Wednesday, February 18, 2009

Chump Change

When I was seven years old I took up coin collecting as a hobby. Back in those days there were still a lot of interesting coins in circulation: the buffalo nickel, the Mercury dime, the Liberty Walking half dollar, and — if you were patient and went through enough rolls of coins — the occasional Indian head penny or “V” nickel.

The most exciting coin of all, however, was the silver dollar. The 1921 “Peace” dollar would do, but the Morgan dollar was preferable — it had a serious-looking 19th century design, and was the very same dollar that filled those heavy payroll bags heisted by stagecoach robbers in Westerns. It was a nice hefty piece of real American history, and it could fill the palm of a small boy’s hand.
The Morgan Dollar

Up until my tenth birthday my allowance was fifty cents a week, which I received in the form of a biweekly dollar bill. During my silver dollar craze I would take that bill down to the bank and ask for a silver dollar in exchange for it. The tellers all knew me, and would oblige me by picking through their selection of silver dollars until they found a date I didn’t have.

I was able to indulge myself in this manner because most of the dollar bills in circulation back then were still silver certificates.
Silver Certificate

The bank had no choice: under its charter, it was required by law to “pay the bearer on demand” a dollar in official United States silver coinage for every silver certificate presented to it.

No one has the same option today. Today all the paper money in circulation consists of Federal Reserve notes, which are not redeemable for anything in particular. You can go to the bank and exchange your dollar bill for four quarters, but those are no longer the shiny silver discs that rang so delightfully on the marble counter at the teller’s window. Nowadays the dimes, quarters, and half dollars are all “Johnson slugs”, the ugly nickel-copper sandwiches that were introduced in 1964 when silver coinage was abolished and the silver certificates were withdrawn from circulation. 1968 was the last year in which the law required that any paper dollar be redeemable in silver.

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The abolition of silver coinage was the culmination of an extended process that took most of a century to complete: the disconnection of American paper currency from any fixed standard of value as represented by precious metals.

By the time the Johnson slugs appeared, the abolition of the silver coinage was an absolute necessity. The price of silver had been allowed to float, and because of inflation the silver in a dollar coin was worth more than $1.25. Entrepreneurs could make a tidy profit buying up silver dollars in bulk, melting them down, and selling them as bullion to silver traders. The old coins had to go, which meant that the silver certificates had to go, too.

From then on the federal government was not required to give you anything for your dollar bill. If you had one, you could go out and buy something that other people were willing to give you in exchange for your piece of paper. But the Treasury was obliged to provide nothing of value in return for that piece of paper except the “full faith and credit of the United States government”, which was worth a lot more in 1964 than it is today.

In the 19th century, the United States adhered first to a “bi-metallic” standard — both silver and gold coinage — and then the gold standard. Under the pressure of the Great Depression, FDR initiated a gradual slide away from gold and into a silver standard for the paper currency, although the Treasury and the Federal Reserve adhered to the gold standard until 1971.

Since then the official currency of the United States has been anchored by nothing more than global confidence in the soundness of the dollar. As long as everybody believed in the same fantasy, then the system could operate. The dollars were printed, credit was extended, the financial markets functioned, and business enterprises were profitable. People went to work and got paid and bought stuff.

They also borrowed money and took out mortgages, which brings us to the mess we’re in today.

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Today’s system of commercial and consumer credit is made possible by the practice of fractional reserve banking. Until the late 18th or early 19th century, banks did not lend out their cash reserves of depositors’ money. The advent of fractional reserve banking made it legal for a bank to lend out a portion of its deposits, and required it to keep only a fraction of those deposits — in modern times, typically 20% — as an actual cash reserve.

This means that when Joe Consumer deposits $1000 into his bank account, the bank can lend up to $800 of it and keep $200 of the deposit as a fractional reserve, maintaining the loan on its books as an asset. At this point the initial $1000 in cash has morphed into $1800 in cash assets and credit — in effect, $800 worth of money has been created.

When the borrower deposits the $800 into another bank, that bank in turn can loan out $640. And so the process continues, forming a geometric progression of assets which cannot exceed $5000 (500% of the original deposit), $4000 of that in loans listed as assets on the books of the respective banks.

This practice seems bizarre and imprudent at first glance, but it was absolutely essential during the expansion of our industrial economies. Industrialization created wealth where none existed before, but without a way to extend the money supply to match the added wealth, the capitalization of industry would have lagged, and growth would have been much slower. Fractional reserve lending allowed credit to be extended to industrial entrepreneurs, and as long as loans were made prudently and repaid on time, and banks retained their depositors’ confidence, the system functioned well.
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Maintaining a gold or silver standard imposed a natural limit on the inflation of the money supply via fractional reserve banking. As long as banks met their capitalization requirements and observed the rules for fractional reserves, the money supply could never expand past the implied mathematical limit.

During times of economic contraction the system sometimes foundered. Then there would be a run on the banks, and some banks would fail. Although the system always righted itself eventually, businesses were ruined and individuals impoverished in the process, so that the political pressure for a system of government controls was irresistible.

Thus was the Federal Reserve born in 1913. The Fed is a consortium of private banks linked closely to the government, and functions more or less as a central bank would in many countries. Its job is to control the money supply by setting interest rates for government lending. By stabilizing swings in the money supply, the Fed’s mission is to prevent bank runs. It’s not always successful: witness the recent run on Washington Mutual and its subsequent collapse — the largest bank failure in history.

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The current gargantuan federal government, so far beyond the size and scope of what the Founding Fathers originally envisaged, owes its origins to the Civil War and Abraham Lincoln. Using military means, Lincoln demonstrated that the government in Washington was the absolute master of the several States.

But the bloated bureaucracy didn’t really take off until Woodrow Wilson invoked his presidential authority during World War I to create federal powers and functions which had never existed before, and which just happened to fit into his Progressive framework.

Not all of these powers were scrapped after 1918, and Franklin Delano Roosevelt took everything a step further when he created the New Deal to fight the Great Depression — once again, an excuse for massive Progressive intervention — and then World War II.

By 1945 the federal government was simply “too big to fail”, and all the layers of emergency powers that had accreted over the previous thirty years became permanent bureaucratic institutions. Once initiated, a new federal program was virtually never abandoned. No cabinet office has ever been abolished — new ones can be created, but they cannot be destroyed; they may only persist and grow.

Decade after decade the government has continued to expand, adding agency upon agency and bureau upon bureau. It has sprawled out across the District of Columbia into satellite fiefdoms in Maryland and Northern Virginia and created nests of regional offices across the rest of the nation. Whenever a congressman or senator perceives an important “constituent need”, a new federal function is created and funded, and becomes a permanent fixture in the Washington ecosystem.

Needless to say, all of this is very expensive. For the first thirty years or so of the federal explosion, increased taxes were sufficient to fund the pet projects and Progressive fantasies of the federal mandarins. But then the post-war boom leveled off, even as the Great Society was mandating a thicker layer of lard on top of the government pudding.

Increased taxation was not good enough. Unfortunately for the feds, raising taxes much further had become politically impossible, yet the internal logic of government expansion required that more money be found.

That’s where the Johnson slugs came in.

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The uncoupling of the money supply from any reserve of precious metals did not automatically doom the country to inflation, indebtedness, profligacy, and ruin.

If the individual functionaries within the system did their jobs properly — if they acted with probity, prudence, fiduciary integrity, honesty, and in the interests of the people they purportedly served — the fractional reserve system could have continued indefinitely.

But there are too many perverse incentives built into a banking system that is not pegged to any external reserve of actual tangible value. By adding new rules, augmenting existing procedures, and tinkering with the arcana of accounting terminology, new wealth could be created where it didn’t exist before. The Treasury could keep issuing bonds, and as long as the price of milk and shoes didn’t rise too much, why then, everything must be fine, mustn’t it?

But it wasn’t fine. Decade after decade of deficit financing created the infamous national debt, which kept growing and growing. But, once again, as long as productivity increased and the economy kept on expanding, inflation could be kept at bay. The national debt, huge as it was, might theoretically be paid off — someday.

Unfortunately, during the last two decades or so, productivity hasn’t really been as high as it seemed. Our national wealth is now denominated at least partially in assets that are over-valued, with real estate as a notable example. Those California house prices — a million dollars for a tiny bungalow on a postage-stamp lot — might have looked good on the asset side of a balance sheet, but they weren’t real money.

That value was conjured out of thin air by cynical or short-sighted people who gamed the system to their own advantage — quite legally, in most cases. But the wealth thus generated was illusory, and could disappear as easily it was created — which it is even now in the process of doing.

The final stroke which broke the banking system — and caused it to collapse years or decades earlier than it would have otherwise — was meddling by the federal government for political reasons.

Meddling was irresistible. And, without a gold standard to enforce fiscal restraint, it was inevitable. Money could always be created out of nothing, so the federal government created it and ordered its agencies to force the private sector to do certain things with it, things that might otherwise be considered foolish or imprudent.

In the case of the subprime mortgage fiasco — the most visible and notorious example — the federal government created government-protected lending institutions and through them forced banks to loan money to homebuyers who would not otherwise have qualified for the loans, and who could not reasonably be expected to pay them back.

Beginning in the 1970s, and continuing until the whole house of cards collapsed last year, the government used Fannie Mae and Freddie Mac — two quasi-government lending institutions which were not bound by normal market constraints — to pump untold billions of dollars into the housing market. Mortgages were issued to people who were poor, or had vaginas, or spoke English badly, or had sufficient melanin in their skin — because they deserved them. Never mind whether they could afford them: it was unfair for them not to own houses, and so the mortgages were issued, backed by the full faith and credit of the United States government.

The rules kept being eased, the system got more corrupt, more and more money flowed through more and more hands, creating an ever-increasing supply of perverse incentives for bureaucrats and businesses to lie, to manipulate the rules, and to line their own pockets.

In the process the demand for real estate increased, driving the price of housing far beyond what it would otherwise be, thus creating the real estate “boom” — which was actually a bubble, and which has now officially popped.

During this period baroque new rules emerged to facilitate the issuing of additional debt. Exotic new financial derivatives were designed. Accounting rules for valuing assets were loosened. Bond-rating agencies were corrupted by their dependence on the institutions whose debt they rated. The securitization of debt removed the traded derivatives ever farther from anything of tangible value. Debt instruments were used as collateral on new debt, which was in turn used as collateral on yet more debt, until the money supply became so attenuated and rarefied that it had almost no connection with anything real. The entire elaborate financial structure of the country’s banking system was spun out of the purest speculative gossamer.

And at every level of the process somebody took a cut, so everyone worked very hard to increase the size of the pie.

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In order to issue all those worthless mortgages, the ultimate guarantor — Uncle Sam — had to create the money by borrowing it himself. T-bills were issued, and buyers snapped them up.

Many of the customers for US Treasury paper were foreign governments, especially in Asia. The Chinese accumulated a large surplus of dollars, and recycled them by buying up more dollar-denominated debt. As long as China kept producing cheap products and exporting them to us, the process could continue. Our manufacturing capacity was diminished, and our money flowed out of the country to buy Chinese goods. But they kept loaning it back to us so that we could continue to fund the federal behemoth and its profligate habits.

The entire system depends on confidence in the dollar — as long as foreign countries continue to believe that real value lies behind the dollar, and that the American economy is strong enough to withstand this level of debt, they will continue to loan money to us, and pump liquidity into the system.

But confidence in the dollar won’t last. It can’t, because all those dollars in circulation, held in reserves in central banks all over the world, are not backed up by enough collateral. The last estimate I read — which was over a month ago, and real estate prices have presumably dropped even further since then — placed the number of dollars in circulation and held in reserves all over the world as thirteen times the amount of tangible assets in the U.S. financial institutions that back them up. That is, if all the holders of dollars across the globe decided to exchange them at the same time, the currency would have to be inflated at least 1,300% to redeem them.

With the addition of the recent stimulus package, American debt now exceeds the entire collective wealth of every man, woman, and child in the United States.

And this debt is almost entirely collateralized by confidence in the dollar. There’s nothing else backing up our currency.

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The national debt is even more alarming if our unfunded liabilities are taken into consideration. One of the ways that successive presidential administrations kept deficits to a theoretically manageable level was by putting the Social Security Trust Fund “off-budget” — i.e., outside of its fiscal calculations. The “Trust Fund”, of course, is a joke — there’s nothing in it but IOUs. The FICA money that is withheld from your paycheck and contributed by your employer disappears instantly into the insatiable maw of federal spending, leaving only a promise that your retirement fund will be available for you when you are ready to collect it. Your future Social Security, like all things federal, depends solely on the “full faith and credit of the United States Government”, a commodity whose value is dropping precipitously.

One recent estimate puts the unfunded liability of Social Security and Medicare — the money which the system will be statutorily required to provide for today’s citizens at some point in the future — at more than $100 trillion. And that’s just for the two biggest federal entitlements — add to them federal pensions, veterans’ benefits, and state, local, and private pensions, and the amount of unfunded liability is unimaginably huge.

All those hundreds of trillions of dollars are mandated by law and must someday be paid out. Yet the money is not there now — where will it come from?

And “someday” is drawing rapidly closer. Much of the unfunded liability will begin to come into play in the next few years as my generation, the Boomers, begins to retire and claim all its benefits. That’s why political leaders of both parties are so keen to get Pedro and Ahmed into the country — they’re looking for somebody, anybody, who will go to work and pay the FICA and income tax necessary to support the Beautiful People as they shuffle off into assisted living.

But it’s not going to work. Even if all the immigrants were skilled and ready to work, even if mass immigration were not doomed to destroy the culture and civil society that holds this entire Potemkin village together, even if the multicultural dream could be fully realized — even if everything else were ideal, the system would not be able to handle the load. The conclusion is inescapable: the persistence of our current political arrangements is fiscally and actuarially impossible.

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This is the broad context in which the current financial crisis has emerged.

The system is going to fail. Failure is unavoidable. The big questions are:

1. How soon will it fail?
2. What form will that failure take?
3. How much civil unrest, violence, deprivation, and destruction will accompany the changeover to whatever new system emerges?

The broad outlines of what is to come are already visible. The banking systems of the West are heading for insolvency, and no amount of bailout money is going to save all the major banks. Bailing them out will only serve to delay the catastrophe and make it worse when it finally arrives. Real value to match the newly-created bailout money does not exist, and at some point the market will mark everything down to its true worth, destroying roughly 90% of the system’s wealth in the process.

One of the first symptoms of the collapse will be a run on the dollar. When confidence finally erodes past a certain point, speculators will start to unload their dollars en masse, and the U.S. government will have to choose between inflating the currency or defaulting on its obligations.

The United States is at the epicenter of the banking crisis, but the European currencies are feeling the pinch first. With the Austrian banks facing the default of Eastern European debt, the euro may be in trouble, and sterling is also widely rumored to be near collapse. The dollar is maintaining its value relative to these currencies (and the yen), but all of them are in the same boat. It won’t be long before investors start unloading their reserves of currency and taking refuge in gold, silver, platinum, and other non-perishable commodities whose value is expected to outlast whatever unpleasantness lies ahead.

After that the major Western nations will experience an unprecedented fiscal and monetary crisis. Mass insolvency, bank failure, an inability to meet entitlement payments, and the suspension of normal commercial activity will be the result.

The modern global economy depends on mass consumption by the wealthy Western democracies of goods produced by the Third World and purchased by savings borrowed from the Third World. This part of the system is already in retreat — consumption in the West has dropped dramatically, Chinese exports have collapsed, and the Chinese are signaling their unwillingness to loan us more money unless we can guarantee that we won’t inflate our currency to pay off our debts. What sane person would believe such a guarantee, even if the Treasury were so foolish as to offer it? The inflation is coming, and the current system will grind to a halt.

We are, in a word, screwed.

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All of this will not just happen. None of the unfortunate consequences will occur in a vacuum, and there will be reactions and counter-reactions on the part of governments and the public, which will make the system chaotic and unpredictable.

Governments will continue to intervene to “fix” the market, and by doing so will generally make the problems worse. Riots, civil wars, insurrection, and revolution will be likely if the maintenance dose of government cash is withdrawn from recipients in the major welfare states. Many other negative consequences are probable, but no one knows when, where, and how much.

Even the wisest and most skilled political leadership would find it difficult to intervene in a way that would mitigate the worst effects. At some point the market will have to realistically revalue the system’s assets, and the results will be painful. The consequences can only be postponed, and thus made more severe; they cannot be avoided.

Unfortunately, wise and skilled political leadership is in short supply all across the West. Our social democracies — with their welfare systems and ideologically uniform media — do not reward risk-takers and visionaries. Cynical time-servers, technocrats, obedient functionaries, and corrupt fixers tend to rise to the top. This is the cohort who will be leading the charge with broom-handle and dustbin lid during the coming debacle.

So far Congress and the Obama administration seem determined to do the worst possible things, economically speaking. Pumping more debt into the system, bailing out inefficient and unprofitable private companies, increasing pork-barrel spending and patronage, nationalizing financial institutions, rewarding corrupt and incompetent administrators, raising taxes, increasing regulation… How much more perverse can they get?

King CanuteGiving bankruptcy judges the right to “adjust” interest rates on individual mortgages will serve only to distort the credit markets further and make the crash much worse when it finally arrives. Appropriating vast quantities of public funds to force a restructuring of private mortgages is senseless when the market value of the mortgaged real estate is half the face value of those loans, and dropping fast.

Barack Obama has assumed the role of King Canute in the current farce, sitting on the foreshore with his hand raised, ordering the tide to stop. A pathetic and futile gesture, but one that he and all the other leaders must inevitably make. They have no other solutions.

“Tide, I command thee: turn back!”

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There are a few possible positive aspects of the current mess. As the crisis matures, supra-national institutions will fail and become irrelevant before nation-states do. Individual nations will reclaim their authority and sovereignty in an attempt to take care of their own.

Here in the United States, in the face of new unfunded mandates, trillions of dollars of federal largesse with strings attached, and volumes of new federal regulations, the several States have suddenly recalled the Tenth Amendment and are invoking their own sovereignty. This is all to the good, because for the last sixty years or so the federal government has extended its effective reach by dangling money before the states and making them dance for it. As the money disappears, the dance will come to an end. Without a bottomless cash drawer, the federal government is a pathetic weakling, and most power will eventually devolve to the states.

Another possible spinoff of the coming financial collapse is that the problem of Islam will solve itself. One of the consequences of the depression is that the demand for oil has dropped dramatically, and the price will be low for years. Not only will the sheikhs lose much of their income, but many of them are heavily leveraged and live on the margin, with their assets tied up in the Western financial markets. Like everyone else, they will see most of their wealth disappear.

And, unlike many other countries, the oil-dependent states of the Middle East have nothing else to fall back on. When the oil money disappears, that’s it. The entire population — millions of people on the Arabian peninsula and in Iran — subsists on state oil revenues, directly or indirectly.

The effects of this are already becoming evident. Hundreds of thousands of guest-workers in Saudi Arabia and the emirates are being sent home to Malaysia, Indonesia, Nepal, Bangladesh, and the Philippines. These latter countries will thus experience the unfortunate secondary effects of the collapse of oil prices. Given that most of the rest of their economy depends on the manufacture of cheap consumer goods for the West, they will be in serious trouble.

If this process is severe and goes on long enough, rioting, civil insurrection, and revolution may well give way to epidemics and actual mass starvation all across the long crescent of Islam’s bloody borders, from Marrakech to Mindanao.

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All of the above is pure speculation.

I’m a rank amateur when it comes to economics and finance. Over the past three months I have read and digested a huge volume of information in an attempt to understand the catastrophe that is unfolding in slow motion around us.

I don’t know if my prognostications are correct. Unfortunately, no one else can predict what’s going to happen, either. The current situation is unprecedented. It is inherently unstable, chaotic, and unpredictable. Don’t believe anyone who says he knows what will happen next year. No one does.

Preliminary indications are that the global economy has actually been a planet-wide Ponzi scheme since at least the beginning of the Industrial Revolution. Like any other Ponzi scheme, it depended on a constant infusion of new suckers. As long as the world’s population was expanding, and the efficiency of industrial production was increasing, the fiscal bubble could continue to inflate.

But the dream is over, and the bill is coming due. The bubble has popped. The scheme is collapsing. The entire finance system will soon become like 1997 Albania writ large.

When the fever has run its course, a new system will emerge. Eventually the market will reassert itself, and production and consumption will resume.

But how much trouble and sorrow lies ahead of us is hard to predict.

Given that the economy of the United States will take the biggest hit — and has the farthest to fall — the era of American hegemony will almost certainly come to an end within the next decade. On balance this will be a salutary thing for the rest of the world. Europe will learn to deal with Russia and Iran on its own. Third World dictatorships will have to extort protection money from a different client. The Japanese will rapidly discover the value of missile defense and a strong military. All the fires that have been prevented or contained by American military power will rage unchecked until their human fuel is fully consumed.

And America will persist in some form, perhaps in several pieces, or as a loose confederation that will warm the heart of Jefferson Davis’ ghost.

Or perhaps we will continue as a single nation, much poorer and unable to project power abroad, but ruled by a despotic central government wielding a citizens’ army of multicultural block wardens to keep the citizenry in line — a continent-wide Cuba from sea to shining sea.

Or perhaps some other currently unimaginable form of government and civil society will emerge.

The only thing that’s certain is that the system cannot continue for much longer in its present form. The laws of economics — which are nothing more than a mathematical model describing what must happen — tell us that a collapse of some sort is unavoidable.

You will know changes soon.


Whiskey said...

America does have an ace in the hole.

The Fort Knox Gold Reserves.

Suppose the dollar does collapse, and has no faith and credit anywhere, by anyone, foreign or domestic?

Unlike Argentina, or Hong Kong, or other small countries that "pegged" their currency to the dollar, the US cannot "peg" it's currency to say, the Euro or Yen.

But it can print gold dollar coins. And silver ones for that matter. All of which have actual real value, as precious metals, and thus retain a floor below which currency cannot be deflated.

It may be that the way for China, Japan, Europe, and other nations particularly the US to avoid certain inflation and currency that is worthless (because of built-in governement demand for deficit spending) is the precious metal coinage.

This also hurts counterfeiters like North Korea and Iran, who use state printing presses to routinely counterfeit (so the US Tresaury alleges) the US and other currencies.

This is particularly true with more sophisticated laser scanners and other equipment that can tell the percentage of silver or gold in a coin.

This is not without cost however. Coins are bulky, don't transmit well, but a combination of coinage currency and electronic credits based on the currency might well kill the paper currency that is now inflated in most nations.

american redneck said...

Sounds about right to me, but I'm also an amatuer when it comes to the economy. This is the most interesting essay I've read in a very long time.

I think it will get very ugly. Last year when there were weeks when gas was hard to find in my county, I witnessed people cursing and threatening other people because the line wasn't moving fast enough. Or they thought someone cut in front of them. My brother-in-law in the adjacent county said there was even a fist fight over gas. Can you imagine how people will react if there is a short supply of everything? How many people will be able to survive on their own. Like provide their own food, shelter, and security, maybe without power or money to purchase anything. Can we think chaos.

Buy more ammo.

Baron Bodissey said...

Ah, Whiskey, but there's the rub -- there isn't enough gold and silver at present prices to match all the dollars, even just in the USA, forgetting the foreign holdings.

That means that, say, 80% of everybody's wealth will have to disappear. And that's just an average; some will lose more, others less.

And some people who are well-positioned to manipulate the currency markets -- Soros comes to mind -- will probably come out of this dsiaster wealthier, just like happened in Germany in 1923.

But the price of gold and silver will continue to rise steeply, and that is the very essence of inflation.

Terry Morris said...


This is by far the best article on this subject I've personally read to date. Thank you for posting it. Masterfully done, sir!

I guess the Tower of Babel has got to fall at some point.

Baron Bodissey said...

Terry Morris --

Thank you very much.

I should have mentioned in the post that there are no links because of the quantity and sources of reading that I did -- at least a hundred articles, many of them in the print media. I didn't take notes, just read & absorbed until I thought I understood a little bit of the topic.

But google some of the keywords, and you'll find much of the same material I did.

christian soldier said...

Thank you for this-You've broken money matters into understandable 'bites'..
At this time in my life-I have decided to study economics and do opposition research by reading and studying the likes of Alinsky...

I'm not giving up the foundations of this great country w/o a fight-

blogagog said...

Question: Baron said, "Until the late 18th or early 19th century, banks did not lend out their cash reserves of depositors’ money."

How would a bank make any money holding deposits then? Did depositors pay a fee to deposit their wealth in the bank or something?

Interesting side note: There is more than 10x as much gold bullion underneath the Federal Reserve building in NYC than in all of Fort Knox. Unfortunately, something like 99% of it belongs to foreign governments.

Dan said...

A few thoughts on your article:

That “necessary” expansion of the money supply is the root cause of inflation and the resulting higher price level leads to more tax revenue. It is the reason that productivity gains do not lead to lower prices- the government inflates the money supply driving up prices up, then siphons it off through progressive taxes to fund harassment services.
It’s not necessary to expand the money supply as money can become more valuable- were just getting screwed. Also it’s worth mentioning that absent a debt load falling prices benefits the poor.

If “The uncoupling of the money supply from any reserve of precious metals did not automatically doom the country to inflation, indebtedness, profligacy, and ruin” then by all means show me the past examples of fiat currencies that did not collapse? What is different this time around?

“The national debt, huge as it was, might theoretically be paid off” it’s not possible because while the money to fund the debt is created via fractional reserve banking the money to pay the interest on the debt is not and as the debt is paid down the created money returns to the ether. The system either expands through new debt so that the interest can be paid or collapses. Compounding the problem any payment on longer term debt primarily pays interest.

It is not the subprime fiasco that caused this it was merely the trigger. If it hadn’t been there something else would have caused it. We have two themes where executives at the top have to be paid ever larger salaries to retain top talent and the wages of everyone else must be squeezed to reduce costs. Once that becomes too imbalanced neither your employees nor anyone else’s can afford your products and there is no one to sell them to. Also don’t discount the need to find new people to take on new debt in order to expand the money supply and stave off collapse.

“this debt is almost entirely collateralized by confidence in the dollar. There’s nothing else backing up our currency.” The dollar under current architecture is debt and is backed up by the government’s ability to raise future taxes. It’s also aided by its relative strength against other currencies. Presently all fiat currencies are going down and unlike most countries our debts are denominated in our own currency.

It’s not just federal pensions, the Pension Benefit Guaranty Corporation and the FDIC will blow up first, and probably in that order with the first providing positive feedback to the second. It’s no longer the future generations problem.

“U.S. government will have to choose between inflating the currency or defaulting on its obligations” It is already trying to inflate. “quantitative easing” is monetization and the only thing holding it back is that money created through fractional reserve lending is being destroyed faster than the FED is printing money giving us a net contraction in the money supply AKA deflation. I think that when they do manage to get traction they will inflate away the value all the way to monetary reset.

I doubt the US will take the biggest hit, we have had a globalized economy before and the last time it collapsed back to national economies in the 30s. While there is massive industrial overcapacity worldwide there is not a massive overcapacity in the US save perhaps auto manufacturing and housing. We will need to re-grow an industrial base.

Apologies for that being is a little disjointed but it’s late and I’m exhausted.

Papa Whiskey said...

Re "Johnson slugs": Johnson was a slug. Worst president ever. The 1965 immigration act, the 1968 Gun Control Act, the mendaciously entered Vietnam War, etc., etc., ad nauseam.

As to means of exchange, do not neglect what the late great Jeff Cooper called "ballistic wampum." A disquisition on the matter may be seen in his book "Fireworks," available at

Better to have it and not need it than need it and not have it.

Afonso Henriques said...

Bron, what an excellent and inspiring essay. I think I agree with you 99,99% because there was a comma that was misplaced.

Ursus Maritimus said...

Judging from Russia/Yugoslavia the collapse comes when people can't live on what the government pays out.

If the revenues arn't big enough to meet their numerical obligations they will attempt to raise taxes and conjure up new money via inflation.
Raised taxes means less revenue and a massive expansion of the sub-legal sector: People will work for goods in hand and never appear on any official payroll. This further depresses government revenue so running the presses to create inflation is a given. Inflation is unthinkable but the government not meeting their obligations is impossible, and when you have eliminated the impossible, only the unthinkable remains.

At the point where inflation have made government payouts worthless someone, probably an academic and probably a leftist, will come along and use nationalist rhetoric to catapult himself to power. See "Milosevic, Slobodan". An academic background gives a comprehensive course in backstabbing and dirty tricks, and a leftist background provides insulation against people calling him on the nationalist rhetoric.

Predicting the exact type of nationalist rhetoric is hard, but it will be an exercise in scapegoating. Ethnic groups that always vote in concert are the ones least likely to be chosen as scapegoats. Those that are the most scattered are the ideal scapegoats, since there is no political upside to pandering to them: A large number of them would still vote against you no matter how you favoured them.
If they additionally have a large number of self-hating public figures that will support the scapegoating, they are the ideal target.

An additional possible dimension in the US is if a state can mobilize opposition to Washington based on the latter exploiting them without providing any value in return, or even providing negative value: "They take everything we own in taxes, and give it away to the 'group' in 'big state', and what is left they spend on jackbooted thugs that come and shoot us if we pay less taxes than what they have 'estimated' we should pay!"

Will the in-state cohesion be stronger than the ethnic group cohesion? Who knows. I believe they are largely orthogonal to each other, and that in-state cohesion is so weak that it won't become a dominant area of conflict.

The process where state divisions and ethnic divisions move from orthogonal and start to align is currently called "ethnic cleansing", though no doubt a new word will be invented for the occasion.

None of this will solve the crisis, but it will dominate politics. The crisis will be solved when the number of people who are employed sub-legally and thus have no vested interest in the continuation of the (now little worth) government handouts outnumber the ones officially employed.

Baron Bodissey said...

blogagog --

Yes, banks charged a fee for holding a deposit. Much like a safe-deposit box.

Baron Bodissey said...

Dan --

When I said, "The uncoupling of the money supply from any reserve of precious metals did not automatically doom the country to inflation, indebtedness, profligacy, and ruin", I meant that if the people entrusted with managing the money supply had followed the same rules that would have been imposed by an actual gold standard, inflation and ruin would not have been the result.

Mathematically speaking, a careful adherence to the rules would have prevented inflation.

This was, of course, beyond the ability of mere human beings to do. We had to have to the gold standard to constrain our natural tendency towards mischief, misfeasance, and greed.

Like so many other ideologies, the ideal of "fiat money" decided to ignore human nature and wish it out of existence. The result is as you describe it.

Hell_Is_Like_Newark said...

The United States used to have up to six different types of currency. One backed directly by gold, another by silver, another by gold held by banks, and what we use today (fiat money).

Call Me Mom said...

Excellent post!
I am not sure I would agree about the demise or at least reduction of Islam. Doesn't Sharia law require a gold based monetary standard?

Afonso Henriques said...

Paul Green, I always blame Kennedy on that stuff! :o

Snouck said...

Baron Bodissey:
"I’m a rank amateur when it comes to economics and finance."

Well. If this is your amateur level, then you must be the really impressive at your job, Baron!

Excellent précis.

Baron Bodissey:
"Here in the United States, ... the several States have suddenly recalled the Tenth Amendment and are invoking their own sovereignty."

That is a particularly glorious gem for us on the other side of the pond. Could you be so kind to direct me to some further reading?

Kind regards,


Baron Bodissey said...

Snouck, thank you.

A couple of weeks ago Dymphna did a lot of research for it here. Follow her links for more information.

Dan said...

Reading again with a clearer head it seems I caught a rather bad case of happy to glad syndrome last night.

Here is a good background essay on the origin of fiat currencies and fractional reserve banking.

Here is a very good free book on it.

AMDG said...

This piece is much more sensible that many monetary policy reports been produced for the use of federal reserves, central banks and other monetary authorities.

Of course, the development of events in the future is still arguable.

Consul-At-Arms said...

I've quoted you and linked to you here: re: "Chump Change"