Fed says no worries about inflation

As you may know, the Fed has created brand-new dollars out of thin air which it has used to loan the US government money. That is, we've been paying our national bills using dollars still wet with ink (figuratively speaking). Dollars straight off the metaphorical printing press. You might even call them counterfeit dollars.

Countries which engage in this generally devalue or destroy their currencies. But the Fed assures us it's okay:

Fears of inflation because of the Federal Reserve’s massive quantitative easing measures are overblown, because the Fed has the ability to pull the liquidity out of the market fast enough to prevent price rises, William Dudley, New York Fed president, told CNBC Monday....

Many analysts have warned the measures carry a high risk of inflation....

“My view is that we have tools to manage our balance sheet so that we’ll not have an inflation outcome,” Dudley told CNBC. “We’re far along in terms of having the interest on excess reserves and, just in case, developing other means of pulling out the excess reserves.”

I'm reminded of Fiat Money Inflation in France (pdf of text here), in which the author discusses the precautions and the care with which the French politicians first engaged in money printing. These men were not idiots, and they believed they had built in mechanisms that would prevent the newly printed money from being inflationary. Just like Mr. Dudley of the New York Fed.

It would be a great mistake to suppose that the statesmen of France, or the French people, were ignorant of the dangers in issuing irredeemable paper money; No matter how skillfully the bright side of such a currency was exhibited, all thoughtful men in France remembered its dark side. They knew too well, from that ruinous experience, seventy years before, in John Law's time, the difficulties and dangers of a currency not well based and controlled. They had then learned how easy it is to issue it; how difficult it is to check its overissue….

It was no mere attempt at theatrical display, but a natural impulse, which led a thoughtful statesman, during the debate, to hold up a piece of that old paper money and to declare that it was stained with the blood and tears of their fathers....

Whatever may have been the character of the men who legislated for France afterward, no thoughtful student of history can deny... that few more keen-sighted legislative bodies have ever met than this first French Constitutional Assembly.

Or, in short, "the best laid plans of mice and men...."

Congressional ignorance

Based on this listing of the educational background of each member of Congress, out of 535 members, there are 14 who have a degree in economics. In this category I'm including such degrees as a BS in "Food and Resource Economics" and a BA in "Agri-economics." There are an additional 16 members with an MBA and perhaps 25 or 30 with a bachelor's degree in business, accounting, or similar. Note that bachelor's degree information is missing for a number of members of Congress.

So, a rough estimate is that about 10% of Congress has had formal training in some aspect of money management or theories about money. However, most of the money-related education was focused on the nuts and bolts of business management or accounting. Only 2 members of Congress have master's degrees in economics, and none has a PhD in that field. (I don't mean to suggest that a degree is required for understanding, however; the two members of Congress with the best understanding of economics would seem to be Ron Paul and Dennis Kucinich, and neither has a degree related to money. But this gives us some indication.)

Money, as they say, makes the world go 'round. If you want to get to the bottom of something, you "follow the money," don't you? Wars are caused by economic factors, though that isn't quite how they tell the story in high school history class. Empires rise and fall because of economics. Domestically, the standard of living of constituents, and to a large degree their overall quality of life, is dependent on the economy in their district. Voters pay more attention to the economy than perhaps any other factor. As Clinton (re)discovered, "It's the economy, stupid."

In short, it's important for the people running a country to understand money, but almost none of our leaders have that knowledge. I don't think the Washington cocktail party crowd knows that the GDP numbers are bullshit, the job loss numbers are rosy-colored, or that inflation has been routinely understated for a couple of decades. It's safe to presume that most of them don't understand bear-market rallies, or why derivatives are a looming problem, or that the existence of the FDIC does not make everything hunky-dory in bank-land. They're smoking their own green shoots because they simply don't know any better. (And hey, Paul Krugman says that everything will be just fine! And he has a PhD so he must be right!)

We all know that Wall Street gives enormous campaign contributions to members of Congress, and that Washington is crawling with lobbyists, and that (more to the point) no legislator ever reads the bill they are voting on. But even if a member of Congress were trying in earnest to do their level best for the American people, they wouldn't be able to ask the right questions on the subject of finance. Someone should show up to a town meeting and ask their member of Congress: "How will confidence in the dollar be affected if the CFTC limits futures positions in gold?" Unless you were talking to Ron Paul you'd get the big, blank stare. And yet, a change in regulations by the CFTC could derail the gold price suppression scheme, thus impugning all fiat currencies as the price of gold rises swiftly, thus accelerating Chinese purchases of tangible, non-dollar assets, thus eroding purchases of Treasuries, thus devaluing the US dollar and making most things we buy much more expensive. It's rather important, yet 99% of Congress can't assess such issues because economics & finance are not their specialty.

Actually, stating that finance & economics are "not their specialty" is a bit charitable. As I wrote about yesterday, many politicians seem to lack basic common sense as applied to economics. Mandating artificially low prices in order to combat a shortage is just plain asinine. Giving $24 trillion to banks when you cannot pay your bills is also plainly idiotic. Nor does anyone in Congress seem to be alarmed that 4 out of 5 workers are in the "service" sector, or that we are having to buy our own Treasuries because there aren't enough takers, or that we are in the hole for somewhere between $70 and $100 trillion if you include future promises (as corporations must do, by law). These things are not sustainable; something has to give.

It's too bad that we cannot look to Congress (or Obama) for good ideas about how we get through this. I think we'd better assume, like the people of New Orleans after Katrina, that we're on our own.

Price control idiocy

As you may be aware, in recent weeks the Massachusetts legislature has completely lost its mind and has passed frothing-at-the-mouth regulations regarding pandemic flu. Aside from violating several parts of the Bill of Rights, the flu legislation also includes this gem:

The attorney general, in consultation with the office of consumer affairs and business regulation, and upon the declaration by the governor that a supply emergency exists, shall take appropriate action to ensure that no person shall sell a product or service that is at a price that unreasonably exceeds the price charged before the emergency.

In other words, if there is a lack of supply of (say) Tylenol, the Massachusetts government should make sure that Tylenol stays really cheap. Yeah, that oughtta solve the problem.

How exactly do these people get elected? Is it like a high school popularity contest? Because apparently they don't actually have to know anything to get the job.

If you have a shortage of something, you ration it. How hard is that to understand?

What they're proposing is to insist that critical items be sold at a low price (relative to demand). Well, if something is priced low, don't more people buy it? Wouldn't the shortage grow worse? Wouldn't rationing be a far more effective way of insuring that key items are available to the public?

Reasons to leave the market

If you own any stocks, you might be feeling good about all the happy-happy talk regarding the economy and the ostensible "recovery." You might have made up for at least some of your earlier losses, and you might not be feeling as bad about the Dow and the S&P.

I'm not so optimistic. In fact, I am very pessimistic verging on horrified. Here are some reasons why:

Low Volume

Share prices may be up, but that's based on very little buying and selling. Many are staying on the sidelines. True "bull market" rallies should have good trading volumes.

Insider Selling

When the big executives at corporations sell their stock, they are required to file reports about this, to prevent illegal / manipulative insider trading. The vast majority of those filing such reports -- almost 95% -- are selling, not buying.

Bad Time of Year

September and October are historically bad months for stocks.

Irrational Rally

In my opinion this "bear market rally" started out as manipulation (using TARP funds or similar, as channeled through Wall Street, with the help of the Plunge Protection Team) and eventually sucked in enough investors to take on a life of its own. It's never been based on fundamentals. How is an economy based on consumer spending supposed to grow and prosper, when 1 in 5 workers are unemployed or underemployed? Riddle me that, Paul Krugman.

1930

There was a massive rally after the 1929 stocks crash, which lasted well into 1930. It was accompanied by happy-happy talk from the Treasury Secretary, the President, economists, bankers, and captains of industry. The glad old days were here again-- until they weren't, and stocks crashed to below their 1929 nadir.

Trailing P/E Ratio

The "P" is the price of a share of stock in a company. The "E" is how much that company earned per share (total earnings divided by number of shares of stock). So in other words, if you pay $30 for a stock and it earns $2 per share, the P/E or price-to-earnings ratio is 15. That's about average, historically. Back in 1999 at the height of the dot-com bubble, the average P/E for the whole S&P 500 reached an all-time high of about 44. And today? Today it's 144. Talk about overvalued.

Elliott Wave Analysis

There's a school of "technical analysis" (chart-reading) which is fairly well respected, and which is predicting extremely dire times ahead for the stock market, sometime in the next few months. It's beyond me to evaluate the track record of the Elliott Wave school, I can only say they're quite popular. When I say "dire" I mean -- depending on the analyst -- predictions of up to a 90% fall in stock prices. I.e. total catastrophe, and the end of 401k plans.

Funny Business

I've been hanging out and reading lots of comments over at Zero Hedge, where many of the commenters are quite expert in the financial markets. The general consensus is: Everything Is Broken. Nothing is correlating like it's supposed to, manipulation is rampant, "portfolio theory" and "hedging" are dead because nothing is working the way it usually does, and many totally ridiculous moves in stocks and commodities are occurring daily. In short, anyone not plugged into the inside circle, that little cabal of Treasury / Fed / Goldman men, is just a pathetic sheep to the slaughter. I provide an illustrative comment, though it may sound like gibberish to some of you:

I'm so fucking bored of this market - without sophisticated heat mapping metrics and explosive liquidity detection behind the bid it is a waste of time trying to trade this market with a balanced risk profile. Forget Alpha, Beta, Delta, Gamma Vega, Rho, Theta - Hedged caution long/short or call/put portfolios are useless - no correlations in anything- THIN VOLUME spiking the fucking FOREX MARKETS!! I have been out on the sidelines for months and no no rational risk prioritising strategy has even worked in theory for longer than a session or so. WHAT A JOKE THIS MARKET IS!!

Truly truly truly flip a coin and save your self the time spent researching and theorizing

Well, hey, that sounds like a healthy situation. Everything they learned in finance school is out the window. You think you can do better than these guys?

Get out, if you can get out... in my humble opinion. Unfortunately I cannot claim Treasuries are a great alternative, as the dollar could be toast within months, so if your money is in a 401k you may be screwed. (If you own a 401k and you are not irate, you are not educated about said 401k, my friend. They are a scam.)

Hold your breath, we're going down again....

Price controls

At some point in the not-too-distant future, when prices begin rising because the value of the dollar is dropping, we can expect the government to try using price controls. As Henry Hazlitt says in Economics in One Lesson, in the chapter on government price-fixing:

When the government tries to fix maximum prices for only a few items, it usually chooses certain basic necessities, on the ground that it is most essential that the poor be able to obtain these at a “reasonable” cost. Let us say that the items chosen for this purpose are bread, milk and meat.

The argument for holding down the price of these goods will run something like this: If we leave beef (let us say) to the mercies of the free market, the price will be pushed up by competitive bidding so that only the rich will get it. People will get beef not in proportion to their need, but only in proportion to their purchasing power. If we keep the price down, everyone will get his fair share.

In practice what happens is exactly the opposite, as shortages develop and these important goods begin to disappear. Eventually, the majority of people don't get their fair share. There are two reasons for the shortage:

First, the chosen items are a great deal, and are cheaper than the non-price-controlled foods. So, instead of fish one buys beef; instead of potatoes one buys bread; instead of orange juice one buys milk. Demand for the artificially cheap goods surges.

At the same time, the second factor comes into play: the low prices cut into the profits of producers of these items. Some producers (say, a small organic dairy farm) can't make it at all, and go bankrupt. Others may shift production away from the low-profit items, say by using milk to make butter and yogurt rather than simply selling it as milk. Large, diversified food producers may give up on the low-profit, artificially cheap foods, and rely on their other products to get by. Any way you slice it, supply of the price-controlled items drops.

It's not hard to imagine what happens when demand rises but supply drops. We run out of those items, is what happens.

Three other consequences of the price controls are

• reduced quality (as businesses try to maintain profits)
• unfair distribution of these goods, as retailers favor some customers over others
• black markets

The next thing a government would usually try is rationing. If the supply of the item in question -- say, milk -- is still reasonably sufficient, then by some sort of coupon system each family can be guaranteed a weekly allotment of milk. The problem of reduced quality is not solved, and the problem of black markets is hugely increased.

On the black market, the price of a good may be very high, so much so that the poor cannot turn to this source of goods, though the rich can. At this point we've come full circle. The whole intention of the price controls was to insure that everyone would have ample access to these staple goods. Yet now the poor are banned from getting more than X amount per week (if they can even find that!), while the wealthy can turn to the black market. You may think that the upper middle class is unlikely to break the law. But history shows that the "black market" in fact becomes very mainstream during periods of government price fixing. Sometimes the legitimate, legal market virtually ceases to exist, and almost everyone who can afford it uses the black market. At that point the poor have almost no access to these goods, which is particularly unfortunate because these are usually important items like milk, gas, bread, or butter.

Although there is a long history of failed government attempts to control prices, politicians don't seem to be able to resist such controls. The public generally doesn't know enough about economics to understand why prices are rising (i.e. because the currency is losing value). In periods of rapid inflation there is usually anger at retailers or producers, and many accusations of "price gouging" and greed. It's easy for legislators to boost poll numbers by mandating a maximum price for key goods.

This happens despite an extremely clear and consistent record suggesting that price controls never come to any good. Consider The Economic Fallacy of Price Controls:

Throughout history, many in positions of power have used price controls to influence economic activity and the results have often been disastrous. As mentioned previously, Diocletian’s own attempts to curb the rampant inflation which was devastating Rome at the time of his reign during the third century A.D., only hastened the economic deterioration of an already declining empire (Watkins). In the aftermath of the French Revolution, the government led by Robespierre instituted price controls (“Law of the Maximum”) on a variety of items (especially on food), which not surprisingly, led to widespread shortages and starvation (DiLorenzo).

Unfortunately, the United States has not been immune to the allure of price controls despite their dismal historical record. In a book review written by author Thomas J. DiLorenzo and published on the Ludwig Von Mises Institute website, he noted that at one point during the American Revolution, General George Washington’s army was in danger of starvation thanks to price controls instituted by “friendly” colonies such as Pennsylvania. These had the effect of causing severe shortages which were only alleviated after the Continental Congress recommended the repeal of these controls in June 1778 (DiLorenzo).

Furthermore, history shows that not even the threat of the death penalty can keep goods from being sold above the legislated price on the black market. The laws cannot be enforced, yet they often dramatically disrupt the economy.

When the president, the Congress, or a state legislature first enacts price controls (2010? 2011?), this is likely to be met with almost universal approval. In our just-in-time economy, it won't take long for the shortages to ensue. Then will come the accusations about "hoarders" who are causing the problem by buying absurd quantities of the cheap, price-controlled items. This won't be true either, as most stores will impose rationing all on their own (similar to Costco and Wal-Mart during the rice shortage a couple of years ago). Everyone will be pissed off, and hardly anyone will understand that the real blame should be put on the heads of the men who have run the printing press for Federal Reserve Notes.

Comic relief

Every Monday, James Howard Kunstler posts his weekly rant on his blog, Clusterfuck Nation. This week's piece was particularly irritable and curmudgeonly (and funny).

Paul Krugman says that we'll soon realize that Gross Domestic Product (GDP) is growing. He actually said that on the Sunday TV chat circuit. Not to put too fine a point on it, but I would really like to know what you mean by that Paul, you fatuous wanker.

Ha! I love it.

Kunstler then goes on to ask exactly how the economy is expected to revive-- more McMansions? More SUVs? More day trading?

Do you mean that the Home Equity Fairy is going to wade into the sea of foreclosure and save twenty million mortgage holders currently sojourning in the fathomless depths with the anglerfish? ... Do you mean that American Express and Master Card are about to declare a Jubilee on accounts in default everywhere? Do you mean that General Motors will produce a car that a.) anyone really wants to buy and b.) that the company can sell at a profit? Are you saying we get a do-over, going back to, say, 1981? Did we win some cosmic lottery that hasn't been announced yet? What's growing in this country besides unemployment, bankruptcy, repossession, liquidation, gun ownership, and suicidal despair? In short, are you out of your mind, Paul Krugman?

GDP figures, according to economist John Williams, are so finagled and manipulated and so politically driven as to be useless. Krugman may be right in strictly nominal terms-- we could see positive GDP numbers for a quarter here or there. We shouldn't be distracted by such things.

As Ilargi over at The Automatic Earth has pointed out, we might instead measure our economic health in terms of the poverty rate, the unemployment rate, the number of homeless, or the percentage receiving food aid. That gives you a better picture of what the economy feels like on the ground, out in the streets. And, politicians take note: poverty measures are surely far better predictors of civil unrest than some bullshit GDP figures nobody believes anymore.

The service economy

According to Wikipedia's entry on the United States:

In 2009, the private sector is estimated to constitute 55.3% of the economy, with federal government activity accounting for 24.1% and state and local government activity (including federal transfers) the remaining 20.6%. The economy is postindustrial, with the service sector contributing 67.8% of GDP.... While agriculture accounts for just under 1% of GDP, the United States is the world's top producer of corn and soybeans....

In 2005, 155 million persons were employed with earnings, of whom 80% had full-time jobs. The majority, 79%, were employed in the service sector.

First of all, to have 45% of the economy coming from the government, at a time when state and federal budgets are a mess, does not bode well. State employees are dropping like flies.

Secondly, having more than 2/3 of your economy in the "service" sector does not bode well, either. Wikipedia describes the "service sector" this way:

The service sector consists of the "soft" parts of the economy such as insurance, government, tourism, banking, retail, education, and social services. In soft-sector employment, people use time to deploy knowledge assets, collaboration assets, and process-engagement to create productivity (effectiveness), performance improvement potential (potential) and sustainability. The tertiary sector is the most common workplace.

Typically the output of this sector is content (information), service, attention, advice, experiences, and/or discussion (also known as "intangible goods").

Deploying collaboration assets? Engaging in process-engagement?

I am strongly reminded of when my husband was subjected to days of meetings with outside "consultants" who insisted on being called "sherpas" [I kid you not] and were there to infantilize everyone and pat them on their little heads and whine about teamwork. I am surprised he got out of there without singing kumbaya. This is one example of "intangible goods," which in this case was a euphemism for "useless crap" and "an utter waste of time."

To be fair, the utility of the service sector to the nation as a whole is to improve productivity, and I am sure it accomplishes that in many cases. But you can only improve productivity when there is actual production going on. I can see that education and social assistance can improve the productivity of individuals, but only if -- later on, down the line -- they will actually be engaged in producing something. I can see that banks are useful to communities when they provide funding for local businesses, but only when those businesses actually produce something. I can see that cooking food for someone or hemming their pants can save them time, but the rest of society only sees that as beneficial if that person engages in productive work in the time saved. How can we have 2/3 of the economy involved in improving productivity when only 1/3 of the economy is production? Isn't that a bit like having 2 efficiency experts per factory worker?

Ah-- but I'm looking at the proportion of GDP, which is measuring the service sector in terms of dollars. More interestingly, 79% of all workers are in the service sector. So it's more like having 4 efficiency experts per factory worker. This is hardly sustainable.

And can I say, I am shocked that only 1% of GDP involves growing or raising food? (Livestock is included in the agriculture sector; it doesn't only mean crops.) Food seems... well, a little bit important to human existence, no? And can I also point out that soybeans are not actually edible unless fermented and that we are poisoning ourselves with all these damned soybeans? If you take out soybeans, actual food production is even less than 1% of GDP, which I find insane.

No, I don't think we will return to a subsistence level where all we need is food, shelter, and clothing. But we do need to think in terms of the basics. We need to know where our food, shelter, and clothing will come from if the currency fails. Sitting around selling each other data and advice does not make an economy. You can't feed the poor with databases, and if you don't feed the poor, they revolt.

As I said in my previous post, collective national wealth is pretty blue-collar. It's the blue-collar workers who built the roads, bridges, dams, subways, and buildings. It's the small, local farmers who we will again have to rely on, when centralized and industrialized agriculture fails in the absence of cheap fuel and cheap money. To have 4 out of 5 workers in the "soft" (that is, mostly non-producing) economy is unsustainable when heading into an economic depression. What on earth will we do with all the unemployed?

Production is wealth

Economics in One Lesson features a chapter on the myth that wars stimulate economies, sarcastically titled "The Blessings of Destruction." In that chapter, Hazlitt writes:

Those who think that the destruction of war increases total “demand” forget that demand and supply are merely two sides of the same coin. They are the same thing looked at from different directions. Supply creates demand because at bottom it is demand. The supply of the thing they make is all that people have, in fact, to offer in exchange for the things they want. In this sense the farmers’ supply of wheat constitutes their demand for automobiles and other goods....

It should be obvious that real buying power is wiped out to the same extent as productive power is wiped out.

The book was written in 1946, at a time when Europe's productive capacity had been decimated by war. In the US today, our productive capacity has been gutted by globalization and offshoring, especially because we had the reserve currency of the world, which we could dole out without having to produce a thing. We abandoned the supply / demand relationship that Hazlitt described; our demand was no longer limited by what we produced. We've been able to buy things with dollars, even after those dollars ceased to represent anything at all (i.e. since August 1971).

We buy things for nothing, no supply of real goods required. Other countries want our backed-by-nothing dollars because oil and various commodities are only sold in dollars. We have had a monopoly and an insane advantage over the rest of the world. If China wants to buy crude oil from Saudi Arabia, it has to pay them in dollars. Thus our currency has always been in demand, and even as our factories closed, we could print more money and maintain our standard of living.

Most of the country seemed not to notice as our textile mills left for Asia and our steel plants closed. Granted, the incomes of the working and middle classes have been stagnant or declining in terms of real purchasing power, but this was masked by taking on debts, mainly credit card and 2nd mortgage debts. Between government debts and private citizens' debts, we've been living well while producing less.

There is no free lunch, of course. We've come to a situation now where our only option for dealing with our debts is to depreciate the currency and pay our creditors back in shrunken (if not nigh-worthless) dollars. Even if the government attempts to avoid that, demand for dollars is waning, which will cause the depreciation anyway. This process will wipe out most of the assets of the working and middle classes.

Our supply of produced goods should have represented our demand, as Hazlitt explained it. We should have bought goods in proportion to the goods we produced. To break that relationship and live high on the hog without producing much is clearly unsustainable. "The American way of life is non-negotiable" is an absurdity. Nobody gets something for nothing, forever.

It should be obvious that real buying power is wiped out to the same extent as productive power is wiped out.

We will come to recognize this again when the currency collapses. The suffering in Allentown and Youngstown will be the suffering of the whole nation, when demand for our primary export (dollars) evaporates. Nothing good can ever come from reduced production. Real wealth is production. Collective, national wealth, in fact, is pretty blue-collar. Disdain for such blue-collar, concrete wealth might explain why the ivory tower folks thought this ridiculous "service" and/or financial economy could ever work. The idea that CDO's and business consulting are necessary goods was just a mass hallucination designed to explain why we still had the highest quality of life on the planet, despite producing less and less. We simply convinced ourselves that we were still producing something.

But you can't eat derivatives contracts, you can't clothe yourself in credit default swaps, and you can't make a shanty out of collateralized debt obligations.

Well we're waiting here in Allentown
For the Pennsylvania we never found
For the promises our teachers gave
If we worked hard
If we behaved
So the graduations hang on the wall
But they never really helped us at all
No they never taught us what was real
Iron and coke
And chromium steel
And we're waiting here in Allentown

The second French hyperinflation

I recently read the very short Fiat Money Inflation in France, about the destruction of the French paper currency around the time of the French revolution. What's interesting about the book is that the author does not denounce the French politicians as total morons. He takes care to show that these politicians started out printing money quite cautiously and thoughtfully. But, as I have said before, when you print more fiat currency you actually reduce the true value of the currency in circulation, exacerbating the deflationary problems in the economy. The people then begin to demand new currency, and yet new currency soon makes the troubles more severe, resulting in another round of demands for more currency. And so it went in France, until the assignats were nigh worthless and the economy was decimated.

As the author writes on pp. 73-74:

The question will naturally be asked, on whom did this vast depreciation mainly fall at last? When this currency had sunk to about one three-hundredth part of its nominal value and, after that, to nothing, in whose hands was the bulk of it? The answer is simple. I shall give it in the exact words of that thoughtful historian from whom I have already quoted [Von Sybel]: "Before the end of the year 1795 the paper money was almost exclusively in the hands of the working classes, employees and men of small means, whose property was not large enough to invest in stores of goods or national lands. Financiers and men of large means were shrewd enough to put as much of their property as possible into objects of permanent value. The working classes had no such foresight or skill or means. On them finally came the great crushing weight of the loss. After the first collapse came up the cries of the starving. Roads and bridges were neglected; many manufactures were given up in utter helplessness."

To continue, in the words of the historian already cited: "None felt any confidence in the future in any respect; few dared to make a business investment for any length of time and it was accounted a folly to curtail the pleasures of the moment, to accumulate or save for so uncertain a future."

In both Weimar Germany and revolutionary France, historians write about hedonism and impulsiveness, "loose morals" and rising crime. Take away the ability to plan for the future, and the society begins to disintegrate.

Today, however, people of very modest means have some ability to protect themselves, because junk silver is cheap and is available in very small denominations. It usually sells for something like 11-12 times its face value. So a 90% silver dime from before 1965, with a face value of 10 cents, could be bought for a little more than a dollar. A roll of such dimes, worth $5 in face value, could be bought for $60 or less. Furthermore, if the worst happens and you need to acquire food using silver, it's those little dimes you want.

Google a coin shop in your area and get yourself some silver. Remember the line "The working classes had no such foresight or skill or means." But you do have the means... you just need the foresight.

Coin shops near Mount Clemens
Coin shops near Winter Park
Coin shops near Ann Arbor

On Ellen Brown's money-printing solution

Economics writer Ellen Brown has suggested that California, or any state, could solve its budget problems by creating its own state bank and essentially printing its own money. As long as the new money goes into new production, this policy is not inflationary, she argues; in fact, issuing new money can create economic miracles.

Generally speaking I believe she is wrong. In a functioning economy, the issuance of new currency to the people will increase prices by more than the rate at which the new money is issued, which means it actually creates deflation in real terms. This is because, in a functioning economy, putting currency into the people's hands also makes currency change hands more quickly. That is, you not only increase the money supply, but you also increase money velocity. Remember that

MV = PQ

When governments increase M, they eventually increase V. This means that the PQ side of the equation (prices x quantity of goods) will rise at a faster rate than M. You might give someone 10% more money, but if prices have gone up by 14% you've only made their situation worse. The government's hope is that if MV increases, production (Q) will increase, but the problem is that production can only grow just so fast, and it basically tops out when full employment is attained.

In short, when you print more fiat currency in a functioning economy, the common people experience a deflation in purchasing power. You harm the economy.

And yet, Ellen Brown points to three historical examples in which money-printing brought economic salvation: the early American Colonies, the island of Guernsey in the English Channel just after the Napoleonic War, and Germany under Hitler. In these instances, the new money spurred production and brought economic relief, and certainly not the deflation in real terms I mentioned above. So what gives?

It occurs to me that these three examples are not representative, and not relevant in today's industrialized world, because in those instances production was at virtually zero. In the early Colonies, there was tremendous room for increased production. On Guernsey, the economy had been decimated:

At the beginning of the nineteenth century, as a result of the Napoleonic wars, the trade of Guernsey was practically extinguished and the people were in despair. Unemployment was rife, the sea defences were breaking down, there were practically no roads, public buildings were in disrepair and, above all, a new market house, where the islanders could exchange their produce, was urgently needed.

And as one economist described it:

The Nazis came to power in Germany in 1933, at a time when its economy was in total collapse, with ruinous war-reparation obligations and zero prospects for foreign investment or credit.

These are cases in which, in the MV = PQ equation, Q was not much above zero, or certainly it was a great deal less than full production. This made it easier to translate increases in the supply of money (M) into increases in production (Q), without rising prices. Also, if you have almost no economic activity and no inventories to speak of, velocity cannot skyrocket because there is initially nothing to trade. Therefore, they did not experience a sudden jump in MV that would have caused prices to jump. Instead, increases in the money supply led to higher levels of production along with price stability. Purchasing power was maintained, while economic activity surged.

The American Colonies example is unique, in that Europeans were multiplying and spreading over the land, thus production could increase almost indefinitely. In the post-war examples, there were skilled and educated people living in an absolutely ruined economy, thus production could increase rapidly once rebuilding began. But in circumstances that are not so dire, in economies which are still functioning, the printing of new fiat currency will translate into real-terms deflation as purchasing power is lost. The perceived solution to this want of money will be to print more currency, causing yet worse deflation in real terms, as prices spike faster than paychecks and savings lose purchasing power. And so begins the hyperinflationary spiral.

Broken windows and broken cars

I'm currently reading Economics in One Lesson by Henry Hazlitt (the entire text is available here). The basic idea of the book is to help you see not only the direct and immediate effects of economic policies, but also the longer-term and indirect effects. Or, as it's commonly put, "the seen and the unseen."

The book starts off by describing the well-known "broken window fallacy." Suppose some disgruntled person comes along and lobs a brick through the large glass window of a bakery. This might be seen, by a rather simplistic bystander, as an economic boon for the town. After all, it generates business for the glazier who replaces the window, and the glazier, in turn, spends some of that money providing business to someone else. Of course, this is nonsense-- destruction does not help a community. We can see that the brick-lobber gives business to the glazier, but what's not seen is what the baker might otherwise have done with that money. He might have, say, bought a suit. Or, as Hazlitt explains:

The glazier’s gain of business, in short, is merely the tailor’s loss of business. No new “employment” has been added. The people in the crowd were thinking only of two parties to the transaction, the baker and the glazier. They had forgotten the potential third party involved, the tailor. They forgot him precisely because he will not now enter the scene. They will see the new window in the next day or two. They will never see the extra suit, precisely because it will never be made. They see only what is immediately visible to the eye.

Now maybe this strikes you as a rather silly example. Throwing bricks through windows can't somehow improve the economy. Surely people are not so stupid as to see wanton destruction as beneficial to the community.

But consider this: the "cash for clunkers" program involves destroying the cars traded in. Apparently we pour something into the gas tank which seizes the engine and renders the car useless. These are mostly paid-off cars in working condition, mind you. They are assets -- real goods -- without attached debts. They are units of wealth which we are destroying. How can this be seen as a good thing? Well, because! Destroying them creates work for automakers.

Well, sure, but meanwhile there are people who can't get jobs because they don't have transportation, and people who are losing jobs when their cars are repossessed. Why didn't the government allot these traded-in clunkers to the needy? Why trash working automobiles? We, as a people, have completely lost all sense of what wealth actually is. Wealth is not a bunch of numbers on a screen, wealth is stuff. Tangible things.

Yes, destroying these older cars breeds demand, and provides jobs to some. But the new cars are not actually owned by their drivers, because their drivers must usually take on debt to purchase the car. And these new car owners might wind up having the car repossessed in the end. If they do make their payments, they will have less money to spend elsewhere. Whatever they spend on the car payment is money they do not spend at restaurants and retailers. Furthermore, the government has taken on debt to pay for the "cash for clunkers" program itself. And on top of that, car companies may have taken on debts in order to ramp up production to meet this new demand. So in other words, we have reduced consumer spending in the non-auto sector, increased various debts, and destroyed some of the collective wealth of the nation, in exchange for retaining auto worker jobs.

And maybe that's a trade-off that we are willing to make. I am very sympathetic to saving American auto manufacturers, because they do have one or two foundries left, plus rail lines and factories and laboratories, and they do, anachronistically, actually make stuff. GM is not some re-insurance company which wheels and deals in derivatives, and Ford is not some business consulting company which contracts out its "consultants" to fire people at other companies, all because managers don't have the guts to do it themselves. No, GM and Ford are producers, and as such they contribute to the nation's real wealth.

However, it is simply indefensible to destroy wealth (cars) as government policy. It is as stupid as paying farmers not to grow wheat and dumping milk in the streets while citizens are starving.

One day we will have to think in real terms again. We will have to survey the remains of the former empire and ask ourselves what we have left. We'll have to inventory our mines, ports, railways, farmland, canals, factories, subways, buildings. We did not evolve into higher beings which no longer require food, clothing, and shelter, but can now live on derivatives contracts alone. The whole holograph, what Jim Kunstler calls the hallucinated economy, can simply evaporate, because it isn't made of tangible things, and doesn't produce anything. And when the mirage of the "service" economy or the FIRE (Finance, Insurance, Real Estate) economy disappears, and the dollar becomes useful only as kindling, we will be short some half a million working vehicles because somebody in Congress thought it was a bright idea to lob a brick through a metaphorical window.

Life during hyperinflation

[I am back from summer hiatus and will be posting regularly again.]

When I first began learning about hyperinflation, my main concern was to understand what it looked like on the street, for the common people. It is hard to imagine a situation where on Monday bread costs $20/loaf and on Wednesday that's risen to $22 and by Friday it's $25 (to make up an example). How does society keep functioning under those bizarre circumstances?

There was an excellent article published in the German paper Spiegel which gives us some details.

At the Junkers plant in Dessau the company gave its workers the equivalent of the day's price of three-and-a-half loaves of bread at 9am every morning. Their wives, who were waiting at the factory gates, took the money and dashed off to the shops before the new dollar exchange rate was published at around midday.

Many doctors insisted on being paid not in cash but sausages, eggs, coal, and the like. Because of the constant increase in prices, shops stopped displaying them in their windows. And when the Prussian authorities forced them to do so nonetheless, it drove prices even higher because traders simply took prospective increases into account....

People lived in a strange kind of tension. On the one hand there was the daily fight for survival, for food, and for heating fuel. "If we more-or-less manage to prevent the city of Cologne from collapsing completely, I shall get down on my knees and thank my Maker," the city's mayor, Konrad Adenauer, said....

Something that occurs to me, when pondering such a situation in the United States, is that if retailers want to take delivery more often, and consumers want to make purchases more often, the price of gas is going to go up faster than anything else, and the traffic will be terrible. Also, I'm not sure the big chain stores will be able to keep up with frequent pricing changes, which will either mean they go out of business, or that they gouge customers. Large organizations that make automated payments to workers will have trouble when workers need to be paid more often. If you pay your workers only on the 1st of the month, they may not have the cash to buy gas to come to work by the end of the month. The logistics of a high-velocity economy -- accelerated not due to real activity or production, but merely because people are frantic -- is hard to imagine in the current United States. A lot of retailers and companies may simply shut down, unable to cope.

On the other hand it was also a time of phenomenal wastefulness. The people were gripped by the urge to panic-buy. They squandered their money, and lived from one day to the next. "We're drinking away Grandma's house" proclaimed one popular tune of the day....

In fact petty crime in general increased in leaps and bounds. Potato fields were plundered, bakeries raided, shop windows smashed. Prices weren't the only thing that went out of control. All values seemed to have been corrupted. Dance halls and strip bars opened up in the cities, and cocaine sales skyrocketed. People lived as if there were no tomorrow. Economist Joseph Schumpeter noted the "disorganizing effects of the collapsing currency on the national character, on morals, and all branches of cultural life."

I once came across a blog written by a man who had lived through Argentina's second currency collapse several years ago, in which banks closed for 5 months and the currency lost three quarters of its value. Crime levels went through the roof, even among the middle class. He said that if someone stepped out in front of your car in an attempt to wave you down, you had to make yourself step on the accelerator, because the odds were very high that this person (or their accomplices) would rob you. After a while, he said, it got easier to do this-- they always jumped out of the way in time. In some neighborhoods people began carrying guns openly, in holsters, like it was the Wild West. Many people made sure they were home before dark and kept their children inside at all times. Such crime levels are what I fear most about hyperinflation. When people can't plan for the future they obviously grow more impulsive, which, combined with poverty, has to lead to crime.

The only objects of real value were tangible assets: diamonds and coins, antiques, pianos and art. The works of contemporary artists like Lyonel Feininger, Paul Klee, Max Pechstein and Karl Schmidt-Rottluff were in especially high demand. And if you had foreign currency, you lived like a king.

One senior mail inspector gained notoriety when it was revealed he had intercepted letters containing foreign banknotes: 1,717 dollars, 1,102 Swiss francs, and 114 French francs - enough to buy two houses for himself and a piano for a friend, with enough left over for an indulgence-like donation to the church....

Notice how few foreign bills it took to buy two houses and more. This is because, in real terms (as measured in a gold-backed foreign currency or in ounces of gold) prices in Germany were actually plummeting drastically. In real terms (gold equivalents) Germany was suffering from an astounding deflation, as I talked about in this post. Fat lot of good it did you if all you had were Marks, though; in that case, prices were rising faster than your paycheck was.

The stupid ones were those who had nest eggs: the thrifty, holders of government bonds, but primarily the country's pensioners. In other words, those who received money without having to work for it, who lived on their pensions or the interest on their savings. Large sections of the middle classes saw themselves stripped of their assets, losing almost everything they had set aside for years....

Today, all major currencies are fiat currencies (that is, just paper backed by collective confidence in its utility). It's hard to say which brands of paper (dollars, Euros, yen, yuan) will suffer the worst inflation, or when. Having small denomination silver will be much more reliable for making purchases, while gold can be used to preserve larger amounts of wealth.

By perverse contrast, the winners of the hyperinflation were those with massive debts; first and foremost the state, but also private individuals who had borrowed money to buy houses, construction land or farmland, and whose loans were slashed by the switch to the rentenmark....

This benefit to debtors is the whole reason why hyperinflation is an attractive option, in the eyes of the government, in a country with enormous debts, both public and private. You start by printing money to pay debts and deficits, and you end by defaulting on debts because the dollars you pay your creditors with are now worthless. Yes, some of the poor starve and die of nutritional deficiencies and resultant disease, but the mega-rich have safely ensconced their wealth in gold and silver, art and antiques, jewelry, and landed estates. The middle class mostly survives but is left with nothing afterward and must start from scratch.

As bad as that sounds, what's worse is that the United States doesn't have the tools to re-start production from scratch. Because of globalization, we offshored all the means of production. Yet production is the only real wealth, and real goods grown or manufactured represent the only real purchasing power for the common people. We are going to be poor in this country in a way that is hard to even imagine. We don't make anything anymore, or if we do, we buy the parts from China and merely assemble it here. We don't even have foundries, nor do we have shoe factories or textile mills, nor enough rail lines or ports. Even our means of food production have been centralized and industrialized into a business model that will, to put it plainly, abruptly cease to exist.

Modern people think they are somehow unlike the people who have gone before, because technology has made our world appear so different than the world of even Weimar Germany, less than a century ago. People photographed in black and white, stuffing banknotes into stoves or hauling it in wheelbarrows, might as well have been living on Mars, for all we care. And yet it's technology -- or more accurately, the centralization and globalization technology has enabled -- that have so terribly impoverished our country in real terms. The American way of life is non-negotiable, say our leaders. All I can say to that is, pride goeth before a fall.

Few could laugh at "the macabre joke of inflation," as writer Klaus Mann termed it. "What breathtaking fun it is to watch the world coming off the rails," he wrote in undisguised fascination. Germany was now witnessing "the complete depreciation of the only truly credible value in this godforsaken era: that of money...."

It is true to say that nothing seemed safe anymore -- all semblance of order went out of the window, and with it faith in the Weimar Republic, in democracy, indeed in the future itself.