|
Those who refuse
to learn from history are bound to repeat it
It is amazing how
fast events unfold in the present crisis. When wepicked our subtitle “Can
It Happen Again” for this talk just a fewmonths ago, it was merely an
afterthought, looking at a remotepossibility. Now, on this Election Day, we
are in the midst of anunacknowledged depression possibly worse than that of
the 1930’s
The financial
mayhem on Wall Street is spilling over every otherstreet in America, nay, in
the whole world. In all likelihood job lossescurrently reported are only the
tip of a monstrous iceberg
When Olivier
Blanchard, the IMF’s chief economist, was askedthe question whether the
world was sinking into another GreatDepression, he confidently replied that
the chance was “nearly nil”
He added that,
after all, we have learned a couple of tricks in theintervening 80 years
So we have,
indeed, a couple of Keynesian tricks, and a fewmore Friedmanite nostrums ―
while we were made to forget theaccumulated economic wisdom of the ages. But
we have not learnedwhat mistakes, made by policy-makers, have caused the
GreatDepression of the 1930’s. And we certainly have not learned how toavoid
the same mistakes again
Keynesian and
Friedmanite precepts rule economics, with noquarter given to traditional
economics that has been exiled. It lookslike the fulfillment of the prophecy:
“those who refuse to learn fromhistory are bound to repeat it”
Promises to pay
which the Treasury and the Fed are neitherwilling nor able to honor
For the past
eight years or so, in my writings and lectures, I have beenadvocating what I
call the “revisionist theory and history of the GreatDepression.”
In the cacophony of Keynesian and Friedmanitepropaganda on promoting the
Brave New World of irredeemablecurrencies, my message was lost. Keynes and
Friedman, for all theirdisagreements on the details how to “manage”
the national and worldeconomy, were in solid agreement on their categorical
rejection ofmetallic monetary standards, that is to say, money based on
positiverather than negative values. Our present monetary system, universallyacclaimed
by academia and media as the ‘wave of the future’, is basedon
negative values: the value of debt. Keynes and Friedman both haveput the
blame for the Great Depression on the “contractionistpropensities”
of the gold standard. And that is all that’s being taught atvirtually
all universities around the globe about the causes of the GreatDepression
The proposition
is put under official taboo that there is no validdefense for
giving the Fed and the Treasury the privilege to issuepromises to pay which
they are neither willing nor able to honor(except insofar
as they honor them as part of their the check-kitingconspiracy)
Bonds minus gold
equals interest rates halved again and again
My revisionist
thesis is simple: the truth is the exact opposite of theofficially upheld
economic doctrine. The cause of the GreatDepression was the forcible removal
of gold from the internationalmonetary system, including the suspension of
the gold standard byGreat Britain in 1931, and the confiscation of the gold
coins of thecitizens of the United States in 1933
To see this clearly
we have to contemplate the main role playedby gold in the monetary system
which is this: gold is the only assetthat can successfully compete with
government bonds for the savingsof people with a conservative frame of mind.
As long as gold isavailable as an alternative to bonds, the public purse is
controlled bythe people. If they don’t like government profligacy, they
can selltheir bonds and stay invested in gold. This is the only message thatthose
in power would read or understand: the rise in the cost ofborrowing by the
government. The rate of interest goes up. The redlights in the corridors of
power start flashing
Confiscation of
gold means cutting the wire to those red lights. Itmeans the removal of the
only effective competition of governmentbonds, gold coins. In the absence of
gold government bonds have acaptive market. They enjoy a monopoly. The
government can affordto ignore all criticism of its monetary and fiscal
policies. It can dowith the public purse as it pleases. Conservative
bondholders nolonger have a choice: they have to buy and hold the bond. The
publicpurse is no longer controlled by the people. The government can causethe
public debt to go to any high level. The government can cause thecost of its
own borrowing to fall to any low level. In formula: bondsminus gold equals
interest rates halved, and halved, and halved; again,and again, and again:B –
G
=
(½)npKeynesians butt in: “Hey, wait a
minute, that’s just it. Isn’t this a goodthing to have? Isn’t
it a wonderful thing to turn the stone into bread; toabolish scarcity, by
making capital abundant through a low interestratepolicy?”
Confusing a low
with a falling rate of interest
Nobody denies
that a low interest-rate structure, brought about by ahigh rate of voluntary
savings, is a great blessing to society. What weface here is a fatal
confusion of low with falling interest
rates. If thefall is prolonged, then the net effect on the economy is lethal,
as itcauses
the destruction of capital which, unless checked in time, couldbring
the entire economy to a screeching halt
Capital
destruction is a subtle process which even the victimsthemselves are unable
to diagnose. The suggestion that pari passuwith
falling interest rates the market price of bonds rises isuncontroversial. It
is an undeniable fact of the markets. It follows thatas interest rates keep
falling, bond speculators reap constant capitalgains, a reward not for saving
but for gambling. Their gains do notcome out of nowhere. They are siphoned
off from the capital accountsof the producers. Entrepreneurs are
unsuspecting. They don’t knowwhat has hit them when they find their
enterprise denuded of capital
The last thing
they suspect is falling interest rates which theywelcome, like everybody
else, as a relief. Whatever it is, relief it isnot. It is the kiss of death
Liquidation value
of bonded debt
To see the causal
relation clearly, let us go through the process ofcapital destruction
step-by-step. As the name suggests, “liquidationvalue” is the
lump sum it takes to liquidate debt, should it benecessary to retire it
before maturity ― for example, in case ofmergers, acquisitions,
takeovers, shotgun marriages, not to mentionnationalization. The point is
that as the rate of interest falls, theliquidation
value of debt rises. Rise it must, because the stream
ofinterest payments, originally set when interest rates were higher, isnow
being capitalized at a lower rate. Since it represents a lowervalue, it falls
short of liquidating the debt
For example, when
I repatriated to Hungary and sold my housewith a mortgage in Canada, the bank
would not accept the balanceremaining in settlement. It insisted on my paying
a ‘penalty’ arguingthat the prevailing rate of interest was now
lower, and the liquidationvalue of my mortgage higher. In other words, I
suffered a capital losson account of falling interest rates
Here is another
example. When the rate of interest falls, themarket immediately bids up the
price of bonds. The higher bond pricerepresents the higher liquidation value
of the underlying debt
Creditors will
not let debtors off the hook, unless they can take anextra pound of flesh for
their consideration. If this is deemed unjust,then complaints should be
lodged with the gods, who ordained thatman be mortal. As is well-known, for
immortal gods a future streamof payments need not be discounted, and full
credit is given for eachand every installment. On Mount Olympus, the rate of
interest is zero
Unfortunately,
however, man is not immortal. For him, the rateof interest is positive. It is
for this reason that falling interest rates, farfrom alleviating the burden
of debt, aggravate it
Open market
operations of the Fed
The grand scheme
to make interest rates fall artificially started by theFed’s breaking
the law in the 1920’s. Open market operations wereintroduced
clandestinely as a way to inject new money into theeconomy. The Fed was to
enter the open market to buy governmentbonds, paying for them with newly
created dollars
It is important
to understand that open market operations areillegal. They were not
authorized under the Federal Reserve Act of1913. In fact, the Act
specifically stated that government bonds wereineligible for the purposes of
collateral in backing Federal Reservenotes and deposits. Eligible collateral
was confined to gold and realbills. Open market operation were ‘legalized’
ex
post facto only later,in the 1930’s, and the practice went
on to become the chief engine ofinflation through the monetization of
government debt on a massivescale. It should be noted that retroactive laws
are not recognized bythe U.S. Constitution
Open market
operations, apart from being illegal, are no less ahare-brained scheme.
Authors responsible for developing this illegalpractice have been ignorant of
its effect on speculation, and the effectof the resulting speculation on the
rate of interest. Bond speculatorsare very much alive to the Fed’s need
to make periodic trips to theopen market to buy the bonds. They lie in ambush
to preempt it. Theybuy the bonds first, only to dump them in the lap of the
Fed at a profitlater. In effect, bond speculators get a free ride at public
expense
They pocket risk
free profits. The entire playing field of the nationaleconomy becomes tilted,
favoring parasites and penalizing producers
This is the fatal
flaw in the Keynesian edifice: the chrysophobic(anti-gold) monetary system
has a built-in instability manifested bythe unopposed bull speculation in the
bond market. The net result is aninterest-rate structure that is persistently
drifting lower. Keynesianspretend that their idol has made a discovery in
justifying deficitspending made possible through open market operations, thusbenefiting
mankind. But as my analysis shows, the goodies distributedby Keynesian
economics are not costless. They come at the expense ofsociety’s
accumulated capital. Capital dissipation is masked by theeuphoria of free
lunch and pork. The damage to society dawns on thepeople later. By then it is
too late to stop the rot. Irreparable damagehas been done. The capital of
society has been destroyed. Everybodyis made to suffer because of Keynesian
profligacy, justified underfalse pretenses
The banking panic
of the 1930’s
The Great
Depression was not caused by the vanishing of demand, assuggested by Keynes.
It was caused by the vanishing of capital. Norwas the destruction of capital
confined to the producing sector. Itaffected the financial sector as well.
From 1930 to 1933 more thannine thousand banks
closed their doors for good in the United States
Depositors and
shareholders lost about $2.5 billion. As a share of theeconomy, that would be
the equivalent of $340 billion today
Economic
historians give credit to Franklin Delano Rooseveltfor meeting the banking
crisis head-on. Only a few days after he wasinaugurated as president in
March, 1933, he declared a bank holidayand ordered all the people under the
jurisdiction of the United Statesto surrender their gold coins. Although
Roosevelt promised to returnthe gold after the banking crisis has subsided,
this promise wasapparently made in bad faith. No sooner had he confiscated
the goldthan he marked up its value, leaving people with paper worth 56percent
less. This neat piece of presidential chicanery was called“devaluation
of the dollar in the national interest.”
Old Coppernose
Yet it was plain
stealing, nothing less, as the great blind senator fromOklahoma, Thomas P.
Gore, had told the president in his face in theOval Office. Senator Gore,
moreover, in a debate on the Senate floor,also said this: “Henry VIII
approached total depravity as nearly asimperfections of human nature would
allow. But the vilest thing thatHenry ever did was to debase the coin of the
realm!” Old Coppernose,as he was nicknamed, did not confiscate the
people’s gold coins. Hemerely diluted them. When the gold wash wore
thin, the effigy ofHenry on the coin revealed a copper nose underneath.
People suffereda loss as a result of this royal chicanery, to be sure, but at
least theycould keep their coin and have a good laugh at the expense of theirsovereign
Keynesian
chrysophobes were jubilant. Roosevelt was their hero
They celebrated
the advent of synthetic money and credit, laying greatstores on the ‘rational’
management of the national currency. Themoney supply was expanded and
deflation halted. At least so the fablesaid. In reality, Roosevelt was
pouring oil on the fire. Capitaldestruction got a new boost. As I have
already explained, interest ratescontinued their free-fall as the only
competitor to government bonds,gold, had been eliminated. Keynesian
economists got the fallen god,the gold standard, to kick around. No one
thought that the fallen godcould, phoenix-like, rise from its ashes in the
fullness of times andhave retribution
Ominous parallels
It is hard to
avoid seeing parallels to the current situation. Interestrates have been
falling for 28 years from 16 percent in 1980 to 4percent today. Capital
destruction has taken a great toll on theproducing sector, causing a large
part of American industry fold tentand seek salvation overseas where wage
rates are lower. As far as thefinancial sector is concerned, up until
recently it appeared that thebanks have escaped the death-trap of capital
destruction. Well, wenow know that they have not. Banking capital, just like
industrialcapital, has also been destroyed by the relentless fall of interest
rates
Banks no longer
trust one other’s promises to pay, because theysuspect that their
counter-party has no capital backing those promises
Banks are walking
dead men, artificially propped up by the Fed andthe Treasury, anxious to
avoid the blame for inaction that ushered inthe Great Depression in 1930.
They are working hard to keep creditflowing. But the financial situation they
face is incomparably moredifficult than that of the 1930’s. This is not
an illiquidity crisis. This isa solvency crisis. It is due to an insidious
destruction of capital
The Fed and the
Treasury are trying to recapitalize the banks byinfusion of new capital in
the form of freshly created Federal Reservecredit. Incidentally, the Fed is
just one of the walking dead men. Itdoes not have the collateral necessary to
create new credit to the tuneof $700 billion. The Treasury has to donate the
Fed the bonds directly
The last time
this imprudent departure from the principles of soundcentral banking has been
invoked was during World War II, when theexigencies of war finance were used
to justify the bypassing of theopen market. The vexing question is whether
irredeemable promisesby the Fed and the Treasury are sufficient to jump-start
banking in theUnited States
There are no
contingency plans for the mobilization of goldreserves to recapitalize the
banks. Gold is the ultimate liquidator ofdebt, toxic and non-toxic. Why not
use the ultimate liquidator, if wereally mean business in eliminating toxic
debt from the system, and ifwe really want to proceed with the task of
deleverage to shrink thebloated balance sheets of banks? Well, the
ideological obstacles areinsurmountable
Sword of Damocles
But the real
difference between now and the 1930’s is the incredibledeterioration in
the credit of the United States, which makes thepresent situation far more
dangerous. The international credit of theUnited States in the 1930’s
was very strong. You were looking at thegreatest creditor country in history.
Today, four score years later, youare looking at the greatest debtor country
in history, in need to borrowabroad to pay interest on its outstanding debt,
in addition to borrowingin order to maintain consumption patterns. A large
part of the debt isheld by foreigners, not under the jurisdiction of the
United States, andcertainly not subject to its taxing power. This is the
sword ofDamocles hanging on a thin thread. At the drop of the hat sources offoreign
credits could run dry. Nobody knows what will happen then
Yet the dollar is
not in immediate danger. Superficially it isstrong and getting stronger.
Treasury bonds are in great demand as the“flight to safety”
continues. For a couple of years, maybe a littlelonger, the dollar will hang
on “by the skin of its teeth”
But the writing
is on the wall: the strong dollar will be beatendown by the U.S. government
in the course of the trade war, to reviveAmerican exports. In addition, the
bill for the unprecedented bailoutswill come in soon enough. The government
deficit will reachstratospheric heights. When the critical mass is reached
and thethreshold of tolerance in total indebtedness is surpassed, the run on
thedollar will become inevitable. In the meantime, serious challenges tothe
hegemony of the dollar may be presented from friends and foesalike. This is
an explosive situation. We are on uncharted waters,aboard a rudderless ship
Worst of all, we
lack leadership. Those in charge of ourmonetary and fiscal system are
dyed-in-the-wool Keynesians andFriedmanites. They have grown up on Keynesian
and Friedmanitebunk no longer applicable in the 21st century. They were
caughtcompletely by surprise by the fast unfolding of events. They do notunderstand
what is happening to this country, let alone the world, nordo they have any
idea how further damage can be prevented. The onlytrade they know is to cut
interest rates; to print more money, rain orshine, and airdrop it from
helicopters indiscriminately. Their compass,economic forecasting, the pride
of mainstream economics, has turnedout to be tea-leaf reading. The only
people who predicted thismaelstrom were non-conformist economists beyond the
pale. Theywill not be allowed to kick in the ball
The outlook is
bleak indeed. Keynesians and Friedmanites willcontinue at the helm. Their
faulty perception will prompt them tothrow even more bad money after bad
money. They will beat downthe ‘strong’ dollar. There will be
competitive depreciation ofcurrencies world-wide, an echo of the trade wars
and beggar-thyneighborpolicies of the 1930’s. At the end of the road
lie the ruinationof the world’s monetary and payment system, economic
cooperation,and division of labor
The ”blame-it-on-the-gold-standard
game” is over
We have been told
that deflations, depressions, bank runs, massiveunemployment, wholesale
bankruptcies can only happen under thegold standard. In a modern, government-managed
economy, equippedwith scientific money-creating techniques, bolstered by the
fine-tuningmanagement of demand, these ills of society have been relegated tothe
history books
A few months of
the year 2008 exploded the myths nurtured formuch of the twentieth century.
The stark reality is that we have notconquered scarcity with interest-rate
suppressing techniques. We havenot succeeded fine-tuning the national economy
with monetary andfiscal policy. We have not learned how to combine high wages
withhigh employment. We cannot turn the stone into bread. We have onlybeen
tinkering at the edges, pretending that we can ladle out riches toall comers
by government fiat
This is not a
subprime crisis. This is not a real estate crisis. Thisis not even a dollar
crisis. This
is a gold crisis. The gold standard wassabotaged in 1933
when the U.S. government reneged on its domesticgold obligations, and again
in 1971 when it reneged on itsinternational gold obligations. The gold
standard strikes back ― witha lag measured not in years but in decades
How naïve it
was to believe that the gold standard could beabused and exiled with
impunity! How dense it was to think that underthe regime of irredeemable
currency basic freedoms can bemaintained! How insane it was to embrace the
notion of legal tenderas the ticket to a bright future!Events of this fateful
year 2008 have dumped Keynesian andFriedmanite economics to the garbage heap
of science, where Marxianeconomics, astrology, alchemy, and many other
discredited anddiscarded theories, the names of which have by now faded frommemory,
already rest
The sooner the
world leadership realizes this, the better
Antal
E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
Read
all the other articles written by Antal E. Fekete
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright © 2002-2008 by Antal E. Fekete - All rights reserved
| 
