People tend to think in terms of black-and-white.
Many of my correspondents think that either hyperinflation or deflation is in
store for the dollar; tertium non datur (no third possibility given). I would say tertium datur. The
third possibility is a hybrid of hyperinflation and deflation. I described
this scenario in my previous article "Opening the Mint to Gold and
Silver". It is possible, even probable, that we shall witness collapsing
world trade and collapsing world employment together with competitive
currency devaluations, as the three superpowers compete in trying to corner
gold. The lure of gold is very strong. "There is no fever like gold
fever" and, contrary to conventional wisdom, governments are especially
A large part of the problem is
that the Central Bank is helpless in the face of bond speculation. The Fed is
no Sorcerer. It is the Sorcerer's Apprentice. It can pump unlimited amounts
of "liquidity" into the system, but cannot make it flow uphill. As
we shall see, new dollars flow to the bond market causing a lot of mischief
there, instead of flowing to the commodity market as hoped by the Fed.
Up to now leading commodities have
outperformed gold. That could change. A select few commodities might continue
in the bull-mode for a time, although gold could easily beat them. Most other
commodities might go into a bear-mode similar to that of the commodity
markets of the 1930's. If that's what was in store, then most investors would
be totally lost. They would be navigating without a compass. There would be
endless debates whether the country is experiencing deflation of
hyperinflation. Your motto in this hybrid scenario should be: "expect
Of course, the Fed will keep
printing dollars like crazy. Few of them, if any, will go into commodities.
Indeed, most of the newly created dollars will go into bond speculation. Why?
Because commodity bulls are running into headwind and face grave risks. By
contrast, bond bulls enjoy a pleasant tailwind. Bond speculation is virtually
risk-free. Under our irredeemable dollar bond bulls have a built-in advantage. The Fed has to make periodic trips to the bond
market in order to make its regular open-market purchases of bonds to augment
the money supply. In order to win, all the bond speculator has to do is to
stalk the Fed and forestall its bond purchases. This is the Achillean heel of Keynesianism: it makes bond speculation
inherently asymmetric favoring the bulls, and that
will ultimately derail the economy on the deflation-side of the track.
Uncle Sam in agony
Russia is not as enigmatic as
China. The Russians' game is gold. China is the big unknown. It looks as if
China prepares to corner silver. Will the Chinese force a silver standard on
their trading partners? It is quite possible that their pile of paper profits
in silver is already so huge that they can well afford to gamble. They find
trading T-bonds most profitable. Indeed, theirs is the greatest U.S. T-bond
portfolio ever, anywhere. They can overwhelm any opponent bidding against
them. Just think about it. The financial destiny of the U.S. is in China's
hand. The good news is that the Chinese have vested interest in keeping the
bond bull charging. They also have a vested interest in keeping the dollar on
the life-support system. The bad news is that the Chinese insist that it is their
finger that must be on the switch. Here is an incredible sight, the U.S.
being under the thumb of China. Not because the Red Army is a match for the
U.S. military, but because Uncle Sam has voluntarily put his head into the
noose. The Chinese ask: why fight shooting wars when you know that your
antagonist is painting himself into a corner anyhow? They know that Uncle Sam
will sooner or later start crying: "Uncle!" in agony. They have all
the marbles. The marbles of saving. The marbles of producing. The marbles of
silver. Maybe, one day, they will also have the marbles of gold.
The Logarithmic Law of Deflation
Most economists are ignorant of
the mathematics of depressions. They have certainly never heard of what I
call the Logarithmic Law of Deflation. It states that halving interest
rates brings about the same proportional increases in bond prices, regardless
at what level the halving takes place. It makes no difference whether you go
from 16% to 8% or from 2% to 1%, the value of long-term bonds will increase
by about the same factor. It can be seen that a much smaller drop in interest
rates could bring about the same proportional increase in bond prices,
provided that the rates are low enough.
Why is this important? Because it gives away the secret of the deadly
deflationary spiral. It is wrong to describe Fed action as cutting
interest rates. We should think in terms of the Fed halving them. The
bull market in bonds can go on indefinitely under the regime of the fiat
currency. People assume, wrongly, that the Fed will run out of ammunition
when the rate of interest is approaching zero. The bond-bull will run out of
breath. Not so. The Fed will never run out of ammunition. The lower the rate,
the smaller cut will do. The Fed can halve interest rates any number of times
without ever reducing them to zero. The bond-bull will never run out of
"Gigolo of science"
The trouble is that the bond-bull
is the root cause of depressions. Falling interest rates create capital gains for
bondholders, yes, but these gains do not come out of nowhere. They come right
out of the capital losses of producers. They are the very stuff out of which
depressions are made. The serial cutting of interest rates by the Fed is
the grave-digger of the economy: it causes wholesale bankruptcies in the
producing sector. The large-scale dismantling of the producing sector in
America during the past twenty-five years is a direct consequence of the
regime of falling interest rates. Production stopped as a result of the
financial sector siphoning off capital from the producing sector. Industrial
jobs were exported as there was no capital left to support them at home. This
shocking truth was never investigated by mainstream economists, sycophants of
Keynes. They did not want to expose the gravest error of their idol in
confusing a low interest-rate structure with a falling one.
Keynesianism is the gigolo of science (Ayn Rand).
As the example of Japan shows, we
are not looking at a ditch into which the Japanese economy has stumbled. We
are staring a black hole in the face, the black hole of zero interest. It can
suck in the Japanese economy. It can suck in the economy of the United
States. It can even suck in the entire world economy. It is powered by the
regime of the irredeemable dollar, and the Fed's policy of serial
Ayn Rand called the confiscation
of gold in 1933 by F.D. Roosevelt "moral cannibalism". As I have
shown elsewhere, the epithet is apt. The removal of gold as the chief
competitor of government bonds was one of the main causes of the Great
Depression in triggering, as it did, a protracted fall in interest rates.
(The other cause was the deliberate manipulation of interest rates lower by
the Fed.) The latter-day equivalent of moral cannibalism is risk-free bond
speculation by the banks, perpetuating the bull market in bonds. It is made
possible by the open-market operations of the Fed that have been
clandestinely and illegally introduced and, by now, have become the mainstay
of the management of fiat currencies. The result is another protracted fall
in interest rates. Could they herald another Great Depression?
What American Century?
There is an historical lesson to learn
here. The twentieth century was not the "American Century" as
advertised. The sun started setting on America as early as 1913 when, in
imitation of the Europeans, Americans embraced the idea of a central bank. An
earlier attempt to establish a central bank in the United States was found
contrary to the Constitution, and the Bank's charter was not renewed. But by
1913 the visionary admonition of Thomas Jefferson was totally forgotten.
"If the American people ever
allow the banks to control the issuance of their currency, first by
inflation, and then by deflation, the banks and corporations that will grow
up around them will deprive the people of all property, until their children
wake up homeless on the continent their fathers conquered. The issuing power
of money should be taken from banks and restored to Congress and the people
to whom it belongs. I sincerely believe that the banking institutions having
the issuing power of money are more dangerous to liberty than standing
In less than a generation after
1913 adventurers invaded America's institutes of higher learning and exiled
monetary science, replacing it with a hodge-podge of dubious nostrums.
America's economy and finance started to be run on a completely false theory.
Gold, and the power to create and to extinguish
money was taken away from the people. It was given to the banks.
Operating on the basis of this
false theory Americans scrapped the foundations of the international monetary
system: they threw out positive values (such as that of gold and
silver) and replaced them with negative values (such as debts and
deficits). As a consequence, outstanding debt can no longer be reduced
through the normal course of retirement. Total debt can only grow. In no time
at all America has turned itself from the largest creditor into the largest
debtor nation of all times. Not only did the U.S. government allow its debt
to grow exponentially; it also allowed it to accumulate in the hands of
America's adversaries. At the same time America's industrial heartland was
dismantled. Well-paid industrial jobs were exported and replaced by
low-paying service jobs.
Hedging versus gambling
The United States is like a train
running downhill without brakes. The derivatives monster is the proof of
that. It has its own dynamics, but it cannot be grasped without a solid
understanding of gold. Under the gold standard interest rates, and hence bond
values, were stable. In fact, that is the main excellence of a metallic
monetary standard: it makes interest and foreign exchange rates stable. There
are no derivatives markets on interest and foreign exchange rates, because
the lack of volatility makes trading unprofitable. Under a metallic standard
"bond trading" is an oxymoron, as is "bond insurance". Private
issuers of debt must set up a sinking fund that will buy up all bonds
offered in the market below par. People buy bonds as a vehicle of saving.
Today, you would have to be insane if you wanted to buy bonds as a vehicle of
Why then are bonds still in
demand? They are in demand because they are by far the best vehicle of
gambling. As I shall now show, under the regime of irredeemable currency,
speculation in bonds is risk-free.
When the gold standard was thrown
to the winds, interest rates started gyrating and bond values were totally
destabilized. After all, bonds promised to pay principal and interest in
terms of a currency of uncertain value.
Mainstream economists betrayed
their sacred duty of searching for and disseminating truth. They started
preaching the false gospel that it is possible to take out insurance against
losses in the bond portfolio. However, the thesis that bond futures can be
used for purpose of hedging the bond price (in exactly the same way as wheat
futures can be used for the purpose of hedging the wheat price) is an
outright lie. Only those price risks can be hedged where the price variation
is nature given, as in the case of agricultural commodities. If the
price variation is artificial, that is, subject to government and
central bank manipulation as are foreign exchange and bonds under the regime
of irredeemable currency, then it is preposterous to talk about hedging. One
should talk about gambling instead of hedging. As in the casino, the
so-called hedger is placing a bet against the house, in this case the central
bank, whose job it is to manipulate the price.
The Derivatives Monster
The derivatives tower is just a
layered pyramid of "bond insurance", so-called. Nobody asks the
question whether insuring bond values is possible in principle. As I have
stated, it is not. Insurance means spreading the risks over a larger
population than that needing compensation. Insurance is the very opposite of
gambling where the player wants to increase his risks in the hope of a
large payoff, not to decrease it.
Now think of an inverted pyramid
delicately balanced on its apex. The apex represents the bond market (layer
1). The next layer is bond insurance (layer 2). But since the value of bond
insurance is inherently even more unstable than that of the bond, it is in
need to be insured as well (layer 3). And so on it goes. The pyramid is
growing at an exponential rate as the need for reinsurance keeps increasing.
There are several problems. First
of all the whole idea is hare-brained, much the same as the idea of
"operation boot-strap". A soldier, no matter how strong he is,
cannot lift himself by his own boot-straps. Similarly, you can't insure bond
values without an anchor. The second problem is that the slightest hitch at
any layer will bring down the house of cards. The principle of insurance
assumes that no tornado will destroy all the insured homes simultaneously.
The same assumption cannot be made about bond insurance. The volume of
outstanding bond insurance is much higher than the existing supply of bonds.
It is even larger than the existing money supply (and goodness only knows
that it is very large.) Therefore it is a physical impossibility to
compensate insurance-holders in case of global trouble. If any doubt arises
at any level about the validity of the insurance policy, the whole
Ponzi-scheme collapses. The Derivatives Monster is meant for simpletons.
The Presidential election year of
I find it frightening that none of
the Establishment candidates for the presidency even vaguely refer to the on-going
self-destruction of the nation's monetary and banking system. Like an ostrich
they ignore the problem. A presidential election year should be a great
opportunity for the nation to discuss its most urgent problems and take
remedial action wherever necessary. In this election year the country is
blessed with the running of a competent and upright candidate who sees and
understands the problems involved, and is willing to engage in a public
discussion of the gold standard as a way to avert national and world economic
disaster. This candidate is Dr. Ron Paul, a physician who did not go into
politics with the idea of making money or accumulating power. He went into
politics as Cincinnatus*, patriot and hero of the old Roman republic. When
Cincinnatus was drafted to become consul, the messengers who came to tell him
about his new dignity found him ploughing on his small farm. He answered the
call, but after solving the problems of the nation he declined the offer to
become dictator for life. He returned home to pick up the plough again.
Already in 1985 Ron Paul called
for the opening of the U.S. Mint to gold and silver as a way to stop the
threatening monetary and banking crisis in his address The Political and
Economic Agenda for a Real Gold Standard. If the country had listened to
him then, people would have been spared of the economic pain of 2007, and the
possibly much greater pains that may be in store.
Ignorance or lust for power?
Not one among the Establishment
candidates is willing to take up the challenge of Ron Paul, thus depriving
the electorate of a singular opportunity to learn about the dangers
threatening the Republic. We are left wondering whether their ostrich-like
behavior is due to ignorance, or to lust for power.
The electorate cannot make an
informed decision in November without understanding the current monetary and
banking crisis and its connection to gold. It is not too late to have a great
debate on the gold standard and on the consequences of maintaining the
irredeemable dollar standard in the face of an escalating monetary and
banking crisis. Labor leaders and captains of industry should demand an
answer to all those questions that the representatives of the financial press
refuse to ask of the candidates.
* Lucius Quinctius
Cincinnatus (c.519-433 B.C.) Cincinnati was named in honor of Cincinnatus.
Ron Paul, The Political and Economic Agenda for a Real Gold Standard, www.lewRockwell.com, January 19, 2008
A.E. Fekete, The Double Whammy of Geopolitical Global Gold Games, www.safehaven.com, January 30, 2008
A.E. Fekete, Fiat Currency: Destroyer of Labor,
Fiat Currency: Destroyer of Capital, www.professorfekete.com
Opening the Mint to Gold and Silver, www.safehaven.com, February 5, 2008
GOLD STANDARD UNIVERSITY
Session Three, will be held in Dallas, Texas,
February 11-17, 2008.
For details, see: www.professorfekete.com.
Antal E. Fekete
Intermountain Institute of Science and Applied Mathematics
Missoula, MT 59806, U.S.A.
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.
Copyright © 2002-2008 by Antal
E. Fekete - All rights reserved