What is Money?

By Peter Schiff
Excerpted from the new economic bestseller, The Real Crash.

Today, we’re accustomed to thinking of small greenish paper rectangles as the definition of money, and we think of the US government as the only source of money. To honestly discuss sound money, we need to realize where our current money customs came from.

At first, it was every man for himself. You ate or wore what you could pick or catch.

Barter was the first advance. If you had some extra meat, and your neighbor had an extra fur, you might make a direct exchange. If food, water, clothing, and simple tools are the only goods on the market, barter is fine – you can always find someone who has what you want and wants what you have.

But as soon as there’s basic manufacturing and prosperity begins increasing, barter becomes inadequate. Say you’re a hunter and you want a bed, but the only bedmaker in town is a vegetarian. What do you do then? You would have to figure out what the bedmaker wanted (maybe tofu), and then find someone who had tofu and wanted meat. If you couldn’t find that person, you would have to find a fourth person (someone who wanted meat, and had the hats that the tofu maker wanted), or try to convince the vegetarian bedmaker to take the meat and trade it for something else.

Meat, however, spoils, and so the bedmaker would have to unload it pretty quickly. So, unable to get your hands on anything the bedmaker wants to consume, you trade your meat for some salt and approach the bedmaker.

“Look, I know you don’t want salt, but think of all the people who do. They use it to preserve their meat and flavor their soup. And this stuff is nonperishable, so you can hold it as long as you want. And if, when the tofu dealer comes through town, he doesn’t want salt, you can explain to him what I’ve explained to you – he can use it to buy something he wants.”

If you and the bedmaker agree, you’ve just created money. Organically, more people in your community begin taking salt for payment, even if they have no intention to use it, because they know others will accept it.

But – and this is important – the value of salt money is not entirely dependent on other people accepting it as payment. If, for some reason, folks stopped taking salt as payment, you could use it as, well, salt.

Salt was a pretty good currency, especially before refrigeration, because it was widely demanded, divisible down to the grain, very portable, easy to weigh, and could easily be tested for counterfeit by tasting it. Romans used salt for money.

But just because salt served as money didn’t mean there would be no other form of money in circulation. Tobacco leaves might be widely accepted as payment. So might gold or silver.

The Greatest Invention Ever?

The point is that money arises naturally in society, as a way of aiding in voluntary economic transactions. It was one of the greatest inventions ever. Money not only made it easier for people to buy what they wanted, it also made saving much more possible – you could accumulate excess money to spend at a later point.

While saving is frowned upon by the elites today, it’s an essential element in economic progress. By making it easier for people to save, money did two crucial things. First, it inspired more industriousness: there was now incentive to work harder to earn more in a day than you could spend in a day. Second, savings enabled ambitious entrepreneurs to make big capital investments: labor-saving machines, warehouses, transportation.

If the saver didn’t have any big plans in mind for his money, he could still make it productive by lending it out. Finance was nearly impossible without money. Sure, you could give your neighbor a pig this year in exchange for a pig and a chicken next year, but there would be a lot more opportunity for squabbling (“this pig isn’t as healthy as the pig I gave you last year”).

With a commodity money, where there is little or no deviation in quality, and using universal, objective measures, like weight, you can lend with the confidence that what you get back will be of the same quality as what you loaned out.

Money also made specialization more practical. If you were really good at one thing – manufacturing nails (to borrow Adam Smith’s famous example) – you could make a living just by making nails. Without money, someone who spent his whole day making nails would have to find (a) someone with excess food who wanted nails, (b) someone with excess shelter who wanted nails, (c) someone with clothes to spare who also wanted nails at that moment, and so on.

Once money is introduced, the nail seller only needs to find (a) people with money who want nails, and (b) different people with everything the nail seller needs who want money. Facilitating specialization creates efficiencies, as folks get to divide up labor according to skill and interest. In countless ways, money improves society.

Competing Currencies

In the past, different types of commodity money competed. Salt had its advantages, but also disadvantages – you had to keep it dry, it was easy to spill. In Rome, rising sea levels made it much harder to get salt over the years.

Meanwhile, gold had a lot going for it. It’s fairly easy to store. Like salt, it’s easy to divide, but also easy to combine: you can make blocks, or coins of different weights or denominations, which can be standardized. It doesn’t rust. It doesn’t tarnish or undergo other unpleasant reactions with chemicals.

Like any money, gold has underlying value. Mostly, we think of its decorative value – across nearly every culture, gold is considered beautiful. Women love it, and pleasing women’s fancies is universally considered a good thing. It has industrial uses due to its resistance to corrosion and how thin it can be hammered.

Gold is also rare enough to be valuable, but plentiful enough that it can be widely circulated. Its supply grows, but never very quickly.

No authority had to declare gold to be money. It arose as a good medium of exchange, and in many cases it won out in competition against other moneys. It didn’t always win out to the exclusion of other types of money, but it was probably the most successful money ever, thanks not to some order from above, but thanks to gold’s own attributes.

This is very important: money doesn’t come from government; it comes from civil society.

From “The Real Crash” by Peter D. Schiff. Copyright © 2012 by the author and reprinted by permission of St. Martin’s Press, LLC. Click here to order from Amazon.

Follow us on Twitter to stay up-to-date on Peter Schiff’s latest thoughts: @SchiffGold
Interested in learning about the best ways to buy gold and silver?
Call 1-888-GOLD-160 and speak with a Precious Metals Specialist today!

Walking Along the Hyperinflationary Cliff

Mark Motive’s Gold Commentary

Would you walk along the edge of a cliff? Sure, you walk around every day (and you’re probably pretty good at it), but knowing that the result of a small misstep would be catastrophic, you’d probably think carefully before walking along a cliff. In fact, you’d probably stay far away from the cliff altogether.

Today, the US economy is walking at the edge of a fiscal cliff. Yes, we’ve managed our way through crises before, but today the risks of even a small policy mistake are greater than ever before. And if we misstep, we’ll fall into the abyss of hyperinflation.

Hyperinflation, defined by economist Phillip Cagan, is a period in which prices rise at 50% or more per month. In some historical cases of hyperinflation, prices rose by a million times over the course of a year! As you can imagine, hyperinflation of this magnitude devastates an economy. However, even a comparatively lower degree of inflation (e.g. 10-20%) can effectively wipe out the purchasing power of savings within a short period of time.

As the talking-heads look at the official Consumer Price Index (CPI) statistics and doubt whether there is currently any inflation, some alternative voices argue that we are already experiencing the early effects of high inflation. After all, anyone who has bought food, driven a car, or paid a medical bill is uncomfortably familiar with the speed at which many prices are rising.

Currently, there are four overarching structural issues driving decisions that can create catastrophic inflation in the US:

Debt growth over economic growth: When a business borrows money, it hopes to make a return that is greater than the cost of the debt itself. The US, however, seems to have forgotten this fundamental business principle decades ago. In fact, many now believe that the US economy requires increasing amounts of debt to maintain the same amount of growth. Consider the data since 2008: the national debt has grown by about 67% but real GDP has been essentially flat. When growth becomes dependent on more-and-more debt, lenders walk away – a process which has already started in the US. Long-time lenders like China have been buying less Treasury debt, and the Federal Reserve has stepped in to make up the difference. This is all due to a preference for debt growth over genuine economic growth.

Deficits and debt monetization: Once government spending reaches a certain level in excess of revenues, the resulting deficits become unfundable by traditional means (i.e. the bond market). Almost always, the central bank steps in to fund the difference by printing currency out of thin air. While austerity is what is truly needed to restructure the unsound economy, the medicine is often too bitter for politicians to swallow; in effect, the economy becomes addicted to deficits. Once a central bank starts monetizing the deficit, that economy is walking along a hyperinflationary cliff.

Diminished capacity to handle crises: Each round of boom-bust that Washington puts us through diminishes our capital stock. In plain English, we’re eating away at the foundation of our economy. In the Great Depression, the US still had tremendous manufacturing and other productive capacities. Now, we specialize in building housing subdivisions and managing retail stores. Our ability to ‘get by’ is diminished, and therefore this crisis is likely to be even deeper and scarier than the ’30s or ’70s.

An insolvent banking system: Despite the economic ‘reforms’ touted by the mainstream media, Western banks remain mired in bad debts. To operate profitably, the banking system needs cheap and easy access to credit. If the Fed were to raise short-term rates, the financial sector would quickly become unprofitable and many major banks would likely collapse. Indeed, the Fed’s highly touted ‘stress tests’ earlier this year inconspicuously did not test higher interest rates – presumably because all the tested banks would flunk. In order to protect the banking system from its past recklessness, central banks are prevented from turning off the printing presses even if the economy has returned to growth.

Today, it might not be clear whether hyperinflation is on the horizon. However, by the time inflation is obvious to the masses, it is too late to do anything about it for two main reasons: 1) The price level is a lagging indicator, because the money printing happens first and leads to higher prices, and 2) By the time everyone notices skyrocketing consumer prices, they have already been priced into the hard assets that could possibly protect investors. Wise investors see the threat of inflation when the money is printed (which has been going on ferociously since 2008) and they move their money into inflation-resistant assets.

Many of your friends and colleagues will be complacent. These are probably the same folks who several years ago missed the warning signs that the housing bubble was about to collapse and that the banking system was about to implode. By the time everyone is talking about inflation, there won’t be much you or the Fed can do except watch our standard of living evaporate.

Despite the nebulous nature of inflation forecasting, the risk of falling off the economic cliff is great enough to warrant action today.

Precious Metals Market Manipulation?

Casey Research’s Gold Commentary

By Doug Casey

For many years now, a meme has been floating around that the prices of gold and silver are being manipulated, which is to say suppressed, by various powers of darkness.

This is not an unreasonable assertion. After all, the last thing the monetary powers-that-be want is to see is the price of gold skyrocketing. That would serve as an alarm bell, possibly panicking people all over the world, telling them to get out of the dollar.

It’s assumed, by those who believe in the theory, that the US Treasury is behind the suppression scheme, in complicity with a half-dozen or so large bullion banks that regularly trade in the metals.

The assertion is bolstered by the fact that governments in general, and the US in particular, are always intervening in all kinds of markets. They try to control the price of wheat and corn with various USDA programs. They manifestly manipulate the price of credit, keeping interest rates as low as possible to stave off financial collapse. And they may well be active, through the so-called Plunge Protection Team, in propping up the stock market.

They were largely responsible for the boom in property, through numerous programs and parastatals like Fannie Mae and Freddie Mac. Why, therefore, shouldn’t they also be involved in the monetary metals? Central banks regularly intervene in (i.e. manipulate) each others’ currencies. So it’s not unreasonable to imagine they’d try to manipulate gold as well.

In fact, the US and other governments did try to suppress the gold price from 1961 to 1968 through what was known as the London Gold Pool. The US alone persisted in trying to do so until Nixon devalued the dollar and closed the gold window in 1971.

But if it was ever doable, that was the time. Although nobody knows exactly how much gold there is above ground, a reasonable guess might be six billion ounces. There was a possibility of controlling the price, in the days of the London Gold Pool, when there were only three billion ounces in existence and when all the gold in the world was worth only $105 billion.

Today, however, the value of the world’s gold is around $10 trillion, nearly 100 times as much. And governments own only 16% of it, whereas when they tried to control the price, they owned about 35%. And the governments, their central banks, and almost all large commercial banks are bankrupt; they have vastly less financial power than they did in the days of the London Gold Pool. Why would they try to do something that’s so obviously a losing game?

I’m not at all disinclined to believe tales of manipulation of markets by the state; I expect it, and as a speculator I relish it. But I like to see evidence for everything. And extraordinary claims demand extraordinary evidence. I’ve read the stuff these guys have written for years and have seen nothing but strident assertions and accusations.

I’m completely willing to believe central bankers are capable of any kind of nefarious foolishness, but I’d like to see proof. I’m constantly reading assertions of how “the boys” come along at “precisely” 1 pm or 2 pm or perhaps “precisely” 11:37 am or 12:16 pm and, on a purely not-for-profit basis, decide to “smack down” the market for gold or silver or both. Meanwhile, the market has been hitting new highs for a dozen years.

As you might imagine, I know many believers in precious metals manipulation theories personally and am only a phone call or email away from those I don’t know. And I’m curious. So I ask questions of these folks, who are generally intelligent, well-informed, and sophisticated.

But I don’t get answers that I find make sense. There have been readily identifiable reasons for other government manipulations in the past. It’s obvious why a government wants low interest rates. It’s obvious why they want high real estate and stock markets. But why – in today’s world – would they really want to spend billions keeping gold (or especially silver) down? You’d think they might have tried to control the price of uranium when it ran to $140 a few years ago. Or perhaps the price of sugar when it ran to 28 cents last year; everybody uses sugar.

Despite the fact that gold can act as an alarm bell, few Americans – or anyone, for that matter – among the hoi polloi care or even know the stuff exists except as an academic matter. Suppressing the gold price is not only vastly harder but much less important than it was during the last bull market.

Here are some questions I’d like answered:

Q: Why do these banks (JPMorgan, etc.) even give a damn, in the first place, what the price of the metals might be?

The only reason that makes any sense is that they are acting as proxies for the US Treasury; the Treasury doesn’t go into the markets itself. But does it direct a commercial bank to act for it to buy or sell gold? It might. But there’s zero proof of any sort that it’s doing that.

These banks have no dog in the fight; they couldn’t care less what the metals prices are and have no reason to try manipulating the market.

Q: Why has there been no word from their traders about how stupid their bosses are for fighting a gigantic 10-year bull market?

These guys all know each other, and they gossip with the same delight as teenage girls.

It’s hard to keep a long-term illegal collusion a secret. Two parties might possibly be able to keep a secret. But six or eight commercial banks acting in broad daylight? It’s said that three individuals can keep a secret, but only if two of them are dead. But for a half-dozen trading operations to do so? Wall Street is the world’s greatest rumor mill. But there’s never been a rumor (outside of those created in conspiracy circles, who offer no sources) that the bullion banks are acting, in concert or individually, as agents of Timmy Geithner.

Q: If, as alleged, these banks have been short gold from the bottom of the gold bear market at $255 in 2001 and the silver bear market at $4.25, also in 2001, how can they possibly absorb tens or hundreds of billions of losses? Did they expect to take the metals to a fraction of their 1971 lows?

Trading desks make mistakes. But they don’t stay short in one of history’s great bull markets – it’s not the way traders earn bonuses. How stupid are the supposed “not for profit” sellers of gold supposed to be?

Q: Exactly where and how do they supposedly get the capital to cover these losses? Haven’t they ever heard the old saw, “He who sells what isn’t his’n must give it back or go to prison”?

No bank can tie up billions in capital fighting the market for a decade.

Q: Exactly who originated this idea of trying to suppress prices using the futures markets?

Here a well-known writer on this subject suggested the following to me, via an email, when I asked: “The big commercials, starting some 25 years ago, discovered they could dominate the market and force technical traders in and out of the market when they wished at great profits to the commercials. But they miscalculated and stayed in too long, and now they are trapped.”

I don’t buy that explanation for several reasons. Of course the big guys, like commercials, are always bullying small speculators. The small guys use technical trading systems, which make it easy to figure out where they’re buying and selling. Small traders are always minutes behind the market. And small traders usually use way too much margin, so they’re prone to being squeezed and panicked. This has always been true, not just for the last 25 years. It’s part of why small traders are notorious for losing. The commercials are typically on the other side of the trade.

But one thing is for certain: nobody (certainly not commercials) allows himself to get in so deep he’s trapped for 12 years in one of history’s greatest bull markets.

Q: Why fight the market, and get trapped, in just gold and silver? Why aren’t they trying to suppress copper, platinum and palladium as well? For that matter, every commodity?

I don’t credit the people who run central banks or national treasuries with a great deal of financial acumen; they’re basically just political hacks, flunkies that went to “good” schools, dress well, and like feeling important in a safe niche in the bureaucracy. But they don’t want to lose their jobs by being that wrong for that long.

Q: Why would the US Treasury (if it’s behind a gold suppression scheme) make things easier for the Chinese, the Russians, the Indians and numerous other developing countries by suppressing the gold price?

Foreign governments would simply take advantage of the lower price to buy more.

The arguments for suppression of gold make very little sense when you examine them. The arguments for silver make absolutely no sense at all; it’s a tiny market that nobody cares about except for silver fanatics, who treat it like a religious icon. That said, I’m at least as bullish on silver as gold – but a discussion of that will have to wait.

If anyone could answer these questions, I’d appreciate it. I advise readers to buy gold – even at current levels – but I’d like to see them do it for the right reasons. And it seems to me the arguments about gold manipulation are more redolent of religious belief than economic reasoning.

France May Be Losing Its Head…

By Peter Schiff

According to the European Central Bank, the Italian banking industry now holds more government debt than the banks of any of the major European economies: nearly €324 billions worth of shaky bonds. The Spanish banking sector is also heavily overweight in government paper, at a new record high of €263 billion.

This bond-buying spree was caused by the “Sarkozy Trade,” or the wild printing of euros by the ECB, which French President Nicolas Sarkozy hoped would relieve France’s own public debt problem. As a result of his campaigning, any European bank can get all the euros it wants at the low, low price of 1% interest for 3-year loans – and instantly convert it into its own government’s bonds. Italian and Spanish 10-year bonds pay above 5.5%, yielding a 4.5 percentage point return for doing nothing (though whether this is a winning trade in the long-term depends on what happens after the first three years).

Just as in the US, private investors can no longer be counted on to purchase all the bonds that European governments would like to issue. So, the ECB is printing the euros to buy them – and thinly disguising the process by funneling it through the banking sector.

Gold & Financial Preparedness

Mark Motive’s Gold Commentary

There is a growing number of people in America hoping for the best… but preparing for the worst. These people – often called “preppers” – believe in self-sustainability, in terms of health, wealth, and liberty. As a former Boy Scout, I can certainly appreciate the desire to be prepared for any eventuality.

Many preppers buy physical gold to protect from some form of economic collapse: the collapse of currencies, the collapse of financial systems, the collapse of governments, or the collapse of society. Even if you don’t think there’s a high probability of collapse, investors need to prepare for a range of possibilities, and protecting from collapse isn’t as simple as buying a few shares of SPDR Gold Trust.

Among the preppers, there is a raging debate on the utility of gold. Let’s examine the arguments on both sides and see if they are useful for our own preparedness decisions.

Guns and Butter

Many people believe that in a collapse scenario, it is more important to own guns and butter (i.e. the means to protect and sustain oneself). If society truly collapsed to the point where people were starving because industrial food production and distribution broke down, the ultimate tools for survival would be grub and guns.

Think about it this way: to a starving person, food is the most valuable thing in the world. How much would you give up to feed your famished family for a month… a week… a day?

In such a scenario, those that control the post-collapse food supply control the wealth – no amount of gold is worth watching your first-born starve. Anyone able to sell surplus food would quickly mop up the gold held by the population. And anyone who owned gold would readily trade it for overpriced food.

However, this scenario would not last long. When people are hungry, they become desperate – especially after they’ve already traded their worldly possessions for a few days’ supply of food. Hunger feeds revolutions – and the first targets would be those with a cache of food, arable land, or other assets that are difficult to hide and transport.

Frankly, in a Mad Max world, brute force will always win. But for those of us without a private army to defend ourselves, having an easily-concealed form of wealth like gold still seems preferable to a stockpile of canned tuna. Fortunately, I think a catastrophe of this magnitude is the stuff of Hollywood.

The Universal Language of Commerce

Even if we did degenerate into a Mad Max world, in all likelihood it wouldn’t last for long. North America can produce more than enough food for domestic demand, and its citizens would presumably work to restore democracy and order. Society would work to rebuild the economic and financial system lost through the collapse, simply because these systems provide lubrication for a functioning society.

For example, if the dollar were destroyed by hyperinflation, a new currency would eventually be formed because the barter system is extremely inefficient. (The need for coincidence of wants creates a very high hurdle for the barter system.) Because they are fungible, divisible, portable, and non-perishable, currencies significantly improve societal wealth by reducing transaction costs, enabling lending, storing surpluses, etc.

Because it is the universal language of commerce, gold could be the new currency, but eventually a more flexible paper-based system would once again arise. Here’s the critical idea: whether or not that system is convertible into gold, gold could be used to transition wealth from the old currency system to the new. As a store of wealth, gold serves as a way to transition assets from one monetary regime to another.

Throughout history, gold has been used as a means to manage these types of transitions. During times of distress, people have converted their wealth into compact chunks of gold to take with them as they escaped a dictatorship or endured a failing currency. Gold is universally accepted as a store of wealth, meaning that it can endure what other stores of wealth (stocks, bonds, paper money… even land) cannot. This is why gold can help preserve wealth across economic transitions. Arable land, and the food that it produces, may not have the same benefits.

The problem with land – even arable land – as a store of wealth and a resource is that title is registered with the government. Collapsing governments throughout history have gone after land owners by taxing them at extraordinarily high rates and even expropriating their property. In some cases, tax rates became so oppressive that land owners simply walked away from their land with whatever possessions they could carry (gold anyone?).

Here’s the caveat: gold can be expropriated too, by decree or by contract dissolution. First, by the sweep of a pen, the government can make gold ownership illegal and force citizens to accept whatever paper they shove down their throats. Despite this, history has shown that attempts at outlawing gold only drove gold underground and underscored its true value. Second, contracts that provide the right to own gold could dissolve if the counterparty goes bust. A contract is only as good as the faith and credit of the signatories, and the viability of the enforcement mechanism (like our collapsed government). Investors must distinguish between physical gold ownership and a contract that facilitates gold ownership.

If you feel confused at this point, you’re getting the message: there is no single, simple answer for protecting wealth and preserving life during an economic collapse. But an important component of any plan is to own and store physical precious metals outside of the mainstream banking system.

Don’t Catch Recovery Fever

By Peter Schiff

Gold has been holding steady in the the $1,600-$1,800 band since early October. This could be attributed to consolidation after last summer’s historic run up to $1,895, but I think this wait-and-see attitude reflects current market sentiment toward the US dollar.

In fact, the first few days of April have seen a sharp dollar rally and decline in gold. This is rooted in deflated expectations of a third round of Quantitative Easing (QE3) after the most recent Fed Open Market Committee (FOMC) meeting. Once again, the markets are responding to the headlines while losing sight of the fundamentals.

This is especially peculiar because the Fed did not explicitly take QE3 off the table. In fact, according to the minutes, if the recovery falters or if inflation is too low, the Fed is already prepared to launch QE3. While there is not much chance of low inflation, I’ll explain below why the recovery is not only going to falter – it’s going to evaporate like the mirage that it is!

It’s a Dead Man Walking Economy

Casey Research’s Gold Commentary

By Doug Casey

In an interview with Sr. Editor Louis James, the inimitable Doug Casey throws cold water on those celebrating the economic recovery.

Louis: Hi Doug. I have to say, Doug, the so-called recovery is looking more than “so-called” to a lot of smart folks.

Doug: The first order of business, as usual, is a definition: a depression is a period of time in which the average standard of living declines significantly. I believe that’s what we’re seeing now, whatever the numbers produced by the politicians may seem to tell us.

Louis: I was just shopping for food and noticed that the bargain bread was on sale at 2 for $5. My gas costs almost as much per gallon. That’s got to hurt a lot of people, especially on the lower income rungs. I don’t need to ask; a member of my family just got a job that pays $12 per hour – about three times what I made working for the university food service back when I was in college – and it’s not enough to cover his rent and basic bills. If his wife gets similar work, they’ll make ends meet, but woe unto them if anyone in their family crashes a car or requires serious medical treatment.

Doug: That’s just what I mean. Actually, the trend towards both partners in a marriage having to work really started in the early ’70s – after Nixon cut all links between the dollar and gold in August of ’71. Before then, in the “Leave It to Beaver” era, the average family got by quite well with only the husband working. If he got sick or lost his job, the wife was a financial backup system. Now, if something happens to either one, the family is screwed.

I think, from a very long-term perspective, historians will one day see the ’60s as the peak of American prosperity – certainly relative to the rest of the world… but perhaps even in absolute terms, even taking continued advances in technology into account. Maybe the ’59 Cadillac was the bell ringing at the top of that civilizational market.

My friend Frank Trotter, President of EverBank, was just telling me that the net worth of the median US citizen is only $6,000. That’s the median, meaning that half of the people have less than that. Most people don’t even have enough stashed away to buy the cheapest new car without going into debt. It used to be that people bought cars out of savings, with cash. Now they have to finance them over at least five years… or lease them – which means they never have even that trivial asset, but a liability in the form of a lease.

With the concentration of wealth among the top one percent, most of those below average have seriously negative net worth, at least compared to their earning capacity. In other words, the US, Europe, and other so-called First-World countries are in a wealth-liquidation cycle that will be as profound as it will be protracted.

By that, I mean that people are on average consuming more than they produce. That can only be done by consuming savings or accumulating debt. For a time, this may drive corporate earnings up, and give this dead-man-walking economy the appearance of returning health, but it’s essentially, necessarily, and absolutely unsustainable. This is an illusion of recovery we’re seeing – the result of our Wrong-Way Corrigan politicians continuing to encourage people to do the exact opposite of what they should do.

Louis: Which is?

Doug: Save. People shouldn’t be getting new cars, new TVs, and new clothes. They should be cutting expenses to the bone.

The Obama Administration, just like the Baby Bush Administration before it (there really is no great difference between the Evil Party and the Stupid Party) stubbornly sticks to the bankrupt idea that economic growth is driven by consumption. This is confusing cause and effect. Healthy consumption follows profitable production in excess of consumption, resulting in savings – accumulated capital – that can either be spent without harm or invested in future growth.

Consumption doesn’t cause an economy to grow at all. To paraphrase: “It’s productivity that creates wealth, stupid!”

Louis: Policies aimed at encouraging consumption, instead of increasing production, are what turned the savings rate negative in the US and resulted in the huge sovereign debt issues we’re seeing in supposedly rich countries…

Doug: Well, the governments themselves have spent way more than they had or ever will have, and that’s par for the course when you believe spending is a virtue. However, it’s the false signals government interference sends to the market that caused the huge malinvestments that only began to go into liquidation in 2008. That has to do with another definition of a depression: It’s a period of time when distortions and malinvestments in the economy are cleared.

Unfortunately, that process has barely even started. In fact, since the bailouts began in 2008, these things have gotten much worse. If the government had gone cold turkey back then – cut its spending by at least 50% for openers – and encouraged the public to do the same, the depression would already be over, and we’d be on our way to real prosperity. But they did just the opposite. So we haven’t yet entered the real meat grinder…

Louis: Those false signals the government sends to the market being artificially low interest rates?

Doug: Yes, and Helicopter Ben’s foolish leadership in the wholesale printing of trillions of currency units all around the world – I don’t really want to call dollars, euros, yen, and so forth “money” anymore. When individuals and corporations get those currency units, they think they’re wealthier than they really are and consume accordingly. Worse, those currency units flow first to the state – which feeds its power – and favored corporations, which get to spend it at old values. It’s very corrupting. There is also an ongoing regulatory onslaught – the government has to show it’s “doing something” – which makes it much harder for entrepreneurs to produce.

In addition, keeping interest rates low encourages borrowing and discourages saving – just the opposite of what’s needed. I don’t believe in any state intervention in the economy whatsoever, but in the crisis of the early 1980s, then-Fed Chairman Paul Volcker headed off a depression and set the stage for a strong recovery by keeping rates very high – on the order of 15-18%. They can’t do that now, of course, because with the acknowledged government debt at $16 trillion, those kind of rates would mean $2.5 trillion in annual interest alone – more than the government takes in taxes.

At this point, there’s no way out. And there’s much more tinkering with the system ahead, at the hands of fools who remain convinced they know what they’re doing, regardless of how abject their past failures have been.

Louis: As Bob LeFevre used to say, “Government is a disease masquerading as its own cure.” Want to update us on when you think the economy will return to panic mode?

Doug: Earlier this year, I was expecting it sooner than I do now. Unless some “black swan” event upsets the apple cart suddenly, I would not expect us to exit the eye of the storm at least until after the US presidential elections this fall. Maybe not until early 2013, as the reality of what’s in store sinks in. I pity the poor fool who’s elected president.

In a way, I hope it’s Obama who wins, mainly because the worthless – contemptible, actually – Republican candidates yap on about believing in the free market, which means if one of them is somehow elected, the free market will be blamed for the catastrophe. Too bad Ron Paul will be too old to run in 2016, assuming that we actually have an election then…

Louis: So, what about those numbers, then? Employment is up, and the oxymoronic notion of a “jobless recovery” was one of our criticisms before…

Doug: Yes, but look at the jobs that have been spawned; they are mostly service sector. Such jobs can create wealth for certain individuals – it looks like we’ve put more lawyers to work again, as well as waiters and paper-pushers – but they don’t amount to increased production for the whole economy. They just reshuffle the bits around within the economy.

Louis: Unlike my favorite – mining – which reported 7,000 new jobs in the latest report, if I recall correctly.

Doug: Yes, unlike mining, which was more of an exception than the rule in those numbers. But that’s making the mistake of taking the government at its word on employment figures. If you look at John Williams’ Shadowstats, which show various economic figures as the US government itself used to calculate them, unemployment has actually reached Great Depression levels.

The US government is dishonestly fudging the figures as badly as the Argentine government – which is, justifiably, viewed as an economic laughing stock in most parts of the world. One reason things are going to get much worse in the US is that many of those with economic decision-making power think Argentine President Cristina Fernandez Kirchner is a genius. A little while ago, there was an editorial in the New York Times – the mouthpiece for the establishment – written by someone named Ian Mount.

If you can believe it, the author actually says, “Argentina has regained prosperity thanks to smart economic measures.” The Argentine government “intervened to keep the value of its currency low, which boosts local industry by making Argentina’s exports cheaper abroad while keeping foreign imports expensive. Argentina offers valuable lessons … government spending to promote local industry, pro-job infrastructure programs and unemployment benefits does not turn a country into a kind of Soviet parody.”

When I first read the article, I thought I was reading a parody in The Onion. I love Argentina and spend a lot of time there. It’s a fantastic place to live – but not because of the government’s economic policies!

Fortunately, though, the Argentine government is quite incompetent at people control, unlike the US. It leaves you alone. And there’s a reasonable chance the next president won’t be actively stupid, which isn’t asking much. But it’s amazing that the NYT can advocate Argentine government policy as something the US should follow. A collapse of the US economy would be vastly worse than that of the Argentine economy – the US dollar is the world’s currency.

In Argentina, they’re used to it and prepared for it to a good degree. Very unlike in the US.

Louis: What are the investment implications if the Crash of 2012 gets put off until the end of the year, or even becomes the Crash of 2013?

Doug: There are potentially many, but generally, the appearance of economic activity picking up is bullish for commodities, especially energy and raw materials like industrial metals and lumber. That’s not true for gold and silver, so we might see more weakness in the precious metals in the months ahead. I wouldn’t count on that, however, because government policy is obviously inflationary to anyone with any grasp of sound economics. That will keep many investors on the buy side.

Plus, the central banks of the developing world – China, India, Russia, and many others – are constantly trading their dollars for gold. There are perhaps seven trillion dollars outside the US, and about $600 billion more are sent out each year via the US trade deficit.

Louis: I know I bought some gold and silver in the recent dip and would love to have a chance to do so at even lower prices ahead.

Doug: That’s the logical thing to do, given the fundamental realities we started this conversation with, but a lot of people will be scared into selling if gold does retreat. A good number will sell low, after buying high – happens every time, and is a big part of why commodities have such a tricky reputation.

Most investors just don’t have the strength of conviction to be good speculators. Instead of looking at the world to understand what’s going on and placing intelligent bets on the logical consequences of the trends, they go with the herd, buying when everyone else is buying and selling when everyone else is selling. This inverts the “buy low and sell high” formula. They let their thoughts be influenced by newspapers and the words of government officials.

Louis: In other words, everything you see calls for gold continuing upward for some time – years.

Doug: I look forward to the day when I can sell my gold for quality growth stocks – but we’re nowhere near that point. But silver might correct less than gold if gold corrects due to the appearance of economic recovery – silver is, after all, an industrial metal as well as a monetary one.

Louis: Which leads to the other reason for owning precious metals – not as a speculation on skyrocketing prices, nor as an investment for good yield, but for prudence.

Doug: Yes. Gold remains the only financial asset that is not simultaneously someone else’s liability. Anyone who thinks they have any measure of financial security without owning any gold – especially in the post-2008 world – is either ignorant, naïve, foolish, or all three.

Look, we saw it coming, but everyone in the world could see Humpty Dumpty fall off the wall in 2008. Now we’re just waiting for the crash at the bottom, and no amount of wishful thinking otherwise is going to change that. It’s a truly dangerous world out there, and blue chips are no longer the safe investments they once seemed to be. You don’t have to be a gold bug to see the wisdom of allocating some capital – and not just a token amount – to cover the possibility that I’m right about what’s coming.

There’s some opportunity cost associated with taking out this kind of insurance, but it’s not catastrophic if I’m wrong, and the cost of failing to do so if I’m right is catastrophic. That really is the bottom line.

Louis: Very well. Any particular triggers you think we should watch out for – warning signs that we really are about to exit the eye of the storm?

Doug: In the US, the Fed being forced to raise interest rates would be one, or inflation getting visibly out of control – which would force a change in interest rates – would be another. Who knows – Obama getting reelected could tip the scales. War in the Middle East could do it, or, as we already mentioned, China or Japan going off the deep end. The ways are countless. Black swans the size of pteranodons are circling in squadron strength. A lot of them are coming in for a landing.

People will just have to stay sharp – sorry, there’s no easy way to survive a depression. As my friend Richard Russell says, “In a depression, everybody loses. The winner is the guy who loses the least.” It will take work and diligent attention to what’s going on in the world and around us. We at Casey Research will do our best to help, but each of us is and must be responsible for ourselves.

Louis: Okay then, thanks for the guru update. No offense, but in spite of the investments I’ve made betting that you’re right, I hope you’re wrong, because the Greater Depression is going to destroy many lives, and the famines and wars it spawns even more – millions, I’m sure. Maybe more. The mind balks.

Doug: Oh, I agree. I only wish I could believe otherwise, because I’m sure it’s going to be even worse than I think it will be… although I hope to be watching it in comfort and safety on my widescreen TV, not out my front window.

Obama’s Pretzel Logic

As this fall’s presidential election takes shape as a contest between Barack Obama and Mitt Romney, the rhetoric out of both camps is becoming sharper and more ideological. Looking to exploit Governor Romney’s increasingly close association with Wisconsin representative Paul Ryan (who has been mentioned as a potential vice presidential nominee), the President dedicated a lengthy address earlier this week to specifically heap scorn on Ryan’s budget plan (Ryan is the chairman of the House Budget Committee). The attack lines used by the President not only reveal a preview of the fall campaign but also offer a glimpse of Obama’s skewed views of the social and economic history of the United States.

The President laid bare his beliefs that America’s source of economic strength has been her historical embrace of collective action, wealth redistribution, and government policies that have protected workers from the ravages of the wealthy. To reiterate, he was talking about the United States, not Soviet Russia. He asserted that prosperity “grows outward from the middle class” and that it “never trickles down from the success of the wealthy.” Accordingly, he concludes that our recent struggles stem from the Republican-led abandonment of these successful policies.

In reaching these conclusions Obama relies on classic “wet sidewalks cause rain” reasoning, and assumes that an effect can be the father of the cause. But as we debate how to move the American economy out of the rut in which it is trapped, it’s important to know where to put the cart and where the horse.

To illustrate his point, Obama singled out auto pioneer Henry Ford, who famously paid among the highest wages in the world at that time his company began churning out Model T’s. By paying such high wages Obama believes Ford created consumers who could afford to purchase his cars, thereby giving business the ability to grow. Based on this understanding, any program that puts money into the pockets of the average American consumer will be successful in creating growth, especially if those funds can be taxed from the wealthy, who are less likely to spend. Obama argues that Republican proposals that reign in government spending, and cut benefits to the middle or low incomes, are antithetical to this goal.

While it is true that the American middle class rose in tandem with her economic might, it was the success of the country’s industrialists that allowed the middle class to arise. Capitalism unleashed the productive capacity of entrepreneurs and workers, which brought down the cost of goods to the point that high levels of consumption were possible for a wider cross section of individuals. While Henry Ford, as Obama noted, paid his workers well enough to buy Ford cars, those high wages would never have been possible, or his products affordable, if not for the personal innovation he, and other American industrialists, brought to the table in the first place.

The economists that Obama follows believe that business will only create jobs once they know consumers have the money to buy their products. But just as wet sidewalks don’t cause rain, consumption does not lead to production. Rather, production leads to consumption. Something must be produced before it can be consumed.

Human demand is endless and does not need to be stimulated into existence. Suppose you want a new car, but then you lose your job and you decide to forgo the purchase. Has your desire (or demand) for the car lessened as a result of your diminished employment circumstances? If you are like most people, you still desire the car just as much, but you may decide not to buy it because of your reduced income. It’s not that you no longer want the car (if someone offered it to you at 90% below the sticker price, you might still buy it). It’s that you have lost the ability to afford it given its price and your income. The best way to transform demand into consumption is to lower prices to the point where things become affordable. Efficiently operating industries increase supply and bring down prices. This is what Ford did 100 years ago and Steve Jobs did much more recently.

But by introducing revolutionary manufacturing processes for the mass production of low-end vehicles, Ford was able to drastically lower the price of a product (cars) that were previously available only to the wealthy. Ford didn’t create desire to buy cars, that existed independently. But he greatly expanded the quantity of inexpensive cars which allowed that demand to be fulfilled through consumption. In the process he created wealth for himself and his workers (his efficient techniques meant that workers could demand high wages) and higher living standards for society as a whole.

Obama believes that prosperity came only in the 20th century after the government began redistributing wealth from rich people like Henry Ford to the middle and lower classes. He ignores the fact that America’s greatest growth streak occurred in the 19th rather than the 20th century, and that America had become by far the world’s richest nation before any serious wealth redistribution even began.

The unfortunate part for the President is that wealth must first be produced before it can be redistributed. But redistribution always creates disincentives that result in less wealth being created. All societies that have attempted to create wealth through redistribution have failed miserably. This should be obvious to anyone who spends more than a few minutes studying world economic history. But the President is on a mission to get reelected and his ace in the hole is to fan the flames of class warfare. It’s a tried and true political strategy, and he looks ready to ride that hobby horse until it breaks.