Dr. Thomas C. Rustici |
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"Thinking The Unthinkable"
Introduction:
Money is the most important economic good in
any society. Romantic writers, poets and philosophers condemn money,
and parade their utter economic ignorance. Money is a medium of exchange.
It spontaneously emerges from trade and commerce in a barter world. It is
the most critical mechanism for the ever expanding division of labor and
division of knowledge based on the principle of comparative advantage. The
free market creates this amazing institution—one that virtually all of
human life rests upon. Money replaces direct barter with indirect
trade. You have apples and want the oranges that I have, but I want
bananas instead of apples. You go to get bananas only to find that person
doesn’t want apples; they want kiwi, and so on. Money solves this
overwhelming problem of the double coincidence of wants in barter.
Everyone trades for one good we call money. Thus, a drastic
reduction of information and transactions costs maximizes profits and
expands the market and division of labor. Money acquires extra
properties also important to our scale of productivity.
It serves as a standardized unit of
account. With money prices, financial accounting and economic
calculation are now possible while non-existent in a barter world.
Profit-loss accounting through money prices guides entrepreneurs into
rational capital allocation. Imagine trying to operate a multibillion
transaction company, like IBM, with just seat of the pants guesses—or pure
gut instinct’? Without financial accounting everything is random
chaos. Money is also a store of value where people can hold value for future transactions. This real savings and investment is the foundation of capital accumulation and economic growth. Inflation destroys the store of value function of money, sabotages capital markets, and interjects “informational noise” into the efficacy of financial accounting. In the limit, the medium of exchange is undermined and with it the entire economic structure. The darkest day in human history occurred when
government discovered the inflation tax. The Romans recklessly ran massive budgetary
deficits and monetized those deficits. Hyper-monetary inflation coupled
with the maximum price controls of the Edict of Diocletian in 301 AD
created severe shortages and decreased the quantity of real goods
available. This repressed monetary inflation magnified inflation. Prices
went up, up and away! When the price of one bushel of wheat increased to
over 2 million denarius coins, the Empire was in full scale
disintegration. However, unlike today, the ancient world was better
positioned to recover from the monetary disaster. Most people used or
exchanged a few hundred relatively homogeneous commodities in a typical
Roman city market. There were almost no services. In the country
side, most were self sufficient; they grew their own food and barter
traded a little with their neighbors. Under these conditions, there
is a quick reemergence of a new medium of exchange. Not so
today. How many heterogeneous commodities are there in
the US economy? Some estimates have this as high as 10,000,000
different goods. Walk into the Mall of America. Go through each of the
stores and count how many different physical goods are in that shopping
mall. A consumer might buy 10 or 15 items, while they don’t buy the
millions of other things that don’t serve their needs. After a
hyperinflation, what becomes the next medium of exchange? Flips
flops, lugs nuts, books, children’s toys, or women’s underwear?
What? How long will it take today to escape from direct
barter?
Post WWI Weimar Germany is another famous case of hyper
inflation. Germany ran extraordinary fiscal deficits. By 1923,
the Reischebank financed 99% of all government spending with new monetary
creation. Extraordinarily absurd inflation taxes caused the mark to
depreciate day by day, hour by hour, minute by minute. During 1923,
the prices doubled every three days on average. This was
unimaginable hyper inflation. In 1919, 8 marks equaled $1, or worth
about 12 cents. This rate of exchange fell to 4.2 trillion marks to the
dollar in the “official exchange rate” and 11.7 trillion marks to the
dollar on the free market in 1923. The price of one egg escalated
from one quarter mark (about 3 cents) to 80 billion marks-- for one egg by
October 1923. The price of a cup of coffee increased from 5000 marks
to 8000 marks while the person was drinking it. In one case a woman
ran into the bakery to buy bread, only to come out of the bakery to find
her wheel barrel had been stolen and all of her trillions and trillions of
marks dumped in the street gutter. The great economist Ludwig Von Mises describes
this as the flight to real goods, the complete disintegration of the
monetary economy. Money lost its store of value, unit of account,
and ultimately its medium of exchange function. From August to
November 1923, the price level exploded by at least another factor of
1,000,000 to one. This increase came from the acceleration of money
velocity. So even when the Reischebank quit running the printing
presses--the demand to hold cash-balances collapsed to zero and prices
escalated along an exponential path. Workers were paid two and three
times a day only to rush out and buy real goods before the prices went
up. Escaping the inflation tax meant abandoning the medium of
exchange. Von Mises commented that, “the government is the only
institution that can continue to take two valuable commodities like paper
and ink and put them together and create something that is totally
worthless.” What were the economic results? German industrial productivity catastrophically declined 50% per capita in one year and at least 30% within a few months. Compare this to the United States during the Great Depression. From 1929-1933, our per capita productivity fell by less than 1% per month on average. In Germany, alternative monies such as Dutch florins, US dollars, Swiss francs, French francs and Italian lira widely circulated throughout the country before the hyperinflation of marks. These foreign monies roughly equaled in value 2/3 of the real German money supply before the inflation. The alternative money placed a floor beneath the breakdown of the division of labor, and Germany was spared the complete reversion to direct barter levels of productivity. What Can We Learn From History? In many
respects, Americans are now in a more dangerous place than either the
early Romans or Weimar Germany. Unlike the Roman economy, the US
marketplace is about 85% service sector in valued output—and by its nature
it is not re-tradable. The remaining 15% of GDP is comprised of
millions of heterogeneous goods. After a hyperinflation the quick
emergence of new money becomes very-very problematic. Unlike Germany, no
alternative currencies circulate through the shops and businesses within
the United States. Not yen, not euros, nothing but Federal Reserve notes
trade at McDonalds in Kansas or the local dry cleaners in Alabama.
Let’s be honest here. When the Federal Reserve inevitably destroys
the dollar, which it will, we need to ask 3 major questions. What becomes
money, how long will it take to become money, and how far will the
standard of living drop? What safeguards the most important institution of
your life? Irving Fisher warned us about this in 1929 that, “irredeemable
paper money has invariably been the curse to the country employing
it.” Inflation is a tax on the value of the cash balances held by certain members in the general public. And fundamental economic laws cannot be wished away. Supply and demand are crystal clear: if you want less of something, tax it, if more is desired—subsidize it. Impose a 1000 % tax on shoes or hats and most people walk around barefoot or without hats to wear. Yet, the rest of the economy still goes on. Life itself is not threatened. Put that inflation tax on money, and nobody wants to hold money. Since money enters every market transaction simultaneously, hyperinflation destroys all markets, limits all exchange and makes financial accounting impossible. Even Lord Keynes, the person most responsible for 20th century inflation understood this point. In 1919 with his Economic Consequences of the Peace
he noted: “There is no subtler surer means of overturning the
existing basis of society than to debauch the currency. The process of
inflation engages all the hidden forces of economic law on the side of
destruction and does it in a manner that not one man in a million is able
to diagnose.” These words are haunting and clear.
“Inflation engages all the hidden forces of economic law on the side of
destruction.” Look at where we stand. Compared to prior generations,
Americans enjoy enormous prosperity from great productivity: vast output
per unit of input. We enjoy more quantity, quality and variety of goods
and services than even the Kings and Queens of the past could have ever
imagined. It is the monetary institution most responsible for this miracle
and yet, it is totally unprotected—wide open to political sabotage.
What happens “the day after” a run-a-way inflation? How long can physical
inventories of consumer goods last? Household cupboards empty in a few
weeks, retail stores another month, warehouses maybe another month.
It is estimated that the total value of all intermediate goods are about
5-6 months of output relative to annual GDP. Without alternative money,
this becomes the outer time limit of survival. Remember: 1) these are
intermediate goods not already transformed to serve consumer needs, and 2)
bottlenecks necessarily arise in barter between the various stages of
production (wheat in the field cannot become flour or bread for the
consumer). With only the volume of finished consumer products in
transit added together, total inventories give us two to three months time
at best. It is safe to say that without some kind of widely accepted
money most Americans will die in short order. This is the kind of ugly
reality we are dealing with—not some academic or theoretical
exercise. Kansas wheat cannot migrate to New York City
consumers by bartering services. Farmer Jones specializes and grows food
for 500 strangers every day. This is why we don’t have to grow our own at
home. How is milk paid for at the grocery store? Maybe give the
cashier a shoe off our left foot? How do they pay the dairy with
that shoe? Does the dairy company pay its employees with little cut up
pieces of that shoe? Does a little piece go to the dairy farmer in
Wisconsin? What happens? The entire economic structure of
productivity free falls into the pit of utter annihilation. While 20
million people may live in our proximity direct barter creates virtual
isolation from each other’s unique comparative advantages. America
stands perched on a very dangerous cliff. Some economists don’t worry about this problem
because it seems too remote. They say, “to get to 1000% inflation
first requires a 100% and that first requires 50% and we are far from
anything like that today. We can always pull back since there is
always time.” Right ? Wrong. I’m an economic historian,
and ALL of world monetary history tells me that this short-sided viewpoint
is a deadly delusion. It is true that a number line is structured
this way. However, how fast inflation moves from 5 to 10% and 10% to
20% is never a fixed constant rate. The speed that inflation moves
through these numbers is often widely variable. It may take five
years to go from 5% inflation to 10% inflation, but it does not follow
that it takes five more years before prices rise at 15% or even a 20%
rate. In the early 1980’s, the Bolivian inflation of the peso went
from 10% to 40,000 % in just a few years. The peso experience does
not stand alone. In Weimar Germany, prices escalated by a factor of
10 billion to one in a short 16 months! In fact, almost every irredeemable
paper money system (among hundreds in world history) has over time ended
up in the ash heap of hyperinflation in the same way. So how much
time is needed to safely “pull back” from the edge when money velocity is
itself a dynamic variable? It is extraordinarily dangerous conceit to
think anyone, no matter how smart, could ever fully know that
answer. A Time for Truth It is time to stare some
very unpleasant realities directly in the face. We layer safeguards
around our nuclear weapons to keep rogue individuals from vaporizing most
of the world. Elaborate protections in the military command and
control are in place to prevent the worst case scenario. That makes sense.
What are the protections against an equally catastrophic monetary
inflation? During the first 124 years of American history there were
few special interest groups, small fiscal deficits, and, government
largely stayed within the enumerated powers of the Constitution. The
norm, with few exceptions meant that paper money was redeemable in gold or
silver. The purchasing power of the US dollar was the same in 1930 as it
was in 1830. However, “sound money” collided with immoral socialist
ethics and the dishonest economics of the redistributive transfer
state. Look at it this way. Before 1913, the few
interest groups in politics could only use chisels and hammers to take a
“chip” out of the foundation of the monetary economy. Just a “little
piece of the action” would not bring down the entire economy. With
the Federal Reserve Act, the government built a vast super highway to the
monetary pillars of our productivity. Major inflation safeguards
were stripped away. In 1933, Franklin Roosevelt nationalized the people’s
gold and left America with the ‘curse of purely irredeemable fiat paper
money.’ Even more inflation safeguards are removed. The
New Deal deficits explode and thousands of special interest groups are
transported in and handed “jack-hammers” to whack away bigger money chips.
Still, no one piece taken threatens the whole system. The Great Society
created a tidal wave of deficits as thousands more special interests
groups get in on the action, only this time the government gives each
group a “wrecking ball” to get a much bigger chunk of money. Today a
growing financial disaster plagues America. Since the federal
government observes no Constitutional limits on its power, tens of
thousands more interest groups now use “truck loads of dynamite” to take
out great boulders of the monetary economy. When annual budget
deficits approach 10% of the GDP, and do so for as far as the eye can see,
expect the Federal Reserve to be ready, willing and able to monetize
everything. America’s demographic transition will
exacerbate the existing fiscal crisis. According to the Census, for at
least the next 25 years—the net retired population expands around 8,000 to
10,000 people per day. This means every 24 hours 8,000 to 10,000
people switch from being net tax payers at their peak earnings years, to
pure tax consumers entitled to Social Security, Medicare and other
benefits. This happens every single day for next 25
years. With certainty this ballooning retiree population can be
counted on to vote their interest. And we are not going to take away
any voting rights. Now consider that the IMF Select Papers estimates
America’s total unfunded liabilities from all government commitments
exceed 200 trillion dollars. If 200 trillion $1 bills are laid end to end,
it stretches from this room to the sun and back about 100 times! All
this future debt will soon come due and become funded national debt—more
properly monetized debt. We are in big——very big trouble—-very
soon. When and if the interest charges on the national debt exceed the value of all new economic growth, the problem cannot be eliminated. Likewise, America cannot be taxed out of the scale of this problem. Children born after 1996 will pay about 70% of their total lifetime income on average to the government in taxes. This kills incentives and destroys economic growth. The Congressional Budget Office has estimated that the net value of the entire United States: all 3 million square miles of land, every house, every building, all consumer durables such as cars, washing machines, refrigerators everything combined comes only to $50 trillion. The unfunded liabilities are four times greater!
Finally, we cannot borrow enough
capital to get through this problem either. The real net savings for the
entire world combined would fall far short of the federal government’s
projected future deficits. So how will politicians fund this gap when they
cannot even balance their current activities? The truth is—you know it and
I know it—they will hyper-inflate the quantity of money. Over time the
Federal Reserve will end up being America’s 1923 Reischebank. We
need an immediate time for truth. What Can We Do? Let me leave you with
a few last thoughts. Suppose the Titanic is traveling in well known
iceberg infested waters. The fog is so thick that no one can see
even one inch past the edge of the boat. No one knows what is coming. Is
it smart for the captain to speed up the boat? No! Is it wise to
STOP the boat immediately until the fog clears? YES! Suppose he
says, “I’m an experienced captain and everyone should trust me with their
life.” He reassures passengers, “In a split-second, I can just always to
pull the boat away from any iceberg danger.” Now the boat hits an iceberg—there is a three
hundred foot long hole below the water line. The captain apologizes,
“Sorry.” Everyone will drown in the North Atlantic waters. It is
prudent and moral to warn passengers about the gaping hole in the
boat—find a life raft now since time is of the essence. But, there
are NO life boats because everyone was told the Titanic could never
sink. Rational people start tying together everything on board that
floats—truth is what it is however unpleasant. Others on board chide
floatation devices as a waste of time, why panic they say—“look people in
the band are playing music, listen how beautiful it sounds, I’ve always
wanted to play in the orchestra.” It’s comforting and whole lot more fun
to play the violin and just ignore floatation devices. That is, until
everyone in the band plays their instrument at the bottom of the Atlantic
Ocean. Reality is never optional! We need to be absolutely honest with ourselves
and our situation. The time for truth is now and time is running out!
History is crystal clear: socialism is poison because it undermines
everything within its orbit be it law, morality or economy. And those that
refuse to learn history’s lessons are condemned to repeat its tragic
mistakes. The federal government will not follow any rule of
constitutional law. In turn, central banks as political institutions
cannot be trusted to obey any rules—monetary or otherwise, except the rule
of inflation. I believe America needs an absolute “wall of separation of
money from state.” We must either abolish or exit the central bank and
return to “honest money” for many—many reasons; the least of which is
short run preservation of personal assets. Redistributive transfer
politics and central banks will certainly destroy the entire institution
of money. If we are unwilling to deal with that hard reality or find
an alternative financial lifeboat, get ready——not only to “think the
unthinkable”—---get ready to “survive through the unimaginable.”
Dr. Thomas C. Rustici |
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