds is perfectly acceptable.

Actually there was one other purpose: Pence kowtowed to the extreme right wing for political purposes. Fortunately it blew up in Pence's face.

Text of the Bill

Inquiring minds may wish to dive into the complete Text of Indiana's ‘Religious Freedom’ Law.

Differences Between Indiana and Federal Legislation

Many people emailed the bill is exactly the same as the federal Religious Freedom Restoration Act, passed in 1993 under Clinton.

They are wrong as explained in What Makes Indiana's Religious-Freedom Law Different?
The Indiana statute has two features the federal RFRA and most state RFRAs do not. First, the Indiana law explicitly allows any for-profit business to assert a right to “the free exercise of religion.”

The federal RFRA doesn’t contain such language, and neither does any of the state RFRAs except South Carolina’s; in fact, Louisiana and Pennsylvania, explicitly exclude for-profit businesses from the protection of their RFRAs.

The new Indiana statute also contains this odd language: “A person whose exercise of religion has been substantially burdened, or is likely to be substantially burdened, by a violation of this chapter may assert the violation or impending violation as a claim or defense in a judicial or administrative proceeding, regardless of whether the state or any other governmental entity is a party to the proceeding.” Neither the federal RFRA, nor 18 of the 19 state statutes cited by the Post, says anything like this; only the Texas RFRA, passed in 1999, contains similar language.

Second, the Indiana statute explicitly makes a business’s “free exercise” right a defense against a private lawsuit by another person, rather than simply against actions brought by government. Why does this matter? Well, there’s a lot of evidence that the new wave of “religious freedom” legislation was impelled, at least in part, by a panic over a New Mexico state-court decision, Elane Photography v. Willock. In that case, a same-sex couple sued a professional photography studio that refused to photograph the couple’s wedding. New Mexico law bars discrimination in “public accommodations” on the basis of sexual orientation. The studio said that New Mexico’s RFRA nonetheless barred the suit; but the state’s Supreme Court held that the RFRA did not apply “because the government is not a party.”
If It Ain't Broken, Don't Fix It Part II

Curiously, one has to wonder if the absurd ruling in New Mexico happened precisely because New Mexico had an RFRA law in the first place.

So how is Indiana supposed to fix the law?

Then again, If Indiana's Religious-Freedom Law Isn't Discriminatory, Why Change It?

Mike Pence Responds

In a Wall Street Journal Op-Ed called Ensuring Religious Freedom in Indiana, Governor Pence says "Our new law has been grossly misconstrued as a ‘license to discriminate.’ That isn’t true, and here’s why."
Last week I signed the Religious Freedom Restoration Act, known as RFRA, which ensures that Indiana law will respect religious freedom and apply the highest level of scrutiny to any state or local governmental action that infringes on people’s religious liberty. Unfortunately, the law has stirred a controversy and in recent days has been grossly misconstrued as a “license to discriminate.”

I want to make clear to Hoosiers and every American that despite what critics and many in the national media have asserted, the law is not a “license to discriminate,” either in Indiana or elsewhere. 

Some express concern that Indiana’s RFRA law would lead to discrimination, but RFRA only provides a mechanism to address claims, not a license for private parties to deny services. Even a claim involving private individuals under RFRA must show that one’s religious beliefs were “substantially burdened” and not in service to a broader government interest—which preventing discrimination certainly is. The government has the explicit power under the law to step in and defend such interests.
Pence's Pack of Lies

Pence's defense reads like a pack of lies.

Here is the amusing part "Even a claim involving private individuals under RFRA must show that one’s religious beliefs were 'substantially burdened' and not in service to a broader government interest—which preventing discrimination certainly is. The government has the explicit power under the law to step in and defend such interests," states Pence.

Good Grief!

According to Pence, the government has an "explicit power" to defend gays against private individuals, requiring the individuals to prove they were "substantially burdened, and not in service to a broader government interest," in service denials.


If that is really the intent of the law (of course it isn't), no Libertarian in his right mind could ever support such nonsense.

What the Legislation is Really About

Several readers emailed that I should read the comments to my first post on this subject.

I did, and I also read every email response as well. I have to say, the volume against me was probably 8-1. One reader got the message.

Reader Daniel replied ....
Hi Mish,

First I'd like to commend you for stating your fair and reasonable opinions about this matter!

Unfortunately it is not a big surprise that wherever there is a large concentration of conservative republicans you still get a whole lot of of bigots as clearly evident by the comments to your article.  Hopefully the future of the republican party will be different than what these guys represent.

I want to make a few points that I believe you share as well. If you do not, I would still like to read your response.

The problem with Mike Pence is not that he signed a bad law.  The problem is that he signed a law that will be used selectively against a specific group of people while other people will enjoy protections already enforced by the Federal government.

The religionists behind this law do not believe in freedom. They use libertarianism selectively when it's convenient to achieve their own version of theocracy which is the polar opposite of freedom.

By signing this law and having the Republican party associated with it, many fair minded individuals who would normally support republican and libertarian policies will no doubt decide to disassociate themselves from such a party.

Anyway, thank you for providing great articles which I read almost daily. 


Reader Daniel, like Pater Tenebrarum gets it. There was no reason for this law other than what I stated above.

  1. To make it clear that discrimination against gays on "religious" grounds is perfectly acceptable.
  2. To kowtow to the extreme right wing for political purposes

Reader Mark slightly missed the mark but nicely raised an important constitutional question. Many emails were hateful.

Right to Be an Ass

I fully support the right of everyone to be a complete ass. Take for example this Email from Damon who wrote ...

"I have read your blog for years but no longer will. I also will not recommend it to others. I support Indiana over the sodomites that are destroying this country. I support Indiana over people like you."

To that I responded "good riddance".

I have no tolerance for bigots, hate-mongers, fake patriots who wrap themselves in the flag, and anyone who pretends their religion is better than all the rest, even if that stance hurts my blog traffic.

That is a stand I make by choice. I do not say things for "political expediency" or to win "popularity points" for this blog.

Mike "Mish" Shedlock

2:07 PM

Downside Data Surprises in Canada; Bad Weather Up North? How About Recession?

The string of bad data reports not only applies to the US, economists up North appear to be no better at predicting the weather than US economists.

Variant Perception reports Downside Data Surprises Continue in Canada.

For the past 6 months, we have been alerting clients to the persistent decline in our Canada leading indicator. This is now showing up in numerous Canadian coincident data releases, with retail sales being the latest to miss expectations last Friday.  The economic surprise index is now declining sharply and there is little sign of immediate improvement ahead.

PMIs continue to fall whilst building permits and housing starts (some of the best leading indicators to watch), remain negative yoy (top chart). However one of our main themes this year has been that of cognitive dissonance, whereby growth disappoints, but higher excess liquidity supports asset prices.
Canada December Retail Sales

On February 20, the Huffington Post reported Canadian Retail Sales Post Biggest Drop Since April, 2010.
Retail sales in Canada in December posted their largest one-month drop since April 2010, as the cost to fill your gas tank plunged and holiday shoppers spent less.

Statistics Canada said Friday retail sales fell 2.0 per cent compared with November to $42.1 billion in December. That compared with a drop of 0.4 per cent that economists had expected, according to Thomson Reuters.

The drop in sales came as sales at gasoline stations fell 7.4 per cent in December due to lower gas prices, while sales at motor vehicle and parts dealers fell one per cent. Excluding motor vehicle and parts dealers, sales were down 2.3 per cent.

Despite the larger than-expected drop in sales, Bank of Montreal senior economist Benjamin Reitzes cautioned not to jump to conclusions based on the retail sales report. Reitzes noted the rise in popularity of Black Friday sales in Canada has pulled some holiday shopping into November.

Sales were down in nine of 11 subsectors, representing 71 per cent of retail trade.
Canada January Retail Sales

On March 20, the Statistics Canada Retail Trade, January 2015 report showed sales down for a second month.
Retail sales decreased for the second consecutive month in January, declining 1.7% to $41.4 billion. Sales were lower in 7 of 11 subsectors, representing 83% of retail trade.

Lower sales at gasoline stations represented the majority of the decline. Excluding sales at gasoline stations, retail sales were down 0.8%.

Retail Sales in Volume Terms Decreased 1.2%.

Gasoline Station Sales Down Seven Months in a Row

Sales at gasoline stations fell 8.8% in January, reflecting lower prices at the pump. This was the seventh straight monthly decrease and the largest monthly decline since November 2008.

Receipts at motor vehicle and parts dealers (-1.4%) decreased for the fourth consecutive month. The overall subsector decline was a result of weaker sales at new car dealers (-1.8%). Used car dealers (-0.9%) and other motor vehicle dealers (-0.5%) also registered declines. Sales at automotive parts, accessories and tire stores (+2.2%) advanced for the fourth time in five months.

Sales Down in Nine Provinces

Retail sales were down in nine provinces in January. Lower sales in Quebec, Ontario and Alberta accounted for most of the decrease.

Quebec (-2.4%) reported the largest decrease in dollar terms, with widespread declines across most store types.

The decline in Ontario (-1.4%) was mainly attributable to lower sales at gasoline stations.

Retail sales in Alberta (-2.8%) declined for the fourth consecutive month in January, reaching their lowest level since December 2013. The decline was largely a result of lower sales at gasoline stations and new car dealers.

Receipts in Nova Scotia fell to their lowest level since March 2013, decreasing for the sixth consecutive month.

Prince Edward Island (+0.5%) was the only province to register an increase in January.

Seasonally Adjusted Numbers

Economist's Theories on Gasoline

Hey wait a second. Didn't economists tell us consumers would take savings on gasoline and spend it elsewhere?

Yes they did. So there is only one possible explanation: Just as in the US, Canadian weather was much worse than economists initially thought.

GDP Decline in January

Please consider Canada's GDP Probably Down In January, CIBC Says After Disappointing Retail Data.
Canada’s economy likely shrank in January, CIBC said Friday following an unexpectedly negative reading on retail sales from Statistics Canada.

Retail sales fell 1.7 per cent in January, StatsCan reported, the second consecutive monthly decline. Analysts had been expecting a slowdown due to lower gas prices, but they weren’t expecting the broad-based declines that were actually seen: Seven of 11 retail sectors shrank in January, including autos, furniture and food and beverages.

Canada’s GDP for January “now looks set for a modest drop,” CIBC economist Andrew Grantham wrote in a client note.

Economists had been expecting that lower gas prices would mean Canadians would spend more on other things, but that doesn't seem to be happening.

"The latest figures suggest that households are becoming more cautious in their spending habits," Grantham wrote, adding he doesn't think Canada will meet the modest 1.5-per-cent growth rate that the Bank of Canada is predicting for the first quarter of the year.

Consumers are showing signs of exhaustion, with household debt levels reaching yet another record high in the last months of 2014, up to 163.3 per cent of disposable income.
Canada in Recession

Flashback, January 31, 2015: Canada in Recession, US Will Follow in 2015
On January 21 when the Canadian Central Bank unexpected slashed interest rates, I wrote Canadian Recession Coming Up.

Following the rate cut, the yield curve in Canada inverted out to three years. Inversion means near-term interest rates are higher than long-term rates.

I saw no other person mention the inversion at the time. An inverted yield curve generally portends recession.

Nine days later, the Canadian yield curve is still inverted. Let's compare what I posted about the curve on January 21 vs. January 30.

Canadian Yield Curve January 21

  • 30-year: 2.044% (Today's Low 1.998%)
  • 10-Year: 1.426% (Today's Low 1.366%)
  • 05-Year: 0.791% (Down 19 basis points, an 18% decline)
  • 03-Year: 0.590% (Down 27 basis points, a 31% decline)
  • 02-Year: 0.560% (Down 29 basis points, a 34% decline)
  • 01-Year: 0.580% (Down 34 basis points, a 37% decline)
  • 01-Month: 0.640% (Down 22 basis points, a 26% decline)

Canadian Yield Curve January 30

  • 30-year: 1.834% (Down 21.0 basis points)
  • 10-Year: 1.250% (Down 17.6 basis points)
  • 05-Year: 0.603% (Down 18.8 basis points)
  • 03-Year: 0.386% (Down 20.4 basis points)
  • 02-Year: 0.392% (Down 16.8 basis points)
  • 01-Year: 0.490% (Down 9.0 basis points)
  • 01-Month: 0.580% (Down 6.0 basis points)

Not only did yields plunge across the board since then, the yield curve is still inverted all the way out to three years.

Recession Has Arrived

There is no point in waiting for further data. The Canadian recession has already arrived.
Canadian Yield Curve March 31

  • 30-year: 1.99%
  • 10-Year: 1.37%
  • 05-Year: 0.78%
  • 03-Year: 0.51%
  • 02-Year: 0.51%
  • 01-Year: 0.58%
  • 03-Month: 0.56%
  • 01-Month: 0.53%

The Canadian yield curve is still inverted albeit very slightly. Instead of attempting to predict the weather, something that is very difficult for economists to do (even in arrears!), perhaps they should watch the yield curve.

Isn't that what they should be doing?

Weather Predicting US Style

For more on weather predicting in the US, please see Economists Fail to Predict Weather Once Again: Chicago PMI Disappoints.

Mike "Mish" Shedlock

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