Endless Money E-Book

William Baker

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 759

Veröffentlichungsjahr: 2009

Beschreibung

A detailed look at how, and why, the American financial systemhas reached its current state Today's economy and capital markets are faced with the long-termbuildup of public and private credit. Furthermore, we face highertaxes, greater spending, and more debt. We are now at a criticalcrossroads and our leaders have few realistic solutions. Proposalscalling for tax reforms or fewer regulations have fallen on deafears. In fact, U.S. democracy has become more socialist and reformis needed immediately. Endless Money is an examination ofhow the U.S. government and the country's financial systems haveembraced socialism, and why cultural deterioration reinforces thetrend and jeopardizes democracy. In it, author William Baker seesthis socialism embodied in two things. The first is thesocialization of income, the second is the socialization ofcredit. * Explores the present socialistic qualities of the Americangovernment and its financial system * Looks back at how today's conditions relate not just to theGreat Depression, but ancient empires such as Rome * Calls for radical changes such as reduced regulatory power ofthe Federal Reserve, a considerable devaluation of the dollar interms of gold, and repeal of income tax * Includes a Web site devoted to book, with recommendations,quotes from the financial community, and think tank contacts Insightful and informative, Endless Money examines ourcurrent economic condition and describes what the United States cando to get back on the right economic track.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Foreword

Introduction

Part One - THE CALM BEFORE THE STORM

Chapter 1 - Unknown Unknowns

The Signal-Man

Unknown Unknowns

Chapter 2 - Wings of Wax

Fake Alpha and Derivatives

Operational Risk

Evidence-Based Investing

The Greatest Risk

Part Two - ENDLESS MONEY

Chapter 3 - The Rise and Fall of Hard Money

The Gold Standard

America’s Beginning: Paper, Silver, and Gold

Bank Money and Public Works: From Boom to Bust

From Greenbacks to Gold

When Banks were Strong

The Triumph of Public Debt

The Aftermath

Chapter 4 - Flat-Earth Economics

Misunderstanding Inflation

Weighing the Evidence

A Short History of the Great Depression

The Academic Orthodoxy

Debt Among Nations

Chapter 5 - Spitting into the Wind

Making Sure “It” Doesn’t Happen Here

A Penny In the Fuse Box

Forced Lending: To Print or Not to Print?

Bernanke: Going Down in History

Chapter 6 - Moral Hazard

The Great Bank Robbery

The Socialist Incentive

Forced to Accept Risk

Fiat Currency—Not Yet a Mainstream Conservative Issue

Part Three - FAUX CLASS WARFARE

Chapter 7 - The Rich are Different from You and Me

Never Realize a Gain

Income Tax: A Billionaire’s Best Friend

Ignoble Pyramids

Charity or Syndicate?

Invisible Money

Chapter 8 - Sharecroppers

How (not) to Repay $1 Trillion

Option 1: Wide Dispersion—Include the Top Four Brackets

Option 2: Somewhat Wide Dispersion—Include the Top Three Brackets

Option 3: Just Tax the Top Two Brackets

Option 4: Just Tax the Top Bracket

Option 5: Just Tax the Super Rich

$1 Million Just Isn’t What It Used to Be

Part Four - ASSUMING POWER

Chapter 9 - The Heart of the Financial System

A Canary in the Coal Mine

Shooting the Messenger

More is Always Better

The New Rent Control

Chapter 10 - A Return to Malaise

Going Deeper into Debt

The E-Bomb: Entitlements

Devil-May-Care Budgeting

Redistribution or Bust!

Malaise

Chapter 11 - Democracy: The Achilles’ Heel of Capitalism?

Shades of Juan Peron

History Repeats Itself

Part Five - SOCIALISM—ROMAN STYLE!

Chapter 12 - From the Golden Era to Totalitarianism

Building Wealth

Credit with Wings of Silver

Squandering Wealth

Coping with Collectivism

Chapter 13 - Other Perspectives

Slavery

Decadence

Fat, Happy, and Defeated!

The Private Sector Did It!

The Unessential Army

Into the Furnace

The Weight of Leveling

Part Six - THE OBSOLESCENCE OF CHARACTER

Chapter 14 - Bending to the Modern World

Secular Society

Rational Man

Occupying the High Ground

Liberal Awakening

Chilling of Inquiry

The Moral Vacuum

Chapter 15 - Self-Indulgence

The Inconvenience of Responsibility

Personal Liberation and the Business of Marriage

Hippies Aging (Not So) Gracefully

Chapter 16 - The New Commandments

Compliance!

The (Growth) Business of Regulation

Part Seven - THE FUTURE

Chapter 17 - Elephants in the Room

Chapter 18 - The Elephant Killer—Gold

Keeping the Genie in the Bottle

Flexible Gold

If Gold Were Money Again

Chapter 19 - America Invicta

The End of Moderation

Barbarians at the Gate

Epilogue

Notes

About the Author

Index

Copyright © 2010 by William W. Baker. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Baker,William W.

Endless money : the moral hazards of socialism / William W. Baker. p. cm. Includes bibliographical references and index.

eISBN : 978-0-470-55800-3

1. Monetary policy. 2. Banks and banking. I.Title.

HG230.3.B354 2009

330.15’7—dc22 2009021625

For my wife, Maris; our children, Chase and Ian; and all our family and descendants to come…

Foreword

It’s an interesting—even entertaining—time to be a student of financial markets and government policy.

Never before has the world witnessed what the economist Ludwig von Mises called a “world-wide crack up boom.” History reveals isolated events: the crack up of the Continental currency in America in 1781 or the bust of the German mark in 1923, which famously resulted in wheelbarrows full of paper currency just to buy bread. But never before has the world seen an event which engulfed the entire planet.

We may go down in history as the first generation to live through one, what do you think of that?

With the seizure of the credit markets in the fall of 2008, the jig was up for just about every major market in the global economy. The emerging BRIC economies—Brazil, Russia, India, and China—fell in unison with stock markets in the United States, Canada, Great Britain, France, and Germany. The commodities markets, which had been beneficiaries of immense speculation for the better part of the trading year, suddenly dropped, squeezing even the true believers from the market. Price for oil, gold, copper—thought to provide refuge from the mayhem in the stock market—crashed along with everything else. The Reuters/Jeffries CRB Index, a broad measure of commodities in general, suffered its worst three-month spell since the Great Depression. Fine art, real estate, exotic financial derivatives—all boomed, then busted.What a sight it was.

In 2008, “there is simply nowhere to hide” was a common refrain among analysts, traders, and individual investors alike. It was a brutal time for anyone who had laid even a portion of their assets on the roulette table that had become the economy. Of course, there were plenty of voices cautioning against irrational exuberance as far back as the mid-1990s—before successive asset bubbles puffed their way through emerging economies in 1994-1997, the tech markets during 1996-2000 and the U.S. housing market during 2003-2007. Still barely anyone noticed that paper shuffling for profits is hardly a sustainable economic strategy until they opened their 401(k)s and noticed paper assets don’t always go up like Larry Kudlow or Jim Cramer said they would.

No harm no foul, we say. You win some, you lose some. That is, until politicians get in touch with the electorate’s emotions.

The crack up of the global financial markets in 2008 was a triumph for central planners. “The free market failed,” they’re only too happy to remind you. Lack of regulation and greed on Wall Street were to blame for the crisis. (Never mind, of course, that Fannie Mae and Freddie Mac, government sponsored firms with their own congressional oversight committee, fostered, encouraged—enabled—the market for mortgage-backed securities. On the eve of the bankruptcy of Lehman Bros., Fannie Mae and Freddie Mac together were directly or indirectly involved in about 8 out of 10 mortgages in the United States.)

On the wave of populist outrage over the crisis, Congress panicked and then went on the offensive.

The conventional wisdom of the day suggested if consumers can no longer spend because they have no money and corporations can’t get the credit they need to finance new ventures or cover up sagging sales figures, then the federal government is the only actor in the economy that can spend, spend, and spend some more to get the economy “back on track.” Unfortunately for all involved, an economy that requires people to spend more than they earn ad infinitum was on the wrong track in the first place and no amount of spending is going to get the national economy back on the road to building prosperity. Say nothing of the natural headwinds already presented by globalized labor markets and cheap production costs found in world’s more industrious economies. Or the fact that the crisis itself has cut tax receipts to the federal government by nearly 20 percent—the largest single-year depletion of federal funds since 1932. Before the crisis peaked, federal spending was already creating historic deficits approaching half a trillion dollars. Now with the bailouts of the banking and auto industries—and the political desire to overhaul the health care industry—the nation is facing deficits in excess of a trillion dollars for years to come.

The trouble with running ever-persistent deficits is that when a real crisis approaches the government—your government—is left without the resources to deal with it. At some point, policy makers will come to realize the only way out of unsustainable debts is to rapidly debase the currency. Because they’re in control of the printing press, they will attempt to do what governments since the beginning of written communication have always done, they will attempt pay off their mounting debts with cheaper and cheaper dollars.

This next phase in our history will be messy, at best. But the greatest danger is that even more ambitious demagogues will come along and do “some very foolish things,” as warned by Warren Buffett in the recent documentary, I.O.U.S.A. Those setting policy in the capitol are under the mistaken belief that a free market economy can produce as much as they can legislate into the hands of others and then produce more. Those who respect the virtues of the market know that it’s a fragile, rare occurrence in history that has produced the level of prosperity we enjoy. Sure there were hiccups in the credit markets.Yes, we witnessed what may be considered the largest global crash in markets in history. But as the economist Joseph Schumpeter observed during the Great Depression—the only challenge to capitalist values within immediate reach—“the capitalist reality is first and last a process of change.” Not the type of change promised by politicians, but the reality that one economic system has been destroyed under its own weight. Let’s not forget to respect private property, thrift, and the spirit of enterprise as we rebuild.

When Bill Baker contacted me about his book on the moral hazards of socialism, I thought, “Yes, another voice of reason!” With so many people confused and swayed by the sound byte news cycle, it’s truly refreshing to find someone nutty enough to research real estate bubbles, the late degenerate period of the Roman Empire, and try to derive principles therein to apply to his own trading practice today. At the very least, Endless Money is a good read. But if you take the time, you’ll find there are many more lessons to be learned from its pages—even if you’re a dog-eared student of markets and governments yourself.

Addison Wiggin Best-selling author Executive Publisher of Agora Financial

Introduction

In 2008 the meltdown of the financial sector took the world by surprise. Yet credit crises have been a part of the human experience since before the birth of Christ. Even in the best times of the Roman Republic, a span of about two centuries, there were about a half dozen credit crises. Man has a penchant for borrowing excessively, which is also to say that we lend our wealth unwisely. Until recently, that is the last century or two, there has been a sharp line of demarcation between money and credit. Now currency is amorphous. It is created at the click of a mouse at a ratio of ten to-one or more whenever a deposit is made at a bank, or it can be produced in quantity when a central bank credits its balance sheet in exchange for government debt, mortgages, or the equally formless currency of other nations. It is essentially credit. Its value is tied to the promises of others, a function of their character or lack of it. Should that value vanish, it becomes a renewable resource. Like new trees that may become lumber to replace rotten planks, the Federal Reserve System (Fed) can produce some more. It is becoming a disposable element, and it has lost its permanence—an unsustainable trend because wealth has been placed at risk for systemic reasons.

Money facilitates many things. It enables the specialization of production and trade. It permits us to store wealth, that is, to defer consumption. And it entitles our union, government, to extract taxation. The major debt crises of millennia ago generally arose from the enormous, recurring costs of war, but they also were inexorably linked to a human inability to gauge the ideal tradeoff between expenditure today and tomorrow. In recent times, financial crises have been extremely rare, because we have chosen a scientific, technocratic path of managing our monetary affairs. The Federal Reserve System has created credit growth of about 7 percent annually since its inception a century ago, sometimes (as recently) allowing it to accelerate into the double digits. In so doing, it bulldozed over any chance of asset prices declining deeply or for long ever since the Great Depression. Until recently this has boosted the confidence of speculators of all types, and repeatedly weakened those who might exercise caution. Our accomplishment bewitched us into a conceit that we had banished our ancient penchant for excess.

Central bankers in the United States and Europe have had a primary mission to keep inflation under control. They may have well proclaimed “mission accomplished” with inflation having consistently averaged less than 3 percent in the last 10 years, only to be rudely awakened. Like a doctor judging an athlete by muscle tone and not internal organs or functions, our underlying condition went undetected. The steroids of credit made consumer prices grow when otherwise buyers would have enjoyed a reduced cost of living, thanks to the productivity gains of capitalism and globalization. In a league filled with contestants on steroids, who could compete without them?

Academia has been supportive of the methodology behind the operation of our central banks and treasuries, but now its halls are aghast and repopulated with experts who would convincingly offer new, ever bolder solutions. Once challenged by a crisis of finance, it convincingly supported our effort to break free from the chains of gold that bound the world together, and our majority voted in landslides to adopt social contracts to protect the weakest. Twice confronted, our paper fetters are aflame and the institutions formed to protect us from the unkind strangers of the free market are dilapidated and looted, themselves in need of our wallet.

Have we the economic literacy to understand what has brought us here? Ignorance is widespread, and where it isn’t, sharp disagreement between schools of thought has become germane to deploying a solution. Our problem is simple: We have repeated a mistake of the ages. We have protected ourselves from harm for so long that we have extended our vulnerability beyond any previous scale. Until recently, the private sector was so encouraged by the prospects offered by the rising tide of paper money that it indebted itself to the tune of over $40 trillion; our government promised entitlements with a present value of over $50 trillion. Combined with public debt of over $10 trillion, these obligations are more than seven times as large as gross national product. But in defi ance to this state of affairs, our experts are about to solve a debt problem by adding more debt, by adding banking credit, and by spending money raised from selling Treasury notes and bonds.

This book sympathizes with a long unnoticed sect of economic thought known as the Austrian School, whose “dean” was Ludwig von Mises and “founder” was Carl Menger. Murray N. Rothbard is a disciple of extraordinary ability whose thoughtful analysis of American history in the Austrian theoretical context was heavily relied upon in this text. I wish to acknowledge the generosity of the Mises Institute in making voluminous quantities of his work available to the public at large and for promoting the dissemination of his ideas to scholars and ordinary financial commentators alike without oppressive copyright limitations. But my view departs slightly from these greats by incorporating some pragmatism and recognizing some moral obligation to undo the massive distortion that operating a fiat currency system and a central bank has caused. I respectfully apologize to all who possess greater knowledge of economics. My grounding comes only from the battlefield of performing equity research and managing money for more than 25 years, where I founded two firms: GARP Research & Securities Co. (an institutional equity research broker dealer, member: FINRA and SIPC) and Gaineswood Investment Management Inc. (an SEC-registered investment advisor). In this text I delight in taking apart the observations of some of the most respected economists of our time. They have earned advanced degrees and pursued careers in the field, earning them Nobel Prizes as long as they did not veer in the Austrian direction (with the exception being Friedrich A. Hayek), whereas I merely majored in economics at one Ivy League college, received a Masters in Business Administration at another, and then sought to continue my learning in the crucible of the financial markets.

Providing research on stocks and managing equity portfolios can be a very humbling experience, for in this endeavor theories are subservient to reality in the harshest way possible, through financial reward or loss.This book opens by relating some experiences of working under this pressure, and the respect for the unknown this brings to one’s mental discipline. Most of all this experience reminds one that the machinations of men seeking to tame the vast unexpected interaction of economic forces that surround us are prone to hubris and error. It is not a giant leap then to question the wisdom of current academic orthodoxy surrounding central banking and fiat currency, for these interrelated institutions are most certainly constructs of man. The experience of analyzing companies and industries teaches one to be open minded, and macroeconomics should be subject to no less healthy respect for the unknown.

Part 2 of the book begins with a compressed monetary history of the United States and the global financial events of the interwar period, which may slow the progress of casual readers, but this frames the policy debate and investment outlook for the remainder of the book. The perspective this provides is that over the long term our nation has swung back and forth several times between operating a fiat currency and using hard money. Simple observation of this history could make a reversal in direction of the pendulum appear inevitable. The unanimous consensus during our lifetime that gold backing of liquid wealth is a barbarous relic could give way, but it would take painful financial circumstances, perhaps a funding crisis for the United States, to force the issue.The balance of Part 2 contains the critique of the mainstream academic interpretation that the Depression was made Great because of misguided adherence to the gold standard, which transmitted economic instability worldwide. Although it is a bit pedantic, readers will be richly rewarded with an alternative perspective that casts the professors of finance as flat Earth believers. While the concept of a flat Earth is probably an exaggeration of medieval scientific inadequacy, the analogy may have enough truth to it to pop the blister of condescension that has been expanding in academic literature, deflating the hauteur fed by the awarding of numerous Nobel prizes. This review also makes the case that World War I, coming on the heels of the founding of the Fed, ushered in an era of dollar diplomacy that promulgated the dilution of gold reserves held by banks and nations. When the burden of debt became too large relative to income by 1929, the United States responded by devaluing and confiscating gold, and then outlandishly embarking on a strategy of cornering the global gold market. Today’s Fed might be similarly incongruous with the times, for it views the meltdown as an illiquidity crisis. With some assistance from the U.S. Treasury, its policy is to float more debt to alleviate the excessive issuance of debt that made the system unstable in the first place. Part 2 closes with a review of the numerous moral hazards inherent in operating a centralized banking system that has been friendly to expansive and redistributive fiscal policies. The structural change to finance over the last century has been enormous: The worst banks of 100 years ago would be pristine in comparison to the best banks and brokers doing business with the public today, because the responsibility of safekeeping has been palmed off onto the taxpayer.

With a cornerstone in history and theory thus laid in place, Parts 3 and 4 move to examine the realms of taxation and politics, respectively. The financial meltdown begun in 2008 provided ammunition to politicians who have been pressing to redistribute yet more income from the rich to the less than rich. Part 3 reviews the historical record, which shows that redistribution was immoderate from World War II until Reagan’s presidency. Reagan succeeded in reducing the burden of taxation on the upper-middle class dramatically through the Tax Reform Act of 1986, whose impact was phased in by 1988. Still, from that time forward, income of the upper-middle class has been redistributed proportionately more than it was during the administration of Franklin Roosevelt, who ostensibly “soaked the rich.”The top income tax bracket in 2008 applies to earnings above $357,700. The inflation adjusted equivalent of this cutoff, $22,500, would merely fall in the 17 percent bracket of 1932. Roosevelt went after the super rich; those earning $1 million annually paid a rate of 63% in the early 1930s, which rose to 77 percent by 1936. But adjusted for inflation, $1 million then equals over $15 million today.

The dunning of the upper-middle class to pay for swelling government expenditures, mostly for entitlements, is one untold story of our era. Another is the role of the super rich, who can skirt taxation through withdrawal of debt capital and hedge this through the use of derivatives, and by minimizing ordinary income. They are the ultimate beneficiaries of the fiat currency system, because otherwise asset inflation through currency dilution would not route profits through this backdoor. Chapter 7 documents the political influence wielded by these elites, many of whom disingenuously call for higher taxation of income. Besides having broken the back of the banking system, where has this trend led us? The swerve to the left politically that occurred in 2008 will result in heightened redistribution and spending. But even without this added burden, the upper-middle class is incapable of paying down even a small fraction of our national debt, yet countries that support the Treasury note and bond markets seem incognizant of this national insolvency. Part 4 expands upon the politics of recent times. Recounting the saga of Fannie Mae and Freddie Mac, it takes a detailed look at the mortgage industry as a government-subsidized redistributive protectorate. It then notes the income shifting and expansion of a government set to begin as contemplated within the American Recovery and Reinvestment Act of 2009, comparing Obama policies to those that brought on the malaise of the Carter years. With a goal of establishing a majority of the electorate that pays no income taxes at all, the new economic overlords may have inadvertently harnessed democracy to strike a fatal blow to capitalism, a theme developed in Part 4’s short concluding chapter.

Historians will write one day that 2008 marked the close of a great financial epoch, one whose heroes were financiers of the ilk of Soros or Buffett, neither of whom built essential institutions but instead were intermediaries that profited by being shrewd conduits of other people’s money. True, a few modern-day industrialists, like Gates, Jobs, or Google founders Sergey and Brin, emerged.While our nation stretched its trade imbalance to the limit, and services as well as tangibles were increasingly produced offshore, even the software code that was the fabric of these great, new American corporations could not afford-ably be constructed here. Ending this epoch may mark the exile of the upper middle class from our social and economic structure. This most productive group felt a rush of wealth from the inflation of the money supply, but it was simultaneously looted with confiscatory state and federal income and death taxes. Seeking to escape the progressive capturing of the fruits of its labor, it withdrew massive amounts of cash tax free through mortgages and home equity lines, only to fall victim to asset price deflation. The beginning of the new era, one born of hope and change from those underneath, will be one of a flatter, more uniform society, unless the trickling down of impoverishment awakens us all to our heritage and unites us, a response we have experienced in other times of challenge. The über wealthy have positioned themselves to collect the trinkets off the fallen bodies now that the battle has been convincingly won, and for this they owe allegiance to demagogues. In what may be one of the best public relations foils of all time, the pinnacle of society may have used class warfare to its own advantage, so for this Part 3 is named “Faux Class Warfare.”

The exploitation of the lower classes to permit the aristocracy to consolidate the estates of the lesser nobles into their own is what happened to Rome. It can happen again here, but the trend might be so slow that future historians might argue whether the United States fell or evolved into a new and better system of global unity, or ponder precisely when or how it happened. Like some other authors have recently done, I draw an analogy to the fall of the Roman Empire, partly to weigh in with some common sense on a topic that is increasingly evoked by some on the left to justify their Marxist leanings. The Roman Empire did not “fall” as the title of the great historian Edward Gibbon’s opus on that score implies. Its poor delighted in handing over the franchise to the barbarians, for their government had turned its citizens into serfs. In ancient times, the highest level of commerce occurred during the Roman Republic, before the birth of Christ. Activity began to tail off shortly after that, when the Roman Empire began to devalue its currency, essentially a tax on cash balances. It raised taxes a century or more later, and taken together these actions combined with legal changes systematically obliterated its middle class. This book takes aim at liberal analyses that draw parallels to the United States, claiming that privatization of government functions or military overextension are common elements that predestine us to lose our station in the world. These arguments could not be more patently wrong, and are exposed for what they are in Part 5.

Paralleling the enormous change in the world’s financial system has been the degradation of our culture, the topic of the sixth part of this book. It runs beyond lewd music, violent movies, or the open acceptance of lifestyles that have been considered perverse for thousands of years. Libertarians, who are the minority that has proselytized for hard currency and fiscal restraint, celebrate the self-expression and self-actualization that has occurred thanks to the prosperity of capitalism, which unshackled us from hard labor on farms or in factories. But economic success has absolved the majority of the populace from the need to pay taxes. Success at the voting booth at securing additional takings threatens to realign incentives so much that producers may no longer see their rewards justified by risks. Such a majority would continue to egg on its representatives to dig surrounding our constitutional foundation, threatening private property rights and the freedom to conduct business without government intrusion. There is a paradox of freedom, that it can mean absolution from responsibility: from repaying debt to honoring familial commitments to enjoying sheer self indulgence and neglecting to save or plan for the future, be it one’s own or that of the nation. Although the clock could never be turned back, the societal impact that modern birth control (and abortion) had upon family formation and savings has been subversive. Affluent baby boomers uniquely would worship at the alter of consumption early in life, deferring marriage. Then, thanks to government policies that subsidized housing in multiple ways, they would stretch already thin balance sheets to invest in McMansions and second homes that carried mortgages payable well into old age. The more plebeian of that generation would not miss out either, leasing cars, maxing out credit cards, and eventually grabbing for the brass ring through variable rate interest-only primary mortgages augmented with home equity loans that could extract any accumulation of net worth to be devoted to more pleasurable ends. Character in the Victorian sense is obsolete; so to pick up the pieces from the financial meltdown we are choosing to embark on an orgy of fiscal stimulus, national debt accumulation, and taxation of the entrepreneurial class, which has been the locomotive of our good fortune.

The book closes by venturing a look into the future, which as the great wordsmith of our time,Yogi Berra, opined, “ain’t what it used to be.”This last part begins by reminding us how reluctant concern over creeping socialism is, and how incognizant everyone from the least to the most educated are concerning the moral hazards of operating a fiat currency in conjunction with a state that is hell-bent on fiscal expansion and providing entitlements. Although we have veered far off the course that our founding fathers set for us, the financial crisis begun in 2008 may contain pressures that should be sufficient to trigger a reexamination of our banking sector and the powers granted to government over the last hundred years or so in a way that is much more deeply fundamental than anything currently under consideration. As of this writing in May 2009 the stock market is booming, but the real economy has yet to respond to the printing of money ordered by the Fed or the stimulus spending voted upon by Congress. Debt levels remain higher than ever, and income and employment is thought to have merely stabilized. How reduced income can support higher debt is a mystery, but then again the scale of government intervention has never been this great in peacetime. In the epilogue, a policy solution that is an alternative to this forceful intrusion is offered. It is not a purely free market approach as advocated by the Austrian School, the major difference being the necessity to protect depositors and account holders who were forced through Fed policy to trust deposits to a weak banking sector, and furthermore were taught to borrow heavily in order to keep up with inflation of asset prices, particularly real estate. But once these wrongs are undone, then the virtue of operating with a hard currency and drastically smaller government sector could be realized.

So the radical solution I would choose would require a shift in thinking to focus upon greatly reduced spending, lopping off most of the functionality of the government’s regulatory apparatus. It would require at least a 50 percent devaluation of the dollar in terms of gold, to be accompanied through printing dollars to compensate busted deposits, insurance contracts, or securities held by those who foreswore conspicuous consumption and saved in supposedly safe bank accounts, annuities, or U.S.Treasuries. In fact, near the end of the book I explore what might be the equilibrium price of gold were it to be used to back the dollar; a price between $5,000 and $10,000 might be expected. When this process is complete, we could then scale back the role of the Fed to limit its policy actions only to times of truly desperate liquidity contraction, if at all. The repeal of the Sixteenth Amendment would be imperative; it should be replaced with a moderate and flat wealth tax. Interestingly, when Augustus restored the flat wealth tax in about 25 Bc, it lit a fire under economic growth in the Roman Empire, for it reduced the marginal tax rate on income to 0 percent! Without constitutional tax reform, the gold purchased by the Fed to back the currency would hastily be shipped back to where it came.

Democracy is a privilege, for which generations of brave Americans have fought. To allow it to implode from the poisonous effects of socialism is to repeat the mistake of the Romans, and to condemn our children to lifetimes of servitude and close supervision by the cold, unfeeling tentacles of the state.There are two types of people who will read this book. One will feel empowered and may rediscover his civic duty. He is also likely to act by reallocating his investment choices, thinking he now has insight as to where we are headed. The second type of reader will feel somewhat impotent and overwhelmed by the changes at hand. But both camps of individuals have more in common with each other than they would like to admit.

Part One

THE CALM BEFORE THE STORM

Wall Street is populated by many types of professionals: those who gather assets, those who package and sell securities, and those who trade them, to name a few. The portfolio manager is unique in that he is solely charged with investing to make money and avoid risk, although in the hypercharged atmosphere near the close of the 20th century such objectivity was subverted by new incentives.

This opening chapter is expressed in a familiar tone, through the eyes of one who participated with this awesome responsibility from the inception of the great 1982 2008 bull market through its collapse. Initially it captures the mood of downtown Manhattan, and then meanders through time to relay the money management mindset as it evolved. To know the collective mental state of the financial markets and of those who manage the money invested in them is to know the reduction of pecuniary thoughts of everyone—consumers, savers, government leaders—into one thing: price. Sometimes price anticipates the future, and other times it is backward looking and completely unable to see what is coming. Because of this unreliability, it confounds analysis by a rational mind. Those able to understand it can feel like the signal man of Charles Dickens, who sees the future but is disbelieved. The irrationality of inflection points is discussed in this context, with examples of the fate of heretic signal men as well as those who enjoyed success when acting on completely sham information. These two odd bedfellows are explained by an outside and ignored dimension, typified by the onset of the banking crisis, when CEOs of banks thought their institutions were sound because of low defaults and delinquencies, but loan balances were perilously close to inflated home values.

In fact, those who apply scientific methods and construct sophisticated portfolios around them eventually see what they have assembled abandoned by the flows of capital, like the dispersion of the peoples who came together to build the Tower of Babel before the job was completed. This chapter begins its conclusion in homage to Nassim Taleb, critic of the modern day builders of risk models, who was one of the few who warned of just such a predicament awaiting us. But the chapter goes further by reminding us, as C.S. Lewis did, that feeling the “clean sea breeze of the centuries” can provide a glimmer of the future, even when it is seemingly irrational. It ends by carrying forward these humbling lessons of the world of finance to the political sphere, which over the decades has become divisive and summarily dismissive of solutions that might unite our moral sentiment, instead embracing socialism and statism. By providing this personal-tone poem of sorts before diving into the observations of this book, a hope is nourished that readers may welcome new opinions and recognize some transcendent ideas that shed light on the danger of our monetarist, political, and cultural impasses.

Chapter 1

Unknown Unknowns

“After partaking of a slight refreshment in almost breathless silence the Gen. filledhis glass with wine and turning to the officers said, ‘With a heart full of love andgratitude I now take leave of you. I most devoutly wish that your latter days maybe as prosperous and happy as your former ones have been glorious and honorable.’After the officers had taken a glass of wine the Gen. said,‘I cannot come to each ofyou, but shall feel obliged if each of you will come and take me by the hand.’Gen. Knox being nearest to him turned to the Commander in Chief Who suffusedin tears was incapable of utterance but grasped his hand when they embraced eachother in silence. In the same affectionate manner every officer in the room marchedup, kissed and parted with his general in chief. Such a scene of sorrow and weepingI had never before witnessed and fondly hope I may never be called to witnessagain.”

COL. BENJAMIN TALLMADGE, THE MEMOIR OF COL. BENJAMINTALLMADGE, COLLECTION OF FRAUNCES TAVERN MUSEUM, P. 103

To be prosperous and happy, in the words of Washington, is the hope he bestowed upon his officers in 1783. Today the average salary in Downtown Manhattan is $115,000, and this mixes in everyone: from the brigade of 20 something women with vampish nails from Staten Island who commute by ferry to their first jobs as adults, to the tired older men who squeeze in and out of the Lex subway line in perspiration on a hot July day or wearing rain drenched pinstripes. One wonders if they might still be working from joy of doing battle with the market or because they lost nearly everything at Drexel Burnham, Bear Stearns, or if it were in the days of yore, that they “took a loss with Auchincloss.” For years, the best and the brightest from Harvard, Stanford, Amos Tuck, and other elite graduate business schools came here alongside the pugnacious of Brooklyn or Jersey who might simply pass a Series 7 exam, all in the quest for profit and a better life. Most might now sit behind a Bloomberg terminal in midtown, in Boston’s financial district, or even in a comfortable class “A”space in suburban Dallas, Minneapolis, or San Diego.

As an institutional portfolio manager, you might lunch with industry analysts, CEOs, CFOs, economists, or strategists. Dick Cheney was on tap for this highly paid entertainment circuit well before becoming Veep or taking the reins of Halliburton. Oddballs sure to stimulate, such as Iben Browning, climatologist and raconteur extraordinaire, might have regaled students of the markets with billions to manage with tales of tree rings and revolutions, long before anyone had even thought about global warming. Lunch might be served for these occasions at Fraunces Tavern, the scene of Washington’s farewell to his officers. Or it might be at the India House or Delmonico’s, which dates back to 1837, or atop a sky-scraper with a sweeping view of the harbor, the bridges, and the Statue of Liberty. If you gaze on the horizon, you can see the Atlantic Ocean.