Category Archives: Economy

Can Cyprus Happen Here?

Cyprus is a small island in far eastern part of the Mediterranean Sea many people know nothing about.  But the recent banking crisis in Cyprus has raised many eyebrows; not only in the Euro Zone but also in Russia and the United States.

The question is not so much what happened in Cyprus, but could what happen in Cyprus occur in the United States?  The answer will come, but first some background on the U.S. current monetary regime that started in 1971.

Global banking systems, whether in Europe, Japan, China, or the United States, are debt-based systems using fiat currencies.  In every case Central Banks control two critical money components; the printing of money and the cost of money.  Most Central Banks can simply print money at will and control the cost of money because they set the interest rates.  Based on current monetary policy across major Central Banks the major beneficiaries are governments and the banking sector.

The entire banking system creates an inherent conflict with those that created the system and the people.  Money (as we use the term today) is used as deposits by savers (asset to the saver and a liability to the bank) and debt is created when banks extend credit to borrowers (debts by the borrowers and assets to the banks).  This is how real people interact with the traditional banking system.

On the other hand, our Government borrows the difference between its expenses and its revenues.  In budgetary terms this is a deficit and deficits add to the national debt.  When government borrows it sell securities to buyers such as foreign governments, primary dealers, and direct and indirect bidders.

Once debt is incurred it becomes nominal because the price is reflected at the time of the transaction.  The debt isn’t adjusted for inflation.  In other words, if you incur a dollar of debt twenty years ago you only need a dollar to pay the debt, regardless of what that dollar may purchase today.  In real terms, for purchases made today, the dollar’s purchasing power is adjusted for inflation.  In real terms (purchasing power) the dollar buys fewer goods.  In nominal terms, a dollar pays off a dollar of debt.

This is an important distinction for many reasons.  Government funds its deficits by borrowing money through the sale of securities.  Those securities have different lengths of maturity (2 year, 7 year, 10 year, 30 year, etc.), and pay interest when redeemed.  If the government wants to run bigger deficits it simply sells more securities.  The result is a larger debt and an increase in interest payments.

The Federal Reserve receives dollars from the buyers of the Government’s securities, deposits those funds, and transfers them to the U.S. Treasury for the government to pay for its profligate spending.  As the U.S. debt increases and annual deficits expand into the trillions of dollars, buyers become concerned as the repayment risk increases.  Buyers may demand higher interest rates to continue buying our debt.  But if the Fed increases interest rates it also means the interest payments on the outstanding debt increase requiring a larger percentage of total government payments to service that debt.

This is where the Fed steps in and monetizes the debt.  The Federal Reserve is also a buyer of the securities it sells.  The Fed holds many auctions of different securities every month.  If one auction is $30 billion of 7 year notes at x % interest and the total buyers (excluding the Fed) only buy $20 billion of the debt, the Fed steps in and buys the $10 billion not otherwise sold.  The Federal Reserve buys it as a direct bidder (who is anonymous). And makes digital entries to transfer $10 billion to the U.S. Treasury and adds $10 billion onto the Federal Reserve’s balance sheet.  Ten billion dollars is now with the U.S. Treasury for the Government to “spend”.  This is how debt is monetized.

Interest rates have both advantages and disadvantages depending on your perspective.  If you are a net producer (a saver), someone living on fixed income like Social Security, etc. low interest rates are inimical to your interests.  After your expenses if you have excess earnings you are a net producer.  If you deposit your excess earnings into a savings account and earn < 1% interest there is no incentive to save (especially when inflation exceeds the interest rate you have real negative interest rates and lose money by depositing it in a savings account).

When Governments run deficits and accrue large national debts high interest rates are inimical to its interest because higher interest rates result in more debt service.  For a net producer, higher interest rates are good.  So, the interests of the government and the interests of a net producer are, for the most part, diametrically opposite.

Likewise, there are net consumers that spend more than they earn.  These people are borrowers who take on debt through credit expansion.  For these people, low interest rates are good.  In fact, we can be a net producer and take on debt (like a mortgage) where we’d prefer a low interest rate on our mortgage but a high interest rate on our savings.  The issue with low interest rates is they are often kept low not only because of government debt but because the Fed is trying to encourage economic activity through consumerism.  In other words, the Fed wants to discourage savings and encourage spending; including taking on more debt through credit expansion.

The Gross Domestic Product (GDP) is a nominal measurement of economic activity.  GDP can grow through real production of goods and services desired by people.  More importantly, GDP can grow through the expansion of the credit market and through inflation.  In other words, GDP can be manipulated higher by printing money even though real production of goods and services are stagnant or falling.

Likewise, increasing credit market debt also drives up GDP.  Credit is nothing more than making a future purchase today.  If you buy a good for $500 you can pay for it today with cash or you can pay for it later through credit.  Credit merely brings future purchases forward to today.  Likewise, for people it is future earnings that pay off this past purchases.  That’s not the case for government as you’ll see.

Below is a chart that overlays the total credit market debt outstanding, Gross Domestic Product, and the National Debt from 1971 through 2012.  I purposely picked 1971 as the starting point because that is when President Nixon broke the 1944 Bretton Woods agreement and removed the United States from the international gold standard which is the starting point of our current monetary regime.

TCMDO-GDP

On the Total Credit Market Debt Outstanding (TCMDO) series I’ve ticked off every doubling of the TCMDO.  From 1970 through 2007 the TCMDO has doubled 5 times which, on average, is roughly once every seven years.  Compare the rate of growth in the TCMDO to the growth rate of the GDP series where it is substantially lower.  So, by 2014-2015 we are due for another doubling of the TCMDO to achieve the same anemic GDP growth rates.  According to the TCMDO growth from 2008 to 2012 it has essentially flat-lined as credit market debt isn’t expanding anywhere near its historical rate.  This presents the Government and the Fed with a major dilemma.

On a side note, many people remember the late 1970s as a troubled economic time with high interest rates, high unemployment, and high inflation.  By 1980, the price of gold reached $200 an ounce.  In inflation adjusted dollars this would be $2400 today.  So, in 1980 gold was at an all-time high.  Private gold ownership became legal again in the 1970s and as inflation and other economic events were destroying the purchasing power of the currency people were buying gold.  But, something happened in 1980 to change that (no, not Reagan’s electoral victory).  Fiat currencies require confidence or else they implode.  By 1980, confidence in the dollar continued to erode and people were buying gold instead.  To stem the tide the Government created a new program called the 401K.  In my opinion, it was created precisely to restore confidence in the dollar and to ensure people would keep their savings denominated in the currency.  In return for contributing your excess savings into 401Ks (instead of gold or other non-dollar denominated assets) you didn’t have to pay taxes at that time.  It was sheer brilliance by the Government to restore confidence in the dollar.    But I digress.

Furthermore, from 1971 forward the trade imbalances began to widen.  If you look at the net balance of payments (net of imports and exports) the U.S. imports between $400 and $700 billion more then it exports.  This has widened ever since Nixon took us off the gold standard.  The primary reason is that gold acts as both a brake and spur when it comes to imports and exports.  Gold always flows in the opposite direction of goods.

Since, the U.S. was the de facto gold supplier under the Bretton Woods gold-exchange standard foreign banks that wanted gold had to exchange dollars for it.  Under that system if the import-export balance got out of kilter (more imports) then gold flowed out of the country.  In the U.S. gold peaked in the mid to late 1950s and then the supply began to shrink as the country imported more and more gold was exported.  By the late 1960s, it was apparent the U.S. wasn’t able to stop the outflow of gold and eventually would not be able to redeem dollars for gold.

If a country wanted to retain its gold it would change the balance of imports and exports or even reverse it so they exported more and imported gold in return.  Gold can act as a “brake” to stop the flow of gold out of the country and also act as a “spur” to start the flow of gold into the country.  Generally, as you increase your exports it is a result of productive growth of goods desired by others.  However, once the gold backing is removed there is nothing to stop or reverse the trade imbalance.  Thus, it follows that jobs get exported as well.  Because the imported manufactured goods were “cheap” it also resulted in a reduction of our domestic production capacity.  Therefore, jobs were lost to overseas manufacturers.  Most people fail to connect the current monetary regime (complete fiat currency without any gold backing) to the loss of productive jobs in the U.S.

It is no coincidence that government deficits ballooned starting in late 2008 through present day.  Deficit expansion allows government to borrow more money in an attempt to boost the economy because the credit market debt is failing to expand at its historical rate.  The Keynesian aggregate demand crowd at the Fed is attempting to stimulate the economy using low interest rates to fund government deficits and private sector credit market expansion.  The next set of bubbles are being inflated whether through sub-prime auto loans, government student loans, or the financial bubble being created in the traditional and shadow banking systems.  The Fed is hoping you will buy the latest gadget, finance a new car purchase, take on a student loan, or simply just use more credit to live beyond your means.

In the past five years the Government has bailed out banks through the Troubled Asset Relief Program (TARP), bailed out private companies like General Motors, passed a stimulus bill in 2009 which failed miserably and only stimulated the pockets of favored constituency groups, increased the annual federal deficit to over $1 trillion per year.

Meanwhile, the Federal Reserve has expanded its balance sheet to over $3 trillion, is purchasing $85 billion a month in mortgage backed securities, and expanded the monetary base (m0) from $800 billion in 2008 to $2.9 trillion today.  The Fed is providing Federal Reserve Notes to foreign central banks – especially Europe – to provide liquidity in their failed banking system.  The Fed also engages in repurchasing agreements with the primary dealers (i.e. Goldman Sachs, J.P. Morgan, etc.) where the primary dealer buys U.S. Securities from the Fed and then “repos” them back to the Fed for cash at a near zero interest rate.  The Fed holds the securities as collateral and the primary dealers use the cash for their own hedge fund and proprietary trading desks.

The government and the banking system are dependent upon one another.  The banking system needs the system to remain intact to continue to reap huge profits through the traditional banking system and fractional reserve banking while the government needs the Fed to set monetary policy in accordance with the Government’s best interest.  Their interests are inimical to the interest of Americans.  Naturally, politicians tell you otherwise, and claim to be against Wall Street and are looking out for all of us on Main Street.  Nothing could be further from the truth.

The traditional banking system is where net producers (savers) deposit their excess earnings and earn a “reasonable” rate of interest on those deposits.  Banks make loans using depositors’ funds to businesses and individuals.  Recall, the reserve requirement of 10% of deposits.  This allows the bank to lend out 90% of its deposits.  Not only once, but multiple times over under our system of fractional reserve banking.  One million dollars of deposits with a 10% reserve ratio can be re-lent up to $10 million.  If a bank has a $1 million dollar deposit it must reserve $100,000 and can loan $900,000.  The bank loans the $900,000 to someone else who then deposits that in the bank.  That $900,000 requires $90,000 to be held in reserve and now $810,000 can be loaned.  This process continues up to a maximum of the total deposits divided by the reserve ratio.

This is financial utopia to the bankers as they charge borrowers interest on the same money lent multiple times over creating a valid claim on money or the underlying asset for which the money was used (i.e. a mortgage is backed by the house itself).  Meanwhile, the bankers aren’t risking their own money they are risking the depositors’ money.

Too often people mistake fractional reserve banking for printing money out of thin air.  That is a misconception.  What this does is create valid claims on money.  The TCDMO of roughly $55 trillion are all valid claims on money.  This is in addition to the initial deposits made by the net producer (saver).  So, there is nearly $70 trillion of claims on $2.9 trillion of base money.

The process of contracting the fractional reserve system works the same way.  As contraction occurs debts come due (claims on money) and must be paid.  They are either paid and the system contracts or people default on their loans.  So, if you don’t pay your loan the bank seizes your asset (i.e. default on your mortgage and the bank now owns your home).  Bankers earn interest on loans or the underlying asset without risking a penny of their own money.

Why does this matter in relation to the question, can Cyprus happen here?

Two weeks before the Cyprus crisis European regulators gave a thumbs up to Cyprus banks.  Yet, in two short weeks the banking situation went from normal to a crisis.  Do you believe anyone in our Government would tell us if the banking system were to collapse?  Of course they would not.  Because, if they told you the system would collapse and your deposits were not secure it would cause mayhem and panic across the country.  Neither the Government nor the Fed can tell you the truth.

We know there are nearly $70 trillion of outstanding debt and only $2.9 trillion of base money.  All debts are valid claims on base money.  Let’s consider deposits at FDIC insured banks in the United States.  Today, there is roughly $8.9 trillion on deposit as FDIC insured banks.  The top 50 banks and bank holding companies account for roughly $5.5 trillion of that, with Bank of America as the largest with just over $1.2 trillion in deposits.

According to regulations all FDIC banks must keep a minimum reserve of 10% of deposits.  Therefore, there are $890 billion of reserves across all the FDIC banks with Bank of America having $120 billion of reserves.

Hypothetically, what if half the people wanted to withdraw their deposits from the Bank of America?  Half the deposits equate to $600 billion and Bank of America has only $120 billion in reserve.  Enter the Federal Deposit Insurance Corporation.  Most people believe their deposits are insured up to a specific limit under the FDIC.  As of 2011 the FDIC had $11 billion of deposit insurance on hand in the Combined Deposit Insurance Fund.  If Bank of America depositors asked for $600 billion of their deposits the FDIC couldn’t cover that.  In fact, if any major bank failed or there was a bank run, the FDIC couldn’t cover 1/100th of the demand.

The entire purpose of the FDIC was to create confidence in the banking system.  The FDIC Act became law in 1934.  In the preceding five years there were thousands of bank failures across the United States.  In 1933, Franklin Roosevelt removed the U.S. from the domestic gold standard, made gold ownership illegal, and debased the currency by forty percent.  The challenge facing the Government was how to create confidence in the banking system so people would leave their deposits in the banks.  The Government gave us the FDIC.

As you read this are you pondering whether your deposits are truly insured?  If not, you should be.  Under the law, once the FDIC uses its reserves ($11 billion) to cover a bank failure they can request no more than $30 billion from the U.S. Treasury.  Anything beyond $30 billion would require an act of Congress.  The other detail most people don’t know about the FDIC Act is it is the Government’s discretion on when you would receive your deposit money back.  That could be a week, a year, ten years, or fifty years.  Below is the applicable section of the FDIC Act governing the repayment of deposits:

(1)    IN GENERAL.–In case of the liquidation of, or other closing or  winding up of the affairs of, any insured depository institution, payment of the insured deposits in such institution shall be made by the Corporation as soon as possible [emphasis added], subject to the provisions of subsection (g), either by cash or by making available to each depositor a transferred deposit in a new insured depository institution in the same community or in another insured depository institution in an amount equal to the insured deposit of such depositor

So, are you deposits truly insured?  Not really.  The FDIC can absorb minor bank failures, but big bank failures would be cataclysmic.  This is why the Government coined the term Too Big To Fail (TBTF) and bailed out the banking system in 2008.

The moral hazard is no longer on the bank or the debt and equity holders of a large bank.  The TARP bailout shifted the burden onto the backs of hardworking American taxpayers.  The risk was socialized amongst the taxpayers while the rewards are privatized within the banking sector.  Financial institutions recognize they have little to no moral hazard incentivizes them to take more risk.  Once government removes moral hazard these financial institutions are free to operate however they please.  Ultimately, this has become Too Big Too Jail as financial institutions receive minor penalties for regulatory infractions and lawlessness.

Of course, the politicians claim they are doing this for the middle class and to save Main Street.  But the politicians are dependent upon these institutions for campaign donations and to keep the banking system going to ensure the politician is re-elected and retains power.  This is true of both Democrats and Republicans.

If a large bank were to fail the options are 1) taxpayers bail it out.  2)  the debt and equity holders bail it out.  3)  the depositors bail it out.   Number three was tried in Cyprus.  While depositors were rightfully outraged by the idea, a complete bank failure means a total loss of deposits.  In the U.S., through bank reserves and the FDIC perhaps 15% of all total deposits would be insured.

To reiterate, do you believe anyone in our government would tell us if the financial system was collapsing?  If the Government explained there is no way to repay the national debt and the only choices are to repudiate the debt or inflate it away would the Government tell us?   If Government was debasing the currency would they tell us?

The answer is a resounding no!

If the Government repudiated the debt it would result in immediate austerity.  Once the debt is repudiated, nobody would buy our debt and Government couldn’t fund its $1.2 trillion per year deficit.  All Government spending would be limited to revenues raised through taxation.  Government is deficit spending to help prop up the economy and that would be withdrawn immediately.  I do not believe the Government will repudiate the debt.

The other option is inflation.  Many people cannot grasp the idea that the outstanding debt will not be paid off with future earnings and revenues.  That’s mathematically impossible as future earnings/revenues are needed to pay for future spending – at least as much as possible.  Clearly, borrowing more money doesn’t pay off past debts.

Wrap your head around this concept.  The debt will be paid off by past earnings.  People pay off debts with future earnings.  Because Government deficit spends it can’t pay off past debts with future earnings/revenues it must use past earnings/revenues.  Those past earnings that net producers have saved/invested will be used to pay off the debt.  The decision comes down to whether the Government wants to tax/confiscate your deposits and/or 401Ks or whether they inflate it away.  One way or the other, or a combination of the two, Government will confiscate your wealth/property.  In Cyprus they talked about taxing depositors.  That could happen here.  More likely, 401Ks will be used in some fashion to pay the debt.  There’s been talk of this for years.

In lieu of or in addition to going after 401Ks that leaves inflation as the only means to retire the outstanding national debt.  In other words print more money and devalue the currency.  Inflation is not an economic event, it is a political event.  It is politically expedient for those in power to inflate away the debt to save the system then to make the difficult choices facing our country.  In the process the currency will be destroyed and everyone with any savings (traditional or in 401Ks) will witness their money become worthless.   Inflation will destroy deposits, 401Ks, money markets, and anything else denominated in the dollar.

But, a third possibility arises.  One that the people themselves will demand and will most likely ensure the politicians are revered as saviors.  An event such as a major bank failure, the threat of taxing deposits or 401Ks, etc. can cause enough panic that a bank run starts.  People will be unable to withdraw their deposits.  Hardships will ensue.   Those people receiving Government payments for food stamps, housing, social security, disability, etc. will also suffer as Government payments will stop flowing.  The people will scream, if not beg the government to ensure they receive their deposits and their Government checks.  This is all the motivation needed to print tens of trillions of dollars of paper money.  Many more “cheaper” dollars used to pay off the debt (remember debt is nominal) and the destruction of the currency in the process.  Of course, the $100,000 you have in a 401K might by ten loaves of bread.

The decisions will be whether to save the system and sacrifice the currency (or vice versa) and to save the government and sacrifice the individual.  Government will choose to save the system and save themselves.

In his farewell address President Andrew Jackson said, “We are not left to conjecture how the moneyed power, thus organized and with such a weapon in its hands, would be likely to use it. The distress and alarm which pervaded and agitated the whole country when the Bank of the United States waged war upon the people in order to compel them to submit to its demands can not yet be forgotten. The ruthless and unsparing temper with which whole cities and communities were oppressed, individuals impoverished and ruined, and a scene of cheerful prosperity suddenly changed into one of gloom and despondency ought to be indelibly impressed on the memory of the people of the United States.

If such was its power in a time of peace, what would it not have been in a season of war, with an enemy at your doors? No nation but the freemen of the United States could have come out victorious from such a contest; yet, if you had not conquered, the Government would have passed from the hands of the many to the hands of the few, and this organized money power from its secret conclave would have dictated the choice of your highest officers and compelled you to make peace or war, as best suited their own wishes.”

The outcome is inevitable.  In fact, it’s a mathematical certainty.

In my opinion, the Government and the Federal Reserve have known for several decades that the current monetary regime that started in 1971 under Nixon was doomed to fail.  It was never a question of if it would fail, just a question of when it would fail.  I believe they are managing the collapse of the monetary regime to avoid the social unrest that will come along with a collapse.  At some point in the future a new monetary system will begin.  What triggers the beginning of that final step and how long the transition takes is unknown.  What is on the other side is unknown.

Hopefully this provides some perspective around recent events and those events starting nearly forty years ago.  I believe it explains many actions our Government and the Fed have taken over the years.  I believe the Government and the Fed know the dollar is in the winter of its demise and a new monetary regime is forthcoming.  I believe they know the current system is unsustainable, and by its very definition what is unsustainable must end.  The only question is when.

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2013 Economic Perspective

Once again fiscal cliff issues are the topic du jour in Washington D.C.  Since President Obama took office in 2009, Congress has not passed a budget.  Instead, a series of continuing resolutions were passed to fund the federal government to avert a government shutdown.  What can we expect in 2013?

Before I answer the question let’s examine recent economic, fiscal, and monetary history.  To properly understand this data it is imperative that you cast aside the narrative espoused by government and the main stream media and look at the facts.

Indicator FY ending Sep 30, 2008 Today (or FY ending Sep 30, 2012)
Outstanding Debt 10.9 trillion 16.5 trillion
2008 budget deficit 459 billion 1.327 trillion (FY ending 2012)
Federal Expenses 2.982 trillion 3.796 trillion (FY ending 2012)
Federal Revenues 2.523 trillion 2.469 trillion (FY ending 2012)
Entitlement Programs + Debt Interest 1.863 trillion 2.569 trillion (FY ending 2012)
Revenue/Expenses as % of GDP 17.7% / 21% 15.8% / 24.3% (FY ending 2012)
Debt to GDP ratio 76.6% 103%
Americans on Food Stamps ~27 million ~48 million
U.S. Household Debt ~13.4 trillion ~12.9 trillion
Labor Participation Rate 65.8% 63.6%
Fed Reserve Balance Sheet ~890 billion ~ 3.1 trillion
Fed Funds Interest Rate 1.81% .15%
10 Year Treasury Yield 3.85% 1.65% (FY ending 2012)
Base Money Supply (M0) ~1.1 trillion ~2.85 trillion
Money Supply (M2) ~7.7 trillion ~10.45 trillion
Total Credit Market Debt Owed ~51.7 trillion ~56.3 trillion
Gold Price ~875 ounce ~1580 ounce
Gasoline Price ~1.85 gallon ~3.73 gallon

Fiscal and Monetary Policy

The $800 billion stimulus passed shortly after President Obama was sworn into office in 2009.  Many consider this a singular event.  However, the stimulus funding was rolled into the baseline expenditures. In effect, there have been five stimulus programs totaling $4 trillion dollars since 2009.

Undoubtedly, $4 trillion of additional spending and nearly $6 trillion of additional debt has achieved absolutely nothing unless the objective is dependency on the federal government.

Fiscal policies created multi-year trillion dollar deficits that result in poor Federal Reserve monetary policies.  The Federal Reserve has been through several quantitative easing periods where the Fed is buying the government’s debt, purchasing mortgage-backed securities, executing repo transactions with the primary dealers, and funding foreign central banks.  The base money supplied has nearly tripled since President Obama took office in 2009.

To minimize interest payments on the debt, the Federal Reserve is pursuing a zero-interest rate policy (ZIRP) which sets interest rates artificially low.  This policy punishes savers and retirees living on fixed income while supposedly stimulating consumerism by expanding credit market debt.  Eventually, the debt buyers will demand higher interest rates to continue buying U.S. Securities.  If interest rates return to historical averages of roughly 5%, then the interest payments on the outstanding debt will increase from $275 billion to nearly $1 trillion per year.

As the money supply expands and the currency is debased the government can pay off the debt with cheaper dollars.  However, the government’s interests are inimical to our interests.  Cheaper dollars means a loss of purchasing power.  In the real world it requires more dollars to purchase the same goods and services.  Moreover, those that are able to save are penalized due to low interest rates.  The real interest rate (interest rate – real inflation) is negative.  By putting excess earnings into a savings account, certificate of deposit, or money market account your principle is eroded due to the Fed’s ZIRP policy.

Tax Policy

As of 2013, tax rates have increased on the so-called wealthy and the payroll tax deduction has reverted back to its historical 6.2%.  In addition, new taxes under the Affordable Care Act take effect this year.  Taxing and spending are the two policy issues that receive the most attention by voters.  This is an area where politicians lie, deceive, cajole, evade, and manipulate on a routine basis.

The simple truth is most of the tax burden is paid by the top 10% of earners.  In fact, the top 3% of earners pay 52% of individual income taxes.  We have a heavily progressive tax system that would make Karl Marx proud.

The Internal Revenue Service published Publication 1304 – Individual Income Tax Returns 2008. The data is summarized below:

AGI Range

# Returns Filed

AGI Total (Thousands)

Total Tax Paid  (Thousands)

Per Filer AGI

Per Filer Tax Paid

Percent of AGI

Percent of Tax Burden

>= 1 million

321,294

1,076,046,308

249,019,686

3,349,102

775,052

13.02

24.1

200K –999.9K

4,054,365

1,385,961,656

287,598,531

341,844

70,936

16.77

27.9

100K – 199.9K

13,851,341

1,845,103,256

232,270,420

133,208

16,769

22.33

22.5

50K – 99.9K

30,925,946

2,193,691,414

184,553,934

70,934

5,968

26.55

17.9

1 – 49.9K

93,297,623

1,762,057,537

78,138,354

18,886

838

21.33

7.6

Total 142,450,569

8,262,860,171

1,031,580,925

*AGI – Adjusted Gross Income

  • A mere 2/10ths of one percent of tax returns filed had an AGI > $1 million. Yet, 24.1% of the entire tax burden is paid by this group.
  • Those filers with an AGI > $200,000 represent 3% of all tax returns filed.  Yet, 52% of the entire tax burden is paid by the top two groups.
  • Compare the top bracket with the bottom bracket and you’ll find the per filer AGI ratio from the top to bottom bracket is 177 to 1.  A filer in the top bracket has an AGI 177 times that of the lowest bracket.  However, the per filer tax paid ratio between the two brackets is 936 to 1.  A filer in the top brackets pays 936 times that of the lowest bracket.
  • 47% of all income tax returns filed had no tax liability.  That is 67 million income tax returns filed that paid nothing in federal individual income taxes.

Employment, Inflation, and Household Income

In further support of the narrative, the government publishes misleading and inaccurate data regarding employment, inflation, and wages.  Unemployment figures are manipulated by two factors; the magical disappearance of people from the work force, and adjustments performed by the Bureau of Labor and Statistics.

If we examine the participation rate for the twenty year period of 1989 through 2008 the average participation rate is 66.52%.  From 2009 through 2013 the average participation rate is 64.4%.  As of the latest BLS unemployment report the participation rate is 63.5%.  We would reach full employment once the participation rate drops to 58% though tens of millions more people would be unemployed.  The last time the participation rate was 63.5% was June 1979.

Year Civilian Work Force Not in Labor Force Employed Participation Rate U3 Rate U6 Rate U3 RateUsing 20Year Avg
1989 186,393,000 62,523,000 117,342,000 66.5% 5.3% 5.3%
1994 196,814,000 65,758,000 123,060,000 66.6% 6.1% 10.9% 6.1%
1999 207,753,000 68,385,000 133,488,000 67.1% 4.2% 7.4% 4.25%
2004 223,357,000 75,956,000 139,252,000 66.0% 5.5% 9.6% 6.32%
2009 235,801,000 81,659,000 139,877,000 65.4% 9.3% 16.2% 11.38%
2013 244,828,000 89,304,000 155,524,000 63.5% 7.7% 15.2% 12.45%

Source – Department of Bureau and Labor Statistics, Non-Seasonally Adjusted employment status.  U3 is the publicly released unemployment rate which doesn’t count under-employed workers or workers discouraged from looking for employment.  In 1994, under the Clinton administration the official unemployment rate (u3) no longer included discouraged workers.

The second issue with the unemployment rate is the adjustments made by BLS.  BLS makes two adjustments; the birth/death rate adjustment and seasonal adjustments.  We’ll examine the July 2012 unemployment figures (as this was done during the election cycle for political purposes).  The July report headline number (preliminary) was 163,000 jobs added on expectations of 100,000 jobs.  In addition 155,000 people left the work force as well.  The June 2012 report was revised lower from 88,000 to 64,000 jobs added.   The July report includes the two adjustments I mentioned.  The seasonal adjustment applied by the BLS was +377,000 jobs.  The birth/death rate adjustment was +52,000.  Compared to July of the previous year the birth/death rate adjustment was a mere 5,000.  So, there was a 1000% increase in the birth/death rate adjustment year over year.  The total adjustments by the BLS totaled 429,000 jobs.  If you subtract 429,000 from the 163,000 jobs added it results in a decline of 266,000 jobs.  But this fact isn’t reported by the government, the main stream media, or most of the alternative news sources.

An alternative source for real unemployment and real inflation data is John Williams’ website www.shadowstats.com.  According to Williams the real unemployment rate is actually closer to 22%.  His most recent chart is included below:

unemployment-rates

The other item heavily manipulated by the government is the inflation rate.  We know this as the Consumer Price Index (CPI).  The headline CPI number published is referred to as the CPI-U (Urban Consumer).  The term “core” inflation is often used which excludes changes to both food and energy.  The term core inflation is an illusion because we all need food and energy.  Government bureaucrats invented the term to managed inflation perceptions.

Over the past 30 years the CPI calculation has changed dramatically.  The calculation used during the Carter and Reagan years is more robust and accurate than the calculations used since Clinton took office.  Traditionally, inflation measured the cost of maintaining a certain standard of living.  A fixed basket of goods with stable weighting was used to measure the price differences month over month, and year over year.

In the early 1990s, the CPI calculation was changed because inflation was rising.  One impact of rising inflation was the impact to Social Security payments.  By law, social security increases were tied to inflation rates (known as COLAs or cost of living adjustments).   If SS payments increased according to real inflation rates SS would become bankrupt sooner rather than later (not to mention under Clinton SS payments became taxable income).  In other words, this was a political maneuver to cut Social Security without having to actual say your cutting Social Security.

To address this, the CPI methodology was changed to a cost of satisfaction measurement rather than a cost of living measurement.  The Clinton administration revised the calculation to change the basket of goods and to change the weighting of the basket of goods as well.  The result was a lower CPI rate. Further revisions have occurred since then and the gap between the 1980 CPI calculation and the current CPI calculation has widened significantly.  The aggregate impact of the methodological change is 5.1%[i].  Below is the CPI chart since 1980 using official BLS numbers and using the 1980 calculation.  The most significant divergences between the “old” and the “new” methodology begin in the early 1990s.

inflation-rates

I have two final points on inflation.  First, the effects of the Affordable Care Act on inflation are just beginning.  I anticipate the ACA will drive up health care costs and inflation.  Secondly, inflation will occur due to a loss of purchasing power due to currency debasement.

What does all this mean for household income?  Using 2011 constant dollars as the basis of comparison, real wages in 1961 averaged just over $49,000 per person.  By 2011, real wages averaged just over $47,000 per person.  In 2011 constant dollars there has been a $2,000 decline in real wages over a fifty year period.

According to Sentier Research, in January of 2009, the median annual household income was $54,962.  In June of 2012, the median annual household income was, again, $50,945.  The rising cost of food also hits middle-class families directly in the pocketbook.  According to the U.S. Department of Agriculture’s Center for Nutrition Policy and Promotion’s most recent data (June 2012), for the moderate-cost food plan for a family of four, the average cost per week is $236.60.

From 2009 to 2012 the median annual household income decreased by 7.3%.  The annual food cost is $12,303.  In the average family let’s assume both people work and each drives 20,000 miles per year.  Assuming an average of 20 miles per gallon for both vehicles and the current gas price average of $3.65 per gallon the average family spends $7,300 annually on gasoline.  Combined the family spends $19,603 on food and gas.  That represents 38.5% of the gross household income.

Let’s assume the family has no federal, state, or local tax liability, but they do have Social Security and Medicare taxes withheld from their paychecks.  At 7.65% the family pays $3,897 in taxes.  Added to the food and gas costs the family has spent $23,500 on these items.  That is 46% of the family’s gross income[ii].

The graph below (published on shadowstats.com) but from Sentier Research shows the decline in real household income since 2000.

What to expect in 2013

The two things we can count on from the federal government are; they will continue to assault your rights and your wallet.  Regardless of the Republican and Democrat composition in the House and the Senate an agreement cannot be reached on balancing the federal budget, cutting spending, reforming entitlements, or raising/cutting taxes.  The debt ceiling is raised routinely.  The sequestration process was supposed to reduce future spending by roughly $88 billion per year or 2.37% of federal expenses.  A simple cut in future spending cannot be agreed upon without the typical demagoguery, name calling, and threats.

Congressman Paul Ryan has prepared a 91 page budget that reduces future spending to a 3.4% rate per year, and includes entitlement reform and replacing Obamacare.  The plan balances the budget in ten years.  Ryan’s budget is D.O.A.  The Senate won’t consider it and the President will declare it dead on arrival.  While Obama is in office there is no chance Obamacare will be replaced.  The house recently passed a continuing resolution that included funding for Obamacare.  I suspect any budget passed by the House will not pass the Senate and signed into law by the President.

I will give Congressman Ryan credit for pointing out what should be obvious to anyone with an IQ north of 80.  We have a fundamental spending problem!  Charts in Ryan’s presentation show that federal debt as a percentage of GDP will reach 250% by 2040.  Spending on social security, medicare, health care, and net interest will be 30% of GDP by 2040 on revenues of roughly 18% of GDP.  Moreover, Ryan’s plan calls for a major simplification of the tax code including the elimination of the Alternative Minimum Tax (AMT), two tax brackets, and a lower corporate tax rate amongst other things.  While positive it is a small step in the long journey to reform government.

Given the recent history, I expect 2013 to look eerily similar to 2012.  The federal deficit for FY 2013 will exceed $1 trillion.  The outstanding debt at the end of FY 2013 will exceed $17 trillion.  The participation rate in the employment markets will remain around 63.6% or decline slightly.  The Fed will continue their ZIRP, expand their balance sheet to nearly $4 trillion, expand the money supply, and buy more debt and mortgage-backed securities.  I anticipate real wages will remain stagnate or continue on a downward trajectory.

Sadly, but predictably, the narrative that we are in an economic recovery will continue.  The stock market at all-time highs provides the illusion of a recovery.  While people may feel better because of nominal gains in the stock market, corporations are reaping benefits of cheaper dollars and the Fed’s push for more consumerism through credit market debt to pump up the economy and the stock market.  Consider, Zimbabwe had one of the best total stock market returns over the past ten years, yet with those gains you could barely purchase a dozen eggs.  Most stock market gains are in 401Ks that are untouchable except for retirees.   Stock market gains do not create real wealth and prosperity.  The increase in the production of goods and services creates wage growth and real wealth and prosperity.

In the not too distant future, expect to hear more talk and perhaps congressional action around private 401K accounts.  Eventually, Congress will act to require a certain percentage of 401Ks be invested in U.S. securities.  Today, there is nearly $19 trillion in 401Ks.  I believe it’s only a matter of time before Congress acts to tap into this source of “revenue”.  This notion isn’t all that unrealistic given that the EU, ECB, and other powers in Europe are attempting to tax bank deposits as a means of bailing out to-big-to-fail banks.  Just two weeks ago, there was absolutely no indication of a crisis in Cyprus.  But, given how the EU is handling this situation it is a clear case where they’ll do anything to save the system at the expense of the saver.

Do you think this could happen in the U.S.?  Before you answer, consider there are roughly $8 trillion of deposits in U.S. banks insured by the FDIC.  Now, does FDIC insurance mean your deposits are secure?  The Deposit Insurance Fund (DIF) balance as of Dec 31, 2011 was $11.8 billion.  It doesn’t take a genius to figure out there isn’t enough FDIC insurance to ensure all these deposits.  By law, the FDIC can borrow up to $30 billion from the U.S. Treasury to cover additional loses.  Anything beyond $30 billion requires an act of Congress.  Moreover, the FDIC Act explicitly states that it is up to the FDIC to decide when you are reimbursed for your deposits.  This could mean weeks, months, years, or decades.  After the EU announced plans to tax deposits bank runs started.  The government immediately shut down all the banks.  They call this a bank holiday.  If any run on banks occurs in the U.S. expect the same reaction.

Most of what will occur in 2013 will be political posturing and preparing for the 2014 elections.  I don’t expect any substantive changes to current policies this year.  In other words, expect more of the status quo from Washington.  I wish I could be more optimistic, but experience has demonstrated Washington is broke and broken.

The global economy and financial condition of certain countries is important to monitor.  Geo-political events are difficult to predict.  The economies of Japan, Italy, Spain, Greece, and France must be watched closely.  The situation in the European Union (EU) is unstable and the future of the Euro and the EU are still unsettled.  Of course, the Middle East remains a powder keg with the situation in Syria and Egypt, and the issues/concerns around a nuclear capable Iran.  A wild-card like North Korea with its recent rhetoric regarding nuclear strikes and the tension between China and Japan is also building.  Needless to say, much is happening on the world stage that could impact us at home.

In closing, we must recognize the U.S. is on an unsustainable path.  By its very definition what is unsustainable must end.   Without any real monetary and fiscal policy changes the only questions are when and how.  Given our experience with the people in Washington the past couple/few decades is it possible for any real change to occur in a timely manner to avoid financial calamity.

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Pop Goes the Debt and Currency Weasel

The entire global monetary system is a debt based system.  The aggregate debt of all countries is roughly $220 trillion and that doesn’t include state and local governments nor does it include unfunded liabilities.  Global GDP stands at $62 trillion.  The global debt to global GDP ratio is 355%.

Central banks continue to debase their currencies in a race to the bottom.  It’s not a race anyone wants to win, just a race where central banks one-up each other in the currency debasement race.  Future economic activity is brought forward through zero or negative interest rate policies intended to spur consumerism through credit expansion.  The Federal Reserve has announced multiple quantitative easing programs over the past three years including expanding the money supply from $800 billion at the end of 2008 to nearly $3 trillion today, the purchase of $40 billion a month in mortgage backed securities, and the swapping of long-term debt for short-term debt.  In fact, the Federal Reserve now owns over 90% of the long-term yield curve (bonds with 10 year maturities and longer).  This week the Federal Reserve announced QE4 and will be adding $85 billion per month to their balance sheet.  By the end of 2013 the Fed’s balance sheet will be at least $4 trillion.  That pales in comparison to the Japanese Central Bank’s balance sheet which stands at 156 trillion Yen.

Trillion dollar government deficits along with various so-called stimulus programs are used to increase economic activity.  Not unlike the depression era programs Franklin Roosevelt’s administration implemented, government intervention failed to produce the results central planners expected.  Shockingly, too many people believe we need more government spending and more intervention by the central planners.

The recession of the past four years has been compared by many to either the early 1980s or the great depression.  It is my assertion this is substantially different than prior recessions or depressions.  Since our founding the economy has experience three major resets, and arguably, four monetary regimes.  The major resets occurred in the 1840s, 1890s, and 1930s.  The four monetary regimes were the silver standard, the gold standard, the Fed Reserve era up until 1944, and finally the Bretton Woods era.  The post-Bretton Woods monetary system is the fifth monetary regime and, demonstrably, marked the beginning of the end for the dollar.

We are long overdue for the fourth reset.  But this reset will be unlike any of the others.   Today we have a fiat currency controlled by a central bank that can print without restraint.  Global debt and credit is the new monetary system backed by nothing of value.  Many countries have accumulated debt far exceeding their capacity to repay it through traditional means like taxation.  Moreover, the prior resets where all deflationary in nature.  The economy was purged of debt and misallocated resources, and any speculative bubbles were burst.

Today, the central planners promote the idea that deflation must be avoided at all costs.  Instead of a great purge, which allows the people to establish new bottoms to initiate the next cycle of economic prosperity, the central planners are doing the exact opposite.  They are creating an inflationary debt and currency bubble.  Debt is piled upon debt with no end in sight.  Goods and services are subsidized which results in the misallocation of resources towards government centric preferences.  Private companies are bailed out by unprincipled and morally bankrupt politicians and central planners.  Consequently, moral hazard is removed from the equation as rewards are privatized and risks are socialized.  The social risk means the people pay for the mistakes, poor decisions, and illegal acts of private companies.  Government is a facilitator and abettor to this global debt ridden, Ponzi entitlement, fiat currency scheme foisted upon the people.  Debt is purchased outright by the Federal Reserve and other Central Banks.  In fact, the Fed has been acting as the buyer of last resort for the past four years.  The final capitulation will come when the inflationary money bubble bursts.  Pop goes the debt based, worthless currency Weasel.  Then the fourth reset will occur.

Another difference most people do not recognize is that debt will not be paid off by future earnings.  Instead it will be purged by past earnings stored in the same currency as the debt.  Through a process of inflationary monetary policy decisions a large swath of past earnings will be diminished if not obliterated by inflation; the silent killer of wealth and prosperity.  A massive transfer of wealth will occur as a consequence of inflationary policies.  Since government only needs money in nominal terms to repay debt it is in the government’s interest to implement inflationary policies.  Government’s interests are inimical to our interests.  Those that live in the real world and operate on real terms will be punished severely as prices continue to rise, gradually at first, then suddenly when the final collapse is upon us.

Initially, equity markets generally react well to inflationary policies.  The past three years the U.S. stock markets have risen because of inflationary policies not because of sound financial fundamentals.  However, nominal gains due to stock markets rising will be meaningless because of currency debasement.  People may feel better or more secure because their 401Ks are rising when measured against the dollar.  But, the dollar’s purchasing power erodes those nominal gains and will be offset by larger loses in purchasing power.  In other words, you can feel good about being able to buy less.

Someone once quipped, “If history has taught us anything it is that history has taught us nothing”.  The Weimar Republic in the early 1920s is eerily similar to what we see today.   As Jens Parsson explained in his 1974 book Dying of Money: Lesson from the Great German and American Inflations.  “Monetary inflation invariably makes itself felt first in the capital markets, most conspicuously as a stock market boom. Prices of national product remain temporarily steady while stock prices rise and interest rates fall. This (is what) happened at the commencement of the German inflationary boom of the 1920… (then) velocity took an almost right-angle turn upward in the summer of 1922, and that signaled the beginning of the end.”[i]

As far as fiat currencies are concerned history doesn’t lie.  Every fiat currency in the history of mankind has ended in collapse.  A perfect one hundred percent record of collapse.  J.S. Kim wrote an article that discusses the history of currencies.  In that article Kim said, “though we have thousands of years of history to draw upon from which it is self-evident that money backed by nothing will always collapse and that granting monopolies on monetary creation always leads to tyranny, we seem not to be able to learn from prior tragedies and continue to yield despotic power to Central Banks and continue to accept fake immoral money as our primary means of conducting trade today.  For those of us that use the thousands of years of monetary history to extrapolate present day conclusions from past day events, we know that it is absolutely insane NOT to expect the US dollar, the Euro, and the Yen to eventually implode and collapse as long as we allow them to be backed by nothing.”[ii]

The world is moving away from the dollar as a reserve concurrency.  A new monetary system will eventually supplant the dollar as the reserve currency of the world.  Debts will be repudiated or paid off via massive currency debasement.  Undoubtedly, most people won’t care how the debt is handled, however they will care when prices rise exorbitantly and the stored wealth and purchasing earned over a lifetime is destroyed by the central planners and government.

I implore you to cast aside what you hear from the media or the DC’vers.  The fiscal cliff is propaganda to divert your attention from the real issues.  Their agenda and interests are very different from ours.  Avoid falling into the normalcy bias trap. You must think objectively.  You must question your premises and the premises of others.  Your beliefs, thoughts, and arguments must be grounded in principles.  Those principles include; truth, unalienable rights, individual rights, and the right to self-determination and self-governance.

Why is government needed?  What is the purpose of government?   The proper role of money in a political society, what money represents, and why should governments control the money supply?  You must understand the philosophic, historic, constitutional, and economic reasons to ensure you can explain these things to others and also apply them to current and future events.  The next reset will be unlike any others in our history.  While it will be painful and destructive in many ways it may provide the only opportunity to reorganize our political societies for decades.

_________________________________________

[i] Thunder Road Report December 2012 by Seymour Price

[ii] The Golden Gift by JS Kim

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Sustainability Dilemma

Advocates for more environmental laws and regulations also call for a reduction in world-wide population.  According to environmentalists all environmental calamities are theoretically caused by mankind.  Ozone layer depletion, global warming, sea level rises, melting ice caps, species extinction, and a myriad of other environmental issues are a consequence of man.

Terms or slogans like sustainable development are used to promote ideas such as green living conditions, poverty eradication, reduction and elimination of fossil fuels, etc.  Sustainable development also encompasses population control.  Programs around fertility and reproductive policies are developed with the intention of reducing the overall world-wide population.  These policies include birth control, abortion, and even sterilization and forced abortions.

These policies are turned into politically divisive issues around themes such as reproductive rights, women’s rights, and poverty eradication.  In linking poverty to over-population, environmentalists also link so-called reproductive rights and environmental calamities to over-population.  Consequently, the agenda to reduce world-wide population is inextricably tied to other causes then advanced by making them politically divisive.  All of this is wrapped into a tidy term called sustainable development.  While this may look pretty from afar, it is far from pretty.

For purposes of this discussion let’s assume the environmentalists are right about man being the cause of global warming and other environmental calamities.  Naturally, a reduction in world-wide population is justified because science has determined environmental problems are caused by mankind.   Advocates for sustainable development developed plans such as Agenda 21 which encompasses:

  • Agricultural and rural resource land use
  • Transportation and land use systems
  • Water, sewer, schools and other public facilities
  • Water and natural resources protection
  • Lands subject to climate change impacts
  • Economic development
  • Community design
  • Social equity, safety, and education
  • Housing and neighborhood revitalization
  • Sustainability of energy, food, and water

This is as invasive as it gets.  But Agenda 21 primarily addresses what can be done to regulate and control activities of the living.  Population control is the opposite, yet complimentary, approach as its goal is to reduce the number of living people on the Earth.  Ultimately, these two go hand in glove with one another.  The origins of Agenda 21 can been found in the 400 page report titled “Our Common Future” which can be read here.  This is one excerpt from the report:

Present rates of population growth cannot continue. They already compromise many governments’ abilities to provide education, health care, and food security for people, much less their abilities to raise living standards. This gap between numbers and resources is all the more compelling because so much of the population growth is concentrated in low-income countries, ecologically disadvantaged regions, and poor households.

This one statement intends to link population growth to poverty, therefore, if you eradicate poverty you can lower population.  In other words, programs such as sterilization, access to free abortions, and birth control are promulgated throughout the world, but especially in third world countries.  Politically, this is sold as a reproductive rights issue or as a humanitarian effort to eradicate poverty.  Ultimately, these are population control programs.

Environmentalists and population control advocates also support increased government social programs.  Those include programs such as government provided free education, health care services, and social security programs.  Those with alternative solutions are demonized as wanting to push granny over the cliff or trying to interfere with a woman’s right to kill her unborn child.

Programs such as Medicare and Social Security programs are vigorously defended by those supporting big government.  The intersection of interests is dynamic.  Those in support of Social Security and Medicare programs are the very same people supporting a woman’s right to choose and more stringent environmental regulations.

Medicare and Social Security are premised upon a Ponzi scheme requiring more people at the bottom to support those at the top.  In other words, more young workers are needed to pay into systems such as Medicare and Social Security to support those receiving benefits from those programs.

Paradoxically, those calling for sustainable development pursue an agenda to reduce the overall world-wide population out of one side of their mouth also call for the retention and expansion of social security and Medicare out of the other side of their mouth.  These two stalwarts of the leftist, progressive agenda are at odds with one another.  Ironically, one side wants to reduce the population while the other side requires the population to increase to ensure the survival of social security and Medicare.   Demonstrably, both social security and Medicare are unsustainable as there are nearly $200 trillion of unfunded liabilities.   If the leftist progressive agenda truly believes in sustainability then use their Alinsky-like tactics and apply the sustainability mantra to Social Security and Medicare.

The triangulation among environmental advocates, social program advocates, and government is a self-created intractable problem.   Two agendas, both centered on population, have diametrically opposing requirements and both agendas are dependent upon government for enforcement and compliance.

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The Era of Debasement

The era of our founders and framers created a society formed upon principles never before instituted in the history of mankind.  The era of our founding generation built a society based upon a bottom-up approach where the people are the sovereigns, the masters, and the government is the servant.  A society that was void of monarchs, aristocracies, or theocracies ruling over the people.

Modern society is a mere shadow of the founding era principles that reigned throughout the Union 200 years ago.  Modern society has degenerated into the Era of Debasement.   Society has debased its most cherished belongings including the Constitution, the currency, free markets, and unalienable rights.  The cumulative consequence is the debasement of society itself.  Modern society no longer represents freedom and liberty, the Rule of Law, or the unalienable right to exercise autonomous judgment and self-direction to preserve and improve one’s life.  Modern society more closely resembles feudal societies from Medieval Europe.

The Constitution

Constitutions matter, until they don’t.  The former Soviet Union had a comprehension Constitution yet people suffered greatly under tyrannical regimes.  A Constitution only matters if it is upheld and enforced.  Those that swear an oath to uphold the Constitution must be held accountable every time they violate it.  Unfortunately, the checks and balances placed in the Constitution to constrain federal usurpation of power are no longer enforced.  Thomas Jefferson said, “The two enemies of the people are criminals and government, so let us tie the second down with the chains of the Constitution so the second will not become the legalized version of the first.”  The chains have been replaced with wet noodles, and the latter have indeed become the criminals that are no longer prosecuted or held accountable.

For all intents and purposes the Constitutional is nothing more than mere parchment.  Whenever a statutory law, regulation, or rule is enacted that is in conflict with the Constitution, the Constitution is supposed to win.  The country has a miserable track record of enforcing the Constitution.  When the Constitution is enforced the government is compelled to live under the Rule of Law.  And, whenever the rule of law is violated we have lawlessness.   Modern society no longer lives by the Rule of Law instead society is based on the Rule of Man.  Consequently, the debasement of the Constitution results in the debasement of society.

Free Markets

Free markets are a natural extension of our unalienable right to contract and association.  Markets are created by the desires of individuals to exchange goods and services.  The adjective free denotes the voluntary act between two people to engage in an exchange for their mutual benefit.  Goods are produced so long as there are members of society desiring those goods.   On the whole society benefits as only those goods desired by society are produced.  Moreover, scarce resources are properly allocated to goods people want.  When people no longer desire a good that good is no longer produced and resources are reallocated accordingly.

Government intervention in free markets reduces or removes the concept of free from the market.  In other words, government intervention retards the natural demand for goods.  This happens in a variety of ways.  First, through taxation government removes capital from the economy and redirects it to government centric preferences.  Those preferences include paying for government itself.  However, in modern society capital is redirected to specific industries, companies, constituencies (such as unions, non-profit groups, etc.).  Government grants and subsidies also redirect capital according to government preferences.

Consequently, many industries are either supported or decimated by government.  Bank bailouts and the bail out of General Motors are examples where an industry or a specific government was resuscitated because of the government.  For a free market to function properly those providing goods and services must adapt to the demands of society.

Once the automobile was invented and society began to purchase automobiles instead of horse and buggies, the horse and buggy industry was severely reduced.   Would it make sense for horse and buggy producers to continue creating these goods if there was no demand for them?  Of course not!  It is natural for goods to disappear from the free market if there is no demand for them.

However, if government props up a business or industry, it results in the misallocation of scarce resources and retards the normal function of a free market.  If the government bailed out the horse and buggy business and continued to subsidize it to keep it afloat how does that reflect the desires of those in society?  It does not!  It reflects the desires of government.

Secondly, and perhaps more importantly, government ignores price signals when it interferes in free markets.  Whenever government subsidies an industry or company, prices are manipulated.  In a free market prices are free to rise or fall depending on supply and demand.  An oversupply of a good may not clear at price x, but when the price falls to a point where there is demand for the product the goods will clear the market.  For instance, 10,000 Ferrari’s are produced every year and generally sold for $300,000.  However, if the supply was increased to 50,000 Ferrari’s and there wasn’t demand the Ferrari’s would go unsold.  Would Ferrari continue to produce (supply) that number of cars if the demand were 1/5th of the total production?  If they want to stay in business they would reduce supply.  But how does the market clear the overproduction?  The goods are cleared because prices fall to a point where additional demand is generated.  Perhaps the price to clear 40,000 additional Ferrari’s falls to $100,000 each.

As long as government is involved in free markets, markets cannot be free.  Markets are now government controlled markets and the market does not accommodate society’s demand for goods.  If the government were to intervene and subsidize the Ferrari business so the 40,000 additional Ferraris produced sell near the original price of $300,000 the government has manipulated the market.  Not only has government redirected scarce resources (capital, which it first has to take from the private sector) to subsidize Ferrari production, but it has artificially held prices higher.  In other words, government intervention caused prices to remain higher than they would in a free market.   So, society ends up paying higher prices and capital is wasted on a good that is not in demand by society.

Today’s markets are driven by growth in the global credit debt market.  That is, GDP growth is inextricably tied to credit expansion.  Credit expansion occurs through the fractional reserve banking system as well as monetary policy.  Interest rates are simply the cost of money over time, and the Fed controls interest rates.   The Fed holds interest rates near zero to spur consumer demand for more credit which in turn drives consumption.  As borrowers use credit money to buy homes, automobiles, or other goods it is supposed to increase economic activity which the government measures through the GDP.  It is not the production of real goods and services that drives GDP growth.  Instead it is the cheap credit money being lent to borrowers that is driving demand.  However, those debts must be repaid.

The following excerpt if from an article by Murray Rothbard on the price clearing mechanism.

If production is too large in relation to consumption, then obviously this is a problem of what is now called “market failure,” a failure which must be compensated by the intervention of government. Intervention would have to take one or both of the following forms: reduce production, or artificially stimulate consumption… Stimulating consumer demand has long been the particularly favored program of interventionists. Generally, this is done by the government and its central bank inflating the money supply and/or by the government incurring heavy deficits, its spending passing for a surrogate consumption. Indeed, government deficits would seem to be ideal for the overproduction/underconsumptionists. For if the problem is too much production and/or too little consumer spending, then the solution is to stimulate a lot of unproductive consumption, and who is better at that than government, which by its very nature is unproductive and even counterproductive?”

We do not need government to have a free market economy.  We need people that want to freely engage in economic transactions with one another.   Government subsidized industries and monetary policy are interventionist actions meant to manipulate what otherwise should be a free market.   In a free market, the people would determine the market bottoms and market tops.  The people would create equilibrium between supply and demand.  Only those goods and services desired by society would be produced; which implies an efficient allocation of scarce resources.

Government intervention in the economy debases free markets and society as a whole.  Free markets are the ultimate expression of decentralization where power is dispersed to the lowest possible level; the individual.

The Currency

A currency that is not backed by something of intrinsic value is a fiat currency.  The Federal Reserve Note has not been backed by anything of value since Roosevelt removed the U.S. from the domestic gold standard in 1933.  Internationally, the dollar served as a surrogate for gold until Nixon removed the U.S. from the international gold standard in 1971.  Before 1971, foreign central banks could exchange Federal Reserve Notes for gold.  In fact, the dollar was the only currency that could be exchanged for gold.

As I written many times, the value of the dollar today is worth 3 cents when compared to the value in 1913 when the Federal Reserve started.  The government controls the printing of our currency.  Which means the government can print money at will.  There are numerous ways the Fed manipulates the currency.  Deficits are funded by borrowing money.  The Treasury sells securities through the Fed and as a result takes in money.  The money is then used to fund deficits.  Eventually, the securities come due and the securities are redeemed for their principle plus interest.   More recently, the Fed has been buying securities outright.  Meaning the Fed buys the security.  It does this by printing money (electronic money).  Whenever the Fed prints money the base money supply expands which fuels the fractional reserve banking scheme.  When the money supply expands it results in more money chasing the same volume of goods and services; which results in higher prices.   This phenomenon is called inflation.

What this means to the consumer is the purchasing power of a dollar is decreased.  It also means any savings/wealth denominated in the currency is debased.   Whenever taxes are increased people understand this means less purchasing power because the government takes more money from everyone.  When the loss of purchasing power happens secretly and invisibly the people don’t understand why things cost more and why the items they bought a year ago cost more this year.   Naturally, people want to blame someone for their misfortune.  Politicians use this to their advantage.  To blame the rich, the private sector, banks, the one percent, or whoever is the bogeyman today.

What most people fail to realize is how the currency impacts their very existence.  In other words currency debasement is a debasement of your life.  The scarcest resource a human being has is time.  You have a limited quantity of time.  You use your labor over a period of time as a means of preservation.  Your labor is translated into currency which is then used to sustain life and to engage in free markets.   In other words when you devalue the currency you devalue a person’s life and the time they’ve labored to receive the currency as compensation.  An anonymous commenter wrote this on currency debasement:

“It’s a lot more than debasing trust, it’s debasing the most inherently limited commodity a human can have: time. Money is the translation of our labor over time into a common unit of exchange. When you destroy it, you are not just destroying paper or perception, you are devaluing the human beings themselves that rely upon it. There’s a word for when people are forced to labor and not compensated for it: slavery.”

Under chattel slavery people were property and whatever the slaves produced was taken by the slaveholder.  To rephrase, the people labored to produce a good or service which another took from them.  If a slave spent ten years working and the slaveholder takes all the slave produced what does the slave have to show for his labor?  Nothing!  Likewise, when you work for many years and the government confiscates your compensation (currency) through a process of inflation, the government has taken from you’re the very same thing the slaveholder has taken from the slave.  Without question slavery is immoral.  Just because the government passes laws – which are in conflict with the Constitution – and uses violence to ensure compliance doesn’t make the law moral.  Legality doesn’t imply morality.  And what is illegal to do privately is not magically legal because the government enacts a law that is used against the people to plunder their property.

If through the process of inflation the government can erode the value of your savings and wealth to by 50%, 80%, or 100% then the government has not only debased the currency, but government has debased your life and your life’s work.   More importantly, your scarcest resource – time — has been confiscated.   Consider this proposal.  If given the choice to work for 40 years and save enough money to retire and live another twenty years would you spend a lifetime doing that if you knew the government would confiscate your life’s savings the day you retire?  Would you work as hard?  Should the government have the power to destroy your life’s savings?  Was it worth your time to labor so hard for so long for that outcome?

Conclusion

We live in the Era of Debasement where nearly every aspect of daily life is controlled by an authoritarian government that uses institutionalized violence to enforce compliance.  The Constitution is mere parchment.  Free markets no longer exist.  The currency continues to be debased.  Our lives are of no consequence to the DC’vers.

The debasement of the Constitution leads to lawlessness.  Lawlessness begets more lawlessness.  The debasement of free markets leads to government mandates, dictates, rules, regulations, etc. to control the people and the markets according to government centric preferences; usually to meet some political or social outcome.  In fact it has reached the point where the government now mandates that you engaged in economic transactions against your will.  The currency is the lynchpin that ties our unalienable rights to life, liberty, and property together as currency is our compensation for our labor and, therefore, our rightful property.

Nobody, including the government, has an unalienable right to your labor. To believe someone else has an unalienable right to your labor is to condone slavery.

But, when government debases the currency, government debases our unalienable rights to life and liberty.  Because property rights are the implementation of those unalienable rights, we are the rightful owners of our property.  When government confiscates property through currency debasement (inflation) government believes it is the rightful owner of our property.  The government acts as though it is the master and the people are the slaves.  This is how society is transformed from liberty to tyranny.

These are the ingredients for the Debasement of Society.

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The Big Lie

A week ago the Federal Reserve announced an open-ended plan to purchase mortgage-backed securities (MBS) to the tune of $40 billion per month until the Fed is satisfied with the unemployment situation.  In some circles this is being called QE Infinity.  This should raise eyebrows everywhere as this is a backdoor bailout for those institutions carrying MBS on their books.  If the Fed is buying MBS from whom are they buying them? What does the purchase actually accomplish?

Primarily, large financial and lending institutions would be selling MBS to the Fed.  This includes Fannie and Freddie MAC, financial institutions such as Bank of America, Goldman Sachs, Citi Group, and JP Morgan.  The Fed’s purchases are another bailout as risky assets are transferred from the balance sheets of financial institutions to the Fed’s balance sheet.  The purchase socializes the risk of these assets because the people are now liable for them as they are now on the Fed’s balance sheet.  If this playbook seems familiar that’s because it was done in 2008 and 2009 through TARP.  The rewards are privatized and the risks are socialized.  Once again financial institutions continue to gamble money and when things go wrong the losses are transferred to the public.  There is no longer any concept of moral hazard as the Fed is back stopping everything.

Secondly, how does the Fed actually buy MBS?  They print money.  Actually, it is really the creation of electronic deposits as the financial institutions receive credits in their account as a result of the sale.  The purchases expand the base money supply as money is created out of thin air to purchase MBS.  More base money chasing the same supply of goods and services results in inflation.  Since Nov 2008 the base money supply has quadrupled from roughly $800 billion to nearly $3 trillion.  Now that Ben Bernanke has become the 4 trillion dollar man, expect inflation to accelerate.

Furthermore, the Fed has been engaged in a program called Operation Twist.  This program has been in place for nearly two years.  The program is designed to swap long-term bonds (10 and 30 year bonds) with shorter duration bonds (2, 3, 5, and 7 year bonds).  The good news is this doesn’t introduce new money into the money supply.  But it does require the Fed to purchase longer term bonds and then turn around and sell shorter term bonds with the goal of netting this out to zero.

But this is not a zero sum game.  First, the Fed has been buying all the long-term bonds for the past couple of years.  There aren’t other buyers.  Moreover, there isn’t much long-term debt remaining to be purchased as most of it has already been swapped with shorter duration bonds.  This means a substantial amount of short-term debt is coming due in the next two to seven years.  Though interest rates on short-term bonds are near zero the payments, including interest, will come due requiring more bond sales.  What happens if nobody shows up to the auction?

Today, the Fed is taking down nearly 60% of all the bond auctions.  The primary dealers (i.e. Goldman Sachs, JP Morgan, etc.) taking down a significant portion of the remaining 40%.  The primary dealers then engage in a “repo” transaction with the Fed where the bond is given to the Fed and cash flows to the primary dealers.  In turn, the primary dealers use this money for their own proprietary trading desks which make investments in financial products such as derivatives, mortgage-backed securities, credit default swaps, hedge funds, collateralized debt obligations,  etc.  Often these positions conflict with those of the financial institutions clients.  This happened during the housing bubble when financial institutions were shorting positions they were otherwise selling on the open markets to other investors.  And, when things go wrong, there is no moral hazard.  Again, the financial institutions privatize the rewards and the risks (i.e. losses) are socialized through program like TARP, and the open-ended Fed MBS purchase program.

The primary reason the Fed is monetizing assets such as mortgage-backed securities is because it has already bought up most, if not all, of the longer term bonds.  The illiquidity in the long-term bond market reduces the Feds ability to buy longer term bonds and replace them with short-term bond sales.

Consequently, it is the people who pay the price as there is more debt, higher inflation, and less purchasing power in the currency.  This all leads to the big lie.

The government is hiding the fact that the government is insolvent.  Bankrupt.  Government officials and the central planners at the Federal Reserve all know the system is insolvent.  To keep the system going the Fed needs U.S. credit market debt to double roughly every eight years (average time to double over the past 40 years).  GDP growth is driven primarily by consumerism.   The economy is 70% consumer spending rather than the production of real goods desired by others.  The consumer takes on debt as they go on vacation, buy homes they can’t afford, new cars, etc.  Government encourages this behavior because they understand that GDP growth is tied to consumer spending which in turn is driven by the credit market.  This chart, courtesy of Chris Martenson, illustrates credit market debt growth over the past 40 years.  What the chart shows is that the credit market is no longer expanding but moving sideways.

The central planners are hoping that people feel richer because of the Feds actions.  That people will begin to buy things on credit to expand the total outstanding credit market debt.  But this hasn’t happened over the past four years and the Fed’s latest move is one of desperation.  The Fed needs to create another bubble to drive up consumer credit demand.

Ultimately, buyers of short-term debt will begin to dry up as well.  The Fed, acting as buyer of last resort, will monetize all debt until the currency is destroyed all in the name of “saving the economy” or “trying to keep down unemployment”.   Every country in the history of mankind that has destroyed their currency has imploded, collapsed.  If the definition of insanity is doing the same thing over and over expecting different results, then the DC’vers and the central planners are insane.

The Zerohedge website provided the following tidbit from the Romney 47% speech.  Notice how this hasn’t been reported on:

“Romney:  [The] former head of Goldman Sachs, John Whitehead, was also the former head of the New York Federal Reserve.  And I met with him, and he said as soon as the Fed stops buying all the debt that we’re issuing – which they’ve been doing, the Fed’s buying like three-quarters of the debt that America issues.  He said, once that’s over, he said we’re going to have a failed Treasury auction, interest rates are going to have to go up.  We’re living in this borrowed fantasy world, where the government keeps on borrowing money.  You know, we borrow this extra trillion a year, we wonder who’s loaning us the trillion?  The Chinese aren’t loaning us anymore.  The Russians aren’t loaning it to us anymore.  So who’s giving us the trillion?  And the answer is we’re just making it up.  The Federal Reserve is just taking it and saying, “Here, we’re giving it.”  It’s just made up money, and this does not augur well for our economic future.  You know, some of these things are complex enough it’s not easy for people to understand, but your point of saying, bankruptcy usually concentrates the mind.”

In this speech Romney acknowledges the problem and explains what the Fed is doing.

But, the big lie is that government – including the current administration, the Federal Reserve, and even a Romney administration — refuse to address the problem.  They are all tied up in a self-created Gordian Knot.  There is not a single politician that would bring down the system on their watch.  Instead, it will be drawn out over a period of time until the entire system collapses.

So, the DC’vers use mystical words like sterilization, quantitative easing, and Operation Twist to hide the fact that they are simply printing money out of thin air.  They are destroying wealth and purchasing power in the process.   That means they are destroying the economy and our lives while protecting the system from collapse.

This is the big lie.  It is the granddaddy of lies.  The lie is so big and the consequences so immense our elected officials can’t even bring themselves to discuss it openly with the people.  Likewise, the people are presented with the facts cannot break free of their normalcy bias and recognize what is transpiring in front of them.

The greatest threat to most people is not some terrorist in the Middle East.  It is not a fellow traveller getting on an airplane.  The greatest threat resides in a ten square mile area called Washington D.C.  The DC’vers and the central planners at the Federal Reserve are our greatest threat.   Ironically, the Federal Reserve building happens to be located on Constitution Avenue.

There is nothing noble, honorable, truthful, or moral in what they are doing.  They are dishonest, ignoble, immoral, and unethical because they perpetrate the lie.  Undoubtedly, it is the people that will bear the burden of their depravity.   It is a heavy price to pay just to “get my guy” into office.

You can argue over the importance of tax rates, energy policy, and environmental overreach.  You can argue whether an Obama or Romney presidency will be better or worse in those regards.  It is irrelevant.  It is all a moot point until the issues with the monetary system and the currency are resolved.  People are focused on the crumbs on the floor while the entire house is crumbling around them.

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The Four Trillion Dollar Man

While U.S. embassies were under attack did you notice the key financial events of the week?  Across the pond, the German court ruled on the constitutionality of the European zone bailout funds.  Germany has been a barrier to open-ended bailout funds which are used to bailout bankrupt countries like Greece, Spain, and Italy.  The ruling was worded in a way that appears to provide some cover domestically for making Germany (which really means all Germans) joint and severally liable for the debts of other countries.

Would you go in joint and severally liable with your Uncle Joe knowing he is unable to manage his finances, balance his budget, and borrows money routinely?  This is precisely the position the German people are now in.  The Germans are on the hook for another country’s fiscal decisions.  While there is more to be seen regarding the consequences of this decision the camel’s nose is in the tent.  Germany wants more control over the fiscal policies of those countries it would bail out or a more powerful European Union with more authority.  If either of those fail to come to fruition it will be interesting to see whether the EU stays together or not.

Meanwhile, Ben Bernanke, the four trillion dollar man, announced an open-ended Fed program to purchase mortgage backed securities, continue Operation Twist, and ultimately expanded the Fed’s balance sheet to four trillion dollars by the end of next year.

The plan is to purchase $40 billion of mortgage backed securities every month.  This was an open-ended position announced by the Fed.  This may last one year, five years, or longer.  Operation Twist is the buying of longer dated bonds (i.e. 10yr, 30yr) and selling shorter dated bonds.  In other words buy $100 billion of 10 year bonds and sell $100 billion of 10 year bonds.  The Fed is already acting as the buyer of last resort as many auctions result in the Fed actually buying the securities being sold because no one else will buy them.

Alternatively, the primary dealers buy the securities and and repo them back to the Fed for cash.  The primary dealers then use the new found cash for hedge funds, their proprietary trading desks (which are often hedged positions against their client’s positions), derivative trading and other higher risk investments.   There is no longer any moral hazard as poor decisions don’t result in failure or bankruptcy.  Instead the government provides bail outs.  This is akin to a person gambling in a casino and choosing between one game with 2 to 1 odds vs. a game with 10 to 1 odds.  It is a risk/reward proposition.  If the person knows they’ll be bailed out if they lose their money why not take a shot at the game with the higher reward.

What does all this mean for the average citizen?

  • The continued debasement of the currency.  Which means the purchasing power of a federal reserve note will decrease.  Real goods and services will cost more.
  • Expect a rise in the price of precious metals.
  • Expect the price of crude oil to rise.  If you pay attention to oil and gold prices you’ll see they’ve been pegged to one another for many years.  If gold rises, oil rises and vice versa.
  • Commodity prices are at record high levels.  Especially corn.  As I covered in another article corn is not only used as feed for animals and food for people it is used in ethanol production.  Expect to see a renewed call for more ethanol as crude prices rise.
  • Expect an increase in worldwide starvation and deaths in third-world countries due to the increase use of corn in ethanol which means less food supplies worldwide.
  •  Expect more rhetoric from politicians claiming they are acting in your best interests.  To save the economy.  To stimulate the economy.
  • Expect more people to be on food stamps.
  • The Fed’s short dated bonds coming due over the next 1 to 4 years has increased substantially over the past couple years.  This will continue under the extended Operation Twist.  Which increases risk as the shorter dated bonds come due they must be paid with interest.  Mostly likely this will force the Fed to sell more short dated bonds.  But who will be doing the buying?

Today the Fed and the primary dealers are taking down significant portions of bond auctions.  There has been a significant decrease in debt purchases by countries like China and Japan.  Which begs the question that Treasury Secretary Tim Geithner once posed; What happens if nobody shows up to the auctions.

Sadly, we may all find out the answer in the coming years.

The current financial and monetary problem was created by the central planners and elected officials in Washington.  Fiscal policy drives up debt.  Borrowing drives up interest payments.  The Fed controls both the money supply and the cost of money (i.e. interest rates).  The arrogance and hubris of a few elitist academics is leading the country to ruin.  We the people do not need central planners controlling the money supply and the cost of money.  Moreover, we the people are forced to use their currency through unconstitutional legal tender laws.

Alternatively, we the people should determine the currency we want to use.  The people along with those willing to lend money should determine interest rates.  Ultimately, we the people should determine whether we control the money supply or the central planners control it.  While I’m not an advocate of a pegged gold standard at least under a gold standard the people control the money not the central planners.

As Ayn Rand famously quipped, “you can ignore reality, but you can’t ignore the consequences of ignoring reality.”  Well we can’t ignore the reality of the consequences of the current monetary system, fiscal policies, and a centralized authority that acts arbitrarily and capriciously.  It is our lives , liberty, and property that are at stake.  Our unalienable rights to freely chart our course in life, to freely choose how we employ our physical and intellectual abilities, and the right to keep what we produce – our property.

The stock markets may like easy money.  Politicians and central planners certainly like easy money.  But we continue to creep closer and closer to the fiscal cliff as we teeter back and forth like a see saw on a fulcrum before the tipping point arrives and the arrogant, self-righteous, sociopaths in Washington leads us all over the fiscal cliff.  The Great Depression will be a walk in the park compared to this.  This is the path we are on.  Slowing it down isn’t the answer.

A complete derailment is needed to restore fiscal and monetary sanity and constitutionally limited government.  To restore freedom and liberty to the people, the people cannot continue to act as lemmings and follow the herd wherever it leads.  Societies collapse.  Nations collapse.  Currencies collapse.  The road of history is littered with failures.

We are not too big to fail.  We are too big to succeed.  Too many see the country as invincible.  The country is not invincible, it is fragile.  It is being held together with chicken wire and string.  There are too few people willing to explain the truth to the American people.  There are too many people that are polarized by politics and ideology or simply cannot overcome their own normalcy bias to believe the truth.

The four trillion dollar man is working his magic, sprinkling his fairy dust everywhere hoping that things will magically improve.  He is ignoring reality.  We are going to have to live with those consequences.

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