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Busted Europe, Busted Dream.

Busted Europe, Busted Dream

by Gary North

Recently by Gary North: Gold Confiscation: A Highly Unlikely Threat

 
  

The European Monetary Union is going to break down. This will be followed by a break-up of the European Union.

This is denied by the New World Order's promoters of international unification. They have been planning for this since the end of World War I. They have been actively implementing this by stealth since the early 1950s. They used treaties to bring this political unification to pass. They used economic unification as the bait. The hook of political unification was always buried in the bait.

The threat facing the NWO is that the economic bait has turned out to be poison. The EMU is based on a common central bank and a common fiat currency. But without a common system of government, there can be no fiscal union. There can be no central planning by Keynesian means.

The nationalism implied by Keynesian fiscal manipulation has led to the Greek crisis. The EMU rested on an unlikely premise: the wisdom of Europe's commercial bankers, who had spent their careers in highly regulated domestic markets. Always before, bankers in large banks could count on their national central banks to bail them out. But, in this new world banking order, the European Central Bank does not have the flexibility to bail out all of the large national banks that are now in big trouble. There are members of the ECB's board who are part of the German-Dutch axis, which favors tighter money and stable prices. The Board must placate them to some degree. This reduces the ECB's response time.

The Party Line of the EU and the ECB is that there is no unity-threatening problem or series of problems facing the central government. They insist that the current problems are temporary.

We have heard all this before.

THE BREAKDOWN OF COMMUNISM

The greatest event of my life was the suicide of the Soviet Union on December 31, 1991. The Communist empire went under without a shot being fired. The Communist Party's senior officers looted the Party's funds and sent the money to Swiss bank accounts. Then they privatized the state's main economic assets so that they and their cronies became incredibly rich.

The second greatest event was the decision of Deng Xiaoping in 1978 to free up Chinese agriculture. That led to the most rapid economic growth in human history. Nothing like it had ever happened to so many people. South Korea's per capita economic growth, 1950 to 1990, was greater, but South Korea was a much smaller nation.

Communism was the most powerful ideology of tyranny in man's history. It failed operationally in the USSR in less than 75 years. It failed in Communist China in less 30 years.

The cash nexus seduced the vanguard of the proletariat. The inevitable socialist victory was exposed as a gigantic fraud. The messianic religion of Marxism went down with the two Communist ships.

Today, the rag-tag army of tenured Marxist professors in Western universities have as their only surviving models Cuba and North Korea. The satellite photo of the two Koreas – bright lights in the south, one light in the north – is the most powerful epitaph of Communism there is.

Now another victory of liberty over centralized politics is unfolding. It is taking place in Western Europe. It is not going to be reversed. The New World Order's number-one poster child – the European Union – has begun to fall apart. Nothing will reverse this.

There are those in the West who will deny this. There are also those who from 1992 until today insist that the collapse of the USSR was in fact a gigantic deception. The Communists are still in control, they tell us. These people cannot bring themselves to admit that Communism lost the battle. Like the original Communists, they believe in the absolute sovereignty of political power. They believe that the West could not possibly have won, because the Communists were better at intrigue and military power. But the West did win, because the Communist leaders gave up the dream of a socialist world and decided to go for the money.

Let me tell you how I knew that the Communists had failed completely. First, the new Russian government changed major cities' names back to their pre-Bolshevik names. Leningrad became St. Petersburg. Stalin re-named Volgagrad to Stalingrad in 1925. Khrushchev changed it back in 1961 as part of his de-Stalinization program. Both changes revealed the nature of politics in Russia. The names of cities were testimonies to the ruling power. That was why the name changes after 1991 were significant.

Second, mobs of people pulled down statues of Soviet leaders. One of the statues that disappeared was that of Pavlik Morozov, the 13-year-old boy who informed on his father. He had been made a hero by Stalin after he was murdered at age 15. He had the boy's relatives executed for the crime, although they all denied that they had done it. The Morozov story was taught to Soviet children until the very end of the regime. His statue has disappeared from the public park built in his memory.

The fall of the Soviet Union was no deception. It was real. That was two decades ago.

There is another fall coming.

BREAKDOWN TO BREAK-UP

I will state it again. The breakdown of the European Monetary Union will be followed by the break-up of the European Union.

The EMS is breaking down. A few columnists in the West are now admitting this. On the whole, however, the Party Line of the media follows the Party Line of the EU bureaucrats: "The crisis in Greece is a temporary aberration. It will be solved by EU, IMF, and ECB policies."

The problem with the Party Line is that Greece keeps flaring up. Short-term interest rates are over 100%, indicating a loss of faith by investors in the Greek government's ability to make interest payments in euros. If the EU, the IMF, and the ECB had a plan to deal with the underlying problem in Greece – its looming inability to make interest payments in euros – they would have implemented it. They keep announcing temporary bridge loans. These "bridge loans" are in fact sinkhole loans. Everyone presumably knows this, yet they do not invest accordingly. The various stock markets' wild gyrations in Europe indicate that hope and fear are balanced, unlike any government's budget.

Hope will degrade into fear as reality sets in. What is reality? That large European banks bought Greek government bonds, because they assumed that no member of the EMU would pull out as a way to default on euro-based debt. But it is clear that this is exactly what Greece will do. The default is statistically inevitable. The sinkhole is a bottomless pit.

The euro was the poster child of European unification, just as European unification was the NWO's poster child for worldwide unification, the dream of the Trilateral Commission. The euro was rammed down the throats of Europe's national central bankers in 1999. They had enjoyed considerable autonomy. National politicians also resented the fact that they would no longer have great influence in domestic monetary affairs. They would henceforth have to persuade the bankers at the European Central Bank to follow policies that would sustain national welfare state policies.

That world is gone, but there are domestic politicians in PIIGS nations who would very much like to restore it. They are being pushed hard by voters to break free of the "austerity" programs being rammed down their throats by the IMF and ECB.

The Bible teaches, "The rich ruleth over the poor, and the borrower is the servant to the lender" (Proverbs 13:22). This ticks off the borrowers. The Bible also teaches, "The wicked borroweth and payeth not again" (Psalms 37:21a). This really ticks off the borrowers. "That's an insult to our integrity!" Then, when their governments announce limited cutbacks in domestic spending, the threatened employees take to the streets. "You owe us what you have promised!"

In short, voters want to impose austerity on the creditors. They do not want creditors to impose austerity on their welfare state governments.

Some interest groups are going to get stiffed. The Party Line at the EU, ECB, IMF is that employees of high-deficit countries are going to get stiffed. The Party Line in the Greek trade unions is that the ECB, IMF, EU bureaucrats are going to get stiffed. Politicians in PIIGS nations claim that no one is going to get stiffed if the ECB, IMF, and EU will just lend more money to tide them over. The commercial bankers want the EU and ECB to serve as lenders of last resort to banks, so that, when the PIIGS default, the bankers will not lose their bonuses. Voters in Germany don't want to get stuck with the tab for bailing out PIIGS or banks. Investors in European stocks keep sounding like Rodney King. "Can't everyone just get along?"

The New World Order's promoters are wringing their hands and pleading, "We worked so hard to sneak through this deal. We are not quite finished with our plans. Now voters are trying to kill it. It's just not fair!" I think of a classic video scene that best describes the present predicament of the NWO.

THE BEST-LAID PLANS

The Wall Street Journal published a report on the breakdown of the EMS. I liked the way it started out:

When the history of the rise and fall of postwar Western Europe is someday written, it will come in three volumes. Title them "Hard Facts," "Convenient Fictions" and – the volume still being written – "Fraud."

The author says that the first hard fact was military necessity in the post-War period. The Cold War began.

The next hard fact was hard money. He correctly identifies this as "the gift of Ludwig Erhard, author of the economic reforms that created the Deutsche mark, abolished price controls, and put inflation in check for generations." Erhard was a disciple of Wilhelm Roepke, who was a disciple of Ludwig von Mises. In mid-June, 1948, Erhard unilaterally abolished the entire Allied military system of price controls, fiat money, and rationing. The next day – literally – the "German economic miracle" began.

The author continues: "The third hard fact was the creation of Jean Monnet's common market that gave Europe a shared economic – not political – identity." The author has fallen for the ultimate fraud. Monnet had been working for political unification ever since he and Raymond Fosdick, John D. Rockefeller, Jr.'s agent, sat together at the Versailles Peace Conference in 1919. In 1919, Fosdick sent a letter to his wife. He told her that he and Monnet were working daily to lay the foundations of "the framework of international government." [July 31, 1919; in Fosdick, ed., Letters on the League of Nations (Princeton, New Jersey: Princeton University Press, 1966), p. 18.] Fosdick returned to New York City in 1920, where he took over running the Rockefeller Foundation for the next 30 years.

Monnet was the front man for the New World Order. He promoted political unification by wrapping it in the swaddling clothes of economic unification.

The author accurately describes the suicide of Western Europe.

In 1965, government spending as a percentage of GDP averaged 28% in Western Europe. Today it hovers just under 50%. In 1965, the fertility rate in Germany was a healthy 2.5 children per mother. Today it is a catastrophic 1.35. During the postwar years, annual GDP growth in Europe averaged 5.5%. After 1973, it rarely exceeded 2.3%. In 1973, Europeans worked 102 hours for every 100 worked by an American. By 2004 they worked just 82 hours for every 100 American ones.

He argues that "It was during this general slowdown that Europe entered the convenient fiction phase." One fiction was that adding new members to the EU would enable the European economy to rival the output of the United States. Another fiction was that there was a central core of outlook and values that would unify the new collective. Here, he is woefully naive. That had been the assumption of the United Nations Organization from the beginning, and the League of Nations before it. That was the heart of Monnet's vision. It did not start in 1973.

And there was, finally, the whopping fiction that Europe had its own "model," distinct and superior to the American one, that immunized it from broader international currents: globalization, Islamism, demography. Europeans love their holidays and thought they were entitled to a long holiday from history as well.

He's got that right!

Then he lists the frauds. First, Greece was allowed into the European Monetary Union. But that was not a fraud. The critics in the 1990s said that all of the Club Med nations would run deficits. They warned that the euro could not hold.

There was no fraud involved in letting in the PIIGS. This was basic to Monnet's vision from 1919. It had to work. It must work. It is ordained to work. This is the NWO's religion.

The non-PIIGS bankers thought it would work. They loaded up on PIIGS sovereign debt.

This was not fraud. This was the implementation of a deeply political religion. This was self-deception on a continental scale.

Yet he is right on this point.

There was the fraud of the so-called Maastricht criteria – the fiscal rules that were supposed to govern the euro only to be quickly flouted by France and Germany and then junked altogether in the current crisis. There was the fraud of the European Constitution, overwhelmingly rejected wherever a vote on it was permitted, only to be revised and imposed by parliamentary fiat.

What is now happening in Europe isn't so much a crisis as it is an exposure: a Madoff-type event rather than a Lehman one. The shock is that it's a shock. Greece was never going to be bailed out and will, sooner or later, default. The banks holding Greek debt will, sooner or later, be recapitalized. The recapitalization will be borne by German taxpayers, and it will bring them – sooner rather than later – to the outer limit of their forbearance. The Chinese will not ride to the rescue: They know not to throw good money after bad.

And then Italy will go Greek. Europe's crisis will lap on U.S. shores, and America's economic woes will lap on Europe's – a two-way tsunami.

He sees that this fraud is not going to hold together. There is a reason for this.

The "fiscal union" that's being mooted will never come to pass: German voters won't stand for it, and neither will any other country that wants to retain fiscal independence – which is to say, the core attribute of democratic sovereignty.

He makes a forecast: "What comes next is the explosion of the European project." Then he makes an assessment: "Given what European leaders have made of that project over the past 30-odd years, it's not an altogether bad thing." I'll say not. It is a great thing. It is, in fact, the greatest thing that is likely to happen in the first two decades of the 21st century. It is the extension of the two break-ups of the 20th century.

But it will come at a massive cost. The riots of Athens will become those of Milan, Madrid and Marseilles. Parties of the fringe will gain greater sway. Border checkpoints will return. Currencies will be resurrected, then devalued. Countries will choose decay over reform. It's a long, likely parade of horribles.

CONCLUSION

The price of the break-up of the ECB, the EMU, and the EU will be high because of the frauds and convenient fictions that preceded them. If Europe's voters had not created welfare states, if they had not consented to a common fiat currency, but instead had abolished all central banking and had allowed competing private currencies, and if they had abolished tariffs and not created a bureaucratic monstrosity of non-governmental agencies with the power of government – the WTO and its peers – there would be low transition costs. But they listened to Monnet. They will now pay the price.

So will all of its trading partners. So will the large American banks that sold credit default insurance to European banks.

September 24, 2011

Gary North [send him mail] is the author of Mises on Money. Visithttp://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North

The Best of Gary North


Link to original article: http://lewrockwell.com/north/north1039.html

TIP OF THE WEEK - Read the "Mystery of Banking" if you plan to invest

Read Rothbard's The Mystery of Banking
Jason Brizic
July 29th, 2011
 
You must read Murray Rothbard's The Mystery of Banking if you are going to invest your hard earned capital in markets tossed around by the Federal Reserve.  Gary North explains below.  You will never read a Wall Street Journal the same again after reading this book.  The is part of taking the "red pill" of Austrian economics.  Ignore it at your own financial peril.
 
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My 1995 Foreword to Rothbard's The Mystery of Banking
Gary Noirth

July 29, 2011

In 1995, I turned over the publishing rights to Murray Rothbard's 1983 book, The Mystery of Banking, to the Mises Institute. I thought that the Institute would do a good job in promoting it. I was correct.

Now that the Mises Institute publishes it online for free, I know it will be widely read. But the new edition does not have my original Foreword. I thought you might like to read it.

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You have in your hands a unique academic treatise on money and banking, a book which combines erudition, clarity of expression, economic theory, monetary theory, economic history, and an appropriate dose of conspiracy theory. Anyone who attempts to explain the mystery of banking--a deliberately contrived mystery in many ways--apart from all of these aspects has not done justice to the topic. But, then again, this is an area in which justice has always been regarded as a liability. The moral account of central banking has been overdrawn since 1694: "insufficient funds."1

I am happy to see The Mystery of Banking back in print. I had negotiated with Dr. Rothbard in 1988 to re-publish it through my newsletter publishing company, but both of us got bogged down in other matters. I dithered. I am sure that the Mises Institute will do a much better job than I would have in getting the book into the hands of those who will be able to make good use of it.

I want you to know why I had intended to re-publish this book. It is the only money and banking textbook I have read which forthrightly identifies the process of central banking as both immoral and economically destructive. It identifies fractional reserve banking as a form of embezzlement. While Dr. Rothbard made the moral case against fractional reserve banking in his wonderful little book, What Has Government Done to Our Money? (1964), as far as I am aware, The Mystery of Banking was the first time that this moral insight was applied in a textbook on money and banking.

Perhaps it is unfair to the author to call this book a textbook. Textbooks are traditional expositions that have been carefully crafted to produce a near-paralytic boredom--"chloroform in print," as Mark Twain once categorized a particular religious treatise. Textbooks are written to sell to tens of thousands of students in college classes taught by professors of widely varying viewpoints.

Textbook manuscripts are screened by committees of conventional representatives of an academic guild. While a textbook may not be analogous to the traditional definition of a camel--a horse designed by a committee--it almost always resembles a taxidermist's version of a horse: lifeless and stuffed. The academically captive readers of a textbook, like the taxidermist's horse, can be easily identified through their glassy-eyed stare. Above all, a textbook must appear to be morally neutral. So, The Mystery of Banking is not really a textbook. It is a monograph.

Those of us who have ever had to sit through a conventional college class on money and banking have been the victims of what I regard---and Dr. Rothbard regards---as an immoral propaganda effort. Despite the rhetoric of value-free economics that is so common in economics classrooms, the reality is very different. By means of the seemingly innocuous analytical device known in money and banking classes as the T-account, the student is morally disarmed. The purchase of a debt instrument--generally a national government's debt instrument--by the central bank must be balanced in the T-account by a liability to the bank: a unit of money. It all looks so innocuous: a government's liability is offset by a bank's liability. It seems to be a mere technical transaction--one in which no moral issue is involved. But what seems to be the case is not the case, and no economist has been more forthright about this than Murray Rothbard.

The purchase of government debt by a central bank in a fractional reserve banking system is the basis of an unsuspected transfer of wealth that is inescapable in a world of monetary exchange. Through the purchase of debt by a bank, fiat money is injected into the economy. Wealth then moves to those market participants who gain early access to this newly created fiat money. Who loses? Those who gain access to this fiat money later in the process, after the market effects of the increase of money have rippled through the economy. In a period of price inflation, which is itself the product of prior monetary inflation, this wealth transfer severely penalizes those who trust the integrity--the language of morality again--of the government's currency and save it in the form of various monetary accounts. Meanwhile, the process benefits those who distrust the currency unit and who immediately buy goods and services before prices rise even further. Ultimately, as Ludwig von Mises showed, this process of central bank credit expansion ends in one of two ways: (1) the crack-up boom--the destruction of both monetary order and economic productivity in a wave of mass inflation--or (2) a deflationary contraction in which men, businesses, and banks go bankrupt when the expected increase of fiat money does not occur.

What the textbooks do not explain or even admit is this: the expansion of fiat money through the fractional reserve banking system launches the boom-bust business cycle---the process explained so well in chapter 20 of Mises's classic treatise, Human Action (1949). Dr. Rothbard applied Mises's theoretical insight to American economic history in his own classic but neglected monograph, America's Great Depression (1963). In The Mystery of Banking, he explains this process by employing traditional analytical categories and terminology.

There have been a few good books on the historical background of the Federal Reserve System. Elgin Groseclose's book, Fifty Years of Managed Money (1966), comes to mind. There have been a few good books on the moral foundations of specie-based money and the immorality of inflation. Groseclose's Money and Man (1961), an extension of Money: The Human Conflict (1935), comes to mind. But until The Mystery of Banking, there was no introduction to money and banking which explained the process by means of traditional textbook categories, and which also showed how theft by embezzlement is inherent in the fractional reserve banking process. I would not recommend that any student enroll in a money and banking course who has not read this book at least twice. Of course, had I thought that there was even the slightest chance that such students would heed my advice, I never would have relinquished the rights to re-publish this book.

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1. P.G.M. Dickson. The Financial Revolution in England: A Study in the Development of Public Credit, 1688--1756 (New York: St. Martin's, 1967); John Brewer, The Sinews of Power: War, Money and the English State, 1688--1783 (New York: Knopf, 1988).

2. The historian Paul Johnson rediscovered America's Great Depression and relied on it in his account of the origins of the Great Depression. See his widely acclaimed book, Modern Times (New York: Harper & Row, 1983), pp. 233--37. He was the first prominent historian to accept Rothbard's thesis.

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Geithner's Victims of Last Resort by Gary North

Geithner's Victims of Last Resort

by Gary North

Recently by Gary North: The #2 Port in the Academic Storm Is About to Close

 

  

You may have heard that the Federal Reserve System is the lender of last resort. This is a misleading concept. The Federal Reserve loans the U.S. government newly created fiat money. The government issues the FED an IOU. It is backed by the full faith and credit of the United States government. But who stands behind the United States government, wallets in hand? You do. And so do I.

We are the victims of last resort.

On May 13, Timothy Geithner wrote a letter to Colorado's Senator Michael Bennet. In his letter, he presented the case against freezing the debt ceiling. The letter is here.

Geithner began with a statement that is muddled almost beyond belief. "As you know, the debt limit does not authorize new spending commitments." Quite true. The debt limit does not authorize anything. It prohibits the authorization of any further borrowing. Officially speaking, prohibiting borrowing is the idea behind the debt ceiling. That is why Congress keeps raising it. Congress does not want to cut spending. It also does not want to raise taxes in order to pay for the spending.

The sentence says the opposite of Geithner's point. We know this because of what came next. "It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past."

He therefore did not really mean that "the debt limit does not authorize new spending commitments." He meant to write this: "An increase in the debt limit does not authorize new spending commitments." Therefore, he reminded Bennet, to raise the debt limit does not authorize any new spending commitments. Geithner, in his befuddled way, was trying to offer Congress a fig leaf to cover its nakedness. By raising the debt ceiling, Congress will be perceived by the voters as spending recklessly, which is an accurate perception. Geithner was trying to say this: by raising the debt ceiling, Congress does not automatically pass new spending laws.

Millions of voters understand this shell game. If the ceiling gets raised, Congress can then vote for new spending bills. If it doesn't get raised, Congress cannot pass new spending bills without cutting existing spending. The debt ceiling inhibits Congress.

Geithner's sales pitch is simple: Congress must raise the debt ceiling in order to meet its existing commitments. He is giving Congress a way to justify this ceiling hike to constituents. "We're not wild spenders. We're merely making it possible to fulfill previous Congressional commitments made to the public. You don't want us to break our promises, do you?"

He then wrote: "Failure to raise the debt limit would force the United States to default on these obligations, such as payments to our servicemembers, citizens, investors, and businesses." This is correct. This is the famous bottom line.

Do you see what this implies? A rising debt ceiling is built into American politics. Using Geithner's logic, there is no escape from an ever-larger national debt. Every year, the ceiling will have to be raised. Medicare is in the red. Social Security is in the red. Combined, they are about $100 trillion in the hole, according to some estimates.

Who is going to buy this Treasury debt as it rolls over every 50 months (today's average maturity)? For how much longer? This money will have to come from somewhere. It will come from money that might otherwise be invested in the private sector.

Ever since November 2010, the money has come mainly from the Federal Reserve System: $600 billion in newly created money. This will stop after this week. Then what?

The constant absorption of capital by the U.S. government cannot go on forever. It will undermine the growth of the economy by transferring investment capital to the Treasury. When the economy stops growing, the deficit will get worse. At some point, investors will stop lending to the Treasury at anything except very high rates. This will turn a recession into a depression. The government will raise the debt ceiling, but it will not get the funds required to keep spending. This process of ever-rising debt will not go on. As economist Herb Stein observed decades ago, when something cannot go on, it has a tendency to stop.

This means that when the Federal Reserve finally stops buying U.S. debt, there will be a great default. I mean finally. I do not mean temporarily. I do not mean this year. The fear of another recession may keep the safe-haven money flowing into the Treasury this year. But, at some point, investors will demand higher interest rates. Geithner's letter raises this specter of higher interest rates if the debt ceiling is not raised. But this threat will also exist if the debt ceiling is raised and raised again, as it will be.

The Federal Reserve at some point will start buying Treasury debt again to keep rising rates from crippling the economy. This means price inflation will return, as it did in the late 1970s. Then it will move above that era's rate of rising prices. This is why the FED will eventually have to face the music: either hyperinflation or the Great Default. I believe that it will choose the Great Default. If it refuses, then the dollar will collapse.

In either case, the division of labor will contract. In either case, there will be bankruptcies. There will be massive unemployment of people and resources.

We are nowhere near this moment of truth. I know there are lots of people out there who say that hyperinflation is imminent. They are wrong.

DEFAULT NOW

Geithner is facing a default if the debt ceiling is not raised. He said that a default would call into question for the first time the full faith and credit of the United States government. He is correct. I can think of no more liberating event. The monster would go bust.

Investors around the world would lose money, he says. I surely hope so. That might keep them from financing the monster again. Anyway, for a couple of years.

He thinks there will still be buyers, but at higher rates. That would restrict the government's spending, since the government would have to pay investors rather than subsidize new boondoggles.

Default would increase borrowing costs for everyone, he wrote. He did not say why this would be the case. If the government defaults, people will invest elsewhere. It seems to me that this would be good for the private sector. Geithner needs to prove his case.

"Treasury securities are the benchmark interest rate," he wrote. They are? Why should a FED-subsidized interest rate be the benchmark? Why should an out-of-control international debtor set the standard?

THE MOB

"A default would also lead to a steep decline in household wealth, further harming economic growth." Think about this. A thief sticks a gun in your belly. He says, "hand over your money . . . forever." He then shares this money – after handling fees – with his fellow mobsters.

Geithner is saying that if the victims ever decide not to let the thief steal any more of their money, this will reduce household wealth. It will indeed – the household wealth of the thieves. It will increase the household wealth of the victims.

"Higher mortgage rates would depress an already fragile housing market, causing home values to fall." Fact: home values have fallen even as the U.S. Government's debt ceiling has soared. There is a reason for this. As the government has borrowed more money, thereby reducing the money available to the private sector, housing prices have fallen. He did not explain this economic fact. He did not mention it. I can understand why not.

"This significant reduction in household wealth would threaten the economic security of all Americans and, together with increased interest rates, would contribute to a contraction in household spending and investment." He meant the households of politicians, bureaucrats, and everyone who is on the take from the U.S. government.

But what about the victims? What about the taxpayers whose net worth is being used as collateral for Treasury debt? Why would a ceiling on the government's pledge of their future wealth produce a "significant reduction" in their future household wealth? He needed to explain this.

Keynesian economists need to explain this.

Keynesian financial columnists need to explain this.

They never do.

AMERICAN TAXPAYERS: VICTIMS OF LAST RESORT

"Default would also have the perverse effect of increasing our government's debt burden, worsening the fiscal challenges that we must address and damaging our capacity for future growth." So, if Congress votes to cap the government's debt, this will produce even greater debt. We must therefore seek national solvency through additional debt. Solvency through debt! I am reminded of another group of slogans: war is peace, freedom is slavery, and ignorance is strength.

What else would a default do? "It would increase rates on Treasury securities, which would significantly increase the cost of paying interest on the national debt." Yes, it would. But the question arises: If the government defaults on its debt, why would it bother to pay any interest at all? The whole idea of default is to stop paying.

It's just like people who owe more on their homes than the homes are worth. They stop paying. If they are evicted – most are not for months or years – they will rent. They will pay less in rent than they pay on their mortgages. In the meantime, they pay nothing except property taxes. (Governments will foreclose when lenders won't.)

The idea of the debt ceiling is to keep the government from running up its tab, based on the future net worth of taxpayers. The idea behind opposing any increase of government debt is this: "Let's stop any new spending projects." Higher interest rates, if they come as Geithner said they will come, will reduce the ability of the government to start new wealth-distribution boondoggles. The money that would have funded the new projects will have to go to creditors in the form of interest payments.

Why is this bad?

It is bad if you are a member of a group that gets payoffs from the Federal Godfather. It is not bad if you are not.

He said that a default will lead to weaker growth. It will lead to more unemployment. A sagging economy will lead to lower tax revenues and "increased demand on our safety net programs." Whose safety net programs? "Ours."

Why will unemployment rise if the government cannot spend borrowed money? Why won't taxpayers save more money, leading to greater economic output and therefore reduced unemployment? Why is it bad for the economy to allow taxpayers to spend more of their own money the way they want to? These questions apparently did not occur to Geithner, or if they did, he chose not to consider them.

A default will lead, he said, to a reduction in "productive investments in education, innovation, infrastructure, and other areas. . . ." He said "investments." That is a political code word for "government subsidies." A default would mean that the government will have to spend less in those areas of the economy in which (1) politicians buy votes, (2) salaried, Civil Service-protected bureaucrats spend money to innovate, and (3) the teacher unions prosper.

He warned that "Treasury securities are a key holding on the balance sheets of every insurance company, bank, money market fund, and pension fund in the world." This is true. This means that taxpayers' future wealth has been mortgaged to provide securities for these outfits. So, if we take this argument seriously, how will the government ever stop increasing the debt ceiling? It won't. The Federal debt system has addicted the world's financial institutions to the promise that American taxpayers are the victims of last resort.

The U.S. government borrows by promising that American taxpayers will fork over the money. The mob has bought itself fiscal credibility. It has guns and badges, and it can finance itself by assuring investors that these guns and badges will be used.

How can this ever be stopped? Geithner or his successors will be able to use this argument forever.

There are two ways that it can be stopped: (1) hyperinflation by the Federal Reserve, which will buy the Treasury's IOUs when other investors cease; (2) default whenever the Federal Reserve stops buying new Treasury debt. One or the other must happen, because (1) the Congress keeps running $1.5 trillion annual deficits, and (2) the Social Security and Medicare liabilities are unfunded.

In the meantime, Geithner implores Congress to kick the can one more time. He will be back for another increase in a year. He is a cheerleader. "Kick it again! Kick it again! Harder! Harder!"

GEITHNER'S PAULSON IMITATION

He said that a default would raise questions about the solvency of the institutions that hold Treasury debt. This could cause a run on money-market funds. It could be "similar to what occurred in the wake of the collapse of Lehman Brothers." He said that this could "spark a panic that threatens the health of the our entire global economy and the jobs of millions of Americans."

This sounds terrifying, but is it true? We have heard all this before: in September and October of 2008. Geithner's predecessor, Hank Paulson, and Ben Bernanke warned high-level Congressmen that this was about to happen. That was how they got Congress to fund TARP. But they never proved that a collapse was imminent. In a persuasive presentation, former budget director David Stockman has shown that no such collapse was imminent.

"Even a short-term default could cause irrevocable damage to the American economy." Irrevocable! Really? Is the American economy so dependent on Treasury interest payments that everything that Americans do or own is at risk? Why? Because "Treasury securities enjoy their unique role in the global financial system precisely because they are viewed as a risk-free asset." I see. Risk-free assets. But risk is inescapable in life. Geithner said that this does not apply to buyers of IOUs from the U. S. Treasury. Not yet, anyway.

When an IOU issued by an agency that is running a $1.6 trillion annual on-budget deficit is regarded as risk-free by investment fund managers, then my strong suggestion is that you not allow those fund managers to handle your retirement portfolio.

"Investors have absolute confidence that the United States will meet its debt obligations on time, every time, and in full." They do? Really? Then they are incapable of reading a balance sheet.

"That confidence increases demand for Treasury securities, lowering borrowing costs for the Federal government, consumers, and businesses." It does? Really? Let me understand this. The demand for Treasury securities increases, because investors with "absolute confidence" in the Treasury's IOUs hand over their money to the Treasury. Yet this transfer of funds somehow lowers borrowing costs for consumers and businesses. I am a bit confused. If the Treasury gets the capital, how can consumers and businesses also pay less for capital? If money goes to the Treasury, how is it simultaneously made available to consumers and businessmen?

You see my problem. I am not a Keynesian. I have this theory that money transferred to X cannot be simultaneously transferred to Y. If money is spent by X on what he wants to buy, it cannot be spent by Y on what he wants to buy. But this is not the case in the world of Keynes.

"A default would call into question the status of Treasury securities as a cornerstone of the financial system, potentially squandering this unique role and the economic benefits that come with it." I ask: Whose economic benefits? The fellow holding the badge and the gun or the fellow with the wallet?

"If the United States were forced to stop, limit, or delay payment on obligations to which the Nation has already committed," he said, "there would be a massive and abrupt reduction in federal outlays and aggregate demand." Again, I have this problem. I am not a Keynesian. I understand cause and effect as follows. If spending by Y (the government) decreases, this leaves more money in X's (the taxpayer's) wallet. When X spends his money without the middleman of the guy with the badge and the gun, aggregate demand does not change. I realize that this is not true in Geithner's parallel universe, but that's how aggregate demand works in my world.

I guess I need a formula. Without a formula, economists cannot perceive cause and effect. So, here goes: $X + $Y = $X + $Y.

To understand this, we need story problems. We all hate story problems, but they help us understand.

(1) "If X spends $1.6 trillion dollars, and Y spends no dollars, how much is aggregate demand?"

(2) "If Y sticks a gun in X's belly and says 'hand it over,' and then spends $1.6 trillion, how much is aggregate demand?"

(3) "If Y comes to X and says, 'hand it over, but this is a loan,' and X forks it over, when Y spends $1.6 trillion, how much is aggregate demand?"

Geithner does not operate in terms of this formula. So, he said that when the government (Y) stops spending, there will be a decrease in aggregate demand. Somehow, the excess money that is now in X's wallet will disappear. "This abrupt contraction would likely push us into a double dip recession." He did not define "us." He wanted Senator Bennet to believe that if Y spends less money, X will suffer a double dip recession. We're all in the same boat, he implied. Why? Because . . . a drum roll, please . . . we owe it to ourselves!

This is Keynesianism's parallel universe. It is a world of endless increases in the U.S. government's debt ceiling. It is a world of endless increases in the Federal Reserve System's monetary base, filled with IOUs from the U.S. government. It is a world in which guns and badges turn stones into bread.

CONCLUSIONS

Here is Geithner's conclusion: "It is critically important that Congress act as soon as possible to raise the debt limit so that the full faith and credit of the United States is not called into question." He went on to say: "I fully expect that Congress will once again take responsible action. . . ."

He and I define "responsible action" differently. He defines it as "authorize people with badges and guns to borrow more money in terms of their ability to get their hands on enough taypayer money to keep paying interest." It is a system in which the taxpayer is the victim of last resort.

I have a different conclusion. I think that Congress will authorize another increase in the debt ceiling. It will do this multiple times. As this limit is increased, there will be a reduction in the number of investors who have absolute confidence in the full faith and credit of the United States government.

Congress is not going to balance the budget, because there seem to be no negative consequences for not balancing the budget, either political or economic. So, the debt will get larger.

At some point, interest rates will rise. Then we will see the negative consequences that Geithner described in his letter.

Geithner is arguing for a delay. That is what most politicians argue for. Today, most politicians have adopted the faith of Dickens' Mr. Micawber: "Something will turn up." They are right: the debt ceiling, then interest rates, then the monetary base, then M1, then the money multiplier, then prices. So will unemployment. Up, up. up.

The key is the money multiplier. When it finally moves up, price inflation will move up with it. Until then, the Federal Reserve can join with Congress in the game of kick the can. The debt ceiling will rise.

Inside the can are lots of IOUs. They are IOU's signed by Congress on our behalf. We are the targeted victims of last resort.

We won't be. At any rate, future voters won't be. The creditors will be.

There will be a Great Default when voters finally say, "We're not going to pay." On that day, your net worth had better not rest on a pile of IOUs issued by the U.S. government. Otherwise, you will be like Thomas Mitchell, in "Gone With the Wind," sitting at his desk in 1865, mad as a hatter, insisting that he was rich. Why? He had lots of government bonds issued by the Confederacy.

So, the victims of last resort will not be the taxpayers after all. They will be the trusting people who retain absolute confidence in the full faith and credit of the United States government right to the bitter end. Either hyperinflation will ruin them or default will, or maybe both: as the Confederacy experienced.

June 29, 2011

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North

TIP OF THE WEEK - Get out of debt, save, and start your own business

Get out of debt, save, and start your own business serving unfulfilled customer needs.

Jason Brizic

June 24, 2011

One of your goals should be to insulate yourself from the coming economic calamity that will result from the insane actions of money-printing central bankers and deficit spending politicians.  Starting a side business to provide a second stream of income is a very good idea.  Many millions of people have lost their jobs.  This will continue to occur due to misguided Keynesian economic policies.  But where do you get the capital to start your business?

Savings are crucial to capital formation.  You use your savings to purchase producer’s goods that you will use to produce goods for others to consume.  The classic example is the lemonade stand.  You start with some money you saved.  You use your savings to buy lemons, sugar, ice, a large cooler, cups, some signage, and some wood to build you lemonade stand.  You didn’t need a business loan from a local banker (debt) to start your lemonade stand.  You started small with just a little bit of savings and a little entrepreneurial savvy of where some thirty customers might be located.

The key to savings is getting out of debt first.  Creating and sticking to a budget that includes savings will allow you to build capital in order to pursue some entrepreneurial efforts without quitting your current job. 

You can get out of debt in several years before massive price inflation hits your checkbook and impairs your ability to save.  I suggest you save between 10 – 15% of your pretax income.  Use this money to repay debts.  When the debts are gone you will have the budget and discipline to save 10 – 15% because you just did it while paying down your debts.

Gary North provides a free get out of debt course with specific action steps to follow.  This is similar to what Dave Ramsey teaches, but it is free. http://www.garynorth.com/public/department125.cfm

Invest in value priced high dividend stocks, precious metals, and rental real estate when you need to diversify some of your savings you are earning from your successful side business.

For more tips, go here:

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TIP OF THE WEEK - The Yield Curve: The Best Recession Forecasting Tool

The Yield Curve: The Best Recession Forecasting Tool

Jason Brizic

June 17, 2011

There is a lot of talk about the economy going into a double-dip recession.  Keep your eye on the yield curve.  Gary North explains.  Visit his site www.garynorth.com.  There is a lot of good free stuff there.  This came from the free portion.  An inverted yield curve will destroy the profitability of mortgage REITs like Annaly Capital (NLY) and American Capital Agency Corp. (AGNC).

The Yield Curve: The Best Recession Forecasting Tool

Gary North

It was on the basis of this indicator that in the November 2006 issue of my Remnant Review newsletter, I predicted a recession in 2007. It arrived in December 2007, according to the National Bureau of Economic Research.

The yield curve is a "curve" of interest rates for debt certificates.

The interest rates for more distant maturities are normally higher the further out in time. Why? First, because lenders fear a depreciating monetary unit: price inflation. To compensate themselves for this expected (normal) falling purchasing power, they demand a higher return. Second, the risk of default increases the longer the debt has to mature.

In unique circumstances for short periods of time, the yield curve inverts. An inverted yield occurs when the rate for 3-month debt is higher than the rates for longer terms of debt, all the way to 30-year bonds. The most significant rates are the 3-month rate and the 30-year rate.

The reasons why the yield curve rarely inverts are simple: there is always price inflation in the United States. The last time there was a year of deflation was 1955, and it was itself an anomaly. Second, there is no way to escape the risk of default. This risk is growing ever-higher because of the off-budget liabilities of the U.S. government: Social Security, Medicare, and ERISA (defaulting private insurance plans that are insured by the U.S. government).

What does an inverted yield curve indicate? This: the expected end of a period of high monetary inflation by the central bank, which had lowered short-term interest rates because of a greater supply of newly created funds to borrow.

This monetary inflation has misallocated capital: business expansion that was not justified by the actual supply of loanable capital (savings), but which businessmen thought was justified because of the artificially low rate of interest (central bank money). Now the truth becomes apparent in the debt markets. Businesses will have to cut back on their expansion because of rising short-term rates: a liquidity shortage. They will begin to sustain losses. The yield curve therefore inverts in advance.

On the demand side, borrowers now become so desperate for a loan that they are willing to pay more for a 90-day loan than a 30-year, locked in-loan.

On the supply side, lenders become so fearful about the short-term state of the economy -- a recession, which lowers interest rates as the economy sinks -- that they are willing to forego the inflation premium that they normally demand from borrowers. They lock in today's long-term rates by buying bonds, which in turn lowers the rate even further.

An inverted yield curve is therefore produced by fear: business borrowers' fears of not being able to finish their on-line capital construction projects and lenders' fears of a recession, with its falling interest rates and a falling stock market.

An inverted yield curve normally signals a recession, which begins about six months later. The stock market usually begins to fall six months prior to any recession. So, the appearance of an inverted yield curve normally is followed very shortly by a falling stock market. Fact: The inverted yield curve is an anomaly, happens rarely, and is almost always followed by a recession.

There have been exceptions, as this report by the Cleveland Federal Reserve Bank indicates.

Here is a great page, published by Fidelity, that explains the four major slopes of the yield curve and how they form. There is even an animated graph that lets you run through almost 30 years of curves, month by month. You can click the Play button, and the graph scrolls by. Stop it at any point. Click here.

For skeptics who want a detailed explanation of the relationship between the inverted yield curve and recession, they can read a 2004 Ph.D dissertation by Paul F. Cwik, which is available on-line at The Ludwig von Mises Institute's web site.

The yield curve for U.S. Treasury debt certificates is the one that investors use to predict the economy. Investors assume that the Treasury is the safest lender -- the least likely to default -- and therefore the rates on Treasury debt are least affected by risk.

The Treasury publishes the various rates here: Treasury debt rates

For more tips, go here:

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The Next Financial Crisis.

The Next Financial Crisis

by Gary North

Recently by Gary North: The Safe Banking Fantasy

 
  

The mainstream financial media are running stories on the next financial crisis. This is unheard of two years into a so-called economic recovery. So weak is this recovery that the old pre-2008 confidence has not returned.

The first sign that "this time, it's different," was Treasury Secretary Geithner's statement, which received widespread coverage, that there will be another crisis.

On May 18, The Daily Beast ran a story on Geithner's unexpected appearance at the initial screening of an HBO movie, Too Big to Fail, which dramatizes the crisis of late 2008, during which time Geithner was president of the Federal Reserve Bank of New York. In an interview, Geithner said this. "It will come again. There will be another storm. But it's not going to come for a while."

That was surely forthright for a sitting Treasury Secretary. He was not specific, but to say that another crisis will come was unique. He added this: "It's not going to be possible for people to capture risk with perfect foresight and knowledge."

That was amazingly forthright. It points to the reality of the naive faith of regulators that they can devise formulas that will keep the system from being hit by some unexpected mini-crisis that will trigger a wider systemic breakdown. He acknowledged that risk analysis, based on statistics, cannot deal with uncertainty: events outside the law of large numbers that serves as the basis of statistics. Ludwig von Mises discussed this in 1949, and Frank H. Knight wrote a book on this in 1921: Risk, Uncertainty, and Profit. Nassim Taleb has called this a black swan event. Whatever we call it, such an event torpedoes the best-laid plans of government regulators as well as statisticians advising leveraged banks.

"Things were falling apart," Geithner said. "We had no playbook and no tools. . . . Life's about choices. We had no good choices. . . . We allowed this huge financial system to emerge without any meaningful constraints. . . . The size of the shock was larger than what precipitated the Great Depression."

That is the official government line, which Treasury Secretary Hank Paulson used to persuade Congress to fork over $700 billion in TARP loans. It justified the Federal Reserve's swaps at face value of liquid Treasury debt in its portfolio for unmarketable toxic assets held by large banks. It justified the 2009 stimulus package of another $830 billion.

The author of the article correctly noted: "In the end, the taxpayers saved the Wall Street investment banks, with Geithner & Co. injecting enough capital to cushion them from bad bets." That is exactly what happened.

GEITHNER RETREATS

On June 6, Geithner spoke at a meeting of the American Bankers Association in Atlanta. Here, his analysis was completely different from what he had revealed in his appearance at the HBO screening. It turns out that the system was saved by investors, not by the government and the Federal Reserve.

Of the 15 largest financial institutions in the United States before the crisis, only nine remain as independent entities.

Those that survived did so because they were able to raise capital from private investors, significantly diluting existing shareholders. We used stress tests to give the private market the ability – through unprecedented disclosure requirements and clear targets for how much capital these institutions needed – to distinguish between those institutions that needed to strengthen their capital base and those that did not.

He did not mention that the reason why investors came to the rescue was that the winners had been bailed out by the taxpayers and the Federal Reserve.

Regulation has saved us, he insisted, and it will continue to save us.

We now have the authority to subject all major financial institutions operating in the United States to comprehensive, consolidated limitations on risk taking. That represents a dramatic change from before the crisis, when more than half of the financial activity in the nation that was involved in "banking" from the investment banks to large finance companies, AIG, and Fannie Mae and Freddie Mac, operated outside those limits.

And the markets where firms came together – like the over-the-counter derivatives markets – will now be subject to oversight, once regulators finalize and implement new rules authorized by Dodd-Frank. We now have much stronger tools to limit the risk that one firm's failure could cascade through markets to weaken the rest of the system.

Overall, and this is the most important test of crisis response, the U.S. financial system is now in a position to finance a growing economy and is no longer a source of risk to the recovery.

He ended with this inspiring promise. "So we will do what we need to do to make the United States financial system stronger. We will do so carefully. And as we do it, we will bring the world with us."

This was cheerleading for government regulation. This is what we have come to expect. The problem is this: it is a full-scale retreat from his admission at the HBO screening.

GEITHNER'S GOOFS

Simon Johnson took him to task in the New York Times on June 9, in an article titled, "The Banking Emperor Has No Clothes." Johnson was the chief economist of the International Monetary Fund, and is a member F.D.I.C.'s newly established Systemic Resolution Advisory Committee. He said that Geithner is naive about the supposedly high degree of safety for the banking system. He complains that Geithner is way too optimistic.

First, he reminds us that the government bailed out the banks. He reminds us of Geithner's admission of this in his HBO interview. Second, he reminds us that the international banking system is interconnected.

But big banks in almost all other major countries have run into serious trouble, including those in Britain and Switzerland – where policy makers are now open about the potential scope of further disasters. French and German banks made large amounts of reckless loans to peripheral Europe and have strongly resisted higher capital requirements, helping to create the current potential for contagion throughout the euro zone (and explaining why the Europeans are so keen to keep control of the International Monetary Fund).

Geithner claimed in Atlanta that U.S. banks are less concentrated than other nation's' banks. But how will that save our banks from a crisis that is triggered outside the U.S.? "Mr. Geithner's most serious mistake is to believe that we can handle the failure of a global megabank within the Dodd-Frank framework."

Mr. Geithner's thinking on bank size is completely flawed. The lesson should be: big banks have gotten themselves into trouble almost everywhere; banks in the United States are very big and have an incentive to become even bigger; one or more of these banks will reach the brink of failure soon.

Johnson then gets to the famous bottom line. The bottom line is this:

There is no cross-border resolution mechanism or other framework that will handle the failure of a bank like Citigroup, JPMorgan Chase or Goldman Sachs in an orderly manner. The only techniques available are those used by Mr. Geithner and his colleagues in September 2008 – a mad scramble to find buyers for assets, backed by Federal Reserve and other government guarantees for creditors.

That this should appear in the New York Times is indicative of the extent to which the old confidence in the banking system is fading.

FELDSTEIN WEIGHS IN

On June 8, the Wall Street Journal ran a column by Martin Feldstein, who served as Reagan's chairman of the Council of Economic Advisers. He is a Harvard faculty member.

Feldstein is a Keynesian. He has a reputation as a conservative. He is on the board of contributors to theJournal. He is regarded as a conservative because he favors tax cuts. But he also favors Federal spending in times of crisis. Somehow, he also comes out for a lower deficit.

He said that Obama's $830 billion stimulus package did not go far enough. "As for the 'stimulus' package, both its size and structure were inadequate to offset the enormous decline in aggregate demand." The money should have gone to the Defense Department.

Experience shows that the most cost-effective form of temporary fiscal stimulus is direct government spending. The most obvious way to achieve that in 2009 was to repair and replace the military equipment used in Iraq and Afghanistan that would otherwise have to be done in the future. But the Obama stimulus had nothing for the Defense Department. Instead, President Obama allowed the Democratic leadership in Congress to design a hodgepodge package of transfers to state and local governments, increased transfers to individuals, temporary tax cuts for lower-income taxpayers, etc. So we got a bigger deficit without economic growth.

This is pure Keynesianism. It is a call for massive spending in a recession. So, should there be another fiscal crisis, Feldstein's recommendation is a bigger stimulus. The problem for his is this: with the economy slowing, it will be even more vulnerable to an unexpected black swan event.

Second, we are getting an economic slowdown, he says, because Obama will not make the Bush tax cuts permanent. This creates uncertainty in the minds of investors. So, he sounds like a supply-side economist. But he isn't. He is a traditional Keynesian.

Third, there is the deficit.

A third problem stems from the administration's lack of an explicit plan to deal with future budget deficits and with the exploding national debt. This creates uncertainty about future tax increases and interest rates that impedes spending by households and investment by businesses.

Fourth, there is the official strong dollar policy that has led to the decline of the dollar. But he never mentions Federal Reserve policy: QE2.

What are our prospects? He is not optimistic.

The economy will continue to suffer until there is a coherent and favorable economic policy. That means bringing long-term deficits under control without raising marginal tax rates – by cutting government outlays and by limiting the tax expenditures that substitute for direct government spending. It means lower tax rates on businesses and individuals to spur entrepreneurship and investment. And it means reforming Social Security and Medicare to protect the living standards of future retirees while limiting the cost to future taxpayers.

All of these things are doable. But the Obama administration has not done them and shows no inclination to do them in the future.

So, here is a Harvard economist saying that we needed a larger stimulus in 2009, but we need reduced spending now. We also need to reform Social Security and Medicare, while protecting the future retirees and limiting costs. All this is doable.

All this is utter nonsense. The politics of Medicare and Social Security have not changed in 40 years because there is no politically acceptable way to limit their costs. Voters will vote against anyone who suggests such a reform. The voters were promised the Keynesian moon, and they will not tolerate the popping of that pipe dream. In short, none of what Feldstein suggests is doable, short of a monumental crisis that enables Congress to start goring specific electoral oxen. And when that crisis comes, Feldstein will no doubt recommend a large deficit, with the money going to the Defense Department.

This is Establishment Wall Street opinion.

WIGGIN TELLS IT STRAIGHT

Then there was an article in Forbes, a conventional outlet, written by Agora's Addison Wiggin. He begins with this.

There is definitely going to be another financial crisis around the corner," says hedge fund legend Mark Mobius, "because we haven't solved any of the things that caused the previous crisis."

Mobius is a legendary hedge fund manager. If he thinks there is going to be another crisis, we would be wise to listen.

Wiggin thinks the Greek debt crisis is a good candidate for a trigger event.

The Greek crisis is first and foremost about the German and French banks that were foolish enough to lend money to Greece in the first place. What sort of derivative contracts tied to Greek debt are they sitting on? What worldwide mayhem would ensue if Greece didn't pay back 100 centimes on the euro?

That's a rhetorical question, since the balance sheets of European banks are even more opaque than American ones. Whatever the actual answer, it's scary enough that the European Central Bank has refused to entertain any talk about the holders of Greek sovereign debt taking a haircut, even in the form of Greece stretching out its payments.

The ECB is determined to protect the Too Big to Fail banks. It always says that it will not lend more money to the Greek government, but it always does. It calls for more bailouts by the German and French governments. The game must go on!

It will accomplish nothing. Going deeper into hock is never a good way to get out of debt. And at some point, this exercise in kicking the can has to stop. When it does, you get your next financial crisis.

CONCLUSION

We are being warned in advance by the financial media: expect another major crisis. The bailouts were not enough. The expansion of the monetary base was not enough. The new Dodd-Frank regulatory structure is not enough.

The international banking system is an interdependent, interconnected system. The system is not transparent. Even if it were, the level of debt – unsecured IOUs – is enormous. Wiggin comments.

Estimates on the amount of derivatives out there worldwide vary. An oft-heard estimate is $600 trillion. That squares with Mobius' guess of 10 times the world's annual GDP. "Are the derivatives regulated?" asks Mobius. "No. Are you still getting growth in derivatives? Yes."

In other words, something along the lines of securitized mortgages is lurking out there, ready to trigger another crisis as in 2007-08.

There is no formula to deal with this. There is no organized government response that is waiting in the wings. There will be another crisis. And when it comes, the response will be the same: to preserve the solvency of the biggest banks, at taxpayer expense and at central bank expense. When it comes to bailouts and central bank inflation, it's all "doable." It will therefore be done.

June 11, 2011

Gary North [send him mail] is the author of Mises on Money. Visithttp://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North

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Link to the original article: http://lewrockwell.com/north/north990.html

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Your Gold Coins.

Your Gold Coins

Gary North

Reality Check (April 12, 2011)

If you did what Bill Bonner and I have been recommending for a decade, you own gold. Bonner began promoting the purchase of gold in the year 2000. I strongly promoted this for my subscribers after September 11, 2001, when the Federal Reserve began pumping up the monetary base in earnest. Neither of us has ever stopped recommending holding money in gold.

I have stressed holding coins, especially tenth-ounce American gold eagles.

I am writing this for those readers who did what I recommended, have quadrupled their money (on paper and in digits), but who may be getting cold feet.

There are good reasons for buying gold. But you should have an exit strategy in mind. You need to consider this.

http://www.garynorth.com/public/7880.cfm

We are told by the mainstream financial media, which never told investors to buy gold over the last decade, that gold is in the final phase of a bubble market. But how can any market be a bubble market when the mainstream financial media are not running report after report on the bubble, telling readers and viewers about how much money people are making.

What mainstream financial outlet warned investors loud and clear, issue after issue, in 1999 that the dot.com market was a bubble? I told my subscribers in February and March of 2000 that it was, and that they should get out. But I published a newsletter. I was not mainstream.

What major outlet warned people in 2006-2007 that the real estate market was a bubble, that wise investors were getting out? I did in November 2005.

Bubbles always continue for months or even years after old timers say they will pop. Old timers have trouble estimating the fear of the buyers at being left out and the fear of lenders at being left out. The two sides -- debtors and lenders -- keep the dance of doom going much longer than old timers can imagine possible. But eventually the dance ends.

I spoke at Lew Rockwell's conference. One of the speakers is a banker. He lives in Las Vegas. He was taught by Austrian School economist Murray Rothbard. He earned a masters degree in economics. Then he went into banking.

As an Austrian School economist, he understands the business cycle. He understands that the Federal Reserve system has pumped money into the economy, creating a housing bubble since 1996. He knows this boom will bust.

He has no illusions about this housing market. Compared to him, I have been Pollyanna. He spoke of the mental outlook of the builders in Las Vegas. They all know it can't go on, but they are determined to party until it does. "Then they will declare bankruptcy and start over," he said. This is their exit strategy.

He was correct. It happened. He lost his job as a Las Vegas banker. He is now a senior staff member at the Mises Institute.

I went on to write the following:

I think a squeeze is coming that will affect the entire banking system. The madness of bankers has become unprecedented. They have forgotten about loan diversification. They have been caught up in Greenspan's counter-cyclical policy of lowering the federal funds rate. Now this policy is being reversed. Rates are climbing. This will contract the loan market. Banks will wind up sitting on top of bad loans of all kinds because the American economy is now housing-sale driven.

http://www.lewrockwell.com/north/north416.html

But I was on the fringes of the investment community. The bubble was about to burst, but the media attracted viewers and readers by staying on the bandwagon. To call attention to what should have been obvious would have reduced the audience. The editors knew better.

So, when I read articles about gold in a true bubble market, I know it isn't. The salaried reporters with no savings, underwater in their homes, and in a dying industry are merely writing what their editors think will sell.

What sells? Articles that confirm what conventional viewers and readers want to hear, namely, that they were not really losers by staying out of the gold market (they were), and that those who buy good now will lose everything (they won't), and that now is a good time to buy stocks and bonds (it hasn't been ever since March 2000).

Mark Faber, who recommends owning gold as a hedge against a declining dollar, recently wrote this: "In my opinion the Fed funds rate should be at 5% . . . That will provide real interest rates. I don't think the Fed will increase interest rates to a positive real rate. So, I'd say to an investor, he should have at least 20 to 30 percent of his money in precious metals."

When asked about his opinion about renewed fears of a bubble forming in the gold market, the student of the Austrian School of economics theory scoffed at the pundits who say the gold trade has become crowded. Faber said he routinely sees less than 5% of attendees at his speaking engagements raise their hands during his casual sentiment polls regarding the precious metals. Sometimes he sees no hands raised, he said.

http://bit.ly/FaberGold

There are many ways to own gold. The ones that most investors choose, and which most investors will rush into during the final phase of the bubble, is in fact not gold. It is a promise to invest in gold. It could be an ETF, which is a form of derivative. It may be a commodity futures contract -- another promise.

But what about gold, in contrast to a promise -- "cross my leveraged heart and hope to die" -- to invest in gold on your behalf?

Gold coins are gold.

WHY GOLD COINS?

The problem with today's economy is that it is built on promises and trust. It is therefore built on debt.

In the United States, the financial promises always come back to these:

1. The Federal Reserve System will remain the lender of last resort. 2. The Federal Deposit Insurance Corporation (FDIC) will pay off all bank accounts up to $250,000. 3. The U.S government stands behind the FDIC's promise with a $600 billion line of credit. 4. The government can get this money from the Federal Reserve System, if necessary.

The problem with these promises is this: the ultimate insurer -- the FED -- can fulfill its obligations in a deflationary crisis only by hyperinflation. That means that the only sure guarantee against the systemic failure of the American banking system is the destruction of the dollar.

If we get the latter, do you want promises to pay gold, which can be settled legally by the payment of digital dollars? Or do you want coins where you can get your hands on them?

On the other hand, if the FED ever refuses to create money, and if the banking system then begins to implode, do you want promises to pay that were issued by a limited liability corporation, such as a futures exchange?

In between hyperinflation and a deflationary banking collapse, people can buy and sell promises to pay gold. They can pay 28% on all profits (no capital gains protection). They can become self-conscious speculators. There is nothing wrong with this.

But what if you are speculating against long-term price deflation? Then you want paper money. But paper money leaves you at the mercy of the Federal Reserve System and the commercial banking system. Mass inflation could appear rapidly (up to 20% price increases), followed by hyperinflation (anything from 20% to infinity).

What if you want an asset that will do well in mass inflation or hyperinflation, but which will not do as badly as most other leveraged capital assets in a banking collapse?

I keep getting this answer: gold coins.

BUT WHICH GOLD COINS?

That depends on what you are trying to hedge against.

If you are a national living in a country whose mint produces gold coins, buy those gold coins. If you are ever in an emergency situation where you need gold fast, and you want to barter it for something you really need, the person on the other side of the transaction will recognize the mint's stamp. He will be more likely to barter.

Do you want a one-ounce coin? Not if you are bartering for small items. You want the smallest-weight coin that your national mint produces. On the other hand, if you want gold as an investment, for which you plan to exchange your coins for digits in a bank, you should buy the most common one-ounce coin with the lowest premium: the Krugerrand. This low premium is consistent. You buy low; you sell low.

If you want something in between, buy a one-ounce coin from your national mint.

The tenth-ounce American eagle commands a premium above the one-ounce eagle these days. This could go away in a selling panic. Be aware of this investment threat.

Americans do not have a true free market with coins produced by the U.S. Mint. Ron Paul held hearings on this issue recently. The Mint keeps getting back-logged with orders during panic-driven periods. It sells only to coin dealers. This creates a premium for coins when these logjams occur. You can read about the problems here:

http://bit.ly/TooFewCoins

PROCRASTINATORS PAY PREMIUMS

Most people listen to a story for years before taking action. This has surely been true of the story of gold. When Gordon Brown, as Chancellor of the Exchequer, sold off half of Britain's gold, 1999-2002, he depressed the world price. He sold it at an average price of $276 per ounce.

http://bit.ly/BrownGold

This was a massive transfer of wealth from the British government to other central banks, which bought most of the gold. This kept down the market price, as central banks shifted demand from the private markets to the Bank of England's bars of gold.

This was the last chance for gold speculators to get in on the deal cheap. Not many people did, of course, because not many people ever buy close to the bottom of any market.

So, gold has steadily moved higher over the last decade. Still, the procrastinators procrastinate.

I don't mean Joe Lunchbucket and Tom Temp. The vast majority of Americans have no liquid savings above a few thousand dollars in the bank. Fewer than 50% have pensions of any size, and the money in these tax-deferred accounts are not at their disposal. The funds they can invest in are not related to gold. They are categories that will keep the fund managers from a lawsuit when markets collapse: American stocks, American bonds, and Treasury debt.

Gold is an investment asset. It therefore will not become popular short of an economic collapse -- hyperinflation followed by a depression. The average person owns no gold coins, nor will he anytime soon.

Where would he buy them? How could 100 million households buy a single gold coin per household? This would be impossible. There are only a few small coin stores in any community. They are mostly mom-and-pop outfits. The U.S. Mint could not meet the demand.

When Wal-Mart has a gold coin section in the jewelry department, then we can start talking about a possible bubble in gold. Not until then.

As more people on the fringe of the Tea Party find out about American gold eagles, they will start buying. This will force up the coins' premiums.

As word gets out about the scarcity of small-weight gold coins, there will be more interest in owning them.

As word gets out that the Federal Reserve's exit plan is a myth, they will start looking for hedges. Gold is a hedge against serious price inflation.

The government is working hard for existing gold coin owners. The government clearly cannot bring the budget deficit under control. Congress has no intention of doing so. When the government can borrow $1.6 trillion a year at rates as low as four-one-hundredths of a percent (90-day) to under 3% (7 years), why should we expect Congress to cut spending?

CONCLUSION

If you have yet to buy a single gold coin, buy a tenth-ounce American eagle to get started. That will not bankrupt you. It will get you over the hump.

Most Americans will never take this initial step. Those who procrastinate will pay a high premium when they at last think: "Maybe I really do need some gold." If you don't know where to start looking, start here:

http://bit.ly/GoldEagles

How To End the Federal Reserve System

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How To End the Federal Reserve System

by Gary North

Things are not always as complicated as they seem. With respect to the Federal Reserve System, it is a deliberate mystery. It was deliberately designed in 1910 to deceive the public, who were opposed the idea of a central bank. The conspirators who met on Jekyll Island in November 1910 knew this. They did good work from their point of view. They concealed the beast.

The general public today knows little about the FED. Prior to Ron Paul's Presidential run in 2007-8, far fewer people understood it.

I have been asked: "How could we get rid of the Federal Reserve? What will replace it?" The answer: either the free market or Congress.

People who think of themselves as free market people often are not. The tax-funded public schools and the state-regulated and accredited university faculties have taught that the modern system of intrusive civil government is necessary for an orderly society. People cannot imagine a market-based society.

There is an old saying, "You can't beat something with nothing." But the free market social order is not nothing. It is expanding around the world, which is why the world is getting richer.

At the Federal level, a free market social order in banking existed prior to 1914. That was back when the dollar was worth over 20 times what it is worth today. On this point, see the inflation calculator of the Bureau of Labor Statistics.

We can go back to that system. We will go back to it. The question is: When? The other question is: At what price?

ENDING THE FED BY LAW

Ron Paul could introduce a bill to end the Federal Reserve System. He could call it: "The Monetary Liberty Act." It would get known as the "End the Fed Act." Here is what the text might say.

The Federal Reserve Act of 1913 is hereby repealed. So are all subsequent acts based on the Federal Reserve Act of 1913.

All authority of the Federal Reserve System to act in the name of the United States government is hereby revoked.

The assets of the Board of Governors of the Federal Reserve System, which are already the property of the United States Government, are hereby transferred to the Department of the Treasury. This includes all of the assets listed on the balance sheet of the Federal Reserve System.

The twelve (12) privately owned Federal Reserve Banks will return all assets held in trust for the United States government within thirty (30) calendar days of the signing of this bill into law.

The gold reserves of the United States government that are held in storage by the Federal Reserve Bank of New York will be transferred to the Government's depository at Ft. Knox, Kentucky, within one calendar year after this bill becomes law. The Government Accountability Office will conduct an inventory of the gold held in storage by the Federal Reserve Bank of New York before and after this transfer.

The Board of Governors will vacate the premises of the Federal Reserve building within thirty (30) calendar days of the signing of this bill into law.

Any pension fund assets of the employees of the various Federal Reserve Banks will remain under the control of those banks. All pension obligations under the authority of the Board of Governors of the Federal Reserve System are hereby transferred to the Department of the Treasury, to be administered under the retirement program of the Department of the Treasury.

This is simple. The Board of Governors of the Federal Reserve System is a government agency. Its authority would be transferred to the U.S. Treasury.

The dozen Federal Reserve Banks are privately owned. All authority of these 12 banks that derives from their connection to the Board of Governors will cease. If they can make a profit, fine. If not, equally fine. The free market will determine which will survive and which will not.

Is this radical? Not at all. There are two historical precedents: the refusal of Congress to renew the charter of the Bank of the United States in 1811, and the refusal of Congress to renew the charter of the Second Bank of the United States in 1836. Both of them went bust.

The standard response is that there must be independence between the Federal Reserve System and the U.S. government. Let us apply this to other agencies:

The Department of Defense
The Department of the Treasury
The Department of State
The Department of Education

I could go on, one by one, to list all of the thousands of agencies that are funded by Federal taxes and which operate by means of the authority of the U.S. government. Only one government agency is defended by publicists, both on and off the payroll of the Federal Reserve System, as deserving to be independent of the government that has transferred authority to it: the Board of Governors of the Federal Reserve System.

The phrase, "the independence of the Federal Reserve System," is a code phrase for "the independence of the four largest U.S. banks from the threat of losses." A growing number of voters has figured this out since the fall of 2008. This is why the Federal Reserve System is facing public criticism for the first time since 1914. This criticism will grow.

All of this may seem Utopian. Ron Paul could not get Congress to audit the FED, which by law possesses this authority. The Congress has been in the hip pocket of the FED for almost a century. The Congress lets the FED run the nation's economy.

But as criticism spreads, there will be more voters who figure out what the FED is and has always been: a government-created cartel of the banks. It operates for the benefit of the largest banks.

Will Ron Paul get such a law passed by Congress and signed into law? No. Does this mean that the FED is forever untouchable? No.

We need the following:

1. A wave of price inflation caused by the FED
2. A subsequent recession caused by the FED
3. A depression caused by the FED
4. A wave of outage in response to the FED
5. An endless series of criticisms of the FED

This will result, ultimately, in the abolition of the FED. Whatever replaces it will decide the economic fate of Americans: Congress (hyperinflation) or the free market (economic stability).

But could the free market replace the FED without a catastrophe following? Yes. We are already seeing this in another sector of the economy.

"YOU'VE GOT ALMOST NO MAIL!"

From the days of America's most famous postmaster, Benjamin Franklin, two decades before the American Revolution, residents of North America have thought that the country could not do without a government-funded postal system. In the past 15 years, this faith has quietly died. The United States Postal Service now delivers mostly subsidized opportunity mail. (I hate the work "junk mail," for I built my business on opportunity mail. But I have not used it for 15 years.) With email, UPS, FedEx, and text messaging, the first class letter is an anachronism. Historians will not be able to trace much after 1998 based on copies of letters.

With no fanfare, the postal system has become optional. The public does not go to the local Post Office often. If it were not for Netflix, a lot of people would not check their mailboxes daily.

All of this has happened without any new legislation. The once unbreakable monopoly of the Post Office is a rusted-out shell, staffed by union-protected workers who probably know their jobs are peripheral. Its volume declined by over 12% in 2010. This is expected to continue. That would cut volume by 50% by 2017. About 40,000 employees were fired in 2010. Saturday delivery will be dropped soon. There is another rate hike scheduled. Yet the outfit will lose $10 billion this year.

All this has happened without any enabling legislation. It has happened quietly. Market competition has reduced the USPS to an anachronism. It is a leftover shell of a bygone era.

In an essay about his youth, sociologist Robert Nisbet remarked that in the year he was born, 1913, the only contact that most Americans had with the Federal government was the Post Office. Later that year, the Federal Reserve Act was passed in a late session, just before Christmas break. Also in that year, the income tax came into effect. The expansion of the Federal government has been relentless ever since.

Nevertheless, the Post Office is slowly dying. No one planned this. The free market has replaced it, despite its official monopoly.

This offers hope. It means that free market solutions can come into existence before a government entity is shut down by law. The Post Office officially is a monopoly, yet its monopoly status has been eroded over the last four decades. It has been almost entirely replaced over the last two decades.

I think of a TV commercial that did not directly attack the Post Office. It was targeted at UPS. But UPS responded much faster than the Post Office could.

While critics of the postal monopoly had for decades tried to get Congress to revoke the Post Office's monopoly, all attempts failed. They were associated with the fringe. Yet, year by year, the Post Office fell behind. It is irrelevant in American life today.

This was not planned by any political group. It was the result of new technologies. People made decisions, day by day, to bypass the Post Office.

AN END RUN AROUND THE FED

I do not expect Congress to revoke the Federal Reserve Act of 1913 in this decade. The powers that be who run this country do so by means of the Federal Reserve System more than by any other semi-private institution. It is at the center of control, because the monetary system is at the center of the economy.

But the central bank faces a problem. To maintain the boom, the FED must inflate. To cease inflating would allow the credit bubble to implode on a scale far more devastating than what happened in 2008. The FED has placed us all on the back of the tiger.

Yet if it does not reverse its policy, it must produce hyperinflation at some point. That will destroy the FED's ability to guide the economy. Hyperinflation will lead to alternative currencies. Digital technology is now international. If buying and selling digital U.S. dollars is no longer profitable, because long-term contracts are not possible under hyperinflation, then the citizens of the United States will do what citizens of Zimbabwe did. They will use other currencies.

If the FED produces a Third World economy through hyperinflation, then people will do what Third World citizens do: find reliable currencies elsewhere. This can be done on-line nearly for free. The Internet has reduced the transaction costs of using rival currencies.

The FED economists know this. They know that transaction costs for using other currencies are low. If the FED's policies undermine long-term contracts, the citizens are not helpless. They can switch.

It will not take legislation to end the FED. All it will take is the FED. If the FED continues to inflate, it will destroy its base: the monetary system based on the FED. But if it ceases to inflate, by ceasing to buy Treasury debt, it will create Great Depression 2.

QE2

Bernanke can get away with QE2 today only because commercial banks are not lending. If they start lending, M1 will rise, the M1 money multiplier will rise, and price inflation will return.

He has bought time with QE2, but he has not bought a way out of the credit bubble that Greenspan created and he created.

He can play hide and go seek with Ron Paul, refusing to show up at the hearings of the Monetary Policy Subcommittee. Congress cooperates. But he cannot play hide and go seek with the business cycle. Greenspan did, but he got out in 2006. He passed on the Old Maid to Bernanke.

The Federal Reserve System bases its power on its ability to control the monetary base. It swapped T-bills for toxic assets to save the big banks, but to replenish its supply of swappable liquid assets, it has to inflate, as it is now doing. QE2 is replenishing the supply of Treasury debt to swap with large banks.

The FED did not bail out any small banks in 2008. It never has. Its unofficial mandate is to bail out the largest commercial banks. This it has done.

I think Bernanke sees another banking crisis coming. This is why he has pushed QE2. Only Hoenig has voted against it. Bernanke has his way with the other members of the Board of Governors and the Federal Open Market Committee. He has not said why this massive increase in the monetary base is mandatory for the economy. To talk about this would create doubts. He does not want to rock the boat. So, he gets away with another $600 billion in monetary base creation.

This is working for now. But the results are unavoidable: either price inflation or continued high unemployment and stagnation, because commercial banks thwart the stimulation. He is on the tiger's back. So are we.

CONCLUSION

The Post Office looked unbeatable for over 250 years. Technology has made it peripheral. The same will happen to the Federal Reserve System. It looks unbeatable. But the Internet can beat it. There are ways out of the FED's trap.

A lot of people will pay a heavy price for Bernanke's policies. That will be the price of persuading those people with the bulk of their assets in digital dollars to sell those assets and replace them with other digits.

This is why I do not think the FED will resort to hyperinflation. The economists know that the FED's victims can escape. The FED will risk mass inflation, but at some point it must say: "We will buy no more Treasury debt." That will be the moment of truth. That will be the day it climbs off the back of the tiger.

So will we all.

March 9, 2011

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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Booms, Busts, and Food Prices

  Booms, Busts, and Food Prices

by Gary North

Recently by Gary North: World's Longest-Using WordPerfect Author Abandons WordPerfect After 30 Years

 

   

Maybe you have heard about rising food prices. It is happening all over the world. We hear of Third World rural populations that are trapped by rising food prices.

Why are food prices rising? Simple: because urban people in formerly Third World nations are getting richer. India and China are the obvious examples. As these economies are freed from the regulations that once burdened them, the growing urban middle class bids up the price of food. People with money in their pockets like to eat more and better food. In the bidding war between rural people with little capital and therefore low incomes vs. urban residents with more capital and higher incomes, rural people lose.

The price of food is rising not just in U.S. dollar terms, but in terms of all currencies. This is not a U.S. phenomenon only. This is international.

When we compare the rise in the price of oil since 1999, the rise in the prices of commodities in general (including gold and silver), and the price of food, food remains a bargain. Two charts are here.

COLLAPSE IN 2008

The recession in 2008 drove down the oil price from $147 to $33 in the final five months. This was a collapse. The price of food fell, too, though not to this extent. Silver and gold fell – silver far more sharply than gold. This indicates the degree to which commodities are tied to the worldwide business cycle. Commodity prices fell because the international economy fell.

Commodities are not the initiating force in price inflation; monetary policy is. The prices of raw materials rose in the first decade of the 21st century because central bank policies around the world were expansionary. When the recession hit in 2008, the prices of commodities fell, but not until several months into the recession. (Gold and silver fell in March, before the others fell.)

There is an ancient error, stretching back to Adam Smith, which says that retail prices rise because of cost-plus inflation. Prices for raw materials rise, forcing up retail prices. This was refuted by Carl Menger, the original Austrian School economist, in 1871. He showed that production costs rise in response to bids by entrepreneurs, who in turn expect rising demand for the output of their enterprises. The prices of economic inputs rise in response to expectations.

When, in the second half of 2008, entrepreneurs and speculators finally recognized the extent of the recession, they stopped bidding for as many raw materials. So, the prices of these production goods fell.

It is true that monetary policy affects the business cycle. It is true that QE2 is inflationary. But let us not mistake cause and effect. The increase in commodity prices all over the world ever since early 2009 is the result of simultaneous central bank policies. The Federal Reserve System and other large central banks began inflating in late 2008 to reverse the banking panic by large depositors, not small depositors, who were covered by FDIC rules.

The policies of late 2008 have not produced mass inflation, because commercial bankers have increased their banks' excess reserves at the FED and other central banks. They are not lending all of the money that they are legally entitled to lend.

QE2 has nothing to do with much of anything. Yet.

QE2 AND PRICES

First, QE2 did not get rolling until early in 2011. For most of 2010, the Federal Reserve System was deflating. This is seen in the chart of the adjusted monetary base.

Second, commodity prices rose in 2009 and 2010.

Third, the cause of this increase was the prior monetary policies of central banks, late 2008 to early 2010.

Fourth, the increase in the adjusted monetary base in 2011 indicates that the "exit strategy" of 2010 has ended. Bernanke keeps talking about being ready to adopt an exit strategy when the time is ripe. This is a smoke screen. The FED actually began to adopt a policy that can best be described as an exit strategy in March 2010. It has made a fast exit from the exit strategy in 2011.

That commodity prices could continue to rise in expectation of a QE2-generated recovery later this year is quite possible. It depends on what entrepreneurs expect commercial bankers to do. Will bankers lend? If so, the M1 supply will rise, and so will the M1 multiplier. That will force up prices. But QE2 may fail to persuade commercial bankers to lend. Then the FED will be pushing on a string.

My point is this: you should pay no attention to anyone who tells you that the rise in food prices has been the result of recent Federal Reserve policies. Commodity prices rose in 2010 despite a policy of monetary deflation by the FED. This is rarely discussed by financial commentators.

I think the upward move of commodities will continue until China goes into recession. China's central bank is raising interest rates. As far as we are told, monetary policy remains expansionist. But rising rates for commercial banks will have the effect of making commercial loans unprofitable for some entrepreneurs. They will cease hiring workers. They will cease buying commodities. This is what the Austrian theory of the business cycle teaches. In order to avoid price inflation, the central bank changes course and lets interest rates rise. This ends the boom.

At the margin, Western consumers are not the source of the rise in food prices. The West is rich. It allocates relatively little of its monthly expenditures to food. When Western incomes increase, the bulk of the money does not go to increased consumption of rice, wheat, and corn. This is not the case in the Third World. When people move from the country to work in urban settings, they increase their purchases of food. Their mark of wealth is their ability to buy more food. They bid against each other. They bid against rural residents.

The rising price of oil and food indicates a growing economy worldwide, just as falling prices in the second half of 2008 indicated a contracting economy.

Oil is extremely volatile because of the inability of buyers to store large quantities in reserve. This is not true of foodstuffs. The food is kept in grain elevators. The price of food is less volatile than energy prices, because entrepreneurs who hold grain in reserve can sell into this increased demand. This increases the supply of food available to retail food producers.

DOLLARS AND FOREIGN CURRENCIES

One of the marks of an ill-informed analyst is the absence of any discussion of foreign central bank policies in relation to Federal Reserve policies. Let me explain.

Food in foreign countries is priced in the domestic currency units of those countries. What the Federal Reserve does is not directly relevant to the economies of those countries.

When the FED increases the monetary base by purchasing Treasury debt, this reduces the interest rate of short-term bills, but it can – and did – increase the mid-term rates. This was not what Federal Reserve economists would have imagined. You can see what happened in February.

Higher rates of limited magnitude have little effect on foreign central banks. They buy U.S. Treasury debt for other considerations than a few hundredths of a percentage point in interest. They buy for reasons of mercantilism: subsidizing their export sectors.

The average resident in a foreign nation bids for food, as for all other scarce resources. But he bids in terms of his nation's currency unit. This has nothing directly to do with the Federal Reserve and QE2. The bidding process raises the price of food. Americans must bid more dollars to buy food. But this demand is in terms of consumers' output, not dollars. Japanese residents bid with yen. Americans bid with U.S. dollars. Chinese residents bid with yuan. But to buy yen, dollars, or yuan, residents must sell their output. They are buying food with their output. This is the fundamental fact of all pricing.

The FED inflates the monetary base. This may or may not lead to increased M1 and a higher M1 money multiplier. At some point, Americans will get their hands on some of this new money. They will bid for goods and services. But they will not bid very much extra for increased food. If Richard Simmons had his way, Americans would bid more for a new Richard Simmons DVD on how to lose weight by this or that technique. They would bid more for fresh fruits and veggies and less for snack foods that most people enjoy eating. Snack foods are more about packaging and taste than about the cost of grains to produce them.

So, what matters most for the price of food in a foreign country is the domestic monetary policy and economic output in that country.

If the central bank of some Asian country tries to keep its currency from rising in relation to the U.S. dollar by inflating the domestic currency, this will affect the price of food there. The increased monetary expansion will fuel the boom phase of the boom-bust cycle. This will goose the economy by lowering nominal interest rates. But this effect would not take place if the central bank did not tamper with the money supply or the interest rate on short-term government bonds.

To blame Bernanke and the FED for the rising cost of food is based on a misunderstanding of the currency markets. It blames a cause which is not in fact the primary cause. The primary cause is rising output – increased bids – in Third World countries that are experiencing economic growth. To the extent that this rising output is based on long-term innovation and capital investment, this is positive. To the extent that it is based on fractional reserve banking and central bank purchases of debt, it is not positive. Rather, it is creating a boom that will turn into a bust, just as it did in the second half of 2008.

DESPERATE CENTRAL BANKERS

Central banks inflate to keep government debt markets solvent. That is their official task. It has been ever since the Bank of England was created in 1694.

Central banks inflate also to keep large commercial banks solvent in a financial panic. That has been their unofficial task for at least a century.

They began doing this as a depression hedge in the early 1930s. John Maynard Keynes announced his last career flip-flop in 1936, with the publication of The General Theory of Employment, Interest, and Money. Here, he set forth his recommended cure for the Great Depression: government spending. This could be done through taxes, borrowing, and monetary inflation. He preferred the second, but he was not limited to it, nor have his disciples been limited. Keynes baptized policies that Western governments had already adopted. He invented a new terminology to cover his tracks. He was merely promoting the crackpot monetary theories of Major Douglas and Silvio Gesell, as he admitted (pp. 353-58).

Bringing Keynesian policies up to date, the unprecedented increases in the monetary base of the Federal Reserve, the Bank of England, and the European Central Bank, beginning in late 2008, were the cause of the reversal of the collapse of the financial markets. This reversed the recession. This led to a recovery of commodity prices after 2008. These effects had impact on the eating habits of Chinese and Indian consumers. China and India are part of the international economy. But the effect on food prices was indirect. They rose because demand for Asian exports recovered. The people involved in the export trade were able to bid up the price of food.

There is talk about food being a bubble sector. Given what happened in the second half of 2008, this is a legitimate conclusion: the bubble popped. If the central banks continue to inflate, and the West's economy avoids another major recession, then food prices will continue to increase. Poor people are becoming less poor, and as they become richer, they will eat more. They will also move from bicycles to motor bikes. Motor bikes consume gasoline.

Commodities rise in price when there is increased demand for them as factors of production. There will be increases in technology in these sectors, but the rate of speed at which Indians and the Chinese are getting richer is greater than increases in production of raw materials. This is a bubble in the sense of central bank policies promoting a boom economy through inflated currencies. But the general upward move of commodity prices, as distinguished from consumer goods prices, will likely continue over the next two decades.

There will be a bust at some point, perhaps in the next few years, and maybe before. Central bankers in China and India will separately decide to put on the monetary brakes in order to avoid mass price inflation. There will be recessions in both nations. This will once again force down the price of food. But this will be a buying opportunity. The long-run trend is up, because the long-run trend of Asian productivity is up.

Bernanke is responsible for persuading all of the FOMC members except Hoenig to vote for the expansion of the monetary base. To the extent that this delays the day of reckoning, when capital is finally priced apart from monetary inflation, the FED is responsible for the bubble in food prices. But this increase has been going on for a decade. This is not recent. It has nothing to do with QE2. Yet.

CONCLUSION

The rise in food prices is a mark of deliverance out of poverty for hundreds of millions of Asians. The fact that they are saddled with imitations of the Bank of England, just as residents of the West are, is unfortunate. It will be even more unfortunate when the era of central banking and the welfare state reaches its apogee and collapses.

The universal bankruptcy of the national welfare states will provide a great opportunity for free market economists to say, "We told you so," and perhaps gain their followers a market for the reconstruction of the political order from the bottom up.

There will be a price to pay. The rising price of food in the boom phase of the great transformation is likely. When poor people get richer, they spend money more on food, but less time producing it. The bubble in food prices is indeed a bubble, because Asian central banks are inflating. But in the long run, food prices and oil prices will rise because newly middle-class people prefer to buy food and fuel with their increased output.

The supreme mark of a more productive economy is the increase in the price of land, meaning the raw materials that land produces. Capitalism is reducing poverty today on a scale never before seen. So, food and fuel prices will rise until new technologies are implemented that allow raw materials suppliers to keep pace with the move from the Asian countryside to the cities. Such innovations will not keep pace for the next 20 years.

Be thankful that you are not some middle-aged peasant trapped in the pre-capitalist economy of some Asian village. For him, this vast increase of urban wealth will be no picnic.

February 26, 2011

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North

 
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Central banking and social unrest.

Rising food prices in the Arab world are much to blame for social unrest.  And who’s actions cause prices to rise?  Why, that would be the central bank of the world’s fiat reserve currency – the Federal Reserve, of course.  And you thought they just tried to control interest rates.

Charts: Food Prices, Commodity Prices

Gary North

Feb. 24, 2011

The United States Department of Agriculture has published this chart of commodity prices, including oil. Food prices have risen, especially after 2006, but not anywhere near as rapidly as general commodity prices and the price of oil.

Image001

  

Image003

http://www1.eere.energy.gov/biomass/pdfs/global_agricultural_supply_and_demand.pdf

The move in oil began in 1999, during the boom phase of the economy. The recession of 2001 did not reverse the rise of prices.

Oil's price tumbled sharply in the second half of 2008: from $147 per barrel in July to $33 in December. Since then, it has risen. Food prices also fell sharply. Food prices have risen steadily since late 2008.

Image004

  

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http://www.fao.org/worldfoodsituation/foodpricesindex/en

The Role of US Debt in the Current Revolution

by Bill Bonner
Daily Reckoning

Recently by Bill Bonner: Revolution in Egypt and Where to Be When Black Swans Appear

 

 

 

Cereal Wars…and Zombie Wars…

Hey, how ’bout that Ben Bernanke… He’s a freedom fighter! Look what he’s done to North Africa!

Seems like every time we pick up the paper another dictator is toppling over. Where does it lead, we wonder? What would a world be like without dictators? Without them, who will the CIA and the State Department give our money to?

On the run this morning (but not quite given up) is Muammar Gaddafi of Libya.

Wait… Is this guy a friend or an enemy? We can’t remember. Wasn’t he a bad guy a few years ago? But recently we’ve heard that he is a good guy. He’s helped with the War on Terror. And he sells oil.

Friend or foe, we don’t know…but whatever he is, he’s beginning to look past tense. As of this morning, reports say he’s lost control of Libya’s second largest city. His troops are firing on protesters in the capital, where he and his loyal guards are holed up in a few government buildings.

His son vows to fight back. He says there will be “rivers of blood” before he gives up.

That “rivers of blood” image was used by Enoch Powell in Britain fifty years ago. It came from Virgil’s Aeneid, in which a character foresees “wars, terrible wars, and the Tiber foaming with much blood.”

Powell was referring to the effects of immigration into Britain from Africa and elsewhere. He thought he saw race wars and power struggles coming as a result.

But the younger Gaddafi uses the language as a threat, not a prophecy.

Still, it didn’t do Powell much good. Maybe Gaddafi will have better luck with it. Most likely, he’ll high-tail it out of the country before the blood is his own. That will bring to three the number of regime changes in the last few weeks. Which leads us to ask: what’s up?

The answer comes from our old friend, Jim Davidson. He pins the revolutions on Ben Bernanke. Behind the popular discontent is neither the desire for liberty nor the appeal of elections. It’s food. And behind soaring food prices is Ben Bernanke.

The Arab world is a model Malthusian disaster, says Davidson. Populations have ballooned. Food production has not. Which makes Arab countries the biggest importers of cereals in the world. And when the price of food goes up, the masses rise up too.

From Jim’s latest newsletter, Strategic Investment:

Food prices hit an all-time high in January. According to the UN’s Food and Agricultural Organization (FAO) “the FAO Food Price Index (FFPI) rose for the seventh consecutive month, averaging 231 points in January 2011, up 3.4 percent from December 2010 and the highest in both real and nominal terms” since records began. Note that prices have now exceeded the previously record levels of 2008 that sparked food riots in more than 30 countries. “Famine-style” prices for food and energy that prevailed early in 2008 may also have helped precipitate the credit crisis that Federal Reserve Chairman Ben Bernanke described in closed-door testimony “as the worst in financial history, even exceeding the Great Depression.”

This time around, the turmoil surrounding commodity inflation has taken center stage with more serious riots and even revolutions across the globe. Popular discontent is not just confined to “basket case” countries like Haiti and Bangladesh as in 2008. High food prices have roiled Arab kleptocracies with young populations and US backed dictators such as Tunisia, Egypt, Bahrain and Yemen. Even dynamic economies have been affected. Indeed, all of the BRIC countries, except Brazil, have witnessed food rioting.

Well, how do you like that, Dear Reader? All those billions of dollars spent propping up dictators – $70 billion was the cost of supporting Hosni Mubarak in Egypt alone – and then the Fed comes along and knocks them down.

The Fed lowers the cost of money so speculators can borrow below the rate of inflation. And then it prints up trillions more – just to top up the worlds’ money supply.

Is it any wonder food prices rise? Imagine you’re a farmer…or a speculator. You can sell food. Or you can hold it in storage. You know the food is valuable. You know the world has more and more mouths to feed every day. You know food production is limited. And you know Ben Bernanke can print up an unlimited number of dollars. What do you do?

Do you sell immediately? Or drag your feet…holding onto your valuable grain as the price hits new highs?

Davidson continues:

While Mr. Bernanke modestly declines the credit for de-stabilizing much of the world, close analysis confirms that he played an informing role. His QE2 program of counterfeiting trillions out of thin air has helped ignite a raging bull market in raw materials with food and commodities – up 28% in the past six months. The fact that the US dollar has heretofore been the world’s reserve currency means that almost all commodity prices are denominated in dollars. As a matter of simple math, when the dollar goes down, the prices of commodities tend to go up.

Today, Libya. Tomorrow…Yemen? Or Saudi Arabia.

In North Africa, Cereal Revolutions…

In North America, Zombie Wars…

Yes, the battle rages in the Dairy State. And yes, Nobel Prize winner Paul Krugman (Economics!) has no idea what is going on:

It’s “not about the budget. It’s about power.”

He thinks it is a battle between the rich and powerful, whom he calls the “oligarchy,” and the decent lumpenproletariat. Wisconsin’s governor is trying to bust the union, says Krugman, so that the elite can ride roughshod over poor government workers, cut their pay, and reduce their benefits (thereby downsizing the state’s budget deficit).

It’s not about money, says the New York Times columnist. He’s wrong, as usual. The Zombie Wars are always about money. There is less money available and more zombies who want it.

In the present case, rather than hire honest people to work at market rates…Krugman wants the state to be forced to deal with a privileged union. Union zombies should bargain with government zombies, he says. Together, in cooperation, not in conflict, they should figure out how to rip off the taxpayer.

Stay tuned…the Zombie Wars are just beginning.

Reprinted with permission from The Daily Reckoning.

February 24, 2011

Bill Bonner is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and The New Empire of Debt: The Rise Of An Epic Financial Crisis and the co-author with Lila Rajiva of Mobs, Messiahs and Markets (Wiley, 2007). Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning.

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