I’ve blogged before on how central banks and fiat currency allow states to silently fund large scale war machines. This idea was reinforced to me today when I ran across this quote in the book War and the Rise of the State:

The wars with Spain depleted the French treasury and forced Francis I (1515-1547) to undertake administrative reforms. Yet his reforms never resolved the fiscal dilemma, since other contenders were also boosting their military spending. France was caught in a cycle of escalating violence, which its own efforts at taxation and military spending only served to propel upward; hence a fresh military crisis loomed every few years. This unremitting fiscal pressure forced centralizing reforms on a government whose inclinations were still largely medieval, but whose aspirations required the organizational accoutrements of a modern state.

Bruce Porter, War and the Rise of the State

This is what you would expect. The French were bankrupting themselves in the so-called “Italian Wars” that seemed to go on and on. War is very, very expensive. So, what did they do about it? They created a central bank:

Two reforms in particular arose from France’s involvement in the wars. In 1523, as it was mobilizing troops for a fresh campaign in Italy, Antoine Duprat, the king’s chancellor, established the first central treasury of the realm, the Trésor de l’Épargne or Treasury of Savings.

Bruce Porter, War and the Rise of the State

This is what states do when the burden of war becomes too high. They look for ways to hide the cost from the public, who would rapidly grow disenchanted with funding endless war if they had to do so up front at face value. This is precisely the reason that nobody younger than 50 knows what a “war bond” is. The direct connection between the citizen and the funding of war has been broken. Instead, the Federal Reserve now prints the money which ends up back in the treasury, through the purchasing of Treasury Bonds, where it can be used to pay for more war. The only effect we see is price inflation on a lag. Basically, our endless wars are funded with debt created and sold by the Fed, and paid for in the form of higher market prices.

This is why I call the Federal Reserve the “silent” killer of millions of people all over the world. It’s the great enabler of vice and moral hazard. The next time a drone strike takes out a wedding party in Afghanistan, you’ll know that the extra .03 cents per gallon you’ll pay for milk in a few weeks helped pay for it.

While everyone else in the world is focused on the policy implications of today’s speech from Fed chair Ben Bernanke, I want to talk about his analysis of the economy.

Basically, Bernanke told us today that the economy has been lagging because home prices keep falling.

“Notably, the housing sector has been a significant driver of recovery from most recessions in the United States since World War II, but this time—with an overhang of distressed and foreclosed properties, tight credit conditions for builders and potential homebuyers, and ongoing concerns by both potential borrowers and lenders about continued house price declines—the rate of new home construction has remained at less than one-third of its pre-crisis level. The low level of construction has implications not only for builders but for providers of a wide range of goods and services related to housing and homebuilding.”

–John Carney, CNBC

Please don’t think that guys like Bernanke are somehow clueless of real economics. He’s just a court historian. He knows what he just said there is BS. He’s simply taking the Greenspanian approach of talking in economic-greek so that people will marvel at how smart he sounds. It took him three paragraphs to say that housing prices are too low and new home construction is weak. Well, guess what makes people buy more homes Ben? Lower home prices. You can’t have high home prices and robust construction at the same time unless you’re in an unsustainable real estate bubble. That must be what ol’ Ben is getting at. He wants to re-inflate the bubble.

Peter Schiff

But another very large chunk of Treasuries go to “primary dealers,” the very large financial institutions that are designated middle men for Treasury bonds. In a late February auction, these dealers took down 46% of the entire $29 billion issue of seven year bonds. While this is hardly remarkable, it is shocking what happened next.

According to analysis that appeared in Zero Hedge, nearly 53% of those bonds were then sold to the Federal Reserve on March 8, under the rubric of the Fed’s quantitative easing plan. While it’s certainly hard to determine the profits that were made on this two week trade, it’s virtually impossible to imagine that the private banks lost money. What’s more, knowing that the Fed was sure to make a bid, the profits were made essentially risk free. It’s good to be on the government’s short list.

Given that the Treasury is essentially selling its debt to the Fed, in a process that we would call debt monetization, some may wonder why it doesn’t just cut out the middle man and sell directly. But the Treasury is prevented by law from doing this, so the private banks provide a vital fig leaf that disguises the underlying activity and makes it appear as if there is legitimate private demand for Treasury debt. But this is just an illusion, and a clumsy one to boot.

–Peter Schiff, Europac

Lewis Lehrman:

http://www.youtube.com/watch?v=yDU2p7oUk6g

James Grant:

http://www.youtube.com/watch?v=Qwj5fx1di1I

Joseph Salerno:

http://www.youtube.com/watch?v=pl566vtfLC0

The Value of a Dollar

I just received the most wonderful book in the mail. It’s a text book called The Value of a Dollar, edited by Scott Derks. It’s a compilation of historical prices from 1860 to 1999 with documentation on where they found the price listed. It seems that their approach was to look at old media and note prices listed for various job openings and goods and services. There are multiple editions of this book out there, but I got the “millenium edition.” It’s the only one I could find used. Brand new, this book is extremely expensive. It’s in the $150 range. Ouch! Find a used copy.

I can’t tell you how awesome this book is. I plan on using it as a research tool for future blog posts dealing with economic history. Just to give you a taste of the info within, here’s a nice little nugget right out of the gate. If you use 1860 as a starting point for what one dollar would buy and then extrapolate it’s purchasing power for subsequent years based on a best calculation of CPI you can determine inflation and deflation in subsequent years. Doing this tells us that in 1879, it took $1.07 to buy what $1.00 would have bought in 1860. Fast forwarding 34 years to 1913, the year the Federal Reserve was born, we see that $1.07 would still buy what $1.00 would have bought in 1860. That means that from 1860(just prior to The War to Prevent Southern Independence) to 1913 there was a grand total of 0.07% inflation.

Contrast that with the next 34 years after The Fed was created(1914 to 1948). By 1948 it took $2.48 to buy what $1.07 had bought in 1913. In other words, it took well more than twice as much money to buy the same goods. Still think granting a small group of bankers monopoly power to print money was a good idea?

** UPDATE: Thank you to Mr. Derks for leaving a kind comment below. Check out his other book series, Working Americans. These are expensive books, so they might be out of the reach of the armchair economist, like yours truly. But, as a research tool they are worth every penny of that price. Especially for a research student or a more formal economist.

Federal Reserve Bank of Kansas City President Thomas Hoenig said soaring farmland prices may be the result of an unsustainable bubble that could damage the U.S. economy when it bursts.

“My nagging concern remains that current distortions in financial markets are increasing the risk that imbalances in asset markets will catch agriculture — and the U.S. economy more generally — by surprise once again,” Hoenig told the Senate Agriculture Committee today, according to his prepared testimony.

“This run-up in farmland values has occurred, however, amid financial markets characterized by high levels of liquidity and unusually low interest rates,” he said. “It is nearly impossible to determine how much of the farmland boom may be an unsustainable bubble driven by financial markets and how much results from fundamental changes in demand and supply conditions.”

–Joshua Zumbrun, Bloomberg

Maybe I should go light on Hoenig here since he appears to be the only semi-rational person employed by the Fed at times. But he’s wrong about a farm land bubble. Guys like Jim Rogers and George Soros predicted a surge in farm land and agricultural products as far back as late 2008. Their rational was like this:

“We’re still going to eat, probably; we’re still going to wear clothes, probably. Farmers cannot get loans for fertilizers right now. So the supplies of everything are going to continue to be under pressure,” Rogers said.

He is the director of two funds which are buying greenfield land in Brazil and existing farms in Canada and starting to farm it. The funds are clearing the land, fertilizing it, irrigating it and hiring farmers and, Rogers said, some day will probably sell the land but that is a remote prospect.

“If I’m right, agriculture is going to be one of the greatest industries in the next 20 years, 30 years.”

Food inventories are at their lowest in 50 years, Rogers said, while the oil and mining sectors are also good bets.

“Even if demand goes flat or down, as it did in the 30s, as it did in the 70s, you can still have a nice market,” he told CNBC.

–Jim Rogers, CNBC Interview (Mar. 2009)

To say that the rise in agricultural prices is a speculative bubble at a time when the world is literally tossing dictators out the window because of soaring food
prices shows the depth of misunderstanding at the Fed. When there actually was a real estate bubble they told us there wasn’t one. I give you Bernanke from 2005:

Ben S. Bernanke does not think the national housing boom is a bubble that is about to burst, he indicated to Congress last week, just a few days before President Bush nominated him to become the next chairman of the Federal Reserve.

U.S. house prices have risen by nearly 25 percent over the past two years, noted Bernanke, currently chairman of the president’s Council of Economic Advisers, in testimony to Congress’s Joint Economic Committee. But these increases, he said, “largely reflect strong economic fundamentals”…

Many economists argue that house prices have risen too far too fast in many markets, forming a bubble that could rapidly collapse and trigger an economic downturn, as overinflated stock prices did at the turn of the century. Some analysts have warned that even a flattening of house prices might cause a slump — posing the first serious challenge to whoever succeeds Fed Chairman Alan Greenspan after he steps down Jan. 31.

Bernanke’s testimony suggests that he does not share such concerns, and that he believes the economy could weather a housing slowdown.

–Nell Henderson, WaPo (2005)

Now, when there’s actual demand backing the rise in farm prices they tell us it is a bubble. There are food shortages everywhere, but somehow people buying farm land is a speculative bubble. Oh lord. It’s terrifying to see how clueless these people are who run our entire economy. We’re doomed.

One of the most frustrating aspects of talking to conservatives about liberty is getting them to see the inherent contradiction between “small government” and “big military.” You can either have large both or small both but you can’t have a mix of one small and one large. Government and the military are one and the same. Where you see big government, you see a big military. The slight exception is Japan, which maintains a small military since they are technically not allowed to even have one according to their constitution(which we wrote after WWII). But, that is the exception and not the rule. On the whole, big government needs big military. Otherwise they wouldn’t stay big for long, or they would never get big in the first place.

I am sympathetic to the modern “Rush Limbaugh” conservative in this respect. The media and government are extremely effective at cherry picking information and delivering it in such a way as to make it seem as if government and military can remain somehow independent. After all, they use this same technique to feign the Fed’s independence from politics as well. I used to believe in this myth myself. Just look at this blog post I wrote back in June of 2006:

With North Korea threatening to do a test fire on it’s newest ICBM that could reach the US mainland and the US activating the missile shield, it reminds me of how important it is to have military bases spread out over the globe. Our bases in the Asian Pacific region have been invaluable at testing the missile shield against a simulated North Korean ICBM. It’s those kinds of tests and strategic placements that ensure the security of this country and we need more of them elsewhere like the middle east. A permanent base in Iraq is a must have. The strategic value of such a base can’t be overstated. Anyone who says otherwise is just being political.

–Dave Jones, Southernbread.org

I read that now and I just shake my head. I had no idea what I was talking about. But, notice how I had a mental separation in my mind between military and politics: “A permanent base in Iraq is a must have. The strategic value of such a base can’t be overstated. Anyone who says otherwise is just being political.” As if being in Iraq in the first place was somehow not political. As if we had any right whatsoever to go in and take over that country and kill thousands more than Saddaam ever dreamed of killing. But, I digress.

Here is the bottom line that finally opened my eyes to what is really going on and made me face reality. Here’s what’s been going on for the last 50 years. The Fed inflates the money supply by buying the U.S. government’s debt, in the form of treasury bonds, with printed money. The money received by the government from these purchases gets spent on gigantic military projects both official and off-budget. In this way, the “military industrial complex,” as Eisenhower called it, feeds off the U.S. citizenry. Not in the form of taxation. But, in the form of inflation. In other words, the Federal Reserve slowly erodes the value of your money over time to fund U.S. military actions around the world. It’s what Robert Higgs calls “death fuel.”

Lew Rockwell says eloquently:

The U.S. central bank, called the Federal Reserve, was created in 1913. No one promoted this institution with the slogan that it would make wars more likely and guarantee that nearly half a million Americans would die in battle in foreign lands, along with millions of foreign soldiers and civilians. No one pointed out that this institution would permit Americans to fund, without taxes, the destruction of cities abroad and overthrow governments at will. No one said that the central bank would make it possible for the U.S. to be at large-scale war in one of every four years for a full century. It was never pointed out that this institution would make it possible for the U.S. government to establish a global empire that would make Imperial Rome and Britain look benign by comparison.

–Lew Rockwell, LRC

Conservatives love to criticize how much money is spent on the welfare state, and that is true. Theft is theft. But, the cost of welfare simply pales in comparison to the size of the theft taking place when it comes to our gargantuan global military empire. Has it not peaked anyone’s curiosity that during WWII our government was literally begging Americans to “buy war bonds,” but now days it magically seems as if we can fight war after war lasting decades on end with no need for special financing? Odd huh. Well, not if you understand the Federal Reserve’s role as I explained above. They print up the money and the Executive branch spends it on war. Simple as that.

As you watch prices rise over the next 20 years to the point where your retirement nest egg you worked 50 years for barely covers your car payment, just remember, you sacrificed your retirement so that we could blow some stuff up and kill tens of thousands of people whom you’ve never met, in a far away land you’ll never visit. What a deal!

There are only two possible explanations for a price increase. Either the purchasing power of the money has declined, or the value of the products being purchased have risen. There isn’t a third option. Unfortunately, the decline in the value(i.e. purchasing power) of the currency itself is usually the last thing considered, even though it’s the most dangerous of the two by a large margin.

This has been on my mind a lot lately with the seemingly endless boom in commodity prices. It’s my belief that commodities(gold, oil, sugar, wheat, cotton, copper, etc.) are rising across the board because of a diminishing confidence in the dollar. And the reason that we see them rising against other currencies as well, is because of how closely tied and dependent the other major world currencies are on the dollar. In essence, the dollar is taking the other currencies down with it.

Investors are fleeing to real goods by buying commodities, and that’s pushing their price up. But, it’s a very specific sort of investment. It’s a hedge investment against falling currency value so that they can continue to invest in stocks. That might seem convoluted, but think about it. In this market you have to invest to make any interest. Bank savings is fruitless since the Fed has interest rates at zero. Right now, putting your money in a savings account is little better than sticking it in your mattress. Interest rates are so low that you are losing money to inflation by doing that. Therefore, you must invest to make anything on your money and keep up with inflation. Leaving out bonds and currencies because of volatility, this leaves commodities and stocks for most people.

The best strategy is to split the two and have part invested in a commodity hedge and the rest invested in stocks. This explains why commodities and paper stocks have both been gaining. The Dow Jones currently stands at 12,229 as I write this. That’s back to pre-crash 2008 levels. Surprised? Don’t be. This isn’t out of the ordinary for hyperinflationary situations. In the Wiemar hyperinflation of the 1920′s the German stock market absolutely boomed, rising from 100 in 1914 to 26,890,000 in 1923. People flocked to it as the only place left where they could actually make money. Of course, the problem with that is the stocks are being driven by inflation themselves and will ultimately collapse along with the currency.

So which is it? Are commodities climbing or are currencies falling? I think currencies are falling. There is no more gold backed currency in the world today, so when people flee to real goods they are going to go to commodities first. Where else would they go? And, it’s going to get worse folks. Much worse over time. The flight to real goods can only be slowed by another boom. And the next boom will be the dreaded crackup boom I’m afraid.