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Ron Hera, founder of Hera Research, LLC, and the principal author of the Hera Research Newsletter holds a master's degree from Stanford University and is a member of Mensa and of the Ludwig von Mises Institute. A native Californian, Ron is a self described "escapee" from Silicon... More
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  • Value Subjectivism And Monetary Instability
    Subjectivism is the philosophy that reality is what we perceive to be real and that no underlying, true reality exists independent of human perception. In other words, the nature of reality for an individual person is dependent on that individual's own consciousness. It follows that each person experiences their own reality that is not shared with others. What is true and what seems moral to one person may not be true or moral for another person, i.e., truth and morality are relative. In contrast, objectivism is the philosophy that reality exists independent of human consciousness; that human beings have direct contact with reality through sense perception; and that objective knowledge of reality can be obtained through perception, evidence and logic, e.g., through scientific methods.

    A subjectivist might view the stock market as a perpetual bubble floating on the hopes and dreams of entrepreneurs and investors who invest in stocks in the same way that gamblers place chips on a craps table in a casino, without any concept of an objective economic reality outside of the game. A subjectivist might view technical analysis, which is based purely on trading activity in the stock market, as the ideal tool to understand financial markets, despite the fact that is has no direct connection to the objective economic realities of the companies that stocks represent. In contrast, an objectivist might view the stock market as a venue for participation in business ownership where stocks have value as a function of the particular businesses that they represent and because of the goods and services that the businesses provide in the objective world. A subjectivist might say that "everything is relative" (although the statement is self contradictory), while an objectivist might say that they "…believe in justification, not by faith, but by verification" (Thomas H. Huxley 1825-1895). Although they may not know it, Keynesian economists, bankers and day traders are often philosophical subjectivists while Austrian economists, advocates of the gold standard and value investors are often philosophical objectivists.

    An objectivist interpretation of morality is that morality flows naturally from people pursuing their own interests and that immorality results from coercion. For the vast majority of individuals, "self interest" includes supporting their own family and community, simply because human beings are social animals. Parents naturally care for their own children, for example. Morality is a natural phenomenon, not a product of coercion. Human beings naturally live peacefully together in communities and the vast majority of individuals experience empathy. Both charity and resistance to coercion occur naturally and voluntarily in human communities. Those who do not experience empathy (sociopaths) and who disregard the interests of their fellow human beings or act in ways that harm the community are extremely rare. Philosopher Ayn Rand wrote "Force and mind are opposites; morality ends where a gun begins." Human beings do not act morally because they are being watched by police or because a gun is held to their heads. In all cultures and at all times and places throughout recorded history, and certainly before, what is immoral is initiating violent force or coercion without cause, most especially when it harms the community. Although particular rules vary from one culture to another, morality is neither subjective nor relative.

    Ironically, the objectivist view of morality has been widely misconstrued as a sanction for selfishness. Selfishness typically results in the deprivation or coercion of others. In contrast, pursuing their own self interest is what human beings naturally and voluntarily do in the absence of coercion. In fact, the idea that what is moral arises in a natural way based on the freedom to pursue one's own self interest, i.e., freedom from coercion, is precisely the moral doctrine of the 1776 American Declaration of Independence:

    "We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness."

    Where money is concerned, there are two fundamentally different concepts of "value", one rooted in subjectivism and one rooted in objectivism. In a monetary context, value subjectivism means that money has value simply because people believe that it does and that whatever people can be persuaded or coerced into using as money, such as a piece of paper bearing a government stamp, therefore has "value". In other words, value subjectivism is the view that the only "value" that exists resides in the minds of human beings as a concept or belief and that, therefore, "value" can be created ex nihilo by persuasion or coercion, i.e., by influencing or controlling (through coercion or fear of coercion) the minds of human beings. Value objectivism means that money has value because it contains the resources and labor required to produce it in the same way that clothing or shelter have value for the survival requirements of human life.

    Of course, subjective value, e.g., the value of a Picasso painting to an art lover, does indeed exist but it is different in kind compared to value linked to biological survival (literally, life and death). The former refers to subjective mental states, while the latter refers to an objective biological reality that exists independent of human consciousness. Residents of the Warsaw Ghetto in 1943, for example, didn't value guns in the same way they valued Picasso paintings. Generally, a product of human labor that has real-world utility, such as a physical tool, will be recognized by human beings as having value relative to the material needs and survival requirements of human life. This "survival value" is absolutely pragmatic and is rooted in the natural understanding that human beings have about their biological needs and their physical relationship to the objective world.

    Commodity money comes about in a natural and voluntary way and does not depend on governments or banks. Natural money develops wherever and whenever human beings obtain things that they do not strictly need purely for the purpose of exchanging them for something else. The good most commonly used as a tool of exchange is de facto money. The Greek philosopher Aristotle first defined the characteristics of a commodity that can be used as money as (1) divisibility, (2) durability, (3) portability and (4) scarcity, i.e., rare and valuable. More recently, money has been described as a medium of exchange, a unit of account, e.g., a standard weight of gold or silver, and a store of value. Of course, money must also be widely accepted, which can be accomplished either through natural forces or through coercion.

    The supply of commodity money naturally remains constrained in proportion to the production of other goods. The resources and labor required to produce natural commodity money exist in relation to other economic resources needed for the survival requirements of human life. Production of commodity money subtracts resources that have direct survival value from other economic activities. Therefore, the law that regulates the production of commodity money is the law of survival. The law of survival is not a proscriptive law (declared by a human authority) but a descriptive law based on observation. The production of commodity money is regulated automatically according to the biological needs of human beings. Thus, commodity money is tightly coupled or "tethered" to physical economic activity in the objective world in the same way as building shelter. Human beings very rarely build more shelter than they need because the economic inputs required to do so are better spent elsewhere once sufficient shelter exists. The price mechanism in modern economics is a reflection of this underlying reality.

    While it is commonly believed that any token can be used as money, this refers only to the medium of exchange, i.e., currency. Currency is precisely a "money substitute", which is a convenience, but is not, strictly speaking, money. Land deeds, for example, can circulate as a currency but they are not the land itself. Creating more currency units in a vacuum, in this case un-backed "land deeds" with no land attached, does not create more land or any other form of wealth in the objective world even if it increases the number of transactions and the size of the economy measured in "land deeds".

    Throughout history, schemes have been attempted whereby currencies that cost virtually nothing to produce, and that have no survival value, have been substituted for commodity money. Artificial money, known as 'fiat currency' has putative "value" simply because it is declared to have a value by a government or central bank. Fiat currency schemes replace the survival value of commodity money with subjective value and substitute a mere medium of exchange for natural commodity money. Modern currencies, including the U.S. dollar, the British pound, the euro and the Japanese yen, are all fiat currency schemes. As a practical matter, a fiat currency unit is worth whatever it can purchase but it is not a standard by which value can be measured because its purchasing power is unstable. In fact, there are several fundamental problems with fiat currencies.

    1. There Is No Spoon - In the popular 1999 film The Matrix, written by Lana and Andy Wachowski ("The Wachowski Brothers"), the protagonist, Neo, has the following conversation with a gifted child who can bend spoons with his mind:

    Child: Do not try and bend the spoon. That's impossible. Instead... only try to realize the truth.

    Neo: What truth?

    Child: There is no spoon.

    Neo: There is no spoon?

    Child: Then you'll see, that it is not the spoon that bends, it is only yourself.

    There is a difference between an abstraction and an abstract concept. "Money" is an abstraction in the same way that "container" encompasses both a bottle and a jar. Abstractions are artifacts of language that generally describe the world. In contrast, an abstract concept is the mental representation of an idea, such as liberty. Abstract concepts are literally ideas that exist in the human mind. Law, for example, expresses the concept of justice but an arbitrary law is not just merely because it is law. Unjust laws certainly exist. Declaring that a stone is a seafaring vessel does not imbue it with the ability to float on water, even if it can skip on the surface if it has enough spin. Such a declaration would be an illogical misuse of language masking an obvious absurdity. Nonetheless, the same obvious absurdity underlies fiat currencies. The erroneous conflation of "money", which is an abstraction, and "value", which is an abstract concept, is an example of sophistry; a trick of words played on unsophisticated minds. In fact, fiat currencies which exist today, not principally as notes or coins, but as electronic digits in computers, have no value.

    2. Coercion - Coercion characterizes fiat currencies because most people would not accept them unless forced to do so against their will. In the United States, for example, the replacement of gold-backed money in 1933 required the use of legal force (criminal penalties of $10,000, ten years in prison, or both) to compel U.S. citizens to accept irredeemable Federal Reserve Notes in place of gold certificates.

    3. Rent Seeking - Fiat currency schemes extract economic rents by forcing commerce to take place in the fiat currency system. Since human beings trade with one another to survive, the ability to freely exchange value for value is a natural right having the same moral foundation as the right to life, liberty and the pursuit of happiness. In a marketplace based on voluntary arrangements, there is no middleman extracting an economic rent in exchange for permission to participate in commerce.

    4. Immorality - Fiat currency schemes are immoral because the primary thing that makes them acceptable is coercion. Forcing people to accept artificial money that has no objective value against their will and self interest is an immoral act. Additionally, fiat currency schemes allow those who control the currency to redistribute wealth by altering the availability, quantity and distribution of the currency, which is little more than legalized theft.

    5. Central Planning - Since fiat currencies are based on coercive, rather than voluntary market relationships, a central authority is required that has the power to eliminate competing currencies, i.e., to establish a monopoly. Central economic planning is not only anti-democratic and the antithesis of a free market, but also inevitably fails. Human society is not blessed with the omniscient and infallible individuals required to make financial and economic decisions in place of the decisions of millions of individuals, households, entrepreneurs and businesses. The record of history, e.g., the USSR, is absolutely clear. Central planning of an economy produces a never ending stream of unintended consequences that lead to never ending interventions and that ultimately destroy economic activity.

    6. Price Instability - Fiat currencies, because they require relatively insignificant physical economic inputs, have no direct relationship to the survival requirements of human life. Since it is decided by central planners, the quantity of currency in a fiat currency scheme is always and inevitably incorrect. This causes price instability and artificially stimulates or depresses economic activity as a function of how much currency is produced and of how it is distributed. As a practical matter, price stability can never be achieved in a fiat currency scheme.

    7. Economic Volatility - Since fiat currencies are loosely coupled to physical economic activity in the objective world, they tend to become increasingly de-coupled and eventually "un-tethered" over time. An economy is the aggregate of millions of independent, individual human actors and there is no way that those responsible for a fiat currency can guess the correct quantity, although they can recognize incorrect quantities after the fact by their consequences, e.g., credit booms, recessions, large-scale price bubbles and economic collapses, such as the Great Depression, which began only sixteen years after the U.S. Federal Reserve was established. Of course, economies can be volatile for many reasons. The effect of fiat currencies, however, is to greatly magnify economic volatility.

    8. Currency Debasement - Voltaire famously wrote that "Paper money eventually returns to its intrinsic value-zero." Fiat currencies issued by governments or central banks represent intangible, subjective concepts of value like "full faith and credit" but the currency itself has no lasting value. Specifically, fiat currencies have a built-in tendency to decline in purchasing power over time as more currency is produced, particularly in fractional reserve and debt-based fiat currency schemes. In debt-based fiat currency schemes, the currency must be constantly inflated or a deflationary vicious circle (a collapse of debt) will set in. Those responsible for the currency predictably produce more than is necessary to maintain stable prices or to sustain stable economic activity, e.g., to diminish the risk of deflation, for political promises and favors, to wage war, etc. Price instability and economic volatility are the result. Currency debasement eventually undermines the basic economic structure of society. In The Economic Consequences of the Peace (1919), John Maynard Keynes wrote:

    "Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

    9. Wealth Redistribution - Arbitrarily increasing the quantity of currency in an economy distorts the distribution of money and, therefore, redistributes purchasing power, effectively stealing wealth from the majority, e.g., savers and wage workers, to serve the interests of a privileged minority. Redistribution of wealth, as opposed to production of wealth, causes a net loss of wealth to society. Government deficit spending, although it may be motivated by good intentions, changes the quantity of currency and results in currency debasement. Thus, government deficit spending operates as a dishonest, hidden tax on savers and wage workers. In his well known 1966 essay, Gold and Economic Freedom, former Federal Reserve Chairman Alan Greenspan, wrote:

    "Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."

    10. Concentration of Wealth - Over time, fiat currency schemes cause wealth and property to accrue to those who enjoy the extraordinary privilege of creating the currency, thus increasing the concentration of wealth in society. Extreme concentration of wealth is economically and ultimately politically destabilizing. An individual with a one million dollar income, for example, will not buy as many consumer products, cars or appliances as ten households with incomes of one hundred thousand dollars. In his remarks at a symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming (August 28, 1998), then Federal Reserve Chairman Alan Greenspan pointed out that:

    "Ultimately, we are interested in the question of relative standards of living and economic well-being. Thus, we need also to examine trends in the distribution of wealth, which, more fundamentally than earnings or income, represents a measure of the ability of households to consume…"

    11. Moral Hazard - Baron Acton observed in 1887 that "Power tends to corrupt, and absolute power corrupts absolutely." Since fiat currencies are created by monetary monopolies ex nihilo, e.g., through loan contracts, they provide a legal means of obtaining something for virtually nothing. As a result, those responsible for fiat currencies enjoy almost unlimited influence over economic and, therefore, political life. Sadly, human beings can never be good stewards of a currency system that provides one group in society with the means to obtain something for nothing. In fact, societies dominated by immoral fiat currency schemes eventually develop a something-for-nothing culture; a culture of entitlement in which, rather than producing wealth, everyone endeavors to live at the expense of everyone else.

    12. Corruption and Cronyism - As a consequence of moral hazard, fiat currencies tend to encourage cronyism and corruption and ultimately produce a culture of corruption. The Roman poet Juvenal wrote "Quis custodiet ipsos custodes?" ("Who will guard the guards themselves?"). History is replete with the horrors of absolute power and with monetary abuses resulting in economic collapse. Just as democide has been a leading cause of death in the last one hundred years, fiat currencies have been a leading cause of poverty. Fiat currency schemes redistribute and concentrate wealth, resulting in a tiny and exceedingly wealthy minority, but they do not produce wealth. Francisco d'Anconia, one of the central characters in the novel Atlas Shrugged by Ayn Rand, explains the following in his famous "money speech":

    "…Money is a tool of exchange, which can't exist unless there are goods produced and men able to produce them. Money is the material shape of the principle that men who wish to deal with one another must deal by trade and give value for value. Money is not the tool of the moochers, who claim your product by tears, or the looters who take it from you by force. Money is made possible only by the men who produce... Not an ocean of tears nor all the guns in the world can transform those pieces of paper in your wallet into bread you need to survive tomorrow… Whenever destroyers appear among men, they start by destroying money, for money is men's protection and the base of a moral existence. Destroyers seize gold and leave its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values… Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims…"

    13. Confidence Failure - Since the value of fiat currencies is essentially subjective, maintaining the perception of "value" in the face of economic decline and despite rising prices can be challenging. Fiat currencies are ultimately dependent on confidence and trust in those responsible for the currency. When fiat currencies are abused, confidence fails and they revert to their intrinsic value (zero). Thus, monetary policy in a fiat currency scheme focuses directly on maintaining confidence. Behavioral economics, for example, has become a primary tool of monetary and economic policy implementation. As a consequence, economic reporting by governments and central banks, and by the news media, does not reflect an objective viewpoint. Management of perception has the effect of influencing the subjective mental states of those who use a particular fiat currency so as to maintain the perception of "value". However, in the best case, perception management is one-sided "spin", and, in the worst case, it is propaganda that is contrary to fact and that simply prevents ordinary people from recognizing the steps they need to take in order to protect their financial interests against currency debasement and other risks associated with fiat currencies. Nonetheless, cognitive dissonance (a psychological tension between conflicting cognitions) can result in the sudden collapse of fiat currencies when economic conditions deteriorate sufficiently or when prices rise too quickly, i.e., the spell of value subjectivism is broken.

    14. Counterparty Risk - The "value" of fiat currencies requires trust in counterparties, but trust, like confidence, is an ephemeral, subjective mental state. In the objective world, agreements between governments and central banks and those who rely on their fiat currency schemes can be arbitrarily modified or broken. In fact, they are implicitly broken whenever a currency is debased. The promises of deposed governments and failed banks become instantly worthless.

    15. Transaction Settlement - A transaction in commodity money is a direct exchange of value for value. When a fiat currency transaction is performed, one party holds fiat currency and the other is the recipient of goods or services, but, like a retroactive breach of contract, the value of the fiat currency can be changed and may even become zero. Since there is always a residual third party to the transaction, i.e., a government or central bank, transactions remain unsettled.

    Fiat currency schemes are philosophically misguided, fundamentally immoral and ultimately unstable. Fiat currencies are premised on value subjectivism and erroneously conflate money and value. They represent a mere medium of exchange and rely on unstable subjective mental states such as confidence and trust. As a result, they are ultimately fragile and prone to fail suddenly when those using them wake from the dream of value subjectivism.

    Fiat currencies are immoral because they are forced on people against their will and contrary to their self interest and because they are a mechanism for legalized theft through currency debasement. Monetary monopolies extract economic rents by holding hostage the rights of individuals to freely exchange value for value. Central economic planning, redistribution of wealth and concentration of wealth undermine economic activity and encourage a culture of entitlement. Since fiat currency schemes are the source of exorbitant power, they engender extreme moral hazard, produce cronyism and corruption and foster a culture of corruption.

    Fiat currencies are subject to the decisions of central planners and are invariably debased producing price instability and increasing economic volatility. Governments and central banks that promulgate fiat currency schemes remain as perpetual counterparties to transactions posing a constant and unlimited risk. Resulting transactions are not fully settled because the value of the currency can be arbitrarily altered after the fact.

    History has shown that fiat currencies are always debased and that confidence in them eventually fails causing vast economic disruptions, losses of wealth, social and political chaos and even loss of life. The inevitable disasters caused by fiat currency schemes are usually followed by a return to commodity money but, once stability is achieved, a new fiat currency scheme is put in place repeating an unnecessary and destructive cycle that benefits few and harms many. Ironically, while commodity money is denigrated by those who benefit from fiat currency schemes, former Federal Reserve Chairman Alan Greenspan noted as recently as 1999 that "Gold still represents the ultimate form of payment in the world. Fiat money in extremis is accepted by nobody. Gold is always accepted."

    Defenders of fiat currency schemes claim that they promote stable prices and moderate economic volatility. In fact, the opposite is true. Fiat currencies not only destabilize economies but undermine the moral basis of society. Without exception, in every historical case when a currency has been de-coupled from the objective world, i.e., from commodity money, the result has been disaster. Fiat currency schemes guarantee unending monetary and resulting economic, social and political chaos marked by brief periods of calm between inevitable abuses, bubbles and collapses.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Mar 26 9:45 AM | Link | 13 Comments
  • The Unholy Alliance Of John Maynard Keynes

    Perhaps the greatest modern champion of central economic planning was the 20th century English economist John Maynard Keynes. Keynes, who was a political socialist and for a time a central banker, advocated the idea that the government should play a large, active role in the economy. Among the consequences of Keynes' economic theories, whether intended or unintended, is the fact that Western economies today are characterized by large, central governments, central banks and massive debts.

    According to Dr. Andrew Gelman, Professor of Statistics and Political Science at Columbia University, "the law of unintended consequences is what happens when a simple system tries to regulate a complex system. The political system is simple. It operates with limited information (rational ignorance), short time horizons, low feedback, and poor and misaligned incentives. Society, in contrast, is a complex, evolving, high-feedback, incentive-driven system. When a simple system tries to regulate a complex system you often get unintended consequences." Professor Gelman's statement seems equally apropos to central banking.

    Government policies based on Keynesian theories and the institution of central banking form a nexus of central economic planning. Control of the central planning process is a winner-take-all proposition for businesses. In the U.S., the result is an unholy alliance of the U.S. federal government, the Federal Reserve (along with the largest U.S. banks) and the largest U.S. corporations. The logical chain beginning with Keynes' fundamental idea that government, supported by a central bank, should play a large and active role in the economy sets the stage for a centrally planned economy and ultimately produces a corporate state.

    The U.S. economy is locked in a downward spiral of economic decline. By growing in size, and by engaging in ever larger economic interventions, the U.S. federal government became itself a material cause of the recession that began in 2007. By attempting to grow the economy through monetary expansion, i.e., consumer spending fueled by debt, the Federal Reserve destroyed savings and fueled a series of disastrous economic bubbles, culminating in the housing bubble. At the same time, the largest U.S. banks engaged in reckless lending and high-stakes gambling on hundreds of trillions in over the counter (OTC) derivatives. OTC derivatives, which amount to risky, largely un-backed wagers, were the root cause of the "too big to fail" doctrine that has virtually bankrupted Western governments since 2008. By seeking ever greater influence over Washington D.C. and by seeking to generate higher profits by cutting production in the U.S., the largest U.S. corporations undermined the U.S. market and economy. The U.S. federal government did virtually nothing to prevent the destructive developments because of the influence of the largest U.S. corporations.

    Following Keynesian economic theories, the policy response of the U.S. federal government to the recession that began in 2007 and of the financial crisis that began in 2008 was to expand the government further and at a more rapid pace. In other words, some of the root causes of the economic imbalances that lead to the recession and financial crisis (the relative size of the government and the resulting economic distortions) were compounded. As a consequence, the so-called "double dip recession" in the U.S. that began in the second half of 2011 will be longer and ultimately more severe than the economic downturn of 2007-2009.

    Baltic Dry Index (BDI)

    The Baltic Dry Index (BDI) indicates international shipping returning to crisis levels. Since the U.S. is the world's largest economy and has a large trade deficit, the BDI suggests that the U.S. is in a recession.

    Leviathan: The Size of the State

    Originally a sea monster referred to in the Bible and, in demonology, one of the seven princes of Hell, as well as its gatekeeper, the name Leviathan was adopted by the English philosopher Thomas Hobbes to refer to an artificial political order, i.e., to the institution of the state. Hobbes was concerned with the distinction between individual rights and the powers of sovereign governments and he elaborated the idea of the social contract. When a government taxes its citizens, it implicitly asserts the right of the government over the property rights of individuals and presupposes that the government can make better use of economic resources than households, individual entrepreneurs, businesses and private investors.

    In theory, the government's use of economic resources accomplishes goals that privately owned businesses cannot, such as national defense or emergency response services, i.e., things that, by their nature, are not economically productive or profitable but still necessary for society. In contrast, embarking upon idealistic projects such as "creating jobs" or "expanding home ownership" encroaches on the productive elements of the economy. However, governments are inefficient compared to privately owned businesses due to the absence of competition. Further, the record of history suggests an inability on the part of central planners to make superior economic decisions.

    Government encroachment on the private sector, like a self fulfilling prophecy, often magnifies the reasons why government intervention was originally believed to be necessary. For example, when the U.S. federal government became involved in education through federally guaranteed student loans, the result was that the cost of a college education rose towards the limit of what students could borrow and repay during their careers simply because the loans were guaranteed by the government. The guarantees produced more and riskier loans, larger loans and higher education costs.

    When the U.S. federal government promoted home ownership for minorities and the poor, mortgage loan guarantees resulted in higher home prices and contributed to the sub-prime lending debacle where banks originated loans to unqualified borrowers in order to sell them to government sponsored entities (GSEs), i.e., to Fannie Mae and Freddie Mac, and to investors as collateralized debt obligations (CDOs) and other mortgage backed securities (MBS).

    Banks were certainly to blame for knowingly making bad loans, which is fraud, but the conditions that made the problem possible existed substantially because of government intervention in the housing market, i.e., opening the door to fraud was an unintended consequence of policies intended to increase lending to unqualified, low income borrowers. Of course, the U.S. federal government did not compel lenders to commit fraud, thus accountability for the U.S. mortgage disaster is shared by the federal government, which interfered with the free market, pursued misguided policies and failed in terms of regulatory oversight and law enforcement, and by banks, which engaged in widespread mortgage related fraud.

    Governments redistribute wealth and manipulate economic activity through taxes, subsidies, guarantees, regulations and so forth, but they do not produce new wealth. Government spending may be for good purposes, or at least stem from good intentions, but it unavoidably favors businesses with close ties to the government over those that are taxed but that do not benefit. Despite the theoretically higher moral purposes of lofty government undertakings, government programs that overlap the private sector divert economic resources to businesses that have the favor of politicians minus the cost of government, thus producing economic distortions and a net loss of wealth for society.

    The Rahn curve is an economic theory proposing that there is an optimal level of government spending, 15% to 25% of gross domestic product (GDP), to maximize economic growth.

    Rahn Curve

    As the government grows larger, economic growth is curtailed and, eventually, the economy contracts, crushed under the burden of government.


    As the government grows in size relative to the economy, not only is economic growth compromised, but the potential for, and the cost of, government waste, fraud and abuse increases.

    How the Government Destroys Jobs

    While politicians extol the theoretical benefits of ever more government control of the economy, e.g., through increased regulation, from the standpoint of individual entrepreneurs, businesses and private investors, the government is a nuisance, an impediment to wealth creation, and the source of countless costs and risks. The larger the government becomes relative to the size of the economy, the more it tends to discourage economic activity. Although roughly 70% of U.S. jobs are created by small businesses, ranging from family owned businesses to high technology startups, the burden of government falls disproportionately on them because they have fewer resources with which to administer and to demonstrate compliance with government regulations.

    When large companies are audited or investigated by any of several government agencies, their accounting, legal and compliance departments are well equipped to deal with such matters. However, when a small company faces the same hurdles or seeks government permits, licenses or certifications, its operations are directly impacted and the associated accounting, legal and regulatory compliance costs can cause the business to lose money or to fail. In the event of an audit or investigation, small business owners in the U.S. generally seek to comply immediately and often pay fines or penalties without contest in order to end the government's interference. While large companies can afford to dispute the government, small businesses face the equivalent of extortion.

    As a practical matter, small businesses in the U.S. are permitted to operate at the sole discretion of government bureaucrats that can effectively shut down small businesses without any evidence of wrongdoing. Setting aside the fact that small business owners live in constant and well justified fear of their own government, the result is a stifling of economic activity and a net loss of jobs. For example, traditional small businesses in the U.S., i.e., sole proprietorships, increasingly avoid hiring employees.

    Free market competition and the inherent uncertainty of economic conditions provide ample risk for startup businesses. A disproportionately large government relative to the size of the economy damages economic activity and discourages investment in new businesses. The aggregate overhead of government regulations and regulatory compliance, along with taxes and potential penalties, e.g., the 2010 Patient Protection and Affordable Care Act ("Obamacare"), increases business costs, amplifies business risks and further increases the burden of regulatory compliance. The result of systematically increasing the costs and risks of doing business-in lock step with the size of government-is to reduce the rate of business formation and to encourage investors to look elsewhere to find returns.

    Total Government Spending (Federal, State and Local) Percent of U.S. GDP

    If the U.S. government, currently almost 45% of GDP, desired to create jobs, the correct policy would be to greatly reduce the countless regulations, taxes and fees that encumber small businesses. The path to job creation is for the government to reduce job destruction. Since no political will to reduce the size of the government exists, however, continued shrinking real GDP and permanent workforce reduction can be expected.

    Money Out of Thin Air

    Central banks, such as the Federal Reserve, are examples of central economic planning, i.e., they control the money supply and exercise centralized control over the value and cost of money through interest rates, bank reserve ratios, monetary inflation and by other means. In contrast to the government's central planning for the putative public good, the Federal Reserve engages in central planning for the benefit of banks. Like the U.S. federal government, the Federal Reserve, through monetary mechanisms, distorts spending and investment patterns, redistributes wealth and preempts the financial and economic decisions of households, individual entrepreneurs, businesses and private investors.

    When a central bank increases the money supply beyond the level necessary to support a sustainable economy or population growth, it destroys the value of savings and wages by diluting the value of money and causing prices to rise. Wall Street embraces the Federal Reserve because easy monetary policies provide an inexpensive way to finance operations and to expand, but there is a cost. Inflationary monetary policies favor speculators over savers and debt over genuine capital formation.

    Banks do not create wealth. The structure of the financial system, where debt-based money is created ex nihilo, virtually guarantees banks a piece of the action whenever wealth is created. When debt service (principal and interest payments) is attached to the income streams of consumers and businesses, excess production is diverted from capital formation into the coffers of banks. The Federal Reserve, therefore, is at the core of a system where, over time, wealth accrues to banks while capital formation is reduced, ironically increasing the need to borrow. The majority of entrepreneurs and businesses have little choice but to borrow and, even if they are successful, the economy as a whole may still suffer due to increased debt levels relative to GDP.

    Keynesians embrace the Federal Reserve's un-backed, fiat money because it permits the government to borrow and spend freely based on the theory that stimulating the economy through deficit spending produces economic growth at a faster pace than debt accumulates. However, as a function of debt service, the number of dollars that must be borrowed and spent to generate each new dollar of GDP becomes larger as the total amount of debt grows.

    Marginal Utility of Debt (Nathan A. Martin)

    The result is debt saturation where further debt funded increases in GDP are impossible and where, therefore, existing government debt cannot be retired, i.e., the result of Keynes' theory, taken to an extreme, is government insolvency and sovereign default. Default, of course, can take the form of monetary inflation in order to debase the currency and reduce the real value of debt, e.g., the Federal Reserve's monetary easing and continued accommodative monetary policy.

    Keynes and the Corporate State

    The U.S. economy is anything but a free market today. In fact, the U.S. government increasingly resembles an oligarchy in which the oligarchs are large corporations, i.e., a "corporatocracy". Thus, the illegitimate offspring of the grand government envisaged by Keynes and the institution of central banking is a corporate state.

    Without a large government, businesses have little incentive to influence it, but with the government (local, state and federal) representing nearly half of the U.S. economy, influencing the government is a mission-critical objective for every company. The size of government implied by Keynesian economics provides motive and opportunity but only the largest corporations have the means to succeed.



    Citigroup Inc


    Citigroup Inc


    Columbia University


    Bain & Co


    General Electric


    Bain Capital


    Goldman Sachs


    Goldman Sachs


    Google Inc


    Bank of America


    Harvard University




    IBM Corp


    Blackstone Group


    JPMorgan Chase & Co


    JPMorgan Chase & Co


    Latham & Watkins


    Credit Suisse Group


    Microsoft Corp


    EMC Corp


    Morgan Stanley


    Morgan Stanley


    National Amusements Inc


    HIG Capital


    Sidley Austin LLP


    Kirkland & Ellis


    Skadden, Arps et al


    Marriott International


    Stanford University


    Price Waterhouse Coopers


    Time Warner


    Sullivan & Cromwell


    UBS AG


    UBS AG


    University of California


    The Villages


    US Government


    Vivint Inc


    WilmerHale LLP


    Wells Fargo


    Total Primary Dealers:


    Total Primary


    Political campaign contributions indicating U.S. Federal Reserve Primary Dealers (Source:

    The goals of businesses seeking to influence the government include winning government business, mandating consumption of products and services (from child car seats to health insurance), avoiding taxes, guaranteeing profits, creating regulatory loopholes, protecting markets, eliminating competition, socializing losses and so forth.

    The influence of Wall Street over Washington D.C. through political campaign contributions, corporate lobbyists and revolving doors (where the same individuals alternate between closely linked private sector jobs and government posts) is almost absolute. Lobbyists are intimately involved in writing legislation that is often rubberstamped by the U.S. Congress, i.e., passed without reading or meaningful debate. The largest corporations support political candidates through campaign contributions and by funding political action committees that, among other things, use corporate public relations tools for political purposes (propaganda). Key government posts are consistently held by individuals with clear conflicts of interest and the existence of such conflicts is routinely ignored.

    The current reality of the United States is that the largest corporations have hijacked the Keynesian central planning powers of the federal government and have used these powers to encourage ever larger and more direct interventions in the economy for their own benefit, as well as laws and regulations that serve as a barrier to free market competition. U.S. regulators, such as the Securities and Exchange Commission (SEC), Commodities and Futures Trading Commission (CFTC) and the Food and Drug Administration (FDA) appear to have been captured by the industries they are intended to regulate. Government regulators selectively enforce regulations, often against small businesses and growing companies, such as organic dairy farmers, protecting the interests of the largest corporations from small businesses, free market competition and consumer choice.

    The largest U.S. corporations (including oil companies like ExxonMobil and Chevron; drug companies like Johnson & Johnson, Pfizer and GlaxoSmithKline; agribusiness companies like Archer Daniels Midland, which are heavily subsidized by the U.S. federal government; agricultural biotechnology companies like Monsanto; military contractors like Lockheed Martin, Northrop Grumman, Boeing, Raytheon and General Dynamics; and banks like Bank of America, J. P. Morgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) have not only been the beneficiaries of government expansion, deficit spending and central economic planning, but, considering political campaign funding practices, have become the de facto oligarchs of America.

    A Downward Spiral

    The decline of the U.S. economy is the logical outcome of Keynesian economics, which enshrines central economic planning and embraces central banking. The unholy alliance of the federal government, the Federal Reserve and Wall Street has all but eliminated capitalism and has transformed the United States from a burgeoning free market economy into a failing corporate state.

    The U.S. federal government, the Federal Reserve and Wall Street each played a role in the progression from central economic planning and central banking to a corporate state. Politicians used Keynesian economics to justify big government, a welfare state and budget deficits. The Federal Reserve sought to grow the economy through monetary expansion, focusing on consumption but ignoring debt levels and inadvertently encouraging financial speculation. At the same time, Wall Street sought higher profits both by eliminating production (and jobs) in the U.S. and by sparing no expense to influence the government. The resulting corporate state undermined capitalism and the free market in the United States and produced a downward spiral of economic decline from which there is no escape without fundamental reforms.

    Feb 10 4:31 AM | Link | 13 Comments
  • Ron Hera Live At The Vancouver Resource Investment Conference (Financial Survival Network)
    Live at the Vancouver resource investment Conference

    Disclosure: I am long UEC.

    Jan 25 6:23 PM | Link | Comment!
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