Quantitative Easing (QE) Explained

Sound Money

Ron Paul before the United States House of Representatives, Committee on Financial Services, Hearing to Receive the Annual Testimony of the Secretary of the Treasury on the State of the International Financial System, March 20, 2012

Mr. Chairman, I thank you for holding this hearing on the state of the international financial system. The Treasury Secretary has neglected to appear to testify on this topic for several years, so I hope the committee will treat this topic with the importance it deserves during this Congress. It is especially important because of the work the G20 has undertaken on global currency reform since 2008. What role US representatives have played in these negotiations is unknown to Congress, nor do we know what global currency reform initiatives are being discussed. I fear that the G20 negotiations will result in a fait accompli that will be forced upon the American people with no opportunity for input or debate.

Ever since the closing of the gold window by President Nixon in 1971, the unbacked US dollar has served as the world's reserve currency. No longer constrained by being required to exchange dollars for gold, the US government has been able to fund its fiscal profligacy with trillions of dollars of new money created out of thin air. The only constraint on government spending is the willingness of investors to continue to purchase the Treasury debt issued to fund the government's massive fiscal deficits.

The federal government's fiscal profligacy has caused the national debt to skyrocket to well over $15 trillion. Even with nearly a trillion dollars of daylight under the current debt ceiling, it is highly likely that the federal government will reach this limit before the November elections. Foreign nations, especially our major creditors such as China, are watching keenly to see if Congress is serious about getting spending under control. Foreign creditors hold $5 trillion of Treasury debt, debt which is becoming increasingly devalued as the federal government runs trillion-dollar deficits and the Federal Reserve continues its trillion-dollar quantitative easing programs. Another increase in the debt ceiling would signal that Congress is not serious about reining in spending and would foreshadow a further decrease in the value of the dollar.

Unhappiness at this current state of affairs has led to calls to replace the current global dollar standard with a new global currency system. Many of the proposals work from the assumption that national governments cannot be trusted to manage currencies in a responsible manner, and that only an international organization such as the International Monetary Fund (IMF) can provide a stable global reserve currency. These proposals dig back to the roots of the discredited Bretton Woods system, only instead of resurrecting the flawed gold-exchange standard they propose a version John Maynard Keynes' "bancor", an international fiat currency based on the IMF's current special drawing rights (SDR).

Rooted in discredited economic thinking and a complete disregard for fundamental constitutional principles, the IMF over the years has forced American taxpayers to subsidize large, multinational corporations and underwrite economic destruction around the globe. IMF policies are based on a flawed philosophy that says the best means of creating economic prosperity is through government-to-government transfers. Such programs cannot produce growth because they take capital out of private hands, where it can be allocated to its most productive use as determined by the choices of consumers in the market, and place it in the hands of politicians. Placing economic resources in the hands of politicians and bureaucrats inevitably results in inefficiencies, shortages, and economic crises, as even the best intentioned politicians cannot know the most efficient use of resources. IMF assistance to foreign countries also has a history of funding graft and corruption among repressive regimes that leave their countries with massive debt to Western banks, with no economic progress having been achieved. As bad as the Federal Reserve has been in managing the dollar, I cannot imagine how much worse our monetary system would be with a single global currency issued and managed by the IMF.

Monetary problems come about because of the government monopoly on money issuance. Like any monopolist, government abuses its position and debases the currency it issues. Even inflating the currency supply by a seemingly paltry 2% a year results in a systematic debasement which severely penalizes savers and benefits debtors, including the greatest debtor of them all, the United States government. The ability to issue the currency in which its debt is denominated, combined with the ability to debase that currency so that the debt can be paid off with increasingly worthless money, gives rise to a temptation which no government official can resist.

To return to sound money, we need to return to the monetary system our founders intended. Gold and silver were to be the only types of currency which the states could declare to be legal tender, the government was not given a monopoly on currency issuance, and foreign coin could circulate just as freely as American coin. Rather than further centralizing currency issuance in an unaccountable international organization such as the IMF, currency issuance needs to be decentralized. The free market can provide currency just as it provides every other good. All that is needed is for government to remove the restrictions on private mints. Gold is gold no matter who mints it, and unlike paper money it cannot be created out of thin air. Gold-backed currency serves as the ultimate check on government spending and debt creation. Only by returning to commodity-backed currency can we return to fiscal and monetary sanity and break the cycle of booms and busts brought upon us by the Fed.

In conclusion, Mr. Chairman, this Committee has a great role to play in the future of our monetary system. We need to keep watch over the administration's negotiations with the G20 and vigorously oppose any efforts to force the United States into a new global currency, while simultaneously laying the groundwork for a return to sound money in this country.

Caution - Falling Currencies

Submitted by Keith Weiner

Caution: Falling Currencies

In 1913, the US Congress authorized the creation of the Federal Reserve.  Its mandate was limited, but it grew over time to become the central planner of all things monetary.  In 1933, President Roosevelt outlawed the ownership of gold.  In 1944, the soon-to-be-victorious allied powers signed a treaty at Bretton Woods, agreeing to use the US dollar as if it were gold.  Their central banks would hold dollars and borrow dollars, and pyramid credit in their own currencies on top of the dollar.

The US dollar was redeemable by foreign central banks, and so this was effectively a scheme for various currencies to have a fixed exchange rate between each other and to gold.  It, at least, had the virtue of limiting credit expansion, as there was still this one tie to gold and hence to reality.

The problem with fixing the price of one thing relative to another is that whichever one is undervalued is hoarded and whichever is overvalued is dumped.  The US government set the price of gold too low, and so foreign central banks were increasingly demanding delivery of gold.

By the time President Nixon was in office, something had to be done.  In 1971, he defaulted on the gold obligations of the US government.  This had the effect of severing gold from the monetary system, plunging us into the worldwide regime of irredeemable paper money.  One consequence was that the exchange rates of the various paper currencies were allowed to “float” against one another.

This was the prescription of Milton Friedman, monetary quack.  He actually said:

“If internal prices were as flexible as exchange rates, it would make little economic difference whether adjustments were brought about by changes in exchange rates or equivalent changes in internal prices. But this condition is clearly not fulfilled. The exchange rate is potentially flexible in the absence of administrative action to freeze it. At least in the modern world, internal prices are highly inflexible.”

And that’s why we have volatile foreign exchange markets today, because Friedman and his followers wanted to compensate for labor law and other regulation that make certain prices ratchet only upwards, but never downwards.

This fraudulent, unworkable, and dishonest scheme of floating exchange rates certainly did not fix the problem of wage and other price inflexibility.  It did cause several others.

One side effect was to loot people’s savings and thereby teach them not to save, because the word ”floating” is disingenuous.  The paper currencies all sink.  There is no mechanism, nor desire on the part of the central bank, to increase the value of the currency.

The floating currency regime is a regime of sometimes-slower and sometimes-faster currency debasement.  Each government engages in a race to zero.  Sometimes one currency is sinking relative to the others, and sometimes others are sinking relative to it.  This is enormously destructive.

The never-ending process of currency devaluation has a follow-on effect: reduced investment.  This of course reduces growth.  This premise must be taken to its logical conclusion.

Savings, as such, is not possible using irredeemable paper.

When saving, the wage earner sets aside a portion of his wage; he consumes less than he produces.   His basic intent is to hoard this value until he retires and needs to exchange it for food and other goods when he can no longer work.  It is advantageous to lend to a productive enterprise to increase his quantity of money, but this is not essential to the concept.  The key is that he can carry value over time.  Gold and silver do this, but paper does not.

Fundamentally, paper currency is a loan to the government.  Unlike a productive enterprise, government is not borrowing to increase production.  Government does not produce anything; it consumes.  Government is borrowing to consume with neither the intent nor the means to ever repay.  And therefore the “loan” is counterfeit (http://keithweiner.posterous.com/inflation-an-expansion-of-counterfeit-c...).  It will not be repaid.

Gold and silver are positive values.  One can hoard them, as one can hoard any tangible commodity.  Paper currency is a negative value.  It is debt.  There is no way to “hoard” it, its value is always falling, and in the end it will default to zero.

The government’s paper scrip loses value gradually, and then suddenly.  We are in the gradual phase now.  This phase will end without much warning (other than permanent gold backwardation:http://keithweiner.posterous.com/61392399).

Savings, under irredeemable paper is perverted into speculation.  People are forced to crowd into one asset bubble after another.  Those who blindly follow always end up transferring wealth to those who lead.  People who bought houses between 2004 and 2008 in the USA still have not recovered.  At least those who deposited dollars into a bank account have not lost as much, yet.  When the markets finally become aware that the banking deposits are backed by mortgages on homes which are worth 25% to 50% less than their mortgage values, bank depositors will lose more.

Eventually, people will discover that they cannot save in terms of dollars (those who don’t figure it out will be rendered economically irrelevant as their wealth is removed from their hands).  Savings is a necessary prerequisite for investment.  Investment is necessary for companies to grow, to develop new technologies, products, and markets.  Growth is necessary to hire new workers.

As existing companies achieve higher productivity of labor, and do not need as many workers to perform the same work, they lay off unneeded people.  In a free market, the unemployed would quickly be hired by growing companies that expand and develop new businesses.  But today’s structurally high unemployment can be traced back to Friedman’s quack prescription (among other government interference).

Weakening the currency not only discourages savings, it also weakens businesses who have to keep the currency on their balance sheet and who have to import some of their inputs.

When a currency loses value, then all who hold it incur a loss.  It is not possible to employ workers and run a business in a country without holding significant amounts of its currency.  Currency debasement therefore imposes constant losses on enterprises that try to operate in such an environment.

Combined with the fact that imported supplies, ingredients, parts, software, and other inputs are constantly rising in cost in terms of the falling currency, and one can see another reason why Friedman’s assertion is false.  In many cases, especially modern products, the cost of the labor input into a product is a small percentage of total cost.

Save your lunch money in gold and silver, the best way to protect yourself against our mad regime.  If you want to speculate, make sure you risk only your beer fun money.

Gold or Cash?

Billionaire Kyle Bass Says Gold Is Going a Lot Higher (and why he told the University of Texas to take delivery of a billion dollars worth of gold)

Time to Accumulate Gold and Silver

By Jeff Clark, Casey Research

Do you own enough gold and silver for what lies ahead?

If 10% of your total investable assets (i.e., excluding equity in your primary residence) aren't held in various forms of gold and silver, we at Casey Research think your portfolio is at risk.

After speaking at the Cambridge House conference last month and talking with many attendees, I came away convinced that most investors fall into one of two categories: those that hold an abundance of gold and silver (which tends to be physical forms only), and those with little or none. While both groups need to diversify, I'm a little more concerned about the second group. Here's why.

Regardless of what you think will happen over the remainder of this decade, one thing seems virtually certain: the value of paper money will be affected, perhaps dramatically. Even if the economy slips into deflation, the deflation wouldn't last long. A panicked Fed would print to the max and set off a wild rise in prices. This is why we're convinced currency dilution will not only continue but accelerate.

Let's take a look at what's happened so far with the value of our currency vs. gold, afteraccounting for the loss in purchasing power.

Both the US and Canadian dollar, after adjusting for their respective CPIs, have lost about a quarter of their purchasing power just since 2000. Concurrently, gold has increased dramatically in buying power, far outpacing the effects of inflation.

This is the core reason why I'm convinced we should hold our savings in gold and silver instead of dollars. Let's take a brief look at how gold and gold stocks might perform if the economy takes a turn for the worse…

What If We Enter a Recession or Depression?

Mayan prophecies aside, many of our panelists last month, including most of the senior Casey staff, believe economic, monetary, and fiscal pressures could come to a head this year. The massive build-up of global debt, continued reckless deficit spending, and the lack of sound political leadership to reverse either trend point to a potentially ugly tipping point. What happens to our investments if we enter another recession or – gulp – a depression?

Here's an updated snapshot of the gold price during each recession since 1955.

Clearly, one should not assume that gold will perform poorly during a recession. Even in the crash of 2008, gold still ended the year with a 5% gain. And with the amount of currency dilution we've undergone since that time, it seems more likely gold will rise in any economic contraction than fall. Indeed, if the response of government to a recession is more money printing, precious metals will be a critical asset to have in your possession.

Even if the gold price ends up flat or down this year, the CPI won't. Gold's enduring purchasing power is why we hold the metal.

How about gold stocks?

In spite of the debilitating 1970s that suffered from stagflation, price controls, three recessions, and the Vietnam war, gold producers rose over 600% while the S&P was basically flat. And that includes a roughly 65% fire-sale correction, much like we saw in 2008. To be clear, gold and silver stocks won't be immune to selloffs if a recession or worse temporarily clobbers our industry. But in the end, we're convinced they will prevail.

Don't lose patience with, or confidence in, your gold holdings. What happens to the price over any short period of time is only one chapter in the book of this bull market, and we think you'll be happy by the time that last chapter is written.