No Such Thing as a Safe Currency, Save One

Jon Nadler of Kitco quotes Bloomberg's Ben Levisohn:

“For all the concern over the $1.6 trillion US budget deficit and record debt load, the dollar is as valuable now as 35 years ago. Measured against a basket of currencies from the G-10 nations proportioned against each other, the greenback is up about 3 percent since 1975, according to the Bloomberg Correlation-Weighted Currency Index. That was four years after the Bretton Woods agreement set up in 1944 to link currencies to gold, collapsed.”

At the same time, Nadler bears bad news about the darn euro, quoting The Sydney Morning Herald, which notes that even prostitutes in Greece are threatening strikes because of loss of welfare benefits:

"The stakes are high, not just for Greece but for the entire euro zone, where efforts to forge a common economic identity are threatened. Last week, the panic spread to Portugal and Spain, and the cost of insuring their debt against a default soared to record levels as investors bet that, like Greece, governments in those countries won't be able to rein in bloated budgets."

Nadler points out that the continent's financial problems are linked to Democratic Party-style social welfare programs that have decimated its economic growth. Again quoting the Sydney Morning Herald:

"on a continent where the culture and legitimacy of the mother state are so deeply ingrained - and now in some cases unaffordable - a question remains: can the European Commission say 'no more' to prodigal nations like Greece and, to a lesser extent, Spain and Portugal? And how will the countries themselves confront the political fallout of economic distress?"

Given the failure of Democratic Party-style economics in Europe, it is amazing that anyone reads the European-style New York Times anymore, or that Americans have elected an administration that is committed to instituting Europe's failed tribalist philosophy here in the more civilized, individualist United States.

Also of importance are the implications of the dollar's strength. I just blogged about the effects on employment of a strong dollar and how the US government and the Fed have orchestrated the exit of high wage jobs via monetary policy. No currency is safe because the others will inflate as much as we do. What is amazing about this process of dollar repatriation given risk in Europe, which, quoting Nadler, I predicted a month ago using my coin flip method of investing, is that massive deficits and expansion of the monetary base, have been accompanied by increasing DEMAND for the dollar. When the supply of dollars goes up, cheapening them, demand also goes up? Is this a curious application of Say's Law, that supply creates its own demand?

I think not. There is a chasm between Wall Street's short term thinking and longer term reality. Keynes said that in the long term we're all dead, but Keynes is dead and we won't have to wait that long, hopefully (from a death standpoint).

If, given the high inflation rates of the past 40 years the dollar has held its own against other currencies, there is no such thing as a safe currency, save one. Spell it G-O-L-D. That does not mean that gold is going up next week or next month. But the world is on a welfare addiction habit, and the welfare addiction is destroying the source of the "good faith" of the US government. By raising spending, providing stimulus handouts and increasing the money supply, the US government is telling America's hard working employees: "You are fools. Look at the looters at Goldman Sachs." By taxing incomes, the US government is telling you: "Do not work, live off government." By subsidizing the welfare mothers on Wall Street, the US government is telling any entrepreneur: "Why waste your time? Get a value-destroying job in New York City."

If you trust the current pattern of events, trust the current strength of the dollar. Otherwise, think about alternatives. Stocks are fine, but inflation confuses investment, credit is overextended, lending is on hold and the US economy is a mess, starting with over-investment in real estate. This will result in downward adjustments in consumers' wealth and reductions in access to credit.

How will those problems be cured? Ben Bernanke has already done it. Expand the amount of money. But entrepreneurship has been hammered through decades of high tax rates, regulation and harassment of small business. My local pharmacist says he spends half his day filling out government forms. The same in other businesses. So stocks are not exciting. Too much regulation; too much mismanagement; too much malinvestment that needs to be cleaned up.

That leaves commodities. But in the short run, they will be subject to ongoing attacks from the central banks. But are you willing to trust the federal government and the dollar over the long haul?

Only A Divided House Will Stand

Mish's Global Economic Trend Analysis has a good discussion of Marc Faber's prediction of economic collapse in 2012. I don't think you can pinpoint it, and don't underestimate the United States. But the current American system is unsustainable and collapse is ahead. Whether the government counterfeiters can continue to make things work for another 20 or 30 years or maybe even longer, no one knows. It took the Roman Empire nearly three centuries following the death of the last of the five good emperors, Marcus Aurelius, to finally collapse. There was lots of corruption, inflation and coin clipping in the ensuing three centuries. However, the Roman system was somewhat more stable in that it did not depend on market coordination to the degree that the United States does. As the Federal Reserve Bank and the government have increasingly distorted market signals, ever worsening misallocation leads to more extreme abuses, which will in turn lead to shortages and crises. Information and resources move much more quickly now than 1500 years ago so comparisons are difficult to draw.

Americans a century from now will be much poorer than we were, not because of any resource shortage but because of the Federal Reserve Bank and the US government. In the nineteenth century Abraham Lincoln fought to preserve the union. He is remembered for abolishing slavery, but that was not his purpose. Rather, he aimed to prevent the southern states from exercising sovereignty. The Civil War was the beginning of Progressivism. The side-effects of the Civil War concerning slavery and race relations usually get the attention, but the Civil War's longer term effects are now being seen. For the manipulation of the federal government by organized special interests, the so-called military-industrial complex, which is first and foremost a financial complex, is a direct outcome of the assertion of centralized power that began in 1860.

The problem is how to save the United States. A centralized federal power facilitates special interest brokerage. If you review the ideas of Mancur Olson in "Rise and Decline of Nations", there are specific criteria for the effectiveness of economic lobbies. A centralized government reduces lobbying costs. Fifty states require fifty times the lobbying costs, likely more. Moreover, opposition interests can concentrate in a few states.

To save the United States, there will need to be radical decentralization. A framing of radical decentralization needs to begin with pragmatism and choice. In a nation that is failing, new ideas become imperative. The popular imagination can awakened by the hope that a renewed, smaller scale America can offer. The big-state liberalism of the twentieth century has devolved into a government-enforced wealth transfer to the incompetent rich. The system has failed and needs to be reinvented.

If You Are a Boomer, You Can Retire—Here’s How

The 202 million Americans born between 1940 and 1994 look forward to retirement, but to retire they will need financial stability. The assets required for retirement amount to roughly $540,000 for a middle-class professional who wishes to retire at age 67 on $70,000 per year including social security benefits. Unfortunately, though, 401-k, pension plans, annuities and other financial arrangements fail to protect retirees from a trio of financial risks—inflation, stock market volatility and deflation. These risks reduce Americans’ prospects for a comfortable retirement.

The steps that the Federal Reserve Bank has taken recently to eliminate deflation and depression may prove to weaken the dollar and cause inflation. In the 1970s, stagflation, the combination of unemployment and inflation, saw inflation rates of 13.3% in 1979 and 12.5% in 1980. That could happen again—and worse.

This past year, according to the Federal Reserve Bank, M1, currency and demand deposits, increased at a seasonally adjusted rate of 37.6% in the three months from August to November 2008. M2, which includes savings deposits, increased 13.9%. In comparison, in the five years that preceded the 1979-80 inflation, from November 1973to December 1978, M1 increased about 37%. In other words, since last summer the Fed has increased the money supply by an amount equivalent to the amount it increased the money supply during several years preceding the 1979-1980 inflation. More ominously, according to the St. Louis Fed, the monetary base grew from $873.8 billion on September 10 to $1,671 billion on December 17, an increase of better than 90%. These fluctuations suggest inflation risk.

Moreover, the recent panic in the financial markets reminds us that 40 or 50 percent fluctuations in stock market prices are to be expected over any twenty year period. No matter what, retirees face the risk of stock market declines.

Those facing retirement also face a third risk: fluctuating commodity and house prices. For instance, oil has descended from $145 to $37 and now back to the $40s per barrel over the past few months. Someone who purchased a year’s worth of heating oil last July suffered losses. Dollar depreciation, stock price depreciation and commodity price depreciation all threaten retirees, but of the three, the least threatening risk is depreciating commodity and house prices. Many retirees would benefit from deflation because deflation would stretch their consumption budgets. But the federal government has made prevention of deflation a key objective. Monetary policy is at loggerheads with retirement policy. Yet, none of the interest groups associated with retirees has emphasized this crucial issue.

Potential retirees thus face three risks. First, they face the risk of inflation, which would significantly erode the value of dollars that they hold and so devalue traditional annuity, savings and money market accounts. Second, they face the risk of stock market fluctuation. Third, they face the risk of price depreciation in commodities and real estate.

Dollar-Based Retirement

Much has been written about retirement in financial terms. Many experts argue that an annuity that replaces 60 to 80 percent of final average income is necessary to retire. In private industry, the old fashioned defined benefit pension plan used to accrue benefits of one to two percent of final average salary per year of service. That would mean that an employee with 35 years of service would get about 50% of pay, often partially reduced for primary social security benefits upon normal retirement age. When social security was added to the pension the result was about 70% of pay. With respect to today’s more popular 401(k) plans, an employee who earns $100,000 and aims to retire at 67 with 70% of pay including social security would need roughly $540,000. But what if the $540,000 is eroded to $400,000, $300,000 or less in real dollar terms over a 2-3 year period? In the late 1970s there were accounts of retirees forced to sell their homes or eat pet food in order to make ends meet because of governmentally-induced inflation.

Commodity-Based Retirement

It is time to rethink dollar-based retirement. Retirees need to pay for a stream of goods and services whose dollar value fluctuates. The most important risk that they face is diminution of the stream of goods and services, not their fluctuating dollar value. A steady dollar income in an inflationary environment poses a greater risk to retirees’ well being than a stream of commodities that meets retirees’ needs in a deflationary environment, even if the dollar value of the commodities is declining.

Retirees need to consider the commodity value of retirement income rather than its dollar value. That is, retirees need to compute their budgets, translate the budgets into commodity equivalents, and then annuitize a stream of commodity consumption into a flow of forward commodity futures contracts. Then, they need to fund the stream. Today, this can be conveniently done with exchange traded funds. Excess assets over and above the required commodity stream could be invested in traditional financial instruments, CD’s, precious metals or other hedges.

The reason this is necessary is the Federal Reserve Bank’s risky, potentially inflationary monetary policy.

In 2003, the average white retiree’s budget was $26,341. Social security, which is indexed for inflation, covered roughly half of this amount. The average retiree spent 15 to 17% of this budget on food, eight to 13% on utilities, 17% on transportation, 2.6% on gasoline 30-35% on rent, and 9-10% on healthcare.* Were inflation to escalate, the average retiree would face risk over and above social security. Commodity contracts could insure this risk.

But if a retiree earns twice the average wage, or about $80,000, and wants to retire at age 67 with an annuity of $56,000, then at today’s low interest rates he needs a pool of goods and services (net of social security) of at least $360,000 upon retirement. At a median October home price of $218,000, home ownership would account for 60% of this fund unless house prices continue to fall. If the retiree wishes to avoid a reverse mortgage or borrowing to fund his retirement (which would create yet an additional risk), he would need the full $360,000.

The $360,000 would need to be allocated as something like $56,000 for food (agricultural futures), $56,000 for energy (energy futures), about $50,000 in materials for home repair and new car costs (materials futures), with the remaining amount in cash, precious metals or other hedges against deflation and inflation to purchase a range of other items. It would be easy to develop more refined budgets that could be annuitized with forward commodities futures using exchange traded funds.

Retirees should not have to fear deprivation. However, for millions of Baby Boomers, the Federal Reserve Bank is creating that very risk. In order to sidestep the financial system’s uncertainties, Boomers need to stop thinking in dollar terms and start thinking in consumption terms. They need to re-conceptualize their retirement planning in terms of a commodity rather than a dollar stream. There is no reason why insurance companies and pension funds cannot furnish such arrangements.

Theoretically, money provides a store of value as well as a unit of account and medium of exchange. Our monetary system’s inability to do so deserves re-consideration. In 1913, when the Federal Reserve Bank was founded, life expectancy was only 52 years for males and females combined and planning for retirement was not an important issue for the average American. To this day retirement planning is not one of the Federal Reserve Bank's priorities. Americans continue to hope for retirement, but recent events suggest that Fed policy and the monetary system may encumber rather than facilitate their goals. Today’s economic theories were developed at a point in time when erosion of fixed incomes affected the wealthy and helped debtors. Today, inflation primarily harms the middle class and poor elderly.


*Pierre Bahtzi, “Retirement Expenditures for Whites, Blacks and Persons of Hispanic Origin. Monthly Labor Review, June 2003, pp. 20-22.

New York Times Aims to Destroy Your Pension

In a December 22 editorial the New York Times openly advocates inflation as a "cure" for unspecified "ailments" in the economy. Goldbug Howard S. Katz, who runs an investment newsletter, brought the article to my attention earlier today. Katz has been tracking the rapid expansion of Federal Reserve Bank Credit, monetary reserves and the money supply and argues that the safest way to secure your retirement is to take a pro-gold, anti-dollar position despite recent run-ups in the dollar. The stimulus the Fed is providing will lead to a bull market in stocks but a super-bull in commodities. Katz also argues that the current "crisis" has been a media phenomenon fabricated in response to bankers' demands for extra liquidity in order to extract additional wealth from America's declining economy (by declining I mean suffering from long-term, century-long misallocation of resources due to Federal Reserve and "Progressive" policies).

Allow me to quote the from the December 22 article entitled "The Printing Press Cure":

"The Federal Reserve as much as admitted last week that lowering the benchmark interest rate — even to zero — would not be powerful enough medicine to revive today’s ailing economy. And so it has opted for the printing-press cure, pledging for the foreseeable future to pump vast sums into banks, other financial firms, businesses and households.

"Economic history — of the Great Depression of the 1930s and Japan’s lost decade in the 1990s — suggests that the Fed is doing the right thing. Confronted then, as now, with the twin scourges of deepening recession and incipient deflation, governments did more damage with too little intervention than they would have done with too much.

"But that doesn’t make such intervention 'good.' It’s a big and unfortunate risk in itself."

One of the outcomes of inflationary Fed policy will be the destruction of retirement benefits based on wages earned prior to the inflation (that is, pensions of people who retired prior to the inflation during the coming 5-10 years). Many boomers will likely fall into this category. As boomers retire on annuities, traditional pensions or hold assets in Guaranteed Investment Contracts, savings accounts, safe bonds or other dollar-denominated assets, their well-being will be destroyed as the Times and Wall Street cheer on.

As well, wages do not typically keep pace with inflation. Thus, the already stretched worker will be stretched ever tighter in a Wall Street drawn noose. Employment relations, already weakened by past rounds of inflation, regulation, and globalization, will become weaker. Employers will find it in their interest to terminate post-retirement medical insurance and other benefits that keep pace with inflation. During the 1970s and 1980s employers resented indexing and escalator clauses that caused wages to keep pace with inflation. It is likely that they will be encouraged to reduce or terminate benefits just at the time that health care costs go under exponentially increasing pressure because of the retirement of the baby boomers. The problem cannot be solved by nationally sponsored health insurance because the cost pressures are demographic. All nationally sponsored insurance can do is ration care so that none of the fingers will be sewn back on, just as they wouldn't be in Cuba or France.

The Times does not say exactly why it thinks the economy is in so much trouble that inflation is necessary. Is there a law of economics that states that a few years of excessive mortgage lending necessitates inflation? Why was late nineteenth century America able to produce rising (instead of falling, as the Times advocates) wages, rising productivity, rising employment levels, absorption of massive amounts of immigration and the very deflation that the Times so dreads? Why was it possible to thrive before the Fed was founded, and why are we now in so much trouble after a century of the Fed's existence?

Two of the funnier sentences in the editorial are these:

"To jump-start the economy requires getting money to those who will spend it fast and in full. That includes unemployed workers, low- and middle-income families, and state and local governments."

Back in the 1940s and 1950s the Times supported urban renewal on the pretext that it would lead to better housing for the poor and middle class. Instead, the funding, which was huge in New York City, was given to developers, some of whom were friends of the Times's owners, the Ochs Sulzbergers. The developers used it to exercise extensive private-use eminent domain, banishing factory jobs from New York, destroying low-income neighborhoods and building expensive office buildings and co-ops for millionaires. The middle class was set up in dreary suburbs on Long Island like Levittown under the same programs (of Title I and Title II) and high-crime urban ghettos for minorities were established featuring dreadful public housing projects built with the Times's glowing support. Yes, the Times always has the interests of the poor and middle class in mind.

Now, the Times tells its readers that there is a "crisis" (what it is is never specified) and that Barack Obama's leadership in the interest of inflation is essential.

I do not normally pay attention to what the Times has to say, and this article sums up why. There are two categories of people who read the Times. The first is the people who take them seriously as an information and opinion source. Such people are lost souls at the fringes of society, and I feel sorry for them. The second is the people who read the Times in order to find out what the lost souls are thinking. But the lost souls are headed for the poor house, and the times when the Times's opinions mattered are passed. Let us bury the last copy of the Times in Adolph Ochs's grave.

As far as your own retirement goes, I would seriously consider gold, gold stocks, silver, agricultural commodities, the "DBC" and Swiss Francs. Keeping your money in US dollars is akin to flushing it down the drain.

Subprime Loans and Abolition of the Federal Reserve Bank

O'Reilly's bluster signifies nothing because he is not willing to discuss underlying causes. We cannot "fix it" if we do not understand the reasons for banking losses (and O'Reilly's claim that there is a CRISIS! is not true. (H/t Larwyn and Stop the ACLU for video clip.)

From the 1820s until 1913 there was no Federal Reserve or central bank. From 1913 to 1932 the Fed had restricted power to expand and contract the money supply. Even so, with that limited power, the Fed managed to create the Great Depression that began with the stock market crash of 1929. Rather than reconsider the Fed's existence, the American political establishment at that time used the high unemployment that Hoover's and Roosevelt's Progressivism caused as pretext to remove all restrictions on the Fed's money-creation power. In the twentieth century, the American economy has been considerably less innovative than it had been in the nineteenth. The Fed has allocated capital in directions that accord with the banking establishment's preferences rather than entrepreneurs'. This effect combines with high income and other taxation to squash innovation.

The Fed has the power to create money, which it does primarily through purchase of bonds from commercial banks. The banks then lend a multiple of the reserves the Fed deposits. As a result, banks profit handsomely from new money. The chief borrowers, hedge funds, large corporations and government, also benefit. As the dollars circulate, more money chases more goods, but the increase in goods is less than the money supply increase. The reason is that the next project is less productive than the last. As the money supply expands, the less valuable projects receive funding. Artificially depressed interest rates facilitate otherwise impractical projects. As the quantity of money increases, bankers become eager to invest since low returns are sufficient to cover their costs.

Similarly, as the Fed "prints money" the stock market is invigorated because lower interest rates increase the present value of future earnings. Interest rates go down because the amount of money goes up. Wall Street and hedge funds benefit from the fresh money because investors are drawn to the market as it inflates. Naive speculators are the victims, not the cause of this process. The Fed is the cause. As well, mortgage borrowers benefit as do homeowners and other real estate investors.

As the money the Fed creates circulates, prices begin to rise because low quality projects are not worth the counterfeit dollars that funded them. Sub-prime loans are an extreme example of this. Rising prices help some, such as debtors. The wealthy, the owners of stocks and hedge funds were helped when the banks lent the hedge funds money. Losses they subsequently sustain due to inflation are offsets to their gains from Fed counterfeit. The inflation losses are less than the investment gains because the fresh money was distributed in a more concentrated way among a few hedge fund managers while the price increases are diffused over all Americans.

Part of the rationale for the Fed's existence is its "expert" management. William Greider's "Secrets of the Temple" is full of naive hyperbolic awe of the Fed's abilities. Similarly, the Economist Magazine recently ran an article praising the "expertise" of the Fed's economists. However, the Fed's historical track record is dismal. The Fed has overseen a long term reduction in innovation, the Great Depression, the 1970s stagflation, and now multi-trillion dollar banking losses for which the average American is asked to further subsidize commercial banks and investment companies who have been milking them dry for decades.

The nineteenth century did just fine without the Fed. The 20th century saw several major economic disasters (there was one in the late 1910's right after the Fed was founded) and a slackening of American innovation. The late twentieth century saw an explosion of misallocation of wealth to Wall Street and real estate development funded through commercial banks. This misallocation seemed to make America richer in the last two decades because houses and cars were getting bigger, but in reality it made America poorer because we could not really afford those houses or SUVs.

The economists at the Fed are responsible for massive misallocation of resources. Their "paper economy" approach has lead to bad ethics, bad investments, less innovation and massive diseconomies of scale, as the very large financial conglomerates that have been picking Americans' pockets now come to them with hat in hand.

The debate about abolition of central banking was diffused throughout America in the 19th century, and although most Americans lacked high school degrees, they well enough understood what was at stake. As education rates increased, Americans' ability to discuss this issue declined. Americans became docile to the claims of quackish professionals who, like the good people who run the Fed, know more about less, and the less they know is irrelevant to practical reality.

The abolition of the Federal Reserve Bank would improve life for all except the economic elite. Investment bankers, real estate developers and hedge fund managers would suffer and would oppose this step. The media, from Bill O'Reilly and Rush Limbaugh on the right to to the editors of the New York Times on the left, do not merely oppose such a step. They find discussion of it threatening because their employers, Rupert Murdoch and the Ochs Sulzbergers, are direct beneficiaries of the system. For instance, O'Reilly's Spin Zone emphasizes the role of "speculators" in causing inflation (a nonsensical distortion that goes back to the days of the Roman Emperor Diocletian in fourth century Rome, which was an inflationary period due to debasement of the currency) but O'Reilly has never once mentioned the Fed. O'Reilly's spin is more vicious than MS-NBC's. At the end of each show Mr. O'Reilly says that he looks out for his viewers. A con man who claims to be honest, Mr. O'Reilly's spin is worse than Chris Matthews's and Keith Olbermann's, buffoons who openly spin the news.

The Federal Reserve Bank ought to be abolished. It is a failed institution, a Progressive Rube Goldberg device that has caused one financial debacle after the next even as it has transferred wealth from the average American to the wealthy.

Kathy Laments the Markets

I received the following e-mail from Kathy of the Lone Star State. My response follows:

> Hello Mitchell,

> I am consumed with news between the naked short selling and credit crisis as you are aware. I am effected by the economy in the construction industry, the real estate industry and my ARM.

> Now I am consumed with stocks since I play in the government's form of white-collar-gambling with small amounts of money I have in the stocks. Suddenly short-selling (more painful naked-shorting) is more and more put to the top of my attention. Here I go again, another portion of the dying economy that I hit!

> So, what I just listened to."the problems of Main Street are now affecting Wall Street". Oh, now it's an issue. Okay.

> I turn to your blog with my head spinning. I see (as if I didn't actually know) that news is not a good place to get my news. So, I am asking where (in your opinion) is the "safest" place to get as close to truthful information as possible? I seem to trust no one coming across the electrical waves.

> Additionally, I am lost. BO scares me for a variety of reasons then I am left with McCain, who supported deregulation but is now pushing regulation and blaming for lack of regulation without so much as an "oops, my thinking was incorrect then but now I see". What am I supposed to do now. I only have 5 weeks and 2 days to get my head right. That is not a lot of time with this. Much fuzz and cloud going on here.

My response:

Stocks may be good now. I wouldn't pull out or sell short at this point. We are heading toward the early stages of another inflation and that is usually good for stocks for at least a year.

One thing I can suggest is Howard S. Katz's newsletter and blog. The newsletter
costs $300 a year and I offered to help him market it because it is very good. I have gotten more than a few ideas from him.

He's at:

http://www.thegoldbugnet.blogspot.com
http://www.thegoldbug.net

I don't have much more than that to recommend. You might try the Wall Street Journal as a basic newspaper. I don't read it myself at this point but I'm thinking of starting. I have been subscribing to the NY Sun, but they are likely to close their doors at the end of this month. Howard and other friends read the Times and the Economist to see what the establishment is thinking, but I don't have the time to make a career of doing that, and they are not good news sources. Fox is a joke. I wish I had something more to suggest, but honestly I don't.

One approach is to assume the opposite of what your newspaper is saying. They say that there's a financial crisis, so assume that there is a bull market coming. If they start saying that the economy's going great, assume that there's high inflation and misallocation of resources, etc.

As far as the general election, I support McCain as the "lesser of two evils" but the time is nearing where I may decide to vote for the Libertarian Party as the "least of three evils".