Friday, September 26, 2008

"For the naive mind there is something miraculous in the issuance of fiat money..."

holbert20080924 As if he too were writing yesterday, economist Ludwig von Mises has advice for those contemplating the imminent nationalisation of Wall St's debts via one trillion dollars of printed money.

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments...
From time immemorial inflation [i.e., printing money] has been recommended as a means to alleviate the burdens of poor worthy debtors at the expense of rich harsh creditors.
However, under capitalism the typical debtors are not the poor but the well-to-do owners of real estate, of firms, and of common stock, people who have borrowed from banks, savings banks, insurance companies, and bondholders.
The typical creditors are not the rich but people of modest means how own bonds and savings accounts or have taken out insurance policies... The idea that millionaires are the victims of an easy-money policy is an atavistic remnant.

And the idea that people of modest means must bail out the pirates in neck ties is equally atavistic. Moreover, the illusion that the money for the bailout will come from somewhere else [Where? Somewhere?] is the illusion of 'fiat money,' i.e., of money printed by central banks that has nothing backing it other than the good wishes and the power to tax of the government.

For the naive mind there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared with that of the government's Treasury Department! The government, professors tell us, "can raise all the money it needs by printing it."[4]

Such is the method by which Henry Paulson's Treasury Department proposes to "increase liquidity," to "raise" the money by which the government's bailout of failure will be achieved -- $1200 per US taxpayer -- more of the same artificially-created inflationary rocket fuel that has already burned the fingers of capital markets, and cost taxpayers a chance at genuine prosperity: little more than smoke and mirrors.

It is enough to stress the point that such a policy of deceit is self-defeating. Here the famous dictum of Lincoln holds true: You can't fool all of the people all of the time. Eventually the masses come to understand the schemes of their rulers. Then the cleverly concocted plans of inflation collapse. Whatever compliant government economists may have said, inflationism is not a monetary policy that can be considered as an alternative to a sound-money policy. It is at best a temporary expedient.

In the long term, the bill will have to be paid. It will be you and I who will be paying it.
[Quote from Ludwig von Mises' Theory of Money & Credit, excerpted here.]

UPDATE 1: To get an idea of the scale of the bailout, it will cost around $1200 per US taxpayer, taken not from their tax payments but -- like all inflationary expansions -- taken from their savings by a backdoor form of theft, and in addition to what they see taken from their pay packets.

This will be a US$700 billion addition to the money supply, adding a huge spike to the graph below. The last big thranche of printed money to hit the markets was over 2001-2004, and as Frank Shostak explained the other day, it was that very rocket fuel that's been blowing out the markets ever since. The world economy was subjected by its central bankers to the largest credit bubble in history, and says Don Rich, the results should have been obvious.

Not only residential real estate, but also corporate, developing market, and nonsecured debt security and loans have been priced at absurd valuations because the central banks of the world kept interest rates at absurdly low levels during the early part of the decade.

The consequence of this "open the floodgates" monetary-policy-induced credit bubble was to induce the entire financial services industry to distort the process assessing risk and reward in the allocation of capital on a system-threatening scale — hence the events of earlier this week. Basically, the central banks of the world pushed interest rates so low as to lure the finance industry into the trap of chasing yields irrespective of risk...

makegraph.php

And now their pyramid is collapsing, they want more of the same!

This $700,000,000,000,000 of counterfeit capital (with more to come whenever Henry Paulson, Ben Bernanke and their successors feel like it) is welfare for Wall Street to be paid out of the pool of real savings that would otherwise go into real investment. As Michael West said on Monday, Henry Paulson and the Senate's Banking Committee "want American taxpayers to hand a cool $US700 billion ($840 billion) to his pals on Wall Street in return for a gigantic bundle of their delinquent assets ... without his pals taking a pay cut. Could there be a finer reward for failure? Could there be a worse deal for taxpayers?"

And the dumbarses on Wall St are too dumb to even see that what they're applauding is their own demise.

The federal government is now admitting that the entire credit-generation process in the United States has collapsed. Going forward, that is bad news for the real economy — for the claims on the profit-generating capacity of the economy upon which the stock market constitutes claims. This is all bad news, not good news, for Wall Street.
More formally, there is a gap between the nominal and real value of debt instruments that across the entire credit spectrum easily exceeds $5 trillion, the risk of which the federal government [i.e., the taxpayer] has assumed.

As J. Boyd Page says in the Atlanta Journal-Constitution, just say no.

UPDATE 2: I liked this comment at the Mises Blog from someone 'supporting' the bailout:

At this point, I don't see much reason to oppose the Wall Street bailout. You see, what the government should do to solve this problem is kill the Federal Reserve, kill the income tax, and cut back the size of government by 90%. But, since there is not a snowball's chance in hell that they are going to do that .... this bailout is just another path to the same eventual outcome.
In fact, if we're lucky, using taxpayer money to bail out Wall Street might suck funding away from all the other useless government departments...

If only it were more than just wishful thinking.

UPDATE 3: Commenter "Terry" corrects me:

The fractional reserve system is best described not as an economic pyramid, but an inverse-pyramid. It is top heavy and built on a comparatively small base of capital.
An objective monetary standard would be representative of a pyramid with a base layer (or layers) of capital which widens -and thus strengthens - as the total economic structure grows.
With an inverse pyramid by comparison, as more layers of credit are piled one ontop of the other, the capital base becomes an ever weaker point compared to the whole. As the weight of yet another layer of credit (i.e. debt) is lumped on top it adds to the instability of the whole structure, with its total weight surpassing that which the (capital) base can support. The inevitable is that the structure falters, crushing and destroying the bottom supportive layer/s - i.e. capital.
This is what we are witnessing now.
The only logical solution to prevent a total catastrophe is to deleverage - dismantle the inverse pyramid, starting at the top, so that the base may preserved, and hopefully a better engineering design adopted (i.e. turn the bloody thing back up the right way around and stop trying to defy the laws of physics!).
What the Fed is proposing now as the solution to the present crisis - a crisis where the giant upside down triangle of debt which is the entire US financial system is dangerously balanced on a small apex of capital - is to make the whole thing even MORE top heavy.
This truly is madness.
If the $1 trillion bailout proceeds, as it seems it will, we will all have but one option left: reach for our hardhats.

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7 Comments:

Anonymous Terry said...

The fractional reserve system is best described not as an economic pyramid, but an inverse-pyramid. It is top heavy and built on a comparatively small base of capital.

An objective monetary standard would be representative of a pyramid with a base layer (or layers) of capital which widens -and thus strengthens - as the total economic structure grows.

With an inverse pyramid by comparison, as more layers of credit are piled one ontop of the other, the capital base becomes an ever weaker point compared to the whole. As the weight of yet another layer of credit (i.e. debt) is lumped on top it adds to the instability of the whole structure, with its total weight surpassing that which the (capital) base can support. The inevitable is that the structure falters, crushing and destroying the bottom supportive layer/s - i.e. capital. This is what we are witnessing now.

The only logical solution to prevent a total catastophe is to deleverage - dismantle the inverse pyramid, starting at the top, so that the base may preserved, and hopefully a better engineering design adopted (i.e. turn the bloody thing back up the right way around and stop trying to defy the laws of physics!).

What the Fed is proposing now as the solution to the present crisis - a crisis where the giant upside down triangle of debt which is the entire US financial system is dangerously balanced on a small apex of capital - is to make the whole thing even MORE top heavy.

This truly is madness.

If the $1 trillion bailout proceeds, as it seems it will, we will all have but one option left: reach for our hardhats.

9/26/2008 11:04:00 am  
Anonymous Anonymous said...

An objective monetary standard would be representative of a pyramid with a base layer (or layers) of capital which widens -and thus strengthens - as the total economic structure grows.

I guess you never learned the very important monetary lesson: that any amount of money is sufficient, and changes in the money supply are harmful per se. The "base" doesn't need to "widen" as "the total economic structure grows".

9/26/2008 10:48:00 pm  
Anonymous Terry said...

"I guess you never learned the very important monetary lesson: that any amount of money is sufficient, and changes in the money supply are harmful per se. The "base" doesn't need to "widen" as "the total economic structure grows" "

Anonymous, your observation is only relevant to a fiat based and/or fractional reserve monetary system.

Where an "objective monetary standard" exists - i.e. where money is a value in and of itself, as with gold - then changes in money supply are not necessarily harmful, as money cannot simply be created out of thin air, it must be produced, an act which by its very definition delimits the harm that can be caused to participants in the economy (self inflicted harm excluded); whatever money one has, one has, and that money is and always will be of *some* value, as opposed to the smoke and mirrors value that fiat money represents and which is entirely confidence driven.

Where an "objective monetary standard" exists, the metaphor of building an economic "base" of capital refers to the fact that all credit is backed by a known measure of capital and must be repaid with the same. This is not the case with a fiat/fractional reserve system.

9/27/2008 12:22:00 am  
Anonymous Anonymous said...

Naa. turns out to be much much simpler than that.

Things were working well then the Democrats fucked it up.

9/27/2008 03:06:00 pm  
Anonymous Anonymous said...

Where an "objective monetary standard" exists - i.e. where money is a value in and of itself, as with gold - then changes in money supply are not necessarily harmful, as money cannot simply be created out of thin air

That limits the harm because it limits the rate at which new money can be fed into the system, but it doesn't actually change anything.

9/27/2008 07:23:00 pm  
Anonymous Terry said...

That limits the harm because it limits the rate at which new money can be fed into the system, but it doesn't actually change anything.

Au contraire, it changes everything.

Under a gold standard not only is the quantity of money limited to the increase in the supply of gold, which is negligible compared to increases in the supply of irredeemable paper money (which is limited only by the number of zeros the issuer can fit on the paper itself), but gold backed money has the characteristic of being a reliable store of value.

Fiat money cannot act as a reliable store of value for its value is entirely based on confidence in the government's ability to tax future earnings to repay today's borrowings which fiat money is tied to.

Operating under a gold standard is tantamount to being forced to live within one's means - only being able to spend capital that exists already. Operating under a fiat system by comparison is tantamount to permanently living beyond one's means and necessitates a day of reckoning occurring at some point, where outstanding claims must finally be called in.

9/29/2008 01:32:00 am  
Anonymous Anonymous said...

Under a gold standard not only is the quantity of money limited to the increase in the supply of gold, which is negligible compared to increases in the supply of irredeemable paper money (which is limited only by the number of zeros the issuer can fit on the paper itself)

Yes; that's what I said.

but gold backed money has the characteristic of being a reliable store of value.

It's a reliable store of value precisely because it limits inflation. Same thing. I don't understand your use of "not only ... but ..." here.

Fiat money cannot act as a reliable store of value for its value is entirely based on confidence in the government's ability to tax future earnings to repay today's borrowings which fiat money is tied to.

Not at all. Fiat money doesn't (necessarily) imply credit creation (or "debt money"). The incentive is there, and once you have money by fiat, that is likely to be the result, but it's not in the definition of "fiat"; in theory you could have fiat money with zero inflation and it would be an ever better store of value than gold (the amount being fixed and perfectly known for all time; how much gold is there in the ground?)

9/29/2008 11:07:00 pm  

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