A trap for fiscal conservative: the chicago school of economics & Milton Friedman

Say you have 2 systems, one virtues and just (say system A) while the other not so (say system B). If the other system (B) gives tremendous profits to some corporations, which system do you think such corporations will try to promote and keep? This other system B isn't it? ...
Well, it is obvious to me that central banking (which always lead to fiat paper money by the way) provides much more wealth and profits to the banking industry, most specifically those banks controlling such central bank. Consequently, that such banking cartel would do whatever they can to keep such system is easy to imagine.
Central Banking allows government to easily grow, spend and increase their debt, which in turns provides the constant flow of money under the commercial bank's fractional reserve pyramid to keep providing loans to the general public. When such system is initially tied to gold, it will inevitably detach itself from it when more money has been printed than there was gold (as FDR has proven with Executive Order 6102 and again with Nixon in August 1971, so called Nixon Shock).

An economist that is well received by the majority of the people on the left is John Maynard Keynes for which his economic views have been called "Keynesian economics". This calls for the government to start spending in downturn (when the fractional reserve banking inverse pyramid collapse - see my previous post http://eggdescrambler.blogspot.com/2011/05/gold-as-money-are-you-mad.html)
Growing the government, particularly in socialism programs isn't the call that the fiscally conservatives would make and hence, they would turn to another economic view. The Austrian school of economics (promoted by such web site has the Mises Institute http://www.mises.org) would have been a good answer since it asks for small government and free market capitalism. Any government regulations and interventions would be interfering with the free market and will results with more issues. In fact, most issues we see today where the media blames the free market actually happens because of one or more government regulation or intervention. The problem for the banking cartel is that the Austrian school also promotes free market money and banking, where there is no such monopoly of money by a central bank fixing interest rates. Although it is speculations from my part, knowing how much financial impact the banking cartel has on the educational community, I believe they knew a wall had to be mounted to keep the Austrian school in the trench views.

To attract fiscal conservatives away from such economic school, the creation of another economic school still promoting free market in everything but money and still promoting small government and anti-socialism views would be ideal. As long as the central banking scheme is left alone and allowed to print, the system can survive. Here comes, somewhere in the 1950s, the Chicago school of economics, inserting itself right between the Keynesians and the Austrian School. It was given such name because so many of the economists of this school were part of the department of economics of the University of Chicago. Note that although Wikipedia list Frederick Hayek as part of this movement, Hayek was part of the Austrian school of economics and in favor of a hard money/free market money. Milton Friedman is one of the most well known economist part of this school. He is the one who advised Nixon to go off the gold standard in 1971, so much for free market... but it does prove the Chicago school was no enemy of the banking cartel. Ironically, Friedman later mention regretting that call as it allowed the federal government to grow even more. What was he thinking?  To his defense, Friedman give several wonderful statements and debates in favor of free market and against socialism of which one of my favorite is the 4 ways to spend money:

So, my point is that I believe the banking cartel probably helped or is the originator of the Chicago school in order to dominate the "alternative" view to the pro-socialism-Keynesian view. If it wasn't there to provide such barrier - or wall - the major alternative would have been the Austrian school of economics with its anti-Central banking view. I think they succeeded since barely today anyone has heard of the Austrian school, even though it is even older than Keynesian economics  (which took main root in the 1930s). However, the latest financial debacles of this century's first decade has woken up a growing segment of the population who have decided to educate themselves more on this very fundamental issue of money, credit and central banking. In that process, they have learned about the Austrian school. If you haven't, start your wonderful journey at mises.org. Recommended books are some by Robert P. Murphy, Thomas Woods or Peter Schiff.

Gold as money? Are you mad?

In the USA and many other countries, we have to go several generations back to find people that actually used both gold and silver coins as money instead of government printed money. This is an important fact to mention as this implies the great majority of today's population look at gold as money from a perspective where they know only about paper money. Several misconception or lack of understanding about money comes from this narrow perspective. In this article, I want to address the most prevalent ones and allow the audience the opportunity to see it from another perspective.
As I stated in another post before, one of the best way to fight the great divide between the rich and the poor is using sound money (concentration of wealth is more acute today than in the past). Government paper money has come in 2 forms in history, either directly printed by the government such as Lincoln's greenback during the American civil war, or via a central bank. By extension, we can include ancient civilizations where their governments (or kings) were debasing their coins with cheaper metals, hence similar to a government directly printing its money (or debasing). Central banking came up for the first time with the Bank of England in the 17th century where a central bank with the monopoly on money prints the money out of thin air and lends it to the government who in turns spends it. This requires the government to pay back the interest on that money, but usually some of that interest is returned to the government. Still, part of that interest flows to the banking corporations owning part of the central bank. Central banking is more subtle and complex but quite more interesting for the bank as we will illustrate in a future post. But in both cases, the poor are the one who will suffer the most as they are the least able to protect themselves from this printing. Essentially, all those government programs to help the poor and some of the middle class are actually paid by the poor and the middle class. When considering the drawback of a monopoly when the government is the sole provider of the service, the overall deal is more a loss than a gain for the poor and nearly all of the middle class.

But let's come back to gold.

If we use gold and silver as money, prices will decline as there is not enough gold. That's bad isn't it!?
It's bad if we are in debt, but good otherwise, as any computer buyers would tell you. Prior to the creation of the Federal Reserve, people were buying houses and cars full cash. It was mainly companies and industries that were getting loans for improving their facilities and increase their productions. Savings was not a losing gain but rather a real pay off since all the technological improvements made everything cheaper - in gold. Any workers would save up 10% or more of their paycheck and then spent it on the car or the house. If they decided to deposit it at a bank and collect interest, the gain was even more - as long as they chose a bank that was making loans to sound companies. Houses build would get even better with even better material with the same price or perhaps even lower price, but since the builders would too enjoy price deflation, they would be able to still make a profit.

If we used gold, it would limit growth in the economy isn't it?
The capacity of the economy is limited by the resources available (human labor and material) to it as well as the new machinery's and tools that can be developed to increase its performance. It would be time consuming initially for Robinson Crusoe, stuck on the island, who needs to knock down coconuts by climbing on each tree until he takes the time to develop some long perch that will help him knock them down from the ground. This applies to an economy as well with new industrial tool and system. That we print more paper money will not change such capacity. If many savers decide to save their gold coins under the bed rather depositing it at the bank to make new loans, such high saving rate hidden from the system would lower the price of everything, making the little amount of gold coins left more valuable for the borrowers (companies) who get them. In essence, the scale is adjusted with the available gold coins in circulation. When the companies increases its output from the new tool/system, more products can come up and those savers might become spenders - buying these new products made in much larger quantities. You suddenly have more products and more gold coins, but it will keep adjusting. The key is the resources available can only vary so much, and a fixed amount of gold, or somewhat increasing via gold mining, will reflect it.

How will governments be able to spend without higher taxes?
I admit, the question is silly, but I've added it to show that it governments would not be able to lie anymore about where the money comes from. Politicians are humans and they love power and it is the very reason they are attracted to politics. To get elected to power or to stay in power requires making and giving promises, spending in favor of a given electoral group. But taxing is not seen favorably by the electors and the amount of taxes required are likely not enough to match the spending. Borrowing is the way they use, but this increases interest rate in an environment with gold as money. The government has to compete with corporations that borrow to improve their manufacturing. More demand, higher interest rate and hence, the government is locked up in higher payments.

One of my favorite: Gold could not be used as money, there is not enough gold
At this current price, that's true. If tomorrow gold was the standard world money (along with any other metal the market would choose), its value would increase to match the true amount of wealth it can be used for exchanges. Note also that its current price is undervalued because of government suppression (see http://www.gata.org/ for more info). Instead of the typical standard family homes selling for about 120 ounces of gold, it would sell for 1 ounce of gold. Likely, we might be talking about grams of gold which is a smaller unit. Basically, the market will naturally adjust its value to match the need of the market, with supply and demand.

Why is paper money more bad for the poor and the middle class?
I don't want to mean all of the middle class, but a large majority of them. In essence, the middle class would be in a better position if not for paper money, even though most would disagree with this statement. To illustrate the reason, we have to understand how the money flow. When money is printed, it will lose value but this devaluing is not shown equally across the board. The monetary system we have today creates paper money out of thin air via 2 ways:

1. Commercial banks when they print money via fractional reserve banking on a new loan for either a business or an individual.
2. The central bank when it buys treasury bonds from the federal government.

Fractional Reserve banking is like an inverse pyramid. A few dollars at the bottom creates 10 times more dollars at the top and commercial loans are on the top of the money printed by the central bank when it buys treasury bonds.
This means the very first class of goods and services that this new money from commercial bank affect are the asset class: stocks, bonds and real estate. If the interest rate is lowered too much, it allows easy lending and hence, a runaway bubble leading to a market crash (think late 1920s after the low interest rate allowed for investors to borrom money to buy stocks - or early 2000s for real estate).
Wouldbe homeowners bid up prices as the interest rates are artificially lowered down. Too many are required to take ever increasing loans to afford a house,... until the bubble burst.

The same as when the soviet unions had politburos figuring out how much of toothpaste or carrots had to be produced rather than letting the free market decide, the same applies to interest rate which is the rent on money. It inevitably leads to misallocation.

I will add more points if I read comments with other questions that require so.
Other interesting articles:
http://www.gata.org/node/9885

Thanks for reading.
Take care

My next 2 posts

Sorry for the delay in my weekly post, I haven't finished it yet.
To give you a heads up, one of my next 2 posts will be about gold as money and the other one about the US constitution as an inspiration for a new Canadian constitution that many of the provinces - in particular Quebec - might like very much, at least some part of it.

About what's missing in "The One Percent" documentary

I just finished watching The One Percent documentary from Jamie Johnson, the great grandson of the founder of Johnson & Johnson.
http://www.theonepercentdocumentary.com/
http://en.wikipedia.org/wiki/The_One_Percent

This movie reflects on the 1% richest people in the USA and the divide between the rich and the poor. It has very valuable content, including the interview with the grand daughter of Warren Buffet. The press reaction includes this wall street journal's article:
The Wall Street Journal: The Rich Man's Michael Moore

Jamie did a good job of trying to catch 2 different point of views on this subject - those of his father's financial analyst and also Steve Forbes as well as economist Milton Friedman. He also interviews other folks with a more penchant for socialist solutions such as the those in favor of the death tax. Although he wasn't able to interview Warren Buffet, Buffet is one of those in favor of the death tax, but one thing that should be mention is Buffet's big profits from it as illustrated here:

The “Oracle of Omaha’s” wealth has come from making wise investments in three different business activities. First, he’s made substantial investments in major corporations that he believes will appreciate; second, he operates a huge casualty and life insurance business which provides massive reserves of cheap capital to support his other two investing activities; and third, he purchases family owned businesses at fire sale prices. The last two practices are directly dependent on the death tax, and it’s unlikely that Mr. Buffett would be the world’s second richest man without it.
Taken from:
http://www.humanevents.com/article.php?id=38595

Things are rarely as they seen and we must always force ourselves to go beyond the obvious.

What I find clearly missing though is an interview with advocates of sound money. He should have interviewed congressman Ron Paul and perhaps other folks at mises.org such as Robert P. Murphy, Lew Rockwell and Thomas Woods jr. The greatest divider between the rich and the poor is the monetary system that we have since 1913 with a central bank. Since 1971 when Nixon untied the dollar to gold on the international market, printing money out of thin air allowed this divide to accelerate. This allowed the federal government to grow even faster and is the fundamental cause of this divide.

I urge Jamie to get more interested in Austrian Economics and in particularly, in sound money and here are a few books and references he could start with:
http://www.tomwoods.com/books/rollback/
http://mises.org/books/economics_in_one_lesson_hazlitt.pdf
http://mises.org/daily/672
http://blog.mises.org/15392/so-you-want-to-learn-austrian-business-cycle-theory/

Here's how can I illustrate quickly why paper money is a great divider:

The rich have more assets than the poor, either in real estate, businesses, stocks or royalties. These assets grows with inflation while the debt - if any - on which they are based diminishes in value with inflation.
The poor on the other hand have mostly wages that will be slow to adjust to catch up with inflation and usually only once a year. Those wages only catch up to inflation while plain saving money is no longer the viable solution. Indeed, since the interest rate are artificially lower by the mean of central banking intervention, and in addition the income on those savings are taxed, the mass avoids saving most of the time. What was in the 19th century simple as piling up cash (which was good as gold) or gold itself in order to save for the future requires investing in stocks or other securities that are highly susceptible to the booms and bust imposed by the artificially lowered interest rates as we have seen with the housing market in the first decade of this century. We could go on with this but this is just to give you a rapid look at what this means.
Of course, the taxation system, being extremely complex, again will advantage the rich over the poor as they can hire the specialists that will navigate the tax code while the poor and middle class have barely any options at all. Since the government is more likely to redistribute that tax money in a very inefficient way, overall the rich gain and the poor and middle class loses. To top it off, when the government is allowed to come up with regulations, this opens the door for some large companies to contribute financially in political parties so to influence those regulations in a way that will limit competition, again benefiting the already rich.

Inflationist deflationist debate

For the last 2 years, I've seen several debates between two groups. The deflationists are those who believe we are heading towards a worst than the 1930s deflation where prices of real estate will crash down, the DOW plunging to 5000 or lower and we will barely see any increase in oil and food price.
On the other hand, we have the inflationists who believe we are headed towards hyperinflation - Wiemar Germany 1922-1923 style. I tend to be in the later group and I will provide my own explanations.
Of course, outside of that is somewhat a large majority of people who agree with CNBC et al that a recovery is in the making.

One of the recent battle was between a guy name Gonzalo Lira in Chile (hyperinflation) and Rick Ackerman in Colorado, USA  (deflation):
http://gonzalolira.blogspot.com/2011/04/relying-on-gods-from-machinery-weird.html
http://www.rickackerman.com/2011/04/hyperinflationists-jailed-in-kiddie-porn-sting/
Both Gonzalo Lira and Rick Ackerman posted several articles on this subject over the last 2 years. It's actually this article from Gonzalo Lira that was republished at ZeroHedge.com that gave him some fame:
http://gonzalolira.blogspot.com/2010/08/how-hyperinflation-will-happen.html

First, before I go on with why I believe the odds of hyperinflation are greater, I need to share with you a few of the books that contributed to establishing my stand.

• The Creature From Jekyll Island by G. Edward Griffin is an excellent work. 2 words can give a quick overview of the conclusion you can come out after reading it: cartel and bailouts.
• http://mises.org/books/economics_in_one_lesson_hazlitt.pdf Economics in One Lesson by Henry Hazlitt and several other great books from the Mises institute on Austrian Economics and the business cycle.
• Rollback from Thomas Woods 
• How an economy grows and why it crashes by Peter Schiff 

As we know, the printing press is driven by the Federal Reserve. There are 2 things that most be considered:

1. The Federal Reserve is a political animal
2. The increase in the money supply (artificially lowering the interest rate) misallocate resources that eventually will starve/affect economic activity that desperately needs investment. Food being one of them.

Let's look at the first item: the political animal
It is the very reason why the Federal Reserve was created. It allowed Congress to spend and make endless promises to their constituents and paying for them via inflation which is usually blamed by the public on speculators, farmers, oil tycoons or you name it, but never on the government itself. On the other hand, it allows bankers to endlessly lend using fractional reserve banking and to receive bailouts. By inflating, the Federal Reserve allows both parties, bankers (or should I say banksters) and politicians to achieve their main goal. However, inflation is terrible for savers who put their money into treasury bonds or CD (certificate of deposits that should be rightly called in this case "certificate of depreciation"). Many retirees have put their money in treasury bonds and the like with an artificially undervalued interest rate, not really catching up to the real inflation, particularly when you account the income tax they will have to pay on it.

For the government, deflation is terrible as revenue plunges. As for the bankers a lot of bankruptcy happens where they end up with devaluating assets in reposition. Getting a bailout for this is the best way as it limits inflation to the bankers specific needs (undo their losses), but there is a limit to how many bailouts Congress can do in a given time without a threat of being voted out by the public. Subterfuge might also be used.

For the public that did not borrow but actually saved, deflation is great as cheap houses and cheap anything is available for them. They are able to buy more and they are not taxed on the increased value of their savings. To claim that lenders loses during inflation might be true of false, it all depends on the type of lender. Is it a private corporation or individual, if so, this lender loses. Is it a bank, if so, they probably win as they have the ability to make more loans via the benefit of fractional reserve banking. With $1000 of deposit, they are allowed to make loans up to $9000 hence, making 9 times their money on interest than you or I would do. It is for this reason that a slight inflation just enough to extract wealth without triggering a complete loss of confidence in the currency is the ultimate target.

But other parties are greatly benefiting from this great federal cow such as the military contractors or any other industries linked to any new federal spending Congress comes up with every year. Essentially, the federal reserve is a tool to extract wealth from the poor and the middle class and redistribute it to industries, bankers and other agencies linked to this spending. It is a common cow that is sucked up by these groups which to me, replicates the famous "Tragegy of the commons" (http://en.wikipedia.org/wiki/Tragedy_of_the_commons). It is a large social programs for the rich and industries. For the same reason that socialism cannot work on the basis that it replicates the tragedy of the commons, the same applies to this Federal government cow which is made possible by the Federal Reserve. When the farmers saw the grassland that they were sharing starting to disappearing, their urge was not to stop. Any of the farmers would think, if I stop, the others will benefit more.

The Federal Reserve might resist continuing this printing frenzy (so called quantitative easing) when it will see high inflation, this will likely trigger a deflationary trend that will scare them all and they will revert to coming back with the same kind of program as in 2008. Only this time, the lag time for the inflationary period to come back will be much shorter, they are getting much shorter and we discuss this more with the 2nd reason below.

Note that if ever the federal reserve made the threat of not re-starting the printing press, another point to consider regarding the fact it is a political animal is that Congress and the White House could make the threat of replacing the federal reserve with its own money, a bit like the Greenback of the civil war (more on that in another post). Enjoying their bank cartel, it is unlikely the Federal Reserve will hold to such a threat if the economy is in a deflationary black hole. I'm not saying this is a certainty, just another possibility.

Artificial low interest leads to misallocation of investments
This is another part that is key to the understanding. Under a fix gold coin standard for example, the amount of money supply is fixed and its corresponding value, at any given time, is linked with the amount of available resource: human labor, material and capital (capital being tools and machinery that increases the production capacity).
I will not go in great details about the Austrian business cycle theory, but essentially, in short, the artificially low interest rate will move some of those resources in location other than what the free market would have chosen had it be free of any government intervention in the money supply (interest rate is the price on money). The farmers, the fishermen, the companies maintaining current equipment and machinery as well as building new machinery that would increase say the output have to compete for resources with the retail sector. Oil is a three letter word and is one of those resources that they have to compete with. The interplay of multiple industries is too difficult to be illustrated with a simple example that will serve the purpose of my explanation. However, to understand more about the Austrian business cycle theory, you can start with  http://mises.org/daily/672.
What this means is those distorsions are getting worst and worst with the can being kicked down the road by the keynesian money printers. Such distorsions are making the booms and bust, inflationary/deflationary cycle closer to each other and I expect this to affect greatly the food supply - which already has been affected.
Although the US government conveniently does not include food and energy in the CPI index to measure inflation, I can assure you based on firm evidence that all humans do eat and require some form of energy.

The last straw...
When you add those 2 factors we described with the velocity of money, you can see the spark that triggers the hyperinflationary bomb. Velocity of money can be seen as the "hot potato" dollars, it's when people want to spend their money faster before it loses value. When there is a lost of confidence, this is too late. Since there is a lag between the time the money has been printed and its corresponding effect in rising prices, by the time the Federal Reserve decides to stop it might be already too late.
Rising oil price choke up the economy which makes it roll back into a downturn again. Since Bernanke's solution is to start printing again to reflate the economy, it takes the economy back on its track (well what appears to be so) but after some lag time, this freshly printed money will make the price rise again. Look at the price of oil in the last 10 years. After 2001, Greenspan artificially lowered the interest rate to kick up the economy and it took several years for oil to move up but see how more rapidly the price went up after the crash of 2008 compared to its rise after 2002. Granted, we have another argument of peak oil but measured in a money that has a fix supply, such as gold, oil has not moved up (and the misallocation argument is still valid).

The Federal Reserve will see a rapid inflation roaring back shortly after trying to fight another deflationary span that will come from this new rising price. In short, it will be coming even faster and once the genie is out of the bottle, it cannot be put back. By the time they decide to stop, the lag time will be their worst enemy, a bit like driving a car with a driving wheel that has a 1 second lag time.

If the Federal Reserve does not print anymore, the interest rate will jack up to much higher level, triggering this deflationary trend they are so against. Will they choose that route or not? If they don't the federal government has to openly admit default on many of its obligation along with a drastic cut in federal spending. Although this seems awful, it is indeed the better option over hyperinflation, but it requires politicians to admit and say the truth, a very extreme rarity in Washington DC.

First post

Always need a first post right?...

My view:
Strong believer in the Austrian School of Economics
Libertarian (at the top of the chart on http://www.lp.org/)
Anti-militarism/empire building
Anti-social candies for the reason that the state/govt is inefficient and easily corruptible and the private sector philantropy much more efficient and would be stronger without any taxes.