In this post, DragonLZ asks a very important question:

What was so much better back in 2003 that justified the incredible bull market that lasted four and a half years, from March of 2003 until October of 2007?

A related question that DragonLZ could have asked is what was so great about Zimbabwe in 2007 that caused it to have the best performing stock market in the world?  But we’ll get back to that.

Little does dragonLZ know that he is at the start of journey that leads to Mises, Hayek, and the Austrian School of Economics, for it is that very question that only the Austrian School can answer.  As he pointed out, there isn’t a very good economic reason why the market kept going up and up.  We agree.  So what did happen?  Here is the Austrian School answer, known as the Austrian Business Cycle Theory (ABCT):

Excessively low interest rates exacerbate the boom and bust cycle

These low interest rates cause an increase in the available funds (business capital.)  From these funds, malinvestment occurs as companies take on projects that would not be justifiable under a system of free market interest rates.  (Rates higher than the prevailing rate.)  This expansion can occur because the Fed (or any central bank) holds rates too low for too long, or through unchecked fractional reserve banking.  If it persists long enough, economic activity can BOOM, but it is an illusion.  Many of the projects are unsustainable, excessively risky, and pull resources away from more efficient alternative uses.  In other words, economic activity gets distorted.  The result is a predictable crash.

Do you think the Fed’s rates don’t have an impact on economic activity?  Then why do they bother manipulating them?  Ask Krugman.

From this most recent boom/bust to the dot.com boom/bust all the way back to the late 1920′s boom/bust…. and guess what…. the panic of 1819, the inflationary boom/bust of John Law’s Mississippi System and the Tulip Bubble before them…

Every single one has the same characteristics.  Easy money at the beginning, resources drawn into sectors that wouldn’t normally justify it, unsustainable development due to scarcity, and it all comes crashing down as entrepreneurs miscalculate risk.  The lyrics from the famous Hayek-Keynes Rap Video explain it better than I can:

The place you should study isn’t the bust
It’s the boom that should make you feel leery, that’s the thrust
Of my theory, the capital structure is key.
Malinvestments wreck the economy

The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?
That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

Who invest in new projects like housing construction
The boom plants the seeds for its future destruction
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies
The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.

Whether it’s the late twenties or two thousand and five
Booming bad investments, seems like they’d thrive
You must save to invest, don’t use the printing press
Or a bust will surely follow, an economy depressed

And that’s how the Austrian School knew that we were headed for trouble.  The Fed had merely reinflated with cheap credit, which Austran scholars knew was unsustainable.  Another bust was sure to follow, worse than the bust which preceded it.

So the story continues, and this is why we urge caution once again.

However, it is foolish to view the Austrian School as anti-stock market.  Nothing could be further from the truth as the following quote shows:

One time, during Mises’s seminar at New York University, I asked him whether, considering the broad spectrum of economies from a purely free market economy to pure totalitarianism, he could single out one criterion according to which he could say that an economy was essentially “socialist” or whether it was a market economy. Somewhat to my surprise, he replied readily: “Yes, the key is whether the economy has a stock market.” That is, if the economy has a full-scale market in titles to land and capital goods. In short: Is the allocation of capital basically determined by government or by private owners? – Murray Rothbard

Now look at this Austrian School examination of the Fed and the stock market in May 2009.  Pretty consistent with what I have been saying all along. This rally is built on cheap money.

This is very dangerous.  Consider that the best performing stock market in the world in 2007 was Zimbabwe.  I’m surprised dragonLZ didn’t ask us why that was justified.  You can see now that it was for the same reason.

While I don’t want to disparage other bloggers that may have libertarian leanings and an affinity for sound money, without an Austrian School perspective on the boom/bust cycle they may sound like PermaBears to the untrained ear.  But just like me, they want economic growth. We all however would just prefer it to be sustainable.

Neither 2003-2007, as dragonLZ pointed out, nor 2009 was sustainable.

“He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our People, and eat out their substance.” – Declaration of Independence, 1776

The below pictures were from a presentation given at yesterday’s “Towne” Hall on May 24.  I’ve added a few comments with documentation links.  The quote above from the Declaration easily applies to the 22.5 million bureaucrats, America’s second largest job sector, who make nearly twice the average wage of the private sector.

While America is not Greece – or Iceland – there are glaring similarities.

While the Republocrats are not King George… they are far worse.

For Liberty and the Constitution,

Jake Towne

USDA link here.  Note the strong rise in number of SNAP food stamp recipients during the past year.  One would expect to see this number dropping or even flat-lining – along with employment rising – if a recovery were underway.

BLS link here.  Note that while the “newspaper” unemployment rate is still 10%, the U-6 figure – which more accurately describes total unemployment is 17% – a depression statistic.  I’ve described the common sense solutions to end rampant unemployment almost overnight in the campaign’s Jobs plank.

Since the BLS drops off workers from its U-6 figure, the real unemployment rate is most likely slightly greater than 17%.  Shadowstats estimates the rate at about 22%.

The current national debt – which is closely tied to the USTreasury market is now over $13 trillion.  Current government plans include massive deficit spending through 2013, and the government’s optimistic projections of a return to “normalcy” even then should be severely doubted.  Source of budget data.  However, due to the cash-based accounting method government uses, this hides the undeniable fact that the real national debt is much larger when GAAP (Generally Acceptable Accounting Principles) are used to identify future taxation sources and future debts such as Social Security and Medicare (see below).

The above is taken from the Treasury Department’s latest report from April 2010 where government’s inlays – social security and retirement taxes, income taxes (both personal and corporate), and excise taxes can be seen.  The average monthly level is about $170 billion per month.

From the same report, the level of government spending, which averages about $300 billion per month.  (Only the government can run that type of accounting, due to its money-printing!)  While Social Security and Medicare are a major expense, the level of “National Defense” spending appears deceptively low as it is just the DoD budget.  As I wrote about in “Guns or Health Care?” plenty of “Other Non-Defense” spending are in fact related to the military – Homeland Security, the nuclear arsenal under the Dept. of Energy, Veteran’s Affairs, the Treasury’s military retirement program, etc.

As seen in the official USTreasury report on page 178/254, the total unfunded liabilities for Medicare and Social Security is a jaw-dropping $107 trillion over the future of these programs.  While I predict the Democrats may bear the brunt of the blame for the collapse of Medicare, one must not forget that it was the Republican’s massive expansion of Part D’s prescription drug plan that worsened the fiscal situation.  One interesting possible interpretation of the recent health care takeover plan is it may simply be a stop-gap solution to temporarily increase taxes over the next few years.  (On Social Security, I will be delivering a presentation in more detail next Friday.)

The above is built from the Federal Reserve H.4.1 data here.  The red line is the total (reported) balance sheet of the FED, which has more than doubled since the time of the Banker Bailout.  While the original TARP bailout (not shown) accounted for much of the initial sharp increase, most of the debt has been replaced by $1.12 trillion of mortgage-backed securities from Freddie Mac and Fannie Mae (the purple line).   This graph shows the nationalization and propping of America’s entire residential housing industry. The yellow and green lines show the cumulative totals of USTreasury and USAgency debt held by the FED.  While the Federal Reserve has admitted it will take losses on the MBS debt, the question remains as to how much and when.

The purchasing power of the dollar has lost well over 94% since FDR took America off the classical gold standard in 1933 through monetary inflation.  The monetary inflation is caused by the FED.  They debase the dollar by creating more and more irredeemable paper dollars.  Graph provided by Bloomberg Financial, 2009.

The above chart shows the “real interest rate” from 1970 to 2009, formula below.  It is an approximation for the dollar’s purchasing power versus time.  While in 1980 it reached nearly +10% (savings rate of ~19% and inflation of ~10%), in 1990 this rate went negative and continued dropping.  The chart shows the capital and savings of America being ruthlessly destroyed by the FED and the government.  Source.

Real Rate of Interest = (Interest Rate earned by a bank savings account) minus (Inflation Rate)

The rising price of gold over the past decade demonstrates the destruction of the world’s paper currencies.  In the past several weeks, gold reached all-time record highs in dollars, yen, euros, Swiss francs, and British pounds.  As described in this article, the gold price is likely suppressed by governments in order to make their own currencies look good as I wrote about in “The Summers Gold Price Suppression Scheme.”  Gold trades over $20 billion USD per trading day – or over $20 trillion annually – a figure larger than the $15 trillion GDP figure used for the United States.

To cap off the situation with the dollar, the latest quarterly banking profile from the FDIC indicates the deposit insurance fund (DIF) is bankrupt.  While consumers at failed banks still receive “insured” funds, the losses are presumably filled in with dollars from the FED, as reported last here.  The current FDIC “watch list” rose to 775 banks, or almost 10% of all FDIC-insured banks in the US per p. 3/26.

The crux of the Over-the-Counter derivatives problem is its enormous size.  However the $600 trillion figure shown is the derivatives’ contracts notional value – a true market value cannot be assessed.  The primary issue with OTC derivatives is that they trade off of exchanges, so their contents are opaque to the rest of the marketplace.  Note that exchange-traded derivatives (EXD) are much smaller.

BIS data here.  Note the sharp drop following the 2008 financial crisis.  More details on derivatives can be learned in “What the Heck are Derivatives?” and “Bring Light to Dark Derivatives!”

Jake Towne is running for U.S. Congress in eastern Pennsylvania’s 15th district in 2010. Prior to returning home, he had been living in Shanghai as an engineer in the semiconductor industry for over 3 years. As part of defending liberty and championing the Constitution, Towne is offering the citizens in his area a novel form of accountable government called “Our Open Office.”

“I remember a German farmer expressing as much in a few words as the whole subject requires; ‘Money is money, and paper is paper.’” – Thomas Paine

America’s monetary situation is becoming fairly ridiculous.  This Monday, the Wall Street Journal carried “Will Nickel-Free Nickels Make a Dime’s Worth of Difference?” on its front page.  The article shares the government’s dilemma that minting each $100 box of nickels costs very close to $200, and that the metal content of the coin is worth more than the face value of 5 cents.  The penny, which was already debased from almost 100% copper to 2% copper in 1982 also costs more to mint than its face value.  The pre-1982 pennies are now worth over double their face value.

The nickel’s mass is 5 grams and consists of 25% nickel and 75% copper.  It is the only US coin to never have been devalued by using cheaper metals since it was first minted in 1866.  At that time, both the penny and nickel were worth far, far less than their face value, but were used as placeholders for gold and silver coins.  America’s dimes, quarters, half-dollars were all 90% silver up until 1964 when the silver content became worth more than the face value.  Today’s dimes, quarters, and half-dollars are nickel plating – done on purpose to resemble silver – sandwiched over a cheap copper core.

While the WSJ hems and haws between substituting wood, plastic, aluminum or zinc in the coins, one of the issues with “toy money” or devaluing the coin currency is that it could cause a psychological trigger as citizens realize Congress and the printing operators at the Federal Reserve intends to pursue its permanent monetary policy of inflation, which is a hidden, insidious tax on all Americans who hold dollars.

From my overseas experience in China, one oddity is bank accounts and many restaurants or shops still issue receipts with two decimal places, even though there is no coin in wide circulation that is worth 0.01 yuan.  These coins stopped being used by the public simply because this amount no longer has any practical purchasing power.  A similar situation now exists in the USA today.

The most sensible solution for Congress to pursue is to halt the inflation and stop minting pennies and nickels altogether.

However, Congress is not sensible.  For reasons briefly outlined here, Congress will continue inflation for as long as it can to maintain this charade of “desperado economics.”  Note the gold price rising to all-time record highs yesterday in dollars, British pounds, Swiss Francs, and Euros.  However, gold’s value is not really rising – it is just the devaluation of the dollar becoming more and more visible to the general public as posted recently in “The Haunted House of Fiat Currencies.”

Today’s dollars are mere shadows of what America’s money once was.  Money made with a printing press is nothing new – Thomas Paine and the rest of the founders were aware of the dire dangers – the phrase “worth less than a Continental” refers to script currency Washington issued the troops which quickly became worth nothing. This campaign has specifically about the nickel debasement two weeks ago, again in January, and well before this campaign started way back in August 2008 when I was just beginning to figure out what the government has done to our money.

While the masses will eventually catch on, forewarned is forearmed.  Here is a snippet from Chapter 17 of Human Action written by economist Ludwig Von Mises:

“The course of a progressing inflation is this: At the beginning the inflow of additional money makes the prices of some commodities and services rise; other prices rise later. The price rise affects the various commodities and services, as has been shown, at different dates and to a different extent.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against “real” goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German Mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.”

[Suggested further reading: the campaign's Federal Reserve plank, Sound Money and Jobs plank, and "One Step Clower to the End of the Yellow Brick Road"  Towne is one of the few writers brave enough to address the transition to sound money here.  While the end result of the crack-up boom predicted by Mises is as above, during the path towards it anything can happen as the amount of credit could be contracting at a faster rate as I wrote about in "'Credetary' Inflation and Deflation" and "Bring Light to Dark Derivatives!!" last year.]

Jake Towne is running for U.S. Congress in eastern Pennsylvania’s 15th district in 2010. Prior to returning home, he had been living in Shanghai as an engineer in the semiconductor industry for over 3 years. As part of defending liberty and championing the Constitution, Towne is offering the citizens in his area a novel form of accountable government called “Our Open Office.”

“None are more hopelessly enslaved than those who falsely believe they are free.” – Johann Wolfgang von Goethe

Recent events not only with the current healthcare bill, but also on the economic front are waking up more and more Americans to the sad truth that the federal government is out of control. A fascist state is quickly developing in America, one of the few rare places in the history of the planet where “life, liberty, and the pursuit of happiness” was not an unattainable dream but instead a mission statement. I first fully grasped where the misguided actions and ideology of the Republocrats would lead America during the Banker Bailout of 2008, and I returned home to fight against the Establishment by running for United States Congress as soon as I could.
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This series addresses the War on Terror. While my stances on both the Iraq and Afghanistan Wars are very clear, in this piece I will propose what to do with Guantanamo Bay and its prisoners.  In Part 1, I explained the history of Guantanamo for knowing its history is key to understanding what should be done with this military base.  In this piece,  I will dissect a recent editorial published in the local newspaper by the incumbent Congressman and then propose my solutions on how to handle Guantanamo Bay prisoners. Following this, no current discussion on terror would be complete without discussing the controversial body scanning and I will add my comments and solutions on airline safety. The last part will summarize border security and just how dangerous the war on terror is – not only to our soldiers who risk their lives everyday and avoiding financial ruin as a country, but also to our liberties as a free society.          (more…)

This short series will address the War on Terror. While my stances on both the Iraq and Afghanistan Wars are very clear, I have not yet formally written on Guantanamo Bay and its prisoners, offered practical solutions to improve our border and airline safety, and commented in depth on our foreign policy and terrorism abroad. In this part, I will explain the history of ‘Gitmo’ for knowing its history is key to understanding what should be done with this military base. Next I will dissect a recent editorial published in the local newspaper by the incumbent Congressman and then propose my solutions on how to handle Guantanamo Bay prisoners. Following this, no current discussion on terror would be complete without discussing the controversial body scanning and I will add my comments and solutions on airline safety. The last part will summarize just how dangerous the war on terror is – not only to our soldiers who risk their lives everyday and avoiding financial ruin as a country, but also to our liberties as a free society.

Readers should be aware that the incumbent in my congressional race sits on Homeland Security and is a rabid supporter of the Bush and Obama administrations’ War on Terror. While I do not question his motives to protect the American people, I do very much oppose his actions and ineffective solutions. Our country’s leaders have not only plunged our nation into expensive, preemptive, and unjust wars for the past decade, but have embarked on a vast extension of a modern-day police state. It is the duty of every citizen to question whether these new restraints over our lives are, in fact, beneficial. I view the infringement of civil liberties that are protected by our Constitution as not only illegal but unnecessary and immoral.

THE GUANTANAMO PROBLEM

“History… should not be forgotten. History itself, whether bad or good, should not be forgotten.” – Chen Zhiyong

“The detention facilities at Guantanamo for individuals covered under this order shall be closed as soon as practicable, and no later than 1 year from the date of this order.” – President Obama by Executive Order, January 22, 2009.  Time’s up.

I remember the years after 9/11 when the government announced they were stowing away “enemy combatants” at Guantanamo Bay, Cuba. CUBA? I remember thinking. Why Cuba? Aren’t they communist and not exactly on cordial relations with the USA? I never pursued my curiosity further than this for many years until I moved abroad to communist China and completely changed my views on the War of Terror.

The origins of Guantanamo’s long, strange trip under US control began when the U.S.S. Maine exploded on February 15, 1898 in Havana’s harbor while Cuba was revolting against the Spanish empire. While the Maine was certainly not attacked by the Spanish navy, to this day it is uncertain whether stored ammunition exploded or the ship hit a mine. At any rate, the battleship was an unwelcome military presence.  (Photo shown entering Havana harbor three weeks prior to explosion.)

William Randolph Hearst’s New York Journal published fictional drawings of Spanish saboteurs attacking the vessel after famously cabling his journalist, “You furnish the pictures, I’ll furnish the war.” As a result, Congress declared war against Spain in April 1898. The war cry was “Remember the Maine! To hell with Spain!“

Led by future President Teddy Roosevelt’s Rough Riders, the motley army won several quick battles before malaria and dysentery could overwhelm them. While Cuba was technically made independent by the Treaty of Paris in 1898, the US government forced Cuba to add the infamous Platt Amendment to its constitution, stripping away completely its sovereignty and enabling the US to intervene in domestic affairs, making it a de facto satellite of the United States from 1901 until 1934. Marines were sent to quell insurrections in 1906, 1912, 1917, and 1920. (1)

Guantanamo Bay, consisting of 45 square miles, was part of the Platt Amendment, and the US Navy established a refueling station to project power around the Caribbean and Panama Canal. Cuba’s independence had no effect on the base besides changing it’s rental agreement. When former lawyer Fidel Castro took over as dictator of a communist police state in 1959 following the Cuban Revolution, he attempted to remove the naval base and, after cashing the first rental check, has not cashed any additional checks sent by the government through the present day.

A Cuban minefield still borders the base on land – the US removed its minefield under Clinton – and the Cuban government still treats the base as hostile. Perhaps from an American perspective, an equivalent situation would exist if China were to take over part of the coast of Oregon, plunk down a base for its navy complete with Starbucks, Pizza Hut, KFC, and McDonald’s, imprison and torture their criminals, terrorists, and prisoners of war there, and then send checks for a rent that we never cash.

It should be plainly obvious that the proper action to take is to not only close down the prison camp, but also to eventually close down the entire military base and return the property to Cuba. This would go a long way towards restoring peace, commerce, and friendship with the impoverished and isolated country. While the harsh socialist economic policies of the Castro regime certainly has not done Cubans much good, neither have American trade embargoes or the attempted CIA invasion in 1961 helped Americans.

It’s time to let bygones be bygones and simply return the property to Cuba. Now, what to do about the prisoners? Well, I will get to that. Let’s first take a look at the incumbent’s claim that closing Guantanamo Bay would weaken national security in part two.

Jake Towne

(1) Note: The Philippines, Guam, and Puerto Rico were also transferred to US sovereignty following the Treaty of Paris. The Filipinos were not granted self-rule and were consistently patronized as our “little brown brothers” by the President and many others. The Filipinos constantly rebelled against the American occupation, costing over 4,000 US soldiers’ lives and likely several hundred thousand Filipino dead from reprisals. Many Filipinos cooperated with the Japanese when they invaded the day of Pearl Harbor.  Although several details are incorrect, please see also Chalmers Johnson’s The Sorrows of Empire, pages 39-45.

Jake Towne is running for U.S. Congress in eastern Pennsylvania’s 15th district in 2010. Prior to returning home, he had been living in Shanghai as an engineer in the semiconductor industry for over 3 years. As part of defending liberty and championing the Constitution, Towne is offering the citizens in his area a novel form of accountable government called “Our Open Office.”

“Paper money eventually returns to its intrinsic value — ZERO.” – Voltaire (1694-1778)

The world champion athletes at the Winter Olympics receive gold, silver, and bronze medals that contain roughly the same amounts of metal as the last Summer Olympics.

• A gold medal contains 550 grams of silver and is layered with just 6 grams of gold.
• A silver medal has 509 grams of silver and about 41 grams of copper.
• The bronze medals likely contain about 450 grams of copper and 50 grams of mostly tin and zinc.

At current market prices, a gold medal is exchangeable for about $494, a silver for about $260, and a bronze for just $3. If the gold medal was solid gold with the same mass, it would be exchangeable for almost $20,000.
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“Whenever you have truth it must be given with love, or the message and the messenger will be rejected.” – Gandhi

“You can chain me, you can torture me, you can even destroy this body, but you will never imprison my mind.” – Gandhi

These are just two of the many lessons it appears that Joseph Stack, aged 53, never learned. For those unaware, Mr. Stack set fire to his family’s home and crashed a private plane into the IRS Austin branch during the workday, killing one other person, injuring 13, and two of the injured are in critical condition. While full details surrounding this incident are still unclear, the FBI believes that his suicide note is genuine. Accounts from Stack’s friends indicate his acts were completely unexpected.
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In Part 1, Fractional Reserve Banking in Pictures, we saw how the banking system creates fraudulent money by creating new money on top of old. The reserve requirement limit used in the example, 10%, is the figure usually given, which means that from a $10 deposit the banking system could generate $90 of new money. Also, the FED uses Open Market Operations to create new money by writing a check upon itself.
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“The few who understand the system, will either be so interested in its profits, or so dependent on its favors, that there will be no opposition from that class. The great body of people, mentally incapable of comprehending the tremendous advantages, will bear its burden without complaint.”

- Lord Rothschild, European central banker

The below slides are meant to explain fractional reserve banking as simply as possible using pictures.  The below demonstration assumes a reserve requirement of 10%, which is the figure typically given by the banking industry and financial experts.  However, in Part 2 I will demonstrate there there is effectively NO set reserve requirement though the banking system obviously carry some level of cash reserves.
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