When the Levee Breaks

Addison Wiggin wrote this essay in while he was in New Orleans for the annual gold conference in November 2002. We thought with everything that has been going on in the past week with Hurricane Katrina that we should run it again…

At the height of "the bubble," just when the wheels started to come off, Mississippi John Law came up with a brilliant plan to save his company and the Banque Royale.

The year was 1720 Paris, over the previous three years and by virtue of Law’s financial innovations, had become the largest and richest city in Europe.

Law’s "innovation" was paper money. Apart from a several hundred-year stretch in China ending in 910, the world had never seen or used paper money. At the outset of The Mississippi Scheme, Law had demanded, on the pain of death, that his banker’s not print more money than could be redeemed in gold from their own reserves. The strict backing of the currency – what was essentially the world’s first gold standard – gave investors of the day such confidence that the currency actually traded at a premium.

But there was a problem. Law’s bank existed by virtue of a deal with the Regent of France, the Duc d’Orleans. The finances of the government in France following the reign of Louis XIV, his wars and the building of Versaille, were a mess. Seeing how much value was being placed in the new bank notes of the Banque Royale, the Regent set another precedent modern readers will recognize: he decided to print his way out of debt. He suggested Law issue currency up to 80 times what the bank held in redeemable gold reserves. Law, being rather preoccupied with the power and prestige the Scheme had bestowed on him, ignored his previous warnings, and let the printing begin.

The new notes flooded into the market and for a while held the value they had gained with solid gold backing. So many people got rich, the Aristocracy of the time coined a new term to describe the: "millionaires". Stories of commoners making so much money fired the imaginations of thousands and thousands more investors and the frenzy got out of hand.

The Invention of Paper Money: New Orleans

New Orleans, the site of this week’s investment conference (sic), was founded at the time, named after the Regent, and meant to become the Paris of the New World. The jumping off point for those who would mine all the gold and silver soon to be discovered in Mississippi (sic).

When people started getting wind of the fact that there was nothing backing Law’s currency but rumours of future profits to be reaped in the New World, they started losing confidence in the new currency. Law trying to keep up appearances just a little longer rounded up all the beggars, bums and thieves in Paris, furnished them with picks and shovels, and marched them through Paris ostensibly on their way to New Orleans… and the mines of Mississippi. The quiet hiss of air leaking out of the bubble accelerated into a screeching "whoosh!" when the same old dirty faces began appearing in the same old dirty doorways and alleys.

In 1971, our own currency, the almighty dollar, was the last modern currency to be officially removed from the gold standard. Ironically, or not, the move was precipitated by the French government. At the time, de Gaulle realized that the US had built up immense debts to governments around the world. If the US wanted to pay the debts back, all we had to do was fire up the printing press, and the world was forced to accept our paper in lieu of these debts. De Gaulle thought he’d redeem his paper for gold… a move that was still legal at the time. Nixon thought better of it. Said no way. And closed the "gold window". Since that day, no one – not you, me or the president of France – can redeem their paper money for gold. And the value of the dollar is largely determined by the confidence investors around the world foresee in future success of US economy.

Doing his part this week to keep up appearances just a little longer, Alan Greenspan lowered the Fed funds rate another 50 basis points. If there’s no gold behind them thar pieces of paper, maybe a boatload of credit will do the trick, eh?


Addison Wiggin,
The Daily Reckoning

August 31, 2005

P.S. They really couldn’t have picked a worse spot to build a city. As you know, New Orleans is about 100 miles away from the mouth of the great Mississippi river. It’s a great location for trade, but rivers of this size, well… they move a lot. In order to keep the city in one piece, the people of New Orleans have had to build an extensive levee system.

Today, the French quarter sits eight feet below sea level, and is sinking. If the levee were to break, the city would flood… and stay flooded. Now they’ve built a sophisticated satellite system to track the movements of the river and break the levee at strategic points north and south of the city. Intervention and improvisation… it’s the human way, isn’t it?

P.P.S. In the meantime, it’s hard to say what’s better about this town: the food or the music. Both are excellent. And unique. After the conference had wound down a bit last night, I went with some of our English colleagues to a jazz club over by the French Market called Snug Harbor. We ate seafood and listened to a band called The New Orleans Jazz Vipers…good ol’ time Dixieland.

At one point we struck up a conversation with a rather audacious gentleman who grew up in the area. He was pudgy, balding slightly, wore outsized sunglasses in the bar (at night) and loudly supported "Hillary for President" without being pressed for his political views. Oh, he was an attorney, too. (You like the guy already, don’t you?)

When he discovered we were in town for an investment conference he was aghast. "You poor sons of b*@$#es! Did any of you call that bubble we just went through!?" He asked with the air of a Senator sitting on a joint investigation panel of Congress.

"He did," one of my colleagues said, pointing to me without interest.

"Ohhh… he’s a rich man!… he is one rich mother_____!" the man screeched over the din of the bar… louder, even than The New Orleans Jazz Vipers.

Maybe, maybe not. But as Bill is wont to say from time to time: "There’s more to life than money."

Editor’s Note: Addison Wiggin is the editorial director and publisher of The Daily Reckoning. Mr. Wiggin is also the author, with Bill Bonner, of the international bestseller Financial Reckoning Day and the upcoming thriller Empire of Debt. Mr. Wiggin is frequent guest on national radio and television programs.

The above essay was taken from Mr. Wiggin’s newly-released book, The Demise of the Dollar…and Why It’s Great for Your Investments.

The days of our fin de bubble summer really are dwindling down to a precious few. In fact, there is only one left.

Not that summer will be officially over; that won’t happen for three more weeks. But tomorrow every child in France returns home, buys his school supplies and braces himself for the beginning of a new school year.

Our family follows a slightly different schedule; we’re moving to London. So, we’ll leave here on Friday. The children begin school on Monday.

In the meantime, we’re still thinking about the remarkable, sidesplitting comedy in front of us.

Last week, Alan Greenspan warned the nation:

"History has not dealt kindly with the aftermath of protracted periods of low risk premiums…Such an increase in market value is too often viewed by market participants as structural and permanent.

"Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes liquidation of the debt that supported higher prices."

It must have slipped his memory that it was he who created risk premiums as low as any ever seen in America; in any case he failed to mention it. Nor did he recall that as recently as a few months ago he assured the nation that its swelling mortgage debt was no problem…nor did he ‘fess up to having urged homeowners to avail themselves of greater credit opportunities offered by innovative lenders.

But that’s just our adorable Maestro…

What is happening just under the Fed chairman’s nose is that consumers are running out of money. Oil hit nearly $70 a barrel yesterday. If it rises another $10 it will equal the shock of the oil crisis of the ’70s, which threw the U.S. economy into its worst recession since the Great Depression. Already, every time the poor householder fills up his tank he has less money left over to buy other things. Convenience stores report, for example, that they are selling fewer snacks; all the money is going into the tank.

For the moment, the consumer is still confident. He believes all is well.

"US consumer confidence stronger than expected," says a Financial Times headline. Consumers are simply charging fuel on credit cards – they’ll worry about how to pay the bill tomorrow.

But that’s the problem with credit expansions; tomorrow always comes.

Today is already yesterday’s tomorrow. Today, yesterday’s bills are coming due. A Reuters headline tells us that more "Workers say they are falling behind." There should be no surprise there. They owe more money to more people than ever before. They are still buying newer cars and bigger houses, but they are giving up their financial independence and security to keep up with the bills. "Number of Americans without health care increases for fourth year," says a headline from yesterday. A few weeks ago, we reported that more Americans face retirement with empty pockets. Company retirement programs have been replaced with individual 401(k)s. But, under the stress of keeping up with appearances, people tend to ignore them.

In short, Americans are ruining themselves.

And why shouldn’t they? Everyone has to play the role he is given. Why must Americans play the parts of people who are ruining themselves? Because "history does not deal kindly with the aftermath of protracted periods of low risk premiums," to quote a reliable source. America has been largely spared the devastation of the 20th century’s wars. She has gained market share over most of the period…she became the world’s largest economy early in the 20th century…and grew stronger and stronger, until she became the undisputed Alpha Nation…the world’s only superpower…and the planet’s only real empire. Investing in America was a fairly low risk proposition. The risks were seen as so low that Americans gradually gave up the cautious virtues that made them great; there is no need to save for a rainy day when there are no clouds in the sky…

And now, assuming we are right about where we are in the cycle, we face the downside…the aftermath. Investing in America now is no longer a low-risk proposition. Now it is a high-risk proposition. Its stocks are expensive. Its factories are old. Its real estate is in a bubble. Its workers are overpaid, compared to Asian competitors. Its bonds are denominated in a currency with no backing – other than the full faith and credit of the world’s biggest debtor.

Of course, Americans could have held back. They might never have bought Amazon at 200 times earnings at the end of the ’90s, and thus avoided the NASDAQ meltdown. They might have elected a conservative president and have avoided the costs of the war in Iraq…and the explosion in Federal spending. And even now, they might restrain themselves; they might cut back their spending and reduce the trade deficit. They might tighten their belts and pay down their credit cards and equity lines. They might tell their legislators to reduce the deficit. "Give us fewer services and fewer handouts," they might say. "Raise our taxes…we don’t want to live beyond our means." Yes…they might even sell their SUVs and hop to work!

That is the marvelously entertaining thing about modern economics…people can always be counted on to do the absurd and idiotic thing. Americans find themselves on top of the world. Now they must find a way to slip off! Otherwise, history would stop in its tracks…and we would have to stop writing. There would be nothing further to reckon with…

So you see, dear reader, Americans ruin themselves for us. For our amusement. And to give us an occupation. Isn’t that nice of them?

More news, from our team at The Rude Awakening:


Sean Brodrick, reporting from Florida…

"Hurricane Katrina smashes ‘Energy Alley,’ a concentrated area of oil production in Gulf of Mexico that supplies about 35% of America’s domestic oil."


Bill Bonner, with more views:

*** The outlook is looking bleaker by the minute in New Orleans. Two levees broke yesterday, and swamped around 80% of the below-sea-level city – rendering it inhabitable for an undetermined amount of time.

"We are looking at 12 to 16 weeks before people can come in," Mayor Ray Nagin said on ABC’s "Good Morning America, "and the other issue that’s concerning me is we have dead bodies in the water. At some point in time the dead bodies are going to start to create a serious disease issue."

After the levees broke, army engineers have been trying to plug them with giant sandbags and concrete barriers, but to little avail. The Chinook helicopters that the Army Corps. Of Engineers have planned to use had trouble getting the 3,000 pound sandbags to the site because of the massive amounts of debris clogging New Orleans’ waterways.

The death toll in Louisiana is unknown, as Louisiana officials put counting deaths on the backburner and decided to focus on rescuing the survivors. The Red Cross reported it had about 40,000 people in 200 shelters across the area in one of the biggest urban disasters the nation has ever seen.

*** "Wait a minute," Elizabeth objected this morning. "You seem to be saying that history merely runs along in its own current and that we are powerless to do anything about it. If you’re right, it doesn’t matter what we do or say. And all the debate about what we should do as a nation is meaningless; it is just so much hot air. Because history has a mind of its own…and maybe a purpose of its own. What we think is irrelevant."

"Well…yes…" we replied, perhaps exaggerating.

*** Ooh la la…homebuilding stocks are probably the bellwethers of the real estate bubble. And the homebuilders are going down. Worse, yesterday’s news brought word that the insiders were bailing out.

"Homebuilding insiders on selling spree," said CBS Marketwatch.

*** President Bush spoke to the Navy yesterday. The Iraq war, he explained, was just another theatre in the vast war to make the world safe for democracy and freedom. An honest nation is concerned only with protecting its borders and its people. What the president was describing was America’s imperial mission – begun by Woodrow Wilson – to transform the entire planet into something more to our liking.

We resisted the lure of empire, for longer than we should have. Now we have come to like it; it is vastly more entertaining than a humble republic for the simple reason that its pretensions are so much grander. Lyndon Johnson only wanted to build a Great Society. G.W. Bush seems to want to build a whole New World Order, to use a phrase proposed by his father.

*** GM and Ford sold cars at a loss for the first half of the year. GM says it is closing more plants. This is bad news for the economy, but good news for the empire. The unemployed factory workers might be lured into the army.

We notice in reading John Keegan’s "A History of Warfare" that the Romans too were aided by a bad agricultural economy. By the time of the Punic Wars, the small landholdings apparently became less profitable. Soldiering seemed an attractive alternative.

By the way, we’re are putting the final touches on our book, Empire of Debt this week. We received this e-mail yesterday from Addison, toiling away in Baltimore:

"Bill, I got a load of charts back today from the designer. I just looked through them… and by the time I got to the end I actually had chills running up my spine. Each chart looks the same Corporate, Municipal, Federal, Consumer, Revolving, Mortgage, Subprime, … all trundle along until the mid seventies then skyrocket. So much, so fast… it’s hard to draw any conclusions at the outset.

"Here’s one: Home mortgages and corporate debt, both, are approaching $9 trillion… so combined they’re approaching twice GDP. More to come…"

(Look for your copy of Empire of Debt in October.)