Monthly Archives: January 2009


You may have heard that the government proposes to create a “bad bank.” Duh! I think they have already created dozens if not hundreds or maybe thousands of bad banks!  Hello!

The U.S. banking system is insolvent, period. It is just a matter of time before it is recognized and dealt with.  If you would like to read the analysis, click here and read the second feature written by Roubini and Parisi-Capone.

The government proposes to use your money to re-capitalize the banks. This is great for the banks and terrible for you.  Why will the government re-capitalize the banks with your money?  Because bankers are influential, they run the Fed, they contribute millions to politicians in both parties,  they are all part of the same fraternity, and because they can.

Should we let all of the banks fail?, you may ask. Yes. We have deposit insurance to take care of small depositors and new banks will spring up in a hurry to fill the void of failed banks. The difference would be that all of the foolish bankers who got us into this mess would either have to find new jobs doing something else or they would have to re-capitalize the new banks with their own money.  The new banks would be much smaller, far more humble, and not inclined to take foolish risks.

Re-capitalizing the banks with taxpayer money is crazy. You cannot have capitalism without failure. Failure and bankruptcy are the price of bad decisions. When taxpayers cover the cost of bad decisions, there are more bad decisions to come. For example, the 1998 bailout of Long Term Capital Management by the Fed averted a financial mess. But the Fed may as well have sent a postcard to every banker on Wall Street and others around the world saying, “If you bet right, you will get millions in bonuses and if you are wrong, we’ll cover the losses.” Guess what happened: Bankers took risks in sub-prime and elsewhere that they did not comprehend!

Debt Deflation

America has been through three periods of debt deflation such as we are now experiencing, although each was somewhat different from the others. The first was in 1837, the second in 1873, and the last from 1929-1933.  A number of noted economists have analyzed and written about these periods. Each began with a period of extreme over indebtedness and neither money supply growth nor any measure of government spending was able prevent the ensuing economic decline because in each case, what economists call the “velocity” of money, fell.  That is to say, the turnover of dollars declined because people and businesses began to favor saving over spending due to the difficulty of repaying their debts.

In each case, the propensity of people to save and save rather than to borrow and spend and borrow and spend some more lasted for something like twenty years.  This resulted in each case in falling prices,  pressure on employment, and declining wages, in short, a debt deflation.  (It also planted the seeds of subsequent prosperity.)

The past periods of debt deflation also resulted in lower interest rates as people favored saving over spending. Whether it works that way this time remains to be seen.  The Fed is committed to buying Treasury debt in amounts large enough to keep interest rates low. The theory apparently is that low interest rates will discourage savings and will instead encourage spending  so that the debt deflation will be averted. This has been described as an experiment of uncertain outcome. If you care, you can read about this in detail here.


The question has been asked, will all of the Trillion dollar bailouts lead to hyperinflation?  I wish I knew for sure!  Here is my best guess today subject to change as conditions develop:  In the near-term we are likely to continue to see deflationary pressure.  While it seems probable that we will have high inflation at some point because of the excessive creation of money, the destruction of wealth from deflation is presently a much greater force.  If no one will pay more than $150,000 for what was once a $500,000 house, what difference does money supply make? That relates to people’s tendency to save rather than to spend and to the possible difficulty in borrowing, that is, slow money velocity.

I think inflation may be more likely at some point because it will be the only way the government can pay off the absolutely unsustainable federal debt. The problem for the government is that when people get a whiff of inflation, then they demand higher rates to compensate for the loss of purchasing power. This becomes a vicious cycle as even more money is needed to re-finance the debt.

If you are really interested in a good discussion of the cause of deflation, click here. I know that still does not answer the question about inflation but it will provide some food for thought.  Who knows? Maybe next week I’ll have the answer!

Times like these are challenging but they also present opportunities for building wealth.  The best first step in that direction is to get out of debt if you are not there already.                                                      <*))) ><


Gold on the Comeback Trail?

The financial crises or disaster, really, that is happening world-wide is making many people again seriously consider gold as money. Gold never circulates as money today, and never will as long as Legal Tender laws require the acceptance of paper currency and debased coins as lawful payment.

This is an example of Gresham’s Law, first spelled out by Thomas Gresham four-hundred-and-fifty years ago in a letter to Queen Elizabeth. This law is about as simple as they come: “Bad money drives out good.”  Gresham noted that people hoarded the coins that were not debased nor clipped, and spent the coins that were. Thus, the “bad” money drove the good money underground and also out of the county because foreigner traders, who were not bound by the Legal Tender laws, could refuse to accept the bad money.

One of the fundamental uses of money is as a store of value. Because governments in industrialized countries around the world are printing money to bail out banks and other lenders and to “stimulate” their economies with make-work projects (more accurately described as pork-barrel spending to buy votes), people are realizing that paper money is likely to become less valuable at a rapid rate at some point in the not-too-distant future.

The government officials in charge of this fiasco are hoping that low interest rates and other forms of  “easy money”  will cause people to forego saving and engage in more spending.  This is also the theory behind one-time stimulus payments that are expected to be part of the administration’s plans to get the economy going.  It won’t work.

History has shown over and over that people tend to hoard one-time payments. Estimates are that about 83% of the 2008 payments were saved and about 17% was spent.  Public works projects are great for buying votes but do little to contribute to sustained economic growth.  If it was possible to spend a country to prosperity, then Argentina would be an economic powerhouse.  It isn’t, and you can’t.

Using gold as money, or backing our currency with gold is an idea that both liberals and conservatives should love.  Liberals because it makes war far less likely when the county has to spend precious gold to finance its wars; and conservatives because it would take away the governments ability to manipulate the economy (and the voters) for political purposes.  

A gold-backed currency, along with the abolition of the Federal Reserve (highly unlikely!), would be the greatest transfer of power from government officials back to the people since the beginning of our Republic.  The current system has worked well to make us all debt-slaves.

There is much more to say about this topic but that will have to wait for another day. What do you think?

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Tim Geithner and Deflation

On New Years Eve, I promised that in my next post I would spell out why we face deflation.   I’ll even throw in a few free comments on Treasury Nominee Tim Geithner!

According to figures from the Federal Reserve Flow of Funds analysis (above), the wealth loss in U.S. real estate, stocks, mutual funds,insurance reserves, and unincorporated business equity totaled approximately Seven Trillion Dollars in the fifteen months that ended on September 30, 2008. When that report was compiled, the Standard & Poors 500 Index stood at roughly 1160. Today, (January 14, 2009) it closed at 832.5.  And home prices fell further in the final three months of 2008 as well, so total wealth loss is even higher today.

That loss of wealth is more than ten times the size of the TARP bankster bailout bill enacted by your friends and mine in Congress. Wealth destruction dwarfs the government’s attempts to guarantee all of our debts.  And remember, job losses really only began in large numbers in September. When job losses result in more mortgage, auto loan, and credit card defaults, wealth destruction and its deflationary impact is likely to accelerate.

The deflationary impact is the result of the forced sale, (or non-purchase in the case of things like autos and appliances) of assets.  Deflation is simply outstripping the ability of government to keep the consumer driven economy going at full pace. Debt destruction is running far faster than bankster bailouts.

In many respects, this is a replay of the 1930’s.  The boom and excessive debt of the 1920’s collapsed. Government intervened but could not stop deflation.  Now, the 1990’s boom and the excessive debt creation of the last thirty years have reached the point of unsustainability.  Lower prices will be the result of consumers inability to borrow and buy.

Now, lets consider Tim Geithner.

Mr. Geithner has problems. That makes him the perfect nominee to run the Treasury Department! Why, because a guy who should be prosecuted for tax evasion and instead is given one of the most powerful positions in Washington will do anything the Obama Administration want him to do.  He is being given a get-out-of-jail-free card and he will owe President Obama big-time! You can be sure he will not stand up for free enterprise and the the American Way. No way! He will be putty in the hands of the most socialist president in American history. This is not good news.

I have contacted my senators along with Senator Grassley, the ranking Republican on the Finance Committee, but it seems Geithner is likely to be confirmed. Go figure.

In my next post, I plan to talk about the comeback of gold as money. Weird idea, huh.

Three Schools – Three Names

The so-called Keynesian school originated with famous British Economist John Maynard Keynes (1883-1946). Keynes published The General Theory of Employment, Interest, and Money in 1936 and by 1941 his ideas came to dominate economic thinking in much of the West.

Monetarist school was popularized by Milton and Rose Friedman and is also associated with the so-called “Chicago School” from a group of economists at the University of Chicago. The Friedman’s 1980 book, Free to Choose explained, among other things, his thinking about the importance of the quantity of money.

The inflation of the 1970’s caused the Chicago school to overtake the influence of Keynes around 1980, but Keynesian thinking has made a comeback in the recent financial chaos.

The Austrian School comes from Ludwig von Mises, Friedrich von Hayek, and others.  They influenced the Chicago School, but have never found much favor in government, probably because they do not favor government intervention in the marketplace.

Government intervention always has unintended consequences!  Click here for a short article that demonstrates a perfect example. Intervention can always be expected to help some companies and hurt others, though it is seldom realized at the time.