Understanding the Potential Events of 2010 and Beyond
By Michael McKay
President, Iowa Capital Management, Inc
February 19, 2010
Executive Summary: The Fed has exploded the Basic Money Stuff (Excess Reserves) that is used by Banks to create and then lend out money (out of thin air). Banks are not yet substantially lending this money out. The Monetary Model (Keynesianism) which the Fed uses demands that this money be lent out. The Government is then forced to get that money into circulation through Welfare and Warfare – the two most expensive things the Government can do. The Gigantic Pool of Basic Money Stuff will get into circulation. Purchasing Power will collapse and here will be a hyper-inflationary event. Gold and Silver will be very important. There is a way out; Stop Fractional Reserve Banking altogether and go to a 100% Reserve System – however this is very unlikely.
1. The explosion of “Excess Reserves” from $1.4 Billion in January 2008 to $1.119 Trillion in February 2010 is a big problem and it will become a bigger problem since the Federal Reserve will likely add even MORE excess reserves in the future.
Reserves are the building blocks of new money created out of thin air by the banking system. Each dollar of new “Excess Reserves” can be pyramided into many multiples of new money.
As banks lend they create checking accounts – that is, new money out of thin air – which require some “fraction” to be kept on reserve at the Fed.
Currently our $1.67 trillion dollar money supply is supported by only $62.5 billion of required reserves, which means the ratio of required reserves to money is only 3.74%.
Therefore, this massive explosion in new “Excess” reserves has the potential of supporting up to $30 trillion in new money. That means that our money supply could increase by 18 times its current level.
There is a direct relationship between the supply of money and the price level; therefore, over time prices in America could increase up to 18 times their current level – and that is if the Fed stops the ‘printing press’ NOW which is not likely.
How does $45 per gallon of gas sound to you?
I provided a basic understanding of this phenomenon in the essay “Monetary Ignorance = You are at Risk”. I encourage you to read it and note that it can be found online at http://oldstatic.radiofreemarket.com/misc/monetary_ignorance.pdf .
For a deeper understanding of this critically important knowledge please listen to an excellent interview with Mr. Doug French, former banker and now President of the Ludwig von Mises Institute: http://www.radiofreemarket.com/archives/february-6th-2010
2. Banks are sitting on, and not significantly lending out, these Excess Reserves but their pregnancy will explode eventually. Why? See #3& #4
Why haven’t we seen the hyper-inflation yet? Because the banks have not used the new Base Money Stuff to create (meaning: lend into existence) the tidal wave of New Money that will happen when that money gets into circulation.
The banks are not finding enough “good prospects” for lending out this Base Money Stuff and until they do this base money is going to just sit there harmlessly – Right? Wrong!!
Please listen to this excellent interview with Dr. Jeffrey Herbener on the ABC’s of Hyper-Inflation at http://www.radiofreemarket.com/archives/december-19th-2009
3. The Keynesian Mandate is SPEND, SPEND, SPEND because Spending is the Path to Prosperity and Savings is – according to Keynesians – evil.
The fundamental money problem that plagues our civilization is the wholesale embracing of Keynesian Economics (which I call “Shop-until-you-eventually-drop-Economics”) by Governments and, of course, Central Banks. For an excellent explanation of the basics of Keynesian Economics please read “A Guide to Keynes’s Dangerous and Destructive Economics” by Dr. David Gordon. It is available free online at: http://www.lewrockwell.com/gordon/gordon72.1.html
This philosophy is in control of our Monetary System and it’s premise is Debt is good, You can spend your way to prosperity, Savings is bad, If the public will not spend then the government must pick up the slack – and
4. If you won’t spend the Government will (even if it means a deficit) – and you can pay later.
And the Government will not just spend this newly created money on things like infrastructure but it is likely to spend more on Welfare (in its various forms of Bailouts and Subsidies) and of course, on Warfare. More and bigger Welfare and Warfare is likely to be coming.
5. Government and Federal Reserve incompetence will be rewarded – with your money and with greater regulations.
In an age where we have Amtrak, the Post Office and so many other Government Incompetence’s to choose from I was particularly appalled by the astounding incompetence of the SEC in the whole Bernie Madoff affair (with which I am going to assume you are familiar). The fact that the SEC could not see his fraud even though it was delivered to the SEC on a silver platter underscores that Government responds to its failures by asking for two things: more money and more power.
Here I would like to encourage you all to read the excellent book, ‘Crisis and Leviathan’ by Dr Robert Higgs. He is the academic who proved ‘The Ratchet Effect’ which explains why the hardest thing to get done in Government is to get a Program, Subsidy or Additional Regulation repealed.
Currently the scale of the Monetary Debacles of the Federal Reserve and US Treasury are at an all time high. As they ‘manage’ the Economy they are also asking for two things: More Money and More Authority.
I expect this phenomenon to be a powerful engine which will channel these new Excess Reserves (see points #1 & #2 above) into our economy no matter what.
To understand my comment ‘No Matter What’ please read page 944 of George Reisman’s book ‘Capitalism’. The section is titled ‘Inflation to Solve Problems Caused by Inflation’ and you can read it free onlin
e at http://mises.org/books/capitalism.pdf .
How long is it going to take for us to see the Much Higher Inflation that must follow such a dramatic increase in the Base Money Stuff? No exact dates can be given. However it is a typical of an 18 to 24 month (or more) lag time between large infusions of new money creation and the higher prices that are sure to follow.
However this time is different. The Federal Reserve and the US Government have been eager to show that they will suddenly and dramatically do whatever it takes to keep the Keynesian- spend-until-you-run-out- of other peoples-money- rollercoaster going. They will likely continue to expand the Basic Money Stuff and continue to Spend it; they are forced to continue this because their Monetary Model requires it.
This means Much Higher Inflation could happen anytime.
6. The US Dollar’s Purchasing Power will eventually collapse not simply erode.
Here you must understand the difference between the words Fiscal and Monetary and why both are important.
Fiscal has to do with what we spend money on.
Monetary deals with the kind of money and money system we are going to use; or to put it another way “What you are going to spend with”.
We all know that government does not produce things – only we do. Government can only derive its money from four sources, namely taxes, borrowing, inflating the money supply, or taking it from others (as in confiscation or conquering via war). That’s it.
The average lifespan of a Fiat Money is between 30 and 40 years and we are now in year 39 since President Nixon in 1971 severed the last reference to Gold and our money. It is just a matter of time and our Fiat Money System will also stop working.
What will happen then?
7. There will be a rush to hard assets.
When prices are constantly going up people will look for ways to preserve their purchasing power.
We all have to eat tomorrow and if we see prices going up today then we will do what we can to protect our ability to acquire things for the foreseeable future.
We will look for better ways to help us be sure we can purchase what we need for our future and that means we will move our money into things that hold promise that they will retain their value.
8. Eventually Gold and Silver will become important to a much wider audience.
Right now very few people own physical gold or silver. Some estimates place it at less than 1% of the population owns bullion.
Try this test out. Take a One Ounce Gold or Silver Coin to the Grocery Store or Gas Station and ask the clerk if you can pay in Gold or Silver instead of Federal Reserve Notes or your Credit Card.
Chances are very likely that you will get a quizzical or confused look. Richard Russell, of Dow Theory Letters, says he does this everyday and he always gets a “No” answer. Furthermore, when he attends more formal events he polls the room to ask how many people own physical Gold or Silver. The answer, he says, is very very few, if any at all.
At this time, the Public simply does not look at Gold or Silver as Money. The really big moves in Gold and Silver I believe will come either when the Public starts thinking of Gold and Silver as Money or even if they simply start thinking that Gold or Silver is important.
In October 2009, when the Chicago Mercantile Exchange changed their rules to allow Physical Bullion holdings to be used as the equivalent to Cash and US Treasuries, they were saying that to them, Gold was Money. This is the canary in the Coal Mine. Soon other Fund Managers are going to ‘get it’ and then I think the trend of viewing ‘Gold and Silver as Money’ will be unstoppable.
When that happens Gold and Silver will likely go parabolic. Before that happens though the Big Money is going to start moving into Gold in a Bigger and Bigger way and then, later, the Public will follow. I believe that this Big Money move has started and will only accelerate as the Fiat Money House of cards starts to tumble.
9. There is a way out; Stop Fractional Reserve Banking altogether and go to a 100% Reserve System – however this is very unlikely.
As stated in #5 above the very system that has created this problem NEEDS to expand itself in order to keep itself going. So what are we to do? We can get ourselves and others educated about Money and Banking. The references provided above are invaluable in this process. The public must demand that the charade of fraud that Fractional Reserve Banking is – be stopped. So, please, educate yourself and others. In the mean time, we are all well advised to get more into a defensive posture. The two most important things to each person will be their Cash Flow and their Purchasing Power. Your job and your cash flow are going to be of immense importance to you. Do whatever you can to make yourself more valuable to your boss, company and customers. Also, you must have investments that have the potential to protect your longer term purchasing power.
Other Valuable References:
What Has Government Done to Our Money?/Case for a 100 Percent Dollar, by Dr. Murray Rothbard, available at htt
There Will Be (Hyper)Inflation, by Thorsten Polleit, Economist for Barclays Capital, Frankfurt, Germany http://mises.org/story/3390
The Depression Is Not Over, by Frank Shostak, Chief Economist for MF Global Worldwide, http://blog.mises.org/archives/011645.asp
Hyperinflation, Money Demand, and the Crack-up Boom, by Thorsten Polleit, Economist for Barclays Capital, Frankfurt, Germany http://mises.org/story/4016