Will The Dollar’s Value Ever Reach Zero?

Mark, who frequently reads and comments, recently wrote:

Preston,
On Christmas day I would have agreed with your assessment and conclusions for the most part. But, by the very next day I had been exposed to an opposing view, which leads to a very different scenario.
Somehow in my Internet quest to learn more and more about the crisis we face I discovered Andrew Gause (www.andygause.com) who is described as a monetary historian and contemporary expert on American and international banking systems. I began listening to archives of his weekly radio shows at http://www.oneradionetwork.com starting with the most recent 12/24 broadcast:http://www.oneradionetwork.com/content/view/689/136/ (you’ll have to sign up for his free newletter to listen) and continued backward week by week.
It is clear to me that this guy understands money, the Federal Reserve, US monetary history, and the current crisis far better than anybody I’ve followed to date. Like Peter Schiff and a few select others he was able to predict the mess we’re in which he documented in his interviews and in the two books he published, The Secret World of Money and Uncle Sam Cooks the Books. His predictions for the future, however, are far different than Schiff’s (and yours.)
I can’t recommend too highly that you take the time to listen to his archived broadcasts.
You’ll recall that I recently suggested that a “one world currency” was coming our way. Gause chuckles at that by saying “you’re predicting the past”. He says we already have it, the US dollar. He feels the Fed and the International banking cartel that owns them (including Citigroup, JPMorgan Chase, and Goldman Sachs being the top 3) are already in control of the world’s banking systems and can keep the dollar going forever by simply adding zero’s (i.e. inflation).
He explains that the current deflation (or disinflation) caused by the 1 trillion dollars recently sucked up by the treasury and deposited into the (NY) Fed will end with the big banks and their corporate buddies buying up recently devalued assets (like GM) for pennies on the dollar as the tsunami of liquidity is suddenly pumped into the market leading to a 70’s style inflation (but short of collapse) over the next several years.
Fascinating stuff!! 3 thumbs up…

I haven’t yet had time to digest the digital media. My girlfriend Auby, my mother, and family friend Pam, were watching the entire Californication – Season One tonight. I liked it. It’s good to see David Duchovny in a high-profile series again. I enjoyed him in The X-Files, and even in that movie he did, Playing God. I remember this one piece of dialogue from that movie where he’s confronted with a thug:

DUCHOVNY: Are you going to hit me?

THUG: Why are you afraid?

DUCHOVNY: I’m just trying to plan my day.

The stoic sarcasm that Duchovny brings to his characters reminds me a lot of myself. Which is to say, I enjoy his work.

At any rate, the gist of Mark’s point is the idea that the central bankers of the world have realized their ultimate goal of one world currency in the US Dollar, and are not going to let that default. While I’m sure that the person Mark is citing, Andrew Gause, has done his homework and knows what he’s talking about, I’m going to have to stick to my guns on this one: The dollar is going to default in the not-too-distant future. But, before I really tackle this question, I think it’s important to review a bit of history.

Bankers have always jealously guarded the power to create money; such power is as much a part of banking as the force is to George Lucas’s Jedi Knights: it is the source of all their power, and thus zealously defended by them. Remove from a banker his ability to create money, and all you’re left with is someone in formal clothes. Of course, money-creation creates problems of its own as well-documented by economists like Murray Rothbard in his book, The Case Against the Fed, as the blog readers who’ve been with me for a while are no doubt aware. It creates a devaluation of the currency as new money enters the system and, as the process continues, will prompt investors to put their money in another currency.

Hence, alternative investment options always create problems for the bankers. If they get too carried away and create too much money, they run the risk of people feeling the currency and eventually having it lose relevance altogether in a hyper-inflationary scenario. That’s why John Maynard Keynes proposed a currency that would circulate universally world over, which he named the “Bancor.” Now, in such a scenario, there is no alternative currency to run to, because this one would have legal tender power all over the world. Think of it as Keynes’s interpretation of Tolkien’s “One ring to rule them all.”

The argument has been put forward that the US Dollar is the de facto universal currency, and therefore, we are living in Keynes’ dreams today. The problems with this argument, is that it’s missing the whole point. The US Dollar does not have legal tender power everywhere, it simply has legal tender power for the world’s most dominant power. Now, yes, that may be good enough for most purposes — but there are competing factions that will not accept US Dollars; some powers, like Iran — who are politically motivated to see the US fall from grace, consequentially pricing their dollars in Euros or Yen instead of dollars. Others simply see the US Dollar as having lost much of its buying power, and therefore prefer to deal in local currencies — as we saw in the news this year where they stopped taking US Dollars at the Taj Mahal.

You see, this is all just a replay of the classic story: The Federal Reserve has created so much money to fund so much debt that the entire edifice of debt now towers over our entire economy and threatens to bring it down, which has lead people to start quietly moving towards the exits. The whole idea of a currency such as the Keynesian Bancor is that there is no exit: the world banking system would oversee the currency, inflating it a bit in each country — which is a far cry from one part of the world inflating the living hell out of its currency and expecting the rest of the globe to play along.

Think of it this way: governments all over the world are envious of the US Government’s ability to simply turn to the Fed in order to run perpetual deficits. These governments would like to do this themselves, but, to do that, they would need to displace the US Dollar as the world’s reserve currency. Thus, we are not in a situation where we could really have one-world currency. Furthermore, this argument supposes that: all the bankers of the world value this idea of one universally accepted inflationary currency, and that they would gladly watch their own people suffer the effects of perpetual inflation brought by a foreign power, rather than take moves to stop it.

I feel that that thinking is too conspiratorial for my taste. Central bankers have always fawned over the governments that oversee them since it could take away their money-creation abilities at any time. Governments allow the mischief of money creation on behalf of their banks because it has always made it easier for said government to run a large debt.

I just don’t think that that nation state-centered thinking is going to change anytime soon.

Honestly, can we really expect the central banks of countries such as China to just keep on honoring devaluing their own currency so they can keep honoring the dollar on, and on, and on, with no expectation that the Chinese themselves might want to become the ones issuing the world’s reserve currency?

It’s human nature.

Someday, someone somewhere is going to decide that they want their power to become the next global empire, and you’d better believe that on that day, they’ll tell the US Federal Reserve just where they can deposit all of the dollars it’s flooded the world with.

When that day comes, do you really think the dollar will be left with any value at all?

An American Christmas Carol: Ghosts of Our Past, Present, and Future; Part I: The Past

Christmas; a time of friends, family, and ritual. Many religious, many secular. Among the latter, are TV showings of It’s a Wonderful Life and various versions of Charles Dickens’ A Christmas Carol.

Well, in the spirit of the season, I thought I’d write a blog series in the spirit of the Dickens’ work. This is the first of a three-parter regarding our current American crisis. In this, the first, we are going to take a look at some of America’s past ghosts that are still haunting us.

The figure of Scrooge is an unhappy one; he has used greed to fill the void left from the emptiness of his existence. In this way, Scrooge is personifying what Scott Peck would later write in The Road Less Traveled that most neuroses are caused by a person’s attempt to avoid legitimate suffering. If Scrooge had but properly grieved the pain and loss that the Ghost of Christmas Past came to show him, then he would not have become the twisted and hated figure upon which the story opens.

It’s ironic that that hated figure actually had a lot of virtues that we as Americans lack; Scrooge was tight with his money and always in search of prudent ways to invest it. Americans seem to work more hours than Europeans, and in that way we should be able to identify with Scrooge’s desire to lose himself in his own work. But it seems we are not using the work as a means to gather financial security (which was his obsession.) Instead, it seems we work to pay off the debts that nevertheless seem to grow year-after-year. In that way, we’re a bit like Jacob Marley; having lived lives absent of the proper virtues, and are now so chained to a hated existence we cannot escape.

While Marley was forced to walk the afterlife in chains of his own making, our nation has gone into debt to foreign creditors. We have lost our willingness to save, and with it, our competitive edge. And now, even our industries. Our only strength now lays in our military superiority — and, unfortunately, history is rather mute of any empires that were able to pay for themselves off of foreign tribute alone. Bereft of owning our own capital, we cannot compete on the world stage, and so we will increasingly be forced to work for our foreign masters in an attempt to pay off our debts.

How did we get here?

Let’s talk a walk with the Ghost of Christmas Past and see if we can figure it out.

When our nation achieved independence, it featured a manufacturing and financial North complemented by an agrarian South. The North and South were natural complements to each other, but over time, their differences got the better of them. A war was fought to determine whether the South would be allowed to become independent from the North, or whether the North would be able to use its expanding influence to dictate terms to the Southerners.

The war proved expensive; far more expensive than either side anticipated. The Northern Government turned to the financial centers to loan it money, but that proved insufficient as the war drew on. So, they returned to the bankers, who then asked them for a favor. The first national banks were chartered during the Civil War, and the act that chartered them gave huge advantages over state-chartered banks. So much so in fact, that several banks switched their charter to become national banks. Next, the Government floated the idea of issuing unbacked fiat money, and which point the bankers asked for another favor: Greenbacks, the first ever fiat money issued, were declared to be legal tender for all debts public and private … save two. According to the laws then, interest or import duties had to be paid in gold coin.

The bankers knew fake money when they saw it, and they were content to let its inflationary power slowly deprive the people of their wealth — as long as the bankers themselves were able to increasingly acquire gold. By allowing this law, the US Government was giving the bankers a mortgage on the future earnings of Americans — and, to top it off, demanding that it be paid in gold.

After the war was won — thanks in no small part to the financial maneuvering of these newly-created national banks — the balance of power continued to shift in their direction. The Republican Party was dominant both during and after the war, and it had a very cozy relationship with banking interests. More legislation was passed under President Grant by which the US Government abdicated controlling its money supply to the national banking interests who were now allowed to expand or contract the amount of bank note currency in circulation according to whatever reasons they say fit. The power to create monetary-based booms and busts had been handed over to the bankers who quickly recognized it as yet another tool for influencing public policy. More than once, the national banks would greatly contract the money supply to incite a panic if they were not pleased with what the politicians in Washington were talking about.

The industrial revolution started booming, and with it came increasing worry regarding the power of large corporations. People grew especially fearful that large corporations would begin conspiring amongst themselves to confiscate wealth from the people. Consideration of antitrust legislation started being brought to the table; the most threatening trust of them all was the national banking system — dubbed by its opponents as “the Money Trust”; which was too smart, too powerful, and too subtle to be undone by a simple act of Congress. Instead, the Money Trust conspired to arrange for the formation of a government-sanctioned banking cartel — its crown jewel being a US Central Bank; privately owned, yet solely responsible for control of the US debt obligation: the US Dollar.

The Trust went to work; in no time at all, they had their allied Republicans in the House and Senate considering a plan to create the Federal Reserve. Surprisingly enough, President Taft took a rather un-Republican stance on the banking bill, refusing to support it, so, the bankers waited until the next administration. Do-gooder Woodrow Wilson defeated Taft to become one of the first Democrats since the Civil War to win the Presidency, and the bankers soon brewed a tempest in a teapot by having Congress call hearings meant to expose the abuses of the banking industry. What would happen next was a foregone conclusion; Congress found that the banking industry was abusive, in need of being cleaned-up — by the creation of a central bank and entrusting the bankers with its ownership.

From there we start to get to the history we all know. Under the Federal Reserve, the boom and bust cycle got much more exaggerated, and soon we had our first “Great Depression.” This prompted the bankers to again ask the Government for more power, and FDR was happy to comply in whatever ways they deemed necessary. And soon, it was insuring banking deposits, declaring bank holidays, even outlawing gold ownership by American citizens — but not American banks.

The bankers found a friend in Macroeconomists such as John Maynard Keynes who legitimized their control by theorizing that the operation of the free market was too unstable to be allowed to function on its own. But really, they were so powerful at this point that all that they had to do was pick the right person for their spokesperson. If Keynes hadn’t been around, they’d have found another patsy.

Keynes told a lot of lies in his theory. Chief among them was that savings was a vice, not a virtue, and that and investment funded by newly-printed money was just as good as an investment funded through odious savings. The bankers now became the national heroes of our society, ever-ready to stand firm in the face of market downturns and do what they have always done naturally anyway — create money in massive quantities.

(Most of the information I used for this blog post came from the excellent book, The Coming Battle: A Complete History of the National Banking Money Power in the United States which details the activities of national bankers in perverting our republic to further their own ends.)

Next time we’ll take a trip with the Ghost of Christmas Present and really assess how far this system has taken us. Until then.

Obama, Keynes, and the Perpetual Motion Machine

Obama is calling for government deficits over the next couple of years to avoid a “deep recession.” I’m not sure if he said it explicitly, but conversations with Democratic friends has shown me that it appears to be a widely held belief that the money can all be made up from tax revenue off of the booming economy that should result after a couple of years or deficit spending. It harks back to what I’ve heard many a Keynesian say; the government needs to run deficits in the down years and surpluses in the up years. “It would only work,” they say, “except that politicians can never bring themselves to reign in their spending.”

Just as markets work towards the betterment of all involved if they perform rationally and with good information, governments would be the perfect guardians of our welfare if only they were somehow free of corruption and not run by power-hungry politicians. Except that we don’t live in an ideal world, so we must make do with the best that we have. However, even if perfection were somehow available, Keynesianism would still be nothing but an intellectual fraud because it’s basically promising the economic equivalent of the perpetual motion machine.

For those of you who don’t know, the perpetual motion machine was a mythical device that, once set in motion, would continue to run forever without requiring any additional energy inputs. There were many attempts in the Middle Ages to create such a device, but they all failed. You can’t get something for nothing, you see. If a machine is to be in motion, then it will require energy. One can not derive more energy from the machine’s motion than it requires to set it in motion and run it. This was not understood at the time, because no one had yet devised the First Law of Thermodynamics which stated that “Energy can neither be created nor destroyed.” 

Similarly, Keynes promises similar benefits to the perpetual motion machine by theorizing that economic downturns are caused by a lack of demand and that the government can step in to become the prime demander, and thereby set in motion a chain of events by which the economy will start booming again. Keynes figured that money put into the system to get the demand humming again could later be taken back out. There’s a reason why Keynes’s system has never worked, and it doesn’t just have to do with greedy politicians. Just as in thermodynamics, you can not prime the pump of commerce and magically create a fountain of wealth from which you can withdraw far more than you put in. As my momma used to tell me growing up, “There ain’t no free lunch.”

Even if the government did exactly as Keynes said, it still wouldn’t work, because Keynes was wrong. Pure and simple. Economic downturns are not caused by “insufficient demand.” Indeed, insufficient demand is impossible, as Jean Baptist Say had started over a century earlier (and I’m paraphrasing), “There is not a supply, which is not also a demand.” That is to say that in order to make a product such as as car, I will demand inputs from labor as well as raw materials of all kinds. If the demand where not there for the car, then the demand would also not be there for the labor for the car or the raw materials. Keynes looked at this situation and said that we needed to stimulate demand for the car in order to employ the autoworkers, but what he didn’t seem to understand was that it is impossible, as a whole, for society to have inadequate demand for anything. Keynes attacked Says law as not being able to explain economic downturns, but Say himself actually clearly states that economic downturns are possible but will be hastened towards ending if the government and people are quickly willing to allow the market to find market clearing prices. (For a clearer understanding of Say’s Law, and the failures of Keynesianism, I’d refer readers to Rehabilitation of Say’s Law.

Try to picture it for a minute. How is inadequate demand possible? If people stopped demanding cars, it must be because they were demanding something else other than cars with the money they were spending the buy the cars. Thus demand lost in one arena is picked up in another. “But what if the consumer simply stopped demanding altogether?” you might ask. In that case, they will be looking for an excellent vehicle with which to park their savings gained by not consuming. As savings accumulates across society, interest rates are lowered because of all the money available to lend. Cheap money, as Keynes could tell you, leads to economic boom times as entrepreneurs can now go out and borrow the savings of the others and demand both labor and raw materials for their new venture. 

What, you still don’t believe me? What if no one ever, ever consumed enough to justify investing? Outside of being nonsense, let’s take a look at that scenario for a minute. Let’s simply it down so we can understand it easily, and let’s look at the economy of Robinson Crusoe who, incidentally, has been the target of so many economics texts that I’ve been tempted to pick up the book. One man alone one a desert island demand food and water, and so he must use his labor to create his the objects he demands. To do otherwise, is to starve and die. Now Crusoe demands other things as well as food and water: shelter, clothing, a boat namely. But to acquire those things, he must also build them himself. So in our economy of one, time spent is the only medium of exchange. Crusoe is free to do what he will with the time he has, but he will starve unless he uses at least some of the time to fish and gather water just as he will be without shelter if he does not spend the necessary time to make a house for himself. Even in our economy of one, Crusoe’s demands are far more than his ability to actually consume given the time he has, and so it is with all of humanity. Our wants are limitless. The idea of insufficient demand, is just a Keynesian fairy tale. 

Keynes wanted to explain the business cycle by saying that consumers weren’t demanding enough, but people always have wants for more than their ability to satisfy. As long as people have money, they will want to spend it and it is only interest rates offering us even more goods in the future if we would but forgo present consumption that incentives us to save at all. An across the board reduction in the demand for all goods is only possible when there has been an expansion of the money supply because then people go from having access to lots of credit in order to buy things to suddenly having less access to credit as they have taken on more and more debt. And so it is not the lack of demand that causes economic downturns, but rather the natural after effect of a previous credit expansion. Where the previous credit expansion to never have happened, then there would have been a far more even flow of demand across time instead of people demanding more than they could afford at one time and demand less in the future when the bill came due from past excesses. 

The reason I go into this is so that we could now understand just how ridiculous Keynesianism is. Credit expansions cause a surge in demand that must later be “corrected” when that source of credit is exhausted. Keynes proposed that the government could expand credit to gain great multiples of extra demand and revenue in the future, but that’s clearly impossible. The demand will naturally fall back to its natural level after the credit runs out, and if the government were to ever withdraw some of the credit in the future in order to try to follow Keynes’s advice to run surpluses in boom times, then the system would crash even harder. And so the source of continual budget deficits is not due to the greed or incompetence of politicians, but rather because credit expansions, once started, must continually be supplied with additional credit lest they collapse in on themselves. 

Some economists understood this. In his book, Human Action: A Treatise on Economics Ludwig von Mises wrote that, “The wavelike movement effecting the economic system, the recurrence of periods of boom which are followed by periods of depression is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion.” Yet here we are, decades after Keynesianism failed to bring us out of the Great Depression or Japan out of it’s “lost decade”, still seeing the same ideas spouted by politicians. Neurosis is the tendency to do the same thing over and over again and expect different results. It would seem we are a very neurotic people.

Jeremy Siegel Defrauds Investors by Calling Stocks “Dirt Cheap”

Dr. Jeremy Siegel wants you to know that know is a great time to buy stocks. In fact, he says he’d be surprised if you didn’t get a 20% return on your investment in the next twelve months. Of course, Dr. Siegel’s crystal ball is proving to not be all that great. In 2007 he predicted that 2008 would be a great year for stocks and that financial stocks should do particularly well. So much for that prediction.

To understand his latest argument, Siegel is putting a fair market value on the S&P at 1380. Since the S&P closed today at 930, you can see why’d he think now was a great bargain, but how did he arrive at that 1380 number? Well he says that the long term fair market value for stocks is to trade at a PE of 15 and he then conjures up a figure for what the next 15 years of earnings for the S&P should be based on the past 15 or so- which is equal to $92 a share. $92 x 15 = 1380. Voila. I could almost hear Dr. Siegel add, “Wil-E Coyote. Super Genius!”

This article struck me as a bit fishy, and not just because I’m a bear. For one, having been a avid read of Bill Bonner, I knew from books such as Financial Reckoning Day: Surviving the Soft Depression of the 21st Century that the long term PE for stocks is to trade at 11, not 15. So I was curious as to how Dr. Siegel came up with such figure. It turns out, he made a mistake. Bonner and the bears are correct in saying that the average long term trailing PE for stocks is 11, 15 is the average PE for earnings from four years ago, not next year’s projected. Currently, stocks are trading at a PE of 18 compared to trailing earnings, as Dr. Siegel himself pointed out in the article where he calls stocks “dirt cheap”, and a PE of 18 is not cheap when the long term average is 11. The upshot is that Dr. Siegel made an error and that stocks are actually expensive on the order of 40% compared to their long term PE ratios, not 40% the cheaper as he claims they are.

The other thing that Dr. Siegel doesn’t seem to understand is that the long term average of stock PE is just that- a LONG term average. There are many bull market years where the PE is trading above 11 and many bear market years where it is trading below 11. Furthermore, these periods of over and under valuation tend to be grouped together in the time line: we see stocks priced well over the long term average through the 1920s and then under during the Great Depression of the 1930s. So if we are continuing the bear market slide that started in 2000, then we should expect stocks to be trading BELOW their long term average. Which means, if the trailing average is 11, we should expect to start seeing stocks trading at PE levels of 8 to 10 as they did in the 1970s. You’d have thought that the author of Stocks for the Long Run might have studied up on the market a bit to see just how long the “long run” can really be.

Of course, all of this bull market analysis is based on the notion that the next 50 years of American history should be more or less akin to the last 50 years or so, and that’s a claim I take issue with. American has dominated the last 50 years of world events as a titan with unmatched military, industrial and economic power. Looking forward 50 years into the future, do we really expect to see that continue? Which brings us back to Dr. Siegel; clearly he is wrong in his analysis, but it he simply mistaken or did he aim to reach for a conclusion that would make other parties happy.

Don’t get me wrong, we all make mistakes. Perhaps Dr. Siegel put less time and effort into his Yahoo columns that I put into this blog and just doesn’t get a chance to double check his math, but I don’t think so. I think Dr. Sigel fudged the numbers to arrive at a rosy outcome. If so, it wouldn’t be the first time a Macroeconomist has gone through a rather dubious trick of logic and math to reach the politically desirable conclusion. Indeed, John Maynard Keynes’s The General Theory of Employment, Interest and Money is nothing but a intellectual fraud filled with straw man arguments, shifting definitions, and math based on dubious assumptions, but it is heralded as a classic largely because it came to the desired conclusion of the day: the free market was inherently unstable unless assisted by the power of government. Macroeconomists are task masters at fudging their numbers to support the conclusions that they feel are popular. Why should we think Dr. Siegel is doing any different here?

The Free Market’s Unlikely Champion

In the dark hours of a collapse is when the free market tends to undergo its most radical depredations. Politicians never seem to grasp the complexities of what’s going on, but understand that SOMETHING needs to be done. Like FDR, they just start changing things and hope for the best. Later, a whole generation of economists would praise FDR for his decisive actions. “It’s not that his actions were particularly good,” they might say, “but something needed to be done.” A crisis can not go unanswered. To believe otherwise is sacrilege in macroeconomics. If one believes that an economy can be managed by comparing aggregate supply to aggregate demand, then one has not only the right, but the responsibility to correct the situation.

“With great power, comes great responsibility” were the fictionalized words of Spiderman’s Uncle Ben to Peter Parker, the main character. Peter resisted being called to the role of hero, but in the end, who else had the power to save the world. And this must be how politicians and macroeconomists must feel. They have been given the almost superhuman power to restore confidence in Capitalism by correcting some of the messier elements of the free market system.

And then there’s France. France has always been the butt of America’s jokes; the nation labeled by Homer Simpson as the land of “cheese eating surrender monkeys.” Americans fancy themselves as rugged individualists living by their wits in the dog eat dog world of free market capitalism.  We seem to feel that France is the sissy brother of our western allies: people speaking a strange language in a system so collectivist in their Socialism that it borders on Communist. Like most of America’s fantasies, we seem a bit off base; our system is far more collectivist (and socialist) than we would like to admit and our attitudes regarding France seem unduly harsh. Truthfully, I feel that those two nations have much more in common that either would like to admit. 

Lest we forget, it was France that enabled us to win our independence to begin with. While Americans seem to approach having an empire as a novel idea with grand appeal, France has already gone through their empire phase, complete with an attempt to take over the world through force. And when it comes to fiscal discipline, France seems to have a better understanding of when the game is up than we do. Experience is the best teacher and France has been burned before in the game of holding foreign currencies in the name of global stability. As Murray Rothbard recounted in A History of Money and Banking in the United States: The Colonial Era to World War II France was made a dutiful martyr early in the game of modern finance.

After the aftermath of the first world war, Britain made an attempt to return to the gold standard at their pre-war par. Normally this would have been a very contractionary move, as Britain had vastly inflated their money supply to fight the first world war and therefore there was a far greater ration of paper pounds to central bank gold to back it. One would expect that they would merely have taken the more conventional move of returning to the gold standard at a new par that reflected the vastly inflated quantity of paper notes in circulation. If Britain desired, for whatever reason, to return to valuing the pound at the old par, then one would then have expected for Britain to start contracting their money supply over the years as the United States did in retiring the greenback after the Civil War. But the master planners in Britain, now doubt influenced by the most prominent British economist of the time, John Maynard Keynes. Instead they desired to actually inflate their money supply while simultaneously revert to redeeming their pound in gold. While this scheme might seem absurd to the likes of ordinary mortals like you and I, the British economists felt they could do it.

Part of the plan was that they would not redeem the pound for gold with ordinary citizens, so it was not a true gold standard but rather what became to be called a gold exchange standard. Since the other nations of the world were also in shambles from the first world war (with the notable exception of the United States) Britain felt that no one else would be in a position to present large quantities of paper pounds for redemption as long as the Britain could get the United States to play along. The Federal Reserve, under the leadership of Benjamin Strong, supported this move by the British, for it required the Federal Reserve to expand its money supply even more than the British were doing. Both countries economies underwent a huge inflationary boom in “the roaring twenties”. We all know how that story ended.

What is often lost on those of us not familiar with Rothbard’s excellent history, is that the central bank of France began acquiring large quantities of British pounds as its industries revived and it ran a trade surplus with its British neighbor. The French became nervous as they watched the British and the United States continue their inflationary campaign. They understood that Britain might have a problem redeeming all of the pounds the French possessed should they be ever be presented. But the British central banker, Lord Montagu Norman, convinced the French that Great Britain would stand by their pledge to redeem their pound in gold, even if they had to start raising interest rates and end their inflationary campaign to do it.

So the French played along and held onto their British pounds. As the situation became increasingly untenable, the French began demanding that the British halt their inflationary ways and instead start contracting their money supply. The British were forced to either abandon their pledge to the world to redeem their pounds or they had to stop inflating. Instead of face the pain that might come with higher interest rates, they chose the abandon their gold standard.  France’s central bank had to take a huge loss on the paper pounds it held in it’s vaults.

Fast forward a few decades, and now the players are slightly different, but the story remains the same. Now it is the United States that is maintaining a gold exchange standard, and France is, once again, acquiring a large number of paper dollars. It received similar pledges from the United States that it would stand by its pledge to redeem the dollars in gold, but France once against watched as first LBJ and later Nixon expanded the money supply to increase government entitlements and fight a war in Southeast Asia. As they saying goes, “Fool me once, shame on you, fool me twice, shame on me.” Or, as President Bush shortened it, “You can’t get fooled again.” And so the French didn’t.

Having been burned by their previous experience with England no doubt colored the French decision to continue presenting their dollars to the United States for redemption. And again the leaders of the currency promising to redeem the dollar in gold, were so resistant to the idea of reigning in their spending, that they chose instead to simply make them irredeemable. Yet again, France and the other nations of the world took a loss on their dollar holdings, and today the loss has now spread over to the include debt instruments backed by the dollar as well. 

So now the French are lecturing the world on the benefits of fiscal discipline: Both French President Nicolar Sarkozy as well as Europe’s central banker Jean-Clause Trichet have recently announced a conference in mid-November that will be attended by all of the major western powers including the United States. The topic of this conference is to be a return to the Bretton Woods accord- the accord which Nixon abandoned by ceasing redemption of dollars for gold. 

It’s not hard to figure out the true motive here. Sarkozy and Trichet want to displace the US Dollar from the reserve currency of the world and instead put the Euro in its place. And why not? God has not ordained the US Dollar legal tender for all debts, the US government has; the history of the dollars reign as reserve currency of the world is one ripe with abuse as America has inflated its money supply and forced the other nations of the world to eat the cost. The nations of the world might be ready for a new currency, and Sarkozy and Trichet are certainly ready to make it the Euro. Odds are, this conference may produce little more than lip service, but there is also a chance that Europe may announce a coup by declaring a standard of redeem ability for the Euro in gold. If so, then I would image a stampede of the nations of the world out of the US Dollar and into this newly found hard money. I can only imagine what would happen to the value of the dollar.

Everything I Need to Know I Learned from a Shock Jock

For those of you who don’t know, I listen to some pretty salty radio. Specifically, I listen to both Howard Stern and Bubba the Love Sponge on Sirius Satellite radio and, while I can’t specifically recommend shock radio for everyone, I can say that both shows have, in addition to a lot of material many would find objectionable, a healthy amount of intelligent dialogue. Both shock jocks have gotten increasingly more political over the last handful of years as both were targeted by George Bush’s FCC chairman Michael Powell with the largest fines in radio history. Having both found their home on sensor free satellite radio, they now both routinely comment on the absurdity of the “War on Terror” as well as favoring Barrack Obama in the Presidential race.

Having been so financially touched by the latest administration, politics has become personal issue for them. I find the politics of the Bubba show particularly interesting as he is not a traditional Democrat but rather someone like myself who has developed a Democratic sympathy out of utter dislike for the policies of the Republican party. Yesterday on the Bubba show, the topic of the housing crisis came up. Specifically they were discussing John McCain’s recent proposal that the government simply buy up all of the troubled mortgage’s and have the government renegotiate better terms with the home owners so as to keep everyone in their homes. Brent, the producer, pointed out that he had reread Ron Paul’s A Foreign Policy of Freedom and that the book had predicted both the housing crisis as well as the government’s bailout of it. Bubba then went on to say words to the effect that:

If they want to stabilize housing prices here’s what they need to do. Stop all this bailout <stuff> and just lower the price. Eventually, the price will get lower to those of us that have some spare change will go out and buy the house as an investment property and fix it up. Crisis solved.

This reinforced in my mind the utter simplicity of classical economic theory because Bubba, who did not even go to college, was doing a wonderful job as describing the effects of Say’s Law. Jean-Baptist Say (1767-1832) was a French economist who attacked the Mercantilist notion that recessions were caused by a shortage of money. Instead, Say argues that money is merely a medium of exchange and one can not actually buy anything without first supplying something else (i.e. a worker must first supply his labor in order to get its money’s worth to then buy goods) that it is not money that is in short supply but other goods. According to Say, a generalized over-production was simply not possible, while a specific overproduction of one given good certainly was. Thus Say’s solution was to allow the markets of goods and services to find their own clearing price and that that would quickly bring an economy back to stability and further help orient the markets production of goods and services towards what the society actually valued. 

Say’s law was attacked by Keynes who theorized that a generalized over-production was not only possible, but that it would tend to be persistent unless the government took action. It is Keynesian theory that lies behind John McCain’s plan, but Keynesians will quickly admit that if Say’s law is correct, that all of Keynes’s theories will fall apart. William Hutt’s A Rehabilitation of Say’s Law points out the how Keynes seemingly intentionally misstated Say’s Law in order that he might then attack it and how Keynes’s misstatement still seems to be accepted by most modern economists as the law itself when it, in fact, is not. 

Say’s law is obvious. So much so that it was unintentionally state by Bubba when describing the John McCain’s housing plan. To allow the economy to quickly realign itself with the actual wants and needs of society, we need to allow the value of housing, bank stocks, and collateralized debt obligations (CDOs) to find their own price rather than have the government move in to buy these products. Do not believe the argument that the “credit markets are frozen” and that no one will buy CDOs at any price. That is simple nonsense. I guarantee that if CDOs are allowed to fall enough in price, eventually they will find a market clearly price and the market will unfreeze itself. The problem is that this market clearing price is probably far below where the banks have it marked on their balance sheets. So you see, the problem is a political one, not a defect of the market itself. 

All in all, I think we would do well to follow the simple logic of Bubba and his crew. Allow the market to find it’s own market clearing price, and let the chips fall where they may.

The Endgame Begins

Despite the fact that I’m an avid gamer, my Chess game is pretty horrible. There was a one point in my life where I thought I might devote some time to it, but that never came to be. I do know through my limited reading on the subject that serious students of the game divide Chess into three parts: opening, midgame, and endgame. Because the game has so much history, and because the number of opening moves are very limited, much of the opening tends to follow historical convention of various “opens.” But the open only goes for the first handful of moves. Before too long, the game has broken from the predictable opening to the midgame where the players have now gone from “following the script” to making moves as best they see fit on their own accord. The midgame is where the players are forced to begin making entirely their own decisions, but the situation is also so dependent on the opening that an experienced player can look at a game in progress and reliably predict what opens both players used.

Then after most of the pieces have been taken, the endgame begins. In terms of moves, the endgame can be the longest part of the game. If played out to its conclusion, it can take quite a few moves to advance a pawn to the other end of the board, regain a queen, and checkmate the opposing king. But often good players will simply concede when they see that that is where the game is going. There are no specific markers that delineate opening from midgame from endgame. It’s more a subjective judegement that people can make when reading over the games moves, but there is, to my knowledge, no textbook definition upon which one can say “Ah, with this move, the endgame has begun.” And yet, it is something that experienced players can recognize immediately. In that way, Chess is a bit like global markets.

When compared to a game of chess, the current financial order can be said to have started back in 1944 when John Maynard Keynes led the Western Allies to agree upon a new financial system near Bretton Woods New Hampshire. As discussed in my book, the Bretton Woods agreement set about a new monetary order by which all of the currencies of the world would maintain pegs to the US Dollar which in turn would be fully redeemable in gold. In this way, all of the world’s currencies were indirectly redeemable in gold. More importantly to the United States, the US Dollar became “as good as gold” to the powers of the world. This is how the “game” of our current financial system opened, and the opening moves were indeed predictable. 

The US Dollar became the strongest currency in the world. It was readily taken everywhere and all nations worked to develop a positive trade balance with the United States so that they could begin saving this new version of paper gold in the vaults of their central banks. The currencies of the world did not vary much against each other as each was pegged to a given amount of dollars. All appeared stable and predictable. But as the game advanced, the situation developed to where their became a strain on the gold reserves of the United States. The United States had enjoyed the ability to, in essence, print paper that others took as gold upon demand. No nation can be expected to not abuse such a monumental privilege. Particularly not when there was a Cold War going on. The 1960s say a huge inflationary expansion of the US Dollar as both LBJ and Nixon expanded social spending while financing an expensive war in Southeast Asia. Various nations of the world, particularly France, began presenting their dollars to the US Treasury and asking for gold. Either the United States would have to stop all of this spending or it would have to cease redeeming in gold. In 1971, Nixon chose the later and the midgame began. 

As mentioned, in the midgame, the players have more ownership in their own decisions rather than following a pre-planned set of moves. Now the currencies of the world were free to “float” against each other. The conversion ratios between one nation and another fluctuated daily. Currency traders and not central bankers increasingly began to determine what a given currency was worth in terms of all other currencies. The US Dollar was now going to have to compete on the world marketplace, but because of how revered it had been at the start of the system, to many of the world’s central banks had too large a stake in it to allow it to collapse; remember, the opening has a huge influence on the development of the midgame. There were some scary times at the end of the 1970s where it seemed like the US Dollar was going to collapse, but ultimately it was simply too pervasive a currency and the economic and military power of the United States too strong to allow its currency to be treated like that of a banana republic- even if there was an amazing similarity between the policies of the two. 

But eventually the midgame ends. After most of the pieces have been taken, the players try to surmise who has the advantage and plan accordingly. In our little game, the pieces have been falling all in a row lately. Whether its the housing market, the stock market, or commodities, one pieces after another has been taken off of the board as a safe place to put your money. Lately even the banking system itself, the equivalent of the king in our allegory, has been in danger of getting captured. The endgame is starting. The players of the world are looking at the board and have realized that the financial order of the last six decades is about to collapse. They are starting to plan accordingly. On October 10th, Italian Prime Minister Silvio Berlusconi announced that the world leaders were considering closing the financial markets of the world so that they would have time to “rewrite the rules of international finance.” He would later say that he was just speculating about a rumor, but one does have to wonder whether he was forced to recant by the other world leaders who had wanted more secrecy maintained around their meeting. 

Whether the meeting was real, or whether it isn’t it does beg the question of when one is going to happen. I say when, because I just don’t see how the powers of the world are going to sit by and watch this deflationary collapse unfold without a fight. Confidence has become shaken in the banks of the world, and part of the reason for this is because the banks of the world have far more liabilities than they have assets when the market actions of the past year have been taken into account. A new plan whereby a large block of nations pledged a significant portion of assets to back their banking system would restore confidence in that banks structure and that nation might thereby gain an advantage in prestige over the other nations of the world. A new economic order to replace the now defunct Bretton Woods agreement must be in the works somewhere; if nothing else, it would be needed as a contingency against further collapse of confidence. 

This all spells the end of the dollar. Like a chess game, the players of the world know that its just a matter of time (a matter of moves) before the once almighty dollar is reduced to far less than the paper its printed on. We are about to once again discover the words of Ludwig von Mises who wrote that “”Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink.”