Could Fed Style Banking Save California?

May 30, 2009

As was mentioned in this column last week, given the defeat of tax hike propositions in California, the state is in a real quandary to find $24 billion dollars by July to close its budget gap.  Without those funds or new debt guaranteed by the federal government, California will face insolvency by mid-summer.  Unlike Washington, Sacramento cannot just print money out of thin air to put off paying its bills indefinitely.  Even that technique of monetary policy is about to catch up with the entire country soon when people begin spending and prices hit the roof.  No, it seems the only way for the Gold Plated State to settle its fiscal woes is to cut payrolls and services.

Not so fast you doomsayers, Ellen Brown, author of Web of Debt, and blogger on the leftist Huffington Post believes she has come up with a scheme to keep the socialistic gravy train in the state rolling without interruption.  She admits California cannot print its own money, but it can open a state owned bank that can create money through credit entries on its books.  To explain how it would work she quotes the webpage for the Federal Reserve Bank of Dallas:  

“Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank…holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”

Pretty neat huh, new money is created by a simple accounting entry and then loaned out again.  Because it owns the bank, the state could afford itself a sweetheart deal by giving itself rates below market value and then roll those loans over as needed until revenues had been generated to pay them off.  Brown credits the state owned bank in North Dakota for that state being one of only 3 currently that are solvent.  She also believes North Dakota’s GNP and personal income growth is directly related to the bank’s operation.  One can have their cake and eat it too in the Peace Garden State.

Now, on the surface, Brown’s assertion that the difference between North Dakota’s solvency and the 47 states that are insolvent in this economic crisis is the state owned bank seems legitimate.  However, upon closer inspection this is proven inaccurate.  First of all, North Dakota is the 3rd least populous state in the union.  It doesn’t even have a million people.  There is little crime, hardly any costs associated with illegal immigration, and much less of a need for social programs.  It is after all a conservative Midwestern farming state.  

Indeed, it is probably because of the state’s two biggest industries, agriculture and petroleum, that North Dakota is doing so well.  These industries have done very well in recent years and would account for the huge growth in the state’s GNP and personal income.  Incidentally, the exclusion of food and energy costs from the consumer price index has contributed to moderating the national inflation rate at a time when both commodities’ costs have been relatively high.  As far as the solvency of the state is concerned, North Dakota is not a low tax state and given the prosperity of the two aforementioned industries it’s no wonder the state’s coffers are overflowing.

Secondly, what Brown is suggesting is responsible for North Dakota’s prosperity is really just fractional reserve banking albeit through a state run bank instead of the private system.  Fractional reserve banking is nothing new and in fact is what the Federal Reserve System is based on (hence the quote from the Dallas Fed).  It is a monetary scheme whereby banks keep only a portion of all its deposits (currently approximately 10 percent) in reserve and loan out the remainder while at the same time maintaining their obligation to pay on demand all deposits to savers.  There are two problems with fractional reserve banking: Loss of liquidity and inflation.  The Fed maintains what is called a discount window for banks to use to borrow short term from the Fed when their liquidity is insufficient.  Fed chairman Ben Bernanke has been asked several times by Congress to divulge the names of banks that utilize the discount window.  He refuses on the grounds that the information would unnecessarily cause a lack of confidence in those banks and put them at risk of real insolvency.  However, it is more likely that the number of banks utilizing the discount window is immense primarily because of fractional reserve banking and to make that information public would destroy all confidence of Americans in the banking system.  Think about it, when a bank writes down a bad loan it is also writing down a deposit it must eventually make good on.  How many banks have written down bad loans in the current crisis?

But fractional reserve is a funny money scheme for another reason.  It is a hidden tax because it leads to general price inflation.  It probably is more responsible for the increase in money supply than low interest rates.  As banks create new money through creating credit out of thin air the value of every dollar is decreased.  It then takes more dollars to purchase the same goods if the supply of those goods has not increased.  More research would be needed, but the Bank of North Dakota’s inflationary policies are probably being offset by the high market prices of their two main industries – food and petroleum.  In any event, besides Alan Greenspan’s artificially low interest rates of the early 2000s, fractional reserve banking also contributed to the housing bubble and will be a contributing factor to the inflation the U.S. will face in the future.

Statists are good at devising schemes to prolong their wasteful policies.  Ellen Brown’s funny money scheme is just the latest.  It won’t work for California because it hasn’t worked for America.  A bailout of the state should be out of the question.  The voters have spoken and they have said no new taxes!  The only thing left for the benevolent politicians in Sacramento to do is to free thousands of non-violent drug offenders, lay off thousands of state workers, and end welfare as they know it.  Maybe then California can be known again as the Golden State.

Let California Fail

May 24, 2009

It is ironic that the federal government is substantially meddling in the financial affairs of other entities given the dilapidated state of Washington’s own finances.  First, there were the banks, investment houses and insurance companies – the most notorious being AIG.  Then the auto companies weighed in getting their piece of bailout funds from Uncle Sam.  Now, it seems the states will be next to tap the national treasury for funds that do not exist. 

There is a saying, “As California goes, so goes the rest of the nation.”  How true these words have become since both are completely bankrupt.  With the defeat this week by voters in the Golden State of ballot initiatives that would have drastically raised taxes to close a $24 billion budget gap, the state is on course for a complete financial collapse by July.  Unlike the national government, California can’t print money to buy more time either – no pun intended.  It must find a way to raise the funds otherwise millions of Californians will not receive checks.

But, not to worry, Governor Schwarzenegger, Senator Boxer and other Golden Staters are putting the squeeze on Treasury Secretary Tim Geithner to guarantee emergency loans that California needs to meet its obligations.  With the state’s credit rating in the toilet, some analysts believe federal backing is California’s only hope to secure the loans it needs to pay its bills.   The proposal would collateralize U.S. taxpayer funds to guarantee private lenders that they would be repaid if California defaulted.  The concept is to take the risk out of lending to California for banks and place it squarely, again, on the shoulders of American taxpayers.

Of course the leverage state officials are using on Geithner is that California is “too big to fail.”  They claim if the state were to go belly up it would send ripples through the rest of the country and even the world.  Further, if Washington allowed the collapse to take place imagine what that would do to the confidence the rest of the world has in us to lead economically.

Clearly the feds are in a totally unenviable position.  If they don’t bail Sacramento out they will look really bad given their enormous generosity towards unscrupulous bankers, and inept carmakers.  Since most of the money California needs to borrow will go to ordinary folks, teachers, cops, government workers, Washington can’t be seen again to favor the interests of Wall Street over Main Street.  Thus, I believe there is no question that the Obama Administration will bailout California.  Naturally, this is a big mistake.

In the first place, if Washington succumbs to the “too big to fail” ploy with California, then what happens if say Wyoming asks for bailout funds.  Can it be denied because its economy is not nearly as important as California’s to America’s health?  Is it proper to favor one group of Americans over another simply by virtue of where they live?  I realize we do that now with things like highway funds, but saving one state and letting another go is a horse of a different color.  What about Wyoming’s portion of the federal bailout funds for California?  If Washington submits to Schwarzenegger’s request it will open up an array of ethical and legal questions pitting states against each other.

Then there is the “moral hazard” that would result with a California bailout.  Given that politicians are not very courageous when it comes to making touch choices, state bailouts by the feds would allow state officials to manage state funds even more irresponsibly.  California is a perfect example.  The statist politicians there have overpaid public employees, spent generously on social services, and overregulated business and the environment.  Bankruptcy is the perfect solution to their reckless spending.  It is what ended socialism in Eastern Europe; it should be used to end socialism in California.  Without it, politicians of all stripes will believe that Uncle Sam will catch them when they fall.  This will impede economic recovery and perpetrate the myth that Washington has a bottomless bank account or a bank account at all.

Which brings us to the question of where does California think the feds are going to get this money anyway?  Our leaders have become oblivious to our financial condition.  When you can’t pay your bills you are bankrupt.  Washington has been bankrupt for a long time, but again has had the means (printing press) to put it off.  And put it off the politicians have.  That is why we now face the economic situation before us – a lower standard of living, mountains of debt both personal and national, and a gigantic task of rebuilding our industrial base so that we can compete again.  You see the politicians since at least 1971 have mortgaged our future; those bills have come due; and we don’t have the money to pay them.

So, California is not alone.  “As California goes, so goes the rest of the nation.”  Both entities are broke.  Perhaps instead of groveling to Washington to bail them out with funds Washington doesn’t have, the politicians in Sacramento can set an example for Washington to follow – deregulate, end the welfare state, disband public unions, and live within your means as a society.  Wouldn’t it be nice if California led the nation in a positive way for a change?

Rothbard as Prophet – Part 2

May 16, 2009

As documented in Rothbard’s classic piece America’s Great Depression, the similarities of the 1920s and 2000s did not end with the beginnings of each crisis in 1929 and 2008 respectively.  It gets much scarier than that.  Washington responded in very similar ways to both crises.  As we know, Hoover/Roosevelt policies made the recession of 1929 into a depression and prolonged recover for at least a decade.  Time will only tell how bad Bush/Obama policies will make our current economic depression.

So, just what were the policies of the Hoover/Roosevelt administrations that exacerbated the U.S. economy into the 1930s and resemble the policies of the Bush/Obama administrations today?  For one, a blatant misinformation scheme to make Americans believe that the excesses of laissez-faire capitalism were to blame for the economic downturns was launched.  In both cases, this was used to deflect any culpability of the U.S. government for the crisis.  But, also and more importantly, it was used as the rationale for heavier government intervention in the economy.  It is ridiculous that then and now the American public has fallen for this deception.  We did not in the 1920s and we did not earlier in this decade have a laissez-faire economy in the United States.  As Rothbard points out, just prior to the 1920s America went through the so called Progressive Era.  This era introduced enormous regulations on our economy.  There was price fixing, a full blown agricultural policy and interstate commerce regulation through the Interstate Commerce Commission and other government agencies.  Let’s not forget that the Federal Reserve Bank began operations in 1913 with the expressed mission to prevent economic downturns through currency regulation.

Of course, many regulations and regulatory agencies founded during the Great Depression are still with us today.  Because we are no longer on the gold standard, the Federal Reserve has even more power today than in the 1920s to regulate our money supply.  The bottom line is that laissez-faire means no government interference in the economy, but Washington has had its grubby big hands on our financial system for a long time.  Therefore, Washington’s attempt to blame laissez-faire for economic troubles in this country, ever, is highly disingenuous.

But, the politicians have used this pretense since the Great Depression to step in and “rescue” our economy from the “greedy capitalists.”  After the stock market crash of October 1929, the Federal Reserve pumped $300 million into the reserves of the nation’s banks.  It expanded its balance sheet by purchasing $1 billion of government securities and provided $200 million more to banks at discounted rates.  Sound familiar?  These numbers are nothing compared to what the Fed and treasury have spent on the current crisis ($12 trillion), but they were a lot given the nation’s GDP at the time was $100 billion.  The scary thought is that by the time Hoover left office his attempt to re-inflate the bubble produced a 25 percent unemployment rate.  What will $12 trillion produce?

Additionally, government works projects were used by Hoover/Roosevelt and are about to be used by Obama.  Hoover raised taxes on the rich and Obama has threatened to do the same by allowing Bush’s tax cuts to expire. Fortunately, a major policy difference between then and now is that Washington has not passed (came close with “buy America” clauses in the stimulus bill) protectionist measures in the current crisis.  Nonetheless, the comparisons in policy are startling given they didn’t work the first time.

Beyond the policy similarities, there are at least two chilling coincidences between then and now.  In 1931, almost two years after the crash, the unemployment rate was only 9 percent.  One and a half years after the current crisis began unemployment is 8.9 percent.  But, more ominously, given Hoover’s inflating of the money supply banks didn’t lend and consumers were not spending in 1932.  Naturally, the short term deflation that resulted improved the economy for a while since it began to deflate the credit bubble which the economy needed to recover.  However, it was only a matter of time before all the new money hit the economy and caused havoc.  One year later, the unemployment rate soared to 25 percent.

Again, today, in spite of the Fed’s pumping of new money into the economy, banks have been slow to lend and consumers slow to spend.  Prices have declined over the past 12 months – for the first time since 1955.  You might say the economy is showing signs of improvement – the stock market is up 25 percent in the last two months.  However, since government intervention caused the Great Depression don’t be too hopeful that Washington’s current intervention will have any different outcome this time.

It is amazing that in both crises the same folks who caused the problem were called upon to solve it.  The easy money policies of the Fed have been responsible for both the Great Depression and our current economic crisis.  After the 1929 stock market crash, the Fed’s re-inflating policies did not allow the economy to rid itself of the malinvestments caused by its previous inflating.  The economy sank into a deep depression.  According to Rothbard’s writing, we are headed for a similar if not worst fate.  If only Ben Bernanke had read Rothbard as a part of his study of the Great Depression.

Rothbard as Prophet – Part 1

May 10, 2009

Federal Reserve Bank chairman Ben Bernanke is touted as an expert on the Great Depression.  Many would say we are fortunate to have him heading our central bank at this time when our economy is suffering through its worst crisis since that dreadful epoch 80 years ago. Yet others believe Bernanke is far from an expert on anything economic given his choice of policies since the current crisis began.  One thing is for sure, Bernanke’s study of the Great Depression did not include reading the works of Murray Rothbard.  For if he had, he certainly would not be pursuing his current policies as leader of the Fed.

Probably the most authoritative work on the Great Depression of Rothbard’s storied career was, America’s Great Depression. Written in 1949, the text is a solid analysis of those policies and personalities that brought on the financial and economic collapse of America in the 1930s.  Rothbard’s work dispels the myths taught in public schools that Hoover was a free marketer and the Great Depression was caused by the shortcomings of capitalism.  Informative for understanding what caused the 1929 recession and for what turned it into the Great Depression, today the book stands as a prophetic manuscript for where we are headed economically. 

Readers of the book will be appalled to realize that there are significant similarities between the decade preceding the crash of 1929 and the decade preceding our current financial and economic crisis.  For one thing, in both time periods the Federal Reserve had well-respected chairman at the helm, Benjamin Strong and Alan Greenspan.  These banking helmsmen were respected because they were both viewed as the great caretakers of America’s economy.  Their policies were revered for the economic booms that they produced.  When things got choppy, administrations of both decades could count on the financial maestros at the Fed to right the ship back on a course to prosperity.

Of course, both maestros used inflationary policies to achieve their ends.  Inflationary used here refers to inflating the money supply.  Strong used banker’s acceptances to inflate the money supply and continually put off downturns.  He also loaned money to brokerage houses, no less onerous than lending to banks, thereby producing the bubble that’s eventual popping is regarded as the beginning of the depression.  Greenspan, on the other hand, was the master of the low interest rate in keeping the boom going.  His lowering of the fed funds rate to practically zero percent for two years after the 2001 recession is regarded as the initial catalyst for the crisis we now face.  He also monetized over $6 trillion worth of federal debt to keep the “prosperity” rolling.  In all circumstances, both Strong and Greenspan pulled off the illusion that prosperity through inflation has no costs.

Indeed, at both times the illusion seemed like reality.  The stock market soared, many companies produced more than was needed in the 1920s and many Americans bought more house than they could afford in the 2000s.  Despite a growing money supply, a general rise in prices (inflation) did not materialize in the 1920s.  Rothbard attributes this to the offsetting effect of the high productivity of the decade.  In essence, too much money was not chasing too few goods as the 20s was a time of great production.

In contrast and more ominously, the inflationary effects of Greenspan’s policies were concealed by government manipulation of the consumer price index (CPI).  The most basic staples of life, food and energy, are no longer a part of the inflation index.  Additionally, the way government statisticians calculated the number changed over time.  For instance, the cost of buying a home increased significantly through the decade due to high demand, yet the CPI was adjusted by bureaucrats to counterbalance the effect this data would have on inflation statistics by increasing the weight of the costs of the depressed rental market upwards in the calculation.  Thus, the inflationary effects of the policies of both Strong and Greenspan were not evident at the time of their inflating, the economy appeared to be growing, and so everyone, politicians, business leaders, and economists were happy.

And the illusions of prosperity were perpetuated because no one in the know ever objected to what was going on.  Presidents, legislators, and economists were silent during both periods about any concern they may have had about the direction of the U.S. economy.  In fact, Hoover and Bush, both liked to say that the economy had “sound fundamentals.”   Yes, as long as the Fed chiefs increased the supply of money and the government statistics were favorable all was well in Mudville.  Thus, in 1929, like in 2008, policymakers were blindsided by their respective crises.

Even Ben Bernanke, the so called expert on the Great Depression, didn’t realize Greenspan was repeating history by egregiously inflating the money supply in the early 2000s.  Even Bernanke didn’t recognize the crisis after it hit.  Makes you wonder what he studied to learn about the Great Depression?  Clearly, it was not the work of Murray Rothbard.

The entire text of America’s Great Depression has been graciously placed online as a PDF file by the Ludwig von Mises Institute.  It can be accessed at:  America’s Great Depression

Obama and Doublethink

May 1, 2009

Happy May Day weekend everyone!  Just a salutation to get you used to the observance of a communist based holiday in light of the fact that the process to turn the U.S. into a totalitarian state is accelerating under our new comrade Obama.  With the military becoming more engaged in our domestic lives (natural disaster supervision), CEOs being fired directly by the president, government arranged bankruptcies, whole companies nationalized under the guise of economic stability, gun confiscation on the horizon, and trillions of non-existent dollars stolen by Washington to bailout the economic dregs of our society, I would say the Obama Administration is setting up a situation where Americans will be so poor and indefensible that our only recourse will be to turn to Comrade Barack for sustenance.  And I haven’t even included the administration’s planned socialized medicine scheme.

Of course, the mainstream media has gone gaga over Obama’s first 100 days.  It is no surprise since our media elites are employed by the same corporatists who stand to benefit the most from our neo-fascist economic arrangement.  Yes, I said neo-fascist and I meant it.  You see a major component of fascism as exemplified in Mussolini’s Italy and Hitler’s Germany is a concept called state capitalism.  Companies are still privately owned but they work very closely with the central government to ensure the economic, social, and military goals of the country are met.  For example, a lot of folks became very wealthy producing armaments for the above mentioned dictators during World War II.  Did they have a choice to manufacture anything less violent?  The answer is no because the state demanded it, but they were allowed to share in the benefits of their toil.  Similarly, Washington has made a plethora of decisions – what kinds of cars Chrysler will make, how much money banks will have available to lend, who will be forced to purchase Merrill Lynch, and who heads General Motors? – all in the name of what is good for our economy (state).  And of course, private shareholders will still share in any profits made.  However, given the business acumen of governments in general and ours in particular there probably won’t be many profits to be had.

Beyond forming close ties with business, another technique of totalitarian regimes is doublethink.  Well defined in George Orwell’s famous novel, Nineteen Eighty-Four, doublethink is the act of simultaneously accepting as correct two mutually exclusive beliefs.  This week the president practiced doublethink.  He claims his administration is going to cut taxes, lower health care costs, stabilize Social Security, and cut the deficit in half while at the same time cheering Congress’s approval of his $3.4 trillion budget.

First of all, yes, the president’s budget does cut some taxes.  However, the treasury will have to borrow more to finance the cuts.  This further expansion of the money supply will inflate prices negating any benefits a taxpayer may realize from a tax cut.  So Mr. Obama are you really lowering the tax burden on working Americans?    

Then there is Obama’s health care proposal. He claims it will lower costs in that area.  But, even the best estimates of the president’s proposal put new costs between $600 billion and $1 trillion over ten years.  That means we are looking to spend an additional approximately $80 billion per year over and above the $2.5 trillion we already spend annually.  How can the president say he is going to lower health care costs when his plan will actually increase them?

For Obama to claim his plan will lower health care costs is humorous, but when he talks about stabilizing Social Security he is downright hysterical.  How is he going to stabilize a system that has at least $50 trillion in unfunded obligations?  Does the government have the money for adequately funding the retirement of baby boomers in another fund somewhere?  Can Washington tax the workforce to raise the money?  Demographically is the ratio between the numbers of workers to retirees going to change for the better?  Is there a lottery large enough for Uncle Sam to win to fund the program?  The answer to all four questions is no, no, no, and no!  The Social Security administration makes Bernie Madoff’s Ponzi scheme look like small potatoes in comparison.  Social Security is dead and for Obama to claim he will stabilize the system is doublethink.

Lastly, the president has stated many times that he is going to cut the deficit in half by the end of his first term.  There are going to be several factors in his way of accomplishing this.  For one thing, as unemployment continues to spike tax revenues will drop thereby increasing the deficit.  Then there are the costs associated with Obama’s plan to “fix” health care and Social Security.  As we all know governments are notoriously famous for cost overruns, so we should assume that even the most liberal cost estimates of these plans are understated.  Lastly, given our politicians propensity for spending, we can reasonably assume that spending will naturally rise over time.  Additionally, who knows what natural disaster or new war will confront us and require future spending?

The president is saying one thing, but he is an intelligent man so must be thinking another.  How can he believe he has the ability to fix these problems given the treasury is broke, we are in depression, and Washington is filled with big spenders and grandstanders?  Perhaps he is delusional and it is manifesting itself in bouts of doublethink?  After all that is a characteristic of totalitarian leaders.