Month: October 2008

This Is Some Rescue

“This is some rescue. When you came in here didn’t you have a plan for getting out?”
– Princess Leia, Star Wars (1978)

And what a rescue it is. What started as a three-page plan to buy troubled assets has grown to a 451 page mess that includes everything from Indian Employment Credits to adding a Seven-Year Cost Recovery Period for Motorsports Racing Track Facility. I guess in the future we know how to get recalcitrant Republican Congressman to reverse course- include more pork. We should all remember for future reference that the government rides to our rescue by way of hurriedly passing a bill no one had a chance to read that includes more spending of money they don’t have.

I’m not sure if this was the kind of rescue that the American people were counting on, but given how they were reacting to this plan (about 90 to 1 against judging from people calling in), it was probably the one that they were expecting. And the thing that no one seems to want to being up is that the government caused this problem to begin with. If not for the government created entities of Fannie Mae and Freddie Mac, we would not have had so extreme a credit explosion in the housing market. If not for the government created entity of the Federal Reserve and it’s nasty habit of keeping interest rates low and solving every problem by throwing more fiat paper at it we would not have had this orgy of credit and speculation to begin with.

Each of these entities was created by the government to rescue the free market:

– the Federal Reserve was created by the government in response to the Panic of 1907 and the desire to have a “lender of last resort” with an “elastic currency” that could bailout any troubled bank.

– Fannie Mae was created by the Roosevelt Administration in an effort to provide credit to the housing market to stimulate the economy. Except that now that had created a government sponsored monopoly of sorts. So in order to fix the situation, they created yet another entity, Freddie Mac, in 1970. 

And here we are, now having to create more programs in order to save our would-be rescuers. Can there be any doubt of the wisdom of Ludwig von Mises in his Critique of Interventionism where he argues that all government interference in the operations of the free market will merely lead to bigger problems later, which the government must then solve with even more interference. According to Mises, all attempts at intervention lead to the same place, Socialism. And here we are.  Watching the Republicans, the champions of the “free market”, back the biggest interventionist step ever proposed. 

Life is full of ironies, but not greater than the ironies of the public sphere. Some hypocrisies are to be expected. After all, this is politics. But I’m sure that the Japanese, who were advised by the Americans to just let the chips fall where they may when their crisis hit, are noticing that we don’t take out own advice very well. But for me it goes beyond irony and hypocrisy that the Republicans continually berate the Democrat’s for being Socialist as they aggressively expand the size and scope of the federal government. To me it proves that the American people have lost the political will to force their politicians to own up to their promises. Thus we are left with people’s perceptions of their government and its actions determined not by the actions themselves but rather what the politicians tell the people their actions mean. According to the Republicans, bailing out a failure caused by three government created entities is merely what must be done to save the “free market” from itself. 

I started this piece with a quote from Star Wars. As a science fiction person I would like to close it with a quote from another piece of SciFi, George Orwell’s 1984. Orwell, like Mises, foresaw the government’s continual encroachment into our lives, just as he foresaw that the government would shape people’s perceptions by telling them that something was it’s opposite. And so I want you to keep in mind our “free market” Republicans, their “War on Terror”, and their often trumpeted habit of being fiscally responsible when you hear that:

WAR IS PEACE
FREEDOM IS SLAVERY
IGNORANCE IS STRENGTH

Answering Taylor’s Questions

My good friend Taylor asks three questions:

1. My point here was that while I agree there is much historical precedent for the value of gold there is no promise it will continue to be valued. In that regard gold is no more valuable than paper money. People have historically wanted gold, so it has value. People currently want cash, so it is valuable. The value is arbitrary; it is valued because people want it. The major difference seems to me to be that people have wanted gold longer than they have wanted dollars. The ” intrinsic value” is still a man-made convention, why does it matter what medium it applies to?

2. It is one thing for my dollars to become worthless from hyper-inflation a-la-Germany in the 20’s, it is quite another for my elected officials to vote to make my dollars worthless over night. Yes, I understand you point that they have been voting my dollar to be of less value for decades, but the marginal inflation we have experienced so far I can stomach, and plan for. Overnight worthlessness of everybody’s savings could cause riots.

3. This brings up another question I have had regarding the gold standard. How does it accommodate its inherent lack of elasticity? I. E., if a Spanish Galleon carrying billions in gold is sunk and unrecoverable there are sever consequences to the market and to commodity values. If one of the US Fed Banks is incinerated, and billions of paper dollars are lost the Fed can quite easily reprint those losses and the impact would seem to be minimal. Similarly, gold is a much more scarce commodity compared to paper. What happens when we have mined it all?

The question of whether and why gold is valuable seems to come up a lot. I’m not sure why; outside of land, I can think of nothing that humans have consistently held to be as valuable as gold and silver have proven to be. Humans have valued many things through each age of human development such as dyes during the Roman times, spices during the Middle Ages, and oil today, but precious metals have been held to be valuable during each and every age.

If we wanted to use a commodity based form of money, we could chose between many forms of wealth currently valued in today’s society. We could use oil reserves (for instance) as a basis for a currency. Oil is a scarce commodity whose value does not depend on the health of the government that is issuing the money and is available in standard units of accounting, but precious metals also have all of these quantities. In addition, precious metals have the further advantage in that they have: a much longer history of being held as valuable; a more dense form of wealth; easier to store; and far more resistant to destruction.

Now I do often hear the argument that humans could just decide that they don’t want gold anymore and it would lose it’s intrinsic value. I don’t really see how that’s possible given how many thousands of years we have favored the stuff, and, even in that highly unlikely scenario, it would still have a value as money so long as the nations of the world agreed to value it as such. Which is just my way of saying that it’s silly for us to worry that gold may one day lose all value given that right now our entire economy is based on something that inherently has no value at all!

Regarding Taylor’s second question, I must confess that I find it extremely unlikely that we could voluntarily go back to a gold standard. Today’s dollars are trading at a much higher level in terms of goods and services than they would based on the comparative fundamentals of our America’s assets compared to its liabilities. Were the US government, to enact a gold standard it would have to set the value of the dollar at a level where it could be faithfully backed by the assets at hand, in which case the dollar would have to be valued far lower.

Taylor is correct is saying that we risk revolt from the citizenry because they would perceive that the government had acted to reduce the value of their currency. This would actually be an misperception on their part, because a continued mismanagement of the currency will eventually make it worthless (hence the title of my book), but people don’t understand these things. In part that’s by design. Politicians obfuscate the real cause of inflation away from their own mismanagement of the currency and instead blame whoever is in reach- greedy merchants, speculators, and other nations attempts at currency manipulation. People seem to have gone along with these explanations, and the true is probably too painful for them to accept. 

This is why I have resigned myself to the eventual collapse of the American way of life. To attempt to adopt a more rational and sustainable economic policy is simply political suicide at this point. People can not willingly give themselves over to the hard discipline of a gold standard if they have any belief at all that they can continue to prosper under the gluttony of a fiat money system. I instead believe it my calling to simply educate those of us who are ready to listen and consider the simple truth of this situation so that the idea will have time to germinate in people’s minds. My hope is that, after the collapse of the American Empire, that we can return to the policies that made us a great people to start with.

Regarding Taylor’s last couple of questions, gold’s strength is in its inelasticity. If elasticity where the best path to prosperity, then Zimbabwe would be a world power by now. Inelasticity forces discipline on a society and a government. To pursue a policy of inflation with an inelastic currency means that eventually a correction must occur. The same is true in an inelastic currency really, but the correction can be delayed for a far longer time. The benefits of an inelastic currency is that there is a shorter period of time between monetary abuse and the painful correction that it more closely links cause and effect in the minds of the people. I consider this a good thing. 

Regarding Taylor’s last question, gold will still possess all of the appropriate qualities of money even if we were to take every last bit of it out of the ground. The money supply does not need to expand in accords with the populace. Indeed, as I point out in my book, one of the most prosperous times for us as a nation was after the Civil War. From 1870 to 1900 the population of the United States was expanding while the money supply was actually shrinking because of the retirement of “Greenbacks” (our first experiment with fiat money) from circulation. It was one of the only times in American history that the buying power of the common’s mans wages actually grew steadily and our GDP expanded at the most rapid pace in our history.

Is It Feasible to Return to a Gold Standard?

I’ve gotten a couple of questions from a couple of different readers regarding how feasible it would be to return to a gold standard. The argument goes something like, “If our national debt $9.6 Trillion dollars, and gold is $900 an ounce, how on Earth could we return to a gold standard since we don’t have nearly enough gold ounces.”

This question confuses the current market value of gold with what a gold standard is. A gold standard is merely a commitment that a currency is now redeemable at a set quantity of gold and does not have to in any way mirror the current market value of gold. The US government could return to a gold standard today if they wanted to by committing to redeem all US dollars into gold at the ratio of $1,000,000 per ounce. Under this standard, the US would now need $9.6 Million ounces or roughly 300 tons, which is easily done. Now a lot of you might be thinking, “But that’s way too high a value of gold,” but you’re again confusing the current market value of gold with a government’s commitment to support it. Setting a high value like $1M an ounce means the government has set a very low bar for itself in terms of gold redeem-ability; somewhat like an out of shape person deciding they can only manage five sit-ups a day to begin. 

Once the exchange rate would be set, the marketplace would adjust to reflect this new reality and probably soon reflect the new exchange rate. That means that, from that point forward, gold really would be $1M an ounce! “But that’s preposterous!” you want to blurt out, but be patient. You see, the entire exchange rate of goods and service would soon reflect this new information, and we’d pretty quickly start to see other prices rising to meet gold’s new price. That would mean you’d probably see oil selling for $100,000 a barrel, and the average rate of labor becoming somewhere around $10,000 an hour. Yes, the adjustment period would no doubt be a bit hairy, but once it was all done, the US would be on a gold standard once again. (Incidentally, if you’d like a more elaborate and gradual plan to implement the gold standard, I’d recommend you check out G. Edward Griffin’s The Creature from Jekyll Island.)

Now once this gold standard was in place and the market place had had time to adjust to the new reality, the government would have to start making some harder choices. If it wanted to implement a new entitlement program or conduct another war, it would have to ask itself “Where are we going to get the gold to do this?” And if it couldn’t? Well, no gold means no program.  No war.

You see, the reason for the confusion at the beginning is that the government has just been conducting whatever programs and wars it wanted to over the last few decades. They have had to face the same question of “Where are we going to get the money to pay for all of this?” but they have been able to answer with, “We’ll just print it.” That’s why the gold standard was eventually abandoned and why our liabilities are so far in excess of our ability to pay that the mere thought of entertaining a gold standard causes the mind to boggle at the discrepancies.

That gold is trading at such a low level in comparison to this nation’s liabilities is no accident. The US Treasury and the Federal Reserve have been working very closely to have the US Dollar maintain its value despite the fact that it continues to be printed at will. In essence, this exercise has allowed us to peek behind the curtain and see that the “Great and Powerful Dollar” is really a construct that is carefully maintained by a few people in the know. This is also why I’ve chosen to entitle my book, “What Do You Mean My Money’s Worthless?” There is simply no way this nation can afford to repay its liabilities and the value of the dollar is going to be the ultimate casualty.

Answering Nat’s Questions

Nat, good friend and now a blog reader, asks two questions:

BTW, Preston, I am about halfway through you book. It’s a good read, especially considering the recent economic catastrophe. I am curious why you think gold should be the standard of monetary policy as opposed to some other commodity. Though problem: If gold were still the standard and in the future we discovered gold on another planet…how would that affect the economy? Supply and demand would dictate that gold would immediately see a reduction in value because of increased supply. I am curious as to your opinion on owning land.

I just read an article that suggested that due to the U.S. making a deal with OPEC to only accept the dollar back in the day that technically, the U.S. dollar is backed by oil…i.e. the OIL STANDARD. What’s your take on that theory?

Let’s take gold first. A lot of what I’m going to say was already well argued by Dr. Murray Rothbard in What Has Government Done to Our Money. As Rothbard argues, the advantages regarding gold is that it has intrinsic value. To argue otherwise is to go against at least 4000 years of human history. Human’s like gold. Always have, always will. Now they also value a lot of other things (real estate, diamonds, art, oil) but the advantages of using gold as money is that it is reasonably easy to transport (unlike real estate), is a dense way to store wealth (unlike oil), can be stored for long periods of time without loss, and can be broken down into fundamental units of accounting to make exchange easy (unlike diamonds). There are few other forms of wealth that meet all of these requirements. 

Now how much people value gold changes over time. Some estimate put the “gold to dollar” exchange ration at about $3000 in the Middle Ages. The entire European What happened next should help to answer Nat’s next question about what if we suddenly found a source of gold that would drop gold’s value relative to everything else, because that’s exactly what happened. The New World was discovered and with it the vast golden wealth of the Incas and Aztecs. The value of gold suddenly dropped to roughly $800 or so. This caused inflation as the cost of goods and services went up in comparison to gold because of this sudden increase in supply, but after this happened the economy went right on about it’s business. There was no calamity. 

Now in regards to your other question, yes I do feel that the US government has made deal with Middle Eastern governments. In fact, John Perkins discusses exactly how the United States got third world governments to play along with our economic wishes in his two books, Confessions of an Economic Hitman and his followup book The Secret History of the American Empire. Perkins books are fascinating because they are basically an inside account of how the American empire was build coming from someone who was involved from the inside. I believe that the CIA engineered the Shah’s rise to power. Similarly, it is common knowledge that we the US government has long been an ally of the Saudi Royal family. That is why the so many of the 9/11 hijackers were Saudis: the Saudi citizens hate the ruling family but feel that they can not get rid of them unless the United States allows it.

Why It’s Worse Than You Think

Recently reader Bob Kraus wrote another comment to my blog which you can read here.

In essence, Bob is arguing that our policies regarding monetary inflation are to our benefit because we are trading the worthless commodity of paper for the very worthwhile commodity of (among other things) oil. Bob acknowledges that he we have “hosed” the rest of the world by perpetrating this sham but, as he puts it, “what else is new?” Bob also acknowledges that the American economy going forward “is going to be a very painful 3 or 4 years for most Americans.” Despite these acknowledgements, Bob remains a stalwart bull for the US economy because he feels that no other country is as innovative or works as hard as the United States. He feels certain that it will be the United States that innovates the next technology that will replace oil and that our manufacturing will return because the dollar has fallen so essentially the American consumer can not afford to buy imports anymore. 

Bob’s thoughts are not uncommon, so I wanted to address them here. Here’s the problem with Bob’s analysis. Currently the US government’s official debt is roughly $9.6 Trillion, but that doesn’t include the liabilities the government just took on with Fannie Mae and Freddie Mac (roughly another $5 Trillion) or the “unfunded” portions of Medicare (roughly $85.6 Trillion). If the US is to make good on its debt then the US is going to have to start seeing savings both on the government level as well as the consumer level, which would be a massive credit contraction over the next couple of decades. Basically we’d be seeing the opposite of what’s been happening over the last two decades where the US has gone deeper into debt. Now given that bull market projections for US stocks earning more going forward are assuming a continuation of the last twenty years, we’d be seeing a much lower level of earnings as the US consumer and government had to drastically rein in their spending. Furthermore, the holder’s of our foreign debt would actually have turn out to not be “hosed” because the dollars the debt would be paid for in a deflationary scenario would actually be worth more than they worth during the inflationary times. That’s assuming that the US actually choses to make good on its debt. 

Now what if it doesn’t? What if instead the US choses the easier path of just defaulting on its debt. Well in that case, I don’t see how gold would not be a far superior investment than the stock market. It’s tough to predict what would really happen were the US Dollar to be rendered worthless, but you could expect a great deal of societal chaos and upheaval as well as a flight of foreign capital from our shores. None of these things are particularly bullish for stocks. 

Regarding Bob’s longer term view of the US as being the best at innovation or working harder that most other nations, well I’d certainly like to hope so. I’m not nearly as confident as Bob is that the US is going to continue to be the source of all things economically good, but even if this is true, the fundamentals of the United States level of indebtedness are simply against any kind of scenario where stocks become strong investments over the next decade or so.

The Republicans Find Religion

A lot of my friends get all bent out of shape when it comes time to elect the President. They act as though it were a matter of life or death to make sure that the next President is the one they happen to be supporting. And, of course, they are correct. The President will have to make many life or death decisions. Still, I can’t seem to get all worked up about who gets elected. In part that’s because I’m a Libertarian. Being a Libertarian means that regardless of who designs the ballots in Florida, or whether we have gone from punch card to electronic voting, my candidate is not going to win. Ever. 

In many ways that’s a relief. I have made peace with the notion that I will never be on the winning side of a Presidential election, and so I experience neither joys nor sorrows come election night. More typically I just get a few chuckles. For the vast majority of voting Americans, however, elections do not seem to bring any peace. Politicians have been studying how to get elected so long that it would seem that they have discovered that the voters seldom if ever hold them accountable to the political promises they made when they were last running for election. And so politics operates like a strange kind of job where you have to continually reapply for the same job you already hold, but no one actually pays much attention to what you say during the interview; if you just promise to be a star performer you’ll keep getting the job because no one really seems to care whether you ever even show up once you have actually gotten the job.

I am reminded of the old Peanuts gag where Lucy holds the ball out for Charlie and pulls it away when he goes to kick it. Lucy has done this to Charlie countless times, but still somehow manages to convince Charlie that this time she really means it. But she always pulls the ball away and then ridicules Charlie with “You Blockhead.” 

That’s how I see the US political system. Every two to six years, the major political parties hold out footballs for the American people to try to kick. The American public has been here before. It knows that every time it goes to kick the ball and elect someone, that the person they elect will unfailingly pull the ball away and not live up to the promises made. I think it’d be a refreshing change if political victory speeches were reduced to the victorious candidate coming before the public and saying, “You Blockhead.”

That’s what makes this current crisis so interesting. There is actually a very short span of time between the actions taken now and the next election, which puts politicians in the very unusual situation of having their recent performance considered by people going to the polls. And this is perhaps why the House Republicans recently took the very unusual action of defying their Republican President’s wishes and voting down his bill. Republicans have traditionally kept a very disciplined core of elected officials. You never see a high profile Republican going to speak at the Democratic National Convention, for instance. And, yet, they may as well have as they gave not only George Bush but John McCain his walking papers and voted down the bill they both vocally supported. Even weirder, Bill O’Reilly recently attacked right-wing “Kool-Aid drinking idiots” in calling for this bailout and attempting to blame Clinton when, according to O’Reilly, it was clearly “Bush’s fault.”

Sacre Bleu! What in the world has gotten into them? Are these the same people who reauthorized the Patriot Act to keep us all safe from terrorism? Or told us how necessary it was that the President conduct illegal wire-tapping surveillance? I mean how is it possible that the Republicans gave Bush Carte Blanche to carry out whatever policies he asks for but suddenly shoot him down on a bailout of Wall Street?

If I didn’t know better, I’d say they suddenly “found religion” and started comparing their actions against the rhetoric. Suddenly the free market, an intangible entity that doesn’t vote and no one really seems to want anyway went from stale talking point to more important than party loyalty.  How on Earth did that happen?Well, I hope the Republicans stop messing with my head, because I’m not used to them actually honoring their free market rhetoric. When there is an unflinching faith in the power of people to decide value in the marketplace, can you then long ignore that the marketplace can’t really function well without an honest money such as gold to go along with it? Am I to hear House Republicans tomorrow call for the abolishment of the Federal Reserve? If they keep it up I’d have to start actually questioning whether I should become a Republican myself!

But then, lest I forget, this is simply politics right before an election. I suspect the Republicans’ sudden “come to Jesus” moment may have more to do with the November elections than with a sudden discovered passion for free market forces. Time will tell, I suppose, but I’m not one to say that that many leopards can change their spots that darn quickly. Still, it was good while it lasted.