How long will banks sit on the bomb?

Analyst Steve Saville points out that the Fed has increased bank reserves 100-fold over the last 14 months - "from around $10B in August of 2008 to around $1000B ($1T) today." These reserves don't constitute an increase in the money supply because they are not available to be spent.

Fortunately, bank lending has declined on a year-over-year basis, so the potential destruction of the fractional reserve system amplifying those reserves 10-fold in the economy has yet to happen.

Even with the decline in bank lending and the general de-leveraging that has occurred within the private sector, the government-Fed tag team has managed to increase the US money supply by around 14% over the past year. If the private banks were to join the inflation party then the risk of hyperinflation would greatly increase, and hyperinflation -- leading to what Mises called a "crack-up boom" -- would be the worst of all possible outcomes.

Banks make their money on loans. How long can they stay this way?

Does the U.S. "export inflation"?

Yes, but not in the way you might think, says Gary North.

When physical money is sent out of the country, it shrinks the supply of digital money in fractional-reserve American banks, making prices cheaper. Inflation is exported mainly by illegal immigrants.

On the other hand,

Bank-created inflation is not exported. It stays in the trade zone of the nation that creates the money. In today's floating exchange rate system, price inflation in the United States does not affect the price level (a statistical index) in any other country for very long or for very much. Bank-created inflation is not exported. It is merely copied. When foreign prices rise alongside America's rising prices, this is because foreign central banks are matching the monetary policies of the Federal Reserve. Domestic digital inflation is always a domestic bank–inflicted wound. Central banks compete with each other to debauch their domestic currencies. This is not free market competition. It is competitive plunder by government-licensed counterfeiters.

Lies, Damned Lies, and the CPI

While the Federal Reserve is a big supplier of stolen goods to the government, it is by no means the only supplier. As Ron Paul points out, simple adjustments in calculations will accomplish the transfer when the machinery of theft is already in place.

According to the government's current version of the Consumer Price Index, life has gotten cheaper for the first time in decades, which means there's no reason for increasing payouts to Social Security recipients. The CPI is the average price for a "fixed" basket of goods and is supposed to help us gauge how much more (or less) it costs us to live.

But "economist John Williams of Shadow Government Statistics has estimated that if the original methodology of CPI had not changed, Social Security checks would be nearly double what they are today," Paul writes. Substituting hamburger for steak is one way officials arrived at the CPI they needed. Meat is meat according to the government, so the basket of goods remains fixed. Next time will it be dog food for hamburger? Social Security was wrong from the start and should be abolished, but in the meantime government should be held accountable for administering it fairly.

Ron Paul's Audit the Fed Bill Gutted

And the agent who did it is Mel Watt, a representative from North Carolina. According to Bloomberg, "Watt’s district includes Charlotte, headquarters of Bank of America Corp., the biggest U.S. lender." By "agent" I refer to Watt's obvious ties to the banking cartel, rather than the people who elected him.

Why does anyone have the unilateral power to change a bill -- any bill -- much less one that has 308 co-sponsors?

Paul says he intends to introduce an amendment when the bill comes to the House floor for a vote, restoring the bill's original language.

Why does the Fed fear deflation?

The U.S. Consumer Price Index fell by 1.5% in August, marking the sixth consecutive monthly decline, writes economist Frank Shostak. Most experts believe that falling prices signals problems for the economy because consumers will postpone buying goods, expecting prices to fall even lower.

Many economists define deflation as a fall in prices, rather than a fall in the money supply. Deflation, therefore, becomes the enemy against which an inflationary monetary policy is directed. With a sufficient increase in the supply of money, prices will rise and people will be more inclined to buy now rather than later when prices will be even higher.

But is this reasoning realistic? Why should falling prices discourage consumption? People must support their lives in the present and so will buy in the present. Even in our inflationary world some prices have fallen deeply while consumers have been buying. As Shostak notes:

From December 1997 to August 2009, the prices of personal computers have fallen by 93%. Did this fall in prices cause people to postpone buying personal computers? On the contrary, since December 1997 consumer outlays on personal computers have increased massively. These outlays stood at $83.2 billion in August 2009 as compared to $3.4 billion in December 1997.

Furthermore, most experts claim an inflation rate of around 2% is good for economic growth, while these same experts would say a rate of 10% is bad. What is the logic here? The higher the rate of inflation, the more pressure consumers will feel to buy now rather than later. So why would 10% be worse than 2%?

Shostak suggests the problem lies in the understanding of inflation and deflation. Inflation is an increase in the money supply, not a rise in prices, while deflation is a decrease in the money supply, not a fall in prices. Generally, though, an increase in the supply of money will produce a rise in prices, while a fall in its supply will lower prices.

New money in today's world is created by the banking system out of thin air. It allows users of the new money to take from the pool of available wealth without contributing anything in return. This exchange of nothing for something impoverishes wealth generators "and weakens the process of wealth-formation."

From January 2001 to June 2004 the Fed's cheap credit encouraged the creation of nonproductive activities. When the Fed tightened monetary policy from June 2004 to September 2007, these activities could not be finished and had to be shut down, and workers employed in these projects lost their jobs. Prices for the goods and services produced by these activities are falling.

Nevertheless, the money supply has been growing, and as long as this is the case we have inflation regardless of what prices are doing. If the CPI were adjusted to include the prices of stocks and commodities there would be more evidence we currently have inflation, not deflation. And if we look more closely at the CPI, some components are indeed rising in price, such as medical care and education.

With all the money the Fed has created the economy is poised to reflect a strong increase in prices, perhaps by the second half of next year.

The best way to create a foundation for sustainable growth is to allow wealth-generators to rebuild wealth. But the Fed and government policies are directed at supporting wealth-generators to fund nonproductive activities, claiming this will keep prices from falling. But this only weakens the ability of the economy to generate real wealth. Addressing the symptoms - falling prices - only makes matters worse.

As long as there are enough wealth-generators funding nonproductive activities, we will see an illusion of success. The illusion will evaporate when the percentage of wealth-generating activities drops sharply due to a lack of real funding. We will then find ourselves in a prolonged recession. And the more the Fed and government try to fix the symptoms the worse it will get.

How do we achieve a real recovery? Allow nonproductive activities to fail and stop increasing the money supply. With the expansion of real wealth and a constant stock of money, we can expect prices to fall.

Whether prices fall on account of the liquidation of nonproductive activities or on account of real-wealth expansion, it is always good news. In the first case, it indicates that more funding is now available for wealth generation, while in the second case, it indicates that more wealth is actually being generated.

Is the recession over?

Yes, and a depression lies in its wake. Why? Lew Rockwell explains:

It is not enough just to stand back and look at points on a chart going up and down, smiling when things go up and frowning when things go down. That is the nihilism of an economic statistician who employs no theory, no notion of cause and effect, no understanding of the dynamics of human history.

So long as things were going up, everyone thought the economic system was healthy. It was the same in the late '20s. In fact, it has been the same throughout human history. It is no different today. The stock market is going up, so surely that is a sign of economic health. But people ought to reflect on the fact that the highest performing stock market in the world in 2007 belonged to Zimbabwe, which is now home to a spectacular economic collapse.

Gold has no intrinsic value

In Part 8 of his series, What is Money?, Gary North writes:

The Austrian School of economics, which was founded by Menger, who taught at the University of Vienna, has always been distinguished above all from the other schools of economic thought by its systematic devotion to a theory of subjective value, meaning imputed value.

If this theory of economic value applies to all scarce resources, this must include gold. There is nothing unique economically about gold's value. It is valued by individual decision-makers in terms of the same subjectivistic process that applies to all scarce resources.

Then where resides gold's stability of value over time? In the minds of acting individuals. Also, in the reality of geology. There is far greater stability of geological conditions than subjective assessments. . . .

When people speak of gold's intrinsic value, this reveals their realization of gold's historic value. Gold has had long historical value, as Roy Jastram's book, "The Golden Constant," revealed over three decades ago. But this constancy is over decades or even centuries, not mere years. . . .

Masses of people once understood what a gold coin was. Their successors do not understand what a futures contract is, or a derivatives contract. Neither did the well-educated fools who lost trillions of dollars a year ago, and whose careers were salvaged only by the Federal Reserve and the Treasury, as run by a Goldman Sachs former CEO.

The Byzantine gold standard lasted over a thousand years. The modern gold coin standard lasted only for a century, 1815–1914. It broke apart because of World War I. Governments wanted to inflate, and the gold coin standard hampered this. So, politicians and central bankers abolished it by fiat.

Modern warfare does not deal lightly with restraints on state power. The gold coin standard was such a limit. It transferred to common people the power to veto the war effort, merely by taking their bank IOUs to gold to the bank and demanding gold coins. . . .

Those who do not trust the wisdom, motivation, and tools of central bankers have a way to express their lack of trust. They can buy some gold coins.

[Click here for links to all of North's installments on What is Money?]