Book Review: Makers and Takers

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

Crown Business; 1st edition (May 17, 2016)

Ms. Foroohar does a fine job of journalistic reporting here. She identifies many of the failures of the current economic policy regime that has led to the dominance of the financial industry. She follows the logical progression of central bank credit policy to inflate the banking system, that in turn captures democratic politics and policymaking in a vicious cycle of anti-democratic cronyism.

However, her ability to follow the money and power is not matched by an ability to analyze the true cause and effect and thus misguides her proposed solutions. Typical of a journalistic narrative, she identifies certain “culprits” in this story: the bankers and policymakers who favor them. But the true cause of this failed paradigm of easy credit and debt is found in the central bank and monetary policy.

Since 1971 the Western democracies have operated under a global fiat currency regime, where the value of the currencies are based solely on the full faith and credit of the various governments. In the case of the US$, that represents the taxing power of our Federal government in D.C.

The unfortunate reality, based on polling the American people (and Europeans) on trust in government, is that trust in our governmental institutions has plunged from almost 80% in 1964 to less than 20% today. Our 2016 POTUS campaign reflects this deep mistrust in the status quo and the political direction of the country. For good reason. So, what is the value of a dollar if nobody trusts the government to defend it? How does one invest under that uncertainty? You don’t.

One would hope Ms. Foroohar would ask, how did we get here? The essential cause is cheap excess credit, as has been experienced in financial crises all through history. The collapse of Bretton Woods in 1971, when the US repudiated the dollar gold conversion, called the gold peg, has allowed central banks to fund excessive government spending on cheap credit – exploding our debt obligations to the tune of $19 trillion. There seems to be no end in sight as the Federal Reserve promises to write checks without end.

Why has this caused the complete financialization of the economy? Because real economic growth depends on technology and demographics and cannot keep up with 4-6% per year. So the excess credit goes into asset speculation, mostly currency, commodity, and securities trading. This explosion of trading has amped incentives to develop new financial technologies and instruments to trade. Thus, we have the explosion of derivatives trading, which essentially is trading on trading, ad infinitum. Thus, Wall Street finance has come to be dominated by trading and socialized risk-taking rather than investing and private risk management.

After 2001 the central bank decided housing as an asset class was ripe for a boom, and that’s what we got: a debt-fueled bubble that we’ve merely re-inflated since 2008. There is a fundamental value to a house, and in most regions we have far departed from it.

So much money floating through so few hands naturally ends up in the political arena to influence policy going forward. Thus, not only is democratic politics corrupted, but so are any legal regulatory restraints on banking and finance. The simplistic cure of “More regulation!” is belied by the ease with which the bureaucratic regulatory system is captured by powerful interests.

The true problem is the policy paradigm pushed by the consortium of central banks in Europe, Japan, China, and the US. (The Swiss have resisted, but not out of altruism for the poor savers of the world.) Until monetary/credit policy in the free world becomes tethered and disciplined by something more than the promises of politicians and central bankers, we will continue full-speed off the eventual cliff. But our financial masters see this eventuality as a great buying opportunity.

Financial Crisis Amnesia



Alex Pollock, quoted from the WSJ:

It is now five years since the end of the most recent U.S. financial crisis of 2007-09. Stocks have made record highs, junk bonds and leveraged loans have boomed, house prices have risen, and already there are cries for lower credit standards on mortgages to “increase access.”

Meanwhile, in vivid contrast to the Swiss central bank, which marks its investments to market, the Federal Reserve has designed its own regulatory accounting so that it will never have to recognize any losses on its $4 trillion portfolio of long-term bonds and mortgage securities.

Who remembers that such “special” accounting is exactly what the Federal Home Loan Bank Board designed in the 1980s to hide losses in savings and loans? Who remembers that there even was a Federal Home Loan Bank Board, which for its manifold financial sins was abolished in 1989?

It is 25 years since 1989. Who remembers how severe the multiple financial crises of the 1980s were?

Full article (subscription req’d.)

A New World?

helicopter-ben-bernankeMonetary policy is in a serious quagmire and central banker policy discretion hasn’t yielded great results. By hook or by crook, we’re headed for a new world. The question is whether it will be a better or worse one than we have now. Remarks from Paul Volcker below:

Paul Volcker: Back to the Woods?

The world since the rule-based monetary system collapsed in the 1970s is not a pretty picture.

Former Federal Reserve Chairman Paul Volcker called last month in Washington for a new Bretton Woods, the 1944 conference of World War II Allies that set up an international gold-exchange regime. His remarks received little media attention.

This strikes me as an underplayed story, especially as Congress considers taking a serious look at the Federal Reserve. Some legislators in particular are concerned that the value of the dollar, while stronger than last year, is still worth less than a 1200th of an ounce of gold.

Mr. Volcker made his remarks at the annual meeting of the Bretton Woods Committee, a nonpartisan organization that has been getting together since 1983. He did not call for a return to the Bretton Woods gold-exchange regime per se and only mentioned “gold” twice. But the title of the speech was “A New Bretton Woods???” Let’s take those three question marks to mean that Mr. Volcker wants to put this question out there emphatically.

Mr. Volcker reprised the history of the Bretton Woods system, which allowed foreign governments to redeem dollars in gold and established the dollar as the world’s leading currency. The system collapsed under the weight of the Lyndon Johnson-Richard Nixon “guns and butter” strategy—paying for both the Vietnam War and expanded welfare benefits and doing so by deficit spending.

“Inevitable” was the word Mr. Volcker used to describe what has been called the “Nixon shock,” a series of policies implemented in 1971 that included suspending the gold convertibility of the dollar. Mr. Volcker didn’t say so directly, but he in effect vindicated Henry Hazlitt, the most prophetic critic of Bretton Woods when the system was first discussed in the 1940s. Hazlitt, then an editorial writer for the New York Times, believed Bretton Woods and the International Monetary Fund, which the agreements set up, were an inflation trap.

In his speech, Mr. Volcker also reprised the efforts to muddle through after Bretton Woods. The Plaza accord of 1985 devalued the dollar against the yen and the mark. The Louvre accord of 1987 sought to stem the dollar’s slide. Or, as Mr. Volcker put it, “a lot of floating, some fixing, some ‘do as you please.’ ”

“By now,” Mr. Volcker said, “I think we can agree that the absence of an official, rules-based, cooperatively managed monetary system has not been a great success. In fact, international financial crises seem at least as frequent and more destructive in impeding economic stability and growth.”

He spoke of the 1970s as “an unhappy decade of inflation ending in stagflation.” He touched on the Latin American, Mexican and Asian crises that followed and the crisis of 2008 and the Great Recession in 2009. “Not a pretty picture,” Mr. Volcker said, adding that he wanted to raise “a neglected question”: “Has the absence of a well-functioning international monetary system been an enabling (or instigating) condition?”

Mr. Volcker made “a plea for attention to the need for developing an international monetary and financial system worthy of our time.” He acknowledged what he styled the “forceful fiscal and monetary policies” of recent years, but clearly reckons them inadequate.

“The provision of ample liquidity by the key national central bankers is still taking place as we meet,” he said. “But those measures don’t really count as structural reforms.” He said he could not answer the question of what approach to take, but tinkering with the International Monetary Fund was “not enough” and would mean “little without substantive agreement on the need for monetary reform and practical approaches toward that end.”

Mr. Volcker added that he wanted to find “ways of encouraging—even insisting upon—needed balance of payments equilibrium” so that countries don’t either suddenly run out of foreign exchange reserves or accumulate too many. “Nor,” he said, “would I reject some reassessment of the use of a single national currency as the dominant international reserve and trading vehicle.”

The ex-chairman noted that we are a long way from a new Bretton Woods conference, but said that “surely events have raised, whether we want to admit it or not, some fundamental questions that have been ignored for decades.”

“It’s easy to say what’s wrong,” Mr. Volcker told me over the weekend, “but sensible reforms are a pretty tough thing.”

His remarks will still be music to the ears of many nursing the idea of monetary reform, even if he hasn’t endorsed gold. A rules-based approach is certainly getting new attention, including at an important conference organized by economist John Taylor last month at the Hoover Institution.

Congress is starting to look at monetary reform. In July 2012 a bipartisan majority in the House voted 327 to 98 for a serious audit of the Federal Reserve. If the Republicans gain the Senate, the audit could end up as law. As could a bipartisan measure to mark the first century of the Federal Reserve by establishing a Centennial Monetary Commission to look to the Fed’s second century.

That effort is coming from Congress’s Joint Economic Committee, led by Rep. Kevin Brady (R., Texas). Sens. John Cornyn (R., Texas) and Rand Paul (R., Ky.) are nursing the measure in the upper chamber. It strikes me as a good moment to get Mr. Volcker in and see if he will back a centennial review of the Fed.

The idea, after all, is to see how the Fed could be improved for the next century. The measure has had tough sledding. But if a paragon like Mr. Volcker got behind the idea and supported a new, rules-based system, the effort might be able to get off the base-metal dime.


US Dollar Value under Management by the Federal Reserve


Eye-opening graph.

Fed advocates will argue that dollar depreciation over this period has also led to more than twenty times growth in wages and incomes. But the uncertainty of currency values does not affect all sectors uniformly and arbitrarily creates winners and losers. So, the growth in incomes has come at the expense of savers and older Americans living on fixed income pensions. It has greatly favored those who have done little except borrow to buy financial assets and real estate. So the question is: do we want an economy of ‘four walls and a roof’ or one of productive factories? The first is a depreciating asset, the second an appreciating asset.

As James Rickards puts it in his book, Currency Wars: “The effect of creating undeserving winners and losers is to distort investment decision making, cause misallocation of capital, create asset bubbles, and increase income inequality. Inefficiency and unfairness are the real costs of failing to maintain price stability.”

More pointedly he writes:

The U.S. Federal Reserve System is the most powerful central bank in history and the dominant force in the U.S. economy today. The Fed is often described as possessing a dual mandate to provide price stability and to reduce unemployment. The Fed is also expected to act as a lender of last resort in a financial panic and is required to regulate banks, especially those deemed “too big to fail.” In addition, the Fed represents the United States at multilateral central-bank meeting venues such as the G20 and the Bank for International Settlements, and conducts transactions using the Treasury’s gold hoard. The Fed has been given new mandates under the Dodd-Frank reform legislation of 2010 as well. The “dual” mandate is more like a hydra-headed monster.

From its creation in 1913, the most important Fed mandate has been to maintain the purchasing power of the dollar; however, since 1913 the dollar has lost over 95 percent of its value. Put differently, it takes twenty dollars today to buy what one dollar would buy in 1913. Imagine an investment manager losing 95 percent of a client’s money to get a sense of how effectively the Fed has performed its primary task.

There is also an implication in the pro-Fed position that gradual inflation is necessary in order to grow the economy – an analogy to greasing the machine. But that is conjecture and disproven by robust growth during the latter half of the 19th century while we experienced mild deflation.  As I have argued in Common Cent$, economic growth is a function of technology and population growth through increased labor productivity. Manipulating price values through monetary policy does little to promote long-term stable growth and only aggravates unfair economic inequality. It seems it takes a long time for each generation to discover this truth.

Bitcoin. The People’s Currency?

Politicians and their appointees are entirely cut out of Bitcoin’s monetary loop. This is a significant difference between Bitcoin and government-issued fiat currencies. Federal Reserve Bank of Dallas President Richard Fisher calls the U.S. dollar a “faith-based currency.” In other words, its value rests on the belief that the government will not print so many dollars that each one becomes nearly worthless. Like Bitcoin, the world’s dollars, euros, yen and pesos carry no guarantees they can be redeemed for gold or some other commodity at a fixed price.

Interesting article from the WSJ:

Bitcoin vs. Ben Bernanke

The chief scientist for the digital currency talks about its appeal—and pitfalls—in a world of fiat money.


Could a virtual currency created by an anonymous Internet hacker someday replace the U.S. dollar? What seems like a ridiculous question has become more intriguing as trading in the digital money called Bitcoin has surged more than 300% in the past year to roughly 60,000 transactions per day.

Gavin Andresen, the 46-year-old lead software developer for the Bitcoin project, is eager to find the answer. “I’m hoping to learn,” he says, whether “a nongovernmental global currency” is possible. “Can you get from where we are to the vision of billions of people all over the world using Bitcoin just like they use any other currency? That’s the grand experiment.”

Thousands of mostly small online merchants are already accepting payment in Bitcoin, though this virtual currency has no intrinsic value and isn’t tied to anything that does. Yet the virtual money that debuted in 2009 with a value of zero and traded for the first time in 2010 at a price of three-tenths of a cent recently changed hands at $97.

For Mr. Andresen, a Princeton graduate who once wrote technical standards for 3-D graphics on the Internet, Bitcoin has already begun to replace the U.S. dollar. In November, the Bitcoin Foundation, where he serves as chief scientist, began paying him in the virtual currency. So far he has persuaded his barber to accept this new money, but only from Mr. Andresen. A haircut costs half a Bitcoin.

The IRS won’t accept Bitcoins, but that doesn’t mean his salary is tax-free. “I get paid in Bitcoin beginning every month. Taxes are computed based on the dollar equivalent.” Luckily, his wife, Michele Cooke-Andresen, is a tenured geology professor at the University of Massachusetts, so their household enjoys some dollar-denominated income.

As Mr. Andresen and I walk down a street in Amherst, Mass., discussing the potential of digital money, almost on cue, an armored-truck driver begins unloading boxes of coins in front of a local bank. “Hauling around heavy boxes of pennies,” observes Mr. Andresen, chuckling. “I didn’t plan that.”

Mr. Andresen’s job is to help refine the software that allows Bitcoins to be traded and stored. He finds the work “fun and terrifying.” The fun part is developing the ability to instantly do business with anyone on the planet via a computer or smartphone.

Bitcoin is attracting attention as a wildly volatile, all-digital currency. How does it work? How are criminals taking advantage of it? How risky an investment is it? In this Bitcoin explainer, WSJ’s Jason Bellini has “The Short Answer.”

To demonstrate the convenience of exchanging the new money, he shows me in a few moments how to set up a digital wallet with a service called BlockChain and then sends me 0.01 Bitcoin, worth about 70 cents at the time he transmits it to my phone. There are plenty of ways to transact digitally with traditional currency too, but Mr. Andresen describes the “huge mess” he encountered when he tried to rent a house in France and was buried in fees and delays in wiring the money. With Bitcoin, “the whole world is now your market.”

The terrifying part of his job is that almost all of the current Bitcoin services now use the same software, so that “any change to the core code has potentially disastrous impact. If everybody rolls out a new version and there’s some problem with it, the whole Bitcoin payment network could grind to a halt.”

Technical glitches, hacker attacks, speculation and fraud have caused wild swings in the dollar price of Bitcoins. Mt. Gox, a Tokyo-based exchange that handles roughly 80% of Bitcoin trading, recently shut down briefly after a denial-of-service attack. The shutdown “popped the bubble,” says Mr. Andresen, and the price plunged to $69 from $266.

So trading has been disrupted and Bitcoins have been stolen and lost. But Mr. Andresen says they have been counterfeited only once, and the problem was identified and resolved. It could happen again in the future, he warns, though he believes it is highly unlikely.

“Can you bootstrap a currency when it’s doing this crazy price fluctuation thing as people become interested and then become not interested? That’s an open question,” says Mr. Andresen. “I don’t know if we have any baby currencies we can point to and say, ‘This is the model you should follow’ or ‘This is the model that worked.’ Definitely experimenting here.”

There are key attributes of the Bitcoin model that are attracting a growing following beyond tech hobbyists. Bitcoin offers privacy and, perhaps most important, an easy way to transact business across borders. The currency cannot easily be confiscated by any government—which also makes Bitcoin attractive to criminals, including drug dealers. The criminal appeal is one reason it’s not easy to buy Bitcoins. A series of startups created to sell Bitcoins to buyers using credit-card numbers failed after the card numbers turned out to be stolen and the encrypted Bitcoins had been sent off into the ether, never to be recovered. As a result, those wishing to buy Bitcoins now must typically pay fees to wire the money, though startups are working on cheaper and easier ways to trade dollars for Bitcoins.

As for the upside, small online merchants would welcome a global payment standard. For this reason Bitcoin or a similar technology could threaten the power of not just central banks, but banks, period. Unlike online payment services that give people with credit cards easier ways to transact business, Bitcoin works best when avoiding the traditional financial system completely.

But perhaps the most intriguing aspect of Bitcoin—at a time when the world’s central banks are creating lots of new money—is the promise that the number of Bitcoins will be capped at 21 million. The software is hard-coded to create that amount over the course of decades, on a prearranged, transparent schedule. Bitcoins are created and awarded when people use powerful computers to solve mathematical puzzles, which become more difficult over time as more people compete to solve them. At the moment, there are more than 11 million Bitcoins in circulation.

Politicians and their appointees are entirely cut out of Bitcoin’s monetary loop. This is a significant difference between Bitcoin and government-issued fiat currencies. Federal Reserve Bank of Dallas President Richard Fisher calls the U.S. dollar a “faith-based currency.” In other words, its value rests on the belief that the government will not print so many dollars that each one becomes nearly worthless. Like Bitcoin, the world’s dollars, euros, yen and pesos carry no guarantees they can be redeemed for gold or some other commodity at a fixed price.

On the other hand Bitcoin, unlike those other currencies, is not legal tender for paying debts. Thus it’s not clear to everyone why the world really needs this grand experiment in virtual currency. E-commerce continues to expand using existing payment networks that rely on traditional banks and government-issued currencies. And despite the Fed’s extraordinary effort since the financial crisis to push money into the economy, most observers see few signs of inflation. What’s the problem that Bitcoin solves?

“I’ll use a visual aid,” says Mr. Andresen. He opens his wallet and presents me with a gift: a 10-trillion-dollar bill once issued by the government of Zimbabwe. He bought a stack of them online for one Bitcoin from a man in Poland.

Mr. Andresen makes clear that he is not drawing a parallel with the “responsible” people who run the Fed. “But there are places in the world where the government hasn’t been so responsible, like Zimbabwe. And actually before they got to those bills I think they knocked nine zeros off of their old currency.”

He adds that he would “not be at all surprised if Bitcoin really took off in a big way in some other part of the world first.” He’s thinking of places where few people have bank accounts or credit cards “and the currency is just as volatile as Bitcoin has been,” he adds with a laugh. During the recent panic in Cyprus, the surging value of Bitcoin captured much media attention. But Mr. Andresen says the gains then were not likely to have resulted from Cypriots seeking a better currency, as some had speculated. Instead, he suspects that spike came from traders sensing an opportunity and perhaps some Spanish, Italians and Russians wondering about the value of their assets.

The reality is that, unlike Ben Bernanke at the Fed, Mr. Andresen is not in charge of Bitcoin. No one is—unless you count Satoshi Nakamoto, the name used for the creator of this new form of money. But that person may or may not even exist. (Mr. Andresen says he hasn’t heard from the person or people known online as Satoshi Nakomoto in a couple of years, and as far as he knows neither has anyone else at the Bitcoin Foundation.) But the software that this mysterious figure created is what makes Bitcoin, or something like it, an intriguing potential medium of exchange, particularly given the transparent plan for creating a fixed amount of currency.

It is perhaps a laughable commentary on the current mania for monetary stimulus that this feature is what seems to have inspired the most criticism of Bitcoin.. The knock on Bitcoin is that its fixed nature will cause an inevitable destructive deflation. As more people use the currency, demand for Bitcoins will grow beyond the finite supply and force up the value of each one, which will force the prices of goods to fall over time. This is portrayed as a recipe for economic disaster by those who like to inflate currencies to relieve the burden on borrowers, including spendthrift governments.

It’s true that deflations have sometimes accompanied economic disaster, but also economic triumphs. For example, in “Money, Markets & Sovereignty,” Benn Steil and Manuel Hinds describe the second phase of the Industrial Revolution in the U.S. between 1870 and 1896. Prices fell by 32% over the period, but real income soared 110% amid robust economic growth, expanded trade and enormous innovation in telecommunications and other industries.

Over a lunch of lamb stew at a French restaurant in Amherst’s downtown, Mr. Andresen considers deflation. He is open about the fact that he owned Bitcoins for years before they became his monthly pay, and he would be among those benefiting from a deflation that makes each Bitcoin more valuable. But he also notes potential general benefits from deflation. If prices are falling, he says, it does encourage people to save instead of spend, because the currency will be worth more later. It encourages people to lend instead of borrow.

And for those who wish to avoid both inflation and deflation, what about a digital currency programmed to maintain stable prices, avoiding mischief by central bankers as well as the possibility of deflation? He says the engineer in him likes the simplicity of Bitcoin’s fixed money supply.

It’s almost time for Mr. Andresen to get back to work. He shares some useful advice about Bitcoin: “I tell people it’s still an experiment and only invest time or money you could afford to lose.” If only investors could as easily follow that advice with fiat currencies.

Unsound Money Funds Unsound Ideas


Could it be that, for all our fighting over taxes and spending, it’s our reliance on fiat money that is at the root of our long travail?

Gee, d’ya think?

From the WSJ:

A Commission for the Fed’s Next 100 Years


As the Federal Reserve approaches its 100th anniversary in December, the focus of monetary reform centers on a bill called the Centennial Monetary Commission Act. Introduced this month in the House of Representatives by Chairman of the Joint Economic CommitteeKevin Brady, the bill would “establish a commission to examine the United States monetary policy, evaluate alternative monetary regimes, and recommend a course for monetary policy going forward.”

Mr. Brady’s bill is not the kind of direct attack on the Fed that has been launched by, say, Rep. Ron Paul, who has called for eliminating the central bank altogether. But the bill—noting that a National Monetary Commission, established after the panic of 1907, led to the Fed’s creation on Dec. 23, 1913—would set up a new commission at the start of the Fed’s second century.

The Centennial Monetary Commission would start with a formal review of the Fed’s performance across the decades, including how its policies have affected the economy in terms of “output, employment, prices and financial stability over time.” The commission would also evaluate a range of regimes, including, in the bill’s language, price-level targeting, inflation-rate targeting, nominal gross-domestic-product targeting, the use of monetary policy rules, and the gold standard.

Mr. Brady proposes a 14-member, bipartisan commission, led by the chairman and ranking minority member of the Joint Economic Committee. The commission would be tasked with making recommendations. The group’s composition would make it more balanced than President Reagan’s 1981 Gold Commission—an important body, but one stacked with partisans of fiat money, i.e., a currency backed by nothing other than government decree. That commission is remembered primarily for its dissent, written by Rep. Paul and another commission member, Lewis Lehrman, a businessman and scholar, calling for a restoration of gold-based money.

It was the collapse of the dollar in the 1970s that led to the establishment of the Gold Commission. The dollar’s value had plunged by 1980 to less than an 800th of an ounce of gold from a 35th of an ounce at the start of the previous decade.

The monetary crisis of the era abated in the 1980s under the combination of Chairman Paul Volcker’s tight money and President Reagan’s supply-side fiscal measures. Over time, value flowed back into the dollar, which had soared to a 265th of an ounce of gold on the day George W. Bush was sworn in as president in January 2001.

Yet by the time President Obama took the oath of office in January 2009, the wars in Afghanistan and Iraq and profligate spending by Congress had driven the value of the dollar down to less than a third of its worth when Mr. Bush was sworn in. Its value has been halved again under Mr. Obama, to less than a 1,600th of an ounce of gold.

Watching this from his perch at the Joint Economic Committee, Mr. Brady last year introduced the Sound Dollar Act. It would end the Federal Reserve’s dual, and often contradictory, mandate that requires it not only to stabilize prices but also to boost employment. The Fed would instead have a single mandate: long-term price stability. [Note: at least that’s something they could actually accomplish if they wanted.]

The Sound Dollar Act would not end the Federal Reserve but would make it more transparent and give presidents of the regional Federal Reserve banks permanent seats on the Open Market Committee. The act also would not set up a gold standard, but it would require the Fed to monitor the price of gold.

Mr. Brady has reintroduced his Sound Dollar Act this year. The Centennial Monetary Commission Act is a parallel and more strategic measure, proposed at a time when there are those who wonder whether Congress has been focusing on the wrong question.

Could it be that, for all our fighting over taxes and spending, it’s our reliance on fiat money that is at the root of our long travail? Rep. Paul forced this question into the Republican campaign during the 2012 primaries, and the establishment of a monetary commission became part of the GOP platform. Mitt Romney, however, failed to stand forcefully on the plank.

Mr. Brady, in any event, seems determined to approach the question on a bipartisan basis and to avoid letting it hang in the ether. His bill would start the commission working in June and give it a year to produce its report.

No doubt it would face a difficult hurdle in the Senate, and there are those who chafe at the idea of another commission, since commissions are so often a way of burying an idea. But a commission created in the Congress, tied to the centennial of the Federal Reserve, and structured in a bipartisan way, is a promising way forward.

This is particularly true when politicians seem to have forgotten that the power to coin money and regulate its value is enumerated in the Constitution itself and granted not to a central bank or the president but to Congress.

One thing is certain: The impetus to reform will not come from the Federal Reserve, which has fought an audit passed by the House last year with overwhelming bipartisan support. Congress clearly needs to step up and lead the way, and Mr. Brady is giving it the chance.

Because that’s where the money is…


And those who don’t pay attention, get fleeced…

If history is any guide, our political czars wouldn’t attempt something so crude as to just grab money from our accounts. No, they’ll do what they have always done: siphon it gradually by printing lots of money and inflating away our savings.

Cyprus and the Death of Deposit Insurance

by Robert Tracinski

From the beginning, the European crisis has been a story of small countries on the Eurozone’s “periphery” revealing fundamental problems at the heart of the system. Now a very small country on the outer edges of the periphery—the tiny Mediterranean island of Cyprus, with about a million inhabitants and 0.02% of Europe’s GDP—is triggering the latest wave of the crisis.

This is not really about Cyprus, of course, but about the precedent that is being set there. In exchange for an infusion of capital into the nation’s banks, Cyprus is being asked to impose a “special bank levy” that would take 6.75% out of all bank deposits up to 100,000 euros, and 9.9% above that.

This is described as a “wealth tax,” except that it’s not a tax. A tax is a regular rule that operates uniformly according to a pre-determine formula. A one-time, ad hoc seizure of money isn’t a tax. It is confiscation. Or we can use a plainer word for it: theft.

The big news isn’t this bank heist, but who is pulling it off. The plan was imposed, not by some wild-eyed revanchist Communists, but by the finance ministers of respectable European countries, who thought up the idea and imposed it on Cyprus. Like Willie Sutton, they know where the money is.

There are special circumstances that made them think they might get away with it. Cyprus is a small island with a large banking center that holds deposits many times larger than the local economy. A lot of this money comes from Russia, and Cyprus is reputedly a tax haven for Russian “oligarchs” (politically connected billionaires) and mobsters. In an American context, you might compare Cyprus to the Cayman Islands, which have been so vilified just having a bank account there is enough to end a politician’s career. Just ask Mitt Romney.

But in showing us what they’ll do to an unsympathetic target, Europe’s leaders are showing us what they would like to do everywhere: dig themselves and the crony banks out of a tight spot through the mass confiscation of wealth. It’s the ultimate bailout plan: they just take whatever they need.

And there is more to it than that. This is confiscation, but it a particular kind of confiscation with particular implications. It is the end of deposit insurance. Depositors, particularly small depositors, are supposed to have an ironclad guarantee that their money will always be there, no matter what—that they won’t wake up one Monday morning to find that 6.75% of it is gone.

That’s why the Cyprus heist is really important. It is a warning that the whole system of deposit insurance is coming unglued.

Deposit insurance is central to modern banking—or rather, it is central to the contemporary system of government-guaranteed, government-regulated, too-big-to-fail banking. Here is how the deal is supposed to work. The government guarantees ordinary bank deposits, but in exchange it imposes regulations meant to prevent banks from failing so that they will rarely have to call on the government guarantees. But then there’s a complication. While the government’s deposit insurance raises enough money to handle the failure of a limited number of smaller banks, there are some institutions that grow so big that the government doesn’t have enough money to cover their losses if things go wrong. That’s one of the reasons why these banks become “too big to fail,” which necessitates even more government support, in exchange for which they are supposed to be placed under an even heavier layer of regulation.

Cyprus is a signal that this whole system is failing. Government regulation doesn’t actually guarantee solvency; in fact, it is the insolvency of the governments themselves that triggered the Euro crisis. Moreover, when things really go wrong, the government can’t actually guarantee all of the deposits—and now we’re starting to wonder whether they’re still interested in trying.

When this system starts to come apart, its consequences are worse than an ordinary bank panic. In the bad old days, when individual banks and their depositors were on their own, if one bank failed—and if it was not bought out or rescued by another bank—its depositors might take a haircut, but only after shareholders and bondholders were wiped out. This gave all of the parties a strong incentive to make sure the bank was solvent and wasn’t taking too many risks. Under the current system, all of these parties are absolved from such a responsibility, but we pay a heavy price for it. When things go wrong, every depositor at every bank gets a haircut, while politics decides who gets hit worse. In the Cyprus deal, European bondholders will be protected, but Russian oligarchs will be looted, and small Cypriot depositors will get caught in the middle. Remember, also, that all of this is being done to avoid a run on the banks—but that is precisely what has been happening in Cyprus, with depositors emptying the nation’s cash machines in an attempt to withdraw their money before it could be seized.

Combine this news with Gretchen Morgenson’s summary of a Senate inquiry into huge trading losses at JPMorgan Chase, one of our too-big-to-fail megabanks. The bottom line is that big banks are still too big to fail and they are still taking undeclared risks backed by taxpayer money. Across the board, the general sense is that the system is failing and government leaders aren’t really trying to reform it. They’re just trying to restore the status quo ante, setting us up for a whole new round of financial crisis.

Can Cyprus happen here? Well, some on the left are already floating plans to rescind the tax exemptions on retirement accounts, making a grab for a big pile of your savings.

But will they do what Cyprus is doing with our bank deposits? Probably not. If history is any guide, our political czars wouldn’t attempt something so crude as to just grab money from our accounts. No, they’ll do what they have always done: siphon it gradually by printing lots of money and inflating away our savings.

I understand if you don’t find that very reassuring.

Storms on the Horizon

We’ve created a game where the winning strategy is to convert debt into real assets as fast as one can accumulate that low-priced debt. The losers will be holding those worthless pieces of debt paper when the music stops. Those who own and control real assets bought with cheap debt will rule the world, if they can keep it. And we call this progress? Red sky at morning, sailors take warning…

Excerpted from the WSJ: (subscription req’d)

Why There Will Be No New Bretton Woods

China has built up an astounding mountain of monetary reserves: $3.3 trillion, approximately 60% of which comprises U.S. government securities. The U.S. has accumulated the world’s largest international debt: $15.9 trillion. Each government eyes the trajectory of the two stockpiles with trepidation—the Chinese fear a collapse in the global purchasing power of their dollar hoard, the Americans a collapse in funding for their debt. The U.S. accuses China of “manipulating” its currency, keeping it artificially low to stimulate exports and discourage imports, while China blames U.S. profligacy and lax monetary controls.

Many hope that the International Monetary Fund, created at Bretton Woods, can be the catalyst for a new cooperative monetary architecture. Yet history suggests that this won’t occur until the U.S. and China come to the conclusion that the consequences of muddling on, without the prospect of correcting the endemic imbalances between them, are too great.

Meanwhile, trade tensions may grow much worse—as they did in the 1930s, during the last great international currency war. China’s recent bilateral agreements with Japan, Brazil, Russia and Turkey to pursue trade without dollars could be a worrisome harbinger, insofar as each would be more likely to undertake global trade discrimination in order to balance its bilateral trade than to stockpile other currencies. The U.S. had sought to eliminate this damaging stratagem permanently at Bretton Woods; it may soon re-emerge.

Deficits, Debt and the Fate of the Dollar

If you have anything to lose, these developments should worry you. Read the following analysis carefully.

Our politicians have made it almost impossible to protect yourself from this risk. The Federal Reserve will distort financial and real asset markets with excess liquidity until the market turns around and crushes it. We see the first signs of dissent from the Midwest banking centers because they are not enthralled by Wall St.-DC financial and political interests. Historically, they have reflected more the interests of Main St., which stands to absorb the brunt of this failed policy.

From the WSJ:

The shivers that ran through the bond market after the budget deal were a signal the Fed ignores at our peril.


The year-end “fiscal cliff” tax deal sent shivers through the bond market, driving the price of 10-year Treasurys to the lowest level since April. There was a good reason. The stubborn resistance by President Barack Obama and Senate Majority Leader Harry Reid to spending cuts left no further doubts about their lack of interest in the nation’s No. 1 economic problem, massive federal deficits.

The bond-market decline came despite the Federal Reserve’s renewed program to gobble up yet more government debt. Presidents of some regional Federal Reserve Banks are growing nervous about this program, judging from the December minutes of the Federal Open Market Committee, which guides Fed policy. Jeffrey Lacker of the Richmond Fed, Richard Fisher of Dallas and Esther George of Kansas City have been among the most outspoken in voicing fears that continuation of the Fed’s manic buying—now running at $85 billion a month in Treasury and agency paper—will ultimately destroy the dollar. The concerns expressed in the FOMC minutes didn’t cheer the bond market either.

These are signals of dangerous times. Forget about the next Washington dog-and-pony show on the debt ceiling. The bond market will ultimately dictate the future of U.S. monetary and budgetary policy.

Bond markets only obey the law of supply and demand. When the flooding of markets with American debt causes the world to lose confidence in dollar-denominated securities, the nation will be in deep trouble. The only force standing in the way of that now is the Fed’s support of bond prices. But regional Fed presidents are prudently asking how long that can be sustained.

Mr. Obama currently is riding high, pumped up by his success in resisting Republican budget-cutting demands during the “cliff” talks. But the deal he muscled through Congress is a hollow victory. His so-called tax on the wealthy will produce scant revenues. The money sucked out of American pocketbooks by higher payroll taxes will curb consumer demand, further slowing already weak economic growth. Only entitlement reforms, which the president refuses to consider, can shrink the deficit enough to reduce the danger it poses.

The Fed’s worst fear is that despite its long-term commitment to buying up government debt, it will lose control of interest rates. That’s why the early-January upward blip in bond yields was a yellow warning light. If Treasury bond prices decline significantly from the artificial levels that massive Fed purchases have supported, several things will happen, none of them good.

First of all, government borrowing costs will rise, making it even more difficult to control the deficit. Second, the value of the Fed’s gargantuan and growing $2.6 trillion portfolio of Treasury and government-agency mortgage bonds will decline. It won’t take much of a portfolio loss to wipe out the Fed’s capital base. Without capital of its own, it would become a ward of the Treasury, costing the Fed what little independence it has left to defend the dollar.

Even now, the Fed faces a cruel dilemma. It can let bond prices fall and suffer the unhappy consequences. Or it can keep on its present course of buying up more hundreds of billions of Treasury paper. That course inevitably leads to inflation.

Over the past four years, the damage to the dollar has been partly ameliorated by global investors fleeing weak currencies elsewhere for the relative safety of the dollar. But there has to be a limit to how long that will be true. We already are seeing signs of renewed asset inflation not unlike the run-up that occurred in the first half of last decade. Stocks and farmland are up and housing prices are recovering from their slump.

Brendan Brown, London-based economist for Mitsubishi UFJ Securities, reminds us that asset inflation is usually followed by asset deflation, and that’s no fun, as the events of 2007 and 2008 testified. More seriously, a rise in the price of assets often presages a general rise in the prices of goods and services.

Inflation can ultimately destroy the bond market, as it did in 1960s Britain during the government of the socialist Labour Party. No one wants to commit to an investment that might be worthless in 10 years, never mind 30 years.

Throughout history, governments have inflated away their debts by cheapening the currency. That process is well under way through the Fed’s abdication to irresponsible government. If Fed policies continue, another huge tax—inflation—will weigh down the American people. The politicians will try to escape public censure, as they always do, by blaming it all on “price gouging” by producers, retailers and landlords. A substantial cohort of the press will buy into that phony rationale and spread it as gospel.

The Fed’s dilemma is in fact everyone’s dilemma, given the universal stake in the value of the dollar. And all because an American president and a substantial number of senators and representatives don’t understand one simple fact: In the end, the bond market rules.

The “Price” is Wrong

“Price is what you pay. Value is what you get.” – Warren Buffett

Quote from Grant Williams (full article here):

the United States TIPS curve is negative out to 20 years, and yet “investors” are still piling money into an asset that is clearly way overvalued. They are guaranteeing themselves a negative return for the best part of a generation because they are worried about generating any kind of return. That is most definitely the aim of the Federal Reserve’s ZIRP—drive savers farther out along the risk curve than they would ordinarily dare to edge in search of some kind of a return—but their policy ensures that, were this just one big game of The Price Is Right, contestants would have no chance of being able to correctly guess many of the prices in the world around them today.

Prices everywhere have been completely skewed by government intervention the world over. So much so that there is frequently no way to ascertain the correct price of many everyday commodities (and in that, I include financial commodities such as stocks and bonds).

I sat on a panel at Mines & Money in Sydney, and a gentleman in the audience asked me a very pertinent question that highlighted the major problem facing savers and investors. I shall paraphrase him here as the question was a little longer, but essentially he was asking this:

“How do I, as an investor, correctly assess the risk of a given investment in the current market environment? How do I invest my money when traditional valuation metrics no longer seem to be effective?”

Luckily, I have no need to paraphrase my answer:

You can’t, because the market is broken. Every day, we sit in the boardroom at Vulpes in Singapore and try to figure out where and how to invest the partners’ capital, and every day it gets harder and harder to do. Equity markets have thinned out to the point of emaciation. There is no volume going through in which to trade, and the interference in all markets (particularly those of sovereign debt) is so heinous as to hinder any form of price discovery. The trickle-down effect of this intervention on commodities and real assets is only just beginning as investors are finally coming to understand that what they must do is protect their wealth from confiscation by governments.

What are equally unpalatable are the clearly manipulated figures that are released by government agencies.