What is a bank? According to a helpful little essay on banks for students at ThinkQuest helpfully titled “What is a Bank?”, a bank is a financial organization in which people deposit their money. A bank is a business. According to the aforementioned essay, “each bank tries to make THEIR bank look better than all of the other banks by offering services that some other banks might not have.” That is to say, banks compete in a market. This is true, conceptually at least, and also true to some extent in reality, although numerous banking laws seriously alter the market and the competition. But it is the pure idea we are after here, and in the pure idea, a bank is a business that competes in a market.

I won’t analyze every “central bank” in the world. I don’t have to because their setup is more or less the same everywhere. I’ll use the Federal Reserve System (the Fed) to represent all of them.

Historically, the Fed and other “central banks” came to be called “central banks” for several reasons. First, they are financial organizations. Second, they hold deposits of other banks and governments. Third, their assets are largely financial assets. Fourth, they make advances or loans to other banks on collateral. Fifth, the government has made them to be at the heart or center of the banking industry and the monetary system. Sixth, government power is itself centralized or national. All of these statements are factual.

Now, this is an imposing array of reasons why “central banks” are called “central banks.” But the most important of these reasons is the fifth reason, which is that the government has used its power to make the “central bank” central. And because the government has used its power to create the “central bank” and make it central, we know that the “central bank” is not a free market institution.

This is the main ground upon which I challenge the notion that a “central bank” is a bank. The concept of “central bank” fails to distinguish a free market business and a bureau created by government power. The term “central bank” undermines this distinction between free market and government. Indeed, it erases it altogether.

The Fed is not a business. It has powers that no ordinary bank has. It has privileges that no ordinary banks have. It doesn’t compete with other banks. The government created the Fed. The government gave it power to create fiat money. The government can alter the Fed’s organization and powers at any time. The Fed’s so-called independence from the government is mythological. It is that of a dog on a long leash. The only independence the Fed has is from the public.

Let’s go back for a moment to the essay on banks that I just cited, because it displays this erasing of any distinction between the free market and government. After defining the term “bank,” it lists the kinds of banks. Quite suddenly, it introduces the term “central bank” in the same breath as ordinary banks that have national or state charters. It says, “There are different kinds of banks. There are national banks, state banks and central banks. The Federal Reserve Bank is the United States government’s central bank. The Bank of England is England’s central bank.”

Suddenly, what this essay told us earlier disappears. We were told that a bank was a business that competed with other banks. But now we are told that the Fed “decides how much money is in circulation” and that it “may tell the [ordinary] banks to charge more interest or keep more money in ‘reserve.’”

Obviously, if the “central bank” has such powers, it gets them from the government. Just as obviously, the “central bank” is not a business and not in competition with other banks if it exercises these and other powers over ordinary banks.

Furthermore, distinctions between monies that ordinary free market banks deal in and the fiat money that central banks produce are completely glossed over and erased.

This essay is representative of the usual thought in the field of economics. Banks are businesses. But then, all of a sudden, there is another so-called “bank” that has an array of powers that business banks do not have. This “bank” is actually a government bureau. Its fiat money is made into legal tender by the government. The government states that it stands behind this money. This “bank” has powers to control and organize the ordinary banks into a cartel.

The facts I’ve pointed out are widely recognized. There is a Wikipedia article titled “Central Bank” that confirms this:

“A central bank, reserve bank or monetary authority is a public institution that usually issues the currency, regulates the money supply and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on printing the national currency, which usually serves as the nation’s legal tender.”

This too makes it very clear that a “central bank” is not a bank, but a powerful Monetary Authority and Fiat Money Administration.

However, the same Wikipedia article almost immediately contradicts itself when it states: “Central banks in most developed nations are independent in that they operate under rules designed to render them free from political interference.”

How can a bureau that is established by the government and possesses extraordinary powers be independent and free from political interference? The “central bank” embodies political interference!

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And to the extent that a Monetary Authority such as the Fed has been granted powers that it can exercise free of political interference, how can such an institution be held accountable? How can it operate without being responsible to the government and, indirectly, to the people?

“Central bank” independence is to a large extent a myth, that is, in the essence of the institution and in those activities in which it is not mythical, it is an unaccountable power.

It may seem as if I am splitting hairs, but what I see is that the common explanations of central banking confuse banking as might occur in free markets with so-called banking as executed by a “central bank” that is empowered by government. They are two entirely different kinds of operations. A thoughtful or questioning reader is bound to feel a degree of discomfort when he encounters these explanations that blur important distinctions.

A “central bank” is a government department. It is a government bureau. It is the government’s fiat money bureau. The “central bank” is the government’s money-printing machinery or money-printing organization or money-printing bureau or money-printing agency. As contrasted with monies produced in a free market, the Fed’s money is state-produced “money.” In the sense of comparing the Fed’s money to free-market money, it is counterfeit. It is held up by the force of government law and power. It is imposed on the public.

A more accurate term for the Fed might be the “Fiat Money Administration.” Perhaps the term “Monetary Authority” would be more accurate. It would be more accurate if the latter were the official name. In the U.S. Constitution, at least, it is clear that there is no power to create a Monetary Authority, and if there were such a power, it could not possibly be delegated in such a way as to make that Monetary Authority independent.

The “central bank” is not a real bank. Everything about it is permeated with government power. At the heart of the financial and monetary system of a nation that is supposed to be an exemplar of free markets is a government money-bureau.

Regards,

Michael S. Rozeff

Michael S. Rozeff is a retired professor of finance living in East Amherst, New York. He is the author of the free e-book Essays on American Empire: Liberty vs. Domination and the free e-book The U.S. Constitution and Money: Corruption and Decline.

Central Banks Aren’t Banks was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

And since you and I are obviously failing to produce the demand that the economy “needs,” the required demand has to come from the state. It can come from government spending (preferably debt-financed) or from the central bank printing more money and handing it to the banks. And the wider public — easily manipulated monkeys that the bureaucracy must think we are — will willingly spend, borrow, consume, invest and consume more.

Is anybody still taking this nonsense seriously? Does anybody really believe that the economy is just some tired old mule that needs a kick in the backside to get going again?

What is really wrong with the global economy? The global bureaucracy. Decades of rising taxation, increasing regulation and persistent redistribution have fundamentally and structurally weakened the major economies of the world. Underneath the glittering razzmatazz of modern technology lies a society sapped of its capitalist juices. For decades, we’ve gnawed away at our capital stock.

To make matters worse, this persistent structural decline has been masked and furthered by another evil the bureaucracy has bestowed on us: a constantly expanding supply of fiat money. Who gets first crack at that money? The banks and wider financial industry, our astute money funnelers. For decades, this has helped project an illusion of savings availability and simultaneously weakened the all-important propensity to save and to create lasting capital.

This cartel fed various asset bubbles, which, in turn, have further enhanced the illusion of wealth — diverting resources away from where they could have generated real prosperity. Now a new generation has been raised on the belief that wealth comes from consumption — not saving and production — and that you can vote for it.

The Bureaucracy Is Killing America

Remember the last time high real interest rates were allowed to cleanse the U.S. economy of such distortions? Way back in 1979-80, Fed chairman Volcker — for a short time only — stopped the printing press. Since then, and until about 2007, we had been in a three-decade-long, relentless credit expansion. The credit boom was beyond anything Mises, Hayek or anybody else of that generation could have envisioned — sadly, so is the coming bust:

Now, thanks to decades of interventionism in other fields — regulation, taxation, redistribution — the real economy that emerges from underneath the credit-funded spectacle is ugly. High unemployment and near-zero growth. Who’s surprised that half of most major economies now consist of government spending, and the other half is severely hobbled by ever-increasing regulation and meddling?

Of course, these hucksters who hijacked the global economy still enjoy the unwavering support of their cheerleaders: the likes of Paul Krugman of The New York Times and Martin Wolf and Clive Crook of the Financial Times. These guys always see the solution to policy-induced disaster in new policies (just like those that got us into this mess): If only the bureaucracy printed a few trillion more in paper money and monetized a few more dodgy bank assets… or if only it spent a few trillion more on various government programs… the old charade could be erected again. Fat chance!

If Only the Public Believed Again…

But you know what the real problem is, according to the bureaucratic elite? It is you. The public. Because some of us naughty little children have finally dared to look behind the curtain and have discovered that there is no Santa Claus.

The bureaucracy bets that you will keep accepting its paper money at face value ad infinitum. After all, that’s the bureaucracy’s final policy tool, the last arrow in its quiver.

But here’s their biggest fear: You, the public, are no longer playing ball. You are selling, or at any rate, not buying with your hard-earned savings the bonds of Italy, Greece and Portugal. You realize that these countries would never repay. So the bureaucrats have no choice but to use the printing press to correct this failure of yours.

Of course, the bureaucracy cannot talk about a failure of the public. When they want to criticize the public, they call it “the market.” And with their media circus, they can weave a new fairy tale in which the villain is “the market” and the bureaucracy is doing all it can to save you from evil market forces.

Do any of these moves by “the market” really look strange? They’re the simple result of entirely rational behavior of wealth-holders who have finally woken up to what’s going on… and simply want to protect their assets. In my view, it is entirely rational that people reduce their exposure to bloated banks and hopelessly profligated governments:

Protecting your wealth demands strategies that go against the attempts of the political class to sustain the unsustainable structures that are entirely the result of their policies. Make no mistake. If you are trying to protect your wealth, you are an enemy of the policy bureaucracy.

Best regards,

Detlev Schlichter

The Economy’s Bureaucratic Enemy 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.

Doug: Sure. This is a story that’s going to end very badly for a lot of people. I’ve said this before, in many different ways, but I think it’s worth saying again, because most people just don’t grok it…

L: Grok. From the Martian word for “drink” and “understand.” In Heinlein’s novels, water was a critical element of Martian culture — makes sense, for a desert planet. When you grok knowledge, as when you drink water, you don’t just hold it in your mouth and spit it out. You take it into yourself, it goes into your blood, and eventually into every cell in your body; it becomes part of you. This is heavy-duty understanding… Sorry for jumping in with the spontaneous lecture. I just suspect many readers will not know the term.

Doug: Or put another way, in the negative case, most people just don’t get what money really is — and what it isn’t. They take it as a given, as part of the cosmic firmament. But it’s not. A prime example of this is the mistaking of debt for money, a phenomenon David Galland pointed out in a Casey’s Daily Dispatch a few weeks ago. This is why the entire world’s monetary system today is headed for a disastrous failure. And this is absolutely inevitable. There’s no way around it.

L: Why?

Doug: Because you can’t use debt as money. As I’ve pointed out before, Aristotle, in the fourth century BC, was the first person to define what money is. And what is it? It’s a store of value and a medium of exchange.

The paper we use today is a medium of exchange — it got that way because governments made it illegal not to accept it — but it’s not a good store of value. And it’s rapidly and radically becoming less of a store of value. What we use as money today is actually not money; it’s currency. Technically, that’s simply a word that indicates a government substitute for money.

What does make for good money? Again, Aristotle gives us the answer. It’s something that has five characteristics: it’s durable and divisible, consistent and convenient, and has value in itself.

L: Some of our readers who’ve studied Austrian economics challenged us on that last bit, last time we talked about gold, because, as the Austrians pointed out, value is subjective. But you don’t mean some sort of value that’s independent of people making value judgments. You mean that people value something that makes for good money, because of its innate qualities — not something “valued” because of government threats of force.

Doug: Right. And for these reasons, gold is almost certainly the best thing to use for money. Not because I say so, nor because Aristotle said so, but because, over time, people have found it to be the most durable, divisible, consistent, convenient, and inherently valuable thing to use. Silver is also good, but it’s less durable because it corrodes. And less convenient, in that it takes about 60 times more of it — at the moment — to offer the same value as gold. Copper is the next traditional step down the ladder.

L: That, plus one reason that’s pertinent today but was not a problem in Aristotle’s world: gold can’t just be printed up on the arbitrary whims of those in power.

Doug: That’s the big one. Using metals as money takes the whole matter out of the hands of the government and its bureaucrats.

L: But we don’t use gold today…

Doug: No, as per David’s example, it’s as though a bunch of friends without any real money started exchanging IOUs for money, and then after a while forgot that the IOUs were supposed to represent, and be redeemed in, real money.

The problem with this is that, in the case of the IOUs between friends, paper is based solely on hope and trust. One can move away, or die, or turn dishonest, or become insolvent — many other things could happen. A guy stuck with a dead man’s IOU has nothing.

With government IOUs, or currencies, it’s worse, because they can increase the number of IOUs in circulation without telling anyone — that’s what inflation is. Since the government creates the IOUs, it gets the benefit of spending them before the inflation they create raises prices, which is basically stealing from the people. And, of course, sometimes governments do “die,” leaving the holders stuck with nothing, just as with the IOUs between friends. In fact, it’s arguably far more likely that such problems will arise from trusting a government to print IOUs than from trusting a friend.

L: Most people feel that they should do right by their friends — government’s don’t have friends, and most see their citizens as being property, like cattle, that require the state’s permission to do anything. Inflating the currency isn’t a crime in their view, just a tool for controlling the dumb masses. But it’s really taxation without representation.

Doug: Sadly so. And since the institution of government is based on force, on compulsion, they feel they have every right to do what they want. They sanitize all types of criminality by saying it’s in “the national interest” or some such poppycock.

L: Okay… but these currencies have worked for a very long time. Why are you right about this and the rest of the world wrong? Why is it inevitable that government currencies will fail?

Doug: [Chuckles] Because governments are not living persons who care and can be motivated to do the right thing. They are collections of individuals — politicians and bureaucrats, not exactly the most desirable types — who pursue their own interests. Regardless of the rhetoric, their interests coincide with the public good only on occasion, like a broken clock being right twice a day. Even in the most enlightened times — even in the best of times — governments have huge incentives to spend more than they take in. These are not the best of times; the population has been trained for generations to expect subsidies and freebies as their due, without regard to who pays or how they will be paid.

I’ll give you an example. When I was on the Phil Donahue Show, the day before the national elections in 1980, I was making the same philosophical points I am now. I explained how they, the taxpayers, would pay for all the goodies — like Social Security and unemployment compensation — that they wanted. A middle-aged guy in the audience asked: “Well, why can’t the government pay for these things?” And the rest of the audience roared approval.

It was then that I first realized that resistance was futile and the situation was basically hopeless. And that someone who can seem perfectly sensible when he’s discussing sports, or the weather, or the state of the roads, was likely to be a moron when it came to economics. And that when he became part of a crowd, it was even worse: he might transform into an imbecile or even an idiot.

Anyway, the dollar has existed for many years, even though it’s degraded over time — first with the creation of the Federal Reserve in 1913, then with the repudiation of domestic gold redeemability in 1933, then with the repudiation of international redeemability in 1971. Even though the government has created trillions of new ones, the dollar is still thought of as some kind of a cosmic standard. In point of fact, it’s no better than the Argentine peso and will have the same fate.

These IOUs have a quite ephemeral reality and are far too easy to create — there’s literally no limit at this point. We don’t even have to actually print them anymore, they’re created by computer strokes — so it’s unrealistic to expect fiscal restraint on the part of any government over time. It’s just too tempting to spend money to make people feel richer than they really are, buying votes.

L: Looking at the deficits and national debt, it certainly seems so.

Doug: The national debt — when was the last time you heard any average person worry about the national debt? Americans have become so used to carrying huge loads of debt around — right out of college with student loans — that it doesn’t even occur to them that there could be any reason for concern over the national debt. It’s an abstraction, like the number of light years to the Andromeda Galaxy.

People used to at least pay attention, though most would say, “It’s not a problem, we owe it to ourselves.” But that was always a delusion. Some people, organized in a club called the government, borrowed it from some other people. But now it’s even more dangerous, because the U.S. government owes it mostly to foreigners: the Chinese, the Japanese, the Taiwanese, and so forth. Americans, who at least theoretically have some interest in keeping the U.S. government straight, are tapped out. So it’s gone to borrow from other societies. And they won’t like it if they are left holding a bunch of worthless IOUs at the end of this experiment.

As the world political situation continues to deteriorate towards something I think will vaguely resemble World War III, the chances are excellent that a U.S. government at the end of its financial rope will default, likely by radically devaluing its dollar. They’re way past thinking in millions. They don’t even think in billions anymore; they’re up to trillions. Soon Obama will have to ask the buffoon he appointed as a science advisor what comes after trillions. Those nice foreigners who gave Americans physical wealth in exchange for pieces of paper are going to find that, indeed, all they got was a bunch of paper. Maybe not even that, but just ledger entries representing pieces of paper.

It’s not just the Chinese and Japanese governments that are going to be unhappy. But hundreds of millions of individuals around the world — in places from Russia to the Congo, to Mexico, to Thailand — that have a trillion of the things under their mattresses, because they justifiably don’t trust their own government’s paper, are going to be even more unhappy with the U.S.

This is big trouble. It’s not just another economic downturn when scores of millions find their life savings go “poof.” What we’re looking at is a cataclysm at some point soon. I hate to sound inflammatory, but I think the situation is much, much more explosive than it appears on the surface, much worse than you see on the TV news.

L: That’s a frightening assessment. But World War III is a topic for another day. As dire as the scenario you paint may be, is it enough to cause currencies to stop functioning as means of exchange? So few people can even conceive of an alternative…

Doug: They probably won’t stop functioning as means of exchange. At least not right away.

Even during Germany’s infamous hyperinflation of the 1920s, or Zimbabwe’s more recent one, in which there were so many zeros after the ones on the bills you couldn’t even count them — people still used the governments’ paper currencies. They still used them! When I was last in Zim, three years ago, we already had to pay for gas with backpacks full of notes; most inconvenient. In the case of Germany, there were still ten- and twenty-mark gold coins available, if not exactly in circulation. People forget that the mark, the franc, the lire, the dollar all used to be names for a certain amount of gold. [Like the pound, all were measures of weight.—ed.]

When World War I started, Germany went off the gold standard — it used to be about five marks equaled a dollar. By 1923 there were trillions to the dollar. Only the Germans who either kept those gold coins under a mattress or had foreign bank accounts still had liquid capital by 1923; everybody else was wiped out. So people didn’t spend their gold if they could avoid it.

That’s what Gresham’s Law is all about. If there is a “legal tender” money — a paper money — floating around, you try to pay your obligations in it. You try to get rid of the hot potato. But you try to get paid in the good stuff and hold on to it. The Weimar inflation of Germany was an utter disaster for that country; it led to all kinds of nastiness.

L: So many people think of Weimar Germany and Zimbabwe as aberrations from far lands, if they think about them at all. Interesting that Germany is at the heart of the euro now, facing Gresham’s Law again.

Doug: It’s been true since at least the days of Rome. But I wonder if it won’t be much more serious this time. All the world’s major currencies are issued by governments of countries that are much more urbanized, with economies that rely mostly on services. In the U.S., the UK, the eurozone, and Japan — all of their currencies are in big trouble for various reasons, and there’s relatively little production of what you might call the basics.

Back in the 1920s, or even a few years ago in Zimbabwe, half of the people still lived on farms, and a lot of people didn’t even have bank accounts, let alone credit cards and pension funds. The demise of the dollar and other paper currencies has got to be much, much more serious than these episodes in the past.

L: Currency regime change hits the global reserve currency — it won’t be easy. Let me come at this a different way. As an advocate of hard money, you understand that inflation of the money supply leads to inflation in prices. If you have 1,000 gold coins in a small village, in the unlikely event that someone digs up enough gold top make 1,000 more gold coins, you now have twice as many coins chasing roughly the same goods, and so prices will go up. But we don’t live in a hard-money economy. We’re off the gold standard. We have fractional reserve banking, we have easy debt financing for individuals, businesses, and governments. So one new dollar gets multiplied and impacts the economy like multiple new dollars. But on the downside, if you have loss of confidence in what amounts to a bunch of currency derivatives, those get wiped out in large swaths, greatly reducing the multiplier effect.

So, is it not possible that we could see the government’s unprecedented creation of trillions of new dollars in debt and currency compensated for by the obliteration of trillions in derivatives, and hence no price inflation?

Doug: That’s a good point. It’s one of the many problems with a paper money system based on credit. All those dollars are created out of nothing — inflation. But when banks fail and bonds are defaulted on, you can get deflation. With a metal money, the money supply grows only about as fast as miners can mine more — which is usually about as fast as the real economy grows. So the value of the money tends to stay constant. Or even go up, in a gentle deflation. That’s a good thing, because it discourages debt and encourages saving. And saving is how either an individual or a society gets wealthy.

But these government officials are now totally out of their depth. I remember in 2007, for once in his life since he became one of the nomenklatura, when Alan Greenspan actually said something clear and understandable. He was no longer chairman of the Fed and was, believe it or not, on the Daily Show, a comedy show. I thought John Stewart did an excellent job when he interviewed him. He asked Greenspan if he knew what the money supply really was — if he knew how big it was. Greenspan, quite candidly, said, “Well, we don’t really know.”

L: I think I found a video of this while you were talking.

Doug: There’s a titanic battle right now between the forces of inflation and deflation. When a big corporation like General Motors, or Fannie or Freddie, defaults on its debt, hundreds of billions of dollars disappear. Assets people thought they had and could have been converted into cash disappear. That’s deflationary. In a sound banking system, in which money is a commodity like gold, money can’t disappear. It can change ownership, but it can’t disappear. But in our current system, it can dry up and blow away as easily as it can be created.

One major problem that stems from this is that some people benefit from government money creation and some don’t. Who gets to spend it first, when it’s most valued, and who gets stuck holding the Old Maid card when it vanishes? It’s usually the little guy — the middle-class guy — who gets hurt when this happens. And in the U.S., the middle class is contracting. The financial gyrations we’re going through are destroying the middle class, which naïvely believes that traditional American values still hold sway and that their government is honest. The lower class has long since lost any values, and the upper class is way too cynical and self-interested to really care. Most middle-class people will end up joining one or the other of these two classes, and that’ll be a moral disaster for the country.

America used to be a place where class wasn’t really important, and you could move between classes easily — not at all like Europe or the Orient. But as the middle class gets squeezed, we’re likely to get class warfare between those on top and those on the bottom.

L: One way to look at the inflation/deflation debate is that even if we do in fact have financial asset destruction — a kind of deflation — on a scale necessary to outdo the truly phenomenal amounts of money creation the U.S. and other governments are engaged in, the implied destruction is just as bad as hyperinflation. The number of banks and other financial institutions that would fail — and with so many people having 401Ks and online brokerage accounts, the number of people whose savings and pension plans would be wiped out — would be truly cataclysmic. That’s what it would take to balance the wanton inflation of the money supply we now see in progress. If that’s the cure, it, too, is deadly.

Doug: I think that’s fair to say. Either way, it’s going to be really serious. As I pointed out a few minutes ago, when you have runaway inflation in a place like Zimbabwe, where most people are living on a subsistence level, people with gardens and chickens will get hurt, but they’ll still get by. It’s not the same when the world’s wealthiest and most advanced economies are falling apart. Americans are going to see a serious drop in their standard of living, which they are completely unprepared for, and it’s going to be a disaster. They don’t have gardens and chickens to tide them over. There’s no way around it.

L: Which brings us back to why. I mean, I’m sure many people can see the picture you’ve painted, but why is it inevitable?

Doug: Because the U.S. government and others like it are between a rock and a hard place. It is simply not a politically acceptable option to step back and let the market correct the gross misallocations and distortions the government has imposed on the economy. They must “do something” — even if they know full well it’s the wrong thing. And “doing something” means spending without raising taxes too much, because they know too much of that will slam the coffin on the economy they are trying to resuscitate. Spending on “stimuli” to “fix” the economy — direct spending on bribes to voters, like extending unemployment “benefits” to years and offering them “free” health care, etc… the way things are structured, the government must spend. Not spending is unthinkable.

There are only two ways to pay for that. They can borrow, which they can only do if they raise interest rates enough to make their bonds attractive, and that, too, would pull the plug on what you so colorfully called the “iron lung economy.” And they can print money, which they can do with some impunity, hoping the bill won’t come due until some other poor fool is in office — but that destroys the dollar sooner or later.

Everything we’ve seen shows that they are doing what is predictable for politicians, since they can appear to be “doing something” with the consequences left to the future: they are destroying the dollar.

The U.S. government is going to be running trillion-dollar deficits as far as the eye can see. Again, they can’t borrow it while keeping interest rates low, so they are going to sell their bonds to themselves, which is to say the Federal Reserve, and inflation is going to explode. There simply is no painless choice, and it’s very close to being totally out of control.

L: What about the apparent recovery of the economy? You dissed “green shoots” in one of our conversations last year, but they seem to be growing more numerous.

Doug: That’s because the government bribed people with that ridiculous “cash for clunkers” program. They gave people $8,000 to buy houses. They are hiring three times as many people to do the census as last time, and the population is not three times as large. And many more bribes. But that’s going to come to an end, and it’s going to get much more grim than it was in the fall of 2008.

L: And this financial apocalypse now, as we termed it last week, is the natural endgame of using fiat currencies instead of real money — this is why you can’t use debt as money.

Doug: That’s why you don’t use debt — IOUs — for money. And those people who are complacent about this, those who read these words and know we’re right but take no action because they can’t believe things will get that bad in America, are going to be very unhappy in the near future.

Readers should do something now, while we’re still in the eye of the storm, while there’s a small cyclical improvement happening, and when most of boobus americanus thinks happy days are here again.

Not only do we have to go through the other side of this storm, but then there’s an even bigger hurricane after that. This is just the beginning of the troubles ahead. Take action now.

L: Financial self-defense 101 — that’s what we teach Casey Research subscribers. But let’s walk through some of the generalities here. Reasonable actions to take would include: buying gold, diversifying assets offshore, and… would you still recommend going to cash with inflation on the way?

Doug: Here’s an easy way to remember it: I would liquidate, consolidate, speculate, and create.

Liquidate: Get rid of any assets you have that might have been favored by the old economy but are likely to be blown away by the new one. That would include speculative real estate holdings in formerly hot markets. Maybe even sell your house, if you can, and rent instead. Or, for sure if you keep your house, get a big mortgage at a fixed low rate that will probably be inflated out of existence. And get rid of your houseful of stuff — the junk filling your basement, your attic, that storage unit you’re renting — anything you don’t really need. Turn it into cash.

Consolidate: Cut your expenses to the bone and consolidate your assets. The best way to do that is to buy gold and silver in cash form (coins) and put them away as savings. The other critical element is getting a major portion of your assets offshore.

Speculate: With the government creating bubbles through its mammoth spending programs, and other bubbles popping, like the collapse of more major corporations, take chances on winning big on bets placed on these trends. It’s possible in such volatile times to make a lot of money, just as you do for subscribers to the International Speculator, and Marin does for the Energy Report.

Create: In the coming years, the world is likely to change as radically as it did entering the industrial revolution. This is going to be a really major change, economically, politically, technologically, demographically, socially, militarily — the whole ball of wax. This is a good time to look around and ask yourself, not, “Who will give me a job?” but, “What goods and services can I provide that people will need in the future and pay me for?” What worked during the late Long Boom won’t work — in order to create, you’re going to have to think creatively.

L: I guess I won’t be working on a business plan to become a personal trainer.

Doug: [Laughs] Nor is becoming a barista a good plan for personal survival at this point.

L: Seriously, I’ve listened to you, Doug. As you know, I’ve decided to buy a lot in your Estancia de Cafayate project in Argentina, I’m consolidating, liquidating, and creating — and speculating, that’s what I breathe, drink, and eat. Thus far, it’s made a huge, positive difference in my life. I sincerely hope our readers are doing or will do the same.

Doug: I know you are. I just wish everyone was as quick a study.

L: Thanks boss. Until next time.

Doug: Talk to you soon.

Doug Casey and Louis James
Whiskey & Gunpowder

March 12, 2010

How to Survive Financial Collapse Right Now was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“It’s getting increasingly evident that this is a once-in-a-century type of phenomenon,” he told the ever-fragrant Maria Bartiromo in an interview with CNBC this week, “not the standard type of liquidity crisis that we have seen in the past.

“It’s verging on the issue of solvency.”

To gauge the true scale of this crisis, Greenspan went on, just consider the fact that it took sovereign credit to stabilize first the U.K. and then U.S. financial systems. When Northern Rock went belly-up last Sept. and then Bear Stearns blew up this spring, Treasury bonds had to be lent out like adjustable-rate home loans circa 2006, covering short-term black holes with government debt.

Without these loans of government bonds, the banks simply wouldn’t lend to each other. They needed securitized tax payments to gain the credibility needed for raising new funds in the market. Short of offering government debt to put up as collateral, they found the cost of borrowing money — when they found any money to borrow — simply too high to bear.

“It’s still very evident from [inter-bank lending] spreads that we have not gotten closure yet,” Dr. Greenspan continued, pointing to the ongoing premium charged for loans backed by anything other than sovereign credit. So to fix the problem — or at least tease it out for months if not years — clearly the world needs more government bonds for the big banks to borrow and put up against cash loans in the market.

“It’s essentially, fundamentally the price of homes in the United States which are determining…the ultimate collateral of mortgage-backed bonds, pretty much around the world.”

Looking ahead, he concluded that “we’re still nowhere near the bottom of the home-price thing” — the word “thing” standing in for “crash…collapse…crisis…deflation” and all the other phenomena Greenspan must still believe can never apply to real-estate prices.

As key contractor, if not the architect, of today’s pan-global banking crisis, he chose to keep U.S. interest rates way below the rate of inflation — making debt pay and savings a suck of real value — for three years straight starting in August 2002:

That period marked the first run of sub-zero returns paid-to-cash since the inflationary ‘70s, back when loose money worldwide led to a bubble in prices that needed 20% interest rates to revive the world’s faith in the dollar.

The start of this decade also saw the gold price — dormant-to-dead ever since the U.S. took that strong medicine at the start of the ‘80s — double inside five years.

“First warning,” as Marc Faber wrote in his Gloom, Boom & Doom Report of Sept. ‘07, of trouble ahead.

“Ultra-expansionary U.S. monetary policies with artificially low interest rates led to bubbles all over the world and in every imaginable asset class. The price of gold more than doubled in nominal terms and against the Dow Jones Industrial Average.”

So why didn’t gold take a dive when Greenspan’s successor — Ben Bernanke — tip-toed his way back to 4% real rates of interest in late 2006…? Because early gold buyers never believed the Fed would succeed in keeping rates there. With housing now a political issue — and home ownership a god-given right for even the flakiest debtors — the first sign of trouble would cause a collapse in real rates, destroying the value of money in the hope of achieving “Reflation Part II.”

Hey, it worked after the Tech Stock bubble blew up. Why not again? And faced with a much greater crisis, or so Ben Bernanke believes, he’s managed to out-Greenspan the Maestro…pushing real U.S. interest rates way down to minus 3% and worse.

Take gold as a marker of stress, and the true extent of today’s crisis becomes clearer still. Bear Stearns’ firesale to J.P.Morgan in mid-March — which required an open-ended loan of $29 billion from the Federal Reserve — saw gold jump to $1,032 per ounce. We think it’s a signal that Alan Greenspan ignores it.

“Central banks, of necessity, determine what the money supply is,” as he told Congress in a 1999 hearing. “If you are on a gold standard or other mechanism in which the central banks do not have discretion, then the system works automatically.

“The reason there is [now] very little support for the gold standard is the consequences of those types of market adjustments are not considered to be appropriate in the 20th and 21st century. I am one of the rare people who have still some nostalgic view about the old gold standard, as you know, but I must tell you, I am in a very small minority among my colleagues on that issue.”

Today, almost a decade later, the Federal Reserve and its peers across the world are trying to prevent the money supply from shrinking again. That was the fear amid the “Deflation Scare” of 2002, which caused the Fed to ordain sub-zero rates, creating not only the bubble in housing but also the collapse of true money values against oil, food and pretty much all raw materials.

The world’s nostalgia for gold, in response, has seen it treble in price vs. the dollar and more than double against the Euro, Yen and British Pound. But the cheerleader for cheap money when running the Fed, Alan Greenspan points instead to government bonds when gauging the size of today’s crisis. A true policy wonk, Greenspan thinks only of political bailouts to protect the system, rather than considering how private investors might choose to protect themselves and their wealth.

Heaven knows they won’t get any help from Bernanke’s repeat of the Maestro’s “reflationary” error.

Regards,
Adrian Ash
BullionVault
August 11, 2008

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

But Hofmann’s hallucinations seem little worse than most acid-induced visions. Or so people tell us…

“Beginning dizziness,” he wrote in his lab journal for 19 April 1943. Looking to find a stimulant for the circulatory and respiratory systems, he’d just concocted — and taken — a big dose of lysergic acid diethylamide-25.

“Feeling of anxiety,” he noted, before adding in due course “Difficulty in concentration. Visual disturbances. Desire to laugh.”

Finally, Hofmann scrawled the words “most severe crisis” and fled the lab on his bicycle. It seemed to stay stationary even as it wheeled him back home, where his neighbor — who brought him a nice glass of milk to calm him down — appeared as a witch in a colored mask.

He felt possessed by demons. The furniture in his bedroom began to menace him. All pretty run of the mill stuff if you dabble with psychotropics, in short.

But such “fantastic images” don’t always ease into the sensations of “good fortune and gratitude” Hofmann got to enjoy later that day. Hallucinations can still cause the “most severe crisis” — even without some fool laying Witches Hat by the Incredible String Band on the turntable.

“Inflation will return to the two percent target,” claimed Mervyn King, head of the Bank of England, and one half of the financial furry freak brothers running Anglo-American monetary policy.

“Growth will eventually recover to a sustainable rate.”

Just a central banker’s wide-eyed hallucination? Maybe not. Like Albert Hofmann’s wobbly bike-ride six decades ago, the credit cycle will get us home in good time, ready to turn once again from boom to bubble to bust. But like any powerful psychedelic, the trip gobbled down by Western investors could last much longer than anyone dares hope right now.

And just what was the Governor smoking when he claimed, “In these [current] circumstances, the household saving rate is likely to rise…”?

The Bank of England has been cutting U.K. interest rates since December. Its latest Inflation Report says it will continue to cut interest rates “in line with [bond] market expectations,” too.

And U.K. households have grown their savings only once when interest rates fell in the last four-and-half decades. That brief period lasted for two years at the start of the 1990s.

Both before and since — and most markedly during the previous post-war recessions (of 1974 and 1981) — people have tweaked their savings almost precisely in line with changes to the rate of interest, as set by the Bank of England itself.

King’s starry-eyed vision, however, “is part of a rebalancing of the U.K. economy, away from spending and importing, toward saving and exporting,” he told reporters last week.

The sky’s turned all purple in Washington too if U.S. policy-makers think the credit crunch will somehow boost household savings there.

Put another way, “who had heard of collateralized debt obligations just 10 years ago?” as Niall Ferguson, history professor at Harvard, asked in a speech opening New York’s new Museum of Finance back in January this year.

“Collateralized loan obligations? Credit derivatives? These forms of financial instrument are of very recent origin. So are the hedge funds; so are the private equity partnerships; so are the sovereign wealth funds; and so are those wonderfully named entities, the conduits…”

Ferguson then flashed up a series of charts “to illustrate the speed with which these phenomena have proliferated.” First, mortgage-backed securities. Starting in 1980 – “when scarcely any such thing existed” — they total $3.5 trillion-worth today. Then he cited “the whole range” of other newly born asset-backed instruments — automobile loans, equipment loans, student loans, credit card-backed debt derivatives…

“Over the counter derivatives outstanding?” the professor asked. “Well, if you’d asked someone to name that figure in 1987 it would have been a very small number indeed.”

Ferguson’s theme bears repeating; he likens the huge growth in complex financial products to an evolutionary spurt, “an explosion of life forms [amid an] unusually benign climate.”

Whereas I see it more as a chemistry experiment gone horribly wrong. The hare-brained PhDs mixing up the medicine are too spaced out to even guess at what’s now sitting in the Petri dish. And the financial monsters it has spawned aren’t merely in the scientists’ minds.

Take hedge funds, for example; Ferguson notes that in 1990, those financial life forms known as “hedge funds” numbered around 600 (also including funds of funds). Now they’ve reproduced and multiplied up toward 10,000.

“As a form, the hedge fund dates back to the 1940s. But this population explosion is of very recent origin.”

The raw numbers also hide a “regular, annual dying out”; there’s chronic survivorship bias in the data. In 2006, for example, 717 hedge funds were culled; the 2007 figure should be even larger. And here, believes Ferguson, we see survival of the fittest in action. If he’s wrong, perhaps it’s just the contingency of life itself, allowing the standard proportion of idiots to thrive and market their “top decile” performance to a new generation of unwitting investors.

“A lot of reporters ask me these days whether we’re in the midst of a commodity bubble,” said Dr. Benn Steil, senior fellow at the Council on Foreign Relations, at the Hard Assets Conference in New York in mid-May.

“In fact, I’m going to Washington to give a Senate testimony. [Because] my perspective is that the more interesting, and indeed more important, question to ask is whether we’re at the end of what I would call a ‘fiat currency bubble’.”

Like Professor Ferguson, Dr. Steil looks back “to the early 1980s” to find the origins of whatever it is we’re now watching mutate, if not die out.

Under Paul Volker at the Federal Reserve, “inflation, and at least equally importantly inflation expectations, were driven out of the system through a pretty ruthless policy of very tight money, high interest rates. Very tight money.”

What followed was “the golden age of the fiat Dollar” says Steil, reminding us that credit expansion was unshackled from gold in 1971, when Richard Nixon stopped redeeming the U.S. currency for bullion altogether. It took tight money — “very tight money” — to bring the resulting inflation of the 1970s under control.

The fiat money experiment then broke out of the lab with the “explosion” of financial life-forms witnessed from 1980 right up to last summer. Indeed, it all ran just fine until around 2002, when the cost of key raw materials — notably wheat and oil, as in Steil’s charts above — began to shoot higher in terms of Dollars and other government-backed currencies.

Measured against gold prices, however, they’ve barely budged. “That shouldn’t surprise people,” says Steil, “because as we go back to the era of the gold standard from about 1880 until the outbreak of the First World War in 1914, prices around the world in countries that were on the gold standard were also remarkably flat.

“The figure looked just like this. So gold is behaving as it has historically.”

In the hot, fetid climate of low interest rates and surging credit supplies, central bankers like Ben Bernanke and Mervyn King are hallucinating if they think they can control the monsters spawned by the fiat money experiment.

And tripped out on delusions of “minor god” status, these furry freaks really do believe they can talk Wall Street and the City back down from their current wave of “worst crisis ever.”

Regards,
Adrian Ash
BullionVault
May 27, 2008

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