Cash Trades on Bluff and Deception

Imagine that the explosive printing of broad money, which has been the case since the founding of the Federal Reserve in 1913, ceased tomorrow. The gold price would spike initially. Zombie banks might go under. The dollar might rally. Goldman Sachs might get caught off balance with carry trade exposure. When that happens, China would have to break its peg to the dollar or see its export economy collapse.

Then what? Stockbrokers and bankers would have to find jobs or start companies in industries that actually produced something.

Yet the argument that we must print and spend our way out of a crisis brought upon us by an excess of consumption and borrowing is being deployed to justify the largest transfer of wealth from Main Street to Wall Street ever. The vampire squid continues to stick its blood funnel into anything that smells like money, extracting record bonuses after the Fed has reliquefied the capital markets but has left homeowners twisting in the wind.

Unlike gold, paper and electronic money can be manufactured at will for next to nothing. Ninety-five percent of all the dollars in the broad money supply were printed since Nixon declared that foreigners could no longer demand gold in exchange for them. Genuine control over the money supply looks unlikely, and the one-way bet this has fostered enticed Americans to leverage up and buy houses, escalating prices beyond the fondest wishes of the most ardent speculators. And high prices had an effect. Now almost a quarter of homeowners have negative equity in their homes, with 15 percent registering a 20 percent loss. University of Arizona law professor Brent White made national news recently when he suggested millions of mortgage holders would be better off walking away.

Quantitative easing, or dropping cash with helicopters because banks won't lend and people can't borrow, might offer support to prices and avert a collapse in the collateral value that backs checking deposits. But it is becoming clear that Americans are uncomfortable with owing more than their incomes can support, so they are hitting bids and paying down debt, forcing the fractional reserve money multiplier to run in reverse. The Fed has injected $1.3 trillion into the system since the credit market froze solid, but broad money has only increased by about one-quarter billion dollars in the past year. So $1 trillion was destroyed.

Above all, phrases like quantitative easing should trip alarms. Citizens bought into similar arguments after the French National Assembly printed up assignats, slowly at first but then with gusto once their salutary effect was recognized, but eventually they wanted to put bankers' necks into guillotines and burn the presses. Tinkering with money really does destroy the wealth of savers, and making someone else pay for your mistakes really is a moral hazard and a perverse form of socialism.

Another bull argument of interventionist central planners is that dropping interest rates to near zero, doubling the broad money supply since the internet bubble, and letting government spending spiral out of control had almost no effect upon inflation, and in fact produced a great moderation. We should target outcomes, not the supply of money, so they did. What the heck if it produced the greatest indebtedness seen in the last century or more.

Surprise, surprise: gold prices scraped along the basement floor by the end of the roaring 1990s because anybody with half a brain knew more money could be made chasing internet stocks. Now that the system proved itself to be unstable, they are utterly mystified that gold would be the only decent performing asset, preferred to holding deposits backed by the full faith and credit of a strapped government and collateral that is a commodity suffering from years if not decades of government-favored malinvestment. Tisk, tisk! For most of this year, gold rose even though there were definite signs of green shoots!

Gold's price reaction to specific events continues to confound cheerleaders of the interventionists and the reporters who choose to curry favor with them. It refuses to fit neatly into black boxes like those that so effectively measured risks for LTCM, statistical arbitrageurs, or anyone else stupid enough to plug in data generated during a period of gluttony for levered returns and think correlations would protect them when the movie began to run in reverse. It refuses to behave, because it wants to become money rather than jewelry. The story of King Midas is not an ode to the bling looted by the captains of Wall Street, but an age-old preference of the common man for rationality and dependability rather than manipulation and fraud. Maybe gold can't be easily valued, but then paper or electrons can, and they are worthless.

William Baker Author of Endless Money: The Moral Hazards of Socialism

Editor, The Conservative Economist

Note: Any resemblance of the above to an article published by Liam Denning in the Wall Street Journal's Heard on the Street column today is purely intentional.

Disclosure: Holder of gold equities, physical gold, GLD, long and short equities.