I often get this question after I presented my case against our fiat money system, and I sense there is a trace of frustration in it, a bit along the lines of, you are telling us that we are in quite a mess but you offer no policy prescriptions. That is a fair point, I guess. Most writers who lament the economic ills of our time usually have a bag of policy advice on offer. Indeed, whispering new policy ideas into the ears of those in power is what most of these writers aspire to. I reckon what separates them from me is that they believe in government and I don’t.

The mess we are in is the result of policy, of the very idea – the silly idea – that the field of money and finance would work better if it were supervised, managed, guided and controlled by the state; that if we had clever, powerful and astute policymakers, consulted by economist philosopher kings, we could enjoy a smoother, better functioning economy. And if ever things were not running so smoothly, we would change the policy.

“So what is your policy, Mr. Schlichter? Could you not be a bit more…constructive?”

My conclusion is straightforward. There should be no policy. The existence of policy is already the problem. What we need is proper capitalism in money and finance. We do not have that now. What we have is limitless state fiat money, quantitative easing, systematic market manipulation, bailouts, regulations, the IMF, the World Bank, the FSA, FDIC, TARP and LTRO. We need proper markets, not more policy, not more manipulation, and not more bureaucracy. And not more fiat money. We need the state to exit the field of money and banking. Completely.

The main problem with monetary policy is that there is such a thing as monetary policy.

The state is the problem. It will not be part of the solution.

Before I tell you what I think should be done, let me give you another reason why I have been so reluctant to offer policy advice. The aim of my book Paper Money Collapse was to expose widespread fallacies and debunk erroneous common wisdom concerning money. It was not to provide a program for reform. The book is meant to be an eye-opener.

Almost the entire discussion on money and banking today is based on deeply flawed theories. This is true of the financial markets industry where I worked for 19 years. It is equally true of most of the discussion in the media and, as far as I can see, academia. The book was meant to debunk a lot of this misinformation.

My intention was to challenge the present consensus and the established orthodoxy. I think this is what needs to happen before we can even talk about the drastic changes that our system requires. Any policy debate of the type you read in The Economist or The Financial Times occurs within the boundaries of the established consensus. Questions of a more fundamental nature cannot be addressed in the context of policy debates.

But I am not going to evade the question about policy. So let me talk a bit about policy and reform.

The big mistake has already been made. The gold standard was abandoned, in a step-by-step process that began around the time of World War I and that culminated in Nixon’s closing of the gold window in August 1971. For more than 40 years, gold has played no official role in global monetary affairs. State paper money ruled. Everywhere.

This was the era of the central banker, the monetary bureaucrat, of artificially cheap credit, of stimulus, of big equity rallies, of bigger real estate bubbles, of constant debasement, of the quick buck and the big bonus, of growing banks and of ever more sovereign debt. The global financial system got unhinged. After four decades of persistent inflationism we have an overstretched finance industry gravely addicted to the constant drip-feed of cheap money and an out-of-control public sector constantly issuing debt that will never get repaid. Capital misallocations and asset mispricing are gargantuan. The establishment prescribes itself ever more easy money to keep the show on the road.

So the first conclusion is, there is no painless exit. The cleansing crisis is inevitable. Simply being honest about the mess we are in would not be a bad starting point for policymakers.

And to acknowledge that this can’t go on forever. Because it certainly won’t go on forever.

Okay, but what next? If you could design policy, what would it be? What is the number one thing that we need to change to restore financial sanity?

Fiat money critics have floated a whole range of policy proposals. There is the return to some form of gold standard. Also, there is the rather fiercely contested debate about whether fractional-reserve banking should be banned or at least restricted. Recently, colleagues of mine at the Cobden Centre in London have introduced a bill to Parliament that would make board members of banks personally liable for bank losses, which is supposed to reduce or eliminate moral hazard. Thus we are already faced with a range of policy proposals. What is my position on them?

I think we can have it much easier. My proposal is more effective and more easily communicated: Let us separate state and money completely. That is the one thing that needs to change. Capitalism is the only economic system that works in the real world [at least if you want to keep on improving the human condition--Ed.]. But what we have today is monetary socialism, albeit a socialism predominantly to the benefit of the rich and well-connected.

We need to get the state out of the economy completely. To achieve this we must get the state out of ALL monetary affairs. The monetary sphere of society should be a no-go area for politicians and bureaucrats. State involvement in finance is the problem. Let us get the state out. Period. That is the one goal we should have. That is the one policy I recommend.

My enthusiasm for any other policy proposal varies considerably and is dependent on how much state intervention the policy still allows or in some cases even requires.

As an opponent of fiat money I am naturally positively inclined to a return to a gold standard. I believe that Mises was right when he wrote:

“If in the coming years or decades our civilization is not to collapse completely the gold standard will be restored.”

But what type of gold standard should be implemented? Would there still be central banks that would ‘administer’ that gold standard? Under any form of gold standard, the central bank would most certainly be more confined in its monetary operations than central banks are today but there could still be considerable room for manipulation. The US Fed was founded in 1913 under what was officially still the Classical Gold Standard but that didn’t stop it from funding the US government’s military spending in World War I and from initiating credit bubbles and business cycles.

By 1933, the dislocations introduced by cheap money were so big that their dissolution – mandatory and normally automatic under a gold standard and indeed inconceivable under a proper gold standard – had become politically unacceptable. The Fed’s mission was accomplished and the gold standard was abandoned. The rest is history as they say.

An official, government-directed return to a gold standard also raises a lot of questions about implementation that would invite lobbying and horse-trading by various pressure groups.

* How much of the existing money stock – obscenely inflated after decades of money printing and fiat money debasement – should be backed by gold, or to put the same question in a different way, what should the new exchange rate between the money in circulation and gold be?

* How much should the existing money stock be devalued? Should banks be allowed to create deposits that are not backed by gold? Should fractional-reserve banking be permitted?

Questions over questions, and the room for political maneuvering and for political abuse are massive. Do we really want politicians, central bankers, bureaucrats, and their economic advisors make all these decisions? I don’t think so.

I know somebody who is best equipped to make all these decisions.

Mr. Market.

We may not all agree on the merits or demerits of fractional-reserve banking but as capitalists we should agree on the benefits, indeed the necessity, of free competition.

So how do we get from A to B? How do we get from the present system of finance socialism, of interest rates fixed by the central bank and asset prices manipulated by the central bank, of nominally private banks operating with the protection of a lender-of-last resort, to a system that again deserves the label capitalist?

Step 1: Privatize the central bank.

Do not even introduce a gold standard. Just transfer ownership of the central bank officially to the banks that have an account with the central bank. This is the first step for the state to exit the sphere of money. The central bank is no longer a public institution run by bureaucrats and politicians but an entirely private undertaking. It is owned and operated by the banks.

The central bank administers bank reserves and provides certain clearing functions. The banks need this, for now at least. Shutting the central bank down is not that easy. But its most pernicious aspect is that it is a policy tool. This would end abruptly with its privatization.

Step 2: The state revokes with immediate effect ALL laws and policies that relate specifically to banking and money.

From this moment on, banks are capitalist enterprises just like any other normal business. There is no lender of last resort (at least not one run by the state), there is no inflation target or other official monetary policy for which the banks function as conduits, which under the present system puts them in the strange position of being profit-seeking enterprises and policy-transmission mechanisms simultaneously. But equally, there is no backstop for the banks from the state any longer. No guarantees, no deposit insurance or taxpayer bailouts. If a deposit insurance institution exists, it is handed over to the banks, similar to the central bank. Again, the state has exited the business of regulating, supervising, licensing, subsidizing and backstopping the banking industry.

Entry into the field of banking is now free. You do not need a license. You do not need an account with the now privately owned central bank (although without such an account clearing with other banks might be difficult). There are no legal tender laws anymore, so if anybody has any bright new ideas about money (Liberty Dollars, bitcoin) they are most welcome to try them. The consumer alone will decide over success and failure.

Monetary policy has ended. Bernanke testimonies on TV will be replaced with reruns of old Simpson episodes. Senators and congressmen will have to find new soapboxes from which to propound their personal economic theories.

Step 3: The state’s gold hoard is handed over to the banks.

What? A gift to the bankers? – I do not consider this a gift to the banks but more a return of property to the bank depositors. The bank depositors are the ones that should benefit from this transfer most.

The present monetary system could only have come about because it was once based on gold. Deposit banking spread at a time when banks still promised to repay deposits or banknotes in specie, and when all banks were thus required to hold (some) gold reserves – reserves that no political entity could create at will. Only slowly and gradually was the gold backing removed and replaced with various implicit or explicit state guarantees, all of which are now practically failing.

Of course, just like investment genius Warren Buffett, the bankers may not know what to do with a pile of gold and may thus be tempted to simply put it on a big heap. I suspect, however, that the bankers will have a very good use for the gold. Their customers – the holders of bank deposits – may be very unsettled by the exit of the state and thus the taxpayer from the business of underwriting the banking industry. Most people only consider their bank deposits safe because they believe the state would not allow Bank XYZ to default, not because they have any confidence that Bank XYZ is run prudently. Now that the state has exited the field of money and banking, the banks are likely to use the gold as additional backing for their balance sheets. They will use the gold as it has been used for thousands of years – to gain trust. And to avoid bank runs.

Will the gold hoard be sufficient?

I don’t know.

Presently, the US government sits on 260 million ounces of gold. At the present gold price of $1,655 per ounce, we are talking $430 billion. The monetary base is presently $2,673 billion; M1 is $2,220 billion and M2 minus money market funds is $9,163 billion. The gold hoard is thus only 16%, 19%, and 5% of these money stocks, respectively. Hardly a proper gold standard but it could be a start. Through proper balance sheet deleveraging and through additional gold purchases the private banks are obviously free to improve these ratios. (Again it is not for bureaucrats or economists to decide what is appropriate. This is the role of the banking entrepreneur.)

But now that the private banks own the central bank, would they not put the printing press into overdrive and create inflation?

I don’t think so. Through quantitative easing the central bank accumulates assets from the banking sector and expands the money supply. The central bank leverages its own balance sheet in the process. The Fed is already levered more than 50 to one, which is more than Lehman and Bear Stearns were when they collapsed. But now the banks own the capital of the Fed. They foot the bill, not the taxpayer. The banks can no longer dump unwanted assets on the central bank. They own the central bank. They cannot transfer risk to it.

Additionally, the public will be very suspicious of an overtly expansionary central bank. They know it is operated by the private banks and entirely for their own benefit. Any inflation concerns will translate into higher interest rates and that is detrimental to the highly leveraged banking sector. I would expect the private banks, now operating without any safety net from the state but under the suspicious gaze of their own customers, to be very cautious about how much money they print.

Easy money is great for the banks for as long as they can lower reserve and capital ratios. That was much easier when they could rely on government backstops or when meeting official regulatory requirements already gave their balance sheet policy an official seal of approval. Now that they are on their own, monetary expansion and thus debt accumulation and leverage are a double-edged sword. It will pay again to run a bank prudently and even advertise your higher capital and reserve ratios.

Furthermore, the relatively sounder banks (if we assume for a moment that those indeed exist) have little interest in running the jointly owned central bank for the benefit of the weakest banks. To the contrary, it is in the interest of the stronger banks to see weaker banks fail and exit the market. At the same time, it is not in the interest of even the strongest banks to see widespread bank runs or a general distrust in banks as that could quickly come to haunt them, too.

I think it is very reasonable to assume that under my plan of complete privatization the key challenge of allowing corporate failure in banking on the one hand but avoiding a complete collapse of the banking system on the other will be managed much better. The reason is that this task is now given to bankers as entrepreneurs who have a keen interest in getting that balance right. As long as banking is under the protection of the state, monetary and banking policy will be conducted for the benefit of the weakest banks, and the strongest banks will simply reap windfall profits.

Does the state get off too lightly?

The state no longer has any responsibility for the banks or money. No more setting of policy, no big hearings in Washington, no bailouts, no IMF, no World Bank. A lot of money will be saved and many explicit and implicit claims on the taxpayer will be eliminated. But also, the state can no longer tell the banks that government bonds are safe and encourage the banks through bank regulation and official capital requirements to invest in them.

There is no longer any bank regulation from the state. Banks will be regulated by the market, which means ultimately by the consumer. The state also loses the central bank and can thus no longer create an artificial demand for its securities. Remember, last year 61% of new Treasuries were placed with the Fed. Why should the banks, which now own the central bank, continue to accept this?

Government bonds everywhere benefit from the idea that states can’t go bankrupt because they can always print the money. This idea is fundamentally wrong as I have argued repeatedly. Once the debt load reaches a certain level, it can no longer be inflated away. If this is still tried, currency disaster will ensue. Be that as it may, with the state officially separated from the field of money and banking, it would have to manage its finances like any other entity, like a private corporation or a household (or almost like any other entity as it still benefits from the privilege of taxation). We would certainly see higher state borrowing costs, lower levels of spending and smaller deficits. This would be an important step to what Doug Casey calls “starving the beast”.

Of course, in such an environment we would not have to worry at all about how the banks arrange their executive pay, how their bonus schemes work, or if bank shareholders hold their board members at all responsible for their mistakes and failures. These are internal affairs of entirely private and capitalist enterprises. If bank shareholders get this wrong and set the wrong incentives, only they will bear the consequences. The idea that banking is a public service for which a specific set of rules and regulations must be designed and administered by the state does no longer apply.

Come to think of it, this proposal looks much better in terms of consistency and clarity than any other, in my humble opinion. Those who argue for an official gold standard are asking the state to design and implement a new monetary order. Those who ask for a ban on fractional-reserve banking ask the state to define what constitutes legitimate banking business and then enforce it. Those who want to introduce new legislation in response to executive pay and bonus schemes, ask the state to interfere in the relationship between shareholder (principal) and manager (agent).

I ask the state to do just one thing: Get the hell out of money and banking! Now!

Regards,

Detlev Schlichter
Paper Money Collapse

The Separation of Money and State was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

It’s sounds new, but it is not. Following the Second World War, John Maynard Keynes pushed hard for a global paper currency administered by a global central bank. This was his proposed solution to the problem of national currency disputes. Let’s just take the inflation power away from the national state and give it to a world authority. Then we’ll never have to deal with a lack of coordination again.

The idea didn’t fly, but the institutions that were supposed to administer such a system were nonetheless created: the International Monetary Fund and the so-called World Bank. It didn’t work out that way. Instead, nation-states retained their monetary authority, and the new institutions became glorified welfare providers, conduits for transfer payments and loads to developing nations.

The dream lived on, however. The creation of the euro and its central bank was a step in that direction. So was the Nixon’s closing of the gold window. Each new currency crisis has created the excuse for further steps toward what Murray Rothbard calls the Keynesian dream.

Why hasn’t it happened yet? Many reasons. Nation-states do not want to give up power. The World Bank and the IMF are institutionally unsuited to the task. Many people in the banking world are also downright squeamish about the idea, with full knowledge of the ravages that unchecked inflationary credit can bring to the world economy. Mostly, there hasn’t been a crisis big enough to warrant such extreme measures.

However, that crisis might have finally arrived. Since 2008, the Fed has demonstrated that among all the world’s central banks, it alone is brave enough to embrace gigantic inflationary measures without wincing. The European Central Bank is under some strictures to not act as a monetary central planner. China is unconverted to the inflationary faith. The same holds true for England.

Ben Bernanke, however, is different: He is revealing himself to be an unreconstructed Keynesian with an unlimited faith in the power of paper money to solve all the world’s problems.

What this means is that it is left to the Fed alone to bail out the world. There is a perverse logic to this. After all, if you are going to be a world empire, operating under the assumption that nothing on the planet is outside your political purview, you bear certain responsibilities as well. Foreign aid and troops in every country are just the beginning. You must, eventually, embrace your financial responsibilities, too. A globalized economy addicted to debt needs an institution willing to step up and guarantee that debt, and provide the liquidity necessary to get us through the hard times.

As soon as the announcement of the new Fed measures came, the smart set of the World Wide Web lit up with the obvious observations that these measures come with massive risk of setting off a global inflationary crisis. It could lead to the final crack-up boom.

The Fed assures us otherwise. It “bears no exchange risk” in undertaking such actions. But as economist Robert Murphy explains:

“Strictly speaking, this isn’t true. If the Fed gives $50 billion in dollars to the ECB, which (at those market prices) gives $50 billion worth of euros to the Fed, then the ECB lends out the dollars to private banks, and before they repay the loans, the euro crashes against the dollar…then the ECB has no means of acquiring dollars to repay the Fed. Even though the ECB has a printing press, it is configured for euros, not dollars.”

He further states what everyone knows but no one is will to say:

“The current round of interventions will not solve the problem. Down the road — probably much sooner, rather than later — the central banks of the world will engage in some further extraordinary measures, again, lest the whole world fall apart. Even so, printing money doesn’t fix the underlying problems. No matter what they do, eventually, the whole financial world will fall apart.”

The speed at which all of this is happening is startling to behold. It was only 36 hours ago that we heard the first public worries about the drying up of credit in Europe. Large corporations were seeing their credit lines tightened. Banks were starting to become more scrupulous in their operations, which is hardly a surprise, given that zero interest rates have made it nearly impossible to make a profit in conventional lending operations.

Where in the fall of 2008, the Fed let the worries about tight credit grow to the point of international mania before it acted, this time, it jumped in to anticipate the inevitable warnings about the imminent death of civilization. Only trillions in paper money can save us now! The Fed saw what was coming and decided to do the deed, even before the demand came.

But rather than settle markets down, the real effect is the opposite. If you go to the doctor with a head cold, and he rushes you to the hospital for surgery, you don’t merely congratulate him for being thorough. You figure that he knows something that you don’t, namely that your condition is way more serious than you thought. Your family is likely to fly into a panic.

For this psychological reason alone, this action is likely to roil markets in crazy ways. The Fed is now paper money printer for the entire world. It’s a new world, and a brave one. If you think that a new era of prosperity, peace and stability awaits, you have been living under a rock for at least a century. There’s not a soul alive who will sleep soundly knowing that Ben Bernanke has elected himself the loan officer of the entire globe.

Regards,

Jeffrey Tucker

Leaping Toward the Keynesian Dream was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Robert Preston, the BBC economics expert, last week claimed that the solution now lies with the ECB, and he spoke confidently of the ECB’s “unlimited resources.” Yesterday, Vince Cable demanded “unlimited powers” for the central bank. He also shamelessly regurgitated the well-worn politician’s excuse for Europe’s problems, namely, that these countries are under “speculative attack.” The advocates of large-scale ECB intervention now include many pundits and commentators, plus, a sizable group of financial market economists and strategists, whom decency obliges me to leave nameless. “It is important to keep the ECB engaged,” as one economist put it, “as only the ECB has unlimited resources.”

Such proclamations immediately invoke Albert Einstein’s famous dictum: “Only two things are infinite, the universe and human stupidity, and I am not sure about the universe.”

Everything Is Going According to Script.

None of what is going on surprises me. It is perfectly in line with what I predicted in my book. However, I am ready to admit that I am a bit baffled by the quick willingness by so many people to embrace what is, ultimately, a sure road to complete economic destruction. In Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown, I explain why systems of elastic money are always suboptimal, unstable and, ultimately, unsustainable. A monetary system like ours must, over time, accumulate dislocations and imbalances that will, finally, become so big that their liquidation through market forces is deemed politically unacceptable. Then, out of desperation, an unwinnable war against economic reality will be fought by means of the printing press. Ever more money will be created ever faster in a futile attempt to outrun the market’s urge to liquidate.

In Chapter 10 of my book, I describe the two final stages of a paper money system as monetization of debt and inflationary meltdown. We are now firmly in the monetization of debt phase. This process will accelerate in coming months and quarters. Not only in the eurozone, but also in the United States and in the U.K. All of these central banks will continue to expand their balance sheets aggressively and use their ability to print money — without limit — to support banks, governments and a wide range of asset classes.

Bernanke (Fed) and Draghi (ECB) pointed out, in their respective press conferences, recently that monetary policy is not a panacea for all economic ills. It doesn’t matter. Policy has no other tools left to postpone the inevitable or to make the status quo appear sustainable again. By the way, it is entirely immaterial what Bernanke or Draghi thinks and says. Their press conferences keep Wall Street and City of London economists busy. But these gentlemen are quickly becoming mere extras in a bigger political game, in which desperation rules, and in which they will simply perform their roles of fiat money producers.

When do we enter the final stage of inflationary meltdown? Difficult to say. It all depends on when the public loses faith in a form of paper money that is being printed in evermore bizarre quantities, only to keep states and banks alive and to project some resemblance of normalcy to the masses.

I do not disagree with the mainstream economists on whether paper money central banks can create, essentially, unlimited amounts of money. Of course, they can. That is precisely why gold and silver as monetary assets were replaced with entirely flexible state money under central bank control in the first place. And I do not disagree that we will soon see more debt monetization by the ECB and other central banks around the world.

What is sheer lunacy, however, is to advocate such a policy as a solution, or part of a solution, to our problems. This is where I draw the line. It is simply beyond me how people who call themselves economic experts, and who must have at least a basic understanding of monetary theory and some knowledge of economic history, can seriously advocate debt monetization as a sensible policy tool.

Dr. Strangelove — Or How I Learned to Love the Printing Press

Our financial market economists now cling to anything that promises to buy them time and some stability, even if logic tells them that what they are advocating is exactly the opposite of what should be done. They are not unlike the gambler who knows he should quit, but out of sheer desperation, is rolling the dice one more time.

Of course, there are always those who are imbued in Keynesian economics and other sorts of interventionist myth to such a degree that they honestly think that there is no problem that cannot be fixed with government stimulus. If the medication hasn’t worked, just keep increasing the dose. Paul Krugman (Nobel laureate) and Christina Romer come to mind. But I don’t quite believe that all economists are in this camp.

Whatever their reasons and motivations, it is quite clear that all these economists are now mouthpieces for the establishment. They are all defenders of the status quo, or of what has passed for the status quo for the past 30 years.

Government bonds should again be considered “risk free” assets, and banks should again be considered “too big to fail” and “too important to fail.” This is so the symbiotic relationship between states and banks that fiat money system fosters, and that has been so mutually beneficial to the political class and the banks, can finally be restored. It is a sad spectacle to see people who call themselves economists — and often, even free-market economists — come up with evermore extreme recommendations of how we can fund Big Government.

To the broader public and the economy as a whole, the collapse of this system would be painful first, but ultimately, hugely advantageous. It would allow a renaissance of real capitalism, rather than the continuation of this system of monetary interventionism that has allowed the state to assume control over such vast resources and the financial sector to enjoy uninterrupted fiat-money-fuelled growth for decades.

What good do these economists expect to come out of ECB debt monetization? Do they really believe that once the ECB has committed itself to buying hundreds of billions worth of Italian government bonds, in order to manipulate the yield on these bonds — against market forces — down to what the political class deems sustainable (let’s say 5%), that then Italian politicians will reform public finances in the country? That they will quickly bring down deficits and the debt load to sustainable levels, at which point, Italy can borrow from the market again, the ECB can safely sell its bonds and reduce its balance sheet and everybody lives happily ever after? Does anybody seriously suggest that this scenario is likely, probable or even possible?

The fact is that none of these governments can be trusted to bring their finances under control, as long as they have access to cheap credit, i.e., to funds at “sustainable” interest rates. Germany forced through the Stability and Growth Pact at the start of EMU (does anybody remember Theo Waigel?) that should have limited debt-to-GDP ratios to 60%, only to violate it herself. Germany’s ratio is now, officially, at 83%. The government is already on the hook for another €211 billion under its EFSF commitments, which are now all but guaranteed to come due, as the bailout fund is supposed to cover first losses on bonds in order to maximize its “firepower,” meaning Germany is already set for more than 90% of debt to GDP. And that is supposed to be Europe’s “stability anchor.”

All rules and guidelines that were designed to guarantee the fiscal and monetary stability of EMU and were implemented at its start have, by now, been broken — without exception. Do you think that this will change once the politicians have obtained the unlimited support of the printing press?

“Quantitative easing” in Japan, the United States and the United Kingdom goes hand in hand with growing debt, not debt reduction. Providing a lender of last resort and easy money and cheap credit to governments does not lead to deleveraging, but to the opposite.

Only default and cutting off a government from additional borrowing will reform the government. That is why I say: Embrace default!

The Future

When the ECB will have implemented its backstop for Italian government bonds, it will end up buying vast amounts of these securities at above-market prices. Draining equal amounts of liquidity from somewhere else in the system, in order to minimize the inflationary impact, will be illusionary. Inflation will creep higher. Concerns about sovereign solvency are, of course, not restricted to Italy. These concerns, plus rising inflation, will put upward pressure on the yields of other bond markets, in particular, Spanish and French bonds. The ECB will have to expand its support program in order to stabilize these bond markets as well. Why should unlimited ECB support be limited to Italy? What is good in the case of Italy must be equally good for Spain and France!

The notion that the ECB could ever change course now and tighten policy, in order to fight rising inflation pressure, will appear increasingly fantastical. Market participants and the wider public that uses the euro will simply not believe it. Inflation expectations will rise rapidly. Money will become a hot potato. When money demand falls, inflation will shoot up quickly, which would require the central bank to establish markedly positive real interest rates in order to restore confidence in paper money. But this would mean allowing several governments that are now reliant on cheap central bank funding to go bankrupt. This will not be allowed to happen, which will undermine confidence in paper money further. We will have reached the inflationary meltdown phase.

All complete paper money systems in history were established to fund the state. Our system is no exception, as becomes increasingly clear. All paper money systems in history failed. Ours will be no exception, either. Our system is the most ambitious. We had a global system of unrestricted fiat money production for 40 years. The endgame is fast approaching.

Regards,

Detlev Schlichter

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

However, I do think many of us who have written such analyses — and I very much include myself here — have not been consistent about making an important distinction, and this has left us unnecessarily open to a reasonable criticism. For example, I have used the analogy of traffic lights to explain why it’s wrong to blame the crisis on irrational behavior. Suppose someone turned all the traffic lights green. The obvious result would be a whole bunch of accidents. Would we blame those accidents on the drivers? Would we say they were acting irrationally? No, in fact we’d probably say they were behaving quite rationally given the signals they faced. A green light doesn’t just mean “go”; it also implies the light the other way is red and that going is safe.

Changing the Incentives

One way to view the housing boom is as the outcome of government’s turning all the lights green, changing the incentives facing market actors and causing their rational responses to distorted signals to produce irrational outcomes. The Austrian story of boom and bust is really a story of the unsustainable boom. Central bank-generated inflation (in this case combined with policies to subsidize housing) led to artificially low interest rates and excessive investment in long-term projects that cannot be sustained by the amount of real saving taking place.

So what’s the problem? Some have interpreted this argument as letting the bankers off the hook too easily. This and similar arguments seem to suggest the bankers were innocent in that they just responded rationally to signals generated by the central bank or Congress. The problem is that, as several critics of mine have rightly pointed out, many of the housing policies were not imposed on the bankers but rather were aggressively lobbied for. In many cases (such as Countrywide), it was the bankers themselves who asked Congress for policies making it easier to lend to marginal customers and for Fannie and Freddie to have access to the Treasury. They also favored the implicit bailout promise, which sustained the mortgage-backed securities market. And many bankers cheered on the Fed’s low interest rates during the middle of last decade.

In addition to any ethically shady dealings banks might have had (and I do believe there are examples of this), we should not hesitate to blame them for the crisis for the reasons outlined: They were at least partially responsible for the passage of many of the government policies that created the boom and therefore the bust. To that extent, then, we can agree with our friends on the left that the bankers were part of the problem, which also suggests that protesting Wall Street is not wrong. None of this undermines the importance of my traffic lights analogy to make the point that rational responses to bad signals is a better way to understand the problem than irrational or “greedy” behavior. But that point needs to be supplemented by reminding people that it was often the bankers in cahoots with politicians who turned all the lights green in the first place!

Face the Facts

The upshot is that we have to acknowledge these issues. For too many people, the claim that “the bankers are responsible” is the same as “the free market is responsible.” We have to disentangle these two claims not by appearing to deny both of them, but by agreeing that the bankers are responsible — and showing that their responsibility consists in preventing the free market from working.

We — and I again include myself here — have to be careful to say that the lesson is not that bankers bear no responsibility, but that the free market bears no responsibility. We should make it clear to those we talk to that bankers are not exempt from Horwitz’s First Law of Political Economy: “No one hates capitalism more than capitalists.”

Regards,

Steven Horwitz

Banks, Not the Free Market, Are to Blame was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

An unhealthy cultural myth has flourished that says everyone must go to college and get an advanced degree, even if it’s something for which there is virtually zero market demand. Meanwhile, below-market interest rates and government-backed loans have lured a couple generations of Americans down the road to higher education.

Further, the kind of education colleges provide — indeed, all of American schooling from kindergarten onward — doesn’t produce innovators, entrepreneurs and job creators.

In a recent article for The New York Times titled “Will Dropouts Save America?” Michael Ellsberg writes:

• “American academia is good at producing writers, literary critics and historians. It is also good at producing professionals with degrees. But we don’t have a shortage of lawyers and professors. America has a shortage of job creators. And the people who create jobs aren’t traditional professionals, but startup entrepreneurs.
• “No business in America — and therefore, no job creation — happens without someone buying something.”

Wealth is only created when value is added (You didn’t think it was when money was printed, did you?) The Austrian school of thought reminds us that value is subjective. People, ultimately, buy what’s worth buying to them with the money they’ve earned.

We cannot put too fine a point on this. It doesn’t matter what the seller thinks the item is worth. It doesn’t matter how much time, energy and material went into making the product or service. You can waste a lot of time, energy and material producing something no one will want to buy. The buyer determines the ultimate value…and whether he will part with his money for it.

There can be misallocations of resources. And when the central bank and government get involved, these allocations can grow very large and go on for a very long time before violently correcting.

So it is that, increasingly over the past couple of generations, there has been a gross misallocation of time and resources into higher education, aided and abetted by the central bank and the federal government.

Millions have been misled into pouring their young adulthood into endeavors that won’t pay off…and going deeply into debt for it. The federal government has encouraged this higher “education,” much like it did home “ownership.” The central bank made the borrowing easy with low interest rates — which powered the real estate bubble as well as the higher education bubble — while government entities backed the loans.

Now the education bubble is bursting. The bubble’s start can be traced to the GI Bill, whereby the government got into the business of shoving more people into college than the market would bear. Over time, the same easy loans and guarantees got extended to most of the population.

Over time, some bad notions gained traction. College came to be seen as the ticket to the good life as opposed to something that people already destined for greater things might undertake to help get them there. As often happens, causation became confused with correlation.

In the last 30 years, higher education has come to be viewed as a human right, something that governments are obliged to guarantee. Lost is the notion that a higher education is a path for the exceptional, particularly those exceptional people going into the hard sciences.

Of course, this doesn’t do anything to change the essential ability of the people now being shoved through the system. All it’s done is water down the quality of what’s being offered so that everyone can join in.

Exceptional people still become scientists and engineers. Everyone else gets a master’s in some field that was recently invented to meet the artificial demand for advanced degrees, for people who couldn’t be scientists or engineers, but who had a head full of misguided notions and a boatload of borrowed money.

Worse, this “education” came to supplant things like entrepreneurship, initiative, the willingness to take risk, to accept and learn from failure. As Ellsberg says in his article:

“But most students learn nothing about sales in college; they are more likely to take a course on why sales (and capitalism) are evil.”

Indeed. We hate to keep turning to the Occupy movement, but it is full of the poster children for this. They came out on the other side of the system unemployable and in debt. They feel lost and angry, unable to think of life past the burden of their student loans. And many of them (not all) feel that “capitalism” is somehow to blame, that the world of profits is somehow divorced from the well-being of people.

It’s criminal when “profits” are doled out to banks and “too big to fail” businesses by the government, with money taken from the taxpayers. But what about the real profits — not stolen goods — in which entrepreneurs take risks and business people add value, when the profits are the reward for serving people’s needs?

So the bamboozled have taken to the street. They would like their student debts to be wiped out, that “the people” be bailed out like the bankers and crony big businesses were. Or even worse, they get it in their heads that all higher education, henceforth, should be paid for by the government. It doesn’t matter whether there is a market demand for expertise in a course of study or not.

Here at the Whiskey Bar, we often rib today’s grad students for having expensive but, essentially, financially worthless degrees in things like transgender studies. We’re often accused of right-wing/conservative close-mindedness for it, too…

But we joke to underscore the point. We’re not disparaging such courses because of cultural bias, but because of economics. We suspect that without the inducement of easy money from the central bank, and the channeling of debt expansion into wrong-headed zeitgeists, the price of a course of study would reflect its inherent economic value. Art history and gender studies would be a lot cheaper to acquire expertise in.

A system has grown up that encouraged enormous debt for nonperforming assets, namely, schooling in things that won’t pay off. People are still falling for it. But markets aren’t mocked forever. There has to be some painful write-down in central bank-distorted asset values before the economy can regain solid footing. This is just as true for higher education as it is for real estate.

It won’t be pretty. We’re not sure how this will play out for those who’ve misallocated their time and energy based on false signals, and with nothing but debt to show for it. But the stories that we told ourselves about what’s valuable were built on distortions that are now coming to an end.

Reality is asserting itself. And the reality is that entrepreneurship is what drives wealth creation, not going into debt to be taught that wealth creation is secondary to cultural studies or worse, that wealth creation is downright evil.

Regards,

Gary Gibson

How College Has Killed Wealth Creation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

What the Fed doesn’t understand is that full employment can exist in perfect harmony with stable prices. That’s because having more people producing goods and services can never by itself lead to an environment of rising aggregate prices. And most importantly, an increasing rate of inflation actually increases the rate of unemployment.Not only do these facts make sense economically but also are borne out in the historical data.

Each and every time the Fed has increased the money supply and sent prices rising, the rate of unemployment has risen, not decreased. The simple reason for this is that inflation diminishes the purchasing power of most consumers. Falling real wages means less discretionary purchases can be made. Falling demand leads to increased layoffs and the unemployment rises as economic growth falters.

The 12.2% year-over-year rise in CPI that occurred in November 1974 led to the cyclical high of 9% unemployment during May of 1975. Likewise, in 1979, the year-over-year increase in CPI reached a high of 14.6% in March and April 1980, which was followed by another cyclical high 10.8% unemployment print in November and December 1982. Once again, year-over-year CPI increased from 1.2% in December 1986 to 6.4% in October 1990. That again corresponded with the rise in unemployment that occurred from the 5% level in March of ’89 to 7.8% in June of ’92.

Today, we find that the unemployment rate is 9.1% due to the credit crisis and the Great Recession. Bernanke believes he can bring that figure down by creating inflation. He has become successful in bringing year-over-year changes in PPI to 6.9% and CPI to 3.9%. Inflation has now arrived. However, the rate of unemployment will only increase from here as long as the Fed mistakenly holds the belief that printing money can solve the employment situation. Quite the contrary, it only causes the dissolution of the middle class.

In reality, the Fed needs to uphold only one mandate: that of stable prices. Fulfilling that mandate by keeping in check the growth of money supply is the only way to ensure our economy displays full employment and maximum economic growth.

Regards,

Michael Pento

The Dual Mandates of the Federal Reserve was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

We found the following in our inbox today from the National Inflation Association:

“The Occupy Wall Street movement is gaining tons of momentum and is likely to continue picking up steam in the weeks and months ahead. Americans are angry, but they aren’t exactly sure what they are angry about, and they don’t know for sure with whom they should be angry. It is easy for them to point their fingers at Wall Street, but Wall Street is in no way responsible for the financial crisis our country has today.

“NIA believes that Occupy Wall Street protesters need to be educated to the facts and truth about the U.S. economy and what is truly causing our economic problems.”

And what exactly is causing our economic problems? In short: inflation. Both the creation of new money unbacked by productive activity — literally, conjured up from nothing at the whim of a central banker — and the artificially low cost of borrowing to expand the amount of debt…again, thanks to central bankers buying government debt with the money they create in order to shove interest rates down.

Inflation erodes the value of savings. It causes middle-class wages to rise more slowly than prices over time. The well connected — mainly, commercial banks — get the money first and benefit, while their spending of the new money causes prices to rise. Everyone else has to beg and hope for cost-of-living increases to their wages.

Inflation also causes asset bubbles that tend to benefit the rich while wiping out the middle class and poor, who pile into bubbles just in time to be left holding the bag.

In other words, inflation is causing the things that have people revolting in the streets. And central banks cause inflation.

Our comments here at the Whiskey Bar (and on our Facebook page) regarding the Occupy Wall Street movement have elicited plenty of responses. Some not so friendly. Like this…

“What utter drivel. Right out of the playbook of a goose-stepping sociopath like Ayn Rand. The fact is rather than sitting at a computer terminal all day long, pounding away nonsense in support of a capitalist kleptocracy, these ‘Occupiers’ are actually doing something constructive, and this is key, OUTSIDE the rigged political system. That is why the powers that be (including, apparently, you) fear them so much. These folks, at the very least, know that the LAST place they should be is ‘seig heiling’ to the Rand playbook by ‘making some money.’”

Ouch.

First, Ayn Rand would have neither goose-stepped nor seig heiled to anything. She was as ardently against the Nazis’ violent corporatist fascism as she was the communists’ totalitarian command economy. Her paeans to selfishness aren’t a call to theft and violence. They’re a dramatization of the importance of ownership — starting with self-ownership — and the drive to improve one’s own condition, leading to a better quality of life for all.

Second, capitalist kleptocracy? Last we checked, capitalism was about making money by adding value and meeting consumer demand, not about stealing anything. In fact, capitalism demands a sacred respect for property rights, starting with the individual’s ownership of himself.

(Capitalism was named by its enemies. We’re starting to prefer the term “propertyism.”)

The political system is the one eager to move around other people’s money. And it’s “political money” in the form of the monopolized currency issued by a government-backed central bank, which has resulted in the impoverishment of the middle class that the Occupiers are so up in arms about. It’s also something that we at the Whiskey Bar are up in arms about (and in an upcoming issue, we’ll propose a way for you to do something about it…and protect your wealth…in time for the Fifth of November)…

But we notice not a little sentiment among the Occupiers not just to stop the theft, but to redirect it.

We understand the anger behind the protests. We just worry about whom the protesters are blaming…and about some of the usual solutions that are floating through their heads. As Tim Staermose of The Sovereign Man writes:

“The anger is understandable. But it’s infuriating to so many of these protesters railing on YouTube against the free market, moaning how capitalism has pillaged the poor for the benefit of the rich.

“Nothing could be further from the truth. There hasn’t been a free market in money and banking for a century. The central bank/fractional reserve system is the biggest cartel in the history of economics. It’s nothing but big government price rigging.

“How can anyone argue we have free markets when the price of money is set by decree? An unelected board of governors at the Federal Reserve simply decides the price of money, and that’s that.

“Nearly EVERYTHING in our credit economy is driven from this number — mortgages, business purchases, trade finance, government spending…and it affects almost everyone on the planet. This is not a free market, it’s an economic dictatorship.”

We were sorely hoping that the collectivist and redistributionist spirit would be exorcised from the movement, perhaps with the help of that other populist movement who are angry at the same things. On this, David Franke says:

“When the protests first began, conservatives and Tea Partiers should have descended on New York to seek to influence the movement in the right direction. From what I have read and seen, some members of the Ron Paul Revolution have been trying to do just that. But the Tea Partiers have reacted like, well, conservatives. And now the opportunity has probably been lost. Occupy Wall Street has been taken over by the liberal branch of the establishment — the labor unions — just as the Tea Party has been taken over by the conservative branch of the establishment — Washington insiders. The union bosses and conservative power brokers saw their opportunity and took it.”

And Ralph Benko already said it in his article “Occupy Wall Street: Contempt of Political Class”…

“An article datelined Madrid, titled ‘As Scorn for Vote Grows, Protests Surge Around the Globe: Many Are Driven by Contempt of Political Class.’ Contempt of the political class? Sounds like…the Tea Party Patriots…Welcome to the party, #OWSers!”

Welcome to the party, indeed, comrades. We have a common enemy. And it’s not Wall Street. Or greed.

It’s a flexible currency that is constantly being created, and in which we’re all forced to transact.

As it stands now, there seems to be awareness, perhaps even a growing awareness, in the movement about what the real source of the trouble is. We hope that the protesters stop being angry at Wall Street and, instead, look behind the curtain at the forces that corrupted Wall Street.

Yes, we mean the central bank again.

Regards,

Gary Gibson

The Real Reason for the Uprisings was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

It will get mass inflation at some point: anywhere from 15% per annum to 30%. But it is not going to get 50% or 100% or more.

Why not?

1. The temporary nature of the payoff

2. The fear of getting blamed

3. The boom-bust cycle

4. The employees’ vested pension fund

1. THE TEMPORARY PAYOFF

Hyperinflation lasts only a few years. People in the hard-money camp ought to know this, but they tend to forget.

Those economic forecasters who keep telling us the dollar will fall to zero forget the obvious: big banks are creditors. Bankers lose when a currency falls to zero. Never forget this. If you believe, as I do, that the Federal Reserve is the enforcement arm of the largest commercial banks, then stop worrying about hyperinflation. But don’t stop worrying about Congress.

Ever since All the President’s Men — the movie, not the book — we have been told to follow the money. So, let us follow the money.

The four big U.S. banks — maybe three, with Bank of America on the skids — make their money by lending money. As with all fractional reserve banks, they borrow short (low rates) and lend long (higher rates).

Under hyperinflation, long-term interest rates skyrocket. This forces down the discounted present market value of bonds and mortgages. Nobody wants to lend long. Who gets killed? Banks and insurance companies that have lent long.

What saves them from bankruptcy is fake accounting. They are allowed to keep their bonds on the books at face value. But, sooner or later, bankers get paid off in fiat money. Their portfolios are locked into bad investments. They can’t sell them without reporting losses. So, they hang on. Month by month, the value of these assets falls.

Hyperinflation is bad for the super-rich. Why? Because they own their assets outright. The super-rich own land and homes. These go up in nominal value, but rich people don’t pay off their debts by selling a gold coin or two. They have no debts to pay off. They are the creditors. They own bonds and fixed-income investments.

When we read of the great hyperinflations, we find that urban people got ruined. Farmers did very well. They paid off their mortgages by selling a few dozen eggs. Wealth moved from cities to rural areas.

Bankers were in big trouble. Farmers were in hog heaven.

Has it ever occurred to you that there have been no hyperinflation periods in Great Britain? The Brits have gone through wars of their own making. Their elite ran an empire from 1700 until 1946. Yet for all the crises, they never had price inflation above 30%. You know why? Because the Bank of England would not allow it. The BoE was privately owned from its creation in 1694 until the government nationalized it 1946. Even after 1946, the bank would not allow hyperinflation.

The Bank of England inflated often. This created the boom-bust cycle on numerous occasions, but never got seriously blamed for any of the busts. This is because not enough people understood the Austrian theory of the business cycle, which was discovered in 1912 by Ludwig von Mises. Even today, hardly anyone knows about it, and of those economists who do, almost none believes it.

Which are the famous hyperinflations? In Western Europe, Germany, Austria, and Hungary after World War I. They had lost the war. There was Hungary in 1946 — the worst inflation ever. It was a Communist nation.

There was China in 1947-48. The nationalist government fell; Mao took over. No more hyperinflation.

There are Latin American examples over and over. These are not major industrial economies. If we count Brazil as industrial, it had a long, severe hyperinflation, 1981-95: That was the longest hyperinflation on record.

I know of only one major hyperinflation in the industrial West: the State of Israel, 1980-86. I went there in 1985 to study it. Life went on. Tourism brought in Western currencies. So did agricultural exports. The experience did not last long. This was the longest hyperinflation in modern times. Wikipedia describes it.

“Inflation accelerated in the 1970s, rising steadily from 13% in 1971 to 111% in 1979. From 133% in 1980, it leaped to 191% in 1983 and then to 445% in 1984, threatening to become a four-digit figure within a year or two. In 1985 Israel froze most prices by law and enacted other measures as part of an economic stabilization plan. That same year, inflation more than halved, to 185%. Within a few months, the authorities began to lift the price freeze on some items; in other cases it took almost a year. By 1986, inflation was down to 19%.”

This is the central fact: hyperinflations do not last long. The currency is ruined fast. Then there is a currency reform. The central bank starts over: boom-bust, boom-bust.

If you time things perfectly, and sell assets to pay off debt, you win. But hardly anyone does. They buy inflation hedges, thinking it will go on for years and years. It ends a lot sooner than the late-comers think.

Then there is a recession. The inflation hedges fall in price. In that period, cash is king. If you have money to lend, you are in fat city. You buy up assets at a discount. In short, you get out in time.

There are few winners in hyperinflation, and they do not win for long. Then the recession hits, and things go back to normal.

2. THE FEAR OF GETTING BLAMED

Ben Bernanke is under fire as no FED chairman ever has been. The critics are in the millions. This is historically unprecedented. There is a cause: Ron Paul. Ron Paul has focused millions of voters’ attention on the FED and Bernanke. Bernanke cannot escape scrutiny any longer.

If there is hyperinflation, millions of voters will know who did it: Bald Ben the Beard and his crew of yes-men on the Board of Governors. Investors know more about the FED today than they did in 2007. This knowledge will increase.

Then there is the Internet. The mainstream media cannot control the flow of information any longer. Word gets out, and you may have noticed, not much of it is favorable to the FED.

The FED is desperate to avoid an annual audit by the Government Accountability Office. This is good. It means that people other than Ron Paul are calling for such an audit.

Rick Perry used the word “treasonous.” Michelle Bachmann has called for a FED audit. Ron Paul is still running. The FED is today the target of Republican Presidential candidates’ sound bites. This has never happened before. This is terrific. They are trying to steal Ron Paul’s favorite issue. I say more power to them. Come one, come all! Pile on!

Milton Friedman made this line famous: “Inflation is always and everywhere a monetary phenomenon.” He was correct. This insight has been resisted by Keynesian economists from day one, but the Keynesians find that the phrase has gotten into the thinking of millions of voters. Keynesians today are calling for larger deficits and Federal Reserve accommodation, but that is because consumer prices are rising very slowly. If prices were rising at 20% per annum, the Keynesians would find it difficult to conceal the source of the problem: the Federal Open Market Committee. The FOMC could not hide.

This is the central political fact facing the FED today: “It can run, but it can’t hide.”

Bureaucrats want to avoid blame. This is their #1 concern. Second is to increase the number of subordinates, in quest of a promotion. Third is to increase the bureaucracy’s funding. But the #1 concern is to avoid blame.

Bernanke will not be able to avoid blame for hyperinflation. He will therefore not adopt policies that produce it.

The FED could be nationalized. Congress could take over. Then all bets are off. But if we are talking about the existing Federal Reserve, with government-appointed academic economists visibly in charge and the privately owned and operated FOMC making the decisions — which will favor large banks — there will be no hyperinflation.

3. THE BOOM-BUST CYCLE

In Western industrial nations, including Japan, the central banks have always ceased inflating whenever consumer prices climbed close to 20% per annum. It has only happened once in U.S. peacetime history: 1977-80. Consumer prices rose in 1979 and 1980 by about 11% per annum. Jimmy Carter took the heat. He pressured the utterly incompetent G. William Miller to quit after only 18 months in office, and Paul Volcker replaced him in late 1979.

Volcker slowed the rate of monetary base growth. T-bill rates soared to 22%. The result was a recession. Carter lost the 1980 election as a result. Then Reagan took a hit: the 1981-82 recession. But prices started slowing, and interest rates began an 18-year decline.

Volcker wound up as a hero. He is still around. He is still beyond reproach. I can think of no person in power in the Carter-Reagan era who has a more distinguished reputation. Yet he oversaw two recessions.

He talked tough. He smoked cigars. Congress did not lay a finger on him.

This lesson is not lost on Bernanke. Bernanke does not talk tough. He does not smoke. But he knows this much: G. William Miller oversaw mass inflation, and never recovered. He is forgotten. He is forgotten because he left the office and made a hasty retreat to become Treasury Secretary — a no-power office. Then he disappeared. Had he held on, he would have become the fall guy: a pariah.

Here is the lesson learned by every Western, industrial central banker: the post-inflation bust will reduce price inflation. The bust can be justified as the necessary requirement to save the economy, save the currency, and save the social order.

Then the dog-and-pony show starts over.

Remember this: the FED will save the largest banks, That is its #1 unofficial task. Central banks all save the largest banks. The rest of the market can drop by 50% or more. The largest banks then re-finance on the new terms, meaning post-mass inflation terms.

As long as the largest banks are saved, the FED can put on the brakes and let the economy move into a recession.

This is the story of all central banks in large Western industrial nations ever since 1900, with only the exceptions of defeated Germany and Austria-Hungary.

The reason why Americans should not take seriously the scenarios of Germany-Austria in 1921-24 is because we are not defeated. There is no way, short of some sort of biological warfare-induced plague, that we will suffer what Germany suffered in 1921-24. In any case, during a plague, there would not be hyperinflation. There would be martial law, price controls, and rationing.

The Patriot Act offers this single advantage: it will make hyperinflation unnecessary.

Boom-bust, boom-bust, boom-bust: this is the pattern. Do not plan your future as if it will be broken.

What follows every hyperinflation? A recession. But, during hyperinflation, bankers are impoverished. So, if the result is the same at the end of the hyperinflation — a bust — why not call it to a halt early, in the mass inflation stage?

It worked for Volcker. It worked for every western, industrial banker in the 20th century except in Germany after the war.

4. THE EMPLOYEES’ VESTED PENSION FUND

The Federal Reserve System offers its employees a retirement plan. It is not as good as Congress’s, but it is better than yours. It is detailed in a 79-page document.

I regard this plan as the best payoff money in America. It is the equivalent of the Mob’s protection money. If you pay it, you receive protection… from the Mob.

We pay this money by letting the FED keep some of the money from interest payments on bonds that the FED bought with digital money created out of nothing. It can cover its operating expenses. Part of these expenses is the pension system.

This pension fund money is our protection money. The FED is not going to create hyperinflation, which would wipe out the value of its pension fund.

How big is this fund? Large and growing fast.

Contributions to the System Plan are actuarially determined and funded by participating employers. In 2010, the System made $580 million in contributions to the System Plan; the contributions may be adjusted upon completion of the 2011 actuarial valuation.

What is the fund invested in? I have provided an extract from the so-called independent audit for 2009. It was 53% in U.S. stocks, 13% in foreign stocks, and 34% in bonds — not non-marketable Social Security Treasury bonds.

Hyperinflation will play havoc with 34% of this portfolio: bonds. Stocks will not keep pace with consumer prices: 53% at risk. Only the foreign equities portion of the portfolio would not be devastated. Maybe.

This is why I do not think we are facing hyperinflation… at least not until Congress nationalizes the FED.

CONCLUSION

Whenever you hear that hyperinflation is inevitable, keep your hand upon your wallet and your back against the wall.

Hyperinflation is a policy option. It has been adopted only once by a Western, industrial nation’s central bank in peacetime since 1946: Israel’s. That is a small nation. Its leaders have not made that policy error since 1985.

If we get hyperinflation, it will not last long: a few years at the most. It will be a great disruption in the lives of most Americans, but if the government does not impose price controls, there will not be devastation. There will be losses. People will have to scramble. They will adjust. They will get poorer. They will consume capital. But they will survive.

If the government imposes price controls, as it probably will, there will be serious shortages for several years. There will be a large increase in the number of bankruptcies. Unemployment will rise. Families will be squeezed badly. But it will not last. The voters will not tolerate it. Without a war, voters will demand a reform. There are too many economists, even Keynesians, who know that price ceilings create shortages.

Hyperinflation is what Ludwig von Mises called the crack-up boom. It cannot last long because the currency system is rapidly destroyed. It no longer serves as a tool of economic calculation. People switch to gold coins, silver coins, and barter. Output falls. Capital is consumed rapidly. But then it must end. When the government cannot buy votes with worthless money, it stops inflating.

Ron Paul has performed a great public service in alerting the voters to the danger of the Federal Reserve System. He has exposed the source of mass inflation and hyperinflation. He has exposed the source of the boom-bust cycle.

The FED cannot escape. Its policies must lead to booms and busts. This is inherent in all central banking. The FED will choose a repetition of the boom-bust cycle rather than impose hyperinflation, for which it can no longer escape blame. Too many people have heard Ron Paul’s warning.

Regards,

Gary North

Gary North is the author of Mises on Money.

Mass Inflation, Yes; Hyperinflation, No was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Fed has essentially one trick. It can legally conjure new money whenever it wants. With this one trick it manages to force interest rates down. Mainly it lends the new money to the U.S. government. That is to say, it buys government bonds.

The artificial demand the Fed creates by throwing billions of dollars at government bonds has a depressive effect on interest rates. But these lower interest rates are not a result of those free market forces we champion at the Whiskey Bar. Rather, they are the result of the machinations of a government-chartered bank with a monopoly on the issuance of currency.

The Federal Reserve’s goal is to make borrowing more attractive because of the lower interest rates…but the boom that results is one built on debt that must eventually be serviced…and inevitably at higher rates.

The Fed also loves it when lower rates make lending money or putting it in interest bearing savings accounts less attractive to investors. People instead seek returns in other markets…like stocks. This is supposed to be a good thing. Notice Ben Bernanke points to a rising stock market as proof that his orchestrations were masterful.

But all he really did—all central bankers really ever do—is create new money and shovel it into circulation. Creating money to encourage mass indebtedness and speculative investing, however, isn’t exactly a winning strategy. It’s like taking up smoking so the nicotine will help your concentration when you’re picking the ponies. Or something like that.

You’ll notice that the stock market is responding less and less to the byzantine stimulus of lower bond yields. And people are up to their eyeballs in debt, and interest rates are rising despite the Fed’s efforts. This is your classic “pushing on a string” scenario. It’s rather like the point at which more alcohol starts shutting down the imbiber’s autonomic functions instead of producing more drunken bliss.

The stimulus of treasury-buying with new money is now having the opposite of the intended effect. After the initial euphoric response, things are getting worse.

And then there’s the matter of all that new money…

We’re not sure why central bankers and so many economists believe that new money can be created out of thin air—without any corresponding increase in economic activity or actual wealth—and inflationary results somehow be avoided…as if the new money will conveniently behave itself and keep from being used to bid up general price levels!

There wouldn’t be much of a problem if the Fed had only created just a few hundred new dollars…even thousands. Enough, say, to buy the legal counterfeiters cool new cars and some snazzy threads. But we’re talking about the creation of billions upon billions of new dollars here. Those dollars are sloshing their way through the economy and they’re going to show up more and more in the general price levels. (Their very creation also makes some of the other big holders of U.S. debt—like the governments in Asia—worried about being paid back with money that’s worth far less in real terms.)

Those new dollars have to get spent into circulation to do their damage, but that’s never a problem. Whoever gets them first will get to benefit before prices go up (and those prices go up at all because the new money is being spent in the first place!)

Cui bono? Why, those to whom the Fed hands the dough first. Traditionally that’s meant the government whose debt the Fed buys with the money it wills into existence, but lately the Fed has seen fit to hand new money straight to banks, because after all this is a crisis. Apparently you fix crises you engineered in the first place by bailing out your cronies in the big banks.

The government uses that money to pay the staff in its countless departments, contractors, military and others counting on a government check. The banks use the money to pay their senior members enough to keep them in million-dollar Manhattan apartments.

The rest of us get to beg our employers to give us raises that keep up with this mysterious price inflation. But it’s really not so mysterious. It happens as the first-users of new money drive up the prices on the things we all need…like food and energy.

The new money doesn’t simply go into the prices that the Fed would like it to, like stocks. It gets all over the place. The least connected, the very poorest farthest away from the new money feel the effects first. In our modern global system, that means that a family in a “developing country” will find themselves paying around half of their meager daily income for the food that used to take only a quarter of it. Eventually they may find that they can’t afford much food at all.

The typical middle class American is only just barely feeling the pinch now, but there’s a lot more pain to be felt. In 2010 Americans spent around 5% of their incomes on food. Things could be a lot worse. In fact, they likely will be soon enough. Increased food and energy prices are currently only a drag on consumer spending. Eventually, however, the essentials could get costly enough to cause serious privation.

The threat of mass starvation tends to lead to all sorts of unpleasantness. Individuals can do prepare by saving in real money (gold and silver and copper-nickel), but that does nothing to remedy the discontent and likely rioting from the millions of others who will not be so prepared.

We can’t say how much of this future woe is already baked in. We do know that more quantitative easing will just make a bad situation worse. It’s not idle speculation. History shows again and again that unbacked money creation by governments and central banks only leads to misery.

The pundits are debating whether or not QE3 will follow anytime soon or if will even follow at all. Let them hash it out. In the meantime, if you can’t or won’t get out of the U.S. entirely, you might want to consider at least not being in the middle of any large population centers.

Regards,

Gary  Gibson
Managing editor, Whiskey & Gunpowder

The Federal Reserve Is Why You Can’t Afford Food And Gas was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

He promoted the idea of educational vouchers issued by local governments and based on taxes extracted from the public. He did not consider the obvious fact that the courts would make this the wedge by which the state would take over private education. He and I debated this in 1993.

Most of all, he promoted the idea that storing gold in government vaults to back the currency is wasteful. It wastes gold. It wastes storage space. It wastes armed guards. So, to make monetary policy more efficient, the Federal Reserve should increase money — he never said which M — by 2% to 5% per annum. He wanted central-bank-controlled fiat money.

The only critics from the fringes of academia were the Austrian School economists. We knew that an efficient government is a dangerous government. We also knew that a central bank that does not face an outflow of gold in response to its policies of monetary inflation will inflate far more than would be allowed in any gold-related economy.

I responded to this argument, which had been picked up by The Wall Street Journal, back in 1969.

Hans Sennholz responded on many occasions. So did Murray Rothbard. But we were not taken seriously. We were not part of the mainstream. Academic economists had long since abandoned any support of a gold coin standard. They did not all support Friedman’s idea of a restrained Federal Reserve. In fact, very few of them supported it. They wanted flexibility. They still do.

Once Nixon closed the gold window, there was no turning back. The monetary base grew, all of the various Ms grew, prices rose, bubbles grew and blew, and the Federal debt rose to today’s gigantic, unsustainable level — unsustainable apart from mass inflation followed by hyperinflation.

The abolition of a currency convertible on demand into gold was only one part of Dr. Friedman’s contraption. The other part was his suggestion of floating exchange rates. This deserves special consideration.

Milton Friedman’s Contraption

Friedman easily took apart the idea of fixed exchange rates. Fixed exchange rates are a form of price control. Friedman was a good enough economist to know that price controls produce shortages. The artificially undervalued currency goes out of circulation. The overvalued currency produces gluts. There will be runs on central banks.

Domestic purchasers of foreign goods say to the central bank: “Sell us the artificially undervalued foreign currency at the official price.” The central bank runs out of foreign currencies. Trade collapses. There is then a devaluation. The official prices of the foreign currencies are raised to new fixed exchange rates.

It was easy for Friedman to expose this as ridiculous. “Just float the currencies,” he said. “Let the free market set their prices.” This was good advice. Price controls do not work as promoted. They always produce gluts or shortages.

But then Friedman recommended his old favorite: pure fiat currencies. He said that these can be managed rationally by means of a fixed rule governing a predictable expansion of money. “Turn it over to the Federal Reserve. All will be well if the Federal Reserve does not tamper with the rate of growth.” As John Wayne said in The Searchers: “That’ll be the day.”

Nixon adopted Friedman’s contraption. First, there would be no more convertibility of gold for foreign official government agencies.

For a little less than two years, there were universal price controls on American goods. These controls led to shortages and a disruption of international trade. The dollar was not officially floated until December 1973.

When the price controls came off, prices rose. In 1975, Gerald Ford launched the WIN plan: Whip Inflation Now. The recession of 1975 did exactly that. Then came the worst monetary inflation in American peacetime history: 1976-80. Gold and silver soared.

Friedman’s contraption clearly was not working. Floating exchange rates were not the problem. The abolition of the gold exchange standard was the problem.

Friedman’s contraption has engulfed the whole world in monetary inflation, bubbles, and busts.

Stockman on the Contraption

In a lecture to the Mises Institute on March 12, David Stockman blames floating exchange rates and the abolition of the gold standard.

That the demise of the gold standard should have been as destructive of fiscal discipline as it was of monetary probity can hardly be gainsaid. Under the ancient regime of fixed exchange rates and currency convertibility, fiscal deficits without tears were simply not sustainable — no matter what errant economic doctrines lawmakers got into their heads.

Back then, the machinery of honest money could be relied upon to trump bad policy. Thus, if budget deficits were monetized by the central bank, this weakened the currency and caused a damaging external drain on monetary reserves; and if deficits were financed out of savings, interest rates were pushed up — thereby crowding out private domestic investment.

This is an accurate assessment of what happened. But the anchor to this was not the fixed exchange rate system, because the IMF had no real authority to enforce them. The anchor was the promise of the United States to sell gold at $35 an ounce. When the chain was cut, and the U.S. kept its gold, the international currency system was cut adrift. The anchor resides in the vault of the New York Federal Reserve Bank.

In the good old days, there was pain, Stockman observed. “Politicians did not have to be deeply schooled in Bastiat’s parable of the seen and the unseen. The bitter fruits of chronic deficit finance were all too visible and immediate.” This ended in 1971.

During the four decades since the gold window was closed, the rules of the fiscal game have been profoundly altered. Specifically, under Professor Friedman’s contraption of floating paper money, foreigners may accumulate dollar claims or exchange them for other paper monies.

But there can never be a drain on U.S. monetary reserves because dollar claims are not convertible. This infernal engine of fiat dollars, therefore, has had numerous lamentable consequences but among the worst is that it has facilitated open-ended monetization of the U.S. government debt.

The government is running a $1.6 trillion deficit. Nothing can be done politically to stop this. We are on a runaway train. The main brakes were removed in 1971. The only brake now is that of the bond vigilantes, but the Federal Reserve is the buyer of bonds today, along with Asian central banks. Stockman observed that “the Fed’s QE2 bond purchases have been so massive that it is literally buying Treasury paper in the secondary market almost as fast as new bonds are being issued.”

Is all this Friedman’s fault? Stockman lets him off the hook, to some extent.

By contrast, under the contraption that Professor Friedman inspired, trade account imbalances are never settled. They just grow and grow and grow — until one day they become the object of fruitless jabbering at a photo-op society called G-20.

In all fairness, Professor Friedman did not envision a world of rampant dirty floating. Indeed, it would have taken a powerful imagination to foresee four decades ago that China would accumulate $3 trillion of foreign currency claims or more than 50% of GDP, and then insist over a period of years and decades that it did not manipulate its exchange rate!

My response: it was all Friedman’s fault, intellectually speaking. When an economist recommends a policy, he also recommends its effects. Friedman failed to see what Austrian School economists had predicted: the unleashing of fiat money, and manipulated rates — dirty floating. Dirty floating is all there is in a world run by government-licensed central banks without gold coin convertibility. But for our saying this, decade after decade, the economics profession has marginalized us.

Conclusion

Milton Friedman was always too clever by half. He advised governments to get more efficient, and they did so. They used his advice to expand their power and expand their reach into our wallets.

We told him so. He did not listen. His followers did not listen. Today, they all sit mute at the side of the road, mumbling about potentially excessive deficits and potentially excessive price inflation, but generally approving of the Federal Reserve.

The problem is the original contraption: (1) government’s monopolistic control over money and (2) central banking as such. Here, Friedman was supportive of government.

The problem was not floating exchange rates or the breakdown of Bretton Woods in 1971. Those were the inevitable results of Bretton Woods, as Henry Hazlitt warned in the late 1940s, and was fired by the New York Times for saying so.

The problem was not even the Genoa Conference of 1922, the contraption designed to solve the inflation that came as a result of the suspension of redemption in the second half of 1914, when World War I broke out.

The problem was the mass confiscation of the people’s gold in 1914: first by commercial banks, then by the central banks.

Milton Friedman’s contraption was just one more ill-fated attempt to deal with the results of the original confiscation. It was one more case of his outlook: “The government was right to confiscate the gold and end the gold standard. That was an efficient way to fight a war, just as withholding taxes are efficient, and vouchers are efficient.”

Milton Friedman spent his career defending the efficiency of the free market. But, on the really big issues, he sold his peers on the efficiency and good will of government politicians and bureaucrats. “Trust them to be efficient.”

The Austrians said the same thing, but added, following Forrest Gump’s mother, “Efficiency is as efficiency does.” The state gets more efficient only in order to tyrannize people on a cost-effective basis.

Milton Friedman’s contraption was the unchecked welfare-warfare state: unchecked by annual taxation without withholding and unchecked by the gold standard.

If that’s efficiency, include me out.

Regards,
Gary North
Whiskey & Gunpowder

March 21, 2011

Milton Friedman’s Money Machine was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.