After the turmoil over the past week, and looking towards the Senate’s likely vote on the Paulson plan on Wednesday, US Army Colonel Andrew Bacevich provides some excellent food for thought in his interview with Bill Moyers:

BILL MOYERS: It’s been a long time since I’ve read a book in which I highlighted practically every third sentence. So, it took me a while to read, what is in fact, a rather short book. You began with a quote from the Bible, the Book of Second Kings, chapter 20, verse one. “Set thine house in order.” How come that admonition?

ANDREW BACEVICH: Well, I’ve been troubled by the course of U.S. foreign policy for a long, long time. And I wrote the book in order to sort out my own thinking about where our basic problems lay. And I really reached the conclusion that our biggest problems are within.

I think there’s a tendency on the part of policy makers and probably a tendency on the part of many Americans to think that the problems we face are problems that are out there somewhere, beyond our borders. And that if we can fix those problems, then we’ll be able to continue the American way of life as it has long existed. I think it’s fundamentally wrong. Our major problems are at home.

BILL MOYERS: So, this is a version of “Physician, heal thyself?”

ANDREW BACEVICH: Well, yes, “Physician, heal thyself,” and you begin healing yourself by looking at yourself in the mirror and seeing yourself as you really are.

BILL MOYERS: Here is one of those neon sentences. Quote, “The pursuit of freedom, as defined in an age of consumerism, has induced a condition of dependence on imported goods, on imported oil, and on credit. The chief desire of the American people,” you write, “is that nothing should disrupt their access to these goods, that oil, and that credit. The chief aim of the U.S. government is to satisfy that desire, which it does in part of through the distribution of largesse here at home, and in part through the pursuit of imperial ambitions abroad.” In other words, you’re saying that our foreign policy is the result of a dependence on consumer goods and credit.

ANDREW BACEVICH: Our foreign policy is not something simply concocted by people in Washington D.C. and imposed on us. Our foreign policy is something that is concocted in Washington D.C., but it reflects the perceptions of our political elite about what we want, we the people want. And what we want, by and large - I mean, one could point to many individual exceptions - but, what we want, by and large is, we want this continuing flow of very cheap consumer goods.

We want to be able to pump gas into our cars regardless of how big they may happen to be, in order to be able to drive wherever we want to be able to drive. And we want to be able to do these things without having to think about whether or not the book’s balanced at the end of the month, or the end of the fiscal year. And therefore, we want this unending line of credit.

The video and transcript of the entire interview are available here. Are we ready to be the change we wish to see in the world?

First, Rep. Marcy Kaptur, Democrat from Ohio:

Next, Rep. Michael Burgess, Republican from Texas:

The rule of law and process of good government are taking a beating this weekend.

I’ve reviewed the “Discussion Draft” of bailout legislation, available here.

Any Representatives or Senators feeling pressured to accept this power grab by our Treasury and Federal Reserve need to understand that they are negotiating with terrorists. It was my recollection that we do not negotiate with terrorists.

Again, what should we do?

First, we should embrace every effort to restore transparency, trust, and the rule of law to our capital markets.

But we must also remember that we are at a critical inflection point, and the banking institutions hold all the cards. Bernanke and Paulson are predicting terrible things if we do not bail out the banks at our expense. Their predictions are well on their way to becoming self-fulfilling prophecy, since the banks ultimately control access to credit.

Many have documented why the bailout plan is unlikely to work as proposed. It is time for principled leaders in Congress to go on offense. So Paulson wants $700 billion to buy toxic assets, “restore confidence”, and get banks lending again?

Why not just round up to $1 trillion, but issue it in United States Notes directly from the Treasury, instead of Federal Reserve Notes?

What’s a United States Note? That’s debt-free currency printed by our Treasury that carries the same legal tender status as the private debt money issued by the Federal Reserve. Except our government doesn’t need to borrow from foreign lenders or the Federal Reserve to put it into circulation. We’d just create it, and exchange this debt-free paper money for the banks’ toxic assets.

Sound odd? It’s not unprecedented — check out how Lincoln funded the Civil War when foreign lenders were only offering financing at usurious interest rates. That’s how U.S. Notes were born, at which time they were given the popular name “greenbacks”. They circulated alongside Federal Reserve Notes from 1913 until 1971.

It’s basically a way to be “helpful” and go along with what the Fed and Treasury are suggesting, but make them play by our rules. In other words, “Sure, we’ll give you the money you’re asking for, but we’re absolutely not going to pay you interest for the privilege of bailing you out.”

Put it this way — having Congress empower the Treasury to issue our nation’s own fiat currency is more Constitutional than delegating the issuance of our currency to a private central bank where all money is created through the people and our government(s) taking on debt.

We’ve used public money to preserve the union before, maybe it’s time to try again.

I think Dennis Kucinich (D-OH) would agree:

Key quote:

“Why aren’t we helping homeowners directly with their debt burden? Why aren’t we helping American families faced with bankruptcy. Why aren’t we reducing debt for Main Street instead of Wall Street? Isn’t it time for fundamental change in our debt-based monetary system, so we can free ourselves from the manipulation of the Federal Reserve and the banks?“

The proposed $700 million bailout is unlikely to increase trust between banks, will threaten our sovereign credit rating, and may even collapse our currency.

It only attempts to protect favored banks, and ignores the reality that trillions of dollars in bad debt must be liquidated before we can recover from this crisis. For every lender there is a borrower, and our borrowers have simply assumed too much debt relative to their income.

Objections from a variety of perspectives are expressed by others:

• Dallas Federal Reserve Governor Richard Fisher - Bank Rescue Plan Would Worsen Fiscal Chasm
• Former Treasury Secretary Paul O’Neill - Bush Doesn’t Get Financial Crisis
• Former FDIC Chair William Isaac - A Better Way to Aid Banks
• BB&T CEO John Allison - Paulson Plan Aimed at Helping “Poorly Run” Banks
• NYU economist Nouriel Roubini - Why the Treasury TARP Bailout is flawed
• New IMF Study Contradicts Bailout Bill Premise and Details
• Over 150 economists - Hundreds of Economists Urge Congress Not to Rush on Rescue Plan

Of particular interest are comments in the last article about the game theory implications of vastly increased central bank lending as well as expectations of a bailout. In short, we’re making the problem worse:

Advocates for a rescue plan this week point to a seizing up of credit markets, reflected in elevated inter-bank lending rates, as reason for action. Some economists are unconvinced.

“I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.

Makes sense, doesn’t it? As also stated by Yves Smith:

Now consider the bailout version of this problem. Yes, the market for bad bank assets wasn’t so hot, but the big reason is not lack of buyers, but unwillingness of banks to accept the lousy realistic prices on offer.

But the government is now moving towards a plan to buy that paper for something closer, maybe a heck of a lot closer, to your price. You now have no incentive to try to unload those assets, so what little trading there was in them has probably gone into a deep freeze.

In other words, “We need a bailout, or else lending is going to freeze up and the financial system is going to collapse” becomes “We expect a bailout, so we’re going to just sit here until we get one.” It’s a self-fulfilling prophecy. Depending on your level of cynicism, one might also consider it a hostage crisis with our economy as the hostage.

Most importantly, also at stake is trust in our nation’s financial system and capital markets. Karl Denninger eloquently makes that point here:

The government cannot simply keep changing the rules to benefit a privileged few.

Focusing on the banks, the current crisis has four related ingredients: liquidity, solvency, capital, and trust. There is plenty of central bank liquidity available for threatened institutions, and due to lack of trust and transparency, banks will not lend to each other — each prefers to go to the central bank for relief. This tendency to look to the central bank for relief appears to be finally threatening the balance sheet at the Fed itself, according to Brad Setser:

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lend out these kinds of sums over such a short-period.

For another look at the Fed’s balance sheet, see this visual map provided by Cumberland Advisers.

Solvency is a problem as threatened institutions are finding it difficult to access additional financing and service their debt. Capital is a problem because creative accounting and assets of unknown value have led to balance sheets (and off-balance-sheet vehicles) that encouraged wishful thinking and reduced trust.

The administration’s proposal to buy toxic assets doesn’t address all of these problems, may make solvency issues worse, and most importantly, it does not address the lack of trust between market participants:

Non-financial private debt is $32.4 trillion dollars as of 2Q 2008. Household debt is $14.0 trillion. Households lost 400 billion dollars last quarter. You wish to add $700 billion more in losses (via government obligations that taxpayers must cover) this quarter; this package is insignificant against the total bad credit outstanding. Federal capacity to “bail the system out” is insufficient.

It will not and cannot work because the issue is trust, not money. There is lots of money (and credit) but it is being hoarded throughout the system. Consumer savings have gone from nothing to the highest rate ever in American history – in the space of a few months. Money is flying into Treasuries because of lack of trust, not lack of money. You must fix the cause of the problem, not apply band-aids.

Despite all this evidence to the contrary, this evening’s New York Times article shows to what lengths our elected representatives will go to do the wrong thing. Allow me to translate:

Officials said there were still more than a dozen points of disagreement, though the centerpiece of the rescue effort remained intact: a plan for the government to purchase up to $700 billion in troubled assets from financial firms as a way to free their balance sheets of bad debts and to help restore a healthy flow of credit through the economy. It could become the largest government bailout in the nation’s history.

We’ve been pretending to object to the administration’s plan, and we’re making a lot of noise, but we’re not really changing anything. We’re still going to pistol-whip the American taxpayer to bail out poorly-run banks, and we hope credit starts flowing again even though this bailout does nothing to support property markets, improve the ability of borrowers to service their debt, or increase trust in the integrity of the capital markets. But hey, we’re all about hope.

Republicans, under pressure from Democrats to deliver 70 to 100 votes from their side, were scouring the ranks and focusing on the two dozen Republicans who were retiring this year.

Both parties were also scouring the political map to identify lawmakers who face little or no opposition for re-election in November, knowing they would be more willing to vote yes.

We’re looking for representatives who can afford to blow off their constituents.

Democratic officials said that despite having control of both chambers in Congress, they were far from having a majority sufficient to pass the measure just from their ranks. And they also warned that Democrats in potentially tough races could not be counted on to provide the votes to put the package over the top when, and if, it reaches the floor.

If David Price ends up voting against this bailout, it will be because he’s getting the message that 4th District voters are ready for principled representation that serves the people instead of corporate interests.

The ultimate cost of the rescue plan to taxpayers is virtually impossible to know. Because the government would be buying assets of value — potentially worth much more than the government will pay for them — there is even a chance the rescue effort would eventually return a profit.

We’re calling it a “rescue plan” because folks don’t like the word “bailout”. There’s no chance this rescue will return a profit, since banks are only going to dump the most toxic of their assets — they’ll hold on to the good stuff. Furthermore, if there was a reasonable chance of a profitable investment, Warren Buffett would be all over the deal himself.

The administration had initially requested nearly unfettered authority to run the rescue program. But in negotiations over the last week, the White House agreed to accept strict oversight of the program by an independent board, as well as a requirement that the government increase its efforts to prevent home foreclosures.

We’ll give the impression of resisting tyranny with empty gestures of “oversight” and some empty pandering about bailing out borrowers. But we allocated the big money to bail out lenders.

I should mention that I tried to visit David Price’s Chapel Hill office on Thursday to express my sentiments as a constituent, not even as a candidate. But when I arrived, the office was closed:

I received word from folks calling his Durham office that there was no one available to answer the phone, and no way to leave a message.

The behavior of so-called Congressional leaders, our deeply-conflicted administration, and my opponent demonstrate supreme arrogance and disrespect for the rule of law.

Washington, you’re fired.

This is a rather long post. Here’s the executive summary:

Practically speaking, what should we do? As unpleasant as deflation sounds, collapsing our currency is worse. We must not collapse our currency to bail out corrupt institutions who benefited from unsound practices. A bailout attempt must not tip us over into a run on the currency. With an existing $9.7 trillion debt and $53 trillion in long-term entitlement liabilities, we are not the world’s best credit risk to abruptly increase our borrowing.

If pain is inevitable, how can we temper the economic turbulence to come?

Here is a plan that I would support:

1. Eliminate capital gains taxes on real estate transactions to encourage existing private capital to buy underlying real assets.
2. Affirm that all voluntary barter transactions between two individuals (human individuals, not “corporate persons” or legal entities) are tax-free, regardless of the medium of exchange.

The first step will help stem the fall in real estate prices without increasing debt or bailing out irresponsible borrowers or lenders.

The second step will restore a more reasonable balance of power between individual Americans who have been pistol-whipped in this economic mess, and the corporations who benefit from an unsustainable system.

Together, they will reduce near-term economic dislocations, while providing a platform for sustainable community-based growth over the long term.

This moment in American history calls for principled leadership by an irate minority in Congress who is willing to stand up for the American people. The human people, the individuals — not corporations who already run Washington through their lobbying machines.

Now for the rest of the story:

Nouriel Roubini has an excellent summary of reasons that the Paulson/Bernanke bailout plan is a bad idea. Key quote:

Thus, the Treasury plan is a disgrace: a bailout of reckless bankers, lenders and investors that provides little direct debt relief to borrowers and financially stressed households and that will come at a very high cost to the US taxpayer. And the plan does nothing to resolve the severe stress in money markets and interbank markets that are now close to a systemic meltdown.

It’s also important to note how bailing out poorly-run banks and financial institutions negatively impacts well-run banks, such as BB&T. I’ve banked at BB&T ever since CEO John Allison took a principled stand against financing development projects resulting from land seizures like Kelo v. New London. Based upon the values demonstrated at BB&T, I was not surprised when I read the thoughtful letter (available here as a .pdf) that Mr. Allison sent to Congress. While everyone in this debate has their own perspective and interests to protect, the letter makes some excellent points:

We think it is important that Congress hear from the well-run financial institutions as most of the concerns have been focused on the problem companies. It is inappropriate that the debate is largely being shaped by the financial institutions who made very poor decisions.

There is no panic on Main Street and in sound financial institutions. The problems are in high risk institutions and on Wall Street.

While all financial intermediaries are being impacted by liquidity issues, this is primarily a bailout of poorly-run financial institutions. It is extremely important that the bailout not damage well run companies.

Corrections are not all bad. The market correction process eliminates irrational competitors. There were a number of poorly managed institutions and poorly made financial decisions during the real estate boom. It is important that any rules post “rescue” punish the poorly run institutions and not punish the well-run companies.

This is a housing value crisis. It does not make economic sense to purchase credit card loans, automobile loans, etc. The government should directly purchase housing assets, not real estate bonds. This would include lots and houses under construction.

The primary beneficiaries of the proposed rescue are Goldman Sachs and Morgan Stanley. The Treasury has a number of smart individuals, including Hank Paulson. However, Treasury is totally dominated by Wall Street investment bankers. They do not have knowledge of the commercial banking industry. Therefore, they can not be relied on to objectively assess all the implications of government policy on all financial intermediaries. The decision to protect the money funds is a clear example of a material lack of insight into the risk of the total financial system.

Mr. Allison presents a balanced perspective, although his statement “The government should directly purchase housing assets, not real estate bonds. This would include lots and houses under construction” can be read as his asking for government support for BB&T’s residential and construction loans.

The bottom line is that Paulson’s proposed plan, and the bailouts done to date, have been for the benefit of well-connected corporations and the individuals who profit from them. That’s corporate socialism. But as BB&T illustrates, there are well-run institutions whose values and business practices are built to last. We must not rescue institutions whose irresponsible behavior has left then vulnerable to this correction. Any  attempts to “save the system” should eliminate the institutions that failed in the process, and allow good institutions to prosper.

Given the strength of the interests involved, I believe we will see a bailout plan out of Congress. Time will tell if any “bailout” allows owners and managers of failed institutions to suffer the consequences of their actions. Regardless of the final plan, however, no bailout will be able to prevent further economic suffering.

Why? We are truly between a rock and a hard place. This crisis resulted from way too much lending, which created way too much money out of nothing, and resulted in irresponsible people, governments, and businesses accumulating way too much debt.

How can we cure too much borrowing with yet more government borrowing, the proceeds of which are given to banks to allow them to lend more, when we’ve already borrowed TOO MUCH and can’t service the debt we have?

For a graphical illustration, check out this blog post:
http://ukhousebubble.blogspot.com/2008/09/crushing-truth-about-us-household-debt.html

For another graphical illustration, consider this image:

Debt on this chart is defined as all U.S. debt (sum debt of federal and state & local governments, international, and private debt, including households, business and financial sector debts, and federal debt to trust funds).

We cannot borrow our way out of debt.

We cannot borrow our way to prosperity.

Collectively, we have borrowed so much that by 2016, the interest on our debts at 6% interest will be greater than the total consumer income. Those who think we can bail out the lenders without considering the collective balance sheet of our nation are ignoring reality.

Where are we going to get the money for a trillion dollar bailout? Will foreign investors recycle another trillion dollars into new bonds issued by our Treasury to pay for it?

As evidenced by the chatter from abroad, Europeans and Asians are not willing to fund our continued largess. Attempting to “monetize debt” by having the Federal Reserve print the money required for a bailout would lead to loss of confidence in the dollar, and potentially catastrophic collapse of our currency.

So we have two choices — collapse of corrupt financial institutions with deflation, or preserving the dominance of corrupt institutions while collapsing our currency  with inflation or hyperinflation.

Practically speaking, what should we do? As unpleasant as deflation sounds, collapsing our currency is worse. We must not collapse our currency to bail out corrupt institutions who benefited from unsound practices. A bailout attempt must not tip us over into a run on the currency. With an existing $9.7 trillion debt and $53 trillion in long-term entitlement liabilities, we are not the world’s best credit risk to abruptly increase our borrowing.

So if pain is inevitable, how can we temper the economic turbulence to come?

Here is a plan that I would support:

1. Eliminate capital gains taxes on real estate transactions to encourage existing private capital to buy underlying real assets.
2. Affirm that all voluntary barter transactions between two individuals (human individuals, not “corporate persons” or legal entities) are tax-free, regardless of the medium of exchange.

The first step will help stem the fall in real estate prices without increasing debt or bailing out irresponsible borrowers or lenders.

The second step will restore a more reasonable balance of power between individual Americans who have been pistol-whipped in this economic mess, and the corporations who benefit from an unsustainable system.

Together, they will reduce near-term economic dislocations, while providing a platform for sustainable community-based growth over the long term.

This moment in American history calls for principled leadership by an irate minority in Congress who is willing to stand up for the American people. The human people, the individuals — not corporations who already run Washington through their lobbying machines.

Our country’s ultimate source of strength and resilience is a self-sufficient community that can feed itself, clothe itself, house itself, educate itself, and trade its surplus production with its neighbors. Today, our communities and individuals have never been more dependent — as evidenced by consumer sentiment, unemployment, foreclosures, and even tent cities in hard-hit areas.

In this moment of crisis, individuals need to be free to help each other, and themselves. We need to level the playing field between corporations (who enjoy “legal personhood” and limited liability) and individual Americans.

People must again have the ability to serve each other as individuals to recreate the wealth that is being destroyed all around us.

I have tried to maintain a sense of decorum and respect for the August Institutions that comprise Our Nation’s Government. I have tried valiantly to speak respectfully of My Opponent, who has Served His Country as a Public Servant for twenty of the past twenty-two years.

But the cognitive dissonance required to maintain that respect is rapidly eroding.

Yesterday, my opponent was interviewed by Bill LuMaye, a popular talk show host on AM 680 WPTF. You can tell my opponent is running for re-election — he has been on Mr. LuMaye’s show about four times in the past two months. My opponent was asked to talk about the financial crisis, and the Paulson/Bernanke bailout plan.

Here’s where I have a problem: all my opponent was able to accomplish in thirty minutes was wringing his hands in sober tones about how terrible the current crisis is, stating how we need to do some kind of bailout, and then blaming The Administration for putting this questionable bailout plan in front of him.

I have one question for my opponent: Are you a Lawmaker, or a Lawpasser?

Do we hire you to watch out for our interests by authoring legislation, or to complain about the quality of legislation that you are provided by the Executive branch?

Why do you wring your hands and bloviate about legislation WRITTEN BY THE EXECUTIVE BRANCH, when the Constitution clearly states that Congress should be writing legislation?

If you don’t know enough to actually write legislation yourself concerning this topic, why should we value your opinions, and what gives you the right to complain?

Why are we paying you anything just so you can sit up in Washington and collect over $40,000 (since 2000) in PAC donations from banks and the American Banker Association?

Why are you echoing The Administration’s Sense of Panic and Urgency, when it is now being reported that this bailout plan has been in the works for a long time?

The White House today is drumming up extraordinary pressure on Congress to approve its plan to enact a $700 billion mortgage bailout fund, suggesting the markets cannot wait much longer and dispatching Vice President Cheney and other top officials up Pennsylvania Avenue to jawbone lawmakers.

But Bush himself continues to do little to explain his plan, and he has refused to be questioned about it.

Asked during a telephone briefing for reporters today whether Bush was speaking with lawmakers, White House Deputy Press Secretary Tony Fratto said the president is aware of their concerns but that Paulson is the salesman.

“It shouldn’t take much analysis to remember what happened last week, which was a very serious freeze-up in our credit markets,” Fratto said. “Our financial markets right now do not need uncertainty, they need increased certainty as to how this rescue plan is going to go forward — and that they can be sure that there is a plan to go forward — and that will begin the correction in our financial markets.”

Fratto insisted that the plan was not slapped together and had been drawn up as a contingency over previous months and weeks by administration officials. He acknowledged lawmakers were getting only days to peruse it, but he said this should be enough.

In October of 2001, in an environment of fear and coercion by the Executive Branch, you voted for The Administration’s last-minute substitute version of the PATRIOT Act and shredded our Bill of Rights.

Now, as a consequence of your fear and ignorance, you are threatening to vote for The Administration’s bailout bill, known as “Cash for Trash” or “No Banker Left Behind” — thus shredding working Americans, feet first.

David, you’re fired.

I was pleased to receive the following endorsement today from Dr. Larry Burk, a radiologist with whom I worked at Duke:

Friends and former colleagues,

I went on the Triangle Farm Tour this weekend and visited the Piedmont Biofuels Coop, a sustainable farm in Moncure, NC, linked to the local biodiesel pioneers at biofuels.coop.  Then today by happy synchronicity, I got an email from BJ Lawson, one of my former Duke med students who is running for Congress in the 4th District, featuring an interview he did with Lyle Estill, VP of Stuff at Piedmont Biofuels and author of Small is Possible: Life in a Local Economy.

Both Lyle and BJ emphasize the need for a vital and sustainable local economy that will provide “Hometown Security” for all of us during these times of turmoil on the national level.  That would be the opposite of the National Bio and Agro Defense Facility that his opponent David Price is advocating bringing to Butner as Chairman of the Appropriations Subcommittee for the Department of Homeland Security.

So, progressives wake up and vote your conscience, not your party this November.  Yes, it is possible to split your ticket and vote for both Obama and Lawson.  I made the radical move of switching my registration from Democratic to Republican to vote for him in the NC Primary where he won 70% of the vote against a hardcore neocon opponent.  BJ bases his platform strictly on the Constitution, and he is more of a peace candidate than most Democrats in Congress now.

Liberty is Priceless,
Larry

Many folks I encounter on the campaign trail share my concerns about the economy and our financial system. In light of our challenges, I’m often asked why I’m so cheerful and optimistic about the future.

The reason I’m excited about the future is that I’ve come to appreciate that we actually do live in a world of abundance. The economic trials we’re experiencing, if handled properly, will ultimately reveal our potential to again prosper as a free society, a strengthened constitutional republic, with strong communities knitted together by the contributions of many.

Why do I believe in such an optimistic outcome?

Because more and more people are questioning the status quo. For us and our family, the questioning started as soon as we started having children — and when we started buying toys. The average lifespan of our imported plastic toys was 6 months from Wal-Mart to landfill. It took us a while, but we now understand that the toy industry is a farce and that we don’t need to worry about lead paint from China — since we don’t buy toys that might as well go straight into the recycle bin anyway. Finely crafted hardwood marble racers? Now those are a blast — and they’ll likely be around for our grandchildren, as well.

How about food? In an age of rising fuel prices, even folks who shop at the supermarket understand the difference between fragrant, fresh South Carolina peaches at $0.99 per pound versus unripe peach-colored baseballs from California for $2.99 per pound. For those who venture outside the supermarket, the variety of local produce and meats available in our local farmers’ markets is truly stunning.

As we shift our attention from the made-for-TV luxuries of a mass-produced consumer culture to the truly visceral pleasures of fantastic local food, high-quality artisanal craftsmanship, and personal attention from committed entrepreneurs to who own their own businesses and truly care about their clients, the world looks much different, and much brighter.

In today’s uncertain times, is it possible to reinvigorate a free market of free people, and stimulate local economic growth at the grassroots?

If Lyle Estill’s Abundance Foundation is any indication, the answer is yes. As part of Taking the Pulse, I had the opportunity to interview Lyle and discuss his new book, Small is Possible: Life in a Local Economy:

It’s a great book, a great discussion, and a great message: we need to encourage hometown security, instead of mindlessly funding homeland security.

Don’t get me wrong — I’m a firm believer in free trade and free markets. But the benefits of free market capitalism require a foundation of Constitutional money and honest banking. Right now, we have neither — and since our government ignores the Constitution and answers to corporate lobbyists instead of the people, we live in a world of unrestrained corporatism that turns a world of natural abundance into a world of artificial scarcity.

It’s time to reinvigorate our local communities, and local economies, in the face of our looming economic crisis and likely banking system “bailout” at our collective expense. How? As I mentioned in my prior post:

Here’s the bottom line: we may or may not be able to prevent a misguided bailout. Ultimately, however, self-sufficient communities are the only lasting antidote to the current crisis. There is one thing that Congress could do to provide a safety net that would empower individuals to build self-sufficient communities:

Congress must unambiguously affirm that all voluntary barter transactions between individuals are tax-free.

What do I mean by “barter transactions”? They may be transactions exchanging time for time, time for goods, goods for goods, time for dollars or private barter currencies (paper or specie), or goods for dollars or private barter currencies. The key point is that human individuals (not corporations or other creatures of the legal system) need to be free to create wealth in their communities.

If the banks get bailed out, the people need to be bailed out. People must again have the ability to serve each other as individuals to recreate the wealth that is being destroyed all around us.

It’s time to restore the unalienable individual rights of life, liberty, and the pursuit of happiness.

The terrorists we must fight are not crouched in caves thousands of miles away.

The terrorists we must fight are threatening us with financial weapons of mass destruction that are destroying our economic system.

As described by Warren Buffet in his 2003 letter to Berkshire Hathaway shareholders, the financial industry has created new types of derivatives that he described as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

As summarized in this BBC article:

Contracts devised by ‘madmen’

“Derivatives generate reported earnings that are often wildly overstated and based on estimates whose inaccuracy may not be exposed for many years” - Warren Buffett

“Large amounts of risk have become concentrated in the hands of relatively few derivatives dealers … which can trigger serious systemic problems.” - Warren Buffett

Derivatives are financial instruments that allow investors to speculate on the future price of, for example, commodities or shares - without buying the underlying investment

Derivates like futures, options and swaps were developed to allow investors hedge risks in financial markets - in effect buy insurance against market movements -, but have quickly become a means of investment in their own right.

Outstanding derivatives contracts - excluding those traded on exchanges such as the International Petroleum Exchange - are worth close to $85 trillion, according to the International Swaps and Derivatives Association.

Some derivatives contracts, Mr Buffett says, appear to have been devised by “madmen”.

He warns that derivatives can push companies onto a “spiral that can lead to a corporate meltdown”, like the demise of the notorious hedge fund Long-Term Capital Management in 1998.

Does any of this sound familiar? It should. We’re living it.

How is Congress reacting to this clear and present danger, which is sitting right across the table from them as it testifies in Washington?

They’re ignorant and scared:

WASHINGTON — It was a room full of people who rarely hold their tongues. But as the Fed chairman, Ben S. Bernanke, laid out the potentially devastating ramifications of the financial crisis before congressional leaders on Thursday night, there was a stunned silence at first.

Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. had made an urgent and unusual evening visit to Capitol Hill, and they were gathered around a conference table in the offices of House Speaker Nancy Pelosi.

“When you listened to him describe it you gulped,” said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

How did we get into this situation? This is the endgame for an inherently unstable system that has been forever destined to fail. As I noted in a previous post:

If asked to pick one word to describe why I’m running for Congress, that word is sustainability. Sustainability doesn’t mean stability, it doesn’t mean safety, and it doesn’t mean protection from life’s inevitable uncertainties. Sustainability does mean recognizing and obeying the natural laws that govern of our world.

Every branch of science has certain laws: Objects in motion tend to stay in motion; force equals mass times acceleration; every action has an equal and opposite reaction; energy in a closed system cannot be created or destroyed but merely changed in form; and closed systems tend towards increased entropy are a few good examples.

These laws of motion and conservation of energy are not limited to high school physics class. Every system in nature must obey these underlying principles — including our financial and monetary systems.

Let’s start with Newton’s laws of motion — it’s a short hop from there to defining leverage as the ability to move a large object a short distance using a small force exerted over a long distance. Leverage is a concept in finance, as well — using borrowed money to increase returns based upon small underlying price movements. Just as the car lifted with a hydraulic jack can hurt you if it falls, a small price movement in an imprudently leveraged investment can wipe out a lifetime of savings.

Next consider conservation of energy and open versus closed systems. Since energy within a closed system cannot be created or destroyed, and since closed systems tend towards increasing entropy, every growing system must be open to an external energy source. In this setting, one can immediately see problems with our debt-based monetary system.

What is debt-based monetary system? It’s where money is debt, and every dollar in circulation exists because a bank created it out of nothing based upon someone’s promise to pay it back, with interest.

Our economy is an open system relative to money, which is created and destroyed by banks. Banks create the money through loans — but they only create the amount you borrow. They don’t create the interest that you also promise to repay. Where do you get the interest? You have to earn it, but first it has to be created — yes, by someone else borrowing more money that they promise to repay with still more interest.

In the end, our monetary system is like a game of musical chairs — the banks create money based upon someone’s willingness to borrow, and the bank’s ability to lend. The constant demand for new money to repay interest on existing money compels growth and new money creation at an accelerating rate.

Refer to the chart of America’s total debt, which raises obvious questions about sustainability. Trees do not grow to the sky — and when banks cannot lend, or people are no longer willing to borrow, the music stops. When the music stops, there are more loans outstanding than money to repay, so everyone left standing loses whatever they pledged in exchange for their loans. Even worse, money that was created out of nothing through borrowing just as easily disappears back into nothing as asset values plummet — so when the music stops, the chairs start disappearing from the room.

Leverage, debt-based money, fractional reserve banking, and interest are fundamental features of our economic system. Our economic history of boom/bust cycles and decisions dominated by short-term gain as opposed to long-term stewardship are fundamental consequences of this underlying system. In short, our system has undesirable consequences and is fundamentally unstable — but it’s working as designed.

Interestingly, now we have the terrorists who created and detonated these weapons holding us hostage. They’re asking us for more power, and to punish us with more debt, only to further enable the corrupt system to which we are hopelessly enslaved in the first place.

In other words, they’ve thrown a massive brick through the window, and are asking us to assume a crippling debt so that we can hire and pay them to “fix” it:

As noted by many, including Kentucky Senator Jim Bunning and Texas Representative Ron Paul, the Federal Reserve and the banking system that controls it are the cause of our systemic risk. Even the Federal Reserve’s own Harvey Rosenblum emphasizes that the Federal Reserve’s job is to create moral hazard, which enables systemic risk:

Rosenblum: The Federal Reserve is in business to create moral hazard. The mere act of being a central banker means that your job description involves creating moral hazard. A central bank is a “lender of last resort,” what more moral hazard can you have than having a lender of last resort that people know, when push can to shove, can be relied upon? The Federal Reserve’s job is to cushion the blow to 300 million American citizens of all the economic shocks that hit out there. What drives me crazy is when I hear people shouting “Moral hazard, moral hazard”… that’s what my job is to do…

Of course, it’s a bit disingenuous to say that the Fed’s job is to “cushion the blow” when the Fed threw the brick that caused the economic shock.

Gary Larson’s classic Far Side cartoon says it all. The Federal Reserve has heaved a gigantic brick through the window of our nation’s economy. Jobs are getting scarce, retirement savings and housing values are declining, and basic necessities are less affordable. Using the current crisis as an opportunity to further empower the Federal Reserve at the expense of the people is not the answer.

We need to restart past conversations, and restore a Constitutional money and banking system that removes moral hazard from the equation entirely. We cannot allow a private monopoly to create money out of nothing to loan to us at interest. The Federal Reserve is welcome to compete in a free market, but accepting private debt-based currency should not be compulsory — it should be voluntary, and other forms of money that facilitate trade and local economic growth should be welcomed.

Alan Greenspan noted that our money system is not a free market — the power over our money is centralized in the hands of the Federal Reserve. That fact, along with the Federal Reserve’s support for the inherently unstable process of fractional reserve banking,  create the bricks that break our windows.

Our founders intended for our money and banking system to be democratized. Our ability to create wealth in our communities is one of our unalienable individual rights. The government is only authorized to establish a level playing field with accurate “weights and measures.” In particular, Congress was given the authority to coin money, and regulate its value — it is not authorized to delegate monopoly authority over our money to a private central bank.

Since 1913, however, our money comes from a monopoly run for the benefit of private banks. The banks have the power to create money through debt, and the people and our governments thus accumulate debt instead of wealth.

So what is Congress going to do? Let’s continue reading about their negotiations with the terrorists:

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.”

Although Mr. Schumer, Mr. Dodd and other participants declined to repeat precisely what they were told by Mr. Bernanke and Mr. Paulson, they said the two men described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day.

“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”

As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky …” he said as his voice trailed off. “Well, I’ll leave it at that.”

Folks, we’re in trouble. When Republicans and Democrats are both ignorant and scared, we do horrible things.

Don’t believe me? Turn off Faux News and read Roubini. Read Denninger. Read Shedlock. This is not a drill, and our elected representatives need to hear our anger at this unprecedented hostage crisis.

In this setting of ignorance and fear, a proposed “fix” is being circulated that will authorize our government to go further into debt to buy toxic debt from failing banks. Note that the “fix” will not work — it will simply push the system further out of equilibrium. Karl Denninger succinctly dissects it here. Key quote:

The claim is that this is intended to “promote confidence and stability” in the financial markets.

It will do no such thing.

It will instead strike terror into the hearts of investors worldwide who hold any sort of paper, whether it be preferred stock, common stock or debt, in any financial entity that happens to be domiciled in the United States, never mind the potential impact on Treasury yields and the United States sovereign credit rating.

What should Congress do? Follow the Constitution: eliminate the money monopoly that is crippling our country. As I noted here:

Return our money to the people, for starters. Do people want to exchange and transact in gold and silver? Great. Do people want to do business in private local currencies that build self-sufficient communities? Great. Affirm that all barter transactions between individuals are tax-free, and let individuals build wealth by helping each other.

Eliminate fractional reserve banking, eliminate legal tender laws, and eliminate our private money monopoly. Our government can use its sovereign power to create currency that is not based upon debt, and based upon how responsibly our government creates that currency, people can choose to accept it or discount it appropriately.

This idea is not new, it’s in fact how we originally grew into a prosperous nation — colonial scrip. Scrip is fine for domestic trade, and specie or other commodities can be used for international trade. Competition between different money systems keeps people honest, and elimination of fractional reserve banking and fraudulent “deposit insurance” keeps banks honest.

Relentlessly seeking another hit of debt will not cure our unsustainable addiction. The poison is not the cure.

It’s time to look around and reassess our national priorities. Republican, Democrat, Libertarian, Constitution, Green, Unaffiliated, Catholic, Protestant, Jewish, Muslim, Hindu, Atheist, Straight, Gay… none of these labels matter. We are all on the same boat. When the boat hits the iceberg, we all sink or swim together.

It’s time to get off the treadmill of a collapsing debt-based currency and empower local economic growth through an honest, Constitutional money system that will strengthen communities by empowering local producers of real goods and services.

Here’s the bottom line: we may or may not be able to prevent a a misguided bailout. Ultimately, however, self-sufficient communities are the only lasting antidote to the current crisis. There is one thing that Congress could do to provide a safety net that would empower individuals to build self-sufficient communities:

Congress must unambiguously affirm that all voluntary barter transactions between individuals are tax-free.

What do I mean by “barter transactions”? They may be transactions exchanging time for time, time for goods, goods for goods, time for dollars or private barter currencies (paper or specie), or goods for dollars or private barter currencies. The key point is that human individuals (not corporations or other creatures of the legal system) need to be free to create wealth in their communities.

Again, If the banks get bailed out, the people need to be bailed out. People must again have the ability to serve each other as individuals to recreate the wealth that is being destroyed all around us.

It’s time to focus on hometown security, instead of homeland security.

This has been a historic week in our financial services industry, and markets. Last night I was joined by David Williams, a financial planner and long-time student of the markets, to discuss the current turmoil and the root causes behind them.

This episode will air as Taking the Pulse, but we wanted to make it available immediately as this situation continues to unfold.

Nothing like a midnight press release from the SEC to let us know that all is well:

SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets

FOR IMMEDIATE RELEASE
2008-211

Commission Also Takes Steps to Increase Market Transparency and Liquidity

Washington, D.C., Sept. 19, 2008 — The Securities and Exchange Commission, acting in concert with the U.K. Financial Services Authority, today took temporary emergency action to prohibit short selling in financial companies to protect the integrity and quality of the securities market and strengthen investor confidence. The U.K. FSA took similar action yesterday.

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Additional Materials

• Emergency Order, Release No. 34-58592.pdf
• Emergency Order, Release No. 34-58591.pdf
• Emergency Order, Release No. 34-58588.pdf
• Form SH
• Form SH Instructions

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The Commission’s action will apply to the securities of 799 financial companies. The action is immediately effective.

SEC Chairman Christopher Cox said, “The Commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets. The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets. This action, which would not be necessary in a well-functioning market, is temporary in nature and part of the comprehensive set of steps being taken by the Federal Reserve, the Treasury, and the Congress.”

I visited China in the summer of 2007 while everything was bubbly and beautiful in their equities markets. Our group met with a representative of the Shenzhen stock exchange, who told us how the Chinese government had taken steps to ensure that China’s markets would always be stable and prosperous. The government knows who is buying and selling every position, so they can identify “market manipulators.” Most importantly, the government has outlawed short selling.

How has this transparency and forbidding short selling helped the Chinese market over the past year?

It’s lost over 60% from its peak. Without any short sellers.

Short sellers simply borrow existing shares, paying for the privilege, and sell them in the open market. They have carrying costs, and must eventually buy the shares back. The fact that they must buy to complete the transaction means that they provide support for stocks during declines — when stocks are going down, short sellers are often the ones buying back to close their positions.

Without short sellers looking to close their positions, declines can be precipitous. In moments of panic, short sellers are the only buyers — so without them, markets can simply crash with no bids offered.

There is a form of short selling, termed “naked” short selling, that is and should be illegal. Naked short sellers don’t actually borrow shares to sell — they literally sell something that they don’t own, without actually borrowing “real” shares. In that case, they are simply counterfeiting stock and dumping it on the market. That’s fraudulent, and must be prosecuted.

The SEC should be prosecuting naked short selling, not eliminating short selling.

This step by the SEC may cause a pop as short sellers rush to close their positions, but it will not prevent insolvent financial firms from facing their ultimate judgment as stockholders eager to exit sell into any strength.

When judgment comes, it will be precipitous.