Prevent Right Click

Dr. Thomas C. Rustici

 

"Thinking The Unthinkable"

 

Introduction:


Good evening

ladies and gentlemen! I want to first thank Elizabeth Currier, Howard Segermark, and Edwin Vieira for their efforts to make this event possible for me and my family. It is truly an honor to be surrounded by so many informed people interested in monetary economics, freedom and the fate of our world. Thank you for your time.


About 25 years ago, my Ph.D Macroeconomics Professor Don Lavoie said on the first day of class, “If I were a truly EVIL man, I would mass exterminate billions of humans from life on earth. I could do this in 1 of 2 ways. I could get control of nuclear weapons, start thermonuclear war and vaporize billions within minutes. This is quick and everyone sees its danger and morally evil consequences. The other way takes a little longer, but with equal certainty kills billions: I would immediately destroy the institution of money.”   This quite frankly shocked the hell out of me! What kind of graduate economics program did I get myself into?


Dr. Lavoie’s point made me think about a book written some years earlier by the late scholar Herman Kahn.  Kahn’s provocative book was entitled, Thinking the Unthinkable.  What actually happens during and after a full throttled nuclear war? The reason it is so “unthinkable” arises from the horrific scale of the destruction it entails. How do we survive, recover and proceed with life? How do we cope with the magnitude of the physical and moral destruction around us on that “day after?” All kinds of questions raced through my mind while sitting in that first class.


I believe we must “Think about the Unthinkable” again—but not about warfare in the expanding nuclear age.   I’m thinking of the second thing a truly EVIL man would do to violently wipe out humanity-- just in slow motion: I would destroy the institution of money with hyperinflation. Let me explain.


Money: The Medium of Exchange

Money is the most important economic good in any society.  Romantic writers, poets and philosophers condemn money, and parade their utter economic ignorance. Money is a medium of exchange. It spontaneously emerges from trade and commerce in a barter world. It is the most critical mechanism for the ever expanding division of labor and division of knowledge based on the principle of comparative advantage. The free market creates this amazing institution—one that virtually all of human life rests upon. 

Money replaces direct barter with indirect trade.  You have apples and want the oranges that I have, but I want bananas instead of apples. You go to get bananas only to find that person doesn’t want apples; they want kiwi, and so on. Money solves this overwhelming problem of the double coincidence of wants in barter. Everyone trades for one good we call money.  Thus, a drastic reduction of information and transactions costs maximizes profits and expands the market and division of labor.  Money acquires extra properties also important to our scale of productivity. 

It serves as a standardized unit of account.  With money prices, financial accounting and economic calculation are now possible while non-existent in a barter world.  Profit-loss accounting through money prices guides entrepreneurs into rational capital allocation. Imagine trying to operate a multibillion transaction company, like IBM, with just seat of the pants guesses—or pure gut instinct’?  Without financial accounting everything is random chaos.

Money is also a store of value where people can hold value for future transactions.   This real savings and investment is the foundation of capital accumulation and economic growth.   Inflation destroys the store of value function of money, sabotages capital markets, and interjects “informational noise” into the efficacy of financial accounting. In the limit, the medium of exchange is undermined and with it the entire economic structure.  

The darkest day in human history occurred when government discovered the inflation tax.
The hyper inflation of the Roman Empire teaches important lessons.  The various Caesar’s had mastered the art of stealing through the inflation tax.  They nationalized the private mints (goldsmith) and monopolized money creation as a new source of revenue.  Political leaders’ recasted private merchant coins, put their own face on the new money, and then debased the coins with inferior metals. They used every trick in the book to cheat and defraud the people by mixing lead in the silver denarius coin or copper in the Aurius gold coin.  They clipped, filed and shaved the coins to mint even more worthless coins. Coercive legal tender laws were imposed to force people into paying the accelerating inflation tax.  Truly evil things happen with hyper monetary inflation.

The Romans recklessly ran massive budgetary deficits and monetized those deficits. Hyper-monetary inflation coupled with the maximum price controls of the Edict of Diocletian in 301 AD created severe shortages and decreased the quantity of real goods available. This repressed monetary inflation magnified inflation. Prices went up, up and away! When the price of one bushel of wheat increased to over 2 million denarius coins, the Empire was in full scale disintegration. However, unlike today, the ancient world was better positioned to recover from the monetary disaster. Most people used or exchanged a few hundred relatively homogeneous commodities in a typical Roman city market. There were almost no services.  In the country side, most were self sufficient; they grew their own food and barter traded a little with their neighbors.  Under these conditions, there is a quick reemergence of a new medium of exchange. Not so today.

How many heterogeneous commodities are there in the US economy?  Some estimates have this as high as 10,000,000 different goods. Walk into the Mall of America. Go through each of the stores and count how many different physical goods are in that shopping mall.  A consumer might buy 10 or 15 items, while they don’t buy the millions of other things that don’t serve their needs.  After a hyperinflation, what becomes the next medium of exchange?  Flips flops, lugs nuts, books, children’s toys, or women’s underwear?  What?  How long will it take today to escape from direct barter? 
Major urban centers like New York, Chicago, or Detroit etc. are not institutionally set up for survival through self sufficiency or direct barter.   The modern world is radically different than ancient times, for both good and bad, and your life depends in its entirety on money.  A fall off this monetary cliff today into economic abyss produces consequences synonymous with thermal nuclear war.


Post WWI Weimar Germany    

Post WWI Weimar Germany is another famous case of hyper inflation.  Germany ran extraordinary fiscal deficits.  By 1923, the Reischebank financed 99% of all government spending with new monetary creation.  Extraordinarily absurd inflation taxes caused the mark to depreciate day by day, hour by hour, minute by minute.  During 1923, the prices doubled every three days on average.  This was unimaginable hyper inflation.  In 1919, 8 marks equaled $1, or worth about 12 cents. This rate of exchange fell to 4.2 trillion marks to the dollar in the “official exchange rate” and 11.7 trillion marks to the dollar on the free market in 1923.  The price of one egg escalated from one quarter mark (about 3 cents) to 80 billion marks-- for one egg by October 1923.  The price of a cup of coffee increased from 5000 marks to 8000 marks while the person was drinking it.  In one case a woman ran into the bakery to buy bread, only to come out of the bakery to find her wheel barrel had been stolen and all of her trillions and trillions of marks dumped in the street gutter.

The great economist Ludwig Von Mises describes this as the flight to real goods, the complete disintegration of the monetary economy.  Money lost its store of value, unit of account, and ultimately its medium of exchange function.  From August to November 1923, the price level exploded by at least another factor of 1,000,000 to one.  This increase came from the acceleration of money velocity. So even when the Reischebank quit running the printing presses--the demand to hold cash-balances collapsed to zero and prices escalated along an exponential path.  Workers were paid two and three times a day only to rush out and buy real goods before the prices went up.  Escaping the inflation tax meant abandoning the medium of exchange.  Von Mises commented that, “the government is the only institution that can continue to take two valuable commodities like paper and ink and put them together and create something that is totally worthless.” 

What were the economic results? German industrial productivity catastrophically declined 50% per capita in one year and at least 30% within a few months.  Compare this to the United States during the Great Depression.   From 1929-1933, our per capita productivity fell by less than 1% per month on average.   In Germany, alternative monies such as Dutch florins, US dollars, Swiss francs, French francs and Italian lira widely circulated throughout the country before the hyperinflation of marks.  These foreign monies roughly equaled in value 2/3 of the real German money supply before the inflation.  The alternative money placed a floor beneath the breakdown of the division of labor, and Germany was spared the complete reversion to direct barter levels of productivity.

What Can We Learn From History?

In many respects, Americans are now in a more dangerous place than either the early Romans or Weimar Germany. Unlike the Roman economy, the US marketplace is about 85% service sector in valued output—and by its nature it is not re-tradable.  The remaining 15% of GDP is comprised of millions of heterogeneous goods. After a hyperinflation the quick emergence of new money becomes very-very problematic. Unlike Germany, no alternative currencies circulate through the shops and businesses within the United States. Not yen, not euros, nothing but Federal Reserve notes trade at McDonalds in Kansas or the local dry cleaners in Alabama.  Let’s be honest here.  When the Federal Reserve inevitably destroys the dollar, which it will, we need to ask 3 major questions. What becomes money, how long will it take to become money, and how far will the standard of living drop? What safeguards the most important institution of your life? Irving Fisher warned us about this in 1929 that, “irredeemable paper money has invariably been the curse to the country employing it.”

Inflation is a tax on the value of the cash balances held by certain members in the general public. And fundamental economic laws cannot be wished away. Supply and demand are crystal clear: if you want less of something, tax it, if more is desired—subsidize it.  Impose a 1000 % tax on shoes or hats and most people walk around barefoot or without hats to wear.  Yet, the rest of the economy still goes on.  Life itself is not threatened.  Put that inflation tax on money, and nobody wants to hold money. Since money enters every market transaction simultaneously, hyperinflation destroys all markets, limits all exchange and makes financial accounting impossible.  Even Lord Keynes, the person most responsible for 20th century inflation understood this point. 

In 1919 with his Economic Consequences of the Peace he noted: “There is no subtler surer means of overturning the existing basis of society than to debauch the currency. The process of inflation engages all the hidden forces of economic law on the side of destruction and does it in a manner that not one man in a million is able to diagnose.”  

These words are haunting and clear. “Inflation engages all the hidden forces of economic law on the side of destruction.” Look at where we stand. Compared to prior generations, Americans enjoy enormous prosperity from great productivity: vast output per unit of input. We enjoy more quantity, quality and variety of goods and services than even the Kings and Queens of the past could have ever imagined. It is the monetary institution most responsible for this miracle and yet, it is totally unprotected—wide open to political sabotage.  What happens “the day after” a run-a-way inflation? How long can physical inventories of consumer goods last? Household cupboards empty in a few weeks, retail stores another month, warehouses maybe another month.  It is estimated that the total value of all intermediate goods are about 5-6 months of output relative to annual GDP. Without alternative money, this becomes the outer time limit of survival. Remember: 1) these are intermediate goods not already transformed to serve consumer needs, and 2) bottlenecks necessarily arise in barter between the various stages of production (wheat in the field cannot become flour or bread for the consumer).  With only the volume of finished consumer products in transit added together, total inventories give us two to three months time at best.  It is safe to say that without some kind of widely accepted money most Americans will die in short order. This is the kind of ugly reality we are dealing with—not some academic or theoretical exercise. 

Kansas wheat cannot migrate to New York City consumers by bartering services. Farmer Jones specializes and grows food for 500 strangers every day. This is why we don’t have to grow our own at home.  How is milk paid for at the grocery store? Maybe give the cashier a shoe off our left foot?  How do they pay the dairy with that shoe? Does the dairy company pay its employees with little cut up pieces of that shoe? Does a little piece go to the dairy farmer in Wisconsin?  What happens? The entire economic structure of productivity free falls into the pit of utter annihilation.  While 20 million people may live in our proximity direct barter creates virtual isolation from each other’s unique comparative advantages.  America stands perched on a very dangerous cliff. 

Some economists don’t worry about this problem because it seems too remote.  They say, “to get to 1000% inflation first requires a 100% and that first requires 50% and we are far from anything like that today.  We can always pull back since there is always time.”  Right ?  Wrong.  I’m an economic historian, and ALL of world monetary history tells me that this short-sided viewpoint is a deadly delusion.  It is true that a number line is structured this way.  However, how fast inflation moves from 5 to 10% and 10% to 20% is never a fixed constant rate.  The speed that inflation moves through these numbers is often widely variable.  It may take five years to go from 5% inflation to 10% inflation, but it does not follow that it takes five more years before prices rise at 15% or even a 20% rate.  In the early 1980’s, the Bolivian inflation of the peso went from 10% to 40,000 % in just a few years.  The peso experience does not stand alone.  In Weimar Germany, prices escalated by a factor of 10 billion to one in a short 16 months! In fact, almost every irredeemable paper money system (among hundreds in world history) has over time ended up in the ash heap of hyperinflation in the same way.  So how much time is needed to safely “pull back” from the edge when money velocity is itself a dynamic variable? It is extraordinarily dangerous conceit to think anyone, no matter how smart, could ever fully know that answer. 

A Time for Truth

It is time to stare some very unpleasant realities directly in the face.  We layer safeguards around our nuclear weapons to keep rogue individuals from vaporizing most of the world.  Elaborate protections in the military command and control are in place to prevent the worst case scenario. That makes sense. What are the protections against an equally catastrophic monetary inflation?  During the first 124 years of American history there were few special interest groups, small fiscal deficits, and, government largely stayed within the enumerated powers of the Constitution.  The norm, with few exceptions meant that paper money was redeemable in gold or silver. The purchasing power of the US dollar was the same in 1930 as it was in 1830.  However, “sound money” collided with immoral socialist ethics and the dishonest economics of the redistributive transfer state.

Look at it this way. Before 1913, the few interest groups in politics could only use chisels and hammers to take a “chip” out of the foundation of the monetary economy.  Just a “little piece of the action” would not bring down the entire economy.  With the Federal Reserve Act, the government built a vast super highway to the monetary pillars of our productivity.  Major inflation safeguards were stripped away. In 1933, Franklin Roosevelt nationalized the people’s gold and left America with the ‘curse of purely irredeemable fiat paper money.’   Even more inflation safeguards are removed.  The New Deal deficits explode and thousands of special interest groups are transported in and handed “jack-hammers” to whack away bigger money chips. Still, no one piece taken threatens the whole system. The Great Society created a tidal wave of deficits as thousands more special interests groups get in on the action, only this time the government gives each group a “wrecking ball” to get a much bigger chunk of money.  Today a growing financial disaster plagues America.  Since the federal government observes no Constitutional limits on its power, tens of thousands more interest groups now use “truck loads of dynamite” to take out great boulders of the monetary economy.  When annual budget deficits approach 10% of the GDP, and do so for as far as the eye can see, expect the Federal Reserve to be ready, willing and able to monetize everything.  
 

America’s demographic transition will exacerbate the existing fiscal crisis. According to the Census, for at least the next 25 years—the net retired population expands around 8,000 to 10,000 people per day.  This means every 24 hours 8,000 to 10,000 people switch from being net tax payers at their peak earnings years, to pure tax consumers entitled to Social Security, Medicare and other benefits.   This happens every single day for next 25 years.  With certainty this ballooning retiree population can be counted on to vote their interest.  And we are not going to take away any voting rights.  Now consider that the IMF Select Papers estimates America’s total unfunded liabilities from all government commitments exceed 200 trillion dollars. If 200 trillion $1 bills are laid end to end, it stretches from this room to the sun and back about 100 times!  All this future debt will soon come due and become funded national debt—more properly monetized debt.  We are in big——very big trouble—-very soon. 
Without massive structural changes—there is no possible way to grow our way out of this debt burden since our funded debts are soon to exceed the size of the whole economy.

When and if the interest charges on the national debt exceed the value of all new economic growth, the problem cannot be eliminated. Likewise, America cannot be taxed out of the scale of this problem.  Children born after 1996 will pay about 70% of their total lifetime income on average to the government in taxes.  This kills incentives and destroys economic growth. The Congressional Budget Office has estimated that the net value of the entire United States: all 3 million square miles of land, every house, every building, all consumer durables such as cars, washing machines, refrigerators everything combined comes only to $50 trillion. The unfunded liabilities are four times greater! 

Finally, we cannot borrow enough capital to get through this problem either. The real net savings for the entire world combined would fall far short of the federal government’s projected future deficits. So how will politicians fund this gap when they cannot even balance their current activities? The truth is—you know it and I know it—they will hyper-inflate the quantity of money. Over time the Federal Reserve will end up being America’s 1923 Reischebank.  We need an immediate time for truth. 

What Can We Do?

Let me leave you with a few last thoughts.  Suppose the Titanic is traveling in well known iceberg infested waters.  The fog is so thick that no one can see even one inch past the edge of the boat. No one knows what is coming. Is it smart for the captain to speed up the boat?  No! Is it wise to STOP the boat immediately until the fog clears? YES!  Suppose he says, “I’m an experienced captain and everyone should trust me with their life.” He reassures passengers, “In a split-second, I can just always to pull the boat away from any iceberg danger.”

Now the boat hits an iceberg—there is a three hundred foot long hole below the water line.  The captain apologizes, “Sorry.”  Everyone will drown in the North Atlantic waters. It is prudent and moral to warn passengers about the gaping hole in the boat—find a life raft now since time is of the essence.  But, there are NO life boats because everyone was told the Titanic could never sink.  Rational people start tying together everything on board that floats—truth is what it is however unpleasant.  Others on board chide floatation devices as a waste of time, why panic they say—“look people in the band are playing music, listen how beautiful it sounds, I’ve always wanted to play in the orchestra.” It’s comforting and whole lot more fun to play the violin and just ignore floatation devices. That is, until everyone in the band plays their instrument at the bottom of the Atlantic Ocean.  Reality is never optional!

We need to be absolutely honest with ourselves and our situation. The time for truth is now and time is running out! History is crystal clear: socialism is poison because it undermines everything within its orbit be it law, morality or economy. And those that refuse to learn history’s lessons are condemned to repeat its tragic mistakes.  The federal government will not follow any rule of constitutional law.  In turn, central banks as political institutions cannot be trusted to obey any rules—monetary or otherwise, except the rule of inflation. I believe America needs an absolute “wall of separation of money from state.” We must either abolish or exit the central bank and return to “honest money” for many—many reasons; the least of which is short run preservation of personal assets.  Redistributive transfer politics and central banks will certainly destroy the entire institution of money.  If we are unwilling to deal with that hard reality or find an alternative financial lifeboat, get ready——not only to “think the unthinkable”—---get ready to “survive through the unimaginable.”
 
    Thank You

 

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