The Greatest Speech Ever Given

The greatest economics-related speech, at any rate. I kid you not. I found myself sounding like a Spirit-infused Southern Baptist listening to a fiery old preacher thundering from the pulpit as I read it:

Thank you very much for inviting me to speak here at the New York Federal Reserve Bank.

Intellectual discourse is, of course, extraordinarily valuable in reaching truth. In this sense, I welcome the opportunity to discuss my views on the economy and monetary policy and how they may differ with those of you here at the Fed.

That said, I suspect my views are so different from those of you here today that my comments will be a complete failure in convincing you to do what I believe should be done, which is to close down the entire Federal Reserve System

My views, I suspect, differ from beginning to end. From the proper methodology to be used in the science of economics, to the manner in which the macro-economy functions, to the role of the Federal Reserve, and to the accomplishments of the Federal Reserve, I stand here confused as to how you see the world so differently than I do.

I simply do not understand most of the thinking that goes on here at the Fed and I do not understand how this thinking can go on when in my view it smacks up against reality.

Please allow me to begin with methodology, I hold the view developed by such great economic thinkers as Ludwig von Mises, Friedrich Hayek and Murray Rothbard that there are no constants in the science of economics similar to those in the physical sciences.

In the science of physics, we know that water freezes at 32 degrees. We can predict with immense accuracy exactly how far a rocket ship will travel filled with 500 gallons of fuel. There is preciseness because there are constants, which do not change and upon which equations can be constructed..

There are no such constants in the field of economics since the science of economics deals with human action, which can change at any time. If potato prices remain the same for 10 weeks, it does not mean they will be the same the following day. I defy anyone in this room to provide me with a constant in the field of economics that has the same unchanging constancy that exists in the fields of physics or chemistry.

And yet, in paper after paper here at the Federal Reserve, I see equations built as though constants do exist.

And the close, Sweet Mises, the close! It is unbelievable! If you can read Robert Wenzel's speech to the New York Federal Reserve without involuntarily emitting one "that's right", "amen", or "halle-fucking-lujah", you simply do not belong at this blog. I sent him the following email:

Please allow me to compliment you, no, praise you, for giving what henceforth must be known as The Greatest Speech Ever Given in the field of economics. It was as if Daniel not only entered the lions' den without fear, but voluntarily, to preach to the beasts of the merits of vegetarianism. The English language simply does not possess the words to describe how magnificent your speech was.

The zero-reserve banking system

Unbelievable. They certainly didn't teach this in our economics textbooks. From Ben Bernanke's testimony to the House Committee on Financial Services:

Given the very high level of reserve balances currently in the banking system, the Federal Reserve has ample time to consider the best long-run framework for policy implementation. The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

Those who have RGD will note that this elimination of reserve requirements would theoretically permit the former fractional-reserve banks to make an infinite amount of loans regardless of what deposits they hold. This would also theoretically provide a rational basis for the hyperinflation scenario, but as I have pointed out many times before, even an infinite money multiple will require an infinity of borrowers.

If this does not make it clear to you that the financial authorities are getting desperate, I don't know what will. The ironic thing is that most people still believe that the fractional-reserve system is based on a 10% minimum reserve requirement.

Inflation vs deflation XI

I'll start off this last round in the debate by pointing out that I have most certainly not claimed that federal spending somehow doesn't count as inflation. I was simply pointing out that the Federal Reserve's attempt to inject money into the economy has been effectively limited to one delivery vehicle because the banks and households have proven to be surprisingly ineffective channels for doing so. Again, Nate inadvertently shows how his refusal to accept the intrinsic relationship between credit and money renders his analysis incorrect.

I very much agree that “for the purposes on inflation it doesn't matter who's spending the new money”. And I agree that “government spending is merely the delivery method for injecting it into the economy”, but what Nate is failing to mention here is that government spending isn't the only, or even the primary, delivery method used by the Federal Reserve. The significant thing is that government spending is the only delivery method of the four the Fed has been attempting to utilize for the past five years that has worked at all. Despite the larger part of the Fed's efforts being directed at the financial sector, that credit sector has continued to shrink. So has the household sector despite the attempts to replace the housing sector bubble with an education bubble. The corporate sector has responded, a little, but the $1.8 trillion increase since 2008 is barely more than half the contraction in the financial sector.

Nate claims that prices are rising everywhere across the board and that it doesn't matter where the government spends the new money. Both assertions are incorrect. Gold prices are down 24 percent since the start of the year. Home prices are up 1.1 percent in that same time frame, but are still down 29 percent from their 2006 peak. Gasoline prices are up from January, but have been trending down since the spring of 2012. And the inflated stock market is showing every sign of a steep, long-overdue price correction. But these are merely symptoms, and short-term symptoms at that. I see them as reflections of the credit disinflation, Nate sees them as signs of incipient hyperinflation. Only time will tell who was correct, so there is no point in further belaboring the price issue.

Nor do I see any point in providing an extended explanation of why Ben Bernanke appears to be signaling an end to the quantitative easing program, or the significance of the initial indications that Shinzo Abe's massive attempt to print money in Japan is failing, because Nate took things in a rather different direction with his focus on the idea that hyperinflation is a psychological phenomenon rather than a material one. Those who are interested can find effective summaries of those two not-insignificant events on Zerohedge. Nate wrote:

Hyperinflation is what happens when people decide that the fiat money they have in their pockets and in their accounts is no longer going to be honored in the future and start spending it as quickly as possible.  That is the unstoppable train of inflation.  The printing presses cannot be stopped because the people will not stop spending the money as soon as they get it.

But this perspective on hyperinflation again fails to account for credit, which is how most people are spending most of their money these days. Even when literal credit cards aren't involved, they are paying their bills with direct bank debits and debit cards that draw from their credit money account. If one considers the recently reported fact that 68 percent of Americans possess less than $800 in savings, it should be clear that they simply don't have any fiat money in their pockets. To quote the report: “After paying debts and taking care of housing, car and child care-related expenses, the respondents said there just isn't enough money left over for saving more.” Emphasis added. Nate's unstoppable train simply doesn't have enough of an engine to leave the station, especially when the credit money that is in those accounts begins vanishing in the inevitable bail-ins. 

In considering the possibility of hyperinflation versus the likelihood of deflation, it is important to do something we have not yet done in this debate, which is to examine the differences between the present situation and the most famous historical hyperinflation. As has been previously noted, in the USA, L1 total credit has remained very close to flat since 2008, increasing only 11.2 percent in five years. By contrast, in the period leading up to the Weimar hyperinflation, the Reichsbank debt increased from 3 billion to 55 billion marks between 1914 and 1918, and to 110 billion by 1920.  

"Businessmen found it very profitable to borrow money from the bank and buy up goods, shares and companies. Their debt was wiped out within weeks by the rapid inflation, and the businessman remained holding the valuable assets he had bought. The net result was a huge "private inflation" caused by the rapid expansion of credit.... By October 1923, 1% of government income came from taxes and 99% from the creation of new money."

It should be readily apparent that Weimar represented a very different scenario than the one we observe today.  We are not seeing an increase in private borrowing, but rather, a net contraction. This means the only way hyperinflation can even theoretically begin in the present circumstances is if the Federal Reserve elects to permit the debtors in the various debt sectors to pay off their debts rather than encouraging them to default by raising interest rates, and uses the government to begin electronically injecting dozens of trillions of dollars into the economy through the mainstream equivalent of food stamp cards.

Is it possible? Theoretically. Is it improbable. I think so, which brings this entire debate back to the beginning, which is that one's opinion on hyperinflation versus deflation depends entirely on one's belief that the Federal Reserve is willing and able to choose the former over the latter. Setting aside the fact that there are already those who believe that Bernanke has followed the Depression-era Fed's lead in choosing the latter on the basis of his cryptic remarks concerning “tapering”, it is my contention that the Fed is not only unable to massively inflate, but that it is totally unwilling to do so.

Nate will have the last word, but since you've indulged his imagination concerning the widespread abandonment of the dollar, perhaps you'll indulge mine concerning the motivations and mindset of the Federal Reserve in the present environment. Inflation and hyperinflation benefit borrowers. Deflation benefits lenders, as they are repaid in increasingly valuable currency. Default also benefits lenders as long as the collateral backing the loan exceeds the value of the outstanding debt. So, in closing, I will simply ask you one simple question: at this point in time, is the Federal Reserve a net borrower or a net lender?

By way of example, let me propose a hypothetical scenario that is perhaps a little outlandish, if not completely in the zone of economic science fiction. The Ciceronian political cycle predicts aristocracy, not tyranny, as the post-democratic political system. And what would be a more effective way to legally establish a wealthy aristocracy with a relative minimum of societal disorder than to encourage vast indebtedness, then trigger mass defaults by raising interest rates, which then results in the acquisition of title to all of the defaulted collateral?  Even the most hard core libertarian couldn't find anything to complain about such an action; (merely the idiocy of the centralized structure that permitted it to happen), and it would be a damn sight more legal than three-quarters of the activities with which the administration's agencies occupy themselves these days.

What "austerity"?

Paul Krugman appears to be moderately pleased that another bearded Scots-Irish hippie has publicly joined the ranks of the anti-austere.

Will it make any difference that Ben Bernanke has now joined the ranks of the hippies?  Earlier this week, Mr. Bernanke delivered testimony that should have made everyone in Washington sit up and take notice. True, it wasn’t really a break with what he has said in the past or, for that matter, with what other Federal Reserve officials have been saying, but the Fed chairman spoke more clearly and forcefully on fiscal policy than ever before — and what he said, translated from Fedspeak into plain English, was that the Beltway obsession with deficits is a terrible mistake.

First of all, he pointed out that the budget picture just isn’t very scary, even over the medium run: “The federal debt held by the public (including that held by the Federal Reserve) is projected to remain roughly 75 percent of G.D.P. through much of the current decade.”

He then argued that given the state of the economy, we’re currently spending too little, not too much: “A substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery.”

Finally, he suggested that austerity in a depressed economy may well be self-defeating even in purely fiscal terms: “Besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.”

Speaking of the Federal Reserve, I note the following numbers:  526.5    560.9    465.4    338.4    378.7    261.4    477.8    344.5    390.1    367.8    260.3    92.7    389    326    398.3    198.2    229.8.

Those are the numbers, in billions, that represent the quarterly increase in federal debt as reported by the Federal Reserve's Z1 credit report.  That is a $6 trillion INCREASE in just over four years, which more than doubled the federal government's outstanding debt.  There is no austerity.  In fact, the idea that the sequester somehow amounts to imposing austerity is rather like a drunk claiming that because he did 20 shots last night and planned to do 24 shots tonight, only doing 22 shots represents teetotalism.

They simply don't make ascetics like they used to.

Bernanke and the housing bubble

In which Ben Bernanke throws Barney Frank under the bus. Even if you're not an economist, Ben Bernanke's attempt to excuse the Federal Reserve for any responsibility in creating the housing bubble really has to be read to be believed. Here's the one of the more damning paragraphs in the 36-page PDF:

First, the cumulative increase in housing prices shown in Slide 5 is quite large. Can accommodative monetary policies during this period reasonably account for the magnitude of the increase in house prices that we observed? If not, what does account for it? Second, house prices rose significantly during this period in many industrialized countries, not just in the United States. If monetary policy was an important source of house price appreciation in the United States, it seems reasonable to expect that, in an international comparison, countries with easier monetary policies should have been more likely to have significant rises in house prices as well. Is that the case?

With respect to the magnitude of house-price increases: Economists who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade can be attributed to the stance of U.S. monetary policy. This conclusion has been reached using both econometric models and purely statistical analyses that make no use of economic theory.

This is extraordinarily deceptive on several levels. Bernanke is first leaving out the fact that regulation of the banks is the specific responsibility of the Federal Reserve and is an inherent part of monetary policy given the fact that most of the money in the system is created by bank loans under the fractional-reserve system. He is, of course, limiting his implicit definition of "monetary policy" to interest rate targets, which is acceptable in general economic discussions but not in a specific one of this sort.

Second, it should be no surprise that Bernanke feels justified by the use of econometric models based on the Taylor Rule because the Taylor Rule is the very rule that was used to justify the Fed's actions in the first place. As Mike Shedlock shows using Case-Shiller housing prices in the place of Owner-Equivalent Rent to calculate CPI-U, the Taylor Rule is fundamentally flawed because it is based on CPI-U. In RGD, I demonstrate a few of the many ways CPI-U considerably underestimates the real rate of price changes; the fact that it doesn't even take real housing prices into account renders it entirely useless as a basis for defending the Federal Reserve's actions or comparing the U.S. housing market with international housing markets.

No doubt there will be a lot of detailed critiques of this paper in the coming month. I may even write one myself. But in summary, "Monetary Policy and the Housing Bubble" is a shameless and deceptive attempt by a failed economist to justify his spectacular failure by using the very models that failed him in the first place.

I recognized the housing bubble in 2002; that is a matter of public record. Bernanke, on the other hand, was still denying it existed in October 2005, less than a year prior to its 2006 peak! "House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas."

Calculated Risk points out two more things that Bernanke conveniently avoided mentioning:

"Bernanke used data from other countries to suggest monetary policy was not a huge contributor to the bubble ... however, Bernanke didn't discuss if non-traditional mortgage products contributed to housing bubbles in other countries. This would seem like a key missing part of the speech.

Bernanke didn't discuss how the current regulatory structure missed this "protracted deterioration in mortgage underwriting standards" (even though many people were pointing it out in real time). And Bernanke didn't discuss specifically how the new regulatory structure would catch this deterioration in standards."

The truth is that the Fed knew about the "protracted deterioration in mortgage underwriting standards" prior to the start: "Even before economic prophets of doom such as Marc Faber, Nouriel Roubini, and Peter Schiff became famous for their correct warnings of imminent crisis, Edward Gramlich, a governor at the Federal Reserve, told Fed Chairman Alan Greenspan that making home mortgages available to low income borrowers would lead to widespread loan defaults having extremely negative effects on the national economy. This extraordinarily specific warning was given in 2000, amidst the wreckage of the dot-com bomb and before the housing bubble even began. Those possessed of a mordant sense of humor may appreciate how Greenspan rejected Gramlich’s recommendation to audit consumer finance companies on the basis of his fear that it might undermine the availability of subprime credit."
- Vox Day, The Return of the Great Depression, x.

Integrity vs intelligence

Calculated Risk is one of the best, and most statistically useful, economics blogs on the Internet. However, I do have to disagree with one of CR's recent posts in which he comments on the character of the current Federal Reserve Chairman. Contra CR, I don't think it is the least bit unreasonable to have serious questions about Ben Bernanke's integrity:

"It is one thing to have different views from those of the Fed Chair on particular decisions that have been made-- I certainly have plenty of areas of disagreement of my own. But it is another matter to question Bernanke's intellect or personal integrity. As someone who's known him for 25 years, I would place him above 99.9% of those recently in power in Washington on the integrity dimension, not to mention IQ. His actions over the past two years have been guided by one and only one motive, that being to minimize the harm caused to ordinary people by the financial turmoil. Whether you agree or disagree with all the steps he's taken, let's start with an understanding that that's been his overriding goal."

I agree with Professor Hamilton.

I assert, to the contrary, that if one is sufficiently familiar with Mr. Bernanke's books and speeches, one is forced to choose between his intelligence and his integrity. I have no doubts at all about the former and I am reasonably confident about his lack of the latter. By way of example, I quote his 2007 speech to the Bundesbank:

"I will begin by reviewing the origins and development of the global saving glut over the period 1996-2004, as discussed in my earlier speech, and will then turn to more-recent developments.... The question at issue, therefore, is whether the decline in the realized saving rate in the United States reflected a decline in desired saving or was instead a response to other, possibly external, economic developments. Or, in textbook terms, did the fall in the realized saving rate in the United States reflect a shift in the demand for savings at any given interest rate (a shift in the saving schedule) or a decline in savings induced by a change in the interest rate (a movement along the saving schedule)? In fact, there is no obvious reason why the desired saving rate in the United States should have fallen precipitously over the 1996-2004 period.5 Indeed, the federal budget deficit, an oft-cited source of the decline in U.S. saving, was actually in surplus during the 1998-2001 period even as the current account deficit was widening."

First, as Stephen Roach of Morgan Stanley pointed out three months before Bernanke gave his speech, there is no "global savings glut". The global savings rate as a percent of world GDP fell from 23 percent to 22.8 percent from 1990 to 2006; the reason Bernanke - in 2007 - chose 2004 as a figure is because the global savings rate had briefly risen to 24.9 percent before falling back below the 24-year average of 23 percent.

Second, Bernanke had to know the answer to the question he posed was "a decline in savings induced by a change in the interest rate" since the interest paid on 6-month CDs from 5.7 percent in 1996 fell to 1.0 percent in 2004. This is not only an obvious reason that suffices to explain the decline in U.S. personal savings, but is one that Bernanke, in his role as a Federal Reserve governor, absolutely had to know. The fact that he cites far more obscure interest rates in his 2007 speech, such as the real yields on inflation-indexed government bonds in the UK and Canada, strongly supports this contention.

Why would Bernanke speak in such a deceitful manner? For the same reason he is stonewalling the US Congress and refusing to allow any audits of the Federal Reserve's activity. He is desperately attempting to keep people from realizing that the Federal Reserve not only created the Great Depression, but that it has most likely played a central role in bringing about its return. The attempts to deceive may be silly and implausible, but it's all the Bernanke has left if his best efforts prove unsuccessful in averting the contraction in 2010 he has to know is in the works.

It's worth noting that the "global savings glut" theory is pure Keynesianism, as is the famous helicopter money response to economic contraction. There's nothing truly monetarist about these practitioners of active and discretionary monetary policy.

UPDATE - Can you spot the savings glut? From Brigitte Desroches and Michael Francis,.

Interview with Gary Nolan

I had a interesting conversation with Gary Nolan, a candidate for the Libertarian Party nomination for President, on the telephone today. He's articulate, surprisingly forceful, and demonstrated a greater intellectual depth with regards to the issues than his web site indicated. I asked him about five issues that were not addressed on the web site, then asked him to tell me about one thing that he particularly felt demanded addressing.

1) On the United Nations and other supranational organizations

I would have nothing to do with them. I would withdraw from them. If they want to rent a building, that's fine. But I do not support these behemoths that they've become, nor would I support them with tax dollars. I would support withdrawing from the United Nations in its current form. If there were a place for all of these countries to send a representative to meet and discuss their problems, fine. But no International Criminal Court or other infringements on US national sovereignty.

2) On the Federal Reserve

I would like us to get rid of the Federal Reserve. Extricating ourself from this mess will be complicated, very, very difficult. I have an econ prof at Case Western who is working on a plan that will enable us to pull ourselves out of this.

3) Public Schools

As a candidate for Federal office, I would get federal government out of education. I prefer private schools and homeschooling to public schools in general. I don't think federal or state governments have the right to take money away from you to educate someone else. In any case, 50% of public school graduates are functionally illiterate. The public schools are not working.


4) Abortion

This is a matter that should be adjudicated (settled) at the state level. My personal position is pro-life, but that should not factor in here as I am a candidate for Federal office and it is not a federal issue.


5) On Gay Marriage

If we get the federal government out, it doesn't really matter. Marriage is a religious institution, only the matter of government benefits such as social security even make this an issue. Get the goverment out of it. If you can get a church or synagoguge to confirm your relationship, that's your business. I favor getting government out of the marriage business altogether.

6) The Wasted Vote (Mr. Nolan's issue of choice)

Right now this argument is coming from the right, that if you vote Libertarian, then the Democrats will get in office. But look at what happened with a Republican Congress and a Democratic president. Gridlock slowed the rate of Federal growth to 2.5%. Now it's 7 to 10% not including defense. If you vote for George Bush, you're saying give me more government. If you vote for Nolan, you're saying give me smaller government, and at the very worst, you're throwing it into gridlock. If you want smaller government, you should vote Libertarian.

Also, check out what's going on at Amazon.com. We've been variously at #1 or #2 since it started.

Gary Nolan appears to be serious about what he's doing. I liked him, and felt that his statements about what is a federal issue and what is not a federal issue was based on intellectual consistency and not a desire to weasel out of taking a position. His answer on the Federal Reserve impressed me most, as he's quite right, you don't extricate yourself from a mess 90 years in the making overnight. He'd certainly crush George Delano in a debate. While I won't make an endorsement until I've talked to each of the three candidates, I view him much more favorably after having the chance to question him directly. Interestingly enough, he's received $13,278 in contributions through Amazon, as compared with only 12,574 for Howard Dean and $7,147 for George Bush. John Kerry leads with $26,464.

Explaining economics to the EPJ

Even in response to public criticism, it seems a little strange to have to explain what is quite literally textbook economics doctrine to someone writing for the Economic Policy Journal. Yesterday, Robert Wenzel claimed "Vox Popoli is caught in the quicksand hailing Denninger nonsense" and attempted to explain himself thusly:

First off, credit is not money. Money in the United States at present is the dollar. The Federal Reserve can create more money by buying credit instruments, but they could buy anything. First off, credit is not money. Money in the United States at present is the dollar. The Federal Reserve can create more money by buying credit instruments, but they could buy anything. It is also true that because of the fractional reserve system, banks create money in Fed orchestrated fashion by issuing credit, but again the banks could buy any asset, including, Salavdor Dali paintings or stock equity, and expand the money supply. The key factor to understand is that it is not credit creation, but the money creation that is at the heart of an expanding money supply. If the Treasury borrowed money but it was bought by investors, without any involvement by the Fed, the money supply wouldn't expand at all.

And what is a "dollar"? A dollar is presently a credit instrument, specifically, a credit instrument known as a Federal Reserve Note. This is what Mises defines as "credit money", and not, as is commonly assumed, "fiat money", nor is it "commodity money", as was the case with the historical dollar, which was defined in 1792 as 24.056 grams of silver. Wenzel clearly doesn't realize that the entire inflation/deflation discussion revolves around the very question he ignores, namely, the current nature of the dollar. Further to this point, as I have repeatedly pointed out, most purchases are not made by currency, but by credit. That is why the inflationary effect of the rapid increase in the M2 money stock, 9.65% in the last year alone, is not showing up in prices to the extent one would normally tend to expect, thus leading to dubious claims of a sudden and simultaneous fall in monetary velocity. The real reason for the unexpectedly moderate effect of this rapid M2 expansion is that the $9.5 trillion increase in the money supply is dwarfed by the $53 trillion in outstanding credit, which has remained stubbornly flat since 2008. To be fair to the inflationistas, however, it should be pointed out that we're not seeing any significant price deflation yet because the Federal Reserve and the federal government have been fighting deflation to a standstill over the last three years with the combination of the large increase in M2 and the 92% increase ($4.8 trillion) in the federal debt. Note that since 2008, this expansion in federal credit is more than twice the size of the expansion in the M2 money stock.

Second, the interest rate maintained by the Fed is not "zero-percent...presently" and it never has been during the crisis. The current effective Fed Funds rate is 0.07%.

This is technically correct... and also happens to be silly and misleading pedantry. The 0.07% Fed Funds rate is effectively free money, especially since the rate was historically over 5%, going as high as 20% in the early 1980s. I also note that the $640 billion that was loaned to 532 European banks yesterday was generally considered to be free money although it has a nominal interest rate of 1%. To put it into practical terms, Best Buy selling new PlayStation 3 consoles for $4.20 instead of $299.99 isn't quite free, but it is perfectly reasonable to describe it that way.

I have no idea where Denninger or Vox Popoli get the idea that credit "shifts demand forward". Credit transfers money from one person to another. If someone invests, say, in a newly issued Treasury Bill, he is foregoing consumption but the money ends up with the government which then spends it. Money invested in a capital good creates future consumer goods, but that doesn't mean that there is no current demand. It merely means that the current demand is for the capital goods.

This is an astonishing admission and reveals that Wenzel quite literally does not know basic economic theory. One finds numerous references to the way in which credit time-shifts consumption by pushing the demand curve outward in various economic textbooks ranging from old ones like Paul Samuelson's 1948 Economics to Greg Mankiw's 2009 Principles of Economics.

For example, Samuelson writes about the time-shifting aspects of credit when he wrongly attempts to distinguish between internal and external debts:

Borrowing and Shifting Economic Burdens Through Time. Still another confusion between an external and internal debt is involved in the often-met statement: "When we borrow rather than tax in order to fight a war, then the true economic burden is really being shifted to the future generations who will have to pay interest and principal on the debt." As applied to an external debt, this shift of burden through time might be true.... If we borrow munitions from some neutral country and pledge our children and grandchildren to repay them in goods and services, then it may truly be said that external borrowing represents a shift of economic burden between present and future generations.
- Economics, p. 424 (1948)

If one realizes that Samuelson's distinction between internal and external debt is only meaningful in a nationalistic context, it should be obvious that the distinction is irrelevant with regards to the question of whether demand is being pulled forward or not. Another example can be seen in a textbook published 61 years later, as Greg Mankiw first references the concept of pulling demand forward in an indirect manner:

[T]he political response to rising inequality—whether carefully planned or the path of least resistance—was to expand lending to households, especially low income households. The benefits—growing consumption and more jobs—were immediate, whereas paying the inevitable bill could be postponed into the future. Cynical as it might seem, easy credit has been used throughout history as a palliative by governments that are unable to address the deeper anxieties of the middle class directly. Politicians, however, prefer to couch the objective in more uplifting and persuasive terms than that of crassly increasing consumption. In the U.S., the expansion of home ownership—a key element of the American dream—to low- and middle- income households was the defensible linchpin for the broader aims of expanding credit and consumption….

In the end, though, the misguided attempt to push home ownership through credit has left the U.S. with houses that no one can afford and households drowning in debt Ironically, since 2004, the home ownership rate has been in decline.
- Principles of Economics, p. 431 (2009)

It's not ironic in the slightest, though, since this is precisely what economic theory dictates and was, in fact, the basis of my own 2002 prediction of the coming collapse of the real estate markets. The demand curve was shifted outwards by the extension of easy credit, pricse rose and home sales increased for a period of time, after which both prices and home sales crashed. Many readers will recall that exactly same thing happened - and that I predicted it at the time - with the automotive and home-buying incentive programs pushed by the Obama administration in 2009. Mankiw eventually proceeds to present the explicit mainstream doctrine to which Denninger referred in his original post:

Why Credit Cards Aren't Money It might seem natural to include credit cards as part of the economy’s stock of money. After all, people use credit cards to make many of their purchases. Aren’t credit cards, therefore, a medium of exchange?

At first this argument may seem persuasive, but credit cards are excluded from all measures of the quantity of money. The reason is that credit cards are not really a method of payment but a method of deferring payment. When you buy a meal with a credit card, the bank that issued the card pays the restaurant what it is due. At a later date, you will have to repay the bank (perhaps with interest). When the time comes to pay your credit card bill, you will probably do so by writing a check against your checking account. The balance in this checking account is part of the economy’s stock of money.

Notice that credit cards are very different from debit cards, which automatically withdraw funds from a bank account to pay for items bought. Rather than allowing the user to postpone payment for a purchase, a debit card allows the user immediate access to deposits in a bank account. In this sense, a debit card is more similar to a check than to a credit card. The account balances that lie behind debit cards are included in measures of the quantity of money.
- Principles of Economics, p. 624 (2009)

Note that it doesn't matter if the concept is described as "deferring payment", "pulling demand forward", "shifting the demand curve outward", or "time-shifting economic burdens". These are four different ways to describe the same phenomenon, and regardless of how it is phrased, it has long been used to attempt to justify the economically incorrect juristic claim that credit is not money.

Finally, defaults, in and of themselves, have nothing to do with deflation/inflation in the system. If the Fed buys Treasury bills and creates money to do so, the money is out in the system. If the Treasury defaults on the Bills issued that doesn't mean the amount of money in the system shrinks. A credit default is thus not "the equivalent of burning paper currency."

This statement merely shows that Wenzel has no understanding of how the monetary system actually works. He clearly pays no attention to the Federal Reserve's Z1 report, otherwise he would recognize that the 19.6% reduction ($3.3 trillion) in financial sector debt and 4.8% reduction ($663 billion) in household sector debt are a) the result of defaults and b) have had a profound effect on the deflation/inflation in the system being the reason behind the massive increase in federal debt and the expansion of the money supply.

Denninger nonsense, and apparently Vox Popoli's, is complex, but when pulled apart at any strand, it doesn't hold up. It has taken six paragraphs to refute two Vox Popoli confused paragraphs. Denninger and Vox Popoli make bold statements without the logic to back them up. It takes many statements to refute their bold ones because the foundation has to be established.

As I said, I am not going to debate these characters on every point. They shift too much without consistency or substance, you could spend decades trying to refute them and they will simply come out with some new statement that doesn't reference their earlier points.

I will only refute them when I see major whoppers or new major characters spouting their nonsense. Just know that their arguments in general are disjointed, tend to ignore reality and tend to use technical terms and/or themes in a manner not used by anyone else on the planet---thus adding even more layers of complexity and confusion to their arguments.

It is more than a little amusing to see someone who neither knows nor understands Keynes, Samuelson, or even Mankiw, let alone Mises, attempt to claim that Karl Denninger and I, two of the very few observers who correctly predicted the present crisis, are spouting nonsense or presenting disjointed arguments. The fact that he doesn't understand them does not make them nonsensical. And his genuine belief that we are using "technical terms and/or themes in a manner not used by anyone else on the planet" only serves to conclusively prove his ignorance of economic theory. While I'm tempted to cut Wenzel some slack due to his support of Ron Paul, that is unfortunately not my idiom. So, to end my response with all the tender mercy of Van Helsing driving home a stake, I shall conclude by quoting Ludwig von Mises:

In a developed monetary system, on the other hand, we find commodity money, of which large quantities remain constantly in circulation and are never consumed or used in industry; credit money, whose foundation, the claim to payment, is never made use of;* and possibly even fiat money, which has no use at all except as money.
- The Theory of Money and Credit, p. 103 (1953)


*I emphasize the bolded text for the benefit of those who may have forgotten the central point of Karl's original post.

Herman Cain: banker's whore or bankster?

It has been interesting to see how feeble a defense those who support Magic Negro Part II: The Republican have been able to make on his behalf. When faced with the fact that he was not only a corrupt Federal Reserve executive, but is still defending the Federal Reserve, the giant zombie banks, and Wall Street despite the economic depression they caused, their only - and I do mean ONLY - response is to cry raciss.

This demonstrates that Herman Cain has little more to offer as a presidential candidate but his race. But, in the immortal words of the French castle guard, the American people already got one, you see. The grand Republican dream of finally being able to accuse Democrats of racism is based on an erroneous assumption that Democrats care about such things; it would appear that Republicans have learned nothing from Clinton presidential scandal when it was learned that feminists didn't mind being legitimately accused of supporting sexism.

Democrats are the modern equivalent of the medieval religious heretics who demonstrated their moral ascension beyond good and evil by their ability to indulge in the latter without harming their immortal soul. Thus, while others are tainted by the mere accusation of sexiss or raciss, actual acts of what would otherwise be considered sexism or racism on the part of a Democrat only proves his ideological saintliness.

As we've seen already with regards to Rick Perry, Cain is more than willing to cry raciss himself. But that's almost irrelevant. The real question is whether Cain is a banker's whore or a bankster proper. While his Federal Reserve history suggests the latter, his astonishing remarks about the central bank and apparent ignorance about the U.S. financial system strongly indicate that his role at the Federal Reserve was little more than affirmative action PR. So, I conclude that Cain is merely a banker's whore like McCain and Obama rather than a genuine bankster like Bernanke.

The corruption of a science

Ryan Grim shows how the Federal Reserve has bought the academic economists:

The Huffington Post reviewed the mastheads of the American Journal of Economics, the Journal of Economic Perspectives, Journal of Economic Literature, the American Economic Journal: Applied Economics, American Economic Journal: Economic Policy, the Journal of Political Economy and the Journal of Monetary Economics.

HuffPost interns Googled around looking for resumes and otherwise searched for Fed connections for the 190 people on those mastheads. Of the 84 that were affiliated with the Federal Reserve at one point in their careers, 21 were on the Fed payroll even as they served as gatekeepers at prominent journals. At the Journal of Monetary Economics, every single member of the editorial board is or has been affiliated with the Fed and 14 of the 26 board members are presently on the Fed payroll.

It's no secret that the financial economists employed by the big banks are untrustworthy, being little more than stock market cheerleaders, but the academic economists are arguably even less reliable. This is an excellent article by the Huffington Post, the best I have ever seen published there. The best part is when Milton Friedman is quoted in a damning 1993 letter: "I cannot disagree with you that having something like 500 economists is extremely unhealthy. As you say, it is not conducive to independent, objective research. You and I know there has been censorship of the material published. Equally important, the location of the economists in the Federal Reserve has had a significant influence on the kind of research they do, biasing that research toward noncontroversial technical papers on method as opposed to substantive papers on policy and results."

While same sort of corruption and monolithic thinking revealed in the economics profession can be seen in other scientific disciplines as well, the difference is that it is more difficult for the Federal Reserve to maintain control of the field despite its massive finances because economic events so easily overwhelm the intellectual edifice that the Fed has constructed.

Alan Greenspan himself has said that the whole intellectual edifice of mainstream economics has collapsed. I very much agree, and further note that it is Greenspan and the organization that employed him which is largely to blame.

The Fed and the Depression

Ben Bernanke defies the common Keynesian position:

It was in large part to improve the management of banking panics that the Federal Reserve was created in 1913. However, as Friedman and Schwartz discuss in some detail, in the early 1930s the Federal Reserve did not serve that function. The problem within the Fed was largely doctrinal: Fed officials appeared to subscribe to Treasury Secretary Andrew Mellon's infamous 'liquidationist' thesis, that weeding out "weak" banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were small banks (as opposed to what we would now call money-center banks) and not members of the Federal Reserve System. Thus the Fed saw no particular need to try to stem the panics. At the same time, the large banks – which would have intervened before the founding of the Fed – felt that protecting their smaller brethren was no longer their responsibility. Indeed, since the large banks felt confident that the Fed would protect them if necessary, the weeding out of small competitors was a positive good, from their point of view. In short, according to Friedman and Schwartz, because of institutional changes and misguided doctrines, the banking panics of the Great Contraction were much more severe and widespread than would have normally occurred during a downturn. …

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

This jocular statement has never gotten the widespread attention it deserves, even if the current Fed Chairman errantly attributes this demonstration of Fed responsibility to the famous monetarist when it was actually the Austrian economist Murray Rothbard who first made the conclusive case in his 1963 book America's Great Depression. It's interesting, however, to see how Bernanke is, despite his promise, following the same general model that his predecessors did. I'll have more detailed analysis of this in a future Voxonomics to see just how closely the Fed is imitating history, but needless to say, this doesn't bode terribly well for the future.

I have to say, I'm really impressed with this timely step by WorldNetDaily, even though I knew nothing about it. If I understand my principles of socionomics, this is a definite bear sign as a broadening interest in technical analysis usually indicates volatility and a down market.

Voxonomics - Peter Schiff transcript

This interview was recorded in March 2008. Thanks very much to Justin, Ian, and Taylor for transcribing the interview:

Vox: You recently wrote about an Alice in Wonderland economy and you mentioned that it was bizarre to see the dollar gaining strength after a 75 basis point rate cut by the fed. What's going on?

Peter: Well, you know, it's the expectations game. The fed had allowed the market to build in an expectation for a larger cut of a hundred basis points. But when they didn't come through with a hundred basis points, Wall Street was able to spin it into "The Fed is now hawkish on inflation", "The Fed is going to be a little bit tougher on inflation". Which, of course, is not true, but it was able to result in a bit of a rally in the dollar. And I think that really has helped lay the foundation for this bounce in the stock market, because people were afraid the dollar decline was going to get out of hand. And they're right. The dollar is going to get clobbered. This is just a short term bounce. What the fed did is completely irresponsible. They shouldn't have cut rates at all. They should have raised rates. They are going to cut them even more. Inflation is just going to decimate the U.S. economy and the value of U.S. dollars. People around the world who hold dollars I think understand this and they are going to be getting rid of them as quickly as they can.

Vox: That makes a lot of sense of course from a conventional perspective. But, if you look at it from the "pushing on a string theory", which says that it's not possible to inflate your way out of a deflationary credit crunch. How do you balance the one against the other then?

Peter: The Fed is going to do all that they can. You can't inflate your way out of any problems, you just inflate your way into greater problems, and that's what's happening. If you look at what it's doing, the Federal Reserve is basically taking on all the mortgage debt that nobody wants. Increasingly, all mortgage securities are going to pass from private hands to public hands as the Fed ultimately ends up being the only mortgage lender in the United States and all mortgages will be originated by the Fed. The Fed's balance sheet will increasingly consist of mortgages. This is pure inflation, as the Fed creates money to subsidize the housing market, to artificially prop up home prices. The dollar is going to cave in. That's the Fed's hope, that they can just create enough inflation to lift nominal home prices to the point where Americans can afford them. And, of course, they need to engineer an increase in average income. They need to see wages starting to rise along with prices so that Americans can have the income to afford the mortgage payment. But, of course, it's all going to be phony money. The dollar, as I said, will collapse. There is going to be no private demand for U.S. dollar denominated debt. All the demand is going to be created by the Fed. We are going to be completely a printing press economy, where instead of being able to borrow money from the Chinese and the Japanese like we've done in the past. All the money that we need to borrow is going to be borrowed from the Fed, which means there's not going to be any real savings behind it. It's going to be a printing press, and prices are going to run out of control.

Vox: When you talk about the Fed being the sole provider of mortgages, are you referring to Steve Forbes' idea.

Peter: No, I'm just referring to what's actually happening, where the Fed is taking mortgage collateral from Wall Street with no questions asked and the fact that Fannie Mae and Freddie Mac are going to be increasingly buying mortgages that nobody else would touch with a ten foot pole. As the private sector is increasingly tightening their lending standards, the government sector is loosening theirs. The private sector has learned a lesson and they want to start to require bigger down payments while Fannie Mae and Freddie Mac are now being told to secure mortgages with smaller down payments than they had in the past. So, this is ultimately going to create a bigger problem for these securities because nobody is going to want to buy Fannie and Freddie debt because it is going to be increasingly risky. So, again, all of that debt is going to find its way to the Federal Reserve. The Fed is going to end up buying all this Fannie and Freddie insured paper because private individuals won't want to own it because its not government insured, so that they'll be able to take their Fannie and Freddie May debt and give it to the Federal Reserve in exchange for Treausuries. So, the whole mortgage industry is going to be socialized and financed by the Fed, which means it's financed by a printing press. A lot of people are criticizing this as a taxpayer bailout, you know "why should taxpayers have to pay for this?" It's not the taxpayers per se who are paying for it. It's anybody who has U.S. dollars: people on social security, people on welfare, people who aren't paying taxes but are receiving government checks. They are going to pay for it because their checks are going to buy less. And Americans who have money saved in pensions and retirement accounts and government bonds and municipal bonds. They are going to suffer. The prices are rising. Oil prices are $100 a barrel. People are going to the supermarket and they are seeing big increases in the price of food. This is all a result of what the Fed is doing. It's got nothing to do with the scapegoats that the government is creating. It's not because of the Arab sheiks jacking up oil prices. It's not because some peasant in China is eating more meat. None of this is true. Prices are rising strictly as a function of the Federal Reserve debasing our money to bail everybody out. This is the price that we pay. Higher prices for all consumer goods and less value for our savings.

Vox: That would explain, obviously, the big leap up in the gold market that happened before the recent correction. One thing that I discussed with Robert Prechter a little while ago was that the jump in metals and commodities was partially the result of a bubble. We had the equity bubble then the real estate bubble and now we're seeing some money move from real estate into commodities. But are you saying that it's simply the result of inflation from these moves by the Fed?

Peter: Sure, and I don't think there's a bubble in gold or commodities. These prices are simply rising to reflect the loss of value of U.S. currency. Now, maybe the rise has gotten ahead of itself a bit, and is due for a pullback. Maybe you have had a lot of speculators that have come along for the ride, but the underlying trend is for these markets to move higher because the dollar and other currencies are going to be moving lower because the central banks are going to continue to debase them.

Vox: The chief economist for the national association of realtors is forecasting that home prices will remain flat in 2008.

Peter: Well, what do you expect? You remember what David Lehrer used to do. They denied that there was a problem, there was no bubble. Then they said it is going to be a soft landing. I mean these guys are shills. All these guys are cheerleaders for the realtors. They are trying to encourage people to buy homes. And if they came out and said that your real estate prices are going to drop by ten or fifteen percent nobody would want to buy, so they constantly come out with rosy forecasts. Just like Wall Street. Wall Street is in the business of selling stocks, so they want to tell everybody things are great. The national realtors are in the business of encouraging people to buy homes. They are not going to come out with a forecast that says home prices are going to drop, because that is going to discourage people from doing exactly what they want them to do.

Vox: No, of course, what I thought was funny was that they were forecasting a flat 2008 from a price of $218,000 with the medium existing homes. Today the report came out for February and the price is already $28,000 lower.

Peter: Yeah, as I said, they are never going to forecast the truth. They are constantly going to be wrong. I don't know why anybody even pays any attention to what their economists say because it's really advertising or propaganda whatever you want to call it. It has nothing to do with some kind of objective economic analysis of the housing market. If that were the case, they would be predicting a substantial decline. How can home prices stay where they are? It's impossible. The government is doing all they can to maintain inflated home prices, but it's not going to work. It could only work in the sense that they create so much inflation that real home prices plunge but nominal home prices hold up. But that's not going to make anybody happy. They are going to live in a home that is still worth what they paid but they are not going to be able to afford to heat it or air condition or put food in the refrigerator.

Vox: Much less take out money based on their growing equity.

Peter: All that's going to grind to a halt unless of course the government finances it. The private market for these home equity loans and second mortgages is drying up. The market realizes that there is no collateral there. And, of course, Americans are desperate. They already owe more money on their homes than they are worth. They are loaded up with credit card debt they can't repay and auto loans and student loans. Nobody wants to lend Americans more money and Americans figure, "we already owe so much money we can't possibly pay it back; we might as well borrow even more because we might as well go out with a bang." Nobody is willing to lend them money of their own, so it is only the government that is willing to do it. Of course, they have no money to lend. All they can do is print it, which means they deprive society of purchasing power through a printing press that individuals never would have willingly given up on their own.

Vox: Sure. Now what are some of the best tips from your new book, which is called Crash Proof, which recommends ways to profit from the coming economic collapse?

Peter: The best thing to understand is that it's not the taxpayers. It's holders of dollars, people who have dollar savings and dollar-denominated investments. So, if you want to avoid the biggest tax increase in U.S. history the only way to do it is to divest yourself of your dollars. The advice that I gave in Crash Proof is really a giant tax shelter. That's what I am helping people do at my company, EuroPacific Capital. We help American savers and investors to get out of U.S. based assets, reorganize their stock portfolios, get into foreign stocks in Europe and Asia. Earn dividends in other currencies. Have bonds in other currencies. Get into commodities and precious metals. Anything other than the U.S. dollar so you can avoid having to pay the price of what Bernanke is doing. I describe the average American investor or saver with a giant bullseye on their back and they're in Ben Bernanke's cross hairs. He's going to shoot you unless you get rid of your dollars. We can help you do that, but people need to do that as quickly as possible.

Vox: Okay. Last question. As an economic advisor to the Ron Paul presidential campaign, do you find a certain irony in the fact that most Republicans failed to support him when he is the only candidate who has a solid grasp of the structural challenges facing the financial markets and the economy.

Peter: I don't find it ironic. Unfortunately the Republicans are not the limited government party that they claim to be. That's how they try to get votes, but if you look at the way Republicans govern, they are politicians just like the Democrats. They want big government. They want high taxes. They want high government regulation as the best way to secure their own re-election. So, they try to appeal to the wing of the Republican party that is libertarian-oriented, limited government, traditional conservative values. They figure that they are going to get those votes because they figure "they've got not choice because the Democrats are even for bigger government than we are. We'll pay lip service to their limited government views so that we can at least keep their votes away from the Democrats. But the reality is that the mainstream rank and file of the Republican party is a big government party just like the Democrats. When Ron Paul comes up and actually tries to run on Republican principles that a lot of people think represent the Republican party they shoot him down. Because the Republican party of today, the modern Rebublican party, has nothing to do with small government and low taxes. They are a big government party.

Vox: You're preaching to the choir here: *laugh*.

Peter: I know. And it's unfortunate, because that's the choices we have in America, is, y'know, which, uh, big-government candidate do you want to support? And unfortunately, the only, y'know, [only] avenue that we have left is to get rid of U.S. assets. I mean, they're going to tax us to death, and they're going to inflate, uh, us to death [and] so Americans need to read the writing on the wall. And, y'know, if you read my book - "Crash-Proof: How to Profit From the Coming Economic Collapse" - I, y'know, I've got a few chapters in the back of the book that really detail the blueprint for how to build a crash-proofed portfolio and [and] get out of U.S. assets - before it's too late.

Vox: Or, better yet, y'know, buy a beach place in the Bahamas and watch it all from the beach: *laugh*.

Peter: Well, I mean, y'know, if you want to physically leave the country - I don't know how bad it's going to get, but I think the first thing you need to do is get your money out of the country, or at least out of U. S. dollar investment. You can do that within a, uh, U. S. brokerage account, like, that's what we do in EuroPacific Capital. I hope it doesn't to the point where it's so bad that we actually literally have to flee the country. And [and] get our bodies out of the country as well. I mean, it might come to that. Uh, but, for now, I'm hoping it doesn't, but I know for sure, uh, that Americans are going to suffer a dramatic diminution in their standard of living, in their quality of life, as a result of what we've done in the past - the huge consumption binge, the borrowing and consumption binge we went on in the past. And now, as a result of what the government is doing to try to delay the day of reckoning. They are making the situation much, much worse. And so people have to be very, very careful about where their money is invested, and, more importantly, what currency those investments are in. Eh, they should go to my website and, y'know, there's a lot of information on my website, uh, to help you, [to help you] understand this problem. And [a-, eh] the address is W- W- W- dot Europac, E- U- R- O- P- A- C- dot net, Europac dot net. Or people can talk to one of my brokers at [at] the company, call eight hundred, seven two seven, seven nine two two - eight hundred, seven two seven, seven nine two two - I've got a whole staff of brokers that can help, uh, y'know, walk you through these strategies.

vox: What kind of timeframe are you looking for? I mean, typically, I tend to have a contrarian edge myself. The housing crash didn't surprise me, and it came along as I expected, but it came along about two years later than I expected. What's your timeframe on this?

Peter: It's always hard to talk about the timing, but I think this is going on right now. The dollar is losing value as we speak. I mean, it's bounced a little bit today against the Yen and the Swiss franc, but it's down, y'know, almost as much against the Canadian and Australian dollars, but, in general, the dollar is going down; these problems are huge. And, y'know, it was amazing once the problems became evident in the housing market how quickly it all unraveled. And so, y'know, things can happen very quickly. And [and, and] the key to this is to be early. Y'know, dont try to finesse it, don't think "hey, maybe we got six more months, maybe we got a couple [ye-] more years" - I don't know, maybe we do, maybe we don't. But, nobody knows for certain. The best thing to do is understand what's going to ultimately happen to the value of the dollar and the cost of living in the United States, our standard of living. And, people need to be protected. Y'know, if you're a day late, uh, y'know, that's, y'know, you're [you're] a day late. You're done. Y'know, so it's better to be early than late, because, y'know you can't survive if you're late, even if it's by a day. So if you're a year early or if you're two years early...uh, but meantime, y'know, our strategies are throwing off some rather substantialdividend yields, uh, while people are waiting, so there's no real opportunity cost, uh, to, uh, being early.

Vox: No, I can recall when the Euro was at point-eighty-eight rather than one-fifty-four, so...

Peter: Yeah, look, and it's going a lot higher. There's nothing that can happen to the dollar based on what they're doing but decline in value. I mean, it's obvious, it's clear what's going on, so, y'know, rather than just remaining ignorant or closing your eyes, uh, people need to understand what's happening and take action before it's too late.

Vox: Well, Peter, I really appreciate your time. Thanks very much.

Peter: Okay, thanks for talking to me.

This is Vox Day

Yesterday, David Frum asked "Who is Vox Day?" The answer is: "The guy who is going to metaphorically kick your impolitic and economically ignorant ass, my dear sir." It's nothing personal, of course, that's just how we roll.

Frum has no economics training and it shows, as his charge that Ron Paul is "too lazy and arrogant" to understand the economic questions and "does not have the faintest idea of what [he is] talking about" is based on outdated stats-based Keynesian macroeconomic theory that has taken a backseat to the praxeological Austrian theory that Paul astutely espouses. One notes that the more economically aware individuals at National Review, gentlemen such as Donald Luskin or Larry Kudlow, would never describe Paul's grasp of economics in such insulting terms, as Luskin's endorsement of Ron Paul or Larry Kudlow's interview with Paul should suffice to prove.

In a subsequent post defending his attack on Paul's economic knowledge, Frum attempts to justify himself by arguing that a) one means of rebalancing the USA's external accounts without recession involves devaluing the dollar, b) this devaluing will be both "equitable" and "surprisingly painless", c) the nation's monetary stock should be determined by central bankers, not by miners, and d) stating that "to treat the gold standard as a live option is to utterly misunderstand modern finance. It can never be restored."

(a) is reasonable enough, although Frum cites no evidence to support his previous claim that Paul is unaware of this, much less too lazy or arrogant to understand it. And it's easy to demonstrate that Frum's accusation is completely wrong, as this 2006 speech by Ron Paul on the end of dollar hegemony shows:

"In the short run, the issuer of a fiat reserve currency can accrue great economic benefits. In the long run, it poses a threat to the country issuing the world currency. In this case that’s the United States. As long as foreign countries take our dollars in return for real goods, we come out ahead. This is a benefit many in Congress fail to recognize, as they bash China for maintaining a positive trade balance with us. But this leads to a loss of manufacturing jobs to overseas markets, as we become more dependent on others and less self-sufficient. Foreign countries accumulate our dollars due to their high savings rates, and graciously loan them back to us at low interest rates to finance our excessive consumption. It sounds like a great deal for everyone, except the time will come when our dollars-- due to their depreciation-- will be received less enthusiastically or even be rejected by foreign countries. That could create a whole new ballgame and force us to pay a price for living beyond our means and our production. The shift in sentiment regarding the dollar has already started, but the worst is yet to come."

Coincidentally, I had dinner last night with a friend who is an important European technology financier. One of the topics he was most interested in discussing was what China's response was likely to be once the decline in value of their dollar holdings became intolerable. This is an area of much concern in financial circles, especially with one of the top five English mortgage banks on the verge of failure and the largest Swiss bank losing CHF 23 billion in the last two quarters alone. Frum isn't concerned about any of this because he thinks the central bankers can sort it out - and simultaneously avoid recession - whereas both Ron Paul and those professional money experts who actually understand the situation are deeply worried.

(Which reminds me, I have another friend who is the CEO of a massive multinational corporation. A few years ago, after getting back from a trip in which he visited with the British central bankers, he told me that he was genuinely terrified at the influence possessed by men he described as "unbelievable idiots". Not more than a month or two later, Gordon Brown, the current British prime minister, sold off 300 tonnes of gold at $275 an ounce. It's now around $800.)

Frum's claim in (b) that monetary devaluation is equitable is downright amusing. He writes: "All holders of dollar assets lose some of their wealth - but the burden falls most heavily on those with the most wealth to lose, who also happen to be the people who enjoyed the biggest gains during the previous increase in the value of the dollar. The burden falls least heavily on those with nothing to sell but their labor."

That would certainly be true, so long as those who have the most wealth are unable to hire anyone capable of advising them to move into Euros, pounds, the yen, or gold. As usual, the wealthy profit from both long and short sides of the equation while those whose wealth is tied up in the stock market or wish to purchase any imported goods suffer. It's not as if those who have nothing to sell but their labor ever buy Japanese cars, Chinese clothes, Taiwanese computers or gasoline for the daily commute, right? Keynes might well have been describing Frum when he wrote in his Tract on Monetary Reform "It is common to speak as though, when a Government pays its way by inflation, the people of the country avoid taxation. We have seen that this is not so. What is raised by printing notes is just as much taken from the public as is a beer-duty or an income-tax. What a Government spends the public pay for. There is no such thing as an uncovered deficit."

Now for (c). When Frum advocates rebalancing through devaluation, he's simply calling for variant on the same trick of escaping debt through inflation that has endangered the U.S. credit markets, the U.S. housing market and all of the individuals who are invested in them. It will be neither equitable nor painless when the credit crunch is in full E-F-F-E-C-T otherwise known as effect. And when it comes to the nation's money stock, miners are to be preferred to bankers as they are VASTLY more trustworthy.

It is astounding that Frum seriously advocates trusting the central bankers to control the growth of the money supply, or, in less flattering terms, inflation. (Yes, that would be the very same clever fellows who sold off their gold at record low prices.) But according to the Inflation Calculator, the value of one U.S. dollar increased 59 percent from 1819 to 1913 on the gold standard, whereas it lost 95 percent of its value from 1913 to 2006. And during that deflationary 19th century period, real U.S. Gross Domestic Product grew more than twice as fast as it did during the inflationary 20th, 43x to 21x, even using the Fed's official inflation statistics which every economically literate individual knows are significantly understated. After all, it's not as if anyone ever buys any of those volatile food and energy products that are conveniently omitted from the "core rate". The modern era has a slight edge in real GDP growth per capita, but it's small enough that it would probably be wiped out by a more realistic measure of inflation.

Finally, (d) is demonstrably false. A return to the gold standard is far from inconceivable or unworkable. Not only was the Swiss economy fully on the gold standard until 1999, but the franc is still 50 percent backed by gold. And Frum's own National Review colleage, Donald Luskin, explained that for more than 10 years under Greenspan, the U.S. economy was on a virtual gold standard: "For almost ten years the funds rate tracked the gold price with astonishing precision. Who can really know what was going on in Greenspan's mind -- but by all appearances, he was conducting monetary policy on a "virtual gold standard" or "price rule." The chart suggests that he was withdrawing liquidity by raising the funds rate when a rising gold price signaled inflationary pressures, and adding liquidity by lowering the funds rate when a falling gold price signaled deflationary pressures.

Greenspan himself explained that a return to the gold standard was, although not without complications, entirely workable, writing: "Even some of those who conclude a return to gold is infeasible remain deeply disturbed by the current alternatives. For example, William Fellner of the American Enterprise Institute in a forthcoming publication remarks "...I find it difficult not to be greatly impressed by the very large damage done to the economies of the industrialized world... by the monetary management that has followed the era of (gold) convertibility... It has placed the Western economies in acute danger...." Yet even those of us who are attracted to the prospect of gold convertibility are confronted with a seemingly impossible obstacle: the latest claims to gold represented by the huge world overhang of fiat currency, many dollars. The immediate problem of restoring a GOLD STANDARD is fixing a gold price that is consistent with market forces.... Those who advocate a return to a GOLD STANDARD should be aware that returning our monetary system to gold convertibility is no mere technical, financial restructuring. It is a basic change in our economic processes. However, considering where the policies of the last 50 years have eventually led us, perhaps there are lessons to be learned from our more distant GOLD STANDARD past.

In light of Luskin's notion that Greenspan was running a virtual gold standard, it appears that he was attempting to do just what he was describing in the essay quoted above, Can the U.S. Return to a Gold Standard? Unfortunately, he ultimately gave into the temptation of Frum-style thinking, and in attempting to avoid recession, created the probability of depression.

We shall have to wait to see precisely how future events unfold, but this should all suffice to demonstrate that Ron Paul's economic understanding is far ahead of David Frum's, so far ahead, in fact, that Paul can even explain the real reason why Frum, a neocon war enthusiast, hates the gold standard.

"If every American taxpayer had to submit an extra five or ten thousand dollars to the IRS this April to pay for the war, I'm quite certain it would end very quickly. The problem is that government finances war by borrowing and printing money, rather than presenting a bill directly in the form of higher taxes. When the costs are obscured, the question of whether any war is worth it becomes distorted. Congress and the Federal Reserve Bank have a cozy, unspoken arrangement that makes war easier to finance. Congress has an insatiable appetite for new spending, but raising taxes is politically unpopular. The Federal Reserve, however, is happy to accommodate deficit spending by creating new money through the Treasury Department. In exchange, Congress leaves the Fed alone to operate free of pesky oversight and free of political scrutiny. Monetary policy is utterly ignored in Washington, even though the Federal Reserve system is a creation of Congress.

Economist Lawrence Parks has explained how the creation of the Federal Reserve Bank in 1913 made possible our involvement in World War I. Without the ability to create new money, the federal government never could have afforded the enormous mobilization of men and material. Prior to that, American wars were financed through taxes and borrowing, both of which have limits. But government printing presses, at least in theory, have no limits. That's why the money supply has nearly tripled just since 1990."

And now we don't even know how fast it is growing, since the Fed no longer reports M3 to the public for fear that it will panic. But the leap in gold prices to nominal all-time highs and emergency rate-cutting suggests that the value of the currency is falling faster than ever. What, Frum asks, will keep future politicians from simply abandoning a future gold standard should it ever be adopted? The answer is simple: the pain of the coming global recession and probable depression caused by the Federal Reserve's inflationary monetary policy will be such that anyone who advocates going off it will be liable to be torn to pieces by an angry mob of survivors.

Mr. Frum is a very good wordsmith who should probably stick to doing what he does best, banging the war drum, nominating the various Hitlers of the month and talking up Republican sacrificial lambs like Giuliani. And speaking of lambs, seeing Frum attack Ron Paul on economic grounds is rather like watching a newborn lamb standing on four wobbly legs, trying to headbutt a lion.

UPDATE: Mr. Frum was kind enough to email me and inform me that in his opinion, there's nothing here that he didn't anticipate and answer in his prior post, except for the ad hominem attacks. Which, if nothing else, proves that he truly hadn't heard of me before. He reminds me of Sam Harris and Me-So Michelle, neither of whom understand the difference between anticipating and answering a response and anticipating and successfully answering a response. There won't be any further response from him, he's a candyass who can only dish it out; he can't take it.

By the way, he thinks you all are "dubious". I'm not sure, but that may well be the nicest thing anyone has ever said about the Dread Ilk!

Downgrade and the debt sectors

Daniel Indiviglio makes some relevant points in his article about the downgrade at The Atlantic and he was one of the few who correctly saw it as a real possibility, but I think he ultimately goes off-track when he calls into question S&P's decision to downgrade the U.S. sovereign credit rating:

S&P was not happy with the $2.2 trillion minimum debt reduction plan. That's understandable. A bigger deal would certainly have been preferable from a fiscal soundness standpoint. But does the agency really estimate that the deal is is so dangerously small that there's a realistic chance that the U.S. could now default at some point in the future? In particular, does U.S. debt really look significantly riskier now than it did in, say, April?

The bond market certainly doesn't think so. Treasury yields are near all-time lows, despite all that political nonsense. And remember, the interest the U.S. pays on its debt is far, far smaller than its tax revenues. If the Treasury prioritizes interest payments, then there's no conceivable way the U.S. could default.

I defended S&P's initial decision to put the U.S. rating on negative watch back in May when politics were becoming poisonous. But to actually downgrade the U.S. after Washington managed to avoid its self-created crisis is another story. S&P should have acted like the other agencies and affirmed the U.S. rating, but kept it on negative watch until more deficit reduction plans were put in place over the next couple of years, as I explain here.

In fact, this might not turn out well for S&P. The firm might think it's acting boldly or proactively. Instead, the market may question S&P's reasoning skills. The rating agency is acting here on an assumption not shared by its peers at Moody's and Fitch: that U.S. politics are so screwed up that they could render the nation unable to live up to its debt obligations. That's despite pretty much everyone agreeing that the nation will be financially able to pay for its debt in the short-, medium-, and long-term.

Indiviglio did a great job of demonstrating that the U.S. downgrade was be almost perfectly in line with the historical Japanese downgrade, which took place when its net government debt reached 60% of GDP.  (It is presently around 225%).  However, he reaches the wrong conclusion, as many have, by getting sidetracked over the way in which S&P's analyzed the political situation in the U.S.A. And while there was never any question of short-term default, (despite the scare tactics of both Democrats and Republicans), I very much disagree that the nation will necessarily be able to pay for its debt in the medium- and long-terms.

The real reason that the downgrade was not only inevitable, but correct, and not only correct, but the first in a series of downgrades, can be seen in projections based on the historical patterns in the Z1 debt sector charts. These show the S&P's worst case scenario to be far too optimistic to be credible.

While the debt figures don't match up perfectly, as August "Net debt held by the public" is a little different at $9.78 trillion than Q1-2011 "federal government debt outstanding" at $9.65 trillion, they are close enough for the purposes of comparison. Utilizing the Q1 figure provides a federal debt/GDP of 64.3%, which is much lower than 74% presently estimated by the end of 2011 by S&P's. However, we can see how they reach that number by plugging in the expected growth in the amount of debt at the post-2008 quarterly average of $365 billion. This indicates an end of year federal debt figure of 10.74 trillion and a GDP figure of $14.513 trillion.

In other words, S&P's is probably assuming that either GDP will contract $490 million in the second through fourth quarters or the rate of federal borrowing will slow down.  Either way, the so-called "double-dip recession" already appears to be baked in the S&P's cake, assuming that its analysts are as capable of reading the Federal Reserve reports as Karl Denninger is. But that's not the interesting aspect, from my perspective. What is interesting is the debt/GDP projections under the three future scenarios, Upside, Base Case, and Downside. Consider these projections of future federal debt to GDP ratios:

UPSIDE: 2011 74%, 2015 77%, 2021 78%
BASE CASE: 2011 74%, 2015 79%, 2021 85%
DOWNSIDE: 2011 74%, 2015 90%, 2021 101%

Where I suspect S&P's has gone amiss, (and perhaps it had no choice in the matter due to its professional obligations), is by taking the CBO scoring figures seriously and thereby utilizing GDP estimates as the primary variable. Based on my calculations, it is also possible that S&P's is simply plugging in the 66-year average rate of increase of federal debt, 5.92%, into their spreadsheets.  But it isn't GDP that has changed so drastically over the last three years and significantly modified the debt/GDP ratio, it is the rapid 82.89% increase in the federal debt over the last 11 quarters. If we utilize federal debt as the primary variable and plug them into S&P's GDP estimates, we get some very different results. (I'm going to ignore the inflation and tax estimates in order to reduce the number of variables; these are estimates for the purpose of critical comparison, not predictive projections.)

The S&P's GDP estimates are as follows:

UPSIDE: 3% GDP growth + lapsed tax cuts
BASE CASE: 3% GDP growth
DOWNSIDE: 2.5% GDP growth

However, net GDP growth over the 13 quarters from Q1 2008 to Q2 2011 is $729.9 billion, or 5.1%. That is an annual rate of growth of 1.57% and assumes that overall credit continues to remain flat at $52.6 trillion while federal debt continues to rise at the rate that private debt contracts. Call it the CURRENT CASE. Plugging in 1.57% annual GDP growth and 22.7% annual federal debt growth provides the following debt/GDP ratios if one begins with the firm numbers from the end of year 2010.

CURRENT CASE: 2011 77%, 2015 164%, 2021 509%

And if we substitute actual rates of federal debt growth for the S&P estimates of it that are based on the notoriously unreliable CBO scoring, it becomes very clear that the debt/GDP projections are wildly inaccurate regardless of what rate of GDP growth is assumed and shows that the problem is not one that economic growth can possibly solve.  In fact, the revised UPSIDE case which takes historical debt growth into account is much worse than the Base Case that does not.

Notice that while the end of year 2011 figure (actually 76.8%) isn't much worse than S&P's is projecting at 74%, it is considerably worse than the DOWNSIDE in 2015 (164% vs 79%) and more than six times as bad in 2021 (509% vs 85%). But are these astronomical ratios even remotely possible? Could federal debt really rise to $26.1 trillion in 2015 from $9.6 trillion at present? After all, that would amount to 39.4% of all U.S. debt outstanding, assuming that the private sectors shrank at the same rate that the federal government sector expanded, and would indicate a Game Over default sometime in between 2016 and 2018.

This chart, which shows the historical percentage for each of the major debt sectors since 1946, demonstrates that at least the 2015 rate is clearly within the bounds of possibility. The Federal Government sector represented more than 39.4% of total U.S. debt until 1955. Furthermore, it also shows that the decline of Financial sector debt, which has contracted $3 trillion since 2008 and fallen from 32.7% of the total to 26.8%, could conceivably continue to dwindle away to less than one percent of the total, which would amount to an additional $11.2 trillion in debt-deleveraging that would need to be replaced by federal debt in order to prevent concomitant economic contraction. (It also, by the by, shows very clearly the real source of America's current economic woes.) Government spending and borrowing is not the root cause of the problem, it is merely a failed attempt to cure the disease of massive private sector debt expansion and contraction.

Now, I am not making any predictions here, other than a general one that because private sector debt will continue to fall, there will be tremendous pressure to continue to increase federal spending and borrowing at rates more similar to that of the last three years than the historical norm. This is because the alternative is an immediate and sizable contraction of GDP.  As ugly as it appears, the CURRENT CASE scenario I have outlined is not a worst case scenario because it does not account for the economic contraction I expect to finally begin showing up in the GDP numbers later this year and in 2012.  The determining factor will be whether the rate of increase of federal debt is closer to the 22.7% annual rate of 2008-2011 or the 5.9% rate of 1946-2011.  Just out of curiosity, I looked at the latter, which in combination with the 1.57% 2008-2011 GDP growth produces the following scenario:

HISTORICAL CASE: 2011 66.3%, 2015 78.4%, 2021 100.9%.

Which of these five scenarios appears to be playing out should be readily apparent by the time the Q4-2011 debt sector numbers are published in the Federal Reserve's Z1 report.  If the Household and Private sectors continue to decline and end-of-year federal debt/GDP is over 75%, then CURRENT CASE is probably in effect.

UPDATE - More like 3 in 3, I would say: "A Standard & Poor's official says there is a 1 in 3 chance that the U.S. credit rating could be downgraded another notch if conditions erode over the next six to 24 months. The credit rating agency's managing director, John Chambers, tells ABC's "This Week" that if the fiscal position of the U.S. deteriorates further, or if political gridlock tightens even more, a further downgrade is possible."

Confessions of a Credit Easer

A mea culpa from the manager of the Federal Reserve's mortgage-backed security purchase program:

Confessions of a Quantitative Easer

We went on a bond-buying spree that was supposed to help Main Street. Instead, it was a feast for Wall Street.

I can only say: I'm sorry, America. As a former Federal Reserve official, I was responsible for executing the centerpiece program of the Fed's first plunge into the bond-buying experiment known as quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I've come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time.

Five years ago this month, on Black Friday, the Fed launched an unprecedented shopping spree. By that point in the financial crisis, Congress had already passed legislation, the Troubled Asset Relief Program, to halt the U.S. banking system's free fall. Beyond Wall Street, though, the economic pain was still soaring. In the last three months of 2008 alone, almost two million Americans would lose their jobs.

The Fed said it wanted to help—through a new program of massive bond purchases. There were secondary goals, but Chairman Ben Bernanke made clear that the Fed's central motivation was to "affect credit conditions for households and businesses": to drive down the cost of credit so that more Americans hurting from the tanking economy could use it to weather the downturn. For this reason, he originally called the initiative "credit easing."

My part of the story began a few months later. Having been at the Fed for seven years, until early 2008, I was working on Wall Street in spring 2009 when I got an unexpected phone call. Would I come back to work on the Fed's trading floor? The job: managing what was at the heart of QE's bond-buying spree—a wild attempt to buy $1.25 trillion in mortgage bonds in 12 months. Incredibly, the Fed was calling to ask if I wanted to quarterback the largest economic stimulus in U.S. history.

This was a dream job, but I hesitated. And it wasn't just nervousness about taking on such responsibility. I had left the Fed out of frustration, having witnessed the institution deferring more and more to Wall Street. Independence is at the heart of any central bank's credibility, and I had come to believe that the Fed's independence was eroding. Senior Fed officials, though, were publicly acknowledging mistakes and several of those officials emphasized to me how committed they were to a major Wall Street revamp. I could also see that they desperately needed reinforcements. I took a leap of faith.

In its almost 100-year history, the Fed had never bought one mortgage bond. Now my program was buying so many each day through active, unscripted trading that we constantly risked driving bond prices too high and crashing global confidence in key financial markets. We were working feverishly to preserve the impression that the Fed knew what it was doing.

It wasn't long before my old doubts resurfaced. Despite the Fed's rhetoric, my program wasn't helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were extending wasn't getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.

If you've read RGD, (published in 2009), then you are aware that even at the time it was obvious that the neither the Fed nor the White House was trying to help home buyers. They could have simply written off the debts owed by mortgage holders, but instead, they funneled trillions to Wall Street.

This proves, once more, that the Federal Reserve has zero interest in fixing, saving, or otherwise improving the US economy. It has other objectives, other goals, and it is a category error to even discuss the Fed's future actions in terms of whether they will be good for the economy or not.

To do so is like discussing whether the future run/pass ratio of the New England Patriots will be good for the New York Yankees. It's not even relevant to the discussion except perhaps as an unintended consequence.  And notice that they changed the name from credit easing to quantitative easing just to make the concept harder to grasp for the average American. Simple, but effective, because MPAI.