The Coming Bond Market Collapse E-Book

Michael G. Pento

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

Seitenzahl: 566

Veröffentlichungsjahr: 2013

Beschreibung

The coming financial apocalypse and what government and individuals can do to insulate themselves against the worst shocks In this controversial book a noted adherent of Austrian School of Economics theories advances the thesis that the United States is fast approaching the end stage of the biggest asset bubble in history. He describes how the bursting of the bubble will cause a massive interest rate shock that will send the US consumer economy and the US government--pumped up by massive Treasury debt--into bankruptcy, an event that will send shockwaves throughout the global economy. Michael Pento examines how policies followed by both the Federal Reserve and private industry have contributed to the impending interest rate disaster and highlights the similarities between the US and European debt crisis. But the book isn't all doom and gloom. Pento also provides well-reasoned solutions that, government, industry and individuals can take to insulate themselves against the coming crisis. * Paints an alarmingly vivid picture of the massive interest rate shock which soon will send consumers and the government into bankruptcy * Backed by a wealth of historical and economic data, Pento explains how the bubble was created and what the U.S. can do to mitigate the impending crisis * Provides investors with sound strategies for protecting themselves and their assets against the coming financial apocalypse * Explains why retirees, in particular, will be at risk as real estate prices decline, pensions weaken, and the bond bubble bursts

Leseprobe

Contents

Introduction

Acknowledgments

Chapter 1: As Good as Gold?

The Great American Money Machine

“Dad, Where Does Money Come From?”

The Implications of a Fiat Currency

Notes

Chapter 2: The Anatomy of a Bubble

The Great Depression—A Historical Comparison

Two Decades of a Bubble Economy

Does CDO Rhyme with Tulip Bulb?

Today’s Bubble in Bonds Rhymes with the Debt-Fueled Real Estate Crisis

Notes

Chapter 3: Bernanke’s Hair-of-the-Dog Economy

Austrian Trade Cycle Theory versus Keynesian Toys and Candy

“End This Depression Now!”—The Game Show

“I’m Not Addicted to Easy Money . . . and I Can Stop at Anytime”

No Way Out—Starring Ben Bernanke . . .

The Thirty-Year Party in the Bond Market

Notes

Chapter 4: Deflation Phobia and Inflation Philos

Fed Busters

Fed-Lore Myth 2: Japan Proves that Debt and Deflation Go Hand-in-Hand

Myth 3: The Keynesian Fed-Lore of the Phillips Curve

Myth 4: You Can Rely on Government Statistics

Myth 5: The Fed Was Created for Your Benefit

Notes

Chapter 5: The Bubble Reality Check

The Investor Reality Check

The Interest Rate Reality Check

The Teaser Rate on U.S. Debt—Reality Check

Banker Reality Check

The China Reality Check

Washington’s Addiction to Debt—Reality Check

Notes

Chapter 6: The End of an Empire

The End of a Monetary System

The Economic Laws of Debt

U.S. Debt—This Time It’s Different

Is Austerity a Bad Thing?

Where Will All the Money Go?

The Bell Is Ringing for the Bubble in the Bond Market

Banana Ben to the Rescue

The Cost of an Empire

Notes

Chapter 7: Real World Europe

The Creation of the Euro

Greece

Dr. Hayek vs. Dr. Keynes

Dr. Keynes and Dr. Hayek and America’s Bout with Hyperinflation

I’ll Take Currency Debasement for $40 Billion . . . a Month

Final Jeopardy

The Canary in the Coal Mine

Notes

Chapter 8: The Debt Crisis

From Pioneer to Penurious . . .

The Sixteenth Amendment . . . The Beginning of the Slippery Slope

Mexican Debt Crisis

The Asian Contagion

Russian Debt Crisis

The Debt Crisis Fallout

What Would It Look Like Here?

It Can’t Happen Here?

I Don’t Want to Be Right

Conclusion

Notes

Chapter 9: What Can the Government Do to Mollify the Debt Collapse?

The Principles of a Free Market

Conclusion

Notes

Chapter 10: How to Invest Your Money Before and After the Bond Bubble Bursts

What to Own When U.S. Debt and the Dollar Collapse

Notes

About the Author

Index

Cover Design: John Wiley & Sons, Inc.

Cover Image: © Mike Kemp/Jupiter Images

Copyright © 2013 by Michael G. Pento. All rights reserved.

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

Published simultaneously in Canada.

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Disclosure: Michael Pento is the Founder and President of Pento Portfolio Strategies (PPS). This work has been written solely for informational purposes and readers should contact an investment advisor before acting on any information contained in this book. No information in this work constitutes an offer to sell or buy any financial instruments or to provide any investment services. Readers understand that there is inherent risk in investing. PPS is a Registered Investment Advisor, registered with the State of New Jersey.

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Library of Congress Cataloging-in-Publication Data

Pento, Michael, 1963-

The coming bond market collapse : how to survive the demise of the U.S. debt market / Michael Pento.

pages cm

Includes bibliographical references and index.

ISBN 978-1-118-45708-5 (cloth) — ISBN 978-1-118-45717-7 (ePDF)

ISBN 978-1-118-45716-0 (Mobi) — ISBN 978-1-118-45715-3 (ePub)

1. Bond market–United States. 2. Bonds–United States. I. Title.

HG4910.P426 2013

332.63′23—dc23

2012049828

To my wife, Jenifer, and my two children, Michael and Giamarie. It is my hope and prayer that my kids will grow up in a land that offers them the freedom to bring their dreams to fruition, rather than a government-provided guarantee of mediocrity. To my parents, Frank and Mary, who ignited my passion for freedom. And to God for allowing us all the autonomy to choose.

Introduction

In November 2011, I founded a money management firm, Pento Portfolio Strategies, for the primary purpose of preparing clients’ investments for what I saw as the next financial crisis. Back in 2005, I correctly predicted the bubble in real estate. However, the new catastrophe I see emerging makes the housing bubble pale in comparison. America now sits in the latter stages of the biggest asset bubble in the history of the planet. The bursting of this bubble will send shock waves throughout the global economy and will have a gravely negative impact on the American standard of living. This bubble will have a profound effect on all Americans—especially those who fail, or refuse, to see it coming. It will affect your job, the value of your house, your savings, and your way of life. The bubble is U.S. Treasury debt.

But don’t think of this author as some Cassandra that is calling for the end of the United States. Cartographers will not have to expunge America from their maps. This great country will survive and thrive after the collapse of the U.S. debt market occurs. The point of this work is to guide our leaders down a path that leads toward a direction that mollifies the damage already done. It will also offer investors the best chance to preserve their current standard of living.

Investors, seeking refuge in what they perceive as the safest of all havens (U.S. Treasuries), have been procuring government debt at unprecedented rates despite the record low interest rates they offer. The Federal Reserve, under the stewardship of Ben Bernanke, has rendered our continued solvency as a nation dependent on the perpetual continuation of artificially produced low interest rates. However, it is clear that Bernanke cannot keep rates low forever. The Federal Reserve’s misguided effort to counterfeit our way to prosperity, coupled with the flawed Keynesian deficit spending model that our government embraces with alacrity, has led to record debts that will never be able to be repaid.

The bursting of the bubble in Treasuries will cause a massive interest rate shock that will drive the U.S. consumer and the government into bankruptcy and send many people throughout the globe into poverty. In order for you to survive the coming debt crisis, you need to be informed and prepared.

In this current economic environment, our government seeks a condition of perpetual inflation in order to maintain the illusion of prosperity and solvency. The problem with this addiction to money printing is that once a central bank starts, it can’t stop without dire, albeit in the long-term healthy, economic consequences. And the longer an economy stays addicted to inflation and borrowing, the more severe the eventual debt deflation will become. As a result, our central bank is now walking the economy on a very thin tightrope between inflation and deflation. The prevalent idea among our government and central bank is that we can borrow and print even more money in order to eliminate the problems caused by too much debt and inflation. But more inflation can never be the cure for rising prices, and piling on more debt can’t solve a condition of insolvency.

Since its inception in 1913, the Federal Reserve has been the perpetuator of asset bubbles. From the Fed-induced bubble of the 1920s that led to the Great Depression, to modern-day bubbles in Nasdaq and real estate, the Federal Reserve’s manipulation of the cost of money has created a bubble economy. And today, the Federal Reserve is perpetuating its largest bubble since its inception—the bubble in the U.S. debt. This book will give you the tools to understand how the Fed created these bubbles and what we as a nation can do to return this economy to a more stable footing. In addition, investors will learn the best way to protect their wealth before and after the bubble bursts.

After World War II the world moved away from hard metal currencies in favor of fiat currencies. Fiat currencies are created by government decree, backed by nothing, and have their worth based on the faith placed in autocrats. Governments can incur tremendous amounts of debt and can always make good on their principal and interest payments because they can print money. Therefore, default initially comes through inflation. Default via inflation is worse than actual default. Inflation is a hidden tax that disproportionately affects those least able to pay it: the middle class and the poor. Default via inflation is always the last step before an actual default.

The fiscally irresponsible administrations of both Democrats and Republicans have placed this great nation on the brink of bankruptcy. And in this book you will learn that throughout history, government spending and money printing has always led nations down the wrong path—the path that leads to a currency and debt crisis.

Currently, the Federal Reserve is pumping scores of billions of dollars each month into the economy in an attempt to reflate the housing bubble. Of course, rising prices occur every time the central bank prints money in excess of what is necessary to address population and productivity increases—the Fed knows this. Inflation is often defined as too much money chasing too few goods. The Fed wants the “too much money” they are pumping into the economy to start chasing real estate in order to reflate the real estate bubble and rescue the banking sector. But the Fed’s fake money isn’t only going back into real estate; sure, it’s driving mortgage rates to the lowest they have been in history, but it’s also driving up the costs of food and energy, while—most importantly—allowing the federal government to, for now, painlessly take on an enormous amount of debt.

Bernanke and Company are operating under the assumption that they can turn off the easy money spigot anytime they want. Instead of providing a strong and stable dollar that would encourage saving and investment, they have opted for cycles of counterfeiting and monetizing that will lead this economy into a depression never before seen. But the truth is, in the long term, the free market controls the cost of money and when our creditors demand an interest rate closer to historic norms, the United States will experience a debt crisis the likes of which the world has never seen.

But you still have time to protect all that you have worked hard for. And we as a nation still have a small window to turn this all around.

In this book we will explore how the bubble was created and delve into the failed fiscal and monetary policies that have gotten us to the dire situation we are in today. We will look back through history and explore how currency debasement and debt monetization has always led to hyperinflation and chaos. We will compare the current condition of the United States to that of Europe and Japan and question how long a worldwide economy can continue on the fiat currency model.

We will explore some historic debt debacles and speculate what a bond market crisis would look like here. We will also suggest how following the path our founders set out in the Constitution, coupled with free-market principles, will get us back to prosperity—and what we can do now as a country to ameliorate the crisis.

Finally, you will be given some great ideas about how you should manage your portfolio to navigate through the tough times that lie ahead.

The United States is now facing an entirely new paradigm. Onerous debt levels have reached the point to which the central bank will soon be forced into a difficult decision—either to massively monetize the trillions of dollars’ worth of our nation’s debt or allow a deflationary depression to wipe out the economy. History clearly shows that the path of least resistance is to seek inflation as a panacea. But you don’t have to let the whims of government wipe out all that you have worked hard for.

The 30-year bull market in bonds started when the U.S. Fed, under Paul Volcker, vanquished inflation. In sharp contrast, we now have global central banks in a coordinated effort to fight deflation—with Banana Ben Bernanke in the vanguard. Once they succeed in generating the inflation they so greatly desire, it will commence the ugliest bear market in bonds that has ever existed. But this coordinated Fed-induced disaster doesn’t have to be your ugly bear. This book will arm you with the knowledge to not only understand and prepare for the inevitable economic cataclysm but to capitalize on it as well.

Acknowledgments

I want to provide a special thank you to Justine Coleman for her efforts in creating this work. Her knowledge, skills, and talent were indispensible toward its creation.

Chapter 1

As Good as Gold?

Nature’s first green is gold,

Her hardest hue to hold.

Her early leaf’s a flower;

But only so an hour.

Then leaf subsides to leaf.

So Eden sank to grief,

So dawn goes down to day.

Nothing gold can stay.

—Robert Frost

On a hot summer night, August 15, 1971, the Who played to a sold-out crowd in Bloomington, Minnesota. Their music spoke to a generation that sought a journey down a different path from their parents . . . a generation that had grown hostile with rules and authority . . . a generation eager to put aside the old ways and forge a new path . . . create a new world, a better world. They promised themselves they wouldn’t get trapped in the sins of the past; they vowed that this time things would be different.

On that same night, a president addressed the nation in a similar vein. It is unclear if Richard Milhous Nixon knew who “the Who” was, but his message for the country was much the same. He, too, wanted a new direction. Toss out old rules that were holding back an economy, in favor of building a New Prosperity—one that would move America forward while “protecting the position of the American dollar as the pillar of monetary stability around the world.” He addressed the nation . . .

I have directed Secretary Connally to suspend temporarily the convertibility of the American dollar except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.

Now, what is this action—which is very technical—what does it mean to you?

Let me lay to rest the bugaboo of what is called devaluation.

If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.

The effect of this action, in other words, will be to stabilize the dollar.1

If you needed any more proof that Dick was not only a horrible president but that he also knew next to nothing about economics, that should close the case. According to Mr. Nixon, Americans need only to worry about a crumbling currency while on vacation—if they could still afford to take one. He either was lying or simply just unaware that when a central bank can print money by decree and is not fettered by the strictures of a gold standard, not only does it lower the exchange rate of the dollar against foreign currencies, but it also lowers its exchange rate against everything you need to purchase within the United States. But even more damaging, the ability to increase the money supply at will has also been the progenitor of every bubble that was ever created.

Nixon’s plan for “New Prosperity” was decided in haste over a weekend summit at Camp David. With this speech, Nixon ended the agreement of Bretton Woods that placed a value internationally on the U.S. dollar’s ability to be exchanged for gold at a fixed amount—in this case, $35 an ounce. It is clear from tapes later obtained from that weekend that Nixon wished to remove any impediment that would keep the Federal Reserve from “printing like crazy.” Nixon was up for reelection. The recent influx of soldiers returning home from Vietnam was creating a spike in the unemployment rate, a spike that he wasn’t sure the market could work out in enough time. Paranoia was setting in. . . .

With this speech, the U.S. dollar was no longer collateralized by gold; it no longer had a precious metal backing. The U.S. dollar was now a fiat currency—a currency established by government decree. Although Nixon loathed economics and monetary policy, it wasn’t lost on him that a fiat currency gives a government carte blanche to spend without taxing. Governments can incur tremendous amounts of debt and can always make good on their principal and interest payments because they can print money. Default comes through inflation instead. Default via inflation is worse than actual default.

Inflation is a hidden tax that disproportionately affects those least able to pay it: the middle class and the poor. Inflation provides a disincentive to savers; it favors borrowers, as borrowers get to borrow in today’s dollars and pay back in tomorrow’s cheaper dollars. Inflation destroys the standard of living of the elderly and those who rely on a fixed income. Inflation breeds resentment among economic classes and contributes to political unrest and disunity. A nation that resorts to the use of fiat money has doomed itself to economic hardship and political disunity.2

On that fateful night, Nixon eliminated the final link the dollar had to gold. It was Franklin Delano Roosevelt (FDR) in 1933, in a move that accelerated bank failures during the depression, who originally took the dollar off the gold standard. We will address the Great Depression in more detail in the next chapter; however, it is clear from centuries of history that when a nation moves off of specie (metal), its population loses confidence. As Ronald Reagan once said, “A great nation that moves off gold doesn’t stay a great nation for long.”3

It is no surprise that the 1970s were a tumultuous period in American history. Much like today, it was a period of stagflation—rising prices and zero economic growth. Your income went down and the cost of everything you purchased went up. Since 1973 the American paycheck has been decreasing in real dollars. Between 1971 and 1982, the cost of living increased from 3 percent to 15 percent, yet the unemployment rate soared from below 6 percent to just under 11 percent. Taking into account Nixon’s decision to go off gold in 1971, it’s no coincidence that the cost of living started to increase from the 3 percent level to the double digits later that decade.

Let’s put in it terms even “Tricky Dick” could understand. Take Pat Nixon’s “Republican cloth coat.” If that coat cost $18 in 1971, it would cost $100 today—good thing Pat didn’t want the mink! In 1971 the Nixons could buy a can of dog food for their dog Checkers for $0.22; that same can costs $1.25 today. How about the cost of bugging the White House or a Watergate break-in in today’s dollars—yikes! Nixon would have a hard time making his famous claim “I am not a crook” because on that day in August 1971, Richard Nixon robbed from every American alive and from future generations—he stole a precious-metal-backed currency from a nation and robbed its people of their purchasing power.

One has to wonder if a young Tim Geithner was watching on the night Nixon addressed the nation. Sitting in front of his Philips color TV, with his Little Joe cowboy hat and holster on, geared up to watch Bonanza, his favorite show. Ah, the disappointment that little Timmy must have felt knowing it would take another week for him to enjoy the exploits and adventures of the Cartwright family on Ponderosa ranch. I can’t imagine that little Timmy realized then what a favor was bestowed on him that night. His future job just got a whole lot easier. He would never have to ponder the question of “who is going to buy all this debt I’m selling at these lousy rates?”4

Thanks to Nixon, Tim just has to tell Ben to keep the printing press going.

The Great American Money Machine

Today our counterfeiter–in-chief, Ben Bernanke, holds the lofty position as the veritable “Master of the Universe.” He sits at the helm of the ultimate printing press and controls the reins of the Great American Money Machine—also known as the Federal Reserve. Ben holds the ultimate power of the known universe: the power to create the world’s reserve currency, the U.S. dollar, out of thin air. I often wonder how many people in the country even know who Ben is or what the Federal Reserve does. One could conjure a “man on the street”–style inquiry affirming who has more name recognition: Ben Bernanke or Kim Kardashian? Unfortunately, while some were busy “keeping up with the Kardashians,” the “geniuses” at the Federal Reserve have been wreaking havoc with our economy, destroying the purchasing power of the dollar and savaging the middle class. Now you could counter that Kim seduced her audience into watching an entire season consumed by her sham marriage to Kris Humphries. But since I have just told you everything I know about Kim Kardashian, for the purposes of this book, let’s focus on Bernanke, the Federal Reserve, and how they have helped create the biggest and most deadly bubble in the history of the planet.

To do this, our story takes us back to the year 1907, and like all great government power grabs—this one begins with panic. . . .

The panic of 1907 was a financial crisis that almost crippled the American economy. Major New York banks were on the verge of bankruptcy; at the time, there was no mechanism to provide timely liquidity. J. P. Morgan, a prominent banker of his day, stepped in personally and took charge, resolving the crisis. Similar to banks today, the banks in 1907 operated on the assumption that people don’t move in unison in demand of their deposits on the same day. The “run on the bank” that ensued after the 1907 crisis gave the public anxiety and led the politicians to create a mechanism for a “lender of last resort.”

The United States had forayed in central banking over its, at that time, more than 100-year history. Past attempts at central banking had failed miserably; they proved the central bank corrupt and left a population disillusioned and disgusted. But those who embraced an illusory concept of a “new paradigm” certainly saw a “new time” in America. One can speculate that some in the political establishment of the day thought that this time things were different—that different times called for this kind of authority and that these “new times” would result in a different outcome.

It’s important to explore the political climate in place in 1907 and the years leading up to the creation of the Federal Reserve. Teddy Roosevelt ran as a Republican, but he was really a Progressive. I love the term Progressive because it is so unapologetically misleading. The term Progressive makes you think “progress,” and who doesn’t want progress? Progress is great. If you look the word progress up in the dictionary, it’s defined as moving toward a goal, to advance. I love progress and advancement! Progressives must have been great . . . WRONG! These Progressives aren’t interested in my progress or your progress; they aren’t interested in the advancement of the individual. Progressives want the government to progress; they want the government to advance. They see progress when the government takes power from the individual and transfers it to government. So when I eat right and exercise, I think, “I’m making progress toward my goal of staying healthy and getting in shape—great!” But it’s only progress to a Progressive when Michelle Obama tells me what to eat and how much to exercise. I think you get my point.

The Federal Reserve was created during a time when all kinds of “progress” was being made, so you would have to assume a major government power grab was in play, and believe me . . . this power grab didn’t disappoint!

There are hundreds of books written about the creation of the Federal Reserve, and this book doesn’t pretend to be one of them. I do not plan at this time to labor through the political posturing and the various iterations that went into the creation of the Federal Reserve. It is noteworthy that unlike Nixon’s ending the gold standard, the architects of the Federal Reserve took a lot longer than a weekend. Like Rome, the Federal Reserve wasn’t built in a day. In retrospect, maybe too long—by the time the Federal Reserve opened its doors on December 23, 1913, it was clear that its original purpose, to prevent a run on the bank, was obfuscated.

In his book The Creature from Jekyll Island, author G. Edward Griffin points out that the Federal Reserve is neither federal nor is it a reserve—in fact, it is not even a bank.5 But the deception just starts there. It is, in fact, a private company whose directors, or governors, are made by public appointment. It was deceptively designed to appear separate from the federal government, to delude the masses into believing that it was making sound monetary decisions independent of political pressures. It is a centrally planned organization that directly influences every aspect of the American economy. It holds a monopoly on dollar printing and runs a cartel on short-term interest rates. It is an organization like no other. It is the money machine of the federal government that enables the state to borrow far in excess of the private sector’s savings.

Just think, as recently as a decade ago Ben Bernanke was pontificating economic theory with a bunch of college students at Princeton University. Then, we can imagine, one day while Ben was debating the Keynesian theory of money demand in the faculty lounge with Paul Krugman, the “red phone” rang. Ben was selected to join the group of “superheroes” tasked with managing the economies of the world at the Halls of Justice, also known as the Federal Reserve. A mere three years later, Ben ducked into a phone booth with Alan Greenspan. When Ben later emerged, he donned the cape and held the title of “Master of the Universe.”

Now if you are a fan of comic strips, and even if you’re not, you know that all superheroes have superpowers—Ben’s powers at the Fed are no exception. The Federal Reserve has three powers at its disposal to manipulate the supply of money.

The first is the reserve requirement, or the amount of money depository institutions must hold on hand against specified liabilities. And by liabilities I mean your money on deposit at the bank. The Fed dictates how much of a depositor’s money needs to sit on hand with them for safe-keeping. We will go just a bit more into this when we consider how money is created and discuss fractional reserve banking later in this chapter. For now, just consider that an easing of the reserve requirement theoretically gives banks the leeway to increase their lending; in turn, increasing the requirement would have the opposite effect.

Next is their cartel on the discount rate. The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank’s lending facility, also known as the discount window. This gives the Fed complete control over the short end of the yield curve. When the discount rate is lower than the prevailing market rate and the yield curve is high, it provides a huge incentive for banks to borrow from the Federal Reserve and loan out at higher rates. Today’s rate stands at zero percent, and Ben has promised it will stand for a very long time.

Finally, we have Bernanke’s favorite superpower—drum roll please—open market operations (OMOs). Through OMOs the Fed usually purchases government securities from banks. However, as the credit crisis has clearly illustrated, if the Fed desires, it can also buy an entire array of toxic assets that are worthless.

Now, like Superman had kryptonite, Ben also has something that he believes weaken his powers—congressional oversight. One would assume that in giving a small group of unelected pseudo-bureaucrats so much power, the people who appointed them would need to know exactly what they were doing. Well, you would assume wrong. Remember, the Federal Reserve is a private company. So you don’t expect that Pepsi is going to open up meetings to the public where they discuss changes to their secret formula. The difference is that if Pepsi were ever to water down their product, the consumer would have the right to switch to Coke. When the Fed waters down its product (money), few people are afforded the discretion to make other monetary choices.

Therefore, the Fed enjoys not only a monopoly on money but also the latitude to hold many of its meetings in the “cone of silence.” In other words, nobody really knows what exactly these clowns are up to. Now, we can give Ben a little bit of credit—his predecessor, Alan Greenspan, seemed to speak in tongues. The media coined the term Fed Speak to describe Greenspan’s cryptic communique. It would take a panel of economists and financial types to decipher what Greenspan was saying. So, in this way, Ben is a veritable man of the people—even going as far as an appearance on 60 Minutes. Mr. Bernanke believes it should be Glasnost at the Fed. However, when your stock-in-trade is counterfeiting money, it isn’t really a good idea to promulgate what you’re up to.

Putting aside Bernanke’s plain-spoken and more accessible posture, he still is obstinate about keeping most meetings and dealings with other central banks secret. There is currently a movement in Congress to audit the Fed, which Bernanke is vehemently opposed to. Apparently, if we knew what he was doing, this would weaken his superpowers and jeopardize the power he holds to control the economy. Maybe Ben should realize that’s the point.

“Dad, Where Does Money Come From?”

As a father of two young children, I grow anxious for the day my son will ask the question every parent anticipates: “Dad, how is money created?” My answer will go something like this: “Son, when the U.S. Treasury and the Federal Reserve really love each other, they create money.” . . . Judging by the amount of money being created today, it is clear that Ben and Tim have a Brangelina kind of love.

The Federal Reserve doesn’t actually need the Treasury; it can create money all on its own—but money is usually created at an administration’s prompting. Tim and Ben, like so many high-profile couples these days, make use of a surrogate to create money. The Federal Reserve introduces new money into the system by increasing its balance sheet through the purchase of financial assets and by lending money to banks. Then, something amazing happens—the money multiplies. This money magic is brought to you by the fractional reserve banking system and this is how it works:

Let’s assume a very simple banking system: we have one bank (Bank A) and a central bank (the Federal Reserve).

You make a deposit of $100 in a checking account, and the Federal Reserve requires Bank A to deposit a fraction of it, let’s say $10 of the $100, with it for safe-keeping. This is the Fed’s Reserve Requirement, and they reserve the right to increase or decrease the percentage held in reserve.

Bank A now has $90 burning a hole in its pocket, ready to loan. Now, technically, this is your money, on loan with Bank A, and you have the right to demand this deposit at any time, but Bank A isn’t going to spend a lot of time worrying about that. After all, it just deposited $10 with the Fed, so it’s good—right?

Well, not much time has to pass before another person comes along and borrows the $90 from Bank A. Now, Bank A pays you interest on your deposit at today’s rate (which is likely next to nothing) but charges this new person, let’s call him Bob, 5 percent for your $90. This may not seem fair, but remember, with the deposit at Bank A, your money is “safe”; it’s not just tucked under your mattress—it’s now safely deposited in a vault at the bank. Well, actually a fraction of it is deposited, the rest just walked out the door with Bob, but I’m sure he’s a great guy.

Now, Bob has all sorts of plans for your $90, but while these plans coalesce he decides to deposit the $90 in Bank A, so it stays “safe.” Bank A considers this as an additional $90 deposit and it deposits $9 with the Fed and has $81 to lend out. It then loans that $81 to Mary, and this continues. Of course, you can forget most of what you just read because: U.S. regulatory changes implemented during the early 1990s effectively removed the requirement for banks to hold reserves. They must hold reserves for demand deposits, but through the process known as “sweeping” they are able to get around this requirement by moving that money into time deposits. Therefore, in effect, banks can expand the money supply far beyond the reserve requirement as long as they have the required regulatory capital to do so.

As I said before, this is called fractional reserve banking, and it allows money to multiply; this calculation is conveniently called the money multiplier. Now, all this is great until Bob and Mary buy houses that they really can’t afford and default on their loans, and you get antsy and want your $100 back. This is where the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve come in; they stand ready to bail out the bad decisions that Bank A made with your money.

Over the past few years, the Federal Reserve has been utilizing its OMOs to push money into the economy in a system called quantitative easing (QE). QE is a “last resort” for central banks when interest rates are already at zero percent. Simply put, the Fed buys Treasury notes and bonds from banks, giving banks money. The hope is that the banks will use the proceeds to lend more money—often to the government—and increase the amount of money in circulation.

We suffered through multiple rounds of it, and the only thing it did was boost inflation to 3.9 percent (as the government miscalculates it) and boost the money supply of M2—a measure that includes outstanding currency and money in checking and savings accounts—to a 29 percent annualized rate.

That is, while the U.S. economy is still in the doldrums, the amount of money in the system ballooned. If you don’t feel the effect of that money, that’s because it hasn’t made it to your pocket; you’ll see where it ended up in a minute.

So what went wrong? Why didn’t QE fix everything?

Well, the Fed was right—if you give banks money, they will lend it out. The problem is, instead of lending it to you or me, they happily lent most of it to Uncle Sam. Yep, the banks sold Treasury notes to the Fed and then used the proceeds to buy more Treasury notes. This obviously hasn’t helped the economy, but it has enabled the government to sell debt at low rates and run an annual budget deficit in the trillions.

As I write, the Fed through its OMOs will be moving toward a run rate of funding about 75 percent of our annual deficit. We have indeed become a banana republic that now monetizes most of its new debt. While most global central banks have adopted the specious idea that prosperity comes from a depreciating currency, the Bernanke Fed is leading the way toward ensuring that the U.S. dollar loses its status as the reserve currency of the world. The United States has left interest at near zero percent for almost four years and has the central bank on record saying that inflation is far below their comfort zone. Therefore, because Bernanke is doing everything in his power to step up the dilution of the dollar, the rest of the world may soon reconsider their decision to continue to park their savings in dollar-denominated assets.

Since the endless QEs have failed to get this economy moving, Ben has created a new dance move he calls Operation Twist. This is Ben’s attempt to manipulate the long end and flatten the yield curve. With long-term interest rates at an all-time low, this new move seems a little like kissing your sister—in other words, pointless. Apparently, the individuals at the Fed aren’t satisfied with all the destruction they have already caused by printing money, keeping reserves low and keeping the discount rate at zero. Ben and his “Merry Men” of manipulators seem not to be content with their cartel on the short end of the curve; these legalized counterfeiters are determined to do the maximum intervention possible in order to not allow this economy to liquidate and experience a real recovery. Imagine that! I realize it’s terribly out of fashion, but the only way this economy will achieve a viable recovery is if we allow markets to work.

There is no doubt that Bernanke has been remarkably successful in destroying the purchasing power of the dollar and in his quest to increase the rate of inflation. However, the truth is that there is no credible exit strategy for the Fed. There is only the prospect of suffering through either a deflationary depression or hyperinflation. Such will be the consequences of not appropriately dealing with our problems of debt, asset bubbles, and inflation in recent history.

The Implications of a Fiat Currency

Let’s review. First, the U.S. dollar is no longer in any way, shape, or form linked to gold. Now, you might say, “Pento, enough with your obsession with gold—who cares?”

My response is: First, I don’t have an obsession with gold. But I do want to make a few points about why it matters—please bear with me.

Take out a dollar from your pocket and think to yourself—what is this worth? The answer is that it’s worth what it will buy you. So if I take this dollar and go to the store and buy a cup of coffee—which, by the way, if you know of a store that sells a cup of coffee for a dollar, I would like to know where that is; I pay a lot more than that. But I digress; if you buy a cup of coffee for a dollar, then that’s the value of the dollar—a cup of coffee. Now, let’s imagine that next week that same cup of coffee costs $10—now what is the value of the dollar? You are less certain because you are starting to lose confidence in your dollar’s value. The next week the coffee is $100—wow! Now you use all the dollars you have to stockpile coffee—you cling to a hard asset, and it dawns on you what a fiat currency really is. That dollar was worth something only because you believed it to be worth something.

The dollar is a fiat currency—it has no real value beyond your confidence in it. No one worked to produce that dollar; no one put their hands in the dirt and got sweat on their brow to deliver that dollar to you. That dollar was created by the Federal Reserve and the fractional reserve private banking system out of thin air. And your confidence in it is your confidence in them.

To paraphrase Milton Friedman, there are no angels in government and there are no angels at the Federal Reserve. They are men and women who have intellectual limitations and are subject to the same pressures as all humans. Earlier, I spoke in jest of Ben Bernanke as a superhero—in case this point needs clarification . . . he’s not. As far as I know, and maybe Donald Trump could verify this, Ben Bernanke was born on planet Earth—he is a human being. Prior to joining the Fed, he was a professor at Princeton University; I mention this only to inform you that he wasn’t beamed down to Earth by some great deity who bequeathed him with all the answers to the world’s monetary questions. Yet he gives the pretense that he was. But ask yourself: is Ben Bernanke smarter than the institution that brought prosperity and stability to the Byzantine Empire for over a thousand years? Can he outintellectualize the standard that engendered the Industrial Revolution—the most prosperous time in this nation’s history? Is Ben Bernanke as good as gold? He’s not. He is just one man who has been erroneously granted too much power.

The chairman of the Federal Reserve is not superhuman and, as such, should not be bestowed with such supremacy over money. You see, even though Superman is a fictional character, his creators had the foresight to have him originate from another planet. Why? Because they know that any human who has x-ray vision would spend his days undressing Lois Lane, and any human that could leap tall buildings would be a starter with the New York Knicks, not making minimum wage as a beat reporter at a second-rate newspaper. Superman is from Krypton because his creators knew that if humans here on Earth were given such power they would find it impossible to exercise such restraint; humans are vulnerable to their own mortal imperfections. Federal Reserve chairmen are vulnerable to facilitating reckless government spending and temerariously using their power in a misguided attempt to save the world.

Why a gold standard? The gold standard is the world’s natural God-given money supply regulator; it has held the test of time. Gold is mined at about a 1 percent increase per annum in supply, so that would mean that gold would flow into the system and the money supply would grow at 1 percent—which is about consistent with U.S. population growth. Take into account a mild deflation resulting from productivity growth, and there you have it: stable money, limited government debt, and no bubbles. A gold standard saves political types from themselves; it forces nations to make choices. No currency should be held hostage by the inherent weakness of man.

During the Johnson administration, the political debate revolved around the need for guns or butter. Up until recently, we haven’t required those choices from our politicians; it’s been guns, butter, health care, bridges to nowhere . . . the list goes on. And there is an illusion that we haven’t been paying for it, but we have—through the devaluation of the dollar and the accumulation of future government liabilities. After all, government debt is simply a tax on future private-sector production with interest. And unless our government wants to admit that U.S. debt is a Ponzi scheme that can be financed only through rollovers, the buyers of our debt must be convinced at all times that we can pay back every dollar borrowed.

But lately they haven’t been fooling as many as they used to; people out there are starting to realize it—people feel what is happening. You can delude the masses for only so long. From tea party rallies to Occupy Wall Street, their lives embody the effects of a fiat currency. Their voice is born from the erosion of the middle class.

Remember—with a fiat currency, governments can incur tremendous amounts of debt and can always (ostensibly) make good on their principal and interest payments because they can print money. Default comes through inflation instead. Default via inflation is worse than actual default. The political types will always implicitly default via inflation before they explicitly default. An inflationary default is surreptitious in nature and so much more palatable at the start.

So go ahead—call me a dinosaur, claim that I am archaic and a barbarous relic . . . I admit it, I believe in the virtues of the gold standard. In the following chapter, we will see that throughout history a deliberate increase in the supply of money has disastrous consequences—and provides a foundation for my argument that the current increase in the money supply courtesy of the Fed has led to what I believe to be the biggest bubble ever.

So fasten your seatbelts—it’s going to be a bumpy ride. In the next chapter, we travel all the way back to the 1600s.

Notes

1. Office of the Federal Register, “Richard Nixon,” containing the public messages, speeches, and statements of the president—1971 (Washington, DC: U.S. Government Printing Office, 1972), 886–890.

2. G. Edward Griffin, The Creature from Jekyll Island: A Second Look at the Federal Reserve (New York: American Media, 2010).

3. Ron Paul, End the Fed (New York: Grand Central Publishers, 2010).

4. Although it is unclear if Tim Geithner actually watched Nixon deliver his speech, we do know from Watergate tapes later obtained that Nixon’s staff struggled with preempting Bonanza.

5. Griffin, The Creature from Jekyll Island.

Chapter 2

The Anatomy of a Bubble

History doesn’t repeat itself, but it does rhyme.

—Mark Twain

In the middle of the seventeenth century, the Dutch Golden Age bestowed many marvels on the world—the artist Rembrandt; the scientist Huygens; the first stock exchange, multinational corporation, and, unfortunately, central bank. It shouldn’t then be a surprise that the creation of the first legalized counterfeiting institution brought about the first speculative bubble revolving around a frenzy over tulip bulbs.

The Netherlands became a major political, economic, and scientific power in Europe during its 80-year fight for independence, spanning the years 1568 to 1648. A large influx of money and intelligence helped the rise of the Dutch republic. These factors are recognized as the main driving force of establishing the Dutch Colonial Empire and mark the beginning of an era in Dutch history now known as the Dutch Golden Age.

At the height of the Dutch “Golden Age,” 1634 to 1637, it is surmised that the price of some rare tulip bulbs garnered as much as 5,000 guilders, or as much as 10 times the annual income of a skilled craftsman. At its peak in 1636–1637, it has been said that an average tulip bulb changed ownership as many as 10 times a day. At times, the price of a tulip bulb was deemed to be worth more than the ground they could be grown on. It may have been the bubonic plague talking, but the Dutch seemed in an absolute frenzy over their newly imported tulips. In February 1637, the number of tulip bulb sellers greatly outnumbered the tulip bulb buyers, and the tulip bulb price fell dramatically, ending what was referred to as tulip mania—the first speculative bubble in modern history.

A cursory review of tulip mania may lead one to conclude that the Dutch during this time period were caught up in a phenomenon Alan Greenspan, centuries later, would refer to as irrational exuberance. John Maynard Keynes hypothesized this as “animal spirits.” Both Greenspan and Keynes propose that people working spontaneously in their own self-interest in search of profits are apt to make reckless decisions. These initial investments yield a sizeable profit, leading additional “speculators” to enter the market; the cycle continues until some poor fool is left holding the proverbial tulip bulb with no seller to be found. Anyone who lived through the 1980s and bore witness to the parachute pants and mullet frenzy would conclude that people do synchronously make questionable decisions. However, as we shall see, a speculative bubble takes more to galvanize than just some enigmatic fashion choices or a fascination with tulips bulbs.

Let’s follow the money in search of some other explanations for tulip mania. In his book Early Speculative Bubbles and the Increase in the Money Supply,1 Doug French explains that an enormous increase in the money supply at the Bank of Amsterdam from 1630 to 1638 coincided with tulip mania. During the 1600s, the Netherlands was the banking and trading capital of the world. Everyone wanted to partake in the strong Dutch currency, and courtesy of the Dutch Central Bank they were able achieve that. Now, I want to make one thing clear: the Dutch Central Bank wasn’t run by the counterfeiters that run the central banks of the world today. To the contrary, the Dutch had a hard metal currency. While other governments were debasing their currency, the Dutch model provided a sound monetary system.

The Bank of Netherlands partook in a monetary practice called free coinage. With free coinage you could exchange gold or silver bullion at the Bank of Netherlands for guilders and ducats. This allowed foreigners to deposit their worn-out gold and silver foreign currency and receive a beautiful, shiny guilder. Dutch currency was in demand, as the Dutch were sought-after trading partners. In some respects, the Dutch fell victim to their own success. The free coinage system in conjunction with the stability of the Dutch banking system led to an inflow of precious metal toward Amsterdam. It was this that led to the increase in metal or specie into the Bank of Amsterdam and thus an increase in coinage and the notes issued (i.e., the money supply).

As in all speculative bubbles, the inflation that the increase in the money supply created led to an increase in speculation and malinvestments. Those malinvestments manifested themselves in tulip bulbs. Similar to today’s speculative bubbles, we see evidence of financial pain in the Netherlands subsequent to the bust—an enormous increase in the number of bankruptcies indicates that the consequence to the economy may not have been limited to tulips.2

A little less than a century later, Scottish economist John Law would distort the Dutch banking paradigm and mold it into his inauspicious model of a central bank that would lead to another speculative bubble. John Law was an eighteenth-century Ben Bernanke–meets–Bernie Madoff. Born in Scotland in 1671, son to a wealthy Scottish goldsmith, Law gambled away his inheritance and killed a man in a dueling match over a common love interest. Law managed to bribe his way out of jail and began writing his piece of monetary fiction called Money and Trade Considered, with a Proposal for Supplying the Nation with Money (1705). Disseminating his fairy tale economic theories that only the likes of Paul Krugman would appreciate, Law laid out his “Real Bills doctrine.” Ironically, this unequivocally refuted doctrine was used as a cornerstone of the Federal Reserve Act of 1913. Shocking!

Law proposed the blueprint for a central bank that would be able to increase the money supply at whim. According to Law, money didn’t need to be backed by gold or silver; money could be backed by land or by nothing at all. The increase in money would subsequently be at the discretion of government. Increasing money would create all sorts of great things—a kingdom could enjoy low interest rates and full employment, all the while keeping prices completely stable. WOW—sounds great! Why doesn’t anybody think of doing that today? Oh, that’s right—that’s what our Federal Reserve does. At the beginning of the eighteenth century, Law’s ideas were novel and heretical; today, unfortunately, these misconceptions are commonplace.

Law peddled his piece of propaganda fiction to various kingdoms with no success. Finally, the French government, struggling with an enormous amount of war debt and the untimely death of their king, wasn’t in the position to let the truth get in the way of what was obviously a very good story. In 1716, John Law created the Banque Generale that later became the Banque Royale, France’s first central bank. The Banque Royale was a private company that had a monopoly on money and financed the French debt; 75 percent of its capital was the debt of the French government. Hmm . . . this is sounding familiar.

Law initially enticed the French people with hard currency in order to gain their trust, and then he peddled his bank note paper currency. Law eventually outlawed the hoarding of precious metal—even jewelry—forcing the French to use his newly created currency.

The French government was straddled with debt from all their various wars. Law and a friend came up with a clever plan to assist France in unburdening itself of debt. Law, through the government, bought and consolidated a trading company called the Mississippi Company, which held France’s rights to trade internationally and more specifically in Louisiana. Law developed elaborate schemes to drive up the price of these shares. Later decreeing Mississippi stock a de-facto currency, as the stock went up in value the King would get 75 percent of the profits, Law would get 25 percent, and the French people would get . . . well, they wouldn’t make out that well on this deal!

Greed quickly set in. Looking to increase his profits, Law created a marketing campaign that greatly exaggerated the wealth of the Mississippi Company, driving speculators in. In 1720, people started to wise up, shares of the Mississippi Company fell, and Law was run out of town.

One can only muse that Law, if he were around today, would have secured a reappointment or perhaps even a promotion to Treasury secretary. After all, as the current logic goes, who better to “fix” all the problems than the person who created them in the first place? Unfortunately for Law, the government of France was not that naïve; Law was extradited to Naples, where he lived out the remainder of his life trying to convince the Italian government to partake in a similar scheme.

Over the past few centuries, enormous innovations have transpired; however, the basic principles of economics still hold true. Like tulip mania in the 1600s, an increase in the supply of money fuels all bubbles and can create a euphoric feeling, giving way to irrational exuberance. Greenspan conveniently fails to mention that this exuberance is actually a symptom of easy money and not a phenomenon unto itself.

Counterfeiters like John Law have existed throughout time and are in abundance in central banks all over the world today. Over the past thousands of years, nations have promulgated devaluation in their currency as a means to mitigate their economic problems. Today, central banks in Europe and the United States are counterfeiting money as a means of alleviating malaise brought about by insolvent nations saturated in debt. Sadly, as history will attest, this never ends well.

Every generation likes to think of itself as living in unique times; many are deluded to believe that their encounters are unique and perpetuate the myth of a new paradigm. Empires that hold the world’s reserve currency eventually succumb to their own hubris and delude themselves into thinking they are above the laws of economics and mathematics. Pundits often argue this new paradigm as a way to dispel universal truths concerning monetary policy and economics. There is no new paradigm; throughout history, nations have never printed their way to prosperity. This time is no exception.

The Great Depression—A Historical Comparison

Today’s counterfeiter-in-chief, Ben Bernanke, touts his bona fides as a student of the Great Depression; he credits his easy monetary stance on a belief that the 1930s’ Fed provided policy that was excessively restrictive and these policies prolonged the length of the Great Depression. Let’s take a look at the Great Depression and see what really happened.

Immediately after its inception in 1913, the Fed got right to work funding World War I—“Wilson’s War.” The newly created Fed set the interest rate on what was then called a Liberty bond. The low-yielding Liberty bond enabled the United States to painlessly enter World War I, a war one could argue the United States may not have entered had a tax on its people been levied.

When the United States exited World War I, there was a retraction in the money supply as the Fed was no longer funding a war, and a corresponding deflation in commodity prices ensued. The depression of 1920–1921 was characterized by extreme deflation—some prices dropped as much as 36 percent, worse than any year during the Great Depression. The deflation was a natural occurrence of the market in response to unwinding the deliberate inflation created by the Fed to fund the war. If you have never heard of this depression, it is because it was short. Why? Because the deflationary process was allowed to occur, malinvestments were allowed to be liquidated, and the economy quickly healed.

The political climate had changed; it seems that America had enough “progress” and elected Warren Harding, who promised a “return to normalcy.” Warren Harding died in office, and Calvin Coolidge became president in 1923. Calvin Coolidge was the last bastion of true conservatism in this country. Coolidge was a leader who believed in minimalism in governing, or laissez-faire—he had faith in what Adam Smith described as the invisible hand.

The newly created Federal Reserve, in a move that would eerily mirror events that occurred in the mid-2000s, decided to take an activist role in the 1920s’ economy. In an attempt to raise prices, help farmers, help the British, and help bankers (most particularly Paul Warburg, one of the creators of the Fed), the Federal Reserve engaged in reckless monetary behavior—what a surprise!

At its inception, the discount window was viewed as the Fed’s “lender of last resort” refuge—a place where banks could come in an emergency, borrowing at a penalty, set to reflect a slight increase to the market. This was designed so the Fed knew that the new money created would retreat from the economy when the emergency subsided. However, during most of the 1920s, that rate sat well below market rates and provided a constant source of liquidity to the economy. Many economists and market strategists, including myself, have studied the Fed in the 1920s and have concluded that the Fed was excessively accommodative during this time. The Fed’s easy-money policies perpetuated an overextension of credit that led to the 1920s’ bubble.