The present system must end, it will end, it will now certainly end badly. And probably soon. As it is inevitable it doesn’t matter what I wish. To wish that this would not happen would be as sensible as to wish that the present summer would not end, and that the days would not get shorter. I don’t wish it and I don’t fear it. The system must go. Good riddance.

What I do fear, however, are the political consequences and the societal fall-out from the crisis, and I particularly fear the responses it will provoke from governments and state officials.

Of course, the fiat money crisis is not a natural catastrophe. It is entirely man-made. It is the direct consequence of political decisions and political action.

In particular, it is the inevitable consequence of the decision to abandon a gold-based monetary system, a system of essentially inflexible and apolitical money, and to replace it with entirely elastic and constantly expanding paper money. This paper money leads to accumulation of imbalances, to capital misallocations, and to resource mis-pricings. Those must lead, over time, to economic disintegration of banks.

It is the direct consequence of the erroneous belief that low interest rates and additional credit are good regardless of whether they are the outcome of true saving and capital accumulation, or simply the outcome of fiat money creation.

There is the unspoken belief that after all my research on the topic I must have some good policy advice up my sleeves. Often people ask me, so what should be done? If what central bankers and politicians are doing presently is, as you say in your book, counterproductive, what should they do instead? What is the solution?

There is an assumption that one cannot simply predict some unpleasant outcome in the field of economics and not offer at least a bit of hope that things may turn out differently. Suggesting the possibility of a way out that would spare us all the painful consequences of past actions, of decades of misguided policy, of cheap credit and limitless money.

I suspect that since I speak so little about specific policy reforms leads people to believe that I don’t care about where we are going, or I might even look forward to the disaster.

What should be done

There is only one possible way out. Stop the printing of money and the artificial suppression of interest rates. Return to hard money. Allow interest rates and market prices to again reflect the true extent of voluntary savings, and to thus allow the liquidation of the accumulated imbalances from previous money expansion.

But because we had a four-decade long period of unprecedented fiat money creation globally, these imbalances are now so big that the necessary liquidation would be very painful. The political class — which got us into this mess in the first place — would never deem it acceptable.

The overstretched banking industry, the overextended asset markets, insolvent governments are all screaming for a cleansing liquidation and recalibration. A crisis has now become unavoidable.

But politicians still think that the power of the state is unlimited, that what they don’t find acceptable will simply not be allowed to occur. Only in the realm of politics is reality optional…somehow reality can simply be made to conform to the wishes of the political elite.

Of course, policy cannot create a new reality. What policy does at the moment is try to postpone the inevitable correction ever further. “Not on my watch” is the modus operandi. This will make the final crisis even worse.

I quoted Ludwig von Mises on this on a couple of occasions but I will do it again. In his magnum opus of 1949, Human Action, the grand master of Austrian School economics said:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

The endgame will be “a final and total catastrophe of the currency system”, and “later” may indeed be soon. Remember, we have been postponing the liquidation for decades and happily piled new debt and new imbalances on top of the old debt and the old imbalances. By not stopping the printing of money and the accumulation of debt and capital misallocations (and by adding to them instead) the policy establishment is making sure that the final crisis will only be worse.

This is why I consider it pointless to come up with policy recommendations. What would be the purpose of presenting a detailed plan of converting to a gold standard, which is what should be done? Mainstream economists, politicians and central bankers will either ridicule or ignore it. They still believe that the answer to all these money-induced imbalances is — more money! They are hell-bent on creating a total currency catastrophe. And they will get it.

A whiff of Weimar Germany

A touch of Weimar? (Chart Greenburger)

Let’s just take a casual look at the events of the past month: While I was hiking in the Dolomites or relaxing in Tuscany, the destroyers of paper money did not rest. The ECB completed a U-turn of embarrassing proportions and switched from exit strategy to buying more PIIGS-bonds funded by the printing press — a policy that continues to this day and that will not end!

And Dartmouth College Professor and ex-Bank of England money-debaser David Blanchflower argues for more quantitative easing from the Fed. When asked how much, the good professor showed his generous side: $ 1 trillion or $ 2 trillion…just print until things look better. We will show this economy who is boss!

British pundit Ambrose Evans-Pritchard argues that real monetary stimulus hasn’t even been tried yet. He recommends some globally co-ordinated monetary blitz — what if all central banks opened their monetary floodgates simultaneously? Surely, that is going to buy us a nice recovery.

If you thought that this lunacy is being greeted with derision, as it should, think again. As I write this, the Swiss government has declared that international cooperation in monetary debasement is a splendid idea — and has just pegged the Swiss franc, formerly the gold-rimmed version of paper money, to the PIIGS. Congratulations!

Make no mistake: They will all get what they are asking for. But to expect anyone who sees the writing on the wall to engage with a policy establishment beholden to the myth that prosperity and jobs can be had through constant monetary manipulation, through artificially low rates, money printing and asset bubbles — that is asking a bit too much. And let’s face it: it is not as if any of them would even want to listen to what I have to say. I put my case out there — it is for others to decide what to do with it.

Here is another, less well-known quote from the great man, Mises:

“Political ideas that have dominated the public mind for decades cannot be refuted through rational arguments. They must run their course in life and cannot collapse otherwise than in great catastrophes…”

We are approaching such a catastrophe with full force. Rather than coming up with a monetary reform (and there is only one true reform: a return to gold) that will certainly be rejected by the powers that be, I think the most sensible thing one can try and do is to protect oneself, one’s family and one’s wealth as best as one can from the ensuing fall-out.

My recommendation has been and still is to reduce exposure to banks and to governments – the two grotesquely bloated entities that have for decades benefited from their privilege to be unconstrained paper money producers and who are now close to OD’-ing on that privilege. Hold gold (and maybe silver) instead of paper money, bank deposits and fixed income securities. Real assets, not paper assets.

The coming monetary meltdown will wipe out vast amounts of paper wealth, and it will facilitate one of the largest transfers of real wealth in human history. Many people will lose a lot.

Sadly, it will be mainly those who produce more than they consume and who save the difference — and then save it in the form of cash, bank deposits and bonds.

All paper money collapses decimate the middle class. No, I certainly don’t wish for this but the chance of this being avoided is practically zero.

Short of the century — coming soon!

As always, some will win, and there is no shame in trying to be among them. Apart from the rise in the gold price and certain other commodities, I think that there is another money-making (no pun intended!) opportunity: fixed income markets will soon be the short of the century.

Those out there who think the world will be just like Japan for the next twenty years are wrong, in my view. Japan’s present state is not stable and it doesn’t constitute an endgame. It is collapse in super-slow-motion.

The ongoing fiscal deterioration and the mind-boggling accumulation of public debt mean that the ultimate endgame there will be inflation and paper money collapse, too. And I doubt that the U.S. and Europe will manage to stretch this out for quite as long as Japan has.

But here is what I fear.

I am very concerned about the political fall-out from the crisis. Although it will ultimately mark the end of state paper money, of politically controlled interest rates, and government-manipulated asset markets, don’t expect the state to leave the economic stage without a fight.

For the immediate future at least, I expect more interference with markets, more regulation, more confiscation via taxation, capital controls and curtailment of property rights and individual freedom. In a crisis, many will demand more government and more state action, not more freedom and markets.

When I spoke to a libertarian audience in Vulcano I was speaking to friends, to like-minded people. People who, like me, value personal freedom and free markets. I sensed that they, too, would have loved me to give them a bit more of an uplifting message.

Many of these libertarians believe that what they are involved in is simply a battle of ideas, and that they can, if they try hard enough, convince others of the benefits of a free society and of capitalism. I don’t think that this is entirely wrong. But I fear that many of them underestimate the opposing forces that the present crisis may unleash.

In the meantime, the debasement of paper money continues.

Regards,

Detlev Schlechter

Why Policy Advise Is Futile And What You Should Do Instead was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

First though, let’s just check to see that markets are still functioning normally. That is, let’s just check to see that heavy government intervention is supporting house prices (by providing guarantees to home lenders), GDP growth (by spending money on infrastructure), and disguising the true state of the labour market (by lying about how many people are out of work).

Yep. Situation normal, all fouled up. The oil price, the U.S. dollar, and bond yields were all up on bullish industrial production figures in the U.S. The “recovery” meme is taking a tenuous hold. Stocks were down. Because why would stocks rise if the economy were recovering?

Ah. Well that tells you something right there. It tells you that stocks haven’t risen in anticipation of a global recovery. They’re just enjoying the benefits of all that monetary and fiscal smack being peddled in Washington, London, Tokyo and Canberra. It’s hard to rally on fundamentals when you’re already over-valued.

Speaking of value, let us now return to the question of element number 79 on the periodic table. The snarky article we mentioned at the top is from Michael Pascoe at The Age, titled “There’s more gold where that came from.”

In the article Pascoe takes on the issue of “peak gold.” But how well has he done in accurately stating the argument for gold? And more importantly, is he right about the relationship between market prices and gold? Well, obviously we think he’s pretty wrong. But let’s see what he’s said.

“Part of the dogma of the less rational gold bugs is that the world is running out of the stuff. As an article of faith, it makes a pleasant change from the idea that fiat money is about to be exposed as huge confidence trick and we’re heading back to the caves.”

Webster’s defines “dogma” as “a religious doctrine that is proclaimed as true without proof.” Already you can see what Pascoe is up to. Gold bugs are nutters and zealots. Apparently 5,000 years of monetary history where gold has proven utility as a medium of exchange and store of value does not qualify as empirical evidence of gold’s value. There’s no pleasing some people, especially those who come to an argument with their mind already made up.

But that’s fair enough. Opinion journalists get paid to give opinions. They cloak themselves in supposed objectivity because that makes their views more respectable to the mainstream. But we’ve never been concerned about respectability here at the Daily Reckoning. Why base your judgments on what other people will think of them?

We’re entirely subjective in our views. But at least it’s transparent. And at least we base our conclusions on facts and arguments. And we’ve not once argued here — although perhaps some gold bugs have — that the world is running out of gold. That is not what “peak gold” means at all.

The first step in any debate is to define your terms. So we will do so here and say that “peak gold” mean’s declining annual gold production. We’ll prove that in a minute. But just so it’s clear, no one in this space is saying the world is running out of gold. But gold IS getting harder to find and more expensive to mine. And the supply of paper money continues to grow faster than annual gold mine production.

We won’t dwell on the subject of paper money too much longer, except to say Pascoe’s dismissal of the current status quo is nearly as laughable as it is naive. He says ‘peak gold’ “makes a pleasant change from the idea that fiat money is about to be exposed as huge confidence trick and we’re heading back to the caves.”

Seriously. How can any objective observer take a look at fiscal and monetary policy of the last three years and assume that central banking and fiat money are not a giant con job on the general public? Fiat money allows the government to create money backed by nothing. Not only does that decrease purchasing power — especially hurting savers and those on fixed income — it accelerates the misuse of real resources.

When it comes down to it, it’s a kind of theft. The government prints money and gets the benefit of using it first before purchasing power is diminished. It trades paper money for real goods and services — things which take labor and raw materials to produce. The systematic inflation inherent in fiat currencies IS theft of real labor and resources.

As long as that inflation makes house prices and stock prices go up, it appears to please everyone. But it’s our argument that the monetary regime in place since August of 1971 — when Richard Nixon took the U.S. off the gold standard — is a) a fraud, and b) in the process of disintegrating. It’s disintegrating because, at its heart, it’s based on the idea that money doesn’t have any real tangible value.

Gold does, of course, have tangible value. To the extent that it’s intrinsically valuable, it’s valuable because its physical properties — relative scarcity, durability, transportability, divisibility, homogeneity — make it particularly useful as a monetary unit of exchange. To suggest it has no inherent value is to misunderstand the qualities that make money useful, and more importantly, sound.

But back to the issue of production. It’s not just the nut jobs in the newsletter industry warning that gold production is falling. It’s the gold miners. Of course you have to discount what they’re saying to the extent that they’re talking their own book. But they do know their own business and they are saying that 2009 could be the last year for some time that gold production rises.

Omar Jabara, the spokesman for Newmont Mining in the US, says that in terms of production, “2009 is the outlier as far as the trend. The trend is that production has been in a general decline since 2000. Why does that matter?

Pascoe says, quite correctly in theory, that price discovery and market mechanisms help ensure that supply grows when prices rise. Or, in his own words, “The ‘peak gold’ story isn’t quite as dodgy as some of the ‘peak oil’ scare mongering the more sensationalist media have trotted out over the years — we’ll never run out of oil as the market mechanism very successfully rations it and because, at a price, we simply make the stuff. Shell, for example, is spending $20 billion building a gas-to-diesel plant in Qatar.”

Running out of gold? Don’ worry!! We’ll just make more of it!

It’s hard to reconcile this with the fact that the gold price has been rising since 2000, but gold production has not. In late 1998 the gold price was in the mid $200s and annual global production was just under 2,500 tons per year. Since then, the gold price is up 340%. Yet production this year is set to be just over 2,400 tons. That’s an increase over last year, mind you. But still down from the production level over ten years ago. So why aren’t higher prices attracting new producers?

Well there are a couple of factors here. First, a lot of the big mines that were producing in the 1970s — especially in South Africa — are seeing production declines. That’s not say all the mines are played out. But they’re having to dig deeper and pay more for labor and energy, all of which leads to rising production costs.

That is, despite the rising price, production costs are rising faster for some companies. Those companies are making less money from the price rise, leaving less to invest in new exploration and production. Besides which, surely Pascoe would know that there’s no such thing as just-in-time gold production.

You have to find the stuff. And it has to exist in an ore body that’s economic to mine at current gold prices. And you have to get permits to mine it. All of that takes time and money — usually years — during which central bank printing presses are busy churning out new paper notes at a much faster rate. The supply of paper money is growing a lot faster than the annual mine supply of gold, which does not look like growing much at all in the coming years.

Barrick Gold’s Vincent Borg says that, “it’s a fact that gold production form mines has been in decline since 2001 and has gone from 85 million ounces to about 75 million ounces a year… It sort of goes down about one million ounces every year and or forecast is that it will continue to decline despite the higher price.”

In most markets, higher prices to attract new producers. But as we’ve said before, quoting our friend Doug Casey, gold mining is a lousy, capital-intensive, highly regulated business. It is not like opening a lemonade stand. Therefore gold production does not automatically increase because prices are higher. That’s a fact, not a dogma.

Yet Pascoe persists. He quotes StandardBank analyst Waler de Wet, who, presumably because he has a South African sounding name, must be right about gold. De Wet told clients that, “Given that the US gold mine production is 10% of global mine production, if you assume gold resources are proportionate to current mine production, global resources could be 330,000 tonnes. That is another 137 years of production.”

The argument here is that higher gold prices turn more resources into proven reserves. That is, marginal gold projects become economically viable with higher gold prices. But the reason that these projects were marginal to begin with is that they were more expensive to bring into production (away from infrastructure, lower ore grades, smaller ore bodies). If the margins don’t improve on the projects, there’s no guarantee anyone is going to bother producing them, especially if the cost of production is rising as much or more than the gold price.

Further, why would anyone assume that “gold resources are proportionate to current mine production?” It seems like a rather large assumption to make. As anyone who’s spent any time analyzing resource stocks knows, a resource is not the same thing as a proven reserve.

The energy market is fortunate that higher oil prices make other sources of unconventional more economically viable. (That’s why Australia’s LNG and coal-seam-gas industries have done so well this year.)

But you can’t just “make more” gold the way you can make more energy. The world doesn’t need oil. The world needs fuel and the work that fuel can do when you burn it. Thus, high oil prices lead to investment opportunities in oil and other energy sources, which eventually brings down the price of energy.

The funny thing is that the last time we checked, the oil prices were above $70. This confirms the peak oil thesis. The age of cheap energy is over. Oil is still out there. But it’s getting harder to find and more expensive to produce. The cheap stuff is going fast.

With gold, of course there is more gold in the ground waiting to be mined. But who’s going to mine it? And at what cost? It’s an expensive business. And even if exploration spending boomed and turned up even more gold, it will take years to bring into annual mine supply.

You could argue that the rising gold price is only a function of scaremongering by newsletters like the Daily Reckoning — or that it’s being ramped up by speculators and fund managers. This would explain why gold producers didn’t increase production to meet rising prices. They saw the price rise as fictional or fundamentally unsound.

We wouldn’t agree with that argument, mind you. But it’s one way to explain why gold production isn’t more price sensitive. The other is the simpler one: gold production is hard to increase, no matter what economic theory or Michael Pascoe says.

But by the end of the article you can see that Pascoe doesn’t really have his head in the argument, just his heart. “The gold price’s recent stall thanks to the Greece and Dubai-inspired up-tick in the US dollar demonstrates just how much of the gold rally has really been a currency story rather than anything intrinsically valuable about the yellow metal.

“It’s just another alternative to greenbacks, one that doesn’t do much productive or pay dividends but relies purely on speculation for any non-currency price improvement. The unkind might think that’s why the gold bugs keep the scare campaigns coming — that and the need to sell more internet newsletters.”

He’s partially right and mostly wrong here. Yes, the rising gold price is a function of the bear market in paper money. Gold is better money than paper, if you’re a gold bull. That makes gold stocks a leveraged speculation on higher gold prices. We don’t have to say any of that to sell newsletters. After all, this one is free.

But we keep saying it because it continues to be important. Only a numbskull would ignore all the warnings about paper money coming from the markets in the last two years. Rising fiscal deficits…insolvent banking systems…the re-monetization of gold by central banks as a reserve asset. These aren’t articles of faith. They’re facts.

Of course gold isn’t an investment panacea. But it’s something you should take a lot more seriously than Michael Pascoe does. Unless you’re worried about being respectable amongst those of your friends who thought that a currency crisis was something that only happened in history books, and not something you ought to prepare for.

Regards,
Dan Denning
from the Daily Reckoning Australia

Editor’s Note: This article first appeared as “Michael Pascoe and the Snarky Disinformation About Gold.” To view the original article, please click here.

Snarky Disinformation About Gold and the Nature of Money was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Born and raised in rural Tennessee, Sir John was the first person in his town to go to college. He went to Yale during the great depression and when things got tight, his father could no longer keep him there. So he helped pay his own way through college with his poker winnings, which sort of adds to his legend. He eventually went on and won a Rhode Scholarship, went to Oxford and set up in Wall Street in 1937.

Now, you can imagine what the world look like in 1937; a lot of bad news, the Great Depression, war looming on the horizon. And in this environment of chaos, Sir John got to work.

One of his famous bets came to him in 1935 when he bought 100 shares of every stock trading for less than a dollar in the NYSE. He made four times his money in the next four years. That was sort of a pattern throughout his career. He was always an investor who was able to find the opportunity during times of market upheaval. He famously bought stocks the day after the ‘87 crash, for example. He also bought airlines after 9/11 and made a lot of money in a short amount of time. So I think he is a good investor to focus on these days because, as investors, we have so many problems to deal with in the marketplace.

I also want to say he started his famous fund in 1954 and it was incorporated in Canada because there was no capital gains tax there at the time. And during 1954–1992 he racked up an average return of 15% a year. That’s a great track record over a long period of time.

He also offered a lot of phrases that we take for granted as common sayings today. “‘It’s different this time,’ are the most expensive words in the English language” — That’s Templeton’s. Maybe his most famous saying is, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” He later added that the best time to buy is during points of “maximum pessimism.”

When I think of Templeton’s influence on me, I think of two things. One is that he was one of the first really successful investors to invest overseas. He was an early investor in Japan, for example, and he drove home the idea that a quality investment idea doesn’t have to be large, U.S. blue-chip company. He was equally at home investing in South Africa, Australia, Japan, wherever. The second thing I think of is that he had this focus on finding great opportunities even when markets seemed like a really bad place to be.

He wrote this when he was approaching his 95th birthday: “Throughout history, people have focused too little on the opportunities that problems present, both in investment and in life in general. The 21st century offers great hope and glorious promises. It is perhaps a golden age of opportunity.”

Now, you might think he’s nutty saying that. And when you look, there is a lot of bad news out there. I think the U.S. economy is probably in recession and Wall Street is a disaster. The dollar is in the tank, debts are high and taxes are going up. My state of Maryland, for instance, just passed the largest tax increase in state history last year. That is pretty amazing considering all the things people get hit with nowadays. And now we are getting hit with higher taxes too. California also had an increase in taxes by some large amount, and Sacramento already has higher taxes than NYC. So to top it all off — as if that’s not bad enough — it’s also an election year! So we have to listen to all the politicians tell us how they are going to solve our problems with a wave of their magic pen.

Today, the big issue is scarcity. When you think about how the prices of everything from food to gasoline are rising, you might think we face scarcity in a lot of things. This may or may not be the case. One thing we don’t have scarcity of, however, is paper money. The money and credit growth for the last 12 months is really incredible. The Australian dollar, the Canadian dollar, the Chinese Yuan, the euro…all these currencies are increasing at 22%, 21% 18%. The only major currencies that are not increasing at a double-digit rate are the Japanese yen and the Swiss franc. So, when we look at market prices, this distorts what we see:

For example, let’s look at oil. Every time I hear that oil is in a bubble, I think of this chart [above]. Basically what it tells you is that as money supply increase, the price of oil has increased along with it. In fact, roughly 87% of the increase in crude oil can be explained just by the increase in money supply. So when you see oil make this huge jump, you have to put it in context. This is true for all commodities. It looks like we have skyrocketing prices, but what we are in fact seeing is the collapse of the dollar. It is just another factor that makes investing difficult, another factor we have to consider.

Regards,
Chris Mayer
August 14, 2008

P.S.: Do you think John Templeton would let the current market get him down? I don’t, and neither should you. Sure, it seems like good opportunities are hard to find these days, but believe me they’re still there. In fact, I know of one investments that will actually pay you income checks. That’s money you can count on. And it may never run out

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

John Maynard Keynes, an early 20th century economist, was the most influential advocate of government influence in the economy. Thanks to him, an entire generation of voters thinks the president “manages” the economy. Keynes’ followers, who populate the halls of government and academia, think the government needs to act when the free market “fails.” They propose government solutions to problems like “liquidity traps” and “insufficient demand.”

These alleged problems became so feared that the U.S. government decided it was necessary to move the dollar to a completely paper, faith-based system — despite historical evidence that every paper money system fails. The Federal Reserve has cemented its role as price fixer for short-term interest rates. It fuels speculative bubbles when the economy slows, and denies all responsibility when bubbles burst. The cycle then repeats.

The New Deal was Keynes’ idea. The era of colossal government — the New Deal — began as a popular reaction to the Great Depression. The Depression started when an inflation-fueled bubble popped, and worsened in the mid-1930s, when the government taxed capital away from entrepreneurs and reinvested it into “make work” programs.

This is one of many examples in which government power grew at the expense of the more efficient free market. These ideas, and the proposed solutions to them, distort the free market’s investment cycles and have gotten the U.S. to the point where it simply cannot function without asset inflation.

Today, the government proposes solutions to problems caused by government interference. Specifically, it and the Fed are throwing more money and credit at a problem that was caused by their own past initiatives to stimulate money and credit. Even a mere recession has become politically unacceptable.

China’s Success Hinges on Its Support for Free Markets

Keynesian economists tend to deny the free market the respect it deserves. It has had an amazing track record in recent centuries. Despite the destructive influences of nutty paper money schemes, deficits, taxation, regulation, and wars, most countries have progressed from subsistence farming to modern living standards at a stunning pace.

The free market rests on a foundation of mutual trust, price signals, profits, free trade, and property rights. It’s important for government to respect this foundation. Communist governments simply destroy it and, predictably, get chaos and poverty. Even in some capitalist countries, popular support for this foundation is shaky.

The Chinese, still Communist in name, but hardly in action, have gained some respect for the foundation of free markets. Their leaders are executing policies that promote better living standards, and they are using free market principles to achieve it. As a result, they prosper. But prosperity doesn’t advance without occasional setbacks. China is dealing with one right now: A shortage of above-ground coal.

In China’s highly publicized winter storm delays, we see an example of how slower economic growth can lead to higher consumer price inflation. Most economists would have you believe that growth causes inflation, when in reality, it’s the opposite. Real economic growth increases the supply of goods and services. So consumer prices would fall if the money supply were held constant. The Wall Street Journal recently reported:

The coal shortage has rippled through other commodity markets, hurting China’s output of steel, copper, zinc, and aluminum as electricity is being diverted for domestic industry and household heat and electricity. China’s largest copper producer, Jiangxi Copper Co., shut down some plants, contributing to higher U.S. copper futures:

Even though the Chinese government supports free markets to achieve its political goals, it still distorts investment cycles with monetary inflation and regulation. Its manufacturing capacity has grown beyond its power grid capacity. This slows real economic growth, which is cutting the supply and raising the price of copper in the U.S. futures market.

Chinese monetary policy, like that in the U.S., ensures that money supply can grow limitlessly at zero cost. No wonder prices for nearly everything are going up. Central banks have pushed inflationary policies beyond all reasonable limits. A recent issue of Grant’s Interest Rate Observer explains why this could be the top financial market story in 2008:

In the dollar and its institutions, there is a deep-seated contradiction. The Fed is America’s central bank, but the dollar is the world’s currency. More than a billion people work and save and spend in the non-American portion of the U.S. dollar bloc. It seems fair to guess that more than a few of them are fed up, if not with the distant institution that sets an interest rate, then with an inflation problem over which they seem to be powerless.

One of the top financial stories for 2008 just might be the dawning of this unwelcome truth on the average American central banker, bondholder, and consumer. Recently, The New York Times, in a dispatch from Shanghai, speculated that China was now exporting inflation, not deflation, and that, on account of this sea change, the American CPI would presently begin to tick higher.

The onset of recession would likely push back the return of what economists will eventually learn to call the “21st century secular inflation” (mark my words). A friend of mine muses that the dramatic re-pricing of ultra-cheap oil transformed the markets and economies of the 1970s. So, too, he speculates, will the dramatic re-pricing of ultra-cheap Asian labor deliver a seismic jolt to the markets and economies of the present day. If so, the dollar, no less than the euro, is likely to suffer impairment against the kind of assets that central banks just can’t print.

If you’re a regular reader of Whiskey & Gunpowder, you probably agree that individuals make better spending and investing decisions than governments. Yet Keynesian plans to “fix” the economy — whether through regulation or inflation — remain uncomfortably popular. The conditions are set for a dramatic consumer price inflation reawakening — if not in 2008, then over the next decade. Long-term bonds are priced to provide negative real after-tax returns over the next decade. Invest accordingly.

Regards,
Dan Amoss, CFA
March 19, 2008

How Paper Money Distorts Investment Cycles was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.