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Who Will Save Us From the Feds

The collapse of the sub-prime mortgage market has had one positive effect: It has exposed the flimsy scaffolding propping up the financial system.

Suddenly, economic pundits are debating two brow-furrowing questions: Should the Federal Reserve hang tough on interest rates to fend off higher price inflation? Or, should the Fed continue lowering interest rates to stabilize a slowing economy?

With the specter of inflation receding, the consensus is rallying behind the risks of recession. Many commentators argue that if the Fed doesn't act quickly, the nation could even be plunged into a 1930s-style depression. Worse yet, we could be on the brink of the ultimate economic catastrophe — deflation!

Deflation is defined as a fall in the general price levels. And it seems to be Mr. Bernanke's worst nightmare. As he warned in a 2002 speech: "Sustained deflation can be highly destructive to a modern economy and should be strongly resisted."

According to him, the sources of deflation are no mystery. "Deflation is in almost all cases a side effect of a collapse of aggregate demand - a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers." And falling prices, we're told, open Pandora's box. "[The] economic effects of a deflationary episode...are recession, rising unemployment, and financial stress."

For the majority, monetary economics is a mystery wrapped in gobbledygook. From childhood to old age, we desire money, work for it, use it, save it, invest it and generally spend our lives agonizing over how to keep what we have and get more.

Yet the masses understand money's origin about as well as they understand quantum mechanics. With general ignorance about the source and nature of money, any economist worth his salt can easily confuse the public about economic policy.

Deflation - Destructive? Nonsense!Sustained deflation is highly destructive? Give me a break! Nothing is more nonsensical than to argue that falling prices, per se, are bad for the economy.

Was it a disaster when computer prices fell dramatically over the past four decades? Of course not. The lower the price, the better. The same is true for shirts, TVs, and rutabagas. Consumers win when competition and innovation increase output. And increased output results in deflation - as long as it remains undisturbed by monetary intervention.

Bernanke says that a collapse in aggregate demand causes deflation "in almost all cases." Piffle! His "almost all cases" really refers primarily to the collapsing demand that apparently caused the Great Depression in the 1930s.

As Murray Rothbard pointed out in his classic America's Great Depression, demand collapsed because of easy money. The new Federal Reserve had poured easy money into the financial system and created a speculative bubble that the economy simply couldn't sustain.

In 1929, in a population of 120 million, 30 million families were involved with the stock market, and a million investors were classed as speculators. Of these, nearly two-thirds, or 600,000, were trading on margin, on borrowed funds. That is, they were trading with funds they either didn't have or couldn't easily earn.

Does that seem similar to the current real estate market? Millions of individuals have leveraged themselves into homes they can't afford - all because the central bank created easy credit policies. Like the stock market bubble of the 1920s, the real estate bubble of the past two decades has reached its limit.

At the time, Keynes explained to the politicians that "falling demand" caused the Great Depression. It's also the argument politicians used to justify massive government spending programs. Mr. Bernanke is following a well-worn path: First pump more credit into an already overheated economy and then, when the bubble bursts, do everything in your power to organize government rescue operations.

History Makes Bernanke a Liar

History also proves that Bernanke's statement is a fraud when he said that deflation comes from a collapse in demand "in almost all cases."

For three decades in the 19th Century, from 1865 to 1895, the general price level fell steadily, dropping by almost 50%. Did this sustained deflation "ravage" the American economy? Hardly. The real, inflation-adjusted, per-capita GNP nearly doubled over the same period! For 113 years, from 1800 until 1913, consumer prices in the U.S. fell 42%. That's an average annual deflation rate of 0.5%. Meanwhile, expanding output created more wealth than ever before in history.

Why didn't innovation and technological advances continue to drive prices downward in the 20th century as they had in the 19th? Because the politicians created the Federal Reserve.

Given the keys to unlimited credit creation, the Fed put the brakes on good, honest, beneficial deflation, and inflation took over. After falling for over a century, the price trend reversed, and from 1913 through this past November, consumer prices rose 2,048%!

Considering the fact that Mr. Bernanke is determined to fight the downturn with more infusions of "the hair of the dog that bit us," the long-term danger ahead is inflation, not deflation.

Meanwhile, as Warren Buffett said in his 2006 annual report of Berkshire Hathaway, "Be fearful when others are greedy and greedy when others are fearful." For the moment, the short-term is gripped by fear, but for the financial savvy it is time to be greedy.

If you haven't done so already, call to setup an appointment to learn where to put your money in this time of fear. I guarantee your 401K plan isn't cutting the mustard. Til the next time.

Thanks

Gary Gray
Tax & Financial Consultant, RFC
G&G Associates
877-817-6031 toll-free
866-361-3872 toll free fax
www.gngassociates.net

"Those who do not learn the lessons of history indeed are condemned to relive them."

LEGAL NOTICE: This work is based on SEC filings, current events, interviews, corporate press releases and what we've learned as financial consultants. It may contain errors and you shouldn't make any investment decision based solely on what you read here. It's your money and your responsibility. G&G Associates expressly forbids from having a financial interest in any security that is recommended to our subscribers