Last week I mentioned that my grandson Josh (Andy’s boy) was accepted at McGill University in Montreal, the University of Indiana’s business school and the University of Michigan. He is interested in pursuing a degree in business and is taking all the requisite (advanced) classes in economics.
He called me yesterday and asked me, “Which Fed Policy would be better, Quantitative Easing or Tapering and what can be done to make things better?” Geese Louise! When I was his age the only question I would ask is where is the party this weekend and who is supplying the beer. After thinking about his question for a moment, I replied, “Josh, that is the wrong question!” A couple of better question would be: (1) “Why should the Fed be allowed to enact untested policies – like Quantitative Easing and Tapering in an attempt to increase or shrink the money supply?” (2) “Why should the Fed be allowed to increase or drop short-term interest rates in an effort to micro manage the economy? I also asked him (3) if he understood what has happened to the value of the Dollar and to our National Debt since we went off of the Gold Standard in 1970?
This is all new to him of course, because the education that these kids receive in economics these days is lacking in the basics. In the classroom it is sacrilege to question the Fed. I wonder if they even teach the students that the Federal Reserve isn’t Federal at all, but a private corporation, which has been illegally (according to our Constitution) awarded the right to create money? That was supposed to be the exclusive domain of the U.S. Treasury. And I wonder if they teach the students that the Fed isn’t even audited? Just sayin’.
I asked Josh to Google what the average rate of inflation rate was in the 1800s. He checked and found that, according to the Bureau of Labor Standards, the average rate of inflation from 1800 to 1913 (The fateful year the Federal Reserve was founded) was only 1.36% per year. Compare that to the 104 years since the Fed was founded: In this period, the rate of inflation increased by 230% – to 3.13% per year, an increase of 230% over the previous century when there was no Central Bank – excuse me, the Federal Reserve. That is, if you actually believe the data provided by the BLS!
The rate of inflation used by the Bureau of Labor Standards (BLS) does not reflect the “real” increase in inflation – especially since 1970. The most realistic data on inflation is available at ShadowStats, a terrific website by John Williams.
Here is a ShadowStats graph that shows what the “real” inflation numbers look like now (not the politically-motivated and downward-adjusted rates – the BLS call it “Hedonic Adjustment”).
According to ShadowStats, the “Alternate Inflation Rate” – what the rate would be if it were calculated using the same basket of goods and services that were used to calculate the rate in 1990 – is running around 6%.
If we use the ShadowStats chart based on the basked of goods and services used to calculate inflation in 1980 instead of 1990, the rate of inflation averages over 10% per year.
And what about the uncontrolled growth of the National Debt? And what affect did the elimination of a gold-backed dollar have on the National Debt?
In 1971 the total National Debt was under $400 Billion. It topped $1 Trillion in 1982 and was just over $3 Trillion in 1990, the year I started Miles Franklin. The 2017 number comes in at $20.24 Trillion. The correlation between exploding debt and elimination of gold backing the dollar is easy to see. For the first 300 years, including WW1, the total National Debt was only $620 Billion. We added $671 Billion in 2017 alone, and Trump’s new Tax Reform promises additional yearly increases of over $1 Trillion each year for the next 10 years, and if the economy should tank and the stock market along with it during that period, it will be much more.
There are a couple of things that bother me. First, the Treasury Department has refused to allow an impartial third-party audit of our gold reserves at Fort Knox. Do we still have the 8,100 tonnes that we claim we have? Many people, including Ron Paul, say it is unlikely. If it were there, why would the Treasury Department not allow an independent third-party audit? The simple answer is they don’t have a good reason not to allow it – if the gold were still there. And if it weren’t the dollar would no longer be a viable Reserve Currency.
So getting back to the question at the beginning of this discussion, which Fed policy, easing or tightening is better? Which works better? Neither one. Take a look at what happened during the last 100-years, the period that the Fed was in charge of money creation and interest rates.
The prior 100-year period yielded very little inflation. A fair metric to measure inflation by is an ounce of gold. Gold was “money” during the 1880s so how did gold hold up? An ounce of gold had about the same purchasing power in 1900 as it had in 1800. And since 1913? 100-years ago a Gold Double Eagle (almost an ounce of gold) could be purchased for $20. A Double Eagle was money. A Double Eagle has a face value of $20 dollars. And up to 1933, $20 paper dollars could be exchanged at a Federal Reserve Bank for once Double Eagle. Today, it takes around $1,350 dollars to buy a one Gold Double Eagle. The coins are still the same, so why does it take nearly 68-times as many dollars to buy the same one-ounce gold coin? Simple. It’s because the dollar has lost most of its value, (its purchasing power) since then, that’s why.
And why pray tell did this happen? Because under the leadership of the Federal Reserve and the undisciplined spending by Congress the amount of dollars in circulation (and credit, of course) has exploded. The following chart shows the accelerated growth in the CPI (inflation) since 1970 when gold was removed as an anchor for the dollar. Since then, we could create unlimited dollars without acquiring new gold backing for the dollar. That’s like giving your teen-age son a credit card without any limitations.
As you can see in the next graph, most of the increase in the money supply is not in physical currency and coin. It is in bank credit. You can thank the Federal Reserve’s policy of Fractional Reserve banking for that. Commercial banks can create ten new dollars (out of thin air) for every dollar on deposit (this is a generalization; short-term deposits are not treated the same way as CDs and savings accounts). Banking – what a racket! Give them a buck, they pay you 1% if you are lucky, then they can lend $10 bucks and charge 6% on their loans. That looks like a return (less overhead) of $60 for each $1 paid out.
So what can we do to fix things? We could re-establish a gold standard. We could pass a Balance Budget amendment. We could accept a decade or longer of very hard times (like the Great Depression) now, rather than do nothing and continue to kick the can down the road which will cause much more pain later on. Yeh, let’s pass the problems on to our grandchildren. Don’t expect any of these things to happen. If we balanced the budget we would have to cut military spending and welfare spending and cut back on Social Security payments and Medicare and Medicaid, etc. We would have to raise taxes substantially. The misery index would be off the charts. The politicians would all be voted out of office. And if we went back to a gold standard, a gold-backed dollar, our money supply would SHRINK dramatically because there isn’t enough gold to back it – unless of course the price of gold rose to hundreds of thousands of dollars an ounce. That would be good for me and for those of our readers who own gold, except if it did happen, I imagine the government would confiscate our gold just as they did in 1933 when Roosevelt needed to EXPAND the money supply during the Great Depression. More dollars meant more gold backing, so they passed a law stealing the people’s gold. I say buy silver and avoid this issue entirely.
The problem is not which Fed policy is bad, the problem is that the Fed causes problems, it doesn’t solve them. Quantitative Easing added money to the economy, which boosted the economy and the stock market – but that resulted in massive bubbles in bonds, stocks, real estate and college tuition, to name but a few. What do you think the new Fed policy of not renewing the maturing bonds in their portfolio (that it purchased during QE),which they call Tapering, will accomplish? That effectively drains money from the economy. Most likely the reverse of what happened during their policy of QE.
Here is what Thomas Kenny had to say about this reversal of policy by the Fed means:
The Fed is no longer a buyer of Treasury bonds—something they have been doing since 2008. The current plan for the Fed, under their quantitative tapering plan, will be to reduce their Treasury holdings by almost $250 billion this year. Time and market action will tell us if that plan comes to fruition. At the same time, it is estimated that the Treasury Department will issue over $1.4 trillion in bonds, nearly three times higher than last year’s issuance. 2018 will see the Fed flip from buyer to seller of bonds and the Treasury issue 300% more bonds than last year. This means that a lot of money will have to come into the bond market in order for rates to not move meaningfully higher. It would seem that unless the Fed was to reverse course, there is nowhere for interest rates to go but up. The “bond kings” Bill Gross and Jeffrey Gundlach have both been warning about this.
Yes, there will be pressure on interest rates to rise (instead of fall); the stock market to fall (instead of rise); the economy to contract (instead of increase); and employment to fall (instead of increase). Of course the Fed knows that so they are trying to “manage” all of these things by gradually unwinding their bond portfolio. However their ability to manage the economy and the markets has not been great. We get too many boom and bust periods and too many “bubble” markets are created when the pump money into the markets. Since when have they ever been able to successfully manage anything? All of the graphs earlier in this discussion clearly show that the Fed’s ability to keep the currency stable and inflation under control is a monumental failure.
Why was I able to go to the University of Minnesota in the early 1960s for a few hundred dollars a year and now Josh’s tuition at McGill or the University of Indiana or Michigan will range from $35,000 per year to $65,000 per year? Why does a Mercedes roadster cost well over $125,000 when I purchased one in 1969 for under $10,000? Why did the house we purchased in 1970 for $50,000 sell for $300,000 in 2005? Where is the stability in the purchasing power of the dollar? Ask the Fed. Why does an ounce of gold that cost $100 in 1970 now cost $1,350 (and not long ago $1,900)? Why does $1,000 worth of silver dimes or quarters or half dollars from 1967 now sell for nearly $12,000? Yes, silver is a form of money. Gold and silver have not increased in price over the last 40 some years – it just costs more paper dollars to buy them – to exchange for what used to be money from 1776 to in mid Twentieth Century.
I ask the right questions. I even have the right answers. Get rid of the Fed. Balance the Budget. Set term limits for our elected officials. Live within our means. Will it happen? Haa, ha, ha. I guess, sadly, that says it all. And NO, I am NOT a PESSIMIST I am a REALIST.