Reality Check (June 14, 2002)
Charles Dickens created a character for DAVID COPPERFIELD, Mr. Micawber. And macabre he was! He was a promoter, a blower of bubbles, a schemer, a spinner of dreams. Nothing ever quite worked for him as planned, but he was always hopeful. His philosophy of life has come down to us in his famous phrase, "Something will turn up."
In the 1935 movie, W. C. Fields played Micawber. This was an example of flawless casting.
Dickens identified the mind-set of the huckster, the man who substitutes schemes on paper for productivity. Dickens was convinced that capitalism is basically little more than a gigantic system of schemes. He saw the system as a bubble. He was wrong about capitalism, but he was correct about the central institution of capitalism, fractional reserve banking. This institution, from the creation of the Bank of England in 1694 until the present, has been the creation of government. It could not exist without The Agreement: "You license our monopoly over money, and we'll guarantee a market for government debt." I call it Micawber's Agreement.
The Agreement is at the heart of the modern world's economy. Only one thing has ever proven successful in exposing this agreement as a Micawberesque scheme: a rising price of gold. This is why, above all else, central bankers strive to keep down the price of gold.
The price of no other commodity attracts as much attention. The price of no other commodity is the subject of extended editorials in financial publications. Gold is not just another commodity, despite what the gold-haters in the media assure us. If it were, then they would not have to keep writing their articles that assure us that it is.
I realize that expert opinion can be awe-inspiring. I fully understand that when Alan Greenspan appears on Capitol Hill, Congressmen, Senators, and WALL STREET JOURNAL columnists are impressed by rhetoric that is matched only by Dwight Eisenhower's and Professor Irwin Corey's. (http://www.professor.irwincorey.com) But, as I listen to his presentations and read them on-line, I keep in mind an image of W. C. Fields. This helps me to put things in their proper perspective.
DISHONOR AMONG THIEVES
Prior to the outbreak of World War I in 1914, gold coins served as money for the masses of the West. Gold bullion is still money within the closed fraternity known as central banking. It is money for central bankers because they do not trust each other. They expect each other to cheat, to debase their currencies, to defer payment, to lie without embarrassment, and to stiff their brethren if they think they can get away with it on the cheap. They know from experience over centuries that debtors cheat creditors. The modern economy is based on massive debt, and every debt is denominated in a means of payment: a currency.
Central bankers want to be able to cheat the public. Cheating the public is the number-one goal of all central banking. The system has always rested on monopoly and deception. At the same time, the number-two goal of central bankers is to avoid being cheated by each other. These goals are always in conflict. That which best protects the central bankers from each other -- a gold coin standard -- also protects the public from central bankers.
In 1914, all central banks except the Federal Reserve System stole the gold that three generations of citizens who had dutifully and foolishly handed over to commercial bankers. The only people who were not big losers were those who had not been rich enough to open a bank account. The "best and the brightest" were the biggest losers. After 1914, shell-shocked European depositors trusted the words -- no longer redeemable in gold -- of the commercial bankers' official representatives, central bankers.
In 1933, Franklin Roosevelt acted as the agent of the Federal Reserve, and confiscated Americans' gold, hiking its price in 1934 by 75%, after the government was in possession of the stolen goods. The government then turned over the stolen gold to the central bank. This is how the system has always worked. This is The Agreement.
Central bankers are like most other debtors: they want to be able to escape their creditors if bad times arrive. They want to be able to get out of their obligations. They did this in 1914. The FED did it in 1933. Central bankers cheated millions of depositors, who had naively believed the commercial bankers' original promise: "Invest your gold with us, and we'll pay interest to you. You can get your gold back on demand at any time (you dumb clucks)."
Central bankers are also like creditors: they don't want to be cheated by their debtors. They wanted protection. They trusted gold. So, having stolen the public's gold with the politicians' blessing, they created an inter-bank gold standard for themselves: the gold- exchange standard. It began in 1922 (the Genoa agreement). They extended it in 1944 (the Bretton Woods agreement). By these agreements, the Bank of England and the FED promised to pay other central banks -- but not the general public -- gold on demand. By 1944, the Federal Reserve System had most of the world's gold. The FED then persuaded the United States government to extend a promise to other central bankers on its behalf: "Invest your gold with us, the United States government, and we'll pay interest to you. You can get your gold back on demand at any time (you dumb clucks)." It worked like a charm. It always does. The market for U.S. government debt became the largest debt market on earth.
On August 15, 1971, President Nixon did to the world's central bankers what all of the central banks and their governments had done in 1914 to their equally naive citizens. Without warning on a Sunday afternoon, he revoked the promise and closed the gold window. "Suckers!"
From that time on, the price of gold in relation to any national currency was set by the law of supply and demand. But, then again, it had always been set by supply and demand. The question of the gold value of any currency is always settled by supply and demand. How much currency is coming out of some central bank? How much gold is being made available by suppliers? Will existing monetary policies be continued?
LIAR, LIAR
The larger the debt, the more tempting the lie. "You're check is in the mail." This is because the present threat of the future costs of defaulting on a loan pale in comparison to the present cost of repaying. Bankruptcy looms. Deferral now looks like a reasonable policy. If the debtor can defer the day of reckoning, he will be sorely tempted to do this. Bankruptcy tomorrow is a greater threat than losing access to the credit markets in a year. Maybe the lie will work. "Something may turn up."
If the creditors keep pushing for payment, the debtor's lie become obvious. At that point, the debtor admits the truth: "I can't repay." When the debtor is a sovereign government, nobody can do much about it. What's gone is gone. It was nice while it lasted.
Creditors may threaten to cut off future loans, but everyone knows that's also a lie. Latin American governments have been playing the default game with gringo bankers ever since the 1830's. Argentina is only the latest example. Brazil will probably follow.
Do foreigners still loan money to the United States government? Of course. Did our government stiff them in 1971? It stiffed their central bankers, but politically speaking, central banking is not a big issue. The public doesn't understand international economics and currency markets, so voters don't toss out governments because their governments have stiffed foreign creditors, including foreign central bankers. If anything, the Senior Liar of the existing government is likely to be re-elected. Nixon was overwhelmingly re-elected in 1972.
The public ought to care. It pays for losses sustained by the nation's bankers. Taxes bail out recently stiffed bankers. The central bank says, "If we win, you get to keep more of your money. So do we. If we lose, you will pay for our losses." Nice work if you can get it.
The way the public pays is through higher taxes, especially the inflation tax. Consider the year of the great confiscation in the United States: 1933. To match the purchasing power of the dollar of 1933, a person needed over $3 in 1971. That is, the purchasing power of the dollar fell by two-thirds. That's what President Roosevelt's unilateral abolition of the gold standard did to trusting Americans who had naively believed the government's promise to redeem the public's gold at $20.67/oz. This depreciation took 38 years. Suckers!
Ever since Nixon's unilateral abolition of the gold- exchange standard in 1971 -- refusing to sell gold at $35/oz to central bankers -- the dollar has fallen in value by almost 80%. It takes $4.44 to buy today what it took $1 to buy in 1971. This depreciation took 31 years. Suckers! See the inflation calculator:
The falling value of the dollar is the irrefutable evidence of the effects of government lies. But hardly anyone cares. Everyone thinks he is getting richer. Through politics, the over-65 crowd has gotten a cost-of- living escalator written into the Social Security law. This is why the government uses the standard Consumer Price Index to calculate inflation rather than the more accurate Median CPI, which today indicates that price inflation is three times higher than the CPI says.
Sometime in 1980, Dan Ackroyd did a skit on "Saturday Night Live" called "Inflation is our friend." He came on- screen with a Jimmy Carter-like accent, which was pretty good for a Canadian. "Didn't you always want to wear $400 suits and live in a $200,000 home. I know I did. Well, now we can. All it takes is a little ink and some paper." Too bad it's true.
THE DEBT RATCHET
A major problem with monetary inflation is the level of debt it produces. The debt level ratchets ever upward, never going back. Aggregate debt is never repaid. Or, as King David wrote, "The wicked borroweth, and payeth not again" (Psalm 37:21a).
Debt today is the foundation of the world's money system. It is not the debt of a warehouse receipt: a fixed quantity of gold in reserve for a specific number of receipts issued (100% reserves). It is a system based on expectations: "payday someday." We have capitalized debt. We have allowed fractionally reserved central banks to use politicians' promises of future payment (i.e., government bonds) as the foundation of our money system. The only way that the politicians can pay off today's level of government debt is by creating even more government IOU's, some of which will be used as the legal reserve to expand the money supply. Debt will then rise even more, in every niche of the economy except (possibly) the section run by the Amish.
Debt is denominated in a currency. Debt locks in everyone's hopes and plans. It also locks in our financial markets. Debt lures us into making decisions based on an assumption regarding money: "There's always more where that came from." And there always is. The Federal Reserve is pumping in new money today, just as it has done since 1933. The St. Louis Federal Reserve's data indicate that the Adjusted Monetary Base has risen by over 10% since May 30, 2001. It has been rising at an 11% rate since early April of this year.
The underlying assumption of every investor is that the government -- meaning the central bank -- will make available enough money for the vast majority of debtors to keep making payments on their loans. Creditors look mainly to next month's payment. If that is secure, they can capitalize this hoped-for stream of income. They can sell the credit instrument to someone else for cash. That's what Fannie Mae and Freddie Mac are all about.
Creditors, like debtors, believe that the FED will keep the debt system going, which means keeping the capital markets solvent with credit-based money. They also believe that price inflation will not rise at anything like the rate of increase in the money supply. They believe that they will be repaid in dollars of fairly constant purchasing power. They believe this in the face of massive historical evidence to the contrary, from the day that Roosevelt confiscated the American public's gold. They simply will not learn. Like the poor, the prophets of deflation are ever with us, never putting together cause and effect, never learning that prices keep rising because the money supply keeps rising. They even applaud the FED for keeping the money spigots open.
Every school of economics except the Austrian School (Mises and Rothbard) believes that a free market in money can't work in theory: Keynesians, monetarists, and supply- siders. They all call for government intervention into money and banking. They all decry "tight money," which they define operationally as monetary growth that allows a recession.
The Keynesians and monetarists are consistent. They reject the gold standard in any form. The supply-siders, whose members have yet to produce a single textbook or economic treatise that explains how their system works in theory, sometimes call for a government-run, government- controlled, government-guaranteed gold standard, which somehow will not keep money so tight that an economic depression results. They proclaim a gold standard that somehow will not destroy the number-one assumption of America's capital markets, namely, "There's always more where that came from."
Whenever you are told about a gold standard that will enable the present debt system to survive the effects of stable money and the massive level of default that will result when the money spigot is closed, ask for a reference to the chapter in the textbook that describes how this is possible. You will be told, Ackroyd-like, "trust me."
If you want Mises' view of why monetary inflation leads to an economic depression after the money spigot is closed, read Chapter 20 of HUMAN ACTION. Or read my on- line e-book, MISES ON MONEY, Part V.
WHOM SHOULD WE TRUST?
Members of the fraternity of central bankers know enough not to trust each other. If they see that one of their member banks is cranking up its domestic money supply, they buy gold from that member. They deplete his bank's god reserves.
The central banks' gold is stored mostly at the Federal Reserve Bank of New York, at 33 Liberty Street. If you saw "Diehard 3," you know this. (I wonder if a majority of the viewers of that film every understood what they were seeing. Probably not.) In each nation's designated cubbyhole in the underground vault at 33 Liberty Street is stacked a pile of gold ingots. Transactions among central banks are settled daily. Men on electric fork lifts carry gold bars from cubbyhole to cubbyhole.
It is clear what the central bankers trust as the final court of appeal: gold. Anyway, that is what they used to trust. I believe this is now changing. In the past, they have trusted the FED not to end the game by confiscating everyone's gold, and telling the world to go fly a kite. So far, this trust has not been violated. America is the world's superpower. It has the largest capital markets. If it were ever to act in the way that a Latin American banana republic acts, the world's central banks would . . . would. . . ? What?
I know. I know. They would sell U.S. government debt. (To whom?) They would buy some other nation's debt. (With what?) They would select some other form of debt to back up their own currencies, thereby replacing the dollar. (Like what?)
What could they do? They could roll on the ground and hold their breath until they turned blue. They could scream. And then, as central bankers always do, they would lend to the highest bidder. That would probably be the United States.
The fact is, the fractional reserve system has sucked in the central bankers. Like depositors who turned in their gold coins in exchange for interest-bearing debt ("deposits"), so have central bankers turned in their gold in exchange for interest-bearing debt ("T-bills"). Like depositors, they can't get their gold back. Nixon ended that option. So, if they want gold, they must buy it in the open market. This would drive up gold's price as denominated in the central bank's currency. This would alert the world that something is wrong with the currency of the nation whose central bank is buying gold. No central banker wants to cause that to happen. So, as individual banks, they dare not buy much gold. So, they don't have much use for gold any more. Because Nixon changed the rules, they have been trapped by the logic of the market for gold: supply and demand.
Central banks today are selling their gold. They are concealing this through lease contracts, which are in fact permanent sales contracts. The bullion banks that have borrowed the gold, sold it, and invested in government bonds cannot possibly repay with actual gold. ("The wicked borroweth and payeth not again.") The central bankers know this. They do not care. The bullion banks are selling gold to the general public, who in turn use the gold for non-monetary purposes. This keeps down the price of gold.
European central bankers have come to the conclusion that they can't sell their holdings of dollars and use these dollars to buy gold from other central bank. They don't dare fly gold home for safe storage in their own vaults. That would panic the world's capital markets. The dollar might collapse, and all of the central banks hold dollars. Like depositors in a bank that is unsound, they dare not withdraw their money for fear of creating a bank run.
Gold therefore isn't useful for central bankers any more. They are trapped by the fractional reserve system that their predecessors created. They dare not display distrust in the dollar because the international trade system rests on the maintenance of public trust in the dollar. So, they do not buy gold as a hedge against a fall in the value of the dollar. Instead, they sell gold. This keeps the price of gold low, which creates the illusion that there is not a looming crisis facing all nations: their governments' inability to pay off their retirement- medical programs to an aging population.
A massive, worldwide default is looming. There is no way to avoid it. The central bankers all know this. No one knows it better than Peter G. Peterson, an investment banker who heads the Council on Foreign Relations. He has written several books about this. The latest is GRAY DAWN (1999). They know. Their governments will eventually call on them to create enough fiat money to pay off the governments' debts to an aging public.
There is only one way that the world's Social Security-Medicare programs can be paid off: with fiat money. Then money will depreciate in value. The central banks are selling gold to the public in order to keep the price of gold from indicating the magnitude of the default- by-inflation that lies ahead.
Central bankers are today resorting to the tried and true method used by overextended debtors down throughout the ages. They are gagging the inside stoolie. The inside stoolie is gold. When the price of gold rises, the public is alerted: "Liar, liar." Central bankers are manipulating the gold market by selling off their gold. Like a riverboat gambler with a fat roll of $1 bills, and a few $100 bills around the outside of the roll, spending a few of them for show, central bankers are selling off their gold reserves in order to keep the reality of the looming currency crisis from becoming obvious. They are deferring the day of reckoning. Why? Because they have a dream: "Something may turn up."
Central bankers after 1815 trusted gold rather than each other, but they have all quietly agreed to sell off gold officially, a little at a time, and sell lots of it unofficially through the gold leasing program, which hardly anyone notices. They keep the sold gold on their books because they define these sales as loans, payable in kind. It's a short-term tactic, and it appears to be irreversible as central bank policy.
They no longer trust gold. Then what will they trust in the future? They will have to trust each other's politicians. That is, they are now trapped, just as the rest of us have been trapped since either 1914 (Europe) or 1933 (the United States).
The public prior to 1914 trusted the banks because the banks promised to redeem gold at a fixed price. This promise was backed up by the courts -- contract law. When World War I broke out, the politicians broke the law on behalf of the banks, authorizing the banks' confiscation of the depositors' gold. Then the politicians confiscated this gold on behalf of their respective central banks, turning the gold over to their central banks. In short, the politicians lied.
Politicians always lie. Their job is to lie. We pay them to lie. We re-elect them for lying well. The question for each voting bloc is this one: "Which political party's lies seem to favor us?" Politics is about wealth- redistribution by force, and the greatest tool of political wealth-redistribution is the lie. "Everyone will retire in comfort." "We will not break our promise to our senior citizens." "The Social Security trust fund is secure, and the fact that it is filled with IOU's has nothing to do with anything." "Taxes will not go up." "We will not go to war." And so on. All lies. We know they are lies, and we select which lies we will vote for, believe in, and invest in terms of.
Nineteenth-century Latin American dictators spotted the willingness of gringo commercial bankers to invest in terms of obvious lies, and they have milked the banking system ever since. It took longer for us gringos to figure out how the system works. But we did eventually learn.
The fractional reserve banking system is a gigantic lie. Commercial bankers represent their depositors, who in turn believe in the biggest lie of all: "Deposit your money with this bank, and we will pay you interest on it, and you can get back your money -- your lent-out money -- on demand at any time." This is the lie of fractional reserve banking. This lie is to capital markets what a perpetual motion machine is to physics. When you hear about a perpetual motion machine, you can be sure of two things: (1) the promoter is lying; (2) there is a hidden power cord or battery somewhere in the system. When you hear about an investment that pays interest, but which you can get back at any time, start looking for the hidden power cord.
Don't trust sellers of perpetual motion machines. Don't trust the machines, either. Look for the cord. If you get the opportunity, cut it.
We live in an era of widespread faith in perpetual motion machines: government benefits for the masses paid for by The Guy Behind the Tree; bank deposits that pay interest on lent-out money that is available on demand; a central bank-run version of the gold standard that has not had redeemable receipts since 1971; the promise of stable prices from a monetary system that rests on government promises to pay. Lies, all lies. And our world is built on them. For now.
CONCLUSION
Your economic future rests on the fulfillment of promises so brazenly false that no one with an IQ above 90 should believe even one of them. It rests on what most people ought to recognize as lies. Yet in the best universities, in the fattest textbooks, in the highest seats of power in the land, all over the world, these lies are not only believed, they are presented to the public as profound truths -- proof that the world is a new and better place.
As for me, I prefer Kipling's version of these new and profound truths. Read "The Gods of the Copybook Headings" (1919). Then plan accordingly.
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