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.

It seems like an odd result for a man to be in such a hurry to get to, at least until you consider the alternative. In a way, it’s an early example of government not being able to get anything right. Not even a hanging…

You see, Guy had just watched his fellow English-Catholic conspirators hanged until nearly dead. Then they were cut down. Their most private parts and entrails were removed and burned before their eyes. Then they were beheaded.

This all happened to Guy Fawkes, too…except wily Guy made sure he was too dead to notice. So what offense warranted this extreme torture and dismemberment?

Guy and his co-conspirators felt that the crown made life miserable for the Catholic minority in England. In truth, the crown was doing exactly that.

So on the 5th of November, they planned to ignite the dozens of barrels of gunpowder they’d packed under Parliament. Their plan was to blow up the king.

The conspiracy was uncovered and thwarted. Torture, confessions and painful executions followed. This was the end of the now-famous Gunpowder Plot.

For centuries afterward, Londoners have organized a curious bonfire on the Nov. 5th anniversary of Guy’s bust. They even gave it a catchy phrase…

“Remember, remember the fifth of November,” they chant.

We say “curious,” because it seemed that half the chanters hated Guy… while the other celebrated his rebellious spirit.

The “Gunpowder” part of our name comes from the Guy Fawkes story. The “Whiskey” comes from the 1794 rebellion in western Pennsylvania, when residents protested new whiskey taxes imposed by Treasury Secretary Alexander Hamilton.

Hamilton had raised taxes in an effort to pay off the national debt. Sound familiar?

I guess you can say Whiskey & Gunpowder welcomes the idea of rebellion.

We believe it’s not only our right, but our duty to fight back when a select few try to tell the rest of us how to live our lives.

Frankly, folks in Washington, D.C., are more concerned about sucking as much as they can from the system before the whole thing collapses.

They’re more concerned about bailing out fellow friends and CEOs than they are about creating a friendly environment for entrepreneurs to thrive.

Take our currency, the U.S. dollar, for example…

It’s been nearly 40 years now since the dollar had even the slightest connection to gold.

Our money is backed by nothing but empty promises. The government holds the power to print itself out of any problem.

That “power” the government holds has corrupted the system. Banks and well-connected businesses know they are very likely to be backstopped by the feds.

So they can still pocket the profits… while you and I shoulder the risks of their bad decisions.

Or take interest rates…

In an effort to create more liquidity — and, subsequently, higher profits for banks as they pay less interest to depositors – the Feds pushed interest rates to historic lows.

Their perverted economic policies encourage Americans to SPEND, rather than SAVE, their money.

Back in Guy Fawkes’ day, the government was punishing Catholics. Nowadays, it’s not about religion.

It’s about the government telling us what we should and shouldn’t eat… forcing us to wear seat belts and helmets for nearly everything… and, most importantly, for punishing the hardworking savers and entrepreneurs that create growth.

In short, it’s the idea people and middle class that are getting squeezed. Actually, hanged is more like it.

Think about it: It’s not the bankers and politicians that’ll be most affected when this economic s%$t hits the fan. They’ll likely have their backdoor deals and bailouts. There’s little you or I can do to stop this.

The poor won’t be affected, either. That’s because they haven’t saved anything that the government can destroy. They don’t have anything to lose. Instead, they’re kept happy, oblivious and complacent with food stamps and social welfare programs. It’s the middle class that will feel the most pain.

The people who’ve worked hard… tried to play the game honestly… saved… and invested wisely.

The people who are frustrated by rising prices… who are now pushed into risking money in the stock market in order to try to gain a decent retirement income.

That’s why, for the first time ever, we’re asking you to band together to celebrate our own fifth November…

How You Can “Remember, Remember the Fifth of November”

This Nov. 5, we’re organizing our own Guy Fawkes event.

Don’t worry…we’re not organizing a protest…we’re not aligning ourselves with the Occupy movement to “quit the banks”…and we’re NOT suggesting violence in any way.

And we’re not suggesting you stock up on gunpowder, like our friend Guy did.

Instead, we want to organize a mass rejection of the U.S. dollar as our currency of choice by ditching the dollar!

That’s right. It’s time to tell Ben Bernanke, Tim Geithner and the Wall Street banks that the fiat dollar experiment — which has sucked wealth away from every American family — has failed!

We want to prove that we as a nation won’t stand for reckless spending… out-of-control money printing… and the threat of future taxation.

So I’m asking you to band together to show the government that we’re “opting out” of this failed U.S. dollar experiment.

In its place, we demand a currency that cannot just be “printed” at the whims of a small group of men with ulterior motives.

It starts today…with two special reports we’d like to send to you for free.

The first report I’d like to send you, for free, shows you how to take advantage of what literally could be one of the LAST hard money loopholes on Earth.

It’s one of the safest “zero downside” investments I’ve ever seen.

You literally… can’t… lose… money… on the deal.

Seriously.

Complete upside.

Inside, you’ll find a simple secret that allows you to turn every U.S. dollar bill into something worth $1.10.

You will also learn how a hedge fund trader — who made millions during the credit crunch — recently put $1 million into this last hard money loophole. He then said in an interview, “You really ought to call your bank and buy some now.”

I call it The Last Legal Hard Money Loophole in America. And it’s yours free when you click here.

Regards,

Gary Gibson

Why You Should Remember the Fifth of November was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Let’s go through the salient points:

1. Write-down of Greek debt to 50%

“Private-sector involvement,” aptly abbreviated PIS, is one of those dreadful phrases that conceals more than it explains. The private sector here means, of course, the banks that were stupid enough to give billions of euros to Greek politicians.

We all know what happens under capitalism to lenders who give money to borrowers, who end up being unable to pay: They lose their money. That is how it should be. That’ll teach them and, hopefully, make them more prudent lenders in the future.

Alas, this is Europe, so there is no capitalism. You can negotiate your losses with the political class and agree on the “appropriate” haircut. In July, a 20% write-off was agreed, now this was upped to 50. Either number is entirely arbitrary.

The positively Orwellian phrase “private-sector involvement” makes it sound as if these poor banks were just innocent bystanders — and respectable members of the private sector, for that matter — who got dragged into this unfortunate business at no fault of their own.

For how much should the “private” sector be “involved”? Well, I would say for exactly as much as it chose to involve itself in the first place, by voluntarily lending money to the Greek government. I mean, have the risk managers and credit analysts at the likes of Credit Agricole and Societe Generale ever been to Athens and inspected the bottomless pit in which their loans were dumped? Or have they, from the start, assumed that the German taxpayer or the ECB would cover their losses?

Of course, a haircut of 50%, as now agreed in Brussels, is better than the ridiculous 20% or so “agreed” in July. But looking at Greece’s dire financial situation, the haircut should be at least 60%, or maybe 90 or 100. There is no reason for the Greek citizens of this and future generations to suffer endlessly because of the corruption of their past governments and the stupidity of their bankers. Embrace default! Just stop paying, go bankrupt, shrink your government, role up your sleeves and start from scratch.

After a complete and proper default, the state will not get loans easily again. This, coincidentally, is an additional bonus of a complete government default. It keeps your future politicians honest. That would be the free-market solution. But again, we are in Europe.

An even bigger haircut, one decided not by political horse-trading but by the market and Greece’s true ability to pay, would be more helpful for the Greeks and would, conveniently, discipline the bankers. Why is it not considered?

Well, the politicians don’t like it, because it would shut much of the government bond market down and make it difficult or impossible for them to keep running deficits of their own, and also, because the banks have skillfully booby-trapped the entire financial system with explosive CDS (credit default swaps) that get triggered if the “private-sector involvement” gets too big. The bankers, increasingly, resemble financial terrorists, effectively declaring, “If you don’t bail us out, we blow the whole place up!”

The bottom line: A haircut of 50% is better than 20, but it is still too little for Greece, and the whole idea that the “private” sector negotiates losses with the politicians doesn’t bode well for the future.

2. Fiscal coordination

Nothing specific was agreed at the summit, but this is where we are going, and the mainstream economists are cheering for it.

For years now, we have heard this in endless macroeconomic research pamphlets and newspaper editorials: There can be no monetary union without a fiscal union. This is, of course, utter nonsense. Complete rubbish. And it doesn’t get any more right by repeating it at nauseam.

The money of capitalism, of the free market and global trade, has always been gold (or silver, but I will refer to gold here). A gold standard is the oldest and best currency union imaginable, and I would argue, the only one workable. Under a gold standard, various countries and their governments use the same currency, gold. There is no central bank and no printing press. Governments have to make do with the income they generate from taxing their local population.

In such a system, the state has to live, just like any other entity in society, within its means. Apparently, this is a truly fantastical notion for today’s politicians and mainstream economists. Under a gold standard, the state may also borrow from the market, but it is clear to the lenders that they assume full risk of default. There is no lender of last resort. This is a powerful constraint on government largesse.

The Greek crisis was a good test to see how closely the European fiat money union could resemble the workings of a proper gold standard. In theory at least, and as intended by the original designs for EMU, there should have been no bailout, and the whole mess should have been a local affair between the Greek government and its lenders, just as it would be under a gold standard.

All this nonsense about the falling apart of the euro was, of course, needless but politically motivated scaremongering. When a government defaults under a gold standard, there is no reason why any other government should give up gold as a currency. Had the no-bailout provision been adhered to, there would equally have been no reason why a Greek default should have affected the acceptance and the usability of the euro in any of the other countries, nor for the Greeks themselves. A currency union does not require a fiscal union.

But EMU is no gold standard, and it already failed its first test of whether it could even be a currency union of some discipline. The gold standard was abandoned globally, precisely so that governments would not have to live within their means. The euro is political paper money, fiat money. It is issued to allow persistent fiscal irresponsibility, as is any other paper currency. Central banks have always been created to fund the state and the banks. The ECB is no different.

This is the global picture in 2011: After 40 years of complete paper money, public debt around the world has reached such momentous dimensions that the major central banks are now increasingly funding the state directly. This is what is happening in the U.S., the U.K. and increasingly, the eurozone. It is either accepted with suspicious equanimity or enthusiastically supported by bank economists and the inflationistas in the mainstream media. The trend is the same pretty much everywhere. It is only that, within the eurozone, it is less clear which government has first call on the printing press. In other paper money economies, this can be done more straightforwardly.

To assume that some form of institutional framework for fiscal coordination will discipline the European governments and reduce the desire for ongoing central bank debt monetization is at least naive. Maybe outright stupid. All governments in Europe are fiscally irresponsible, even the German one.

In the run-up to EMU, Germany imposed the Maastricht criteria on her European partners. Anyone remember the 60% debt-to-GDP limit? Laughable. Today, Germany is at 83% and rising, which may look relatively prudent if compared with Belgium or Greece, but if Germany has to pay up on its already-agreed-upon commitments under the European Financial Stability Fund, she will go above 90% in one giant leap, roughly where Ireland was when her creditors said, “No mas!” Germany may have the lowest unemployment rate in 20 years and, last year, had the highest GDP growth in 20 years, but she is still running deficits, accumulating debt every year, just like anybody else in Europe.

On a long-enough timeline, everywhere is Greece!

The bottom line: We will see a plethora of treaty changes, top-level EU summits and other pointless boondoggles. All to no avail. To assume that governments will not collectively resort to the printing press and that they will, instead, discipline one another, when all of them are long-standing, habitual and incorrigible fiscal offenders, is beyond ridiculous! If you believe it, call me, I may have something I want to sell you!

3. “Unlimited firepower” courtesy of the central bank

I guess you might argue that it could have been worse. Merkel could have given in to demands by Sarkozy to use the ECB straight away to leverage the €440 billion bailout fund. Seems like she didn’t, and Sarkozy will have to go, hat in hand, to the Chinese and see if they have some change to spare. However, this is not a long-term solution, and once Italy and Spain are in trouble, the bailout fund will be depleted.

One of the most shocking aspects of this crisis is how acceptable it has become for the mainstream economists and the pundits in the media to point toward the “unlimited resources” of the ECB. True, a fiat money central bank can print unlimited amounts of paper and electronic money to bail out everybody, the government, the banks, the pension funds, etc. It is just that such a policy used to be advocated only by suicidal cranks. That’s likely because it is a sure recipe for complete currency annihilation.

Today, established and supposedly highly regarded economists point out the importance of “keeping the ECB engaged,” because only the ECB has the “unlimited” resources to underwrite the boundless fiscal profligacy of modern democratic governments and their vote-buying political elites, and to underwrite the gargantuan debt pile.

As the hysterical calls by the inflationistas for a bold ECB policy get ever shriller, Mario Draghi, the new money-printer-in-chief for Europe, has already signaled his support for the ECB’s debt monetization policy, that is, ongoing buying of depressed and ultimately worthless government bonds with the help of the euro printing press.

Anyone who has any savings stored in the euro-area should be extremely concerned about what is going on here, and in particular, about the tone of the debate. When the mainstream speaks of “unlimited” resources of the ECB, they do in fact mean unlimited. The creation of new euro-currency units will be without ANY LIMIT. And the remaining inflation will also be without limit.

The bottom-line…On the face of it, the German position has won: deeper haircuts and no use of the ECB for leveraging the EFSF for now. But from where is the money for the larger EFSF going to come? Italy and Spain will remain under pressure. Nobody has the money to save them or to recapitalize the banks again when the big deficit countries lose access to the market and fail.

The ECB is not off the hook. Resorting to the printing press has become a global policy theme for the past three years, and sadly, such thinking is now part of the mainstream. The balance sheet of the ECB will not shrink; it will grow. There is no exit strategy. Pressure for further and accelerated monetization of debt, of budget deficits and bank balance sheets, will continue and intensify. The endgame will be inflation.

Regards,

Detlev Schlichter

Europe’s Future Comes Into Focus: Hyperinflation 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.

The insidious method of this undercutting the competition? Underpricing of the currency. More accurately, however, the Chinese central bank is just matching the monetary inflation of the U.S. central bank. If China’s government underprices their currency, it’s only because they are trying to keep up with the U.S. government underpricing its currency.

Politicians are calling for China to knock it off. Or else. They want China to let their currency appreciate against the dollar, instead of losing value as quickly as the dollar.

In difficult times like these, it’s natural for people to look for someone to blame. The usual targets are being drug out before the crowds. The Occupiers around the world are blaming capitalism and the rich. The politicians in the U.S. are blaming China.

China’s undermined the might of U.S. manufacturing. They didn’t play fair. It’s not just a matter of outcompeting U.S. manufacturers on quality and price. They dealt from the bottom of the deck with currency manipulation.

That sort of thing ignores what policies and practices here in the U.S. might have done to make American business less competitive in the first place. It’s far easier to point the finger at foreigners.

Even if China’s currency is “unfairly” undervalued, politicians and lawmakers may be doing more harm than good by seeing to it that imports from China cost more.

This is where the unintended consequences come in. Unintended consequences are inevitable when politics interfere with individual preferences in the market. Tariffs or a rising renminbi would increase the price of Chinese imports in the U.S. This is supposed to lead to more jobs for Americans, as manufacturers would then find no benefit to set up in China.

But the goods produced here would be more expensive than they used to be coming out of China. More-expensive everyday goods are not exactly what Americans may need, with wages stagnant, falling and disappearing altogether.

The argument is that American jobs would be created, and the economy as a whole would be better off. But the true benefit would be for some exporting manufacturers, while the rest of society would pay for it in higher costs of goods.

Price inflation is currently written off as a nonissue because the “core” stuff of food and energy — which tends to rise plenty — are discounted. A rise in the renminbi would mean that all the other things Americans buy would no longer be cheap. Their prices would rise, too.

Further, a higher renminbi would mean that the Chinese themselves would have  more purchasing power per capita. Right now, China’s government would like for its purported economic might to benefit its people, whose purchasing power has been kept down in order to fuel the export market. These Chinese consumers would use that stronger renminbi to bid for the the same commodities that Americans wish to buy. We wonder how long it would take for American politicians to start blaming the Chinese for allowing their currency to rise, and causing higher food and gas prices in the U.S.

So a rapid rise in the strength of China’s currency could, easily, mean higher prices for everything in the U.S. There may be a rise in overall employment, but there is certainly no guarantee for a rise in overall wages to offset higher prices. In fact, it’s unlikely that the Federal Reserve would abandon its inflationary policies anytime soon. So Americans may end up in much the same situation the Chinese find themselves in now: with a strong export market but declining purchasing power.

Our stance is that it was government that caused the problems in the first place and government that will make the problem worse with more nonmarket solutions. The U.S. is going down the path of protectionism, continued currency debasement, trade wars that could end up being hot wars.

After a generation of accelerated debt expansion, thanks to central bank policy that resulted in wild malinvestments and bubbles in housing and education, Americans will have to contend with being poorer for a while. The scapegoating of China may score political points, but it will lead to bad economics that will make life even harder for Americans.

And there’s always the possibility that protectionism could lead to open hostility between the U.S. and Chinese governments. Wars cost both human misery and dollars. They’re paid for with higher taxes and currency debasement. But wars also tend to get a lot of popular support, if spun properly. So Americans may cheer as they find their standards of living declining even further, while their troops are shooting at yet another enemy.

Regards,

Gary Gibson

Protectionism Could Lead To American Poverty was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

To act under these constraints — or rather, lack of constraints — is what constitutes politics and political action, and it should be clear from the outset that politics, then, by its very nature, always means mischief. Not from your point of view, of course, but mischief from the point of view of those subject to your rule as ultimate judge. Predictably, you will use your position to enrich yourself at other people’s expense.

More specifically, we can predict, in particular, what your attitude and policy vis-a-vis money and banking will be.

Assume that you rule over a territory that has developed beyond the stage of a primitive barter economy and where a common medium of exchange, i.e., a money, is in use. First off, it is easy to see why you would be particularly interested in money and monetary affairs. As state ruler, you can, in principle, confiscate whatever you want and provide yourself with an unearned income. But rather than confiscating various producer or consumer goods, you will, naturally, prefer to confiscate money. Because money, as the most easily and widely saleable and acceptable good of all, allows you the greatest freedom to spend your income as you like, on the greatest variety of goods. First and foremost, then, the taxes you impose on society will be money taxes, whether on property or income. You will want to maximize your money-tax revenues.

In this attempt, however, you will quickly encounter some rather intractable difficulties. Eventually, your attempts to further increase your tax income will encounter resistance in that higher tax rates will not lead to higher, but to lower, tax revenue. Your income — your spending money — declines, because producers, burdened with increasingly higher tax rates, simply produce less.

In this situation, you only have one other option to further increase or at least maintain your current level of spending: by borrowing such funds. And for that, you must go to banks — and hence, your special interest also in banks and the banking industry. If you borrow money from banks, these banks will automatically take an active interest in your future well-being. They will want you to stay in business, i.e., they want the state to go on in its exploitation business. And since banks tend to be major players in society, such support is certainly beneficial to you. On the other hand, as a negative, if you borrow money from banks, you are not only expected to pay your loan back, but to pay interest on top.

The question, then, that arises for you as the ruler is: How can I free myself of these two constraints, i.e., of tax resistance in the form of falling tax revenue and of the need to borrow from and pay interest to banks?

It is not too difficult to see what the ultimate solution to your problem is.

You can reach the desired independence of taxpayers and tax payments and of banks, if only you establish yourself first as a territorial monopolist of the production of money. On your territory, only you are permitted to produce money. But that is not sufficient. Because as long as money is a regular good that must be expensively produced, there is nothing in it for you except expenses. More importantly, then, you must use your monopoly position in order to lower the production cost and the quality of money as close as possible to zero. Instead of costly quality money, such as gold or silver, you must see to it that worthless pieces of paper that can be produced at practically zero cost will become money. (Normally, no one would accept worthless pieces of paper as payment for anything. Pieces of paper are acceptable as payment only insofar as they are titles to something else, i.e., property titles. In other words, then, you must replace pieces of paper that were titles to money with pieces of paper that are titles to nothing.)

Under competitive conditions, i.e., if everyone were free to produce money, a money that can be produced at almost zero cost would be produced up to a quantity where marginal revenue equals marginal cost, and because marginal cost is zero, the marginal revenue, i.e., the purchasing power of this money, would be zero as well. Hence, the necessity to monopolize the production of paper money, so as to restrict its supply, in order to avoid hyperinflationary conditions and the disappearance of money from the market altogether (and a flight into “real values”) — and the more so the cheaper the money commodity.

In a way, you have, thus, accomplished what all alchemists and their sponsors wanted to achieve: You have produced something valuable (money with purchasing power) out of something practically worthless. What an achievement. It costs you practically nothing, and you can turn around and buy yourself something really valuable, such as a house or a Mercedes; and you can achieve these wonders not just for yourself, but also for your friends and acquaintances, of which you discover that you have all of a sudden far more than you used to have (including many economists, who explain why your monopoly is really good for everyone).

What are the effects? First and foremost, more paper money does not in the slightest affect the quantity or quality of all other, nonmonetary goods. There exist just as many other goods around as before. This immediately refutes the notion — apparently, held by most, if not all, mainstream economists — that “more” money can somehow increase “social wealth.” To believe this, as everyone proposing a so-called easy-money policy as an efficient and “socially responsible” way out of economic troubles, apparently, does, is to believe in magic: that stones — or rather paper — can be turned into bread.

Rather, what the additional money you printed will affect is twofold. On the one hand, money prices will be higher than they would otherwise be, and the purchasing power per unit of money will be lower. In a word, the result will be inflation. More importantly, however, all the while the greater amount of money does not increase (or decrease) the total amount of presently existing social wealth (the total quantity of all goods in society), it redistributes the existing wealth in favor of you and your friends and acquaintances, i.e., those who get your money first. You and your friends are relatively enriched (own a larger part of the total social wealth) at the expense of impoverishing others (who, as a result, own less).

The problem for you and your friends, with this institutional setup, is not that it doesn’t work. It works perfectly, always to your own (and your friends’) advantage and always at the expense of others. All you have to do is to avoid hyperinflation. For in that case, people would avoid using money and flee into real values, thus, robbing you of your magic wand. The problem with your paper-money monopoly, if there is one at all, is only that this fact will be immediately noticed also by others and recognized as the big, criminal rip-off that it indeed is.

But this problem can be overcome, too, if, in addition to monopolizing the production of money, you also set yourself up as a banker and enter the banking business with the establishment of a central bank.

Because you can create paper money out of thin air, you can also create credit out of thin air. In fact, because you can create credit out of nothing (without any savings on your part), you can offer loans at cheaper rates than anyone else, even at an interest rate as low as zero (or even at a negative rate). With this ability, not only is your former dependency on banks and the banking industry eliminated; you can, moreover, make banks dependent on you, and you can forge a permanent alliance and complicity between banks and state. You don’t even have to become involved in the business of investing the credit yourself. That task, and the risk involved in it, you can safely leave to commercial banks. What you, your central bank, need to do is only this: You create credit out of thin air and then loan this money, at below-market interest rates, to commercial banks. Instead of you paying interest to banks, banks now pay interest to you. And the banks, in turn, loan out your newly created easy credit to their business friends at somewhat highe,r but still submarket, interest rates (to earn from the interest differential). In addition, to make the banks especially keen on working with you, you may permit the banks to create a certain amount of their own new credit (of checkbook money) in addition and on top of the credit that you have created (fractional-reserve banking).

What are the consequences of this monetary policy? To a large extent, they are the same as with an easy-money policy: First, an easy credit policy is also inflationary. More money is brought into circulation, and prices will be higher, and the purchasing power of money lower, than would have been the case otherwise. Second, the credit expansion, too, has no effect on the quantity or quality of all goods currently in existence. It neither increases nor decreases their amount. More money is just this: more paper. It does not and cannot increase social wealth by one iota. Third, easy credit also engenders a systematic redistribution of social wealth in favor of you, the central bank and the commercial banks within your cartel. You receive an interest return on money that you have created at practically zero cost out of thin air (instead of on money costly saved out of an existing income), and so do the banks, who earn additional interest on your costless money loans. Both you and your banker friends thereby appropriate an “unearned income.” You and the banks are enriched at the expense of all “real” money savers (who receive a lower interest return than they otherwise would, i.e., without the injection of your and the banks’ cheap credit into the credit market).

On the other hand, there also exists a fundamental difference between an easy, print-and-spend money policy and an easy, print-and-loan credit policy.

First off, an easy credit policy alters the production structure — what is produced and by whom — in a highly significant way.

You, the chief of the central bank, can create credit out of thin air. You do not have to first save money out of your money income, i.e., cut your own expenses and, thus, abstain from buying certain nonmoney goods (as every normal person must, if he extends credit to someone). You only have to turn on the printing press and can, thus, undercut any interest rate demanded of borrowers by savers elsewhere in the market. Granting credit does not involve any sacrifice on your part (which is why this institution is so “nice”). If things then go well, you will be paid a positive interest return on your paper investment, and if they don’t go well — well, as the monopoly producer of money, you can always make up losses more easily than anyone else: by covering your losses with even more printed paper.

Without costs and no genuine, personal risk of losses, then you can grant credit, essentially, indiscriminately to everyone and for any purpose, without concern for the creditworthiness of the debtor or the soundness of his business plan. Because of your “easy” credit, certain people (in particular, investment bankers) who otherwise would not be deemed sufficiently creditworthy, and certain projects (in particular, of banks and their main clients) that would not be considered profitable, but wasteful or too risky, instead do get credit and do get funded.

Essentially, the same applies to the commercial banks within your banking cartel. Because of their special relationship to you, as the first recipients of your costless, low-interest paper-money credit, the banks, too, can offer loans to prospective lenders at interest rates below market interest rates — and if things go well for them, they go well; and if they don’t, they can rely on you, as the monopolistic producer of money, to bail them out in the same way as you bail yourself out of any financial trouble: by more paper money. Accordingly, the banks, too, will be less discriminating in the selection of their clients and their business plans and more prone to funding the “wrong” people and the “wrong” projects.

And there is a second significant difference between a print-and-spend and a print-and-loan policy, and this difference explains why the income and wealth redistribution in your and your banker friends’ favor — that is set in motion by easy credit — takes the specific form of a temporal boom-bust cycle, i.e., of an initial phase of seeming general prosperity (of expected increases in future incomes and wealth), followed by a phase of widespread impoverishment (when the prosperity of the boom period is revealed as a widespread illusion).

This boom-bust feature is the logical — and physically necessary — consequence of credit created out of thin air, of credit unbacked by savings, of fiduciary credit (or however else you may call it) and of the fact that every investment takes time and only shows later on, at some time in the future, whether it is successful or not.

The reason for the business cycle is as elementary as it is fundamental. Robinson Crusoe can give a loan of fish (which he has not consumed) to Friday. Friday can convert these savings into a fishing net (he can eat the fish while constructing the net), and with the help of the net, then Friday, in principle, is capable of repaying his loan to Robinson, plus interest, and still earn a profit of additional fish for himself. But this is physically impossible if Robinson’s loan is only a paper note, denominated in fish, but unbacked by real-fish savings, i.e., if Robinson has no fish because he has consumed them all.

Then, and necessarily so, Friday must fail in his investment endeavor. In a simple barter economy, of course, this becomes immediately apparent. Friday will not accept Robinson’s paper credit in the first place (but only real, commodity credit), and because of this, the boom-bust cycle will not get started. But in a complex monetary economy, the fact that credit was created out of thin air is not noticeable: every credit note looks like any other, and because of this the notes are accepted by the takers of credit.

This does not change the fundamental fact of reality that nothing can be produced out of nothing and that investment projects undertaken without any real funding whatsoever (by savings) must fail, but it explains why a boom — an increased level of investment accompanied by the expectation of higher future income and wealth — can get started (Friday does accept the note instead of immediately refusing it). And it explains why it then takes a while until the physical reality reasserts itself and reveals such expectations as illusory.

But what’s a little crisis to you? Even if your path to riches is through repeated crises, brought about by your paper-money regime and central-bank policies, from your point of view — from the viewpoint as the head of state and chief of the central bank — this form of print-and-loan wealth redistribution in your own and your banker friends’ favor, while less immediate than that achieved with a simple print-and-spend policy, is still much preferable, because it is far more difficult to see through and recognize for what it is. Rather than coming across as a plain fraud and parasite, in pursuing an easy-credit policy, you can even pretend that you are engaged in the selfless task of “investing in the future” (rather than spending on present frivolities) and “healing” economic crises (rather than causing them).

What a world we live in!

Regards,

Hans-Hermann Hoppe

Why the Sate Demands Control of Money was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Economists blame China’s inflation on the dual pressures of consumer demand that is outstripping food supplies and a bank-lending boom they say Beijing allowed to run too long after it helped the country rebound quickly from the 2008 global crisis.”

The fact is that both the “lending boom” and “consumer demand” are simply the manifestations of monetary inflation, and originate solely from the PBOC’s expansion of the money supply.

Real consumer demand results in falling, not rising, prices. The only component of consumer demand that is pushing prices higher is artificial monetary demand in the form of more paper bills in consumers’ hands driving up prices, not in an increased desire to consume a greater physical quantity of goods.

As for a bank-lending boom, a boom in lending can occur only when an increase in money available to be lent is increased dramatically. So to say that inflation is caused by a lending boom is to say that inflation is caused by the printing of money (but without actually saying it). Though this cause and effect is obvious, reporters — and economists — choose to circumscribe the real explanation.

So what has the Chinese government done about the lending-boom and consumer-demand problems?

Concerning the lending boom, the article says:

“The government has clamped down on lending, but analysts say it will be months before the effects of that and other curbs are felt. They say inflation should climb further through at least midyear before easing.”

The government has “clamped down,” mainly by raising interest rates, as shown in Figure 2:

Mainstream economists believe this will do the trick, as they think that interest rates are the primary means of growing and slowing an economy. They ignore, or are not aware, that the money supply is what is driving inflation, “demand” and GDP growth. Manipulating the interest rate alone, without — as happens in most central-bank-run economies — simultaneously changing the money supply will usually have little effect.

Sure, with higher interest rates, borrowing costs are higher. But inflation also raises the rate of profit, which means business can profitably pay a much higher rate to borrow. But even when interest rates exceed the height of the rate of profit and cause businesses to quit borrowing and investing, all the money that has been pouring into the economy will still push prices higher. Economic activity might slow or stop, but prices will still rise. The only thing that will stop inflation is ceasing to expand the money supply. And even that will have a delayed effect.

Using Price Controls to Stop Inflation

As for the “consumer demand” component, the article says:

“Attempts at price controls, subsidies for the poor and orders to local leaders to guarantee adequate vegetable supplies have had mixed results. Beijing also has resorted to the blunt tool of freezing prices of electricity and some other basic goods, but that is starting to backfire.”

In other words, the government has tried to further manipulate the economy to compensate for the adverse effects of its printing of money. It should be no surprise the results are “mixed” and are “starting to backfire,” as shortages are the natural result of price controls.

Economic Growth as a Problem

The report also says that not only is inflation a problem, so is economic growth:

“Beijing also is struggling to control an overheated economy that expanded by a rapid 9.7% in the first quarter of this year, barely slowing from the previous quarter, despite Beijing’s efforts to steer growth to a sustainable level after 2010′s double-digit gains.”

Though the news report says “also,” in reality, this is the same monetary issue we’ve been discussing. There is no such thing as an overheated economy. “Overheating” is the Keynesian term for price inflation arising as a result of too much monetary pumping into the economy. It is the monetary pumping that has pushed China’s GDP into double-digit gains. As for sustainable growth, it is only monetary GDP growth that is unsustainable. Real, true economic growth is always sustainable and could never exceed what Keynesians call an economy’s “potential long-term growth rate.”

Speculative Money Flows

A different Associated Press article, referring to China’s artificially undervalued currency and the trade imbalances it causes, claimed that another problem could be speculative money flows:

“Many countries worry about speculative money flooding their economies and inflating assets like real estate or stocks.”

The notion of capital flows and money crossing borders is misunderstood by most people. Except for physical paper bills belonging to tourists, to drug dealers or to foreign workers sending cash earnings home to relatives, money does not cross borders. Money generally remains in the country to which it belongs — and merely changes ownership. As this section will show, “speculative” money “flowing across borders” really consists only of the domestic central bank trying to keep its currency artificially priced.

So-called “capital” or “hot money” does not “flow” from one country of origin into another country. However, money created in one country can be — and is to a limited degree — used to buy the currency of another country and direct it into the purchase of asset prices in that country (bidding asset prices higher in the process). If a disproportionate amount of local currency is channeled into asset prices in a country, less currency is being spent on goods and services in the economy, causing consumer prices to fall.

But in reality, consumer prices in countries with booming asset markets do not usually fall while asset prices rise; both usually rise in tandem. This is because the local money supply is increasing and pushing up both classes of prices (i.e., financial assets and consumer prices), even though one is rising faster than the other. It is therefore local money, not foreign money, inflating assets.

Also, in order for foreign demand to redirect purchasing power from local consumer prices to asset markets, there would need to be quite an overwhelming demand for domestic investment from abroad, resulting in a very large portion of local currency being purchased by foreigners. It seems fairly unrealistic that, in absence of already-rising foreign markets, such a strong desire for investment in a foreign country would exist on the part of these overseas investors.

Additionally, such a massive redirection of purchasing power would cause consumer goods to drop so low relative to their previous purchasing-power parity that foreign consumers, as opposed to foreign investors, would then purchase local consumer goods — because they would be so cheap in local-currency terms to those consumers — for the purposes of importing to their home country (i.e., being exported from the local country). This would increase the value of the local currency.

But again, we do not witness consumer prices falling or currencies rising (because they’re usually fixed) in the various countries experiencing asset-price booms. Therefore, the usual originating cause of booming asset prices in a country is that country’s central bank creating more money, pushing up both consumer prices as well as asset prices, not foreigners directing the local currency they purchase into asset prices.

What’s seldom noted is that when a country does not print money at rapid rates, it — almost categorically — does not experience “speculative money flows.” International investors and speculators usually take part in investing as a mass movement only in local asset markets that are already booming. The asset markets are booming because a large amount of the money being printed in that country is inserted into financial assets. Otherwise, if the money supply were not expanding, those same asset prices could not rise in price.

Also rarely explained is that “speculative money flows” usually occur between countries that have pegged or partially pegged currencies. Otherwise, as explained above, if the currencies of two different countries are freely floating, as one country expands its money supply, its currency will fall in price against its paired currency. Therefore, as a country’s asset markets rise in price, its currency would fall in price, largely in inverse proportion. This would cause the rising asset prices in the country to appear less appealing to foreign investors, as their gains would be offset — upon conversion back to their own currency — by a depreciating currency. Also, if investors just kept buying a currency whose supply was not expanding, its price would rise. This too would cause local asset prices to become less appealing. By contrast, speculators usually keep piling into currencies that are expanding and that are held artificially low, not ones floating freely.

Here is the real cause of so-called “money flows”: When a country keeps its currency artificially low relative to the opposing or “paired” currency, it does so, as we have seen, by its central bank buying the paired currency with newly created domestic currency. Thus, there is foreign currency “flowing into the country,” and the new domestic currency created for the purpose of purchasing the foreign currency is channeled into asset prices (and to a lesser extent, usually, consumer prices). It’s true that the domestic central bank takes ownership of foreign currency, but only the domestic currency circulates domestically. Thus, it is local currency, not foreign “speculative money,” that both causes and sustains local asset prices.

The Coming Bust

It has been shown that China is now letting its currency rise because it needs to stop printing money in order to tame inflation. Its currency has been artificially low (i.e., below the market price) for many years due to the fixing of its price to the U.S. dollar by way of printing the money that it uses for selling yuan (the printed money) and buying dollars. But such actions have resulted in price inflation.

Therefore, letting its currency rise will cause a recession, since reduced money supply and credit growth rates are the usual initiating factors that bring on recessions (reduced rates of spending alone can cause recessions, but they are usually preceded by prior reductions in money and credit). It has been rapid increases in money and credit that have driven the current boom in China, and it will be the reduction in the growth rate of those variables that causes the bust.

The economic boom in China has consisted of rapid increases in true economic growth accompanied by — but not driven by — an increase in monetary spending. The increase in monetary spending, in turn, has been driven by wild credit growth, and has resulted in massive overinvestment in particular industries. There has been no shortage of commentaries and videos highlighting building booms, mania-type herd-mentality home buying and the mass creation of buildings, shopping malls and even multiple entire cities in China that stand unoccupied — all dramatic, yet classic symptoms of credit bubbles.

The signs of bubbles are common, and date back to the 1600s. Even if we knew nothing about money and credit and their causing of financial bubbles, we should by now recognize the typical bubble-oriented characteristics — i.e., exponentially rising prices, investment and purchasing manias, exuberance over a new and unusual trend, etc. — and know that they are symptoms representing an actual bubble.

Given the lag effect of money and credit on the financial system and its transmission to the real economy, it is difficult to tell exactly when the rising interest rates and slowing money supply will result in reductions in the rate of spending and a reversal of the money multiplier, but when they do, a Chinese credit contraction, financial meltdown and economic malaise won’t be far behind.

Conclusion

Mainstream economists and the financial press are usually Keynesian. This means that they like to hide the true cause of economic problems. Their explanations, therefore, are ones that try to show how the tail can wag the dog. But these fallacious explanations have been around so long and are so widely taught that most people who do not know real economics — including most of these same Keynesians — easily believe these improbable explanations.

With respect to their explanations of the Chinese economy, it is not true that China imports inflation and that merely letting its currency rise will solve the problem. The real story is that the inflation is due to the printing of money that keeps its currency artificially low, and that the rising currency is a side effect of doing what’s necessary to stop inflation — stopping (or merely slowing) the printing presses. The rub is that a slower rate of money growth will also cause a reduction in spending and a credit contraction, which in turn will cause financial and economic problems.

Regards,

Kel Kelly

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

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

Currencies and Prices

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

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

Similarly, Bloomberg News reported…

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

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

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

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

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

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

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

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

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

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

The Real Relation Between China’s Rising Currency and Inflation

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

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

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

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

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

Check out Abe's most recent report here.]

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

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

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

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

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

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

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

But to its credit, it also separately said:

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

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

Regards,

Kel Kelly

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

Even though their conclusion strikes me as absurd, these quasi-monetarists are serious thinkers, and it would be a big task to comprehensively critique their position. Yet despite their sophisticated calls for the Fed to “target NGDP growth,” shape expectations and so forth, in practice, their message is being distilled by the second-handers into calls for unadulterated handouts of paper money. As we will see, I don’t have to engage in caricature; pundits like Matt Yglesias and Martin Wolf are openly calling for helicopter drops of money as a solution to our economic woes.

This is a very disturbing development. Just as the interventions (which crippled recovery) of the Hoover administration in the early 1930s led to a massive increase in government under the New Deal and the abandonment of the gold standard, so too have the “stimulus” packages and other failed programs of the Bush and Obama administrations gotten us to the point where raw money printing is being seriously discussed as a policy option.

Yglesias and Wolf on the Printing Press

Our first exhibit is from progressive darling Matt Yglesias, who commented on the “Occupy Wall Street” movement by blogging:

“My view is that the best demand of all [would be] ‘free money for the rest of us.’ There are a lot of different specific ways this can be implemented, but the basic shape of things is that the powers that be are great believers in the importance of the credit channel to economic recovery and, thus, have been willing to provide all manner of free money to players in the banking system. Debt cancellation is a form of free money for the indebted. But why give free money only to banks? And why give free money only to the indebted? Why not free money for everyone? ‘Everyone,’ of course, includes the indebted. But it also includes ordinary people who didn’t happen to avail themselves of the credit binge. It’s an idea so good that it sounds almost silly. ‘Everyone knows’ that you can’t just hand out free money to everybody. Except, actually, you can. Most of the time, it wouldn’t be advisable to do this. In the long run, money is neutral, and making more money can’t make you more prosperous. But in the short term, free money for everyone impacts prices. Most of the time, it would do so in a dislocating, bad way, but under today’s circumstances, it would do so in a useful way. I don’t know what the best way to turn this into a slogan is, but the point is that if the different institutions that together constitute ‘the government’ worked together, they could put more dollars into our hands. Creditors won’t like it, because doing this would devalue their existing debt claims, but so what.”

To the untrained eye, it might seem as if Yglesias is utterly bereft of economics training, but actually, he is simply giving a pop version of the worldview of the quasi-monetarists. Yglesias’s recommendation to have protestors demand “free money for everyone” is actually logically consistent with the much-more-nuanced views touted by the academic economists I’ve mentioned above.

When I saw Yglesias’s post, I was disheartened, but I took comfort in the fact that, after all, he was just a young guy firing off snappy posts. The “serious” members of the intelligentsia — guys who are over 50, flew in private jets and have never played Grand Theft Auto — surely wouldn’t fall for such raw inflationism, right? Except that distinguished Financial Times columnist, Martin Wolf, recently wrote:

“It is the policy that dare not speak its name: the printing press. The time has come to employ this nuclear option on a grand scale….

“What is to be done? The first task is to abandon what Adam Posen, an outside member of the monetary policy committee, calls ‘policy defeatism’…

“It is vital, then, to sustain demand. With fiscal policy set on kamikaze tightening, and conventional monetary policy almost exhausted, that leaves ‘quantitative easing’….

“Personally, I would favour the ‘helicopter money,’ recommended by that radical economist Milton Friedman. This would be a quasi-fiscal operation. Central bank money could pass via the government to the public at large. Alternatively, the government could fund itself from the central bank directly. Better still, the government could increase its deficits, perhaps by slashing taxes and taking needed funds from the central bank. Under any of these alternatives, the central bank would be behaving like any other bank, creating money in the act of lending.

“In current circumstances, a policy of direct financing of government by the central bank should recommend itself to monetarists and Keynesians. The former have to be worried by the fact that U.K. broad money (M4) shrank by 1.1% in the year to July 2011. The latter would have to be pleased that governments could run still bigger deficits without increasing their debt to the public.”

This is where the discussion of monetary policy has landed: We are now openly discussing having the central bank print up new money to pay the government’s bills, and this is supposed to be great because it won’t cost the taxpayers anything.

This situation is ironic because, for the last three years, analysts have said things like, “Investors right now are content with low yields on long-term bonds, because they trust the Fed to adhere to its inflation target. But if they ever sense that the Fed was beginning to monetize the government’s debt — as happened in Zimbabwe — then all bets are off, and we’ll see a sharp increase in inflation expectations and bond yields.”

This struck some of us as ludicrous, because by definition QE1 and QE2 were operations in which the Fed created hundreds of billions out of thin air in order to buy Treasury debt.

At least before, however, the analysts could be forgiven for not seeing the obvious. After all, Fed officials did a great job obfuscating what they were doing. They made it sound as if the government’s Treasury were just sitting there, minding its own business, and the Fed said, “Hey, we need to buy hundreds of billions of bonds from some organization in order to achieve our interest rate objectives. Any ideas?”

Now that Martin Wolf (and a growing chorus of other inflationists) is openly calling for central banks to monetize deficits, I wonder if we will at least classify the operation as monetizing deficits. That would be progress.

Austrian and Public Choice Versus Chicago

Among other lessons, this latest development illustrates the importance of having different schools of thought, even among those who are generally free market. Wolf is being entirely fair when citing Milton Friedman, for it was Friedman (and co-author Anna Schwartz) who famously blamed the Great Depression on tight monetary policy. We can’t know what Friedman himself would say were he alive today, but people like Sumner have made a convincing case that Friedman would call for more inflation.

On these pages, we have argued many times that artificially low interest rates and monetary inflation misallocate resources and, in fact, set the economy up for a further crash; I won’t rehash the argument here. Let me simply reiterate that it’s an odd thing to blame our current woes on “tight” monetary policy, when the monetary base and the M1 monetary aggregate look like this:

I’ve had such arguments with the quasi-monetarists before, and we always reach a standoff: They focus on things such as “sticky prices,” money demand and “expected growth in total income,” whereas I focus on the coordinating role of market prices and the capital structure.

In light of the calls for “free money” (for everyone or for governments, respectively) by Yglesias and Wolf, perhaps the public-choice school of economics will have something to say here. Once we let the inflation genie out of the bottle — even if it were the “right thing to do” in these unusual times — can’t free-market economists see that it will never go back?

For example, if the Fed really did guarantee a basic income to every American — as Yglesias discussed in an earlier blog post — wouldn’t that policy be as hard to end as Social Security? If the Fed began making loans directly to small- and medium-sized enterprises (as Wolf discusses in his piece), wouldn’t capital allocation become irreversibly politicized?

Conclusion

The world has been in a strange environment in the last three years, in which massive expansions in central-bank balance sheets haven’t led to $10 gasoline and $5 loaves of bread. Regardless of which school of thought can best explain these events, we are all going to rue the fact that the grand lesson flowing out of this episode is that money printing can bring prosperity. Now that this idea has firmly taken root, it will take a large collapse in consumer purchasing power to remind everybody why “inflation” used to be a dirty word.

Regards,

Robert P. Murphy

Inflationists in Wolves’ Clothing 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.