The Official Counterfeiter

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In a recent
report, "The
Ultimate Subprime Borrower: Uncle Sam
," I made this observation:

The easy
money policy of Greenspan’s Federal Reserve, beginning in the
summer of 2000, lured in the suckers: creditors and borrowers.
The FED sent a false signal to the credit markets.

I do not want
readers to get the impression that the Federal Reserve under Alan
Greenspan was unique in this regard. The primary function of all
central banks is to send false signals to borrowers and creditors
all the time. Their secondary function is to bail out large commercial
banks that suffer bank runs and even face bankruptcy (bank + rupture).
Bank runs are the consequence of commercial banks’ implementation
of the central bank’s policy of deceiving borrowers and creditors.

This is not
taught in money and banking textbooks, with one exception: Murray
Rothbard’s 1983 book, The
Mystery of Banking
. As far as I know, no college or university
professor ever assigned this book. It is much too controversial.
It explains in detail why central banking rests on the dual assumption
that (1) theft through monetary inflation is morally neutral and
(2) is often (i.e., all the time) the best monetary policy. Keynesianism,
monetarism, and supply-side economics all rest on this dual assumption.
They debate only on which rate of theft is wise at any time. You
can download the book for free here


In a free market
society, the rate of interest is set by means of a competitive capital
market in which each individual decides to lend, borrow, or stay
out of the credit markets. His decision depends on his subjective
assessment of how valuable future income is to him.

Some people
are highly future-oriented. Ludwig von Mises called this outlook
low time-preference. Other people are highly present-oriented. Mises
called this outlook high time-preference. Most people are somewhere
in between.

When a person
has low time preference, and if he seeks future income, he is willing
to lend his capital (money) at a low interest rate. The borrower
does not have to offer him a high rate of return to persuade him
to forfeit the use of his wealth for a specified period of time.

In contrast
is the high time-preference individual. He wants the use of his
money now, so that he can buy consumer goods and services. He wants
gratification — maybe not instantly, but soon, very soon. To persuade
him to forfeit the use of his money, a borrower must offer him a
very high interest rate.

The free market
allows high time-preference people, mid-time-preference people,
and low time-preference people to come together and make offers
and counter-offers to borrow or lend. In other words, they make
bids. The capital markets are gigantic auctions for capital. Through
these objective bids, the subjective time preferences of acting
individuals produce specific rates of interest in specific capital

A rate of interest
is, at bottom, the price of obtaining capital for a specific period
of time in a specific risk market. It is governed by the subjective
time preferences of capital owners and borrowers.

Borrowers possess
a crucial capital asset: their likelihood of repayment. This is
determined objectively by such factors as their net income, net
worth, existing debts, and record of past payments. Modern credit
markets have profit-seeking credit-rating services that trace individuals’
past payment performance. They assign an objective number to each
individual. Lending institutions use this number to assess individual
credit risk.

This is another
way of saying that borrowers can capitalize their moral commitment
to repay. An objectively good credit rating reflects a morally good
commitment to repay. The psalmist wrote 3,000 years ago: "The
wicked borroweth, and payeth not again" (Psalm 37:21a).

Banks have
long functioned as brokers in the loan markets. Lenders hire bankers
to screen candidates for loans. Borrowers go to bankers to obtain
money deposited by lenders. This is a legitimate economic function
of banks. They capitalize on their specialized information of the
credit markets, including borrowers’ likelihood of non-payment.

A rate of interest
is ultimately a product of subjective assessments of the relevant
discount for time and objective assessments of credit risk.


Any tampering
with any rate of interest by a government agency or a government-licensed,
private, profit-seeking agency constitutes a deliberate attempt
to use legalized coercion to deceive lenders and borrowers about
the prevailing subjective discounts for time and the objective credit
risk of borrowers.

Central banks
have been licensed by governments and given monopoly control over
domestic banking. Politicians assume that central bankers will deceive
the public in government-approved ways. This assumption is usually
correct. Occasionally, this assumption is incorrect. These occasional
departures are called, respectively, mass inflation and recession/depression.

First, a central
bank begins its process of deception by hiring economists to decide
which economic theory to apply to statistical information. This
theory shapes which information is collected.

Second, a central
bank hires specialists to collect statistical information on the
overall economy. Sometimes, the government supplies this information.
Often, this information must be supplied to the government by private
individuals or businesses on threat of negative sanctions for refusing
to supply it.

Third, other
central bank economists interpret the significance for the overall
economy of the collected information. They pick and choose in terms
of the prevailing economic theory, which includes a theory of the
boom-bust cycle.

Fourth, a different
group of economists decides whether to buy, sell or hold government
debt certificates in order to change the prevailing interest rates
or keep them the same. A central bank can buy long-term government
debt to lower the capital markets’ long-term rate of interest: bonds
and mortgages. Rates will then fall. Or it can buy short-term debt
to influence the overnight rate of interest that commercial banks
lend to each other. Rates will then fall. It can also sell debt
certificates in order to produce the reverse effects. Central banks
rarely do this for more than a few weeks.

The underlying
presuppositions of central bank deception are these:

  1. The free
    market is not a reliable agency to allocate capital.
  2. Central
    bankers have both a legal right and a moral obligation to alter
    the rate of interest.
  3. An economic
    boom (expansion of the division of labor) is preferable to whatever
    conditions the free market would otherwise impose.
  4. An economic
    bust (contraction of the division of labor) is to be avoided because
    (a) it may produce bank runs, and (b) incumbent politicians, who
    officially have the authority to set central bank policy or even
    revoke its grant of monopoly, fear the political results of an
    economic bust.
  5. It is preferable
    to be a central banker, whose career is protected by the government,
    than to be a commercial banker or an economist who competes in
    an unhampered market.

Over time,
#5 replaces #1, which replaces #2, etc. How much time? This is an
empirical question. My guess is about three weeks.


When central
banks buy any asset, they create money to buy it. The seller of
the debt certificate then spends the newly created money.

The seller
of the debt certificate is like an auctioneer. He likes lots of
people to show up at his auction. The seller of a promise to pay
future money wants to pay a low rate of interest. The more lenders
who show up at the auction, each bidding against the other, the
better it is for the borrower. Sellers keep saying, "I’ll accept
a lower rate." The borrower thinks, "How much lower?"

When no lenders
in the debt market have counterfeited money to buy the debt, there
will be no long-term price inflation. Under such conditions, rates
do not fall as a result of counterfeit money being used to buy the
debt certificates. Every lender forfeits the use of his money during
the period of the debt. The borrower spends this money, but the
lender would also have spent it. No new purchasing power comes into
the market.

A central bank
is the government’s officially licensed counterfeiter. So, when
a central bank creates new money to buy debt, there is no offsetting
reduction of spending, as would otherwise be the case with a non-counterfeiting

is illegal because governments, central banks, and commercial banks
want no competition. What they are really protecting is their government-protected
trademark. If anyone could create money, this would destroy the
purchasing power of money.

I once saw
a cartoon of a counterfeiter who had a graph on the wall. The line
sloping downward and to the right was "value of money."
The line sloping upward and to the right "price of paper."
The upward line had just intersected the downward line. The counterfeiter
yells: "Stop the presses!"

In a purely
government-run counterfeiting operation, the insulated bureaucrats
may not stop the presses this early. Hence, we had the great mass
inflations in history, such as Germany, 1919—23, and Hungary, 1945—48.

When central
banks issue counterfeited new money, governments spend this money.
The new money multiplies through the fractionally reserved commercial
banking system. In this sense, the central bank’s holdings of government
debt serve as the legal monetary base of the commercial banking
system. When the central banks increases the monetary base, commercial
banks increase their loans. When the central bank sells assets,
commercial banks must decrease their loans.

In the early
stages of the boom, the central bank’s purchases of government debt
lower the rate of interest, meaning short-term rates, unless the
central bank buys bonds. Lower rates send a signal to borrowers:
"There is more capital available." But there isn’t. There
is merely more money. At a lower price, a greater quantity is demanded.
The level of debt rises. More business projects get started. If
the borrowers are consumers, more consumer purchases take place.
"Happy days are here again!"

But then prices
begin to rise, or else they don’t fall as they otherwise would have.
Why? Because the newly counterfeited funds that were lent to borrowers
and immediately spent into circulation added to the money supply.
On a free market, funds lent could not be spent by the lenders to
buy anything.

As prices rise,
the boom accelerates. Buyers think, "I had better buy now,
before prices rise further." Sellers think, "I had better
hold onto my property; prices are rising." So, prices continue
to rise. But, at some point, they rise so high that new buyers cannot
afford to buy any more. Then, like an ocean liner that has hit an
iceberg, the economy begins to slow; then it sinks. Capital that
had been invested in booming sectors of the economy is revealed
to have been invested in items that consumers are no longer willing
to buy.

A financial
bubble is always fiat-money created. It is created by interest rates
that are set below what would have prevailed on a free market. When
it pops, and investors lose money, they rarely blame the official
counterfeiters: the central bank and the commercial banks.


Florida was
a bubble real estate market for five years. It began reversing in
2006. Here
is a recent report, published in Florida Today
15). In Brevard County, it’s a buyer’s and renter’s market.

Just ask
Sharon Montano, 44, an assembler at DRS. The Palm Bay resident
lived with her three teenaged sons in a three-bedroom, $745-a-month
unit at Country Garden Apartments until six weeks ago, when she
decided to rent a four-bedroom home for $945 a month.

boys needed a backyard. They couldn’t play on the grass there.
The kitchen (in the apartment) was really small and I hated cooking,"
she said. "There are so many restrictions in an apartment,
and so much comfort in a house."

he wishes he didn’t, Ken Myers owns 15 rental homes along the
central coast of Florida, including five in Brevard County.

Like many
home flippers — people who build or buy homes, improve them if
need be and then sell them for a profit — Myers made money for
three or four years until the new home market softened about a
year ago.

"I was
trapped into renting," he said.

To compete
in this market, Myers has to keep rents low, negotiate for less
than his monthly costs and even offer the first month free.

got mortgages for $2,700 a month, and I’m renting a 3,000-square-foot
(house) for $1,200. I’m upside down," Myers said.

He plans to
stick it out until the housing market reverses.

He think that
will be soon.

Florida owners
thought so in 1926, too.

This situation
has taken place because of Federal Reserve policy, as well as central
bank policy in Japan and China, which also have bought U.S. government
debt. They created fiat money, bought dollars, and bought T-bills.
Rates fell from mid-2000 to mid-2003. Now they have risen. Those
who got sucked in are finding that the bubble mentality has begun
to fade.


There are no
free lunches. There is no free money. At some point, a rational
counterfeiter shouts, "Stop the presses!"

FED dramatically slowed the presses, beginning in February, 2006.
monetary base from March 15, 2006 to March 14, 2007 was up by 1.8%

There are
winners in the boom phase who become losers in the bust phase. The
bust phase is beginning. The losers will soon feel a great deal
of pain.

21, 2007

North [send him mail] is the
author of Mises
on Money
. Visit
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible

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