Wall Street Protests, Black Death and The Case Against the Fed

Wall Street Protests

On my way home I stopped to speak to several Wall Street protestors. Many seem angry and confused over bailouts for fat cats, banks, and the corporate elite while they struggle to find work, pay off debts, and redress unfairness.  I don’t blame them for their fears and protests. Several told me that capitalism was corrupt. Socialism would work much better instead.  Oh, how people never learn from history.

First, I find it ironic that Cubans are desperate to flee in make-shift rafts across shark infested waters to leave a crumbling socialist state to reach America. Second, how can capitalism fail when we don’t have free markets in the U.S.?  Our cartelized banking system reflects corporatism. If you believe that prices matter in their ability to send signals to freely exchanging participants about how to allocate resources most efficiently and you believe that centralized planning ultimately fails (as shown by countries like Soviet Russia, North Korea, Communist China, etc.), then the Federal Reserve should be abolished.

Some of the protesters remind me of those who burned people alive at the stake to stop the bubonic plaque in the 1300s rather than fight the real cause—fleas on rats. Three minute rap video of the Bubonic Plague of 1347 (“Black Death”) http://www.youtube.com/watch?v=rZy6XilXDZQ

Question Everything

Before I provide an example of why the Federal Reserve’s debasement of the U.S. dollar is devastating to the poor and middle classes which is—I believe—the cause of the protests, I ask that you never accept what I say at face value. Seek out counter-arguments to disprove even your own most cherished beliefs.

I am not saying you should attack yourself like Jim Carrey in Liar, Liar’s bathroom scene:http://www.youtube.com/watch?v=95CiLobvTj8

Nor will disagreeing without a basis help you find the truth. http://www.youtube.com/watch?v=Dx32b5igLwA&feature=related

I will put forth an Austrian argument of the case against the Fed but here is an article on, Why I am not an Austrian Economist (a critique on Austrian principles) http://econfaculty.gmu.edu/bcaplan/capdebate.htm

A discussion of the above article both defending and attacking Austrian economic theory. http://mises.org/Community/forums/p/3841/52624.aspx

An extensive reading list: http://mises.org/Community/forums/t/762.aspx

Of course, seeking out counter arguments against your investment thesis is critical to improving your thinking process and investing. Stress test your ideas.  Be as astute in laying out the arguments against your idea as for your idea.

The Case Against the Fed

An example of the devastating effects of the Fed’s Dollar debasement on America’s poor and middle-class is excerpted from Murray Rothbard’s
The Case Against The Fed. Found here for free at: http://mises.org/books/fed.pdf  (164 pages). 

In real life, then, the very point of counterfeiting is to constitute a process, a process of transmitting new money from one pocket to another, and not the result of a magical and equi-proportionate expansion of money in everyone’s pocket simultaneously. Whether counterfeiting is in the form of making brass or plastic coins that simulate gold, or of printing paper money to look like that of the government, counterfeiting is always a process in which the counterfeiter gets the new money first.

This process was encapsulated in an old New Yorker cartoon, in which a group of counterfeiters are watching the first $10 bill emerge from their home printing press. One remarks: “Boy, is retail spending in the neighborhood in for a shot in the arm!”

And indeed it was. The first people who get the new money are the counterfeiters, which they then use to buy various goods and services. The second receivers of the new money are the retailers who sell those goods to the counterfeiters. And on and on the new money ripples out through the system, going from one pocket or till to another. As it does so, there is an immediate redistribution effect. For first the counterfeiters, then the retailers, etc., have new money and monetary income which they use to bid up goods and services, increasing their demand and raising the prices of the goods that they purchase. But as prices of goods begin to rise in response to the higher quantity of money, those who haven’t yet received the new money find the prices of the goods they buy have gone up, while their own selling prices or incomes have not risen.

In short, the early receivers of the new money in this market chain of events gain at the expense of those who receive the money toward the end of the chain, and still worse losers are the people (e.g., those on fixed incomes such as annuities, interest, or pensions) who never receive the new money at all.

Monetary inflation, then, acts as a hidden “tax” by which the early receivers expropriate (i.e., gain at the expense of) the late receivers. And of course since the very earliest receiver of the new money is the counterfeiter, the counterfeiter’s gain is the greatest. This tax is particularly insidious because it is hidden, because few people understand the processes of money and banking, and because it is all too easy to blame the rising prices, or “price inflation” caused by the monetary inflation on greedy capitalists, speculators, wild-spending consumers, or whatever social group is the easiest to denigrate.

Obviously, too, it is to the interest of the counterfeiters to distract attention from their own crucial role by denouncing any and all other groups and institutions as responsible for the price inflation. The inflation process is particularly insidious and destructive because everyone enjoys the feeling of having more money, while they generally complain about the consequences of more money, namely higher prices. But since there is an inevitable time lag between the stock of money increasing and its consequence in rising prices, and since the public has little knowledge of monetary economics, it is all too easy to fool it into placing the blame on shoulders far more visible than those of the counterfeiters.

The big error of all quantity theorists, from the British classicists to Milton Freidman, is to assume that money is only a “veil,” and that increases in the quantity of money only have influence on the price level, or on the purchasing power of the money unit. On the contrary, it is one of the notable contributions of “Austrian School” economists and their predecessors, such as the early-eighteenth-century Irish-French economist Richard Cantillon, that, in addition to this quantitative, aggregative effect, an increase in the money supply also changes the distribution of income and wealth. The ripple effect also alters the structure of relative prices, and therefore of the kinds and quantities of goods that will be produced, since the counterfeiters and other early receivers will have different preferences and spending patterns from the late receivers who are “taxed” by the earlier receivers.

Furthermore, these changes of income distribution, spending, relative prices, and production will be permanent and will not simply disappear, as the quantity theorists blithely assume, when the effects of the increase in the money supply will have worked themselves out.

In sum, the Austrian insight holds that counterfeiting will have far more unfortunate consequences for the economy than simple inflation of the price level. There will be other, and permanent, distortions of the economy away from the free market pattern that responds to consumers and property-rights holders in the free economy. This brings us to an important aspect of counterfeiting which should not be overlooked. In addition to its more narrowly economic distortion and unfortunate consequences, counterfeiting gravely cripples the moral and property rights foundation that lies at the base of any free-market economy.

Are you surprised with the government’s and banker’s lust for inflation at the expense of the poor?  Imagine if the Afghanistan and Iraq (undeclared) wars had to be paid for through sur-taxes rather than the hidden taxes of debasement? Think of the lives saved as Americans rebelled against paying for ten years of military conflict.

The status quo press and economists say here in this New York Times article:http://www.nytimes.com/2011/11/06/opinion/sunday/worldly-philosophers-wanted.html that “UNFETTERED” capitalism caused the global crisis.  With flawed thinking (logically false premises can not make an assertion true) like that is it any wonder the Fed has the cover of legitimacy?

10 responses to “Wall Street Protests, Black Death and The Case Against the Fed

  1. I am trying to figure out who gets the new money first. The Fed creates it against the Treasury’s promise to pay it back later, because the Treasury is taking in (taxes) considerably less than it is spending. Running this deficit, the government is spending the new money on all sorts of things. But I don’t see how the government becomes any better-off for it. I can see the people benefiting from healthcare, pensions, education, defense, infrastructure being paid with the counterfeit money instead of being cut.

    It’s a fake and expensive way to keep the status quo. But if the alternative is soup lines and 20%+ unemployment, what would the people, who are the sovereign in a democratic country, choose? Isn’t it better to get that real welfare check, which although backed by fake money still buys food?

    Besides, how exactly do the banks benefit from being repaid in debased money? The borrowers, not the lenders, are the beneficiaries of inflation. Just as the US as a whole is the beneficiary of paying off its debt to foreigners with watered down dollars.

    Of course, there is an advantage to spending today against spending tomorrow when inflationary forces are in play. With low nominal interest rates and high expected inflation, the real interest rate is negative, so it pays to spend rather than save. Inflation would be a way to get everyone spending today, which seems to be what everyone wants, no? Demand goes up and the economy starts moving again.

    If it were up to me, the whole debt mentality of spending today and hopefully earning it sometime in the future has to go. But this requires discipline that people, especially in the US, do not have. And to get it would be awfully painful.

    Nice post, by the way, got me thinking :o)

    • Dear Mik:

      I respectfully do not follow your logic. The only way would be if theft and central planning make people better off. I don’t think so. The entire production structure is distorted by ponzi finance. Printing money doesn’t create capital goods which is the only thing which will increase future production. The “investment” education, infrastructure, defense are mal-investment leading to an inevitable bust. Stop and think of receiving green paper in the jungle—are you better off?

      Going to free market money and eliminating the Federal Reserve and central planning would reduce unemployment, increase productivity and eliminate soup lines.

      Google Austrian Theory of the business cycle.

      • John, I always appreciate a different point of view.

        Definitely having paper in the jungle won’t greatly boost my survival chances. But paper in civilized societies has the enormous advantage of building flexibility in the financial system. So, instead of being tied to the value of a pile of metal, whose price can fluctuate for different reasons, thus causing similar problems as the ones you mention (deflation in the case of gold; inflation in the case of paper), but providing no way to solve them, having paper, which can be issued and withdrawn, gives us a tool to better manage the system. Now, whether we use this tool properly or not is a matter of human nature and not something inherent in the tool (like the guns-don’t-kill-people issue).

        Look at the Great Depression. Although the Fed existed, the gold standard was in force as well, which is why the Fed couldn’t do much to alleviate the pain. The source of the crisis was the mindless expansion of credit, which I am against. But is seems the gold standard didn’t preclude it from happening.

        As for inflation, the Fed, too, can cope with inflation, like Paul Volcker did in the 80’s. It is more about the will to do right even when tough decision have to be made and the people that have to make them rather than about the innate fallibility of the idea of a central bank.

        Just because the central bank has autonomy does not mean there is central planning. On the contrary, it helps – just as having the legislative, executive, and judicial powers separated helps.

        Nowadays, Fed-bashing in quite in vogue, making it easy to see all the negatives and overlook the positives. I recommend Alan Greenspan’s memoirs “The Age of Turbulence.” It reveals a very capable person, probably the best qualified man to run the Fed, and a humble, fallible human being. I would argue that, without 20-20 hindsight, he acted rationally under the circumstances and did what he deemed right. And the people labelled him the Maestro.

        Fast forward to today, the world is populated by Captain Hindsights who analyze, from all angles, the should-have’s and put the whole blame for the crisis on him. But he can’t be an idiot and a genius at the same time. The truth is that even very capable people make mistakes. Think about Buffett’s unwritten autobiography “Why Smart People Do Dumb Things.”

        Maybe Greenspan didn’t put enough weight on the heady housing market when he cut interest rates after 9/11, but who did? 9/11 has been used to justify just about anything. Why not a “much needed” economic stimulus to keep the country going after this awful blow?

        As for the roots of the housing problem, they go back to the early 90’s and to the government. “Reckless Endangerment” is a wonderful chronology of the events.

        Concerning a USA without the Fed, I would direct you to the link in my previous post. (I didn’t write the article and I have no affiliation with the author, so it’s not a shameless plug – just a well-argumented opinion on the topic.)

        Please excuse my wordiness and the book references, but they are worth a mention. Now, I will go read “The Road to Serfdom” to see what all the rage about this Austrian School is.

        • Dear Mik:

          I partially agree, disagree, disagree and disagree. But, as my Ex used to say, “Who cares what YOU think?” Here is a 20 second clip of us during happy times. http://www.youtube.com/watch?v=lxUCCRUD0TI&feature=related. What we are seeking is understanding the economic causality to make sense of our world not whether I or you are “right” or agree/disagree.

          Yes, money is a MEDIUM of EXCHANGE so it facilitates exchange and thus specialization in the economy that drives productivity and creates wealth. Money is important but its abundance and scarcity has NO BEARING on production, productivity or exchange. You can buy a house with a nickel or $10 million dollars. The house remains the same, the exchange ratio differs.

          The classical gold standard CAN BE INFLATIONARY as this article illustrates by use of the tulip mania in Holland http://mises.org/daily/2564. There is nothing special about gold what is important is that individuals who freely exchange determine WHAT is money NOT the government.

          The Fed, created in 1913, helped to CAUSE the Great Depression by the massive increase in inflation (inflation is NOT rising prices–rising prices are the EFFECT of inflation).

          http://mises.org/books/capitalism.pdf See chapters 15 and 19
          http://mises.org/Rothbard/AGD.pdf pages 85 to 169 on money supply, the Fed and inflation.

          You are making the argument of “AN ELASTIC CURRENCY” discussed here http://mises.org/daily/3560
          A devastating critique here: http://mises.org/books/desoto.pdf

          Finally, if YOU TRULY wish to master the theory of money and credit read: http://mises.org/books/Theory_Money_Credit/Contents.aspx

          The many “Austrians” who pounded the table in 2005, 2006, 2007, 2008 on the housing cresis. They did NOT predict the bust but pointed out the INEVITABLILITY of the housing bust http://mises.org/journals/scholar/Thornton6.pdf. Go to youtube.com and type in Peter Schiff housing bubble. Just like a bond bubble is inevitable today.

          As Hayek describes in the FATAL CONCEIT (better than Road to Serfdom in my opinion) Greenspan and Bernanke would be clueless about knowing where the economy is going. Even Greenspan in 2009 admitted it in Congressional testimony. Greensapan FAILED as a private forecaster of interest rates. The FED’s sole purpose is to bail out banks. The Fed cartelizes our PONZI financial system. I say ponzi because that is what fractional reserve banking is as shown here: http://mises.org/books/mysteryofbanking.pdf

          Ok, I will read your link and if you read the above (all light and breezy reads) we can have a discussion to seek the truth. If you were to understand only one part of economic history–understand the Great Depression.

          If you would like a link to a course on the New Deal, let me know.

          • John, I will go through the links and in due time I will better acquaint myself with the Austrian School. But I wouldn’t like to go into polemics about the economy. I am neither an expert in the field nor am I a macro investor. I am just of the opinion that the Fed, and central banks in general, are not at the center of some universal conspiracy against humanity. And even if they were, these are the rules we have to play by right now.

            Do you happen to know of any countries successfully implementing the Austrians’ ideas at present?

          • OK. If you would like to take a free course on money and credit taught by an Austrian Economist Professor let me know. Also go to http://www.tomwoods.com/media/ and view free lectures/videos. Google a pretense of knowledge by F. Hayek and read his nobel prize speech. The Fed is central planning and price control at work in the economy.

            No. No country has an unfettered market. But Canada did not have as bad a bust in housing as the USA. Why? I do agree that the Federal Reserve members are not purposely evil just ignorant and suffering from “fatal conceit.”

            Agreed that we must operate in the world as is, not what we want it to be.

            Obviously, if the Fed has pumped huge reserves into the banking system AND loans start being made in our fractional reserve banking system then look to see a hugely depreciated dollar with the effect of rising prices. We should all pray for those on fixed incomes like the old and infirm.

            Better to find franchise-like companies that can pass on prices. Xom, Novartis, Intel, etc.

            Good luck on your learning journey. I used to believe in Keynesian economics. I was an econ. major in school. I learned that the world was flat.

          • Thank you for the offer. Once I have the basics, I might take you up on that course.

            As for the future, it does look bleak – not only for the old and infirm on fixed incomes, but also for the young and firm, who will have to support them while paying down the debt and making a living with their devalued dollars.

            It is in such testing times that people have to keep their faith and learn their lessons. After all, we have recovered from far greater catastrophes to be wiped out by some inflation.

            I believe that to a great extent our progress (or regress) is determined by our own expectations – a self-fulfilling prophecy, Pygmalion effect, faith or whatever you might call it. That’s why I think telling a little lie (debasing the currency a little) to an otherwise capable person (nation) who is temporarily down may actually help more than kicking him and telling him how he will live in misery from now on. In the former case he can very well move on, recover and do more great things, in the latter – he might break, lose his faith and his balls, and live on as a bum.

            Reality provides enough checks for those who unjustly have their expectations set too high.

            P.S. Do you write this blog all by yourself? Yesterday I went through my RSS feeds and there were some 50 new posts from you. Wow! Very prolific!

  2. Dear Mik:

    There are about 200 posts but I have not posted much in the past few days due to travel. But I, myself and me write the blog but many people who wish to remain unnamed contribute.

    My suggestion is to start with the basics. go to http://www.mises.org and download the free book–Economics in One Lesson by Hazlitt. Also download the audio lectures for each chapter in the media section. The book is only 160 pages. Read in a few hours or listen to MP3 lectures about each chapter.

    But you should not study Austrian economics to learn about just monetary theory or credit cycles though important, but to understand the time element of production which will help you understand the business risks of certain businesses. Why is US Steel so much more volatile in its profitability structurally than Hershey foods or P&G? Once the bust begins why–if interfered with–does it take so much time for recovery in that particular part of the economy? We can NOT predict but we can understand causality. I don’t know WHEN a price control will fail/have unintended effects, but I can know that it WILL INEVITABLY fail. Or as the man in Omaha says, “If something can’t continue, it will end.” Yes, when people all about you are making millions flipping houses, it is tough to remember.

    Google Mises and Ben Graham together and see how their thoughts and theories were related.

    It took many years of trading futures in the pits to beat my economics courses out of me. Samuelson predicted that the Soviet Union was growing and much stronger economically than any other country in 1982–go figure.

    Good luck on your journey to learn and tell us what your journey is like–what you find true and false.

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