People who talk about banking and currency crises are commonly portrayed as Chicken Little characters. In reality, forecasting a banking crisis is rather like predicting that the sun will rise in the east and set in the west.

While the Federal Reserve system has remained in place since 1913, it has gone through multiple crises. The Great Depression saw the US move from a fractional reserve gold standard to a pure paper standard. This was an implicit default on the part of the government.

Around thirty years later, Richard Nixon closed the international gold window (which allowed foreign entities to exchange dollars for gold at $35 an ounce), severing the last linkage between the dollar and gold. It’s been almost 40 years since then.

American banking systems have typically only lasted between 20-40 years before collapsing. The clearest historical precedent for our current system dates back to the post-Civil war greenback period that lasted from 1865-1879.

The cracking of a government bond-driven railroad bubble combined with foreign pressures from gold-standard European nations eventually pushed the US onto a gold standard.

In fact, gold has never ceased to perform an important function in international finance. Central banks all over the world still maintain vast holdings.

Whenever there is a paper standard, there must also be pervasive efforts to suppress the price of gold. During the Civil War, Treasury Secretary Salman P. Chase suspended specie redemption and even outlawed gold sales at one point in an attempt to halt the rise in its price. That effort had the opposite intended effect, and eventually caused a total collapse in government finances and the destruction of the greenback.

The fiscal struggles that the US government and the Federal Reserve deal with today are broadly similar to those faced in previous eras. As private and public interests lurch towards gold, history repeats itself and Gresham’s law will assert itself.

Is Tim Geithner smarter than Salman Chase?

I was taken aback when someone suggested listening to an NPR Planet Money show about how the New York Fed spent over a trillion dollars buying  mortgage backed securities.

The reporter sounded incredulous when she discovered that the Fed creates money from nothing. I get the sense that mainstream observes believe that “The Fed prints money” is just a figure of speech and not a statement of truth.

I have no idea how you can get a job at a major financial reporting network and not understand the basic mechanics of the banking system, which can be explained in under five minutes to a bright child. However, the overall tone of the piece was positive.

The brave, public-minded Fed printers stepped in to rescue America from the perfidy of Wall Street.

This is untrue.

All you have to ask is who the Fed’s shareholders are – the same banks that were rescued by that self-same Fed. The government held down the economy while the banks raped it, and then the Fed came in to swab out the blood and muck. That’s not as inspiring a propaganda tale, but it’s the nauseating truth.

It’s more palatable to the public to say that a brave, neutral academic like Ben Bernanke swept in to rescue the innocent American people from the predations of the bankers. Except that the Fed is actually owned by those banks.

I mean, really.

The green pieces of paper  in your wallet are called Federal Reserve Notes for a reason. The Fed manufactures the damn things for the benefit of its shareholders.

Price Fixing Power

The Fed can fix prices on any asset to any level that it wishes. It can ratchet prices up, or prices down. If the Fed wanted to, they could corner the entire market for eggs in the United States. Bernanke could conceivably make it so that you have to spend $10,000 to buy a dozen eggs. It would create a lot of inflation elsewhere in the economy, but the Fed can do it.

It’s the same way with Treasury bills. Pundits like Paul Krugman will state that the low yields paid on Federal debt are evidence that the “market believes that the US is a safe investment.” This is not  only fallacious – whenever someone says “the market believes X” or “asset X traded [in a direction] on Y [news], they’re engaging in the narrative fallacy because it’s impossible to prove causation – it also ignores the role of the Fed in fixing prices.

The Fed has publicly admitted to buying Treasuries. When they buy those bonds, they do so at a set price. Whatever price the Fed bids at acts as a price floor. Recall the story I linked to earlier from NPR. The Fed stepped in to buy a massive portion of the Mortgage Backed Securities market in the aftermath of the 2008 crash. This set a price floor on the mortgage market, combined with the Fed’s ordinary fixing of interest rates.

Even people who understand the Fed in theory aren’t willing to imagine the implications of this kind of absolute control over certain elements of the economy.

People want to believe on a fundamental level that the Fed’s powers are somehow limited. No. That’s like believing that a computer programmer has no control over his own program. They can manipulate the rules at will.

That’s the point of owning the banking system.

The only hard limit may be political. When public rage builds to the point to which it can no longer be contained, the Fed and the US government will collapse. This is because it is too expensive to rule over angry serfs. It’s much easier to rule when they are contented, iPad-addled slaves willing to take on jumbo ARM mortgages and six figures in credit card debt.

Also, the public finances are unsustainable in real terms. Even Citibank and Morgan Stanley have noted that the two options for the government are either hyperinflation or default.

In 2008, when I and other Austrian types stated that would be the ultimate result of the bailouts, it was a lonely position to take. While mainstream economists and commentators admitted that there were serious structural risks to the economy, it was still considered fringe-lunatic to point out the simple truth that the emperor is naked.

The idea that the US government will be able to continue to finance its operations rests on the assumption that organic demand for Treasuries among foreigners will remain insatiable while the US economy goes through a sharp recovery.

Every year that the GDP numbers fail to meet projections, state economists increase the estimates for long-term economic growth. Those curves grow sharper every time, because the thinking must become more magical in order to justify the continued path to devastation.

Bernanke’s 8/27 Speech

As usual, the Fed chairman managed to say nothing in thousands of words. As noted on this blog, Bernanke and all Fed chairmen have a marked record of saying one thing, and then doing another. That’s the point of central banking secrecy – it enables more effective market manipulation.

Bernanke downplayed inflation fears due to his brazen monetization of the debt. And perhaps we will not see significant inflation for years to come. After all, when the Fed prints money, it’s really just stealing purchasing power from every dollar holder in the world. That includes Colombian drug lords with tens of millions of stacked notes. When you have the world’s reserve currency, it gives you the power to render a secret international tax. There’s still a lot of purchasing power left for the Fed to steal, both domestically and internationally.

Reuters has a solid summary of his speech.

STOP PAYING INTEREST ON EXCESS RESERVES

The Fed could try to spark more lending by cutting the interest rate it pays banks on reserves they hold at the central bank from the current 0.25 percent. This would only be effective if there was unsated loan demand, which some doubt.

OPEN A NEW LENDING FACILITY

The Fed could open or keep open a lending facility to increase credit availability for any sector of the economy it wants to help, such as commercial real estate.

The Fed would have to argue that crisis conditions exist in order to lend to non-banks, and may be shy about doing so after similar actions were criticized during the 2007-2009 financial crisis.

The Fed could not only stop paying interest on excess reserves, but start charging money for it. I’ve discussed that possibility in the past.

The latter suggestion – opening a new lending facility – is already under development. For months, I’ve suspected that the new bubble would take the form of an expanded business lending facility. My theory has developed from two sources – the first being that businesses have unique taxpayer identification numbers and their own credit ratings. The second relates to the bipartisan rhetoric about the economy emanating from politicians.

When an initiative is unpopular with the general populace, politicians can evade major consequences by acting in concert. The bailouts were despised nearly unanimously among most sectors of the population, but the initiatives passed with almost no dissent.

Even if the politicians had miraculously rejected the bailouts, the Fed could’ve acted unilaterally despite the public opposition. But it would have been illogical for the politicians to have opposed the bailout. The Fed is crucial to maintaining the petty corporate empires that maintain the political class in the lifestyle that it has become accustomed to.

The Hellflation Death-Bubble

Due to corporate person-hood, an expansion in business lending would create tremendous moral hazard. Unsecured business loans can be discharged without consequence to the individuals running the business. Robber barons like Donald Trump built their empires on the innate loopholes in the corporate credit system.

Trump can raise money in the credit markets to build some new gaudy glass tower. If the markets go his way, he’s repaid. If the markets turn against him, that corporate entity can declare bankruptcy, socializing the losses.

Here’s how I would create a hell-bubble that would temporarily bail out distressed states and the Federal government by creating massive inflation.

1. Expand small business lending facilities combined with expansions to the business grant program.

2. Promote the securitization and collatoralization of business loans through the SBA. The SBA’s relationship to the business lending market is already similar to the FHA’s relationship to the housing market.

3. Enact a propaganda campaign in concert with the banks. Hinge it on ‘faith in free enterprise, entrepreneurship, and the American spirit.’ This enables both left and right to say “See? We are Very Serious Capitalists. Banks are an engine of prosperity and economic growth.”

4. All businesses participate in the low-cost credit bonanza. They must, because if they don’t, they will be destroyed by price inflation. Everyone must join the bubble – and like it.

5. Flee to Paraguay, get plastic surgery, change name, retire on mountain of accumulated gold.

If you can seriously argue that the banks would not acquiesce to such a plan, I direct you to this quote:

The Independent Community Bankers of America is “wildly supportive” of the bill, said chief economist Paul Merski, whose Washington-based lobby represents almost 5,000 lenders. The American Bankers Association favors passage and the National Federation of Independent Business, which lobbies for small companies, says it supports financing for “creditworthy” firms that have trouble getting loans.

It sounds like they like-y the plan! Banks can only earn revenue from loans and fees. Borrowing money from the Fed and buying Treasuries at a tiny spread does not make for a high-style private jet corporate lifestyle. Participating in another hellish lending bubble does. Note that the lobbyists don’t mince words – they are “wildly supportive.” They’re chomping for more profits. They have to make up for zero interest rate policy in loan volume. The only way that they can grow is to create insane amounts of credit.

Banking regulations are flexible. The decision on whether or not to shutter a bank with too many non-performing loans is almost entirely arbitrary. People seem to get stuck on this. They stomp their feet and say “The rules are the rules!”

But force is the whole of the law. The constitution is just a piece of paper. As Mao said, “Political power grows out of the barrel of a gun.”

If the Fed and its minions wish to “lighten up on banking regulations” they can choose to do so. They own the banks! What they say goes!

But… But… There’s No Demand for Credit

This is a common refrain among the deflationary crowd. Mainstream commentators obsessed over the “credit crunch” and the “lack of liquidity available to small businesses” in the wake of the bailouts. Much of that talk has subsided, seeing as due to current market conditions, few banks can make wholesale speculative credit risks.

The only way that banks can get back in the game of dumping fresh credit into the economy is if they know that there are broad-based political guarantees that they can socialize the risks. That is how it worked during the housing bubble. Banks could only afford to go nuts if they knew that the government would c keep the bubble inflated and to provide them with subsidized exit strategies to socialize their losses.

The banks must be allowed to expand lending in tandem for a proper inflationary episode to occur.

Such an event is unlikely given the current rules for the system. This is  where the deflationist camp of economic commentators is correct. They point out that if the regulations remain static, banks have no incentive to lend.

However, the rules have never remained the same. The Fed and the government are always changing the rules on the fly to fit their interests. This is not a solid-state system that behaves predictably. If the Fed wants to tinker with the laws of gravity, so to speak, it can do so.

Credit creates its own demand for more credit under the inflationary Federal Reserve system. Think of it in terms of credit card balance transfers. When you fill up one credit card, you pay off the debt with a zero introductory rate balance transfer card. When you have a mortgage and interest rates decline, you refinance. Continual price inflation creates an irresistible impetus for more credit.

Typically, inflationary malinvestments take the form of an overproduction of capital goods. A new small business lending facility would fit that bill. You would finance a thoroughly inflation-driven boom in business activity that would serve basically no purpose other than to suck up free money from the Fed. For example, it could cause 10,000,000 new cupcake businesses to bloom. This would drive up the prices of commodities involved in cupcake production. Cupcake Technician would become the most popular major at Ivy League universities.

Hedge funds would trade trillions of dollars in Collatoralized Cupcake Obligations. It may sound retarded, but what the hell, if the Dutch could go gonzo for tulip bulbs…

Under a central banking system, there can be nothing resembling a free market. The price signals manipulated by the central authority will always trump the efforts of entrepreneurs to meet genuine market demand. Because the central planners will always rig the economy to favor those economic players that meet the demands of the banking system over those of the customers. Meeting real market demand is merely a side-show relative to positioning yourself to shower in the free-money bonanza.

Austerity in the USA?

My most successful tweet has been my novel definition of austerity:

Austerity (n) : 1. A euphemism for snowing the bond market. 2. An excuse to sell state assets in corrupt & opaque auctions.

The Fed can’t raise interest rates without destroying the American government. This blocks off the Paul Volcker tactic of raising interest rates skyward to head off a suddendeath of the dollar. The only realistic option for the government to stem dollar depreciation is to radically cut spending and to default on pension obligations like Social Security and to reduce Medicare payments.

There has been significant rumbling in “responsible” public policy circles about methods for cutting Social Security. This would have to be a universal political motion to be successful.

I doubt that the US government can cut spending. It’s not a relatively tiny country like the United Kingdom, which notedly began loudly jawboning about radically downsizing government without taking any real actions shortly after the conclusion of their elections earlier this year. Also, the vast number of dollars in circulation internationally change its fiscal position relative to other smaller economies. The only comparable fiscal bloc is the Eurozone.

Any rhetoric about spending cuts will only show up after the elections. No one runs on spending cuts. The most important political base for any representative are the gangs that they create through their spending initiatives. And it’s very difficult for politicians to cut off their own power bases unless they all coordinate to cut in unison.

This is why Republicans and Democrats are currently squabbling about a Muslim YMCA-type club in downtown New York while the fiscal crisis develops. I don’t think that either party wants to have unique ownership over what comes next. The operating idea is that if the politicians collectively share responsibility, no one will be held responsible. It’s cowardly, but effective.

My guess is that such political coordination will prove to be impossible. Politicians will talk about spending cuts in an attempt to manipulate the bond markets while waiting for the Fed to bail them out with inflation. The hope will be to stem hyperinflation caused by political action from foreign governments, businesses, and major market players.

Why Has the Fed Delayed ‘Bold Action’?

Bernanke has more psychologizers-from-a-distance than the Soviet politburo ever did. I try to avoid such guesswork because it’s so notoriously inaccurate. I doubt even Bernanke’s wife has a full understanding of what he might do.

But I’ll just make the observation that by holding off on creating the conditions for renewed inflation, he’s created more demand for inflationary policy.

The drier that the economy becomes, the louder that the serfs will scream for more liquidity. The Fed must demonstrate on a basic level that has mastery over the economy and the government. As a negotiating tactic between the Fed and government power blocs, avoiding willy-nilly printing provides at least some impetus for the government to act to stiffen the dollar.

We can see this operating dynamic between Jean-Claude Trichet and the Euro countries. One man and his star chamber can dictate policy (in broad terms) to purported democracies thanks to his near-absolute control over the credit markets. The Central banks don’t want to kill the sub-rulers that keep society organized into easily taxable corporate plantations. But Senators, Presidents, and Prime Ministers can become too big for their britches for the tastes of the banking cartel.

It’s a classic battle between a monarchy and its intransigent barons.

The peasants are the shock troops. The economists are the esoteric priests that provide moral absolution to the warmongers.

And we’re the collateral damage.

But orthodox, statist economics essentially believes that the role of the state is to “stimulate aggregate demand” to play the role of head magician in the economy. They believe that entrepreneurs and businessmen ought to be lead down a path of infinite expansion through the manipulation of price signals.

F.A. Hayek cogently argued that prices are signals that enable markets to coordinate. Prices allow economic entities to communicate quickly about supply, demand, scarcity, and abundance. If the economy is a system, prices are integral to the smooth running of that program.

When prices are manipulated through violence – government intervention – it disrupts the order of the market.

A perfect example of this is through what happened in the long – and still floating – housing bubble. Housing prices have skyrocketed in the United States, thanks to a comprehensive system of subsidization, combined with the unavoidable malinvestments brought about by the banking system.

As you can see from this chart, housing prices began a nearly vertical leap shortly after Freddie Mac began issuing Collateralized Mortgage Obligations (CMOs). Michael Lewis’ Liar’s Poker actually covered the rise of that bond market, while his Big Short told the tale of the collapse.

The state stepped in through its quasi-governmental organizations (the banks and the GSEs) to generate a massive expansion of credit to the housing market. This fucked up price signals.

“Price signals” is a technical-sounding term. The truth is, that price manipulation caused millions of people to waste their lives in unproductive industries. It created a vast class of semi-skilled construction workers, real estate brokers, and investment bankers to hock the ultimately worthless securities that it was based on.

But when the state-banking apparatus manipulates prices skyward, you would have been stupid not to jump on the rally train. Just look at that chart! You could have yammered on endlessly about the fundamental problems in the system – and been right, eventually – but price is an impartial arbiter. During that multi-decade ultra-boom, it was idiotic to be short the housing market.

The housing bubble was an ideal government program.It generated massive tax revenues and created the illusion of prosperity for current incumbents in the economic system. While it disenfranchised the poor and the young, it empowered the already-established by causing the price of their primary asset to continually rise – seemingly risk-free. It seemed like a state-led win-win relationship.

In reality, it tricked society into joining a massive ponzi scheme that transferred ever-increasing amounts of wealth into the banking system and government coffers. Rather than nurturing a propertied middle class, it generated a vast speculative bourgeoisie. Those people could maintain a middle class lifestyle only so long as the market continued its upward march. Once the price manipulation could no longer be sustained, it caused a devastating collapse that has yet to complete.

By manipulating a relatively small set of prices through the banking system, the entire American culture was lead down a self-destructive path. In the same way, by keeping the price of corn depressed, American waistlines have ballooned due to the over-consumption of synthetic foods constructed from that grain. Rather than eating a more diverse and healthier diet, the gonzo system of agricultural subsidies encourages us to eat a diet made up of mostly corn and corn-fed animals.

In order to create a stable society, officials and professional economists will need to cease the endless tinkering with prices in their never-ending attempts to jerry-rig social change.

This question pops up everywhere, underlying concerns about “failure to launch” and “boomerang kids.” Two new sitcoms feature grown children moving back in with their parents — “$#*! My Dad Says,” starring William Shatner as a divorced curmudgeon whose 20-something son can’t make it on his own as a blogger, and “Big Lake,” in which a financial whiz kid loses his Wall Street job and moves back home to rural Pennsylvania. A cover of The New Yorker last spring picked up on the zeitgeist: a young man hangs up his new Ph.D. in his boyhood bedroom, the cardboard box at his feet signaling his plans to move back home now that he’s officially overqualified for a job. In the doorway stand his parents, their expressions a mix of resignation, worry, annoyance and perplexity: how exactly did this happen?

It’s happening all over, in all sorts of families, not just young people moving back home but also young people taking longer to reach adulthood overall. It’s a development that predates the current economic doldrums, and no one knows yet what the impact will be — on the prospects of the young men and women; on the parents on whom so many of them depend; on society, built on the expectation of an orderly progression in which kids finish school, grow up, start careers, make a family and eventually retire to live on pensions supported by the next crop of kids who finish school, grow up, start careers, make a family and on and on. The traditional cycle seems to have gone off course, as young people remain un tethered to romantic partners or to permanent homes, going back to school for lack of better options, traveling, avoiding commitments, competing ferociously for unpaid internships or temporary (and often grueling) Teach for America jobs, forestalling the beginning of adult life.

The 20s are a black box, and there is a lot of churning in there. One-third of people in their 20s move to a new residence every year. Forty percent move back home with their parents at least once. They go through an average of seven jobs in their 20s, more job changes than in any other stretch. Two-thirds spend at least some time living with a romantic partner without being married. And marriage occurs later than ever. The median age at first marriage in the early 1970s, when the baby boomers were young, was 21 for women and 23 for men; by 2009 it had climbed to 26 for women and 28 for men, five years in a little more than a generation.

When there’s a lack of understanding about economics, popular writers struggle to craft narratives to explain the social permutations caused by pervasive state policy and central planning.

Young people are avoiding habits that are heavily taxed and regulated by the state.

Getting tattoos, mooching off your parents, pursuing graduate degrees in intergalactic basket-weaving, and getting drunk are all relatively untaxed. Of all that voluntary activity, very little of it is sacrificed to the State. When you enter into a voluntary arrangement to work, a solid chunk of that goes to the government. The State circumscribes what you can do in those interactions.

It’s a sign of sloppy thinking to ascribe the behavior of such young people to their innate stupidity, evil, lack of responsibility, or some confusing cultural change. They’re responding to the confusing incentives of the mixed economy.

Older people are already entrenched within the system, so their habits are more difficult to break. Because older people tend to have more skills, more experience, and better contacts than younger people, they command higher wages. Physical labor has been displaced by knowledge work. Older people rarely suffer as many disadvantages as they used to on the labor market.

Higher education has also been devalued over the decades. Young people have to spend more of their productive years accruing degrees to gain more advantages in the work place.

I also question whether or not this is really a new phenomenon. My parents came of age in the 1970s. They were born to solid upper-middle class families. My mother was one of the founding members of the (now Tony award-winning for his choreography in the Lion King) Garth Fagan dance company. My father tooled around a couple different undergraduate colleges, hoping to become a professional basketball player.

He didn’t find his first “real” job until he was in his mid-30s, after he finished his two law school degrees. My mother received her undergraduate degree from Columbia while she was pregnant with me, when she was 36 years old. They both took a long time to “grow up,” and I think that’s the case with many people of the time. During that era, it was a sensible idea to spend decades pursuing post-graduate education. The domestic economy was also quite weak throughout the 70s. Once the economy began to boom again, my father found a job in the right industry at exactly the right time and working with exactly the right people.

Speaking purely for myself, I was seriously demoralized by watching my parents earn a tremendous amount of money and then lose all of it. It made me seriously question whether or not it made any sense at all to prize career above all else. They went from one of the wealthiest families in the US to being extremely broke – both have far more delinquent liabilities than assets (which are negligible), and as far as I know, almost no income. Whatever money that was set aside for me and my sister was withdrawn to cover debts years ago. They’re both 60 years old, and both looking for jobs.

So, the example that they set was that it’s possible to attend the best schools in the US, become an executive in some of the most profitable corporations in American history – and still wind up miserable and destitute, in the hock to hospitals and banks.

I’ve developed different attitudes about work, wealth, and life than my parents. I’ve certainly learned to work harder than I would have if my family had remained wealthy. It probably changed my personality for the better.

If my experiences had been different, I would’ve acted otherwise. That’s, more or less, what drives most intelligent young people. Noting that the elder generations have annihilated themselves and their society, how can we ensure a better result for ourselves?

The notion that young people don’t want to get married and have children is also more than a little stupid. The problem is that doing so well requires an inordinate amount of stable income and savings. I would love to start a family! It’s just not a realistic immediate goal for me, nor for many other people. I hope to make it happen before I’m 30, but we’re all working on self-advancement in the midst of heavy recessionary headwinds. Maybe I’m unusual for a guy, but I know that I’m usually happier in a monogamous, long-term relationship. And I don’t think that I’m even in a minority in that respect, even if polls say differently.

Publications like the New York Times do a disservice to young people when they tout incipient “recoveries” and “green shoots.” This propaganda has real effects on what young people choose to do. If people believe that a recovery is coming, they will avoid working as hard as they would otherwise. Recessionary times call for innovation and hard work to capture competitive advantage.

There’s also a general lack of a sense of personal responsibility for all the failed public policy promotions over the decades. The educational system has failed to teach students in-demand skills in a systemic fashion. Our system of money and credit along with tax policy and government lending policies forcibly redirects massive funds to higher education. Yet in the face of the utter failure of this system, its supporters can think of nothing else but to recommend “reform” rather than abolition.

Young people are just fine. It’s the old folks that think they know how to centrally plan an economy that are preventing them from realizing their potential.

Seeing as he’s written for Grant’s Interest Rate Observer, whose owner has sometimes associated with the Austrian school, this is perhaps not so surprising.

The same sort of story could be told about every recent government intervention in markets. Risk has systematically been shifted from the banking system to the banking system. It is hard to believe that many banks will actually turn out to have been successfully recapitalized in this way, once the system equilibrates. Without any significant cuts in government spending or increases in taxes (in fact most governments are actually spending more, in the name of stimulus) the only new money available to the government comes from financial markets themselves, so using it to try to rescue financial markets on more than a short-term basis is probably futile.

Simply endlessly printing more money is more likely to lead to catastrophic failure – devaluation, inflation, default, or all three – than to any permanent rescue of the situation. That, in an open economy with large cross-border trade and capital flows, debasing your currency is not a long term solution to any real economic problem is something we’ve known for a rather long time. A one-off devaluation is sometimes useful, but the endless abuse of segniorage has not traditionally been viewed in a very favorable light. Someone will pay in the end; now we are beginning to see who it is. Anyone who holds a lot of sovereign debt is at risk of eventually discovering that it is fairy gold, ghost money, mere joss paper that didn’t ever correspond to any pile of goods and services actually available in this world. (Imagine an endless stream of ships leaving America full of cargo and returning from China empty, as if we were paying war reparations, individual Americans making terrible personal sacrifices to make sure the debt was paid…. The scenario is just so implausible.)

Why these simple facts have taken so long to percolate throughout society has been a mystery to me. The failure of journalists, politicians, mainstream economists, and others to merely take note of reality in regards to the bailouts has been impressive.

In some ways, the crass theft of the bailouts has been the greatest gift to free-market libertarians ever. It made the ruling class look like a bunch of morons. And as Jeff Tucker wrote back in July, it makes Austrians look like a bunch of eerily skilled psychics.

But it’s not magic. It just comes from an understanding of the principles of economics, history, and reality. Money printing, in the popular mind and that of mainstream economists – is a sort of magic that creates “wealth.” In reality, it’s just theft through counterfeiting.

So modern China is a sort of suicide machine, a train to nowhere with no emergency brake. It is deliberately designed to prevent the passengers from being able to avoid a crash. Not only does the Party espouse false beliefs, it seeks to prevent Chinese people from forming their own, true beliefs in the light of all the available information. Now it turns out it has had them all working long days these last many years just to pile up credit with the Jade Emperor. And who’s down there in Hell, spending it all, no doubt on dancing girls and lavish banquets, and laughing uproariously at your present difficulties? Perhaps the Great Helmsman himself, with Jiang Qing pouring out the wine….

You could replace some words along with a few of the characters and say the same thing about the United States and its clones in Europe.

The weird thing about all this is that it’s a familiar story to anyone who pays attention to international affairs or history in general. There are no special differences between American politicians and Hungarian ones. They use similar language, abuse similar myths, use the same financial tricks, and enjoy the service of idiotic myth-making journalists – many of whom are not even on the payroll. Our academics are just as stupid and corrupt.

I can respect basic corruption. If someone receives bribes and acts on it, it’s at least understandable. What troubles me is how easily some people can be corrupted with no inducements whatsoever.

But with the erosion of popular support for the Obama presidency, that ideology has increasingly become less coherent.

Like the right wing, the left is less based on philosophical principles and more based on emotionally-driven stances. The left-wing base is often skeptical of war, but the professional left and its intellectuals will invariably argue in favor of it. In general, people who consider themselves left-wing sympathize with the poor and disabled, while wanting corporate power to be limited.

They believe in “regulation,” but by disinterested bureaucrats who are above the pettiness of commerce. They decry campaign financing and corporate driven legislation, but rarely notice that the regulatory state has always been driven by corporate cartels that enjoy subsidies and protections from the central state.

Liberals will often express sympathy to ideas that crime ought to be dealt with through social reform rather than punishment – although their politicians behave differently.

Like libertarians, the grassroots liberal base has been continually disappointed by the results of political action. Their representatives lift their spirits and open their wallets during campaigns, but disappoint them once in office.

I notice a pervasive sense of malaise among liberals. The vehemence with which some of them argued in favor of the muscular regulatory state, the academic apparatus, and the basic legitimacy of the governing system has faded.

From speaking with Obama supporters and organizers during the campaign, I noted that many young people genuinely wanted to roll back the abuses of the Bush years. Although many were light on knowledge and experience, there was a genuine belief that they could use the State to re-make American society for the better.

I was never suckered in, but that’s largely because I’m a grognard on matters of history, politics, and economics. If I spent more time on ordinary human pursuits, I might’ve  been an enthusiastic supporter. I remember when someone asked me why I refused to support the campaign, I fell to one data point: that there are more black men imprisoned than were enslaved on the Antebellum plantations. I have never been able to suppress my conscience long enough to vote or donate money to a politician. The state is involved in many everyday crimes and depredations that the common man regards as normal.

Asking me to support it is like demanding that I give my approval to the Cosa Nostra. Why? I pay my protection money – isn’t that enough?

Successful revolutions are rarely incremental.

What will lefties do next? What is there left to believe in?

And most importantly, what takes the place of the progressive ideology if the Federal Reserve collapses? The very existence of the activist state relies on the presence of a central bank. The plumb-line, extreme-left response is to nationalize the Fed and place it under direct political control. Such public banking dramas have played out all over the third world to disastrous effects. The Fed as it exists is not exactly a bastion of monetary responsibility, but its partial independence prevents the entire Ponzi from collapsing overnight.

Questions for Liberals

Why is the State the way that it is?

By what process are corporations and other nominally private interests able to wield political power?

What role, if any, does the State play in creating and sustaining poverty?

Are your claims about the virtues of the State reflected in reality?

Can you justify the existence of the State using a consistent moral argument?

Why, after decades of such heavy influence over culture and politics, has your ideology so consistently failed in achieving its stated ends?

This is not even remotely true, and it never has been.

Newt Gingrich recently wrote an Op-Ed entitled How America became a ’secular-socialist machine.’

Neither statement is true. Secular organizations are taxed at punitive rates relative to religious “non-profit” ones. Under George W. Bush, “faith-based” charities received special support from the government – as many still do today. The idea of separation between church and state is a myth.

Is America socialist, in the Marxian sense?

Clearly it’s not, as there’s still some degree of private property, although socialist rhetoric, certain socialist arguments, and many socialist programs dominate the political order here. In the general public, it is considered beyond the pale to make consistent arguments based on sanctity of private property and the non-aggression principle.

It is rather silly that Gingrich claims to support Hayek in his piece, seeing as the Republican party has historically been an enthusiastic supporter of central banking.

Abraham Lincoln, after all, introduced the hyperinflationary greenback.

Death and Taxes

The American government taxes in two ways. It either does so through direct taxation, or indirectly through the process of inflation.

The Chicago school monetarists (who have Milton Friedman as their standard-bearer) often support lower direct taxation and regular inflation.

But that is, nonetheless, an obscenely high-tax regime. They may talk a good game sometimes, but most mainstream “free market” economists babble constantly about free-rider problems, market failures, public goods, game theory, and other state-justifying nonsense.

It’s impossible to support the principle of private property and central banking simultaneously without willful self-deception.

Their intellectuals are completely indistinguishable from those on the “left.” As far as I can tell, they speak the same language, work for the same think tanks, attend the same schools, and support the same policy initiatives. There may be slight disagreements here and there about specific numbers, but otherwise, they represent a unified philosophical front in favor of central planning and economic management by experts.

It goes down to moral principles. If you support the free market merely because you think it’s more efficient than socialism, you may not only be incorrect in some cases, but you end up trapped in a never-ending cascade of arguments from effect.

After all, only central banking could create the “wonders” of Dubai. The free market would have left it a desert. Central banking created ultimately useless towers, indoor ski mountains, and unused highways.

That was “productive.” It generated massive “growth.” But it was divorced from real market demand. Governmental fiat manufactured it. The narcissism of the ruling sheiks and their enabling bankers generated that “development” – not the natural interplay of supply and demand.

I argue for free market capitalism because it is consistent with the non-aggression principle. It doesn’t require systemic theft and violence to uphold. I’m indifferent to how productive or efficient the system is. The absence of coercion is the only important element in the system.

It may actually be less productive in certain instances than an economy driven by central planning. In terms of GDP (an equation which privileges and double-counts government expenditure), the free market is far weaker than the mixed economy. This is how the USSR was able to keep up with the USA during the endless dick-measuring GDP competitions of the Cold War.

Favoring capitalism is not about choosing which system creates the most “growth” or “productivity.” Both concepts are abstractions. They’re attempts to slap on a patina of objectivity to what is ultimately an expression of subjective values.

This is one of the many fundamental disagreements between Austrian economists and establishment ones. Austrians make the observation that value is subjective. Prices are objective at the point of transaction.

Other economists will make the argument that prices are the expressions of an “efficient market” of rational, self-interested humans who behave in a predictable fashion. It is a sort of mad determinism that denies the complexity of human interactions.

“We Want Free Markets and a Strong National Defense”

I’ve seen some Republicans say such things in articles and speeches.

They want neither!

It seems absurd that even some libertarians will praise the military and the intelligence agencies while screaming about the socialism in the economy. There seems to be a magical disconnect between how these people view the separation between military and social affairs.

There is no separation. The military and police are not somehow different classes of human being that follow alternate moral codes. These cadres are as much an effect of our economic system and general conceptions of morality.

It makes me wonder what kind of people these Republicans would be if they lived in the USSR. Would they praise the Red Army and the KGB while whining about the bread lines and lack of cosmetics brands to choose from? Where’s their sense of priorities? It’s the existence of those institutions that make the economic controls possible.

“Boy, we hate all this control over the economy – but our brave Soviet soldiers can defeat any enemy! Our Hind helicopters will annihilate the Mujahadeen! The bureaucrats are our enemies, but their soldiers are our friends!”

The military and the intelligence agencies are both terrible at achieving their stated ends for the very same reason that socialist economies collapse. Military logistics is merely re-branded central planning. Public military structures are completely un-moored from price signals. It’s perhaps unsurprising why mercenary forces like guerrillas - often supported by market forces and not taxation – are so much more cost-effective than forces reliant on central planning.

Wars are fought and won based on logistics. And the free market will always offer a more resilient and effective logistical chain than a centrally planned economy. The Army is a Communist institution.

The soldier or marine doesn’t even own their own rifle. Their superiors can imprison or even execute them for misplacing it or firing it on their own initiative.

Don’t bring up Blackwater and Halliburton to me – government contractors fall prey to the same socialist calculation problems.

This error is particularly glaring among Objectivists, who should know better.

The American military is a giant socialist toilet seat of continual failure, yet you can often count on leaders from the Ayn Rand Institute and elsewhere to glorify the military-intelligence apparatus and its ends. Their failure to apply their own principles consistently is an ongoing and seemingly never-ending embarrassment, and a vast mis-allocation of intellectual and financial resources towards wasteful ends.

The right wing as a whole is asleep to these issues. While some may be developing a taste for the rhetoric of free markets, as they have in the past, the moral basis for capitalism continues to slip through their grasp. Because, at its base, both conservatives and liberals are little more than power-seeking nihilists that permute their rhetoric to score votes and donations.

In practice, Republicans favor central planning and a completely counter-productive and politically-motivated socialist national defense force. For Republicans to now suddenly paint themselves as inspired by Austrian economics to return peace and freedom to a fundamentally violent and controlling State is absurd.

It’s always fun to hurl epithets like “Communist” and “socialist” around – but I believe that that pleasure should be retained exclusively by authentic free-marketers!

When such a subsidy is held indefinitely, the price also increases indefinitely.

While it may be true that a subsidy may make something more affordable to a certain class of consumer than it was in previous years, the overwhelming long term trend is to make that service less affordable over time.

This is not a controversial principle. Economists of every school recognize it.

But journalists frequently repeat fallacies from politicians and corporate PR departments about the effects of subsidies.

One example is the “Making Home Affordable Program” which offered a minor tax credit to new home buyers and to lenders that modified mortgages owned by the Government Sponsored Enterprises (GSEs).

Rather than “making homes more affordable,” this is an example of how such programs make homes less affordable in aggregate. Since the onset of the financial crisis, the State and its banking institutions have fought to prevent housing from becoming more affordable.

There is no free market in the United States in housing, energy, medical care, education, transportation, infrastructure, media, software, science, agriculture, banking – or, well, anything. Price signals are completely distorted. As the orthodox economists who rule the country see the manipulation of “aggregate demand” as a core tenant of what they do, our entire lives are spent essentially chasing the policy initiatives of the ruling class – whether or not we understand the process.

Once the interventions become so extreme that it would cause catastrophic dislocations in the economy to unwind, it becomes a “radical” position to argue against complete madness.

It becomes “responsible” to advocate that ordinary people purchase land on leverage at 5:1, 10:1, or even infinity to one. The same financial advisor that would instruct someone to avoid using leverage when purchasing stocks or bonds will have no problem advocating leveraged speculation on land, automobiles, and education.

Of course this results in an exponential compounding of risk for both the financial system and the society as a whole. It’s rather like being trapped in a car racing towards a cement wall at 200 miles an hour.

Instead, the media prefers to retransmit the advice of oligarchs like Bill Gross. It would be best for the mortgage market to fall apart. The entire process of mortgage securitization, trading, and guarantees is crazy. The price of land should be allowed to fall to meet wages.

This ends when intellectuals, the press, and the business classes remove their support for the system.

In February, Ben Bernanke said “We’re not going to monetize the debt.” during his testimony to Congress.

He recently contradicted his earlier pronouncement by proclaiming that the Fed would directly purchase at least $10 billion in Treasuries per month.

I consider this misleading. The Fed backstops all the major banks. If you count the bond purchases of those quasi-arms of the Fed, which can borrow from the discount window and have the implicit promise of a bailout if necessary – in that picture – then the prospects for future inflation is a near-certainty.

The belief that inflation can be controlled is predicated on the assumption that the political process at the federal and state level can be corralled around rapid spending cuts and reductions in future liabilities.

This is naïve. Reducing government spending is a tremendous coordination problem that has never really been solved in American politics, or anywhere else. Government grows until it collapses completely. Any politician that moves out of this mold will always be speared for breaking solidarity. The most important constituency for any politician are the interest groups that they empower while in office. The more workers they recruit for their rolls, the more votes that they can count on for re-election.

There are too many entrenched interest groups that can bring strikes and violence to bear on the political class for genuine government reduction to take hold in the US.

One example I enjoy using is to point out that a very large portion of the country is addicted to drugs that are partly funded and distributed by the state. Few addicts will willingly cut themselves off from their suppliers. Their organs would fail. Some would go mad!

The love of government money is not just a metaphor. It’s become a physical requirement for many people. There’s an entire class of elderly voters that will die from lack of access to pharmaceuticals and medical intervention provided by the government.

Much of the economy relies on either a government or endless credit expansion from Federal Reserve member banks. The metaphor for this financial-governing system as the Matrix is apt. It controls nearly everything in the economy. Just looking at the official numbers for employment in the government says little, as it fails to count government contractors and companies that receive much of their business from government money or through regulatory requirements.

This is why no serious action will likely be taken. There will be too much electoral chaos caused by competing interest groups for political resolution to occur. Inflation is a convenient mechanism of looting the public without resort to taxation. It ultimately dissolves the society, but because it is an authoritarian process, it avoids the risks and complexities of rapid changes in legislation.

Gary North explains and debunks the deflationist arguments in these articles from 2009.

As North notes, “The Federal Reserve can re-ignite monetary inflation at any time by charging banks a fee to keep excess reserves with the FED.”

Buy Gold?

The notion that the only strategy to employ to protect your personal finances or business from inflation is to buy gold coins and sit on them like Scrooge McDuck has always bothered me.

This a weak strategy for most people of modest means and any business. The process of severe inflation is usually drawn out over several years to a decade.

There are few ultimate winners during most periods of major inflation. The velocity of trade and the violent swings in volatility shake out most players from their savings, no matter what form those savings held in.

Businesses can rarely afford to allow funds to sit idle for extended periods of time, particularly when interest rates are at zero. Inflationary environments punish those businesses that fail to spend as much money as possible to increase cash flow usually wind up bankrupt.

Even those people who have precious metals will probably have to liquidate at some point to cover expenses and keep themselves alive. Unless you’re self-sufficient – and no one is – the increasing cost of living will deplete those savings beyond the capacity of anyone without an entire vault of the stuff to keep them alive.

Furthermore, when most article writers, newsletter advertisers, and advisors suggest that people buy gold, they make few mentions of the importance of money management. Momentary downturns in the price of gold will have a disproportionately negative effect on such a portfolio. Few people have the tolerance for such major downturns, will liquidate, and then be under-capitalized in the future.

When people buy gold, they usually have no clear exit strategy.

When do they sell?

How much do they sell?

At what price?

Promoters never tell you. All they say is ‘Gold to $2,000, $5,000 or $50,000!’

Even if they’re correct in the long run – which they very well may be – they have no idea how long it will take, or what path the price will take before it reaches that point.

I’m aware that arms of the Fed manipulate the price of gold – just as they manipulate the price of every conceivable asset class. We live in an economy that’s nudged and controlled by a banking cartel and a lunatic government. Both players are committed to pumping the prices of stocks, bonds, and other securities. While that process will ultimately fail, the time line could be drawn out. There’s no way to know.

That being said, I have no problem with people buying and selling gold. I believe in free choice of currency, and think that commodity money will play an important part in international trade in the years to come.

I just hate single-minded strategies that fail to take into account all contingencies and financial idiosyncrasy. I’ve known people who earn less than $2,000 a month who have plowed savings into coins. It makes little sense for people who have liquidity problems to do that.

The wealthy can do as they will.

Understanding Inflation Vectors

I’m addressing a general audience who may be unaware of monetary issues from an Austrian perspective.

In the Western system, banks create money as debt. When you buy an iPhone for $500 on your Visa card, there’s no corresponding debit for the credit card company. Money is deducted from the system when you repay the balance, but the bank keeps the interest payment as its profit. In this way, the money supply expands over time. The Federal Reserve’s theoretical mandate is to control inflation in the economy. When economists at the Fed perceive that the money supply is growing too fast and prices are increasing faster than the economy expands, they are supposed to raise interest rates to prevent inflation.

This lesson from Chris Martenson is a succinct explanation of this process to those of you who may be confused.

Inflation trickles into the economy primarily through the banking system.

The investment banks and other capital market players are the primary beneficiaries of monetary expansion. They have the greatest access to new credit and the expertise necessary to play the markets.

Higher education is driven largely by government funding, government loans, and private loans. Money squirts directly out of the banks directly into a professor’s wallet, while keeping a horde of administrators and paper-pushers comfortably employed.

Medicine receives massive government support, and the heavily regulated insurance agency makes up the difference.

The real estate markets are also almost completely credit-driven. Despite the housing crash, the government and the banking system continue to redistribute money to pump up asset prices in that market.

The auto industry is also heavily tied to credit expansion. Car companies are not in the business of making cars so much as they are interested in originating loans.

There are other major sources of credit creation (like business loans), but they’re not industry specific.

It’s important to focus on these sectors because during inflationary periods, those who avoid the free-money party end up becoming destitute. Businesses that focus too much on servicing customers are at a severe disadvantage compared to those who just focus on originating loans and then selling the obligations.

Drinking From the Liquidity Pipe

I was too young and feckless to ride the real estate bubble. But I’m sad that I wasn’t more business-oriented back then, because it would have been nice to have won a fortune from that speculative boom.

Whatever bubbles emerge in the near future, the cycle will be much faster than in previous eras. The distribution of wealth will be less broad.

An example of such a renewed bubble can be found through this recent Bloomberg article, which described how the FHA has provided 3.5% down payment jumbo loans for vacant luxury condos in Manhattan. There are many such new buildings scattered around the city that have been largely vacant for over a year. This is because the current owners haven’t been able to find buyers at the prices necessary to cover their commercial real estate loans.

Now, the government has stepped in to bail out those reckless speculators.

It may be vile, but it’s profitable for those on the right side of government policy.

If and when the government generates a “housing recovery,” it’ll be sensible for plenty of people to become real estate brokers again – brokering real estate sales to other real estate brokers who will then broker more real estate sales… and so on. It’ll be fun!

Another example can be found from working any predictable government contract. The government moves in trends, initiatives, and five year plans. The people who can best profit from these kinds of initiatives have tight connections to the government and various lobbyists. Marketing to the government is a different procedure from approaching ordinary consumers. The fashion over the past couple years has been in “green” companies, focused on assisting other companies in securing tax credits, guaranteed government loans, and other goodies straight from the loot-bags of Chairman Bernanke.

A recent new initiative (that came largely by surprise) is a $600 million appropriation for border security in southwestern states. Someone needs to sell the barbed wire, drones, missiles, bullets, and vehicles for the small army to be deployed there against destitute Mestizos attempting to cross a sacred imaginary line.

War is always a great inflation play. If you’re selling bullets, armor, airplanes, or services to the military, you’re benefiting directly from the process of inflation. If you don’t mind that your products will in all likelihood be used to murder innocent people abroad (with a few competing gang members as collateral damage), then profit away from their deaths. Why not? It’s patriotic, after all.

Strategies for Non-Inflation Driven Businesses

Not all businesses can be directly involved in the credit creation process. There will always be at least some people involved in the dreary business of buying and selling products and services according to market demand rather than central planning initiatives.

When the value of money declines rapidly, the velocity increases. No one wants to be left holding the increasingly depreciating paper, and it pays almost nothing to keep funds in reserve.

This provides a temporary boost to businesses like advertising and marketing. As companies seek to burn excess cash, they must look for expenditures that have low capital requirements but relatively high returns. Few businesses can afford to save up for capital investment during a period of high inflation. Instead of, for example, buying new machines, a company will be better served by increasing advertising budgets. Other companies must follow suit to match the efforts of their competitors.

This saturates the market and batters consumers with messages more than they are accustomed to, but those same consumers are also seeking to rid themselves of their money as fast as possible.

Hiring new employees is also a reasonable response to inflation, but due to taxation and other factors, it carries additional risks.

During periods of severe inflation, wages also often increase – sometimes substantially – while purchasing power stagnates or declines.

The financial industry also grows massively during inflation. Inflation always appears first within the financial markets. More traders, analysts, brokers, programmers, and managers are needed to handle the increased volume and velocity of securities trading.

Speculative Activity

I’ve noticed an unusually high interest level in startup businesses backed by venture capital investment in recent years. A good portion of the work that I’ve done has been for venture-backed companies (of varying sizes and levels of success).

This article from Institutional Investor puts some numbers to this trend. Venture capital investment has increased at an exponential rate in recent years, although with limited returns. There’s also been increased media and academic attention paid towards startups aimed at high growth.

With interest rates at near zero and equity markets volatile (and at negative returns over ten years, and severe negative returns when adjusted for inflation), high net worth individuals are pressed to seek out havens from inflation. Some choose real estate, gold, and buying businesses outright, while others prefer to take stakes in portfolios of highly speculative businesses.

The desperation caused by low interest rates and the general chaos in the economy can cause more people to become lured into this sector. As employment stagnates and declines at many major companies and working conditions worsen, workers seek shelter in entrepreneurship.

The least risky way to play such businesses is to provide services to them as a contractor or an employer. Even in an inflationary environment, getting stuck with illiquid shares in a startup can be a financial death sentence. On the bright side, the high growth requirements of such businesses often make them hearty consumers of goods and services. They need expansive sales and marketing teams once the core product has developed.

The real winners from the 90s startup boom were the investment bankers and Herman Miller (the manufacturers of the Aeron chair). Most of the entrepreneurs and many of the venture capital funds washed out.

Political Risk in Inflation

The greatest source of risk during inflation is political. Whenever there has been an inflation in history, the government has rapidly instituted price controls, levies, taxes, sanctions, and other regulations to attempt to hide the extent of the redistribution of wealth.

But price controls also bring opportunity to smugglers and the direct beneficiaries of state policy.

The government always attempts to control the path of inflation. This makes investors dependent on the whims of planners. It’s relatively simple to create a speculative bubble. All you need to do is create tax incentives and reduce regulatory barriers in the industry that you wish to direct capital to. The rest of the economy remains tightly controlled and taxed, but the bubble area is a free-for-all zone that provides large scale employment or investment opportunities.

The public mind becomes fixated on the bubble sector while ignoring the suffering outside of that cordoned-off area. Because all inflation is a sleight of hand – no wealth is created, it’s merely redistributed – this ensures political support for the process.

Social Permutation and Inflation

Inflation is an upending of the social structure. The formerly wealthy become destitute overnight. The poor usually become poorer. The middle class feel temporarily rich, but then lose it all – and they blame themselves for bad decision-making.

The society cycles through fashions and cultural memes at a greater rate than in previous eras. Companies perpetually need to slap on new packaging to excite consumers into buying what is essentially the same product at a higher price than in previous years. Adulthood becomes further delayed, because the process of inflation herds young people to take on more credit-financed education to distinguish themselves from competitors.

Under an inflationary regime, population movements also accelerate. During the 1970s, “white flight” caused the affluent to leave the cities for the suburbs. During the long housing boom, states like Arizona bloomed in an inflationary bonanza, as people flocked to become wealthy by buying and trading land on leverage.

The Foreign Factor

Low interest rates apply serious pressure on all actors in the economy to shift money into speculation. That includes international holders of dollars and dollar-denominated assets. When a dollar circulates around the world, it acts as a sort of loan to domestic dollar-holders. Every dollar kept overseas increases the purchasing power of domestic dollars by an infinitesimal amount. This is partly why the government encourages American businesses to offshore as many operations as possible through its tax policy.

If you ever have to wonder why a tax or regulation exists, it often comes down to controlling the rate of inflation. The core of the banking system is so fundamentally bizarre that it requires all sorts of regulatory contortions to prevent it from being abused so badly that the entire society collapses rapidly.

Inflation pushes investors to seek returns in foreign lands without much dollar exposure. The dollar, in those places, has unusually high purchasing power. But there are only so many places in the world that are friendly to foreign investment. Once the foreign country becomes saturated with dollars, it applies pressure on those dollar holders to repatriate the currency.

Because inflation can such a savage and sudden process, this creates an ugly feedback loop for domestic price inflation.

In previous periods of high inflation, global trade was not nearly such a major factor. China and India were either primitive, socialist, or undeveloped. The great inflation of the United States after 1971 (and Nixon’s visit to China in 1972) played a large part in the growth of China as an economic power and the relative decline of the American industrial base.

Dollars flee depreciation and taxation, in that order. The Fed can gun inflation domestically to re-attract domestic investment, as long as asset prices rise faster than the rate of taxation. I expect Chinese interests in particular to aggressively pursue US assets to chase higher yields.

General Outlook

The Fed will continue to fix interest rates at a low rate to maintain a floor on the bond market and to lure money into speculation.

When establishment apologists say that “the market says that there is no risk in the bond market” because rates are low, they’re engaging in the narrative fallacy and relying on the nonsensical efficient markets theory. Treasury bonds have a low yield because the Fed (and its arms) buys the damn bonds at a high price with its infinite money.

Simultaneously, investors, foreign countries, and banking interests will push the government to cut expenditures as much as possible in a last-ditch attempt to limit the creation of new money. Tax and regulatory policy will be used to direct the inflation towards politically favored classes.

This will happen contrary to democratic will. Both parties will find an accelerating loss of support.

Politicians pay close attention to polls because it is the best method to prevent revolution. Even autocrats must bow to the general popular will to keep rabble-rousers from building a base of support. Extremist factions will become more popular as politicians are forced by financial reality to ignore their constituents to a greater degree.

Even if the ruling classes successfully default on unfunded obligations to Social Security and Medicare, there will still be the multi-trillion dollar obligations of Fannie and Freddie to take care of.

Hyperinflation is chiefly a possibility because foreign countries may not cooperate with the government’s attempts to cover its debts. James Rickards has prominently discussed the possibilities of China, Russia, and other foreign governments increasingly shifting to gold as a store of value or using baskets of currencies to value certain commodities. Another bout of inflation will end the dollar’s relatively short reign as the global reserve currency.

It’s important to self-educate, prepare, and act to preserve your health and property.

Inflation is an epic loot-fest. It is a savage lash upon the worker wielded by a heartless overseer who demands that they work harder for less. It causes ruination to the saver.

And it is manna from heaven for the financial oligarchs and the ruling politicians.

But it will not necessarily end the criminality. While it may be comforting to believe that the wicked will receive their just desserts, history demonstrates that evil often triumphs to great public applause.

As Murray Rothbard once said, “Unfortunately … if fiat money could not continue indefinitely, I would not have to come here to plead for its abolition.”

Indeed. The theft can continue forever, even as the base of wealth deteriorates, real quality of life erodes, while the culture coarsens and becomes more violent.  The gestating intellectual revolution may turn the tide.

But it will be a struggle.

The government and the global financial system itself nearly endured a complete collapse in 2008 as a direct result of policies followed for over 20 years.

In order to restore the system, the executive branch and the Federal Reserve seized hundreds of trillions of dollars and then redistributed the funds to banking and insurance institutions in order to restore their solvency. Further seizures were authorized for “stimulus” aid for infrastructural projects that never seemed to materialize.

The money was simply stolen! And the money that wasn’t stolen directly has been robbed through the process of monetary expansion.

Virtually all non-Austrian economists supported this measure as a necessary initiative to “save the economy.” Stimulus and government spending was held up as the cure for the economic downturn.

The Federal Reserve’s public mandate, after all, is to maintain price stability and to smooth out the business cycle. It has never succeeded at this. The business cycle is a purely monetary phenomenon, and the Federal Reserve controls the money supply.

Hank Paulson and the Bush administration rushed through the bailout program, fatally tainting the already-weakened Republican party. The bailouts were tremendously unpopular on a bipartisan basis.

I will grant that the bailouts were necessary to maintain the government and the financial system – but that neither of those goals were worthy ones.

Barack Obama re-affirmed the Paulson initiatives soon after he entered office. He then pursued a detour into creating a new public health program, which somehow managed to piss off both the liberal base, right-wingers, libertarians, major corporations, and some doctor groups. Only the insurance companies that wrote the legislation were happy with the bill.

This, combined with the continuation of two unpopular wars, has discredited both popular ideologies.

You’d be hard pressed to find enthusiastic defenders of either party today. Only months ago, partisans were common. Now, even political mercenaries are wavering on their loyalty to the cause.

There Are No Political Solutions

There are no adjustments that can maintain the viability of this social arrangement.

Policy makers have limited maneuverability. Deficits at the state and federal levels are unsustainable in that the bond market is unlikely to remain tranquil for long enough for any serious adjustments to take hold.

Maintaining the public finances is impossible politically.

Cutting spending will result in revolts – possibly violent ones – from public sector employees and interest groups. When the political system collapses, many people accustomed to state-directed unemployment will have no more purpose for life.

When the Soviet Union collapsed, an entire class of highly-educated people wasted away. A statistically significant portion of males actually drank themselves to death.

This is because their education rendered them useless. They were priests for Communism. Once Communism fell, their purpose for living dissipated.

Raising taxes is infeasible, because it would further weaken the private economy and potentially reduce overall tax income. In any event, corporate interests would oppose any serious tax increases, and would react to changes in policy by improving tax avoidance efforts.

Increasing spending on the level of another major stimulus bill will be challenging to achieve, as bond holders – like PIMCO – become more aggressive in demanding spending reductions.

Relying on the Fed for inflation will also cause a bond market revolt and generate severe political unrest.

The End

This government will collapse. It doesn’t matter that policy wonks can come up with theoretical constructs that will somehow balance the budget and restore order to the land.

That’s not going to happen. Once an ideology fails, it becomes too expensive to propagandize the public to submit to further government programs. The costs for advertising apply to the state as much as it does the private sector. When there’s increased resistance to a message, it becomes more expensive to propagate.

The state has, on its side, an entrenched class of priests, and a populace accustomed to indoctrination.

That forestalls the inevitable, but will be insufficient. Reality is absolute. The state can manage perceptions for a period of time, but eventually, accurate information percolates, overwhelming the illusion.

I’m unsure about the timing or what form the collapse will take. It may take years, as the government has adapted many clever methods to control inflation that have been unavailable to most regimes in history.

But this is a process as certain as gravity.