Of (Economic) Myths And (Central Banking) Heretics

Now that a revisionist political backlash against a system that failed its constituency in every possible way is in full force judging by the sea of red almost visible on the metaphoric CNBC heatmap (and literally so, after a casual glance at the turn in the AUDJPY pair derivative known as the futures), it is time for today's little political diversion to end, and for everyone to redirect their attention to where it belongs: namely the Marriner Eccles building located ironically enough on Constitution Avenue in D.C. With just over 12 hours left until what some consider the most important decision in the history of Keynesian economics, and of the fiat monetary regime, we wish to bring to you an extract from William Buckler's recent edition of his most excellent Privateer newsletter. In it he talks about myths and heretics, about dogma and revolution, about ignorance and abuse thereof, but mostly, he talks about the Federal Reserve, and its imminent end. Since pretty much everything else about what may happen tomorrow has been said, here is an essayistic view about what may happen the day after tomorrow.

Of Myths And Heretics

Around 250 BC, the Greek mathematician Eratosthenes proved that the earth was round and calculated its circumference with remarkable accuracy. Almost 1800 years later in 1519, 237 men under Ferdinand Magellan set out in five ships from Seville in Spain. Three years later, 18 men in one ship returned, having completed the first widely known historical circumnavigation of the earth. Even after this proof, many clung to the myth that the earth was flat. Some still do to this day.

In the 15th century, Copernicus displaced the Earth from the centre of the universe, holding that it revolved around the sun - which was the centre of a universe of fixed bodies. In the 16th century, Galileo discovered the moons of Jupiter, proving that not all “heavenly objects” orbit around the earth or the Sun. Giordano Bruno went still further, maintaining that the universe was infinite and therefore had no “centre”. Copernicus got away with it, not having the instruments to prove his contention. Galileo was forced to recant. Bruno refused to recant and was burned at the stake. The reaction to these discoveries by the “powers that be” is typical and reverberates throughout history.

In 1654, Bishop Usher published a work in which he solemnly calculated the age of the earth to be 5659 years. According to the learned gentleman, “Creation” took place at nightfall on the “day” preceding October 23, 4004 BC. Both the Egyptians and the Babylonians had calendar systems which went back further than that. No matter, the “age” of the earth was still hotly contested in the “developed” world in the late 19th century during the debate over Darwin’s theory of evolution.

The Great Modern Myth - Orthodox Economics:

You can unearth long lasting “debates” in every branch of human knowledge. There is a very old and very tenacious tendency to never let the facts intrude on a good theory. In this regard, the study of economics and finance is not immune. The problem is that it is more destructive than any other modern controversy - as the world is just now beginning to discover.

All forward steps in any field of knowledge are made by those who do NOT conform to the orthodox. The problem is that once a particular set of rules and theories does become orthodox, a huge vested interest is quickly built up, all of whom are united in their desire to ridicule, suppress or shun those who do not conform. Religious controversies are the best known example of this, but the practice is rampant in any field of endeavour. It reaches its most virulent level in areas which impinge directly on politics in general and the pursuit of political power in particular. The 20th century had the sad distinction of being the era when government and economics became (seemingly) inextricably intertwined - an even more dangerous development than the previous marriage of church and state.

One of the great achievements of the Founding Fathers in the US was their constitutional separation of church and state. This absolute separation has since been sadly eroded but it still stands as one of the laws which governments must obey and thus as an impediment to the pursuit of power. With economics in general and money in particular, the opposite is the case. Here, there is no constitutional or any other kind of barrier to keep the government out of the lives and the pockets of its citizens. The justification for this has evolved into modern orthodox economics. It is taught by (almost) all institutions of “higher” learning and practised by (almost) all economic decision makers both inside and outside government.

The “Sanctum Sanctorum”:

Translated from the Latin, this means “holy of holies”, the most sacred place within a sacred building. The same is true with a set of ideas which seeks to justify the conduct of human beings. At the base of these ideas, there is a core which cannot be talked about, let alone debated, without incurring the wrath of those who rule. At the heart of government power today lies their complete control over money.

In an article in the UK Telegraph newspaper on October 27, Mr Ambrose Evans-Pritchard talks about “the New Keynesian priesthood that rules our money and our lives”. The metaphor is an apt one. We can only hope that this “priesthood” will fall without the Reformation” that hit the Catholic Church in the 16th and 17th centuries. We can also hope that the “revolt” won’t take as long this time. The “Reformation” lasted over a century and ended - in 1648 - after 30 years of one of the bloodiest wars in Western history. The Fed is, however, nearing its century and there has been no shortage of wars.

Orthodox Fed Policy:

Read any press release put out after any Federal Open Market Committee (FOMC) meeting over the past 20 plus years. You will find two statements (or reasonable facsimiles) contained in it. One is that the policy aims of the Fed are and will remain the maintenance of “sustainable economic growth and price stability”. The other is the perpetual affirmation by the Fed that “longer-term inflation expectations remain contained”. These two pieces of monetary “holy writ” were a constant right through the long “reign” of Alan Greenspan which began way back in August 1987. They remained a constant under Ben Bernanke - who ascended the US monetary throne in February 2006 - until very recently.

In the nearly 70 years since the US Dollar officially became the world’s reserve currency in 1944, the Fed has always held as financial “holy writ” its ability to produce both economic “growth” and price “stability” through its monopoly over the US currency. Even the “inflationary 1970s” and a short period of 20 percent plus US interest rates did not shake that belief. The Fed has never wavered in its belief that no matter how many of them they created out of thin air, the US Dollar would NEVER be rejected.

Economic Growth And Price Stability?:

Economic growth and price stability are the stated aims of the Fed. In orthodox (read Keynesian) economics, the two are mutually exclusive. You can have one or the other but you can’t have both. To understand this, it is only necessary to realise that Keynesians measure “economic growth” by means of statistics, notably the Gross Domestic Product or GDP. According to the Wikipedia, the orthodox definition of the GDP is: “the market value of all final goods and services made within the borders of a country in a year”. A “market value” is a price. If prices are “stable”, market values cannot increase (or decrease). And if this is the case, then economic growth cannot take place. According to the Wikipedia again: “Economic growth is the increase of per capita gross domestic product (GDP). It is often measured as the rate of change in real GDP”. If there is no change, there can be no growth.

In the real world, prices are exchange ratios between goods and services on one side and money (the medium of exchange) on the other. In that same real world, the only constant is change. That being the case, stable prices are not only undesirable, they are impossible. There is one, and only one, stable item which can be introduced into the process of production and exchange. That one stable item is the physical dimension of what is used as a medium of exchange. We are not talking about the number of units of money, we are talking about the composition of the individual monetary unit. A defined weight and fineness of monetary metal is and has always been the ONLY way to produce this “stability”.

Given the use of such money and a completely unhampered market, prices are free to fluctuate as much or as little as circumstances dictate. In an economy which is truly “growing”, the supply of goods and services available in exchange for money is increasing. New wealth is being produced faster than existing wealth is being consumed. In such an economy, prices are not stable, they are FALLING!

Falling prices are what the Fed and every other central bank fears more than anything else. The reason for this becomes obvious when one considers the nature of the “money” these central banks produce.

“The Difficult We Do Immediately”:

“... The impossible takes a little longer.” This motto has been used by many organisations, the original being the US Army Service Forces in WWII. Actually, it is a perfect motto for Ben Bernanke and will hopefully stand in future as an epitaph of the Fed and every other central bank.

The “difficult” part of what the Fed and every other central bank does is not actually very difficult at all for them, but it most certainly would be for you and me. Today, one of the accepted and primary roles of governments everywhere is to “run” the economy. It is true that they spend all their time passing new rules and regulations into law in order to do the “running”, but their primary means has been and remains their total control over the money in the nation they govern. The institution which justifies and facilitates this is the central bank. It actually produces the money, both physically and as computer entries.

The “impossible” part is the one which Ben Bernanke is just starting to suspect now. For almost forty years, the Fed has maintained the facade that a purely paper fiat money can function in a market economy just as well as an objective REAL money can. Central to this task is their contention that they can control the economy and prices by manipulating the amount of “money” they issue. This is the impossible. It has never been successfully done in the entire history of paper fiat money.

When the Fed talks about “stable prices”, it is not actually serious, it just wants to be taken seriously. The last thing in the world which the Fed or any other central bank wants is stable prices for the paper assets which form the ultimate “collateral” for the paper money they emit in such vast torrents. Any lowering of these prices puts the Fed’s “mandate” of economic growth into danger. From there it is a short step to the collapse of the money itself which has absolutely NOTHING else behind it. To forestall that step being taken, Mr Bernanke is now poised to defy the impossible on a scale never before attempted.

Jettisoning “Stable Prices”:

Ben Bernanke started warning us all about the perils of what he called “deflation” long before he became Fed Chairman in 2006. He gave what is probably still his best known speech way back in November 2001. His title was: “Deflation - Making Sure “It” Doesn’t Happen Here”. He proceeded into the meat of his speech in the following manner: “So, is deflation a threat to the economic health of the United States? Not to leave you in suspense, I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small.”

Almost nine years and some hair raising experiences - most of which had to do with very “significant deflation” in the paper asset markets later - Mr Bernanke has changed his tune. Not only has he decided that “deflation” (falling prices in his jargon) is a significant threat, he has decided that it is an imminent threat. Sadly, the direct means at the disposal of the Fed with which to deal with this threat have already been deployed to their fullest extent. Official US interest rates have been non existent for almost two years. The Fed’s balance sheet - paper “assets” which still retain a “value” only because the Fed owns them - exceeds $US 2 TRILLION. The Fed spent most of 2009 monetising Treasury debt with no benefit to either the real US economy or to the still uncomfortably high official US unemployment rate.

So now, the whole world awaits the Fed’s announcement of a second attempt to pump up the US economy by means of creating US Dollars and using them to buy US government (Treasury) debt. As the “decision date” of November 3 draws closer, the focus of global markets discards almost all other considerations. But what is it, precisely, that the Fed hopes to accomplish?

Encouraging Inflationary Expectations:

When, not if, the Fed and Mr Bernanke do announce their second program of US government debt monetisation, they will have admitted in public that the first (March to October 2009) program has failed them. Further, they will have confirmed for a second time in about a year and a half that the ultimate job of all central banks is to act as a “lender of last resort” to the governments which control them. Third, they will have demonstrated for all that have eyes to see that the “full faith and credit” of government which is the only underpinning for modern fiat money is an illusion. It is no more credible in the light of FACTS than contentions that the earth is flat, that the universe is fixed in place or that “creation” took place well over a million years after the first recognised human beings walked the earth.

Modern governments and their central banks cling to the tenets of orthodoxy in the economic and financial realm with fanatical zeal. They have no choice, their power depends upon them. The situation has now reached a level where the US political and financial establishment have decided that to retain power they have no choice but to risk losing it altogether. The surest evidence of this is Mr Bernanke’s stated intention to encourage “inflationary expectations” amongst the American people.

The Eye Of The Tiger:

Like most organisations whose main aim is to accumulate power in the hands of the government, the Fed has always relied on what Elihu Root (see the quote earlier in this section) described as “optimism”. Another word for this is ignorance. Ignorance is not a pejorative term, it simply means a lack of knowledge in a given field of human endeavour. No human being has ever lived who is not totally ignorant about many vitally important areas of knowledge. But no VALID field of human knowledge has ever relied upon ignorance as its prime justification. This is what the Fed now proposes to do.

The fact is that inflation - an increase in the total stock of money - is the modus operandi of every central bank which has ever existed. Central banks still exist only because the vast majority of the people they rule do not equate what they do with inflation. Mr Bernanke now proposes to change that. In doing this, he is placing the biggest bet in history on economic and financial ignorance. All such bets lose.