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Cash for clunkers seems to be all the rage this week.  Hundreds of news stories and blog posts are telling everyone how successful it is, how it RAN OUT OF MONEY IN ONE WEEK when it was supposed to last until November, and how this will boost the economy.

Bullshit.

Here’s an excerpt from the Daily Reckoning.com explaining why it’s bullshit.

And as Bill has been pointing out, this is just another example of the government promoting the idea that the future doesn’t matter – just spend for today. He wrote in Friday’s essay: “Instead of letting the consumer buy a new car when he is ready, the feds give them money to buy now. So, he buys in 2009 and not in 2010. What good is accomplished? It is as if they didn’t expect 2010 to ever arrive…”

The Wall Street Journal backs us up here: “The subsidy won’t add to net national wealth, since it merely transfers money to one taxpayer’s pocket from someone else’s, and merely pays that taxpayer to destroy a perfectly serviceable asset in return for something he might have bought anyway. By this logic, everyone should burn the sofa and dining room set and refurnish the homestead every couple of years.”

This is what’s known as the “broken window fallacy” that I posted about in February 2008.  It’s a classic story and you can read all about it on the link, but here’s the main part as told by Henry Hazlitt’s classic “Economics in One Lesson” (Which I urge you to read.) It’s copied from my earlier post -which was copied from Lew Rockwell’s post on Mises.org.

A kid throws a rock at a window and breaks it, and everyone standing around regrets the unfortunate state of affairs. But then up walks a man who purports to be wise and all knowing. He points out that this is not a bad thing after all. The man fixing the window will get money for doing so. This will then be spent on a new suit, and the tailor too will get money. The tailor will spend money on other items, and the circle of rising prosperity will expand without end.

What’s wrong with this scenario? As Bastiat put it, “It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way which this accident has prevented.”

You can see the absurdity of the position of the wise commentator when you take it to absurd extremes. If the broken window really produces wealth, why not break all windows up and down the whole city block? Indeed, why not break doors and walls? Why not tear down all houses so that they can be rebuilt? Why not bomb whole cities so construction firms can get busy rebuilding?

It is not a good thing to destroy wealth. Bastiat puts it this way: “Society loses the value of things which are uselessly destroyed.”

It sounds like an unexceptional claim. But herein rests the core case against everything the government does. Perhaps, then, we can see why the allegory is not better known. If we took it seriously, we would dismantle the whole apparatus of American economic intervention.

If you are with me to this point, perhaps you have a hard time believing that anyone really believes that wealth destruction is actually a good thing. Let me try to show that the fallacy is as pervasive as ever.

After every natural disaster, we at the Mises Institute start what we call the “Broken Window Watch.”

After hurricane Katrina, the Labor Secretary said, “[W]hat will happen — and I have seen this in previous catastrophes and hurricanes — there is a bright spot in that new jobs do get created.”

And The Economist said, “While big hurricanes like Katrina destroy wealth, they often have a net positive effect on GDP growth, as the temporary downturn immediately after the storm is more than made up for by the burst of economic activity that takes place when the rebuilding begins.”

And the New York Times said, “Economists point out that although Katrina has destroyed a lot of accumulated wealth, it ultimately will probably have a positive effect on growth data over the next few months as resources are channeled into rebuilding.”

That’s what we’re doing with Cash for Clunkers.  We’re diverting capital from where it would naturally go into a program to destroy valuable assets and replace them.

Why not apply the concept elsewhere? How about cash for houses? Cash for liquor? Cash for newspapers? Cash for trips to Europe?

Yes, there will be a temporary boost to the economy, but it comes at the expense of next year, and the next year, and the next year.  WHO IS PAYING FOR IT?  We all are, and all we’re actually doing is postponing the day of reckoning.  You cannot borrow your way out of debt, and that’s what this program is trying to do.

gk

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Get used to this headline.  U.S. consumers fall behind on loans at record pace

According to the story Soaring U.S. unemployment and a shrinking economy drove delinquencies on credit card debt and home equity loans to all-time highs in the first quarter as a record number of cash-strapped consumers fell behind on their bills.

Delinquencies on the value of all card debt soared to a record 6.60 percent from 5.52 percent in the fourth quarter as more cardholders relied on plastic to meet day-to-day expenses, the American Bankers Association said.

Late payments on home equity loans rose to 3.52 percent from 3.03 percent, and on home equity lines of credit climbed to 1.89 percent from 1.46 percent.

The wasted trillions in the various stimulus and bailout packages are simply dragging this out in my opinion.  And today there’s talk that a second stimulus package is needed – are they freaking nuts?  If BoA and Citi and AIG and GM and Chrysler and (insert bailout recipient here) had been allowed to fail, other – solid – companies would be snapping up their assets at fire sale prices today.  And investors in those badly run companies would lose their money.  That’s the way it’s supposed to work.

Instead we’re taking money from smart investors and companies (via taxes) and propping up the bad ones.  And somehow most people – and economists – think this is a good idea.

News flash – most people and economists are simply partisan hacks, saying whatever they think will advance their political agenda.  And they’re wrong.

gk

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In the NY Times today, Paul Krugman does a good job of explaining why Ireland is in deep trouble.  Unfortunately, Mr. Krugman draws the wrong conclusions from the Irish experience – he thinks we need to nationalize banks, when the lesson to learn is to not bailout private banks.

Mr. Krugman says Last September Ireland moved to shore up confidence in its banks by offering a government guarantee on their liabilities — thereby putting taxpayers on the hook for potential losses of more than twice the country’s G.D.P., equivalent to $30 trillion for the United States.

The combination of deficits and exposure to bank losses raised doubts about Ireland’s long-run solvency, reflected in a rising risk premium on Irish debt and warnings about possible downgrades from ratings agencies.

Hence the harsh new policies. Earlier this month the Irish government simultaneously announced a plan to purchase many of the banks’ bad assets — putting taxpayers even further on the hook — while raising taxes and cutting spending, to reassure lenders.

Sound familar?  To me it sounds like the multiple rounds of bailouts that we’re doing in the US.  The sad part is that if the US and Irish governments would have simply let the bad banks fail, we’d be on our way out of this mess by now.  Instead, we’re sinking deeper and deeper into the private sector problems.

For now, the United States isn’t confined by an Irish-type fiscal straitjacket: the financial markets still consider U.S. government debt safer than anything else.

But we can’t assume that this will always be true. Unfortunately, we didn’t save for a rainy day: thanks to tax cuts and the war in Iraq, America came out of the “Bush boom” with a higher ratio of government debt to G.D.P. than it had going in. And if we push that ratio another 30 or 40 points higher — not out of the question if economic policy is mishandled over the next few years — we might start facing our own problems with the bond market.

Duh.  That’s what many of us have been saying for over a year.  The Chinese are eventually going to get tired of loaning us money to buy more stuff from them.  The US government debt will be paid eventually – but with inflated dollars.

And it all could’ve been avoided if we wouldn’t have started this whole bailout process.  Let the banks that took high risks go broke.  Let the companies and individuals who invested with them go broke.  The good banks (yes, there are some) would have bought those assets at a fire sale price and turned them into a profit center.  But now we’re all on the hook for the private sector losses.

Let’s call it “Going Irish”.  We can also call it dumb.

gk

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Today’s Daily Reckoning had a good piece (as usual) from Bill Bonner.  He had an imaginary conversation with Tim Geithner about how to handle the debt bubble.  I wish I would have thought of that, but I’m not known for being original.    Here’s part of the conversation where Tim calls up Bill and asks for Bill’s advice:

“We need to recognize, first, that this is not just a regular recession. So you can forget the usual recession remedies – a few points off the Fed funds rate…a little counter-cyclical fiscal spending. This is much more serious.

“What we have here is a depression. It’s a depression because it requires a fundamental restructuring of the international financial model. You know how it worked during the Bubble Epoch; Asians made things…Americans bought them. Asians made money; Americans spent it. Asians saved; Americans borrowed. And now the Asians have money; and Americans have debts. Not really very complicated, is it?

“Well, these programs of trying to bailout businesses…and the banks…and the economy…you can see how they are all a waste of money. All of these efforts are trying to revive the old model. They’re trying to free up credit so that Americans can buy more! Now, we don’t really have to explain why that won’t work, do we? More debt won’t do Americans any good; more IOUs from Americans won’t do China any good.

“Instead, the model has to be taken apart and reconstructed. China needs to sell more to people with money – its own people, mainly. Americans need to pay down their debts before they can take up serious consumption again.”

“But wait, Bill,” Mr. Geithner interrupted. “Won’t that cause serious disruptions? When Americans save, in order to reduce their debts, they take away the single primary source of demand for the world economy. If they don’t begin buying soon, businesses all over the world will go broke. That’s why I’ve spent so much money trying to bail out the banks. Americans have no money. So the only way they can spend is if the banks provide credit. So, we have to save the banks first…then they’ll begin lending…and then the economy can begin growing again.”

“Uh…no. That’s not how it works. Even if you make all the banks solvent, whom are they going to lend to? Who’s going to borrow? Americans have too much debt already. Right now, if they get any money, they’re holding onto it…and using it to pay down their debts. They’re not going to start spending just because a bank offers them a loan.

Good stuff!  One thing that Bill left out is the power of savings.  Americans don’t have any savings to speak of, that’s why our government needs to borrow from China and Japan.  When the government ran up huge debts during the Depression and WWII, American citizens were the people who provided that money.  They provided it from savings, and we don’t have the money to do that today.

So when we purchase something made in China (or Germany) we have to effectively borrow that money in order to buy it.  That’s what a trade deficit does over time.  Wealth is extracted from the country with the deficit, and it flows into the country with the surplus.  It’s not rocket science.

Note – I am NOT suggesting that we pass protectionist measures to combat the trade deficit.  The fix to that is to simply live within our means and only purchase what we can afford.  That means paying as you go.  No new debt.  Pay down the old debt and save actual money.  When the debt is gone, people can once again buy more things – as long as they pay for it.

Robert Heinlein wasn’t the first to say it, but he said TANSTAAFL in a way that I remember it.  “There Ain’t No Such Thing As A Free Lunch”.  He’s right, and we’re finding that out in the US now.

I’m currently re-reading volume one of The Story of Civilization. “Our Oriental Heritage” and it’s amazing how many times throughout history that government (and people) think they can rewrite the laws of nature.  Supply and demand is one of those laws, and no amount of wishful thinking and no amount of new regulations is going to change it.  The countries that have tried it in the past are gone.

I fear we’re following rapidly down that well trodden path.  I wish that weren’t the case, but idiots keep voting for bread and circuses.  Unless that changes, we’re going downhill.

gk

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I was commenting on a post on KnoxViews.com tonight, and it occurred to me to make a simplified chart of the depression era showing how government spending does not equate to economic stimulus for the economy.

Here’s part of my comment and the new chart.

A popular misconception is that Hoover cut spending and Franklin Roosevelt increased it.  The facts are that Hoover increased federal spending from $2.9 billion in 1928 to $4.6 billion in 1932. That’s a 63% increase in 4 years – yet the unemployment rate rose from 3.3% in 1929 to 23.6% in 1932.

FDR’s New Deal then raised spending from $4.6 billion in 1932 to $8.2 billion in 1936 – a 76% increase which is not that much different than the increase under Hoover.

Despite these massive increases, which basically tripled total federal spending from $3.3 billion in 1930 to $9.4 billion in 1940, the unemployment rate was still 14.6% on the eve of WWII.

I made a table to see if there’s any correlation between spending and employment, and it’s pretty plain that there isn’t.

Federal spending data is from the GPO and unemployment stats are from the BLS

Can you see any link between changes in government spending and unemployment? I don’t either – and that means Keynesian theory is bogus.

I’ll put it this way – if huge increases in government spending stimulate the economy, why aren’t we booming right now after Bush’s doubling of the national debt in just 8 years?

Bush was the biggest spender in US history, adding as much debt in 8 years as all the other presidents combined did in 212 years. Surely that should be enough to stimulate the economy if Keynesian economics actually worked.

Why didn’t it?

gk

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It’s easy to find dumb articles on the economy these days, but this one by Robert H. Frank in the NY Times is quite possibly the dumbest collection of nonsense that I’ve read in quite some time.

Mr. Frank is an economist at Cornell – evidently Cornell has loose requirements on who can claim that title – and he has his facts wrong.

For example, Mr. Frank states:  In 1929, President Herbert Hoover thought that the best response to a collapsing economy was to balance the federal budget. With incomes and tax receipts falling sharply, that meant cutting federal spending. But as almost all economists now recognize, President Hoover was profoundly mistaken.

Everyone has heard some variation of that basic statement over the years. The problem is that it’s simply not true.  That’s a polite way of saying that Mr. Frank is lying.

Hoover did not cut federal spending – Hoover increased federal spending.  Here is a chart of federal spending from 1928 -1940.   (Source data is the GPO here – link opens Excel spreadsheet.)

As anyone can plainly see, federal spending actually increased every single year from 1929 through 1932 – the four years of the Hoover presidency.  Yet Mr. Frank states that Hoover cut spending. The fact is that federal spending increased from $2.9 billion in 1928 (the year before Hoover took office) to $4.6 billion in 1932.

That’s a 63% increase in federal spending in just 4 years!  How can Mr. Frank be that ignorant of history and still write authoritatively about economic history?

And this data also lets a little air out of the myth that FDR’s spending brought us out of the depression.  It’s true that FDR increased spending, but when you actually look at the numbers, he increased spending in his first term from $4.6 billion in 1932 to $8.2 billion in 1936 – a 76% increase.  That’s not dramatically larger than Hoover’s 63% increase.  And during his next 4 years, FDR increased spending from $8.2 billion in 1936 to $9.4 billion in 1940 – a meager 15% increase in 4 years.

I have no doubt that “almost all” Keynesian economists will continue to propagate the lies about the Great Depression, Hoover, and FDR, but you and I know that they’re lying.

With that common fallacy exposed, we now turn back to Mr. Frank.

Mr. Frank states When a downturn throws people out of work, they spend less, causing still others to be thrown out of work, and so on, in a downward spiral. Failure to use short-run deficits to stimulate spending amplifies that spiral, causing further declines in tax receipts and even bigger deficits. That this path makes no sense is a settled issue.

It sounds good, but his statement that this is “a settled issue” is false.  It’s false because of his implicit premise that government deficit spending creates productive employment.  I have no doubt that government spending can employ otherwise idle people, but this is not a net gain for the economy.  The government simply transfers wealth from one segment of society to another – it doesn’t create wealth.  Mr. Frank’s major flaw is in his unstated assumption that the government can allocate resources better than individuals.

Take the current auto bailout as an example.  What would have happened if the government didn’t bail out GM?  GM would have declared bankruptcy.  People who had invested in GM stocks and bonds would be SOL – and that’s the way it should be.  When you invest your money, you (whether you realize it or not) are incorporating risk in choosing where to invest.  You may choose to invest in something risky like a dot com or alternative energy start-up, because you balance the risk of them going bankrupt against the possibility of huge returns.

It’s your money – invest it however you want.  But don’t bitch and moan and beg for a bailout when the money you invested disappears because the company goes broke and leaves you with a sock puppet.

In the case of a GM bankruptcy, valuable assets such as factories and parts would be auctioned off to the highest bidder.  Assets with no value are wiped out and those who invested in them would lose money.  Some would be unable to survive and would themselves go broke.

In other words, the “bad” (non-profitable) assets of GM would disappear.  But the “good” (profitable) assets would be sold to private investors (or companies) who would put them to productive use.  Good companies survive and thrive off of the mistakes of their competitors.  Just imagine how many productive  jobs Honda, Toyota, or Nissan could provide using GM facilities and patents.

Mr. Frank also shows his ignorance when he states Once the downturn ends, there should be no need to incur additional debt. Indeed, there are many ways to pay down debt without requiring painful sacrifices. A $2 tax on each gallon of gasoline, for example, would generate more than $100 billion in additional revenue a year.

Politicians and economists have been saying that they’ll balance the budget and start paying down the debt for as long as I can remember – and I’m 47.  It has not happened in my lifetime.  Not once.

The last time the US reduced the national debt was 1957.  (Source is the US Treasury.) When do you suggest we start making payments on the principal Mr. Frank?

And a $2 per gallon tax on gasoline would be an additional $283 billion in taxes at the current rate of consumption of 141.9 billion gallons per year. (Source is US Energy Information Administration.)

Mr. Frank also says It’s also useful to put the nation’s debt burden into perspective. Over the last eight years, Bush administration deficits raised the national debt by almost $5 trillion. Given the current crisis, it’s easy to imagine a similar increase during the next four years. At recent interest rates, servicing $10 trillion of extra debt costs about $400 billion annually — a big amount, to be sure, but less than 3 percent of the economy’s full-employment output. We’ll still be the richest country on the planet even after paying all that interest.

Bullshit.  That’s like saying you got the highest score of those who failed.  I’m not a fan of Bush – since I consider Bush the worst President in my lifetime, that’s the understatement of the year – so I don’t like it when Obama imitates Bush.  Liberal or Conservative – big government is big government.

The 3% figure Mr. Frank gives is technically accurate – when you take the $400 billion figure he uses – but why does he use that number?  The bottom line is the one that matters.

The national debt is currently over $11 trillion (source US Treasury).  The US GDP for 2008 was $14.2 trillion (source BEA).

Our current national debt is 77% of GDP.  If Obama adds $5 trillion more in the next 4 years (as seems likely) our debt will be over 100% of GDP.  And if Mr. Frank thinks that’s sustainable, I’ve got some great beach-front property to sell him.

I could go on and on about the errors in Mr. Frank’s article – such as his mistaken assumptions about the wealthy – but you can read it yourself.  I’m amazed that the NY Times editors allowed an article this full of errors to be published.

gk

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I wrote about this last month, and it’s been in the news again this past week, because there’s once again discussion to “relax” the mark to market accounting rule known as FAS 157.  I expect that the discussion in Washington is what’s behind the rally in financial stocks this past week.  It doesn’t really matter, as the financials are no where near the end of their crash.

They will be going lower no matter what accounting mechanism they use, because eventually they need to fess up and pay their debts – unless we keep giving them billions.  In that case, we’ll all go down with them.

I read an article on CNN.com a few minutes ago titled “Quit whining about accounting!“  which reminded me of the discussion, and the story has some good quotes.

Sure, mark to market may be prolonging the problems for big banks such as Citigroup and Bank of America, because as long as these companies are stuck with soured mortgage-related assets on their books, they will need to keep taking huge writedowns that cause them to report massive losses.

“The problem with the mark-to-market rule is that it requires you to value assets under the presumption that you are going to liquidate everything today in a fire sale. Most financial institutions are not liquidating,” said Richard Ebeling, senior research fellow for the American Institute for Economic Research and a professor of economics at Trinity College in Hartford.

He has a good point. But changing the rules to make these assets look more attractive than they currently are – because they might one day be worth something again if you click your heels three times and chant “There’s no place like a foreclosed home” over and over – is not the solution to the banking crisis.

I agree.  Changing the valuation so you can just make something up for the value of an asset is dumb.  That’s Enron accounting.

“Those who oppose mark-to-market rules say it exacerbates the downside because it is giving a false signal about the economic value of securities. But the truth is that’s not the case,” said Patrick Finnegan, director of the financial reporting policy group for the CFA Institute, a nonprofit organization that administers the Chartered Financial Analyst exam for investment professionals.

Finnegan argues that current market values are the only way to reflect assets on a bank’s balance sheet, since anything else would be mere guesswork.

In my previous post, I referred to this “guesswork” as Mark to Myth, because that’s what it is.  It’s saying “I paid $1 million for this 2 years ago, and I say it’s still worth $1 million – It doesn’t matter if my neighbor just sold his $1 million home for $500k, Mine is still worth $1 million.”  That’s ignoring reality, and that’s dumb.

“Companies are fighting for their survival and they want to use accounting to obfuscate their true financial position. Who’s to say their view is more sound or fundamentally reliable than what the market thinks?” said Finnegan.

The call for changing accounting standards, much like the blame game that’s being played with short sellers, shifts the focus from the real problem. Banks aren’t struggling because the rules are stacked against them; banks are struggling because they made bad decisions throughout the bubble years.

A moratorium on mark-to-market accounting would only reward bankers for their reckless behavior of the past.

What’s more, it only would serve to delay what obviously must be done: banks need to get rid of the assets soon — whatever the short-term cost — instead of sitting on them indefinitely.

The really sad thing is that someday the value of these assets may actually rise, and if the banks change the accounting rules, they won’t get to claim the increased valuation because they’ll be using a different model.  These are the same short-sighted idiots who got us into this mess, and right now they’re looking for any rope at all to grab – even if it has the shape of a noose.

gk

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It’s a cool rainy day in Knoxville, so I’ve been catching up on my reading.  Yesterday’s Daily Reckoning had a great article titled “How to Save the World” and I want to post a bit of it here with some comments, because it sums up the cause – and the solution – to the economic train wreck we’re all watching.

I like this line: It is not often that we are called upon to advise the world’s government. In fact, we can’t remember a single time. But we can’t resist a lost cause. So, we offer the Daily Reckoning Plan to Save the World, or DRPtStW for short.

Humor like that always make Bill Bonner’s articles a great read.

Just read the Financial Times. This week it has a windy series on the “Future of Capitalism,” inviting readers to imagine how the decaying old creed might be reformed. Alas, for capitalism, it’s out of the frying pan, into the toilet. Larry Summers, Obama’s number one financial advisor, voiced the prevailing view: “This notion that the economy is self-stabilizing is usually right, but it is wrong a few times a century. And this is one of those times…there’s a need for extraordinary public action at those times.”

Larry Summers is wrong.  The economy is self stabilizing – if only government would get the hell out of the way and let the stabilization happen.

The gist of his program can be expressed in another wistful absurdity: The consumer economy died because of too much spending; now we will revive it by spending more. “Give me your cunning bankers, your hopeless CEOs, your huddled masses of chiselers, spendthrifts and boondogglers,” says the Obama team, “and we’ll give them other peoples’ money!”

This is Keynesian economic theory in action.  It’s just as wrong now as it was in the 1930’s, but the government feels it has to do “something” even it it doesn’t makes sense.

Note – government spending in times of economic slowdown can help alleviate the suffering, but only the government has money to spend.  We’re $11 trillion in debt. Too much debt caused the problem – does anyone really think borrowing more is going to fix it?

“There’s no place that should be reducing its contribution to global demand right now,” explained Summers. “The world needs more demand.” But it was demand that the world recently had too much of. English speakers took on too much debt to create it…and built too many houses and too many shopping malls to satiate it. And despite the ready cash offered by Bush, Bernanke, and Paulson, demand has sunk, because the real problem is not an absence of spending, but a surfeit of debt. In America, for example, total debt went from 150% of GDP in the ’80s to 350% in 2007. The financial markets panicked when it became clear that debtors didn’t have the cash flow to pay off the debt…and that an entire world economy had been fizzed up to supply products to people who couldn’t afford them. Investors have been discounting debt-soaked assets ever since.

The fix is obvious – reduce the level of debt. About $20 trillion worth of debt, in the United States alone, needs to disappear. Then, consumers can go back to doing what they do best – consuming. But how do you reduce the debt level? Former Treasury Secretary Andrew Mellon had the right idea in 1929: ‘Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate…It will purge the rottenness out of the system…Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.”

It really is that simple.  That’s capitalism.  People who make bad decisions go broke, and people who make good decisions get wealthy.  Government interference only gums up the process and keeps it from working.  Which is about the only thing governments do well.

What’s the cure for a depression? It’s a depression. Let willing buyers and sellers mark debt down to what it is really worth. Mellon’s plan was not followed by the Hoover or Roosevelt administrations. Instead, they introduced elaborate bailouts, stimulus programs, and boondoggles. That is why the depression is known as the Great Depression, rather than the So-so Depression. By the end of the 30s, the US economy was almost exactly the same size it had been at the beginning. Likewise, in Japan, holding off liquidation brought a “lost decade” in the ’90s. Bush followed in Hoover’s footsteps. And now, the Obama administration follows in Roosevelt’s and Miyazawa’s.

Here’s our advice: forget it. Let the depression do its work. Let the bad times roll!

Great article Mr. Bonner.

gk

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I mentioned this a couple of times before, here, and here, but it’s escalated a bit this week.  Bloomberg (and a bunch of other places) has a story on it today.  According to Bloomberg, The US is pretty much reduced to pleading with China to keep us afloat.

“There’s no safer investment in the world than in the United States,” White House Press Secretary Robert Gibbs said yesterday at a briefing in Washington.

Gibbs was responding to comments from Wen that China, the U.S. government’s largest creditor, is “worried” about its holdings of Treasuries and wants assurances that the investment is safe. “I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets,” Wen said at a press briefing in Beijing.

“Of course we are concerned about the safety of our assets,” Wen said after an annual meeting of the legislature. “To be honest, I am a little bit worried.”

China is right to be worried.  And Obama is right to be worried that China won’t keep giving us their money.  The US will have to resort to printing even more money if China won’t loan it to us.

President Barack Obama is relying on China to sustain buying of Treasuries amid record amounts of U.S. debt sales to fund a $787 billion stimulus package and a deficit this year forecast to reach $1.5 trillion. Investors abroad own almost half of all U.S. debt outstanding, and China last year overtook Japan as the biggest foreign buyer.

The US seems to be counting on this: “China won’t sell the U.S. debt now as that will only drive down Treasury prices, hurting not only the U.S. but also the value of its own investments,” said Shen Jianguang, a Hong Kong-based economist at China International Capital Corp.

But look at it from the Chinese point of view – why should they throw good money after bad?  To them, the US is becoming a bad investment, and at some point every investor has to cut their losses and salvage whatever they can from a bad investment.  Think Bear Stearns and Lehman Brothers.  Or Citi and Bank of America.  Or AIG or GM.  The list is long.

I doubt that the Chinese will simply dump their current holdings, but what if they simply stop buying more bonds?  Without their deep pockets buying up the US debt (loaning us money) the price of treasuries will drop, causing interest rates to surge.  Which only increases the need to borrow more money simply to pay the increased interest on the debt.

The US effectively has an “option ARM” from the Chinese right now.  We’re not making enough to pay the interest – much less reduce the principal.  So the amount we owe goes up every day.  When it becomes clear that we’ll never pay that debt, the Chinese will stop making our interest payments.  When that day comes – and it will come someday -  look out, inflation will soar.

Buy gold.  I don’t see anything else that will protect you from hyper inflation.  Maybe the Yaun. 

gk

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Sometimes when I get an idea about something to post, I find that someone has said it infinitely better than I could.

This is one of those times.  Read this from Ron Paul – which I copied from a DailyReckoning.com email unashamedly because they took it from Paul’s website.  There’s a link to it at the bottom of the post.  (I voted for Dr. Paul, but not enough others did.  Just think about how great it would be if we had elected him!)

Enjoy!

gk

IN GOVERNMENT WE TRUST? (PARTS 1, 2 AND 3)
By Congressman Ron Paul

Many who agree with me on a lot of other issues, do not understand my enthusiasm for gold and sound money or why I spend so much time studying and talking about monetary policy. It’s true that I talk about money differently than most, but the fact is sound money offers many benefits. For example – peace.

Can sound money really bring about peace? Actually, it plays a big part in peaceful international relationships. Money based on commodities, rather than paper, is not subject to government manipulation, and is a key component to free and honest trade. History shows that if countries engage in trade with each other, their governments tend to find ways to get along for the same reason you do not kill your customers at your place of business, even if they occasionally annoy you. If someone outright cheats you, however, you may engage in “war” by taking them to court, for example, and the relationship will sour. Governments and central banks with unfettered power to manipulate currency also have the ability to cheat their creditors. One way they do this is to simply create enough currency to pay off debts. This devalues the currency and “cheats” the recipient out of what they are owed. It would not be fair if you watered down your product the way our government waters down its currency, so it is not hard to understand, in these simplified terms, why loose monetary policy contributes so much to ill will and war around the world.

Sound money, on the other hand, simply is what it is. Removing governmental power to manipulate money, removes the temptation for government to spend, print and cheat. Sound money ensures that our government’s spending priorities would be brought into sharp focus and reduced to only what we can afford.

Sound money also limits the ability to wage wars of aggression. Imagine how much more careful Washington would have to be about starting a war if they did not have this financial sleight of hand at their disposal! Fiat currency allows government do expensive things they should not be doing while paying the bills with cheap money. The Federal Reserve has lately been auctioning off large amounts of treasury bills as a way to finance the wars in Iraq and Afghanistan, and our crushing entitlement burden. The resulting devaluation of the dollar is quickly eroding our image as a good trading partner in the world. As a consequence, there is therefore more talk of economic isolation and war.

This vicious cycle of spending, fighting and inflating is not what Americans want. It is what the government wants, and it has had to deceive the citizens into allowing and supporting it. Sound money curbs the government’s ability to engage in these shenanigans and reduces the wars we fight to only truly defensive ones, for which Americans are more than willing to stand and fight. So in these ways, sound money is very conducive to peace.

Another benefit of sound money is financial security.

Can sound money give you financial security? There is something very comforting in knowing that what you earn today will retain its purchasing power in the years to come. Indeed, the same silver dime that bought a loaf of bread in the 1960’s can still buy a loaf of bread with its precious metal content – which is worth about $1.00 today. An ounce of gold has always been about evenly exchangeable for a finely tailored men’s suit, which these days is roughly $800. And in these days of fluctuating gas prices, when priced in gold, oil has been stable. Meanwhile, since the creation of the Federal Reserve, the fiat dollar has lost 94 percent of its purchasing power. The erosion of purchasing power rapidly accelerated when it was completely uncoupled from gold in 1971. This sort of fluctuation in the medium of exchange creates a lot of uncertainty in the marketplace and necessitates that you either take extraordinary defensive maneuvers, or face financial ruin. Trusting in government for financial security in retirement is not a safe option. Indeed, a recent study by the Consumer Bankruptcy Project shows that bankruptcies among those 75 and older has more than quadrupled since 1991. This represents wealth and savings that have been eroded by inflation, and trust in entitlement promises that were more fantasy than reality. Even with the pittance that social security pays to seniors, it is bankrupt and bringing the economy to its knees. It is no wonder that many in the younger generations want no part of it, and they should not be forced into a failed system.

On the other hand, holding physical gold can defend against aggressive government monetary policies that threaten to inflate away the value of your life savings. During the hyperinflation in post WWI Germany, what used to be a comfortable nest egg was suddenly the value of a postage stamp. If one held just a portion of their savings in precious metals, the crisis was greatly softened. Gold will never be worth nothing, even if the exact price fluctuates. There is a famous photograph, however, of a German woman during this time period burning piles of tightly bound banknotes to keep warm.

Imagine if the money you earned had honest, stable value, or even appreciated like an investment! No such special measures, like converting dollars to gold, would be required to ensure that your savings would sustain you in your golden years. That is the way it could be and is supposed to be. However, the government’s thirst for power will not be easily, or cheaply, quenched. Fiat currency is one tool governments have to extract wealth quietly from the working class. It is time for the people to wake up to this ruse and look to the Constitution to restore sound currency.

Sound money keeps government spending in check, keeps trade fair and honest, which reduces the temptations, and many underlying causes, for governments to wage wars. It also gives you the peace of mind of knowing that your savings will be able to sustain you in your retirement.

So if sound money is such a good thing, what is stopping people from simply trading with each other in gold and silver? Why are you still being paid in fiat dollars, and why can’t you pay for gas in gold? The answer is that the government has enacted policies that provide considerable stumbling blocks to such transactions.

One of the main stumbling blocks is Federal legal tender laws, which state that government-controlled fiat currency MUST be accepted for many kinds of monetary transactions. In light of this, Gresham’s Law takes effect. Gresham’s Law states that bad money drives out good money. Meaning, if someone is forced to accept your bad money, it is to your advantage to pass it off, like a hot potato, in exchange for something of value. Any good money you have, you will hoard. Eventually, real money is driven out of circulation and under people’s mattresses, so to speak. In the absence of legal tender laws, people are free to accept the medium of exchange of their choice, and are likely to insist on payment in something of real value.

Related to legal tender laws, contracts in gold are not enforced. Meaning if two parties agree to exchange goods or services for gold, and end up in a dispute, the courts will simply settle the dispute in Federal Reserve notes. While gold clauses have been legally enforceable since the late 1970’s the fact remains that disputes over gold clauses might well be resolved in court with a dollar figure calculated in terms of Federal Reserve Notes. In the recently decided case of 216 Jamaica Ave v. S&R Playhouse, which reversed a district court decision, the court upheld the enforceability of a gold clause, but sent the case back to the district court to decide what obligations the gold clause imposed on the defendant. It is not inconceivable that this will result in a decision that the value of the “gold coin” referred to could be valued by the court in terms of Federal Reserve Notes, not in terms of ounces of gold. Furthermore, given the federal government’s actions against Robert Kahre (the Nevada businessman who paid his employees at the legal tender face value of gold bullion coins) it is obvious that the government is still waging a war on gold. Whether either of these cases establishes a precedent remains to be seen. Additionally, because 31 USC 5103 establishes Federal Reserve Notes as legal tender, it would likely take a court challenge to determine whether a gold clause or legal tender law takes precedence.

Governments should do very little, in my estimation, but it should enforce contracts and property rights through the courts. But in this instance it shirks this basic duty, when it comes to gold, as one way to keep control of our economy and the medium of exchange. One is also expected to pay sales tax on the purchase of gold. This is as ludicrous as if you paid sales tax at the bank when you converted dollars into quarters! The IRS also expects you to pay capital gains tax on gold, which is so backwards, since gains on gold really represent decline in the value of the dollar!

Legal tender laws should be repealed at the Federal level. Congress has the Constitutional duty to protect the integrity of our money. However, since it has passed this duty off, and the Federal Reserve has only debased our currency, Congress should no longer force Americans to do business in dollars if they would prefer to transact in gold, or silver, or cigarettes or seashells, for that matter. Free people should be free to associate and do business in ways that benefit them. Instead they are forced to use the unstable dollar to their own detriment, and the benefit the government.

Regards,

Ron Paul
for The Daily Reckoning

Editor’s Note: The above was reprinted from Congressman Paul’s weekly column, “Texas Straight Talk”. You can find this, and more, here.

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