Lawson for Congress

Yay, the subprime mortgage crisis is officially over! See here, it’s in the Financial Times!

Looks like Obama has as much experience in economics as he does in foreign policy. Regardless of his experience, though, he’s following the “bubble script” perfectly. We’ve identified a scapegoat and figured out a way to bailout (at least symbolically) those affected. Now all that remains are a few criminal prosecutions and a wave of legislation and regulations to eliminate home ownership through private financing. That’s definitely something the government should do — it’s about time we went back to our roots and started to view home ownership as a right. Not just with taxpayer-guaranteed mortgages by Mac and Mae, but just imagine a Department of Housing and Urban Development that actually provides housing!

In all fairness, though, Obama is halfway right. Here’s a quote: “Washington needs to stop acting like an industry advocate and start acting like a public advocate”. It’s clear that corporate and special interests own our government. But what Obama doesn’t realize is that the root cause for this subprime mess is actually the easy money made easier by our own government and Federal Reserve.

Finally, I do understand his frustration. I once dealt with a particularly dangerous mortgage broker (from a major bank, no less) who was routinely counseling folks to take more equity out of their homes so they could “put it to work”. I should have questioned his logic to his face, but was too polite at the time. Why would you recommend that people take more money out of their homes? It’s not like they’re coming to you, Mr. Mortgage Broker, with a rational plan to use the funds as investment capital.

Oh, but I forgot. He’s compensated based upon how much business he does. And his interest in the client is purely short-term. I haven’t checked, but hopefully that guy has found a job where his short-term, instant-gratification mindset is better rewarded.

When an economic and monetary system rewards such self-destructive behavior, it’s time to question the foundation of the system.

David Walker, our Comptroller General and head of the Government Accountability Office, is taking his message to the street. Despite his ability to communicate directly to our elected officials in Washington, it appears that he’s just not getting though to our senators and representatives. Perhaps they’re too busy discovering new ways to shelter payments from their favorite lobbyists.

No, instead, he’s decided that he needs to talk to us. That’s right, we the people. The voters who elect these august leaders, and then watch their antics from the comfort of our couch.

Why is he so concerned? He understands that we are wearing a noose that is slowly tightening around our neck. You might not feel it just yet, but it’s there. The government’s own annual report shows a pretty bleak situation: as of 2006, the federal government has $1.5 trillion in assets, but $10.4 trillion in liabilities. But those are just the assets and liabilities “on the books”. Like Enron, we have lots of interesting liabilities that are not on the balance sheet. As I wrote in a discussion over at Redstate:

[The balance sheet] also does not account for the massive unfunded (and unfundable) long-term net liabilities of Social Security and Medicare. I wasn’t going to bring this up, as I didn’t want to depress you, but even the optimistic official estimates are sobering. Look at pages 46-47:

Social Security: ($6.4 trillion)
Medicare Part A: ($11.3 trillion)
Medicare Part B: ($13.1 trillion)
Medicare Part D: ($7.9 trillion)
Railroad Retirement: ($101 billion) <– what a bargain!

Add those up… over $38 trillion in long-term liabilities that are not on the balance sheet.

Of course, there are those who try to put things in perspective. Various commenters then tried to reassure me that the balance sheet doesn’t include significant assets, as well — namely the value of land owned by the federal government, and the assets owned by the American people.

OK, so if our government owns a few $trillion in land, and the total wealth of our citizens is estimated at $55 trillion, how does that help us fund these entitlements? I guess we can just sell off the National Park System, and confiscate the majority of private assets and sell those as well. But who will buy them? Perhaps the Chinese? Good plan. I feel much better.

Seriously, check out the presentation U.S. Financial Condition and Future Fiscal Briefing, available at the GAO’s Web site. Or just watch David Walker’s 60 Minutes interview below:

While his message is a wake up call, I actually think he’s too optimistic regarding how much time we have. You see, he’s focused solely on our government’s out of control spending. He’s not considering the impact of our fiscal policies on our place in the global economy. Having spent time in China and seen firsthand the impact of their rapidly-growing middle class, it is clear that China is transforming over the next 4 to 10 years from a low-cost producer and exporter to the world’s most voracious consumer.

We are the world’s largest debtor nation with a population of 300 million, and we will soon be competing for food, energy, natural resources, and manufactured goods with China’s 1 billion consumers. Also consider that China is, slowly, allowing their currency to appreciate. As their middle class grows and domestic consumption expands, their domestic market will become more valuable than export markets. At that point, the People’s Bank of China won’t need to keep their currency artificially low relative to our dollar. So not only will we be competing with their billion consumers, we’ll be competing with a currency that is significantly weaker than it is even today.

Unless we can reign in our government, and again make our nation attractive for investment, it’s going to be a rough ride. Perhaps we the people will wake up in time to realize that we actually do have the power to change the equation.

This might not surprise you, but after reading this CNN/Money article entitled, “Panic on Wall Street: A brief history of fear”, I’ve come to the conclusion that CNN doesn’t understand how our banking system works. Here are some interesting quotes that portray unfortunate financiers as innocent bystanders victimized by panic and circumstances outside of their control:

If the Panic of 1873 has one timeless lesson, it’s the physical inability of everyone to escape from trouble at the same moment. Jay Cooke, the railroad financier, had been stiffed by international lenders, and his bank (which then fronted the intersection of Wall and Broad) was suspending payments…

Which brings us to the Great Panic of ‘07, the drama - and trauma - that changed everything… The directors of the Knickerbocker Trust thought they were being secretive when they met in a private dining room to discuss whether they should open their doors the next day, given its president’s connection to a speculative copper scheme. They weren’t secretive enough. According to Wall Street lore, they carelessly left the door ajar, and their conversation floated to the ears of a bystander and then, it seemed, to all 18,000 of its depositors… Soon they were lining up at Knickerbocker’s palatial new headquarters at 34th Street and Fifth Avenue. For several days Knickerbocker tried to buy time (one trick was for tellers to count and recount the cash very slowly).

Of course, while the bankers take their hits, the depositors at these insolvent institutions are big losers as well. What’s amusing about this “history” is that Jerry Useem, the Contributing Editor, never even questions the underlying reason that bank panics and credit crunches occur. Could it be that banks lending more money than they have on deposit for lending isn’t really a good idea? Isn’t our entire banking system technically insolvent, since every $1 of central bank deposits is magically transformed into $10 in loans (assuming a typical 10% “reserve ratio”)?

Particularly telling is the portrayal of Andrew Jackson’s struggle against central banking:

Andrew Jackson rid the nation of a central bank in 1836, which helped produce the Panic of 1837. An unforeseen effect of his policies - a host of barely regulated banks flooding the nation with paper money - produced bad results as well as some innovations: Reserve requirements could be met, for instance, by adding a layer of gold coins over a much bigger pile of tenpenny (or subprime) nails.

In short, while Andrew Jackson was able to remove the central bank, he wasn’t able to eliminate unsound fractional reserve banking. When one such unsound bank in Massachusetts collapsed, it was discovered that its bank note circulation of $500,000 was backed by exactly $86.48. Why is this obvious absurdity, and the banks’ protection from criminal prosecution if they suspended payments, not called into question?

Instead, Jerry’s underlying message is a not-so-subtle “thanks” to our Federal Reserve, whose ability to “inject liquidity” creates the moral hazard that ensures panics involving the financial system will recur over, and over, and over again. And every time a panic happens, we go through the same cycle: bailout those immediately affected at taxpayer expense, look for a scapegoat, wave the flag of justice with high-profile criminal prosecutions, and overreach with new legislative and regulatory “solutions” that ignore the underlying problem and further distort the market. You think getting a mortgage is tough now, just wait until you see what the regulators have in store for you over the next couple of years.

If you’d like a more accurate history of the U.S. banking system, The Creature from Jekyll Island by G. Edward Griffin is a good place to start. Here’s a quote regarding the period described in the CNN article just for comparison:

“The period between the Civil War and the enactment of the Federal Reserve System was one of great economic volatility and no small measure of chaos. The National Banking Acts of 1863-65 established a system of federally chartered banks which were given significant privilege and power over the monetary system. They were granted a monopoly in the issue of bank notes, and the government agreed to accept these notes for the payment of taxes and duties. They were allowed to back this money up to ninety percent with government bonds instead of gold. And they were guaranteed that every bank in the system would have to accept the notes of every other bank at face value, regardless of how shaky their position. The net effect was that the banking system of the United States after the Civil War, far from being free and unregulated as some historians have claimed, was literally a halfway house to central banking. (Emphasis mine)

“The notion of being able to generate prosperity by simply creating more money has always fascinated politicians and businessmen, but at no time in our history was it more in vogue than in the second half of the nineteenth century. The nation had gone mad with the Midas complex, a compulsion to turn everything into money through the magic of banking. Personal checks gradually had become accepted in commerce just as readily as bank notes, and the banks obliged their customers by entering into their passbooks just as many little numbers as they cared to “borrow”. As Groseclose observed, “The manna of cheap money became the universal cry, and as with the Israelites, the easier the manna was acquired, the louder became the complaint, the less willing the people to struggle for it”.

“The prevailing philosophy of the time was aptly expressed by Jay Cooke, the famous financier who had marketed the huge Civil War loans of the federal government and who now was raising $100 million for the Northern Pacific Railroad. Cooke had published a pamphlet which was aptly summarized by its own title: How Our National Debt May Be a National Blessing. The Debt is Public Wealth, Political Union, Protection of Industry, Secure Basis for National Currency. “Why,” asked Cooke, “should this Grand and Glorious country be stunted and dwarfed — its activities chilled and its very life blood curdled by those miserable ‘hard coin’ theories — the musty theories of a bygone age.” As it turned out, however, the chilling and curdling came, not from the musty hard-coin theories of the past, but from the glittering easy-money theories of the present. The Northern Pacific went bankrupt and, as the mountain of imaginary money invested in it collapsed back into nothing, Cooke’s giant investment firm disappeared along with it, triggering the panic of 1873 as it went…

“Altogether, there were four major contractions of the money supply during this period: the so-called panics of 1873, 1884, 1893, and 1907. Each of them was characterized by inadequate bank reserves and suspension of specie payment. Congress reacted, not by requiring an increase in reserves which would have improved the safety margin, but by allowing a decrease. In June of 1874, legislation was passed which permitted the banks to back their notes entirely with government bonds. That, of course, meant more fiat money for Congress, but it also meant that bank notes no longer had any specie backing at all, not even ten per cent. This released over $20 million from bank reserves which then could be used as the basis for pyramiding even more checkbook money into the economy.

“It has become accepted mythology that these panics were caused by seasonal demands for farm loans at harvest time. To supply those funds, the county banks had to draw down their cash reserves which generally were deposited in the larger city banks. This thinned out the reserves held in the cities, and the whole system become more vulnerable. Actually that part of the legend true, but apparently no one is expected to ask questions about the rest of the story. Several of them come to mind. Why wasn’t there a panic every Autumn instead of just every eleven years or so? Why didn’t all banks — country or city — maintain adequate reserves to cover their depositor demands? And why didn’t they do this is in all seasons of the year? The myth falls apart under the weight of these questions.

“The truth is that, if it hadn’t been seasonal demand by agriculture, the money magicians simply would have found another scapegoat. It would have been “immobile” reserves, lack of “elasticity” in the money supply, “imbalance” in international payments, or some other technocratic smoke screen to cover the real problem which was — and has always been — fractional-reserve banking itself. The bottom line was that, in spite of an elaborate scheme to pool the minuscule reserves of the country banks into larger regional banks where they could be rushed from town to town like a keg of coins on the old frontier, it still didn’t work. The loaves and fishes stubbornly refused to multiply.

(from The Creature From Jekyll Island, pp 407-409)

Many bloggers and pundits have dismissed Rep. Ron Paul as an ineffective leader based upon a perceived inability to “build coalitions” or make “meaningful legislative accomplishments” during his twenty years in Congress.

But if “building coalitions” and celebrating legislative “victories” means violating the oath of office to support the Constitution, can you blame him? Just because insanity prevails doesn’t mean he should sacrifice his sanity and good judgment.

However, as President, Ron Paul’s often-singular “no” vote would be much more meaningful. It’s called a veto — and as a result, the ridiculous spending, taxation, and borrowing that characterizes our federal government would require a super (2/3) majority to override President Paul’s Constitutional voice of reason. That alone would restore some sanity to our national debate.

This isn’t to say that Congress isn’t an important part of the problem. It is. But adult supervision by a President who respects the Constitution would have tremendous impact.

Here are the current numbers that shape our reality:Current National Debt: $8.9 trillion ($5.0 trillion held by public, $3.9 trillion by government)

National Debt in 2006: $8.5 trillion ($4.9 trillion held by public, $3.6 trillion by government)

Interest Expense on National Debt in 2006: $406 billion ($222 billion on debt held by public)

Largest departments by expenditure in our federal government (2006):

Department of Defense: $633.9 billion
Health and Human Services: $627.4 billion
Social Security: $593.1 billion
Department of Veterans Affairs: $113.8 billion

Note that since Social Security should be paid out of a completely separate, and sacrosanct, trust fund, it should not compete for tax receipts. Therefore, the interest payment on the national debt (at $406 billion) is effectively the third largest “department” in the federal government!

How does this compare with the size of the economy?
GDP (2006 current dollars): $13.2 trillion

Our debt, which is being used to fund operations, is 67% of our national “income”. It’s one thing to borrow money to invest in an asset you expect to appreciate in value, or to generate income. That’s called leverage. But consistently borrowing money just because you can’t balance your operating budget — well, that’s called stupidity.

Where do we get the money that we spend (2006)?
Individual Income Taxes: $1.0 trillion ($1.8 trillion including earmarked deductions)
Corporate Income Taxes: $350 billion
Additional Deficit: $247.7 billion

Tax payments by AGI and percentages (2004):
Top 1%, with AGI >= 328k, pay 37% of taxes
Top 5%, with AGI >= 137k, pay 57% of taxes
Top 10%, with AGI >= 100k, pay 68% of taxes

Sources:
http://www.treasurydirect.gov/NP/BPDLogin?application=np
http://fms.treas.gov/fr/index.html
http://www.ntu.org/main/page.php?PageID=6
http://www.bea.gov/national/index.htm#gdp

We can’t begin to address our fiscal crisis unless we question the role of government. That questioning can’t stop at the federal level, although it needs to start there. Since states can’t create money, they have a built-in limit on their ability to grow. But the federal government, with its unique ability to monetize its debt, has shown itself unable to exercise even the smallest shred of self-restraint.

But hey — maybe I shouldn’t be so concerned with these figures. In fact, since we’re acting as if the national debt doesn’t really matter, why don’t we just do away with the income tax entirely and fund our government ENTIRELY with borrowing? What does it matter if we add to the deficit by $250 billion with tax receipts of $1 trillion, or just borrow $1.25 trillion? That way we can have our cake and eat it too.

On the other hand, there’s someone else who doesn’t see it that way. His name is David Walker, and he’s our Comptroller General in charge of the Government Accountability Office. His recent report, which provides a none-too-sanguine perspective, was written up last week in the Financial Times. I’d encourage anyone who isn’t yet concerned with our government’s profligacy to the point of insanity to read these two articles.

Some have claimed that a Constitutionally-restrained federal government would be more expensive than the “single state” alternative driven by an all-powerful federal government. The typical rationale is that supporting fifty state bureaucracies is more expensive than a single national bureaucracy for any issue or department in question.

I strongly disagree. History has shown that a Constitutionally-limited federal government and state governments operating in the context of the 10th Amendment are vastly more cost-effective. Why am I so sure? Four reasons:

1) We survived the first 140 years as a nation without a federal income tax, and state taxes during that time were far less than the 30-35% (at least) federal tax burden we shoulder today. Historically, the burden has not been “shifted” from states to the federal government — it’s just been increased at every level to the point of threatening our economic viability as a nation.

2) Every time the federal government picks up a new area to regulate or fund, it typically steps on the toes of, or competes with, existing state regulations and agencies. Education, transportation, and energy are perfect examples. But if a state hasn’t seen fit to regulate something, why is relying on a newly-omniscient Guardian of the Public Good in Washington a good thing? And when the Feds *do* show up at the party, it’s not like the state bureaucrats just give up and retire. You still have Departments of Education and Departments of Transportation in every state. Can you show me an example of a federal department, that if eliminated, would require creation of new bureaucracies at the state level? Other than the Department of Defense, I’ve come up empty.

3) The federal government’s other favorite trick is the “unfunded mandate”. That involves passing a federal law that requires the states do something, but doesn’t provide funding to do it. The RealID act is a perfect example — how are the states going to fund this national ID card? Well, that’s your state’s problem. Maybe they can just reduce Medicaid benefits so we can all afford to smile and show our papers. Oh and did I mention Medicaid? The federal government has decreed that your state has to provide that to illegal aliens, as well. There’s irony in there somewhere, if only I could find it.

4) Most importantly, the federal government ALONE has the power to run an unbalanced budget funded by borrowing and printing new dollars in a fiat currency. Sure, state and local governments can float bonds for capital expenditures like schools and roads, but they can’t just “borrow” money like the feds through the Federal Reserve System to finance an operating deficit. Like I said, try that technique yourself at home. You won’t like the results!

Why do folks line up to go into federal government? That’s where the power, and the funds, are. It pains me to read my Congressman’s Web site, and see him trumpeting the fact that he’s bringing home $300,000 in federal appropriations to fund our local county’s mental health program.Why did that money leave the state in the first place? Where did it come from? Assuming we should be funding it, shouldn’t we be funding it ourself, in a way that respects our local needs and priorities? If we weren’t sending 30% of our incomes to D.C., we’d have a lot more wealth to deal with things at the state and local level.

Even more importantly, our federal government makes fleecing the public through corporate and special interest lobbying much more cost effective. If corporations had to lobby for corporate welfare and protectionist policies on a state-by-state basis, they might actually be motivated to compete based upon creating value in the marketplace instead of legislating and regulating current and potential competitors out of business.

Then take a look at the quality of your state government. Why do many people fear an increased role for state government? Well, if you’re like me, you look at your state government and are underwhelmed by its intelligence, competence, and integrity. (North Carolina is a particularly good example of using state government as a stepping stone to incarceration. Crazy stuff.) State and local governments are widely perceived to be the minor leagues, which is exactly opposite of what our founders intended. The action should be at the local level — that’s where elected officials are closest to the needs and priorities of the citizens!

A Constitutional federal government would encourage more competent state governments. First, there’s nowhere to hide. If a hurricane is bearing down on your coast, and you can’t expect to scapegoat FEMA’s incompetence when the disaster response is, well, a disaster, you might have a workable emergency plan in place. But to the extent that state governments learn dependence on Washington, they are less motivated to take care of themselves.

Second, the issues and responsibilities upon state governments should be greater. Elevating the responsibilities of the state and local governments will encourage more competent folks to seek office. And if it doesn’t, the free market will work as our Founding Fathers and Mothers intended — there are still fifty states from which to choose.

Many individuals appear unwilling to think about their role and involvement in state government. I understand that people might not just want to pick up and leave if the state government doesn’t meet their high expectations. But it’s your state government! It is, and should be, more accessible than the federal bureaucracy in Washington. So your involvement is necessary to ensure that the state approximates your values and priorities in its execution.

Relying on a “benevolent dictatorship” in the form of an omniscient and increasingly-powerful federal government is a dangerous game. Evidence to date suggests that it doesn’t work all that well. While we have functionally ignored the 10th Amendment to our Constitution for some time now, I’m hopeful that enough people are waking up to the dangers of centralized power that we’ll again legalize the Constitution and the 10th Amendment.

There has been a flurry of recent activity in a series of threads over at the Republican blog Redstate.com. I’ve linked the threads below, and then summarized the final thread’s conversations.

Ron Paul’s Currency Plan and Merovingian France
Answer to Ron Paul’s supporters: the Federal Reserve is the Lender of Last Resort
Attention, Ron Paulites: Please help me understand how alternative currencies will work.

blackhedd begins:

I’m posting this as yet another diary because the other ones have gotten too big to keep track of.

And we are now graced with the presence of some new Paulites here at RedState, so I’m hopeful they’ll be able to enlighten us economic illiterates.

I’ve been trying really hard to understand what you want to do. Here’s where I am so far.

Let’s leave the global financial system alone for a moment. This world deals with everything, including currencies, on a risk-adjusted basis. They can and do respond almost instantaneously to changes in the risk profiles of various assets. They’re also big boys and they can take care of themselves.

However, they’re totally in cahoots with both the US Treasury and the Federal Reserve. (And the ECB, and the Bank of England, Japan, the People’s Bank of China, and so on.)

That badly taints the US dollar as both a store of value and a medium of exchange, because we know the dollar is fictitious, and will be created and destroyed willy-nilly by non-market actors (viz., the Fed) in order to serve the interests of the big financial players.

Ok, so far, that should be non-controversial.

We also know that the Fed is fully capable of preventing disruptions in the financial world from messing up the real world, where people go to work and make goods and services. Not only have they proved it several times, but Ben Bernanke also has spent a lifetime studying how that happened in the Depression, and one supposes he’s learned a few tricks.

Ok, so far, still non-controversial.

Now we come to the interesting part. We the people are getting the shaft, because we’re forced to hold funny money that can have all of its value taken away at the whim of non-market actors that we can’t control.

That’s the problem we’d like to solve here.

Now it’s true that the American people have responded to this situation by holding assets other than cash (most notably, residential real estate). In fact, the national saving rate as a percentage of income is now roughly zero. So one could argue that the whole issue is a non-problem. But leave that aside.

Ok, so the proposal is to give legal status to private “money,” to be 100% backed by gold and/or silver.

How exactly is this expected to work? We know that we want everything to be as unregulated and free-market-based as possible.

We also know (because the Paulites have said it again and again) that there will be no fixed dollar-gold exchange rate, as in past gold-standard periods. Rather, the dollar-value of gold-backed money will be fixed by the already-functioning free market in gold.

Did I get that right? Ok, good.

Now that means there will be depositary institutions (Citigroup for example) that will hold publicly-auditable gold reserves, and offer (presumably) certificates. Now there is no requirement that these depositaries be regulated or chartered. Therefore, as with the Federal government during gold standard periods, gold certificates MUST be fully-convertible on demand. Otherwise there will be no public confidence in them.

Are you all still with me?

Now just as with all forms of private currency (e-gold, Second Life, even the US Government), the depositaries need to make a living. Banks normally make a living by lending money at interest. Now comes the first difficult question for the Paulites:

Do you permit fractional reserve lending?

Uniformly, the Paulites have said no. Presumably you wouldn’t allow anything like the 10% fraction that we have today. But during the late 19th century when we had full gold convertibility, banks were allowed to lend against fractional reserves (they didn’t usually hold gold reserves directly but were required to deposit government bonds with Federal authorities). But of course we won’t do that now, since we’re requiring depositaries to hold their own gold.

In the late 19th Century, what happened is that the specific reserve fraction fluctuated over time, as the public found its own preferred balance between deposits and currency.

The problem with all of this, which the Paulites must address, is bank runs. It’s inevitable that banks will close during panics if they use any kind of fractional reserve. Remember, under full gold-backing by private institutions, there is no credible deposit insurance.

So here’s the most likely outcome:

Depositaries will make their livings as SecondLife and e-gold do now: they will take a small percentage of all gold transactions. In order to keep all the money from ending up owned by bankers, we will then depend on the “natural” inflation of the gold supply that takes place through yearly mining.

Among the things we’ll have to forego: the practice of writing paper checks on bank deposits. All transactions will be done in paper gold certificates. (Of course, these can still be done electronically.)

Also, there will be no more risk capital, since there is no real way to earn a rate of return by lending money. But that’s ok, because the real point is to make sure that the money stays sound.

Now I’m stuck. Paulites, please answer this for me: how can I buy a house or a car? Who’s going to lend me the money to do it? Or do I stick to dollars for any kind of transaction involving finance?

Responses:

Not that hard by Whitfox

Easy enough. As mentioned, there is no fractional-reserve lending. Therefore, during a bank run, all assets are available for distribution. Heck, there’s no other place for assets to be, since banks can’t make loans - they must mantain 100% reserves. Naturally, they’ll be charging a fee for that, not giving interest.

So how do you finance a boat? The rent-to-own model still works without creating currency. After your final payment, the boat is yours. Until then, you’re just renting it, with the option to continue renting until ownership is obtained.

Financing a business is more interesting. Sales of equity are fine. Sales of bonds aren’t, since that again creates money from nothing more than a promise. The closest you can come to the latter is selling assets to the bondholder and getting a rent-to-own agreement in return.

As said, this much is easy. What’s much, much harder is:

* Is the removal of debt from financing actually worth the market restriction you’re getting? You can argue that Treasury bonds are a net loss to the United States, since we taxpayers have to keep paying interest on them. But we’re not talking about Treasury bonds here, but Ron Paul’s new currency.

* Is there any point in making this alternate currency, and then restricting it from current finance opportunities? It’s not clear the markets will be leaping for joy about money that can’t be invested in traditional ways. Also consider any advantage in having precious metals evaporates the instant you invest it into something.

* What’s the cost of the transition? All government mandates have their costs, and reorganizing financial institutions to deal with new restrictions won’t be cheap.

As mentioned on the other thread, I can’t support Ron Paul in this, much as I appreciate the idea of finance reform.

 

There’s no problem with bond sales by bhday

A company can sell a bond, and put the money to work to pay you a rate of return. If you buy the bond with your hard currency, no “new” money has been created. The company has just assumed an obligation to pay you back.

In fact, this mechanism (selling bonds) is used by the People’s Bank of China specifically for the purpose of “sterilizing reserves”. When new USD come in to pay for exports, the PBC gives the exporter RMB in exchange for their USD. The PBC then sells a bond to Chinese banks and insurance companies to “soak up” an equivalent amount of RMB so no new net RMB are created.

That’s just a temporizing measure, though, since those bonds then become reserve assets in China’s fractional reserve banking system… and the banks will inflate by loaning against those assets…

Although the PBC regulates reserve ratios etc. to try and minimize inflation, they can’t hold it off forever. That’s the reason why EVENTUALLY China’s currency will float.

Amazing how all this stuff is related…

 

Doesn’t quite work by Whitfox

Say I start up a newspaper, and I get a money from selling a bond. That money buys a printing press and the services of some copywriters. Where’s the money going to come from if I get a payment demand? I may not make enough money to pay it back, even if I sell my used printing press.

This is creating money, not in the form of dollars, but in the form of that bond. It may or may not ever be repaid. If that risk gets included in the contract, we’re really trading partial ownership in the venture for money.

Our finance law giving sales of debt (bonds) so much privledge over sales of equity is one of the places there’s room for improvement, IMO.

 

Sure it does… by bhday

Bond == Securitized Loan

If you’re starting up a new newspaper, you’d typically get a collateralized loan, or pursue equity investment. If you’re an established media company with a good track record looking to expand, you can likely sell a bond which is just a loan that’s packaged for purchase by investors.

So you want to start up your newspaper, and blackhedd (with a few of his friends) take a hard look at your business plan. They think you’re going to be able to reverse the decline in the print media business with your plan for a new Republican newspaper called the “Daily Red State”.

Because they believe in YOU, and the business plan you’ve proposed for the DRS, they take THEIR EXISTING MONEY and give it to you in exchange for a promise to be repaid over time, with suitable interest to compensate them for the risk. Additionally, because they are debt (instead of equity) investors, they have first claim on the assets of the DRS in the event you can’t pay them back as expected (ie, default).

Again, in the context of “This is creating money, not in the form of dollars, but in the form of that bond. It may or may not ever be repaid. If that risk gets included in the contract, we’re really trading partial ownership in the venture for money.” –> The bond BETTER be repaid, or blackhedd is going to take over your business. The risk of default will ALWAYS be included in the contract. The key difference between debt and equity investors is that debt investors have first claim on the business’ assets in default. Equity investors (people who buy stock) are co-owners of the assets with you so you all succeed (or lose) together.

Regardless, NO NEW MONEY HAS BEEN CREATED. The dollars that Blackhedd Syndicate, LLC loan you were earned by them, and not created out of thin air by a fractional reserve banking system.

Regarding, “Where’s the money going to come from if I get a payment demand? I may not make enough money to pay it back, even if I sell my used printing press.” –> Your creditors expect you to get the money to pay the interest and principal back over time from your customers, and successful execution of your business plan. If they call in the loan and take over your business because you’re not successful and default on the loan, then they (and you) are likely to take a loss. But that’s the free market at work, and perhaps everyone overestimated the popularity of a daily newspaper comprised of insightful blog postings from redstate.com.

But again, no new money is created when an owner of capital (Blackhedd Syndicate, LLC) lends its existing money to someone else. It’s just when banks create new capital out of thin air by lending 10x as much money as they have in the vault that things get, well, inflationary.

Fiat currency + Fractional reserve banking –> Rewards debt and speculation, benefits banks at the expense of the capital owners

Sound currency + “Honest” (not fractional reserve) banking –> Rewards saving and investment, puts banks and their customers (who are the owners of capital) on equal footing

The problem with this picture is deflation by blackhedd

You’re pretty astute about how I and my partners would go about evaluating a new media venture, and how we would expect to be rewarded for making the investment. You’re even perceptive about what would make me take an interest in the venture in the first place.

But the net result of successful business activity is always the production of goods and services that improve people’s lives in ways that are tangible enough to attach a price to.

In a strict sound-money world, as both production levels and productivity levels increase (the latter as a direct cumulative result of the increase in physical capital), the price that ordinary people pay for goods and services must fall.

And so does the price they receive for their labor. Remember, I’m not going to fund the newspaper unless I get my coupon payments every six months, plus return of the principal when the bonds run off. Multiply me by all the other investors, and over time we become a class of fat cats with most of the gold, while no one else has very much to speak of.

Over a hundred years ago in Chicago, a Presidential candidate with a huge voice said what I just said, but in a much more concise and compelling way:

“You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold!”

We’re getting closer… by bhday

blackhedd, this is great. We’re getting there.

Regarding “But the net result of successful business activity is always the production of goods and services that improve people’s lives in ways that are tangible enough to attach a price to…. In a strict sound-money world, as both production levels and productivity levels increase (the latter as a direct cumulative result of the increase in physical capital), the price that ordinary people pay for goods and services must fall… And so does the price they receive for their labor.”

You’ve illustrated a potential cause of price deflation for whatever goods/services are subject to increased production and increased productivity levels. But the subsequent argument about wage deflation does not follow from that. Just because a particular item is cheaper now due to greater production or productivity does NOT imply that anyone’s time or labor is less valuable.

The bottom line is that in a free monetary system, where gold or silver or platinum (or whatever) is transferred among buyers and sellers as a medium of exchange, the purchasing power of any individual unit of money WILL NOT REMAIN CONSTANT over time. It will fluctuate, appropriately, based upon the supply and demand for money itself.

I repeat, we “sound money” folks are not against inflation or deflation per se. Inflation is a loss of purchasing power of an individual monetary unit — and in an “honest” system, that simply reflects a decreased demand for money. Deflation is a gain of purchasing power of an individual monetary unit, and simply reflects an increased demand for money.

Perhaps this example will help. Most people get stuck on sound money because they are obsessed with the “quantity” of money. Will we have enough money to create growth? What if there isn’t enough “circulating” because people are hoarding it? (You said earlier that you’re real concern is ECONOMIC ACTIVITY, not MONEY… and I agree 100%. Let’s just see how this plays out.)

Let’s take the case of folks irrationally hoarding gold coins, taking them out of circulation. What happens? The purchasing power of the remaining gold coins go up, and prices go down. Voila, deflation. The money you have now buys more stuff. How is that a problem? Does that hurt economic activity? If you were saving to make an investment, or start a new business, your now-increased purchasing power might be the impetus for pulling the trigger on your latest entrepreneurial venture. Your investors likewise feel that their dollars will now provide enough working capital to fund the business plan, and you start creating value and true wealth in the market. All because prices of goods had fallen (or the purchasing power of your money had increased).

Now let’s look at the flip side. All of sudden these irrational hoarders start dying off, and their relatives find these massive supplies of coins in walls, mattresses, and closets. Assuming the relatives choose to spend or invest the coins, they will then re-enter the economy. Just as the hoarding drove demand for money up (and price levels down), this “dishoarding” drives demand for money down (and price levels up). So more money available means higher prices, or inflation. Is that a bad thing? No… as I’m sure you’d agree, this money is now available for spending or investing… it may be spent on goods and services, or invested still your NEXT entrepreneurial venture. So while low prices may have been the impetus for investment in the deflationary environment, access to this newly-freed capital will be the impetus for investment (and subsequent growth) in the inflationary environment.

Get it? The quantity of money ultimately DOESN’T matter. Prices will adjust to their appropriate monetary ratio based upon the availability of the “moneystuff”, whatever it is.

So we sound-money types don’t fear inflation or deflation *in a free market*. But we should ALL fear inflation AND deflation in a “managed” system with a fiat currency and fractional reserve banking… because the boom/bust cycles that result disrupt what we all want, which is real economic growth.

***

Regarding ” Remember, I’m not going to fund the newspaper unless I get my coupon payments every six months, plus return of the principal when the bonds run off. Multiply me by all the other investors, and over time we become a class of fat cats with most of the gold, while no one else has very much to speak of.”

Huh? That doesn’t make any sense to me at all. First of all, you’re a CREDITOR, not an investor. You loaned me the money to start a paper. I pay you back out of my earnings as expected and you receive your desired rate of return. No more, no less. But I participate in the upside of my equity position, and when Rupert Murdoch decides he wants to buy the DRS, I (and my equity partners) have a huge payday. But on the balance, we all do well — we should, we created real value in the market.

***

Regarding ” Over a hundred years ago in Chicago, a Presidential candidate with a huge voice said what I just said, but in a much more concise and compelling way:
“You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold!” –> Ironically, we’re kind of on the same page here. There’s no reason that ONLY gold should be coined into money. Silver will also work fine, as well. There’s no need to fix a ratio between the two, however, as that will also take care of itself.

Alright, hang on… by bhday

This shouldn’t hurt a bit

First, I also disagree with the assertion, “Fed is fully capable of preventing disruptions in the financial world from messing up the real world.” –> As previously stated, eons of history suggest otherwise. Which is why we’re having this discussion.

Regarding the question, “Ok, so the proposal is to give legal status to private “money,” to be 100% backed by gold and/or silver. How exactly is this expected to work?” –> Easy. Just repeal the legal tender laws. The only institution that will be *required* to accept Federal Reserve Notes for settlement of debts is the federal (and perhaps state and local?) government (i.e., you could always pay taxes in Federal Reserve Notes). Anyone else can take ‘em or leave ‘em. Most folks would continue to take ‘em, but they would be instantly subject to open market competition.

Regarding the question, “The problem with all of this, which the Paulites must address, is bank runs. It’s inevitable that banks will close during panics if they use any kind of fractional reserve. Remember, under full gold-backing by private institutions, there is no credible deposit insurance.” –> “Honest” banks that support hard currency would (again) distinguish between time deposits and demand deposits (that’s where we’ve again lost our way). A time deposit (i.e., a CD) pays interest, but CANNOT be withdrawn until it matures — because the money literally isn’t in the vault, it’s out working and earning you interest. A demand deposit (i.e., a checking account) is something that YOU pay for, for the convenience of drawing against it via Web banking, checks, ATMs, or whatever. (You could still write checks, though… we WOULDN’T need to eliminate “the practice of writing paper checks on bank deposits”.)

Your demand deposits would sit in the vault until you needed them, no loans would be written against them. Your time deposits would be put to work following the risk/reward profile YOU choose (or maybe you’d continue to invest in stocks, real estate, or whatever). Complete confidence in demand deposits == No runs on banks. The previously-cited financial instabilities during the “gold standard” eras resulted from fractional reserve banking gone awry, not the currency itself.

In this world, you wouldn’t NEED deposit insurance. But you’d probably look for an independent “Consumer’s Reports” seal of approval on your bank of choice to ensure it had the appropriate audits and internal controls in place.

Regarding “In order to keep all the money from ending up owned by bankers, we will then depend on the “natural” inflation of the gold supply that takes place through yearly mining.” –> I’d question this assertion, as there’s no one forcing you to use one bank or another to intermediate transactions. And banks have expenses, too. It’s not like they will be earning “abnoral profits” if there’s truly a free market for their services. They’ll pay employees who will spend money, etc.

Regarding, “Also, there will be no more risk capital, since there is no real way to earn a rate of return by lending money.” –> This part is emphatically NOT true. The key difference is that YOU will be lending YOUR money, and not allowing the bank to create new money out of thin air based on your deposit. If YOU have the money, you can choose to buy a bond, or a CD, or any other instrument that then allows YOU to lend your money to someone else. You can use a bank as an intermediary, or perhaps even you could create an “S&L” with your friends and loan to people YOU trust. The heart of the current system’s immorality is that it CREATES NEW MONEY in loans, and takes value from YOU, who put the deposits there in the first place.

Regarding, “Now I’m stuck. Paulites, please answer this for me: how can I buy a house or a car? Who’s going to lend me the money to do it? Or do I stick to dollars for any kind of transaction involving finance?” –> Again, lots of options. You can borrow for things that make sense. Does it make sense to borrow money for a depreciating, non-revenue generating asset? Uhhh… not really. So you really *should* save for a car. Should you borrow to start or expand a business? Sure. But you can also look for investors. Should you borrow for a house? If the the real estate market isn’t inflated beyond belief due to loads of cheap money, that’s not the worst thing in the world to do.

If none of this makes any sense, I’d highly recommend that you read Dave Ramsey’s book, “Total Money Makeover”. We have a belief system regarding consume debt that is (as you’ve noted) both highly rational (due to our inflationary currency) but ultimately self-destructive.

I should also note that you *could*, if you wanted, by bhday

purchase private deposit insurance. The insurer would be incented to watch the bank closely, and it would be cheapest to buy insurance for deposits in the best banks.

The free market would be an amazing thing…

How do I get compensated for taking risk? by blackhedd

In what follows, I’m assuming that your new commodity-money system operates alongside of the existing financial-money system, and only supplants it to the degree that free markets determine.

If I may assume that (and nothing any of the Paulites have said contradicts it), that simplifies the analysis because I don’t have to throw away the whole existing infrastructure that is based on capital-asset pricing models.

That allows us to concentrate strictly on personal business that would now be transacted in commodity money.

You disposed of the problem of bank runs as I expected you would: by strictly ruling out fractional reserves. Strictly speaking, this rules out commercial banking as well.

Insofar as demand deposits are concerned, we’re in agreement. The reason to continue having them is that gold is cumbersome and inconvenient to hold compared to paper or electronic gold-certificates, so someone has to be the custodian of the physical metal. And since that someone (I call it a depositary, you call it a bank) needs to be paid to provide the service, you and I agree that they should take a small fee either for every transaction or a yearly fee for deposits.

As you say, the services provided to demand-depositors are something they have to pay for. We’re agreed on this point. Now my point about this that you brushed past is that since the total amount of gold is fixed, if the depositary/bank takes, let’s say, 50 basis points per year from your deposits (about the load of the most efficient mutual funds), then after a couple hundred years, the bank owns everything and the depositors own nothing. Of course, the “natural” inflation of the gold supply through mining takes care of this little problem.

On to time deposits. What you’re proposing amounts to this: I give my money to a bank, which gives me in return a piece of paper that is no different from a traditional coupon-bearing fixed-income security.

The bank, in turn, uses its resources (of wisdom, judgment of character, personal contacts, and knowledge of current business conditions) to invest my money in ways that will bring them a high enough return to make coupon payments to me, and still have a profit for themselves.

Now in a low or no-inflation world, interest rates are generally very low, because (obviously) investors don’t need to be compensated for the (nonexistent) risk of inflation.

But investors still need to be compensated for taking credit risk and market risk. What if the bank invests the money from my CD in a business that fails?

So the rate of interest can never be zero. But in a strictly non-inflationary world, a non-zero interest rate is socially unsustainable because, given enough time, the investors own everything and the people own nothing.

So what rate of interest is low enough to forestall this outcome, yet high enough to make investments worth making? That’s why I said that there is no risk capital in your world, and we still need my world of finance and capital assets backed by (somewhat) inflationary money.

My conclusion at the end of the day is that your system is useful primarily as a hedge against total catastrophe, which can result from market failures, government malfeasance, incompetence, or all three.

Since Paulites consider total catastrophe to be a foregone conclusion with only the timing in doubt, this is a very reasonable hedge for them to buy.

Since I’m a financially-oriented guy, I take a risk-adjusted view of everything. Since you’re willing to buy a hedge against total catastrophe, I’m willing to sell it to you. Let’s meet in New York next chance you get and discuss deal terms.

 

 

 

Wow, maybe this WILL take a while… by bhday

Ok, deep breath… Here we go:

Regarding “That allows us to concentrate strictly on personal business that would now be transacted in commodity money.” –>

What? I’m starting a business here, a real entrepreneurial venture called the Daily Red State, with your commodity money that you earned through great effort. There’s no distinction between “personal” and “commercial”.

***

Regarding “You disposed of the problem of bank runs as I expected you would: by strictly ruling out fractional reserves. Strictly speaking, this rules out commercial banking as well.” –>

Hmmm… Why does this rule out commercial banking? A bank simply holds deposits (demand deposits for a fee, and time deposits that earn interest). An HONEST bank just doesn’t confuse the two, and never lends out more than its depositors have allowed it to. Commercial or retail, there’s no difference. This free market system would encourage and reward honest banks.

***

Regarding “As you say, the services provided to demand-depositors are something they have to pay for. We’re agreed on this point. Now my point about this that you brushed past is that since the total amount of gold is fixed, if the depositary/bank takes, let’s say, 50 basis points per year from your deposits (about the load of the most efficient mutual funds), then after a couple hundred years, the bank owns everything and the depositors own nothing. Of course, the “natural” inflation of the gold supply through mining takes care of this little problem.” –>

What? All we’re talking about is a network of warehouses that store physical assets. Those warehouses will compete in a free market for their services, which are not highly technical. That competition will make the storage service available as cheaply as possible — because if anyone starts earning “abnormal” profits, you are free to open a competing warehouse next door. In the absurd case you postulate, if a bank could truly own EVERYTHING just by guarding the gold at 50bp per year, then EVERYONE (myself included) would open a bank to do just that. That

Economically, here’s what happens: The person paying the storage fee is the person holding the “demand” on the gold. After you loan me your sound money at 8% to start the DRS, I have claim on that gold. My carrying cost for this capital is 8.5% (8% interest, plus 0.5% storage fee). But I am going to deploy this capital into printing presses and other investments that I expect to grow at 20%. (You believe it too, which is why you gave me the loan.) So not only am I going to earn a better rate of return than the interest plus the storage fee, that storage fee will go down as I start spending the money.

The point you make is actually a strong argument for the *pro-growth* nature of free-market money in an honest (non-fractional-reserve) banking system. There IS a cost to just leaving gold idle in the vault. You could take it out of the vault and hide it in your mattress, but that doesn’t scale too well. What you’ve illustrated is that in this environment capital does NOT benefit from being lazy — it will always seek to be invested in a way that maximizes its return, and certainly will cover the (very small) storage fee.

***

Regarding “On to time deposits. What you’re proposing amounts to this: I give my money to a bank, which gives me in return a piece of paper that is no different from a traditional coupon-bearing fixed-income security… The bank, in turn, uses its resources (of wisdom, judgment of character, personal contacts, and knowledge of current business conditions) to invest my money in ways that will bring them a high enough return to make coupon payments to me, and still have a profit for themselves… Now in a low or no-inflation world, interest rates are generally very low, because (obviously) investors don’t need to be compensated for the (nonexistent) risk of inflation… But investors still need to be compensated for taking credit risk and market risk. What if the bank invests the money from my CD in a business that fails?” –>

Well, the bank better not make too many bad investments, or else they will lose their depositors’ money. But they will ONLY lose the money that was put at risk. And that risk could be minimized by (again) private insurance. So let’s say that the bank (or ANY institution — doesn’t need to be a “bank”) offered an interest-bearing deposit that gave you 5% interest over 6 months. The prospectus said that the deposit funded short-term working capital needs for your local gas and electric utility company. Would you invest in that? Sounds pretty safe to me. But it’s your choice. Say you could also buy principal protection insurance for another 50bp. Thus, your RISK-FREE return was 4.5%. Does that sound better to you? You’re still covering the storage cost, and you’ve preserved your buying power over time since interest rates reflect the supply and demand for money discussed in my prior post.

The free market can provide all that, and more. It slices, it dices… it’s the invisible hand! (Meanwhile, the bank has been forced through competition to get quite lean, and charges the utility 6% to borrow the funds. It can be profitable on a spread of 1% due to the lack of government regulations and compliance requirements. It just needs to satisfy its private insurers demands for transparency and internal controls).

***

Regarding “So the rate of interest can never be zero. But in a strictly non-inflationary world, a non-zero interest rate is socially unsustainable because, given enough time, the investors own everything and the people own nothing… So what rate of interest is low enough to forestall this outcome, yet high enough to make investments worth making? That’s why I said that there is no risk capital in your world, and we still need my world of finance and capital assets backed by (somewhat) inflationary money.” –>

I’m not following the assertion that nonzero interest rates imply all wealth flows to investors over time, and “people own nothing”. The reality is that in a free-market monetary system, ALL the people (and institutions) are investors. There is no difference between saving and investing. Say you (as a corporation or individual) keep two months’ worth of money in a demand deposit account. You pay your bills out of that account, live within your means, and structure the rest of your assets in equity investments, real estate, fixed income, and short-term certificates of deposit for ready access to emergency capital. YOU are the investor. I am the investor. We all are investors. As we invest, we are by definition taking risk. All our investments are risk capital in different types of assets. We DO NOT want all our assets just sitting in a demand account, withering away. That would be irrational. So we manage our demand deposit balance accordingly.

Now granted, this system is NOT for everyone at first. The only people who will participate are those who understand that true wealth comes from creation of value in the marketplace (like you said earlier), and not from some misguided effort to finance conspicuous consumption. Folks with credit card debt, subprime mortgages, car loans, and so forth will probably feel more comfortable in the inflationary world, where they can try to get ahead on the hamster wheel of paying down their debt with a depreciating paper currency. While prior discussions have characterized that behavior as “rational” and “smart”, in the long run it’s a form of slavery to the banking industry. But the banking industry isn’t complaining.

But that’s at the micro level. At the macro level, the real problem comes when a nation of debtors with a national debt can no longer sell bonds to China because they no longer need, or want, to support their fixed RMB exchange rate. Then we’ll all be competing with a billion Chinese to buy food and energy in the global market with an even weaker paper currency:
http://www.redstate.com/stories/economy/sino_american_economic_relations…
http://blog.lawsonforcongress.com/2007/08/12/the-china-conundrum/

***

Regarding “My conclusion at the end of the day is that your system is useful primarily as a hedge against total catastrophe, which can result from market failures, government malfeasance, incompetence, or all three. Since Paulites consider total catastrophe to be a foregone conclusion with only the timing in doubt, this is a very reasonable hedge for them to buy. Since I’m a financially-oriented guy, I take a risk-adjusted view of everything. Since you’re willing to buy a hedge against total catastrophe, I’m willing to sell it to you. Let’s meet in New York next chance you get and discuss deal terms.” –>

The problem is that when that hedge pays off, your paper money, contracts, and promises will be worthless. Seriously, all we RonPaul™ supporters are asking for here is free choice. The dynamics have changed — this time, the cross is not of gold, it’s of paper. WJB did not want to be limited to gold, we don’t want to be limited to paper.

I would caution you not to be too comfortable with our current position, and more importantly our trajectory, as a nation and an economy. We have a number of challenges facing us, and the stability of our currency within the international monetary system is a significant one. The governmental assault on domestic job creation and the entrepreneurial environment is also critical. It’s not too late to make a difference, but folks need to get educated on these topics, and quickly.

Reply To This — User Info — #44

To re-emphasize… by bhday

First, I hope these posts have illustrated how a free-market commodity currency in a non-fractional-reserve banking system is the *most* pro-growth monetary system imaginable. Since there is a small but real cost for holding commodity money in a demand deposit account, all monetary assets will immediately, and efficiently, be assigned through investment to their highest-yielding (and thus most valuable) use. That’s the key to responsible growth. It doesn’t require subsidies, “adding liquidity”, or social engineering. Just let the market do its job separating the good ideas from the bad.

Second, while I welcome the discussion, at some point I need to suggest that you read the following books:
What Has the Government Done to Our Money? (Murray Rothbard, available from www.mises.org)
Economics in One Lesson (Henry Hazlitt)
Economics for Real People (Gene Callahan)

They’re straightforward easy reads and debunk a lot of myths and misunderstandings that permeate our current dialog.

 

 

One of the most influential books for our family was Dave Ramsey’s Total Money Makeover. Dave slays the myths about consumer credit and our debt-strapped society, and after reading this book several years ago, we put ourselves on a trajectory to live debt-free.

Dave’s pointed analysis of our personal finances accelerated my broader interest in the financial system as a whole. After looking at the reality of debt, credit, and inflation both at the micro and macro level, I love finding real-world examples that bring things together in a cohesive way — such as today’s furniture shopping at the local flea market.

We needed a new bookcase. When evaluating the market comparables, we found the following:

New (Target.com): Four-shelf imported bookshelf made of MDF (particleboard) with cherry laminate finish. Price - $140.
New (Ethan Allen): Imported hardwood bookshelf atop hardwood hutch. Utility and appearance similar to flea market model below. Price - $1600.
Used (Flea Market): 20th-century American-made hardwood curio cabinet with three-door glass cabinet, atop three door hardwood hutch with three drawers. Lots of shelves, finish in great condition. Price - $500.

Economically, what is the best purchase? If you’re interested in “saving money”, you could spend $140 on the plywood/laminate bookshelf. But after ten years (if it makes it that long), the particleboard/laminate bookshelf will be in the trash heap or recycling bin. You traded $140 in purchasing power for something to hold your books, but over time, that purchasing power (from your perspective) will disappear into the dustbin of history. The money is literally “spent”.

The new Ethan Allen furniture is over 10x as expensive as the Target solution, and although it still holds your books, it is solid wood and built to hand down to your children. However, it’s made overseas using lumber that may have been non-sustainably stripped from a hardwood forests. It also took a lot of fossil fuels to get the thing to your door. But environmental concerns aside, you’re being asked to trade $1,600 in purchasing power for hardwood furniture that will hold your books.

The flea market solution is starting to look even better. It’s a nice piece of furniture that was built to last. It’s been well treated, and when you purchase it from the local antique dealer, your purchasing power is transferred to someone who is in business for himself in your same community. But the best part is that you’re only being asked to trade $500 (instead of $1,600) for the same functionality.

So how is a well-built used dresser a hedge against inflation? Well, thinking ahead ten years, have you really lost anything? Has your money been “spent”? If you need to sell this bookcase in ten years, someone will be willing to pay you whatever a well-built bookcase is worth at that time. If you damage it, you may take a loss. But if you are careful and take care of it, the value of that item to a new owner should be about the same as it is now. So you’ve just traded $500 in cash for an asset that, over time, should hold its value pretty well. Additionally, in ten years, the new Ethan Allen bookcase will likely be valued similarly to the flea market one — after all, they’re both used bookcases that look about the same and provide the same value to the owner. So why spend $1600 now, when your likely “exit” should you choose to sell it in ten years might be closer to the inflation-adjusted equivalent of today’s $500?

Finally, if you’re at all tempted to buy the Target bookshelf that will disintegrate in ten years, then keep in mind what you’re doing. You are literally giving away your purchasing power, and getting nothing but some help holding books for a limited amount of time in return. You’re effectively “paying rent”, and not actually buying anything of lasting value. Not only are you not hedging against inflation, but you are becoming immediately poorer as a result of your spending habits.

So there you have it. You can recycle, buy American (again!), save money, and hedge against inflation by doing something as simple as purchasing nice used furniture at the flea market or local antique store. Oh, and one more thing — Ethan Allen will tempt you to finance that new $1,600 bookshelf… thus paying even MORE money for the privilege of taking a greater loss later. If you think that’s a good idea, you REALLY need to read Dave Ramsey’s book!

If there’s any truth to reincarnation, given the current environment, I’d love to come back as a multinational corporation. While I’d read about the tax minimization strategies of large corporations, it never really hit home until I saw it firsthand.

I recently transitioned from a small technology startup company to a large multinational corporation. As part of my orientation to the new environment, I had a great opportunity to meet folks throughout the organization, and learn about the tremendous corporate resources at our disposal. One of the most memorable conference calls occurred with my introduction to the corporation’s overseas subsidiary. I’d done enough reading to know the purpose for this entity, so when the director on the call asked if I knew what they did, I figured I could show off: “Sure, you’re an intellectual property holding company that upstreams income for tax efficiency.”

(In English, that means that the businesses operating in the United States and other high-tax jurisdictions sell their products as “intellectual property” to this overseas subsidiary. Then, the U.S. operating business pays a handsome royalty to the overseas subsidiary for using/selling their product every year. Thus, the net income of the U.S. operating business is minimized, since the royalty payments to the overseas subsidiary are subtracted from revenue. Since tax is calculated based on net income, the corporation can then deliver more post-tax income to its owners.)

Judging from the prolonged silence on the other end of the phone, I thought something might have been lost in translation. The response, while delayed, was emphatic: “Uhhh… You can’t say that.” You see, the IRS takes a dim view of companies that set up corporate structures just to minimize taxes. (I don’t understand why, though. Why shouldn’t a person or a corporation act in its economic best interest?) So while there is widespread acknowledgment that this technique is being used, the IRS generates work for lots of accountants and lawyers to show conclusively that these sorts of overseas subsidiaries are not just passive intellectual property holding companies. Instead, they need to be operating companies that direct strategy and operations for the business units located in the high-tax jurisdiction.

As you can imagine, there are lots of late-night discussions as to how one might “prove” or “show conclusively” that an offshore company is really calling the shots and not just sitting there generating huge tax savings. You’ve clearly got to hire people over there, and those people have to be busy. They have to create Excel spreadsheets, PowerPoint presentations, have conference calls, and put cover sheets on their TPS reports. It also helps if they travel and interact regularly with their colleagues in the United States as well. Isn’t that a wonderful system?

Over time, I began to realize that I was incorrect with my initial response. This overseas subsidiary did not just collect income, it really did play an active role in operations. But is that a good thing? When you have highly-specialized, nuanced products serving folks in the U.S. market, is it good business sense to have to balance the input from “corporate” half a world away? How does that serve the customer? How does that help make the organization more agile and responsive to challenges in the marketplace?

Hint: it doesn’t. Overall it hurts the company’s competitiveness. But it still enhances the after-tax profitability of the company relative to just earning the income in the high-tax jurisdiction.

Consider this: when a country’s tax system is so punitive that companies who can afford it will create entire divisions overseas, is that country likely to create a lot of new entrepreneurial ventures as well? In the world of Internet-based businesses and global competition, the answer is increasingly no. While there still are certain industries where the advantages in the United States outweigh the high costs, new ventures are increasingly creating jobs and wealth outside of this country.

This data is a bit dated, but it gets the point across. As recently as 2005, we’re squarely in the middle of the pack, and behind China and India. So I’ll ask the question again, when will our government stop strangling the goose that lays the golden eggs of domestic entrepreneurship and job creation?

I just watched this utterly shocking interview with Dick Cheney from 1994. In 1994, Dick Cheney asked the question, “How many additional dead Americans is Saddam’s life worth?” His answer at the time was “Not very many.”

I wonder what caused such a drastic change of heart, in light of his specific predictions about the quagmire (his own word) resulting from toppling Saddam’s regime?

Why did we invade Iraq? Was it really WMD? Some claim they all disappeared to Syria, but we’ve not found them in Iraq. Was it 9/11? But Saddam Hussein wasn’t involved in 9/11, according to President Bush:

Regardless of why we invaded, we didn’t do it through a Constitutionally-required congressional Declaration of War. More importantly, having addressed the WMD issue and with Saddam now executed, why are we still there? Perhaps you’d like to hear Richard Holbrooke’s perspective, as interviewed on the Charlie Rose show:

http://www.charlierose.com/shows/2007/07/31/2/a-conversation-with-richard-holbrooke

Finally, there is an alternative perspective (thanks to dry British wit):