* * * * * * * * * * * * REMINDER * * * * * * * * * * * * *
On the days that I don't publish, like today, you will
receive Bill Bonner's DAILY RECKONING. This will help you
to keep pace with the changes in the markets. Bonner and
I agree on most things in the field of economics, so the
two letters will reinforce each other.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * *
Gold and Economic Freedom
The Daily Reckoning
London, England
Wednesday, September 15, 2004
---------------------
*** Fed Chairman Greenspan contributes to Daily Reckoning!
*** The Gods laugh: Dick Cheney was born. Will the lumps
survive?
*** Volatility... Germany... China... faith... being
faithful and more!
---------------------
Don't ask. Don't tell.
The San Francisco Chronicle notes that neither candidate
has mentioned "the U.S. debt disaster."
No bigger threat faces the nation... except perhaps the
menace of ruining itself in military adventures.
And yet, in this great "nation of courage," none of the
leading politicians has had the gumption to say anything
about it. Faithless, gutless... they throw about empty
phrases and hollow promises, alternately flattering the
voters or bribing them, while cheating the next generation
and hoping no one will say anything.
Candidate Kerry has pledged that he will not cut Social
Security benefits. Yet the Social Security Board of
Trustees has come up with a new measure of the unfounded
"fiscal gap" between what the federal government can expect
to receive in revenues and what it has promised to pay. The
number - $72 trillion - comes to nearly seven times the
size of the nation's annual GDP and nearly 50% more than
the value of all the assets tucked away in every burg and
backwater in the entire country. In technical, accounting
terms... as the Great Mogambo might say... the whole
freakin' country is broke... busted... no bread... like
nuthin'...
But who cares? Who complains? Who worries?
Not us! We're buying gold every time the metal drops below
$400 and enjoying the show. Don't worry about us, dear
reader. We'll be all right.
But what about the poor lumpen? What about the poor
schmucks who actually take George Bush, Alan Greenspan,
John Kerry - or practically any other public figure - at
his word? What about the poor boobs who took the advice of
one Fed governor and bought a new SUV gas guzzler - just as
oil prices began to rise? What about the poor fellows who,
lured by Alan Greenspan's extraordinarily low lending
rates, went out and bought a bigger house than they could
actually afford? What about the million of ordinary
Americans who count on Social Security for retirement?
Laurence Kotlikoff figured that Social Security benefits
would have to be cut by 45% - "immediately and forever" -
in order to close the fiscal gap. What will the poor lumpen
do?
We don't know. But what troubles our sleep are the whispers
of the dead. "Watch out," they remind us. "Ruin the middle
class... and bad things will happen."
In America today, a curious and disgraceful conceit has
arisen. America is "good"... no matter what it does.
America will always be "good"... no matter what it does.
Good things will always happen to good nations.
"When America was created, the stars must have danced in
the sky," said Dick Cheney, full-time Vice President... and
occasional astronomer.
When Dick Cheney was created, the gods must have laughed...
for no sooner does a people come to believe that it enjoys
some special grace... some special dispensation from the
laws of Nature, Gravity, and Morality... then bad things
begin to happen.
"Germans are not bad people," the dead whisper. But when
bad things happen... few people have the courage to stand
against them. What set Germany off on its course toward
complete destruction in the 1930s was President Wilson's
disastrous conclusion to World War I, which humiliated and
bankrupted Germany... followed by the hyperinflation of the
1920s. The middle class was disillusioned by the war... and
then ruined by hyperinflation. The old verities - hard
work, saving, integrity, religious faith - were shaken...
and fell. Germans began to look for new verities. What they
found - the master race - was preposterous, but very
popular.
And now the news from Tom:
---------------------
Tom Dyson, from Charm City...
- "I really believe we have a disaster scenario in the
making," said a high-ranking economist in The New York
Times yesterday. "As soon as the markets see these
unsustainable levels of debt, the dollar could very well
crack."
Today's doomsayer is C. Fred Bergsten, the director of the
Institute for International Economics. His gloomy
prediction was prompted by the release of the latest
current account data.
Trade and capital flows between the United States and the
rest of the world reached a record deficit of $166.2
billion last quarter, according to the Commerce Department.
"This is a far larger share of GDP than we've had in the
past," said an economist at the Economic Policy Institute.
"This just can't go on."
Investors didn't care and pushed the Dow to a sneaky
3-point gain, closing out a fourth winning session at
10,318. The Nasdaq gained too, adding 5 points, to 1,915.
Meanwhile, gold continues to lurk. Yesterday, it climbed
$1.40, closing at $405.10. Today, it's back down again,
losing 50 cents.
The blame for such a large deficit can be laid squarely on
currency valuations, say economists. They say the dollar is
overvalued - particularly against currencies in the East -
and that encourages U.S. consumers to spend beyond their
means when they should be saving.
Here at The Daily Reckoning, we wouldn't argue with that
logic, and we'd agree that the dollar might be overvalued
relative to other international currencies - although if
you lived in the Midwest, you'd never know it. "Here, each
time we order breakfast, we get far more than we can eat at
a price that seems preposterously low. If the dollar is too
high, you can't tell it by food prices. Or by the price of
gasoline. Or just about anything else," wrote Bill last
month, from Farmington, N.M.
The Bush administration, reports The New York Times, has a
different explanation. They blame the rest of the world for
selling their wares too cheaply. "The Bush administration
interpreted the current account deficit as a sign that
other countries were lagging behind the United States and
needed to pump up their economies," says a government
spokesperson. "The deficit actually makes the country more
attractive to foreign investors." More attractive like a
swimsuit model with a beard...
The dollar seemed uninterested in the news, but then again,
why should it be? The dollar's floating rate should reflect
all the millions of routine transactions occurring every
day. An invoice arrives from South Korea for a batch of
clock radios, a Japanese exporter hedges the dollar
exchange rate on a shipment of new cars in transit to
Vancouver.
Showing little regard for politicians, economists or the
fundamental laws of gravity, this year the dollar has
strengthened, but not by much. Against the euro, the dollar
has gained about 5 cents, to 1.2152, its current level. And
in Japan, the dollar has gained almost 4 yen, from 107.5 at
year-end 2003 to its current level of 110.32.
We suspect hedge funds may have played a hand.
These days, the currency markets are extremely sensitive to
movements in the expected level of short-term interest
rates. Hedge funds entered the carry trade so
aggressively... the "Greenspan Put" offered them the keys
to a moneymaking machine: a carte blanche to buy long-dated
Treasurys covered through the leveraged sale of short-term
T-bills at a 300-basis point spread. The unwinding of this
transaction, it could be asserted, has more bearing on the
dollar than any other dynamic.
But that was last year. Making money in 2004 hasn't been
quite so simple. "After several years of rich pickings,
2004 has been an annus horribilis for many hedge funds
specializing in the currency market," begins an article in
the FT. "Many funds will have entered the year with
short-dollar positions in the belief that the greenback
would continue to slide in 2004. However, the dollar has
firmed since January."
"Hedge funds are getting chopped to pieces in the forex
markets," says another currency strategist.
---------------------
Bill Bonner, back in London:
*** "Did you notice that the volatility index hit a record
low," asked colleague Dan Denning. "You know what that
means. People have never before been so complacent. They're
sure that nothing much will happen."
Meanwhile, investors, speculators, homeowners, politicians,
consumers... all seem to be working overtime piling straws
on the poor camel's back. As long as the beast stands,
people believe they have nothing to fear. And the longer he
stands, the more sure they become.
But eventually, without warning... and when everyone has
stopped worrying about it - which is to say, when the
volatility index has hit a record - the creature's legs
buckle. In a second, he has collapsed. Where once he stood,
there is nothing but a cloud of dust.
"Yes, that's the problem," Dan continued. "It can happen so
fast... once you see it, it's too late to do anything about
it."
*** A reader comment, with "notes from a China tourist":
"Our first visit to China was in 1984. Even then, it was
clear to me that China was destined to become an economic
giant. The cities were still pretty dirty and pretty basic.
The people went to the market every morning and could be
seen carrying home a live chicken for dinner, because they
had no refrigeration.
"The milkman rode a three-wheeled bike with a flatbed on
which there were wooden cases with milk in 8 oz. bottles,
again because of no refrigeration. The public got around on
bicycles and buses. Medical facilities (the reason for our
visit) were basic, except for an occasional piece of
high-tech equipment, and the docs were pretty good and
trying to get better.
"Nanjing Road in Shanghai was a dirty, tree-lined
boulevard
lined by shops offering little or no merchandise for sale.
The arrival point at the airport in Shanghai was a
two-story block building into which one walked from the
plane, across the tarmac, to deal with the officials. The
bus ride downtown was through several miles of small
farms.
"Fast-forward to 2000. The Shanghai airport is as modern as
any in the United States. The little building from 1984 is
still there, but not in use. The road to town is an
expressway traversing a totally urban landscape all the way
to downtown.
"Nanjing Road is an elegant blocks-long pedestrian mall
lined by multistory stores offering merchandise competitive
in every way with any Western department stores, often the
Western merchandise itself, and the people are buying. In
contrast to 1984, when they usually had two outfits, one on
their backs and one in the laundry, they are well dressed.
"Not only do the Chinese now have refrigerators, they have
color TV, stereos, computers, and their apartments have air
conditioners hanging out of the windows. The old
Russian-built hotels have been beautifully updated. Cell
phones are visible everywhere. Cars have replaced bicycles,
resulting in horrendous traffic. A futuristic city has
risen across the river from the Bund in Shanghai, where
there was a swamp 16 years earlier.
"And the modern airport? It was closed two weeks after our
visit in 2000 to be replaced by a totally new facility in
another location.
"I don't think it is going to take anything like 40 years
for China's economy to draw even with ours, and then pass
us."
*** A reader comments on "faith":
"I do take issue with your belief that people of "faith"
also think everything is OK. In some conservative religious
circles, pastors and churchmen have been predicting the end
of the United States for quite some time, often with much
more negativity than is seen in this e-letter."
"In particular, some have pointed out that due to the
sinful nature of modern North America, a negative end is
virtually assured. A return to the 'gold standard' will
have no effect on this spiritual issue at all. In fact,
there is a hint in the Bible that near the end, gold may
actually become temporarily worthless (Isaiah 2:20).
"In reality, the minds of many (but not all) modern men
have become corrupted due to their sinful nature, and as a
result, God cannot bless them.
"Nor are they likely to make wise choices, especially with
their finances. Two Bible statements, one from the Old
Testament (Deut 28:15-68) and another from the New
Testament (Rom 1:18-32), seem to indicate that this (among
other things) will be one of the problems near the end.
*** And another on the faithful:
"I'm the guy who wrote you the alien comment several weeks
ago. Thanks for printing it - word for word - the world
needs to know... THEY'RE HERE!"
"Hey... the pastor who said you were negative all the time
and that things will eventually work out... well, I work at
a church... I'm the janitor and maintenance man... I know
all about how a pastor's mind works...
"How many times over the years, I would have liked to smash
his 'rose colored glasses' on the floor!
"Well... just wait... someday the American people are going
to find out the truth about this country's secret
programs... boy, will their faith be smashed to pieces.
"The USA already has the secrets to free abundant energy,
anti-gravity craft (which we are flying around now),
super-weapons (they will even shoot down alien UFOs, which
we have done several times already... the Russians have
these also) and possibly time travel! It's hard to believe,
isn't it? This country is spending $1.7 trillion per year
funding these super-secret programs. No wonder the
Treasury's printing presses are working around the clock.
"America's faith will evaporate when the truth comes out
someday!
"We better all go buy an assault weapon while the ban is
temporarily off. You should also buy a RPG weapon while
you're shopping around. Lots of ammo and food and clothing
and survival gear are also needed...
"Go bury it in the woods for safe keeping.
"An extremely dangerous world is about to unfold... "
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---------------------
The Daily Reckoning PRESENTS: Hard money week. Readers
maybe surprised when they see who wrote this essay. It's
about promoting gold as the key element of monetary
organization, written in 1966. This essay is taken from
"The Liberty Dollar Solution," edited by Bernard von
NotHaus.
*** Are you entertained by markets and mayhem? Do you
possess the rare ability to write well? Contact us.
[EMAIL PROTECTED]
GOLD AND ECONOMIC FREEDOM
by Alan Greenspan
Since the beginning of World War I, gold has been virtually
the sole international standard of exchange.
Gold, having both artistic and functional uses and being
relatively scarce, has always been considered a luxury
good. It is durable, portable, homogeneous, divisible and,
therefore, has significant advantages over all other media
of exchange.
But if all goods and services were to be paid for in gold,
large payments would be difficult to execute, and this
would tend to limit the extent of a society's division of
labor and specialization.
Thus, a logical extension of the creation of a medium of
exchange is the development of a banking system and credit
instruments (bank notes and deposits) that act as a
substitute for, but are convertible into, gold.
A free banking system based on gold is able to extend and
thus to create bank notes (currency) and deposits,
according to the production of the economy. Individual
owners of gold are induced, by payments of interest, to
deposit their gold in a bank (against which they can draw
checks).
But since it is rarely the case that all depositors want to
withdraw all their gold at the same time, the banker need
keep only a fraction of his total deposits in gold as
reserves. This enables the banker to loan out more than the
amount of his gold deposits (which means that he holds
claims to gold rather than gold as security for his
deposits). But the amount of loans which he can afford to
make is not arbitrary: He has to gauge it in relation to
his reserves and to the status of his investments.
When banks loan money to finance productive and profitable
endeavors, the loans are paid off rapidly and bank credit
continues to be generally available. But when the business
ventures financed by bank credit are less profitable and
slow to pay off, bankers soon find that their loans
outstanding are excessive relative to their gold reserves,
and they begin to curtail new lending, usually by charging
higher interest rates. This tends to restrict the financing
of new ventures and requires the existing borrowers to
improve their profitability before they can obtain credit
for further expansion.
Thus, under the gold standard, a free banking system stands
as the protector of an economy's stability and balanced
growth. When gold is accepted as the medium of exchange by
most or all nations, an unhampered free international gold
standard serves to foster a worldwide division of labor and
the broadest international trade. Even though the units of
exchange (the dollar, the pound, the franc, etc.) differ
from country to country, when all are defined in terms of
gold, the economies of the different countries act as one -
so long as there are no restraints on trade or on the
movement of capital.
Credit, interest rates and prices tend to follow similar
patterns in all countries. For example, if banks in one
country extend credit too liberally, interest rates in that
country will tend to fall, inducing depositors to shift
their gold to higher-interest-paying banks in other
countries. This will immediately cause a shortage of bank
reserves in the "easy money" country, inducing tighter
credit standards and a return to competitively higher
interest rates again.
A fully free banking system and fully consistent gold
standard have not as yet been achieved. But prior to World
War I, the banking system in the United States (and in most
of the world) was based on gold, and even though
governments intervened occasionally, banking was more free
than controlled. Periodically, as a result of overly rapid
credit expansion, banks became loaned up to the limit of
their gold reserves, interest rates rose sharply, new
credit was cut off and the economy went into a sharp, but
short-lived, recession. (Compared with the depressions of
1920 and 1932, the pre-World War I business declines were
mild indeed.)
It was limited gold reserves that stopped the unbalanced
expansions of business activity, before they could develop
into the post-World War I type of disaster. The
readjustment periods were short and the economies quickly
re-established a sound basis to resume expansion.
But the process of cure was misdiagnosed as the disease: if
shortage of bank reserves was causing a business decline -
argued economic interventionists - why not find a way of
supplying increased reserves to the banks so they never
need be short! If banks can continue to loan money
indefinitely - it was claimed - there need never be any
slumps in business. And so the Federal Reserve System was
organized in 1913. It consisted of 12 regional Federal
Reserve banks nominally owned by private bankers, but, in
fact, government sponsored, controlled and supported.
Credit extended by these banks is in practice (though not
legally) backed by the taxing power of the federal
government.
Technically, we remained on the gold standard; individuals
were still free to own gold, and gold continued to be used
as bank reserves. But now, in addition to gold, credit
extended by the Federal Reserve banks ("paper" reserves)
could serve as legal tender to pay depositors. When
business in the United States underwent a mild contraction
in 1927, the Federal Reserve created more paper reserves in
the hope of forestalling any possible bank reserve
shortage.
More disastrous, however, was the Federal Reserve's attempt
to assist Great Britain, who had been losing gold to us
because the Bank of England refused to allow interest rates
to rise when market forces dictated (it was politically
unpalatable). The reasoning of the authorities involved was
as follows: If the Federal Reserve pumped excessive paper
reserves into American banks, interest rates in the United
States would fall to a level comparable with those Great
Britain; this would act to stop Britain's gold loss and
avoid the political embarrassment of having to raise
interest rates.
The "Fed" succeeded: it stopped the gold loss, but it
nearly destroyed the economies of the world in the process.
The excess credit which the Fed pumped into the economy
spilled over into the stock market - triggering a fantastic
speculative boom. Belatedly, Federal Reserve officials
attempted to sop up the excess reserves and finally
succeeded in braking the boom. But it was too late: By 1929
the speculative imbalances had become so overwhelming that
the attempt precipitated a sharp retrenching and a
consequent demoralizing of business confidence.
As a result, the American economy collapsed. Great Britain
fared even worse, and rather than absorb the full
consequences of her previous folly, she abandoned the gold
standard completely in 1931, tearing asunder what remained
of the fabric of confidence and inducing a worldwide series
of bank failures. The world economies plunged into the
Great Depression of the 1930's.
In the absence of the gold standard, there is no way to
protect savings from confiscation through inflation. There
is no safe store of value. If there were, the government
would have to make its holding illegal, as was done in the
case of gold.
If everyone decided, for example, to convert all his bank
deposits to silver or copper or any other good, and
thereafter declined to accept checks as payment for goods,
bank deposits would lose their purchasing power and
government-created bank credit would be worthless as a
claim on goods. The financial policy of the welfare state
requires that there be no way for the owners of wealth to
protect themselves.
This is the shabby secret of the welfare statists' tirades
against gold. Deficit spending is simply a scheme for the
"hidden" confiscation of wealth. Gold stands in the way of
this insidious process. It stands as a protector of
property rights. If one grasps this, one has no difficulty
in understanding the statists' antagonism toward the gold
standard.
Regards,
Alan Greenspan
for The Daily Reckoning
Editor's Note: Alan Greenspan is chairman of the Federal
Reserve and conductor of the world's greatest experiment in
paper money.
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