Editor's note: As we said in yesterday's edition of the weekend Masters Series... Richard Maybury is among our favorite free-market thinkers and historians today... His Uncle Eric book series and U.S. & World Early Warning Report are must-reads for anyone interested in money, business, history, and government.
Today, we have the conclusion of Richard's essay – originally published in the January 2010 Early Warning Report – on the true nature of the Fed's "counterfeiting" and its effect on the economy. This essay is packed with invaluable investment insight you won't get anywhere else.
The Fed-Caused Disaster Is Here, Part II
By Richard J. Maybury
The conventional view...
... of the government's monetary policy is that officials try to inflate the money supply at a rate that will keep us in a safe zone between inflationary boom and deflationary bust. (Figure E.)
If they print less money – meaning if they "tighten," as in 2004 to 2007 – we get a recession. If they print more – meaning if they "loosen," as in 2001 to 2004 – we get a double-digit inflation, meaning prices rising at more than 10% per year. (The prices do not need to be those of consumer goods, they can be of stocks, real estate, raw materials, or anything else, depending on where the money flows to. Usually, it flows into whatever firms and investments are fashionable.)
I believe the assumption that the lines between boom and bust are parallel is based on an unwillingness to face the fact of malinvestment...
The sides of the monetary policy channel are not parallel, they converge. (Figure F.) As the malinvestment grows, so does the amount of money needed to prop it up. The Fed's maneuvering room eventually disappears. Any injection big enough to avert a depression will lead to runaway inflation.
Please read that last sentence again. I think it describes where America is now, and it is the main point of this issue of Early Warning Report.
When I last wrote about this in September 2008, I suspected the disaster I had been writing about since 1992 had finally arrived. Now, I think that suspicion was right. The Fed has run out of maneuvering room. Its 96 years of creating money out of thin air – which means 96 years of creating malinvestment – have finally put us in a situation where the choice is no longer between double-digit inflation and recession, it's between triple-digit inflation and depression.
In short, I think the odds are very high that if they print enough money to keep the depression from happening, they will send the dollar into a hyperinflation like the one in 1779, when George Washington wrote, "a wagon load of money will scarcely purchase a wagon load of provisions."
The main sticking point...
... is that no one knows where all the money goes, so the malinvestment is not identifiable until the counterfeiting stops and the wave of bankruptcies begins. We cannot foresee which businesses will go under or who will lose their jobs, so the political pressure from all quarters to continue counterfeiting dollars is overwhelming.
There is no easy way out of this mess – no way to make a fresh start – without a colossal shakeout of the existing malinvestment.
Very likely, after 96 years of Fed counterfeiting, there are whole cities in the wrong locations.
It takes a lot of newly created dollars to keep this malinvestment alive. The money supply when the Fed began operations in 1914 was $11.6 billion. Today, it is $1,695.9 billion – a 145-fold increase.
When the Fed's counterfeiting stops, the flow of new dollars to these assets will, too. The cones will dry up, and prices of the assets in the cones will plunge to their real values.
The only way to delay this disaster is to continue the counterfeiting, which is what the Fed is doing.
In other words, the Fed is the Hurricane Katrina of the economy. These arrogant, socialist Fed power junkies have locked us into a runaway inflation. In the past 18 months alone, they've increased the money supply 24%. And, the monetary base, which is the raw material from which the money supply is made, has been increased 129%. Much of the base is still in the banking system, but I think it will pour out into the general economy this year.
For investors, buying non-dollar assets is paramount. However...
... stay cautious.
In 1979, Fed chief Paul Volcker took office as the dollar was headed down the tubes. Volcker decided to save the greenback by tightening monetary policy severely. This drove interest rates beyond 15%. Non-dollar assets crashed, and most were moribund for two decades.
I think there is a 30% chance of the Volcker episode being repeated, so don't bet the farm on non-dollar assets. The strategy that makes the most sense to me is the Permanent Portfolio and Variable Portfolio plan explained in Harry Browne's Fail Safe Investing. The little book only takes about 45 minutes to read.
Harry's main point is the same as mine – diversify, diversify, diversify – and he shows you the investment mix that is as close to bulletproof as anything I've ever seen, while allowing room for speculation in non-dollar assets if you so desire.
Note this: When Volcker began tightening to save the dollar in 1979, the unemployment rate was 6%, and it topped out at 10.8%. If Fed officials tighten now to save the dollar, they'll be starting with joblessness at 10%. This means, in my opinion, if they tighten they will be flirting with massive social upheaval, and they know it, so they are sacrificing the dollar to buy as much time as they can, hoping they will be out of office before the catastrophe arrives.
In short, over the past 96 years, Fed officials have created so much malinvestment that their only choice now is between big riots today and even bigger ones tomorrow. The fact that they are continuing their loose dollar policy to keep the malinvestment alive as long as possible means they have chosen the bigger riots tomorrow. My guess is, somewhere between six months and three years.
Summary
If you did not receive your share of the Fed's freshly created dollars last year, then that's your proof the Fed's newly minted greenbacks are not distributed uniformly. Some parts of the economy receive more than others, and these areas become hot spots, or cones.
My main point about all this is that the government and mainstream press do not want to acknowledge that inflating the money supply causes malinvestment. That's the key to understanding the whole mess, malinvestment – the cones. In its 96 years of behaving like a counterfeiter, the Federal Reserve has undoubtedly misled tens of thousands of businesses, large and small, into locating in the wrong places, doing the wrong things, at the wrong prices. This malinvestment must be shaken out before we can make a fresh, noninflationary start.
Keeping it all alive requires mountainous injections of newly created money, which is nearly certain to destroy the value of the dollar.
I think much of the rest of the world has figured this out, which is why they have been scolding U.S. officials, and openly searching for ways to escape from the dollar, including buying non-dollar assets such as gold, silver, platinum, oil, and other tangible assets. (See my video "How to buy precious metals" on our home page www.richardmaybury.com. Click on Broadcasts.)
This is why I have recently raised my estimate of the global velocity of the dollar. Many foreigners are clearly trading away their dollars as quickly as they can. But, as usual, Americans remain oblivious. Most Americans graduate from high school or college knowing nothing about currencies.
Again, if no one from the Fed handed you your share of the fresh greenbacks last year, then you know the newly created dollars are not distributed uniformly. And knowing this, you can reason out the implications, which are profound. They are why, for us ordinary mortals who don't work for the Federal Reserve, counterfeiting is illegal.
I hope you own a lot of non-dollar assets.
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