Dr. Thomas C. Rustici
"Thinking The Unthinkable"
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.
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 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
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
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.”
Dr. Thomas C. Rustici
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