Gold: Inflationary, Deflationary, or Something Else?

From my article, "Government's Perennial Enemy":

It's very difficult to inflate sound money because sound money, by its nature, is difficult to create. It emerges in trade as a highly marketable commodity, but one that's also relatively scarce. Sound money starves the state but not the economy as long as prices are allowed to fluctuate. Yet there was once some confusion about gold's character. As Mises wrote in The Theory of Money and Credit (p. 416):

When in the 'fifties of the nineteenth century gold production increased considerably in California and Australia, people attacked the gold standard as inflationary. . . But later these criticisms subsided. The gold standard was no longer denounced as inflationary but on the contrary as deflationary. 

It was considered insufficiently 'elastic' (deflationary) even during the period 1896-1914, when gold discoveries in Alaska and South Africa spurred an annual inflation rate of two percent. But clearly, the objections to a gold standard were not so much based on its alleged inflationary or deflationary tendencies but on the fact that the market controlled its supply, rather than politicians and their pals in the fractional reserve banking racket. Quoting Mises again:

It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. [p. 414]

But constitutions and bills of rights are the products of government and are subject to government's shifting interpretations. We should never let politicians or central bankers 'interpret' anything for us, especially money. An authentic gold standard would be entirely removed from state influence, and for that reason would afford much-needed protection against government assaults on our liberty. 

Bond Basics

Understanding bonds is crucial if you are to understand the market's moves in response to Federal Reserve statements and actions. (For example, see Robert Murphy's article Can the Fed Become Insolvent?)  Investopedia has a tutorial on bonds but it's spread over multiple pages with various "floating" pop-ups and animated ads that can be distracting.  In the interest of education, I've combined the tutorial into one document, presented here.

Bond Basics: Introduction

The first thing that comes to most people's minds when they think of investing is the stock market. After all, stocks are exciting. The swings in the market are scrutinized in the newspapers and even covered by local evening newscasts. Stories of investors gaining great wealth in the stock market are common. 

Bonds, on the other hand, don't have the same sex appeal. The lingo seems arcane and confusing to the average person. Plus, bonds are much more boring - especially during raging bull markets, when they seem to offer an insignificant return compared to stocks. 

However, all it takes is a bear market to remind investors of the virtues of a bond's safety and stability. In fact, for many investors it makes sense to have at least part of their portfolio invested in bonds. 

This tutorial will hopefully help you determine whether or not bonds are right for you. We'll introduce you to the fundamentals of what bonds are, the different types of bonds and their important characteristics, how they behave, how to purchase them, and more.

(Before proceeding, it would be helpful for you to know a little about stocks. If you need a refresher, see our Stock Basics tutorial.) 

Bond Basics: What Are Bonds?

Have you ever borrowed money? Of course you have! Whether we hit our parents up for a few bucks to buy candy as children or asked the bank for a mortgage, most of us have borrowed money at some point in our lives. 

Just as people need money, so do companies and governments. A company needs funds to expand into new markets, while governments need money for everything from infrastructure to social programs. The problem large organizations run into is that they typically need far more money than the average bank can provide. The solution is to raise money by issuing bonds (or other debt instruments) to a public market. Thousands of investors then each lend a portion of the capital needed. Really, a bond is nothing more than a loan for which you are the lender. The organization that sells a bond is known as the issuer. You can think of a bond as an IOU given by a borrower (the issuer) to a lender (the investor). 

Of course, nobody would loan his or her hard-earned money for nothing. The issuer of a bond must pay the investor something extra for the privilege of using his or her money. This "extra" comes in the form of interest payments, which are made at a predetermined rate and schedule. The interest rate is often referred to as the coupon. The date on which the issuer has to repay the amount borrowed (known as face value) is called the maturity date. Bonds are known as fixed-income securities because you know the exact amount of cash you'll get back if you hold the security until maturity.

For example, say you buy a bond with a face value of $1,000, a coupon of 8%, and a maturity of 10 years. This means you'll receive a total of $80 ($1,000*8%) of interest per year for the next 10 years. Actually, because most bonds pay interest semi-annually, you'll receive two payments of $40 a year for 10 years. When the bond matures after a decade, you'll get your $1,000 back. 

Debt Versus Equity 

Bonds are debt, whereas stocks are equity. This is the important distinction between the two securities. By purchasing equity (stock) an investor becomes an owner in a corporation. Ownership comes with voting rights and the right to share in any future profits. By purchasing debt (bonds) an investor becomes a creditor to the corporation (or government).


The primary advantage of being a creditor is that you have a higher claim on assets than shareholders do: that is, in the case of bankruptcy, a bondholder will get paid before a shareholder. However, the bondholder does not share in the profits if a company does well - he or she is entitled only to the principal plus interest. 

To sum up, there is generally less risk in owning bonds than in owning stocks, but this comes at the cost of a lower return.

Why Bother With Bonds? 

It's an investing axiom that stocks return more than bonds. In the past, this has generally been true for time periods of at least 10 years or more. However, this doesn't mean you shouldn't invest in bonds. Bonds are appropriate any time you cannot tolerate the short-term volatility of the stock market. Take two situations where this may be true: 

1) Retirement - The easiest example to think of is an individual living off a fixed income. A retiree simply cannot afford to lose his/her principal as income for it is required to pay the bills. 

2) Shorter time horizons - Say a young executive is planning to go back for an MBA in three years. It's true that the stock market provides the opportunity for higher growth, which is why his/her retirement fund is mostly in stocks, but the executive cannot afford to take the chance of losing the money going towards his/her education. Because money is needed for a specific purpose in the relatively near future, fixed-income securities are likely the best investment. 

These two examples are clear cut, and they don't represent all investors. Most personal financial advisors advocate maintaining a diversified portfolio and changing the weightings of asset classes throughout your life. For example, in your 20s and 30s a majority of wealth should be in equities. In your 40s and 50s the percentages shift out of stocks into bonds until retirement, when a majority of your investments should be in the form of fixed income.

Bond Basics: Characteristics

Bonds have a number of characteristics of which you need to be aware. All of these factors play a role in determining the value of a bond and the extent to which it fits in your portfolio.

Face Value/Par Value 

The face value (also known as the par value or principal) is the amount of money a holder will get back once a bond matures. A newly issued bond usually sells at the par value. Corporate bonds normally have a par value of $1,000, but this amount can be much greater for government bonds. 

What confuses many people is that the par value is not the price of the bond. A bond's price fluctuates throughout its life in response to a number of variables (more on this later). When a bond trades at a price above the face value, it is said to be selling at a premium. When a bond sells below face value, it is said to be selling at a discount. 

Coupon (The Interest Rate) 

The coupon is the amount the bondholder will receive as interest payments. It's called a "coupon" because sometimes there are physical coupons on the bond that you tear off and redeem for interest. However, this was more common in the past. Nowadays, records are more likely to be kept electronically. 

As previously mentioned, most bonds pay interest every six months, but it's possible for them to pay monthly, quarterly or annually. The coupon is expressed as a percentage of the par value. If a bond pays a coupon of 10% and its par value is $1,000, then it'll pay $100 of interest a year. A rate that stays as a fixed percentage of the par value like this is a fixed-rate bond. Another possibility is an adjustable interest payment, known as a floating-rate bond. In this case the interest rate is tied to market rates through an index, such as the rate on Treasury bills.

You might think investors will pay more for a high coupon than for a low coupon. All things being equal, a lower coupon means that the price of the bond will fluctuate more. 

Maturity 

The maturity date is the date in the future on which the investor's principal will be repaid. Maturities can range from as little as one day to as long as 30 years (though terms of 100 years have been issued). 

A bond that matures in one year is much more predictable and thus less risky than a bond that matures in 20 years. Therefore, in general, the longer the time to maturity, the higher the interest rate. Also, all things being equal, a longer term bond will fluctuate more than a shorter term bond. 

Issuer 

The issuer of a bond is a crucial factor to consider, as the issuer's stability is your main assurance of getting paid back. For example, the U.S. government is far more secure than any corporation. Its default risk (the chance of the debt not being paid back) is extremely small - so small that U.S. government securities are known as risk-free assets. The reason behind this is that a government will always be able to bring in future revenue through taxation. A company, on the other hand, must continue to make profits, which is far from guaranteed. This added risk means corporate bonds must offer a higher yield in order to entice investors - this is the risk/return tradeoff in action.

The bond rating system helps investors determine a company's credit risk. Think of a bond rating as the report card for a company's credit rating. Blue-chip firms, which are safer investments, have a high rating, while risky companies have a low rating. The chart below illustrates the different bond rating scales from the major rating agencies in the U.S.: Moody's, Standard and Poor's and Fitch Ratings.

Notice that if the company falls below a certain credit rating, its grade changes from investment quality to junk status. Junk bonds are aptly named: they are the debt of companies in some sort of financial difficulty. Because they are so risky, they have to offer much higher yields than any other debt. This brings up an important point: not all bonds are inherently safer than stocks. Certain types of bonds can be just as risky, if not riskier, than stocks.

Bond Basics: Yield, Price And Other Confusion

Understanding the price fluctuation of bonds is probably the most confusing part of this lesson. In fact, many new investors are surprised to learn that a bond's price changes on a daily basis, just like that of any other publicly-traded security. Up to this point, we've talked about bonds as if every investor holds them to maturity. It's true that if you do this you're guaranteed to get your principal back; however, a bond does not have to be held to maturity. At any time, a bond can be sold in the open market, where the price can fluctuate - sometimes dramatically. We'll get to how price changes in a bit. First, we need to introduce the concept of yield. 

Measuring Return With Yield 

Yield is a figure that shows the return you get on a bond. The simplest version of yield is calculated using the following formula: yield = coupon amount/price. When you buy a bond at par, yield is equal to the interest rate. When the price changes, so does the yield. 

Let's demonstrate this with an example. If you buy a bond with a 10% coupon at its $1,000 par value, the yield is 10% ($100/$1,000). Pretty simple stuff. But if the price goes down to $800, then the yield goes up to 12.5%. This happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). Conversely, if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200). 

Yield To Maturity 

Of course, these matters are always more complicated in real life. When bond investors refer to yield, they are usually referring to yield to maturity (YTM). YTM is a more advanced yield calculation that shows the total return you will receive if you hold the bond to maturity. It equals all the interest payments you will receive (and assumes that you will reinvest the interest payment at the same rate as the current yield on the bond) plus any gain (if you purchased at a discount) or loss (if you purchased at a premium). 

Knowing how to calculate YTM isn't important right now. In fact, the calculation is rather sophisticated and beyond the scope of this tutorial. The key point here is that YTM is more accurate and enables you to compare bonds with different maturities and coupons. 

Putting It All Together: The Link Between Price And Yield 

The relationship of yield to price can be summarized as follows: when price goes up, yield goes down and vice versa. Technically, you'd say the bond's price and its yield are inversely related. 

Here's a commonly asked question: How can high yields and high prices both be good when they can't happen at the same time? The answer depends on your point of view. If you are a bond buyer, you want high yields. A buyer wants to pay $800 for the $1,000 bond, which gives the bond a high yield of 12.5%. On the other hand, if you already own a bond, you've locked in your interest rate, so you hope the price of the bond goes up. This way you can cash out by selling your bond in the future. 

Price In The Market 

So far we've discussed the factors of face value, coupon, maturity, issuers and yield. All of these characteristics of a bond play a role in its price. However, the factor that influences a bond more than any other is the level of prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, thereby raising the yield of the older bonds and bringing them into line with newer bonds being issued with higher coupons. When interest rates fall, the prices of bonds in the market rise, thereby lowering the yield of the older bonds and bringing them into line with newer bonds being issued with lower coupons.

Bond Basics: Different Types Of Bonds

Government Bonds

In general, fixed-income securities are classified according to the length of time before maturity. These are the three main categories: 

Bills - debt securities maturing in less than one year. 

Notes - debt securities maturing in one to 10 years. 

Bonds - debt securities maturing in more than 10 years. 

Marketable securities from the U.S. government - known collectively as Treasuries - follow this guideline and are issued as Treasury bonds, Treasury notes and Treasury bills (T-bills). Technically speaking, T-bills aren't bonds because of their short maturity. (You can read more about T-bills in our Money Market tutorial.) All debt issued by Uncle Sam is regarded as extremely safe, as is the debt of any stable country. The debt of many developing countries, however, does carry substantial risk. Like companies, countries can default on payments. 

Municipal Bonds 

Municipal bonds, known as "munis", are the next progression in terms of risk. Cities don't go bankrupt that often, but it can happen. The major advantage to munis is that the returns are free from federal tax. Furthermore, local governments will sometimes make their debt non-taxable for residents, thus making some municipal bonds completely tax free. Because of these tax savings, the yield on a muni is usually lower than that of a taxable bond. Depending on your personal situation, a muni can be a great investment on an after-tax basis. 

Corporate Bonds 

A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally, a short-term corporate bond is less than five years; intermediate is five to 12 years, and long term is over 12 years. 

Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The upside is that they can also be the most rewarding fixed-income investments because of the risk the investor must take on. The company's credit quality is very important: the higher the quality, the lower the interest ratethe investor receives. 

Other variations on corporate bonds include convertible bonds, which the holder can convert into stock, and callable bonds, which allow the company to redeem an issue prior to maturity. 

Zero-Coupon Bonds 

This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, let's say a zero-coupon bond with a $1,000 par value and 10 years to maturity is trading at $600; you'd be paying $600 today for a bond that will be worth $1,000 in 10 years.

Bond Basics: How To Read A Bond Table

Column 1: Issuer - This is the company, state (or province) or country that is issuing the bond. 

Column 2: Coupon - The coupon refers to the fixed interest rate that the issuer pays to the lender. 

Column 3: Maturity Date - This is the date on which the borrower will repay the investors their principal. Typically, only the last two digits of the year are quoted: 25 means 2025, 04 is 2004, etc. 

Column 4: Bid Price - This is the price someone is willing to pay for the bond. It is quoted in relation to 100, no matter what the par value is. Think of the bid price as a percentage: a bond with a bid of 93 is trading at 93% of its par value. 

Column 5: Yield - The yield indicates annual return until the bond matures. Usually, this is the yield to maturity, not current yield. If the bond is callable it will have a "c--" where the "--" is the year the bond can be called. For example, c10 means the bond can be called as early as 2010.

Bond Basics: How Do I Buy Bonds?

Most bond transactions can be completed through a full service or discount brokerage. You can also open an accountwith a bond broker, but be warned that most bond brokers require a minimum initial deposit of $5,000. If you cannot afford this amount, we suggest looking at a mutual fund that specializes in bonds (or a bond fund). 

Some financial institutions will provide their clients with the service of transacting government securities. However, ifyour bank doesn't provide this service and you do not have a brokerage account, you can purchase government bonds through a government agency (this is true in most countries). In the U.S. you can buy bonds directly from the government through TreasuryDirect at http://www.treasurydirect.gov. The Bureau of the Public Debt started TreasuryDirect so that individuals could buy bonds directly from the Treasury, thereby bypassing a broker. All transactions and interest payments are done electronically. 

If you do decide to purchase a bond through your broker, he or she may tell you that the trade is commission free. Don't be fooled. What typically happens is that the broker will mark up the price slightly; this markup is really the same as a commission. To make sure that you are not being taken advantage of, simply look up the latest quote for the bond and determine whether the markup is acceptable.

Remember, you should research bonds just as you would stocks. We've gone over several factors you need to consider before loaning money to a government or company, so do your homework!

Bond Basics: Conclusion

Now you know the basics of bonds. Not too complicated, is it? Here is a recap of what we discussed: 

• Bonds are just like IOUs. Buying a bond means you are lending out your money.
• Bonds are also called fixed-income securities because the cash flow from them is fixed.
• Stocks are equity; bonds are debt.
• The key reason to purchase bonds is to diversify your portfolio.
• The issuers of bonds are governments and corporations.
• A bond is characterized by its face value, coupon rate, maturity and issuer.
• Yield is the rate of return you get on a bond.
• When price goes up, yield goes down, and vice versa.
• When interest rates rise, the price of bonds in the market falls, and vice versa.
• Bills, notes and bonds are all fixed-income securities classified by maturity.
• Government bonds are the safest bonds, followed by municipal bonds, and then corporate bonds.
• Bonds are not risk free. It's always possible - especially in the case of corporate bonds - for the borrower to default on the debt payments.
• High-risk/high-yield bonds are known as junk bonds.
• You can purchase most bonds through a brokerage or bank. If you are a U.S. citizen, you can buy government bonds through TreasuryDirect.
• Often, brokers will not charge a commission to buy bonds but will mark up the price instead.

Give gold & silver coins this Christmas

For those on your shopping list who seem to have everything, consider giving them gold or silver coins.  Even if they have nothing, giving them gold and silver would be thoughtful, though they might appreciate getting something useful as well.  I have experience with only one company, but compared to the rules others have imposed on sales of gold & silver this one I can recommend for people who don't have a lot of money to invest.  The company I've dealt with is Camino Coin of Burlingame, California.  Call them at (800)-348-8001 and ask to speak to someone about buying bullion coins.  Once you reach an agreement about what to buy, they will give you a total price, including any shipping charges, along with a contract number.  You then write a check for that amount and get it in the mail within 24 hours.  Once it clears they will fill your order and ship it registered mail in thoroughly secure packaging.

Not many people alive today have held real gold or silver coins in their hands.  If your gift recipients need educating on the significance of commodity money, consider giving them a book or two to go along with the coins.  See my home page for recommendations.

Fifth Edition of "The Creature"

The fifth edition of G. Edward Griffin's masterpiece, The Creature from Jekyll Island, will start shipping Monday, November 22, 2010.

According to Mr. Griffin's website, Reality Zone,

The 5th Edition includes a no-holds barred analysis of bank bailouts under the Bush and Obama Administrations that are shown to be nothing less than legalized plunder of the American people. Many other updates have been added, including a revision to the list of those who attended the historic meeting at Jekyll Island where the Federal Reserve was created.

Originally published in 1994, Creature has undergone 26 printings.  If you have not read the book, your Federal Reserve education is incomplete.  It is a compelling read throughout - except for his use of intrinsic value.  He says gold possesses intrinsic value.  I disagree.  Value is in the beholder of the thing valued, not the thing itself.  It is subjective. 

There is nothing mystical about gold, he writes on page 145 (fourth edition, hardbound).  "It is merely a commodity which, because it has intrinsic value and possesses certain qualities, has become accepted throughout history as a medium of exchange."  Those certain qualities, along with its scarcity, are the reasons people have valued it.  As Gary North has written,

It was Carl Menger's profound insight in 1871 to recognize that economic value is imputed by each individual. The value of the tools of production, the value of land, and the value of labor expended in the creation of a final consumer good do not move forward in time from the value of the inputs. They move in response to entrepreneurs' estimates of future value imputed by customers. This was Menger's great discovery. . . .

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.

Gold's startling fall in price from $850 to $250, 1980–2001, reveals just how non-intrinsic gold's value has been. The money supply doubled, prices doubled, and gold's price fell by 70%. . . .

The defender of intrinsic value is relying on a pre-1871 theory of economic value. He is claiming that there is objective value out there somewhere. The last major economist who defended such a theory of economic value was Karl Marx. He defended the labor theory of value. His economic analysis could never escape the problem of the waterfall. No one made it through human labor, but it can have high economic value. Why?

Menger would have answered: "Because people value it." But why? "That is for them to say. It is not for an economist to say."

The "intrinsic value" issue is minor, and whether you agree with the author or not, it does not seriously impact the rest of his book.  Creature is priceless, a must-read.

Is the Fed a Great Success Story?

As a public cartel, the Federal Reserve can count on the government to protect it from competition and to shield it from legal action.  The purpose of a cartel is to create above-market rates of return for its members, in this case the largest commercial banks.  The justification given for cartels is that competition would thwart the higher standards sought by cartel members.  Since the goal of higher standards is supposed to benefit the public, the public will pay a high price.  In asking if the Federal Reserve has been successful, therefore, we also need to ask: From whose perspective?  Has the Fed made life better for the general public?

The answer can only be: Are you kidding?

1.  The Fed was sold to the public as a means to eliminate recessions and depressions, which prior to 1913 were called Panics.  Recessions have their origins in fractional reserve banking.  Far from eliminating this practice, central banks were created to protect it.  Why do they protect it?  Because it provides above-market rates of return during the inflationary boom the Fed creates.    

2.  One of the Fed's stated goals is to preserve price stability.  In seemingly innocuous increments, the Fed has debased the dollar with reckless abandon while telling us this is the path it must follow to assure prosperity and full employment.  In the 1880s, the U.S. experienced one of the most prosperous periods in mankind's history, while the dollar actually appreciated in value.

3.  Earlier generations of Americans debated monetary policy, but the Fed, through its secrecy and mind-numbing obfuscations, has taken monetary matters out of the arena of public debate.  People are more interested in who will win the Heisman than in the counterfeiting cartel draining their wealth and making them more dependent on government.  Even with Ron Paul exploding on the scene, mention the words "Federal Reserve" to almost anyone and brace yourself for a blank stare.

4.  As society's sole engine of inflation, the money cartel is funding the creation of a debt-laden super-state over a debt-burdened populace whose forerunners basked fat and prosperous under a smaller government and no Fed.

5.  During the 1920s, as a favor to special interests, including the Bank of England, the Fed inflated the economy into a crisis that led to the abandonment of the market's choice of money: gold coins.  Leading experts blame the "mentality of the gold standard" for causing the Great Depression because it "limited the ability of governments and central banks to respond to adversity."  And what, one should ask, brought on this adversity?

The crisis was not caused by sovereign individuals engaging in voluntary trade with their preferred choice of money, but by the state-run gold standard and the banking cartel.  The state failed to protect depositors by failing to uphold contract law. 

The public had been persuaded to deposit their gold coins in banks in exchange for IOUs, which circulated alongside the coins.  The banks promised to redeem their IOUs on demand, a promise they could only keep for relatively few depositors because most of their reserves were loaned out.  In June, 1917, the Fed began the process of centralizing the public's gold.  The public was being acclimated to using IOUs instead of coins, a circumstance they would be comfortable with when confiscation arrived.  As Gary North points out, trust moved from the people to the banks, then from the banks to the central bank under state protection. 

The transfer of trust moves from economics to political sovereignty. But a system based on political sovereignty is not trustworthy. It has the ability to cheat, and no agency can bring charges. No agency of appeal exists.

And none exists today as we witness pirates in fine clothes looting our capital to boost the economy.  Since 1933 Americans have been forced to use "IOU nothings" for money.  Such a system produces winners and losers, with the winners being those who control the money.  The losers are the ones with blank stares.

6.  The Fed recently made news when it celebrated the 100th anniversary of its founding at Jekyll Island, Georgia.  Ben Bernanke told the gathering that "We are committed to our price stability objective. I have rejected any notion that we are going to raise inflation to a supra-normal level."  Perhaps he really believes his policies won't reach a "supra-normal" level of inflation.  He once believed the Fed's policies wouldn't cause a housing market meltdown, either.

7.  In his myth-shattering account of the Federal Reserve, G. Edward Griffin wrote this about the Fed's founding (p. 23):

What emerged [from the secret Jekyll Island meeting of 1910] was a cartel agreement with five objectives:

1. Stop the growing competition from the nation’s newer banks;
2. Obtain a franchise to create money out of nothing for the purpose of lending;
3. Get control of the reserves of all banks so that the more reckless ones would not be exposed to currency drains and bank runs;
4. Get the taxpayer to pick up the cartel’s inevitable losses;
5. Convince Congress that the purpose was to protect the public.

It was realized that the bankers would have to become partners with the politicians and that the structure of the cartel would have to be a central bank.  The record shows that the Fed has failed to achieve its [publicly] stated objectives.  That is because those were never its true goals.  As a banking cartel, and in terms of the five objectives stated above, it has been an unqualified success.

If central banks are such pariahs, why do they continue to exist?  Gary North offers this explanation:

The collapse of the Soviet Union brought derisive laughter from academia, worldwide. The Marxists have never recovered, nor is it likely that they will. The emperor had no clothes. No similar derisive laughter has greeted central bankers after their centrally planned disasters have brought economic devastation to tens of millions. On the contrary, politicians call for more of the same. The voters are somewhat skeptical, more ready to cry out, "The emperor has no clothes!" Politicians are not. They know where their bread is buttered, and with what: fiat money for their political action committees.

 So, yes, the Fed has been a success - if you're a Fed insider.

Still Have Faith in Interventionism?

The government "bubble" has grown quite a bit over the last two years, as Steve Saville reminds us.  Drawing on an article by Robert Murphy and adding some points of his own, he notes:

1. The government seized Fannie and Freddie, thereby effectively nationalizing a large portion of the entire US housing market
2. The Fed nationalized AIG
3. The treasury secretary told everybody that he needed $700 billion pronto to patch up the financial sector or the world would end; the treasury secretary then proceeded to partially nationalize the US financial sector
4. The federal government took over two of the Big Three car companies and threw traditional creditor rights out the window
5. The Fed more than doubled the monetary base in six months' time
6. The new Obama administration borrowed almost $800 billion to spend on "stimulus"
7. The federal government has taken a giant leap forward to socialized medicine
8. The federal government also banned offshore drilling (though the rules are yet again undergoing revision)
9. The $8000 tax credit and other subsidies designed to encourage greater spending on houses
10. The "Cash For Clunkers" program designed to encourage greater spending on cars
11. The push for "Cap and Trade" and other legislation designed to address the imaginary hobgoblin that was originally known as "Global Warning" and is now known as "Climate Change"
12. The altering of accounting rules that miraculously transformed insolvent, loss-making banks into highly profitable enterprises

But wait - according to government statistics U.S. employers added 151,000 jobs during October.  Maybe that number as well as other economic indicators would be far better if the interventions had been far more intense. Hasn't that been Paul Krugman's complaint all along, that the government's not spending enough?

And that's the part you take on faith - assuming you don't understand Austrian economics or economic history.  Consider (from the Economic Collapse Blog):

1. Over 42 million Americans were on food stamps during the month of August, an all-time record and 17% higher than August, 2009.
2. The "official" unemployment rate in the United States has been at nine and a half percent or above for 14 consecutive months.
3. In the past 60 days alone, the price of cotton is up 54%, the price of corn is up 29%, the price of soybeans is up 22%, the price of orange juice is up 17%, and the price of sugar is up 51%.
4. The American Bankruptcy Institute says that there will be about 1.6 million consumer bankruptcies in 2010.  That would represent a huge increase over 2009.
5. U.S. states are mostly flat broke.  The biggest ones are.
6. With a "fiscal gap" of $202 trillion (by one economist's calculations), the U.S. government is completely broke.
7. Major U.S. trading partners are seeking ways to protect themselves against the Fed's latest round of monetary inflation, euphemistically labeled quantitative easing.

From Gary North:

David Stockman, who was briefly Reagan's budget director before he resigned, recently wrote an article on the gargantuan size of the Federal deficit. He made an important but neglected observation. Ever since the third quarter of 2008, the nation's nominal GDP has increased by a tiny $100 billion, but the Federal debt has increased by 25 times the GDP increase.

It has taken $25 of Federal deficits to produce $1 of GDP growth.

And Howard Katz gives us a little background on GDP:

Members of the paper aristocracy measure the nation’s economy by a statistic called Gross Domestic Product.  Gross Domestic Product was invented in the 1930s by a Russian national who worked his way into the New Deal and devised the formula for GDP.  He presented this without proof that it actually worked and measured the real economy.  Hardly any American can pronounce his name.

          For example, if a man invents a thermometer, he is obliged to show that it actually does measure the real temperature.  If he takes it outside in January and it measures hot and in July measures cold, then his thermometer does not work, and he is a failure.

          This is the case with GDP.  For example, a very poor period in the American economy was the early 1940s.  This should not be a surprise because the world was at war, and everyone was engaged in the destruction of goods.  One could not buy a new house in the early 1940s because none were being built.  One could not buy a car for the same reason.  Gasoline was rationed to 3 gallons a week.  Butter and many food items were also rationed.  You would walk into a store and find that it did not have the item you wanted to buy.  But real GDP rose sharply during this time.  This is the thermometer which reads hot in January. 

Keep in mind that the price of gold, the canary in the coal mine, keeps inching up, too, along with silver and other precious metals.  And we have not yet reached critical mass, when the public suddenly realizes the Fed's paper dollar is a means of looting them, by design, and they panic to buy anything of value in an effort to preserve what wealth they have left.

How Americans Gave Up Their Gold

Have you ever wondered how the American people could surrender their one means of keeping government at bay?  Garet Garrett gives us some details in his 1953 book, The People's Pottage (pp. 33-41):

In view of further intentions not yet disclosed it was imperative for the government to get possession of all the gold. With a lot of gold in private hands its control of money, banking, and credit could have been seriously challenged. All that the government asked for at first was possession of the gold, as if it were a trust. For their gold as they gave it up people received paper money, but this paper money was still gold standard money—that is to say, it had always been exchangeable for gold dollar for dollar, and people supposed that it would be so again, when the crisis passed. Not a word had yet been said about devaluing the dollar or repudiating the gold standard. The idea held out was that as people surrendered their gold they were supporting the nation's credit.

This decree calling in the gold was put forth on April 5 [1933]. There was then an awkward interlude. The Treasury was empty. It had to sell some bonds. If people knew what was going to happen they might hesitate to buy new Treasury bonds. Knowing that it was going to devalue the dollar, knowing that it was going to repudiate the gold redemption clause in its bonds, even while it was writing the law of repudiation, the government nevertheless issued and sold to the people bonds engraved as usual, that is, with the promise of the United States Government to pay the interest and redeem the principal "in United States gold coin of the present standard of value." . . . .

By resolution June 5, 1933, the Congress repudiated the gold redemption clause in all government obligations, saying they should be payable when due in any kind of money the government might see fit to provide; and, going further, it declared that the same traditional redemption clause in all private contracts, such, for example, as railroad and other corporation bonds, was contrary to public policy and therefore invalid. . . .

[What eventually followed] was a modern version of the act for which kings had been hated and sometimes hanged, namely to clip the coin of the realm and take the profit into the king's revenue. . .

At the President's request the Congress, on January 30, 1934, passed a law vesting in the Federal government absolute title to all that gold which people had been obliged to exchange for gold standard paper dollars the year before, thinking as they did that it was for the duration of the emergency only and that they were supporting the nation's credit. They believed the statement issued at the time by the Secretary of the Treasury, saying : "Those surrendering the gold of course receive an equivalent amount of other forms of currency and those other forms of currency may be used for obtaining gold in an equivalent amount when authorized for proper purposes."

Having by such means got physical possession of the gold, it was a very simple matter for the government to confiscate it. All that it had to do was to have Congress pass a law vesting title in the government.

The following day, on January 31, 1934, the government devalued the dollar and pocketed the roughly $2 billion in profit.  Relying on Americans' trust, Roosevelt had accomplished a revolutionary feat in four steps:

1.  Give us your gold so we can build up the nation's credit.  In exchange, we'll give you receipts you can later turn in to get your gold back.  Incidentally, if you don't cooperate we'll hit you with a heavy fine and throw you in prison.

2.  We've decided not to honor the gold clause in the bonds we've sold you.  In other words, your bonds will be redeemable in paper money rather than gold.  The same goes for private contracts that stipulate payment in gold.  You can only use government paper money to meet contractual obligations.

3.  Remember that promise we made about exchanging your paper gold for the gold you turned in?  We've decided to break that promise.  We're keeping the gold.

4.  We hereby declare gold to exchange for more dollars than it did when we took it from you.  We'll keep the profit.  It will help the recovery.

In ruling on the subsequent "gold cases," the Supreme Court said yes, it was all done legally, if perhaps underhandedly.  How could government get away with an immoral act?  No one had the power to stop it.

Garrett later concludes (pp. 103-104):

Those who take the New Deal to have been the beginning of revolutionary change in the character of government are wont to cite its laws, and its many innovations within the law and to forget that if it had been without the means to enforce them all of its intentions would have died in the straw. It had to have money; and not only a great deal of money, but freedom from the conventional limitations of money. It knew that. [Emphasis added]

Name the Party, Candidate, and Election Year

Excerpts from the Party platform:

"1. An immediate and drastic reduction of governmental expenditures by abolishing useless commissions and offices, consolidating departments and bureaus and eliminating extravagance, to accomplish a saving of not less than 25 per cent in the cost of Federal government. . .

"2. Maintenance of the national credit by a Federal budget annually balanced. . . .

"3. A sound currency to be maintained at all hazards."

In his campaign for the presidency, the candidate said:

"I accuse the present Administration of being the greatest spending Administration in peace time in all American history—one which piled bureau on bureau, commission on commission, and has failed to anticipate the dire needs or reduced earning power of the people. Bureaus and bureaucrats have been retained at the expense of the taxpayer. . . . We are spending altogether too much money for government services which are neither practical nor necessary. In addition to this, we are attempting too many functions and we need a simplification of what the Federal government is giving to the people."

For the answer, see this.

Policies are made for the sheppards, not the sheep

The Fed exists to keep the big banks profitable and to help fund government's massive spending programs.  QE II is an open policy of monetary inflation to help achieve these ends, but the Fed has been QE'ing all along.  Andy Sutton reports:

The Fed has been backdoor monetizing for some time now. There are many different ways they’ve done this such as using currency swaps with the ECB, and other ‘facilities’ in foreign jurisdictions like the UK to make their purchases for them. Notice at around the same time China started cutting back on its exposure that Great Britain, broke as a stone, started ramping up bond purchases. It is a pretty safe bet that this is none other than Mr. Bernanke and Co. at work.

This has been going on and will continue. However, the shift towards overt monetization should tell us that the Fed is stuck and is beginning to panic. The stimulus didn’t work. The last round of asset purchases, totaling nearly $2 Trillion that we know of, only fattened bank balance sheets and did almost nothing to help Main Street. I am inclined to believe that was the whole idea though since the Fed has been incentivizing the banks NOT to expand lending.

One of those incentives is the interest the Fed pays banks on their reserves.

What about consumers?  Won't some of this new money help them out?  More money in the economy usually means higher prices, the very reason the Fed is inflating, making it more difficult for consumers to maintain their lifestyle without borrowing.  Banks love it when you borrow.

. . . much of our ‘growth’ the past few decades has been derived from a service oriented, consumption driven model. The fuel for that growth has been the expansion of consumer credit, so much that consumer credit outstanding and GDP have marched in near lock step since the turn of the century. This tells us that our ‘growth’ has been borrowed, and is in fact, not growth. Throw in the inflation of the early part of this decade and there has been negative growth across the board. The prosperity has been put on plastic and now hangs like a boat anchor around the necks of most Americans.

Graphically, it looks like this:

Sutton adds:

The current contraction, which is showing signs of exhaustion, has only clipped 6.49% off the total consumer debt outstanding.  While this is significant in that it is unprecedented, it is not enough to substantially decrease the costs of servicing the debt for consumers. Since being bailed out, banks have continued to raise rates on many forms of revolving debt to keep profits steady.

The Experts Give Us QE II

The Fed's $600 billion promised purchase of Treasury bonds over the next eight months gathered the headlines, but the fine print adds an additional $35 billion per month to purchase more Treasury debt with proceeds from mortgage bonds the Fed plans to retire.  Total money created from nothing for the next eight-month period: $900 billion. 

The stock market is trying to figure out if this is good or bad.  On Wednesday the Dow rose 26 points, and so far today it's up 188.83 points, currently sitting at 11,403.96 as of 3 PM. EDT.

But gold buyers reacted with horror to the Fed's plans.  Adrian Ash reports:

THE PRICE OF GOLD in wholesale dealing lept at the start of US trading on Thursday, extending an overnight rise to within 0.5% of last month's record highs – and gaining $50 per ounce inside 21 hours – as the US Dollar sank in response to the Federal Reserve's hotly-anticipated "QEII" asset purchase program.

"Currency devaluation remains firmly en vogue," said one London bullion dealer this morning.

Currently, gold is selling for $1,384 per ounce, according to Kitco. 

In a Washington Post Op-Ed piece, Ben Bernanke justified QE II this way:

Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. Although low inflation is generally good, inflation that is too low can pose risks to the economy - especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation (falling prices and wages), which can contribute to long periods of economic stagnation.

Even absent such risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

And Mish's Global Economic Trend Analysis mentions the views of Dr. El-Erian, CEO and co-CIO of PIMCO, who predicts QE II will fail for at least three reasons:

1. The Fed is going it alone, without meaningful structural reforms
2. Emerging economies burdened by capital inflows in the wake of QEII will react with currency wars, protectionism, and capital controls
3. Resultant commodity price increases will increase input costs and reduce earnings of American companies

The only structural reform that would help us would be to de-structure the Fed entirely, along with every other organization in Washington.  Mish offers his own analysis:

Add a junk bond bubble to the list of consequences (unintended or otherwise).

Bernanke is clearly misguided enough and arrogant enough to purposely blow a junk bond bubble as an "intended consequence", even though the housing bubble bust proves without a doubt the asininity of such policies.

Thus, it's hard to say if Bernanke wants a junk bond bubble or is merely willing to live with one.

Then again, Bernanke is dense enough to not have any clues about what is happening. He did not see the housing bubble, the recession, the huge rise in unemployment, and any number of other things that happened. In fact, he even denied there was a housing bubble.

In the academic wonderland in which Bernanke lives, it is perfectly possible he is oblivious to the bubbles he is creating.

However, looking at things from every angle, given that Bernanke Admits Targeting Stock Prices, I am leaning towards the first option: Bernanke is misguided enough and arrogant enough to purposely blow more asset bubbles as an "intended consequence", hoping he can deal with them later.

A Cross of Gold

This is a long read - 23 pages - but a very worthwhile one.  Edwin Vieira clarifies many ideas about money, both sound and unsound.

Astute Americans need to envision, and then to bring about, a new monetary system in which no one talks about “the price of gold”, but only of “prices in gold”.  No “price of gold” exists when a fixed weight of gold is the actual unit of money. Under those circumstances, all prices are stated in terms of gold. When a fixed weight of gold is the unit of money, “the price of gold” is a meaningless concept, or at best a tautology: namely, “the price of a unit of gold” is precisely “a unit of gold”. In that context, asking what is “the price of gold” would be as sensible as asking today what is “the price of a nominal 'one-dollar' Federal Reserve Note”.