1913

"Unfortunately, the further you run from your sins, the more exhausted you are when they catch up with you. And they do."
--Dalton Russell (Inside Man)

In no year was more damage done to liberty in the United States than 1913. Newly elected President Woodrow Wilson was quick to add to the foundation of the Progressive Era that Theodore Roosevelt had built. Wilson's contributions were whoppers.

Although the Sixteenth Amendment was ratified a month before Wilson took office, Wilson had strongly supported it. The Sixteenth Amendment gave the federal government the power to tax individual incomes. This opened a huge resource stream to central government that was not previously available. Markets for political favor via wealth redistribution could now be made on a much larger scale. Today, this is a multi-trillion dollar market.

A month after Wilson took office, the Seventeenth Amendment was also ratified--also with Wilson's strong endorsement. Article 1, Section 3 of the Constitution assigned the power to elect US senators to each state legislature. The wisdom of this is that the longevity of senators' tenures were tied to the defense of their states' interests rather than to federal interests. The Seventeenth Amendment changed the process, opening senatorial elections to popular vote. This has eroded balance of power between federal and state governments because people tethered to federal government programs are more likely to vote in federal government lackeys rather than strong supporters of state interests.

In December of 1913 the Federal Reserve Act was signed into law. Politicians understand that the power to tax is limited by citizens' tolerance for having their property forcefully taken from them by government. If government's appetite for economic resources exceeds its power to tax (and it always does), then a central bank with authority to print cash offers the perfect confiscatory weapon. Instead of taxing property directly, government uses the freshly minted cash to claim economic resources, leaving less resources and more currency for the citizenry at large. Inflation is often called 'the invisible tax' because people have difficulty recognizing its confiscatory effect on their wealth.

It is inconceivable that the federal government could have grown into its Leviathan state today without these three events. For lovers of freedom, 1913 was a very bad year.

One hundred years later, we pay a steep price for that misfortune.

Anchoring the Poor in Poverty

There will be no more isolation
In our secret separation
--The Fixx

Thomas Sowell discusses two government policies that serve as taxes on the poor. Money printing (inflation) devalues dollars currently in existence. It is often called 'the invisible tax' because it is difficult for many people to recognize.

Rather than confiscating wealth by direct taxes, the State confiscates wealth by using newly printed dollars to procure resources. Subsequently, there are less resources to purchase--and more dollars to purchase them with. Prices go up and purchasing power goes down. The net effect is the same as direct taxes. Wealth has been transferred from private hands to the State.

Money printing disproportionately hurts the poor because low income people operate mostly with cash. Unlike the wealthy, they have little savings that they can convert into assets, such as gold, that hold their value during inflationary conditions. Inflationary conditions leave the poor running on a hamster wheel as they perpetually struggle to keep up with cost of living increases.

Another government-imposed tax consists of loss of welfare benefits. People trying to climb out of poverty while collecting welfare payments can face situations where a marginal dollar of production costs more than staying on welfare. Tax a behavior, and expect less of it (Econ 101). Welfare benefits serve as the poor's version of 'golden handcuffs' that encourage persistent squalor and discourage productivity.

Inflation and welfare anchor the poor in poverty.

position in gold

Stimulus Tax

Don't ask me what I want it for
If you don't want to pay some more
--The Beatles

The other day, Juan Williams waxed poetic about the economic stimulus enacted under the Obama administration. He failed to consider the effect of the $trillions of money/credit created by the Fed and other central banks worldwide.

Stated differently, he does not account for inflation. Since 2009, base money (above) has more than tripled. This is inflation as classically defined: expansion of the supply of money/credit above the pace of productivity improvement.

Lew Rockwell astutely notes that inflation is a tax. This tax is typically 'invisible' to Everyman because value degrades slowly; it does not get taken out of each paycheck like withholding to the IRS.

Lew also observes that the current inflation remains largely trapped in our financial system. If/when that money leaks into peoples' wallets, then prices of goods and services (the popular metric of inflation today) will surely surge.

Make no mistake, the 'tax cuts' that Juan Williams touts as part of the 'successful' Obama stimulus have been more than offset by the $trillions in purchasing power lost by the govt printing press.

Inflation: A State-Induced Phenomenon

"You're here because you know something. What you know you can't explain, but you feel it. You've felt it your entire life, that there's something wrong with the world. You don't know what it is but it's there, like a splinter in your mind, driving you mad."
--Morpheus (The Matrix)

Inflation, whether classically defined as expansion of the money supply incommensurate with underlying production or currently defined as a general increase in prices (nice review of the evolution of the inflation term here) is a phenomenon of the State. The State owns the printing press and creates money by fiat. The consequence of that money printing is an increase in prices.

Sometimes prices increase quickly and sometimes they increase slowly. There are various reasons for inflation's varied effect on prices. One is that there are many categories of prices--i.e., goods and services, commodities, securities, real estate, etc. Newly printed cash might flow toward a particular category while leaving others relatively unaffected--at least for a while.

For example, the Fed is currently printing about $1 trillion annually as part of its Quantitative Easing (QE) program. Much of that cash has been going straight to banks. Banks, being the first users of the cash, have elected to use it to speculate in stocks and other financial markets. It should not be surprising that stock prices are hitting all time highs while goods and service prices have remained muted. QE cash has flowed primarily thru securities channels, thus pushing up prices in that category.

Another factor that varies inflation's effect on prices is confidence in the currency. If people feel that currency is maintaining its purchasing power, then they will be more inclined to hold onto it. When people hold onto money, prices do not increase and might even decline. However, if they lose confidence in a currency's purchasing power, then people will try to get rid of it like a hot potato. Prices rip higher as people do so.

The State hopes that prices increase at rates that people take for granted or do not notice. That way, the State can print cash to fund its interests without fear of reprisal. If it can do so, the State possesses the perfect tool for confiscating resources: an 'invisible tax.' As long as people don't notice or can't see it, then the State will use it to pick as many pockets as possible.

The State, however, has a few problems. One is that, like most thieves, State always desires more. If a particular amount of inflation is working, then why not increase it a little? As such, the State is likely to escalate its money printing ways until it is finally found out.

Another problem the State faces is that it does not not have complete control over the factors that influence inflation's effect on prices. Although stock and other security prices have been primary outlets for QE-induced inflation, at some point other price categories are likely to reflect inflation as well. For example, high priced securities might be sold, and sellers might spend the proceeds on, say, goods and services which will push those prices higher. Banks might also elect to make more loans that effectively put QE cash into the hands of consumers which, again, pushes goods and service prices higher.

It is also possible that people begin to lose confidence in the dollar. In 1920's Germany, money printing practices of the Weimar Republic were in broad view. Yet it took years before citizens connected the dots and realized that this inflation would destroy the purchasing power of the money in their wallets and in their bank accounts. Once confidence broke in the institution known as the German mark, we witnessed a rise in prices like the world has not since seen in an industrialized country.

Inflation is a State-induced phenomenon. Inflation lines the pockets of the State and its interests--until the State loses control of it.

Inflation Reduction Act

I bought a novel, some perfume
A fortune all for you
But it's not my conscience
That hates to be untrue
I asked of my reflection,
"Tell me what is there to do?"
--Squeeze

As we've discussed, leftists are rarely honest with their rhetoric. They label things largely contrary of their actual effects.

Cast in point: the proposed Inflation Reduction Act. 

As Ron Paul discusses, the bill does the opposite. It increases government spending by hundreds of billions of dollars. It takes resources out of the hands of private citizens and puts them into the hands of bureaucrats.

Not only does this increase the risk of capital misallocation, but it must be funded. To the extent that citizens are taxed, it reduces economic resources available to people during an era of high price inflation and slowing economic activity.

It is a universal truth that slow economic activity motivates easier central bank monetary policy (read: inflation).

To the extent that taxes won't cover the spending, then those funds must either be a) borrowed, which taxes future incomes, or b) printed (the reason why inflation is called the 'invisible tax').

There is little doubt that the Inflation Reduction Act will ultimately result in more inflation, not less.

Inward War

In violent times
You shouldn't have to sell your soul
In black and white
They really, really ought to know
--Tears for Fears

I have seen several studies recently claiming that the world is in the midst of an unprecedented war-free period. At first, these claims drew double takes from me. However, if one defines war as formal military conflict between two or more countries then these claims may be true, as we haven't had large scale 'outward wars' in some time.

Of course, there have been hundreds of conflicts that look like war that might not qualify under the above definition. Drug wars in Central and South America, East European conflicts, the War on Terror, etc. The social and economic impact of these 'non-wars' has been huge. For example, the US alone has spent more than $1 trillion on the War on Terror. Imagine applying that pile of economic resources toward voluntary, peaceful concerns.

More significant yet has been the 'inward wars' being waged by governments worldwide against their own citizens. The core competence of government is force--force that can be employed in either offensive or defensive manners. Overwhelmingly, governments are using offensive force. They are acting aggressively against citizens.

Because they are usually not called such, government programs of aggression sometimes fool people into thinking governments are keeping peace rather than waging war. Taxes, for example, are viewed by some as just means of acquiring resources for various interests rather than as confiscation of resources by strong armed agents. However, taxes constitute violent acts against the citizenry--as our founding ancestors ably recognized.

Expansion of the money supply by central banks is also seen as peaceful. However, when money is printed it lowers the value of money already in people's wallets. Those who get control of newly minted cash first effectively confiscate resources from others. Because the gradual theft of resources can be difficult to recognize, inflation is sometimes called the 'invisible tax.'

Sovereign debt is perhaps the most egregious indicator of today's inward war. Governments borrow on promises that it enslave citizens in order to obtain resources to make creditors whole. Sovereign debt levels have never been this high in history. And they are growing thanks to QE..

While outward wars may infrequent at the moment, intensity of inward wars has never been greater.

Why Don't People Care About Inflation?

It ain't no use
We're headed for disaster
Our minds said no
But our hearts were talking faster
--Donnie Iris

In response to an Ask Fleck post yesterday, Fleck admits to wondering about this question often: Why don't people seem to care about inflation? It is perplexing. Because it reduces the purchasing power of money in people's wallets, inflation amounts to theft. One would think that people would be outraged about their property being ripped off.

But it doesn't generally work that way for several reasons. One is that low-to-moderate inflation rates can be difficult to notice in daily transactions. Only over large periods of time where the cumulative effects can be seen, or until the inflation rate really picks up, do people begin to notice. This is why inflation is sometimes called the 'invisible tax.'

Another reason is that government measures generally under-report inflation, which makes people think that their purchasing power is not being lost at rates as high as they actually are. Moreover, we are told that a 'little' inflation is generally good. People tend to believe this and forget how the compounding effect of even a 'little' inflation can erode purchasing power and wealth over time.

Most people are also debtors. Debtors generally welcome inflation because it allows them to pay back loans with money that is less valuable than the funds that they originally borrowed. For instance,  borrowing $100 dollars that can initially buy, say, 50 cans of soup can be paid back with $100 (plus interest) that can buy only 30 cans of soup.

Unfortunately inflation rates must often begin to go vertical before people wake up to the dangers wrought by their permissiveness. By that time the toothpaste is out of the tube.

Printing Press Preference

The deception, with tact
Just what are you trying to say?
--The Fixx

Chris Rossini explains why politicians prefer the monetary printing press for extracting wealth from the populace. It is confiscation by stealth.

Direct taxation, on the other hand, is overt confiscation. People can readily see how much of their wealth is being taken. There is a limit to direct taxation beyond which politicians are reluctant to venture because the people will push back.

Wealth confiscation via inflation is much more difficult for people to discern in the near term. They cannot easily recognize how much of their wealth is being taken when the government prints dollars and spends them while they still have value. Only later do people figure out that the purchasing power of the dollars in their pockets has been eroded.

Inflation is the invisible tax. Using the monetary printing press to confiscate wealth could very well constitute the ultimate in political expedience

How Much Cash?

I'm out of money, out of hope
It looks like self-destruction
How much more can we take
Of all of this corruption?
--Molly Hatchet

How much cash to hold continues to be a difficult decision for me. In unhampered markets cash is backed by hard assets and therefore a reliable proxy for production. More cash means more economic resources set aside and saved. Those savings can be applied toward future consumption or for investment projects. Although it resembles just a piece of paper, cash in unhampered markets becomes a store of value.

In hampered markets cash is not backed by hard assets. Instead, it is printed by fiat. In this situation cash is an unreliable proxy for production because the quantity of economic resources that can be bought with cash declines as more cash is printed by fiat (a.k.a. inflation). Under fiat money conditions, people are prone to save less because they are hesitant to hold cash that will buy less resources over time. Because cash no longer stores value, people will be prone to consume income rather than to save it, and/or convert cash into other assets (e.g., gold) thought to hold their value and be better proxies for saved production.

Right now I would like to be a significant saver of cash. However, the world of financial repression that we live in has me concerned that saving cash today is an increasingly losing proposition for tomorrow. My cash savings could be indirectly confiscated through inflation as greater supply of fiat currency renders each dollar that I save worth less in terms of economic resources that can be purchased. Indirect confiscation by process of gradual monetary devaluation is why inflation is sometimes called the 'invisible tax.'

I am also increasingly concerned about the prospects of direct confiscation of cash. The situation in Cyprus two years ago showed us that governments might enact capital controls that impair ability to withdraw cash during times of crisis. Worse yet, there is the possibility that physical cash could be banned in favor of purely electronic transactions. That could give desperate governments even more confiscatory control. Cyprus also demonstrated that governments could simply dip into cash deposits and take some. For example, government might expropriate, say, 20% of cash balances to help fund bailout programs in times of 'national crisis.'

The present economic environment, defined by extreme monetary and fiscal policies alongside record leverage, makes me increasingly wary of holding cash. Risk associated with holding cash, as I see it, is extremely high. As such, my cash balances are currently lower than they have been in some time.

position in gold

Dollar Destruction

Now that ain't workin'
That's the way you do it
Lemme tell ya them guys ain't dumb
--Dire Straits

Nice graphic that provides a sense of how much purchasing power has been lost in the dollar over the years.

It should be noted that the USD was not destroyed right out of the gate. From the country's founding thru the early part of the 20th century, the purchasing power of the dollar held steady--with notably exceptions such as the Civil War.

What this means is that if the above graphic were done in 1900, then what the dollar could buy in 1900 was about the same as what the dollar could buy in 1800. There would be little if any difference.

It was not until the Federal Reserve took the reigns in 1913 that the dollar's decline began in earnest.

The gradual, covert nature of this loss in purchasing power is why inflation is often referred to as "the invisible tax."

Privacy, Property, and Gold

I'm falling down a spiral, destination unknown
Double crossed messenger, all alone
Can't get no connection, can't get through
Where are you?
--Golden Earring

Extending yesterday's post, holding large currency preserves capacity for private transactions but does not prevent devaluation due to inflation. The problem with paper currency is that it always gets debased by government in order to obtain resources from its citizenry.

Preserving purchasing power requires a money that resists debasement. Over the years, that money has been come from precious metals--gold and silver. Money backed by gold and silver cannot easily be debased because concerns about inflationary practices of government will cause precious metal to move from government to private hands--thereby affording citizens protection against having their property confiscated by an 'invisible tax.'

1850 $20 Liberty PCGS XF40 CAC

Take, for example, the US 'double eagle,' a coin containing nearly one ounce of gold with a face value of $20 that circulated from 1850 until 1933. During that period, anyone could walk into a bank and exchange $20 worth of paper money for a gold double eagle. When concerns grew that the federal government was printing too many paper dollars, then more people would accumulate double eagles, thereby draining gold from government vaults until bureaucrats slowed down the printing presses.

Once gold backing was lifted from the dollar by FDR in 1933, then people could no longer sanction the federal government for inflationary practices. This gave the feds license to print $trillions at their discretion with predictable consequences.

1926 $20 Saint Gaudens PCGS MS65 CAC

Today, a $20 bill from the 1920s buys less than what a dime could from the same era. On the other hand, a double eagle from the same era, such the 1926 Saint above, has more than $1200 of purchasing power today based on its gold content alone.

Larger denomination currency, plus its backing by gold, rightly protects privacy and property.

position in gold, silver

Locking In Bailouts

And when one litte bump leads to shock, miss a beat
You run for cover and there's heat
--The Fixx

ZeroHedge reports that the 2015 federal budget plan jammed thru last nite includes provisions for permitting FDIC insurance to apply to banks failing due to derivative losses.

The big winners are the big banks (who helped craft the legislation, natch), as they own the lion's share of derivatives exposure. The big losers, of course, are taxpayers who foot the bill for the bailouts.

'Taxpayers,' in this case, should be broadly construed. The FDIC is thinly capitalized and could never cover the losses of big bank failures. The only alternative will be to make depositors whole thru money printing.

When this occurs, we all pay the Invisible Tax.

Financial Repression

"You're from Receiving, aren't you?"
--Brantley Foster (The Secret of My Success)

Carmen Reinhart (of This Time is Different fame) writes one of the more cogent pieces to appear on op-ed pages that I can recall. What separates this piece from typical op-ed drivel is linking assertions to tests of truth, using logic and/or empirical evidence.

Reinhart discusses the onset of policies being deployed by governments and central banks that help liquidate debt burdens and ease debt service. She terms these policies 'financial repression' because they are essentially taxes on bondholders and savers.

Financial repression is the consequence of massive buildup in debt around the globe. Reinhart's Fig 1 shows that central govt debt among developed nations is at its highest peacetime level ever--nearly 100% of GDP. Factor in private sector debt and unfunded liabilities and the degree of leverage is much higher.

The important thing to note is that the spike higher to record debt levels came in response to problems caused by already high debt levels. The credit crisis of 2007-2008 was 'fixed' by adding more debt to the system. This, of course, is classic Ponzi--both unsustainable and unstable.

Reinhart observes that large debt:GDP ratios have been reduced throughout history via some combination of: economic growth, austerity (spending cutbacks), debt default, inflation, and financial repression. She also notes that the last two options are only viable for debts denominated in domestic currency. Indeed, for those countries that do have control over their own printing press, inflation and financial repression have been the preferred avenues for coping with the debt overhangs since 2008.

A focal point of financial repression is central bank intervention that keeps nominal interest rates lower than market. All else equal, this reduces government interest expense and leads to deficit reduction. However, when central bank intervention results in negative real interest rates (as is now the case), then this action amounts to a transfer of wealth from creditors to debtors--in the present case from savers to governments.

As Reinhart notes, this is a tax that is largely invisible and discriminatory, thus it is likely to be politically palatable to policymakers and to the masses.

Reinhart also touches on the growing practice of 'monetizing debt,' although she does not term it that. Her Fig 2 indicates that sovereign (and GSE) debt is increasingly owned by government entities rather than by 'outside' market players. This "means markets for government bonds are increasingly populated by nonmarket players, calling into question the information content of bond prices relative to their underlying risk profile--a common feature of financially repressed systems."

Nice point. Financial repression also amounts to distortion of information. Market truths morph into...false signals that have a propaganda feel to them.

Not only do savers have their capital robbed from them during financial repression, but information that might help those people regain their footing is taken from them as well.

Reinhart think financial repression will be with us a long time. My sense is that the time period may last only until the chaos unleashed by financial repression drives systemic collapse.