What You Should Know About |
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the Economy...That No One
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What You Should Know About |
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the Economy...That No One
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Gold Derivative Banking Crisis
Imagine that you are back in the 18th century. The world is about to change, with advances in shipping, the new world (America) is now within reach. Would you have the foresight to invest? Sir Isaac Newton did, and after he made 7,000 pounds profit he went back for more. However, what he invested in would come to be called, "The South Sea Bubble." When it was over, Sir Isaac Newton had not only lost his 7,000 profit but 13,000 pounds more.
It is easy for sane, rational people to get caught in the excitement of money making opportunities. During the Tulip Mania a single tulip bulb sold for more than a large house in London's fashionable Mayfair district or a thriving French brewery.
People living in the late 1920s were looking at almost identical economic conditions as the 1990s. Average people were making lots of money in the stock market and all kinds of new inventions were making life better. At that time, those people who did not understand the cause of the economic boom would come to lose their savings in both the stock market and in the banks. The economic contraction that started late in 1929 caused many businesses to close and more than twenty percent of the workforce to lose their jobs. By the mid-Thirties the deepening depression touched the lives of everyone in one way or another.
So why was our economy so good during
the last decade?
Have we seen the bottom and will the robust good times come back soon?
Because there is a great deal of misunderstood and just plain wrong economic ideas in circulation today it is necessary to start from the beginning. We will go through several simple economic principles and theories, test them with the facts of history and then show how they relate to our situation today.
We must start by discovering not only the obvious, but also the hidden consequences of what happens when governments engage in easy credit monetary policies.
The first step in understanding the very complex subject of monetary policy is to understand how modern banking works. Today all banks work under what is called fractional reserve banking. Fractional reserve banking is when a bank, loans out part of the money their depositors have put into their checking and savings accounts. This doesn’t sound too bad until you realize that the bank has promised to give back all of the depositor’s money on demand and have also loaned out part of it, all at the same time.
The way the bank gets away with this is that most of time the vast majority of depositors keep a large portion of their money in the bank. Of course the higher the portion of money a bank loans out the greater the danger the bank will run short when depositors try to withdraw their money.
This process of Fractional Reserve banking fools individuals into thinking that there is more money than there really is. Both the depositor and the person who is loaned the money think they have the same money at the same time. The depositor's checkbook shows the money and the borrower spends it too. In this way the bank has created new money in a bookkeeping juggling act. This is, of course, fraud! Even if the depositor knows that his money is being loaned out, it is still a fraud because he is counting on the bank's reputation for safety to keep the other depositors from withdrawing their money all at the same time. Our government participates in this fraud by insuring deposits. It must me noted that the government insurance has only enough reserves to cover a small number of bank failures.
Another way of understanding fractional reserve banking is to imagine what would happen if you applied this idea to your own checking account. If you write a large number of checks you may notice that your bank statement shows you with a larger balance than you really have. This is because some of your recently written checks may not have had time to be cashed or have been cleared by the bank. If you were to try to spend a small portion of this extra money you might get away with it. If you are very careful you could get away with it for a long time. But what you would be doing would be stealing. You would be using money that is not yours. Just as it is wrong for you, it is also wrong for the banks.
The effect of Fractional Reserve banking to create money is multiplied by the fact that when a bank makes a loan the money ends up in someone's bank account. If a person deposits $100 in a bank and the reserve requirements are 10% then the bank will keep $10 for reserves and loan out $90. This 90 dollar loan ends up in someone else's bank account in either the same bank or another bank. The deposit of the loan is treated just like any other deposit and the bank loans out $81 (keeping $9 which is10% of the $90 for reserves.) Of course the $81 ends up in yet another person's bank account and the process continues. The end result of this is that for every $100 deposited almost $1,000 can be loaned out. This is a very simplified example and in real life the maximum amount is rarely reached. The point here is that by is very nature Fractional Reserve Banking creates money out of thin air.
Fractional reserve banking is not only accepted but promoted by most college and university economic professors. These professors teach that it helps both the depositor and the borrower. They say that the depositor earns interest and the businessman can borrow to expand his enterprise. The truth is that the same goals can be accomplished without fractional reserve banking and without fraud and without creating money from nothing. By using CDs (certificates of deposit) with fixed expiration dates the bank can safely loan out not a portion but all of the money and have the borrower pay it back by the time the CD is due. If you had a CD and needed money before its due date you could sell it just as bonds and stocks are sold.
The second step in understanding our current economic condition is to understand what money really is. To do this let us start with the most fundamental principle in economics which is that people trade value for value. In other words people trade their time or the goods they produce for the time or goods produced by others. An employee trades his time not for money but for what the money will buy. So in reality the employee is trading his labor and time for food, housing, cloths... etc. All economics breaks down to barter trading. Money just a product that makes the bartering easy.
All of civilization is based on the division of labor. By specializing in a small group of tasks one can become very skilled and efficient. That is why concentrating on one product or service allows one to become very productive.
It is the function of money to facilitate trading and thus promote the division of labor.
For a trade to take place it must be of mutual benefit. If one person grows wheat and the other grows corn, and if they trade part of their harvest with each other they will both have a better diet. In other words, a trade is the voluntary exchange of one value for another value.
As a civilization develops more people can specialize and produce a larger variety of products. With more products, barter trading becomes more difficult. One has to find someone who both has what you want and wants what you have. Throughout history, one product has become so popular that everyone wanted it. This product then took on the special function of allowing people to make complex trades. Instead of having to barter, one could trade for the special product and then trade the special product for what one wanted. In this way this special product becomes the standard of value which could be used to judge the value of everything else. For the last five thousand years the product most civilizations have chosen to use as this media of exchange has been gold. Because gold is easy to recognize and it doesn't tarnish, it is easy to see why this rare metal was the natural choice to use as money.
It is important to understand that real money must be a real product. In order for money to hold value, it must be of real value. Remember that trading is trading value for value. This brings us to the issue of paper money. Because paper money is not a product it is not real money, it is a promissory note. There is nothing wrong with borrowing a product as long as it is returned. There is also nothing wrong with trading promissory notes as long as the notes are repaid as promised. A currency that is freely redeemable for gold or silver is a valid promissory note.
Even more unfortunate is that governments often give in to this temptation. The result of making more promises that one can keep is bankruptcy. When governments print fiat paper money they are making promises they can’t keep and that is why the value of that money drops.
There have always been people who seek the proverbial "free lunch" or perpetual motion machine. What these people desire is something for nothing. With this in mind let us turn our discussion to our third step, which is to understand how governments handle money.
Governments are highly motivated to borrow money for two reasons. First, governments want to spend more money than the people are willing to pay in taxes. Second, they believe the Keynesian theory that creating more money will stimulate the economy.
Most governments realize that if they try to borrow large amounts of money from private banks, the competition for the banks' limited funds would cause interest rates to rise. To get around this problem, governments create central banks.
Long ago it was discovered that most of the time there are large amounts of cash sitting in bank vaults. This was because prudent banks held large reserves, so if there were a run on the bank there would be enough money to repay depositors. The creation of a central bank changes this by making loans to the banks when they are short of cash. This system allows banks to hold smaller reserves giving them more money to lend. To further utilize bank reserves, the central bank requires member banks to hold their reserves not in gold but in government securities. To control this system, central banks set reserve requirements, adjust the discount interest rate and buy and sell securities. With these controls the central bank has the power to increase or decrease the money supply.
As governments borrow more and more money, the central bank must continually lower reserve requirements. As reserves drop, banks become overextended. If the government demand for funds continues, then the central bank will buy government securities with money they create themselves. If a member bank buys government securities, it will be used for the bank's reserve requirements, enabling them to lend out even more money. This process increases the money supply several fold.
When central and member banks increase the money supply, it is obvious that the newly created money does not represent real wealth. The new money is just a number written in a ledger book. As this newly created money is spent, products are purchased faster than they can be produced and inventories fall. Keynes believed that causing shortages would stimulate more production. In reality these shortages cause prices to rise. Another problem with this is that the excess buying also includes products from other countries. This is why, when a country inflates its money supply, it causes a trade imbalance with other countries.
Besides inflating the money supply, a governmental easy credit policy also causes distortions in the economy. In a free market, interest rates are based on the quantity of savings. If people put more money in bank savings accounts then the banks, with more money to loan, will lower interest rates. The lower interest rates will encourage businessmen to borrow for capital equipment, which will be used to increase production. As production increases, prices fall and people will be tempted to buy more and save less. Less savings will raise interest rates bringing savings and capital expansion back into balance. In a free market Interest rates are self regulating, automatically adjusting up and down for the best possible economic growth.
However, when governments create artificially low interest rates they are sending false signals to businessmen and they over-expand. At first the increased buying of capital equipment creates new jobs in the equipment manufacturing business and the economy booms. The increased demand for labor causes wages to rise. This causes the cost of consumer goods to rise and sales to fall off. Suddenly, there is a contraction as sales volume falls, inventories increase and business start to sell at any price. As business start to lose money they lay off employees and there is a recession. It is government created easy credit that short circuits the automatic checks and balances of the free market and causes booms and busts.
The Federal Reserve Act was signed into law on Dec. 23, 1913 with the idea that it would end the business cycle and create continuous prosperity. The first thing the Federal Reserve did was to lower reserve requirements. Then in 1917 they relaxed requirements even more, enabling the government to fund World War I. It was not until after the post World War I depression of the early twenties that the Federal Reserve Board started seriously inflating the money supply. The Federal Reserve board, with a new nationally coordinated monetary policy, made it possible for banks to lend out more than four billion dollars in newly created money.III This 40% increase in bank lending made the roaring twenties possible IV. People thought the party would never end and the stock market would go up forever.
The government's easy credit policy gave banks more money to loan than business could use so new borrowers had to be found. Many banks were encouraged to loan to war torn Europe to help them rebuild their economies. This seemed to work out well for all parties. The Europeans who couldn't get American dollars because our protective tariffs prevented them from trading their goods for dollars could now borrow dollars from American banks. The Europeans bought our products with money we loaned them, and our banks got rid of their excess money.
There is one small problem with this arrangement. The Europeans had no way to pay back the loans. The high tariffs kept Europeans products out of the U.S. so they had no way to obtain the dollars to pay us back. As a result, banks had to keep making new and larger loans to keep the Europeans from defaulting.
By the late twenties, the Federal Reserve Board began to realize that there were many problems developing. Bank demand for money from the Federal Reserve was increasing and speculation on land and stocks increased dramatically. Herbert Hoover, as Secretary of Commerce, warned the Federal Reserve against the careless use of their new engine of money creation. V The Federal Reserve Board decided to end their easy credit policy. They stopped buying and started selling government securities.
By the end of 1928, after having sold 63% of all the securities the Federal Reserve held, the economy was still going strong. VI This was because banks could still easily get money by re-discounting or selling bills to the Federal Reserve. VII In simpler terms, this means that a bank could get money by selling its loans to the Federal Reserve. After many debates, late in August of 1929, the Federal Reserve raised the re-discount rate from 5% to 6%. Because money always flows to the highest interest rate this rate hike caused a flood of gold to flow into the United States from Britain. Because at that time gold was money this foreign gold drove the stock market ever higher.
On September 23, England raised their interest rates by 62%. Within 48 hours Austria, Denmark, Norway, Sweden and the Irish Republic also raised their interest rates. VIII Now the gold flowed out just as fast has it had flowed in. As stock prices began to fall, banks were forced to call in the broker loans. But the only way the brokers could repay the loans were to sell their stocks. The selling caused prices to fall further, which caused more loans to be called in, and the resulting crash is history. During the next three years as foreign countries defaulted on their loans over nine thousand banks closed, the money supply dropped 31% and more than nine million people lost their savings.
In 1933, F. D. R.'s pragmatic solution to the depression was to devalue the dollar and outlaw private ownership of gold. It was only by taking gold away from American citizens that he could rebuild the gold reserves and start re-inflating the money supply. However none of F. D. R.'s programs worked, and from 1933 to 1939 unemployment only decreased modestly from thirteen to nine million. IX
The real block to recovery was the government's increase in taxation and labor policies. By raising the percentage on the upper tax brackets wealthy people stopped investing in the stock market driving it ever lower. The labor laws gave unions the power to prevent wages from falling during the deflation. As prices fell manufacturers were forced to lay off people in order to keep costs under control. It took World War II to distract the government away from its economic meddling to bring wages and prices into balance and end the depression.
In 1944 the Bretton Woods international monetary agreement was signed. This agreement brought back gold convertibility to foreign exchange. Because the Federal Reserve was still expanding the money supply, gold once again began to flow overseas. Between 1944 and 1971 America lost more than half of its gold reserves. X This crisis brought about a new and just as pragmatic solution.
If gold reserves were the problem, the government reasoned, then just get rid of the gold standard. In 1971, the Federal Reserve ended the international link between gold and the dollar. By renouncing our obligation to redeem our money for gold we in effect declared bankruptcy. The real cause of the inflation of the mid-seventies was not the oil crisis but the flood of dollars being repatriated from foreign countries who no longer trusted our currency. Now instead of a gold drain, there were wild fluctuations in exchange rates. It was economic anarchy. By 1982, this turmoil created an international banking crisis.
In late 1981 President Ronald Reagan signed into law a massive tax cut, which reduced the the income tax rates 25%. At the same time President Reagan failed to cut spending causing an explosion in the national debt. To finance this increasing debt interest rates remained high. These two factors had a totally unexpected consequence. Because capital flows to the most profitable markets, America, with lower taxes, and high interest rates became very attractive to foreign investors. In order for investors to buy American stocks or bonds they had to exchange their currency for U.S. dollars. This demand caused a shortage of U.S. Dollars in foreign countries and so these countries had to hold more U.S. dollars in reserves to accommodate all the exchanges. Because these capital flows into America were not the result of a conscious plan almost no one has realized how profound a change this was in the world economy.
The key idea to remember is that foreign central banks now needed to hold dollar reserves just as they had held gold in the past. (Please look at the Balance of International Trade chart. chart II)
To understand this situation, think of what would happen if you became a super star and your autograph was worth thousands of dollars. Your personal checks, with your signature, would suddenly be so valuable that instead of cashing the checks, people would hold them or trade them like money. Every month, no matter how many checks you wrote, your balance would not go down. After a while you might reason, If no one is going to cash my checks, why not spend the money accumulating in my account. The danger here is that if your fame should falter, people might cash all of the checks they were holding.
As in the check book example above, it is the trade deficit that is the real cause of our economic good times. The trade deficit in 1999 was $271,300,000,000.XI If you divide this amount by the total population of America, it works out to be $990 per person. A family of four would have received $3,961 or $330 per month. The trade deficit, which in essence is like a free loan, has not been a one-time event, it has been going on month after month, year after year since 1982. This money is pure profit and so it doesn't take very much to make a big difference. It is like winning $990 every year in the lottery. It's extra money that you can spend any way you wish.
Now, your free loan doesn't come to you as a check in the mail, it comes in the form of lower prices. When the Federal Reserve inflates the money supply and the new money is used to buy imported products, two things happen. First, we get rid of the newly created money, which helps keep the amount of money in America stable. Second, as long as the foreigners do not spend this newly created money, it's just like not cashing our checks and we have received their products for free. By importing products without really paying for them, we increase our wealth. It is this combination of increased wealth and exported excess money that keeps the value of the dollar much higher than it should be, which translates into lower prices for you and me. Because you don't have to pay income tax or sales tax on lower prices, your free loan is pure energy to the economy.
Today, because the dollar has become the international medium of exchange, foreign governments hold on average 60% of their reserves in dollars. The foreign governments kept most of their reserve dollars not in currency but in U.S. Bonds. When foreign governments buy bonds they are not buying U.S. products they are loaning us money. But this is not the only way the foreigners loan us money. Just as most of us are unaware of the free money were getting the foreigners are unaware of all the money they are loaning us. Because the dollar has become the international medium of exchange, dollars are used by foreign business. The Japanese use some of their dollars to buy oil from the Arabs. The Arabs then use the dollars to buy German cars, then the Germans buy Colombian Coffee and then Colombians buy Japanese steel. As long as the dollars stay out of America we have our free loan. This situation could only exist with unbacked paper money. Because gold is a valuable product, when it is used for international exchange, it is exchanging one product for another product. A paper dollar on the other hand is not a product and does not contain value in itself. A paper dollar is a promissory note to be redeemed by some good or service at some future time. That is why every dollar overseas is a loan waiting to be called in and we are the ones who are liable for the debt.
Before we can answer the second part of our question about the future, we must understand the two main factors that cause an economy to grow, which are freedom and reason. (For a more complete discussion of the nature of freedom and reason read Ayn Rand's book Capitalism: the Unknown Ideal.) With an increase in freedom, people can trade easer and faster, which results in a greater division of labor. As you remember it is the division of labor that is the basis of civilization and a high standard of living. Reason is the process of clear thinking necessary to produce goods and services in efficient cost effective ways.
Contrary to popular belief it is not working physically harder or putting in more hours that dramatically increase production. It is also not scientific advances that drive the economy. The thirties were filled with all kinds of new discoveries and it did not end the depression. It is the business man, it is the entrepreneur, in his constant efforts to make more money who brings us the new inventions, cut costs and boost production. The entrepreneur thrives only when he is free to think and free act on his own ideas. It is only from the minds of men who are unafraid to try new things and who are willing to risk everything they own that brings prosperity to us all. A business man must use reason to predict the future needs of his customers. Can you imagine using astrology to know when to order bananas for a grocery store? The Russians have had not only great natural resources but great scientific technology. They put the first satellite in orbit, they built a supersonic airliner and have nuclear power plants but couldn't feed their own people. The Russian failure was the result of having bureaucrats instead of business men.
It is important to realize the huge amounts of time and money it takes to bring a new product to market. This is why the value of money must be stable for business men to make wise decision.
In the recent past there have been two periods of economic growth. The expansion from 1880 to 1920 was a result of a move to the great stability of the gold standard. The expansion from 1945 to 1968 was also the result of the stable value of money.
But this second period of stability was an illusion because the Federal Reserve was increasing the money supply. As a result of this increase many of the new dollars were use to purchase foreign goods. Because we were on a semi-gold standard the foreigners turned in their dollars for gold and the results were that America lost of more than half of it's gold reserves. X
Today, the Federal Reserve is still creating new money and it is still causing distortions in the economy. As a direct result of these distortions many corporations do not do long term planning or investing to increase productivity as they once did. They make money by lobbying for special tax breaks and government subsidies or by downsizing their companies. The quick profits from downsizing are not the same as the company building profits that come from new discoveries and inventions.
In the stock market, the cost of a stock compared to the amount of dividends it pays is at record highs. People do not buy stock to collect dividends; they buy stock speculating that its price will go up. This is the same type of speculation that went on in the Twenties.
In the Twenties, with the Federal Reserve easy credit policies, people were able to buy stock on credit (margin.) This resulted in rapidly rising stock prices. Today regulations greatly reduce margin buying but the Federal Reserve still has an easy credit policy and so the abundant credit just finds another place to go. Companies use the easy credit to borrow money to buy their own stock which drives the price up, making fortunes for the stockholders (at least on paper.) Of course these companies are greatly increasing their debt which will have to be paid back out of future profits. In the first quarter of 1999 IBM has spent $2.1 Billion buying its own stock and in the last four years it has reduced the number of its shares by 22%. At the same time IBM has increased its outstanding debt to $30 billion dollars. (from New York Times 4/25/99 by Gretchen Morgenstern)
Another way companies use Federal Reserve easy credit is to use investment banks to play the options market. They use options to leverage their ability to buy and sell their own stock. The Dell computer company made more profit selling "puts" and buying "calls" in the options market than they did making computers. In the past three years Dell made more than $3.1 billion playing the market, while the company's net income over the same period was just $2.5 billion. Dell is not alone, many companies are playing the same game. In fact, in the third quarter of 1998, Microsoft pocketed an estimated $225 million from the sale of puts alone. (from Forbes 4/5/99 by David Raymond)
It is not necessary to understand the options market to understand that this is gambling and very risky. If the stock market should go down these companies will be in very serious trouble.
America has gone from the greatest creditor nation to the greatest debtor nation in less than twenty years. Personal debt is at record highs. (Please look at the savings and consumer debt chart. chart IV) In addition to our trade deficit our government has borrowed more than five and a half trillion dollars with two trillion coming from foreigners. (Please look at the national debt chart. chart V)
Many people believe that the productivity gains from all our new technologies will sustain our booming economy indefinitely. Today there are many shining stars like the integrated chip manufactures, computer industry and the Internet. In the twenties there was a similar technology boom. The automobile industry matured allowing people to travel greater distances. Electricity was brought into nine million homes and factories. More that six million new phones were connected. Telephone lines spanned the nation for the first time. Radio gave instant communication. Farmers progressed from horse draw plows to tractors. Bakelite, the first plastic, exploded into all kinds of products. Airplanes developed and brought us air mail. From 1919 through 1929 output per worker in industrial manufacturing rose by 43 percent. The point is that the new revolutionary technologies of the twenties, which it could be argued have had an even greater impact than today's discoveries, did not prevent the breakdown of the economy.
Unfortunately, easy credit causes other problems. Because the Federal Reserve keeps interest rates artificially low, banks can no longer attract savers. This is a fundamental change in society. Banks have traditionally loaned out these savings to trustworthy people to build homes and expand factories. This function protects the investment of the people's savings and keeps capital flowing to the most productive sectors of the economy. Savings now flow into the stock market through mutual funds, pushing stock prices far above prudent levels. It should be noted that mutual funds and the stock market in general are not insured like bank savings accounts. If the market should decline the life savings of millions of people will also decline.
So what will happen in the future? Both history and theory have shown us that government manipulation of the money supply has always led to the breakdown of the economy. It is a matter of fact that the money supply has and is increasing (Please see the Money Supply Chart chart III) and that we have an ever growing trade balance deficit. The foreigners may have been fooled into exporting their prosperity to us for many years but we would be even bigger fools to think that they can continue to do it forever. At some point the foreigners will run out of money to lend us, and they will go broke. This process will take many forms because foreign governments also inflate their own money supplies. The nations that try to stimulate their falling economies by lowering interest rates and printing money will go through devastating devaluations. As a foreigners currency falls the foreign citizens will hoard dollars. That is why the harder the foreign governments try, the worse their situation will get. As painful as the idea is, there can be no doubt to the answer of our second question. No, the current good conditions cannot go on into the future.
It should be clear to all that even before the terrorist attack the bubble had been pierced and a collapse was in progress. Because the bubble was so big and the distortions to the economy so great there is no chance for a soft landing. Even with all of the FED's interest rate cuts it will not stop the collapse. The reason is simple, there is no free lunch. You can not create free money or free (lower) interest rates without cost. The cost in this case is that lower interest rates cause a currency to drop in value. This is why the FED rate cuts will at some point hurt the dollar. This is a fact of reality that can not be avoided! It may take a while for the dollar to fall but there is no doubt that it will fall. As the dollar falls all foreign goods will be more expensive. Rising oil and imported goods prices will hurt the economy! The bottom line is that the FED action may change the character of the collapse but it can not stop the collapse. We will have stagflation instead of deflation. Not only will the FED action lead inflation but so too will the massive spending the Federal Government will do to stimulate the falling economy and finance the war.
History teaches us that most collapses do not move in straight lines and that they can take years to run their course. During a collapse there are many false rallies. This is why it is sometimes hard to know when one is in a collapse. In the early1930s people lost more money buying the dips than they did in the initial crash in 1929.
There are 10 more facts that indicate the process of a collapse has started.
... it is important that people understand that the economic downturn is not caused by greedy businessmen or evil foreigners, but by our government's corruption of the money supply. We have seen how it is the nature of the Federal Reserve to create easy credit. The consequences of easy credit are distortions in the economy. It misleads businessmen to expand when there is no market for their goods. It causes stock speculation to drive the market to unrealistic heights. Finally, as these distortions drive out real savings it causes recessions and depressions. The only true cure for the coming economic disaster is to return to the gold standard and to eliminate the Federal Reserve. In order to pay back the massive government debt there must be real and substantial cuts in federal spending. People must learn to rely on themselves instead of counting on government to fix everything.
The following is from Allen Greenspan's Humphrey-Hawkins
testimony.
It clearly shows how it is impossible for a central bank to control an economy.
Dr. Ron Paul: “We have concentrated here a lot today on prices, and you talk a lot about the price of labor, labor costs. And yet that is not the inflation according to sound money economics. The concern a sound money economist has is for the supply of money. If you increase the supply of money, you have inflation.
Just because you are able to maintain a price level, (a) certain level that because of technology or for whatever, this should not be reassurance because we still could have malinvestment, we can still have our excessive debt and borrowing. And it might contribute even to the margin debt and these various things.
So I think we should concentrate, especially since we’re dealing with monetary policy, more on monetary policy and what we’re doing with the money. It was suggested here that maybe you’re running a policy that’s too tight. Well, that – I’d have to take exception to that, because it’s been far from tight. I think that we have had a tremendous growth in money. The last three months of last year might be historic highs for the increase of Federal Reserve credit. In the last three months the Federal Reserve credit was increasing at a rate of 74%. It is true, a lot of that has been withdrawn already. But this credit that was created at the time also influenced M3, and M3 during that period of time grew significantly, not quite as fast as the credit itself. But M3 was rising at a 17% rate.
Now, since that time, of course, a lot of the credit has been withdrawn, but I have not seen any significant decrease in M3. And I wanted to just refer to this chart that the Federal Reserve prepared on M3 for the past three years. And it sets the targets. And for three years you’ve never been once in the target range.
You know, if I set my targets and I perform like that as a physician, my patient would die. I mean, this would be big trouble in medicine. But here it doesn’t seem to bother anybody. And if you extrapolate and looked at the targets set in 1997 and carried that set of targets all the way out, you only missed M3 by $690 billion. I mean, that’s just a small amount of extra money that came into circulation. But I think it’s harmful. I know Wall Street likes it, and the economy likes it when the bubble’s getting bigger. But my concern is, what’s going to happen when this bursts? And I think it will unless you can reassure me.
But the one specific question I have is will M3 shrink? Is that a goal of yours, to shrink M3? Or is it only to withdraw some of that credit that you injected for the non-crisis of Y2K?”
Mr. Greenspan: “Let me suggest to you that the monetary aggregates as we measure them are getting increasingly complex and difficult to integrate into a set of forecasts. The problem that we have is not that money is unimportant, but how we define it.
By definition, all prices are indeed the “ratio of an exchange of a good for money.” And what we seek is what that is. Our problem is we used M-1 at one point as the proxy of money, and it turned out to be a very difficult indicator of any financial state. We then went to M-2 and had the similar problem. We have never done M-3 per se because it largely reflects the extent of expansion of the banking industry. And when in effect banks expand, in and of itself, it doesn’t tell you terribly much about what the real money is.
So our problem is not that we do not believe in sound money. We do. We very much believe that, if you have a debased currency, that you will have a debased economy. The difficulty is in defining what part of our liquidity structure is truly money. We have had trouble ferreting out proxies for that for a number of years. And the standard we employed is whether it gives us a good forward indicator of the direction of finance and the economy.
Regrettably, none of those which have been able to develop, including MZM – has not done that. That does not mean that we think that money is irrelevant. It means that we think our measures of money have been inadequate. And, as a consequence of that, we, as I have mentioned previously, have downgraded the use of the monetary aggregates for monetary policy purposes, until we are able to find a more stable proxy for what we believe is the underlying money in the economy.”
Dr. Paul: “So it’s hard to manage something you can’t define?”
Mr. Greenspan: “It is not possible to manage something you can’t define.”
The bottom line here is that there is no way to control or regulate an economy based on unbacked paper money because you can't determine the value of this fiat money! It should be obvious that unbacked money by its very nature has no value! Through out history every attempt by governments to use Fiat money has failed in the long run! We have only had fiat money since 1971 which is really a very short time.
George Bernard Shaw "You have to choose [as a voter] between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect for these gentlemen, I advise you, as long as the Capitalist system lasts, to vote for gold."
Voltaire (1694-1778) "Paper money eventually returns to its intrinsic value ---- zero."
Daniel Webster, speech in the Senate, 1833 "We are in danger of being overwhelmed with irredeemable paper, mere paper, representing not gold nor silver; no sir, representing nothing but broken promises, bad faith, bankrupt corporations, cheated creditors and a ruined people."
Thomas Jefferson to John Taylor, 1816 "I sincerely believe ... that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale."
Daniel Webster "Of all the contrivances for cheating the laboring classes of mankind, none has been more effective than that which deludes them with paper money."
St. Louis Federal Reserve Bank, Review, Nov. 1975, p.22 "The decrease in purchasing power incurred by holders of money due to inflation imparts gains to the issuers of money--."
Federal Reserve Bank, New York The Story of Banks, p.5. "Because of 'fractional' reserve system, banks, as a whole, can expand our money supply several times, by making loans and investments."++
Federal Reserve Bank of Philadelphia, Gold, p. 10 "Without the confidence factor, many believe a paper money system is liable to collapse eventually."++
Federal reserve Bank of New York, I Bet You Thought, p.19 "Commercial banks create checkbook money whenever they grant a loan, simply by adding new deposit dollars in accounts on their books in exchange for a borrower's IOU."++
Federal Reserve Bank of Chicago, Modern Money Mechanics, p.3 "The actual process of money creation takes place in commercial banks. As noted earlier, demand liabilities of commercial banks are money."++
U.S. Supreme Court, Craig v. Missouri, 4 Peters 410. "Emitting bills of credit, or the creation of money by private corporations, is what is expressly forbidden by Article 1, Section 10 of the U.S. Constitution."++
James A. Garfield "Whoever controls the volume of money in any country is absolute master of all industry and commerce."++
Frederic Bastiat, The Law "When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it."++
Irving Fisher, 100% Money "Thus, our national circulating medium is now at the mercy of loan transactions of banks, which lend, not money, but promises to supply money they do not possess."++
John Maynard Keynes, The Economic Consequences of the Peace, 1920, page 240 "If, however, a government refrains from regulations and allows matters to take their course, essential commodities soon attain a level of price out of the reach of all but the rich, the worthlessness of the money becomes apparent, and the fraud upon the public can be concealed no longer."
John Maynard Keynes, The Economic Consequences of the Peace, 1920, page 235ff "Lenin is said to have declared that the best way to destroy the Capitalistic System was to debauch the currency. . . Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose."
Ralph M. Hawtrey, former Secretary of Treasury, England "Banks lend by creating credit. They create the means of payment out of nothing."
Robert H. Hemphill, former credit manager, Federal Reserve Bank of Atlanta "Money is the most important subject intellectual persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it is widely understood and its defects remedied very soon."
Sir Josiah Stamp, former President, Bank of England "Bankers own the earth. Take it away from them, but leave them the power to create money and control credit, and with a flick of a pen they will create enough to buy it back."++
Rt. Hon. Reginald McKenna, former Chancellor of Exchequer, England "Those who create and issue money and credit direct the policies of government and hold in the hollow of their hands the destiny of the people."++
John Adams, letter to Thomas Jefferson "All the perplexities, confusion and distresses in America arise not from defects in the constitution or confederation, nor from want of honor or virtue, as much from downright ignorance of the nature of coin, credit, and circulation."++
Wm. Jennings Bryan "Money power denounces, as public enemies, all who question its methods or throw light upon its crimes."++
George Washington, in letter to J. Bowen, Rhode Island, Jan. 9, 1787 "Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice."++
George Bancroft, A Plea for the Constitution (1886) "Madison, agreeing with the journal of the convention, records that the grant of power to emit bills of credit was refused by a majority of more than four to one. The evidence is perfect; no power to emit paper money was granted to the legislature of the United States."++
Article One, Section Ten, United States Constitution "No state shall emit bills of credit, make any thing but gold and silver coin a tender in payment of debts, coin money---."++
John C. Calhoun, Speech 5/27/1836 "A power has risen up in the government greater than the people themselves, consisting of many and various powerful interest, combined in one mass; and held together by the cohesive power of the vast surplus in banks."
Andrew Jackson: To delegation of bankers discussing the Bank Renewal Bill, 1832 "You are a den of vipers and thieves. I intend to rout you out, and by the eternal God, I will rout you out."
Treasury Secretary Woodin, 3/7/33 "Where would we be if we had I.O.U.'s scrip and certificates floating all around the country?" Instead he decided to "issue currency against the sound assets of the banks. [As opposed to issuing currency against gold.] The Federal Reserve Act lets us print all we'll need. And it won't frighten the people. It won't look like stage money. It'll be money that looks like real money." [Emphasis added.] (Source: 'Closed for the Holiday: The Bank Holiday of 1933', p20 - Federal Reserve Bank of Boston)
John Kenneth Galbraith "The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it." Money: Whence it came, where it went - 1975, p15
John Kenneth Galbraith "The process by which banks create money is so simple that the mind is repelled." Money: Whence it came, where it went - 1975, p29
From http://fame.org/NotableQuotes.asp
In GATA's continuing search for the truth about what is really going on in the gold market, they presented the following centerfold, Gold Derivative Banking Crisis. This was published in Roll Call, a Washington, D.C. publication, which is delivered to the House, the Senate, the White House, and many other venues in our country's capital.
An Open Letter to Senate and House Banking Committee Members
Gold Derivative Banking CrisisExtensive research has led the Gold Anti-Trust Action Committee (GATA) to the conclusion that the gold market is being recklessly manipulated and now poses a serious risk to the international financial system.
Annual gold demand, currently at record levels, exceeds mine and scrap gold supply by more than 1,500 tonnes. In the Washington Agreement of Sept. 26, 1999, 15 European central banks announced that they were capping their lending of gold and would limit their official sales of gold to 400 tonnes per year for the next five years. Some major gold producers have reduced their forward sales, and speculators have reduced their borrowed gold selling. Commodity prices and wages are rising. Yet the price of gold has declined steadily. With demand so much greater than supply, the price of gold should be rising sharply.
According to the Office of the Controller of the Currency, the notional value of the off-balance-sheet gold derivatives on the books of U.S commercial banks exceeds $87 billion, which is greater than total U.S. official gold reserves of approximately 8,140 metric tonnes.
Gold derivatives surged from $63.4 billion in the third quarter of 1999 to $87.6 billion in the fourth quarter, after the Washington Agreement was announced. The notional amount of off-balance-sheet gold derivative contracts on the books of Morgan Guaranty Trust Co. went from $18.36 billion to $38.1 billion in the last six months of 1999.Veneroso Associates estimates that the private and official-sector gold loans stood at 9,000 to 10,000 tonnes at the end of 1999. Most of these loans represent gold that has been sold in the form of jewelry and cannot be retrieved. Mine supply of gold for all of 1999, according to trade sources, was only 2,579 tonnes. Thus the gold loans are far too big too be repaid back in a short time. The swift $84 rise in the gold price following the Washington Agreement caused a panic among bullion bankers. But that was only a warning of what is to come.
Federal Reserve Chairman Alan Greenspan and Treasury Secretary Lawrence Summers, responding to GATA's inquiries through members of Congress, have denied any direct involvement in the gold market by the Fed and the Treasury Department. But they have declined to address whether the Exchange Stabilization Fund, which is under the control of the treasury secretary, is being used to manipulate the price of gold.
Several prominent New York bullion banks, particularly Goldman Sachs, from which the immediate past treasury secretary, Robert Rubin, came to the Treasury Department, have moved to suppress the price of gold every time it has rallied over the last year.
The Gold Anti-Trust Action Committee believes that U.S. government officials and these bullion banks have induced other governments to add gold supply to the physical market in recent years to suppress the price. Britain's National Accounting Office is now investigating the Bank of England's decision to sell off more than half its gold. Contrary to proper accounting practice, reductions in gold in the earmarked accounts of foreign governments at the New York Federal Reserve Bank are being listed by the Commerce Department as the export of non-monetary gold. These "exports" from the Fed occur upon rallies in the gold price.
Why would anyone want to suppress the price of gold?1) Suppressing the price of gold has made it a cheap source of capital for New York bullion banks, which borrow it for as little as 1 percent of its value per year. Gold is borrowed from central banks and sold, and the proceeds are invested in the financial markets in securities that have much greater rates of return. As long as the price of gold remains low, this "gold carry trade" is a financial bonanza to a privileged few at the expense of the many, including the gold-producing countries, most of which are poor. If the price of gold was allowed to rise, the effective interest rate on gold loans would become prohibitive. 2) Suppressing the price of gold gives a false impression of the U.S. dollar's strength as an international reserve asset and a false reading of inflation in the United States.
Too much gold is being consumed at too cheap a price. Massive amounts of derivatives are being used to suppress the gold price. If this situation is not corrected soon, there will be a gold derivative credit and default crisis of epic proportions that will threaten the solvency of the largest international banks and the world standing of the dollar.
As you are aware, a 90 page document of our extraordinary findings was personally delivered to your offices last Thursday.
The Gold Anti-Trust Action Committee requests that a full and complete investigation be launched into this matter as soon as possible.
The longer the gold price is artificially held down, the bigger the eventual banking crisis.
Gold Anti-Trust Action Committee, Inc.
Bill Murphy, Chairman, LePatron@LeMetropoleCafe.com
Chris Powell, Secretary / Treasurer, GATAComm@aol.com
Ethan B. Stroud, Attorney at law, formerly Justice Department, Treasury Department
John R. Feather, Attorney at law, formerly legal staff, Federal Reserve Bank
Suite 1203, 4718 Cole Avenue, Dallas, Texas 75205
(214) 522-3411 phone
(214) 522-4432 fax
www.gata.org
Additional reading suggestions
Economics In One Lesson By Henry Hazlitt
Capitalism: the Unknown Ideal By Ayn Rand
Data from the Federal Reserve
12/8/99 to 4/23/2001
Note the rapid rise and fall in the M1
money supply in late 99 and then the decline
for most of 2000. Now note the current rise starting in mid Dec. 2000.
This is one reason for the current stock market volatility.
Corporations have been adding so much debt
to their balance sheets in the past few years that in 1998,
the latest year for which these data are available, non-financial corporate
leverage had risen to a postwar high
From http://www.ntrs.com/index.html
The margin chart above, which shows that margin debt increased
at an annualized rate of about 220% in the past three months. Also shown in the
chart above is a surge in stock market trading volume that coincided with this
explosion in margin debt.
From http://www.ntrs.com/index.html
"FRED index" - Federal Reserve Bank of St. Louis
http://www.stls.frb.org/fred/dataindx.html
This chart compares the M1 money supply (currency and checkable deposits) with the consumer price index. You will notice that there is a close relationship from 1959 to 1982. From 1982 on, it is clear that the two diverge. As the money supply increases, people have more money and so with every purchase they bid prices up. Only large-scale governmental borrowing from foreigners can account for the current money supply to price difference.
The Federal Reserve chooses to publish trade balance numbers differently than other economic numbers. Instead of using the current balance they use the deviation from the previous month or quarter. By only looking at the change from month to month or quarter to quarter, it is easy to lose grasp of the whole picture. On the news a reporter will say that the trade deficit fell from 12 to 9 billion dollars. What they are saying is that last month we overspent 12 billion dollars and this month we overspent 9 billion dollars. In other words, in the last two months we have overspent 21 billion dollars. In the chart above each month's deviation has been added together so it reflects the real position of our trade balance. You can see that starting at the end of 1982 our trade balance dramatically turns south. It was at this same time that the stock market started the current Bull Run.
M1 is narrowly defined money, consisting of the most liquid financial items -- currency and checkable deposits. M2 and M3 are broader monetary aggregates. M2 includes M1 and what are primarily household holdings of savings deposits, time deposits, and retail money market mutual funds. M3 includes M2 along with institutional money funds and certain managed liabilities of depositories (large time deposits, repurchase agreements, and Eurodollars). L includes M3 and other liquid assets.
The importance of this graph is to show that the money supply is growing no matter which measure you look at.
Inflation discourages savings and encourages borrowing. The first chart on this page shows how savings have remained at about the same level while consumer debt has steadily increased. The second chart shows our government's national debt in constant 1947 dollars. This inflation adjusted chart shows not only that the debt is real but that it has increased steadily since 1982.
America has had a party with borrowed money. Like the grasshopper in the fable of "The Grasshopper and the Ant" when winter comes we will pay the price for having lived for the moment and not thought of the future.
I Ray Worseck, "Inside Quote" (A.G. Edwards, Jan. 1998), p. 3
II Henry Hazlitt, "Gold versus Fractional Reserves" (Fame.org, 1979), p 3
III Alvin H. Hansen, Fiscal Policy and Business Cycles (W. W. Norton & Co. .Inc. 1941), p 76
IV Benjamin M. Anderson, Economic and the Public Welfare (Liberty Press, 1979), p 128
V John Chamberlain, The Enterprising Americans (Harper Colophon Books 1963), p 227
VI John Kenneth Galbraith, The Great Crash 1929 (Houghton Mifflin 1961), p.35
VII Murray Rothbard, America’s Great Depression (Richardson & Snyder 1983), p 117
VIII Gordon Thomas & Max Morgan-Witts, The Day the Bubble Burst, (Doubleday 1979), Page 311
IX John Chamberlain, The Enterprising Americans, p 230
X Richard M. Salsman Gold and Liberty, (American Institute for Economic Research 1995), p75
XI http://www.bea.doc.gov/briefrm/tables/ebr10.html
XII John Chamberlain, The Enterprising Americans,p 226
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