Sunday, November 23, 2008

Yes Virginia, The Big Recessions and Depressions ARE the Same

Here we go again. Although every recession is unique in the details, this one and those the country has experienced since the 1800s have at least one fundamental underlying similarity: The boom that preceded them.

[Thanks to for this image of Tatsu, a new ride at Magic Mountain.]

Let’s compare what is happening today to what happened during the Great Depression. In the 1920s after World War I inflating of the currency, Florida underwent a damaging real estate boom and bust cycle. Florida’s experience was so violent that one contemporary economist in 1928 called it "the Florida gamble."

"When Florida land first started its upward course there were good substantial reasons for advancing prices ... [but] advancing prices drew those individuals who were speculatively inclined as molasses draws flies. ... Large building projects gave an appearance of substance and worth to the whole affair. In 1924, pessimists were nearly all united that the Florida boom must soon end. But the mass of people, than whom there are no greater gamblers, had Florida fever. ... Then the bubble broke, as they always have and always will. In the wake of the boom followed disaster, defunct banks, and depression."

Hmm. Real estate bubble. Sounds familiar.

In 1925 through 1928 as the Florida gamble unwound, the concomitant US stock market boom was showing foreboding signs of euphoria. The article continues:

"The [stock market] boom has not collapsed, and, from all appearances, is stronger than it has been for some time. That seeming invulnerability and capacity for unlimited progress is a market feature of all such speculative periods as they near an end. It is to be hoped that the Florida bubble will not be completely paralleled [in the stock market]. Banks all over the country have entered on a new experiment in the past few years, the practice of loaning large amounts against securities [italics added]. [Also sound familiar?] A collapse in the stock market would make thousands of banks unwilling investors, very much as the Florida banks found themselves in the real estate business after 1925. Such an experience, with the inevitable blood-letting at the hands of receivers for the least fortunate, would be a blow to our progress that would force upon the country many months of painful convalescence." [Quote from an unpublished paper, "Stock Speculation Versus Florida Memories," E.C. Harwood, 1928.]

As we now know, the Florida real estate bust of 1925 was followed by the stock market crash months after Harwood wrote this prescient article.

Hmmm. Stock market bubble. Again, sounds familiar.

Between 1800 and 2008, Americans have experienced boom and bust cycles; yet economists as a class are known for their disagreement about the cause, with two notable exceptions.

One is the Austrian school of economists, scholars like Von Mises and Hayek, to whom our attention seems to turn cyclically after every recession, but of whom we tend to lose sight as soon as we get another taste of easy credit. They've been warning about credit imbalances and poor banking practices for over a century.

A more scientific thinker, this time from among the empirical economists, is the author of the articles noted above. Through extensive study of banking statistics, Harwood concluded that markets in general, and international markets in particular, work best when unhampered; but that they can only function well when the trading medium is staid. Like the Austrians, he concluded that fluctuating fiat currencies and/or poor banking standards are a catalyst for excessive credit creation, resulting in speculative boom/bust cycles. Using his analysis, he predicted the 1929 crash as evidenced in his articles published in The Annalist of 1928 and early and mid-1929. He also predicted the devaluation and flight from the dollar of the 1970s.

Furthermore, he maintained that the world would continue to suffer damaging speculative peaks and crashes until voters realize that it is our incompetent monetary policymakers who create them. Legislators must acquire enough humility to admit that human agents cannot micromanage the quantity of money—a failing even Milton Friedman feared—and that government’s only role should be to support the natural money-creation process through the establishment and maintenance of sound banking principles and of some form of currency measuring stick.

Both Harwood and the Austrians believe that, to date, the only such device that has succeeded for any length of time is the gold standard in one form or another. The duty of our economic wizards is to find the version of it that fits today’s parameters.

What are the chances our present or future administration will see fit to look for this solution? About zero. Expect more rides in the future.

See more about Edward C. Harwood at the American Institute for Economic Research.

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Sunday, November 16, 2008

Gold Standard Talk Again

[Thanks to for the image.]

Here's another mention of the gold standard. Doug Noland over at Prudent Bear points out this article by Judy Shelton appearing in the Wall Street Journal Saturday.

The pertinent paragraph:

"... [I]f anyone has demonstrated irresponsibility, it is not those who chased misleading price signals in pursuit of false profits -- but rather global authorities who have failed to provide an appropriate international monetary system to serve the needs of honest entrepreneurs in an open world economy.... [T]he inflationary pressures which caused us to go off the gold standard in the first place have only worsened. Moreover, [Paul Volcker] suggests, floating rates undermine the fundamental tenets of comparative advantage.

"[quoting Volcker:] 'What can an exchange rate really mean,' he wrote in 'Changing Fortunes' (1992), 'in terms of everything a textbook teaches about rational economic decision making, when it changes by 30% or more in the space of 12 months only to reverse itself? What kind of signals does that send about where a businessman should intelligently invest his capital for long-term profitability? In the grand scheme of economic life first described by Adam Smith, in which nations like individuals should concentrate on the things they do best, how can anyone decide which country produces what most efficiently when the prices change so fast? The answer, to me, must be that such large swings are a symptom of a system in disarray.'"

Now, if the G20 read this on Saturday morning, they had some food for thought.

Don't get your hopes up, however. Politicians get too much bang for their fiat-currency buck to give it up. A standard somehow set to gold would tie their hands behind their back.

Even if they want to get back to some kind of standard, the present will not be the time to instigate it. Monetary authorities are now pumping as much liquidity and capital as they can into the system, and a standard would put a gold wrench into the works.

We are now on a path where there can be only one of two outcomes:

- Either we inflate out way out of this crisis and we manage to get back to a semblance of calm, at which time the authorities will have to mop up all that excess liquidity or watch it turn into another global bubble that will last who-knows-how-long until another crisis occurs;

- Or there will be a general flight from all fiat currencies to gold, because either panic or renewed inflation settles in. Gold will explode in exchange value in all currencies, eventually to settle at some amount that will represent the market's evaluation of each currency's real gold-exchange worth.

In other words and in my opinion, if we want to stabilize economies in the future, we will have to get back to gold either by the door or by the window, as the French say.

Mr. Volcker will probably be Obama's adviser. What will he suggest? Wouldn't it be ironic if the resolution of our monetary madness came from the big-government left.

Shelton wrote "Money Meltdown: Restoring Order to the Global Currency System." See more on this book at Amazon.

See also this article at the American Institute for Economic Research, and this AIER book on the prospects for a resumption of the gold standard and what it would take; plus this book on gold's role in history.

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Greenspan's Song

For a little comic relief, read this neat poem by Rob Peebles over at Prudent Bear.

Live, love, laugh. For tomorrow we pay.


Friday, November 14, 2008

Talk About A Gold Standard? Naaahhhh.....

Oh yes there is.

[Thanks to for this photo of a 14 carat gold cup.]

My friend Walker Todd, former collaborator at the Federal Reserve Banks of New York and Cleveland and now a researcher at the American Institute for Economic Research is talking about it loud and clear.

Read his piece at the Christian Science Monitor.

I mentioned another gold standard proponent Larry H. White in the past, and I write a lot about the gold standard and also here, and you'll remember my mantra:

"You can take gold out of the standard, but you can't take the standard out of gold."

I really believe it.

Too bad there's little chance of it happening.

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Tuesday, November 11, 2008

The 2008 Bailout: The Pandora's Box of All Pandora's Boxes

If there ever was a Pandora's Box, the Big Bailout of 2008 has to be it.

Pandora's Box
[Thanks to for the image.]

How did we get here?

After a difficult time in the early 1900s, we began our drift away from sound monetary and banking policy by turning towards government for the prevention of business cycles.

We thought we were doing the right thing in creating the Federal Reserve. Since then, it has evolved into the monster it is today.

It started as a tool for maintenance of the stability of the banking system, but it has become the all-knowing, all seeing Poobah-Controller of the Issuance of Purchasing Media, in the place of what we had back then, the gold standard. In fact, we've gotten so far away from this standard that we officially abandoned it in 1971.

Today, it is increasing clear that the Fed has no real control of the money-creation process. Meantime, Congress has decided to come to the rescue of one failing institution after another, most recently General Motors. Ford and Chrysler will not be far behind.

Where will it end? How will this turn out?

No one knows; and the more the government messes around with this, the murkier the future becomes.

We are already in a good recession (see the statistics of the American Institute for Economic Research), and it may start out to be deflationary. But our leaders will not let price deflation happen. They will pump as much credit into the system as they think they need to keep prices and the economy stable. After all, that is their mandate. (See what I have to say about their mandate here.)

Yet deflation enriches us through lower prices. (It also means reducing the supply of purchasing media, but that's a separate story. See my discussion of this definition confusion.) If prices were to decrease, we would all be better off. For example, do you prefer the price of tuna fish at $3.99 a can, or $2.99? Duh.

Deflation (i.e. lower CPI) is not bad in and of itself. What is bad is what usually accompanies deflation. In most deflationary episodes we have recession and/or depression: Bankruptcies, decreased consumption, loss of jobs, stock market losses, bank closures.

But the Fed is forgetting that by "curing" the symptom of recession (i.e. by stopping price deflation) they are not necessarily curing the cause of that recession.

To cure this recession, Congress must allow the market to rid itself of a century of inflation. That can only be corrected through a deflationary process, even if it means we must undergo some recession. If the Fed and the Treasury try to keep it from happening, they will maintain the distortion of inflation instead of allowing it to cure itself.

What method will they use to accomplish this? They will try their darnedest to prevent deflation/recession/depression by turning on the printing presses (issuing fiat currency and credit) to whomever needs it the most, or cries the loudest, or threatens to close. They have borrowed billions, and created billions, in this effort. Where will it stop, now that the presses are running full speed?

Businesses are quickly learning that they must start screaming for cash. The cash is available. First come, first served. Yet by continuing the inflationary process and handing out cash, our own elected officials are fleecing us on a daily basis.

They will fund these bailouts with the raises we will not get, with the value we are losing on our houses, with the pension investments we bought at inflated prices and that have vanished.

Our salaries are now in negative growth, banks steal our savings every day through poor interest remuneration (they get cheaper money from the Fed), and our social security incomes and pension allotments are not keeping pace with the CPI. As my Dad used to say, "Stand still, little lambs, to be shorn." (For more about him, see my last post.)

In the longer run (when, I don't know), we the people must reject these shenanigans and turn to gold as a refuge against government destruction of the monetary units of the world.

That's the day Pandora will close her box. I hope I live long enough to see it happen.

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