Saturday, November 7, 2009

Putting It All Together

[Nota bene: Having researched this post for months, I pondered long and hard about whether to put it up. I did not like where its logic was taking me, but the logic is inescapable. (Take your time, and follow all the links below; together, they tell the tale.) Then a loyal reader sent me this "open letter" made famous by Glenn Beck, and I decided, thanks to that author's plainspokenness, that there needs to be more of laying things out openly for all to see, and less of pretending that things are going along just fine. To tell the truth, there are no two ways about it. This will be either a post to which we may return again for its prescience, or one that we can all laugh about in ten years. For all our sakes, and not my own, I hope and pray it will be the latter.]

These are seemingly isolated events, reports and essays published, all within the last nine months:

Can anything be concluded from these various happenings? Is there a common thread among them?

I submit that there is a common thread, and that it has to do with the inherent risks and disconnections from risk that accompany an economy based on nothing more solid than fiat (paper) money. The only thing that has held the system together since the first Bretton Woods agreement is the restraint of the United States in printing paper dollars. When that restraint was first relaxed, the United States was forced by the amount of paper money it had created to close down the gold window in 1971, making the dollar a completely fiat currency for the first time. With the irrational panic ensuing after last year's threatened collapse of the whole house of cards, even the last vestiges of restraint on the creation of more and more fiat money have now entirely disappeared.

What little restraint remained has been thrown to the winds of political megalomania, which conceives that simply by printing ever more and more money, the economy will eventually take heart and recover. In the meantime, however, the only sector which recovers is the financial one -- because it gets to play with all that money, and receive compensation for playing. Washington sends the money (in the form of bailouts and guarantees) to Wall Street, which takes its cut and then ships the money back to Washington for another round. Meanwhile, precious little money is making its way to Main Street (which is why inflation has not grown to be serious yet).

The printing of money to pay for political schemes has always had a side benefit for the politicians who dream up the schemes, and who pitch them to the unsuspecting public as programs for reform. (Let us remember that the much touted Stimulus Bill, rushed through a Congress which did not read it, and now proven an utter failure, was given the official title of "the American Recovery and Reinvestment Act of 2009.") The bills are now so long and complex that no one reads them before voting to pass them, and no one person knows all that is in any bill. The process allows politicians to stick in many little hidden rewards to the special interests represented by the faithful lobbyists. Those specially benefited reward the politicians by returning generous contributions to their political campaigns.

And so the vicious circle goes round and round. Certain sectors receive special handouts and rewards, which do nothing to stimulate the economy as a whole, because there is no overall coordination, but only a stuffing of the particular hands which offer to pay something back so the politicians can get re-elected. Then the politicians come to the "rescue" of the wrecked economy yet one more time, and vote more rewards and special handouts, and on and on. We truly have, and have had now for a long time before Mark Twain ever said it, "the finest government that money can buy."

But the game has to come to a crashing end once the printing presses are made to run without stopping. For the cycle feeds on itself. The more that is handed out, the more that is paid back to the politicians, and the more they are in hock to meet ever higher demands as the economy continues to sink. Think of the old fairy tale of the magic porridge pot: the image of the entire village being drowned in a sea of never-ending porridge is a perfect analogy to our current economy awash in paper dollars. Or, to use another image from fable, the sorcerer (the one who can bring things under control) is away, and the apprentices are in charge.

The chief apprentice, by the name of Ben Bernanke, assures us that all will be well, and that when the time comes he will magically be able to suck back in all those dollars that are floating around the economy before inflation takes over. But the talk of a new reserve currency demonstrates that Mr. Bernanke's promise is an empty one. Once the dollar stops being the world's preferred medium of exchange, not even Mr. Bernanke's figuratively cavernous vaults will be able to accept back all the dollars that people will be trying to dump in a flight to a more sound currency. The inflation that most people are anticipating is the slow, insidiously building kind, which the Fed admittedly has tools to fight. No one seems to be preparing, however, for how to handle the consequences of the dollar losing its reserve status when so many dollars are being printed. If raising interest rates or reserve requirements at that point does manage to curb runaway inflation, it will do so only at the cost of an economic collapse that is even worse than the current one.

All of this was explained long ago, by the Austrian economists -- chiefly Ludwig von Mises. Here is a concise summary of his business cycle theory, written back in 2001, but every bit as true as if it had been written yesterday:

Business cycle theories are legion and they come and go. But the only explanation that has stood the test of time was first advanced in 1912, in Ludwig von Mises’s masterwork, The Theory of Money and Credit. Elaborations on the theory, by Mises and his student Hayek in the 1930s, culminated in the Austrian theory of the trade cycle.

The theory begins by observing the profound effect that interest rates have on investment decisions. Left to the market, interest rates are determined by the supply of credit (a mirror of the savings rate) and the willingness to take risks in the market (a mirror of the return on capital). What throws this out of whack is manipulation by the central bank.

When the Fed feeds artificial credit into the economy by lowering interest rates, it spurs investments in projects that don’t eventually pan out. In this economic boom, the high-tech and dot com manias resulted from a decade of sustained money growth via lower interest rates. When the Fed stepped on the brakes to prevent prices from rising, it prompted a sell-off, and hence a downturn.

What’s tricky to understand is what can’t be seen. Just because prices aren’t going up doesn’t mean the money supply is in check. Just because people in some sectors are getting rich doesn’t mean that the prosperity is on solid ground. Just because the stock market is going up doesn’t mean that the architecture of investment (to use Jim Grant’s phrase) is in good working order.

This is not rocket science, and we can be sure that as a trained economist and financier, Ben Bernanke knows all this perfectly well. So what is behind the charade he is currently running? Let's review the basic facts one more time:

1. The monetary base is expanding beyond all limits, into unknown territory, while the Fed is lending money to banks at 0.25% interest or less.

2. Unemployment -- even the government's artificially limited "official" figures -- is headed into territory not seen since the Great Depression.

3. The value of the dollar is steadily sinking with respect to other currencies, giving rise to plans to replace it as a reserve currency.

4. The price of gold in dollars is as high as it ever has been historically, and is headed still higher.

The conclusions follow as does night the day. Fewer and fewer people are gainfully employed, and those who do have jobs are working for less and less in terms of real value. Those who have the ability to do so already demand ever more and more in terms of compensation, and pretty soon those who manufacture goods will be forced to start doing so as well. A massive inflation is inevitable, and cannot be stopped. The only question is when enough people will recognize that it has begun, and whether the result will be runaway inflation, as occured in Germany in 1923.

Remember: runaway inflation is possible only with fiat currency. Having a currency backed by gold acts as a natural brake on the printing of paper money -- print too much, and people will choose to hold gold, making the currency worthless. (It is the same phenomenon we are observing now in the gold futures market -- there are signs of a time coming when no amount of paper dollars will convince a person to part with any gold. As the article just linked puts it succinctly: "Gold is not available at any price quoted in Zimbabwe dollars.") Some people -- especially economists since Keynes -- think that the brake works too well, and keeps the economy from growing, as well as producing panics when there is not enough money to go around. But would you rather be riding in a car with some brakes than one with no brakes at all?

Why, then, would President Obama, Timothy Geithner and Ben Bernanke allow us to continue down the present path, when the place where it is taking us is so readily foreseeable? One has to ask that question, but that does not mean one can discover the actual answer. None of the possible answers, however, is comforting. (I reject, for the reasons already given, the possibility that the three of them are acting out of ignorance; it may be out of overconfidence that they can keep the lid on the situation, perhaps, but not ignorance. As I say, however, neither of those possibilities offers any comfort.)

One more possible answer is those SDRs from the IMF. As Mr. Stiglitz acknowledges toward the end of his essay, the United States is currently allocated the largest share of new issues under its rules. So perhaps the government expects still to run the show, with or without the dollar.

But SDRs are useless for purchasing groceries. Here at home we will be stuck with our paper dollars, until the world's bankers manage to propose a uniform currency which all major countries will agree to accept. Even Mr. Stiglitz does not see a world currency any time soon -- although the collapse of the U.S. economy, followed by chaos around the world as it tries to dump dollars, might hasten the time when it becomes a reality.

And note that a switch to a different world reserve currency, such as SDRs, would still keep the world on a paper money standard, where the money supply would still depend on the integrity of central bankers. (Is that an oxymoron? No, their integrity may in fact exist, but whether it does is irrelevant in the final analysis, because central bankers, as we see in the case of Mr. Bernanke, are ultimately no match against the tide of political forces that make prudent monetary policy impossible. And if you think those forces are unmanageable now, just wait until the whole world's economy is tied to one fiat currency.)

As I pointed out earlier, fiat money gave us Weimar Germany in 1923, and also Zimbabwe in 2007; there are a lot more examples in this Wikipedia article. No historical precedent for runaway inflation should ever again make one willing to go through the upheavals it brings. Unless--

Unless you were elected president with a hidden radical agenda (based on principles taught by your idol, a man with the name of Saul Alinsky), which you knew in advance would not be popular, and which might result in your serving only a single term. If, however, a general crash were to occur well before the next election, you might just conceive that with everyone on the bread lines, looking to the government for assistance, and with the economy in shambles (as it was in 1936), voters will not dare to think of switching horses midstream -- just as they did not do with Franklin Roosevelt. (As an added plus, you could always blame the crash on the failed policies of your predecessor.)

Then, just wait -- just wait until they see what's in store for them in your second term. But by then it will be too late.


  1. My dear, dear Anglican Curmudgeon,

    I could not agree with you more. Each paragraph was an exquisite delight to read and to vigorously nod in agreement with.

    Are you of an age where you remember the old Midas Muffler commercials? "You can pay me now or you can pay me later?" And the lesson was paying later was a lot more costly than paying now. It's not just the fact that we're self-inflicting this pain upon ourselves, but that we're doing it to our children, our grandchildren, and beyond. I'm just ill.

    Parallel tracks. TEc and the Anglican Communion going downhill. Theological Liberalism.

    United States and the EU going downhill. Political Liberalism.

    Liberalism is a bad drug taken by choice. Just say no.

  2. That was an outstanding post. Thanks and God bless.

  3. Had my ne'er-do-well cousin, Lord Peter Wimsy, not squandered the family fortune on his wine and book collecting as well as his amateur crime detecting, I'd have translated the paper money into Krugerrands, Maple Leafs, and Gold Eagles ages ago.

    P.S., Love the flag, LSP.

  4. Outstanding post. Bumped this on my blog.

    In ICXC

  5. You're right, I think, except in one thing which is worse than you think.

    I don't think Congress is in charge; I don't think the President is in charge, either. For some time now, under more than one administration, I've concluded they both obey whoever IS in charge, telling them what to do. And who might that be? A few corporate elite, plus a even fewer very wealthy families.

    Most, with names like Saul Alinsky.

  6. Thanks Death - gotta love the South. Too bad about your feckless cousin; same story here - persistent failure to invest family fortune in gold. Now I'm looking forward to hauling miserable stipend back to the parsonage in the back of the pick-up. Wretched prospect.

  7. Dear Mr. Haley,

    I am sad to say that I had come to very nearly the same conclusion as have you. I only fear that you may be being a trifle optimistic (as opposed to Bernanke, et al., who, if your surmise is correct, are being breathtakingly overoptimistic).

    Pax et bonum,
    Keith Töpfer

  8. The "common thread" is: how will the world establish a stable monetary system?
    The world AND the U.S. will be better off when the U.S. Dollar is replaced by, and incorporated into, a Single Global Currency, managed by a Global Central Bank within a Global Monetary Union. In Europe, 16 countries are using one currency. Why not the 192 U.N. members?
    We don't need to wait for the further decline, and perhaps rapid decline, of the dollar to start planning for the Single Global Currency.
    The primary problem with the euro and currencies of other monetary unions is that they still must co-exist within the international multicurrency system itself where the value of those common currencies must still fluctuate in value against each other. With a Single Global Currency, there are no such fluctuations, by definition.
    In addition to eliminating currency fluctuations, the use of a Single Global Currency would eliminate the current foreign exchange trading expense of $400 billion annually, eliminate currency risk, eliminate current account imbalances, and eliminate the need for foreign exchange reserves.
    With a Global Central Bank with a primary goal of monetary stability, inflation would likely be lower.
    The world should begin researching and planning now for a Single Global Currency, which will save the world - literally: trillions. It is not a cure for the current recession, but will help lay the groundwork for a more stable future.
    The Single Global Currency Assn. promotes the implementation of a Single Global Currency by the year 2024, the 80th anniversary of the 1944 Bretton Woods conference. We will reach that point through the creation, expansion and merger of currencies of nations and monetary unions.
    That's only 15 years away. The Assn's website is See, also, the book, "The Single Global Currency - Common Cents for the World," and the ICFAI University Press book, "A Single Global Currency - Perspectives and Challenges."
    Morrison Bonpasse
    Single Global Currency Assn.
    Newcastle, Maine, USA
    email: morrison(at)

  9. Thanks to TU&D (I do remember those commercials -- it was back when ads tried to appeal to your better judgment, instead of to your desires),DB, John, Anastasia LSP and Martial Artist for the confirmation that I was not off on a wild tangent.

    Mr. Bonpasse, it is very good to hear from you, and to know that there are people earnestly working out there for a new Bretton Woods arrangement. However, unless you can devise a system that will have a built-in brake on the creation of fiat money, the fact that it will be a single global currency will not save it from the destruction which creeping inflation inevitably causes.

  10. What a tremendous bit of fact gathering and clear thinking... ruined by a flashy bit of conspiracy theory.

    Complex systems need no conspiracies to form emergent behaviors. This doesn't change any of the brilliance of the rest of the article, it just makes it impossible for me to share with others who will dismiss it because of the last few paragraphs.

    Please, from one conservative to another, please keep to the facts because the facts are sufficiently damning without any embellishment.

    You may be right about the conspiracies, but it's unprovable, unlike all the other facts which are very much provable.

    People don't have to be evil to be wrong.

    Sorry, if this annoys anyone. I really did appreciate the fantastic article and the hard work that went into it.

  11. Thank your for noting the facts, nothinghypothetical -- you live up to your moniker.

    I did not mean to imply that there is any kind of conspiracy going on here -- I said at the outset that the facts demonstrated that "no one was in charge." And as you point out, given all the complexity of our current system, a conspiracy would take far more effort to direct than would ever be at anyone's ability to marshal. No, it is not a conspiracy, but a simple example of birds of a feather flocking together. If you were trained as a young activist to think that enormous opportunity comes out of crisis, you will not shrink back from policies that exacerbate crisis, because you have the (over)confidence that you will be able to make use of the opportunity thereby engendered to achieve marvelous things that otherwise never would have been within your grasp. That is not so much a purposeful and knowing conspiracy to bring the crisis about (because, as you say, the things that will emerge out of complexity are by no means within the control of any faction or group at the top), as it is a case of people acting true to their beliefs. In this case, it just happens to be that there are at this moment more people at the helm who hold to a belief that a crisis will be more helpful to them than it will be harmful to the rest of the country.

  12. You make a good point. However, you splice it very thin saying that they "wouldn't shy away" from policies because of "over-confidence".

    I accept that's a very real possibility, but not a penny more (which is one penny I hear much more often).

    Thank you for the clarification.

    I have struggled a great deal in the present crisis between those who I completely agree with and something I see building that will be more harmful than all the possible conspiracies of the opposition.

    Nothing makes my stomach churn more than defending those who are very likely guilty, simply because they may not be guilty from those who are probably correct that they are guilty, but have turned that strong possibility into a rhetorical certainty at the cost of their integrity.

    How's that for a tongue twister?

    I guess I'm one of those conservatives who's more concerned with the conservative soul (the souls of conservatives?) than the political crisis.

    Thanks again for the article and your response to my comment.

  13. The US elite are engaged in the last act of failed states: the looting of the treasury.

  14. nothinghypothetical,

    You are correct that no conspiracy is required to explain the phenomenon. But there is a (not necessarily the only) root cause of this problem and also of many of the ills that have come to afflict our legal (i.e., legislative and justice) systems in the U.S. and the West during the past century or so. It is, at least in significant part, the result of the widespread acceptance by the political elites of the progressive fallacy. And they have managed, through endless repetition, to convince enough of the electorates of the truth of that fallacy to ensure their continuance in the corridors of political power.

    The fallacy is that "if we just get enough experts into the room and feed them all of the data, they can arrive at the one best solution." This fallacy is a direct descendant of the constuctivist rationalism of the Cartesians.

    It is fallacious for two reasons. First, in human society we do not share universal problems nor universal priorities, so it is often the case that there is NO "one best solution," but rather that a variety (sometimes a substantial number) of solutions that will be required. Second, in a society as large as humanity's numerous cultures, by the time the data is gathered, collated, reported and analyzed, it is, by definition stale, that is it is past its 'sell by' date.

    This is very ably discussed in an article by Russell Roberts. And is the subject of an entire essay by Hayek entitled "The Result of Human Action but not Human Design" published in an anthology by the University of Chicago (Studies in Philosophy, Politics and Economics). Of course, understanding of this was not original to Hayek, having also been discussed by the Scottish philosophers Adam Ferguson and Adam Smith.

    Of course, there is an even simpler (not to mention very much earlier) understanding which we can recognize as a core element of Original Sin, wanting to be like (or be our own) God.

    Pax et bonum,
    Keith Töpfer

  15. Keith,

    Absolutely correct. And if I came off as overly critical it is only because I expect "my side" to have the highest possible standard of rhetoric. Forgive me if I communicated anything else.

  16. An extraordinary still methodically printing out and reading the links.

    Have sent it to the founder of The Haverford Trust Company in Philadelphia and will meet with him to discuss it. I suspect he will be passing it on to others

    ...Truly information that everyone needs to know.
    Thank you so very much