The World of Wonders: Everybody Goes Nuts Together (part 2 about Monetary Magic)

Summary: We live in an age of wonders, in which things unforeseen or even unimagined become daily fare for the news, or remain unremarked. This is the 3rd chapter in this series, attempting to open your eyes to the amazing things taking place. Today we have the second half of a guest post by Nathan Lewis looking at the monetary madness that slowly infects the major nations, as we confuse the ability to print money with magic. Here he looks at the history of using monetary magic as an easy solution to a nation’s financial problems.

This is part 2 of Nathan Lewis’ essay; part one was Monetary Magic applied to cure America’s economic ills.

Enter into the Hall of the Center Banker. Prepare to see wonders. — Enter the Hall of Center Bankers & see the wonders!

Contents

Introduction
Everybody Goes Nuts Together
About the author
Leave a Comment!
For More Information
A Last Resort, if all else fails …

(1) Introduction

An amazing aspect of our age of wonders is how easily we have come to accept fantastic new developments as “the new normal” (the evocative phrase coined long ago by Alan Watt). The world’s major central banks — Bank of Japan, European Central Bank, Peoples Bank of China, and the Federal Reserve — have all, in different ways, taken measures beyond anything they imagined before 2000. People were shocked in 2002 when Bernanke explicitly said that:

… the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.

Now they put Bernanke’s words into action — indeed, going beyond that by guaranteeing much of the world’s banking system — but we’re no longer shocked. Rather the majority of economists and financiers has a confidence in the effectiveness of monetary policy — hence the enthusiasm about the coming recovery in late 2013 — and complacency about Central Banks ability to avoid the disasters of the past users of monetary magic.

Today Nathan Lewis takes us on a tour of past monetary follies, showing how people get the economic theory that justifies what they want to do. We are rationalizing animals.

(2) Everybody Goes Nuts Together

Excerpt from the Q4 2012 Letter of Kiku Partners
by Nathan Lewis
Part 2.

A trillion dollar platinum coin! Har har. One of the remarkable and recurring characteristics of episodes of government printing-press finance throughout history is that a broad swath of the population, including sophisticated intellectuals, begins to spout complete nonsense in favor of further money-printing. There have always been silly people, especially regarding economic topics, but sometimes these silly people rise to the forefront and find a large and enthusiastic following.

Today in the U.S., these are the proponents of “Modern Monetary Theory,” expressed in simpler terms by the extraordinary popularity of the “trillion dollar platinum coin” meme, especially among liberal-leaning commentators {see posts about it here}. It took the Huffington Post by storm for a few weeks {see the articles here}. The notion is really just plain old money-printing, with a diverting story involving legal loopholes and a shiny geegaw to make it all seem a little more interesting than it really is. However, these indications of popular sentiment also translate into political realities: with these articles burning up the Internet, Congressmen and Federal Reserve board members find it easier to go along with the popular flow than to fight the tide as a Ron Paul-like fire-and-brimstone prophet of monetary doom. Perhaps it all got to be a bit much even for Ron Paul, who retired recently.

This is fundamentally a political process, so it is helpful to see what people tend to do in these situations. Try this one:

Yet each of these issues [of money], great or small, was but as a drop of cold water to a parched throat. Although there was already a rise in prices which showed that the amount needed for circulation had been exceeded, the cry for “more circulating medium” was continued. The pressure for new issues became stronger and stronger. The … populace and the [liberal party] were especially loud in their demands for them; and, a few months later, … with few speeches, in a silence very ominous, a new issue was made of six hundred millions more;—less than nine months after the former great issue, with its solemn pledges to keep down the amount in circulation. With the exception of a few thoughtful men, the whole nation again sang paeans.

See the all-powerful Fed Chairman of Oz!

In this comparative ease of new issues is seen the action of a law in finance as certain as the working of a similar law in natural philosophy. If a material body fall from a height its velocity is accelerated, by a well-known law, in a constantly increasing ratio: so in issues of irredeemable currency, in obedience to the theories of a legislative body or of the people at large, there is a natural law of rapidly increasing emission and depreciation.

The first inflation bills were passed with great difficulty, after very sturdy resistance and by a majority of a few score out of nearly a thousand votes; but we observe now that new inflation measures were passed more and more easily and we shall have occasion to see the working of this same law in a more striking degree as this history develops itself.

During the various stages of this debate there cropped up a doctrine old and ominous. It was the same which appeared toward the end of the 19th century in the U.S. during what became known as the “greenback craze” {1868-1875; see Wikipedia} and the free “silver craze.” {late 19th C; see Wikipedia} In [this country] it had been refuted, a generation before … just as brilliantly as it was met … years later in the United States by James A. Garfield and his compeers. This was the doctrine that all currency, whether gold, paper, leather or any other material, derives its efficiency from the official stamp it bears, and that, this being the case, a government may relieve itself of its debts and make itself rich and prosperous simply by means of a printing press:— fundamentally the theory which underlay the later American doctrine of “fiat money.”

The passage was written in 1896. It is from Fiat Money Inflation in France: How It Came, What It Brought, and How It Ended by Andrew Dickson White. As for what it brought: it brought about the downfall of France’s ancien regime, and more specifically, the beheading of Louis XVI in 1793, four years after the money-printing began {printing the assigats; see Wikipedia}. How it ended: with Napoleon, who put France back on a gold standard system in 1803. He was so popular, as a result, that when he declared himself emperor in 1804, it stuck. The democratic principles of the Revolution were, by then, totally forgotten.

This is a really splendid book, more of an extended essay, in an elegant and readable 19th-century style, and it is available for free online in .pdf form. It is well worth the two hours or so it takes to read.

Does Washington seem a little dirty today? This is another common feature in episodes of currency-depreciation and printing-press finance. France in 1791:

Nor was this reckless and corrupt spirit confined to business men; it began to break out in official circles, and public men who, a few years before, had been thought above all possibility of taint, became luxurious, reckless, cynical and finally corrupt. Mirabeau himself, who, not many months previous, had risked imprisonment and even death to establish constitutional government, was now — at this very time — secretly receiving heavy bribes.

When, at the downfall of the monarchy a few years later, the famous iron chest of the Tuileries was opened, there were found evidences that, in this carnival of inflation and corruption, he had been a regularly paid servant of the Royal court. The artful plundering of the people at large was bad enough, but worse still was this growing corruption in official and legislative circles. Out of the speculating and gambling of the inflation period grew luxury, and, out of this, corruption. It grew as naturally as a fungus on a muck heap.

It was first felt in business operations, but soon began to be seen in the legislative body and in journalism. Mirabeau was, by no means, the only example. Such members of the legislative body as Jullien of Toulouse, Delaunay of Angers, Fabre d’Eglantine and their disciples, were among the most noxious of those conspiring by legislative action to raise and depress securities for stock-jobbing purposes. Bribery of legislators followed as a matter of course, Delaunay, Jullien and Chabot accepted a bribe of five hundred thousand livres for aiding legislation calculated to promote the purposes of certain stock-jobbers. It is some comfort to know that nearly all concerned were guillotined for it.

It is true that the number of these corrupt legislators was small, far less than alarmists led the nation to suppose, but there were enough to cause wide-spread distrust, cynicism and want of faith in any patriotism or any virtue.

For you fans of “modern monetary theory”, here’s France in 1793:

And now was seen, taking possession of the nation, that idea which developed so easily out of the fiat money system: the idea that the ordinary needs of government may be legitimately met wholly by the means of paper currency; that taxes may be dispensed with.

Let’s look at another example:

[The businessman] himself, the richest and most powerful industrialist in [the country], whose empire of over one-sixth of the country’s industry had been largely built on the advantageous foundation of an inflationary economy, paraded a social conscience shamelessly. He justified inflation as the means of guaranteeing full employment, not as something desirable but simply as the only course open to a benevolent government. It was, he maintained, the only way whereby the life of the people could be sustained.

The [head of the central bank] whose industrial interests were negligible did not in essence depart from this argument, and in a speech on [the] currency … greatly vexed [the British ambassador] because he had (in the ambassador’s words) ‘pressed into the shortest space the maximum number of fallacies and errors’.

As though his powers to wreck the economy were not great enough already, at the behest of the [Treasury], and in the expectation that money supply would thereby be divorced from political expedience, the [central bank] was that same month declared autonomous, with [the head of the central bank] its uncrowned king. He quickly showed that he, too, considered the fall in the exchange to be quite unconnected with the gigantic increases in note issue, and went on ‘merrily turn[ing] the handle of the printing press completely unconscious of its disastrous effect’. There was evidence, [the British ambassador] believed, that 90 bankers … out of every 100 expressed and perhaps held the same views. At any event, the financial press reported them without dissent.

This was Germany in May 1922 – after the notorious hyperinflation had gone on for quite some time, and had become a full-blown catastrophe {from When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany, Adam Fergusson (2010)] The German case is rather extreme; but, it is also well-documented, and shows what happens to people’s minds in these situations.

Admittedly, all this talk is rather unfashionable at this time, as not much seems to have happened since the autumn of 2011. Yet, I see no meaningful deviation from a path towards further decline in currency value. All the indicators point to continuation and acceleration — and potentially some sort of “hyper-“ event at some future time. There is no particular need to make predictions, just to get the direction right and be willing to wait.

In general, everything has taken longer than it seems like it should. In conversations with a friend, we agreed that we could not find any helpful historical precedent for the present period – this strange episode of apparent (though not convincingly real) and annoyingly persistent sort-of prosperity within the context of what certainly appears to be a broader course of catastrophe. The usual narratives and pace, and associated strategies and tactics, that have characterized market and economic history don’t seem to quite apply, except in the vaguer sense we are using here.

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(3) About the author

Nathan Lewis is the principal of Kiku Capital Management LLC, which manages a private investment partnership. He was formerly the Chief International Economist and Global Strategist for firms providing investment research to institutions. His book Gold: the Once and Future Money was published by Agora Book Publishing and John Wiley in 2007, and is now available in five languages.He has written for the Financial Times, Huffington Post, Nikkei Business, Daily Reckoning, Japan Times, Daily Yomiuri, Pravda, Asian Wall Street Journal, Dow Jones Newswires, Worth, and other publications. He has a weekly column at Forbes.com. His website is: New Worlde Economics.

He has spoken before audiences at the Heritage Foundation, New York Society of Securities Analysts, Utah Gold Money Summit, and other venues. In August 2012, he testified before the House subcommittee on Domestic Monetary Policy on the topic of “parallel currencies.”

Here is a series by Lewis at The Huffington Post, explaining the hidden workings of our financial system, using Goldman Sachs as the lens. I recommend reading them.