Deep Politics Monitor: February 17, 2012

Feb 17, 2012

Discussing Interest and Gold with the Daily Bell

From Real Currencies Blog, December 29, 2011:

The Daily Bell responded to an article on the Banker’s love for Gold, published on Henry Makow’s site.

They make a number of important points, which I will address one by one for clarity’s sake.

But first allow me to address a few minor issues:
Daily Bell: “From what we can tell, Mr. Migchels is something of what might have once been called a “greenbacker” – in US parlance. What that means, near as we can tell (regarding Migchels), is that he wants money to be publicly issued without interest”

This is only partly true. I’m not sure that Government is the best entity to provide the money supply. In fact, I believe a free market for currencies, with or without the Government partaking in it, is probably the best approach.
I am, however, completely convinced that if the Government insists on a monopoly, it should never ever surrender this monopoly to a Private Central Banking Cartel.
I’m also firmly convinced that if Government insists on printing money it should do so either in the form of debt free units, or interest free credit.

Because, and that is the basic discussion, Austrian Economics ignores redistribution of wealth from poor to rich through interest. They only see how inflation allows the Plutocracy to rob the middle classes.

I am not “generally dismissive” of Austrian Economics. I think it makes a great case for Free Markets. Austrian Economics has been indispensable in exposing Fractional Reserve Banking. These are wonderful accomplishments.
I do believe ignoring the problems of interest and explaining it away as a normal free market pricing operation is wrong, as discussed further below.

Followed by:
“Nonetheless, we admire Mr. Migchels’s imagination and courage in setting up an alternative monetary system that is actually gaining traction in the Netherlands. We simply and profoundly disagree with the concept.”
I assume they disagree because the Daily Bell believes I’m creating interest free currency for or through Government. I’m not. The Gelre is a privately controlled currency, competing with Euro in the marketplace. As long as one doesn’t break the law, it is not illegal to float your own currencies. Not in Europe, not in the US, see the Berkshares.
So the Gelre is a purely free market solution to the problem.

Furthermore, I do have a problem with the Greenbacker thing. Not because I consider the term derogatory, I don’t, but because the Greenback was a certain system. Debt Free paper money spent into circulation by Government.
This is probably the worst approach available to Government, although it still is much better than allowing a Private cartel to monopolize money. The Greenback is better because it is interest free, saving the taxpayer the 700 billion per year the Federal Government currently loses to debt service.
But it is far from perfect. Government will inflate, Austrian Economists are right on that. Furthermore, Government will use it’s prerogative to spend it into circulation to finance wars and other Plutocracy pet projects.

That’s why Social Credit is much better. It is a Greenback, spent into circulation by the people, not Government. The people know better where to spend the money. Most importantly, the Government no longer has an incentive to inflate the money supply: they would not be able to spend it themselves and the people are fully compensated for inflation by the fact they spend the inflationary cash themselves.

Public Banking suggests an interest free credit money supply. So not the debt free Greenback.

Bill Still is probably the most famous ‘real’ Greenbacker. But I would only support him as the lesser evil, although it was his brilliant film “the Money Masters” that got me into this business.

Now, to the main issues.

InterestOf course, the Daily Bell is right to say that people have a right to ask for interest, as much as they have a right to either accept interest on a loan they want. Nobody is suggesting we should outlaw it. The challenge for interest free currency is to make it superfluous. By providing interest free credit. Nobody will ‘choose’ to take out a loan with interest, if they can get one without.

The Daily Bell concludes: “And so we would ask, in closing this article, what does the issue of interest matter if one is determined as Mr. Migchels and Ms. Brown are to put the issuance of money in human hands? It is not interest that will prove the ultimate problem but the VOLUME and VALUE of money itself.”

This is the basic discussion. The volume is an issue. We agree that the Money Power uses the boom/bust cycle and inflation to rob the middle classes. The matter of volume not that of interest: the boom/bust cycle and inflation are results of manipulating the quantity of money. Interest is also a means to that end, but not the most important one.

The manipulation of the quantity of money must end. There are two ways of doing this and they should both be pursued. The first is, that the middle classes are wrong to hoard paper assets. They never should. Paper is a good means of exchange, but a very bad store of value. If the middle classes understood this, they would not be destroyed by inflation. The second path is more obvious: the manipulation of the volume of money must end. And yes, the free market is probably the best guarantor of that.

However, the idea that the volume of money is THE problem is completely wrong. If there is a THE problem, its interest, with the volume being a good second.

And real monetary reform, if it is to end the slavery to the Money Power, must solve both.

I comprehensively dealt with the interest issue here, here, and here. It is concise, but too long to repeat here.

The basic problem is, that interest is a wealth transfer from poor to rich.
The rich have money and lend it out to the poor, who pay interest to the richer classes.
The poorer you are, the greater the part of your income you lose to interest.

It transpires that the poorer 80% pay more interest than they receive. The middle classes are to a large extent compensated for their losses to the rich from what they receive from the poor. But the poor suffer horribly from interest: when you own zero net assets, you lose 45% of your income to interest. Because of capital costs included in prices. Just think about that, it’s huge. And invisible.
At this point 50% of Americans own zero net assets or less. Globally the situation is even worse, and interest truly is a Global phenomenon.

Only the richest 10% receive more interest than they pay.
But even they pay considerable amounts to the richest 1%. And even within the richest 1% the redistribution continues: the poorest 0.8% pay interest to the richest 0.1%.

This is what explains the incredible centralization of wealth at the top of the food chain. This is the interest drain.
And all this money over time inexorably ends up at the absolute top of the pyramid.

All this was established through research by Professor Margrit Kennedy, a leading interest free currency activist and intellectual leader of the German RegioGeld (Regional Currency) Movement. There are dozens of regional currencies in Germany, they have sprung up since the Euro was introduced. They all aim to reduce capital costs and capital scarcity.

The Problems of Gold in a Free Market

Because of the interest issue, it should be clear that Gold is absolutely unacceptable as a currency monopoly. If Gold is the only allowed means of exchange, interest free credit would be impossible.
The Daily Bell is not in favor of a Gold monopoly. Neither is Gary North.
The ‘Why Bankers Love Gold’ article was aimed against a Gold Monopoly and the Daily Bell recommends a free market for currencies, which they expect to be dominated by metal backed currencies. Of course, in practice it would all be paper, plastic, and bits and bytes. The question is, what is backing these tokens.

However, they are surprised by the notion that Gold would not hold up in a free market for currencies. In response to a comment by Memehunter, quoting my article on Gary North, they elaborate on why they think I might be wrong.

They suggest that Gresham’s Law does not apply: “As we pointed out before, this is a misconstruing of Gresham’s Law. Gresham’s Law only applies to tender manipulated via government compulsion: ” ‘When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.’ It is commonly stated as: “Bad money drives out good”, but is more accurately stated: “Bad money drives out good if their exchange rate is set by law.”

However, the source for this info is Wikipedia, and I don’t believe the Daily Bell will blame me for not accepting that as Canon Law.
It may be true that this was the situation at Gresham’s time, but it is clear that his observation is true always when different units circulate side by side and one of them is overvalued. Or losing value.

Its simple to establish. What will you pay with, if you have a choice: Federal Reserve Notes or your Gold Coins?
I think everybody knows the answer to this question.

But then the Daily Bell says it is not the payer who matters, but the seller, and he’ll prefer Gold:
” It is not a question of what people will prefer to PAY with. It is a question of what the SELLER DESIRES. Migchels would seem to have it reversed. If you want to make a purchase in a free-market economy, absent monetary coercion, you will need to accommodate the wishes of the seller. And we would argue that any seller would likely be more comfortable selling his goods or services for for notes that are backed by gold or silver rather than notes that are simply backed by the issuers stated willingness to pay. It seems like common sense to us.”

But is this really so? I’d suggest firms accepting only Gold would have a major problem in the face of competitors accepting both paper and Gold. The initiative is with the consumer and the firms accommodating them will prevail.

Let’s also keep in mind that very few people own Gold.

So the seller won’t be able to dictate the means of exchange. Only in the endgame of hyperinflating currencies could he plausibly not accept them.

Another crucial aspect to consider is the price of credit, interest. Clearly, if in a free market where Mutual Credit Facilities offer mortgages at 0% interest, it would be difficult both for Gold and Banking currencies.

Concluding

The goal of monetary reform, as I see it, is to free people and the commonwealth from the enslavement to the Money Power.

Interest is the biggest issue, followed by the boom/bust cycle. Both must be addressed to free people from economic slavery. And this slavery is real, as witnessed by the incredible fact that people who own nothing, which is the vast majority of the globe’s population, lose 45% of their disposable income to capital costs included in prices we pay for our daily needs. All this money is inevitably all sucked up by the absolute top of the pyramid.

It is because Public Banking and Social Credit profoundly dampen the interest drain to the Plutocracy that they are such important models, vastly superior to the current ways.

Even better is a combination with a free currency market. In it Gold will play a role as a store of value only. It will not finance many transactions and will therefore not be very important for the economy at large.

Update 1/1/2012: Go here to find out how it all ended.

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A Greenbacker Invents a Nut-Case History of Libertarianism

Is Ron Paul a Reptilian? Austrian Economics, Religion and Devils

From The Daily Bell,

Ron Paul's Masonic Jewish Economics ... Whether or not a currency is backed by gold makes no difference. As long as we pay interest, it is still Masonic Jewish (i.e. Illuminati) economics. The real alternative is interest-free currency. – HenryMakow.com

Dominant Social Theme: Austrians are the devil?

Free-Market Analysis: In his latest musings on Austrian economics, money-entrepreneur Anthony Migchels seems to make the case that Austrian economics may be part of a Zionist plot to impose one-world government.

Now, we have pointed out that Anthony Migchels, like "greenbacker" Ellen Brown, is certainly an energetic and eloquent spokesperson for the view of a kind of money-from-nothing. He believes that money ought not to be backed by commodities and that "people" ought to control money rather than "banksters."

Whatever else Anthony Migchels is doing, he is certainly livening up the debate over Austrian economics in an unexpected way and Henry Makow has given him a platform to do it. He is quite an entrepreneur and quite a commentator ...

But in this latest article, Mr. Migchels offers up the idea that Austrian economics is infected by Masonic Jewish interests. The implication is that because Austrian Murray Rothbard and his mentor, Ludwig von Mises, were Jewish and (in the case of Mises) received some money from Rockefeller foundations, they are part of a Masonic plot to create a one-world order using the Austrians' favorite money metal, gold.

Why use the religion of people to characterize their arguments? And is everyone who receives Rockefeller money a Zionist? This is the reason we have made the case repeatedly that characterizing the one-world conspiracy as "Zionist" may DISTRACT from the reality of what is occurring.

A kind of mafia evidently runs the world behind the scenes today. The mafia uses the Jewish people in particular and hires Jewish people to help in its goal of creating global governance. This is no different in our view than the way the Italian Mafia operated in the US. The mafia/cabal USES religion. In fact, in our view, the cabal SEEKS anti-Semitism and wishes to whip it up.

It is evident and obvious (to us anyway) that Austrian economics' theoretical underpinnings are sympathetic to free banking and competitive currencies. Even Murray Rothbard acknowledged that in his historical work. And later in life he apparently acknowledged free banking as well.

But to characterize Austrian economics as part of a Jewish plot to create a Hegelian dialectic to move the world closer to a New World Order seems to us to disregard – or casts into doubt – significant insights of Austrian economics.

It is true that ANYTHING may serve the power elite as a tool to create a Hegelian Dialectic. But everything we have observed about Austrian economics over the past 25 years leads us to believe that the elites in no way wished to acknowledge Austrian economics publicly much less make it part of a larger debate. (Perhaps they are moving to do so NOW, but that's a different issue altogether.)

Was the DEVELOPMENT of Austrian economics part of an elite manipulation? Austrian economics is rooted generally in the evolving economics of the past millennium and stands athward modern infections such as economectrics and Keynesianism.

Its history can be traced back to Jesuits in Spain centuries ago, to the French who opposed Napoleon's state-planning, to the Renaissance's renewed interest in science, to the Scottish "Enligthenment" including Adam Smith andDavid Hume, to Carl Menger's initial conceptualization of marginal utility, the dividing line between classical and neo-classical economics, to Ludwig von Mises' insights into human action, etc.

Is this really an elite manipulation? Don't ignore, please, the insights that this discipline provides to us, insights that buttress freedom.Marginal utility shows us that only the market can determine price accurately. Human action shows us that only people by their own free will can determine their futures and the futures of their loved ones.

The alternative to marginal utility and human action seems simple to us: It is the State's merciless Leviathan. Why make a case for authoritarianism? Why seemingly denigrate concepts that show us logically that freedom is preferable to slavery and free markets are preferable to totalitarianism?

Mr. Migchels writes: "All this has become relevant because of Ron Paul, of course. He is not the man Patriots think he is. In 2001, he said, 'There's nothing to fear from globalism, free trade and a single worldwide currency ...'."

In fact, it seems to us that free-market orthodoxy buttresses Ron Paul's remarks. Absent government, the free market itself would likely create a kind of free-trade and universal money. Probably some sort of private gold and silverstandard. That's a far cry from IMPOSING one.

Ron Paul, given his background and beliefs, was merely observing what the free market is capable of doing. It can create a peaceful and prosperous world that includes lots of voluntary commerce. The DIFFERENCE between Ron Paul and the globalists is that he wants to create prosperity via freedom. Globalists want to create one world via force.

It is true that within this context Ron Paul speaks of commodity money. But he speaks of its VOLUNTARY acceptance. And in recent years, Ron Paul has been very careful to speak of money competition. He simply believes that gold will win out. Mr. Migchels, Ellen Brown and others seem to have a different point of view. They believe in fiat. (OK ... May the best money win! Within a free-market system, of course.)

Mr. Migchels, who has founded his own "social credit" monetary system in the Netherlands, writes, "Social Credit is the best debt-free currency I know: it's a Greenback created by Govt, given to the people to spend into circulation, instead of Govt. In that way, the money is located at the base of the supply line. People know where to spend the money better than govt."

At its root, at its heart, does social credit use some sort of government force to initially implement its facility? Of course, another question is: Who is doing the printing for social credit money and HOW MUCH MONEY IS TOO MUCH?

Only the free market can determine the quantity and value of money, in our view. Anything other than the free market must lead to inflation and then price inflation. If government is doing the printing, then there is no "governor." The volume of money will likely always exceed what is necessary.

Thus the argument is NOT between gold and fiat. The Austrian argument is ineluctably between free banking (money competition) and those who seem to favor some sort of state force to implement various monetary schemes.

Will social credit win the day by offering its benefits WITHOUT government force and without interest? It seems to be almost too good to be true. All products, to the best of our knowledge (and money is a product), have a cost involved. Interest recognizes these costs.

Conclusion: Why argue that Austrian economics is part of a larger Zionist plot? Modern Austrian theory abjures the force of government and is fairly anarchical in its presentation. Isn't that what all those fighting against global governance claim to endorse?

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Breaking: $6 Trillion In US Bonds Seized In Zurich, Said To Pose "Severe Threats To International Financial Stability"

From zero hedge By Tyler Durden

Back in the summer of 2009, a peculiar story circulated when two Japanese individuals were arrested trying to smuggle $134 billion in US bonds into Switzerland from Italy. The story quickly died down after it was subsequently reported that the bonds were merely fake bearer bonds. Nobody heard much about it since then. Until today, when out of the blue we get a new story which blows that one out of the water. According to Bloomberg, "Italian anti-mafia prosecutors said they seized a record $6 trillion of allegedly fake U.S. Treasury bonds, an amount that’s almost half of the U.S.’s public debt." From here the story just gets weirder: "The bonds were found hidden in makeshift compartments of three safety deposit boxes in Zurich, the prosecutors from the southern city of Potenza said in an e-mailed statement. The Italian authorities arrested eight people in connection with the probe, dubbed “Operation Vulcanica,” the prosecutors said. The U.S. embassy in Rome has examined the securities dated 1934, which had a nominal value of $1 billion apiece, they said in the statement. Officials for the embassy didn’t have an immediate comment." ...And weirder: "The individuals involved were planning to buy plutonium from Nigerian sources, according to phone conversations monitored by the police." ...And really, really weird: "The fraud posed “severe threats” to international financial stability, the prosecutors said in the statement." Ok great, however one thing we don't get is just how can $6 trillion in glaringly fake bombs be a "threat to international financial stability."

More from Bloomberg:

The financial fraud uncovered by the Italian prosecutors in Potenza includes two checks issued through HSBC Holdings Plc in London for 205,000 pounds ($325,000), checks that weren’t backed by available funds, the prosecutors said. As part of the probe, fake bonds for $2 billion were also seized in Rome.

HSBC spokesman Patrick Humphris in London declined to comment when contacted by telephone.

Phony U.S. securities have been seized in Italy before and there were at least three cases in 2009. Italian police seized phony U.S. Treasury bonds with a face value of $116 billion in August of 2009 and $134 billion of similar securities in June of that year.

The U.S. Secret Service averages about 100 cases a year related to bonds and other fictitious instruments.

As a reminder, total US debt in circulation is just over $10 trillion. So if the allegedly "fake" bonds were sufficiently threatening to put international financial stability at risk, just what is going on here?

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Updates:
All in the “Dragon” Family?

CONFIRMED: The Trillion-Dollar Lawsuit That Could End Financial Tyranny

Why Were The Trillions In Fake Bonds Held In Chicago Fed Crates?

$6 Trillion in US Bonds: Part of the Collateral for the Stolen Treasures of the Chinese Emperors?

Box History

Henry Blodget, "the reason we have zero-percent interest rates is to bailout the banks"

From CapitalAccount 16 Feb 2012:
The rating agency moody's has warned it is considering downgrading the investment banking world's biggest players -- this includes Bank of America, Goldman Sachs, JP Morgan, Morgan Stanley...the list goes on and on. I like the way the Wall Street Journal put it: "Moody's is worried about everything in investment banking." And speaking of worries -- Art Cashin of UBS in his note this morning says traders are worried about a Greek default, but not for the reasons that you may think. What they are really worried about isn't the bond holders, but the guy's holding the insurance: the credit default swap (CDS) market. Wait, we thought everyone was perfectly hedged? So what kind of risk is really lurking in the US banking system then, and what could it do to an economy on zero percent interest rate life support? Well, our guest Henry Blodget may have an answer to that. He is CEO and founder of Business Insider, and is with us to talk about this, as well as the subject of a recent article of his titled "Dear Walmart, McDonald's, Starbucks: how do you feel about paying your employees so little that most of them are poor?" Henry makes a fair point in this article, but if it's true that CEO's and executives are paying their employees so little, then why are we so worried about taxes and not focused on the deterioration of wages in America? Henry Blodget points out that Henry Ford made a point of paying his workers better than other firms with the added hope that they could eventually be not just the producers, but also the consumers for his own products: his automobiles. And is the solution to our economic disease a forced redistribution of wealth through taxes, or is there something more fundamentally and structurally flawed at work here that is responsible for the inequities in today's wealth? How important is the banking sector in all of this, and how can a banking sector that is so corrupt and so broken possibly play a constructive part in bridging these tremendous gaps?

Follow us @
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http://twitter.com/coveringdelta
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Related:
Could Moody's and the Greek CDS time-bomb take down the "Goodfellas of Wall Street?"

Completed ECB Bond Exchange Is "Biggest Screwing Of Our Lives"

Money, Banking and the Federal Reserve

From mises.org, FEBRUARY 16, 2012:

Steeped in American history and Austrian economics, this extraordinary film is the clearest, most compelling explanation ever offered of the Fed, and why curbing it must be our first priority.

Thomas Jefferson and Andrew Jackson understood "The Monster". But to most Americans today, Federal Reserve is just a name on the dollar bill. They have no idea of what the central bank does to the economy, or to their own economic lives; of how and why it was founded and operates; or of the sound money and banking that could end the statism, inflation, and business cycles that the Fed generates.

Dedicated to Murray N. Rothbard, steeped in American history and Austrian economics, and featuring Ron Paul, Joseph Salerno, Hans Hoppe, and Lew Rockwell, this extraordinary new film is the clearest, most compelling explanation ever offered of the Fed, and why curbing it must be our first priority.

Alan Greenspan is not, we're told, happy about this 42-minute blockbuster. Watch it, and you'll understand why. This is economics and history as they are meant to be: fascinating, informative, and motivating. This movie could change America.

(NTSC format for DVD) or (NTSC format for US VCRs)

From: Documentaries , Tuesday, March 02, 2004 by Mises Institute

Available for download as Wmv , Mp4 .

Battlefield USA 2012: Gerald Celente on year's top trends

From RT, 16 Feb 2012:

Gerald Celente, the founder of the Trends Research Institute gives RT's Marina Portnaya his predictions for the headlines of tomorrow. OWS movement, US presidential elections, economic embargo on Iran are among the issues discussed.
RT on Twitter http://twitter.com/RT_com
RT on Facebook http://www.facebook.com/RTnews

On the rhymes of bubble cycles an the "bang point"

From globaleconomicanalysis FEBRUARY 16, 2012

By Mike "Mish" Shedlock

John Mauldin posted an extraordinary interview by Kate Welling of Dr. Lacy Hunt, the chief economist of Hoisington Investment Management.

Dr. Lacy Hunt correctly identifies fractional reserve lending as the culprit behind the massive rise in debt. Hunt also explains why government spending cannot help, why Europe is in worse shape than the US, why a US recession is coming, and why Ben Bernanke is an exceptionally poor student of the great depression.

The entire PDF is a lengthy 29 pages, but well worth a read in entirety.

Here are some pertinent snips from "Face The Music".

Face The Music
Road Back To Prosperity Is Through Shared Sacrifice, Says Lacy Hunt.

Kate: Happy New Year, Lacy. And thanks for sending all those charts to background me for our conversation. I have to say the first one stopped me — showing debt as a percentage of U.S.

Lacy: If you confine your analysis to post-war period, you only have one major debt-dominated cycle and that’s the one we’re currently in — and have been in for a number of years. But if you go back far enough, you have three more. You have the 1820s and 1830s. You have 1860s and 1870s and then you have 1920s and their aftermath. Sometimes it’s essential to take your analysis back as far as you possibly can.

Kate: Doesn’t your second chart, on the velocity of money [below], show how none other than Milton Friedman was misled into thinking that it was a constant because he only looked at post-war data?

Lacy: That’s correct and, in fact, I was misled along with him because I was also doing analysis based on the post-war data. Friedman’s period of estimation was basically from the 1950s to the 1980s. Well, if you look at the velocity of money in that time period, it’s not a constant, but it’s very stable around 1.675. So if you tracked money supply growth then, you were going to be able to get to GDP growth very well. Not on an individual quarterly basis, but even the individual quarterly variations were not that great. Until velocity broke out of that range after we deregulated the banking system. Now, velocity is breaking below the long-term average and it’s behaving exactly like Irving Fisher said, not like Friedman said, absolutely.

Kate: What a perfect example of the difference your frame of reference can make.

Lacy: Keynes and Friedman both felt that The Great Depression was due to an insufficiency of aggregate demand and so the way you contained a Great Depression was by your response to the insufficiency of aggregate demand. For Keynes, that was by having the federal government borrow more money and spend it when the private sector wouldn’t. And for Friedman, that was for the Federal Reserve to do more to stimulate the money supply so that the private sector would lend more money. Fisher, on the other hand, is saying something entirely different. He’s saying that the insufficiency of aggregate demand is a symptom of excessive indebtedness and what you have to do to contain a major debt depression event — such as the aftermath of 1873, the aftermath of 1929, the aftermath of 2008 — is you have to prevent it ahead of time. You have to prevent the buildup of debt.

Kate: And that your goose is cooked if you don’t you cut off the credit bubble before it overwhelms the economy?

Lacy: Yes, and Bernanke is thinking that the solution is in the response to the insufficiency of aggregate demand. That was Friedman’s thought. That was Keynes’ thought and most of the economics profession has traditionally thought the same way. They were looking at it through the wrong lens. Fisher advocated 100% money because he wanted the lending and depository functions of the banks separated so we couldn’t have another event like the 1920s.

Kate: You’re saying that Fisher argued against fractional reserve banking?

Lacy: Yes, and so did the people that more or less followed in Fisher’s footsteps, principally Charles Kindleberger and Hyman Minsky. Minsky felt that the way you prevented a major debt deflation cycle was to keep the banks small.

Kate: Prevent them from ever becoming too big to fail in the first place?

Lacy: Right. Don’t let them merge. You don’t want them to get big. I actually gave a paper with Minsky once, in 1981, in which he advocated that position. Kindleberger was very precise in “Manias, Panics, and Crashes,” when he said that when you have a small credit problem, or many small problems, some say, you don’t want the Federal Reserve to respond. Because if the central bank comes in and bails out a small problem, then that will be a sign to those who want to take more risk that they don’t need to be cautious — they can always count on the central bank to come in and bail them out. If they do, Kindleberger said — and this was in ’78 — then the future crisis will be even greater. “A free lunch for speculators today means that they’re likely to be less prudent in the future. Hence, the next several financial crises could be more severe.”

Kate: Once again, we didn’t prevent the excessive buildup of debt, so now we have to deal with pressing deflationary forces.

Lacy: That’s why Fisher wanted to segregate the lending and deposit-taking functions of the banks.

Kate: Does that sound a mite like Paul Volcker, daring to suggest banning the banks’ speculative proprietary trading activities — and getting nothing but grief from the industry for his efforts?

Lacy: Well, that’s right. Fisher couldn’t get it done, either. And warned that we would do it again. I had a brief acquaintance with Kindleberger; I didn’t know him well, but I knew him and he was helpful to me. He taught Ken Rogoff. And, in fact, “This Time, It’s Different” is really a quantification and verification of a lot of the qualitative themes that Kindleberger expressed. My sense was that Kindleberger thought that once the economy got into over-trading, there was no one who was going to stand in its way.

Kate: Over-trading?

Lacy: That was the old-timey term that Kindleberger used. He said there are three phrases of behavior as you move toward manias, panics, and crashes. The first phase is over-trading, where you start buying assets at prices far beyond their fundamentals. People enjoy this phase, because initially it boosts income and raises wealth and so forth. So it becomes very irrational. Then you get to what he called the discredit phase, where the smart people start pulling their funds out. Then you get what he called revulsion. The classical economists used those terms: Over-trading, discredit, revulsion. As I said, I got the impression from Kindleberger that once you get into that over-trading phase, there’s no one who is going to stand in the way of it.

Kate: Why stand in front of a freight train?

Lacy: Especially when it doesn’t seem to be in anyone’s interest to stand there. Regulators, banks, companies, investors, everybody’s having a good time; profits are being made, employment is strong.

Kate: So we’ve just seen.

Lacy: No one dealt with the credit excesses in the subprime market, until the crisis hit. And no one dealt with the excessive speculation in the financing of the railroads in the middle of the 19th Century, or in the financing of the canals and turnpikes and steamship lines in the 1820s and 1830s. Nor did anyone step in to try to stop the foolishness that was going on in the 1920s.

Kate: I noticed you picked something Bernanke wrote to illustrate conventional wisdom

Lacy: Bernanke rejected Fisher and Kindleberger in his book, “Essays on The Great Depression.” And notice that he doesn’t reject Fisher because he says Fisher’s data is flawed. He doesn’t reject Fisher because Fisher’s argument is flawed or Kindleberger, either. He rejects them because an excessive buildup of debt implies irrational behavior.

Kate: Well, hello!

Lacy: That’s the world I live in. You, too, probably.

Kate: To mention that what can seem rational on an individual level can be irrational when an entire economy does it.

Lacy: We see it all the time, every day of every week. And yet Greenspan’s rejection of the danger of an excessive buildup of debt in his book put him in a different mindset, not just in evaluating the events of the 1930s, but when it came to understanding what was going on in the early part of this century, up to 2006 and ’07. Because he thought he could respond to a debt problem and contain it. But that was not at all what Fisher taught. Fisher said you have to prevent a debt deflation ahead of time. That’s a very powerful, critical, difference. What Fisher is saying is that once you get into this extremely over-indebted situation, and the prices of assets begin to fall, these two “big bad actors,” those are the terms he used, control all or nearly all other economic variables. Then, if you attempt to respond to the problem by leveraging further, it’s counterproductive. That’s the term Fisher used in one of his letters to FDR expressing concerns about deficit spending.

Kate: Debt becomes cancerous.

Lacy: That’s right. Carmen Reinhart and Rogoff wrote in their paper for the NBER called “Growth in a Time of Debt.” They found that after you get above 90% of debt to GDP that you lose 1% off the median growth rate, and even more off the average growth rate. So it’s clear that debt plays a major role in the economy. Most of the time, it is a benign factor, but you get these irregular intervals in which debt builds up excessively. And, once it has built up excessively, it’s a controlling influence for a long time. Plus, you cannot solve that over-indebtedness problem by getting deeper in debt. That’s the problem.

Kate: True, but you can postpone it a while.

Lacy: The point is that it doesn’t really matter whether you’re using the Federal Reserve’s monetary tools to get the private sector to leverage up or whether you’re engaged in deficit spending at the federal level to try to address the insufficiency of demand. Both tacks take you in the wrong direction. Now, what we’re beginning to understand — at least with regard to governments, because we have known this is true for the private sector for a long time — is that there comes a point in time at which additional debt is no longer available. That’s where a lot of countries in Europe are. And that is probably where we’re going in a number of years. We’re not there now, but that’s where we’re headed. We spent $3.6 trillion last year at the federal level. We borrowed around 35% of that and we had tax revenues to cover around 65%. Some of the European governments are trying to borrow more than that ratio, and it’s being denied to them. Reinhart and Rogoff call that the “bang point.” When that happens, your spending levels then have to fall back to your tax revenues. That’s where we’re headed unless we correct the problem. It’s obviously going to get greater, because we have built-in guaranteed increases in our obligations under Social Security and Medicare. That’s why I also sent you a passage from Exorbitant Privilege, by Barry Eichengreen. He’s a Yale Ph.D., taught at Harvard many years, Cal Berkeley. In the last three years, federal outlays have averaged 25% of GDP, which is the highest three-year period since 1943 - ’45, when we were in a multi-continent war. What Dr. Eichengreen is saying is that federal outlays are going to go to 40% of GDP within 25 years, without major structural reforms.

Kate: Just based on the programs in place and demographics?

Lacy: Yes. To him, that means that the current laws cannot remain unchanged and I agree with him. I don’t think you can transfer an additional 15 percentage points of GDP to the government. There’s no practical way that we can do it. But the political process doesn’t seem to want to respond in advance, so it’s very difficult to see how this is going to work out in any salutary way.

Kate: Let’s put some numbers on this. The first chart you sent me [first chart] shows total public and private debt in the U.S. approaching 400% of GDP.

Lacy: Yes, that’s the conventional approach, using publicly held federal debt as the measure of government debt. But that, in my opinion, is really not appropriate. The more appropriate measure is really gross federal debt. [chart immediately above].

Kate: And the difference is that the gross figure includes debt held in intragovernment accounts?

Lacy: That’s correct. But what Dr. Eichengreen is saying, and I agree, is that even that gross debt number is not really sufficient because we’ve also got $59 trillion, at present cost, of unfunded liabilities in Social Security and Medicare. We have about $52 trillion of current debt, public and private, the way I measure it. We have about $15 trillion in annual GDP. So if you substitute the gross government debt for the privately held debt and if you use the IMF’s projections for the increase in gross government debt going forward and you assume private debt-to-GDP stays flat, well, we’re going to new peak debt levels in the next several years.

Kate: And we’re not the only nation in this fix.

Lacy: The situation in Europe is worse. I put together some charts that are interesting; took a lot of effort, anyway. If you look at U.K. debt, public and private [1st chart below] it’s 100 percentage points higher than in the U.S. The Japanese debt [2nd chart below] is approaching 150 percentage points higher. The Eurozone, just the countries in the Euro currency zone, have got about $62 trillion in current debt equivalence (3rd chart below). They only have $14 trillion of GDP equivalent. So they’ve got about $10 trillion dollars more of debt than we do and $1 trillion less of GDP. I have another little piece of information on that score that’s interesting: Their unfunded liabilities also appear to be greater than ours. A study published in 2009, but really based on data from 2006, called “Pension Obligations of Government Employer Pension Schemes and Social Security Pension Schemes Established in EU countries,” by Freiburg University, which was commissioned by the European Central Bank, showed that the unfunded pension liabilities of the EU member countries studied amounted to about five times their GDP. And the report only covered unfunded liabilities in 19 of the 27 EU member countries — 11 members of the Euro currency zone and 8 non-currency zone countries. Now, Europe had a big recession, too, in 2008, which opened the gap further. So their unfunded liabilities are about five times their GDP, whereas in the U.S., they are about four times. The debt problems in Europe are at an advanced stage relative to where they are here. Also, their demographics are much worse than ours. [See article for charts]

Kate: That’s sure what’s going on in Europe.

Lacy: The Europeans have two problems. No. 1, they’ve been financing themselves short. They have an enormous rollover problem and a lot of the folks who have lent to them don’t want to extend those loans. In addition, the folks that don’t want to extend their loans are being asked to make even bigger loans and so, the borrowers are not really responsive. Do you know John H. Cochrane? He is at the University of Chicago, a very serious economist. Cochrane’s argument is that at the point in time that the markets lose confidence that there is a future stream of revenues to pay off the debt, to service the debt, then the discount rate will move up sharply. It doesn’t matter what monetary or fiscal policies are, the discount rate explodes. That’s what’s really happening in Europe. Perhaps, because Europe is in a graver situation, indebtedness-wise than we are, it’s buying us some time. But we don’t seem to be willing or able to, we don’t seem to have the political will to deal with our problem.

Kate: Certainly not if you listen to what we’ve heard so far in terms of campaign rhetoric.

Lacy: Part of the problem is that these are serious matters and to solve them, it’s going to require a lot of sacrifice by a lot of people. That’s why I really like that Eichengreen quote. The thing is, no one wants to have austerity. We all enjoy the good life. We don’t want to have to raise taxes; that’s unpleasant. We’re going to have to change the benefits tables for Social Security and Medicare. We’re going to have to cut discretionary spending — even though it has already been cut substantially. Right now, the four main components of the federal budget are Social Security, Medicare, Defense and interest payments on the debt. By the end of this decade, if market rates are unchanged —

Kate: Quite an assumption.

Lacy: Yes, but at these rates, by the end of the decade, the three top components of the budget will be Social Security, Medicare, and interest; that’s according to the Congressional Budget Office projections. If you hold market interest stable through 2030, by then interest payments will absorb 35% of the budget. If the market interest rates go up by two percentage points, that adds about $300 billion a year to our deficit. By the way, that’s why you hear it said often that one of the solutions is to inflate our way out.

Kate: That’s supposedly the easy alternative, at least politically.

Lacy: But I don’t think you can do that because your debt is 350% of GDP. If you get an inflationary process going, interest rates will rise proportionately with inflation. So, if inflation goes up 1%, in time, interest rates will go up 1%. But your debt is 350% of GDP. If the inflation rate goes up, you will not get an equivalent rise in GDP, because what we’ve learned is that in inflationary circumstances, a lot of folks can’t keep up. In fact, most of your modest and moderate income households will not keep up.

Kate: Not good, considering that “the 99%” are already restive, with reason.

Lacy: That’s correct. We saw this in a microcosm in 2011. The Fed engaged in quantitative easing; they got the inflation rate up temporarily, but the main effect was to reduce real income. So, if you try the inflationary route, you’re not going to be able to inflate your way out of debt trouble. This other variable, your interest expense, is going to rise proportionately with inflation, and your GDP won’t keep up. Many will lag behind and that will worsen the income or wealth divide. So inflation is really not a potential savior in the current situation. Which then forces you back to the conclusion that the only viable way out is austerity, although no one wants it.

Kate: I suppose all this means you expect a recession this year?

Lacy: Well, consumer spending will slow this year very dramatically from a very weak base. We had a decline in real disposable income in 2011. GDP rose, but GDP measures spending, not prosperity. In 2011, as is often the case, when inflation rises, households initially try to maintain their standard of living. So in the face of rising inflation and trailing wages, which was the story in 2011, families resorted to increased credit card usage or to drawing down their saving. But in addition to a decline in real disposable income in 2011, we also saw a net decline in net worth [lower chart below]. And a year-over-year decline in net worth has been associated with the start of all the recessions since 1969.

Debt Stimulates Until The Collapse

Lacy Hunt makes a stunningly good case why adding on more Keynesian stimulus is doomed to failure. Should Bernanke actually succeed at creating inflation, interest on the national debt would crucify us all.

Please note the references to 100% backed money. Recently, there has been a number of seriously misguided articles on how the gold standard failed to prevent depressions prior to 1929. Such articles fail to point out that fractional reserve lending which allows extending more credit and making more loans than there is money is the culprit. The solution is 100% gold-baked money and the end of fractional reserve lending.

Fisher and Hunt have this correct, as do the Austrian economists.

Unfortunately, in their inflation predictions, most of the Austrian economists only consider money supply and not the collapse in credit and the value of that credit on the books of banks. This led to galling bragging by Keynesian economists who are likewise clueless about what is really happening and why.

Simply put, what cannot be paid back won't, debt will collapse back to a more sustainable level, and benefit promises that people expect will be reneged on, just as is happening in Europe today.

This process is the debt deflation cycle I have talked about at length for years.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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