Peter Schiff on avoiding the brick wall

Peter Schiff, who was famously ridiculed for calling the crisis of 2008, steps up as a prognosticator again in his new book, The Real Crash: America’s Coming Bankruptcy - How to Save Yourself and Your Country.  We had way too much government and cheap credit leading up to 2008, he says, and even more government and cheap credit since then, which is why the next crisis will be the real haymaker. 

His book is divided into two main sections.  Part I addresses the problems, while part II, which is by far the lion’s share of his discussion, presents solutions.  In a nutshell, the problem is government, and the solution is to take an ax to it - again and again.   Since this view is currently unacceptable to policymakers and the public at large, we can only hope reality will win out before calamity hits.

The Real Crash is encyclopedic in its coverage and highly readable in its presentation.  Is there a government agency that truly serves the interests of all Americans?  He finds few.  What about services people actually want, such as K-12 education: Could they be done better at the state or local levels?  Or better still by the free market?  In most cases the answer is a profound “Yes!” to both.

Living on Bubbles

Our problems stem from a love of bubbles and the flawed economic theory that blesses them.

During Alan Greenspan’s reign at the federal reserve we had a savings and loan bubble, followed by a tech bubble, followed by a housing bubble.   Now with Ben Bernanke at the Fed, we have a government bubble, meaning the Fed is creating money that the banks are then lending to the Treasury to expand government.  “If you keep replacing one bubble with another, you eventually run out of suds. The government bubble is the final bubble.”

When the dot-com and housing bubbles burst we at least had something to show for them - “a few good Internet companies and some pretty nice McMansions, [but] no such benefits will remain when the government bubble pops.”

The Fed, Schiff says, should let interest rates rise so people can start saving again.  The Fed’s low rates discourage savings, which are

the key to economic growth, as it finances capital investment, which leads to job creation and increased output of goods and services. A society that does not save cannot grow. It can fake it for a while, living off foreign savings and a printing press, but such “growth” is unsustainable— as we are only now in the process of finding out.

But for politicians and central bankers, rising interest rates are an abomination.  The cost to service the national debt would go through the roof, while the economic contraction that would likely result would raise the deficit.  The federal government would have to spend less, and many of the country’s biggest companies depend on government spending, through contracting, subsidies, or consumption.

But rising rates and the terrible pain it would cause is the good news; the bad news, if the Fed continues to hold rates low, is the economy will eventually go into hyperinflation.  “Rising interest rates will be productive pain— like medicine,” he writes, “while hyperinflation will be destructive pain.”  If we stay the course and pretend everything will somehow work out, we could be facing a crisis worse than the Great Depression.

Bernanke on the Great Depression

Chairman Bernanke, of course, is well-known as an “expert” on the Great Depression, and many people are betting the farm that he and his Keynesian staff have the skills to steer us back to sunny beaches and bikinis.  Bernanke’s approach is to keep asset values from falling by any and all means.  One of the reasons the depression of the 1930s became great, he believes, is because the Fed allowed the money supply to fall following the Crash.  With less money in the economy, prices nosedived.  People didn’t consume as much, consequently businesses didn’t profit as much, therefore employees got fired, and the economy headed south in a self-perpetuating spiral. 

“Sustained deflation can be highly destructive to a modern economy and should be strongly resisted,” Bernanke said in a 2002 speech that inspired his nickname.  And by deflation, he means “falling prices.”

Schiff explains what’s wrong with this analysis.

First, for 100 years prior to the 1929 Crash, bank deposits actually gained value each year.  In other words, we had a century of deflation, that much-feared condition that Bernanke has vowed to avoid at all costs.

Second, from mid-1921 to mid-1929, the Fed increased the money supply by 55 percent, giving rise to a real estate and stock bubble.  Most but not all economists missed the bubble and its inevitable consequences because rising productivity kept consumer prices fairly stable.  Even as stock prices were falling only days before the Crash, Irving Fisher said stocks had reached a “permanently high plateau,” and he expected to see “the stock market a good deal higher than it is today within a few months.”  In 1928, Ludwig von Mises had published a full critique of Fisher’s monetary theory, claiming that Fisher’s reliance on price indexes would bring about the Great Depression.  Nonetheless, Fisher’s stable price theory carried the day, and when the sky fell the Fed, along with Hoover, “did something,” as Schiff explains:

Hoover’s Fed actually boosted the money supply by 10 percent in the two weeks following the 1929 crash. Repeatedly throughout Hoover’s term, the Fed created more money. But the money supply fell because people began hoarding cash, and banks stopped lending out their money.

Also,

Deposits went down by 30 percent, but most of that was due to people pulling their money out.

In other words, the money supply shrank despite the Fed’s interventions, not because of its inactions.

Did a falling money supply promote massive unemployment?

Not by itself.  Hoover insisted on keeping wages high, and during his re-election bid in 1932 boasted that the wages of U.S. workers were “now the highest real wages in the world.”  They probably were, and by not allowing wages to fall along with other prices, unemployment soared.

Had Hoover simply allowed the free market to function, the recovery would have been so strong that he likely would have been elected to a second term, and Teddy would have been the last Roosevelt to occupy the White House. Instead he handed the Keynesian baton to Franklin Delano Roosevelt . . .

None of this, as we know, is even close to the standard view of the Depression.  Instead, we’re told

that government needs to play a bigger role in battling downturns, and the Fed needs to pump in cash to jump-start the economy. This bad lesson stays with us today, and beginning in the early 1990s, this way of thinking started the cycle of bubbles that put us where we are now.

End Keep the Fed

The one puzzling part of Peter Schiff’s masterpiece is his view that the federal reserve, as originally conceived, was a good idea.  He describes the Fed as “reckless,” the “biggest culprit in discouraging savings,” and insists “we never should have trusted the Fed to respect its boundaries.”  But he also says:

The original intention of the Fed was something I might have supported had I been around back then. In theory, it was an agent of stability that could also promote economic growth. . . .

The Fed would increase the money supply as the economy expanded, and then reduce the money supply as the economy contracted. . . .

In theory the Fed was a good idea. It’s just that in practice it did not work, because politicians quickly abused it.

He argues that before 1913, banks were issuing their own currencies backed  “by assets, such as gold, and by the banks’ loan portfolios.”  If “you traveled to California, your bank note from Connecticut might not be honored by other merchants or the California banks.”

Thus, he concludes, it was natural “for bankers to hatch an idea of a “banks’ bank.  Banks could deposit some of their assets— commercial paper or gold— with the Fed, and the Fed in return would issue its own bank notes to the individual bank.”

While this may sound plausible, questions arise as to (1) why the “banks’ bank” needed “guns and badges” (i.e., government cartelization) to make it work; (2) why loan portfolios or commercial paper can be assumed to be an acceptable substitute for gold coin; (3) why a central bank is needed to expand and contract the money supply - in other words, why assume the supply/demand relation of the free market fails when the good in question is commodity money; (4) why the historical record of central banks acting as an agent of stability and sustainable economic growth is short on examples; and (5) why did the Fed, at its creation, possess a massive inflationary structure if it was sold as a means to promote stability?

I believe central banking, by its nature, is a means of institutionalizing, centralizing, and cartelizing moral hazard.  It is my view that the Fed was never a good idea, but one of the absolute worst ever brought to fruition. 

These concerns notwithstanding, his critique of the Fed as it currently exists is emphatically on the money.  Though he doesn’t support its abolition he does say, “In an ideal world, there would be no Fed, and I think the nation would be better off if the Fed had never been created.”

How we can save ourselves

Readers of his book don’t have to be swept up in the impending disaster.  Unlike the crash of 2008 when investors flocked to the dollar as a safe haven, he believes the dollar and U.S. bonds will collapse before the U.S. economy goes under.  He devotes a chapter to crisis investing based on the observation that since Americans have been living beyond their means, many others have been living beneath their means. 

Elsewhere in the world there are more creditors than debtors, and there is pent-up demand and excess production. In the future, these economies will see a surge in demand, while ours will see demand fall. . . .

Bottom line: purchasing power is shifting. You should try to invest in companies that will benefit from this shift. These will primarily be foreign companies. Of course, many foreign companies sell to the United States. These aren’t the businesses I’m talking about.

He describes his investment strategy as

a stool with three solid legs: (1) quality dividend-paying foreign stocks in the right sectors; (2) liquidity, and less volatile investments, such as cash and foreign bonds; and (3) gold and gold mining stocks. 

Of particular interest to this reader was his section on the poor man’s investment strategy.  If consumer prices head for the moon the government will likely impose price controls, thereby creating shortages.  Solution: buy in bulk now and stock up.  One advantage is that

any returns are tax free. For example, if you buy a box of cornflakes today and eat it two years from now when the price of a new box is 40 percent higher, that’s a 40 percent tax-free return.

His writing is full of fresh and sometimes bold insights on long-standing issues.  Readers will find his discussions on drug prohibition, marriage, abortion, guns, health care, and prostitution especially engaging, I believe.  His detailed historical and legal discussion of the income tax is the best I’ve ever read, nor does he pull punches in describing it:

It’s hard to imagine a tax more destructive of productivity, more destructive of entrepreneurship, more destructive of our lives, more difficult and costly to comply with, more subject to gaming, or more absurd in its logical consequences. Congress should immediately, fully, and permanently abolish the income tax, and the Internal Revenue Service (IRS) along with it.

He would replace the tax with a revenue-raising tariff on imports.

Yes, tariffs suck. But they suck less than income tax. In fact, they might be preferable to a national sales tax.

Conclusion

Peter Schiff has written a riveting guide on what to do about our snowballing social, financial, and economic problems.  Inasmuch as he recommends freeing people from government, his solutions are far from pain-free and consequently will not be popular with the political class or their dependents.  Well, it’s time they got over it.  As Schiff writes in his introduction, it’s as if we’re headed down an icy hill with politicians in the driver’s seat accelerating toward the bottom. 

We need a grown-up to grab the wheel and steer us into the ditch on the side of the road. That won’t be pretty, but it’s better to go into the ditch at 80 miles an hour than crash into a brick wall at the bottom of the hill at 120.

The Real Crash is a must-read.

Ben Bernanke Goes Back to School

[Note: A version of this article is available as a video commentary.]

In the opening chapter of his book Essays on the Great Depression, Fed chairman Ben Bernanke tells readers, “I am a macroeconomist rather than a historian.”  Though the book was published in 2000, his recent statements about the classical gold standard and the origins of the federal reserve suggest the vast revisionist literature pertaining to U.S. economic history is still largely unknown to him.[1]  His comments, in fact, sound like they were pulled uncritically from a public high school teacher’s manual: Why did the government institute a central bank?  To rein in the gold standard, which was creating crises.

This approach proved not to be a problem, though, when he lectured George Washington University students on March 20, 2012 about the Fed and gold.   On that day he told the class that

in the period after the Civil War until World War I and really all the way into the ‘30s, the United States was on a gold standard.  [28:43]

Never mind that there were two different gold standards before and after World War I, and never mind that both functioned under the thumb of government in vastly different ways.  Bernanke, the macroeconomist, aggregated them both into one category, calling it “a gold standard.” 

He continued:

There was more volatility in the economy, year to year, under a gold standard than there has been in modern times.  So, for example, movements in output variability was much greater under a gold standard, and even year-to-year movements in inflation, the volatility was much greater under a gold standard.  [31:56]

Earlier, he defined a gold standard as

a monetary system in which the value of the currency is fixed in terms of gold.  So for example by law, in the early twentieth century, the price of gold was set at $20.67 an ounce. . .  [Though central banks managed the gold standard to some extent,] a true gold standard creates an automatic monetary system.  [29:38]

On this last point he’s correct, a true gold standard is “automatic” in the sense that it works without, and only without, government intervention, [Mises, p. 280] though that’s a distinction that somehow eluded him.  Even Milton Friedman, never a champion of monetary freedom, admitted that,

If a domestic money consists of a commodity, a pure gold standard or cowrie bead standard, the principles of monetary policy are very simple. There aren’t any. The commodity money takes care of itself. [Salerno, p. 356; emphasis added]

A monetary system that “takes care of itself” would have no need of a Fed or a Fed chairman.  Central bank employees would have to find some other way to generate income.  Bernanke could always go back to being a college professor, but maybe not.  Who and what would he teach?  Thanks largely to Ron Paul, the Fed is suffering by far the worst criticism in its history, which was the main reason Bernanke was holding class at GWU.  If the Fed is abolished, it will put a huge blot on the resumes of FOMC members.  It’s one thing to lose one’s job because of shifting demand among consumers, but quite another to lose it because your policies caused major economic crises and helped put millions of those consumers out of work.

Over the centuries, people have chosen gold and silver as their preferred medium of exchange when these metals were available.  As economist Jörg Guido Hülsmann points out, there is a tendency in the market for the best monies to emerge. [p. 76]  Market participants would not select a money that was “unstable.”  If they did, they would switch to a more stable money, provided they were free to do so.

Yet, Bernanke suggests that the alleged volatility of the market under the government-tainted gold standard, and the periodic crises that emerged, means the market had made a bad choice and had no way of correcting it voluntarily.  Was there no better money available?  Is that why we ended up with paper as money and a board of bureaucrats determining how much of it we should have?

The public was told, in effect, that it was necessary to remove money from the monetary system to get it to work.  Why?  The Fed functions as a lender of last resort, and the Fed can’t lend something it doesn’t have.  It can’t lend money, so it lends printed pieces of paper or their digital equivalents and calls that money.  Whether we agree with this or not is irrelevant; we’re forced to use it or abandon the enormous benefits of indirect exchange.

We know that money created from nothing allows the user of the money to get something for nothing.  Paper money, therefore, acquires a new trait: no longer just a medium of exchange, it becomes a medium for wealth transfer.  Since the transfer lacks transparency for most people, it becomes the ultimate political tool.

Most monetary economists regard this arrangement as a good idea.  Of course, most of them have income arrangements with the Fed, as well.  [Hulsmann, p. 16]  

What do we know about paper money regimes?  Rothbard notes that they “were considered to be both ephemeral and disastrously inflationary.”  [p. 353]  But he was referring to the days of yore - what about modern times?  Bernanke’s predecessor delivered a now-famous speech in 2002 pointing out what happened to prices when the dollar was no longer anchored to gold domestically. 

In the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And, in the four decades after that, prices quintupled. Monetary policy, unleashed from the constraint of domestic gold convertibility, had allowed a persistent overissuance of money.

If you’re going to balloon welfare, if you want to fund unpopular or undeclared wars, if you want to buy votes, buy the media, buy the economists, if you want to establish a massive military-security state, if you simply love power and pomp, then there’s no substitute for a central bank’s printing press.  Along the way it debilitates the middle class, creates a dependent, credulous electorate, makes moral hazard commonplace, eats away the economy’s capital structure, makes perpetual war the norm, and ultimately destroys the social order.  None of this, of course, was mentioned in Bernanke’s lecture.

Gold and prices

Instead, he tried to make the case that a gold standard is not the wealth guardian its proponents believe it is.

One of the strengths that people cite for the gold standard is that it creates a stable value for the currency.  It creates a stable inflation, and that’s true over very long periods.  But over shorter periods, maybe up to five or ten years, you can actually have a lot of inflation, rising prices, or deflation, falling prices, in a gold standard.  [36:56]

And the reason is, the amount of money in the economy varies with things like gold strikes.  So, for example, [in] the United States, if gold was discovered in California and the amount of gold in the economy goes up, that will cause an inflation, whereas if the economy is growing faster and there’s a shortage of gold, that will cause a deflation.  [37:11]

A sudden discovery of gold such as occurred in California in 1848 will, to the extent the new gold is used as money, reduce the effectiveness of each monetary unit.  However, unlike the paper dollars the Fed proliferates in abundance, gold has highly-valued nonmonetary uses competing with its monetary employment.  On the market, the production of money, like the production of all goods, is regulated by profit and loss, as economist Jeffrey Herbener pointed out to a House subcommittee recently.  As the demand for money increases, the value of monetary gold would increase.  If demand is strong enough, profit opportunities arise in mining and minting.  As profits increase the resources used in mining and minting rise because of increased demand for those resources.  As the price of resources increases, profits dissipate, and so does production.  Thus, a gold standard, because of market mechanisms, will not allow a “perpetual overissuance of money.”

A “shortage of gold” might lead to deflation, but what does that mean?  Price deflation results when the production of nonmonetary goods increases at a faster rate than the production of money, or when the demand to hold money increases.  But are falling prices an economic evil?  Herbener reports that

two of the periods of most rapid economic growth in US history were from 1820–1850 and 1865–1900. In each of these periods, the purchasing power of the dollar roughly doubled [meaning prices dropped].

A gradual decline in prices is the norm for a free market economy.  It encourages people to save, which builds up the economy’s capital structure.  It also encourages consumption because goods get cheaper.  The electronics industry today is probably the best example of how falling prices allow more people to enjoy the market’s bounty.

Herbener refers to the 2004 paper of Andrew Atkeson and Patrick J. Kehoe  in which they examined evidence for empirical links between deflation and depression across 17 countries for a period of 100 years.  Atkeson is an economics professor at UCLA, and Kehoe is an economist with the Federal Reserve Bank of Minneapolis. Their conclusion:   

A broad historical look finds more periods of deflation with reasonable growth than with depression, and many more periods of depression with inflation than with deflation. Overall, the data show virtually no link between deflation and depression. [emphasis added]

In a speech given in November, 2002, a month before Greenspan’s talk about the Fed’s inflation habit, Bernanke promised an audience that the Fed would make sure deflation wouldn’t happen here.  He made that promise because as a supposed expert on the Great Depression, he believes the Fed followed a deflationary policy that deepened and prolonged the crisis.

But there are serious problems with this analysis.  For the countries for which they had data (all except Chile), Atkeson and Kehoe report that

In 1929—34, all 16 countries had deflation, 8 had deflation and depression, and the other 8 had deflation but no depression.

That alone makes the deflation charge suspect.  But even worse, as economist Robert Murphy has written, if deflation (as a fall in prices) is so harmful, how do we explain U.S. prosperity of the period 1926-1928 in which consumer prices fell 2.2, 1.1, and 1.2 percent, respectively?

True, the deflation of the early 1930s was far greater but it was still less than the deflation of a decade earlier.  Murphy:

From their peak in June 1920, prices fell 15.8 percent over the next twelve months, a one-year deflation that was 50 percent more severe than any 12-month fall during the Great Depression. And yet, the 1920–1921 depression was so short-lived that most Americans today are unaware of its existence. [emphasis added]

 Fractional-reserve banks are prone to runs

In the 19th century, notes and demand deposits issued without gold backing created bubbles that alarmed note holders and depositors.  When they came to the banks in large numbers to claim their property, and the banks were unable to deliver, a crisis resulted.   

Bernanke cites the movie It’s a Wonderful Life as an example of what happens during a bank run.  [15:27]  In the story Jimmy Stewart owns a bank and finds the lobby filled with townspeople clamoring for their money.  Problem: His bank doesn’t have nearly enough money to pay them off.  Why not?  Bernanke:

No bank holds cash equal to all their deposits.  They put that cash into loans.  So the only way the bank can pay off its depositors, once it gets through its minimal cash reserves, is to sell or otherwise dispose of its loans.  [17:13]

“Minimal cash reserves”?  Why is the bank making loans with funds it promised to make available on demand?  Does that not qualify as embezzlement?  The people asking for their money were depositors, not creditors.  If they had loaned the bank money by opening a savings account at interest or purchasing a CD, there would be no obligation to redeem their accounts in full on demand.  But as depositors, they had the right to expect their money to be there when they came to get it, and the bank should’ve been charging them a fee for safeguarding it.

Jimmy Stewart’s bank was solvent, he says, but merely illiquid. [20:10]  But is this true?  The deposits the bank held were liabilities due on demand.  An institution is solvent if it is “able to pay all debt obligations as they become due.”   As we see in the film, Jimmy Stewart’s bank could not pay all obligations as they became due.  His bank, as with all fractional-reserve banks, was insolvent. 

But Bernanke doesn’t see it that way.  He blames the depositors, calling their run a “self-fulfilling prophecy.” [17:32]  If only they had believed and never lost confidence, the bank’s fraud would never have been exposed. 

Bernanke goes on about how a central bank could’ve spared Jimmy Stewart  much grief by loaning him the funds to pay off the depositors  [20:00] - “funds,” of course, meaning printed bills, not gold, since no bank can conjure gold into existence.  But having a central bank as a rescuer is a moral hazard, a way of keeping insolvent banks operating while postponing the calamity that results from fractional reserve banking.

Conclusion

The gold standard has been blamed for problems that in fact were caused by government meddling in the monetary system.  Fractional-reserve banks should’ve been allowed to fail, but instead government often came to their rescue by allowing them to suspend specie redemption while permitting them to stay in business and collect debts owed to them.  In supporting fractional-reserve banks, the government was guaranteeing moral hazard and future crises.  The public was misled into believing the gold standard was unstable and that a central bank was the path to monetary deliverance.  With gold as the scapegoat, it was fairly easy to get rid of it.  History and theory tells us that abandoning gold means embracing inflation and big government, while putting liberty and sustainable prosperity on the chopping block.

Ben Bernanke should be back in school, but not as a teacher. 


Notes:

1.  See for example Gabriel Kolko’s Triumph of Conservatism and Murray Rothbard’s The Case Against the Fed.

Ben Bernanke vs. Gold

On March 20, 2012 Ben Bernanke lectured students at George Washington University on the value of central banking and the "volatile" system it replaced, the classical gold standard.  Here is my video response to some of his claims about gold.

On the Money: Ben Bernanke vs. Gold

On the Money - A Dime a Gallon

Welcome to my first video commentary.  Newt said he could get gas prices down to $2.50 a gallon.  Ron Paul did somewhat better, but is his claim believable?  This is the question I explore.

On the Money - A Dime a Gallon

“Just War” and Debt Becomes Just War and Debt

A just war, in Murray Rothbard’s view, “exists when a people tries to ward off the threat of coercive domination by another people, or to overthrow an already-existing domination.”  Like all wars, a just war is laced with dangers beyond the inferno of the battles, especially if war funding relies to a significant degree on the printing press.  The American Revolution is a case in point. 

On June 22, 1775 the colonial delegates assembled in Philadelphia, under the inspiration of Gouverneur Morris [1], decided to print $2 million in “bills of credit” called Continentals.  The plan was to begin redeeming them in 1779, not with hard coin, but by levying taxes in the Continentals themselves, which would then be retired.  So appealing was the idea of printing money that by 1779 a total of $227 million had been issued.  The bills were everywhere, and everywhere despised.  In a letter to John Jay, president of the Continental Congress, George Washington complained that “a wagon load of money will scarcely purchase a wagon load of provisions."  By December 1779 the Continental had fallen to 42-1 against specie, and by spring of 1781 the currency was virtually worthless.

Individual states were also printing money to finance the war, and the British too adopted the printing press as a war strategy, printing Continentals and using Tories known as “shovers” to shove the imitations into circulation and thus accelerate the currency’s depreciation.

Inflationists in Congress accepted the depreciation as a clever way to impose the necessary taxes to pay for the war, though Gouverneur Morris thought it was too bad that Washington’s soldiers would suffer the most from this tactic.  As the value of the currency rapidly approached zero, the Continental army turned to direct theft (“impressment”) to acquire their provisions when merchants balked at trading goods for something worthless.

The Continental was allowed to die without redeeming it, but in 1779 Congress began emitting “loan certificates” that were also used as money.  A big chunk of this money hung around after the war as a peacetime public debt.  Robert Morris, the leader of the nationalist faction, pushed for its redemption at par in specie as a means of stuffing the pockets of associates who had purchased the certificates at highly depreciated prices.

Redemption was also a way of rallying support for taxing power in Congress.  Under the Articles of Confederation and perpetual Union, which was ratified on March 1, 1781, the United States of America was considered a “league of friendship” rather than a central government, with each state retaining “its sovereignty, freedom, and independence.”  Although the Articles recognized the obligation of Congress to pay all debts incurred before ratification, the Articles did not give Congress the authority to coerce such payments from the states.

To the nationalists, the lack of taxing power and other alleged deficiencies made the Confederation government “the laughing stock of the Atlantic world,” as historian Leonard L. Richards notes in his masterpiece, Shays’s Rebellion: The American Revolution’s Final Battle.  [2]  Throughout the 1780s, they tried fruitlessly to get enough of them together to replace the Articles.  In modern parlance, what they needed was a “New Pearl Harbor,” a major crisis that could be propagandized for political ends.  In 1786, Shays’s Rebellion provided the break they needed.

Shays’s Regulators

As the official story is told, indigent farmers in western Massachusetts were unable to pay their taxes, so the courts were sending them to jail and seizing their farms.  To avoid the penalties for defaulting on their debts, the story continues, Daniel Shays and a few other “wretched officers” from the Revolution led backcountry rabble to shut down the courts. 

Massachusetts Governor James Bowdoin called out the militia to put a stop to the uprising.  When most of them sided with the rebels, he turned to wealthy Bostonians to fund a temporary army.  Led by General Benjamin Lincoln, the army prevented the insurgents from seizing the federal arsenal at Springfield in late January 1787, then crushed the rebellion permanently a week later in a surprise attack at Petersham.  Though the top rebel leaders fled to other states, most of the others eventually returned to their farms.  Bowdoin agreed to pardon the rebels if they signed an oath of allegiance to the state, which the vast majority did.

As Richards argues compellingly, the standard story of Shays’s Rebellion as an uprising of debtor farmers does not wash.  Richards had discovered by accident that the Massachusetts archives had microfilmed the signatures of the 4,000 men who signed the state’s oath of allegiance.  Since many of the insurgents also included their occupations and hometowns, he was able to gather more information about them with the help of town archivists and historians.  For example:

•  At the time of the rebellion Daniel Shays owed money to at least 10 men.  Of those 10, three were rebel leaders.  For every rebel who went to court as a debtor, another went as a creditor.
  
•  Colrain, the most rebellious town, had 12 families involved in debt suits during 1785 and 1786.  Yet only four of these families provided men to the town’s total of 156 rebels.  Their leader, James White, who led the assault against the Springfield arsenal, was convicted of high treason.  He was also one of Colrain’s creditors.
  
•  In 1786 creditors in Connecticut took over 20 percent of the state’s taxpayers to court.  Yet there was no comparable revolt in Connecticut.

It wasn’t debt that triggered the rebellion, Richards concludes, it was the new state government and its attempt to enrich the few at the expense of the backcountry. 

Like other states, Massachusetts had issued notes to help fund the Revolutionary War.  Immediately upon issue they depreciated to about one-fourth par, and later declined to about one-fortieth of their face value.  Many soldiers were paid in these notes, then later unloaded them to speculators at high discounts.  Speculators bought roughly 80 percent of the notes, of which half were owned by just 35 men.  Every one of these 35 had served in the state house during the 1780s or had a close relative who did. 

The legislature voted to consolidate its war notes at face value and praised the speculators as “worthy patriots” who had come to the state’s aid in its time of need.  But these men did not buy the notes directly from the government; they bought them for a song from farmers and soldiers, who were now being taxed to redeem them at full value.  The speculators, most of whom had stayed home during the war, were seeking to benefit at the expense of veterans.

Poll and property taxes were to account for 90 percent of all taxes.  The poll tax placed a fine on every male 16 years or older.  Thus, a regressive tax ensured a wealth transfer from farm families with grown sons to the pockets of Boston speculators.

Nationalist versions of the insurgency spread throughout the states and upset many elites, including George Washington, who was enjoying a peaceful retirement at Mount Vernon.  According to Washington’s trusted friend and former artillery commander General Henry Knox, who was planning to build a four-story summer home on one of his Maine properties, the insurgents wanted to seize the property of the rich and redistribute it to the poor and desperate.  David Humphreys, one of Washington’s former aides living in New Haven, told him the uprising was due to a “‘licentious spirit among the people,’” whom he characterized as “levelers” determined “’to annihilate all debts public & private.’”

The “rebels,” for their part, saw themselves from the very beginning as Regulators whose purpose was “the suppressing of tyrannical government in the Massachusetts State.”  The Shays Regulators drew upon the success story of Vermont in the 1770s in which Bennington farmers, in a dispute with New York land speculators, had stopped courts from sitting and terrorized surveyors sent on behalf of the speculators.

On March 19, 1787 Knox wrote Washington hinting that he would be given the president’s chair at the Philadelphia convention in May.  Knox stressed that Washington would not be presiding over some middling conference of tinkerers amending a defective document but instead would be leading a prestigious body of men as they created a more “energetic and judicious system.”

Nationalists at the Constitutional Convention that spring wanted a stronger central government - an elective monarchy, in Alexander Hamilton’s view.  Though they didn’t get the results they pushed for, the nationalists and their intellectual heirs of today have shown that their lust for a more “energetic” government will not be thwarted by words on paper. 

Hamilton’s Funding Proposals

As Rothbard notes, there were two ways to fund the debt:  One way that was compatible with the decentralized nature of the union under the Articles was to apportion the Congressional debt among the states and let them raise taxes to pay their share.  The other way was crucial to “the cherished principles of national aggrandizement”:  Give Congress the power to tax so it can do the funding.  [3]  Article I, Section 8, Clause 1 secured this power.

In January 1790 the 34-year-old Hamilton, as Treasury Secretary, presented his plan to Congress for retiring the Revolutionary War debt.  The $54 million federal debt would be funded at par and the federal government would assume responsibility for the states’ $25 million war debts.  The plan called for converting federal debt into bonds that would mature after an assigned period of time, paying 4 percent interest on long term bonds and 6 percent interest on those of shorter duration.  The new government would pay the principal on the debt from a sinking fund established through the post office.  Revenue for the fund would come from an import tariff and an excise tax on what Hamilton labeled “pernicious luxuries” that included whiskey.  His plan was not to pay off the debt, but to recycle it.  When bonds came due he would have new bonds issued to replace them.  As long as interest payments on the debt could be paid, the government’s credit was assured.

Among those opposing his plan was Hamilton’s former Federalist Papers ally, James Madison, who argued that repaying the debt at par to current bearers was stiffing war veterans and farmers for the benefit of wealthy “stockjobbers.”  He favored a plan of discrimination, wherein the government would pay the original bearers the face value of the certificates and the current bearers the highest market value plus interest. 

Aside from the near impossibility of finding the original bearers, Hamilton opposed discrimination on the grounds that it amounted to a “breach of contract” if the government did not pay to the bearer on demand the full value of their certificates.  How else would the government “justify and preserve their confidence”?  The buyer of a depreciated security, Hamilton argued,

is not even chargeable with having taken an undue advantage. He paid what the commodity was worth in the market, and took the risks of reimbursement upon himself. He of course gave a fair equivalent, and ought to reap the benefit of his hazard; a hazard which was far from inconsiderable, and which, perhaps, turned on little less than a revolution in government. . . .

In funding wealthy speculators in this manner, Hamilton was well aware this would concentrate investment capital in relatively few hands and would encourage them to make further investments in the federal government.  This was a critical part of his agenda: to strengthen the union at the expense of the individual states.

Senator William Maclay, one of Hamilton’s most vocal critics, brought the public into the debate with a scathing article he wrote for a Philadelphia newspaper in February, 1790.   Assumption, he argued, was a means of reducing state governments to insignificance and of establishing a “pompous Court,” by which he meant an arrogant and powerful central government.  “The people will be meddling with serious matters unless you amuse them with trifles,” he said caustically.  A pompous Court in partnership with a pliant press would keep the people amused as it goes about its task of having the citizenry subsidize New York’s monied class.  The Treasury will grow in influence, and thus

shall the capital of the United States [New York] in a few years equal London or Paris in population, extent, expense and dissipation, while for the aggrandizement of one spot, and one set of men, the national debt shall tower aloft to hundreds of millions.

As the debate raged throughout the spring and early summer, Hamilton, sensing defeat, turned to Secretary of State Thomas Jefferson for help.  Jefferson invited Madison and Hamilton over for supper and together they cut a deal.  In exchange for the needed votes, Hamilton would agree to relocate the nation’s capital from New York to Philadelphia for 10 years, then finally to a place on the Potomac, where it would be next door to Virginia, more accessible to the South generally, and removed from Hamilton’s power base.  The arrangement was consummated when the Residence Act narrowly passed both houses in early July, and the Funding Bill became law on August 4 by a slim margin. 

Still, the issue did not die.  On December 16, a date immortalized by the Boston Tea Party in 1773, Virginia’s General Assembly issued a formal protest.  Unlike many heavily-indebted northern states, Virginia had already imposed taxes to redeem a large part of its debt and had expected the balance to be extinguished in the near future.  Hamilton’s plan of assumption would benefit the more profligate states while imposing heavy taxes on Virginians for which the Assembly had no way of providing relief.  Furthermore, since no clause of the Constitution gave Congress the authority to assume the debts of the states, and given that obedience to the law of land was held as a “hallowed maxim,” Virginia could not “acquiesce in a measure” that was clearly unconstitutional.  As the perpetuation of debt in England has threatened everything that relates to English liberty, the Assembly noted, the same can be expected in the United States if assumption is not repealed.

It wasn’t.

The eight Massachusetts men in the House had been badly split on many issues regarding the new government, but on assumption they were united, since the debt would be funded by means other than direct taxes.  According to Governor John Hancock, the consolidated debt of Massachusetts was $5,276,955, of which $5,055,451 ended up in Hamilton’s program.  Institutions claimed $347,097 of this amount, while the remaining part belonged to 1,480 individual citizens.  Included in this group were speculators living in or near Boston who would be awarded almost 80 percent of the monetary total.  [4]

State leaders in Massachusetts had tried to pay off the state’s war debts by 1790, and for this they had imposed an onerous tax scheme borne mostly by farmers in the west.  Hamilton’s plan removed this burden.  Since many of them were subsistence farmers, rarely buying anything from the outside world, the new taxes amounted to almost no tax at all.  The federal debt thus had little effect on their everyday lives. The taxes that drove them to shut down the courts in 1786 were gone.

Conclusion

Hamilton’s funding proposals were step one in a fiscal policy that later included a rudimentary central bank and a proposal to protect favored American industries from foreign competition.  By hijacking the legal system Hamilton did indeed manufacture a “revolution in government,” one that overturned the revolution of 1776.   Though ostensibly constrained by the new constitution, he reinterpreted key clauses in such a way that the government could do almost anything, as long as it was declared to be in “the public interest.”

Somehow, ordinary Americans found themselves to be the public whose interests required subordination to the decrees of the government.  The Whiskey Rebellion of 1794, in which Hamilton joined President Washington and 13,000 conscripts and officers from the creditor aristocracy of the eastern seaboard to crush penny-ante tax protestors in western Pennsylvania, dramatized this point.  So did the War to Prevent Southern Independence and every war or crisis since.  So did the Sixteenth Amendment, the Seventeenth Amendment, the Federal Reserve Act, the Current Tax Payment Act of 1943 (Withholding), the Patriot Act, the National Defense Authorization Act . . . I leave it to the reader to fill in the rest.  Today, with Hamilton’s “implied powers” interpretation of the Constitution deeply ingrained in public rhetoric, a major political figure like Nancy Pelosi can respond contemptuously to a question about ObamaCare’s constitutionality without fearing congressional censure.

As the U.S. national debt continues its ascent to the heavens with the blessings of leading economists, the massive tower of IOUs sways to and fro at the mercy of political currents.  Will Asians continue to buy the debt?  Will the Fed be pressured to monetize more of it?  Will the Fed say “Enough!” and let interest rates soar?  Will the government, with its dedication to endless war and cheap money, take over the task of obliterating the dollar so it can fulfill the grandiose dreams of the political class?

Or will people finally say “Enough!” and remove the government from monetary affairs altogether?

George F. Smith is the author of The Flight of the Barbarous Relic, a novel about a renegade Fed chairman, Eyes of Fire: Thomas Paine and the American Revolution, a script about Paine's impact on the early stages of the Revolution, and The Jolly Roger Dollar: An Introduction to Monetary Piracy.  Visit his website. Send him mail.


References:

1.  Conceived in Liberty, Volume IV, Murray Rothbard, Mises Institute, Auburn, AL, 1999, p. 379

2. Shays’s Rebellion: The American Revolution’s Final Battle, Leonard L. Richards, University of Pennsylvania Press, 2003, p. 25

3. Conceived in Liberty, pp. 394-395

4. Shays’s, p. 157

Who's the real winner?

The Washington Post ran an article that all but concedes the GOP nomination to Mitt following his big win in Nevada, his second consecutive victory. 

the former Massachusetts governor’s win here, coupled with his enormous Florida victory just days ago, proved Republicans have begun to coalesce around his candidacy in earnest. He swept nearly every voting group in Nevada including those that have been slow to come aboard, such as tea party activists and voters who describe themselves as extremely conservative.

But who is really winning here, and who is losing?

Those who are “extremely conservative” apparently find nothing objectionable to the existence of the IRS or the Federal Reserve System, or to the Department of Education that grinds out an increasingly groupthink, uncompetitive population of Americans.  But, you say, conservative Republicans have been trying to get rid of the DoED since Carter created it, except for the neoconservative Bush II who expanded it with No Child Left Behind (NCLB).  The governor has had glowing words for NCLB, which is not to say he will keep it.  His rhetoric of late has had a Tea Party flavor, so there’s no telling what he really believes.  Any man who receives the support of over 100 registered lobbyists is up for grabs.  Any candidate whose biggest supporters are the biggest banks will not suddenly turn Austrian when the next crisis hits.  Can you see Romney standing triumphantly over the dead carcass of the Fed, his biggest donors’ best friend?  Neither can I. 

But these are technicalities.  The extremely conservative conservatives know a global superpower needs staggering amounts of revenue, so there’s no need to disturb the flow of wealth from their paychecks and pockets to military contractors.  Many of them probably are military contractors.

The real issue is not whether Romney (or Gingrich or whoever, except Paul) calls for the abolition of the income tax or the Department of Education.  They could conceivably make a powerful speech calling for their elimination - during the campaign.  They will say whatever the voters’ ears are expecting because the campaign is for the voters.  They like to believe they’re in control.  For the voters, the post-election period is the morning after.

Barack Obama campaigned on “change” in 2008.  We got more stimulus, more debt, more war - in most respects, Bush III.  George W. Bush called for smaller government in his run for the presidency in 2000.  Once elected federal spending mushroomed with wars, subsidies, police state measures, and a massive new entitlement.  Ronald Reagan said government was the problem not the solution.  He gave us more of the problem.  In 1940 Franklin Roosevelt promised not to send our boys overseas to fight in the European war, all the while working covertly to get the country into war.  In some respects the Democratic Party platform of 1932 sounded almost laissez-faire.

The Democratic Party solemnly promises by appropriate action to put into effect the principles, policies, and reforms herein advocated, and to eradicate the policies, methods, and practices herein condemned. We advocate 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 twenty-five per cent in the cost of the Federal Government. . . . {emphasis added]

Keep in mind that back then government was a midget compared to today.

We favor maintenance of the national credit by a federal budget annually balanced . . . .

We advocate a sound currency to be preserved at all hazards . . . .

You might say the New Deal was not in keeping with these “solemn promises.”

Then there was Woodrow Wilson.  He was re-elected in 1916 for keeping us out of the war, then by May the following year was instituting a draft to ship Americans to France to join the carnage.  Wilson knew what his overseas crusade would turn out to be.  During the night of April 2, only hours before asking Congress for a declaration of war, Wilson spoke privately to Frank Cobb, editor of the New York World, a Progressive newspaper with strong ties to the Democratic Party.  Lamenting a decision he regarded as necessary, he told Cobb that once war was declared, people will

forget there ever was such a thing as tolerance.  To fight you must be brutal and ruthless, and the spirit of ruthless brutality will enter into the very fibre of our national life, infecting Congress, the courts, the policeman on the beat, the man in the street.

According to Cobb, Wilson also said “the Constitution would not survive” the war, and that “free speech and the right of assembly would go.”  He made sure that happened.  Nor did he let these considerations prevent him from addressing Congress.

Like today’s war hawks, he didn’t let financial considerations bother him, either.  In 1913, state worship had given birth to the twin indispensables of tyranny, the income tax and the federal reserve system.  As Ralph Raico tells us,

Taxes for the lowest bracket tripled, from 2 to 6 percent, while for the highest bracket they went from a maximum of 13 percent to 77 percent. In 1916, less than half a million tax returns had been filed; in 1917, the number was nearly three and half million, a figure which doubled by 1920. . . .

Through the recently-established Federal Reserve System, the government created new money to finance its stunning deficits, which by 1918 reached a billion dollars a month⎯more than the total annual federal budget before the war.

The consequences of Wilson’s decision?  Sheldon Richman: “Communism in Russia (and everywhere else it later reverberated), Nazism in Germany, the Great Depression, the New Deal, and World War II (not to mention the Cold War and the growth of the American leviathan).”

War and the growth of the state - they’re inseparable.

This is why presidential candidates, with one conspicuous exception, can be counted on not to remove or lessen the power of any of the state’s vital organs, such as the income tax, the central bank, or the Department of Education.  They might be replaced or altered but not at the expense of state power or revenue. 

This is also why Ron Paul wants to eviscerate the state.  A government unrestrained by law is an individual’s worst enemy.  For Paul it’s not a "policy position," it’s a conviction.  He’s been fighting to remove legal coercion from our lives since his first day in Congress, in 1976.  Got room in your hip pocket?  He wants to downsize it until it fits - government, that is.  A vote for Ron Paul, then, is a vote for honest, responsible, peace-loving people.  If that means you, then a vote for Paul is a vote for yourself.  A vote for any of the others is a vote for lobbyists, bankers, and warmongers - people who most definitely don’t have your welfare in mind.

In this light, who really wins when Mitt, Newt, or Rick is declared victorious?

The Heist Known as Fed Accommodation

Fed Chairmen often speak of "accommodation" as if it's the magic needed to solve economic problems.  But 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. [BLS inflation calculator]

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 printers.  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. [Bonner and Wiggin, p. 245]

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. [Sennholz, p. 69]  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.

On June 17, 1930, with the economy fighting the recession brought on by Fed monetary policies, President Hoover signed the Smoot-Hawley Tariff Act, raising tariffs on over 20,000 imported goods to unprecedented levels.  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 Ludwig von 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.” [Mises, p. 66]  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.

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. [Hazlitt, 1982]  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. [Keynes, 1919, Ch. 6]

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.

The foregoing is an excerpt from my book, The Jolly Roger Dollar: An Introduction to Monetary Piracy.