About the only thing he got wrong was his prediction that the financial collapse would be inflationary, but of course he called gold correctly (it was about $300 at the time).
To everyone else in the western world, November 11 is Armistice Day or Remembrance Day, a day to contemplate the lessons from and the ending of the Great War. WWI of course destroyed Europe, setting the stage for fascism and communism, and ended the longest and fastest period of economic growth and improvement in living standards in modern history.
In America, today is Veterans’ Day, and we are expected to celebrate soldiering and pretend that the wars into which politicians have thrown our young men have all been for our benefit, specifically the protection of our freedoms. It’s just another opportunity to beat the drums, like staging a ballgame on the deck of an aircraft carrier.
The market is a force of nature, like gravity. To use it is prosperity. To fight it is misery.
By bankers, for bankers.
This is a bailout of bankers. The Fed was created by bankers, and the Treasury is run by a banker, so there are no surprises here.
The plan is to have the government take banks’ bad mortgage debt (will they add credit card, auto, student and corporate debt?), so that they are no longer insolvent. Solvency has always been the issue, not liquidity — that is a red herring. By no means will all of the bad debt (out of $50 trillion in total domestic financial and non-financial sector private debt) be absorbed by this program, which is going to move $700 billion at a time.
The fact that the government still relies on a market for its bonds puts limits on the pace at which debt can be socialized. There has been a great demand for Treasuries of late as safe havens, so the first tranche or two should be absorbed easily. Bonds may even rally more as assets prices continue to plunge.
Later, after the bulk of the deflation has passed and the bond market is saturated, this demand will ease and the Fed will have to buy greater and greater amounts of bonds with newly created dollars. The government’s spending needs are infinite, but the tax base and bond market are finite, so this phase of inflation can lead to currency failure. That can be chaotic, because contracts become meaningless when currencies are worthless. Out of such episodes arose Napoleon and Hitler.
Econ 101: Savings = Investment. Lesson: reward savers with deflation.
We should embrace deflation, not fight it, because it restores sanity. The irresponsible go broke, and the prudent are rewarded. When money is tight, prices need to come down, and this encourages the savings that will turn to investment after the dust settles. Those who were smart enough to go into this crisis with savings are the ones you want allocating the capital for rebuilding, not the swindlers who beg for newly printed ‘stimulus’ money for their pet projects.
Your neighborhood, a government housing project.
Let’s assume the program actually removes all bad debt from bank’s balance sheets. Once again, they are fully capitalized and ready to issue loans, with assistance of course from an accommodating Fed. That will ‘fix’ one side of the reflation machine. On the other side, borrowers will still be choking on their existing debt and in no condition to take on more.
So the next step on the road back to inflation city will have to be debt relief for borrowers. As the owner of huge amounts of mortgages, the government is likely to be a very accommodating creditor. Can’t handle $2000 a month? Well, just pay $1000, but promise to spend the rest, ok! Or it could offer a quickie default: we take the house, but you can rent from us for cheap. In either case, the government has title to an enormous amount of housing stock, so all of America takes on the air of an inner city housing project.
(A side note: Once government becomes your landlord, it has a lot more leverage to force the installation of whatever it wants in your home, from ugly fluorescent lighting and those ‘efficient’ toilets that clog, to monitoring devices for your ‘safety’.)
The Crash is the Market, and It cannot be stopped.
Crashes are the market’s way of correcting the perversions of bubbles blown by bankers and governments. They are not market failures. The Market never fails. It is a force of nature. Bankers and politicians can shackle us with their guns and laws, but they cannot change the way the universe organizes itself. Any scheme but freedom, the absence of force (such as theft, a form of which is inflation), will be thwarted by the Market. Tax cheats, corrupt politicians, crooked brokers, smugglers and prostitutes are as plentiful as the laws that create them. In the absence of force (as George Washington said, “government is not reason; it is not eloquent; it is force”), the Market will reward honesty and industry above all else. When force is used liberally, society rewards George Bush Jr and Angelo Mozillo.
The government has tried to thwart the Market for so long, from the New Deal to the S&L crisis and beyond, that the distortions have become too big to support, and this time the Market is taking its revenge. Saving some big banks and some borrowers is certainly possible with bailout programs (rent seekers should call their lobbyists ASAP to get on that list!). But $50 trillion is way, way beyond anything the government can handle, so there will still be massive debt deflation left and right, and asset prices will continue to crash.
Debt revulsion is the fly in the reflation ointment.
To reflate, we need willing and able borrowers and lenders (inflation is the net increase of money and credit, deflation is their net decrease). Even if all bad debt is taken off the books of both borrowers and lenders, can the Feds rekindle America’s affair with debt? The answer is yes, eventually, but it won’t be any fun this time.
If the government forces the issue before the Market has cleared the way for growth, people will only be willing to borrow again to protect against the decline in the value of currency. During the crash, currency will continue to gain in value, so for at least the next couple of years, borrowers are going to be very wary of debt. They don’t want to repeat this nightmare, and besides, with asset prices crashing, the economy in a tailspin, and new regulations restricting commerce, where on earth can investors profitably deploy this capital? China? Not so fast — investing abroad may be restricted. Even with a 0% loan, can borrowers generate any return at all in this environment? With poor investment prospects and no need to protect against inflation, few will be willing to borrow.
This is why the traditional reflation machine will stay broken. This is the machine that Greenspan operated for the bankers with such mastery. But try as Bernanke might, this machine will not start up again until money or credit is somehow flooded into the economy through other means.
In Hugo Chavez’s Venezuela, people borrow not for productive uses, but to speculate in any kind of asset that will lose value at a slower rate than inflation plus interest. It is a sickening thought, because it totally perverts all economic decisions and leads to staggering waste. We have just experienced a milder version of this in the US, but at least we built a few useful things with the credit, though most will go to waste.
In Venezuela, people invest in new automobiles, sometimes fleets of them, because the sum of interest and depreciation on the vehicles is less than the rate of general price increases. Hence, cars bought new appreciate in Bolivars as they rust in driveways. Venezuelan society is in a later stage decay than the US, but it may resemble our future.
The new New Deal, and the Neverending War
So how do you get that stubborn price level (the rearward looking indicator, CPI, was negative in August — expect more and bigger negative numbers for many months to come) to start ticking up again with gusto? After a general asset price crash, which I emphasize cannot be prevented at this point, the government can spend and spend and spend.
If you think the bridge to nowhere was ridiculous, you haven’t seen anything yet. Our sociopathic leaders, with hearty encouragement by esteemed professors, seem to have no problem with the old Keynesian theory of burying bottles stuffed with cash and letting people dig them up. Hey, it puts people to work and raises the price level! Let’s all pray for more hurricanes while we’re at it. Think of the boost to GDP!
Expect lots of pork for ‘green’ energy projects, and expect those projects to cost more than they produce and have all kinds of perverse effects. Expect national ‘service’ programs (if mandatory, they are national enslavement programs) such as have been touted by Obama, Hillary and the media wing of the Fascist party (now the only party in power in the US).
We were all taught in school that although FDR’s valiant efforts helped put Americans back to work, what really saved the US from sinking into a big hole the earth was War, glorious War. How lucky of us to already have two of them going and plenty more enemies lined up just in case!
Ron Paul is not just the lone voice of reason and honesty in Congress, he’s also a great writer. In the latest of his weekly essays, he spells out how sound money (gold and silver being tried and true examples of which) restrains governments from engaging in mischief such as wars of aggression:
“Can sound money really bring about peace? Actually, it plays a big part in peaceful international relationships. Money based on commodities, rather than paper, is not subject to government manipulation, and is a key component to free and honest trade. History shows that if countries engage in trade with each other, their governments tend to find ways to get along for the same reason you do not kill your customers at your place of business, even if they occasionally annoy you. If someone outright cheats you, however, you may engage in “war” by taking them to court, for example, and the relationship will sour. Governments and central banks with unfettered power to manipulate currency also have the ability to cheat their creditors. One way they do this is to simply create enough currency to pay off debts. This devalues the currency and “cheats” the recipient out of what they are owed. It would not be fair if you watered down your product the way our government waters down its currency, so it is not hard to understand, in these simplified terms, why loose monetary policy contributes so much to ill will and war around the world.
Can sound money really bring about peace? Actually, it plays a big part in peaceful international relationships. Money based on commodities, rather than paper, is not subject to government manipulation, and is a key component to free and honest trade. History shows that if countries engage in trade with each other, their governments tend to find ways to get along for the same reason you do not kill your customers at your place of business, even if they occasionally annoy you. If someone outright cheats you, however, you may engage in “war” by taking them to court, for example, and the relationship will sour. Governments and central banks with unfettered power to manipulate currency also have the ability to cheat their creditors. One way they do this is to simply create enough currency to pay off debts. This devalues the currency and “cheats” the recipient out of what they are owed. It would not be fair if you watered down your product the way our government waters down its currency, so it is not hard to understand, in these simplified terms, why loose monetary policy contributes so much to ill will and war around the world.
Sound money, on the other hand, simply is what it is. Removing governmental power to manipulate money, removes the temptation for government to spend, print and cheat. Sound money ensures that our government’s spending priorities would be brought into sharp focus and reduced to only what we can afford.
Sound money also limits the ability to wage wars of aggression. Imagine how much more careful Washington would have to be about starting a war if they did not have this financial sleight of hand at their disposal! Fiat currency allows government do expensive things they should not be doing while paying the bills with cheap money”.
It’s no secret that deficits and inflation are how wars are financed. Every major war fought by the US, even the Revolution, was funded by printing currency and/or selling bonds (often at great profit to bankers selling the bonds). Whenever the US had been on a gold standard before a major war, it would be dropped, as in the Civil War and WWI. All combatants in WWI dropped gold upon entering, and they again dropped it permanently by WWII. To be fair, many also ran huge deficits to pay for socialism in the 1930s, the national socialist (Nationalsozialistische, i.e. NAZI) kind and otherwise.
Vietnam, along with Lyndon Johnson’s ‘Great Society’ welfare expansion, was an immediate cause of the final severance of the dollar to gold and silver, first with the withdrawal of silver coinage in 1964, then with the default on our gold-backed bonds in 1971.
Many know that after Rome’s wars stopped paying for themselves and the welfare state got out of hand, inflation kept the game going. The silver Denarius of Augustus’s reign was slowly diluted to nearly 100% copper over the following 200 years. When merchants resisted the debased coinage, Emperors resorted to brute force to give value to their fiat money: use it, or else.
The income tax was established in the horrible year of 1913, the same year the US got its central bank. (This also happens to have been the last year of peace, free trade and the international gold standard before war, depression, fascism and communism destroyed the best of western civilization.)
The tax got its foot in the door with a top marginal rate of 7%, but as soon as the US was conned into WWI, the rate shot up to over 75%. It came down after the war and was 25% through the 1920s, but FDR raised it in the Depression and WWII to over 90%, where it remained until 1963. Few people remember that the top rate remained over 70% until the Reagan administration got it down to 50% and then 28%.
The reason these rates are collectively forgotten is that they were felt by very few. In nominal dollars, the top bracket started at $500,000 in 1913 and went to $2,000,000 in WWI and $5,000,000 during WWII. Multiply these figures by about 20 and 15, respectively, for the equivalents in 2008 dollars. Even the top bracket of $200k in 1980 was big money–it would buy a nice beach house or Park Avenue apartment.
The top bracket was lowered to under $30k by 1988, and while it has since been raised to over $300k, thanks to inflation this is merely an upper middle class income. It’s worth noting that in the 1920s only the top 20% paid any direct federal tax at all, whereas now the average American works for half the year to cover the sum of various taxes.
The lesson here is to not be surprised if federal rates are hiked to well over 50% in the coming years as the budget deficit shoots past the $1 Trillion mark. And I wouldn’t count on the top bracket going back to $60 million either, now that middle class earners are used to the government calling them rich.
Last Thursday, news arrived that US client state Georgia had invaded the predominantly Russian breakaway region of South Ossetia, and we also learned that two more carrier groups were headed for the Persian Gulf.
You might think that open warfare in the petroleum-rich and strategically important (think pipelines) Caucasus and additional preparation for a potential bombing of Iran would put an end to the slide in oil prices. But you would be wrong. Oil lost $10 on the week and closed at a 4 month low.
Does this tell us that the odds of war with Iran did not actually increase last week? Or that the conflict has already been priced in for more than a year? It is remarkable that even these heady developments could not make up for the shift in trader psychology as demand slacks with the global economy sputtering towards stall speed.
It just goes to show that there is no money in buying the news and no sense in trying to explain away day-to-day price movements by the headlines or changes in ‘fundamentals’.