An Economy Undermined by Failures of the Monetary System, the Concentrated Media, and Political Will
David Jensen is the Principal of Jensen Strategic a Vancouver-based strategic planning and business advisory services company.
With economic growth estimates for 2005 of 2.5% and 3.4% respectively, Canada and the US look forward to steady if not stellar growth of their economies in the coming year. The Bank of Canada notes for 2005 that "the prospects for continued robust growth are quite favorable" 1.
Yet all is not as promising as it seems. Central Banks (Canada's and the U.S.'s included), on false grounding in economics and using a monetary system based-upon an endless cycle of debt creation, have for decades maintained that the economy could be controlled by central planning and manipulating the amount of money and interest rates in the economy. This has allowed over-spending for massive government programs, unsupportable promises of future benefits to retirees, and costly military adventures all incredibly coupled with seemingly endless growth in consumers' net worth and consumption.
In a repeat of errors committed in the 1920's, failure of central bank monetary policy led to the 1990's dot.com stock market bubble and correction in 2000 which now reveals a distorted economy saturated with unsustainable and increasing levels of debt just to continue the economy. The post-bubble response of the US Federal Reserve Bank in lowering interest rates to 1% now leads to rampant and destabilizing financial speculative bubbles in the economy including the North America-wide real estate bubble.
We have a concentrated media in both Canada and the U.S, which has provided little critical analysis of economic policy choices, and a political ruling class most interested in short-term crises and solutions, which hand-off chronic but acute problems to the next elected official. The result is in that we have not had any accountability and correction of highly visible economic policy failures by our government and monetary authorities that have been visible for years. We are now on the brink of a strong economic correction likely impacting our populations for generations.
Immediate and bold remedial action by government is required to mitigate the impact of the coming correction.
Under the placid surface [of the economy], there are disturbing trends: huge
imbalances, disequilibria, risks -- call them what you will.
Altogether the circumstances seem to me as dangerous and intractable
as any I can remember, and I can remember quite a lot.
Paul Volcker, Former US Federal Reserve Bank Chairman 2
April 10, 2005.
If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers conquered
Thomas Jefferson
The Debate Over the Recharter of the Bank Bill, 1809
The above two statements were made almost 200 years apart, however, they have a common concern - the consequent damage from the manipulation of the money stock (i.e. the money that exists in society) for economic gain.
Economists and politicians have long known that increasing the money stock has the beneficial consequence of stimulating the economy. The initial short-term effect is that it increases the money available to be spent and invested which for a period increases economic activity. However, manipulation of the money supply has negative consequences which have damaged countries (including Canada and the U.S.) who travel down this road, including: Inflation. In simple terms, with a fixed amount of goods in an economy, increasing the stock or amount of money (called the "money stock" by economists) results in more dollars being available for a basket of goods, causing inflation (or a rise) in the price of goods. Damaging because it impoverishes those holding savings and those on fixed incomes, price inflation of goods in the economy has a further negative impact in that, once it starts to climb, hoarding behavior by consumers and businesses to forward purchase goods creates artificial shortages driving prices even higher in a damaging spiral. Once the inflation spiral is started, it can only be shaken from the economy through an economic slowdown usually induced by sharply higher interest rates. Investment bubbles and mania. Examples include:
• 1920's stock market mania leading to the 1929 Crash followed by the 1930's Depression;
• the 1989 Nikkei stock market and real estate bubble in Japan followed by a 15 year malaise in Japan; and
• the 1990's dot.com stock market bubble followed by its correction in 2000; a market bubble and crash which created by and has now been so mal-addressed by the US Central Bank (the Federal Reserve or "Fed") that we face our impending economic correction Inevitable internal economic distortion resulting in growing imbalances which ultimately correct with economic busts, deep recessions and depressions.
It is the last item which politicians, central bankers, and economists popular in the political realm have denied is a consequence of their centrally-planned monetary control.
Readers in Canada or the U.S. will likely not have a concern regarding the current economy - however, as Chairman Volcker notes, large distortions exist beneath the surface which will manifest themselves. These distortions and coming correction are visible to our political leaders, but while Volcker notes that urgent action is needed, he also notes governments tend to react after the fact - which in this case will impart great damage to the both the U.S. and Canada.
The coming economic fall-out now militates that the damaging, anachronistic centrally-planned attempts by central banks and politicians to steer the economy using the monetary system must be curtailed.
Jefferson's Insight
If we read Jefferson's comments with today's definition of inflation and deflation, it makes little apparent sense. However, the meaning of the words "inflation" and "deflation" have changed over time so that they now mean, respectively, an increase or decrease in consumer goods prices. In their more classic economic sense, inflation refers to an in increase in the money stock (cash and debt) outstanding in the society. Deflation refers to a decrease in the money stock.
Jefferson's warning now becomes a little clearer. History is riddled with monetary inflation accompanied by uneconomic activity, speculative booms, and investment mania, all resulting from the excess inflation of the money stock, followed by crashes. There is nothing surprising or even unreasonable about market speculation - so long as one realizes the dynamic causing the speculation and limits exposure be it real estate, equities, bonds, interest rate derivatives, and other financial instruments. However, few retail investors do understand when a bubble is underway and the top usually occurs after the flow of new credit or increases in the money stock starts to slow - a visible signal within the financial system but not to the average investor.
Extraordinary Popular Delusions and the Madness of Crowds3 was initially published in 1841 and documented excess credit and money creation inducing trading bubbles and collapses such as the Dutch Tulip Mania (Holland - 1630's), John Law's Mississippi Scheme (France - 1720 : a stock market bubble engulfing France induced by massive inflation (or debasement) of France's money stock), The South Sea Bubble (England - 1720 : investment mania where even Sir Isaac Newton lost his family fortune), etc.
In a more recent work4, Edward Chancellor documents more than a dozen historical and contemporary monetary and credit booms that drove speculative mania including the 1920's stock boom, the late 1980's Nikkei stock market and real estate boom in Japan, and the 1990's dot.com stock market bubble in the US.
The excess which can be attained during an investment bubble are well illustrated by the following words from an investment prospectus to raise money during the South-Sea Bubble of 1720: "A company for carrying on an undertaking of great advantage, but nobody to know what it is."5
Creation of investment bubbles and their subsequent crashes are directly and obviously negative as they simply result in the transfer of wealth from the public to those promoting investments (such as through Initial Public Offerings (IPO's) of a stock ) during an investment bubble. Thus, the phenomenon of speculative boom and bust acts as a "wealth ratchet". The financial industry, speculators, stock industry promoters and traders make enormous profits on the ascent stage and, if savvy, can roll-out of investments with gains into cash or other stable asset positions before a correction, then buy assets at prices of pennies to the dollar in the subsequent bust when investors must liquidate assets to settle losses.
Key bankers, politicians, and Wall Street traders wanted the creation of the U.S.'s central bank in 1913 and worked through a White House insider Edward Mandell "Colonel" House to see the Federal Reserve Act developed and passed. (Colonel House was a wealthy Texas patrician who had never served in the military and whose family fortune was acquired by his father in the South during the American Civil War.) Although called the Glass-Owen Bill (after Congressman Carter Glass and Senator Robert Owen), the Federal Reserve Act was the creation of President Wilson's point-man on banking matters, Colonel House.
The immediate effect of the creation of the new central bank (The U.S. Federal Reserve Bank) to control the money supply was the price inflation of 1914 to 1920, then the 1920's stock market mania and crash of 1929 which revealed that average citizens who were skeptical of the wisdom of creating a central bank were correct. That the Fed caused the stock market bubble resulting in the crash of 1929 and the Great Depression is not argued by today's supporters of the Fed. In 2002, at the 90th birthday party for famed economist and monetarist Milton Friedman, then Fed Governor Ben Bernanke commented "You were right, we did it. But thanks to you we won't do it again."6 Whether the Fed and other central banks can prevent another financial rupture is a question on which the jury is still very much out.
Our "Stable" Economy - Stable or a Redux to Another Apparently Stable Time?
So what is former Chairman Volcker's concern today? The economy is healthy: inflation is apparently low, the stock market has corrected to lower stock price to company earnings (p/e) ratios, the housing market is booming, we are looking forward to further growth: what's the problem?
First, The US (and in fact the World's) economy is still very much in recovery from the dot.com stock market crash of March 2000. As we will see, Mr. Greenspan's declared victory when stating "we were very much correct in our decision to address the after-effects of the bubble rather than the bubble itself" may have been a little premature.
The stock market bubble of the late 1990's was a textbook recreation of the 1929 bubble and the late 1980's Japanese Nikkei stock market and real estate bubble. They all relied upon the creation of excess credit in turn brought about by excessive monetary policy of central banks (note that money enters the economy as loans from banks to borrowers. Increasing the money stock therefore means increasing the debt level in the economy).
The origin of the 1920's stock market bubble, notes Economist Murray Rothbard was that, in order to "assist" Britain in artificially maintaining the strength of its currency while it was in economic decline, America increased its money stock by an average of 7.7% annually over an 8 year period from 1921 to 1929. In his words, it was "a very sizable degree of (monetary) inflation"7 and "the entire monetary expansion took place in money substitutes which are products of credit creation... The prime factor in generating the (monetary) inflation of the 1920's was the increase in the total bank reserves."8
Yet, like today, while the 1920's economy roared ahead, consumer price inflation was apparently tame while the stock market appeared "reasonably" priced. Rothbard notes "The fact that general prices were more or less stable during the 1920's told most economists that there was no inflationary threat, and therefore the events of the great depression caught them completely unaware."9 Economists who support manipulation of the economy by varying the money stock and interest rates are dubbed "monetarists". The father of modern monetarism and the Quantity Theory of Money, which is the basis of central bankers' expansion of the money supply, is Irving Fisher, who was himself so enthused a...