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An unhappy
anniversary
Another forgotten anniversary
that haunts the nation is the re-establishment of the gold standard in the United States by the Roosevelt
administration on January 1, 1934. What? -- you may
ask incredulously. Roosevelt re-introducing the gold standard in the United States?
You had better believe it. That's exactly what he did. He fixed the statutory
price of gold at $35 per ounce 75 years ago. This price was observed until
1971 as it was also incorporated in several international treaties, and
confirmed by the solemn promises of several presidents following Roosevelt. It is a great pity that
Roosevelt-worshippers frown upon the idea of following the leader. They
should demand a return to the gold standard now, 75 years after Roosevelt showed the way out from the economic quagmire.
To be sure, this is
an unhappy anniversary. Roosevelt's gold
standard was bad. He discriminated against American citizens so outrageously
that the evil dictators of the day dismissed the idea of duplicating Roosevelt's measures in their own fiefdoms. Roosevelt's gold standard denied Americans the right to
demand gold at the statutory price in exchange for Federal Reserve notes.
Worse still, criminalization of the ownership of gold stayed on the books. At
the same time, under Roosevelt's gold standard, the Swiss, for example, could
routinely take Federal Reserve notes to a Swiss bank and exchange it for gold
at the statutory price (even though, after 1936, they could no longer get
gold for their own paper currency at the statutory price!) Surely this was a
national dishonor: the American government
discriminating against its own citizens, giving monetary rights to foreign
nationals that were denied to Americans, in clear violation of the letter and
the spirit of the Gold Standard Act of 1900, let alone the American
Constitution.
Pigs making monetary
policy
Nor is it possible
to argue that the American government continued to serve the interest of the
American people after March, 1933, when Roosevelt confiscated gold belonging
to the American people, only to write up its value from $20.67 $35 per ounce
a few months later, allegedly "in the interest of the national
economy". This great government of this great nation, stealing from its
own citizens in the national interest? And selling the loot abroad at a high
mark-up? Where will it all end? Never mind the
Constitutional prohibition on confiscation without due process. Never mind
that the Constitution does not recognize fiat money. Never mind that the only
kind of money the Constitution recognizes is silver and gold. Just ask simple
questions about basic morality. The moral standard of the U.S.
government in its dealings with its own citizens has reached an all-time low,
as shown by the new norms set in the monetary field.
This land of free
men was turned into an Animal Farm where pigs have been running wild and
making monetary policy for the past 75 years. It is small wonder that men of
utter depravity, like Bernie Madoff, could operate Ponzi schemes unobserved and with impunity for as long as
he did. Just how long could the legal system stand up to assaults of this
width, this depth, and this magnitude? The name Bernie Madoff
reads like the Biblical writing on the wall, suggesting that ours is a Madoff dollar; ours is a Madoff
Social Security; and ours is a Madoff Medicare.
What basis for optimism is there for the next 75 years? To find out, let's
review the past 75 years.
Stabilizing interest
rates
Rotten as the New
Monetary Deal was from the point of view of the American citizen, the system
it established has ensured prosperity for the post-World War II era. That is,
until it was disrupted by a second episode of overthrowing the gold standard
in 1971 which, regrettably, was not followed by a second episode of
rehabilitation.
Roosevelt's gold standard,
for all its negative aspects, has succeeded in stabilizing interest rates.
This was a major feat. There is only one way to stabilize interest rates: by
setting up an international gold standard. And for a very simple reason, too.
Gold is the ultimate extinguisher of debt, the only one there is. Governments
can legislate to have legal tender, they can legislate to make ownership of
gold a crime; but they cannot legislate to make their own debt serve as the
ultimate extinguisher of debt. If they prevent gold from discharging this
function, then debt will start proliferating until critical mass is reached.
The debt implosion that follows is bound to wipe out prosperity. This is the
God-ordained role of gold in the monetary system.
A stable interest
rate structure is not to be confused with falling one. The former is a
great blessing; the latter is a great scourge. It took 36 years after 1971 to
find out how the difference feels on the hide. Falling interest rates mean
falling prices and falling employment. Quite possibly, with a lag. They
mean serial bankruptcies. They mean deflation and depression.
Cassandra's gift
The role of
Cassandra is a thankless one. She was the daughter of Priam,
king of Troy
and his wife, Hecuba. Hers is one of the great stories of antiquity. Cassandra
fell asleep in the temple
of Apollo, and the god
fell in love with the sleeping beauty. He offered to give her the ability to
see the future if she were to return his love. She promised to do that, but
when time has come to deliver on the promise, she reneged. The god Apollo was
furious, but there was no way for him to take back the gift of clairvoyance.
The best he could do was to make other people to disbelieve her prophecies.
And it so happened that, when she predicted the rape of Troy by the Greeks after the ten-year
siege, she was ridiculed, discredited, even declared insane by the Trojans.
I may be forgiven if
I feel like Cassandra. Having published my predictions on the Internet for
the better part of this decade, I have been disbelieved and ridiculed. (I
have not yet been declared insane.) I have warned that the Federal Reserve's
policy of relentlessly suppressing the rate of interest will lead to a
disaster. I have consistently argued that a falling interest-rate structure
is corrosive on capital. Having destroyed capital it will destroy employment.
Having destroyed employment it will destroy prosperity. It will be the cause
of serial bankruptcies. I was talking about the black hole of zero interest
that tears limb from limb in swallowing all creatures approaching it. I
specifically mentioned the example of the American auto industry as being the
next likely major victim of the deliberate policy of driving interest rates
ever lower. Rather than helping American auto-makers, falling interest rates
have denuded the auto industry of its capital.
Financial capital
not spared
Let me pause here to
make a confession. If anything, I did not see far enough to realize all the
consequences of the Federal Reserve's driving the economy into the black hole
of zero interest. I failed to see the simultaneous destruction of financial
capital. I thought that the devastation would be confined to productive
capital. In fact, I thought that the banks were the beneficiaries of falling
interest rates. They were the vampire sucking the life-blood of the
producers. The financial sector was siphoning capital away from the accounts
of the producing sector. I should have seen that exactly the same argument
applies to financial capital as to productive capital. They are both being
destroyed piecemeal by the falling interest rate structure.
The present banking
crisis is the result of wiping out the capital of the financial sector,
through the same process that has wiped out the capital of the producing
sector: the Federal Reserve's deliberate and declared policy to drive down
interest rates. The banks could have saved themselves if they had just kept
picking the fruits of capital gains on their bond portfolio. Bond values have
appreciated in the wake of falling interest rates. Pocketing capital gains
plus clipping coupons could have been a very profitable pastime for the banks
still. But in their infinite greed they were not satisfied. They coveted
more. They had recourse to 'securitizing' toxic garbage and started peddling
it, world-wide, as Madoff was peddling his Ponzi tickets. That was their
undoing. As long as securitized garbage was kept in their balance sheets, the
dirty little secret was safe. But when it was put into circulation, the
scandal could no longer be kept under the bushel. "Look, Dad, the banks
have no capital!" Following the cry of the little boy, other spectators
at the parade, too, could see that the emperor had no clothes.
Obama will not rock
the boat
I was not so
naïve as to expect that the rank and file of mainstream economists would
give credence to my predictions. After all, these gentlemen cut their teeth
by chewing on the Keynesian bunk that it is the sacred mission of governments
'to turn the stone into bread' by driving interest rates down, if need be, all
the way to zero.
More surprising was the reaction of labor leaders and the captains of the
auto industry. They treated me with thinly veiled contempt, refusing even to
take the trouble of going through my logical argument point by point. In this
argument there was nothing offensive to labor or to capital. My offensive
comments were concerned with Keynesian dogmatism and the government's
embracing it without even a perfunctory critical examination. Apparently, the
leadership of labor and the captains of industry are just as committed to the
error of Keynesianism as the government. They will live to regret their
obtuseness.
It gives me no
pleasure to say, on this unhappy New Year's Eve, that "I've told you
so". The world is at the brink of the worst economic collapse ever,
wiping out capital and employment indiscriminately. What makes this occasion
especially unhappy is that the incoming administration of Mr. Obama, rather
than starting from an ideological tabula rasa (clean slate) as it
should, has already committed itself to the same destructive Keynesian
ideology and Keynesian policies that are responsible for the financial and
economic catastrophe in the first place. The Secretary of Defense appointed
by president Bush is not the only one who will keep his post. Foxes in charge
of the chicken-coop at the Treasury will also be reappointed. There is not
the slightest hint of an impending critical reappraisal to find
responsibility at the highest echelons of the Treasury and the Federal
Reserve for the gross mismanagement of the economy.
The same program of
driving interest rates down to zero will be continued uncritically. The
road-map has already been spread out for all to see. Having driven the short
term rate of interest to the ground, the Fed is now set about the business of
driving down medium and long term rates as well. Ben's helicopters stand
ready to take off and bombard the U.S. economy back into the Stone
Age with freshly printed, crisp Federal Reserve notes.
Evils of bond
speculation
I have started Gold
Standard University Live, now defunct, to resurrect the study of the role of
gold in the economy, in particular, its inevitable interaction with the rate
of interest. Mainstream economics has completely (not to say criminally)
ignored the consequences of the systematic destruction of the gold standard
by the government. The enormity of one of the consequences stands out in
particular. The effects of speculation on the rate of interest have been
deliberately ignored.
Clearly, speculation
was not a problem under the gold standard. Interest rates were stable and
speculators left them alone. No profitable bets could be made on their
variation. But when currencies were cut adrift from their gold moorings,
their future value has become uncertain, and interest rates started bouncing
up and down madly like a yo-yo. Naturally, speculators welcomed the new game
as manna from heaven. It opened up a new casino where bets could placed on
the future course of bond prices. The result was predictable: speculators were
betting that interest rates would keep trending upwards or, what is the same
to say, bond values would keep trending downwards. Speculators could drive up
interest rates to double digits, and some more. Understandably, they did not
think that the U.S.
government could maintain the purchasing power of the irredeemable dollar,
once the gold prop was removed and discarded.
Open market
operations
This unintended
consequence of destroying the gold standard was not welcome news in Washington. The Federal
Reserve got busy to prove the speculators wrong, by driving down the rate of
interest. As one U.S.
senator put it, "we have to make the speculators burn their fingers
right to the armpit!" In addition to vengeance, there was also the
ideological legacy of Keynes that animated monetary policy, and has become
the earmark of our age.
There was more. Back
in the early 1920's the Federal Reserve launched a new policy of monetizing
government debt. To be sure, the practice was illegal. Government bills, notes,
and bonds were not included in the list of eligible paper that could be held
against the note and deposit liabilities of the Fed, as stated in the Federal
Reserve Act of 1913. If and when a Federal Reserve bank, having fallen short,
had to have recourse to backing its note and deposit liabilities by its
holdings of government debt instead of eligible paper, stiff and progressive
penalties were supposed to be collected by the Treasury. That made the
practice of monetizing the debt of government prohibitively expensive.
But what if the
Treasury "forgot" to collect the penalty? Well, that would be too
bad, a severe bout of absent-mindedness -- but that's just what an accomplice
in the conspiracy to undermine the monetary order would do.
The new fraudulent
practice was called 'open market operations'. (It was legalized ex post
facto in the 1930's.) Economists have failed to analyze the effect of
open market operations on bond speculation. "See no evil, hear no evil, speak no evil." I leave the problem to future
researchers to find out whether economists made an error of omission, or
whether they knowingly became accomplices to the conspiracy of the Treasury
and the Fed in a scheme to the aggrandize the power of the federal
government.
Here is what happens
when the Federal Reserve resorts to open market operations to buy government
bonds as the preferred means to increase the money supply. Bond speculators
are very much alive to the need of the Fed to make periodic trips to the open
market to buy the bonds. They lie in wait for the Fed. They want to preempt
it; they want to buy the bonds first. Later, they would dump them in the lap
of the Fed, making risk-free profits in the process at the expense of the
public. The Fed does not mind being ambushed. It condones the risk free
profits of the bond speculators. It all comes to the same thing: lower
interest rates by hook or crook.
Destruction of bank
capital
With the open market
operations of the Fed providing a dependable tail-wind, the sails of
speculators are bulging. The unison bullish response to monetary policy by
the speculators has the effect of steadily driving down the rate of interest.
The Fed could report to the boss: "mission accomplished".
Nobody bothered to
investigate the question whether the symbiosis of the Fed and bond
speculators (mostly banks) might somehow have a detrimental effect on the
economy. It certainly looked like a brilliant scheme of creating positive
value out of nothing -- nay, out of negative value! Nobody has raised
the objection that there "ain't no free lunch", that in our world
strict conservation laws govern and draw a line between what is possible and
what is not. In particular, it is not possible to create value out of
nothing. Any appearance to the contrary must involve the destruction of value
somewhere else.
Indeed, creating
bond values out of nothing has coincided with the destruction of capital.
Capital consumption is an insidious process. It has no obvious symptoms. If
anything, like narcotics, it has a euphoric effect on the economy. Its role
is to desensitize the victim before picking his pockets. It may fatten the
wage envelope, widen profit margins, jack up managerial compensation, but all
that is charged to the capital account. As long as there is a capital
account, that is. Trouble bursts on the economic scene when the bottom of the
capital barrel has been scraped clean. Of course, by that time it is too
late. Nothing can be done to stop the rot.
This is what we have
experienced in the fateful year of 2008. While the capital of the banking
industry was eroding, there was a feeling of euphoria, a sense of
weightlessness, the exhilaration of levitation as capital consumption has
given banking operations an extra lift in defying gravity. But no sooner had
the last crumbs of consolidated capital disappeared than gravity came back
with a vengeance and the banking industry fell out of the sky. All banks,
at the same time. It was not a consequence of local mismanagement. It was
not primarily a consequence of too lenient lending standards,
it was not primarily a consequence of reckless risk-taking. It would have
been a statistical oddity if all banks had bankrupted themselves at the same
time. There was a common cause: the erosion and ultimate destruction of
capital.
Recapitalizing banks
with irredeemable debt
The U.S. Treasury
has embarked on a policy of recapitalizing the banking industry with credits
based on issuing more irredeemable debt of the U.S. government. This
feeble-minded ploy has apparently been endorsed by the Obama team waiting in
the wings. It may well work for a time. More specifically, it may work as
long as foreigners continue to accept the irredeemable promises of the U.S.
government in exchange for real goods and real services. But since foreigners
are themselves in deep financial and economic trouble, concerted action of
central banks to use the irredeemable debt of the U.S. as the ultimate
extinguisher of debt is not promising, to say the least.
I am not predicting
that the world's payments system will collapse in a matter of a few weeks. I
can see a prolonged agony ahead for the dollar. The dollar is on a
life-support system, powered by the ongoing bull speculation in bonds.
Virtually all non-conformist observers predict that the bond market is doomed
and it is already on its last leg. They expect that bond values will fall
into the abyss, followed by the dollar. When economic forecasters show such a
high degree of unanimity, it is a warning that unfolding events will follow a
different script.
The sudden death of
the bond market is not a scenario that appears a likely outcome. Bond
speculators have been enjoying a bull market for 25 years. They are
well-heeled financially, sitting on mountains of paper profits. They are not
yet ready to cut and run. After all, theirs is the only bull market in town,
the only game of musical chairs still going strong, after the dot-com, the
real estate, the stock market games had the music stopped on them.
Madoff Economics
The 'grapes of
wrath' are ripening in Academia. Having exiled monetary science, agents of
Madoff Economics (alias mainstream economists) have exposed society to
untold dangers. All the people are going to be put through the wringer
indiscriminately. No one will be spared.
What means Madoff
Economics? It is the economics of "garbage in - garbage out". It
features the central economic doctrine of Keynes that capital is for
window-dressing purposes only. The smart guy does not need capital. The guy
who is even smarter can milk previously accumulated capital for his own
purposes.
For the first time
we shall witness global destruction of capital in an advanced economy. The
fabric of society is breaking down. Madoff Economics will continue to have a
monopolistic influence in the councils of government. Adventurers will
continue to be in charge, and will continue to display utter lack of
responsibility for the damage they are causing to society. The script will be
played out in full, to the bitter end. There will be no tabula rasa
after Inauguration Day. Pigs will continue running Animal Farm, making
monetary policy, until the fruit trees are picked bare of fruit, the barns
are swept clean of grain, with nothing left in the cupboards or in the cookie
jars.
Calendar of events
Szombathely, Martineum Academy, Hungary,
March 27-29, 2009
Encore Session of Gold
Standard University
Live.
Topics: Is There Life
after Backwardation?
Will the Gold Standard Be Released from Quarantine?
The Vaporization of the Derivatives
Tower
Labor and the Unfolding Great Depression
Further announcements will be made at the
website: www.professorfekete.com.
San Francisco School of
Economics, July-August, 2009
Money and Banking, a ten-week course based on the work of Professor Fekete,
who will be in attendance. TheSyllabus of this
course is can be seen on the website: www.sfschoolofeconomics.com.
Antal E. Fekete
Professor, Intermountain Institute of Science and Applied Mathematics,
Missoula, MT 59806, U.S.A.
Gold Standard University
DISCLAIMER AND CONFLICTS
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
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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.
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