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Nevertheless liberty is precisely what is compromised when a central bank issues even a single fiat (credit) dollar, never mind a virtual mountain of monetized obligations*. We just don't know it yet… or fully understand it. But a creeping socialism has already surrounded us. And although there are many government made distortions (otherwise known as policies) knotted throughout the free market system, it is our central banking organizations, which are responsible for allocating (or misallocating) most of our scarce capital and resources this century. Rhetoric? Not at all, on the contrary, a dead serious contention that we will bear out in this report. Failing that, we will do it in a future report. Just kidding. We'll do it right the first time.
America's Identity Crisis:
Socialism, or Capitalism?
Not surprisingly, the vast majority of people are confused about the differences between capitalism and socialism. This becomes evident when people are seen to depend on the government for capitalism to work. And it doesn't help that the government is confused about its own role in the economic processes of the day. But capitalism begins and ends with the individual not the state. In fact, it has nothing to do with the state. It is the natural economic consequence of human freedom, a process that can only be described, not constructed, as to its ability to ensure maximum individual potential, and achievement. It is first a state of mind, and perhaps the only state of mind, which can execute its promise.
Adam Smith discovered that this natural economic process (capitalism) worked because a free market price mechanism most efficiently determined the allocation of the world's scarce land, labor, and capital to their most productive uses. Ayn Rand discovered that the process of capitalism would only work if the rights of the individual were guaranteed sanctity over those of anyone else, particularly any collective. I couldn't agree more.
But the efficacy of the price mechanism is the subject of unresolved debate between the opposing factions. It is difficult for statists to accept that contained within a free market price is the right mixture of all of the variables that determine the needs of all the resources involved in a particular transaction, at a particular moment. It is equally difficult for capitalists to prove that this is indeed the case, except with reason, for the invisible hand has always been handicapped by bureaucratic intervention.
Hence, the question of whether the free market price mechanism can allocate the world's scarce resources better than a centralized planning structure remains largely a matter of philosophy. For, we have never really seen a free market at work before, and increasingly so, because our price mechanisms remain largely dysfunctional.
When we finish this treatise, the hope is to convey how existing statists (closet socialists) have been successfully manipulating the price mechanism in order to achieve their insidious goals, at the expense of our (including their) long-term liberty.
On the Mechanism of Prices
The data that policymakers rely upon in their deliberations is contaminated with prior policy byproduct, and therefore, can at best perform as assumption. I will concede that it must be difficult to plan not just for one future, but also the nation's future. However, therein lays one of our fundamental paradoxes. A free market system ought not to have anyone planning anything for the individual. It's just not included in the package. Although the intentions may "seem" good, the consequences are often not, and the assumptions that are made to explain the contaminated data inputs are rarely adequate. Rather they are often only convenient propaganda.
Experience with the average statesman in the real world reveals that while he or she gains nothing monetarily (in most cases) from his public service for doing good deeds, he gains everything in influence. And in some countries, influence is worth more than money. Thus, perhaps ingrained in his or her psyche is a quest for power, without a doubt, under the guise of righteousness. And whenever we exchange freedom for some vestibule of righteousness (a temporary safety), it is done at the expense of essential liberty. Ayn Rand points out that self-sacrifice is the value encouraged by every statesman in order to empower the state at the expense of the individual. Ask not what your country…
Yet, the lack of faith in the ability of a free market price to do the "required" work may also expose the socialist's true fear (insecurity) that true competition will render him powerless, or common. For his value is in finding advantage over others, in the name of others… sort of like Clinton's potential Real Estate ploy in Harlem?
Furthermore, socialists need to believe that the free nature of things left to their own in the natural world tend towards disequilibria… sort of like Mr. Soros' relentless chanter about the inherent instability of markets. Thus, it is no surprise that if market distortions cannot be understood for what they are then neither can the socialist nature, which ALWAYS contributes to these distortions.
So, in all cases, socialism is misplaced ideology if its proponents do not believe that free markets are indeed the problem. They have to. For there is no other crutch to justify their constant meddling. Socialists advocate the belief that free markets, left to their own, will become corrupt, wild, and monopolized by the greedy bourgeoisie. They point to one impure example of free markets after another to support their view. They believe that people should not have to suffer to fulfill the capitalist vision of the ideal economic system. They believe that business cycles can be manipulated, extended, and even eliminated. They believe that they cannot only control the price mechanism, but supplant it.
In Capitalism: The Unknown Ideal, Ayn Rand builds an irrefutable case against the altruism that drives socialism, and she is right. It begins in the soul of every individual; it is always (historically) a matter of life and death, not a matter of belief, that the individual is more important than the collective.
Ironically, Alan Greenspan, perhaps the greatest statesman in US history, happens to be one of two people whose name appears under the title on the cover of her book… maybe in the hope that inside of the man lays a true capitalist, rather than a self sacrificing altruist. Remember this, the next time you hear someone refer to the Greenspan Put.
So the chains of arrogant socialism have yet to be broken. On the topic of the evolution of mankind's pursuit of freedom, Rand says this:
first man was enslaved by the gods, but he broke their chains…
Today, the statists enslave man. May he break their bloody chains!!
If God has created man in his own image, who is doing man a favor by oppressing his individual evolution with the idea that he should submit to the state everything that he is? Who does God submit to? To be sure, I am not religious but I think the point was worthwhile.
Yet it (the transfer of liberty from man to state) is done whenever man is encouraged to sacrifice his individual potential for a greater cause. It is done whenever the state asks man to let it do for him what he cannot do himself. It is done whenever the state interferes with reality, manipulates it, alters it, or intervenes in it for all our sake. The state never has and never will support your right to individual freedom. It will not show you how to maximize your individual potential. It is not in the state's interests. All I can say is that I hope that Mr. Greenspan does not destroy this century long fight for capitalism by calling himself an objectivist. It would be an injustice to symbolize him as a capitalist. For we see nothing but policy maneuvering in his stewardship.
How did it come to this? For one…
Keynes was a Statist in
the fight AGAINST Individual Freedom
The American government knows this. They know that the key to power rests with their ability to bestow prosperity of any kind upon the voting (unassuming) public. Clinton made it work, and as a result we have grown to trust the government, and even worse, have assigned to it a Full Faith And Credit (Jim Cook) in its ability to invent "policies" that make us (feel) wealthier. And so we find that at the core of the debate between socialists and capitalists is usually John Maynard Keynes. He is the one blurring factor, and perhaps (besides Paul Krugman) the only socialist ever to have successfully clouded the distinction between capitalism and socialism. This is probably because his disciples accept the efficacy of the price mechanism, when it is convenient.
For those who are unaware, Keynes is generally credited with the recipe, which gave the US government a cure for the depression - deficit spending. His work is celebrated and taught in schools across North America as the optimum mode of capitalist achievement. It has given statists the license to manipulate the economy under the guise of capitalism, laboring under the belief that they can make capitalism better. When that system of government finally manifested in the collapse of the Bretton Woods arrangement, Milton Friedman saved face with his contribution to the state, by forwarding the argument that this system can be perpetuated if we crush the constraints, which inhibit us from controlling the money supply and from manipulating the public's inflation expectation sets. And Nixon made it so.
Keynes was oft quoted saying that "in the long run we are all dead." I hate that expression. Is that what we should tell our children, that Dad and Mom don't give a hoot about what happens to the world in 100 years, or that their children will be affected? It's the kind of thing you might expect to come from the mouth of a high roller? Oh, what do I mean?? I know it's only an expression... but incredibly, it happens to also justify the vast array of Keynesian economic theory. Furthermore, we are here… at the long run!!
Economists with Keynes in them will tell you that Austrian economics is a mind-f___. You can fill in the blank. The reason, they will claim, is that the only way a boom can end is if people think it will end. Thus, Austrian like theories of business cycles as well as other mostly unalterable economic laws such as, markets go up and they go down, or too much money "is" inflation, are regarded as self-fulfilling, or pessimistic.
Implicit in this criticism is that there is no such thing as an economic law, which cannot be managed. But there is more. Implicit in this view is also the natural inference that positive thinking is the key to the successful application of policy... always look on the bright side of life*.
Besides, Wall Street is hedged against pessimism now, isn't it?
I cannot stress more that there is nothing wrong with optimism. I, for example, am optimistic that somewhere in that mess of an institution they call the Federal Reserve Board is someone who cares. I am also optimistic that free markets, with institutions that exist only to protect that freedom, will some day get their chance to show their stuff. In the meantime, let's give further consideration to what Keynes contributed… it will be short.
For that is in The Long
In the end, Keynes is a government hero. He made government what it is today - big, deceitful, pompous, ridiculous, and plain socialist. Thus Keynes should go down in history as a statesman, not a capitalist. He proved that man needs the state's help to get along, and therefore that the individual ought to concede some essential liberty, to the state. He is not my hero.
It is our contention that Americans now live in a socialist country, almost as bad as the one we live in, Canada. For, the same economists that peddle these confused ideas are the same ones that think that they can keep the capital markets animated by sheer psychological manipulation of our will. Do our elected officials really think that way? Some do. I can assure you of that. Others, like Keynes himself, will know that they cannot fool all of the people all of the time, but will sure do it anyway. Why? Because their sheer arrogance and position in government gives them the idea that if it breaks, it can be rebuilt, all over again. Well folks, it's broke.
Ask yourself if you have ever met a single human that did not have a single insecurity. I'm sure some of you have, but I would bet most have not. Yet, most of these people are in charge. They are not infallible and for the most part, know it, which is why their forefathers got together to develop a constitution as the foundation for a number of institutions that are supposed to act as a check on our reckless ambitions, which far too often probably grow out of our desire to compensate for our insecurities (sorry, couldn't leave that unfinished).
But reason like this is the old economy stuff. Long before we became fully conscious of our own bias, right? Before we conquered the world with a mysterious ability to generate prosperity for ourselves. So, if we do not need these old institutions to generate prosperity, why do they exist at all? For since we (the collective) can so easily create our own prosperity, we need not fear failure.
Are we not empowering the state when we believe that the Fed can make the dollar or stock market go up, for instance, or that our scientists will have figured out how to duplicate human life, or that the IEA and OPEC can contain out of control energy markets? Is the international banking cartel arrogant in thinking that it can not only sell gold in increasing quantities, but that it can completely eliminate the psychological bond (though they would say restraint) that those who seek freedom have developed with gold.
Now that is arrogance. And they have most of us believing that they will do it too. But the bond is not a matter of inhibition. It is a matter of trust… a trust that the state has so far been winning.
Dark Days Ahead for Capitalism
If you are still confused and think that we live in a democracy and a free market system, then perhaps this will help. A journalist* writing for Bloomberg wrote an article called Central Banks Rule the World, in which he described his encounters with Greenspan fans in Portugal among his global travails. The title is Exhibit A, for our socialist case against the bank. Exhibit B follows:
In his column, Pesek says that,
Fix things? Exhibit B. Someone please save us from these statists and give us back our free markets!! Forget about guessing where the friendliest economic climate is going to be. That is a matter of speculation not banking policy. What is troubling is that investors find solace in the success of US monetary alchemy, and thus compromise some liberty in allowing Greenspan the right to intervene into the stock market and economy's fate on their behalf. Exhibit C. For some reason, the fact that the myriad of options and resources employed to fix things so far have created enormous economic problems and social consequences seems to evade Wall Street. But there is a reason for that. For one, Wall Street has married the banking business, and thus, the Fed, our most dangerous source of the seeds of socialist destruction. Worse, they have allowed the Fed to dismantle the pillars, which up to now had kept them out of the stock and insurance trades.
The Inflationist Agenda
What an understatement. But America's real problem is inflation… remember, inflation is too much money. How do we know that there are too many dollars? Because the dollar price of most energy prices has soared beyond what is explicable by either OPEC prodding or inventory shortfall, or the deregulation in California. Because the dollar price of platinum and palladium have soared skyward. Because the dollar price of most agricultural prices has gained considerably. Because the dollar price of most industrial materials continues to trade higher. Because the commodity indexes have risen dramatically over the past twelve months, even though the dollar price of gold and silver have been a drag on them. And finally, because all of this is happening in the midst of an economic slowdown, or perhaps recession… that's how we know there is too much money.
Furthermore, the author misses the point. America's reliance is not really reliance. It's more like a deliberation. For, consider the effect of the type of monetary inflation in the US on a closed US economy. Boom. Dollar loses its purchasing power and prices of everything begin to rise. The government loses its ability to manage the paper exchange price of the currency because it is only priced in other goods. Now imagine two, three, or more trading partners pursuing the same "inflationist" monetary policy, on their own. The same thing would happen in each country, in isolation. The currency would break down against the (objective) value of most goods. In fact, every country on this planet that has ever tried to inflate their money supply has met with the same, or nearly same, consequences.
But what if these countries developed a paper fiat system internationally? What if, instead of breaking down, foreigners bought up the excess dollars, which are created on the backs of domestic consumers, who are persuaded to exchange them for excess foreign goods and services? This way, consumers can buy goods from Europe and Asia with an artificially managed dollar exchange rate? Thus inflation could be contained this way, if foreigners can be coerced into financing the resulting trade deficit in order to help maintain the high value of the dollar. Exhibit D.
And if bankers around the world exchanged their gold reserves for dollar reserves, then foreign investors may also be persuaded of the dollar's credibility this way. Exhibit E. But this one actually messes everything up. Now, rather than being able to pass the hot potato (trade deficit) along, to another country, the US is stuck with it. The reason is that by depressing the dollar price of gold, the international currency regime effectively becomes a hierarchy where the dollar stands atop like the mighty tower of Babel.
Suddenly, it appears that there is no other currency in the world with such a high psychological stature as to allow foreigners the confidence to finance such a ridiculously overblown consumption cycle in their own countries. So in anticipation of this potential problem, we believe that the genius minds behind the alchemy of international finance decided that it was time to develop new currency blocs like the Euro, and promote it as an alternative to the dollar, an alternative that they can control and exploit. It is no surprise to us then that it was an American economics professor at Columbia University, Robert Mundell, who was the chief architect of this plan. The idea was to dilute the polarity of the hierarchy by creating equal size Paper Mountains.
The Europeans would be better choices of course (than the Asians) because the European banks were already short a whole bunch of gold. Now that the Euro is ready, international policymakers and investment advisors have been trying to promote the same investment cycle, perhaps so that they can now unwind some of these excesses in an orderly fashion. As long as this all works, as we have mentioned in past issues, the officially announced government "estimates" of inflation (PPI, CPI, and GDP deflator) are accepted by nearly everyone. But there are many things going wrong.
Dollar inflation has been soaring and has driven global energy prices over the past two years to such an extreme that California's deregulation plan literally exploded. The declining stock market is a major problem because most European investors are long it. Can the Fed support the stock market with monetary policy without aggravating commodity prices, and just long enough to unwind the "hot potato?" We doubt very much that they can.
Certainly two things are obvious: first, so far there is no unwinding, only patchwork solutions to postpone the consequences of ongoing problems, and second, inflation of the money supply is the core problem in the first place. The Fed wouldn't have to resort to all out manipulation and alchemy in every aspect of finance if an inflationist monetary policy did not exist in the first place. So the new question is, with all of the alchemy, what have they really done to the real economy? What have they done to the invisible hand? Oh brother, where's the beef?
Central Banks Rule the
But when the bank sets interest rates, it is interfering with the free market price mechanism. How? Let us not forget that if credit exists a natural interest rate must exist. The natural interest rate, like every other real price in this economy, is theoretical however. In theory it is the price of credit at which the forces of consumption and savings are in balance. Call it equilibrium. But, is this equilibrium?
Personal Savings Rates -- 30 years
I'm sure that the Keynesian would step up to the plate and suggest that these conditions may persist for some time… and he would be right. So long as the gap, between what the theoretical natural interest might be and what actual interest rates are grows, it's a good deal for consumers. Now, ideally, provided we could get the data, it would be interesting to compare this to the same data for G10 countries so that we could try to guestimate some kind of long term equilibrium and thus maybe an approximation of this natural interest rate. Notice, in the chart, that from the early 1970's up until even the early nineties, the two forces were roughly in balance… apart from the year leading up to the 1987 stock market crash. Now, notice how after about 1992, the forces of consumption blew this equilibrium away.
What is happening here, we believe, is that the Fed has forced interest rates below where the market is supposed to have been, for some time now, and in the process only encouraged more consumption and disequilibria. Thus, we speculate that the natural interest rate, as well, must have risen in the latter part of the decade.
According to Wiksell*, this interest rate must equal the expected rate of return on investment in say, dollars… or the opportunity cost of capital, if you will. This rate reflects the individual's choice between spending and saving. If his propensity to consume is high, he will require a higher interest rate to induce him to save rather than spend. His choice comes down to choosing between whether some good priced at $100 today is worth more to him than say the prospect of earning $10 on that capital over a year. The amount of return that it takes to get him to save is his time preference rate, which equals the opportunity cost of money (Keynesian term, not mine), which equals the economy's natural interest rate.
A good proxy for the natural interest rate during the late nineties might then in fact be the annual return on blue chip stocks. But the high return on stocks relative to government set interest rates, probably also amplified the return in stock markets, which probably amplified the forces of consumption. Can you see how many potential permutations there may be to the distortions created by monetary policy? If so, Exhibit F. Furthermore, this process undermines the nation's entire capital structure. For if the individual consumer requires a higher rate of return than is offered in order to save, and as a result, does not, then who is there to finance the longer term production processes in the new economy? Thus, rather than deepening, the nation's capital structure must be thinning, or eroding… just another distortion.
And through this monetary manipulation, this is how they roughly try to manipulate the economy, and us. It is not business, nor are the markets truly free. Those who control the money spigot decide where to allocate resources or profits, not the free market. And all of this is done in order to get us to consume more not less, and it is designed to empower the state. Still don't believe us?
Krugman* wrote this in an essay about Japan's liquidity trap. In the article he is suggesting that the Bank of Japan, were it committed to inflation, would be more likely to get out of its liquidity trap. The reason, he claims, is that the banker who promises to inflate can make the horse drink out of the trough. This is such a short-term truth at best, and one with enormous consequences. So to sum up Mr. Krugman's definition of a credible commitment... a banker that promises to print ever more money will make monetary policy more effective, not less, so long as it puts that fresh money where its mouth is by changing market expectations.
Monetary policy has turned into the theory of mass psychology, and in order for it to work; its authors have to increasingly manipulate the masses. But go ahead, be manipulated, and empower the state.
Inflation Destroys the
Furthermore, there is no formula that will determine how much of the price of any good is affected by the interaction of real demand and supply, for it, and how much of the price is affected by a change in the purchasing power of the currency. The reason is that there is a lag between the economic fact and the psychology of the economy's participants, which determines the unit's actual purchasing power in the here and now. This value, which is assigned to the medium of exchange, today, is a function of consensus perceptions about the ability of the monetary unit to maintain its value in the future.
And to the extent that, in this Fiat based money economy, participants base their views of the future purchasing power of particular money upon its performance in the recent past, the actual inflation breakdown often lags the cause. Indeed, Ludwig von Mises showed exactly that, when he proved that all prices do not rise at the same time, at first. This is precisely why, for instance, the hyperinflation in Germany, in 1923, lagged the dramatic expansion in the supply of Reich marks, though not nearly as inflation today has lagged the greatest expansion of dollars ever seen. Though that can be attributed to the combination of financial alchemy and statist propaganda.
So why are we discussing all of this? Because perhaps there is a message somewhere in these markets, in these strange times. What does it have to do with your investment strategy? Everything and a half. For we believe that the gold standard is one of the institutions that can and will guarantee our economic freedom, and thus your individual rights. Without a gold standard, you might as well let the government manage your money for you.
Thus, to the silent but growing rumblings within the establishment that democracy may not be sustainable in the company of unregulated markets, we have the following message:
Yes, democracy is possible, but the money must be honest. For it is through the political mechanisms, which have accumulated influence under this "monetary" regime, that we have become socialized. It is as the result of the overwhelming influence of an array of socialist mechanisms, gradually introduced through policy and way too often mandated by ourselves, that we have become enslaved by the state, which allocates resources according to the wishes of its most powerful authorities, who today are the central banking cartels, rather than the invisible hand, that we have not achieved the utopian idea of honest money. For true individual freedom in a dynamic democracy is not possible without the condition of economic freedom, period. And economic freedom cannot be possible without some kind of anchor that stabilizes the coin of the realm, and ensures our monetary freedom. Look no further than ills in our own economy for proof of that.
Stay tuned, next week we're back to the markets… and it only gets more interesting.
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