Robert C Green II .com

I was listening to NPR this morning on my way to work. They had an interesting segment on how to save the financial system (The story can be found in written form here).

The first part of this story is really what we all already know – we are going to pay for being so indebted. Nationalization and socialism is just around the corner. Obama will raise taxes. Our debt burden will slow down the economy and make life quite difficult.

The section called “Twin Peaks” is what really fascinated me . The point is that there are two moments in US history where our debt levels have been equivalent to 100% of the GDP – 1929 and 2007. This is not happy news.

We are in massive debt just like we all were in the 1920s. Who let us get here? To put it simply, the Federal Reserve. We have been operating at record low interest rates since 2001. Now the interest rate is around 0%. That means that credit and lending have been super cheap. Cheap enough to cause market distortions that would encourage us all to borrow more than we could afford.

In the late 1920s the Fed knew the interest rates were too low but did not raise them quickly enough. Credit was too cheap and the country was in too much debt. The following is taken from http://eh.net/encyclopedia/article/Smiley.1920s.final:

By early 1928 the Fed was again becoming worried. Stock market prices were rising even faster and the apparent speculative bubble in the stock market was of some concern to Fed authorities. The Fed was also concerned about the loss of gold and wanted to bring that to an end. To do this they sold securities and, in three steps, raised the discount rate to 5 percent by July 1928. To this point the Federal Reserve Board had largely agreed with district Bank policy changes. However, problems began to develop.

During the stock market boom of the late 1920s the Federal Reserve Board preferred to use “moral suasion” rather than increases in discount rates to lessen member bank borrowing. The New York City bank insisted that moral suasion would not work unless backed up by literal credit rationing on a bank by bank basis which they, and the other district banks, were unwilling to do. They insisted that discount rates had to be increased. The Federal Reserve Board countered that this general policy change would slow down economic activity in general rather than be specifically targeted to stock market speculation. The result was that little was done for a year. Rates were not raised but no open market purchases were undertaken. Rates were finally raised to 6 percent in August of 1929. By that time the contraction had already begun. In late October the stock market crashed, and America slid into the Great Depression.

If you want to blame someone, then blame the Federal Reserve. The Fed has distorted the credit market by keeping interest rates artificially low and the money supply artificially high through a combination printing fiat money (money that is worthless) and fractional reserve banking. This intervention in the free market has caused many speculative bubbles that are now all bursting (dot.com bubble, housing bubble, the list goes on) and crashing our economy. Had the free market been left to work, lending would have slowed long ago under higher interest rates. This would have at least lessened these bubbles if not stopped them altogether.

If you really want to help, then End the Fed so this will hopefully not happen again.

Ever since I entered graduate school in 2005 I have had a (probably unhealthy) obsession with the economy, poiltics, and investing. This is all the more interesting because I was ( and hopefully will be again ) studying computer science. After reading quite a bit I have come to two real conclusions:

1. I am a Constitutionalist and a Libertarian
2. Our economic problems ( and quite possibly our political problems) are based on our monetary system

I believe my first conclusion explains itself. If you read the US Constitution or the writings of the founding fathers, then you know that you should be a libertarian who believes in the US Constitution. Enough said.

My second conclusion merits a bit more explaining. As it is, I believe it is wise of me to defer to those who have already made this argument. So let me stand on the shoulders of giants and send you here (The Case For Natural Money) to begin. I’ll most likely say more about this soon.

The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered.

~ Thomas Jefferson

Usually I think Glenn Beck is a bit over the top and pro war. This time he is right on the money.

Inflation/deflation actually has nothing to do with prices. A price is the value a person assigns to an object. This value changes over time, with adjustments in supply and demand, and with changes in production costs. Prices always vary and, in a capitalistic society, tend to decrease dramatically.

Inflation is an increase in the amount of available money in circulation. This erodes purchasing power and makes every dollar worth less. It also makes debt easier to pay off. This is why you cannot save and get rich. Our money is simply devalued too quickly to keep up.

Deflation is a decrease in the amount of available money in circulation. This adds to purchasing power and makes every dollar worth more. It also makes debt more difficult to pay off.

The Fed has inflated our money and financed it with debt. Welcome to the US and our fiat money system.

I just read this article and have again been reminded of why sound, private money is important to capitalism. There are a few reasons, especially in the USA. Most of these are spelled out in the article I just mentioned, but I will still repeat some here while adding a few of my own.

1. Sound, private money avoids inflation. Sound money is inherently tied to a commodity or some scarce resource. Since natural resources cannot be created out of thin air (as fiat money can) inflation is negligible and if it does occurs, occurs very slowly. This means that you’re savings actually is worth something as it is not devalued by every new dollar printed by the US government.
2. Sound, private money allows wealth creation through savings, not only investment.
3. Once wealth is earned through savings, investment is pursued as a way of gaining wealth at a higher rate.
4. Sound, private money limits the expenditures and flexibility of governments. This inherently limits government and keeps it out of your life.
5. Sound money provides just scales for commerce.
6. Private money insures competition amongst currencies.
7. The US Constitution says so: “No state shall coin money, emit bills of credit, or make anything but gold and silver coin a tender in payment of debts” (Art. I, Sec. 10)

I also feel that I should take a moment here to explain what inflation really is. In the world as it stands, countries use a monetary system known as fiat currency. This means that the currency has value simply because it is believed to have value. In reality there is no value to the currency – it is just paper and very low value metals.

Historically gold, silver, bronze, and copper had always been used as currency because the have intrinsic value and are scarce. The dollar itself was originally backed by gold as well. The old saying went, “Good as gold. Sound as a dollar.” This meant that government s could not print more money than the gold/silver that they had on hand.

After WWII, the US was in a rare position and, as its currency was backed by gold and still sound currency, it became the worlds reserve currency. US dollars were a safe investment.

Once the backing of gold was removed (Thank you FDR and Richard Nixon) the government was free to print as much currency as it wanted in order to fund programs and pay bills. They still do this and they print roughly 10% more money every year. This means that every year the money supply increases by roughly 10% and the value of your cash on hand decreases by 10%. Basically US citizens don’t only pay taxes, they also let the government steal an additional 10% of their wealth through inflation.