Thursday, May 26, 2011

That Other Invisible Hand

As Adam Smith explains, the free market brings its wonders to the world by virtue of an invisible hand.  Individuals cooperating under the international division of labor and seeking generally to satisfy their own wants end up promoting the general welfare, often without intending to or without realizing it.

Not to be outdone, government too has developed a systemic hand that is usually not seen.  Unlike the market, when this hand moves, we lose.  Through inflation, government snatches the market’s bounty for its own purposes, enervating our lives accordingly.

As a “stealth tax,” inflation requires no legislation to impose, no agency to collect, and diverts responsibility for damages onto politicians’ favorite whipping boys.  It gives government the ability to buy almost anything for nothing, while creating endless problems that serve as a pretext for intervention.  Inflation is the foundation of arrogant government and a prescription for our own demise.

Government inflates through its central bank, the Federal Reserve System.  The Fed does many other things, but its foremost responsibility is to make the dollar buy less without leaving a trail.

Central banks such as the Fed are engines of inflation.   Inflation is not some curse of capitalism; it is government policy, and it destroys capitalism .  Inflation, economist Judy Shelton explains, chisels

away at the foundation of free markets and the laws of supply and demand. It distorts price signals, making retailers look like profiteers and deceiving workers into thinking their wages have gone up. It pushes families into higher income tax brackets without increasing their real consumption opportunities. [1]
Inflation is alluded to in the Fed’s charter, which calls on it “to furnish an elastic currency.”  [2]  Ben Bernanke once boasted about it: “[T]he U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” [3]

If this sounds like counterfeiting, be advised that almost no one sees it that way, especially government and Fed officials.  According to the MSN Encarta dictionary, a counterfeiter is a person who makes “a copy of something, especially money, in order to defraud or deceive people.”  Does that shoe fit the Fed?  You decide.

The Fed’s inflation is often part of a process called “monetizing the federal debt,” a stultifying expression describing the hocus-pocus used to cover government’s deficits.  In simple language, government puts ink on pieces of paper and calls them “securities,” in response to which the central bank puts ink on pieces of paper, calls it money, and buys the securities (though indirectly).

Like magic, the federal government has new money to spend – thanks to the tooth fairy known as the Fed. 

When government imposed its central bank on us in 1913, pulling money from a hat was more of a challenge than it is now.  If the Fed printed too many paper tickets, people would begin to wonder if the banking system could redeem them in gold on demand, as stated on the tickets.  The fear of a bank run acted as a brake on inflation.

Since inflation is the increase in the money supply, gold imposed a limit on the amount of government debt the Fed could buy, which in turn put restrictions on government spending.  Restrictions on government spending put restrictions on government expansion.  If gold could be eliminated, those restrictions would go away.

When the Fed was being sold to the public, its advocates told people it would prevent panics and recessions by virtue of its power to provide money and cheap credit on demand.  Eight years after its inception the country slid into a recession (1921), and after another eight years the stock market crashed.  By the time a new administration took power in 1933, the economy was on its knees.

Assured the free market had failed them, a bewildered public turned to government for deliverance.  On April 5, 1933 President Roosevelt issued Executive Order 6102, in which he ordered all persons to turn in their gold or face a possible 10-year prison sentence and a $10,000 fine.  He gave them until April 28 to comply. [4]  For this and countless other New Deal interventions, most historians regard Roosevelt as a demigod for “saving” capitalism.

After the gold heist, dollars were no longer redeemable, at least domestically.  Foreigners were allowed (though not encouraged) to swap their dollars for gold until August 15, 1971, when President Nixon repudiated the government’s redemption obligations.

With gold completely severed from the dollar, our monetary system lost its best defense against political caprice.  Not surprisingly, inflation rose to double digits by 1973.  As economist Ludwig von Mises tells us, the gold standard makes the supply of money depend on the profitability of mining gold. [5]  The pure fiat dollar faces no obstacles to its production, other than the integrity of government and Fed officials.

Nevertheless, spokespeople for government’s monetary monopoly assure us the proliferation of printing press dollars helps the economy.  As such, the Fed doesn’t inflate, it accommodates.  Inflation is a dirty word for its “accommodative monetary policies.” [6]

Fed Accommodation

What happens when the Fed “accommodates” us by increasing the stock of money?

First, it reduces the value of the dollar.  More dollars means each one buys less, putting upward pressure on prices.  Technology and improvements in production tend to push prices downward, but because of inflation fewer people can afford admission to the market’s bounty.

As a rough idea of how far the dollar has plummeted, $5,000 in 1913 had greater buying power than $110,000 in 2011. [7]

Second, a depreciating dollar discourages savings.  Why put money away if it’s going to lose value?  Instead, millions of investment neophytes put their funds in the stock market in an attempt to protect themselves against Fed printing presses.  Has this been a successful hedge?

During the biggest bull market in history – 1984 to 2001 – the S&P rose 14.5 percent a year.  But frequent trading by fund managers and high fees reduced the average rate of return to 4.2 percent annually.  According to Vanguard group founder John Bogle, if you include the results of 2002, the average return from equities was under 3 percent per year – less than the inflation rate. [8]

Third,  new injections of money spur a tinsel prosperity, and the Fed keeps injecting new money to feed the boom.  With so much borrowing and spending, prices may rise even faster than the rate of currency inflation.

As the public broods over higher prices, a semantic shift takes place.  Inflation comes to mean not an increase in the money supply, but the rise in prices itself.  [9]  Thus, businesses that charge higher prices become the villains, while government officials  that threaten price controls are the avenging angels.  Most people have no idea what the Fed does, so government can scapegoat business and appear to be defenders of the public weal.  Nor do most people understand that price ceilings create shortages, by encouraging consumption and retarding production.  Shortages, in turn, bring on government-imposed quotas, which foster corruption, black markets, and violent crime.

Fourth, as the influx of dollars drives prices higher some industries find themselves at a disadvantage with foreign competitors, tempting them to lobby Washington for protection from imports.  Protective tariffs and quotas, of course, push prices up further, while sometimes sparking trade wars as other countries retaliate on American exports.  And trade wars can lead to shooting wars.

In June, 1930, with the economy fighting the recession brought on by Fed monetary policies, President Hoover signed the Smoot-Hawley Tariff Act, raising tariff levels to the highest in U.S. history.  Other countries immediately retaliated, markets shut down, and economic conditions worsened worldwide.

Fifth, inflation raises nominal incomes, pushing people into higher tax brackets, which increases government tax revenue.  As people’s wealth goes out the window in depreciating dollars, taxes consume more of what remains.

Sixth, inflation shifts wealth from people who can’t or don’t know how to defend themselves from monetary destruction to those who can.  As a simple example, a person living on a fixed income may find his buying power so depleted he sells a family heirloom to pay for an unanticipated expense.  Or a bank that was part of the lending spree that helped drive prices skyward may foreclose on the homes of some of its borrowers, whose incomes were ravaged by monetary debauchery.

Seventh, the Fed’s “accommodative” measures keep people working much later in their careers because they cannot afford to live off their deteriorating pensions.  Dollar depreciation is a huge reason why both husband and wife work in many families.  

Eighth, because government often gets the new money first, it can fund controversial measures such as war and bailouts without drawing taxpayer ire.  Government simply puts the funding on its charge card, prompting the alchemy of Fed debt monetization.  We get the bill, of course, but this way it’s spread over everything else we buy, so we never see it itemized. 

Ninth, because inflation has an uneven affect on prices, raising some faster or sooner than others, people have a hard time distinguishing illusion from reality.  As cheap credit abounds, business people, investors, and cube dwellers hear the siren call of can’t-miss profit opportunities.  Fortunes are made then lost, and companies that lose money find it harder to keep employees.

Tenth, government may pose as the savior of a group of voters they’ve impoverished, such as the elderly, by subsidizing their medical expenses.  New entitlements create the need for more revenue, which fuels more inflation, pushing the dollar closer to a complete collapse.

Eleventh, as Mises observed, “under inflationary conditions, people acquire the habit of looking upon the government as an institution with limitless means at its disposal: the state, the government, can do anything.” [10]  Through deficit spending the state will devour limited resources trying to maintain this illusion.

If gold is the barbarous relic its many detractors claim it is, we might expect the Fed’s fiat currency to be a better deal.   But even former Fed Chairman Greenspan admits that it isn’t, telling a New York audience in 2002 that prices soared in the decades following the gold heist of 1933. [11]

Lord Keynes, the 20th century’s guru of deficit spending, never spelled out how deficits should be financed, admitting only that increased taxation was not the answer.  [12]  Perhaps he had pangs of conscience about calling for inflation outright, since he knew it would destroy society in a manner that not one man in a million  could diagnose.  [13]

Political issues dominate the news, but how little we hear about the policies nurturing those issues, one of which is government’s power to confiscate wealth with the Fed’s invisible hand.

We should wipe every trace of the Federal Reserve from our lives and allow the market to freely choose our monetary standard, which most likely would be gold.  In the meantime, the FOMC should be prohibited from purchasing any more “assets.”


1 “Capitalism Needs a Sound-Money Foundation,” Judy Shelton, The Wall Street Journal, February 11, 2009,

3 Remarks by Governor Ben S. Bernanke, November 21, 2002,Deflation: Making Sure “It” Doesn’t Happen Here,”

5 Mises, Ludwig von, Economic Freedom and Interventionism,

6  Remarks by Governor Ben S. Bernanke, January 4, 2004, “Monetary Policy and the Economic Outlook: 2004,”

8 Bonner, William and Wiggin, Addison, Financial Reckoning Day: Surviving the Soft Depression of the 21st Century, John Wiley & Sons, Hoboken, New Jersey, 2003. p. 245

9 Sennholz, Hans F., Age of Inflation, Western Islands, Belmont, Massachusetts, 1979. p. 69

10 Mises, Ludwig von, Economic Policy: Thoughts for Today and Tomorrow, Regnery Gateway, Washington, D.C., 1979, p. 66

11  Remarks by Chairman Alan Greenspan, December 19, 2002, “Issues for Monetary Policy,”

12 Hazlitt, Henry, “Keynesianism in a Nutshell,” 1982,

13 Keynes, John Maynard, Economic Consequences of the Peace, 1919,


JLM Wealth Strategies said...

Absolutely brilliant!

Gary said...

Yes, terrific! I immediately went out and ordered your book.

doublenickel said...

This is the most concise, accurate account of the government's counterfeiting activities and their terrible effects I've ever read. It should go viral, and would except that the population is largely illiterate. Bravo!
BTW--I think that the money of choice should be silver--it makes better currency than gold, and the dollar is already defined in the Constitution as a weight of silver. Let gold be for wealth storage. But that's just me :-). Another thought--since the dollar has a definition, and the gov and fed insist on using the word "dollar" to designate something other than that, shouldn't some officials be subject to the same prosecution as Bernard Von Nothaus, who was prosecuted largely on the basis of calling his product "Liberty Dollars"? Last I heard, govt officials are not exempt from the law (I'm so naive).

doublenickel said...

A further comment--seems to me that Von Nothaus has a better claim to the term "dollars" for his product than does the government--his are a real weight of silver (I don't know if they correspond to the Constitutional definition of 371.25 grains of silver, though)

George said...

Doublenickel, you are not alone in thinking of silver as the best money, by any means. Guido Hulsmann in his masterpiece The Ethics of Money Production promotes silver as the money of choice. Quoting (pg 27):

One cannot tell on a priori grounds what the natural money of a society is. The only way to find this out is to let people freely associate and choose the best means of exchange out of the available alter- natives. Looking at the historical record we notice that, at most times and most places, people have chosen silver. Gold and copper too have been used as monies, though to a lesser extent.

On page 210 Hulsmann writes:

Silver, the only serious competitor for gold among the commodity monies, has one grave disadvantage from the point of view of a government bent on inflationary finance. Because of its bulkiness, the use of silver entails higher transportation costs, which makes it less suitable than gold for fractional-reserve banks trying to quash systematic bank runs through cooperation.

Recently, I've posted two articles on BRC that are favorable to silver. "Silver the New Gold?" by Gijsbert Groenewegen, and "Can You Pass the 2011 Silver Quiz?" by Jeff Clark. Both are excellent.

BTW, I strongly recommend reading Hulsmann's book. You can read my review of it at

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