A new golden age

“The designers of the good ship euro wanted to create the greatest liner of the age. But as everybody now knows, it was fit only for fair-weather sailing, with an anarchic crew and no lifeboat. Its rules of economic seamanship were rudimentary, and were broken anyway. When it struck a reef two years ago, the water flooded one compartment after another.. European officials now recognise the folly of creating the euro without preparing for trouble. It would be wise to be planning now for what to do if it sinks.. Even now, after decades of “European construction”, many Eurocrats cannot conceive of the euro as a wreck. Those who have worked hardest to keep it afloat are exhausted and know it is not in their power to save it anyway.”

– Charlemagne in ‘The Economist’, November 26th.

The business of investment for at least the past four years has been akin to conducting a detective inquiry: whodunit? Just how did we end up in this mess? To tackle one’s enemy, one first needs to identify it. In the popular conception, a myth gleefully adopted by politicians, it is all down to corrupt American investment banks, poisoning the collective well of global capital with subprime mortgage filth – what Professor Robert Vambery in this week’s Economist nicely if grimly refers to as adding three quarts of milk to a quart of sewage and creating four quarts of sewage in the process. And then the poison spread. It is a neat little tale but nowhere near sufficient to explain the extent of our current malaise. We can throw some mud in the direction of politicians, but that is a little like shooting the messenger; they have only been dispensing the bread and circuses and pension and welfare benefits on the never-never that everybody has been clamouring for. The culprit we find the most culpable, and which draws all these disparate threads of blame into one cohesive narrative, is a fundamentally corrupt money system.

At this point, Keynesians and other economically retarded or wilfully ignorant financial onlookers typically have their eyes glaze over. But the frequency of repetition of the Austrian perspective does not make it any less true. To have a properly sound economy, one needs sound money. Everyone is for the former, but few can see the essential requirement for the latter.

Jörg Guido Hülsmann in his masterful The Ethics of Money Production lays out the historical facts. Money is useful because it replaces the messy inconvenience of barter.

In the history of mankind, a great variety of commodities – cattle, shells, nails, tobacco, cotton, copper, silver, gold, and so on – have been used as media of exchange. In the most developed societies, the precious metals have eventually been preferred to all other goods because their physical characteristics (scarcity, durability, divisibility, distinct look and sound, homogeneity through space and time, malleability and beauty) make them particularly suitable to serve in this function.

When a medium of exchange is generally accepted in society, it is called “money”. How does a commodity such as gold or silver turn into money? This happens through a gradual process, in the course of which more and more market participants, each for himself, decide to use gold and silver rather than other commodities in their indirect exchanges. Thus the historical selection of gold, silver and copper was not made through some sort of a social contract or convention. Rather, it resulted from the spontaneous convergence of many individual choices, a convergence that was prompted through the objective physical characteristics of the precious metals.

At this point, politicians and bankers should already be cringing. Precious metals have throughout history been adopted as money through free choice. Their adoption has never required the coercion of the state. Hülsmann points out that in no period of human history has unbacked paper money ever spontaneously emerged on the free market.

In all known historical cases, paper money has come into existence through government-sponsored breach of contract and other violations of private-property rights. It has never been a creature of the free market.

Hülsmann also points out, and this could not be more topical, that in a truly free market, paper money could not withstand the competition from the monetary metals; paper currency would ultimately be completely eradicated.

Of course we now operate under a fiat money system, in which money is given the dubious legitimacy it possesses by means of the power of the state. It is merely worth making the non- trivial observation that no unbacked paper currency has ever lasted. This observation is, of course, more poignant given current events in Europe.

The problem is made more acute, and global, by the fact that, as Chris Martenson points out, we operate with debt-backed money. At the local bank level, all new money is loaned into existence. At the central bank level, money is simply created out of thin air and then exchanged for interest- paying government debt. This next sentence should be read aloud, in an ominous tone:

Perpetual economic expansion is a requirement of modern banking

Not least, so that existing debts can continue to be serviced.

The problem of our age is that the level of global accumulated debt is so huge that it can never be paid back. Certainly, the austerity now being pursued in varying degrees across the western economies ensures that we will have insufficient economic growth to maintain debt service costs. The only question now is in what form much of the unpayable debt is repudiated – explicitly by outright default, or implicitly, by further money printing that is likely to spiral out of control.

The adjective ‘iatrogenic’ comes from the Greek ‘iatro’ (healer) and ‘genic’ (caused by): it refers to an illness caused by the doctor himself. And this is surely the way to describe the current policy prescriptions of our current monetary Doctors Frankenstein: the best way to “cure” an ailing economy is simply to pump more money in. This prescription ended up killing the Weimar patient and there is no reason to believe the experience will be any less painful this time around. Unfortunately, in the mythology of our current overly politicised economy, there can be no hard choices, so a series of soft options continues to be pursued until – like now – we are left with the hardest choices of all.

Fund manager Doug Noland of the Federated Prudent Bear Fund summarises the situation well:

The global credit crisis took giant leaps forward this week. With even the euro region’s depleted “core” succumbing, crisis dynamics are now anything but isolated to “periphery” markets and economies.. Problems at Europe’s “periphery” will not be easily resolved by German and French guarantees, Eurobonds, a leveraged bailout fund, the ECB, or the Chinese. The markets recognize there will be no quick fix, while worries mount that global finance and economies may be much less sound than earlier believed.. I don’t believe that the expanding nature of global market illiquidity is garnering the attention it deserves. And it’s difficult to envisage a scenario where the liquidity backdrop doesn’t continue to deteriorate. European banks are likely still in the early innings of their historic retrenchment. With financial implosion risk seemingly growing by the day, I fear an escalating crisis of confidence with respect to derivatives and counterparty issues. This is a major issue for global financial institutions and the vulnerable global leveraged speculating community.. I would not be surprised by some announcement of concerted international policymaker measures to bolster confidence in global market liquidity. The financial breakdown scenario is no longer outrageous. The global crisis has afflicted the core, with literally tens of trillions of sovereign debt and banking system liabilities now in the markets’ bad graces.

All of which should serve to remind us that money is far too important to be left to politicians. As the financial world edges ever closer to the brink, desperate investors are fleeing to all sorts of things in a crazy delusion of apparent safety. That US Treasury bonds (issued by a country with a national debt of $15 trillion) are among those ‘safe havens’ is a sign of just how far down the rabbit hole we have fallen. In the short term, the last true safe haven will see even its price, as expressed in unbacked paper money, oscillate uncomfortably. But given the perhaps existential severity of the global challenge, the one true money is now the only logical choice. And given the role of the banks as global plague-carriers, and politicians as their wing-men, it should offer particular comfort to investors that physical gold comes with zero counterparty or political risk.

This article was previously published at The price of everything

7 Comments

  • Paul Marks says:

    Bloomberg and CNBC are still pushing American government bonds as a good investment.

    Even though (even as I write this) the globel Central Banks (not just the Fed – but the Bank of England, the European Central Bank [and its pet the traitors at the Swiss Central Bank), and the Bank of Japan) are pushing out yet more Dollars – in an effort to prop up the stock markets.

    Even people with no training in Austrian economics (such as the financial journalist Neil Cavuto – who has often warned people that the stock market going up whenever more credit money is thrown at it, is an obvious scam) know all this is a scam – so the people at Bloomberg and CNBC (who go around saying buy American bonds and/or invest in the credit bubble stock market) may (or may not – it is a difficult legal matter) be leaving themselves open to future legal action.

    As they are clearly giving financial advice in bad faith. If it can be shown they make any financial gain for giving such dishonest investment advice……

    And it is “dishonest” (not just mistaken). No one (at least no one “in the trade”) can miss a 15 trillion Dollar debt – or a Federal Reserve that has inceased the monetary base by some 300% since 2007.

    It is just not POSSIBLE that they do not know.

  • joebhed says:

    This is a rather unique and interesting post.

    While stemming from the usual Austrian approach of how badly governments are at managing national, cum regional, money systems, it then tranverses the political ideology lines into the architecture of money.

    Isn’t it somewhat ironic that after a couple of hundred years of libertarian money-speak the author relies, not on Hulsmann, but on Chris Martenson as the gatekeeper of the knowledge that the REAL problem with the evolution of our financial crisis is the fact that this is a DEBT-BASED system of money?

    I find it so refreshing that the author resorts to this deeper recognition of the CAUSE of the crisis, because in fact, it ain’t just about fiat money, it’s about debt-money.

    However, may I offer that one should be drawn to an deeper examination, again, of the mechanics of debt-based money in order to have a full appreciation of its role in our demise.

    I have found none better than Dr. Bernd Senf of the Berlin School, here giving his first English-language lecture on “The Deeper Roots of the World Financial Crisis”
    http://blip.tv/file/4111596

    It’s only for those who give a shoot about what’s really down there in the foundation.

    Thanks again for this thoughtful post.

    • Toby Baxendale says:

      Evening Joebhed,

      Is not the fiat stuff debt money?

      The only money I see as having no debt now is things like gold sovereigns

      • joebhed says:

        G’day, Toby.
        Of course all modern fiat is debt-based.
        That is the problem.
        Chris Martenson is right about that.
        Perhaps only coins are non-debt based.

        My point is the NEED for a non-debt based system of money.
        An equity-based means of exchange.
        Issued through government payments for goods and services.
        With full-reserve banking.
        A permanent money system.
        Economic and financial stability.
        Order.

  • John Spiers says:

    Four Quarts of Sewage

    Well, who put in the sewage?

    When a bank robber has done his job, the banker and many depositors are chagrined. Who is happy? Why, the bank robber! But he must be very, very quiet, or he will be beset with outraged depositors and apoplectic bankers.

    To mix the metaphors, the problem with the quart of sewage in the gallon milk pail is there is a paper trail as to who deposited the sewage into the pail. Anglophone bankers in general and American in particular are the culprits. Sure German and Greek bankers alike fed at the trough, but they were educated in “banking” by the anglophone bankers, mostly at Goldman Sachs, if not the LSE. Bank robbers are a charismatic lot, and if they dominate banking, serious men find other work and the field is left to adoring clerks.

    The transaction tax, a threat to ruin the London exchange, is blackmail, which is usually the first threat a bank robber encounters as people figure out whodunnit. At some point the world will get around to Wall Street. Bank robbing bankers and their ganymede politicians (Barney Frank is slipping out of town) are subject to blackmail. Right now they can get us to pay.

    Along with the yeoman work of defining terms should come the herculean task of specific recommendations on how to manage the unwinding of the crisis. Since the economy involves everyone, recommendations for reform are desultory without a plan to sort out the present mess.

    The masses look to politics for relief, and we vote in “change” but only of dramatis personae, not policy. Presently the policy is “taxpayers will pay.” The false dilemma is taxpayers pay or the economic system crashes. The true alternatives are claw back and disgorgement instead of taxes and inflation. Yes, with claw back and disgorgement AN economic system will fail, the obnoxious present system, but not THE economic system, the 3 quarts of milk.

    Banker George Soros is profiting wildly at present on home loan financial shenanigans as he finances the homeless Occupy Wall Street crowd. He is betting that people believe they have no alternative, so on he goes. But there is an alternative. We can withdraw our consent to be governed. Mention that, and Cameron, Obama & Co warn that way lies Somalia! No, that way lies Hong Kong, where a trio of private companies issue the currency, as once was in these climes.

    Part of the project of reform must be a credible option to dismantle government. Once banking is defined and clarified, then also demonstrate how government need not be involved. If not, then nothing will change. If so, the political class will through a George Soros under the bus and ply free marketers with what we may want.

    John Spiers

  • john in cheshire says:

    To my mind, most if not all Western governments have been keeping us, the masses, quiet by giving us bread and circuses while they got on with the business of implementing their socialist experiments. We are where we are because of the socialisation of all power bases (public and private) in the so-called free world. The consequences of that are such things as the sub-prime mortgage affair and not vice versa. Am I wrong in thinking this?

  • Simone says:

    At this point, Keynesians and other economically retarded or wilfully ignorant financial onlookers typically have their eyes glaze over.

    Please, Tim (& The Cobden Centre more generally), don’t do this. This aggressive attitude towards dissenters has two effects:

    (i) To make these articles entirely useless for convincing those across economic lines of the article’s claim.

    (ii) To give a strong impression that these articles are merely for the titillation and gratification of those who agree with the Centre’s stance.

    I came to this site knowing I was indulging in a somewhat guilty pleasure; I knew I would find nothing to challenge my outlook. I thought, however, I might find some interesting and insightful analyses that I had not encountered before and had not occurred to me. Perhaps it would furnish me with some further arguments for my views.

    This sort of phrasing suggests that the site’s purpose is to provide gratification to the reader for their ‘correct’ views and to indulge in pleasurable groupthink. Perhaps to do this more than to use the tools of Austrian analysis to examine contemporary issues. Please don’t let this become the central motivator for the Centre.

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