I had
an interesting chat with a reader TH about what the central bank officials
and politicians hope to accomplish. This article addresses
that question and is fairly complicated so you may need to read it multiple
times. Bernanke warned the investment community of what he would do in
a Nov 21, 2002 address before the National Economists Club in Washington DC.
For
decades, perhaps even centuries, the world has been in an inflationary credit
expansion. The zenith was reached and now the world is in a
deflationary credit contraction. Holders of capital are seeking
the safest
and most liquid
assets. The central bank officials and politicians are attempting to
prevent this natural and probable consequence of economic
law. They may as well attempt to repeal the law of gravity.
Short of marching everyone off to the gulag, which they may try, they
will fail.
Bernake’s
address was titled ‘Deflation: Making Sure “It”
Doesn’t Happen Here’. He argues there are two bulwarks
against deflation in the United States. First,
the resilience and structural stability of the U.S. economic system
and second, the Federal Reserve System.
First, as
we are seeing with the increasing nationalization of
industries through bailouts the ‘resiliency’ and
’structural stability’ of the US economic system is being
increasingly undermined. Voluntary price discovery is being replaced
with the coercive force of government. This will only lead to
less efficient markets and allocations of capital. The US economic
system and therefore its earning and productive power is quickly evaporating.
This loss of earning and productive power negatively affects the quality of its currency.
Second, is
the parasitical Federal Reserve System. The Federal Reserve
System’s interference in the market regarding the supply and cost of
money grossly distorts the pricing mechanism as individuals engage in human
action to discover price through value and utility calculations. On
June 16, 2008 I discussed this on the Korelin Economics Report. Next
we turn to Bernanke’s toolbox.
The
first problem with Bernanke is his poor use of words. Like most
babbling idiots, or perhaps it is done intentionally to confound and confuse,
his language is vague and indecisive. For example, he defines
deflation as ‘a general decline in prices’. The Austrian
school of economics defines deflation as a decrease in the money supply.
In application, Bernanke’s definition confuses effects
(decline in prices) with the cause (decrease in the money supply).
Deflation is no more a decline in prices than wet streets are rain.
Quantitative easing is a tool of
monetary policy. The effect is an increase in the quantity of
currency without regard to maintaining its quality. Quantitative is
relating to, measuring, or measured by the quantity of something rather than its
quality.
Not all ‘dollars’ are defined equally. Even
traditional economists and government reports index in terms of ‘1986
dollars’ or ‘1977 dollars’ to account for the differences
in quality
of the currency or its purchasing
power. Because there is no definition of the dollar it
is subject to payment risk.
A
commodity currency such as gold is not subject to this risk. For
example, 1 ounce of gold in 1986 is equal to 1 ounce of gold in 1977 or 577.
The quality
of the money is consistent and comparable. The names of the national
currencies arose to define a particular type and weight of metal of a given
purity. For example, a ‘dollar’ was 371.25 grains of .999%
silver.
However,
now the term ‘dollar’ has no definition. The quality of the
money is called into question in direct proportion to its quantity.
The inconsistent quality
of currency undermines the confidence in it. As the Adjusted Monetary
Base erupts the distrust
of the currency increases.
The
alphabet soup lending facilities (TALF, etc.) and bailouts by the various
governments throughout the world could be considered quantitative easing.
In effect, the current policy is transmogrifying commercial debt risk
which the world does not want to buy into sovereign debt risk which the world
does want to buy. The Bank of Japan practiced quantitative
easing by maintaining short-term interest rates at close to their minimum attainable
zero values and flooding commercial banks with excess liquidity.
Bernake suggests (1) keeping a buffer zone of interest rates from 0%,
(2) ensure financial stability and (3) cut rates to stimulate the economy
when the economy deteriorates. Then he makes his infamous helicopter
state.
Bernanke
said, “What has this got to do with monetary policy? Like gold, U.S.
dollars have value only to the extent that they are strictly limited in
supply. But the U.S. government has a technology, called a printing press
(or, today, its electronic equivalent), that allows it to produce as many
U.S. dollars as it wishes at essentially no cost. By increasing the number of
U.S. dollars in circulation, or even by credibly threatening to do so, the
U.S. government can also reduce the value of a dollar in terms of goods and
services, which is equivalent to raising the prices in dollars of those goods
and services. We conclude that, under a paper-money system, a determined
government can always generate higher spending and hence positive inflation.
Of course, the U.S. government is not going to print money and
distribute it willy-nilly.”
It is
true the currency will not be distributed ‘willy-nilly’ like
being thrown out of the helicopter. Instead, it will be directed
towards the favored factions like the Wall Street banks while retirement
plans are looted. The problem is with the premise that there will be
borrowers for the newly created liquidity. Japan ran into a problem
with interest rates being at 0% but there being no borrowers. When
negative real interest rates occur the holders of capital seek the next level
down in the liquidity pyramid: gold and silver. The deflationary credit contraction continues in spite of the monetary
policy and quantitative easing the central bank officials and politicians
engage in.
These
are good reasons to have a portion of your wealth in the precious monetary
metals of gold and silver. For large amounts I recommend GoldMoney which can also
function as a currency in ordinary daily transactions. If interest
rates for currencies are going to 0% then why hold paper that is subject to
counter-party risk when you can hold gold? Gold is the ultimate
insurance, is no-one’s liability, the ultimate store of value
and is always accepted. Gold
is the penultimate of safe and liquid assets.
Trace Mayer
RuntoGold.com
Trace Mayer,
J.D., holds a degree in Accounting from Brigham Young University, a law
degree from California Western School of Law and studies the Austrian school
of economics. He works as an entrepreneur, investor, journalist and monetary
scientist. He is a strong advocate of the freedom of speech, a member of the
Society of Professional Journalists and the San Diego County Bar Association.
He has appeared on ABC, NBC, BNN, many radio shows and presented at many
investment conferences throughout the world.
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