The Gathering Economic Storm

What a ride we have had during the past few years! Due to the enormous credit expansion and the resulting huge amounts of new money created by the Federal Reserve, it seemed that everybody was getting rich. Credit was so cheap and easy to get that anybody could buy a house with no money down, no means of ever being able to pay the mortgage, and on original “teaser” terms that made it easy for even the poorest slob to become the proud “Owner” of a mansion. Never mind that the original, extremely low payments would only last for a couple of years and would then drastically increase. Since “house prices always increase”, you could always immediately sell your palace at a hefty profit and move on.

The Perpetrators of these sub-prime loans sold them to financial institutions who packaged, sliced and diced them into CDO’s (Collateralized Debt Obligations). These “assets” were then used to borrow additional money from the Federal Reserve who was very accommodating, or were sold to unsuspecting investors worldwide.

Unfortunately, when the sub-prime mortgages started to be reset, many of the home owners could not make the much higher monthly payments and the number of foreclosures increased drastically. This put pressure on house prices. Those who were counting on being able to sell were sorely disappointed. House prices don’t always increase. Sometimes they go down!

The financial firms who did all the wheeling and dealing in these (bad) collateralized obligations suddenly saw the basis of these financial instruments crumble. Worldwide literally hundreds of billions of Dollars went up in smoke. Rather than let those institutions that did not use due diligence when buying and repackaging these loans bear the consequences of their frivolity, our government and the Fed are doing their utmost to shift the burden to the taxpayer!

The Federal Reserve, a quasi-private institution created in1913 to protect the value of the Dollar, i.e., prevent inflation, has done just the opposite. Since its creation, the Dollar has lost most of its value. Especially over the last couple of decades, first under Greenspan, and now with Ben Bernanke at the helm, the Fed has created enormous amounts of debt by lowering interest rates. This has created massive amounts of new money.

Where the “normal” increase in the money supply used to be about 3-4% per year, it is now about 15%. Such a continuous, drastic increase in the money inflation may let everybody feel rich for quite some time leading to increases spending and a booming stock market. However, the day of reckoning will eventually come and the larger the excesses, the bigger the fall!

Many decades ago, Ludwig von Mises, the father of the famous Austrian school of economics, predicted the following:

“There is no means of avoiding the final collapse of a boom expansion brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved”.

Continuing the feverish expansion of the money as still practiced by the Fed may postpone the coming recession somewhat and give our bloated government some more credits to spend our children and grandchildren into the poorhouse. Continuing this policy will eventually lead to a total collapse of our financial system. The Dollar will ultimately be only worth the paper it is printed on.

How far are we on this path to the complete collapse of the Dollar?

Today (January 3, 2008) gold is trading above $850 per ounce for the first time. Only a few of years ago, it was $260. Since gold is a fixed commodity that can not be diluted, it is an excellent measuring staff. It tells us that the Dollar is deceasing in value at a rate of between 10 and 15% per year. If we continue on this path, in 10 years one Dollar will have a present-day value between 20 and 35 CENTS.

Today crude oil traded at $100 per barrel for the first time in history. Due to the diminishing value of the Dollar, the oil producers need to ask more and more for this commodity just to stay even.

There is only one way to avoid a catastrophe: drastically raise interest rates. Since such action will cause a contraction of the economy and a deep (but probably short) recession, our politicians will not tolerate such action. They would be blamed by the voters for the economic downturn. This would ruin their chance for re-election. This kind of medicine was administered at the end of the Carter administration by then Fed chairman Volcker when interest rates climbed to more than 20%. This led to a short recession, followed by a robust expansion of the economy when interest rates could be lowered with only moderate inflation.

Inflation is not only rampant in the U.S. but to a lesser degree in most other countries as well. All countries have followed the Unites States’ lead and have abandoned the gold standard. The relative value of the Dollar against most other currencies reflects the fact that inflation is larger in the U.S than in most other countries. In all of history, ALL fiat money ends up completely worthless. It always has happened and we are seeing the beginning of the end of our monetary system.

Politicians are always eager to increase spending. They have to continue and bribe the electorate with more and more goodies. However, since there is a limit as to how much taxes can be levied, printing new money is such an irresistible way to finance all their new schemes. Today’s voters won’t feel any pain. Only future generations will pay dearly for today’s politician’s bribery schemes.

In the long run, the Federal Reserve has to be overhauled to eliminate inflation (i.e. make it impossible to put excess money into the economy), or better yet, be eliminated. In addition, it is time to put us back on the gold standard. The United States became the strongest economic power on earth BEFORE we had the Fed, and while we were on the gold standard.

Unfortunately, I don’t see any of this happening soon. Of all the presidential candidates only Ron Paul has acknowledged that we have a serious financial problem that can only be solved by drastic changes such as the abolition of the Federal Reserve and the return to the gold standard. Since the Republican Party will absolutely not allow Ron Paul to be nominated, nothing will be done to save the Dollar.

That’s why I am buying gold! It is now trading above the prior high of $847 reached in January, 1980. However, if we adjust this high for inflation, the peak was actually $2,120 in present-day Dollars. I see gold reaching $1,000 in the first quarter.

“We didn’t need a central bank when we were on the Gold Standard. People would buy and sell gold and the markets would do what the Fed does now” Allan Greenspan

“I’ve been in the forecasting business for 50 years, and I’m no better than I ever was, and nobody else is either”. Allan Greenspan.

Hugo vandenBergh
Magister Contradictionis