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Economics...Goethe Predicted Dollar Slavery

Very long read...from Forbes
http://www.forbes.com/sites/keithweiner/2014/02/28/the-fed-poisons-the-stock-market/

Economics...Goethe Predicted Dollar Slavery
The Fed's Bubbles Destroy Capital
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In ancient times, people hoarded whatever they could. Salt, and later silver, worked well because they are nonperishable, widely accepted in trade, and easy to store. People accumulated stockpiles, buying a little at a time. Then in retirement, they sold some each week to pay for food and other expenses.

Hoarding works, though there is a major drawback. You can never be sure that you have enough. You can outlive your savings. To try to avoid this disaster, you have to spend as little as possible. Neither the worry, nor the austerity, make for much fun in your golden years.

People eventually discovered a better way. Lending is a win-win deal that makes life a whole lot better. A business needs capital to increase production. It borrows money, and in exchange offers to share some of its new profit with the lender. The lender is a saver or retiree who is glad to put his money to work. He is earning money on his money—interest. Interest greatly accelerates wealth accumulation during his working years. Interest allows him to live in retirement, without literally eating his capital.

It is impossible to overstate the importance of interest. It literally built our civilization. From the voyages that discovered and colonized the New World to the industrial revolution to the large manufacturers in the 20th century, there is one thing in common. They would have been impossible without raising capital. This capital was invested to obtain a return.

Unfortunately, the Fed has been waging a war on interest for decades, pushing it down. Now the interest rate is nearly zero. The Fed’s economists tell us that this somehow helps employment. It doesn’t, but it does inflict collateral damage.

For instance, it harms the saver. Zero interest drags down his rate of capital accumulation. At least the saver is still working, but those who can no longer work are even more vulnerable. Economist John Maynard Keynes called for the “euthanasia”—his term—of those who depend on fixed income, like retirees.

Having one’s income cut off can feel like being strangled. Most people won’t sit there passively. If they can’t earn interest, then they turn to an alternative. They’re forced to speculate. This creates bubbles—rising asset prices—like real estate in the 2000’s. There’s always a good bubble inflating somewhere, and people pile in.

Bubbles pop and speculators take big losses. However, there’s an even more important, but subtler, point. An entire generation can’t pay for retirement by speculating their way to wealth. Let’s look at why not.

Bubbles do not produce new goods and services. They don’t create new wealth. For example, there was a copper bubble from 2009 to 2011. The price of copper more than tripled from $1.40 a pound to $4.60. Lots of people bet on it.

Consider the fictional case of Joe, who bought $100,000 worth of copper. A few months later, he sold some. He took a profit, yet he still has $100,000 worth of metal.

There is an old saying that you can’t have your cake and eat it too. And yet here’s Joe, who still has his money and he bought a motorcycle also.

It’s not possible to consume without producing. Yet, while Joe’s copper wager produced nothing new, he consumed the bike. Logically, if Joe did not consume new production then he must be consuming old production.

Joe consumed part of his savings.

Joe doesn’t see the loss, because he is only thinking in dollars. Instead of looking at the trade in terms of paper, let’s focus on the loss of metal. Joe starts out with 15 tonnes of metal. He sells four to buy that new Harley, and has 11 left. Joe spent a big chunk of his copper, and now he has less.

Most people don’t want to eat their capital. However, in a bubble they’re tricked. They think copper went up, but it’s just a mirage. In reality, the copper only went out—out the door. Now it’s gone.
Speculating may seem similar to earning interest, but it achieves the opposite result. Interest creates new income by financing new production. Speculative gains come from paying out existing capital as income, and consuming it. We are all harmed by this destruction.

Interest rate suppression undermines our civilization. It destroys the capital on which it depends.
The Fed Poisons The Stock Market
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The Fed has pumped trillions of dollars into the financial system since 2008. The unintended consequences of this bank bailout have spilled over into the markets. Fed money injections go directly into bonds, tending to push up their prices. Since interest rates move inversely to bond prices, the effect is to cut interest. After the 2008 crisis, the Fed pushed the ten-year Treasury yield down from 4 to 1.5 percent, though it’s bounced a bit from there.

An artificially low interest rate is bad enough, as it hurts savers and retirees on a fixed income. However, a falling rate is deadly poison to business. This toxin operates by two different mechanisms.

Businesses constantly face a trade off between labor and capital equipment. Suppose Acme Corp. is considering buying an expensive new widget-making machine. Acme holds off because the monthly payment is too high. When the interest rate falls, then the payment fits its budget. Buying the tool and laying off workers increases the company’s profits. The first mechanism of falling rate toxin is layoffs across the economy.

Normally, replacing tedious and backbreaking work with machines is a good thing. It frees people for jobs that produce more and stress their bodies less. However, our Fed-distorted interest rate isn’t normal. Few new jobs are being created, and people aren’t freed for anything except unemployment. The destruction of labor is a human tragedy that deserves its own story.

High unemployment means weak consumer demand, and therefore soft prices, for the products made by Acme and other companies.

The Fed’s rate suppression has a second path of attack. Successful companies constantly look for opportunities with a return on investment (ROI) greater than their cost of capital—i.e. the interest rate. Lower interest rates perversely encourage them to chase smaller margins. Suppose the prevailing ROI is 5 percent but the interest rate is pushed down to 2.5 percent. Acme and many other companies are happy to borrow at 2.5 to expand, because they hope to make 5.

Normally, growing a business is a good thing because it offers new goods to consumers, and creates wealth for investors. However, when the Fed pushes down the rate of interest, the rate of profit tends to follow, with a variable lag. The end result is not wealth creation, but profit margin compression.

Shrinking margins are bad enough for new borrowers, who get less bang for their cheaper buck, but they’re deadly to old borrowers. The rate of profit can be pushed below the old borrowers’ original rate of interest. Then, a new competitor may drive them out of business.

Consider a restaurant, Sleepy Steak & Potatoes. Sleepy borrowed at 5 percent to build a nice store. What if their competitor, Hip Hotpot Fusion can borrow at 2.5 percent? Hip Hotpot builds a bigger place with taller ceilings and high-end finishes. Former Sleepy customers switch to Hip. This is churn—one business simply supplants another, creating little or no wealth.

Labor destruction, margin compression, and churn are the result of corporate decisions. Business executives are not stupid. The problem is that they must live or die in a Fed-distorted market. They have little choice. If they don’t seize an opportunity, then a competitor can. They’re forced to be like Olympic ski jumpers. If one skier is unwilling to risk life and limb and push it to the limit, he gets beat by the next athlete who is.

It’s pretty obvious that lower interest rates encourage more borrowing, and we’ve looked at two ways that each downtick incentivizes businesses to load up on more debt.

The effect on the stock market is not simple. Rising profits tend to push stocks up, but that’s not the whole story. Higher debt makes companies more dependent on credit market conditions, and lower profit margins make them more sensitive to consumer spending. Companies and their stock market valuations become brittle, vulnerable to small changes. Stocks can crash if credit stops flowing, like it did in 2008.

When the next heart attack strikes, the Fed deserves the full blame.
A Gold Man In Monetarist Territory

On November 3, the Manhattan Institute hosted the fall meeting of the Shadow Open Market Committee (SOMC). This is a 40-year old group, with many illustrious economists among its membership, starting with its founder, Allan Meltzer.

The SOMC is not shy about criticizing the Federal Reserve, though they remain committed Monetarists. These students of the Chicago School make a great show of their dispute with the followers of John Maynard Keynes. Monetarists lean more towards free markets, but both schools share one key idea: fiat currency.

It’s interesting that most people assume that former Fed Chairman Ben Bernanke and current Chair Janet Yellen are cut from the same cloth. That’s because their policies have been indistinguishable in practice. However, Bernanke is a Monetarist who openly credits Milton Friedman and Yellen is part of the New Keynesian School.

Distinguished Professor of Economics at Rutgers University, Michael Bordo spoke on a panel at the SOMC meeting. In his remarks, he made an offhand dismissal of gold. The SOMC had considered the gold standard, but rejected it.

During the Questions and Answers period, I had an opportunity to ask a question. I began by noting that the Fed is the central planner of money and credit. I asked why the SOMC didn’t favor gold and a free market in money. Professor Bordo didn’t want to respond, so the panel moderator, Carnegie Mellon economics professor Marvin Goodfriend, responded. He told the audience and me that we could revert to the gold standard as a last resort. But, he said, he is an “optimist” (his word) and believes that the Fed can do better.

Forget the endless debasement of the value of the dollar. Forget the economic alphabet soup of GDP economy, CPI inflation, M0 money supply, and U6 unemployment. Eyes glaze over when these technical topics are debated, and they’re just a distraction from a timeless question. Can men be trusted to conduct their own affairs voluntarily? Or should some be appointed to rule the affairs of others by force?

In other words, free markets or central planning.


Philosophers and armies have battled over these two opposite visions for millennia. Through most of the 20thcentury in much of the world, central planning won. So did the Grim Reaper. The socialist experiments in Russia, China, and so on racked up a body count of well over a hundred million. America isn’t there yet, but it’s trending in that direction. Just ask the family of Eric Garner, a man recently choked to death by the police, in an incident that began over a cigarette tax.

The Russians and Chinese didn’t die merely because the wrong people were in charge. However, if central planning puts the Stalins and Maos in control, then that’s a compelling argument against central planning by itself.

They died because central planning cannot even deliver food. Food requires plowing, planting, harvesting, and distribution. These are simple activities, yet socialism is unable to organize them. The socialists inherited food-producing countries, and made it impossible to produce food.

Most countries are smart enough not to again attempt central planning of food. Instead, they think they can make it work with something much more complex: money and credit.

I want to shine a spotlight on that curious word of Professor Goodfriend. Optimism, he said, was the basis for his belief in central planning. I think we are way past the point where that claim deserves any serious merit. Whatever word one may use to describe a belief in central planning, it is not optimism.


Let’s not get distracted with debating the details of central banking, such as the ideal money supply growth. Central banking is the monetary system of socialism, which is why Karl Marx included it in his ten planks. By contrast, gold is the monetary system of the free market.

That’s the issue. Freedom or socialism. Gold or fiat currency. A free market or the Fed’s central planning. Life and happiness, or poverty and death. Take your pick.

Goethe Predicted Dollar Slavery

The dollar has been losing its value for a century (though there have been corrections, like the one since 2011). The dollar was once worth 1555mg gold. Now it’s worth a mere 25mg, a loss of 98.4 percent under Federal Reserve management.

Everyone knows about devaluation, yet few realize how far it’s gone. We attempt to use prices to adjust the dollar. The basic idea is to calculate how much less the dollar can purchase today. For example if the grocery bill for milk, eggs, bread, and cheese doubles, then it seems the dollar has fallen by half.

This method of measuring the dollar’s drop is fatally flawed. Companies are constantly cutting costs and, as a consequence, real prices. By measuring only the difference between the rates of descent of the dollar versus real prices, we see a small part of the dollar’s loss. We’ll demonstrate this point with two visual examples.

First, let’s drop two balls from a cliff, one iron and the other rubber. After a few seconds, the iron is down 100m but the rubber has fallen only 80m (due to air friction). Do we say that the rubber ball has gone up 20m?

Second, consider a fat man on a diet. He loses a lot of weight, and now his trousers are loose. We don’t say that the slacks got bigger, any more than we say the rubber ball went up. We can’t use falling objects as a measure of height or dieters as a measure of clothing.

This is obvious and uncontroversial. However, unlike freefalling balls and weight losers, the devaluing dollar is in widespread use as a unit of measure. It’s hard to grasp why we shouldn’t use something we’re using constantly.

The government got its paper dollar into circulation by force. It confiscated the people’s gold and outlawed gold ownership. It enacted legal tender law to force savers to lend dollars. It imposed a capital gains tax to force consumers to pay for goods with dollars.

Then in 1975, gold ownership was decriminalized. Today, there is a movementto legally recognize gold. Yet, there is one more insidious trick keeping us chained to the dollar. We are all indoctrinated to think the dollar is money, and that money means the dollar. It starts in kindergarten and continues through graduate school. Every book, movie and TV show reinforces the dollar edifice. It’s built into law, regulation, and the tax code.

The brainwashing has been almost 100 percent effective. As proof, I offer exhibit A, a Google search for pictures of money.

As exhibit B, I offer the gold bugs. They are convinced the dollar will soon be worthless. But even they think of gold’s value in terms of dollars. Whenever the dollar drops they say, “Gold is going up.”

John Pierpont Morgan could set us straight with just six words from 1912, “Money is gold, and nothing else.” Yet this is both too little and too much. A pithy quote is insufficient to overcome the hardening of belief that occurred over many decades. And it demands a giant leap—a paradigm shift. Few are ready to jump yet.

Much of what we think we know about money is wrong. We’re stuck in the dollar paradigm. To think outside this box, we have to look at the dollar dispassionately. The dollar is just an irredeemable paper currency. It is not money, no matter what the government decrees or what people believe.

Many people believe that the market was free until the Fed’s unconventional response to the crisis of 2008. However, there is no such thing as a free market if we cannot use what we want for money, and the Fed has the power to create and allocate credit by command.


Johann Wolfgang von Goethe predicted this confusion in 1809, “None are more hopelessly enslaved than those who falsely believe they are free.”

Inflation Is Counterfeiting

Most people have a basic idea that inflation is when prices rise, and that this is caused by an increase in the money supply. Since the Federal Reserve is rapidly increasing the money supply, it is only common sense to expect this will hurt us sooner or later. It is absolutely wreaking havoc, though not how you might assume. A simplified idea of inflation is good enough for casual conversation. However, to see what quantitative easing is doing to us requires a more precise understanding.

Inflation is, at root, a monetary fraud.

It helps to understand the dollar, before building the fraud case. The dollar is a debt. Did you ever wonder why we call it a dollar bill? Bill is an old word for a certificate showing that money is owed. On the paper dollar, they don’t print “bill” but “Federal Reserve Note.” Note is another word for money owed. The dollar is a debt owed by the Fed.

The Fed is a bank, and like any bank it must have an asset to match every liability. So long as it owns a dollar’s worth of good assets for every dollar it owes, then the Fed is solvent. However, if its assets fall below its debts, then the market will not accept its currency.

The lion’s share of the Fed’s assets is the US government’s debt—Treasury bonds. Yes that’s right, the government’s debt is its central bank’s asset. If you are picturing Uncle Sam’s purse owing money to his billfold, that is about it. Incredibly, the billfold counts the purse’s promises to pay as an asset.

The system holds together so long as Uncle Sam is servicing his debt. This is not in jeopardy in the near future, but debt default is inevitable. The sad reality is that the government has no means to repay it. The issue is not simply the sheer size, though 17 trillion is certainly an alarming number. Nor is it just the lack of discipline of our political class, though they certainly love to spend. The debt itself is inherently bad.

In my last column, I said that lending and borrowing literally built our civilization. Let’s first look at this kind of borrowing and then at how government debt differs.

Many startups borrow money to start or grow their businesses. In 1977 Steve Jobs used a $170,000 loan to launch Apple Computer. This money was well invested, and helped build an enduring powerhouse. Apple made its founders and their investors very rich, and improved the lives of billions of people globally.

A loan transfers capital from lender to borrower. This enables the borrower to immediately consume resources that it does not own—the lender’s resources. In exchange, the borrower promises to return these resources in the future and a bit more as interest.

It works so long as the borrower uses the capital to produce something new. New production generates new profits. These profits are enough to pay back what was borrowed plus interest, and enough for the borrower to make money too.

If the borrower does not increase production, then it must default sooner or later. This is because it has no means—no profits—from which to make payments. This can happen through honest error, when an entrepreneur miscalculates the market opportunity for his new product. Unfortunately, there are also criminals who do it on purpose. Bernie Madoff wasted investors’ money on his lavish lifestyle, producing nothing. Criminal schemes like that always collapse.

This unfortunately describes the US government. Some of its borrowing does finance new production, but the bulk is consumed. Like Madoff, the government has no way to repay, though it can keep its scheme going far longer. It can borrow fresh money to pay off old debt as it matures, but the scheme must inevitably collapse.

Borrowing without the intent to repay is not really borrowing at all. It’s fraud.


The Fed buys the government’s fraudulent bonds, issuing dollars to finance these purchases. The Fed deceives us into accepting this bad paper as currency by making its new dollars look like real currency. This is the very essence ofcounterfeiting.

Inflation is the official counterfeiting of the currency. The consequences will be the total collapse of the people’s trust, along with the government’s bad bond and the Fed’s bad dollar.

Inflation Is A Weak Argument For The Gold Standard

The most popular argument against the fiat dollar is that it’s prone to inflation—defined by most people as rising prices. We must switch to the gold standard, according to this argument, because the paper dollar causes consumer prices to rise relentlessly.

It’s true. Prices have been going up ever since the Fed began centrally planning the dollar. If you’ve ever seen an old Coca Cola sign or Sears Roebuck catalog, or just remember the price of gasoline in the 1960’s, you know how much it adds up over long periods of time.

The Fed’s mission is supposedly to fight inflation. In fact, one of its Congressional mandates is to keep prices stable. This is like setting the fox to watch the henhouse, with a mission to keep the hen population stable. No one really believes the Fed cares about stable prices.

The Fed itself openly hungers for rising—that is unstable—prices. Their Federal Open Market Committee has a policy to cause two percent annual increases. This is robbery, pure and simple.

Unfortunately, the inflation argument just isn’t compelling. Suppose you try it on Joe the skeptic. He shrewdly asks, “So inflation is like a tax?”

“Yes,” you concede. “It is. As I just showed you, the government is taking a portion of your wealth every year.”

Joe may be skeptical, but he’s not stupid. “Sales tax is four times worse than inflation, and the income tax rate is a lot higher than sales tax,“ he notes. He’s right.

Joe concludes, “We should go back to the free market.” He is a free-market skeptic. “Just put inflation on the list of taxes we should repeal someday.” He just doesn’t see any urgency over a two percent tax. We can quibble that inflation is really higher, but that doesn’t change the equation. For reference, the Bureau of Labor Statistics calculated 1.5 percent inflation last year.

One complication with the rising prices argument is that some prices aren’t rising. Last year, I bought a pair of Levis jeans at Macy’s for $45. I recall buying a pair of Levis at Macy’s in 1983—over 30 years ago—for $50. We can dismiss this as the result of improved production efficiency and cheaper labor. Still, the fact is that the price dropped.

The prices for some things are falling. You can get a cheap computer that fits in your pocket today. It outperforms a cabinet-sized computer that cost $15,000 in 1983 dollars, and does a lot more besides.

Consumer prices are a lousy way to try to measure the falling dollar or inflation.

Even if you somehow overcome these objections, the argument is not compelling to Sally, the wage earner. She trusts that her annual raise will more or less keep up with inflation. And it does, more or less. There is a slow loss, but it’s a fraction of the inflation rate. In retirement, her pension and Social Security check will be indexed to inflation. “I have to go back to work now,” Sally says, as she walks away. She doesn’t have enough money in the bank to get worked up over how much value it’s losing.

Nor is the argument compelling to John, the investor. “The value of the properties I own has gone up 22%,” John states proudly. “I only put down 20%, so my return is much higher than that.” John is also heavily invested in the stock market. “My stocks have tripled since 2009,” he adds. “I don’t really want the Fed to print so much but, if anything, it’s good for me,” John says as he gets into his Ferrari. “Talk to you later.” His portfolio is going up much faster than inflation.

The inflation argument distracts us from two critical problems. Debt at every level of the system is rising exponentially. At the same time, the interest rate is collapsing.

These problems cannot be so easily dismissed.

What Happens When Credit Is Mispriced?


The 1-year US Treasury bond pays a yield of 0.23 percent (not a typo), and the 30-year bond has a scant yield of 2.9 percent. That’s nothing compared to Switzerland, where the yield is negative on all bonds maturing in five years or less. Yes, you pay them to lend to them.

These rates are the result, not of a market, but of central planning. The Federal Reserve and its counterparts around the globe have bought up bonds relentlessly. A higher bond price is the same as a lower interest rate (the bond price and interest rate are inverses). Now rates are obscenely low.

What happens when the government sets the price of something too low? Most people could tell you that the end result is a shortage.

rices-down-22-nara-513811

The government can’t create more stuff. What happens is that economically lower uses displace higher uses. Normally, price acts as a filter. Those who are willing to pay the most, get the goods. They outbid everyone else. For example, a trucker can have all the diesel fuel he needs but a teenager hoping for a weekend cruise in her parents’ yacht is left high and dry. This is the best outcome, because the truck is carrying tons of valuable products to customers who want to pay for them. Delivering products is a higher use of fuel than amusing a teenager.

If the government dictates a 25-cent cap on the diesel price, then that bored girl can afford to tank up. She’ll be happily at sea, for a while. Then trucks will stop rolling for lack of diesel—perhaps even those delivering fuel. Then it gets worse. No new fuel will be ordered to replace what’s consumed, because gas stations cannot operate at a loss. That’s when the shortage begins in earnest. Venezuela is now in this stage, its people suffering from a lack of everything from medicine to toilet paper.


It’s important to understand that there is nothing intrinsically wrong with yachting. However, if a teenager can’t afford diesel fuel at the market price, then she should not be burning it. What’s bad is to force an uneconomic use of resources, which is what price controls do. The diesel price cap enables her weekend cruise at the expense of someone else, the diesel retailer. She’s literally burning his capital.

Fortunately, the government doesn’t try to cap fuel today. Unfortunately, it caps the interest rate instead. The interest rate is the price of credit, the cost of borrowing money. Artificially low interest enables uneconomic uses of credit.

A recent example occurred in shale oil producers. A brief look at Energy XXI illustrates the problem. About a year ago, when oil was over $100, the company borrowed half a billion dollars. Moodys rated its bond b3, which is at the bottom of the category described as “high credit risk,” and one step above the one labelled “poor quality.” Energy XXI paid 7.5 percent interest. That’s not enough to compensate investors for the risk of default, much less provide an acceptable rate of return to lock up cash for seven years.

Many oil producers shouldn’t have been given credit. They couldn’t afford it, until the Fed pushed the rate of interest down. Like our young wannabe yachter, price suppression enabled oil companies to consume someone else’s capital. Now that the oil price has dropped 47 percent, from around $107 to $57, the defaults will begin. The destruction will be obvious, especially to the buyers of these bonds.


No one wants to be left out in the cold, but not every desire to consume resources can be satisfied. The function of the price system is to sort activities that produce wealth from those that destroy it. Government-imposed distortion only enables resource consumption that would otherwise not be possible. This harms the owner of the capital that’s destroyed.

It also harms the rest of us. That squandered capital is not available to finance a cancer cure, self-driving car, or anything else which benefits millions of people.

Accumulated Capital of Centuries Going Up In Smoke


In the ancient world before civilization, life was hard. People endured long days of toil, to produce a meager subsistence. Today we don’t work so much, though we have abundance the ancients could not imagine. What is it that allows us to be so much more productive?

We have capital.

Think of capital as something that adds leverage to human effort. No one is strong enough to lift a truck. However, anyone can pump the lever on a hydraulic jack and raise it up. The jack multiplies your strength, letting you do more work with less effort. The jack is a form of capital. The concept is much broader than merely a mechanical device. It applies to production too.

Think about life with no capital whatsoever, on a desert island. You hike up a steep volcano to drink from a rainwater pool. You climb palm trees to pick coconuts and catch fish with your hands. You gather wood and build a fire on the beach to roast your fish. You collapse in exhaustion, only to do it again tomorrow.

What happens if another guy swims ashore?

You might want to hire him to help you, but you can’t pay. And so he must repeat the same tasks and getting the same scant diet.

Suppose you both begin to work even harder, sacrificing in the present for a better future. You add an extra climb for coconuts every day, and catch one extra fish. Each week, you can both afford to spend one day working at tasks other than for immediate survival. You make a net for catching fish, a hut for drying them, and a bowl to carry water from the pool. With these items, you spend less time getting food and water, and you can store food. You have accumulated some capital.

When the next guy swims ashore, you can pay him to work your net. He will earn more than he could on his own, and you have a profit after paying him. Profit enables you to accumulate further capital: a food storage hut and a sheltered fire pit.

Capital is what makes employment and wages possible. The greater the capital base, the higher the wages that people earn. Today, a machinist for example, can earn enough to buy all the healthy food he can eat, spare clothing, healthcare to provide a life expectancy of 78 years, plus the means to travel and communicate, and various forms of entertainment. Much of this was beyond reach for all but the richest people in the 19th century, and even the richest died of simple infections.

In the free market, there is always a strong incentive to accumulate capital. People can act contrary to incentives of course, but most prefer making profits to losses.

Unfortunately, our most important market is not free. Money and credit are centrally planned. The Federal Reserve is directly or indirectly in charge of every key variable in the dollar system.

The Fed distorts the capital markets almost beyond recognition. If offers aperverse incentive—to make a profit by destroying capital. For example, companies borrow money to buy back their own shares, driving up their share prices (and executive bonuses). David Stockman was the Director of the Office of Management and Budget under President Reagan. He said that CEOs “use the Fed’s flood of liquidity, cheap debt and soaring stock prices to perform a giant strip-mining operation on their own companies.” Strip-mining is a great term for it.

The Fed destroys savings with zero interest rates, and herds savers intobubbles. It causes wages to fall, creates chronic pressure to lay off workers, and encourages people to go into personal debt. I could go on and on.

Though the Fed does cause rising prices, this is but a candle next to the towering inferno where the accumulated capital of centuries is going up in smoke.



Dishonest Money Tears the Fabric of Society

Many families have a deadbeat lurking somewhere in the family tree. Let’s consider the story of a rich man, whom we’ll call Gomez. His 34-year old son, Pugsley, is between jobs. “Dad, I need to borrow a thousand bucks.”

“What do you need it for?”

“To get the landlord off my case.”

“How are you going to pay me back?”

“I’ll figure something out.”

Gomez thinks about it, and decides to draw up a loan contract. Pugsley signs and Gomez writes him a check for $1,000.

How much would you pay to buy this loan from Gomez? Personally, I wouldn’t touch it with a ten-foot pole.

Gomez also lends to his daughter Wednesday, Cousin Itt, Uncle Fester, and 996 other unemployed and unemployable creatures. Then he goes to his lawyer, and bundles it up as a security. The offering memorandum is over a hundred pages and it looks like a beautiful thing. At least that’s what the ratings agency says.

counterfeit-bill

Gomez sells a 5-year bond, backed by a thousand loans that cannot and will not ever be repaid. But, hey, it offers 2.2% interest. Thanks to the Fed, there is scant interest to be earned anywhere. The market, full of institutions that can borrow at near zero and hungry for anything with a yield, buys up Gomez’ bond.

Your bank, which borrows from you and other depositors, buys the bond. That means it’s now backing your savings account, your money. Your money is safe so long as the bond remains good.

Gomez can call it a “bond” if he likes, but that’s a lie. A true bond finances a productive enterprise. For example, Apple uses the money to finance a new plant to make sapphire screens for the iPhone. Investors in the Apple bond can rest assured that Apple will pay back the debt with interest, from the profits made by selling phones.

Gomez’s bond is going to default, though he may be able to kick the can down the road for quite a long time. For instance, he could sell a new bond to pay the old one.

The bond stinks like a week-old fish, and any bank account depending on its repayment is also rotten. It’s counterfeit, all of it.

This is how I think of inflation—the issuance of bad paper money.

The proportion of bad credit in the market is growing, like a tumor that takes over and displaces healthy cells that support life. Every day, counterfeit bonds mature and have to be paid. Issuers sell new bonds to pay the old ones. The new bond is typically larger, because of the interest that’s constantly accumulating.




This is a crime, a debauchery, a debasement on massive scale. By comparison, Charles Ponzi was the junior varsity.

How does it make you feel, to see fraud conducted in the open and with the approval of the government? I know how it makes me feel, but this is a G-rated column suitable for audiences of all ages, so I will hold back a few choice words.

How does society respond to something like this

Steve Forbes answers that question, in his book Money. He noted that, “The stealth thievery of monetary debasement trickles down too.” If the top bankers and government officials are crooks, people wonder, why should we be honest? Forbes quotes Henry Hazlitt’s answer to this question, “Reward comes to depend less and less on effort and production… Corruption or crime [seems] a surer path to quick reward.” Forbes closes the chapter with a universal truth, stated in his own words, “When people stop trusting money, they stop trusting each other.”

Inflation—monetary counterfeiting—can cause prices to rise. Unfortunately, that’s the least of the harms it does to us, and to our savings.

Inflation Is Counterfeiting

Keith WeinerKeith WeinerContributor

America Needs The Gold Standard More Than Ever

Keith WeinerKeith WeinerContributor

What's Wrong With Borrowing More and Getting Less?

Will New Money Market Rules Break Money Markets?


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On Wednesday, the Securities and Exchange Commission announced changes to money market fund (MMF) regulation. According to the SEC Chairwoman, Mary Jo White, the new rules, “will reduce the risk of runs in money market funds…” Her worry about financial stability seems to contradict the views of the Federal Reserve and establishment economists.

Last week, Fed Chair Janet Yellen said, “The financial sector has continued to become more resilient…” Since February, “further important progress has been made in … strengthening the financial system.” Nobel laureate economist Paul Krugman actually mocks any concern as “the desperate desire to see a debt crisis.”

To understand Ms. White’s claim that the new rules, “will reduce the risk of runs in money market funds…” let’s look at the two new MMF rules. The first is simple enough (though blatant cronyism). During times of stress, MMFs can charge a fee to withdraw your money, or even delay paying.

A poster for the 1896 Broadway melodrama The W...
A poster for the 1896 Broadway melodrama The War of Wealth depicts a typical 19th-century bank run in the U.S. (Photo credit: Wikipedia)

MMFs are basically mutual funds, though with a share price fixed at $1. The second rule allows the share price to change with market conditions. In normal times, the MMF share price doesn’t need to change. MMFs invest only in short-term debt, which is not volatile. They respond to small price changes by adjusting their yields.

We aren’t in normal times. Let’s not forget that the Fed is still reacting to the last crisis with what they call unconventional policy response. MMFs now face liquidity risk, when investors don’t want to buy more because they need to sell, to raise cash.

This is a real problem for the borrower, typically a corporation selling short-term debt to finance itself. When each debt contract matures, the issuer must sell a new one. If the market seizes up, it can get into big trouble.

When I was a boy, I would sometimes roughhouse with other kids. My mom once told us, “It’s all fun and games until someone puts out an eye.” The credit market is just like this. It’s all fun and games until someone misses a payment. When they can’t roll their debts, many corporations may miss a payment.

It’s a serious threat to money market mutual funds, because they own this debt. It’s what they hold as assets. While the market value of the MMFs asset is falling, the share price of the MMF remains fixed at $1. Suppose the fund’s assets drop to 90 cents. That means the fund loses 10 percent with every redemption. If there are enough withdrawals, then remaining investors get stuck holding an empty bag (MMFs are not FDIC insured).

The SEC says it wants to fix this problem.

By allowing the share price to drop if necessary, it does remove the incentive for investors to rush for the exit. Sure, investors take losses and risk further losses, but the threat of total loss is eliminated. By allowing penalties, it discourages withdrawals, but investors who need their money badly enough will take it out anyway. By allowing MMFs to delay paying, it prevents runs that might occur even with a floating share price and withdrawal penalties.

The SEC is right to plan for another crisis. Insolvency caused the last one, and the Fed responded by buying bonds and cutting the interest rate. This masked the problem, while encouraging everyone to borrow more. The timing of the SEC’s new rules may be coincidence. If not, then the next crisis may erupt soon.

A floating share price creates the perception of risk that MMFs never had. The possibility of fees and delays adds a risk that’s hard to quantify. MMFs are now a less attractive place to park money than they used to be. Some investors may pull their money before the new rules go into effect in 60 days.

The SEC is trying to walk a tightrope. MMFs contributed to the last crisis but with its regulatory change, the SEC may precipitate the very run on the bank it is so desperately trying to prevent.



What's Wrong With Borrowing More and Getting Less?

Spending is popular. Most voters like free goodies and dislike tax hikes, so government turns to borrowing. Borrowing enables it to spend more than it can afford. The difference between higher spending and lower tax revenues is called the deficit. Another way of thinking of the deficit is: how fast the debt is growing.

The debt is growing at an alarming rate.

Just 7 years ago, the national debt was about $9 trillion. Today it towers to nearly $18 trillion, and it’s on track to explode to $35 trillion by 2021. The growth rate of this debt monster is not sustainable.

Some economists serve as eager apologists. While their logic may sound tempting, it’s just propaganda. For example, they tell us not to look at the debt number by itself, but instead compare it to Gross Domestic Product. GDP is usually rising, so this makes the monster appear smaller. However, the ratio of debt to GDP is rising too. It has topped 100%, which means the government debt is bigger than the economy.

There is a more ingenious way to lie with statistics—don’t even look at the debt at all. Instead, look at the interest expense on the debt, and compare that to GDP. This would seem to banish that monster to the space under the bed. Interest expense is small relative to GDP. The trick is that it’s just an artifact of the falling rate of interest. Of course the monthly payment is lower, if you have a lower interest rate.

Paul Krugman, the Nobel winning economist, doesn’t use such statistical sleights of hand. He goes straight to what he believes is the economic principle. He claims that when the government borrows to spend, it creates growth.

There is a grain of truth here. Some borrowing is good. For example, Steve Jobs borrowed $170,000 to launch Apple. He used the money to produce a computer that people wanted to buy. By increasing production, Apple served its investors and its customers. Everyone wins.

By contrast, government borrows mostly to spend on wasteful purposes. Krugman doesn’t quibble over waste. He embraces it, and explicitly defends it. He wants the government to invent a threat from space aliens, to justify spending to defend against their invasion. Unlike with Apple, this is not self-sustaining. As soon as the government stops buying needless hardware, everyone hired to build it will be unemployed again.


It’s just common sense that waste is bad. As far back as 1850, Frederic Bastiat wrote to debunk that kind of thinking. In That Which is Seen, and That Which is Unseen, he said, “To break, to spoil, to waste, is not to encourage national labour; or, more briefly, ‘destruction is not profit.’”

There is a way to see the flaw in Krugman’s logic, visually. We can measure the economic growth when we borrow. Let’s look at a graph of the marginal productivity of debt—a measure of how much growth we get from each newly borrowed dollar. Think of it as the bang for the buck of borrowing.

Marginal Productivity of Debt

This data is from the St. Louis Fed. It compares total credit market debt with GDP. The graph goes back to 1951, with a trend line to make the point clearer.

Over time, new debt is buying less and less growth. In the early 1950’s, the number was greater than one. That’s what we want, and what Krugman’s argument implies. Unfortunately, it has been eroding for a long time. It collapsed as a consequence of the crisis of 2008, and briefly surged as a consequence of the Fed’s aggressive response. It’s now below zero again, which means we’re borrowing, but despite (or because of) this, the economy is shrinking.

Borrowing to buy pork may please voters, but it does not lead to a rising economy. It leads only to rising debt. The debt works like a treadmill, making us borrow faster and faster to stay in place.


We Need a Declaration of Monetary Independence

Voting is one of the most sacred rights of free people. Without the vote, we are prey to any tin-pot tyrant to come along. He can rule without a care for our property and lives, seeking only to loot the people for his own ends.

By 1776, the tyranny of King George had become intolerable, and the Founders wrote the Declaration of Independence. This statement of principles emphasized the “consent of the governed” and the “right of Representation in the Legislature”. Men fought for these principles. Men died for them.

However, they left some unfinished business. In 1870, after having fought again for those same principles, they ratified the Fifteenth Amendment to the Constitution. Now the right to vote—the franchise—could not be denied to someone based on race. Unfortunately, they still left some unfinished business.

The signing of the Declaration of Independence
The Signing of the Declaration of Independence. (Photo credit: Wikipedia)

In 1920, after the women’s suffrage movement fought for many years, the Nineteenth Amendment was ratified. No one could be denied a vote on the basis of sex.

Now everyone has the vote. Politically, we’ve come a long way. By contrast, we have lost precious financial freedom. We have lost the right to vote with our money. Allow me to explain.

Before 1933, savers were in control. If you didn’t like the risks taken by the banking system or the interest rate, you could withdraw your gold or silver coin. Putting your money under your mattress is not just a quaint expression. Back then it was a real option.

This choice has an important and beneficial economic effect. When you withdraw your gold, it forces the bank to sell an asset, like bonds, to raise the money to pay you. This drives down the price of bonds and drives up the interest rate. When interest rates become high enough, people are again attracted to deposit their gold.

Think about going to the supermarket and seeing lobsters in the display case. You would love to have them for a romantic dinner, until you see the price. Then you buy the pork chops instead. If you buy the lobster, it encourages the store to raise the price. If you decide not to buy, it puts pressure on the store to lower the price.

This economic law works with interest rates the same way as with seafood. It’s far more important with interest. Everything in the economy is impacted by the rate of interest.

Unfortunately, the interest rate isn’t set this way anymore. There is no point to putting paper dollars under your mattress. If you don’t like getting 1/10 percent on your savings account, then tough luck. Withdrawing it for cash is like jumping out of the frying pan into the fire. You are still lending your savings—now to the Federal Reserve—only you get no interest. The Fed in turn lends it to banks and the US government.

We can complain about the paltry interest rate in bank accounts or bonds under the Fed’s zero interest rate policy. We can worry about the risks in the banking system, and the too big to fail policy. We can petition our lords at the Fed for mercy, and beg for relief from the drought of interest that withers our savings.

The fact is that our preferences don’t matter. The Fed may be trying to somehow stimulate employment and exports. It may be dealing favors to Wall Street and certain industries like construction. It may be desperately staving off bankruptcies by doling out cheap credit to insolvent debtors. Whatever its motivations, the Fed does to us what it wants.

We suffer under our monetary king. The Fed does to the savers what King George did to the colonists.

We are disenfranchised, and urgently need a Declaration of Monetary Independence.

What Distorts Your Investments and Undermines Your Savings?


Everyone knows the dollar is falling. For Pete’s sake, the stated policy of the Federal Reserve is to push it down. Fed Chair Janet Yellen asserts that devaluation will fix the economy and unemployment. It won’t. It will, however, undermine two important functions of the dollar. Money is the unit of account and the store of value.

It’s important to know if a business is creating or destroying wealth. For something small like a chicken coop, this is a simple determination. If a chick eats two bags of corn from egg to market, and you trade it for five bags of corn, then you have created wealth. You added value and made a profit.

However, most businesses are more complicated than chickenfeed. Investors put in capital, and get repaid over a long time. Only by keeping accurate books can we know if a business is creating or destroying wealth. Suppose you buy the equipment to manufacture and retail lemonade. After months building your shop, you begin selling. Unlike chickens, you don’t have the convenience of trading lemonade directly for raw materials. You need a way to put investment, expenses, and revenues on equal terms. You need a common denominator—money.

Money makes it easy to measure profit or loss. Suppose you consume 100 kilos of sugar, 2 crates of lemons, and 3 bags of pink food dye, producing 5,000 cups of lemonade. Without money it’s hard to tell if you’re creating value, much less earning an acceptable rate of return on your capital. By putting dollar figures on everything, like $1 per kilo of sugar and so on, anyone can understand this business.

Suppose an investor puts $100,000 into our little lemonade stand, but it only earns $1,000 a year. It’s obvious that this investment is a loser. Unfortunately, the dollar can distort this simple picture. The Fed has practiced alchemy in reverse. It hasn’t turned lead into gold. It’s turned the dollar from gold into rubber. Now elastic, the dollar deceives investors.

When the dollar drops, then the price of lemonade may rise proportionally. If the price jumps enough, it may make the investment look like a winner. Changing the value of the dollar compromises the integrity of the books, but of course it doesn’t change the reality of a bad investment.

Investors can be tricked into allocating precious capital to a bad business that wastes it. The falling dollar, used as the unit of account, masks their losses.

We all need a way to store value for the future. Suppose you retire from the chicken business, selling your last 10 chickens for $50. A few years later, you decide to get back in. You go to buy some newly hatched chicks, but now they sell for $50 each. You got robbed, but you learned a lesson. It’s better to buy used cars, or whatever else, than to hold money.

The falling dollar gives savers a bitter choice. They can suffer endless losses by holding cash. Or they can try to escape by holding something else instead, like old cars. Yet old cars incur losses too. They are illiquid (except for oil leaks), and storing them on the lawn annoys the neighbors. Cash or clunkers, it’s a lose-lose proposition.

It also drives up the price of a car, harming those who can least afford it. Poor workers, priced out of cars, may lose their jobs. The same thing happens with any other good that savers prefer instead of cash. The poorest, priced out of the market and deprived of the goods, may starve, freeze, or suffer. Is this what Janet Yellen intends by discouraging people from holding cash? No matter, it’s reality.


When the dollar falls, prices tend to rise. People call thisinflation. It’s their key complaint about the dollar regime, but it’s the least of the harm inflicted on us. The people themselves, pushed by perverse incentives, do infinitely more damage. Two prime examples are investing in bad businesses and hoarding junk.

The Gold Standard Institute Presents The Gold Standard: Both Good and Necessary, in Manhattan on Nov 1. You are cordially invited to join us for a discussion of ideas you won’t get anywhere else. I will talk about the problems with dollar, other than rising prices. I will address why we have not recovered from 2008, and we can’t without gold.



America Needs The Gold Standard More Than Ever


The godfather of modern economics, John Maynard Keynes, dismissed the concept of gold as money—the gold standard—as a “barbarous relic.” Another economics titan, Nobel Prize-winner Milton Friedman, conceded that gold is good in theory, but opposed gold in practice, arguing that a return to a gold standard is “neither desirable nor feasible.”

Both Keynes on the left and Friedman on the right got it really, horribly wrong.

The gold standard is neither barbaric nor impractical, and it is more urgently needed every day. This is because the standard of paper money is failing. It has set in motion an accelerating series of crises, each worse than the previous. The nation cannot continue to borrow to infinity, nor can the U.S. endure zero interest much longer.

Campaign poster showing William McKinley holdi...
Campaign poster showing William McKinley holding U.S. flag and standing on gold coin “sound money”, held up by group of men, in front of ships “commerce” and factories “civilization”. (Photo credit: Wikipedia)

An examination of history supports the case for gold. Under the gold standard in the 19th century, the quality of life of most people improved faster than ever before, or since. It didn’t last because, unfortunately after the turn of the century, war preparations required huge expenditures.

Waging what was later called the Great War could only be financed by one means: debt. And there was only one way to borrow. In most countries, a central bank was already established, and by 1913 even the freest country had created a central bank. They called it the Federal Reserve.

Central banking is simply central planning—government interventions—applied to money and credit. The gold standard is simply a free market in money. Intervention conflicts with a free market, and gold lost the battle. It’s no coincidence that economies collapsed one by one after the war.

All too soon, men were marched off to war again. By the end, much of the world was reduced to rubble and desperate political leaders sought credit to finance postwar reconstruction. The U.S. named its terms: other countries had to treat the U.S. dollar as if it were gold. The Allies signed the treaty, at Bretton Woods in New Hampshire.

But the U.S. dollar was not as good as gold. It was merely Uncle Sam’s promissory note. Perversely, the greater the world’s demand for money, the more debt the U.S. government could issue, which enabled more spending. The crisis came to a climax in 1971, when President Nixon’s gold default created the current system. By Nixon’s decree, the dollar became an empty promise, backed by literally nothing.

Since then, we have had a worldwide regime of irredeemable fiat money. Debt has exploded, doubling about every eight years. The interest rate skyrocketed until 1981, and then went into free fall. The financial system will soon collapse, though when is hard to predict.

Gold, because it empowers savers to keep debt and interest in bounds, can prevent catastrophe.

The main argument against gold is that we need loose monetary policy to get out of recessions. The crisis of 2008 debunks this. Our monetary planners didn’t see the crash coming, and their short-term patches—stimulus and bailouts—have fixed nothing. The next crash looms.

The practical argument against gold is that we don’t have enough of it. This is simply untrue. The 19th century gold standard was run with just a few hundred tons of the metal in London, a tiny fraction of what the US has today. The argument is also frivolous. If the market is allowed to set the value of gold, no particular quantity is necessary.

There is also an argument against a lone country adopting gold. Currency devaluation encourages exports, lifting employment and the economy. It is true, so far as it goes. A falling currency cheapens export goods in world markets. But to fixate on this point ignores destruction of business capital and rising cost of imports, including raw materials. Japan’s economic history confirms this. The yen rose along with exports for decades. Since 2012, the yen has fallen. Japan’s balance of trade is falling with it.

Everyone is better off under gold. Even if other countries remain tethered to failing paper currencies, America should adopt the gold standard. Stable money will allow Americans to thrive. A major component of prosperity is the discipline gold imposes on government spending.

Keynes was wrong that gold is barbarous. Indeed, without gold, the world is now careening toward barbarism. Friedman was wrong that gold is impractical and the West’s teetering economy proves it. What we need more than ever, with the U.S. leading the world, is a path toward adopting gold as money.



Unfunded Liabilities are Fraudulent Promises

The U.S. government reports its debt at more than 17 trillion dollars. To put this sum in perspective, it’s well over 50 thousand bucks for every man, woman, and child in America. Of course children and retirees don’t work, so the debt burden on each working adult is much higher.

Unfortunately, this is only a small part of the total debt. The government excludes a much larger sum from its books, commonly called the unfunded liabilities—future obligations it must pay, but which it has no way to pay. These obligations stem from numerous programs.

For example, bank deposits are guaranteed through FDIC and mortgages via Fannie Mae. These guarantees have risk and cost, in other words, financial liability. Together they add up to trillions of dollars. The largest of the unfunded liabilities are from Medicare and Social Security, which dwarf the liabilities from all others combined. I’ll focus on Medicare to keep it simple, but most of what I say also applies to Social Security.

Government spending
Government spending (Photo credit: 401(K) 2013)

Medicare is like insurance in many ways. Here’s how insurance is supposed to work. The insurer charges a monthly premium and in exchange, promises to pay claims. So long as the insurer follows two simple rules, it will be able to pay. One is the premium must be high enough. The other is the premium must be invested properly. The investment is the key. It’s the asset that funds the liability.

Medicare does charge a big premium, in the form of a tax on your paycheck. It may or may not be high enough, but the government spends it entirely on current benefits and its general budget. It does not invest it. This is why we say that Medicare liabilities are unfunded.

Medicare is a complex and massive government program. To see its fatal flaw more clearly, let’s look at a simple example first. Mendacious Corporation (not a real company) sells a policy that’s guaranteed to pay $1,000 next year. The company charges only $100 premium, so obviously it won’t be able to pay.

So an investigative reporter interviews the CEO and asks him how Mendacious can possibly honor its promise to pay next year. He looks into the camera and says, “Don’t worry, we will sell more policies before then. The premiums will give us plenty of money to pay out.”

Of course this is fraud, a classic Ponzi scheme. Money from new participants is used to pay the old. Every Ponzi scheme is always one step ahead of insolvency. Each new dollar keeps it alive for a day, but at the same time adds to the burden. Mendacious will implode sooner or later.

With Medicare, the government is Mendacious. It takes in new money from current workers and pays it out to beneficiaries. It promises workers that it will pay them in the future, but it fails to plan, or account, for that. It just assumes that there will be perpetual growth in the number of new workers entering the scheme. Meanwhile liabilities are growing out of control.

Medicare and Social Security should be put into receivership immediately, to minimize further losses for retirees and workers. The problem only gets worse and bigger every day we kick the can down the road.

So how much has the government racked up in unfunded liabilities? No one knows for sure, but I’ve seen credible estimates starting at $127T and going up from there. Assuming the bottom end of the range, the burden on each and every working person is about $1M.

The term unfunded liabilities is a dry and antiseptic term that makes people’s eyes glaze over. It serves to conceal a crime so big, that it makes Bernie Madoff look like a fourth grader stealing his classmates’ lunch money.

The reality is not very complicated. Our government has been making promises that it cannot honor. When it defaults, retirees and workers will realize that they’ve been robbed of their savings and pensions. Most will never fully recover.

The best way to help everyone understand the truth is to use plain and accurate language. Instead of unfunded liabilities, I suggest fraudulent promises.

Can The Fed Raise Interest Rates?

Everyone wants to know when the Fed will raise interest rates. The Federal Open Market Committee meeting last week only added to the speculation, with Fed watchers parsing every word of the press release. However the question should be, not when the Fed will raise interest rates, but if. Before our central planners can raise rates, they must deal with a problem of their own making.

Let’s look at it, not from the perspective of the individual investor, nor even the commercial banks, but from the point of view of the Fed itself. The banking system now has large excess reserves. These bank assets are cash above what they are required to hold, which they choose to deposit at the Fed. It may seem counterintuitive that, to the Fed, these reserves are a liability. One party’s asset is always another’s liability in our monetary system.

The Fed borrows to finance a portfolio of bonds (like any bank). Since the crisis of 2008, its appetite has been voracious. It has borrowed about $3 trillion more, largely the excess bank reserves. The Fed pays 0.25% interest for these funds, which are used to purchase bonds earning 2.5%. Right now, the Fed is making a tidy profit. On $3 trillion, 2.25% is about $68 billion a year (which it then pays to the Treasury, unlike a bank).

This all works so long as the cost of borrowing is low. However, the Fed’s low cost is the banks’ low incentive. The banks can pull out at any time, and they will – as soon as they find a better deal.

The Fed has used short-term borrowing to buy bonds that mature in ten years. Think of the Fed’s borrowing of the bank reserves like a balloon mortgage. The catch is that it must be renewed every day—at the banks’ sole discretion. The Fed has to keep it going until the principal on its bond portfolio is repaid in ten years.

The Fed risks a crisis.

This brings us back to the question of whether the Fed can raise rates. Though Icriticized Marvin Goodfriend’s support of central planning, I thought he gave an excellent talk about the Fed’s dilemma. At the Shadow Open Market Committee (SOMC) meeting last month, he noted the growing pressure on the Fed to raise rates. We can’t have zero interest forever, but higher rates will destroy the Fed’s cash flow.

The Fed will be forced to pay a lot more to retain those three trillion dollars. Banks lend to one another at the Federal Funds Rate. The Fed has currently set this rate at 0.25%, but according to Goodfriend and the SOMC, it should be around 4%. If a bank can make that much by lending to other banks, it will not lend to the Fed at 0.25%. So upwards, the Fed’s interest expense must go. It could lose 1.5%, or $45 billion a year. Ouch.

There’s no good way to cover this shortfall. The Fed can try to borrow to pay for its losses, but that is unsustainable and self-defeating. That only digs the hole deeper, not to mention destroys credibility (presumably, credibility was one reason to raise rates).

Unfortunately it gets worse.

If the Fed Funds Rate goes to 4%, then the interest rate on 10-year bonds will go a lot higher than that. This will cause the market price of the bonds in the Fed’s portfolio to fall (a bond’s price moves opposite to its interest rate). Of course the Fed’s liabilities remain, so this portfolio will have a large negative net value.


On top of its cash flow problem, the Fed will have a solvency problem. No one knows what may happen if the Fed becomes bankrupt. The Fed isn’t going to want to find out the hard way. Maybe our wise central planners can find a way to change the rules to let them have their cake and eat it too—to stay solvent and raise interest rates.

I would not put my capital in harm’s way, to bet on a big rate hike.



Why Can't The Fed Spot Bubbles?

The topic of whether the Federal Reserve can see bubbles in advance, and what they can do about them, is hotly debated. There is little agreement as to how to define a bubble, if the central bank can actually see one develop, whether it should act, what it could do if it chose to act, or how it could clean up afterwards.

The New York Times DealBook highlights many of the competing ideas. In thisarticle, they say central banks “could have raised rates sooner.” Now they are trying to “show they have learned the lessons,” but “unfortunately, some economists remain skeptical about bubble-fighting…”

They should be skeptical. Janet Yellen, currently Chair of the Federal Reserve,spoke in 2005 when she was President of the San Francisco Fed. At the peak of the housing bubble, she tentatively offered that, “House prices could be high for some good, fundamental reasons.”

As it turns out, they weren’t.

Economic theory explains that central planners can never know what the right price for anything is. This is how economist Ludwig von Mises predicted the collapse of the Soviet Union back in 1921. He said, “The problem of economic calculation is the fundamental problem of Socialism.” He was referring to the absence of prices formed in the market. He continued, “Only so far as they [Soviet rulers] refer to [the West’s] price system, are they able to calculate…”

It takes a market with many different actors including producers, consumers, market makers, and others to determine prices. By contrast, a government policy committee is no market. Neither is a cabal of banks under the committee’s thumb.

And doesn’t that describe the Treasury bond market? The Fed sets the short-term interest rate, and heavily influences long-term rates. The banks play their part, taking the skim offered to them.

The Fed is setting the interest rate—the price of credit. This essential price affects the price of everything else. So it’s not surprising that the Fed doesn’t know when other prices are wrong.

The price of an earning asset depends directly on the interest rate. Warren Buffet, for example, calculates the value of a company by projecting its earnings, and discounting each future year. Next year’s earnings are worth less today, earnings the year after are worth even less, and so on. This is because oftime preference. It is better to have your cash today than tomorrow. If you are going to give up the use of your funds, then you want to be compensated.

Buffet uses a rate of interest to discount future earnings. A higher rate gives a lower present value, and vice versa. Think of it this way. If you’re getting paid $100 next year, and you discount it at 10 percent, then it’s worth $90 today. However, it’s worth $98 if you discount at 2 percent. For reference the 10-year Treasury rate is 2.3%, though investors may demand a premium to this.

The rate of interest has been falling for over three decades, which means the calculated present value of assets has been rising.

The math is simple. Anyone with a calculator can tell if an asset price is out of range based on its cash flows, such as earnings or rents. That’s not why the Fed can’t spot bubbles.

The Fed’s problem is that the calculation depends on a rate of interest that it heavily influences. Its analysis is therefore circular and self-fulfilling. It’s like taking a picture of a painting. Of course the two images match, but what does it prove?


Asset prices rise in value when the interest rate falls. Therefore, we need to know if the interest rate is right. The Fed can no more see that, than you can feel your own body temperature.

The Fed can’t see the forest for the trees. Or perhaps I should say: it can’t see the bubbles for the soapy water in its eyes.



Europe Stricken With Negative Deposit Rate

On Thursday, the European Central bank announced cuts to three of its benchmark interest rates. This is nothing unusual since the global financial crisis began. We are now accustomed to desperate central bank responses. Interest rates have been falling for decades, and the trend continues. What is unusual—unprecedented for a major central bank—is to lower the deposit rate below zero.

A negative deposit rate means that when a bank keeps extra cash on account at the central bank, it pays the central bank a percentage. It’s like telling the banks that having cash is a privilege, for which they must pay. If it sounds pretty crazy, that’s because it is. First, let’s look at what the ECB says it will do. Then we can dive in and see the likely outcome.

broken-euro free to share and use commercially per Bing Image Search 6_7_14

Mario Draghi, President of the ECB, said, “the measures will contribute to a return of inflation rates to levels closer to 2%.” The central bank has been talking a lot about the problem of deflation, by which it means falling prices. The ECB hopes to avoid this fate worse than death, by pushing more euros into circulation. It actually wants prices to relentlessly rise, for salaries to relentlessly lose purchasing power, and for savings to relentlessly erode.

With fiat money, prices rise. This is especially hurtful to people who are struggling to afford food and shelter. Pushing up the cost of living does no good to anyone, but harms the poor most of all. Only a central banker could truly love inflation.

By cutting the rate of interest charged to banks when they borrow, the ECB gives them an incentive to lend more. By making banks pay to park their idle cash, the ECB gives them a disincentive to stay safe by not lending. More money in the economy is supposed to lead to higher prices and a lower euro, which are believed to help the economy.

It’s not going to happen. To understand why not, let’s use Deutsche Bank as an example.

This bank has about €16B in cash. Suppose it lends out a billion to Volkswagen to help finance the Scania acquisition. Volkswagen pays the money to Scania shareholders, but they immediately deposit the money in banks, including Deutsche Bank. Assuming Deutsche Bank isn’t losing market share, the same amount of cash ends up back where it started. Deutsche gets it back, and parks it at the ECB again. It can’t avoid paying that negative deposit rate.

Cash never leaves the banking system. It is a closed loop, with money transferring from one party to the next, but always remaining in the custody of a bank. Lending does not avoid the need to deposit cash at the ECB, or in the US, at the Federal Reserve.

There is a way for banks to reduce their deposits at the ECB. They can buy government bonds and bills from the ECB. The ECB, being the central bank, has no need to deposit the euros in a commercial bank. If extra cash becomes a hot potato that no commercial bank wants to hold, they can get rid of it by trading it for government bonds.

The actual effect of this new ECB policy won’t be much of an increase in business lending or consumer prices. The result will be even lower interest rates on government bonds. Before this announcement, the yield on the 10-year Irish government bond was lower than that on the 10-year US government bond. Spain’s bond is not far behind. Rates will fall further under this new ECB policy, enabling Europe’s insolvent governments to borrow even more money.

The ECB has significant political challenges that prevent it from brazenly buying trillions of government bonds the way the Fed has been doing for years in the U.S. This new scheme will achieve the same result by different means.



The Biggest Monetary Change In 80 Years

The Swiss people put an initiative on their ballot to reverse decades of regression. They’re trying to get gold back into the monetary system, in the hope of halting the destructive process of currency debasement. I am sad to see the measure defeated on Sunday, even though I had concerns about it.

The simple fact that gold backing for a currency is up for vote in Switzerland shows how much the world is changing. A gold initiative wasn’t possible before 2008, and even today, no other country is ready for it yet.

Most people care little about monetary policy. Even the critics of central banks mostly quibble over minor rule changes or who to put in charge. Few have any serious interest in the gold standard. This, unfortunately, includes the gold bugs.

big-changes

Gold bugs say they love gold, but they don’t necessarily advocate gold as money. They want something else, and the Swiss referendum shines a spotlight on it. The gold bugs focused on the requirement of the Swiss National Bank to buy gold. Jim Rickards, bestselling author of Currency Wars: The Making of the Next Global Crisis, said:

“[T]he Swiss gold referendum could have a massive impact on the gold market. It would be extremely bullish, not only putting a floor under gold but also sending the price of gold up significantly.”

Got that? The Swiss referendum will drive up the gold price. The gold bugs don’t care about the monetary implications. They just want to make a few bucks on their gold trades. Let me present one more bit of evidence.

A common gold bug refrain is that the Federal Reserve and its cronies are suppressing the gold price. Addressing and debunking this allegation is beyond the scope of this article, though I have spent many gallons of electrons on this topic elsewhere. There is no monster under the bed, and no dark banking cabal that suppresses gold.

Conspiracy theories about gold price suppression are just the frustrations of people who want to sell their gold. They’re frustrated because they bought with the intention of selling at a profit, but then the price dropped.

In one area, gold bugs agree with gold standard advocates—the slow collapse of the dollar. Gold bugs often say, “All fiat currencies eventually reach their intrinsic value—zero.” This is a good reason to own gold. On the other hand, they fail to understand that a rising gold price simply reflects the falling dollar. It doesn’t make anyone richer. Sure, you may have more dollars, but each of them is worth proportionally less. If you really believe that the dollar will fail, then you should buy more gold while you can. A lower gold price is good, because it lets you accumulate more.

And that’s the irony. Although the gold bugs say they believe the dollar will fail, they don’t want to accumulate more gold. Their crying for a higher price betrays their desire to sell their gold. They are like stock market or real estate speculators. They just want their luck to turn at the asset bubble roulette table.

Central banking encourages speculation, and the gold bugs certainly have the right to bet on the gold price. But let’s please keep that away from the fight to move to the gold standard. Publicly counting the profits from a Swiss currency referendum comes across as self-serving. That won’t win anyone over to the cause of honest money.

We urgently need to restore honesty to the monetary system. We need sound money. There is an emerging, but global movement in support of this cause. That is the biggest monetary change in 80 years.



Swiss Gold Initiative: Good Idea With Unintended Consequences

There is now a very interesting initiative on the Swiss ballot, which will require the Swiss National Bank (SNB) to hold 20 percent of its reserves in gold. The voters will decide on November 30. I won’t predict the vote, but I want to discuss the likely impact of a yes vote.

Much of the analysis of this initiative is about the price of gold. A typical prediction is that it will go up, as SNB buying will exceed supply. However Mike Shedlock notes that, “Nearly all of the gold ever mined is available…” That’s because gold is not consumed. The SNB is small compared to worldwide gold inventories, so it won’t move the price much. Shedlock adds, “It is entirely possible that SNB purchases could significantly alter perceptions…” I agree sentiment is ripe for a change.

The price isn’t very interesting, unless you’re a gold trader. It’s much more important that the referendum brings the first positive monetary change in decades. It reintroduces a link between gold and banking, and imposes a barrier to currency debasement. For this, the Swiss are heroes.

swiss gold coin

There is a key flaw in our system of floating currencies. Every financial asset is someone’s liability. When a currency moves, it creates winners and losers. Big moves can harm banks with loan portfolios outside their home.

That’s why the SNB currently doesn’t allow the euro to fall below 1.2 francs. To maintain this currency peg, the central bank sells francs and buys euros. There is no limit to this deliberate franc devaluation, which robs Swiss savers, investors, and businesses.

Big exporters, like Swatch and Nestle, may have lobbied for a weaker franc, hoping to make their products more competitive, but that’s a sideshow. The real purpose of franc devaluation is to shield the Swiss banks from euro devaluation. They’re vulnerable, because they do a lot of lending outside the country. They have assets denominated in euros and liabilities denominated in francs. They suffer losses when the euro falls, or the franc rises.

Two examples help illustrate the problem. First, say Jens in Germany borrows a million euros from Credit Suisse. As the euro falls, Jens repays the bank in smaller and smaller euros. On the franc-denominated books of Credit Suisse, the value of the loan drops like a stone. Jens is happy but Credit Suisse is not.

Second, let’s look at Adriana in Italy who also borrows money, but not in euros. She gets a million francs from UBS. As the euro falls, Adriana experiences it as a rising franc. Her monthly payment goes up and up. UBS is happy, at least initially, because Adrian’s loan is in francs. However Adriana is getting squeezed. When she defaults, then UBS becomes unhappier than Credit Suisse.

Either way, the capital of the Swiss banks is eroding. If the euro falls enough, then the banks could go bust. Only they know where the line is, but it’s likely not too far below the current peg of 1.2 francs.

Depositors won’t feel the currency pain, at first. They are happy to own Swiss francs, especially if the franc is rising. Instead, they should worry about the unintended consequences of breaking the euro peg. Their strong francs will not be good in the case of bank insolvency.

Unfortunately the regime of paper money imposes a bitter dilemma on the Swiss people. They have a choice of slow losses by devaluation, or total losses by bankruptcy. They deserve a better option, a practical roadmap to the gold standard.


It’s great that the Swiss people are striving to move towards gold. I am a passionate advocate of the gold standard, and I want to cheer for my Swiss friends. Yet I must caution them today. I realize they have spent a lot of money and political capital to come so far, but I don’t want to win this battle and lose the war. They need a new initiative, which takes into account the banks’ euro-denominated loans.



Oklahoma Moves Towards the Gold Standard

There is strong opposition to any proposal to end the Federal Reserve and move away from its paper dollar. The Fed has many ideological and, of course, crony supporters. So it’s interesting that there was little controversy in Oklahoma around removing one of the obstacles to the use of gold as money. Republican Mary Fallin, the governor of the Sooner State, signed into law legislation that recognizes gold and silver as money. There was bipartisan support, particularly in the state Senate.

Oklahoma doesn’t force anyone to accept gold or silver in payment. It simply exempts them from state sales tax. While sales tax on the metals was probably a minimal source of revenue for the government, it was certainly a major competitive disadvantage to bullion dealers. Price sensitive buyers simply shopped out of state.

gold silver coins3

Utah has a similar law, which also exempts the monetary metals from capital gains taxes, and Arizona has been trying to pass one. Capital gains tax on the metals is a roadblock preventing their circulation. Although the Oklahoma law is more modest, exempting only sales tax, it’s an important step towards the gold standard.

For a hundred years, nearly every law and decree pertaining to gold was bad. The Federal Reserve was created in 1913. President Roosevelt is infamous for confiscating the gold belonging to the people in 1933. President Nixon is reviled for defaulting on the government’s international gold obligations.

It’s encouraging that Oklahoma is joining the trend to right these wrongs. Their new law is no mere tinkering with the sales tax. It’s about gold and silver as money, and the text of the bill states this clearly. Other states are working on gold bills, including Kansas, Texas, and South Carolina.

The gold standard movement is profoundly important. It’s becoming obvious that the dollar system is unsustainable. Debt is rising out of control, and the benefit of additional borrowing has diminishing returns. For example, companies like Cisco and Autozone are borrowing to buy their own shares, but are not investing in growth. Cisco recently announced another big layoff. Millions of job seekers are left out in the cold, and savers are euthanized.

How are people supposed to feel when they’re marginalized? What are they supposed to think about the endless news stories of our so-called recovery? How should they respond to the rising stock market and booming luxury sales?


We are at a crossroads. The road we’ve been taking for decades seems easier, but it’s paved with debt. This way descends to a bad place of central planning and wealth redistribution. Eating the rich, as Thomas Piketty proposes, helps no one and impoverishes everyone. If there’s any doubt, visit with the latest victims of socialism. Not long ago, the people of Venezuela were middle class. Now they are struggling with desperate shortages of basic consumer goods.

The other path is paved with gold. This way leads to a rediscovery of the founding principle of America. We began with absolute respect for individual rights, including property. The gold standard is just the right of property in the area of money. Everyone has a right to choose what to buy, and what money to use to buy it.

For thousands of years people have chosen gold, when they had that right. People will choose it again if we let them. Oklahoma is leading the charge of this growing American—indeed, worldwide—movement. Their new law is a step in the right direction. Congratulations to my friends in Oklahoma. I hope those who live in other states, and all over the world, will also rejoice in this victory.

Krugman's Fed Defense Cashes In On Inflation Confusion

I think it’s the greatest sleight of hand, ever. Advocates of monetary fraud have flourished their capes, made grandiose gestures, lit off flash powder, and cued the drummer to crash the cymbal.

“Behold, inflation!”

With an airy wave of his hand, the master illusionist directs the crowd’s attention to prices, especially consumer prices. “Keep your eyes locked on consumer prices. If they go up,“ he practically whispers to the spellbound people sitting on the edges of their seats, “then you know you have trouble. Trouble in the monetary system. Trouble starts with T, and that rhymes with P and that stands for printing money!” (with due respect to Harold Hill from The Music Man.)

And so, good and honest folk have accepted this definition of inflation. Inflation means rising prices, and rising prices means inflation. Anything else isinconceivable (with due respect to Vizzini from the Princess Bride). This view serves the monetary central planners, but no one else.

Nobel Prize winning economist Paul Krugman exploits this inflation confusion. This week, he wrote a column in which he had a good laugh at the expense of his opponents. The money quote (if I may use such a double entendre) is this.

“Events and data may have made nonsense of claims that the Fed’s policies would inevitably produce runaway inflation, and made those insisting on such claims look like fools…”

He is mocking everyone with common sense. By Thor’s beard, it’s obvious to a child that the Fed’s policies are bad. If many make the mistake of assuming quantitative easing must lead to rising prices, that does not make quantitative easing good or make them fools.

Krugman is counting on people not to make a few connections. One, industry works constantly to improve efficiency. Real costs, and therefore real prices, are falling. If prices fall fast enough, then the rate of inflation may appear to be low, or even zero or negative. This doesn’t mean that there is no inflation. It means we’re not looking in the right place.

Two is the effect of the falling interest rate. It’s been dropping for decades. Suppose Joe is a manager at Acme Mills. Joe wants to buy new looms to weave more fabric, but he just can’t make the numbers work. Then the Fed pushes down the interest rate. The dirt-cheap money makes Joe’s business case. He builds the plant and pushes a million yards of tweed fabric into the market. This additional supply causes the price of tweed to drop.

Three, millions of people have been pushed out of the workforce. There is a growing class of unemployed working-age adults. They don’t show up in the official unemployment statistic, because they have given up looking. Here is the most recent graph showing this phenomenon.

At the end of the boom in 2000, the participation rate was about 67.5 percent. Now it’s 62.5 percent and falling rapidly. The labor force consists of about 156M people today, so 5 percent represents almost 8M people.

What happens to someone’s purchasing power when he loses his job? What happens to demand when 8M people lose their lobs?

The facts are simple. Relentless cost cutting, falling interest, and falling demand all put downward pressure on prices.

Of course, there are other forces that apply pressure in the upward direction. For example, drought in California makes many foods more expensive.

The bottom line is that some prices could be falling such as electronics, some prices could hold steady such as clothing, and other prices could be skyrocketing like beef. None of it lets the Fed off the hook.

A recurrent theme in this column is that we suffer many injuries from our irredeemable paper dollar and the Fed’s reckless management of it. Rising prices is the least of them.

Disgruntled Fed Lawyer Blows Whistle on Regulatory Capture

In 2008, the monetary system plunged into acute crisis. The Federal Reserve, in charge of banking regulation—not to mention the dollar itself—didn’t see it coming. So in 2009, it hired David Beim to learn why not. He blamesregulatory capture. In his words, it’s like “… a watchdog who licks the face of an intruder… instead of barking at him.”

Beim recommends hiring the kind of people who won’t get captured. Unfortunately, that flies against the wisdom of management legend Peter Drucker. He said, “The fault is in the system and not in the men.” In other words, don’t blame your people when your perverse incentives cause perverse outcomes.

The Fed hoped Carmen Segarra was the right kind of person, when it hired her in 2011 to regulate Goldman Sachs. On the job, she quickly noticed that Fed employees seemed afraid of Goldman, and thought this was backwards. She said, “The Fed has both the power to get the information and the ability to punish the bank if it chooses to withhold it.” Drucker was no advocate of fear as a motivator, either.

Increasingly disgruntled, Segarra secretly recorded her meetings with not only Goldman but Fed colleagues as well. She accumulated 46 hours of audio. I could not find it online, but This American Life worked with ProPublica on aprogram containing excerpts plus commentary by Segarra and Beim.

One player in her story is Mike Silva, the senior Fed regulator for Goldman. According to Segarra, Silva related a story from 2008. At the time, he was chief of staff for Timothy Geithner who was the president of the New York Fed. A large money market fund was collapsing and a general bank run was imminent. Silva told his staff, “… when I realized that nobody had any idea how to respond to that, I went into the bathroom and threw up. Because I realized this is it, it’s just this small group of people, and right now at this moment we have no clue.”

It’s like something out of Atlas Shrugged, missing only the whiskey and cigars.

The crisis occurred under Fed management. It admitted it didn’t see it coming. And now it’s obvious that the Fed’s top people didn’t know what to do, either. Despite that, there’s a steady drumbeat for more aggressive banking regulation. This is just plain wrong.

We understand authoritarianism when we experience it personally. Most of us have been stopped some time at a sobriety checkpoint. Have you ever had an officious cop demanding to know where you’re going, what you’re doing, and why? It’s infuriating.

A cop is nothing compared to a bank supervisor. Imagine being forced to invite him into your home. He eats and goes to work with you. He even sleeps in your home—you house him at your expense. He can demand to know anything he wants, and he “has both the power to get the information and the ability to punish” you. That’s the reality a bank lives with every day.

Americans fought and died for the vision of the Declaration of Independence. People should be free to act as they please, except in the case of crimes like robbery or murder. The government, by contrast, has no right to act, except as granted in the Constitution. We are reversing this, especially in banking. The final step will be to put government bureaucrats in charge of running the bank, with management passively along for the ride. Does this sound farfetched?

A chilling anecdote related by Segarra shows that it’s not. Goldman Sachs asked the Fed regulators to approve a deal they were doing with Banco Santander . According to ProPublica interviewer Jake Bernstein, Fed regulator Mike Silva knew that the deal was perfectly legal and wondered if he wanted banks doing these sorts of transactions.

Capture is just a distraction. Anyone who has to get permission for his every move tries to charm the decider. Just ask someone who has kids. The issue is the rule of law vs. the rule of men.

Do you want the government to have the power to decide it won’t let you do something, even when it’s legal?



Three Unexpected Reasons Why We Use the Paper Dollar

Do you really want to know why we have a paper fiat currency? The reason is simple, but not obvious. Let’s make a few observations and then form our conclusion.

When you talk to people about the fiat dollar, you encounter three reasons for their acceptance. One, most people are apathetic. They don’t really know what money is, and they don’t care. So long as they have food and shelter and a little to spend, they put the monetary system out of sight and out of mind.

Two, most people who have studied economics have been indoctrinated in the ideology of central planning. Whether the issue is automotive fuel efficiency, wages, or healthcare, they have been programmed to believe that a free market leads to a bad outcome, but socialist planning improves the result. Centuries ago, it took geniuses such as Adam Smith and Frédéric Bastiat to explain why that’s untrue. Today, a smart middle school student can debunk it, but its popularity lives on. This leads us to the third reason.

Three, many people like to get something for nothing. No one really believes that printing money leads to wealth and prosperity. They just want to be a beneficiary. Tens of millions of people receive transfer payments of one sort or another. Millions more work in the transfer system at a government agency, private contractor, law firm, lobbyist, etc. Whole sectors of the economy now depend on the monetary scheme, like hogs feeding at a trough.

For example, consider the real estate sector. Development and construction would immediately cease if the Fed allowed the interest rate to rise substantially. Buyers would balk if the cost of financing skyrocketed. For example, MetLife Real Estate Investors just bought a 22-story office tower in Houston. They paid almost $300 per square foot. Rental rates in that area are about $24 per square foot per year. After expenses, the owner will be lucky to get a 5% return on its money, not counting the risk of a drop in real estate. This building would sell for a lot less, if interest rates were higher.

Another case is the municipal sector. Most cities have perpetual budget shortfalls. They sell bonds to raise cash so they can spend more than they get in taxes. They depend on artificially low interest rates. If the rate goes higher, their game will be up. Municipal workers and contractors will be laid off. Local bars and even artists have all become dependent on endless city spending. Light rail, downtown art projects, stadiums, and other public spending have numerous beneficiaries.

The biggest deficit spender of all is the federal government. Makers of electric cars like Tesla receive government subsidized loans. Tesla also benefits, as do drug makers like Merck, from subsidies to their customers. Over 47 million people get food stamps. Millions get a subsidy for college. There are countless programs that give money to people, including welfare and Social Security.

Spending is very popular. However, few people want to lose more to taxes on their income, property, or purchases. Government borrowing is the magic that lets them eat their spending cake and have their low (well, less high) taxes too. It seems like a good deal. Modern economics provides a cover, letting people feel that it’s really OK.

Endless borrowing is simply not possible in the gold standard. With each increase in borrowing, the interest rate goes up. This restricts the flow of credit, especially to borrowers who have neither the means nor the intent to repay. Governments are the biggest borrowers, and they lack the means to repay. This is why most people oppose the gold standard. It is a threat to the gravy train.

While the gold standard may not be a panacea for every government ill, it certainly imposes some discipline on spending. This restraint is decades overdue, and sorely needed, even if it upsets those on the take.

Why Did Ron Paul Say Gold Could Go To Infinity?

This week, former Congressman Ron Paul said gold could go to infinity. Many people will be tempted to buy gold based on his prediction. It’s certainly exciting to think about the upside, the profit potential. Who doesn’t want to buy whatever’s going up? However, in the case of gold, there is a serious error in this thinking.

Dr. Paul has put his finger on something very important. The government is abusing its credit, and borrowing itself into oblivion. If this continues, then the value of the government’s debt and currency will drop, probably quite rapidly. This means the price of gold will skyrocket.

Suppose you buy gold today at $1300, and then the price doubles. Should you rush out to sell the gold, to take profits? At $2600 an ounce, you have twice as many dollars for your ounce of gold.

Ron Paul

This is a phantom profit because each dollar is worth half as much. The rise in the gold price simply reflects the falling dollar. An analogy may help clarify this key point. Imagine being on a rowboat. The boat is tossing up and down on big waves, and at the same time the tide is going out. You look up at a lighthouse on a rocky peninsula jutting out into the sea. You wonder something.

“Why is the lighthouse jerking up and down, and why is it rising?”

Your friend is in a helicopter, a few hundred feet above you. He sees that the lighthouse isn’t going anywhere. It’s your boat that’s moving.

Let’s use one more analogy to cement this important idea. A carpenter needs to measure the length of a board, so he stretches out some rubber bands. The board is 4 rubber bands long, and he cuts it. He comes back later, but finds that the board has increased in length. Now it’s 5 rubber bands long, and he wonders what’s happening.

It’s easy to see that measuring a board with something stretchable is silly. To measure length, you need something rigid. Steel doesn’t stretch or compress, which is important in getting an objective measure of length. It’s the same in taking other measurements, such as weight, temperature—or economic value. We need the right unit of measure.

Gold is the objective measure of economic value.

The dollar is the exact opposite. It is designed to be bent and twisted by our monetary central planners. In a speech last year, Federal Reserve Chair Janet Yellen used the word “flexible” four times in describing her policy goal of creating inflation, which is to say stretching that rubber band.

Some past central planners did not want to stretch the dollar. Others, like Yellen, do it out of faith in their theories. Some, like Treasury Secretary John Connally, were brazen and cynical. In 1971, he told his foreign counterparts, “The dollar is our currency, but it’s your problem.”

The fact is that the dollar has been going down for 100 years, since the creation of the Fed. Here is a graph of the dollar price, measured in milligrams of gold.

dollar 1913 2014

Over this period, the dollar went from 1644mg to 24mg, a stunning collapse of 98.5 percent. The picture couldn’t be clearer. It makes it easy to see what Dr. Paul is saying.

To frame it in different terms, Gold is not going anywhere. The dollar is simply falling. This is exactly what you would expect, given a flexible paper currency, and the siren song to abuse it for political expediency.

For decades, the decay of the dollar has been slow. Your losses to hold cash were relatively small. Hopefully the decline will remain slow, but Dr. Paul is sounding the alarm. He is warning that, on our present course, it will accelerate.

If you buy gold, I encourage you to do it for the right reasons. I outlined one last week, not lending to risky borrowers. Ron Paul gives another, avoiding a falling currency.

Whatever you do, keep your eye on that lighthouse.

Your Personal Debt Is Not Entirely Your Fault


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If you’re in debt and sinking deeper, you’re not alone. Especially if you are young, the high price of a college education combined with a weak job market has hit you hard. It’s easy for older people to say you should spend less, but life would be a lot less fun without a mobile phone, nice car, new clothes, or going out with friends. This is how credit card debt piles up on top of a car loan and student loans. I don’t want to let you off the hook entirely, but I need to say something important.

It’s not entirely your fault.

You—and all of us—are the collateral damage of the zero interest rate policy of the Federal Reserve. This policy causes decreased savings and increased borrowing, and therefore debt. Let’s look at the savings side first.

saving and spending

It’s discouraging to look at your bank balance month after month, and see that it doesn’t really increase except when you make a deposit. Setting aside money out of your paycheck can feel pointless. It’s a sacrifice of your quality of life today, and for what? The dollar is falling. If you live without a car today, so you can set aside the money until you turn 65, it might be enough to buy a skateboard. Saving feels like a really bad deal. It’s not entirely irrational to spend valuable money now, before it loses its value.

In a normal world, the compounded interest eventually adds more to your bank balance every month than your new deposits. Zero interest does something more serious than just demoralizing savers. It eliminates compounding, making it much harder to grow your savings. Even if you save the same percentage of your monthly income as your parents did, your savings account will fall farther and farther behind. They were earning interest.

Now, let’s look at borrowing. Unlike what the bank gives you on your stagnant savings, the interest you pay on your debt is not zero. Compounded interest works just fine on what you owe, increasing your burden of debt with each passing month.

However, borrowing is extraordinarily cheap by any historical comparison. When the cost of borrowing is too low, it becomes an irresistible siren song luring people into debt. That $60,000 annual bill to attend Harvard doesn’t seem so bad if you can borrow the money. It’s even better if your low monthly payment is only $650 a month, and best of all if payments are deferred until after you graduate.

When credit is too cheap, people use it to buy what they want. This pushes up the price to the point, well, to the point where the cost of a year at Harvard is now sixty grand. The prices of other things you need like a car and a nice place to live, are also bid up. If you refuse to borrow, you are out of the game. It is a no-win situation.

With little incentive to save, and with the lack of compounding working against you, it’s no wonder that you don’t put 10% of your paycheck into the bank every month. The rising cost of a lifestyle worth living is fueled by those who borrow more. It can feel like you have little choice but to borrow to keep up.

Many older people may offer you advice, or try to make you feel guilty. That’s not helpful. My message is something quite different. The Fed, with its zero interest policy, deserves much of the blame for your financial troubles. Until we get out from under the Fed, you won’t get out from under your growing debt.

Thomas Piketty Pens Communist Manifesto
Thomas Piketty is a Frenchman who had been promoting wealth redistribution in obscurity. Now that Harvard University Press has published his book,Capital in the Twenty-First Century, he has catapulted into the spotlight.

I didn’t read his book, though you don’t have to in order to understand why it’s mostly wrong. Piketty makes an observation, a diagnosis, and a prescription. His observation is right, so let’s start there.


Piketty says that return on capital is higher than the growth rate. He believes the return on capital is 5 percent and the growth rate is 1 percent. The share of wealth owned by the rich is increasing.

Why Did Both Silver and Gold Become Money?
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We live in a world of central banks and paper money, so the question of why two different metals became money may seem moot. However, it is important to understand honest money if we are to break the cycle of financial crises and move forward to the gold standard.

Gold and silver share many physical properties. They are heavy, shiny, soft, conductive, and durable metals. It’s somewhat coincidental that they are so similar. Gold and silver fill different human needs, and evolved through different paths.

Money solves a problem called the coincidence of wants. For example, suppose the maker of leather moccasins is hungry. He can only trade directly with the fisherman when the fisherman happens to need a new pair of shoes. Barter is extremely inefficient and therefore limited.

Instead of directly trading shoes for fish, the shoemaker exchanges his shoes for salt, and then trades that salt for the fish he wants to eat. Indirect trade makes it possible for the shoemaker to trade with the fisherman, as both can agree on using salt. Unfortunately, this leads to a new problem. Using an intermediate good adds an extra trade to every transaction, and there is a frictional loss inherent in every trade (see my article for a full explanation).

Marketability is a measure of the amount of this loss, which is different for each good. The more marketable the good, the less the loss one incurs. For example, food is more marketable than footwear. Salt is more marketable than food. Gold is more marketable than salt.

Avoiding losses is a powerful motivation to use the more marketable good in preference to the less marketable. This is why everyone is motivated to find the one good with the least loss. Gold is the most marketable good, the best money.


If gold is the best, then why is silver also money?

It is significant that a second commodity survives and coexists with gold to this day. No one wants to use the second best money, and lose more than the bare minimum. One explanation is that smaller denominations are possible with silver coins than with gold. It is important to have coins for grocery shopping, but there is a more important economic principle than just making small change. Silver is the most marketable good in one important case.

Everyone needs to save while working, to pay for expenses in retirement. Working people must set aside part of their weekly wages. Silver has an advantage over gold, which becomes clear with an example. Suppose Jen makes $1000 a week. She wants to set aside $100. This is a tiny amount of gold, well under 1/10 ounce. It’s an extremely small coin, and it costs more to manufacture and is harder to sell. To buy it, Jen must pay a big premium over the value of the gold in the coin. This cost comes straight out of her savings.

Fortunately, Jen can turn to silver. Her weekly savings will buy about 5 ounces of silver. Compared to a 1/10 ounce gold coin, a 1 ounce silver coin is a typical size. It’s priced closer to the value of the silver it contains. The bottom line is that Jen loses much less of her hard-earned money by using silver.

Wait a minute. Earlier, we saw that gold had the least loss, that gold is the most marketable good. Now silver seems to claim this title. This is not a contradiction. There are two types of marketability. For larger transactions, such as typical commercial trades, gold is superior. Gold imposes the least loss in these trades. In other transactions, far less value is exchanged. The most important is the typical small purchase used for savings. For saving, silver is superior to gold because it offers a smaller loss.

With this background, it’s possible to state the reason why there are two forms of money. Gold is the most marketable good when large values are traded. Silver is the most marketable good in small transactions.