Banking and the Money Supply II: Deflation

Deflation vs. inflation: which is it going to be? We've looked at what the terms mean. We've looked at the mechanisms that bring about inflation and monetary statistics to describe the money supply. Now its time to look at the reverse process: deflation. We will also look at a few phenomena that have no influence on the money supply, but are sometimes blamed for one or the other.
  
Deflation

As you might have already guessed, deflation occurs principally through the reversal of the processes that lead to inflation. It can also be accomplished through a few other processes, which will also be discussed.  

Sale of Assets Just as when the FED buys assets money is created, when it sells assets money is destroyed. Because of these twin properties, I like to think of the FED as a something like an infinite capacity black-box: when assets go in, money comes out; when assets come out, money goes in. That's the easiest description I can think of.

In a more detailed analysis, the FED will sell assets into the market, withdrawing money from the deposit accounts of buyers. The FRN liability (Federal Reserve Notes, or US dollars for those of you who forgot) is redeemed and retired by the FED as it absorbs the FRN into its vaults and out of the banking system, and the asset passes from the vaults of the FED back into the market. The asset and liability columns of the T-account are wiped clean:
In the course of this process, bank reserves are reduced as those FRN leave the banking system. If the banks are comfortable with their reserves and reserves are above the legal requirement, nothing more need occur. In our example, the bank is in trouble as it has no reserves and will have to sell other assets to meet legal reserve requirements. Or go to jail. If banks choose to increase reserves for whatever reason, the process continues. By selling their own assets or calling in loans, banks increase money held in reserve, clear their T-accounts of assets and contract the money supply further:

Our example is a little extreme for two reasons. First, I am feeling lazy and did not want to draw out a whole new T-account chart. I just cut and pasted it. Normally, it would be a little strange for a bank to sell to its own depositor, but I suppose it might happen. But it does illustrate a good point. Selling assets also increases the reserve ratio by reducing liabilities, e.g. deposits, e.g. the money supply, not simply increasing reserves. It is an unwinding of the fractional reserve process. I could have had the bank sell to another bank or another private entity to simply increase its reserves. But that would have placed a strain on the buying bank, which would have lost reserves and would likely have had to shuffle things around even more. And I just can't stand the thought of having to draw out another and another of these durn things to explain all that.

The net effect overall from the banks' point of view is a transfer of assets out of the banking system and a reduction of bank deposit liabilities. From our point of view, it is a reduction in the money supply. Bonus question: what is the net effect when fractional reserve banking is used by banks to buy assets, then when the banks get in trouble and are unable to pay back depositors, the FED prints money to bail them out instead of forcing them to sell their assets to raise the money? Hmmm? Anyway, the point is that selling assets effectively reduces the fractional reserve multiplier, and the money supply. That constitutes the "desirable" deflationary routes engineered by the FED for control of the money supply, and autonomous contraction initiated by banks themselves. Incidentally, from a graph of the AMB, it is clear that the FED rarely deflates through the sale of assets. M1 and M2 indicate that the banks themselves are more likely to contract the money supply on their own, and at those times not by very much. For the most part, the monetary base is continually increasing, with short periods of stagnation. S0, there you have it, the two major forces of deflation: banks allocating more money towards reserves, e.g. decreased lending/selloff of assets, and the sale of assets by the FED. The exact opposite of inflation.  

Other Deflationary Forces

 The other routes for deflation are not nearly as important. First, depositors could withdraw currency en masse and hold it as cash outside of the banking system. This is deflationary because money held in physical cash is not on deposit with the banking system. It is held in deposit in your pocket, and cannot serve as reserves for the fractional reserve process while it is sitting in there. If enough cash is withdrawn, it will force banks to begin selling assets and call in loans in order to meet reserve requirements, or it will force the FED to purchase assets to provide banks with new reserves.

Of course, eventually the money that is withdrawn is likely to be redeposited and the effect reverses. Two exceptions exist. The first is that the withdrawn money is destroyed, as in, put into a pile and set on fire. Obviously, this is rare. As angry as some of us may get over inflation, we don't generally do this.

The second is not so rare. The money can be held permanently by private persons outside the banking system. This is most frequently the case for money that leaves the country. Many foreigners choose to hold paper US dollars as savings in preference to their local currencies as the purchasing power of the US dollar has tended to hold up better in the recent past, despite the inflation engineered by the FED. These dollars circulate in "bankless" black markets, or are simply stored up for a rainy day.

Central banks can (and do!) also hold US dollars as reserves, though they usually prefer Treasury debt. These dollars "back" their own currencies, just as our currency is "backed" by the Treasury debt and other assets held on the FED's balance sheet. By buying and holding dollars, foreign central banks create more of their own currency and reduce the quantity of dollars in circulation, artificially propping up the value of US dollars and distorting trade. But that is a long and involved topic of its own best left for another time... Imagine: there are banking systems out there even more screwed up than ours! In any event, this effect tends to tamp down the inflationary effect of printing ever more dollars, but could come back to haunt holders of US dollars in the event of a major devaluation. But I suppose that in a major devaluation this will be the least of our worries.  

Bank Failures and the FDIC

At one time, bank failures also resulted in deflation of the money supply. Bank failure occurs when financial strains cause the value of a bank's assets to be substantially less than the liabilities imposed by the bank's expenses, deposits, or depositors attempting to withdraw their funds all at once, e.g. a bank run. Over the past year or so, a few banks have failed almost every week. If you check Yahoo!Finance late on Friday afternoons, after markets have closed, you can usually read about them in the news stories. The FED closes them when markets are unable to respond to prevent panic. It's been happening like clockwork for some time, though most people pay little attention.

Since the introduction of the FDIC, bank runs have become virtually nonexistent, but at one time they were frequent. Note that bank failure is not the same as bankruptcy. Technically, banks are always bankrupt, in that they cannot possibly honor all their contracts simultaneously. They only stay in business because not all contracts are enforced, not to mention because the FED and the government cover for them when they get into trouble. This is different from a businessman who owes more money than his business is worth. The businessman is not obligated to pay his debts all at once; his debts are amortized, and as long as he can make his payments, he is still in business.

In contrast, a bank is required to refund all of a depositor's money at any time. All the depositor has to do is ask. This is a basic problem of time mismatch: borrowing short and lending long. The carry trade. Whatever you want to call it, depositors essentially act as ultra-short term lenders or creditors, while the bank is busy making long term investments. The bank can't possibly fulfill the terms of its agreements, if they are enforced. The banks are fully aware of this discrepancy in expectations, and in many ways it is a sort of fraud.

This is precisely why deposits are listed under the heading liabilities. The bank is obligated to pay them back. In the old days, when a bank run would occur, word got out and depositors began withdrawing money until there was none left, then the bank was forced into liquidating its assets and repaying what deposit claims remained with the funds raised through asset sales. Naturally, there was not enough, and some depositors lost money into thin air. Money was destroyed in the process, and M1 or M2 would have reflected this loss as deposits evaporated and the money supply contracted. Hence, lost deposits due to bank failures results in deflation. With FDIC protection, accounts are insured up to $250,000. Most people are smart enough to spread out deposits so that they get full protection, but theoretically if a deposit was over this amount, the surplus would evaporate in the event of a failure.

You can simply accept that "deposits are protected" but it is instructive to look at the actual transactions to understand how money is conserved by this process. The FDIC does not actually have any money. It has assets in the form of Treasury debt, much like the FED itself. When the FED takes control of a failing bank, it begins the process of liquidating assets and paying off depositors. The remaining funds that must be raised are obtained by selling the assets held by the FDIC. These assets are sold to other banks, which buy them with money from reserves, initiating fractional reserve multiplication. So the money "lost" in the failure is made up for by fractional reserve multiplication. Pretty simple, really, but it took me awhile to get it.

The FDIC was created in 1933. Prior to 1933, bank failure resulted in deflation, but since that time it has not. So long as Congress continues to authorize funds for this agency, it will not. There is no need to fear a catastrophic deflationary spiral as a result of bank failures, which some claim occurred in the early years of the first Great Depression. Of course, it is still a political question, since the FDIC has already pretty well exhausted its asset base and Congress could theoretically refuse to provide any more funds, but I think it is a rather safe bet that Congress would not do that.  

Other Notable Absences: Deficit Spending, Default, and Falling Asset Prices

A few readers may not see their pet deflationary or inflationary forces at work here. Of course, I have missed some, as this is not exactly an exhaustive work. On the other hand, there are many events which have been attributed as inflationary or deflationary but in reality are not. I'll go through a few here.

Contrary to popular belief, deficit spending is not inflationary. Deficit spending is funded by issuing Treasury debt certificates. These certificates are bought by private investors and the money is transferred to the government and spent into the economy at large, passing back into private hands. No money is created in the process.

Deficit spending by the government is no different from the issuing of corporate bonds. The result is private transfers of money, not creation of money, and not inflation. Banks may buy the debt with depositor funds, yes, and in this case it results in multiplication by fractional reserve accounting. But the inflation is a result of the accounting, not the issuing of the debt itself. The FED may buy the debt directly, resulting in inflation of the monetary base, but again, that is as a result of the bank buying the asset, not the debt itself.

One way that deficit spending can get politically intertwined with inflation is that a large deficit can create a political incentive for the FED to buy the debt, increasing the monetary base in the process. Many, if not all, central banks engage in this nefarious practice regularly. By having the central bank buy debt, the government can obtain loans at interest rates far below market rates since the central bank supplies artificial demand for the debt. And when debts begin to pile up, it can be tempting to have the central bank simply buy up all of the debt and forgive interest payments owed by the government. This results in large-scale inflation for holders of the currency and repayment of debt in currency of depreciating value, effectively giving the governments creditors the shaft and allowing the government to default on its debts without legal bankruptcy. Nice of them, huh? I guess arbitrary authority is a good gig if you can get it...

This is called debt monetization, and though it will destroy a nations credit rating and its economy, it becomes a very real possibility as interest payments begin to absorb a politically unacceptable fraction of the budget, or fiscal deficits begin absorbing politically unacceptable fractions of GDP. The former will generally lead to the latter. Many nations are approaching these levels of debt, in particular the US and Japan, two of the largest economies in the world. A rise in interest rates to normal levels after years of suppression by central bank policy could effectively render the debt unpayable, especially for Japan where debt approaches 200% of GDP.

But, as I said, fiscal deficits in and of themselves do not cause inflation. It becomes inflation when central banks like the FED fund the deficit by buying debt certificates. Whether or not the central bank chooses to do so is a political question, not an economic question, though it does have economic consequences.

Occasionally, you will encounter the belief that default on a loan destroys money and results in deflation. You are especially likely to believe it if it is your money! This is not the case, however. The lender will not be paid back, and the price of his asset (the bond) goes to zero. But the money he lent to the borrower is still in the economy, whether or not he ever sees it again. Whether or not loans are repaid has no effect on the money supply.

 A fall in asset prices, like a stock market crash or the popping of a housing bubble, does not result in deflation either. The price of the asset in question simply falls. Your investment account or 401(k) does not "have less money in it." It is "worth less" (or just "worthless," as the case may be!) But the same amount of money is still floating around out there in the economy. A brokerage account contains assets, not necessarily money. A rising stock market does not create money and a falling stock market does not destroy it.  

Conclusion

Monetary inflation occurs principally through the purchase of assets by the FED and through fractional reserve banking. Fractional reserve accounting increases the money supply by counting the same money twice, once as deposits and a second time as money lent out. By lending money out which gets re-deposited into the banking system, fractional reserve banking can increase the money supply by up to ten-times reserves, which are the initial deposits provided by the FED through purchase of assets.

Deflation occurs principally through the opposite mechanisms: sale of assets by the FED and banks choosing to increase their cash reserve holdings by selling assets and calling in loans. A few other avenues of deflation exist, but these are more limited in scope. Deficit spending, market crashes, defaults and bank failures do not result in changes to the money supply. These forces, however, can exert political pressure for central banks like the FED to create inflation in order to "paper over" these problems and allow debtors to legally shirk their obligations.

Next up: how the FED influences interest rates!

Three-Cheers for Mark Alger!

Mark Alger writes a most excellent piece at Eternity Road in which he castigates a leftist troll for his advocacy of socialized medicine:

What the parties seeking to socialize our system fail to apprehend (or admit) is that they are headed in exactly the wrong direction, that if they turned around 180 degrees and began dismantling the system of price controls, of market-distorting subsidies, the counter-productive Gordian Knot of regulation and myriad state regulations (which, I submit, are ultra vires), there would be an instantaneous response from the marketplace—a flowering, if you will, of resources and goods and services that beggar even the miraculous market we have now in medicine.

Particular kudos for his remarks on the success of the Underwriters' Lab vs. the FDA:

Not stumping to remove regulation entirely, here, but a great deal of what passes for regulation is, in reality, ass-covering for bureaucrats and does little to enhance public safety. (In fact there have been myriad anecdotes relating just the opposite—that FDA meddling has made the market in drugs LESS safe.) I submit we would be far better served by a system modeled on the Underwriters’ Laboratories, which has made certain classes of manufactured goods far safer than before, and at virtually no cost to the consumer. (Nobody’s asking for government insurance for flat-screen TV’s, after all, and have you been watching the prices plummet on those things lately?)

Probably 95% of the problems we have with healthcare are due to non-market forces screwing things up. What I have found most frustrating about this debate is the narrow characterizations which been allowed to participants. I don't care whether you are a capitalist or a socialist, there are serious things wrong with our system, but you'd never know it from the way most conservatives have defended the "free-market" we have in healthcare and how great it is without the slightest qualification or reservation. The Left could not have scripted a more insipid or alienating argument to people who really do experience legitimate difficulties navigating the obtuse, Byzantine system we have created. It goes something like this: you either suck it up and cough up ungodly sums to pay for things that would be much cheaper if markets were actually free or you are a commie bum looking for a handout. Sorry, no dice with this capitalist. Or with Fred Reed:

I believe that Econ textbooks say that price controls haven’t worked from Diocletian on. Wrong. They work splendidly. Ask Bausch & Lomb. If you could make over twenty-two bucks on a dime’s worth of salt water, wouldn’t you be in favor of governmental interference in the economy?

Let me explain medicine briefly. It’s an unholy scam. Here in Mexico my wife occasionally gets ear infections. At any pharmacy, we pick up Amoxicillin, 250mg three times a day for ten days. Six bucks.

Recently we were staying in Maryland with friends, and she got an ear ache. Amoxicillin is by prescription only in the US, which means that doctors have a monopoly on ear aches. It was Friday evening. It was either agony until Monday or go to one of those mall-based walk-in clinics, which wanted $150 for the appointment and prescribed $78 in medicines.

It’s a scam, pure and simple.

Hat-tip to Ben for helpful input...

Banking and the Money Supply I: Sources of Inflation

In order to determine whether we face a future of mass inflation or a deflationary spiral, we need to understand exactly what these terms mean, by what mechanisms they occur, and how the consequences of inflation and deflation play themselves out in the broader economy. Last time, we knocked the first one out when we looked at two possible ways to describe inflation and concluded that the expansion of the money supply was more useful than descriptions of price movements. Conversely, deflation is best defined as a contraction in the money supply. We also briefly touched on the effects that expansion of the money supply has on the economy, and even society at large. We will now examine just how the money supply is influenced by America's central bank, the Federal Reserve (FED), and the banking system it serves. Once we are finished, we should have a general idea of the "rules of the game" and the laws that govern the creation and destruction of money under the present banking regime. Warning! I have been told by many sources, some of which I consider reputable, that I haven't a clue what I'm talking about when I discuss fractional reserve accounting. Occasionally I have been told that goes for pretty much everything else, too, whacko, so why not shut the heck up. That may be the case. I might get a few things wrong. I am, after all, an amateur. But I try not to let snide remarks and piddling considerations of fact prevent me from making a fool of myself. If you want the story straight from the horse's mouth, check out "Modern Money Mechanics," a self-indicting document put out by the Federal Reserve Bank of Chicago some years ago. Inflation You have probably heard the charge of government "printing money" from many sources. You may have heard the charge refuted by stating that all money is "debt based," and since debts must be repaid, money is therefore not printed and that this system is therefore "fair." The reality is that the new money created by the banking system is generally not "printed" -- printed and coined money are called currency to distinguish them from the broader concept of money, which may have no physical existence at all except as entries on an accountant's books. It is debt based, but this is not to say that "it eventually gets repaid" or somehow isn't real. Money is created through accounting practices used by the banking system. I hope that sounds as irrational to you as it does to me. After all, how can it be called "accounting" when the result of doing it is an increase in the thing we are supposed to be "counting?" When I count things, I usually wind up with the same quantity at the end as when I started, though sometimes things get hairy when I run out of fingers and toes. But banks don't; they usually manage to come up with more, at least right up until the point that they fail and start taking money from taxpayers. Wouldn't it be more honest, you might ask, to call it something else, like maybe "multiplying?" Or, some more judgmental types might suggest, "lying" or "fraud?" But as we will see, honesty is really beside the point here. We are talking about America's financial system! Boring as it may seem, to understand inflation and deflation we will have to understand at least a little bit about how banks do their accounting. But I promise, it isn't that bad. You'll make it. The inflationary accounting trick that results in changes to the money supply comes from two primary sources: fractional reserve banking and asset purchases/lending by the FED. Neither is really that hard to understand. Well, not "understand," since it doesn't actually make any sense. It's just the way things are done, that's all, and if you want to know what's going on, you'll just have to get used to it. Fractional Reserve Banking and the FED You probably heard about how the practice of fractional reserve banking multiplies the supply of money in your high school economics class. For most young people, this seems a little strange, but hey, more money is better, right? And it says so in an actual textbook. On economics, no less. It is not until we reach adulthood that we recognize that most statements appearing in textbooks are either lies, blasphemy, or incoherent nonsense. Luckily, like most of those other bothersome fact thingys that inflict themselves on us while we're at school, it probably went in one ear and out the other without really sticking anywhere in between. But since that is the subject of today's post, for most of us we'll need to go over it one more time. Reserves Most such discussions start out with "when you go to your bank and deposit $1000 in your bank account..." But I'm not going to start there, because that's not where money starts. If money started with you, you probably wouldn't go to work every day. You'd probably sit at home and exude money. I would. But here in the US of A, most private parties that make a habit of exuding money wind up in prison on charges of counterfeiting. There's only room for money exuder in the US, and that is the FED. As we'll see, money starts with the FED. So in talking about fractional reserve accounting, I'm going to start with "reserves," which is a deposit of money sitting in a bank that is initially provided by the FED. The FED produces reserves by buying assets and lending money. In banking, buying assets vs. lending money is usually a distinction without a difference. Banks usually buy "debt instruments," like bonds and mortgage notes. So, they are buying a contract that stipulates that the holder of the contract is entitled to regular payments with the return of principle plus interest over time. Just like a loan extended by the bank. Either way, money it transferred out of the bank to somewhere else, and some party owes the bank money. When the FED buys an asset or extends a loan to another bank, it assumes ownership of the asset/loan obligation and credits the seller/borrower with money that never existed before. The FED creates money when it buys assets. Simple as that. The FED is taken to be able to issue an endless supply of money, so that it can buy as many assets or as few as it likes, regardless of price, and extend loans of any quantity whatsoever. The money issued is considered a liability of the FED balanced by the asset it purchased, which becomes part of the FED's balance sheet. Our money units are called Federal Reserve Notes (FRN) because they constitute liability claims against the assets held by the FED. Theoretically, anyway. Try enforcing your pathetic little "claim." It keeps track of such purchases with neat little 2-column charts called "T" accounts that look something like this: Looks nice, doesn't it? Clean, tidy and "balanced." Neat little charts produced by highly educated, meticulous people in spiffy suits have the uncanny ability to create the air of legitimacy, don't they? I mean, look at the balance. These people are smart! And so meticulous! Brings a certain German political movement to mind... Legitimate or not, money is created out of thin air, ex-nihilo, from nothing, by this process. This ex-nihilo money is called the "monetary base." It is also sometimes called "high-powered money" because it has yet to be multiplied by the fractional reserve system. Fractional Reserve Banking The money which the FED spent to buy the asset from the private seller enters the banking system as new "reserves" in the seller's deposit account with his bank. A fraction of these new reserves must be kept "on reserve" while the remainder may be lent out. Thus begins the process of fractional reserve banking. At this time, the legally required fraction is 10%, but banks are not required to lend up to this amount. Usually, they do not. Whatever fraction is left over above the 10% that is not lent is termed "excess reserves." Like the FED, banks use the same neat little T-account charts to keep track of their own pilfering shenanigans. A bank which has lent out money up to its reserve requirement would have a T-account that looked something like this: Remember: virtually all money is held in some bank account, somewhere. Though it is conceivable that the borrower is walking down the street with a large roll of currency in his pocket, it isn't likely. The money lent out to the borrower will more likely wind up in another bank account as soon as the borrower spends it on whatever it is he borrowed the money to buy. This is indicated by the T-account above. Notice that the money deposits fall in the liability columns. Deposits are considered a liability with the bank and do not disappear when money is lent out. The entity holding the deposit account is still considered to have money on deposit with the bank. It may withdraw and spend this money at any time, and the bank simply has to come up with the money for transfer. Both the money lent out and the deposit held at the bank are considered and accounted as money at the same time. Lending up to the required minimum reserves increases the money supply by 90% of the initial reserves. I don't care what neat little chart some bankster wants to show me, this accounting is not legitimate. It is not accounting when the money supply increases as a result of a transaction. It is fraud. Further, the money which has been lent out is spent by the borrower and winds up in the deposit account of the seller in another bank as new reserves exactly as before. From there it can be lent out to yet another party and held as a deposit simultaneously, getting counted twice, exactly as before. If this continues up to the theoretical limit, which it rarely does, the initial asset purchased by the FED will result in 10X the purchase price in circulating money. You'd think this system would strike any sane, reasonably intelligent person as stupid. But that's how we do things. Most of us go along with it without giving it a second thought. What could possibly go wrong? Notice the difference between bank lending and lending you might do on your own. Suppose you buy a bond from a corporation that needs to borrow money. You give your money to the corporation, and they give you the bond with a promise to pay you back over time. No money is created or destroyed by this process, whether you get paid back or not. It simply changes hands. Purchases and loans by banks are unique in this regard. Why they are afforded such privileged status, I do not understand. But that is the system. Monetary Statistics: AMB, M1 and M2 The "money supply" can be monitored by a variety of monetary statistics which are available for free at the website of the Federal Reserve Bank of St. Louis. You may ask, "Why are there several measures? Isn't there only one supply of money?" Yes, there is. But in another of those zany aspects of the world of economics, economists cannot even come to an agreement on what money actually is. You might have guessed as much considering the type of accounting they permit right under their noses. I do not want to go into any boring details trying to define money. Most of us have a basic understanding of it as the thing we use as the universal exchange medium for other goods. For the absolute best, most readable, concise introduction of money I have ever read, see Mises on Money, a free mini e-book hosted by LRC. Here, I will stick to the basic gist of the monetary statistics I think are most useful. The Adjusted Monetary Base (AMB) is simply the supply of money put into circulation as the result of the accumulated transactions of the FED. This is the "high-powered" money supply which enters the banking system as the result of FED asset purchases, before multiplication by the fractional reserve process. M1 and M2 are two different descriptions of the money supply which are produced by adding up money in circulation. The principal difference between them is that M1 does not contain money held in "time deposits," a.k.a. savings accounts and CD's, since this is not considered as "available" for spending as is money held in "demand deposits," a.k.a. checking accounts. These money statistics do include the results of fractional reserve multiplication. MULT is the M1 multiplier. It is equal to M1/AMB. It is an expression of the effect that fractional reserve multiplication has on the monetary base to produce the circulating money supply. Now that we've dealt with the principle sources of money and monetary inflation, and have had a look at how to describe these quantities, it is time to consider the sources of deflation. But I'll leave that for next time... ------- Cross-posted at Eternity Road

Inflation: What it is and what it is not

Presently, there is much debate going on about whether we now face inflation or deflation, and among the fringe like me, whether we may in fact be facing inflationary or deflationary collapse. You'd think that with a century of economic philosophy and know-how under their belts, the community of economists would be able to arrive at a simple answer to such a straightforward question. But you'd be wrong. What is even more surprising is that in the face of the inability to give a straight answer to such a basic question, there is still the slightest shred of faith in our economic technocracy to plan and regulate our markets in anything like a beneficial manner. The fact is, economists can't even agree on what the terms inflation and deflation mean. Inspiring, isn't it? Actually, this disagreement is a big part of the problem. It needs a solution. I'll try not to bore you with too many details, but a basic discussion about what all this means might just help to clear up a lot of the nonsense. Inflation as Rising Prices Mainstream economists define inflation something along the lines of "a general increase in the price level." If one price rises, say, on a barrel of oil, it is not considered inflation, but if overall prices that we encounter everyday are all rising together, it suddenly is. Deflation would naturally be the opposite. The phenomenon of generally rising prices is loosely attributed to an increase in the money supply over the long term, but it is acknowledged that over the short term, many other forces can and do have a much larger influence. Among this crowd the most important economic statistic for describing inflation or deflation is the Consumer Price Index (CPI). This is a description of the price movements of a "representative basket of goods" from data compiled regularly by the Bureau of Labor Statistics (BLS) . Setting aside disagreements about just what "representative" means and what should go into the index, plus the validity of the various changes that have been made over the years, this does on first glance seem to be a straightforward measure of "a general increase in price levels." No doubt, the prices of everyday goods we will be buying every day as consumers are a very important consideration to us as we go about our daily business and make plans for our future. But does our interest in a particular statistic render it valid as a descriptor, let alone a determinant of economic cause-and-effect? Does this statistic and others like it, which our technocratic overlords use to determine the "right" policies going forward, actually have any relevancy to the decisions they are actually making? Very, very little, in my opinion. Basing economic policy on the movements of the CPI and other suchlike statistics is a bit like a soccer coach basing his decisions on the physical attractiveness of his players. This may actually be of interest to him, a somewhat creepy thought depending on the circumstances. It may even be important to his players, who might have joined the team for the purposes of getting in better shape or losing weight. But a team which forms the basis of its training regimen around the importance of beauty as a key determinant of the ability to play soccer well isn't likely to excel at the sport itself. On average, a team with players that are more physically fit would probably do slightly better than one that allowed its players to get quite overweight, but for the most part makeup, perfect hair, and plastic surgery aren't going to do much for dribbling and passing skills. Attractiveness is only tangentially correlated with performance. If such a team's skills are put to the test in the real world by engaging in competition with another soccer team that has more realistic ideas, it is likely to receive a sound beating. Likewise, the importance that the CPI and other indices may have for us as consumers does not necessarily translate to importance in understanding the behavior of an economy. Instinctively, we understand that an increase in the money supply should translate to an increase in prices, yet in practice this very often doesn't seem to be the case. Mainstream economists have figured out pretty well when the money supply can be increased with very little effect on consumer prices. During the height of the financial crisis last October, even some nominally conservative commentators called for "reflation" of the economy through expansionary monetary policies, knowing full well that there was no immediate danger of inflation. They were right; there was no immediate danger of consumer price inflation. But that does not mean that there are no consequences for increasing the money supply. I return again to the idea that increasing the money supply should increase prices. We know this should be the case. But if it is not increasing consumer prices at this time, what prices are being increased, and what will the effects of this price distortion be? Once you have asked this question, you are halfway to understanding the shortcomings of mainstream economic theory and the basic premises of the Austrian school of thought. Inflation as Monetary Expansion We have seen that defining inflation in terms of prices does not give us the most useful definition in terms of understanding economic cause-and-effect in a straightforward manner. Now, we can move on to a more useful definition. The Austrian School defines inflation in terms of cause rather than effect. Inflation is taken to be, simply, an increase in the money supply. Changes in prices levels such as measured by the CPI might be talked about in terms of "price inflation," and increasing levels of credit as "credit inflation," but the word inflation itself is always in reference to increasing money supply, and sometimes to the host of economic phenomena that accompany such increases as "an inflation." Price movements, whether taken individually or collectively, are irrelevant. Occasionally, you will encounter the term "monetary inflation" to differentiate this view of inflation from the mainstream price-level view. And for the record, I occasionally lapse into the common usage. But, from a purely philosophical standpoint, inflation is taken to refer to an increase in the money supply and the view that increasing prices are the sole indicator of inflation is rejected. Some Effects of Inflation Once we have rid ourselves of the notion that inflation is determined in terms of prices, and begin to logically work through the economic consequences of increasing the money supply, a whole host of economic phenomena begin to make more sense. First of all, we will realize that the "new" money must enter the economy from somewhere, and that the price increases we have been looking for will begin here. In the old days, when gold literally was money, it was a well-known phenomenon that when a gold deposit was discovered, prices for mining supplies and everyday items near the deposit would begin to rise dramatically. As a consequence, it also became well known that one didn't have to become a miner to partake in the find -- plenty of gold could be had by supplying the miners with goods! Only part of this price distortion effect was due to "gold fever" convincing would-be miners to part with more money than they might otherwise have deemed prudent. A large share was simply the effect of more gold being in circulation around the mines that were producing it. The gold mining community was able to bid resources away from surrounding areas with the gold it was producing because it could afford to pay higher prices for goods. It spent the "new gold" first, before it had a chance to spread out through the rest of the economy. High prices have been a California staple for a very long time! Today, the sources of new money are government through the Federal Reserve and the banking system through fractional reserve banking. By spending the "new money" first, they are able to bid resources away from other bidders. One of the effects is ballooning government, which most are familiar with. Another is a ballooning financial sector. More subtly, the new money enters the economy through credit markets. Goods bought on credit, typically investments, capital goods, real estate, and the like, tend to see their prices increase first in response to a monetary expansion. Consumer goods, which aren't typically bought on credit, must wait for the "monetary injection" to work its way through the rest of the economy. There are knock-on effects as well: once the prices of certain goods have taken off, for example houses, suppliers of those goods, such as homebuilders, begin to see improved profits and start expanding their businesses in response to this "new demand." These price and profit changes send stock markets on a roller-coaster ride. And when the supply of new money suddenly dries up, usually as a result of the technocrats recognizing the monster they have created with their price distortions, the effects reverse. Credit becomes scarce, banks feel the pinch, prices fall, and workers get laid off. But note here -- falling prices are not the result of deflation, or a decrease in the money supply. The distorted price levels of an inflating economy can only be sustained by continuous flow of new money. Once this slows down or stops, the party is over. Reduction of the money supply is not necessary for a fall in prices to occur. Inflation has a great many other effects as well, from the boom-bust cycle to the expansion of welfarism and despotism to the erosion of social mores. These are far too numerous to go into here, but suffice it to say, virtually all are a bane to civilized society. Conclusion Inflation, while popularly understood as a general increase in price levels, is far better understood in economic terms as an increase in the money supply. This is the Austrian view of inflation. In understanding inflation on these terms, we focus on an important determinant of economic causation, rather than on a statistic of narrow practical interest and little economic consequence. Short term price changes are far less important to understanding the economy and making predictions than monetary policy and changes in the money supply. An understanding of the routes of entry of the "new money" that produces inflation can help to illuminate the practical consequences of increasing the money supply. By "uncoupling" our view of inflation from price changes, and thinking of price changes on their own, separate terms, we may better understand such disparate phenomena as the underpinnings of the business cycle, the stock market, political economy, and the broad cultural developments that result from the erosion of social mores. Through a better understanding of these effects, we may also make better plans for our financial future.

Vox: It Ain't Over Yet...

Vox Day gives a brief and excellent explanation about why we shouldn't believe the talk of recovery:

Contrary to the belief of mainstream economists, economics is not a giant confidence game in which the government can fool enough people into feeling sufficient consumer confidence to generate a self-fulfilling prophecy of economic growth. Even as the composite leading indicators and GDP numbers turn positive, real measures of economic activity are pointing in precisely the opposite direction. International shipping has begun to slump again. After a three-month rise spurred by an aggressive stimulus program, steel prices have begun to fall once more in the world's largest steel-using country, China. Nearly 40 percent of the stocks traded on the New York Stock Exchange are the worthless stocks of four zombie corporations

being propped up by the federal government, BAC, C, FNM and FRE. Total U.S. loans and leases are down 4.6 percent for the year, an initial sign that the inevitable deleveraging process has begun. The percentage of failed bank deposits in 2009 are rapidly approaching three times the percentage of failed bank deposits

in 1931, and the FDIC has been forced to request a $500 billion credit line from the U.S. Treasury to stave off looming bankruptcy.

The map is not the land. The statistics are not the economy. This is not a recovery; this is the false dawn that precedes the darkness.

Precisely. I particularly like the analogy "The map is not the land. The statistics are not the economy." Better than I would have thought up, but pretty much exactly the same idea I posted just a day ago.

Funhouse Economics

Chris Mayer asks the question that has been bothering me for some time:

But with all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? When the stimulus money stops flowing will the recession get worse?

He goes on to describe these distortions as having the effect of a funhouse mirror as one tries to look at the numbers and figure out what is going on with the economy. It is an apt description. I am bearish on the economy, flat-out, for at least 5 years and possibly more, no question. I don't plan on changing my opinion until I see some very big changes, and frankly, I don't see anything in the pipeline that even comes close. Personally, my bets are on a near systemic collapse, and any coming recovery will have to be in its aftermath. So it becomes difficult for someone like me to explain a stock market rally going on six months now since the March lows. In fact, the phenomenon appears to be global, with stock markets around the globe caught up in the euphoria. What to make of this? There are two main answers, in my opinion, and Mayer supplies one of them. China, like virtually every other nation around the globe, has been dabbling in "stimulus," even to such a degree that it would make an American central banker blush:

China supposedly grew in the first quarter at an annualized rate of 15%. Yet, the government also spent a lot of stimulus money. As Eric Sprott writes in his latest letter to shareholders:

“The Chinese have injected a stimulus equivalent to 64% of their first half 2008 GDP in the first half of 2009…The Chinese government has effectively spent and lent enough in six months to buy 122 Ford Class aircraft carriers at US$8.1 billion a piece. It is akin to the US government injecting (and US banks lending) almost $4.5 trillion USD to its citizens and businesses before July 2009…an ungodly sum that would impact every asset class under the sun. Is it any wonder then that the Shanghai stock exchange has more than doubled from trough to peak since its November lows?”

Time for some critical thinking. You do the math: had the government of China not provided a monetary black hole equivalent to 64% of GDP to shovel all those wasted resources into, growth would have been... that's right, a wee-bit negative, to make a generous approximation. Do you suppose these artificial sales might have had some impact on stated earnings, you know, the ones investors use to price shares in said companies? Do you think the Chinese government can afford to continually supply the funds to purchase 64% of GDP, just to keep the wheels turning and the stock market burning? If the government does not, who will? Does it seem like a good idea to provide artificial markets by government fiat? Does this really count as actual growth, as the numbers would have you believe? Consumers have had their say; they didn't want the goods. Why is it productive for the market to continue to produce them? A market bull trying to justify the present rally in Chinese stocks is going to have to provide some pretty convincing answers to some very tough questions. Nothing I have seen would stand up to scrutiny. Similar efforts have been going on around the globe, not typically to the degree the Chinese have chosen to pursue them, but their effect is the same nonetheless. Investors and government will not accept the liquidation of malinvestment that is clearly needed to put the market on more sustainable footing, and they are pumping the economy full of freshly printed dollars in order to keep the game of pretend going a little longer, supplying phony consumption and cooking the books in the process. The numbers do not reflect what is really going on, which is waste of resources and capital consumption. But the numbers are what stock prices and business decisions are based on. The second answer is slightly more subtle. Cost cutting measures, such as layoffs and shuttering of once productive capital, are increasing earnings by reducing company spending. This is actually healthy, painful as it may be for those experiencing it, as it is part of the process of reallocating capital towards satisfying consumer demand (or possibly phony demand provided by wresting purchasing power away from consumers, a.k.a. stimulus, as the case may be. But that is not healthy.) But the point is this: unemployed capital and labor do not make for a growing economy. We will not have "recovery" until this trend reverses, and companies cannot expect to continue to improve earnings by tossing workers out the door and idling capital. Continue to do this, and you have no economy. They are going to have to show improved earnings by making money the old fashioned way -- engaging in productive economic activity that satisfies consumer demand -- before we can say we are coming out of the woods. Don't be fooled by the hype. Remember two things: the stock market is not the economy, and the economy, governed as it is by the unbending physical laws of the universe, cannot be fooled by phony accounting. At its most basic level, economic growth is something that anyone can understand: real capital accumulation, leading to higher productivity aimed at satisfying consumer demand, and increasing real wealth. Not number jiggling. Not phony accounting. Not pushing money around in circles. If you do not see this occurring, things are not getting better. Things may feel nice now, but there are dark days ahead. I am sure that we will see asset prices rise and fall along the way thanks to all the confusion and deception, possibly quite dramatically. But until you see this simple model being satisfied, you can be certain that there is no wealth creation going on, and the economy is not getting better. Right now, it is devouring itself, but the numbing effect of printed money prevents us from feeling it. We are getting poorer, but we just can't tell. Looking at cooked books doesn't help us figure it out. I do not know when the next downturn will be, but I expect a "double dip" type recession, possibly followed by something like a long flatline, if we are lucky. At a minimum, the dollar is on death row, we just don't know when the sentence will be carried out. Fiat currencies across the globe are not doing much better, but that is another post for another time. If we are not lucky, it will be a catastrophic breakdown. And I'm not feeling all that lucky.

I've Been Promoted!

I have just received the great honor and privilege of being promoted by that most esteemed internet-curmudgeon, Fran Porretto himself, to one of the select few co-Conspirators at Eternity Road! I will now be cross-posting my more significant economics posts to his website!

Amateur's Guide to Gold and Silver Coins

If you visit this site regularly, odds are that you're worried about the economy. We all hear "buy gold and silver to protect against the collapsing dollar," but most of us are newbies who don't know much about gold or silver coins, how to buy them, what to buy, or have any idea of what a reasonable deal is. It is intimidating. The market price on a 1 oz. American Eagle coin runs ~$1000 these days. We're not talking about pocket change. What to do? I'm also an amateur at this, but I have actually bought a few coins. If you haven't bought any at all and haven't got a clue what you are doing, stick around. You might learn something. Gold There are a ton of different forms of gold out there and a ton of different dealers vying for your money. The first thing you want to sort out for yourself is: why are you buying these things? What do you want to do with them? Be sure you have answered these questions for yourself before you begin. You need to know why you are buying gold, other than because that's what the guys on TV are screaming at you and that's what the economic loony-tune at 3CNB says. I recommend Gary North's book The Gold Wars, which you can read for free in PDF format, before you get started. If you are just looking to hold gold as you would hold a stock or a bond with a broker, gold coins may not be the thing for you. Goldmoney.com allows you to buy and sell gold or silver metal (measured in "goldgrams") and store it in their facilities for a monthly fee. That way, you don't have to worry about thieves breaking into your home and stealing your precious investment. Of course, you won't have the gold in your hand, either, which carries its own risks. In any event, I think this method is better than most "digital methods" in that Goldmoney actually holds physical gold in physical vaults, while most ETF's and the like trade in futures contracts. In other words, ETF's trade in "paper gold" and since it is a breakdown in the "paper" financial systems we are talking about here, better to have the physical stuff than a pile of potentially worthless paper. But, as I said, it is still not the real thing in your hands, so, though you have eliminated one source of insecurity, you are still stuck with another. Physical Gold If you want the real thing in your hot little hands, you have many choices available to you. First, you have to decide what you want to purchase. Second, you have to decide how you will go about purchasing it. Buying Gold Let's deal with the second problem first. You have two basic choices: a retail coin store, or an online/over-the-phone distributor. The first option is probably the least intimidating and most straightforward: you'll have someone to talk to, and can make your purchase as if you were at a department store or any other retailer. Like other retailers, prices and service vary; so you'll want to be selective. The most important thing is to know the market price of the items you're looking for before you show up. You can do this by getting a quote from several online distributors for comparison, or by looking up the spot price of gold and estimating. I'll talk about that later. As far as finding a particular store to go to, you'll just have to look that up yourself. I recommend using Google maps. Put the map roughly on an area where you live, zoom in to your city, and type "gold coin" or suchlike in the search box. Then, start shopping! A couple of notes about retail: you'll pay slightly more, but you get the added benefit of privacy. Some folks don't think of that. You'll pay more because you are paying for overhead, plus the dealer's assumption of risk by acting as a market-maker. His inventory fluctuates in price by the minute, so those coins you see in his display case represent a risky proposition just so you can looky-looky before you buy. He expects to be compensated. Online dealers can buy from the market the moment you make your purchase, so they have lower operating risk. Privacy can be had by dealing in cash with the retailer. Of course, you'll have to abide by certain restrictions. I will not go into those, as I don't know them all that well and don't really worry about them so much. I figure that between this website and all the other craziness I get myself involved in, Uncle Sam's got my number already. Besides, I don't plan on skirting the law, anyway. Suffice it to say, if you plan on "protecting your privacy," do your homework! If you go with an online/over-the-phone dealer, you will likely get slightly better prices, but you will have to pay for shipping and you will have to wait for your purchase to show up in the mail. That last one can be excruciating, especially if you have spent several thousand dollars on a purchase. However, I have made many transactions to date, and have never had a problem. For online/over-the-phone purchases, I highly recommend Franklin Sanders, a.k.a. The Moneychanger. He's permanently listed under the "resources" section of this website. He's an honest dealer, has very good prices to boot, and he's something of a hero in my opinion for standing up to the IRS in a harrowing tale you just have to read to believe. He has a Monthly Acquisition Program (MAP) to help you accumulate gold and silver efficiently over time. Basically, you send him money every month, he sends you coins at the best price he can get on the market on approximately the 15th of each month. If you do this, you will wind up with a crazy mix of coins, but you will usually get a better price with less headache than if you were to try to do it by yourself. But remember: one day, you'll have to redeem your coins, and that can be its own headache. I'll talk about that later. Other coin dealers: I have had Camino Coin Company recommended to me by a reputable source, but have never bought from them myself. Other dealers I have never bought from: Colorado Gold, Gainseville Coins, and if you can afford to buy in bulk, Tulving. But again, I have never done business with any of these companies, and cannot specifically recommend them. Another place to buy coins is at estate sales, eBay, Craigslist, pawn shops, and the like. You might get a handsome deal if you know what you are doing. Or you might get ripped off. I have seen coins at pawn shops with an asking price of 50% over their market values. If you are not an expert, I'd stick with people like The Moneychanger until you get your feet wet. Gold Coins/Bars What should you buy? There are all kinds of crazy denominations to buy gold in, from kilogram bars that will run you $30K to tiny little things that you will lose if you sneeze too hard. I will deal with them all together. First, as tantalizingly cool as they are, I would not recommend giant bars for average people even if you can afford one, because you will have to redeem so much at once. Unless you plan on paying for a house with a gargantuan chunk o' gold, this is a stupid plan. Of course, you may actually be planning on doing that... I've certainly tried crazier things. Sometimes they pan out... I would also not recommend buying "numismatic" coins -- coins whose value is determined by some historical or collectible significance. If you just like coin collecting, fine. Have at it, as a hobby. But we are talking economic collapse scenarios here. Nobody gives a rip if Abe Lincoln sneezed on your special commemorative nickel 150 years ago and it still has the booger on it; you're bartering goods for dinner. All that mumbo-jumbo is going to wear thin on people and it's going to be a tough sell unless you happen to find just the right buyer who will give you the "real" price. Stick to bullion, whose value is derived from precious metal content. It'll be easier to price and more liquid in the market. And with that, we return to the topic of redeeming one's gold. Remember, you can't eat gold, wear it (in most cases), or use it to give you shelter from the rain. It's value is in the ability to trade it for other things, like paper money, goods, or services. To be a good trading item, it needs certain properties, key among these, other people have to want it, be able to recognize it, and it must be meaningfully denominated. If you have to cut your chunk o' gold in pieces with a hacksaw to make change, well, it just isn't practical. For that reason, I would not recommend anything larger than a 1 oz. gold coin or bar, which is worth about $1000 at today's prices. Obviously, that is like carrying around a $1000 bill, which should already tell you we are at the upper practical limit. But for a long-term storage of value, these denominations are much more efficient than smaller denominations, which tend to trade at higher premiums over the spot price. Which is to say, you'll be paying a lot more for smaller coins relative to their gold content, at least in today's market. Which brings us to the types of coin/bar you'll be looking at. This is actually a very important issue, since you'll want other people to recognize your gold as being legitimate when you want to make your trade. It is best to buy something other people will know. The most popular/recognizable coins, in my opinion, in order of preference from most desirable/recognizable to least, would be: the American Gold Eagle, the Canadian Maple Leaf, and the South African Krugerrand, followed by an assortment of other coins in no particular order: the Austrian Coronnae, the Mexican Peso, the British Sovereign, the French Franc and a whole boatload of others. The first three coins come, conveniently, in 1 oz., 1/2 oz., 1/4 oz., and 1/10 oz. denominations. The Austrian 100 Coronnae contains .98 oz of gold, and the rest have odd contents specific to each coin. The only popular bar that I'm aware of is the Pamp Suisse bar, which is also 1 oz. The convenient and uniform, interchangeable weights of these coins/bars is a definite plus as it allows easy conversion to dollars, and, at least in theory, to one another. The "boatload of others" are not so easily converted, unless you have a good calculator and a spreadsheet of data handy, or are a lot smarter than I am. To most people, this is a detriment, although a dedicated coin dealer shouldn't have much trouble providing you with a market should you decide to redeem your gold. Most dealers will pledge to buy back the coins they have sold to you at market price on some future date, should you want to sell. The second thing to consider with coins/bars is composition. Most of the coins are actually alloys; they contain another metal, usually copper, to give the coin hardness and durability. To compensate for the dilution effect, the coins actually weight more than their "gold content mass," i.e., a 1 oz. American Eagle weighs more than 1 oz. in total, but contains exactly 1 oz. of gold. The exceptions: the Maple Leaf, and Pamp Suisse bar are pure gold, as is the Austrian Philharmonic, which you might also encounter. This is important because pure gold will be softer and more prone to physical damage than a "real coin" equipped for the demands of circulation, such as the Krugerrand, Sovereign, Eagle, Peso, or Franc. This may not matter to you; your coins may sit in the attic, comfortably protected and gathering dust. But, if you are like me and you are worried about worst case scenarios in which you might actually find yourself using your coins as real money in a barter -type economy, better to go with the more durable varieties. But be prepared; you will pay a bit of a premium for them. If you just want cheap gold, go with the Pamp Suisse and Maple Leaf; if you want functional coins, the Eagle and Krugerrand are your best bets. This brings us to pricing. The Eagle is by far the most desired gold bullion coin here in the US. It generally sells for a premium of 8-10% over the spot price of gold, i.e. at $1000/oz., you can expect to pay about $1080 to $1100 for a 1 oz. Eagle. In recent times, as demand for these coins has risen, the smaller denominations (1/2 - 1/10 oz.) have seen premiums skyrocket; the smaller the coin, the higher the premium. It is now common to be asked to pay 25-30% over spot for 1/10 oz. Eagles. And, people are paying it. I find this to be a bit steep, so I would rather use larger silver coins for this value range (~$100) than pay the premium. But, suit yourself; just expect to pay more for smaller coins. Expect a lower premium on Krugerrands, even lower on Coronas and the "boatload of others," and Maple Leafs and Pamp bars to trade near the spot price, Maples just a tad higher. Kind of just what you'd expect. To me, the Krugerrand is the best bet this late in the game, and if you can find fractionals, I would snap them up if they are under 10-15% over spot. But that's just me. Silver Coins As with gold coins, there are about a zillion varieties of silver coins available through pretty much the same channels as the gold coins. I'll stick to 3 varieties that I think are your best investment: "junk silver," silver "rounds," and Silver Eagles. Silver "rounds" are a bit like silver versions of Maple Leafs. In fact, you can get 1 oz. Silver Maple Leafs, which I would lump in with silver rounds. They are basically 1 oz. solid silver coins. They are an economical buy in that they have low premiums over spot, but they have the same drawbacks as the solid gold "coins:" low durability. Luckily, silver is a bit harder than gold, and you are only talking about a ~$15-20 coin, so you don't have quite as much to worry about. These generic "coins" are produced by a variety of companies, such as Engelhard, and Sunshine Minting. Some of them are quite ugly. But their job is to reliably and recognizably hold 1 oz. of silver, and that they do. If you are looking for cheap silver, this is probably your best bet. Expect to pay a bit over premium, but not as much as with Silver Eagles or junk silver. Junk silver is the fairly well established trade name for pre-1965 American silver coinage: half-dollars, quarters, and dimes. NOT nickels, as I once thought, and even posted about long, long ago. Nickels have pretty much always been made of nickel, with few exceptions. Junk silver coins contain 90% silver alloy, and actually circulated for quite some time until inflation got the better of them and their melt value (the value of their precious metal content) was far higher than their face value (i.e. 25 cents for a quarter). This is kinda the thing we are trying to hedge against, incidentally. Today, a junk silver quarter will run you about $3 or more. Since these coins circulated quite effectively for a long time, you can rest assured they are durable enough to serve in a barter economy, should it come to that. And their denominations are small enough that they are good for everyday transactions. $1 face value (i.e., four quarters, two half-dollars, or ten dimes) contains .715 oz. of silver no matter the combination of coins used to arrive at $1; prices are usually quoted in multiples of face value, i.e. 14x face value at recent prices, or $1.40 for a dime. The multiple is tied to the spot price of silver but is not identical to it. You will not get $1 face value, or .715 oz. of silver, for the spot price of .715 oz. silver. You will generally pay more, and the premium is considerably higher than for silver rounds. Expect to pay close to what the coins would trade for if $1 face value actually contained 1 oz. of silver. If you decide to buy these coins, I would buy them from The Moneychanger or another online dealer, as you will likely get a far better price than at a retail coin shop. The Cadillac of silver coins is the American Silver Eagle. The design is quite attractive, unlike some of the generic rounds. Unfortunately, they are also pure silver, so you won't get the durability of junk silver. Expect to pay anywhere from $3-5 over spot per 1 oz. coin, and probably more as the price of silver rises. Fun coins, but not that efficient as investment vehicles. There are many other types of silver coin and bars out there, but they just won't be as recognizable as these coins and will likely be less liquid. For my money, I prefer a base investment of junk silver for a possible barter scenario with some silver rounds for higher value denominations. OK, and maybe a few Silver Eagles just for fun. Investing in Precious Metals Let me first say that if you are looking to me for your advice on precious metals investing, you need to look further. Read The Gold Wars, then get involved with either The Moneychanger or Gary North. I repeat -- I am only an amateur. Both of these men are experts in the gold and silver markets and very honest and honorable people. A subscription to North's website is one of the best investments you can make in my opinion, and can save you from a lot of rookie mistakes. If you save yourself just one $1000 mistake, you will have paid for your subscription for many years. When you are making an investment, at the end of the day the person who will be held accountable for your decisions is you. Nobody else. Make sure you know what you are doing and fully understand and are comfortable with the risks you are taking. Remember, anybody could be wrong, including an amateur like me. That said, I will share my thoughts on what I think is a good investment strategy for the next several years. I would buy a fair amount up front in a few block purchases to get started. If you haven't bought any yet, you are behind in the game and need to get going. Generally, retailers will discount your sales tax if you make a purchase over $1000. It is usually worth your money to add a few silver rounds or some junk silver to get the purchase over $1000; $80 (the tax on $1000) will get you several coins. Once you are comfortable with your position, buy coins here and there as you see fit with some fraction of whatever you manage to save. If you will be making an investment of any size, you might try to keep down the quantity you have physically on hand to a comfortable level by also having an account at Goldmoney. Over the next 5-10 years, I expect inflation to take off pretty badly, so I wouldn't want large cash positions or especially fixed income assets (bonds and CD's, etc). I would hold enough for emergencies, and not too much more. I think that treating your coins or your Goldmoney account as your savings account is a good idea; remember, you can always sell them to get your money back if you need it. I like Franklin Sander's MAP Program in this regard. Just send him what you scrounge together, and you get some coins in the mail. Yes, you'll get crazy, unpredictable stuff, but it is gold and silver and it is kind of fun. Like Christmas just for you, once a month! You'll also get smaller denomination coins at better prices than you could on your own without a lot of effort. A couple of other points: remember that the precious metals markets can be just as volatile as anything else, and sometimes even worse. There is a lot of risk involved as with any investment, and you may lose money, possibly a lot of it. The spectacular rise and fall of silver in the late 70's to 1980 is one such incident. The day will likely come that you need to sell off your meticulously acquired coins, and possibly quickly. Selling a coin is not as easy as selling a stock; it takes time. You can mitigate your risks to some degree in this regard by using Goldmoney, which will allow you to make transactions more rapidly, and by leaning towards gold rather than silver. Gold is typically less volatile. You can also get a subscription to North's site, which will keep you much better informed than you would likely be on your own. Storage is also an issue here, unlike with stocks held at a broker. Remember that silver has a much lower value density than gold. $3000 of gold takes up approximately three 1 oz. coins and could easily be carried in your pocket without much notice. $3000 of silver weighs about 5 kilo's and would require a hefty bag or a box. Owning such coins can make you the target of theft as well. Be careful where you store your coins and who knows about them. You wouldn't want to do something stupid like post on the internet for all the world to see your interest and likely ownership of gold and silver coins. I mean.... ummm.... never mind... You should also be fully cognizant that by entering the precious metals market, you are entering a heavily manipulated market. The government very much will not want you to succeed. It will work against you at every step, tracking your purchases if it can, using its considerable economic and political clout to push prices down, and charging you an exorbitant tax when you redeem your coins on the "profit" you made as a result of the government's own currency debasement. The IRS treats gold as a "collectible." Unfortunately, we live in a world where we have to worry about such things as inflation, manipulation, and theft of our property. The thieves in the street and the thieves in government unite against us. In a non-inflationary world, we could just leave our money in the bank and not worry, for it would be earning real interest and be there for us in our times of need and in our retirement. But that is not the world we live in. To protect more of what you have earned from the thieves, you will have to fight back. In my opinion, precious metals are one of your better weapons.

The Acceptable Politician

Mackay has taken a liking to one Joe Wilson, R-SC: What, he asks, is my opinion? My minimal requirements in policy stands for support of a politician:

• abolition of the Federal Reserve and the replacement of the US dollar with a private gold coin standard
• abolition of the income tax
• abolition of all public welfare
• abolition of all federal support for public education
• overturn of Roe v. Wade
• limited franchise

Given more time, I could probably think of a few more, but for the present discussion, these should suffice. There are several triggers that will begin the ticking of a time bomb which will eventually destroy any upstanding, liberty-oriented system. In the days of Solomon, there were acts of the king like the taking of foreign wives and the worship of foreign gods. Today's systems are more susceptible to items such as these. Note that the original Constitution as written upheld most of these proscriptions, and the culture of the day strongly discouraged violation of the others. Note also that each was overturned over the course of the last century or so: public education began in the late 19th century, the FED was established in 1913, the income tax a few years later, the franchise became virtually universal in the early 20's, major welfare schemes (Social Security, et. al.) began in the 30's, and on and on. Prior to this time, there wasn't all that much change to speak of, though some might include such instances as the Civil War and the centralization of power it brought about. Regardless, the process accelerated rapidly near the turn of the 20th century. Each breach in our legal armor led to accelerating erosion, both legally and culturally, and to further major breaches. Each breach has its mechanism of operation. Welfarism and the income tax set up internal conflicts and budgetary bloating that will eventually bankrupt any system, not to mention enormously detrimental effects on work ethic, thrift, and productivity and the corrosive effects of dependency. The expansion of the franchise inevitably leads to political debasement. Fiat currencies insidiously and nearly invisibly lead to a number of woes: economic instability, expropriation of property from individuals and aggregation of power with centralized government, cultural debasement, and more. "Cultural debasement?" you ask. Why, yes. Yes indeed:

But asset inflation—ultimately, the debasement of the currency—as the principal source of wealth corrodes the character of people. It not only undermines the traditional bourgeois virtues but makes them ridiculous and even reverses them. Prudence becomes imprudence, thrift becomes improvidence, sobriety becomes mean-spiritedness, modesty becomes lack of ambition, self-control becomes betrayal of the inner self, patience becomes lack of foresight, steadiness becomes inflexibility: all that was wisdom becomes foolishness. And circumstances force almost everyone to join in the dance... ...Inflation is not a bogey for everyone—not for those who wish to restructure society, for example, or for those who want government control of ever more aspects of people’s lives. But for the rest of us, the consequences of its full-blown return are not likely to be good: for inflation is not an economic problem only, or even mainly, but one that afflicts the human soul.

All are morally repulsive and inimical to liberty. One might take exception to my including universal sufferage, e.g. "democracy" on the list. Note here the change in how we define "democracy." In the days of Tocqueville, democracy referred to the right of each man to rule over his own life as he saw fit. Voting had little or nothing to do with it. Today, we take democracy to mean the right of all men to rule over one another as they see fit. All that matters is the vote. This is a very different proposition. In both cases, America strived to live up to the "democratic ideal," and as we are now discovering in the case of modern times, much to American's chagrin. The notion that there ought to be a universal right of everyone to "have a say" in his governance is laughably silly both in theoretical and practical terms. After all, what say did we have over the law of universal gravitation, or all ye Christians and Jews, the Ten Commandments? Do they not govern you behavior? Are they legitimate rules, or is God a tyrant? In other words, law does not derive its legitimacy from the democratic process. That some may argue that it does only illustrates their personal delusions. Legitimate law is legitimate law, regardless of how anybody votes on it. And now that you have your little vote, just how much influence have you had over your government? The answer: precisely as much as the other teeming millions who turn out to vote for the same set of goons every year, reliably sending 96% of incumbents back to their thrones. None. "Ah!" comes the retort, "but you miss the point! The role of the universal franchise is not to determine what is legitimate, but to ensure wisdom in our governance by tapping into the wisdom of the many." But if this is the case, then why must everyone have a vote, including such as the incompetent and the criminal? Clearly, this is not the point. In my view, the modern drive for universal franchise stems from issues of pride and recognition/acceptance, a warped version of the egalitarian instinct of the democratic ethos, wrapped up as it is in the so-called civil rights movement. Enlightened governance is completely beside the point. Rather obviously, I might add. But I've gotten off-topic. This was not supposed to be an essay on the evils of modern democracy. The point is this: all of these are essential policies, non-debatable, non-optional points for anyone who is committed to a libertarian/conservative/classical liberal social order, and anyone I'm to vote for in any election. To oppose any of them is to undermine the most fundamental aspects of what makes a civilization workably free, and, frankly, is to embrace eventual civilizational collapse. There is a self-reinforcing aspect to decline as well; once the ball gets rolling, it becomes difficult and then impossible to stop. Failure to hold the line leads inevitably to the horrors we now confront, or imagine we confront, in the form of Dear Leader Obama. Or, for you "liberal" types who managed to read this far, Bush before him. In this light, what am I to make of one such as this Joe Wilson, R-SC, the agitator with the audacity to call Mr. Obama a liar? Is he a champion for freedom? Well, calling Obama a liar simply isn't enough. What does he believe, and how does he vote? After all, gangsters don't just shake down passersby and hold up convenience stores. They beat up on rival gangsters as well. That we catch a glimpse of one such act doesn't make any of them redeeming characters to my mind. It takes a bit more than that. Fundamentally, the Democrats and Republicans (sans Ron Paul) are two sides of the same political coin. As far as I'm concerned, unless Joe Wilson or any other politician is in complete and unabashed support of certain fundamental principles now generally considered radical, he is functionally little more than a brownshirt beating up on a redshirt with his own idea of how the American totalitarian state should look (OK, so he's not a Nazi. But you get the idea: he's not exactly the opposite of a Democrat, either). He's not the solution, he's part of the problem. What do I care if his vision is different from Obama's? Who's to say that his vision is even remotely feasible, that his proposed policies would lead to the outcome he envisions? Without the points I have laid out (and obviously some others!), both paths inevitably lead to a centralized, fascist, and ultimately suicidal state, even if neither side intends it to be so. One will just take longer than the other to play out. It isn't enough that one is passionate. Marx, Lenin, Mao, and Mussolini were passionate. It isn't enough that one's heart is in the right place. Laws of cause and effect don't care if you are aware of them or how you feel. I'm glad that someone has the guts to harangue the President and the Democrats over their relentless fibbing, but I see very little practical difference between the men who reside in Washington these days, Ron Paul excepted. America likes to think it defeated fascism in the 20th century, but the truth is, the era has poisoned politics, possibly for all time. Very few of us can think outside the fascist paradigm; we think the state is naturally responsible for far too much, especially the obligation to "make things right." Too much of our identity is tied up in the state and its actions, and other institutions have been hollowed out. Our minds simply don't operate the way they once did, and our perspective has been permanently slanted. We can't very well hold our politicians' feet to the fire when our own minds are off in la-la land. What exactly will we hold them to? Squaring the circle properly? The fascist state is in our blood now, as liberty was once long ago. Is Joe Wilson, R-SC going to change any of that? I doubt it. When he decides to call for the FED to be abolished, to end fractional reserve banking, abolish the income tax and public schools, etc., I'll start taking him seriously. But by taking any of those political stances, he'd never hold elective office again. Unlike 99% of America, I don't want a politician who is passionate. I don't want a politician with vision or an agenda or goals. I don't want him to sponsor any initiatives. I don't want a politician who bases his decisions on the outcome he would like to obtain. He shouldn't like to obtain any outcome; he should uphold the law, defend the Constitution, stay out of my business, and let the chips fall where they may. The future of America should not be under the guidance or direction of any man or group of men, regardless of their elective status! It should be determined solely by the actions of free men, acting of their own accord, on their own behalf, subject to a just and disinterested law! That is the essence of a classical liberal social order, but it is anathema to modern America. To leave our fate open to chance is just too scary a proposition; there is no longer any faith in liberty. Sorry, Mackay, there really is no hope in national politics. It doesn't matter who wins the next election. We're circling the toilet bowl, and there is no turning back. The best we can hope for is a few more peaceable laps before the real nastiness begins. There is no salvation in politics. You are looking in the wrong place.