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On January 16th, the American Institute for Economic Research reported: “The fear of price deflation is moving the Federal Reserve in the direction of [openly] establishing an official “inflation target” that would be the goal of monetary policy. The fundamental problem with inflation-targeting is that it is the Fed would be shooting for an annually planned rise in prices and depreciation of the dollar. . . . The inflation rate target most often suggested . . . is around 2 percent per year. . . .”
The Federal Reserve was allegedly created for the primary purpose of “fighting inflation”. That alleged purpose has been pure crap for the past 70 years. The Fed’s real goal has always been to fight deflation (which is the seemingly dangerous attribute and/or cause of a economic downturn, recession and especially depression). Deflation was best fought by ensuring that some minimal amount of inflation (1% to 3%) occurred each year. Evidence of the Federal Reserve’s and federal government’s determination to constantly inflate the dollar is seen in the fact that the purchasing power of today’s dollar is about three cents as compared to the dollar’s one-hundred-cents purchasing power in A.D. 1933. It is impossible to believe that the dollars has lost over 95% of its purchasing power over a period of 70 years except by the plan and intent of the “masters of the universe” to make 1 to 3% inflation a “fact of life”. Our current economic problems stem from the fact that the “masters” have either intentionally abandoned their inflationary objective or they’ve simply miscalculated, lost control of the economy and deflation has begun to occur “naturally”. All that’s changed with the Fed’s current plan to set an “inflation target” is that the Fed will 1) stop lying about its job as an “inflation fighter”; and 2) openly admit the “inflation targeting” (inflation creation) that’s been taking place for at least 70 years. Note that both inflation and deflation are almost impossible with a monetary system that is based on gold or silver. Inflation and deflation are primarily attributes of paper and digital currency systems. Also, note that there are two kinds of deflation: price deflation (caused by rising productivity) and monetary deflation (caused by a reduction in the supply of currency in an economy). The two kinds of deflation are not entirely separate, but they exist as two opposite ends on an economic scale. At one end of the scale we find price deflation (caused by increasing productivity)—which is not bad. For example, I bought a computer for $6,000 in A.D. 1983 that didn’t have 5% of the capability of the computer I bought last month for $600. That’s a classic example of price deflation caused by rising productivity. As people work smarter and more efficiently in a competitive market, they learn to create products that deliver more capability for less cost. Price deflation takes place when the money used in the economy is primarily a medium of exchange. Price deflation (caused by rising productivity) should be everyone’s ideal. Price deflation is the hallmark of advancing civilization. Price deflation is the implicit definition of the “American Dream”—the idea that every generation of Americans would live better (cheaper) than the previous generation. Rising productivity (price deflation) allows a handful of men using hi-tech machines to build an Egyptian pyramid in months that once took thousands of men decades to complete. So long as price deflation is caused by rising productivity, it means more wealth for less work. Who could be against genuinely earning more money for less work? With price deflation, you might pay five cents today for something that cost $1.00 fifty years ago. At the other end of the deflationary scale, we find monetary deflation—which can be everyone’s nightmare. “Monetary deflation” reflects a decrease in the supply of currency (today, credit) when that “credit” functions more like an economic commodity than a “medium of exchange”. For example, suppose you were building a 100-story skyscraper and the nation suddenly ran out of steel. The entire project would have to stop until more steel was found or produced. Today, construction of that same skyscraper could be similarly stopped if the nation ran out of the “commodity” called “credit”. Our national economy is something like a “skyscraper” under construction. We have entered a period of monetary deflation; our supply of the “commodity” called “credit” has suddenly declined; construction of our economic skyscraper has stopped and we are therefore falling into an economic depression. Why are we running out of credit? Because the world’s banks rely on “fractional reserve banking” to implement loans. Fractional reserve banking allows banks to loan, say, $10 for every $1 they hold as assets. Fractional reserve banking is a great system for stimulating the economy since it allows banks to create credit out of almost nothing. I.e., if the bank holds $1 million in assets, it might be able to use the $1 million as collateral to lend $10 million in credit. ($1 million in assets could “create” $10 million in credit “out of nothing”.) If a bank were charging 10% interest on $10 million that it loaned, it could generate a $1 million annual profit on the original $1 million in collateral—that’s a potential 100% annual return on its assets. Thus, fractional reserve banking is a figurative money tree that can generate spectacular leverage, fantastic profits and enormous economic stimulation—so long as the price of the underlying assets holds steady or inflates. Fractional reserve banking is not necessarily a bad thing—so long as it’s based on real assets. I won’t say it’s right, but it’s at least reasonable that a bank holding one million silver dollars as assets might be able to use those real silver dollars as collateral to justify lending $10 million in credit. The problem is that the world’s bankers have begun to believe their own lies that paper debt instruments (promises to pay) are just as valuable and good as real “assets” (actual payments in gold or silver). As a result, the world’s financial system is currently based on promises to pay rather than payments (gold and silver). Those promises (national and global debt) are now too great to ever be repaid. What can’t be paid, won’t be paid. Therefore, the world’s fractional reserve banking system (based on promises rather than real assets) is collapsing. Under fractional reserve banking, banks are using promises to pay (debts) as if they were assets (payments). They are treating accounts receivables as if they were payments. That’s fraud. It’s irrational; it’s insane; it’s wicked. If the price of the underlying “assets” (debt instruments) used by banks to generate fractional reserve loans begins to fall, all economic hell breaks loose. Why? Because the same fractional reserve leverage that caused great economic growth can also cause a “leveraged” economic collapse. For example, suppose a bank defined a $1 million debt instrument (promise to pay) as an “asset” and used the promise to pay as collateral to justify loaning $10 million to consumers. Suppose the original borrower went bankrupt and could no longer keep his promise to pay the full $1 million. Suppose the value of that $1 million debt instrument fell by half (from $1 million to $500,000). When the value of the original $1 million debt instrument (promise to pay) fell by half, the bank would have to call in HALF of the $10 million in loans based on that debt instrument. Thus, if the price of the original debt instrument owed by one borrower fell by $500,000, the bank might have to call in $5 million in loans made to ten other borrowers. When $5 million in loans are called in, the ripple effect is significant (people lose jobs, investments sour, stock prices fall, etc.). As other investments sour, their underlying debt instruments (promises to pay) are also reduced in value since those promises to pay also can’t be kept. Insofar as this “second tier” of debt instruments have been used as collateral for additional loans, those “third tier” loans are also called in, and a downward economic spiral begins to expand and accelerate. If unchecked, the fractional reserve-based economy can begin to implode. That’s roughly what’s happening to our economy today: we are in the midst of a leveraged implosion. This phenomenon may explain why banks were gov-co’s first target for “stimulus” grants of billions of dollars. Government would get more “bang for the buck” investing in the banks than it would in private individuals. For example, because I’m a private individual unable to engage in fractional reserve banking, if I were unable to pay a debt for $1 billion and government bailed me out with a $1 billion “loan,” they’d only prevent the disappearance of $1 billion in bad debt. But if the gov-co invested the same $1 billion in a troubled bank that had engaged in fractional reserve banking, the gov-co might prevent the bank from calling in $10 billion in “fractional-reserve” loans and thereby prevent $10 billion in credit from suddenly disappearing from the economy. Contrary to popular jealously, the gov-co didn’t give $1 trillion to the bankers because the bankers are rich. The gov-co gave $1 trillion to bankers because the gov-co might reap a “leveraged” $10 trillion benefit. Nevertheless, the fact remains that those who live by the leverage, die by the leverage. For example, thanks primarily to monetary inflation, homes that were originally built for $200,000 were recently inflated in price to, say, $400,000. Based on the assumption that monetary inflation would continue forever, people who paid $400,000 for the $200,000 house didn’t feel the least bit “ripped off” since they expected to soon sell the same house to some other fool for $600,000 (who would find some even greater fool who’d one day pay $800,000, etc.). I.e., I didn’t mind being ripped off because I expected later rip you off, and you would later rip some other guy off. In a world of never-ending inflation, we were no longer investors; we became a nation of mutual rip-off artists. Given that monetary inflation was seemingly guaranteed by the Federal Reserve, banks gladly made “sub-prime” loans to people who were 1) fool enough to pay $600,000 for a $200,000 house; and 2) unlikely to be able to repay the loan. After all, if the borrower defaulted on the loan and the bank had to foreclose, our endless monetary inflation would’ve pushed the price of the house from the $600,000 that was loaned to, say, $800,000. So, if the bank was forced to foreclose, it could still sell the house for at least $700,000 and generate a $100,000 profit. Thanks to endless inflation, banks could loan $200,000 to a homeless bum to buy a house, and never worry about losing a dime. Once the bum signed his name on the mortgage, the bank could use the mortgage (promise to pay) as if it were an asset (actual payment) and collateral to justify lending another $2 million in magically created credit to American and foreign consumers. The banks couldn’t lose. The problem is that the monetary inflation—which bank business models presumed would never end—ended. The bum stopped paying on his mortgage and worse, the price of his house (previously set at $200,000) fell to $100,000. That ultimately caused half of the $2 million in loans (based on the bum’s signature and mortgage/“asset”) to be called in. One bum stopped payment on a $200,000 loan, and $1 million in credit was vaporized out of the economy. Note that under fractional-reserve banking, credit is “magically” created out of nothing. It’s quite a miracle to behold. But, conversely, when a loan and debt instrument suddenly loses value, that value is not transferred to someone else—it simply disappears and ceases to exist and goes back to the “nothing” from whence it was created. The sudden disappearance of credit is every bit as astounding as it’s original “magical” creation. The glee and sense of wonder people feel at the creation of credit (out of nothing) is no greater than the shock and sense of fear people feel when that credit suddenly disappears back into the void. Such disappearance can bring us back to the analogy of the 100-story skyscraper: When the supply of steel suddenly “disappears,” the whole project is suddenly put on hold. Electricians, plumbers, glaziers, carpet installers, painters are suddenly unemployed because the economy ran out of steel. Similarly, if our nation runs out of the credit commodity, the whole economy can shut down. Fractional reserve banking is a house-of-cards, it’s a Ponzi-scheme based on the illusion of credit (promises to pay) rather than the reality of real payment in gold or silver money. If just one or two cards are removed from the fractional-reserve house-of-cards, the whole house will collapse. On a grander scale, there are now an estimated $800 trillion to $1 quadrillion in “derivatives” (a special kind of debt instrument) circling the globe. These debt instruments (promises to pay) are regarded as assets (payments) and at least some of them are used as collateral to secure loans from banks. Other derivatives are owned by banks and used as “assets” to justify loans to bank customers. It is mathematically impossible for a global economy that generates a $60 trillion annual GDP to also generate $800 trillion in derivative debt instruments. Yes, it’s happened, but that happening was based on fraud. $800 trillion in global derivatives is tantamount to me having a personal $1 billion line of credit on my Master Card. There is no freaking way that I’m worth $1 billion. Yes, someone might be fool enough to grant me $1 billion in credit but, at bottom, that grant would have to be based on fraud or gross negligence. Same thing with $800 trillion in global derivatives. There’s no way that number can be rational and real. It has to be based on fraud. That fraud became apparent in summer of A.D. 2007 when billions of dollars in derivatives were auctioned off in New York and no one would bid more than fifteen cents on the dollar. The auction was cancelled rather than actually sell $100 billion in derivatives for $10 billion and thereby create evidence of the derivatives’ real price (and underlying fraud). Just as the price of homes purchased with subprime mortgages began to fall, the price of derivatives would no longer rise and also began to fall. Insofar as those derivatives had been used as collateral under fractional reserve banking to justify issuing leveraged credit, for every $1 billion fall in the price of derivatives, $10 billion in credit “disappeared” from our economy. If $100 billion in derivatives were suddenly seen to be worth only $10 billion, $90 billion in presumed value would be lost and potentially $900 billion in credit might suddenly disappear from our economy. In A.D. 2007, the system had run out of greater fools. People stopped believing that promises to pay (accounts receivable) were as good as payments. In retrospect, it appears likely that the failed derivative auction of A.D. 2007 marked the beginning of our national economy’s end. |
February 1, 2009...12:12 PM
Those Who Live by the Leverage, Die by the Leverage
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