-- Posted Monday, 27 August 2007 | Digg This Article
Let me present a syllogism. 1. Theft is immoral. 2. Inflation is theft. 3. Fractional reserve banking is inflationary. 4. Central banking is government-guaranteed fractional reserve banking. 5. Immorality leads to judgment.
Therefore, we should expect. . . ?
Economists, other than Murray Rothbard's disciples, never associate the concept of theft with monetary inflation. They speak of theft in terms of reduced inefficiency and increased transactions costs, not morality.
When it comes to avoiding morality, they are worse than lawyers. A lawyer might appeal to morality if he had a really weak case. This appeal might persuade a jury. An economist would rather lose the argument than appeal to morality. He regards the shame of invoking morality as personally more inefficient than winning the argument by an appeal to morality. Once you appeal to morality, academic economic theory collapses. Economics was the first science to be self-consciously designed to avoid moral questions.
So, when stock market bulls attack Federal Reserve monetary policy, they do not invoke morality. They invoke the falling return on investment. Having invested their money or other people's money on the assumption that the central bank's monetary policy will always hold down "interest rates" we are never told which ones they loudly decry as unnecessary the widespread and accelerating losses that are being sustained because the central bank has slowed down the rate of monetary inflation. Why unnecessary? Because the central bank can create liquidity by buying Treasury bills.
This will lower the interest rate on T-bills. But how does this lower all interest rates? How does it lower bond rates and mortgage rates, which always have an inflation-defense premium in them? It doesn't. It raises them.
The critics say that this forced reduction of the FedFunds rate is only temporary. They are not calling for sustained inflation. Oh, no. They just want a little loosening of monetary restraint, just this once. Just get overnight money rates down.
This is what Japan has been doing ever since 1990. It gets overnight money rates down. It keeps it down, year after year. So, international traders grew bold. They borrowed yen at less than 1% to buy other currencies. Then they used these to invest in bonds at 4% or more. It's like money in the bank.
Yes, it is. But what happens if there is ever a bank run?
A MODERN BANK RUN
The "run" has begun. The Japanese yen is now rising against foreign currencies. Those who borrowed short and lent long are facing a serious crisis: their debt is in yen, and it is rising fast. So, they sell longer-term debt and buy yen with the money. This forces up long-term rates.
Which raises mortgage rates.
Which undermines the housing bubble.
Which undermines consumer confidence.
Which leads to more saving and less spending on consumer goods.
Which produces a recession.
In anticipation of the recession, the stock market falls. This produces a televised tantrum by Jim "Mad Money" Cramer.
Which catches the FED's attention.
Which then lowers a symbolic interest rate (discount window). Which creates brief euphoria among fund managers.
Which leads Cramer to tell people to buy, buy, buy.
Which is called a bull trap.
The FED must now make a decision: inflate slowly (2% a year) or inflate faster (5% a year). I don't think the FED would consider 10%. Economists believe in change at the margin. So, 4% or 5% will probably do it.
Restore confidence in the gigantic confidence game that all modern finance is based on. This game rests on this slogan: "Too big to fail." It is more than a slogan. It is a mantra, a confession of faith. It is the shema Mammon.
The FED will act to increase liquidity sufficiently to prevent disaster in the stock market. This will calm the markets. This will once again persuade investors that there is a safety net for them. Ironically, this perception is designated a "moral hazard." This is the only time the word "moral" is seriously used in modern finance. A moral hazard correctly named occurs when central banks intervene to save specific industries, i.e., too-big-to-fail industries.
Greenspan used the phrase. His words are worth considering. In testimony before the House Banking Committee (Oct. 1, 1998), in the wake of the near-meltdown of the financial futures market the previous August as a result of the Long-Term Capital (Ha!) Management, Ltd. collapse, he said:
Of course, any time that there is public involvement that softens the blow of private-sector losses even as obliquely as in this episode the issue of moral hazard arises. Any action by the government that prevents some of the negative consequences to the private sector of the mistakes it makes raises the threshold of risks market participants will presumably subsequently choose to take. Over time, economic efficiency will be impaired as some uneconomic investments are undertaken under the implicit assumption that possible losses may be borne by the government. That sounded good. It sounded almost as if he had reverted to his free market youth as a follower of Ayn Rand. But he was in front of Congress to justify the Federal Reserve Bank of New York's intervention, calling the lending banks together over the weekend and recommending that they inject another $3 billion into LTCM, Ltd. So, he added this:
But is much moral hazard created by aborting fire sales? To be sure, investors wiped out in a fire sale will clearly be less risk prone than if their mistakes were unwound in a more orderly fashion. But is the broader market well served if the resulting fear and other irrational judgments govern the degree of risk participants are subsequently willing to incur? Risk taking is a necessary condition for wealth creation. The optimum degree of risk aversion should be governed by rational judgments about the market place, not the fear flowing from fire sales.
What is a fire sale? The FED apparently has a new operational definition: "Anything that leads Jim Cramer to throw a tantrum on CNBC."
Central banking has been a moral hazard ever since Parliament gave a monopoly to the privately owned Bank of England in 1694. Central banking exists primarily to protect large fractional reserve commercial banks from bank runs, and therefore to preserve the fractional reserve banking system nationally. Of all modern institutions, none has been more committed to subsidizing moral hazards than central banking.
Along the way, central banks preserve stock markets from sell-offs that might produce runs on commercial banks, or what is the same today, cascading cross-defaults when overextended banks cannot pay off each other at the end of the business day, which today is international.
INDIVIDUALS ARE TRAPPED BY THE SYSTEM
Jesus told His disciples to be in the world, not of the world. This has been the message of most major religious reformers throughout history. It is good advice.
We live in a world that we have inherited. It is not mainly of our making. We are forced to make choices in a world that has structured and limited the choices we make. This is always true.
Consider the FED's choices regarding monetary policy. There is this inescapable choice: stable money leading to a recession and maybe a depression, given the prevailing level of debt, vs. monetary inflation, which keeps the debt structure alive and encourages additional debt to "pay off in cheap money." This policy subsidizes the market for new moral hazards. "When the price falls, more is demanded."
At the top of the visible hierarchy of control, politicians and central bankers say they want to avoid making this choice between stable money and inflation, but one or the other policy cannot be avoided in the long run. This makes short-run decision-makers out of politicians and central bankers.
A few of us prefer this choice: a money system that is not tied to credit and debt in any way. That would mean a monetary system tied to gold and silver, as it was in 1914. This is not available as a choice, nor is it likely to be, short of a complete financial collapse, which unfortunately would kill most of my readers a breakdown in the division of labor.
So, we must make second-best or third-best choices with our money because generations of politicians made very bad choices.
As investors and decision-makers, most people tend to go with the flow. The flow is established by central bank policy: in the United States, in Japan, in Europe, and in China. Going with the flow is bad when you are floating toward Niagara Falls.
We are trapped in an international credit system which has relied on monetary inflation to pump up the capital markets. This has led to a huge expansion of debt. To keep this debt from imploding in a wave of defaults "cascading cross defaults," Greenspan called this central banks inflate even more.
This is a vicious circle. Ever since 1914 World War I and the first year of the Federal Reserve System the West has been unable to escape from this circle. As a result, the dollar buys 5% of what it bought in 1914. (See the Inflation Calculator at www.bls.gov: the Bureau of Labor Statistics.)
None of this is new. Leaders always face choices. These choices will affect those under their authority. Sometimes the effects are catastrophic.
I believe we are trapped in a vicious monetary circle. We cannot get out at anything like zero price.
Americans have been in this sort of situation before. As background, let us consider a similar vicious circle. Let us go back 230 years to the Constitutional Convention of 1787.
GEORGE MASON'S DILEMMA
I am in the process of editing and revising an amazing manuscript on conspiracies in American history. It was written as a series of newsletters over 40 years ago. The author is dead, as far as I know. Some of the chapters hold up well. I am not sure. No one has seen these articles in over 40 years, and very few saw them then. A decade ago, I paid to have them scanned in. I have added footnotes where I can. I have been editing the final copy this week.
In one of the newsletters, the author cited a statement by George Mason. Mason is rightly called the father of the Bill of Rights. He was a participant at the Constitutional Convention in 1787. Here is the passage cited:
As nations can not be rewarded or punished in the next world they must be in this. By an inevitable chain of causes & effects providence punishes national sins, by national calamities. I wanted to cite the source in a footnote. Google lets us locate sources more easily than ever before in man's history. I tracked it down late in the evening on August 22. Mason made this statement on August 22, 1787 230 years to the day prior to my search.
What caught my attention was its context. Here is the full citation.
Slavery discourages arts & manufactures. The poor despise labor when performed by slaves. They prevent the immigration of Whites, who really enrich & strengthen a Country. They produce the most pernicious effect on manners. Every master of slaves is born a petty tyrant. They bring the judgment of heaven on a Country. As nations can not be rewarded or punished in the next world they must be in this. By an inevitable chain of causes & effects providence punishes national sins, by national calamities.