Monty Pelerin's World

Economics, Finance and Politics Through The Prism of Classical Liberalism
ObamaCare Showdown with Judge Vinson
In a post a couple of days ago entitled ObamaCare -- The Final Straw That Keeps on Giving I speculated on the possibility of impeachment for violation of the oath of office for any Congressperson voting to expend funds on what was declared an unconstitutional law. Subsequent to that post, the mainstream media reported that Judge Vinson had granted a motion for stay. It is likely, if all you read was the "Pravda" version of the news that you might believe that the Judge Vinson has blinked and the Administration has been relieved of any responsibility pertaining to his first ruling. Nothing could be further from the truth. The Administration is brazen in its words and actions. Judge Vinson was obviously angry in his second opinion. He should be because as Avik Roy states (my emboldening):
Judge Vinson acknowledges that other judges have upheld the law, and that none of us know how Obamacare will fare at the Supreme Court. But this much we do know: The stakes in this case are as high as any in the last 35 years. Will we have a federal government with unlimited powers, including the authority to regulate “mental activity”? Or will the Supreme Court find that the Constitution still contains one or two constraints on federal power?
From the Constitution and The Rule of Law flow all the greatness and goodness of this country. Without them, we are finished. For this reason, it looks as if Judge Vinson served up an ultimatum rather than backing off as conveyed via the mainstream media. Karl Denninger, in his inimitable fashion, has his usual no-holds barred take:

Now We're Cooking: Judge Vinson

If you remember, I questioned whether Obama was crossing the line into sedition with his statement that he intended to ignore a declaratory judgment. Well, they apparently (after stalling) asked the Judge for a stay, and got something a bit different than they asked for in reply. Judge Vinson began with:
My order of January 31, 2011 (Order), granted summary judgment for the plaintiffs (in part); held the individual mandate provision of The Patient Protection and Affordable Care Act (the Act) unconstitutional; and declared the remainder of the Act void because it was not severable. The defendants have now filed a motion to clarify this ruling (doc. 156) (Def. Mot.). During the four-plus weeks since entry of my order, the defendants have seemingly continued to move forward and implement the Act.

Yep.  That's exactly what Obama did - he basically gave you the finger Judge.

As Judge Vinson continues...

Even though I expressly declared that the entire Act was void, and even though I emphasized that separate injunctive relief is not necessary only because it must be presumed that the Executive Branch will adhere to the law as declared by the court, which means that declaratory judgment is the functional equivalent of an injunction, the defendants have indicated that they do not interpret the Courts order as requiring them to immediately cease [implementing and enforcing the Act]. See Def. Mot. at 4; see also id. at 6 (we do not understand the Courts declaratory judgment of its own force to relieve the parties to this case of any obligations or deny them any rights under the Act). They have reportedly continued with full implementation of the Act.

They sure have.  How's that middle finger look to you, Judge Vinson?

A litigant who tries to evade a federal courts judgment --- and a declaratory judgment is a real judgment, not just a bit of friendly advice --- will come to regret it. Badger Catholic, Inc. v. Walsh, 620 F.3d 775, 782 (7th Cir. 2010).

Oh, I think I'm starting to get the picture here - you're a wee bit pissed.  Well, I would be too.

So to clarify my order and judgment: The individual mandate was declared unconstitutional. Because that essential provision was unseverable from the rest of the Act, the entire legislation was void. This declaratory judgment was expected to be treated as the practical and functional equivalent of an injunction with respect to the parties to the litigation. This expectation was based on the longstanding presumption that the defendants themselves identified and agreed to be bound by, which provides that a declaratory judgment against federal officials is a de facto injunction. To the extent that the defendants were unable (or believed that they were unable) to comply, it was expected that they would immediately seek a stay of the ruling, and at that point in time present their arguments for why such a stay is necessary, which is the usual and standard procedure. It was not expected that they would effectively ignore the order and declaratory judgment for two and one-half weeks, continue to implement the Act, and only then file a belated motion to clarify.6

One sentence reduction: Up your ass with your dishonest argument, Mr. President.

After careful consideration of the factors noted above, and all the arguments set forth in the defendants motion to clarify, I find that the motion, construed as a motion for stay, should be GRANTED. However, the stay will be conditioned upon the defendants filing their anticipated appeal within seven (7) calendar days of this order and seeking an expedited appellate review, either in the Court of Appeals or with the Supreme Court under Rule 11 of that Court. See, e.g., NML Capital Ltd. v. Republic of Argentina, 2005 WL 743086, at *5 (S.D.N.Y. Mar. 31, 2005) (district court granted motion to stay its own ruling, conditioned on as prompt as possible appeal and a motion for an expedited appeal).

Reduction: You can have your stay.

But - you must either shit or get off the pot.  Right now.

Madison is Merely the Opening Act
Madison, WI may be taking up most of the domestic headlines with its budget battles, however that will change. All states and municipalities are, to various degrees, similar to Wisconsin. Government spending is not sustainable. The fantasy world of the last couple of decades produced higher GDP as a result of debt expansion. Neither the GDP nor the tax revenues generated are coming back any time soon. Governments at all levels spent like drunken sailors, assuming the cornucopia of excess tax revenues would never close. It has. Now hard decisions must be made. There is not enough revenue to pay for current spending no less add new government programs.  There are no easy solutions for the profligacy of the past. Rollback of government is painful. It can either be managed via the political process or it can be imposed via draconian action. Democrats not in power better learn to cooperate in managing the cuts lest they be cut out of the process completely. Cuts are coming. They must. Here is an example of what one municipality plans: Providence School Superintendent to Send Dismissal Notices to All 1,926 Teachers; Providence is Bankrupt. Unless cuts can be managed via the political process, drastic actions like Providence will be imposed. There is no other choice! Taxpayers are unwilling to be exploited by government anymore. Increased taxes are not a solution. Nor is delay. Hopefully the protests can be limited to Madison-style and not progress to Cairo or Tripoli events.
Economic Mess is Structural Not Cyclical
[caption id="attachment_9670" align="alignleft" width="97" caption="Chris Martenson"][/caption] [caption id="attachment_16437" align="alignright" width="100" caption="John Williams"][/caption] For more than a year, I have argued that regardless of what you want to call our current economic crisis, it is not current and not cyclical. It is secular. That is, the problems that surfaced began many years ago, back in the 1970s. Chris Martenson, who interviewed John Williams of, obtained the following quote from Mr. Williams:
If you look at the government’s latest statistics - the poverty survey of 2009, which is the most recent release, with average and median household income adjusted for inflation (and they use a really gimmick low inflation rate with that one) - it shows that not only has household income been falling the last year or two, but it’s below its near-term peak before the 2001 recession. Household income has not recovered above that, and if you use the CPI-U (the usual inflation rate to deflate that by instead of the gimmick one) it shows that household income today is below where it was in 1973. Again, the average household has not been able to keep up here. If income growth is not keeping ahead of inflation, very simply you can’t have consumption growing faster than inflation on a sustainable basis.
Many will attack median household income, claiming that there are more single head of households today than in the past. That is true, if you go far enough back, and probably true for the period under discussion.  The War on Poverty started the disintegration of families in the mid 1960s. A different measure, not dependent upon families, is weekly wages. Real weekly wages today, using the government's arguably understated inflation figures, are lower than they were in 1964. This drop is not a function of the current economic problem because they dropped below in the early 1970s and never recovered. In the interview (podcast), Williams and Martenson discuss the how the following came about:
  • John came to understand how changes in the way the key economic indicators are calculated has resulted in an outcome in which they no longer reflect reality. No one believes, values or knows how to accurately apply them anymore.
  • There is rampant precedent for political manipulation of how these indicators are calculated. Past administrations forced changes in the forumlae for many reasons - a common one being optics.
  • Using erroneous indicators is dangerous - not just for the governement, but for everyone. When inflation is running higher than most expect (as it is today), investors are cheated out their returns, wage earners wonder why their paychecks buy less goods, and fixed income earners suffer greatly. Unfortunately, there are myraid incentives for politicians and corporations to embrace artificially-low calculations - as they justify reducing obligations owed.
  • The key approaches to calcualting inflation are especially convoluted, especially the practice of applying hedonics. If we instead calculate inflation according the formula used in 1980, we would see a number closer to 8%+ vs today's 1.5% rate.
  • Similarly with unemployment, John calcualtes the true rate in the country today is 22% (vs the reported 9%).
  • In sum, he sees the US suffering from structural issues that are extremely hard to address - but impossible if we continue to let fantasy data be our guide. Our circumstances are not sustainable and, in his eyes, have us on an inexorable path to higher inflation - and likely hyperinflation.
Martenson provides additional commentary on his site or you can read the linked article here.
The Canary is Dying and So Is Our Future
Wikipedia describes the use of animals as early warning sensors. Canaries were used by miners:
The classic example of animals serving as sentinels is the canary coal mine. Well into the 20th century, coal miners in the United Kingdom and the United States brought canaries into coal mines as an early-warning signal for toxic gases including methane and carbon monoxide. The birds, being more sensitive, would become sick before the miners, who would then have a chance to escape or put on protective respirators.
Early warning signals can be useful in finance and economics, although they are difficult to find.  Established and reliable relationships are key. When an established relationship begins to fail, it could provide the same warning as a dying canary in a coal mine. For miners, a dying canary was a sign to take protective action, including leaving the mine. For investors, failing established relationships could provide the same signal. More than a few sophisticated investors consider the dollar as the key variable to watch. Because prices are the transmission mechanism for economic allocation and change, shifting value in the purchasing power of the dollar will reflect inter-country changes. In effect, the dollar is their early warning mechanism. It is their canary.

The Dollar Relative to Other Currencies

The dollar and Treasuries are considered safe havens. That mantra is one of Wall Street's favorites. The belief is grounded in many years of history. Since the end of World War II, the US has been considered economically stronger, politically more stable and fiscally more responsible than other countries. When world risk and uncertainty increase, foreign money tends to move into lower risk areas. Dollar-denominated assets, particularly Treasuries, is a preferred destination. There is nothing inherent in the US that makes it a safe haven. Nor is there any assurance that it will continue to be regarded as such. Just as this status was earned by relatively prudent fiscal and economic behavior, so it can be lost by profligate behavior. The last decade or two, and especially recent years, has dramatically altered the financial condition of the US. Perception seems slow to change, although astute analysts now consider the US to be no safer than some other areas of the world. Irresponsible behavior on the part of the US government has jeopardized the country's financial condition. As a result its fiscal condition no longer differs from many other countries. For those who follow such matters closely, the US appears to be the beneficiary of the gap between its actual financial condition and its perceived condition. Many consider the dollar and Treasuries as "the canary in the coal mine." To understand the irresponsibility of the US, the dollar's performance against a basket of other currencies is all that is required: {Click on Chart to enlarge} The weakness of the dollar versus other currencies since 2002 is apparent from this chart. From a high of about 120, the dollar dropped to a low of around 72 by 2008, a loss of almost 48%. This loss is a relative one, not an absolute one. That is, it represents a loss against other fiat currencies not against a fixed standard. Given that most fiat currencies were losing purchasing power during this period, the absolute loss is larger, although difficult to measure. What is reflected in the chart is the dollar losing purchasing power faster than other currencies (which also were losing but not at as fast a rate). Some interesting observations are available from the above chart. The rebound in the dollar in 2008 reflects the financial crisis. Reflexively, there was a run to dollars as a safe haven. Once it was apparent the world was not ending, the dollar reverted to its pattern of decline. In late 2009, the dollar rallied again. That rally reflected the fear that various countries in Europe were going to default and the fear that the Euro might not survive. Once that crisis stabilized, the dollar returned to its longer-term pattern.

Implications of The Decline in the Dollar

The implications of this loss in value of the dollar are significant. A few comments should suffice to provide an understanding:
  • During this period, foreign investors in the US stock market would have had to earn 48% to break even on their investment. Their funds in the US declined by 48% relative to the currency they were repatriated to.
  • US investors in foreign markets, if they broke even in those stock markets, would have realized a 48% gain when they repatriated the funds.
  • In terms of global purchasing power, Americans lost 48% of their purchasing power. This loss reflects a reduction in the standard of living of each American relative to their international counterparts. Their counterparts gained 48% relative to Americans.
The phenomenon of measuring currencies relative to each other is equivalent to measuring the rise and fall of particles floating in a septic tank. At any particular time, one particle may be rising or falling relative to others. At a different time, it may be doing the opposite. This is relative measurement. It is also an appropriate analogy if you understand what a septic tank contains. There is no better analogy for fiat currencies than particles in a septic tank.

The Dollar Relative to Gold

No absolute measurement of the decline in the dollar is perfect. Comparing the dollar to the price of gold is probably the closest one can come. Throughout history, gold has represented either actual money or an alternative currency. Gold has unique properties because it has little industrial demand to drive its value and its supply is relatively fixed. Fluctuations in gold's value represent primarily its demand as an alternative to fiat money. The price of gold is shown in the following chart:Click on Chart to enlarge} From 2002 until today the price of gold rose from about $300 per ounce to over $1,400. In terms of gold, the dollar lost 79% of its value.


For those who think a price index is a more reasonable method to approximate the decline in the dollar, The practical problems of creating and maintaining a proper index are overwhelming and impossible to circumvent. The Consumer Price Index, a well-known index is replete with flaws. It is also highly politicized and manipulated for political advantage. (See for criticisms of the CPI.) The US government's own data shows that the dollar has lost 96% of its purchasing power since 1913, when the Federal Reserve was created. Most of this loss occurred subsequent to 1975.

The Value of the Dollar

Regardless of what method you use, the value of the dollar has dropped precipitously. For the period 2002 to 2008, it dropped 48% versus other currencies. We know this figure understates the absolute drop because the comparison (the basket of currencies) was itself deteriorating. This measure alone is indicative of failed policies and a faltering country relative to other countries.

The Dollar as a Canary

Analysts who believe an economic apocalypse is in our future are hard-pressed to describe when and how that unfolds. Almost all, however, point to the dollar as playing a central role in the drama. If the dollar is the transmission mechanism to the next stage, it would appear to be the economic equivalent of the miner's canary. In retrospect, the dollar has been a dying canary for a number of years. It may be one of the longest deaths on record as it has been in critical care from 2002 until today. Interestingly, for most of this period, the economy appeared to thrive. The illusion of  economic health was generated by the world's largest credit boom. Credit expansion produced increases in GDP and other macro indicators. It also created distortions at lower levels of statistical aggregation. Macroeconomics looked good; the neglected microeconomics did not. While macro gets the headlines, micro eventually wins the game. Distortions at the micro level eventually break through to create the crisis. That is exactly what happened in 2008. For the period 2002 until 2008, financial markets reflected the underlying damage the government was inflicting on the economy via their continuing devaluing of the dollar. The astute investor heard this canary chirping and looked behind the dollar decline to understand what was happening. The credit expansion was obvious. Less obvious was the hollowing out of the economy that was occurring as a result of distorted prices and interest rates. Mispriced assets and credit cause faulty economic decisions.

Crossing the Rubicon

Even less obvious to most observers was the government crossing the financial Rubicon. Rather than allowing the economy to adjust and purge itself of its excesses and misallocations, government decided to try and cover these up and restart the boom. Current government policy is geared at suppressing the adjustment in distortions by heaping more credit onto the fire. Thus far, it has managed to increase reported GDP while suppressing the coming correction. By embarking on this course, the government has committed to a continuous policy of increasing credit. Not only must credit continue to be increased, it must be increased by ever greater amounts. This course cannot be stopped or altered without plunging the country into a Depression. Supplying more credit is akin to providing more drink to an alcoholic. All it does is defer the "drying out" period at the cost of making it that much more painful. Understanding the fact that  simple trend and recognizing that government committed to a treadmill that it had no ability or intention of getting off, Investing in gold for the past ten years was a dramatic winner without a down year. But that is history. Will it continue? Probably, but no one knows for sure. For those who say that gold is a bubble, there are two rejoinders. First, are you watching Ben Bernanke and what he is doing? Second, bubbles typically end with parabolic type moves. Gold has not shown that kind of movement yet.

The Dollar as Continuing Canary

While government can continue to supply unlimited amounts of credit, it cannot control the value of the dollar. Markets are already in the process of writing off the dollar. At some point massive inflation, possibly hyperinflation, will occur if the current course is not altered. Markets are bigger and stronger than governments. They discipline economies and governments, not the other way around. Is it possible to utilize the dollar as miners used to utilize a canary? There probably is. Bill Bonner of the Daily Reckoning focuses on a key relationship -- the behavior of the dollar vis a vis gold and geopolitical events. Given what is happening around the world, especially the unrest in the Middle East, one would have expected the dollar to have strengthened. Mr. Bonner points out:
This could be important: the dollar has NOT gained from the unrest in the Arab nations. People no longer seem to see the dollar as a haven of safety. Instead, they turn to gold…
According to Mr. Bonner, we may have reached the point where the dollar is being increasingly recognized as just another junk fiat currency, afflicted with all the ills that have always plagued fiat currencies. Instead of running to the dollar as in the past, Mr. Bonner points out:
The smart money is buying gold. But the dumb money – which is most of it – is still against gold. It doesn’t understand that monetary systems are temporary…that they ALL fall apart eventually…and that, when they do, people turn back to real money – gold.
He utilized this chart to show the decisive separation of the dollar and gold which coincided with Bernanke announcing QE2:

Dollar vs. Gold after QE2

One thing we know already is that the dollar and gold parted ways last summer, right about the time Ben Bernanke stood before the Grand Tetons at Jackson Hole and announced his grand design to continue debasing the dollar until something good happened.
This chart is the sign of a canary dying. The US no longer has a currency believed in by the rest of the world. It has destroyed its reputation as a fiscally responsible nation and hollowed out its economy with questionable tax and regulatory policies. It is managed by a corrupt class determined to enrich themselves and maintain their positions no matter what harm they inflict on the country. Our short-term destiny has been written by the Fed and government. We are headed for a Great Depression that will likely make the 1930s look minor. For the last couple of years, everything has been a charade to make the sheeple believe that matters are getting better. In Mr. Bonner's words:
The party’s a flop. It’s a fraud. A bunch of stuffed-shirt zombies are standing around with drinks in their hands. Listening to awful music. Talking a line of guff. And no one is listening.
Our standard of living will continue to decrease. That is certain. How much is uncertain and a function of government meddling. The canary may not be dead yet but it is terminal. Take appropriate action now!
Lazy Man's Guide to Mises
The name Ludwig von Mises is synonymous with classical liberalism. He was an unrepentant champion of freedom and free markets. His beliefs, unlike so many of us, were not something he inherited from his parents or society. Many he obtained from others, but many he was the original developer using his incredibly strong and fertile mind. He was unique in the sense that he truly added to the body of knowledge. His ideas were not popular amongst the ruling class and the institutions they controlled, like academia. In our slide towards socialism, how popular might the political elite consider statements like the following?
A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism: is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings.
Mises' uncompromising commitment to what he considered to be the truth resulted in this great man living in relative obscurity during much of his lifetime. He sacrificed prestige and income to stay true to his beliefs. Contrary to the poseurs that proclaim to be economists but are little more than prostitutes for the State, Mises never deviated from his truths. His understanding of economics was complete. Yet his view of the future was not hopeful. In order to preserve society, it was necessary for the people to understand economics. On this matter, he commented:
Is the attempt to guide the people on the right road not hopeless, especially when we recognize that men like John Maynard Keynes, Bertrand Russell, Harold Laski and Albert Einstein could not comprehend economic problems?
Tragically, here was a man who could see the implications of various acts, laws and policies decades before others and lived with the knowledge that these actions could only result in societal destruction. In his autobiography, he wrote, in what must have been an especially sad moment:
My theories explain, but cannot slow the decline of a great civilization. I set out to be a reformer, but only became the historian of decline.
Nowhere was his prescience as clear as his views on central banking. Almost 100 years ago, he laid out the fallacies in central banking and how these institutions would destroy the economies they were supposed to serve. He also foresaw major wars and the Great Depression. For Mises, economics was not some narrow realm of prices and market transactions. It was the realm of all of all human behavior, the very substance of society:
Only he who fully understands economic theory can comprehend the great questions of economic and social policy.
Mises, based upon his solid theoretical framework, was prescient on many historical events and trends.  He was truly a giant of the 20th Century. Mises, not Friedman or Keynes, was the greatest economist of his time. An audio by Ivan Pongracic is a painless way to learn about Mises and what Pongracic considers his five greatest contributions.
Posted: Wed, Feb 23 2011 6:27 AM by Monty Pelerin
Filed under:
Hyperinflation is a Small Price to Pay
The US is hurtling toward out-of-control inflation while the political class tries to convince the hoi polloi that inflation is not a problem. Government-generated CPI data show tame inflation. Federal Reserve Chairman Ben Bernanke claims deflation, not inflation, is the danger to the economy. Despite government propaganda every shopper knows inflation is already a serious problem. The Financial Times presented annual price increases for various items, which included the following:
  • heating oil +41%
  • copper +59%
  • silver +91%
  • palladium +212%
  • corn +91%
  • wheat +79%
  • cotton +143%
These data indicate that inflation is upon us. The magnitude of these numbers suggests hyperinflation. The effects of inflation are not limited to the US and not limited to rising prices. Spiraling food costs have been cited as a factor in political upheaval in several countries, including most recently Egypt. The US Federal Reserve, although it may be argued to be a primary driver, is not alone as a producer of inflation. As pointed out by the Daily Bell there is plenty of blame to go around:
Central banks have pumped something like US$20 to US$50 TRILLION into the world's economy to try to reinflate economies that collapsed in 2008.
The divergence between what governments want you to believe regarding inflation and what is painfully obvious grows larger with time. In the US obvious anomalies in government reports, especially unemployment and claims that an economic recovery is underway, make the reports incredible. Few citizens believe that the recession ended 19 months ago. That claim contradicts what they experience every day. The Federal Reserve has tripled the money supply in an effort to protect the banking system and the economy. Currently, most of this money sits in the banking system as excess reserves which could be lent out, potentially at ten-fold leverage. At some point, these banks will lend these funds out. Then, per the Daily Bell, the Fed must take decisive and rapid action:
As this currency begins, finally, to circulate, price inflation must result, unless such money is quickly removed. Central bankers have continuously claimed that excess currency can be removed from the larger economy before it does its inflationary damage …
Inflationary damage is already evident as per the numbers above. Unless the removal of these excess funds occurs in a timely fashion, the country runs the risk of hyperinflation. Mr. Bernanke has stated on many occasions that he is prepared to withdraw these funds before they can create damage. It is not clear what Mr. Bernanke considers damage, but one might think that rising food and energy costs might qualify. Surely uprisings in Tunisia and Egypt should qualify, if in fact they can be attributed to Central Bank policies. The reality is that Mr. Bernanke is unable to reverse the time bomb he has placed in the banking system. To suggest otherwise reflects either duplicity or unlikely ignorance on the part of Mr. Bernanke. He will not be able to withdraw the funds he put into the banking system for the following reasons: 1. Central banking is not science. Mr. Bernanke has no way of knowing when and what to do. The uncertainty is not due to personal limitations but results from the complex nature of economic activity and monetary transmission mechanisms. He cannot know any of the following:
  • What the rate of price increases ahead will be.
  • How much of a reduction in the money supply should occur to dampen expected increases.
  • What the effect of such a reduction would do to economic activity.
Even if Mr. Bernanke could know the unknowable, he would still be unable to manage matters because lags in the effects of monetary policy are variable and fickle. Further, monetary transmission linkages are complex, which means Mr. Bernanke cannot know what sectors of the economy might be affected and by how much. Mr. Bernanke says he admires Milton Friedman, the father of modern monetarism. Yet, Mr. Friedman was against using monetary policy as a tool to manage the economy. In Friedman’s opinion any attempt to do so would exacerbate economic problems and cycles. That is why Mr.Friedman advocated a mechanical monetary rule for Central Banks rather than discretionary policy decisions. Complicating these problems is what appears to be a personal problem. Chairman Bernanke's ability to forecast anything correctly over the past three or so years should make anyone nervous about his judgment. He appears to be living proof that economic forecasting exists to make astrology look respectable. 2. Political interference is never bi-directional. Politicians never want to remove stimulus. That was evidenced in Europe where Trichet recently reversed on a decision to withdraw currency from the banking system. For the political class (and I do include Central Bankers in that group) there is never a good time to remove stimulus. 3. The Fed cannot return the money supply back to reasonable levels. Of the first two problems, the first is insoluble and the second intractable. Were it possible to overcome them, there is still no way to do what Mr. Bernanke says he will do. The Fed’s balance sheet precludes it. In rescuing the financial system, the Fed bought junk assets, injecting new money into the banking system. They bought these assets at prices greater than their actual value. To remove the excess funds from the banking system, the Fed must sell these toxic assets back to the private sector. Unfortunately, no buyers will pay what the Fed did for these assets. They will only pay what they are perceived to be worth which is less than when the Fed overpaid for them. It might be possible to sell Treasuries into the private sector to reduce the money supply; however the Fed doesn't have enough Treasuries to accomplish the task.  Furthermore, the more Treasuries that leave the Fed's balance sheet, the more the Fed’s balance sheet becomes a collection of junk assets, jeopardizing the viability and continuity of the Fed. 4. Monetary expansion cannot stop. The secret behind all of Bernanke’s bravado is that monetary expansion cannot stop. Deficits of $1.5 Trillion are the current and expected norm. There is little political will to stop them. Has anyone suggested balancing the budget in a year or making meaningful cuts, probably in excess of $500 billion? (Apparently Rand Paul has suggested this latter number, although he appears to be quite alone in his boldness.) Without dramatic political action, the Fed will continue Quantitative Easing. Otherwise the Federal government will default on at least some of its obligations. Foreign and domestic demand is insufficient to absorb the new Treasury debt necessary to fund the deficits. Mr. Bernanke, to the extent he even has a choice, will continue to expand the money supply rather than be responsible for a government default. Get prepared for QE3, QE4, ... ad nauseum. The phrase "lender of last resort" described the intended role of Central Banks. They were created to provide liquidity to assist banks in trouble and prevent bank runs. Today the phrase has taken on new meaning. Central Banks have become the lenders of last resort for insolvent governments. The Fed is unable to withdraw funds from the economy for the reasons above. They will be forced to continue to add funds to keep the government liquid. We will have hyperinflation because there is no way or intention of withdrawing the excess funds from the banking system. Mr. Bernanke, regardless of his intentions, now has one client – the Federal Government. It is his duty to keep them solvent regardless of his job description. The myth of government must be preserved no matter what the costs, including a hyperinflationary depression. This article originally appeared on American Thinker
Faking Our Way to Sovereign Bankruptcy
As political events in Egypt play out, including likely contagion to other parts of Africa and the Middle East, attention is diverted from the real threat to our country -- government insolvency. From Jeff T. Allen, writing in  American Thinker:
There will soon be a crisis affecting US citizens beyond any experienced since the Great Depression.  And it may happen within the year.
Unlike the Great Depression, however, we will enter such a shock in a weakened state, with few producers among us and record mountains of debt.  More cataclysmic is the specter of inadequate food, as less than 4% of us farm ...
Fantasy Land Political lip service will not solve this problem, only spending cuts will. Yet lip service is all we get. President Obama's State of the Union address spoke of the problem but not to the problem. Obama offered no spending cuts, while proposing a host of new spending programs. The release of his budget reflects more of the same - phony promises but no real action President Obama continues to revel in his world of fantasy and duplicity while the economy and world crumbles. Mr. Obama appears delusional and more interested in political posturing than constructive effort. Newly elected Republicans seek $100 billion in immediate cuts but struggle to get to this level. Smaller numbers elicit calumny from Democrats and the media. Democrat Majority Leader Harry Reid reacted this way to the potential cuts:
"In many cases, these proposals may mean taking workers off the assembly line or taking teachers out of the classroom or police off our streets," Senator Harry Reid, the Nevada Democrat and majority leader, said.
Characteristically, Reid touches the political hot buttons in an attempt to scare people. While Reid is correct that low-level cuts will be harmful, it is for an entirely different reason than he suggests. Small cuts ensure a government default, civil unrest and economic collapse. Head-in-the-sand politics must end. Feigned ignorance and cowardice will not serve politicians well. Reality is on the way and they are apt to be run over by it. For politicians like Majority Leader Reid, the remainder of this article may be detrimental to your health. Do not proceed without a cardiac care unit on standby. Fiscal Conditions John Mauldin, in his recent newsletter, argues that public spending in welfare states has reached a turning point:
Clearly, we are looking at a watershed event in public spending in the United States, United Kingdom, and Europe. Because of the Great Financial Crisis, the usual benefit of a sharp rebound in cyclical tax receipts will not happen. It will take much longer to achieve any economic growth that could fill the public coffers.
Welfare states are faced with life-or-death problems that may not be soluble. To understand the gravity of the situation, two studies are useful. The BIS Study The Bank of International Settlements (BIS), is known as the Central Banker for central banks. In addition to other duties, BIS produces respected research pertaining to the world economy. They warned of the inevitable debt crisis long before it was apparent. They are less political than central banks. As a result, their analysis can be more objective. Below is an excerpt from a BIS Working Paper which presented the necessary surpluses by country necessary to regain sounder fiscal condition.
[Table 6.1] presents the average primary surplus target required to bring debt ratios down to their 2007 levels over horizons of 5, 10 and 20 years. An aggressive adjustment path to achieve this objective within five years would mean generating an average annual primary surplus of 8-12% of GDP in the United States, Japan, the United Kingdom and Ireland, and 5-7% in a number of other countries. A preference for smoothing the adjustment over a longer horizon (say, 20 years) reduces the annual surplus target at the cost of leaving governments exposed to high debt ratios in the short to medium term.
These numbers have deteriorated since the table was constructed. For example, the US budget deficit is now expected to be in excess of 10% of GDP in 2011, not the 7.1% shown. The implications of the table are discussed below, but first a look at the problem from a different perspective. The Jagadeesh Gokhale Study Almost a year ago, an article entitled Welfare States - R. I. P. showed debt levels from around the world. This analysis included funded and unfunded (Social Security, Medicare, etc.) liabilities while the BIS study dealt only with funded debt. The US government then had debt and unfunded liabilities equal to 8.4 times GDP. Today the number is almost 9 times. In 2005 the EU averaged 4.3 times GDP. The ratios for the PIGS, those troubled EU countries, were as follows: Portugal 4.9, Italy 3.6, Greece 8.8 and Spain 2.4.  A methodological difference understated these ratios versus the US.  It was crudely estimated that using the same methodologies, the EU and the US would be comparable. An Intractable Problem According to BIS, the US must run higher than a 2.4% budget surplus (higher than the Table above to reflect worsened conditions). A surplus this size has not occurred since the inception of the modern welfare state. To achieve this surplus, the US would have to cut spending by $2.0 Trillion in one year! (Note that any combination of cuts and tax increases necessary to produce this figure would suffice. This discussion assumes cuts only and tax increases would drive economic activity down and likely not be effective.) Obama claims his new budget produces $1 Trillion dollars of cuts over 10 years. (At first blush, it is seen to contain at least 15 different tax increases to achieve his claim.) Even if his numbers were real, that is half of what BIS says is required in the first year and every year thereafter for 20 years! Over Obama's 10-year horizon, the BIS say that $20 Trillion is required. To achieve it, requires spending cuts of more than 50% of total government spending immediately! The BIS solution is daunting, but not satisfactory for two reasons:
  1. It only returns governments to their 2007 fiscal conditions. After 20 years of extreme austerity the US would return to the condition that preceded the financial crisis. That assumes that markets would allow us this much time. Returning to the condition precedent to a financial collapse does not seem too assuring.
  2. The BIS cuts do not address the unfunded liability problems which would have to be dealt with as well, although presumably with less urgency.
The Gokhale study, based on 2005 data, concluded that government finance was unsustainable. By 2007, financial conditions had worsened. The simplest way for most to understand the implications of the Gokhale data is to put it in terms that they can relate to. Several examples of that were provided in Spiraling to Bankruptcy. One illustration had the government confiscate all private wealth and apply it to their liabilities:
If the Government confiscated everything, the social programs would still be $50 trillion short and the Government would still be bankrupt. Furthermore, no company or individual would be left with anything.
Another translated government debt into the equivalent amount owed by each individual:
Assuming a total population of 315 million people, the portion of Federal Government debt that is owed by every man, woman and child in this country is about $381,000! Or, a family of four owes $1,525,000 of which they are unaware. This amount is in addition to whatever mortgages, credit card debt, car loans or other loans a family might have.
Both the BIS and Gokhale studies convey the desperate situation we are in. The BIS provides a solution via massive cost-cutting. Gokhale does not provide a solution. Neither study accounts for the additional state and local liabilities. Neither takes into account the federal guarantees of Fannie and Freddie which amount to another $5 Trillion. The Federal Government is in what is known as a Debt Death Spiral. They are unable to pay the actual and implied interest on their debt. Hence, the unpaid balance is added back to the amount owed, making the problem worse next year. This debt spiral is growing exponentially. Unless this spiral is reversed, there is no way to escape a certain mathematical end. Faking It To Bankruptcy The supposed budget-cutting Republicans are having trouble agreeing on $100 billion of cuts. That is considered too much by some. Obama, on the other hand, claims he is cutting even as he submits a record-shattering spending budget. Politicians, unless their last name is Paul, believe budget cuts of any reasonable size are not possible. In the fantasy world of politics, perhaps they are correct. The real world, however, is ruled by higher laws, unconcerned with politics. Physics and mathematics are beyond political influence. These forces don't think or care; they just are. They unemotionally influence events, oblivious to human needs, wants or suffering. Pure forces of nature cannot be bargained with or overruled. A clash between these two worlds is imminent. A year ago in Welfare States - R. I. P., I speculated that we would come to this point:
The inability of politicians to say no or not play Santa Claus appears to be universal. It has every welfare state headed for bankruptcy. It is unlikely that politicians will act to head off this problem, but markets will eventually put these states out of their misery.
Lack of action is not necessarily a sign of ignorance amongst the ruling class. We got here as a result of their cowardice and Santa Claus politics. That is not about to change. The brighter politicians surely understand the situation as well as I have tried to explain it and probably better. Refusal to act is dastardly but likely "good" politics. Initiating cuts of the magnitude necessary to avoid Armageddon would precipitate our version of an Egyptian rebellion. In the political mind, even a benevolent dictator with virtually unlimited power could not solve the mathematics of this problem. Given this attitude, it is rational for politicians to pretend ‘til the end. In effect, they are faking their way to sovereign bankruptcy. Even though it is useless, they will do anything to keep the economy afloat for as long as they can. Once the true condition is known, we will be indistinguishable from Egypt. Apparently that will be fine with President Obama who stated that what was happening in Egypt was democracy at work. Will he feel that way when the US population realizes what has been done and reacts? Monty Pelerin originally posted this article on American Thinker
Bernanke’s Cowardice Has Sealed Our Fate
Proper formatting of this article can be found on author's website at The history of government management of money has, except for a few short happy periods, been one of incessant fraud and deception. Friedrich Hayek The day after the election the Federal Reserve launched QE2, the second round of Quantitative Easing. This public relations euphemism attempts to hide the fact that the Fed is “printing money” (the Fed actually does it electronically these days). “Cheating, debasing and inflating,” as in stealing from the public, is a more accurate description. Bernanke indicated from 600 to 850 billion additional dollars would be created. To put this in perspective, the Tarp package was in this range. The total Federal Reserve balance sheet was $829 billion at the end of 2004 and only $869 billion in August 2007. At the end of 2009 it had ballooned to over $2,200 billion. This announcement means it is headed to $3,000 billion (3 trillion). Ben Bernanke weakly defended his action with the following justifications: … further support to the economy is needed Easier financial conditions will promote economic growth. higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. The first two statements are true as stated, but unlikely to be affected by additional QE. The third is partially true, although it is unclear that his action will raise stock prices. Furthermore, empirical data is not supportive of the alleged relationship between stock prices and spending (see the Kass reference below). Many economists and analysts believe that the Fed actions will not help. Several believe they will actually make conditions worse (two examples are Doug Kass and Pimco’s El Erian). The Real Reason for QE2 Mr. Bernanke’s justification for committing nearly another trillion dollars does not meet the “smell” test. In prior life, Professor Bernanke would flunk an Econ 101 student for such weak justification (of course we know no one really gets an F at Princeton, no matter how deserved). Mr. Bernanke’s performance was a charade meant to hide the fact that the government is now illiquid! Mr. Bernanke instituted QE2 because the Federal Government has reached the point where it cannot pay its bills. If the Fed does not buy government bonds (print money), checks will stop for programs like Social Security, Medicare and Medicaid reimbursements, military pay, etc. The Madoff Model of government just ended. There are no longer enough bond buyers or taxpayers to pay for the profligate spending of the US government. For more than a decade, responsible economists and analysts warned how this situation had to end. That point has apparently just been reached as a result of some of these reasons: We are increasingly viewed as a profligate, fiscally irresponsible country with no willingness to change. Our debt levels have become dangerously high, raising the probability of sovereign default. Our annual deficit is 3 to 4 times larger than ever before and looks like there is no political will to address it. Interest rates are too low to compensate for the perceived risk. Foreign countries that supported us are now either unwilling or unable to purchase our debt. Solving Insolvency The root cause of the liquidity problem is insolvency. Insolvency is a condition where eventually obligations cannot be met. Illiquidity then results. QE2 provides liquidity, but does nothing to solve the insolvency issue. Unless the insolvency problem is solved, illiquidity will continue. From a mathematical standpoint, it is possible to solve the insolvency problem. From a practical or political standpoint, it is likely impossible. Our funded Federal Debt is almost 100% of GDP. Our unfunded social obligations are about another $100 trillion. The total net worth of the country is about $55 trillion. Government has promised benefits that are twice what everything in the country is worth. To understand the math, see Spiraling to Bankruptcy. Laurence Kotlikoff referred to a recent International Monetary Fund assessment of the US financial condition: … the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.” The government would have to double every tax it collects (including payroll taxes) to run 5% surpluses for decades in order to bring government obligations into manageable range. Such tax increases would plunge the US and probably the world into an economic Dark Ages. Alternatively current government spending could be cut by about 50%. Managing spending forward so that a 5% surplus was maintained would also work. Bernanke’s Morton’s Fork Mr. Bernanke was faced with two choices, neither of which was good. He could have refused to initiate another round of QE which would have forced the government to make tough decisions. Such action might have put the economy into another Great Depression. He likely would have lost his job and been blamed for any economic difficulties that followed. He chose the other option – provide the needed funds. As such, he chose to be the Enabler-in-Chief, reinforcing the out-of-control government fiscal policies. This choice likely enabled him to keep his job (for the time being) and made him appear to be the White Knight responsive to economic needs. Unfortunately for the country, his choice makes matters worse, much worse. The Road Ahead With QE2, the government will be able to pay its bills. If the shortfall were temporary, Bernanke’s actions might be considered prudent. Of course if the shortfall were temporary, the government would be able to borrow in the marketplace. Without a solution to spending excesses and social commitments that cannot be met, there is no end to our shortfalls. Welcome to QE2, soon to be followed by QE3, QE4 … and hyperinflation. QE2 is just another step toward “banana republic” status. We are on the same road travelled by Argentina, Brazil, Zimbabwe, Weimar Germany and many others who destroyed their currencies. These countries did not intend that result. Each step was justified based on the expediency of keeping the government going. As Hayek pointed out: I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments. In every case, including our own, the government had already failed. Its attempt to survive made matters much worse for its citizens. QE2 may only represent the first step, but its effects alone are apt to be profound. Pimco’s Bill Gross anticipates it will produce a 20% decline in the value of the dollar. If you were China or Japan, would you want to buy Treasury Bonds? Would you continue to hold dollar-denominated assets? These types of considerations trigger currency runs. Mr. Bernanke has deferred the day of reckoning. His action will not prevent government collapse. It will ensure it, along with collapses in the currency, economy and likely society itself. This little man, unelected and unaccountable to anyone, has just sentenced the country to an Economic Apocalypse. Milton Friedman’s concern seems especially appropriate: The power to determine the quantity of money... is too important, too pervasive, to be exercised by a few people, however public-spirited, if there is any feasible alternative. There is no need for such arbitrary power... Any system which gives so much power and so much discretion to a few men, [so] that mistakes - excusable or not - can have such far reaching effects, is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic - this is the key political argument against an independent central bank. How Will This End? There is no pleasant ending. Political activity over the past fifty years guaranteed that. As Ludwig von Mises observed: Credit expansion can bring about a temporary boom. But such a fictitious prosperity must end in a general depression of trade, a slump. The best solution is for Mr. Bernanke to cease and desist from his QE policy. That would require the political class to face up to its problems. It would require a massive roll-back of the welfare state and government. It would require resizing government to a level that productive citizens would support. Transitional hardships would occur, including civil unrest and possibly a Depression. The worst solution is the one that Mr. Bernanke has selected. If he stays on this course, fiat money will become worthless. So will Social Security checks because they will have no purchasing power. All fixed income and savings will be wiped out. The middle class will be financially destroyed. Markets will cease to function except on a barter system. Food and other necessities will be in short supply, possibly to the extent of health risks developing. Unimaginable civil unrest is likely. A Greater Depression is assured. Unlike the first Great Depression, citizens would be without any financial wherewithal. Their savings and fixed income will have been stolen from them via hyperinflation. In short, it would be the worst Economic Hell imaginable. Mr. Bernanke was unwilling to tell you what is happening. His action has moved us into the eye of a massive storm. Do not be lulled into complacency for as von Mises stated: A fiat-money inflation can be carried on only as long as the masses do not become aware of the fact that the government is committed to such a policy. Now you know and others will pick up on this quickly. Make like the political elite and protect yourselves from the Level Six economic hurricane that Mr. Bernanke is stoking. A version of this post originally appeared on American Thinker.
Keynes as "Useful Idiot"
The milk of American politics may be money, but the fuel for American socialism is Keynesian economics. Keynesianism’s inherent bias toward bigger government has made it the indispensable tool for statists around the globe. Politicians' natural wont to spend and control benefited immensely when John Maynard Keynes published the General Theory in 1936. His work initially provided rationale for the ad hoc efforts to fight the Great Depression. Subsequently, it provided support for growth in government. The “Keynesian Revolution” represented a massive paradigm shift. Paradigm shifts in scientific fields were dealt with by Thomas Kuhn in his famous book, The Structure of Scientific Revolution. The change process is generally characterized by an older paradigm being discarded after a newer one demonstrates its superiority. That is the evolutionary process of progress. Kuhn dealt only with the natural sciences, although the same process applies elsewhere. Greater verification problems, vested personal interests and political considerations ensure that the process will be less smooth in the social sciences. The adoption of Keynesian economics provides an excellent example. Classical economics, the prior paradigm, had developed over centuries. Its body of knowledge evolved as a result of trial and error, itself a form of the Kuhnian evolutionary process. Classical economics argued for a limited role for government. This constraint was an impediment to politicians’ natural desires to increase power. Keynesian theory never “earned” the right, at least in a Kuhnian sense, to replace its predecessor. It did not demonstrate relative superiority. It was simply ordained by the ruling Continue Reading at [Sorry but I cannot find way to link]
Desperate Economic Action Ahead?
Aug 10 2010 The Apocalypse The economic condition of the country continues to decline toward its rendezvous with an, as yet, unknowable catastrophe. Speculation regarding this outcome is natural because self-interest, if not self-preservation, is at stake. Here is but one possibility. It is not a prediction, but a look at a series of not improbable events that could develop. Any similar government desperation would change our economic world overnight. It is mid-year 2012. The country has officially been in recession since the end of 2010. Many believe that it never recovered from what began in 2008. The word depression is now commonplace. Trust in Congress has fallen to single digits. Similarly, government reports and statistics are increasingly mocked by the public. The media is likened to Pravda because only government-speak is allowed. Distrust, despair and fear are everywhere. 2012 Economic Scenario: Official unemployment numbers approach 14%. Unofficial estimates of unemployment range from 30 -35%. There are no signs of a turnaround in employment. The Dow-Jones average has hovered around 4,500 for the past month. Official GDP has been declining for four consecutive quarters. Independent analysts estimate the true numbers have been declining for two years. Tax collections continue to drop while Federal spending accelerates. The deficit is expected to exceed $3 Trillion. Federal debt now exceeds $16 Trillion. The rate of foreclosures has doubled from the previous high in 2011. Personal and corporate bankruptcies have reached levels thought impossible. Major companies have left or announced intentions of leaving the U.S. to avoid the confiscatory taxes and regulations. College students, unable to find jobs, are emigrating to more favorable economies. California, Illinois and several other states are in bankruptcy court. Almost a thousand municipalities have filed as well. Many states and municipalities are using IOUs for payments. Welfare and unemployment checks are two months behind on average. Social Security checks and Medicare reimbursements are delayed. Some private pension funds have reduced their payments by 10 – 25%. Hospitals and doctors refuse to see Medicare patients until Federal reimbursements, already eight months behind schedule, are paid. Public unions across the country are on strike. Large areas are without teachers, police, firemen or hospital staff. Food stamps are rejected at grocery stores because of slow reimbursement and government default risk. Martial law has been imposed in several cities to counter rioting and looting. Isolated runs on banks have occurred. Mattress-stuffing is considered less risky than zero interest returns from banks. The dollar is rejected by local merchants around the world. Oil is priced in a weighted basket of currencies of which only 20% represents dollars. Foreign disinvestment in Treasuries has been accelerating as a result of trade wars, concerns of default and the desperate need for funding at home. Gold is selling at $2,800 per ounce. Despite QE on a scale not even Paul Krugman would have recommended, the economy continues to deteriorate. Treasury and toxic asset purchases have swelled the Fed’s balance sheet from $800 billion in 2008 to $6 Trillion. Despite incredible money-creation, the deflationary spiral continues. Banks continue to add more excess reserves. Creditworthy borrowers refuse to borrow. People and businesses everywhere have hunkered down, waiting for the next shoe to drop. Many withdraw funds from the banking system in fear of its collapse. The Emergency Measure It is against this backdrop that the President of the United States appears with a major economic announcement. Treasury Secretary Chris Dodd and Fed Chairman Barney Frank, both in their best solemnity, accompany him. President Joe Biden (in office for six months after former President Obama resigned “to spend more time with his family”) issues a short, terse message: The Federal Government, as a result of our national economic emergency, will be recalling all US dollars effective immediately. Continue reading »
Walter Williams, American

I recommend highly an interview by Daily Bell with Dr. Walter Williams. The interview conveys what Dr. Williams is about and what America is supposed to be about. Very worthwhile and he is a breath of fresh air and sense.

Daily Bell described Williams thusly:

Yes, throughout his career Dr. Williams has been a courageous, even lonely, voice, standing against black victimization and for freedom at a time when there were very few voices to be heard sounding his sentiments. He has spent his life attempting to explain "real" economics; he did so at a time when such discussions had all-but-flickered-out. He provided a bridge between that barren age and the incredibly substantive and energetic conversation going on today in the Western world and especially in America. He is a pioneer; we look forward to his autobiography; we are certainly glad we had a chance to interview him.

From the interview, I extracted Williams' official pardon of white Americans. His sense of humor is often reflected in his writing to reflect absurdity, as it was in this pardon:

Proclamation of Amnesty and Pardon Granted to ... All Persons of European Descent Whereas, Europeans kept my forebears in bondage some three centuries toiling without pay, Whereas, Europeans ignored the human rights pledges of the Declaration of Independence and the United States Constitution, Whereas, the Emancipation Proclamation, the Thirteenth and Fourteenth Amendments meant little more than empty words, Therefore, Americans of European ancestry are guilty of great crimes against my ancestors and their progeny. But, in the recognition Europeans themselves have been victims of various and sundry human rights violations to wit: the Norman Conquest, the Irish Potato Famine, Decline of the Hapsburg Dynasty, Napoleonic and Czarist adventurism, and gratuitous insults and speculations about the intelligence of Europeans of Polish descent, I, Walter E. Williams, do declare full and general amnesty and pardon to all persons of European ancestry, for both their own grievances, and those of their forebears, against my people. Therefore, from this day forward Americans of European ancestry can stand straight and proud knowing they are without guilt and thus obliged not to act like damn fools in their relationships with Americans of African ancestry.

The Pretence of Knowledge


The "Pretence of Knowledge" was the title of economist Friedrich Hayek's 1974 Nobel speech. In his first few sentences, he described the then-prevailing economic condition in words appropriate to today:

... [this economic condition] has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things.

Hayek's words in 1974 were not meant to describe today's condition, although they were extremely prescient. His hope was that the limits of knowledge would be recognized by the economics profession so that we would never reach our current situation.

Hayek's call was for professional humility at a time when Keynesians arrogantly believed they could manage the economy and the business cycle. His was a caution about how little we really know about the economy and can ever know about it:

.. in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, ... will hardly ever be fully known or measurable.

Hayek described the role of economics as follows:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

Two decades earlier Hayek had dedicated his The Road to Serfdom to the socialists of all parties in hopes that they would see the error of their ways. This warning was ignored by the political class as his Nobel speech was subsequently ignored by most economists.

Last week the Chairman of the Federal Reserve, Ben Bernanke, testified before Congress. He described the condition of the economy as "unusually uncertain." That phrase, fogged up enough to make Alan Greenspan proud, was inconsistent with Mr. Bernanke's prior "pretence of knowledge." Peeling back the Fedspeak, Mr. Bernanke essentially admitted that he was baffled by the economy and had no idea what might happen next.

For anyone who has looked at Mr. Bernanke's (the Fed's) forecasting record, this quasi-admission should not surprise. Mr. Bernanke has not foreseen anything with reasonable accuracy. As Mish pointed out:

Ben Bernanke was pretty certain there would not be a recession, that housing was not in a bubble, that the unemployment rate would peak at 8.5%, that paying interest on reserves would enable the Fed to hold short-term rates above 2%.

Bernanke was wrong on every count. At least now he admits he is guessing.

Most economists have ignored Hayek's caution for humility. Bernanke's doubts in his recent testimony are both new and troublesome. It suggests that he does not know what to do next. He has tried everything that he “knows” in dosages never before imagined. Despite his actions, monetary and fiscal actions have not moved the economy. This is not the way the world is supposed to work, at least according to the (increasingly disrespected) prevailing macro-economics.

Mr. Bernanke and others of his generation and training have absorbed what Mark Twain described as dangerous knowledge:

It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.

In modern days, Twain’s aphorism was formalized by Thomas Kuhn. Kuhn wrote The Structure of Scientific Revolution which dealt with the difficulty of changing scientific paradigms.We are at the point where increasing numbers of people question the value of the existing economic paradigm. Bernanke’s testimony may be the start of his Thomas Kuhn moment.

A long battle between the defenders of the old paradigm and the rise of a new one is about to take place. Bernanke, most professional economists and politicians will do everything they can to protect the status quo. Crises often shorten the period of acceptance for something new. That was the case in the 1930s when we accepted the false paradigm of Keynesianism. Desperation caused hundreds of years of economics to be thrown overboard for an unproven theory.

Two years into the crisis with unemployment still rising (using the broader measures) and stimulus almost exhausted, the economy is dead man walking. Negative GDP numbers are likely to appear once the stimulus ends. While government may have some bullets left, they fired their missiles and howitzer shells and are left with small arms. Somewhere Mr. Hayek must be smiling and thinking: "I told you so more than fifty years ago."


The incorrect paradigm that has guided government policies for about 70 years is spent. Economies around the world have been crippled as a result of its incorrect prescriptions --  increased taxation, spending, debt and regulation. Even the highly socialist European economies appear to recognize the errors in such stimulus policies. In the Financial Times Jean Claude Trichet, Bernanke’s counterpart, has recently been highly critical of U.S. stimulus efforts.

To be fair to Mr. Bernanke, it is not his fault. As Hayek explained, no one is capable of doing what cannot be done. Mr. Bernanke's sin was to pretend otherwise, not his failure to do the impossible. Of course, to not pretend would have made Mr. Bernanke ineligible for government employment. Whether he truly believed he was capable of managing the economy or he just tried to maintain the crucial statist political myth is not knowable. My guess is that Bernanke was motivated primarily by his sincerity to the false Keynesian paradigm but also recognized the necessity of maintaining the myth.

Critics will judge Mr. Bernanke harshly. They will argue that prior Fed chairmen did better jobs. That conclusion is false, although arguing it is as subjective as judging a beauty contest and as useful as last week’s newspaper. The reality is that other Fed chairman had options not afforded Mr. Bernanke. Because they preceded him, they worked with an economy less damaged than Bernanke inherited. It was their decades of false paradigm prescriptions that so damaged the current economy.

A free-market economy is a self-correcting mechanism, despite all the protestations of Keynes, his followers, government economists and politicians. Benign neglect is all that is required for economic recovery when an economy is free and flexible. Prior Fed chairman did not practice benign neglect. Like early physicians, economists believed their form of bloodletting cured the economy. This myth was especially convenient for politicians who could claim credit while buying votes at the same time.

Cumulative abuses weakened the economy's resilience. The patient is now so weak that additional bloodletting is likely to cause death. It was Mr. Bernanke's misfortune to attain the job at the wrong time. While this may buttress the case that he was no worse than his predecessors, it certainly doesn't excuse his judgment.

For any thinking economist, not blinded by the false Keynesian paradigm, it was obvious where this economy was going at least ten years ago. Bernanke’s decision to accept the job was equivalent to knowing history and accepting the captaincy on the maiden voyage of the Titanic. Should we be surprised that Bernanke is unable to forecast with any accuracy? Or are we to presume that his ego was so big that he believed he could navigate the ship through the icebergs?

Hayek’s final book, written in 1991, had the title of The Fatal Conceit. Although not directed specifically at economists, the phrase is an accurate description of the economics profession for much of the past 70 years. Our economy is broken and on the verge of collapse.

Our economy is broken and on the verge of collapse. Send thanks to most any economist that has served in government over this period or taught at an Ivy League school.

Monty originally posted this on

Monty Pelerin blogs at


Inflation: The Last Gasp of the Obama Economic Crisis

Inflation: The Last Gasp of the Obama Economic Crisis

Inflation is neither strategy nor solution; it is the last gasp of a desperate ruling class. Inflation is the inevitable ending of this awful economic crisis. The only questions are how much and when.

Rising support champions inflation as a salvation strategy. Richard Russell in a recent newsletter provides the rationale (emboldening by Mr. Russell):

In my opinion, the US MUST default on its debt. There are two ways to default. One is simply to renege on the debt …. The other way to default on the debt is to inflate it away. I'm absolutely convinced that this is the path that the US will take. If the US inflates enough, then over time (many years) the devalued dollar will tend of reduce the power of the debts.

Mr. Russell lived during the Great Depression and has been involved in the financial world since. His experience and observations are valuable. The desperation of our current economic situation should be apparent when default is presumed the only option. The idea is hardly unique to Mr. Russell. Anyone who has studied the numbers knows the mathematical impossibility of paying off the debt.

I differ with Mr. Russell not on the government’s intent but on their ability to execute such a strategy. They do not possess the knowledge to manage such a strategy. Nor is the government likely to have the luxury of time to succeed, given the rate we are adding new debt.

I expect inflation because it is based on a universal political characteristic -- cowardice. Politicians are not going to stop welfare, social security, unemployment and Medicare, at least not willingly. Furthermore, the Federal Reserve is not going to force the government into insolvency. The Fed, while de jure independent, is de facto not. It was created by legislation and can be disposed via legislation. The Fed must be a willing slave for the government.

Bernanke will "print" so long as the Federal Government is unable to support itself via tax revenues and market-based bond sales. Government as presently constituted will never regain this stasis of self sufficiency. The Fed has been forced into an accelerating Quantitative Easing spiral which will not stop until market or political forces intervene. The timing of the end and its ultimate form are not yet knowable.

Former Fed Chair Paul Volcker understood the dangers [To read rest of article, click here


Our Patrick Henry Moment is Here
Our Patrick Henry Moment Is Here By Monty Pelerin Obama's election was supposed to transform America, at least in his mind. This country's first socialist president strode into office confident that he would remake this country. Fortunately for the country, the timing of his election was twenty, if not fifty, years too late. Socialism has failed in its pure form wherever it has been tried. Now it has failed in its modified form. While much of the world realizes this, President Obama is either ignorant or has more sinister plans for the country. In the 1920s, Ludwig von Mises demonstrated via economic reasoning why socialism could not work. His argument was that without market prices, there was no way to properly allocate resources. About ten years later, Friedrich Hayek supported Mises' conclusion from a different angle. He approached it as a "knowledge problem" and argued that no central authority, regardless of how intelligent, could possess enough information to make proper and efficient decisions for tens of millions of people and businesses. History validated the theory of the two Austrian economists. Russia, China, Eastern Europe, Cuba, and North Korea produced inevitable the misery, poverty, and brutality. The two countries that continue the system are amongst the poorest countries in the world, held together only by totalitarian rule and outside economic support. With the recognition that socialism did not work, "do-gooders" changed their efforts to a system that would be part capitalism and part socialism. They believed that capitalism could be used for resource allocation while the "caring nature" of socialism could ensure equitable distribution of wealth. President Clinton expressed interest in what was then referred to as a "third-way." Western Europe had adopted this approach decades earlier. Interestingly, Mises argued that a "third way" could not work, either. In the 1940s, Mises demonstrated that one intervention begets additional interventions. A so-called mixed system is nothing more than capitalism with interventionism imposed. Mises showed that any such system eventually degenerates into full-fledged socialism. In a collection of essays entitled "Planning for Freedom," Mises concluded: There is no other alternative to totalitarian slavery than liberty. There is no other planning for freedom and general welfare than to let the market system work. There is no other means to attain full employment, rising real wage rates and a high standard of living for the common man than private initiative and free enterprise. The countries of Western Europe have, as Mises predicted, deteriorated into social welfare states likely never imagined or intended at their inceptions. As full-blown socialism approached, these countries became insolvent. Soon all will be forced to either dismantle their welfare states or incur sovereign defaults. The U.S., while never formally adopting either socialism or the mixed system, drifted into the mixed system by gradually adopting many socialist programs. As a result, the U.S. faces the same future of insolvency as its European counterparts. In terms of history, the mixed system dates back only to Bismarck in the 1880s. It was initiated in a few countries in the first quarter of the twentieth century. Its widespread acceptance occurred after World War II, when several countries chose not to return to the decentralized economies that existed prior to the war. England was the prime example. Industries nationalized for the war effort remained nationalized after the war. England rapidly devolved into a third-rate economy as a result. Prime Minister Thatcher reversed the decline by re-privatizing most of these industries. It took only about fifty to seventy years for the mixed systems to fail. That is literally a moment in terms of history. Many people are still reluctant to admit that socialism is a failure despite the theoretical warnings and the actual failures themselves. With socialists, it is never the system and always the people that are the cause of failure. "If only we had better leaders." As Hayek and Mises pointed out, it has nothing to do with leadership. There is a fatal flaw in the concept. As a result of attempting to extend the socialist myth, governments and their populations are now burdened with debt, much of which will never be paid. We are on the verge of a worldwide depression that will hit as governments run out of resources. It is likely that politicians will continue to play the game of "extend and pretend." But we have reached Ms. Thatcher's end-point: "The problem with socialism is that you run out of other people's money." How ironic that President Obama's first major achievement was ObamaCare. In May, Greece was ordered to privatize its health care system. This month, it was reported that England was going to overhaul their health care system. England was frequently referenced as a model of affordable, efficient health care by ObamaCare advocates. Apparently, the English government and its people view it differently. These instances are not one-time events. Nor will they be limited to health care. The welfare states of Europe will soon be dismantled in part or whole. So too will the entitlement programs in the U.S. The laws of economics and physics are immutable. They are above legislation. Countries do not have the resources necessary to honor their commitments, period! Our Founding Fathers, without using the term socialism, designed a Constitution to protect against such incoherent schemes. Over time, the Constitution was vitiated by "living document" interpretations, penumbras, and other nonsense. Now, the U.S. stands on the precipice of failure just as Western Europe. It is insolvent, and there are no other alternatives than to default or dismantle. The world is at a very dangerous inflection point. We are about to enter a depression. Politicians are not going to back away from socialism willingly. They and large numbers of other beneficiaries will do whatever they can to retain the status quo. Despite the unequivocal failure of the modern welfare state, it is unlikely to disappear quietly. The status quo is always difficult to change. It becomes especially so in desperate economic times and for people who believe they are entitled to be taken care of by others. The welfare state is headed for the dustbin of history. That is certain because it is no longer sustainable. The critical question is what will replace it. As Mises pointed out, there are only two alternatives: freedom or totalitarianism. There is no middle ground. There is no political compromise that can bridge this gap. Regardless of which side of the issue you are on, the battle will be bitter and likely last a decade or more. Economically, everyone will be hurt, including many of the "well-off." Whether our moral and ethical code is strong enough to get through this together is moot. We are not like our ancestors in the sense of their strong commitment to community, responsibility, forbearance, and integrity. We are the pampered generation, entitled to gratification now and willing to cut corners to get it. In many ways, this problem is more serious than that faced by our Founding Fathers. After all, King George had little control over their lives or fortunes. Yet these principled men risked both rather than accept even a little bit of tyranny. Theirs was a fight of principle; ours is one of survival. The fight is made more important when it is coupled with a depression. We know what monsters rose to power during the last depression and their effect on the world. We will either get liberty or totalitarianism. There is no middle ground. For me, the choice is clear and was stated by Patrick Henry more than two centuries ago: "Give me liberty or give me death." I am willing to sacrifice just as much as our Founding Fathers did so that my grandchildren and their grandchildren can live in the same country I grew up in. I hope enough others feel the same. Monty Pelerin blogs at
Final Post
I have been very frustrated by the site behavior at It is perhaps the best site on the web as a result of its enormous content. Unfortunately, I can no longer post on this site because of the inability to cut and paste from my site. It is not practical for me to re-write my content in order to submit it to I have no idea what has changed, but am unable to get any response from the webmaster or anyone else. If things are ever corrected, I will post here again. I want to thank those who followed my posts and communicated via comments or direct emails. In the meantime, I intend to post to my own site only at If anyone has a solution to this problem which developed about a month or so ago, I would be pleased to hear from you. Monty Pelerin at
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