What if we had the following economic system?

This system would shower the globe with free goods day and night, asking nothing and giving nearly everything. Most of what it generated would be free goods, and every living person would have access.

Anyone who amassed a private profit would do so only because he or she served others, and the system would require this person to cough up communally owned information: Everyone on the planet would know the reason for anyone’s success.

It would serve all races and classes this way. It would serve the common man slavishly and knock the elites when they become proud and arrogant. It would make it beneficial to everyone to include ever more people in its productive potential and give everyone who wants it a stake in the outcome.

That system has a name. It’s called the free market. This is more obvious in the digital age, but the proliferation of free goods has always been a major feature of capitalism. It’s just that people haven’t really talked about it, though Robert Murphy’s outstanding Lessons for the Young Economist does an excellent job.

In fact, the free market is the most misunderstood idea out there, by its detractors and, just as often, by its proponents as well. As for the characterization of the market as a utopia for profiteers, moguls and scamsters, one doubts that people who think this way have ever really tried to make a buck in a competitive system. It’s hard as heck. The whole process is seriously tilted against private gain at public expense.

Now, I could go on with a theoretical argument here, but sometimes personal examples get the point across better. To be sure, we do not live in a free market now; instead, the world’s largest and most intrusive apparatus of intervention interferes with ours. But there is enough of a market remaining in this world to clue us in to how it works, and sometimes the simplest retail example suffices.

So let me tell you about the barbershop I stumbled into yesterday. The people there cut hair. But they also have pingpong tables, darts, pool and free beer that you can drink at a bar.

I walked in with a friend and stood marveling at the pingpong table and asked: “Can we play?” They said, “Oh, sure.” So we played and played.

Finally, after a while, I asked, “Pardon me, but can I have a haircut?” They were pleased but surprised since they thought I was just another person who wanted to only play pingpong! They were perfectly happy to let me play for free.

The haircut happened; I hung around for a beer, continued to be dazzled by this extraordinary entrepreneurial venture and finally asked if they had a Facebook page. “Of course,” came the answer. I took a picture, posted it on my page, liked their page and, within minutes, people all over the world were talking about this little place. “Salon de barbier avec tables de pool et pingpong, dards et bière gratuite,” said one share in France that swirled around that network.

Now, consider this: Did I do the place a favor? The owners probably think so. It is a new business just starting out. It needs advertising and promotion. On the other hand, look what I did: I immediately alerted every other potential competitor to a great idea to get customers in the door. Now every barbershop in town can “steal” the idea. They can buy a pingpong table, grab a case of beer, put up a dartboard and off they go.

The barbershop would absolutely love to find a way to reach possible customers without also giving away its tricks to its competitors. But you know what? This is not possible. One comes with the other. Information is a free good; once it is released, it can be consumed and used by anyone who runs across it.

What then happens to the competitive advantage enjoyed by the new and struggling place? It is seriously threatened. It faces wicked competition, even from big chains that can implement these suggestions in a few days at very little cost. The thing that made the new place cool and great is now copied by everyone else. If this happens, the new place will face new pressure on its bottom line. It will be forced to innovate again.

To be sure, every other barbershop in town is unclear whether this pool-and-darts thing really is the magic bullet to achieve success. So rather than emulate that strategy right away, others might wait to see how it works for the first adopter. It might flop. Or it might be amazing. If it is amazing, others will adopt the practices, but there’s a problem: The first mover has the advantage. It already has a loyal clientele and a fan base.

Billions of bits of information (free goods!) hit business owners every day that allow them to copy the successes (and failures) of others. Knowing which to implement and which not to is an essential part of the job. It might even be the hardest part of the job.

But here’s the point I’m making: It is not possible to succeed in this market without giving away the “secret recipe” to success. Fortunately, there is no patent or copyright on things like putting a pool table in a barbershop, so the government can’t stop learning from taking place. And this is the way it would be in a pure free market in every industry. To succeed means first to give — giving goods and services to customers (this is the key to profitability) and then giving away the method by which you succeed (or the reason for your failure) to everyone in the world who cares. The very act of doing commercial enterprise — which always tends toward being an open-source undertaking — make your methods an object of study.

The information you give away is the price you pay for the prospect of profits. But those profits are always being threatened by competitors who emulate your successes. This means that you can never rest, you can never be satisfied with the status quo. You must innovate and revamp on an ongoing basis — and you have to do this with an eye to bringing the public what it wants in the most-efficient possible way. This is what gives the market such dynamism, such forward motion, such an innovative spirit.

Chances are that you are reading this article in a venue that is perfectly free to you. Maybe you saw it on a website you did not pay for or saw it linked on a social network that you do not pay to use. These are free goods, the means that capitalists use to entice your interest in what they are doing.

But these free goods are only the start of what the market offers. The most-valuable free good that that market is cranking out by the minute is the ocean of information about success and failure, about what people want and don’t want, about what works and what doesn’t work. This vast reserve of information is being poured out globally and constantly, and it is like a relentless shower of blessings on civilization. Digital networks have increased the blessing by degrees no one ever imagined possible.

The example of the barbershop might not seem like much, but if you understand it — really understand it, and the underlying dynamic it reveals — you understand the thing that has lifted the entire world out of the state of nature into the glorious prosperity that is currently spreading all over the world. This is the market at work — that network of exchange, cooperation, service, innovation, emulation and competition that makes the world tick, all in the service of human well-being. The more market we have, the more progress we will see.

So let’s ask the question: Why is it that so many people think they are against the free market? It must be because they don’t really understand it. I would first suggest Robert Murphy’s book. Then I would invite them to join me for a beer and a game of pingpong and ask what they think made this little slice of heaven possible?

Regards,

Jeffrey Tucker,
Executive editor, Laissez Faire Books

The Market That Really Matters was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The U.S. government holds it and reports it on their balance sheets. The International Monetary Fund, the European Central Bank, China, Germany, Russia, India — they all hold gold. Turkey bought about 41.3 tons of gold for official reserves in November. Goldman Sachs is expecting central banks to buy 600 tons this year. Look at the combined official holdings to date: 30,744 tons.

Why?

Contrary to public mythology, gold has no statutory role in the monetary system at all. The paper standard has ruled since 1973, though most people are still slow to figure that out. Sure, it is an asset but so are many things that governments and central banks own: computers, land, buildings, mortgage-back securities however toxic, and many other things. There is no special reason why gold should be reported, listed, touted, purchased in scary times, but not these other assets.

The truth is that gold does have a huge and continuing role to play. And it is more than purely psychological. It is deeply embedded in the history of money itself and in the development of the world economy as we know it. Governments destroyed the gold standard long ago but they know better than anyone that there is no surer means of financial security, proven over nearly all times and all places.

But here is an interesting question. What precisely are governments and central banks seeking to protect with their gold holdings and acquisitions? It is not you and me. It is about their system and their interests. As much as they love foisting the paper stuff on the population, risking even the destruction of the means by which we earn, save, and provide for ourselves, when it comes to government and central bank finance, gold serves serves them well. They deny it publicly but their actions speak more loudly than their press conferences.

This is one reason among a million that you can’t trust government to manage or even make the money that runs the economy. This should and could be the job of the private sector. The first time that I heard Murray Rothbard make this claim, I was amazed. Doesn’t everyone know that this is a primary function of government? But he was not only correct about this; fantastic research his book on this topic came out (What Has Government Done to Our Money?) has reinforced the point.

The leading historian of private coinage is George Selgin. His book Good Money is one of the most fascinating books on monetary history ever written. The country is England and the time is the Industrial Revolution. The official Mint was cranking out only large denomination coins suitable for old-world trade by large companies, but this was a time when the bourgeoisie was being born. Small manufacturers all over the country needed small denominations to pay their workers. They didn’t wait for the government to make the stuff. Button makers jumped at the chance to mint small denomination coins for factories to pay their workers.

What emerged from this event was a highly developed and extremely sophisticated system of private coinage at the very heart of England’s birth into the modern world. Selgin’s book tells the entire story in remarkable detail, and the publisher went all out with this book to provide a large section of beautiful color images of many of the private coins of the period, with even a comparison to the government’s unimaginative and often ugly coins. The free market picked up where government left off!

You can guess what happened. The result was the same as today when private traders have come up with digital currencies to compete with the government: the state shut them down. Don’t mint your own money; the government hates the competition! Selgin’s book covers the drama with energy and wit, revealing a slice of history that is hardly known by anyone.

Laissez-Faire Books is the only source for the hardbound version of this fascinating book, and there is a limited number still available. And this format is precisely what you want in a book of this importance: the format alone turns treatise to treasure. Never let anyone tell you that the private sector can’t be wholly in charge of the monetary system. Selgin has demonstrated otherwise.

This is the history but what about the future? In 1982, the Reagan administration pushed through a bill that created a U.S. Gold Commission to look into the question. It was the great missed opportunity, because — no surprise — the fix was in on what the commission would decide. Ron Paul and Lewis Lehrman were both on the committee, and they dissented from the majority opinion.

The dissenting opinion wasn’t just an opinion paper; it was a wonderful book on the past, present, and future of gold as a monetary unit. It ends with a detailed plan for restoring sound money and liberating us from the tyranny of paper. The book is out in a special edition of Laissez-Faire Books: The Case for Gold.

Can gold really be the money of the future? Nathan Lewis thinks so and he makes the case in Gold: The Once and Future Money. He points out that without a gold standard, with money that is sound and tied down to strict limits on production, the whole theoretical apparatus of government finance stops making any sense. What does it matter how much debt you run up if you can just print the money to pay for it? Perhaps this might have something to do with why government can’t seem to control its spending. And how can we even have a rational discussion of tax policy and its likely affect on revenue streams and the government deficit so long as any revenue shortfall can be made up for through the magical powers of the central bank?

The absence of gold, Lewis argues, has introduce irrationality and fiscal chaos into government finance. Nor has it served the population well. It is directly responsible for the creation of the boom and bust cycle — paper gives the central bank massive power to manipulate interest rates — as well as the relentless declines in the value of the dollar. The system has failed, he says, and if governments don’t repair the money, the private sector will respond, just as it did in the early years of the industrial revolution.

Growing economies are about change. Industries are born and industries die. Business come and go, and even seeming Goliaths are often slayed by start ups. The jobs we do change. The types of production that nations specialize in are constantly in motion. All this global enterprise changes the face of the earth every half century or so. Thanks goodness for change: without it, there would be no supporting the 7 billion people who inhabit this place.

There are very few things in this world that do not change, but one of them is the perception and reality that sound money is rooted in the gold standard. Powerful presidents could not kill it, though more than a dozen have tried. Elite economists have tried to wish its place in the world away but couldn’t do so. It is the ultimate immovable object in the world of economics. That gold as a monetary unit will outlive us all is one of history’s few sure bets.

Regards,

Jeffrey Tucker

The Monetary Metal That Won’t Die was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

This article explains the real story behind the commonly espoused explanations regarding the taming of China’s inflation. It also breaks down many of the peripheral issues on the topic that are regularly discussed in the press, and exposes the false theories associated with these issues.

Currencies and Prices

In explaining how a rising currency will help tame inflation, most pundits relay that revaluing a currency to a higher price will cause import prices to be cheaper, thereby lowering domestic prices. For example, Credit Agricole CIB economist Dariusz Kowalczyk stated:

“Policymakers have sent a clear message that currency appreciation will be used as a tool to counter imported inflation [due to near-record global prices for oil and other commodities].”

Similarly, Bloomberg News reported…

“Chinese officials may also seek to speed up gains in the currency, also known as the renminbi, to fight inflation, lowering the cost of imported U.S. goods such as Boeing Co. aircraft and Microsoft Corp. software.”

The truth is that there is no such thing as importing or exporting inflation, because each country or currency area has its own individual currency, which is separate from another region’s currency. Prices within a particular currency area can rise only when that particular currency is inflated. (A rare exception is when other currencies also circulate within the same currency area, and an increase in the quantity of the other currencies causes prices to rise in that currency. But even in this case, the depreciating currency will likely soon stop circulating, as it will be shunned for the stronger currency.)

But currency changes can indeed affect prices by way of changes in the supply of goods. A country whose currency is artificially undervalued — such as China — will artificially export more and import less. If the currency is allowed to rise toward the market exchange rate, it will begin to export less and import more.

All else being equal, a higher-priced currency will indeed result in a lowered price of imported goods. When imported goods cost less, consumers have more money to spend on domestic goods; purchasing power increases. Or if the amount saved from spending less on imports is spent on acquiring greater amounts of the imported goods, there will be less demand for domestic goods, causing domestic prices to be lower. In either case, what has lowered prices is a stronger currency.

The previous explanation applies only to cases where “all else remains equal.” But a currency that rises with all else remaining equal is one that was previously artificially weak, for the purpose of exporting as much as possible and is, thus, being revalued by the marketplace to its true market price. Otherwise, excluding short-term fluctuations, one currency moves against another because of changes in the relative supply of currency units, and corresponding changes in relative consumer prices between the two currency regions in question. Currency movements absent these fundamental changes are due to government manipulation of the currencies.

The flip side of the rise in the price and purchasing power of a currency is that goods in that currency are then more expensive in terms of foreign currencies, resulting in fewer goods exported. Exporting less is economically beneficial, as it leaves more goods remaining inside the country, increasing the supply and lowering the price of domestic goods.

Therefore, it would seem that higher-priced currencies are better, since they result in cheaper imports and lower domestic prices. But if the currency is too expensive and artificially overvalued, fewer goods are exported, causing less foreign exchange to enter the country. An artificially high currency will, eventually, cause the country to run out of foreign exchange. This, and goods too expensive from the view of other countries, will cause trade to cease, resulting in lower standards of living.

The essence of the trade-off is that a country can have a weak currency and increase exports so as to obtain more foreign currency, or it can have a strong currency and increase imports so as to obtain more goods.

So what is the optimal level of a currency’s price? Does a country want a stronger currency or a weaker one? Does it want more cash or more goods? The fact is that a country is not an “it.” A country consists of millions or tens of millions of individuals, each having different goals and different valuations. Government bureaucrats cannot set an ideal currency price that is optimal for everyone. Thus, the only optimal currency price is that which is set by all market participants jointly, by way of their supplying and demanding both goods and currency based on their needs and desires.

And in reality, the optimal currency price they, the market, will settle on will be the price that, adjusting for transportation costs, causes domestic prices of internationally traded goods to approximate the price of those same goods in other countries. In other words, they will make relative prices equilibrate across countries, just as individuals do within a country. Otherwise, arbitrage opportunities would exist, and the result would be a leveling of relative prices and real currency valuations. That optimal currency price will also result in the country exporting about the same amount as it imports; the balance of payments will tend toward zero. Trade surpluses and deficits derive from mispriced currencies arising from government manipulation.

The Real Relation Between China’s Rising Currency and Inflation

A manipulated currency can cause domestic prices to be artificially higher or lower than they would otherwise be, but it cannot cause prices to rise on a sustained basis; it cannot cause price inflation. Aside from rising prices due to a continual reduction of goods produced and existing in a country, the only thing that can cause price inflation is that country’s expansion of the money supply, which results in increases in demand. Aggregate prices rise only with reduced supply or increased (monetary) demand. Thus, contrary to the popular perception displayed in the quotes above, China’s re-pricing of its currency — alone — will not reduce price inflation.

[Ed note: Our currency expert, Abe Kaufman, weighs in with his insight on the Chinese/U.S. currency war discussion.

"We need China to keep buying our bonds, so politically, it's really risky to escalate the tensions. Still, the uncertainty regarding China -- whether we have a trade war or not -- will cause sentiment swings in the markets. Then add China's real problem…not the trade war, but whether China's economic slowdown will be controlled or severe. As fears ebb and flow, we could see the effects in several currencies, such as the Australian dollar, the Brazilian real and more.

"Luckily, all that volatility is the perfect environment for the sphere I operate inside -- a relatively new way to play currency moves easily and inexpensively.

"Unlike the mainstream currency markets, this new market gives you a chance to turn 2% moves in currencies into potential 150% gains in less than a week. And as China worries continue, we could continue seeing those kinds of gains again and again."

Check out Abe's most recent report here.]

What will reduce China’s price inflation is ceasing the activity that is holding its currency artificially low: money printing. As Figure 1 shows, it is doing just that.

In general, China can keep its exchange rate even with the dollar only by creating new money at as fast of a rate as the Federal Reserve creates dollars. In addition to the rate of creation of one currency versus another, the amount of currency actually on the market available for exchange makes a difference as well. In this respect, China reinvests the dollar reserves it obtains from its trade surplus — which come about from an artificially low yuan and an artificially high dollar — into U.S. Treasuries, instead of selling them in the foreign exchange market, so as to prevent the dollar from falling (and yuan rising) from the increased supply.

But additionally, in order to keep the yuan artificially lower against the dollar than it would otherwise be — given the market supply and demand for each currency — the Chinese central bank, the Peoples Bank of China (PBOC), actively buys dollars and sells yuan in the marketplace. It pays for the dollars by creating yuan with which to buy them.

When the PBOC creates yuan, it expands the money supply. It is, therefore, this expansion in the money supply, not an artificially low currency per se, that is creating price inflation in China.

Exchange Rate vs. Money Supply as the True Cause of Inflation

When one has knowledge of the true nature of China’s currency and inflation situation, it can be very frustrating to hear mainstream economists focus on the currency as a cause and solution for inflation, instead of focusing on the originating cause of money creation. Even the World Bank misstates the problem:

“‘Strengthening the exchange rate can help reduce inflationary pressures and rebalance the economy,’ the World Bank said in its latest quarterly update on the world’s third-largest economy.”

But to its credit, it also separately said:

“Inflation expectations can be contained by a tighter monetary policy stance and a stronger exchange rate.”

While the comment is still vague in terms of giving the real link between monetary policy and the exchange rate, it at least notes the monetary-policy issue.

Regards,

Kel Kelly

The China Bust: Tic Toc Part I was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The social and economic pathology of 19th century colonialism is well studied, but the monetary pathology of its successor, the neo-colonial reserve currency system of the dollar, is less transparent. In order to remedy this pathological defect, the United States must rid itself of its enormous Chinese financial colony, whose exports are subsidized by the undervalued yuan in return for Chinese financing of the U.S. twin deficits. Both China and the United States must also free themselves from the increasing malignancy of the dollar reserve currency system, the primary cause of inflation in both China and the United States.

In the end, only monetary reform, including an end to the reserve currency system, can permanently separate the dollar host from its yuan colony. Without monetary reform, the perverse effects of the dollar reserve currency system will surely metastasize into one financial and political crisis after another—even on the scale of the 2007–2009 crisis.

It is, of course, a counter intuitive fact that China has been financially colonized by the United States. But why is this a fact? Simply because China has chained itself to the world dollar standard at a pegged undervalued exchange rate, choosing therefore to hold the exchange value of its trade surplus—that is, its official national savings—in U.S. dollar securities. It is true that the dollar-yuan strategy of America’s Chinese colony has helped to finance a generation of extraordinary Chinese growth. But China now holds more than 3 trillion dollars of official reserves and more than a trillion dollars in U.S. government securities. These Chinese dollar reserves directly finance the deficits of the American colonial center. This arrangement clearly resembles the imperial system of the late 19th century. The value of a British colony’s reserves were often held in the currency of the imperial center, then invested in the London money market. Thus, the colony’s reserves were entirely dependent on the stability of the currency of the colonial center. While China is America’s largest financial colony, most other developing countries are also bound to neo-colonial status within the reserve currency hegemony of the dollarized world trading system.

China’s dollarized monetary system reminds us of nothing so much as the historic colonial financial arrangements imposed by the later British Empire on India before World War I—India actually remaining a financial colony of England long after its independence in 1947. How did the sterling financial empire work? The imperial colony of India, beginning in the late 19th century, held its official Indian currency reserves (savings) in British pounds deposited in the English money market; independent developed nations at that time, like France and Germany, held their reserves in gold. That is, France, Germany, and the United States settled their international payment imbalances in gold—a non-national, common, monetary standard—holding their official reserves, too, in gold. But the London-based reserves of colonial India were held not primarily in gold, but in British currency, helping to finance not only the imperial economic system, but also the imperial banking system, imperial debts, imperial wars, and British welfare programs. Eventually, as we know, both the debt-burdened British Empire and its official reserve currency system collapsed.

For more than a generation now, a similar process has been at work in China. China is America’s chief colonial appendage. The Chinese work hard and produce goods. Subsidized by an undervalued yuan, they export much of their surplus production to America. But, like the Indians who were paid in sterling, the exports of Chinese colonials are substantially paid in dollars, not yuan—because bilateral and world trade, and the world commodities market,

have been dollarized. And thus it may be said that the world financial system is today an unstable neocolonial appendage of the unstable dollar.

China, like its predecessor the British colony of India, has chosen to hold a significant fraction of what it is paid in the form of official dollar reserves (or savings). These dollars are promptly redeposited in the U.S. dollar market, where they are used to finance U.S. deficits. Every Thursday night, the Federal Reserve publishes its balance sheet, and there we now read that more than $2.5 trillion of U.S. government securities are held in custody for foreign monetary authorities, 40 percent of which is held for the account of America’s chief financial colony, Communist China. It is clear that without financial colonies to finance and sustain the immense U.S. balance of payments and budget deficits, the U.S. paper dollar standard and the growth of U.S. government spending would be unsustainable.

It is often overlooked that these enormous official dollar reserves held by China are a massive mortgage on the work and income of present and future American private citizens. This Chinese

mortgage on the American economy has grown rapidly since the suspension of dollar convertibility to gold in 1971. China—poor and undeveloped in 1971—was at that time very jealous of its sovereign independence, sufficiently so to reject its alliance with the Soviet Union—even earlier to attack U.S. armies on the Chinese border during the Korean War. In an

ironic twist of fate, China surrendered its former independence and, as a U.S. financial colony, joined the dollar-dominated world financial system. China’s monetary policy is anything but independent. It is determined primarily by the Federal Reserve Board in America, the pegged yuan-dollar exchange rate serving as the transmission mechanism of Fed-created excess dollars pouring into the Chinese economic system. Perennial U.S. balance of payments deficits

send the dollar flood not only into China but also into all emerging countries. The Chinese central bank buys up these excess dollars by issuing new yuan, thereby holding up the overvalued dollar, and holding down the undervalued yuan. Much of these Chinese official dollar purchases are then invested in U.S. government debt securities. So even though America exports excess dollars to China, China sends them back to finance the U.S. budget deficit—much like marionettes walking off one side of the stage, merely to reappear unchanged on the other side.

This is the little-understood arbitrage mechanism of the pegged exchange rate system by which Fed-created excess dollars are bought and held as reserves by the Chinese central bank, in exchange for which newly created yuan are issued, thereby supercharging inflation in China. The Chinese dollar reserves, which are reinvested in the United States, help to ignite inflation in the United States. It is clear that the workings of the official dollar reserve currency system cause purchasing power to be multiplied, or at least doubled, in both countries. But these central bank issues of new money are unassociated with the production of new goods and services during the same market period. Thus total spending, or purchasing power, exceeds the total value of goods and services at prevailing prices. When total demand exceeds total supply, the price level must rise.

But just as the subservient, colonial Indians were constrained not to sell their sterling reserves too quickly, so the Chinese are constrained—by politics, diplomacy, and self-interest—not to dump their depreciating American dollars. The Indians had to consult their imperial bankers, even though the English were debtors to their Indian colony, because the Indians did not wish to anger the colonial center, nor to precipitate a sterling crisis. From time immemorial, creditors with too large a stake in an over-sized debtor often beg leave of their debtor to get their money back.

China is frustrated by circumstances similar to those of a colony of imperial Britain. Hostility has arisen in the debtor—the United States. Fear of setting off a dollar slide haunts the hostile creditor, China. The difficulty of finding a suitable portfolio of alternatives for a trillion dollars in U.S. government debt annoys the outspoken Chinese financial colony, as it calls for a new world monetary system. But there seems to be no genuine alternative to the very liquid dollar market. De facto illiquidity of official Chinese dollar reserves is enforced by political sensitivities, not by market salability. The debtor, as the saying goes, is “too big to fail.” Thus arises an unstable stalemate, a yuan-dollar pegged exchange rate regime constantly on the edge of a crisis.

The “exorbitant privilege” of the dollar is matched by the insupportable burden of America’s overvalued reserve currency role, which has tended to deindustrialize the colonizer, gradually increasing social inequality by reducing the standard of living of lower- and middle-income American families. The reserve currency country then feels compelled, as the Fed does today, to depreciate the dollar in the vain hope of eliminating the trade deficit and the balance of payments deficit—by becoming more competitive abroad as it becomes poorer at home.

The perversity of the official reserve currency system is endless as China now endures high inflation engendered by its colonial status in the world dollar system.

The floating, pegged exchange rate system based on the dollar has been slowly decaying since the end of World War II. But the dollar-based reserve currency system, because of the unmatched scale and liquidity of the dollar markets, could last another generation. When it will collapse cannot be predicted. That it will collapse, without systemic reform, I think inevitable. Few predicted the timing of the collapse of the pegged dollar system of Bretton Woods. But it did collapse in August of 1971, followed by America’s worst decade since the Great Depression.

Ultimately America, the leader of the unstable world financial system, must choose bet ween two options.

1. The United States can wait for the eventual demise of the world dollar standard under chaotic

conditions, similar to the final sterling collapse and the subsequent collapse of Bretton Woods in 1971. This option is analogous to the intrepid daredevil who leaps from his 10th floor window, secure in the fact that he is still unhurt two floors from the street level.

2. Or, America could take the lead in reforming the official reserve currency system based on the dollar. Such a monetary reform program would entail a careful windup, by agreement, of the world dollar standard. At the same time America would reestablish by statute a dollar convertible to gold, i.e., a dollar defined in law as a weight unit of gold. Gold would replace the dollar as the world’s reserve currency.

The reform would, first and foremost, establish a tested, non-national, neutral monetary standard as the basis of a stable dollar—one which reasonable sovereign trading partners could accept. Gold would become the international settlements currency and thus would replace the dollar as the basis of world trade and finance. Inasmuch as monetary history shows that no unstable national currency can permanently serve as the crucial world reserve currency, it follows that neither can an unstable basket of national currencies, nor can a fiction such as the SDR—the reserve asset created by the International Monetary Fund to supplement member countries’reserves.

But we are left with the question: what does the evidence of American history suggest as the basis for a stable dollar?

The stability of the U.S. dollar has varied widely in its history. This variation is explained by two factors: the monetary standard chosen for the dollar, and whether other countries have simultaneously used cash and securities payable in dollars as their own reserves, even as their monetary standard itself (i.e., official reserve currencies in place of gold).

The United States has alternated between two kinds of standard money: inconvertible paper money and some precious metal (first silver, then gold). The dollar was an inconvertible paper money during and after the Revolutionary War (1776–92), the War of 1812 (1812–17), the Civil War and Reconstruction (1862–79), and again from 1971 to present. The dollar was effectively defined as a weight of silver (and gold) in 1792–1812 and 1817–34, and as a weight of gold in 1834–61 and 1879–1971. The minted gold eagle, set equal to 10 dollars, and subsidiaries thereof, was provided for in the Coinage Act of 1792. The dollar was not used by foreign monetary authorities as an official monetary reserve asset before 1913, but the dollar has been an official “reserve currency” for many countries since World War I (along with the pound sterling). The dollar has been the primary official reserve currency for most countries since 1944.

Applying two criteria divides the monetary history of the United States into distinct phases. We

can compare the stability of these monetary regimes by examining the variation in the Consumer Price Index (as reconstructed back to 1800) by two simple measures: long-term CPI stability (measured by the annual average change from beginning to end of the period of each monetary standard) and short-term CPI volatility (measured by the standard deviation of annual CPI changes during the period).

Weighting these criteria equally, the classical gold standard from 1879–1914 was the most stable of all U.S. monetary regimes (as the table shows).

After the failures of several generations of unhinged paper currencies, pegged and floating exchange rates, America should embrace a stable monetary system tested in the laboratory of human history—the cornerstone of which the elites have rejected for a century. It is now time to restore that cornerstone—the true gold standard, shorn of the economic pathology of official reserve currencies. Now is the time to restore the American monetary standard authorized by the Founders in the Constitution—Article I, Sections 8 and 10. Now is the historical moment for America to take the lead and again give the world a real money, the Founders’ gold dollar of the Coinage Act of 1792. What the Founders learned from the paper money inflation of the Revolution, the recent past has taught us again. America and the world need a monetary standard which, unlike the paper-credit dollar, cannot be created at zero marginal cost with which to dispossess the  prudent and to subsidize the U.S. government and insolvent financial institutions at near zero interest rates.

For America to establish the gold standard would provide the least imperfect monetary solution to the problems of a century of financial disorder—engendered over and over by central bank-manipulated paper money, official reserve currencies, and floating pegged exchange rates. Only a stable dollar, a dollar defined by statute as a weight unit of gold, can pin down the long-term price level, restoring the incentive to save and ruling out extreme inflation and deflation. Such a dollar convertible to gold would reopen the road to confidence in the long-term value of the U.S. monetary standard. This is the durable road to economic growth and prosperity—financed by increased long-term savings, increased long-term investment, and rising demand for labor at rising real wages.

China: American Financial Colony or Mercantilist Predator? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

To begin with, the U.S. Government now employs cash-sniffing dogs at most international airports. If you are carrying more than $10,000 in cash and don’t declare it to the Government when coming in or out of the U.S., your cash will be seized.

According to a blatant propaganda “newscast,” $3.2 million has been seized at Logan Airport in Boston in the last year.

Some government apologists might say, “If you aren’t doing anything wrong, why wouldn’t you mind being x-rayed, sniffed, patted down, detained and questioned?”

Besides the obvious absurdity of that question, the main reason this is of concern is because in every case in history when a government has inflated its currency into worthlessness they always institute capital controls. Just ask anyone from Argentina or Italy. And it won’t take much to change the rules from having to “declare” $10,000 to “not being allowed” to take $10,000 out of the country.

Not to mention that if you do declare you are taking $10,000 out of the country, who knows what kind of database you will end up on. You are obviously highly suspicious if you have more than a few hundred bucks! Only Wall Street bankers and others associated with the Government are supposed to have more than a couple dollars! The most ludicrous example of the War on Money came across the newswire today, “Feds Seek $7 million in Privately Made Liberty Dollars.”

The news story is only about 10 paragraphs long yet it has dozens of logical absurdities. Even in the Headline is one.

According to the headline, part of the reason they want to seize these dollars is because they are “privately made”? Yes, we wouldn’t want to compete with the private Federal Reserve banking cartel!

And I know the Constitution is passé in the US, nowadays, but how in the world can this man be in trouble for making silver coins? The constitution states:

No state shall enter into any treaty, alliance, or confederation; grant letters of marque and reprisal; coin money; emit bills of credit; make anything but gold and silver coin a tender in payment of debts.

He is in trouble because he is making currency out of gold or silver yet, the Federal Reserve, another private organization, is not doing anything wrong by making paper currency NOT backed by gold and silver coin?

Apparently, the thing they “got him on” was the following:

Federal prosecutors successfully argued that von NotHaus was, in fact, trying to pass off the silver coins as U.S. currency. Coming in denominations of 5, 10, 20, and 50, the Liberty Dollars also featured a dollar sign, the word “dollar” and the motto “Trust in God,” similar to the “In God We Trust” that appears on U.S. coins.

Ignoring the fact that the dollar sign was originally used for Spanish and Mexican pesos and was stolen by the U.S. to use for its dollars and the fact that the word dollar actually comes from the word thaler which was a silver coin minted in Bohemia, according to the Feds, he was trying to pass off coins, made of silver, worth more than $35/ounce, as quarters, which are now made from 92% copper and 8% nickel, and worth $0.06 in metal value.

Boy, that’s quite the racket! Passing off highly valuable silver to people who were expecting to receive near-worthless copper and nickel tokens! It’s a good thing they stopped him before it was too late!

Anne Tompkins, the U.S. Attorney who was put on this important case, stated:

“Attempts to undermine the legitimate currency of this country are simply a unique form of domestic terrorism.”

Anne, if attempting to undermine the currency of the US is a form of terrorism, why has Ben Bernanke not been tracked down and sent off to the Guantanamo concentration camp?

This “news” story finished by quoting an unbiased source: a group named the Southern Poverty Law Center, a group that tracks political extremism which has apparently been tracking Bernard Von NotHaus, the proprietor of the silver coin making terror enterprise. According to the story, long before the government began its investigation into von NotHaus, the group was raising concerns about the popularity of Liberty Dollars among fringe groups on the far right.

“He’s playing on a core idea of the radical right, that evil bankers in the Federal Reserve are ripping you off by controlling the money supply,” said Mark Potok, spokesman for the group. “He very much exists in the world of the anti-government patriot movement, whatever he may say. That’s who his customers are.”

The U.S. has started another war. The war on money. Anyone with any amount of cash more than will buy them a couple NFL tickets, beers and enough to pay for parking is suspect. And if you are one of those deluded people who think the Federal Reserve is evil and is ripping you off and you buy gold or silver to protect yourself, you are a domestic terrorist.

It’s going to be a fun few years ahead in the U.S. If you live there and haven’t defected yet, time is running out. If you choose to stay or are unable to leave, I wish you luck!

Regards,
Jeff Berwick
The Dollar Vigilante
Whiskey & Gunpowder

April 11, 2011

Currency Controls and the War on Money was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

In 1933 President Franklin Delano Roosevelt signed Executive Order 6102, which made it illegal for U.S. citizens to hold gold bullion.

Prior to that, the $20 bill was essentially a warehouse receipt for a one-ounce gold coin. Prior to the Federal Reserve Act of 1914, the $20 bill actually told you this.

After Executive Order 6102, $20 notes weren’t allowed to be exchanged for gold anymore. Americans couldn’t legally own or trade gold as money and savings, only as jewelry or collectible coins.

A year after making monetary gold ownership illegal, FDR revalued gold from $20.67 per ounce to $35 an ounce with the Gold Reserve Act. The Act also required all gold and gold certificates to be turned over to the Treasury.

The dollar was debased. A chunk of the gold it used to be good for was legally removed. Instead of  “containing” 1/20 an ounce of gold, each dollar now only contained (or represented) 1/35 an ounce. And of course you couldn’t actually own the gold itself.

In 1971 Nixon severed the last official ties between gold and the dollar. The dollar quickly sunk to its real value, which had been debased by years of money supply inflation.

By 1975 Americans were allowed to own bullion gold again, but during the roughly 40 years bullion gold ownership had been illegal, the dollar had been drastically debased. At its former lowest point in the summer of 1980, the dollar was worth only 1/850 an ounce of gold. It regained some value for a while, but for the past couple of years a dollar would only get you less than 1/1000 an ounce of gold (right now it gets you less than 1/1300 an ounce).

That was the story with a piece of paper that was merely standing in for a monetary metal. But what happens in the case of circulating coins actually composed of monetary metals?

Let’s look at quarters, dimes, nickels and pennies…

• Prior to 1964, U.S. quarters and dimes were 90% silver. From 1965 to 1970 half dollars were 40% silver “clad” over a copper-nickel or “cupronickel” mix. Now quarters and dimes and half dollars have no silver in them at all. They are now entirely copper and nickel, but only enough to get a little more than 1/4 their face value.

• Prior to 1983, U.S. pennies were 95% copper and 5% zinc. In 1982 we started getting pennies made of 97.5% zinc with only 2.5% copper plating. Since 1983 every new penny has had this composition.

• The U.S. nickel has been cupronickel since 1946: 75% copper and 25% nickel with trace amounts of manganese. But that’s probably about to change…

Why are quarters and dimes no longer silver? Why is the penny no longer mostly copper? And why will the nickel likely follow suit fairly soon?

Because the amount of silver and copper and nickel in each case came to exceed the face value of the coin. The debasement of the U.S. currency over time has required the metal in the coins to be replaced with a cheaper substitute.

The average American has no idea what inflation really is or why currency debasement is a problem at all. He figures one metal is as good as another in minting of the currency…that when the face value of a coin falls below the value of the metal in the coin, it’s nothing more than a curiosity. Substitute a cheaper metal, they think. Problem solved.

And indeed the problem is solved for the government, which mints the coins made of real money at a loss after the effects of bouts of the inflation started by monetization of government debt. Savers and the overall economy on the other hand…their problems are just beginning…

But that is a story for another time. For now let’s look at the opportunities to be had when the government makes metals available for a fraction of their market price via coins…And let’s see if there are any opportunities left (Hint: there are!).

If you had seen the writing on the wall in the early 1960’s and started hoarding quarters and dimes while they still were almost wholly silver, you would have found that your dimes were worth a high of $3.57 each. Your quarters would have been worth $8.93 each.

In fact, these 90% coins still trade just like regular silver bullion bars and rounds. They were taken out of circulation — “hoarded” — by those savvy to debasement (Gresham’s Law tells us that good money will be hoarded when bad money floods the market). These coins were collected without any transaction costs. They were bagged up with different face value totals: $1,000 bags, $500 bags, $250 bags, $100 bags and $50 bags. These bags now sell with a transaction cost.

Each of these bags traded for over 35 times their face value because of the silver in the coins. At least they did at silver’s peak in 1980. Even after the peak and during the ensuing 20-year slump they were selling for more than three times face value.

Now thanks to waves of money and credit expansion from the Federal Reserve, silver (and gold) is pushing back toward its old highs. These bags of so-called “junk” silver are trading at more than 20 times their face value. They may hit 30 times face value again…and beyond…

Between 2000 and 2006 I was a big believer in silver as an investment (I still am). I begged all my loved ones to sell their (overpriced because of credit expansion) homes, pay off their credit cards and shove the rest of the money into silver.

No one listened. Here are a couple of graphs that makes them wish they had.

The red vertical lines in both graphs represent the start of 2006.

If you had sold your house at the very peak of the housing bubble in 2006…just before silver took off…you could now sell your silver and buy back your house…plus five more houses like it.

And there’s a lot more potential for that trade to get even better.

Silver shot up about fourfold, while real estate plummeted by a quarter or a third. That’s “so far.” Silver’s price could multiply again — even if does dip in the interim — while housing could drop even more.

Even if you didn’t catch the peak, but just saw the writing on the wall in 2000-2005, you’d still have done pretty well by selling your home and buying silver. You wouldn’t have gotten quite as much for your house, but you would have gotten silver at around $4 instead of $9.

Silver probably has another trick or two up its sleeve. It probably has a lot more upside than gold. It will probably play catch up till the silver/gold price ratio gets larger. Who knows?

Look at the other coin that was debased: the lowly penny…

Prior to 1984, the penny was almost all copper. Now those old pennies have been driven out of circulation and hoarded (Gresham’s Law strikes again). And they’re worth just under three times their face value: Almost three cents for the old one-cent piece.

Copper hasn’t had quite the success that silver has. Non-debased silver coinage has been worth 35 times face value and is currently worth 20 times face value and climbing. Copper coins’ triple-bagger over nearly thirty years doesn’t seem nearly as impressive. That’s because it’s not. But it is telling.

The thing is, silver now has transaction costs. Whether you buy bars, rounds or pre-debasement coins, you have to pay a middleman. You have to pay shipping if you get it online.

Meanwhile, copper pennies are still floating around, but hard to find. It’s really not worth the effort to gather underpriced copper this way.

But nickels? That’s a different story. Every single circulating nickel still has 3.75 grams worth of copper each…along with 1.25 grams of nickel. The silver dimes and quarters and the copper pennies are gone, but the copper-nickel or cupronickel nickel is still the only kind of nickel there is. For now…

What if you could have simply been there to start collecting silver quarters and dimes when they were actually circulating? You’d just have had to walk up to your bank and withdraw your money as quarters and dimes. This would have worked up to 1963. After that you’d have to sort through your quarters and dimes to make sure you didn’t have one of the new, non-silver ones.

The best opportunity with silver coins has long passed. But there is still a similar opportunity with silver’s humble cousin, the cupronickel five-cent coin.

Buy Two, Get One Free

Copper is currently about $4.60/lb. Nickel is currently about $13.00/lb

120 five-cent pieces is $6.00. Those 120 coins contain a pound of copper and 1/3 pound of nickel. That’s about $8.93.

If you deposit $6 in any bank in the nation, then withdraw your money as nickels, you get almost $9 worth of metal. That’s an immediate 50% return. That’s like paying for two thing and getting three.

You can’t legally cash in on it now (anti-smelting laws for pennies and nickels were introduced in late 2006). But the bullion market for cupronickel coins will develop, just as it did for silver U.S. coins. This will happen once the government starts minting five-cent pieces made out of cheaper metals.

To those who doubt this will happen, I refer you to the bags of silver coins trading as bullion for over 20 times their face value. You can easily order such a bag right now by going to any of a number of online bullion dealers. These bags of coins sell right alongside silver bars and rounds.

Right now, the government is subsidizing your copper and nickel purchases…and cutting out the middleman. As much as we complain about government, we ought to stop and offer them a little thanks for this.

The debasement of the U.S. nickel is looking very likely. Right now you have another opportunity to do what the silver coin hoarders did back in the early 1960’s.

Hoarding nickels right now gives you an immediate benefit. You get between $0.07 and $0.08 of copper and nickel for a mere $0.05. Thanks to Uncle Sam. But your good uncle won’t subsidize this forever. He can’t afford it.

What’s even more is that there is a hedge against deflation risk that you just don’t get with bullion. You see this discounted metal is minted. It will always have a nominal value of what’s stamped on it by its issuer.

So if the dollar strengthens and copper, silver, and gold all get cheaper in dollar terms, you can still spend your nickels just like any other money. Your purchasing power stays the same, maybe even increases.

But if the dollar declines, then the value of the cupronickel in the currency will rise against the face value. Eventually — at two or three times face value — these five-cent pieces will trade as bullion just as 90% silver quarters and dimes did and still do.

Again, there is currently no transaction cost to saving in nickels and no risk from plummeting metal prices. There is literally nothing (in case of deflation) to lose and everything (in case of inflation) to gain.

Your only real problem is storage; a few thousand dollars of nickels takes up a lot of space…and it’s heavy. But people had the same problem with silver when it was cheap. I doubt they’re complaining now.

Having “too much” cupronickel won’t seem like much of a problem if inflation continues to drive the cupronickel in five-cent pieces far in excess of face value.

At worse the dollar strengthens and you’ve just saved money whose purchasing power has increased. That is not a bad worse case scenario at all.

The cupronickel is the last bit of honest U.S. currency there is. Right now it’s dying slow, like the others did. But things could speed up quick.

The cupronickel could surprise us all. Gold and silver are having their day. Maybe eventually cupronickel will, too. What cannot be dismissed is the current discount on the stuff (thanks, Uncle Sam) and the extremely limited downside.

Regards,
Gary Gibson
Managing Editor, Whiskey & Gunpowder

February 16, 2011

Gold, Silver, Copper, Nickel and the Slow Death of Money was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

But we had serious and complicated legal, financial and economic discussions. Fiat currency, fractional reserve banking and derivatives have completely broken the pricing mechanism. A tiny volcano burps and entire transportation systems grind to a halt. We addressed tough questions about survivalism in the suburbs. And then focus turned to the timing of the evaporation of the FRN$.

Euro Gold

But the FRN$ is below the Euro in the liquidity pyramid. The FRN$ has deeper capital pools, more economic underpinning, greater liquidity, a stronger economic union and more thoroughly self-deceived owners of colored coupons and imaginary digits. Therefore, the Euro will evaporate before the FRN$. And that is precisely what is happening.

Fiat currencies represent the common stocks of nations, or in the Euro’s case the common stock of a weak coalition of nations. Since gold is the numaire par excellence then lets take a view at the Euro zone’s stock through that lens.

A few weeks ago when I was around Doug Casey he remarked that the Euro will be gone in about five years. As the above chart shows, the Euro has lost about 75% of its value in the last 10 years. Mr. Casey may be slightly optimistic about this particular intrinsically worthless colored coupon that represents the common stock of that monetary union.

Euro Zone

So what has happened in the Euro zone as its common stock has been evaporating? Government budgets have exploded, economic output has slowed, individuals are rioting and causing material amounts of damage, governments are being toppled and armed forces, despite being prohibited by the law that they ultimately enforce, are striking.

For example, on 26 April 2010 King Albert II of Belgium accepted Prime Minister Yve Leterme’s colation government’s resignation after futile blathering to resuscitate the government dissipated. This highlights one of the common themes in Europe as Belgium is a prototype of cultural differences with French and Dutch speaking communities disputing while the government debt as a percentage of GDP is over 100%. These giant parasitical vampire squids cannot be supported by the underlying  livestock base. But a friendly tip, if you are in Bruges be sure to get a waffle as they are delectable.

Another fun example, also on 26 April 2010, hundreds of Greek air force pilots called in sick. Sure, these armed services members are not legally allowed to strike but such civil disobedience happens when members of the enforcer and brutalizing class do not get their paychecks or those paychecks are reduced due to ‘austerity measures’.

Sure, Greek Finance Minister George Papaconstantinou incoherently babbles about cutting the budget deficit through structural reforms instead of salaries but the truth of the matter is that government, like the vampires in Daybreakers, would rather suck the humans dry and then die than curb their appetite and coexist. It is economic law, not voluntary restraint by the vampire squids, through undulating waves of mass psychology that forces limited government.

Despite what Merkel and Germany do the die is already cast with regards to the Euro and Euro zone. Interest rates must go up and the market is already forcing this with rises in debt default insurance rates. Additionally, the European banking system is still in terrible condition. On 23 April 2010 Moody’s lowered National Bank of Greece’s credit rating one grade to A3/A. Other Greek banks will likely be downgraded such as Emporiki, Agrotiki Bank, Piraeaus Bank, Eurobank, and Alpha Bank. Plus, Belgium banks need to be cleansed along with plenty of other banks throughout Europe from England to Austria and France to Norway.

The Euro Is Broken

The Euro is broken. This was its destiny. This is the destiny of all fiat currencies. These bureau-rats cannot stop this anymore than Cnut the Great could command the tide to halt. If these impotent bureau-rats are so powerful then why did they fail to pass legislation commanding the ash cloud to disperse?

So what will a post Euro Europe look like? Hopefully, the Europeans do not go back to doing what they have been doing for thousands of years. But those are some of the ominous clouds on the horizon.

Conclusion

Gold has hit record highs around €860. The Euro is the only possible fiat contender as the world reserve currency and for rational investors it fails muster. Like the Euro the FRN$ is destined to evaporate but this will likely happen later and over a longer period of time.

As the political situation continues deteriorating in Europe holders of capital will continue turning towards the precious metals to protect and preserve their wealth. Europe has a rich culture, delicious foods and fine art. Hopefully I will be enjoying it next month and at a lower cost because of the evaporating Euro.

But Europe also has a savage past that only the vampire squids desire to see again. After all, luring countries to increase their debt load while destroying the production and productive capacity is bad for everyone but the sociopathic bankers. And I should be gone before that happens.

Regards,
Trace Mayer
RunToGold.com
Whiskey & Gunpowder

April 27, 2010

Euro Gold and the Euro Zone was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Since I have no desire to go to China, I am thankful for my contacts who do! (To paraphrase Chris Farley from the movie Tommy Boy, you can stick your head up the backside of a cow to see a good steak, but why not just take the butcher’s word for it?)

The nice thing about currencies is that the categories of information and the pricing structures vary little around the globe. For instance, if you were looking to add a retail stock to your portfolio, the numbers you’d look for in an American company may not be the numbers you’d think important in China.

Instead, the numbers that we care about when looking at currencies are bigger and easier to compare.  Is an economy expanding or contracting? More importantly, why is it doing so? Is it expanding because of government stimulus? What is the ratio of new stimulus to new growth? What likelihood is there that growth will continue if stimulus is removed? Is the stimulus about to be removed? Are rates falling or rising? What is the government policy toward the currency? How about debt ratios to GDP?

All of these are important considerations in the forecast of a currency. And we will consider some of them today in relation to China.

Now let me begin by saying that like with all good stories, China has two sides, a boom side and a bust side. There are those who are bullish on China, and those who are bearish. If I do a good job today, you’ll have a decent idea of the arguments from both sides.

Let’s begin with the headline figures.

China’s most recent numbers for growth as measured by GDP and posted by Trading Economics come in at 10.7%. But we also know that China’s growth has been based upon sizeable stimulus  — $586 billion at last count. It’s pretty remarkable, even if it comes nowhere close to U.S. stimulus spending. We spent 25% more in our first round of stimulus alone, and as much as $1.5 trillion (in various forms) altogether.

As a ratio to population, that makes the U.S. stimulus 10 times the size of the Chinese stimulus. So why aren’t we seeing 10% growth rates like the Chinese? Actually, if we’re spending 10 times per capita as much, why aren’t we seeing 100% growth rates? Seems like a straightforward equation, doesn’t it? It would be, if it weren’t for other “mitigating” factors. (Perhaps the most outstanding is debt, but more on that another time.)

China’s interest rate is 5.31%. Its inflation rate, 2.7%. Jobless rate, 4.3%. All told, some very nice numbers. But let’s continue: exports are reportedly up 45%; imports of crude oil nearly 60%. (Although, please bear in mind, China is no more free of number manipulation than any other country. And in this recession, we’ve learned a lot about number manipulation…)

So let’s summarize. China’s interest rate, while not as low as the rest of the world, is still low by recent standards. There was a time, only 20 years ago, that rates under 8% were considered absolutely bullish for equities. (Seems hard to imagine now.) So at just over 5%, that’s not too bad. Official inflation is not yet out of control… still below the 3% level, and most folks in the United States (especially the administration) would be doing cartwheels in the street for a jobless rate below 5%.

And yet all is not well.

ECONOMIC SHANGRI-LA: TOO GOOD TO BE TRUE?

The problem is, China has a bubble, which is inflating even as we speak, although the government is trying very hard to keep a lid on it. The bubble is similar to what ours was… real estate and housing.

Across much of the country, housing prices rose 10% last year. But in the special economic zone of Hainan (largely comprised of an island off the southeast corner of the mainland), house prices rose 50%! The geography and designation of Hainan is important. It is the largest of the special economic zones, where free enterprise is blossoming. But a 50% rise in housing prices is not “under control” by any definition. If houses are skyrocketing in the prosperous zones, it’s evident that the People’s Bank of China has no more clue on controlling price inflation than the Fed does. Also, how much more difficult does it become to translate the positive economic changes of Hainan to other less fortunate parts of the country without creating the same problems?

Also consider what has really been taking place. The Chinese government hasn’t really had to face how to export these changes to poorer, rural areas, since many of the peasants have flooded into the cities in search of the new jobs. After 1,000 years as an agrarian society, the country estimates it will be majority urban in just five years.

SAVING VERSUS SPENDING: WHAT WOULD YOU DO?

The Western media continues to perpetuate a popular myth — the myth of the Chinese consumer. In the United States and Europe, the average savings rate is very low. One reason is because the American and European consumer doesn’t need to save. If something happens to his job, he doesn’t need a rainy day fund. He has a myriad of social programs that he will eventually qualify for.

So while I personally have no desire to live in a country with a welfare “safety net,” one of the upsides is this: When the bureaucracy fumbles the ball and drops the economy on its ear, the unemployed just collect their benefits… and maybe eventually food stamps or heating assistance or whatever the government may dole out.

But up until relatively recently, China was not the same. You lost your job, you lost your income. Period. The government didn’t provide unemployment insurance. There weren’t any food stamps. Bills come in you can’t pay? Too bad. You lost your house. You went hungry.

Even now things aren’t much improved. The welfare that exists is inefficient and rife with corruption. So the Chinese are more inclined to put some money away for a rainy day instead of spending.

Here in the West, our GDP is 70% direct consumerism. In China, it is only 30%.

But do you think it is likely that the Chinese will undo generations of spending and saving habits overnight? No way. The American consumer is paying off the debt form his “big party”… I guess his European counterpart is as well. We will not continue to buy exports. And for the reasons just stipulated, the Chinese won’t be picking up their own slack domestically either.

THE ACE UP THEIR SLEEVE

All that being said, China is still able to fund more stimulus if it should so desire. But as King Solomon asked, “Can a man take fire into his bosom and not be burned?”

In other words, while China may be able to keep the illusion of growth going for some time yet, it has bought into the same failed model of Keynesianism that the West has used. It is already combating bubbles, even though its official inflation rate is not in the red zone. If it continues to put the brakes on its red-hot economy, we can certainly look for a second dip into recession.

Its first round of stimulus was equal to just under 15% of GDP. With the stimulus funds they created jobs. It can afford to keep going it from a treasury standpoint. It has to afford it from a social unrest and upheaval standpoint. But the big questions remain can they afford it — and can they control it — from an economic standpoint.

My vote is obviously, no. And there has already been some evidence of it. China used its last round of stimulus to build the largest shopping mall in entire world. It now sits 99% vacant. The Chinese government is not very proficient at allocating capital.

So they may be able to manipulate it for some years yet. But NO central bank, dealing with a FIAT CURRENCY, has ever won at this game.

Regards,
Bill Jenkins
Whiskey & Gunpowder

March 22, 2010

Is China Going Boom Or Bust? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

As you may know, California is bankrupt. That ball got rolling back in December 1994, when Orange County declared bankruptcy. Once one of the most prosperous districts in the state, it watched a pool of riskily invested and highly leveraged money go south, and the game was up. After losses totaling $1.6 billion, a liquidity trap was sprung from which Orange County’s Treasurer Tax-collector Robert Citron could not escape.

Although considered somewhat of an isolated incident, it wasn’t long until related problems began to emerge. Now the state faces endless traffic jams, aging schools and hospitals, falling cash accounts and an annual budget more dependent on volatile tax revenues than at any time in state history. And it looks like the crunch will come to a head under Gov. Arnold Schwarzenegger. But here’s the real problem.

All by itself, California is the eighth-largest economy in the world. So its bankruptcy would spell trouble for those that are interconnected with it — especially neighboring states that depend on California’s economic machine for their own growth.

But does California care? It doesn’t seem that way. Its state budget is larger than any other in the United States ($56 billion). And yet that still isn’t enough money to keep it out of trouble. It refuses to live within its means, and is determined to borrow at ever-increasing levels. For proof, remember that California voters rejected a bill that was really called, “The California Live Within Our Means Act.”

Why the arrogance? Perhaps it believes the Fed will step in with a bailout. After all, billions and billions have been given to private corporations… why shouldn’t a state benefit equally — especially if it would sink the U.S. economy otherwise?

But the corporate bailouts came with strings attached. So it’s easy to see the government telling the state to take action to get out of its mess. Reduce spending, cut programs and implement austerity programs until California’s budget is actually balanced.

Then make the very real threat to exorcise it from the Union if it doesn’t comply.

I’m sure you’re saying, “Wait, wait, hold the phone! Nobody is talking about this. There’s no chance that California is going to be kicked out of the United States”

And I am sure that you’re right. But we’ve heard very similar language used when it comes to talking about Greece and the European Union. And, in fact, that’s what today’s commentary addresses. Is it more likely that Greece will be removed form the European Union than that the state of California will be removed from the United States? After all, there are some similarities that make the comparison of the two cases worth considering.

Will California Go Greek?

Each party, Greece and California, are members of a union or conglomerate of political entities. Each one shares a united currency with the others in the union. Each one has particular trade interrelations as well as financial interrelations with others in the union. Lastly, each is “bankrupt,” and that has a certain dilatory effect on those around it.

As you may know, Greece has gotten a lot of bad publicity of late, and it has really hurt the euro — down around 10% in the last few months alone. Does the negative position of the Greek economy warrant such a drag on the European Union as a whole? Generally, they are only considered to be about 2–3% of the economy as a whole. California, on the other hand, is a little more than 10% of the U.S. economy as measured by GDP.

Thus, in theory, Greece should only drag down the euro by 3% on balance, but California should drag down the U.S. dollar by 10%. Overall, then, the USD should have fallen total of 7% against the euro… all things being equal.

But the problem is — all things are NOT equal. Here’s why.

California is a part of a 235-year-old republic. Even though it has not been a member for that same period, it nevertheless is a part of a union that has stood many difficult tests of time.

On the other hand, the European Union is still an experiment. It is barely out of adolescence, and we don’t know yet if it will even grow to stand among the older economies of the world. Also, even though both parties are entities in union structures, the structure of each union is different and addresses problems differently. The long and short of it is that California’s position in the United States is significantly more substantial than that of Greece in the European Union.

So right now California looks like a keeper and Greece a goner. If Europeans are reluctant to break up their happy (till now) Union, they only have a few options:

1. The European Union offers “solidarity” but no financial support.
2. The European Union offers a unified fiscal support from all members.
3. The European Union designates the stronger countries to subsidize the Greeks.
4. A mixture of numbers 2 and 3. Many have maintained that a bailout would be a violation of the Maastricht Treaty, the paperwork that created the European Union. However, the treaty itself is somewhat like a vicious dog that has no teeth or claws.

Here is an excerpt from the consolidated treaty, a piece that is commonly called the “No Bailout Clause”: The Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. There you have it… NO BAILOUTS.

However, when a member does get into fiscal hot water, that language is no longer effective or applicable. At that point Article 100 takes over. It reads: Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, acting by a qualified majority on a proposal from the Commission, may grant, under certain conditions, Community financial assistance to the Member State concerned. The President of the Council shall inform the European Parliament of the decision taken. NOW, there you have it… BAILOUTS PERMITTED.

I only give you that so you are aware that bailouts can and will be formulated in the upcoming disasters. And they do not violate the treaty itself.

However, the bigger question remains, if the European Union allows fiscal support for Greece, does that mean carte blanch permission for others to run to the EU money window and collect assistance for their carefree spending days?

It certainly seems to me that if the European Union makes this decision, which, as we have seen, is fully allowable by law, it will lose all credibility. And that may be the only thing that stands between them and ruination of the Union. It may end up collapsing on itself, even if no members ever leave, and its downfall will be the loss of confidence in the currency.

So then, how much further could the euro fall? Could it go all the way to parity? Most certainly. But before that point we will likely see many waxing and wanes of each side of the currency pair. We see a little rebound in risk appetite.

But what does all this mean for the United States and its currency?

The United States

Philosophically and economically, the United States is on a rendezvous with history… unfortunately, the path we are taking is a crash course. Many people have to come realize that we are nearing the end of a gigantic global economic experiment. No one has really walked this particular path before. A circumstance where every major nation in the world (and many minor ones too) is utilizing paper currency that has no backing of any value except for the promise of the issuing government. And we have all come to see what that is worth.

And as the saying goes, the bigger they are, the harder they fall. No currency is bigger than the U.S. dollar. No economy is bigger than that of the United States. When it comes, great will be the fall of it. Fortunes will be made. But so long as it remains the reserve currency, it is very difficult (although not impossible) for it to collapse.

It is difficult because each time it falls and gets cheap to buy, there are many who still buy it because the majority of the world’s goods are priced in U.S. dollars. So when the dollar gets cheap, so do the world’s commodities to those who are buying in currencies other than the dollar.

For us here in the United States, a cheaper dollar means more expensive everything: gas, groceries, cars… you name it. But when the dollar is cheap and other currencies are strong, it becomes a good time to stock up. Such buying will continue to prop up the dollar until a different reserve is found or created. Since such a thing will not occur overnight, the prospect for currency fluctuation over the next several decade — and our opportunity to profit from it — will be tremendous.

But make no mistake: the dollar is in trouble — one foot in the grave and the other on a banana peel.

Regards,
Bill Jenkins

February 19, 2010

Will California Be Removed from the United States? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

So the last decade of rising gold prices simply mirrored the US Dollar’s steady decline. Right…?

Well, no actually as I have repeatedly noted…and never less than when clutching a whisky and ginger this past Yuletide…typically to a fast-emptying room.

Gold’s tripling-and-more since Tues 4th Jan. 2000 came against all major currencies, let alone the minor ones. In fact, when judged against a truly globalized basket of the globe’s truly basket-case currencies — those various monies issued by the top 10 economies in terms of Dollar-GDP — gold turned decisively higher in mid-2001…looking back only a handful of times and never for more than a 20% drop.

All about the Dollar? Don’t you believe it.

Yes, volatility and violence rose together as the gold price pushed higher. And yes, the Dollar-price gains outstripped those in the Euro (292% vs. 180%) and commodity-led Canadian Loonie (179%).

But your local fund managers, financial advisors and op-ed pundits would have been hard-put to beat those returns with anything else. And as gold remains (at least in the view of die-hard, gloating and lone-drinking “gold bugs”) the only viable one-world currency, it’s worth glancing at just how it performed against the last decade’s various top 10 monies by economic weight…

* NB: The GGI is rebased for the top 10 currencies by economic output each year. The 13 gold-lagging currencies above all made one appearance (or more) in the last decade’s data. 2009 positions given here, courtesy of the IMF. The US accounts for 32%, the Eurozone 27%.

Of course, no one much cares for the last 10 years of data, however — not outside the relative performance tables of mutual fund sales teams.

But whether you think gold warned of trouble ahead when it first doubled to the start of 2006…or you feel it merely worked-as-prescribed when it almost doubled again during the financial crisis that then followed…it’s clear that the decade of gold just ended was a long way from a “Dollar down” story alone.

And all this without the much-fabled price inflation which newcomer pundits believe is essential for a long-term rise in the gold price. Just imagine what the price might do from here if a true surge in the cost of living now shows up worldwide.

Regards,
Adrian Ash
BullionVault

January 6, 2010

One Golden Decade and 13 Decayed Currencies was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.