A Vote of "No Confidence", Part I

The Daily Reckoning PRESENTS: This morning, we heard from our friends at the Charles Goyette show in Phoenix that Republican Congressman Ron Paul made his presidential intentions clear on today’s show. Even if he didn’t, we think it’s a darn good idea. See what Dr. Paul thinks the price of gold is telling the U.S. economy, below…


The financial press, and even the network news shows, have begun reporting the price of gold regularly. For twenty years, between 1980 and 2000, the price of gold was rarely mentioned. There was little interest, and the price was either falling or remaining steady.

Since 2001 however, interest in gold has soared along with its price. With the price now over $600 an ounce, a lot more people are becoming interested in gold as an investment and an economic indicator. Much can be learned by understanding what the rising dollar price of gold means.

The rise in gold prices from $250 per ounce in 2001 to over $600 today has drawn investors and speculators into the precious metals market. Though many already have made handsome profits, buying gold per se should not be touted as a good investment. After all, gold earns no interest and its quality never changes. It’s static, and does not grow as sound investments should.

It’s more accurate to say that one might invest in a gold or silver mining company, where management, labor costs, and the nature of new discoveries all play a vital role in determining the quality of the investment and the profits made.

Buying gold and holding it is somewhat analogous to converting one’s savings into one hundred dollar bills and hiding them under the mattress – yet not exactly the same. Both gold and dollars are considered money, and holding money does not qualify as an investment. There’s a big difference between the two however, since by holding paper money one loses purchasing power. The purchasing power of commodity money, i.e. gold, however, goes up if the government devalues the circulating fiat currency.

Holding gold is protection or insurance against government’s proclivity to debase its currency. The purchasing power of gold goes up not because it’s a so-called good investment; it goes up in value only because the paper currency goes down in value. In our current situation, that means the dollar.

One of the characteristics of commodity money – one that originated naturally in the marketplace – is that it must serve as a store of value. Gold and silver meet that test – paper does not. Because of this profound difference, the incentive and wisdom of holding emergency funds in the form of gold becomes attractive when the official currency is being devalued. It’s more attractive than trying to save wealth in the form of a fiat currency, even when earning some nominal interest. The lack of earned interest on gold is not a problem once people realize the purchasing power of their currency is declining faster than the interest rates they might earn. The purchasing power of gold can rise even faster than increases in the cost of living.

The point is that most who buy gold do so to protect against a depreciating currency rather than as an investment in the classical sense. Americans understand this less than citizens of other countries; some nations have suffered from severe monetary inflation that literally led to the destruction of their national currency. Though our inflation – i.e. the depreciation of the U.S. dollar – has been insidious, average Americans are unaware of how this occurs. For instance, few Americans know nor seem concerned that the 1913 pre-Federal Reserve dollar is now worth only four cents. Officially, our central bankers and our politicians express no fear that the course on which we are set is fraught with great danger to our economy and our political system. The belief that money created out of thin air can work economic miracles, if only properly “managed,” is pervasive in D.C.

In many ways we shouldn’t be surprised about this trust in such an unsound system. For at least four generations our government-run universities have systematically preached a monetary doctrine justifying the so-called wisdom of paper money over the “foolishness” of sound money. Not only that, paper money has worked surprisingly well in the past 35 years – the years the world has accepted pure paper money as currency. Alan Greenspan bragged that central bankers in these several decades have gained the knowledge necessary to make paper money respond as if it were gold. This removes the problem of obtaining gold to back currency, and hence frees politicians from the rigid discipline a gold standard imposes.

Many central bankers in the last 15 years became so confident they had achieved this milestone that they sold off large hoards of their gold reserves. At other times they tried to prove that paper works better than gold by artificially propping up the dollar by suppressing market gold prices. This recent deception failed just as it did in the 1960s, when our government tried to hold gold artificially low at $35 an ounce. But since they could not truly repeal the economic laws regarding money, just as many central bankers sold, others bought. It’s fascinating that the European central banks sold gold while Asian central banks bought it over the last several years.

Since gold has proven to be the real money of the ages, we see once again a shift in wealth from the West to the East, just as we saw a loss of our industrial base in the same direction. Though Treasury officials deny any U.S. sales or loans of our official gold holdings, no audits are permitted so no one can be certain.

The special nature of the dollar as the reserve currency of the world has allowed this game to last longer than it would have otherwise. But the fact that gold has gone from $252 per ounce to over $600 means there is concern about the future of the dollar. The higher the price for gold, the greater the concern for the dollar. Instead of dwelling on the dollar price of gold, we should be talking about the depreciation of the dollar. In 1934 a dollar was worth 1/20th of an ounce of gold; $20 bought an ounce of gold. Today a dollar is worth 1/600th of an ounce of gold, meaning it takes $600 to buy one ounce of gold.

The number of dollars created by the Federal Reserve, and through the fractional reserve banking system, is crucial in determining how the market assesses the relationship of the dollar and gold. Though there’s a strong correlation, it’s not instantaneous or perfectly predictable. There are many variables to consider, but in the long term the dollar price of gold represents past inflation of the money supply. Equally important, it represents the anticipation of how much new money will be created in the future. This introduces the factor of trust and confidence in our monetary authorities and our politicians. And these days the American people are casting a vote of “no confidence” in this regard, and for good reasons.

The incentive for central bankers to create new money out of thin air is twofold. One is to practice central economic planning through the manipulation of interest rates. The second is to monetize the escalating federal debt politicians create and thrive on.

Today no one in Washington believes for a minute that runaway deficits are going to be curtailed. In March alone, the federal government created an historic $85 billion deficit. The current supplemental bill going through Congress has grown from $92 billion to over $106 billion, and everyone knows it will not draw President Bush’s first veto. Most knowledgeable people therefore assume that inflation of the money supply is not only going to continue, but accelerate. This anticipation, plus the fact that many new dollars have been created over the past 15 years that have not yet been fully discounted, guarantees the further depreciation of the dollar in terms of gold.

There’s no single measurement that reveals what the Fed has done in the recent past or tells us exactly what it’s about to do in the future. Forget about the lip service given to transparency by new Fed Chairman Bernanke. Not only is this administration one of the most secretive across the board in our history, the current Fed firmly supports denying the most important measurement of current monetary policy to Congress, the financial community, and the American public. Because of a lack of interest and poor understanding of monetary policy, Congress has expressed essentially no concern about the significant change in reporting statistics on the money supply.

Beginning in March, though planned before Bernanke arrived at the Fed, the central bank discontinued compiling and reporting the monetary aggregate known as M3. M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation. Yet this report is no longer available to us and Congress makes no demands to receive it.

Though M3 is the most helpful statistic to track Fed activity, it by no means tells us everything we need to know about trends in monetary policy. Total bank credit, still available to us, gives us indirect information reflecting the Fed’s inflationary policies. But ultimately the markets will figure out exactly what the Fed is up to, and then individuals, financial institutions, governments, and other central bankers will act accordingly. The fact that our money supply is rising significantly cannot be hidden from the markets.

The response in time will drive the dollar down, while driving interest rates and commodity prices up. Already we see this trend developing, which surely will accelerate in the not too distant future. Part of this reaction will be from those who seek a haven to protect their wealth – not invest – by treating gold and silver as universal and historic money. This means holding fewer dollars that are decreasing in value while holding gold as it increases in value.

A soaring gold price is a vote of “no confidence” in the central bank and the dollar. This certainly was the case in 1979 and 1980. Today, gold prices reflect a growing restlessness with the increasing money supply, our budgetary and trade deficits, our unfunded liabilities, and the inability of Congress and the administration to reign in runaway spending.

Denying us statistical information, manipulating interest rates, and artificially trying to keep gold prices in check won’t help in the long run. If the markets are fooled short term, it only means the adjustments will be much more dramatic later on. And in the meantime, other market imbalances develop.

The Fed tries to keep the consumer spending spree going, not through hard work and savings, but by creating artificial wealth in stock markets bubbles and housing bubbles. When these distortions run their course and are discovered, the corrections will be quite painful.

Likewise, a fiat monetary system encourages speculation and unsound borrowing. As problems develop, scapegoats are sought and frequently found in foreign nations. This prompts many to demand altering exchange rates and protectionist measures. The sentiment for this type of solution is growing each day.

Though everyone decries inflation, trade imbalances, economic downturns, and federal deficits, few attempt a closer study of our monetary system and how these events are interrelated. Even if it were recognized that a gold standard without monetary inflation would be advantageous, few in Washington would accept the political disadvantages of living with the discipline of gold – since it serves as a check on government size and power. This is a sad commentary on the politics of today. The best analogy to our affinity for government spending, borrowing, and inflating is that of a drug addict who knows if he doesn’t quit he’ll die; yet he can’t quit because of the heavy price required to overcome the dependency. The right choice is very difficult, but remaining addicted to drugs guarantees the death of the patient, while our addiction to deficit spending, debt, and inflation guarantees the collapse of our economy.

Special interest groups, who vigorously compete for federal dollars, want to perpetuate the system rather than admit to a dangerous addiction. Those who champion welfare for the poor, entitlements for the middle class, or war contracts for the military industrial corporations, all agree on the so-called benefits bestowed by the Fed’s power to counterfeit fiat money. Bankers, who benefit from our fractional reserve system, likewise never criticize the Fed, especially since it’s the lender of last resort that bails out financial institutions when crises arise. And it’s true, special interests and bankers do benefit from the Fed, and may well get bailed out – just as we saw with the Long-Term Capital Management fund crisis a few years ago. In the past, companies like Lockheed and Chrysler benefited as well. But what the Fed cannot do is guarantee the market will maintain trust in the worthiness of the dollar. Current policy guarantees that the integrity of the dollar will be undermined. Exactly when this will occur, and the extent of the resulting damage to financial system, cannot be known for sure – but it is coming. There are plenty of indications already on the horizon.

Foreign policy plays a significant role in the economy and the value of the dollar. A foreign policy of militarism and empire building cannot be supported through direct taxation. The American people would never tolerate the taxes required to pay immediately for overseas wars, under the discipline of a gold standard. Borrowing and creating new money is much more politically palatable. It hides and delays the real costs of war, and the people are lulled into complacency – especially since the wars we fight are couched in terms of patriotism, spreading the ideas of freedom, and stamping out terrorism. Unnecessary wars and fiat currencies go hand-in-hand, while a gold standard encourages a sensible foreign policy.

To be continued next week…

Congressman Ron Paul
for The Daily Reckoning
January 18, 2007

Editor’s Note: Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency. He is known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives: Dr. Paul never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the “one exception to the Gang of 535” on Capitol Hill.

To learn more about Dr. Paul, see here:

Congressman Ron Paul

First, there was the New Woman.

Then, there was the New Economy.

Now there is the New Inflation.

Asset inflation is as different from the regular kind as an illicit affair is from an ordinary one. It is much more agreeable when it comes in…and much more painful when it goes away.

And it is not all created by central banks or Treasury Departments.

By now, we understand central bank inflation only too well. It worms its way down to the consumer economy through the banking system. Eventually, but not immediately, prices rise. And when prices rise too steeply, voters begin to howl…businesses get jumpy…investors start to flinch…and the whole economy goes sour like old milk.

But this ‘New Inflation’ is different. It is the ‘Wave of Liquidity’ that is floating up prices of capital assets…and rich peoples’ toys…all over the planet. Yes, dear reader, the rich have done very well out of all this new liquid. It has boosted up their wealth. Their stocks, their bonds, their property…even the works of art that adorn their walls have floated up.

Where does all this money come from? Ah…that’s what is new about it. And it is why the financial industry is making so much money.

It works like this. You have a house worth $100,000. You take out a mortgage for $50,000. Then the mortgage is mixed together with other mortgages, stirred, shaken and sold to a financial house, X. There, it is used as collateral for a loan of $500,000…which is invested in a leveraged buy-out of a Company Y…which then issues bonds worth $5 million, which are taken up by hedge fund Z, that borrowed the money to buy them from the Japanese at a low interest rate, exchanged it for dollars, and now invests in these junk bonds at twice the yield.

At every step, the financial intermediaries make their commissions, their spreads, and their fees. At every step, the amount of notional ‘money’ in the world multiplies. Your income has not changed…your house is still the same…business Y makes no more profits. The real economy remains just as it was. This feverish financial activity…this ‘financialization of the economy’ adds nothing…not one jot or tittle…to the real wealth that is in the world. There are no more factories…no more diamonds…no more steak sandwiches. All this money-shuffling produces nothing but more profits for the money- shufflers and more wealth for the rich people around the table.

As long as the credit bubble expands…it also expands the values of the assets held by the rich. Their stocks, bonds…junk bonds…and all other assets, go up in price. Which means, that they are the beneficiaries of the New Inflation. When their junk bonds or houses or stocks go up in value…they have more purchasing power. They can trade financial assets for other assets. They can use them to buy a time-share in a corporate jet…or a vacation house at St. Barts. Or, they can simply buy more ‘stuff.’

We can be sure that they are not going to drive up the price of toilet paper or margarine, however. Consumer prices are, broadly speaking, unaffected. The rich don’t use more toilet paper just because they have more money. Nor do they eat more hamburgers. But insofar as they have more purchasing power, thanks to this New Inflation, they grow richer, compared to the rest of the world.

This might not make much difference, eventually, of course. Every dollar created out of thin air eventually goes back from whence it came. All this pseudo-wealth – created by the New Inflation – will eventually disappear. Credit booms are typically followed by credit busts. Junk bonds typically have their moments of glory, followed by their hours of desperation and defeat. Things that go up so spectacularly can be expected to go down in a sensational way too.

But here is where the real problem arises. While financial assets rose in price, so did the debt burden on the proletariat. The New Inflation meant new wealth to the rich; to the lumpen…the booboisie…it meant debt-financing. What the middle and lower classes got out of it was an opportunity to ruin themselves; which they took up readily.

New Inflation is sure to be followed by New Deflation. We wonder what that will feel like.

More news:


Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“Unfortunately, the markets don’t appear to be too satisfied having to eat off the disappointment plates, and they have taken yen even lower to the 121 handle. OK fellas, that’s a little harsh, don’t you think?”

For the rest of this story, see today’s issue of The Daily Pfennig


And more views:

*** A note from our good friend Chris Mayer:

“I recently finished a book titled From Wall Street to the Great Wall, which further brings home this point. ‘Electrical power shortages are chronic today’ in China, the authors note. ‘Blackouts are not uncommon, and manufacturing is affected directly.’

“Later, the authors quote a story from the Guardian: ‘China is on the biggest power plant building spree the world has ever seen.’ Hydroelectric dams, coal-fired generators and nuclear facilities sprout like weeds throughout China. ‘The equivalent of Britain’s entire electrical output is being added to the capacity of the country’s national grid every two years.’

“Really, the power story is only part of a bigger thread. The more you look into this sort of thing, the more you find that it is about more than just power (or just water, for that matter). It’s a combination of all of these things. What we’re talking about is infrastructure. Admittedly, infrastructure is an ugly four-syllable word that leaves a lot of room for interpretation. As with pornography, you know it when you see it.

“India, often paired up with China in these kinds of stories, has its own infrastructure problems. Wandering cows in the middle of pockmarked roads is only one of them. So notes The Wall Street Journal: ‘The nation’s capital is bedeviled by the same sort of cramped airports, rough roads and frequent power outages that recall the darker days (often literally) of China’s own economic opening.’

“These are the headline cases. At the margins, though, you see similar trends in smaller emerging markets. All of it is more fuel for the perfect storm.”

*** “Died in Burma in World War II”…”Fought in Zulu Wars”…”Victim of Rajasthan Uprising”…”Died at Verdun.”

We were taking a little tour of Canterbury Cathedral before the Matins service on Sunday morning. What was striking was how many monuments there were to fallen soldiers of the British Empire. We think of the British Empire as a commercial undertaking – and it was commercial, in the sense that the profits were realized by private companies, and not by the British government directly.

But like all empires, it needed its fighting men to maintain order and subdue the locals. The English army – with its regiments made up of soldiers from all over the British Isles and its auxiliaries drawn from its colonies and vassal territories – established a Pax Britannica. Then, the English, being in the superior position, were able to set the terms of trade.

The story of the British colonial wars is either a story of great heroism and sacrifice in the service of bringing civilization to the heathen…or a story of brutality, bamboozling and bumbling in an effort to make a buck…depending on how you look at it. Either way, many of its most illustrious participants seem to be memorialized at Canterbury Cathedral.

We haven’t been writing much about the American Empire recently. Not because we’ve changed our minds about it – we just thought you were getting tired of hearing about it.

But our visit to Canterbury rekindled our interest.

First, we note that the United States now has its soldiers garrisoned in 144 different countries. That is a far bigger empire than even the Romans had. And bigger, in some ways, than the British Empire, too.

But ours is a much funnier empire than the other two.

*** MarketWatch reports that Ben Bernanke urged Congress to put the federal budget on a long-term sustainable path. “If early and meaningful action is not taken [to lower the budget deficit], the U.S. economy could be seriously weakened, with future generations bearing much of the cost,” Bernanke said in testimony prepared for delivery to the Senate Budget Committee. Bernanke said that recent narrowing of the deficit was simply “the calm before the storm” as spending on entitlement programs will begin to climb quickly during the next decade.

Now the word is that the total cost of U.S. war in Iraq may rise to as much as $2 trillion. When it was said to be $1 trillion near the beginning of the adventure, the amount was so high that it was dismissed or ridiculed. Now, we find that the tab might be twice as much. Either way, it’s a lot of money, especially if you don’t have it.

There is one thing you have to remember about empires. They are vast public spectacles. As such, they must follow the rules of all public spectacles. They must begin with lies…develop into farces…and end in disaster. No empire has ever failed to do so. When no substantial enemy threatens it, an empire must find one; and if no rival empire can be found to destroy it, it must find a way to destroy itself.

That was what we thought was really behind the war in Iraq from the beginning. There were so few terrorists, more needed to be created. This goal seems to have been achieved.

But the point where this empire is weakest is financial. Every previous empire had found a way to make the business pay, but America has not made a profit at empire for twenty years. Its businesses are now at a competitive disadvantage; they have higher costs and no domestic source of new capital. Americans do not save.

What’s more, maintaining the empire has become an expensive business. Even Osama bin Laden saw the weakness and publicly announced his strategy – he would make America bleed cash. Now, we see that this is exactly what has happened. The war in Iraq cost $2 billion per week in direct costs. It costs $10 million for each Iraqi ‘insurgent,’ whatever that is, killed. Plus, the war on terror costs billions more.

So far, at least, if the great empire wants to ruin itself…at least it is doing what it must.

But you already know that, don’t you, dear reader? You’ve read Empire of Debt…and if you haven’t, you can buy your copy here:

The Most Feared Book in Washington!

The Daily Reckoning