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In The Belly of A Horse
09 July 2002
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"If a nation expects to be ignorant and free in a state of civilization, it expects what never was and never will be." Thomas Jefferson

If the Fed didn't existů
Profits might. There may have been a tech boom, only profit, rather than "too much money" would have driven it. The difference is that in one case economic actors are making the correct choices.

If there were no Fed, consumers might save more of their money, and the economy might be less prone to the unintended imbalances between consumption and savings. In fact, the economy may not need to depend on foreign savings at all.

If there were no Fed, bureaucracy and debt could not outgrow the contributions that are made by capitalism. Neither could ignorance and corruption.

If there were no Fed, our bank deposits couldn't be insured by the government. But maybe they wouldn't need to if the market quickly disciplined reckless banks. There certainly would be no petty cash fund for the bankers and government to dip into as the result of their own screw-ups.

If there were no Fed, over hedging might not be possible. But then, it may not even be necessary.

If there were no Fed, the value of our money would not necessitate its management, and the layperson wouldn't have to worry about debasement and excessive taxation.

If there were no Fed, deflation would be possible even in terms of money substitutes.

If there were no Fed, investors would have nobody to subsidize their stupidity, and thus wouldn't be so keen to offer themselves up as a sacrifice for the big wealth transfer. What I mean here is that the stock market isn't for everyone, but the Fed makes it seem so, for a while anyway.

If there were no Fed, the invisible hand wouldn't have arthritis and markets wouldn't be "inherently unstable."

If there were no Fed, Bush would really be the President, and Gore would have been too afraid to run.

If there were no Fed, other countries would not need a central bank of their own to finance the accumulation of dollar reserves so that they can trade and sustain the US dependent global economy (or inflation scheme).

If there were no Fed, the same nations might finally be persuaded to legislate private property rights as a means to achieve the same ends they only think they are today.

If there were no Fed, OPEC wouldn't need to exist to protect its monetary interests, and the world might never run out of oil.

If there were no Fed, we wouldn't have to save the stock market to keep the country from going to war, or from being fully employed.

If there were no Fed, the individual's word might be as good as gold, in business or in politics. Maybe even in law (joking here).

That's fifteen benefits the Fed interferes with and there are more, but time is limited.

I can think of no convincing justification for the existence of a central bank except for in its role as lender of last resort. But I can think of no compelling reason that would necessitate a lender of last resort, save where monetary policies or lending becomes profligate.

Sure, some believe markets are inherently unstable. We disagree, and propose that those claiming so have helped to justify the Fed. How does a lender of last resort ply its trade? Does it have an inexhaustible source of funds? It does, in our collective ignorance.

Nearly every time the Fed whisks its safety net onto the economy it leads to a new financial boom. Hmmm. I wonder what we should make of that?

I'll tell you what I think. Those condemning the market for its instability, completely disregarding the Fed's influence in this drama, provide the main support for the Fed's charter, and they may even benefit from the volatility or wealth transfer.

"Mankind soon learn to make interested uses of every right and power which they possess or may assume. The public money and public liberty, intended to have been deposited with three branches of magistracy but found inadvertently to be in the hands of one only, will soon be discovered to be sources of wealth and dominion to those who hold them; distinguished, too, by this tempting circumstance: that they are the instrument as well as the object of acquisition. With money we will get men, said Caesar, and with men we will get money." --Thomas Jefferson: Notes on Virginia, 1782.

Think about that quote the next time there is a crisis worthy of the Fed's help, in so far as it is only too happy to help. I wonder at what point they will get the idea to initiate the crises? It's only logical after all. Did I say that out loud...

The Greenspan Horse
A central bank can in theory act in the capacity of a gold standard (using the term loosely), but then why would we need the central bank at all? Well for one, a central bank that claims to be acting in such a capacity is asserting its superiority to gold-as-money. It claims to be better. It may or may not see gold as its natural enemy. In a perfect world it could even be an ally. But the central bank that does not strive to better gold-as-money must by definition be its enemy, if gold is in fact the better money. Else, how else could it survive?

Some people may need to beat up on other people to feel better about themselves. If gold is the better money, a central bank's survival would depend on its ability to either demonstrate its superiority, or to beat up on gold. If it chooses to employ the latter, it is no longer simply an opponent of gold. It becomes an enemy of money, and thus by extension, to capitalism.

If a central bank refutes the principles of sound money should we be surprised it is in support of too much of it? Should we be surprised at the legitimacy of terms such as elastic money, fractional reserve lending, or that growth requires more money?

Money doesn't breed greed and corruption by itself. Too much money does. It also breeds malinvestment. It should be no surprise who is ultimately responsible for that. It is the same institution we all are most afraid to banish. It is the institution whose currency we are trained to need.

Among the many confused enemies of money there is one group that fights with other theoretical weapons than those used by its usual associates. These enemies of money take their arguments from the prevailing theory of banking and propose to cure all human ills by means of an "elastic credit system, automatically adapted to the need for currency." It will surprise no one acquainted with the unsatisfactory state of banking theory to find that scientific criticism has not dealt with such proposals, as it should have done, and that it has in fact been incapable of doing so - Mises in "The Theory of Money and Credit," pp. 112, in the section, "The Enemies of Money; Money Cranks."

Mises spent the next page or two doing so - by summarizing the illegitimacy of this concept - and also devoted several hundred pages to it along with the many other banking theories of the day. The point is that many of today's popular generalist economic doctrines have already been scientifically rejected at least 75 years ago. It's just that most people are too lazy to know it. I hate that conclusion just as much as you may, but it's true.

Ignorance is not bliss. On the contrary, our leaders count on it.

Federal Reserve Chairman Greenspan is not ignorant. He was, or is a student of von Mises', and it is more than likely his mastery of the subject is what makes him such a worthy opponent to gold, capitalism, and money. Who better to take charge of the agents of inflation than one who knows why gold is consistently the better money?

A central bank is to capitalism what the Trojan horse was to the mythological city of Troy. It's not a safety net, but rather a tool for plunder. It's certainly not a gift, but then, neither was the big wooden horse.

It's Value Not Quantity
In a final note on inflation I'd like to share with you an email that I'd sent to a friend of mine asking our take on the (overall) debt issue and its consequences for prices. I've edited it a little since sending it originally:

I think most everyone perceives this debt issue as ultimately deflationary due to the quantitative aspects of currency and money that determines their values. As the credit cycle busts the money supply is expected contract, etc. Only, the proper phrase should be "currency supply," not money supply, because applying the latter term to M1, M2, M3, etc, is what convinces us that deflation is the natural consequence to an unbridled credit expansion, as if the value of the so called money only depended on its supply. If it did, the Fed would've been out of business long ago.

Thus, as these aggregates decrease in quantity we are persuaded to believe that the 'money' has become scarcer. Some of us contend that as the deflation becomes an increasing threat the rate of growth in this 'money' supply will be forced to grow and eventually result in hyperinflation as an unintended overreaction. We don't really disagree with that scenario, but I think it will happen as the Fed becomes increasingly desperate. Not about deflation, but about the value of the currency its banks produce in profligate quantities.

Mises showed years ago that the monetary aggregates were really only money substitutes. The value of those money substitutes is what we believe will fall against most everything else, and the supply of them will not matter because people will simply not want them (remember all talk about supply and demand is relative to each other) if they no longer qualify as money. An economy has certain requirements of money, and at some point during any inflation in it the substitute currency no longer does that job. The money is no good, if you will.

Despite the fact that process is ultimately set off by inflation it will matter increasingly less that the supply increases or decreases except to the extent those changes sway or lag a deterioration in the value of the currency or the demand for it relative to whatever qualifies as real money. In the end, it's all about the value of the dollar, not simply its supply, which is why I have become so convinced the inflation breakdown is upon us - almost regardless of what happens to money "supply."

The reason is that the value of the assets that kept demand alive for the currency has been falling for 2 years, finally uprooting the value of the currency itself. The next stage (after the attempted manipulation to save the day) is panic. And not just by the market. But predominantly in the highest offices of our land, when they find that the value of the dollar lies outside their control and when they are convinced it will devalue regardless of what they do. At the moment I think they still believe they can do something to prevent that outcome.

I believe the final decisions that will be made will involve creative ways to increase the so-called money supply for many reasons. But it will I think least involve desperation about deflation at the time. It will probably just be simple blank desperation - the kind that comes when you don't know what else can be done. In other words, the kind that will result when they realize that even less of the currency won't help it from becoming worth less.

Imagine the value of your own 'money' falling and there is nothing you can do about it. I mean nothing. Assume you have zero options except to control the supply of it, but you know that even decreasing its supply will not support its value. You might find that a large part of its utility was in how generally available it was and that by decreasing its quantity you'll simply help it become less desired, if anything.

That's what I believe the Fed will one day feel.

So they will increase its supply, and increase it, hoping that they can still come out ahead. At that point in the monetary cycle you've got something that looks like 1920 Germany.

There is no end to the ways the money supply can be persuaded to grow. It is true that we can't really push on a string. But the string analogy doesn't apply in the new economy. The reason is there are many strings and some of them are designed to pull along the value of certain assets, and thus push (influence) the demand for new currency.

The "money" supply is an important gauge to the extent too much of it undermines the prevailing system of production, for it's the efficacy of that system which ultimately determines demand for the currency. The current state of the system of production is such that it has been corrupted by too much currency. And more of it isn't going to make it all better.

Productivity can't save a society or system corrupted by easy money any more than it could've helped the city of Troy defend itself against the quiet army hidden in the belly of the wooden horse.

Ed Bugos

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