06/04/10 Baltimore, Maryland – One of the most puzzling questions from history is why smart people do such moronic things. Bonaparte was warned; it seemed obvious to anyone who knew the lay of the land that the Russian campaign was foolhardy. In WWI, both sides should have called it quits by 1917. And what was Rudolf von Havenstain thinking? The president of the Reichsbank printed up billion-mark notes; surely he must have known they would cause trouble.
But people come to think what they must think when they must think it. One decision leads to another one. Each one is rational, as far as it goes. But put them together and you are on your way to hell. Von Havenstain was just trying to keep the economy from collapsing. In the pageant of unwelcome possibilities, he judged inflation less ugly than a Bolshevik uprising.
The US central bank had its Havenstain moment last year, in March, when it began buying private sector securities – effectively adding billions to the world’s money supply. A worldwide bull market followed. Equities rose about 70%. At the end of March a year later, the “quantitative easing” program came to an end. After spending $1.2 trillion, the feds withdrew and the bull market ended. Since then, the S&P has lost 8% of its value. The Shanghai stock market has just hit a 12-month low and is now down 60% below its January 2008 high.
Now we see both how our modern monetary system began…and how it will end. In the sunny days of August, 1971, Richard Nixon was merely solving another problem caused by another solution. The solution to the world’s problems in the ’60s was to spend money on the war in Vietnam and the War on Poverty. The spending of the ’60s created the debts that Nixon had to reckon with – particularly to the French. Rather than pay the foreigners in gold, as had been customary for hundreds of years, the Nixon team defaulted. They changed the world’s monetary system, beginning the monetary equivalent of Napoleon’s march on Moscow.
They thought they were doing the world a favor. A more ‘flexible’ currency system would give financial authorities another powerful weapon with which to fight downturns. Instead of holding gold as their main monetary reserve, nations switched to holding each other’s paper. Henceforth, one’s reserve assets were another’s liabilities – all netting out to zero.
With this new weapon in their hands the feds won every battle – from the Latin American debt crisis of the ’80s to the mini recession of 2001. But the trouble with money that grows on trees is that you are soon raking it off your lawn. The pile of international reserves, other than gold, grew from under $300 billion in 1971 to more than $8.5 trillion today. Prices rose too. As measured in Britain, consumer prices rose as much in the last 40 years as in the entire preceding 700.
According to Alan Newman, daily trading volume has ballooned more than 25 times since the 1970s. The financial industry has gone from a minor activity representing only 3% of GDP in the ’70s, to a substantial 7.5% of GDP today…and its single major source of profits.
This financial dervish produced plenty of dust but less and less forward motion. Net private investment in the US hit a high in 1978 at about 8% of GDP. It has been declining ever since, recently hitting zero. After WWII, wages and real GDP increased steadily. But without investment in new plants and equipment, hourly wage gains stopped in the 1970s, while real GDP gains declined. People kept up appearances by borrowing heavily. But that only caused another problem.
The private sector is now solving the problem of too much debt by cutting back. Consumer credit is falling. Commercial and industrial loans are falling. The money supply, as measured by M3, is deflating at the fastest rate since the Great Depression – more than 9% annually. And prices – as measured by the US core CPI – are going up at the slowest paces since 1966.
This correction is natural and normal. But the feds want to stop it anyway. What can they do? ECB council member Patrick Honohan, from Ireland, has the answer. He applauds an “important new weapon,” referring to the very same hot cannon that blew up in Rudolf von Havenstain’s face 9 decades ago. The ECB has begun its own program of quantitative easing. It bought 35 billion euros of bonds in the first 3 weeks of the program.
“Restoring market confidence in the solidity of governments’ finances is absolutely crucial,” Honohan said.
Mr. Honohan is neither evil nor stupid. He is merely putting one foot in front of the other. He judges the need for confidence greater than the risk of inflation. Reasonable…as far as it goes. But where does it lead? The Rhine, the Niemen, and the Volga have all been breached. Sooner or later, he will be on the banks of the Berezina.
Bill Bonner
for The Daily Reckoning
Bill Bonner
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010.
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“Mr. Honohan is neither evil nor stupid. He is merely putting one foot in front of the other.”
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like a drunk on the road to sobriety
excellent analysis
When this whole thing we call civilization goes t^ts up – it will seem evil and stupid enough.
Harry, where are you? Tell us what kind of haircut you’re getting in the market? Getting your head handed to you? When I see you on the street corner begging, I’ll laugh at you, punk.
Bad old Nixon took America off the Gold standard in 1971
And look what happened since…
Terrible things like the U.S. standard of living at least doubling since then.
People living in large houses with 3 bath rooms and 3 cars…
Honking huge stores like Wal-Mart super centers and Costcos at every corner with mini vans and SUVs streaming out of the parking lots groaning with booty.
Ooh it’s all so terrible all this wealth…
The InvestorsFriend,
At least you and I did not get over extended so we can happily party on, but millions of other folks are not so lucky.
The music has stopped and we have chairs, but let us not forget how many families have no chairs.
@ Investorsfriend,
I do believe you do not travel to the ghetto very often. Not saying I live there, but they do exist and you clearly have defined routes in your day that allow you to only entertain costco and Walmart for your disposable needs.
ALL (most) of that crap is from China. So what are the net effects? A few rich guys make some money over here, and a few rich guys get rich over there, Americans consume more than anyone else on the planet, thus negating some savings… but, oh yeah… then there’s a whole factory of people that are making some type of steady income over in China and thus adding to their economy (both in government and private savings)
The Chinese businessmen are getting pushier with their pricing across the board as they view their influence getting up to par if not far past the US of A very fast.
Remember, we are supporting a technically Communist country still. I love how some people get all pissed at Cuba and not China!? Its all about money.
I know it’s more complicated than just that but there go some nuts and bolts!
-
Nixon’s global economic campaign was comparable to Napolean’s or Hitler’s Russian campaign. Winter set in!. The only difference is paper torn under sheer
weight of commitment.
Ambition! Ambition!. Historically, how many iron men have been played out?
Smart ones are prone to mislead. Wisdom is perpetual friend.
No can deny the massive increase in living standards in the United States despite going off the Gold standard in 1971.
Poverty existed then and Poverty exists now. Poverty once meant starving. Now it means relatively poor but still probably a warm bed, food , cable TV and a cell phone.
Povverty or not you simply can’t deny the world of luxury created in the U.S. since 1971.
You can talk about a future decline that you predict. But you can’t deny that the living standards of today are vastly improved since 1971.
how much money did you make today harry??
To TheInvestorsFriend (or is it enemy??) – yeah, standards of living have gone up but that is because the wealth generating machine (US free-market economy) has outpaced the best efforts of the feds to replace the “free” in “free-market” with “rigged”.
However, as BB has repeatadly pointed out, over the past few years the feds are now winning the game and there’s not much wealth left to squeeze out of a tapped out economy.
It’s like if you win the lottery and put a million dollars in the bank then proceed to use an ATM and not look at how much your money dwindles while you spend it on cars/houses/fabulous lifestyle. then one day you go to use ATM and there’s no money left so you spend whatever money you have in your pocket on more lottery tickets expecting to just win and put another million dollars back into the bank…
If you can’t recognize this then you truly are the investor’s enemy
Like the wise Salomon once said: what has been, will be again, what has been done will be done again; and there is nothing new under the sun. Ecclesiastes 1:9. And he lived before Aesop!
The guy’s name was Havenstein, not Havenstain. “stein” means stone.
I know what stain means, by the way. And he wasn’t a “von” either as far as I can remember.
Will be interesting to see, however, if Axel Weber follows his footsteps on the road to hyper, hyper…