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Address
at the Annual Dinner of the
Committee for Monetary Research and Education, CMRE
on October 16, 2008
New York City
Madam President,
Ambassador Middendorf, Distinguished Guests, Ladies and Gentlemen:
Happy Birthday CMRE!
It was 75 years ago,
in 1933, that the predecessor of CMRE, the Economists' National Committee
on Monetary Policy was formed by a group of monetary scientists in
response to the Roosevelt Administration's emergency measures such as
suspending the gold standard and devaluing the dollar. The Committee pointed
out that abandoning the gold-standard violated sound economic and moral
principles, let alone the Constitution. Strong protests were lodged calling
attention to the dangers involved in the regime of irredeemable currency,
which invites management based on political opportunism or expediency, rather
than on economic and market forces. The Committee also pointed out that
monetary and fiscal measures designed to create purchasing power artificially
not only served to perpetuate existing maladjustments, but could be expected
to lead to new ones. The mission of the Committee was to study all pertinent
issues in the field of money and credit, and to expose the weakness of
unsound monetary proposals such as lowering interest rates or raising prices
by fiat, monetizing the government debt and merging all monetary and fiscal
control in the hands of a single authority.
In 1971 the
successor Committee, CMRE, took over the torch holding it high as a beacon,
and to spread light into the dark corners of the conspiracy of the U.S.
Treasury and the Federal Reserve System. CMRE pointed out the economically
and socially harmful consequences of currency manipulation through unsound
monetary and fiscal practices.
Ladies and Gentlemen,
please sing along with me "Happy Birthday To You!"
Cassandra's plight
Sad to say, as it
turns out, the 75th anniversary is an unhappy one: CMRE's Cassandra-role has
come full circle. As you may recall Cassandra, the youngest daughter of King
Priam of Troy, fell asleep in the temple of Apollo. The god was enamored with
her beauty. He promised to teach her the art of prophecy in return for her
love. She accepted the offer, but when it was her turn to deliver, she
reneged on the bargain. Feeling double-crossed, Apollo was outraged. But it
was too late now: there was no way to "un-teach" Cassandra. Still,
the god thought of a way to revenge her: to the gift of prophecy he added the
curse that, though Cassandra always spoke the truth, nobody would ever believe
her.
CMRE's fate is
similar: the jealous gods stopped people from believing her dire predictions
which were dismissed, even ridiculed, by the mainstream. Now, as some of
these predictions have come true and credit collapse is a reality, the drama
is unfolding before our very eyes. We are not reading history: we are living
it. The global banking system has run out of capital and is in ruins,
bringing the world to the brink of abyss.
Remember the great
antagonists at CMRE dinners of old: Hans Sennholz and John Exter? Sadly, they
are no longer with us. Their endless debates centered on the question whether
it will all end in a hyper-inflation or a hyper-deflation. Now we know: we
are going to have the worst of both worlds. The global banking system is disintegrating
in hyper-deflation; the irredeemable dollar will survive only to succumb to
hyperinflation later. In the meantime, it will be depression that may eclipse
the Great Depression of the 1930's.
My task here tonight
is to point out the ultimate causes of the crisis, and to describe a viable
resolution -- if my Cassandra prophecy is not drowned out in the cacophony
surrounding the collapse of the economy.
Destabilization of
interest rates -- wrecker of productive capital
The problem goes
right back to the U.S. government's foolish decision to destabilize interest
rates by cutting the dollar adrift from its gold moorings in 1971. It was a
case of declaring bankruptcy fraudulently. The unintended consequences of the
default were most serious, even though academia and media refused to analyze
them. They blithely assumed that the U.S. was free to renege on its
international gold obligation with impunity.
As a consequence of
the default interest rates shot up to 20 percent by 1980, from where they
started their long descent that still continues.
The public's
perception is that declining interest rates are good for you, and they are
good for the economy. Not so long ago academia and media were ecstatic in
singing the praise of Alan Greenspan and his Fed for bringing about the
Nirvana of the regime of falling interest rates.
This perception is a
colossal mistake. A falling interest-rate structure is lethal. It is an
insidious destroyer of capital. It means that wealth is stealthily siphoned
away from the capital accounts of the producers, in order to enrich the
latter-day pirates, the bond speculators who make obscene profits in the
falling interest-rate environment.
As is well known,
falling interest rates and rising bond values march in lock-step, albeit in
opposite directions. We are all familiar with the fate of TV manufacturers
and steel-makers in America. What has hit them? Well, their capital was
destroyed by the relentless fall of interest rates. The writing is on the
wall concerning the fate of the auto-makers. What is ailing them? The same
thing: the fading of their capital. Well-paid jobs in car-manufacturing will
also migrate to Asia, leaving the only jobs, hamburger-flipping that cannot
be outsourced, for the American workers.
Destabilization of
interest rates -- wrecker of financial capital
For a time it
appeared that capital devastation was confined to the productive sector, that
it would spare the financial sector. After all, the latter was ready to try
any and all innovations, fair and foul, in order to squeeze the last drop of
profits out of the system by juggling mortgages, bonds, and equities. One of
these innovations was derivatives, in particular, credit-default swaps.
The present crisis
did not start in August, 2007, as widely assumed. It started half-a-year
earlier, in February, when the price of credit-default swaps (essentially the
premium on insuring bond values) took off like a rocket. It dawned upon the
world that the financial sector had no immunity to capital destruction. Bank
capital has been devastated just as insidiously as productive capital has.
Falling interest
rates mean that bank capital has been financed at rates far too high. The
resulting shortfall in capital should be compensated in the balance sheet by
repeated injections of new capital. If banks fail to do this, then they are
paying out phantom profits in dividends and compensation. They pile more
losses upon losses. When they run out of capital, as sooner or later they
must, capital dissipation stops, for there is nothing left to dissipate. For
the banks it means sudden death.
The wrecker's ball
of swinging interest rates
You may have seen
the wrecker's ball in action. It is lowered into the building through the
roof. Once inside, it is made to swing wide enough to knock down the opposite
walls. The action of swinging interest rates on the economy is similar. Rising
rates destroy capital by rendering it submarginal. Falling rates, on the
other hand, destroy capital by raising the liquidation-value of debt, making
it an unbearable burden on the firm.
Interest rates have
been falling for the past 28 years. The present banking and credit crisis is
a direct consequence of this prolonged fall. A glance at the interest rate
chart will convince you of that. It shows a fairly stable curve leading up to
1971. At that point the swinging of the wrecker's ball started, driving the
rate of interest to unprecedented extremes, first up, then down.
Liquidation value of
bonded debt
Falling interest
rates destroy capital in a way that is more subtle than destruction through
rising rates. The liquidation-value of debt, contracted earlier at higher
rates, rises. 'Liquidation value' is the lump sum it takes to liquidate debt,
should it be necessary to retire it before maturity -- for example, in
case of takeovers, mergers, shotgun marriages, bankruptcies, or the
nationalization of the banking system. The point is that as the rate of
interest falls, the liquidation value of debt rises. Why? Well,
the stream of interest payments now has to be discounted at a lower
rate. Therefore at maturity it falls short of liquidating the debt.
Here is a familiar
example, the liquidation value of bonded debt. When the rate of interest
falls, the market immediately bids up the price of bonds. The higher bond
price represents the higher liquidation value of the underlying debt. The
fall in the rate of interest, far from alleviating the burden of debt,
aggravates it.
Bank capital has
been eaten away by the fall of interest rates. The impairment has been
ignored and, after 28 years of negligence the global banking system stands
denuded of capital. Those shareholders who can read balance sheets see
through the fancy values banks are putting on their assets. They dump the
stock before bank capital goes all the way to zero.
This is not a real
estate crisis, nor is it a sub-prime crisis. This is a crisis caused by the
destruction bank capital across the board, through the wrecker's ball of
swinging interest rates. In the final analysis, it has been caused by exiling
gold from the banking system.
Dissipating capital
under false pretenses
People tend to have
a religious faith in the Fed's miraculous power to create something out of
nothing. They think that the Fed is above capital requirement and accounting
rules. They think that the Fed is above the law. They dismiss the idea that
the Fed, too, can suffer from capital inadequacy, or that it may not be able
to escape the ill effects of falling interest rates.
The Federal Reserve
Act (as amended) explicitly forbids the Treasury from participating in the
earnings of the Fed. The purpose of this provision is to retain the undivided
surplus in the Federal Reserve System to meet emergencies precisely like the
present crises. The conspiracy of the Treasury and the Fed ignores this
provision of the law. Year in and year out the Fed remits about 90 percent of
its earnings to the Treasury under false pretences, calling it the
"franchise tax on Federal Reserve notes". No sooner had the
Treasury received the remittance than it spent the proceeds, and more, on
consumption. As a result, the Fed is left with no undivided surpluses and no
cushion to fall back on in hard times. And the Treasury has debt far greater
than it has resources to retire. This high-handed disregard for the law is
motivated by the desire to foster a public image of the Fed as an institution
with supernatural powers. The Fed has the magic wand and can wave it to solve
any problem by throwing money at it. In this view the Fed is not a bank, but
the embodiment of divine power.
The printing press
is sputtering
Chairman Ben
Bernanke is given to boasting publicly that the government has given the Fed
a tool, the printing press, with which it can print any amount of currency
necessary to stop any deflation and any depression.
I submit that the
Chairman is wrong. The printing press is not everything. The Fed has to
operate under the same rules as all other banks. It has to have capital; it
has to have an unimpaired balance sheet; it has to observe capital ratios. Above
all, the Fed has to put up collateral before it can print new Federal Reserve
notes, or create new Federal Reserve deposits. The fact is that the Fed, in
addition to dissipating its earnings decades after decades after decades, has
also been digging its own grave by pushing interest rates ever lower. Its
capital has been destroyed just as that of all other banks. Right now it is
near the point that it cannot put new currency into circulation in want of
collateral. The printing press is sputtering. The magic wand is
broken.
Dead man walking
The Supplementary
Financing Program of the Paulson-Bernanke duo means that, in preparation
for the $700 billion bailout, the Fed is given securities by the Treasury directly,
bypassing the open market. The last time this imprudent departure from
the principles of sound central banking has been invoked was during World War
II, when the exigencies of war finance were used to justify the bypassing of
the open market.
But what does it all
mean in practical terms, if we strip away the jargon created in order to
mystify the public? It means that the Fed, just like all other banks, has
virtually zero capital. It means that the Treasury must recapitalize the Fed
by giving it $700 billion worth of newly issued securities. It also means
that the bad assets of the banks, some of which have been absorbed into the
balance sheet of the Fed, are monetized through the back door.
But the worst part
is that the Fed is now a dead man walking, propped up by conspirators who want
to conceal from the people the fact of its demise. This is just the latest of
conspiracies between the Treasury and the Fed. In creating a central bank in
1913, the government usurped powers not granted to it under the U.S.
Constitution. One successful usurpation calls for another. Now, 95 years
later, the government is frantically trying to resurrect its creature, the
Fed, from the dead.
Lipstick on a pig
One expert observer,
Thomas Szabo, calls the $700 billion bailout "putting lipstick on a
pig", in the form of the Supplementary Financing Program. Szabo does
not beat around the bush. He tells it as it is: The Federal Reserve is
bankrupt, and the U.S. Treasury Department quietly rescued -- actually, took
over -- the world's largest central bank on September 17, the day the
Supplementary Financing Program was announced, which was nothing less than a
clandestine federal bailout, a de facto takeover of the Federal
Reserve. Szabo, who was a practicing auditor for 8 years, has gone on
record in saying that the Fed, if it were an ordinary business enterprise,
would have had to file for bankruptcy.
Why gold?
If gold had been
retained as a component of the banking system, there would have been no need
to invent credit default swaps, and the unprecedented destruction of bank
capital would have never occurred. Gold is unique among financial assets in
that it has no counterpart as a liability in the balance sheet of someone
else. Gold is the only financial asset that will survive any consolidation
of bank balance sheets. Gold will not be netted out, like paper assets
are, in case of mergers, acquisitions and takeovers. The rescue effort is
administering one wrong medicine after another. Consolidation of banks
through mergers and takeovers is not the way to go. Cutting interest rates is
not the way to go. These measures make the condition of the patient worse, as
they accelerate the process of destroying capital.
All the measures to
check the burgeoning credit crisis that have been proposed and put into
effect are based on misdiagnosis. The shriveling capital ratios are not due
to loose lending standards or to a reckless increase of bank assets. They are
due to the destruction of bank capital through falling interest rates. Recapitalizing
banks with irredeemable promises to pay will not solve the problem.
Resolution:
recapitalize banks with gold
The long-term
solution is the recapitalization of the banking system with gold. This means
the issuance of new gold-denominated bank shares. It means mobilizing the U.S. gold reserves for the backing of the note and deposit liabilities of the Federal
Reserve banks. The new shares of the recapitalized banks will then circulate
in trading the old assets of the banks.
This will accomplish
at least two things. First, the banks will be recapitalized in such a way
that takeovers, mergers, acquisitions will not endanger bank capital as they
do now. Second, there will be a reliable norm to value the old banking
assets. Those of them that can be salvaged will be salvaged, and will once
more become marketable. The rest can go to the garbage dump of history, to
join the Continentals, the Assignats, the Reichsmarks, and the toxic assets
of the 1930-33 banking crisis.
Troubled Ass
Relief Program (TARP)
Unfortunately, our
leaders don't have the wisdom and the moral fortitude to admit that they have
been wrong all along about gold and its role in the financial system. Just
last Saturday President Bush announced, before the finance ministers of the
G-7 nations, that he is making a volte-face indiscarding his earlier
concept of buying toxic bank assets, and is embracing the concept of buying
into the "intoxicated banks" themselves. In plain English, he is
turning his Troubled Asset Relief Program into a Troubled Ass
Relief Program (no pun intended). No thought is given to recapitalizing banks
with gold, the ultimate liquidator of debt.
Ladies and
Gentlemen, be prepared. The earth is shaking, the Debt Tower of Babel is
toppling and, it will bury prosperity underneath the rubble. The Titanic of
the once proud American banking system has collided with the iceberg of
falling interest rates, and is sinking.
Sauve qui peut!
Antal E. Fekete
Professor,
Intermountain Institute of Science and Applied Mathematics, Missoula, MT 59806, U.S.A.
Gold Standard University
aefekete@hotmail.com
DISCLAIMER AND CONFLICTS
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
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