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Revisionist Theory of Depressions Can It Happen Again?

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From the Archives : Originally published April 11th, 2008
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Category : Gold University





Those who refuse to learn from history are bound to repeat it


It is amazing how fast events unfold in the present crisis. When wepicked our subtitle “Can It Happen Again” for this talk just a fewmonths ago, it was merely an afterthought, looking at a remotepossibility. Now, on this Election Day, we are in the midst of anunacknowledged depression possibly worse than that of the 1930’s

The financial mayhem on Wall Street is spilling over every otherstreet in America, nay, in the whole world. In all likelihood job lossescurrently reported are only the tip of a monstrous iceberg

When Olivier Blanchard, the IMF’s chief economist, was askedthe question whether the world was sinking into another GreatDepression, he confidently replied that the chance was “nearly nil”

He added that, after all, we have learned a couple of tricks in theintervening 80 years

So we have, indeed, a couple of Keynesian tricks, and a fewmore Friedmanite nostrums ― while we were made to forget theaccumulated economic wisdom of the ages. But we have not learnedwhat mistakes, made by policy-makers, have caused the GreatDepression of the 1930’s. And we certainly have not learned how toavoid the same mistakes again

Keynesian and Friedmanite precepts rule economics, with noquarter given to traditional economics that has been exiled. It lookslike the fulfillment of the prophecy: “those who refuse to learn fromhistory are bound to repeat it”


Promises to pay which the Treasury and the Fed are neitherwilling nor able to honor


For the past eight years or so, in my writings and lectures, I have beenadvocating what I call the “revisionist theory and history of the GreatDepression.” In the cacophony of Keynesian and Friedmanitepropaganda on promoting the Brave New World of irredeemablecurrencies, my message was lost. Keynes and Friedman, for all theirdisagreements on the details how to “manage” the national and worldeconomy, were in solid agreement on their categorical rejection ofmetallic monetary standards, that is to say, money based on positiverather than negative values. Our present monetary system, universallyacclaimed by academia and media as the ‘wave of the future’, is basedon negative values: the value of debt. Keynes and Friedman both haveput the blame for the Great Depression on the “contractionistpropensities” of the gold standard. And that is all that’s being taught atvirtually all universities around the globe about the causes of the GreatDepression

The proposition is put under official taboo that there is no validdefense for giving the Fed and the Treasury the privilege to issuepromises to pay which they are neither willing nor able to honor(except insofar as they honor them as part of their the check-kitingconspiracy)


Bonds minus gold equals interest rates halved again and again


My revisionist thesis is simple: the truth is the exact opposite of theofficially upheld economic doctrine. The cause of the GreatDepression was the forcible removal of gold from the internationalmonetary system, including the suspension of the gold standard byGreat Britain in 1931, and the confiscation of the gold coins of thecitizens of the United States in 1933

To see this clearly we have to contemplate the main role playedby gold in the monetary system which is this: gold is the only assetthat can successfully compete with government bonds for the savingsof people with a conservative frame of mind. As long as gold isavailable as an alternative to bonds, the public purse is controlled bythe people. If they don’t like government profligacy, they can selltheir bonds and stay invested in gold. This is the only message thatthose in power would read or understand: the rise in the cost ofborrowing by the government. The rate of interest goes up. The redlights in the corridors of power start flashing

Confiscation of gold means cutting the wire to those red lights. Itmeans the removal of the only effective competition of governmentbonds, gold coins. In the absence of gold government bonds have acaptive market. They enjoy a monopoly. The government can affordto ignore all criticism of its monetary and fiscal policies. It can dowith the public purse as it pleases. Conservative bondholders nolonger have a choice: they have to buy and hold the bond. The publicpurse is no longer controlled by the people. The government can causethe public debt to go to any high level. The government can cause thecost of its own borrowing to fall to any low level. In formula: bondsminus gold equals interest rates halved, and halved, and halved; again,and again, and again:B G = (½)npKeynesians butt in: “Hey, wait a minute, that’s just it. Isn’t this a goodthing to have? Isn’t it a wonderful thing to turn the stone into bread; toabolish scarcity, by making capital abundant through a low interestratepolicy?”


Confusing a low with a falling rate of interest


Nobody denies that a low interest-rate structure, brought about by ahigh rate of voluntary savings, is a great blessing to society. What weface here is a fatal confusion of low with falling interest rates. If thefall is prolonged, then the net effect on the economy is lethal, as itcauses the destruction of capital which, unless checked in time, couldbring the entire economy to a screeching halt

Capital destruction is a subtle process which even the victimsthemselves are unable to diagnose. The suggestion that pari passuwith falling interest rates the market price of bonds rises isuncontroversial. It is an undeniable fact of the markets. It follows thatas interest rates keep falling, bond speculators reap constant capitalgains, a reward not for saving but for gambling. Their gains do notcome out of nowhere. They are siphoned off from the capital accountsof the producers. Entrepreneurs are unsuspecting. They don’t knowwhat has hit them when they find their enterprise denuded of capital

The last thing they suspect is falling interest rates which theywelcome, like everybody else, as a relief. Whatever it is, relief it isnot. It is the kiss of death


Liquidation value of bonded debt


To see the causal relation clearly, let us go through the process ofcapital destruction step-by-step. As the name suggests, “liquidationvalue” is the lump sum it takes to liquidate debt, should it benecessary to retire it before maturity ― for example, in case ofmergers, acquisitions, takeovers, shotgun marriages, not to mentionnationalization. The point is that as the rate of interest falls, theliquidation value of debt rises. Rise it must, because the stream ofinterest payments, originally set when interest rates were higher, isnow being capitalized at a lower rate. Since it represents a lowervalue, it falls short of liquidating the debt

For example, when I repatriated to Hungary and sold my housewith a mortgage in Canada, the bank would not accept the balanceremaining in settlement. It insisted on my paying a ‘penalty’ arguingthat the prevailing rate of interest was now lower, and the liquidationvalue of my mortgage higher. In other words, I suffered a capital losson account of falling interest rates

Here is another example. When the rate of interest falls, themarket immediately bids up the price of bonds. The higher bond pricerepresents the higher liquidation value of the underlying debt

Creditors will not let debtors off the hook, unless they can take anextra pound of flesh for their consideration. If this is deemed unjust,then complaints should be lodged with the gods, who ordained thatman be mortal. As is well-known, for immortal gods a future streamof payments need not be discounted, and full credit is given for eachand every installment. On Mount Olympus, the rate of interest is zero

Unfortunately, however, man is not immortal. For him, the rateof interest is positive. It is for this reason that falling interest rates, farfrom alleviating the burden of debt, aggravate it


Open market operations of the Fed


The grand scheme to make interest rates fall artificially started by theFed’s breaking the law in the 1920’s. Open market operations wereintroduced clandestinely as a way to inject new money into theeconomy. The Fed was to enter the open market to buy governmentbonds, paying for them with newly created dollars

It is important to understand that open market operations areillegal. They were not authorized under the Federal Reserve Act of1913. In fact, the Act specifically stated that government bonds wereineligible for the purposes of collateral in backing Federal Reservenotes and deposits. Eligible collateral was confined to gold and realbills. Open market operation were ‘legalized’ ex post facto only later,in the 1930’s, and the practice went on to become the chief engine ofinflation through the monetization of government debt on a massivescale. It should be noted that retroactive laws are not recognized bythe U.S. Constitution

Open market operations, apart from being illegal, are no less ahare-brained scheme. Authors responsible for developing this illegalpractice have been ignorant of its effect on speculation, and the effectof the resulting speculation on the rate of interest. Bond speculatorsare very much alive to the Fed’s need to make periodic trips to theopen market to buy the bonds. They lie in ambush to preempt it. Theybuy the bonds first, only to dump them in the lap of the Fed at a profitlater. In effect, bond speculators get a free ride at public expense

They pocket risk free profits. The entire playing field of the nationaleconomy becomes tilted, favoring parasites and penalizing producers

This is the fatal flaw in the Keynesian edifice: the chrysophobic(anti-gold) monetary system has a built-in instability manifested bythe unopposed bull speculation in the bond market. The net result is aninterest-rate structure that is persistently drifting lower. Keynesianspretend that their idol has made a discovery in justifying deficitspending made possible through open market operations, thusbenefiting mankind. But as my analysis shows, the goodies distributedby Keynesian economics are not costless. They come at the expense ofsociety’s accumulated capital. Capital dissipation is masked by theeuphoria of free lunch and pork. The damage to society dawns on thepeople later. By then it is too late to stop the rot. Irreparable damagehas been done. The capital of society has been destroyed. Everybodyis made to suffer because of Keynesian profligacy, justified underfalse pretenses


The banking panic of the 1930’s


The Great Depression was not caused by the vanishing of demand, assuggested by Keynes. It was caused by the vanishing of capital. Norwas the destruction of capital confined to the producing sector. Itaffected the financial sector as well. From 1930 to 1933 more thannine thousand banks closed their doors for good in the United States

Depositors and shareholders lost about $2.5 billion. As a share of theeconomy, that would be the equivalent of $340 billion today

Economic historians give credit to Franklin Delano Rooseveltfor meeting the banking crisis head-on. Only a few days after he wasinaugurated as president in March, 1933, he declared a bank holidayand ordered all the people under the jurisdiction of the United Statesto surrender their gold coins. Although Roosevelt promised to returnthe gold after the banking crisis has subsided, this promise wasapparently made in bad faith. No sooner had he confiscated the goldthan he marked up its value, leaving people with paper worth 56percent less. This neat piece of presidential chicanery was called“devaluation of the dollar in the national interest.”


Old Coppernose


Yet it was plain stealing, nothing less, as the great blind senator fromOklahoma, Thomas P. Gore, had told the president in his face in theOval Office. Senator Gore, moreover, in a debate on the Senate floor,also said this: “Henry VIII approached total depravity as nearly asimperfections of human nature would allow. But the vilest thing thatHenry ever did was to debase the coin of the realm!” Old Coppernose,as he was nicknamed, did not confiscate the people’s gold coins. Hemerely diluted them. When the gold wash wore thin, the effigy ofHenry on the coin revealed a copper nose underneath. People suffereda loss as a result of this royal chicanery, to be sure, but at least theycould keep their coin and have a good laugh at the expense of theirsovereign

Keynesian chrysophobes were jubilant. Roosevelt was their hero

They celebrated the advent of synthetic money and credit, laying greatstores on the ‘rational’ management of the national currency. Themoney supply was expanded and deflation halted. At least so the fablesaid. In reality, Roosevelt was pouring oil on the fire. Capitaldestruction got a new boost. As I have already explained, interest ratescontinued their free-fall as the only competitor to government bonds,gold, had been eliminated. Keynesian economists got the fallen god,the gold standard, to kick around. No one thought that the fallen godcould, phoenix-like, rise from its ashes in the fullness of times andhave retribution


Ominous parallels


It is hard to avoid seeing parallels to the current situation. Interestrates have been falling for 28 years from 16 percent in 1980 to 4percent today. Capital destruction has taken a great toll on theproducing sector, causing a large part of American industry fold tentand seek salvation overseas where wage rates are lower. As far as thefinancial sector is concerned, up until recently it appeared that thebanks have escaped the death-trap of capital destruction. Well, wenow know that they have not. Banking capital, just like industrialcapital, has also been destroyed by the relentless fall of interest rates

Banks no longer trust one other’s promises to pay, because theysuspect that their counter-party has no capital backing those promises

Banks are walking dead men, artificially propped up by the Fed andthe Treasury, anxious to avoid the blame for inaction that ushered inthe Great Depression in 1930. They are working hard to keep creditflowing. But the financial situation they face is incomparably moredifficult than that of the 1930’s. This is not an illiquidity crisis. This isa solvency crisis. It is due to an insidious destruction of capital

The Fed and the Treasury are trying to recapitalize the banks byinfusion of new capital in the form of freshly created Federal Reservecredit. Incidentally, the Fed is just one of the walking dead men. Itdoes not have the collateral necessary to create new credit to the tuneof $700 billion. The Treasury has to donate the Fed the bonds directly

The last time this imprudent departure from the principles of soundcentral banking has been invoked was during World War II, when theexigencies of war finance were used to justify the bypassing of theopen market. The vexing question is whether irredeemable promisesby the Fed and the Treasury are sufficient to jump-start banking in theUnited States

There are no contingency plans for the mobilization of goldreserves to recapitalize the banks. Gold is the ultimate liquidator ofdebt, toxic and non-toxic. Why not use the ultimate liquidator, if wereally mean business in eliminating toxic debt from the system, and ifwe really want to proceed with the task of deleverage to shrink thebloated balance sheets of banks? Well, the ideological obstacles areinsurmountable


Sword of Damocles


But the real difference between now and the 1930’s is the incredibledeterioration in the credit of the United States, which makes thepresent situation far more dangerous. The international credit of theUnited States in the 1930’s was very strong. You were looking at thegreatest creditor country in history. Today, four score years later, youare looking at the greatest debtor country in history, in need to borrowabroad to pay interest on its outstanding debt, in addition to borrowingin order to maintain consumption patterns. A large part of the debt isheld by foreigners, not under the jurisdiction of the United States, andcertainly not subject to its taxing power. This is the sword ofDamocles hanging on a thin thread. At the drop of the hat sources offoreign credits could run dry. Nobody knows what will happen then

Yet the dollar is not in immediate danger. Superficially it isstrong and getting stronger. Treasury bonds are in great demand as the“flight to safety” continues. For a couple of years, maybe a littlelonger, the dollar will hang on “by the skin of its teeth”

But the writing is on the wall: the strong dollar will be beatendown by the U.S. government in the course of the trade war, to reviveAmerican exports. In addition, the bill for the unprecedented bailoutswill come in soon enough. The government deficit will reachstratospheric heights. When the critical mass is reached and thethreshold of tolerance in total indebtedness is surpassed, the run on thedollar will become inevitable. In the meantime, serious challenges tothe hegemony of the dollar may be presented from friends and foesalike. This is an explosive situation. We are on uncharted waters,aboard a rudderless ship

Worst of all, we lack leadership. Those in charge of ourmonetary and fiscal system are dyed-in-the-wool Keynesians andFriedmanites. They have grown up on Keynesian and Friedmanitebunk no longer applicable in the 21st century. They were caughtcompletely by surprise by the fast unfolding of events. They do notunderstand what is happening to this country, let alone the world, nordo they have any idea how further damage can be prevented. The onlytrade they know is to cut interest rates; to print more money, rain orshine, and airdrop it from helicopters indiscriminately. Their compass,economic forecasting, the pride of mainstream economics, has turnedout to be tea-leaf reading. The only people who predicted thismaelstrom were non-conformist economists beyond the pale. Theywill not be allowed to kick in the ball

The outlook is bleak indeed. Keynesians and Friedmanites willcontinue at the helm. Their faulty perception will prompt them tothrow even more bad money after bad money. They will beat downthe ‘strong’ dollar. There will be competitive depreciation ofcurrencies world-wide, an echo of the trade wars and beggar-thyneighborpolicies of the 1930’s. At the end of the road lie the ruinationof the world’s monetary and payment system, economic cooperation,and division of labor


The ”blame-it-on-the-gold-standard game” is over


We have been told that deflations, depressions, bank runs, massiveunemployment, wholesale bankruptcies can only happen under thegold standard. In a modern, government-managed economy, equippedwith scientific money-creating techniques, bolstered by the fine-tuningmanagement of demand, these ills of society have been relegated tothe history books

A few months of the year 2008 exploded the myths nurtured formuch of the twentieth century. The stark reality is that we have notconquered scarcity with interest-rate suppressing techniques. We havenot succeeded fine-tuning the national economy with monetary andfiscal policy. We have not learned how to combine high wages withhigh employment. We cannot turn the stone into bread. We have onlybeen tinkering at the edges, pretending that we can ladle out riches toall comers by government fiat

This is not a subprime crisis. This is not a real estate crisis. Thisis not even a dollar crisis. This is a gold crisis. The gold standard wassabotaged in 1933 when the U.S. government reneged on its domesticgold obligations, and again in 1971 when it reneged on itsinternational gold obligations. The gold standard strikes back ― witha lag measured not in years but in decades

How naïve it was to believe that the gold standard could beabused and exiled with impunity! How dense it was to think that underthe regime of irredeemable currency basic freedoms can bemaintained! How insane it was to embrace the notion of legal tenderas the ticket to a bright future!Events of this fateful year 2008 have dumped Keynesian andFriedmanite economics to the garbage heap of science, where Marxianeconomics, astrology, alchemy, and many other discredited anddiscarded theories, the names of which have by now faded frommemory, already rest

The sooner the world leadership realizes this, the better


Antal E. Fekete

San Francisco School of Economics


Read all the other articles written by Antal E. Fekete 



Copyright © 2002-2008 by Antal E. Fekete - All rights reserved









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Professor Antal E. Fekete is a mathematician and monetary scientist., with many contributions in the fields fiscal and monetary Reform, gold standard, basis, discount versus interest and gold and interest.
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