Get Rich, Quick

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The New York Sun

The question that intrigues us this morning is whether that most celebrated of liberal columnists, Frank Rich of the New York Times, is going to end up in harness with those of us who favor honest money. I’ve been thinking about it because Mr. Rich issued a column the other day lamenting derivatives, which he quotes Warren Buffet as calling “financial weapons of mass destruction.”

Neither Mr. Rich nor Mr. Buffett made mention of the fact that derivatives are concentrated on the balance sheets of just a handful of banks and that those balance sheets are subsidized and protected by ordinary people. In the United States, bank balance sheet assets are systemically protected by the so-called “lender-of-last-resort” money creation facility at the Federal Reserve. Bank liabilities are protected at the micro level by so-called Federal Deposit Insurance, which is not insurance but is a subsidy to the banks.

So, since bank balance sheets are protected, what’s to stop banks from making imprudent loans or investments and from engaging in outright gambling, or what is called “proprietary trading”? The metaphor that I like to describe this arrangement is a poker game whereby the players get to keep their winnings, but if they lose ordinary people replenish their stakes. Who wouldn’t play in a game like that? And what’s to stop players from pulling to an inside straight against three showing?

Normally, a regulator would be standing over their shoulders and saying: “that’s a stupid bet, don’t do it.” So, what do our subsidized players do? They make off-table bets. Think, off-balance sheet “Special Investment Vehicles” and derivatives. At the end of the third quarter of 2009, according to the Controller of the Currency, five American banks — JPMorgan Chase, Goldman Sachs, Bank of America, Citibank, and Wells Fargo — had entered into nearly $200 trillion of derivative bets. And trillions of dollars of bailout money was advanced to cover derivative losses of bank counterparties, e.g., AIG, as well as losses on dodgy mortgages and other investments.

Where did the trillions of bailout money come from?

The answer is that all of our money is created out of nothing by the banking system of which the Federal Reserve is a part. Let’s lay aside for a moment the question of where in the Constitution the government is authorized to do that. When the banking system creates money out of nothing, it depreciates the purchasing power of money that exists, but more importantly, it depreciates the purchasing power of money that has been promised for future payment, e.g., pensions, annuities, savings, rents, etc. In other words, claims on real wealth that people are depending upon for later, when they can no longer work, are being depreciated as new claims are being created and transferred to financial sector participants now.

Later, when seniors attempt to buy what they need to live, their dollars will be worth only a fraction, perhaps a small fraction, of what they think they are going to be worth. Because the purchasing power of legal tender irredeemable paper-ticket-electronic money (the kind we have now) always approaches its cost of production, which is near zero, seniors will be left holding an empty bag at a time when they can no longer work. Then what?

Clearly, something is very wrong. Mr. Rich has high hopes that the Financial Crisis Inquiry Commission will get to the bottom of things. No chance of that. The root of the problem is that we are forced to use legal tender irredeemable paper-ticket-electronic money instead of the kind of money mandated by our Constitution: gold and silver. It is the only way to provide what everyone in the productive sectors of our economy wants, what ordinary people all over the planet want — monetary stability: interest rate stability; foreign exchange rate stability; balance sheet stability; that their savings and pensions will be there when they retire, and so on.

The financial sector, however, wants volatility, because it garners virtually all of its profits from trading. The founders of America foresaw these dangers and tried to guard against them with language in the Constitution making it clear that they viewed gold and silver as the only legitimate forms of money. They wrote extensively of their hostility to paper money.

I predict that if Mr. Rich stays with the story, and keeps an open mind, he will come to understand this and see the need for what I call a Global Currency Initiative, composed of industry and labor, to thrash out the kind of monetary system that suits the needs of ordinary people and productive enterprise.

Mr. Parks is the executive director the Foundation for the Advancement of Monetary Education, or FAME.


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