Tuesday, October 06, 2009

"Shabby Secret"

Even if I didn't know that gold hit a new all-time high today, this blog's site stats would have told me something was going on, with lots of search engine hits on the posts I've made about gold. Without getting into a longer post, gold's surge represents something basic: consequences. And while that surge may be overdone in the short term, regular readers know what I think about the long term. In early September I wrote:

For those who understand the big-picture intersection of monetary policy, statism, and the exigencies of a system in which all of Wall Street is explicitly and permanently backstopped, preparation and protection -- and that means a mix of national borders as well as assets -- should be paramount right now.

As consequences continue to show up in gold and the currency markets, the debate will get louder about who is to blame (a reader emailed me that gold's new high was a popular topic today -- no doubt accompanied by lots of exclamation marks -- on the Right's politically-oriented websites). There's no doubt that Obama's spending is causing international concern about the dollar. But just as important is the new status quo of "too big to fail" for the financial sector and what that means for various aspects of Federal Reserve policy. The implicit government guarantee of a few GSEs was an important factor in the financial crisis. There's now an explicit government guarantee of every large financial institution on Wall Street. Almost two years after the Bear Stearns debacle, there are still no plans by the government to unwind or repudiate that guarantee -- indeed, some believe it should be codified -- so apparently it's permanent. And remember, the guarantee encompasses more than just occasional hundred billion dollar bailouts. It means unlimited liquidity, as well as artificially low interest rates that let banks "repair their balance sheets" by borrowing for almost nothing and lending to the public at 20%. The rest of the world sees this. As the currency markets and gold get more attention, the main challenge to honest discourse will come from those who focus solely (and predictably) on Obama's spending while ignoring the importance of Wall Street's perpetual blank check.

A quick point about "preparation and protection." In every country that has gone down this road, the only people who weren't destroyed financially were those who took measures to protect themselves. I don't know how long the protection window will stay open. But I don't think it's a stretch to suspect that in Bernanke and Geithner's desks, there are contingency plans -- not yet discussed in any leak-prone groups, and never to be found in transcripts or minutes of meetings released to the public -- to close that window. I'm not just referring to anti-gold measures. Plans could include many different types of capital controls, including restrictions on the individual's ability to own foreign currencies.

The best explanation of why protection can't be tolerated past a certain point is Alan Greenspan's 1966 essay, "Gold and Economic Freedom." This essay is well known to Fed watchers and gold bugs; I first read it over ten years ago, and it strongly influenced how I think about economic policy and the financial markets. Before Greenspan retired, Ron Paul asked him if, having been Fed chairman, he would take back any part of it. Greenspan's reply: "I wouldn't change a single word." If you've never done so, read the entire essay and find out what the "shabby secret" is. In this excerpt, keep in mind that an updated definition of "the welfare state" should include Wall Street:

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.


Blogger Jimmy the Saint said...

Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes.

Sounds like Greenspan's love of Ayn Rand is coming out here. Has Greenspan repudiated his government(was he technically considered a Gov't employee?) pension? Does he still think huge Wall St. bonuses are a good idea?

10/07/2009 2:11 AM  
Anonymous Pete said...

Why can't the Fed use a base dollar price of gold to determine its money supply decisions? Gold goes up;too much money in circulation. Gold goes down; too little money in circulation. Wouldn't that help stabilize the dollar?

10/07/2009 10:14 AM  
Anonymous Thomas Daulton said...

Ahhh, apparently you didn't read the article, Pete. Greenspan's whole point is: mathematically, that would be a great plan. Easily do-able. The problem is, politically, that leads to a point where the government's spending money (i.e., deficits, credit, essentially via fiat currency) would dry up right at the very moment when it wants to shower some largess upon its favored and fortunate friends. No government ever seems able to make the rational choice at that moment. Those types of rules get broken faster than pie crusts. Doesn't matter what form of government, nor the politics of its friends; it happens whether the friends are Left or Right. Mostly I detest everything about Ayn Rand, Objectivism, and its followers -- but once in awhile they hit upon a nugget of truth, and this is one of them.

{Don't gloat too much, though, Rand-oids: of course it should go without saying that the very same author of this article later went into government and fell into this exact trap he wrote about, in a truly spectacular way. Objectivism's most powerful acolyte was just as blind as all the State-ist schmucks that Objectivists constantly denigrate. We will all spend decades paying for Greenspan's belief that the Finance, Insurance, and Real Estate sectors were inherently incapable of ever doing any wrong. Not a very "objective" viewpoint on his part.
The power of money tries to blind and bias you, no matter how theoretically solid your philosophy; therefore I think it's a howling error to write a philosophy based specifically on the morality of money.}

10/07/2009 1:31 PM  
Anonymous Pete said...

Thomas Daulton, I did read the whole article. I was not referring to the gold standard. I was referring to the fed using the dollar price of gold as an indicator of the relative demand for dollars. Try re-reading my post.

10/07/2009 4:33 PM  
Blogger Fel said...

What a greedy bastard Greenspan is. All that money creation helps rich people a whole lot more than the poor schmucks Greenspan and his ilk are eternally trying to protect their ill-gotten gains from being "confiscated" for.

10/09/2009 3:11 AM  
Anonymous Thomas Daulton said...

OK Pete, so let's imagine that the Fed is following your advice right now, today. Gold has hit a record high. Your mathematical indicator is flashing "Red Alert". There are too many dollars in circulation. So what does Ben Bernanke do when he wakes up this morning?

Besides punditry, Bernanke's only real power is to influence interest rates. (No comment on whether this power is "legal".) Does he raise interest rates? Are you crazy? In the middle of the greatest depression in 70 years? What would the business press say?

Does he recommend to his boss that he cut the Federal Budget? OK so how do Barack and the Congress respond to his recommendation...

* Cut the military budget? Are you crazy? When everyone is saying that we need 40,000 more troops in Afghanistan? To say nothing of how the big military contractors will react if anyone tries to whittle down their cash cows.

* Take back some of those stimulus and recovery "loans"? First of all, that's a pittance if they're not gonna cut the military budget. Second, do they sit back and watch the tens and hundreds of thousands of layoffs mount up in the headlines, with an election coming up next year?

* Cut some entitlements? Trim a few hundred thousand dollars off of TANF here and there? Do you remember the election ad about shaving pennies in half?

Besides which, the spin I'm hearing on the news today is that the weak dollar is a sign that investors are investing in other things besides currency -- businesses and stocks -- which is a sign of recovery. Oh and a weak dollar is strengthening our exports, hypothetically.

Business, the press, and the voters are going to crucify anyone who actually acts on the mathematical recommendation of reducing the money supply. It's castor oil that nobody wants to give or take. Sure we'll have some up and down fluctuations, but in the aggregate, no government can actually follow the rule you recommend.

In a sane, rational economy, one of the first three above decisions would be made (raise interest, cut major military spending or reduce welfare for big businesses.) We don't have a sane, rational economy.

10/09/2009 11:29 AM  
Anonymous Thomas Daulton said...

No really, this is an honest question: am I missing something fundamental here? As far as I know, the Fed can create dollars (through bond-selling, essentially debt), and the Fed can _inject_ liquidity through various nefarious means, but the Fed cannot destroy dollars already in circulation. Right? They have ceded that power to private banks, and private banks only do that through destruction of credit lines. Meanwhile, when Congress mandates deficit spending, money is created. Right? The Fed can slow or stop the rate of money creation, but can't destroy money. Or can they? Meanwhile they'll have a tough time slowing the rate of money creation in the middle of a gigantic financial crisis. Will it happen?

10/09/2009 11:48 AM  
Blogger Unknown said...

I really don't see hyperinflation happening in the US. Demand is too low. All the money the Fed is printing is small compared compared to the reduction in the money supply caused by the credit crisis.

We seem to be tracking Japan's trajectory of two decades ago, and the Yen didn't have hyperinflation.

Mr. Daulton: The Fed makes a lot of short-term loans. By failing to roll them over, the Fed can destroy money. Usually this is done by raising the relevant interest rate, discouraging borrowers.

10/12/2009 10:08 AM  
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