by Gary North
A lobster trap lures a lobster in. The more he pushes forward to get at the bait, the less able he is to back out. A lobster trap is a forward-only device. The lobster thinks he will get the bait. In fact, the trap gets him. It doesn't kill him. It immobilizes him. Then the person who set the trap comes back, hauls the trap out of the water, and extracts the lobster. Then he re-uses the trap.
Central banking is a gigantic lobster trap. It is set by the commercial banking industry and the government, which grants the central bank a monopoly over the control of the monetary reserves (government debt) that are used by commercial banks to issue loans.
The trap's bait is a two-part promise: (1) establishing an economy that does not suffer from economic depressions; (2) establishing price stability.
The Federal Reserve Act was passed in 1913 in the aftermath of the recession of 1907. Its success can be measured by (1) the recession of 1921, the Great Depression of 1929—39, the recessions of 1957, 1970, 1975, 1980, 1981, 1990, and 2001; and (2), the decline in the value of the dollar — approximately 95% since 1913. (Inflation Calculator.)
Like any good lobster trap, the lobster is caught, removed, and consumed. Then the lobsterman replaces the bait. To get a nice, fresh lobster, you have to replace the bait.
From time to time the central bank suffers a setback: a recession or a bout of price inflation or both. This is part of the extraction process. The lobsters that got caught in the trap are wiped out, or at least suffer losses. The little ones are tossed back in to fatten up and be lured back in a second time. Lobsters are stupid. They don't remember. The larger ones are consumed.
The same promise works over and over. "This time you can trust us. This time, there won't be another recession. This time, you can count on us to keep prices stable." And another batch of trusting lobsters is lured back in.
THE PROBLEM WITH THE BAIT
There are no free lunches in life, not even for lobsters. Lobstermen are not in the business of feeding lobsters. They are middlemen for those who eat lobsters. Lobsters, however, are short-sighted. They don't understand cause and effect.
Neither do voters.
Commercial banking is based on a promise: "Deposit your money, and we will pay you interest, and you can get your money back at any time."
Now, if the deposit were gold, you would have doubts. You would think: "If I put my gold coin into a jar and bury it, there will be only one coin there when I dig it up. So, if I hand it over to a banker, he will put it in a vault. It won't multiply in a vault any more than it will multiply in my jar in the ground. If I want to get it back on demand, it had better be there. But if it's there, the bank can't do anything with it. There is no way a bank can pay me interest, any more than my jar can pay me interest." This is logical.
But men, like lobsters, rarely think straight. They are unable to apply the logic of the gold coin to paper money. They surely can't apply this logic to bank accounts. They don't say to themselves, "I've seen this one before. He can't pay me interest and also let me get my money back at any time."
It's the wonderworld of alchemy: the logic of gold no longer applies. Pieces of paper or digits somehow make the law of matter go away. The same item can somehow be in two places at the same time. "It's a miracle!"
The government allows commercial banks to lure in depositors by making a promise that cannot always be fulfilled: "interest, plus withdrawal at any time." Banks lend out money that they take in from depositors, and are paid interest by borrowers, part of which they share with depositors. The banking system rests on a premise: not many people will ask for their money back at one time. When a few people do — the ATM phenomenon — money that is held in reserve can be used to pay them off. A fraction of the money is held as a reserve, "just in case." This is fractional reserve banking.
Enter the central bank. It buys a government T-bill. It writes a check to buy it. The money it just created to buy the T-bill is spent into circulation by the government. If a non-authorized private company did this, it would be called counterfeiting. But because a central bank does it, it is called enlightened monetary policy. Its money creation is legal because the government has authorized the central bank to create money out of nothing in order to buy a T-bill created out of nothing. It's a wash!
Well, maybe not a wash. It's more like an acid bath. The new money that the central bank just created is added to the total money supply. It gets deposited in a commercial bank. Wonder of wonders: the banker now has more money to lend at interest.
If there is new money in the hands of consumers, then they will be able to go into the marketplace and bid up the price of goods and services. The free market is a gigantic auction in which buyers (sellers of money) bid against each other, and sellers (buyers of money) bid against each other. Out of their competing bids — buyers vs. buyers, sellers vs. sellers — comes an array of prices. But some buyers (sellers of money) now have more units of money to sell, thanks to the central bank's purchase of government debt.
Remember lobster bait #2? Price stability. How can the auction keep prices stable if some sellers of money have more money to spend as a result of the central bank's purchase of a T-bill? The answer: sellers of goods must produce more things to sell for money at a profit. But if sellers can really do that, then they would have done it without the additional fiat money. But then prices would have fallen: some of the bidders to buy money would be out there lowering the prices of whatever they are trying to sell.
The bait of price stability has to be paid for. There are no free lunches, not even for lobsters. The bait is paid for by people with money to spend who would otherwise have been offered a deal by sellers. "Tell ya what I'm gonna do. For you, this week and this week only, there's a special discount available."
Prices are stable because there aren't as many discounts.
Lobster bait is paid for by the lobsters.
It's a terrific deal for lobstermen and gourmets. Butter producers are also in on the deal. (In the central banking game, the butter producers are called economists.)
PAYING FOR BAIT #1
Bait #1 is the promise of recession-free living. The central bank promises that it has the ability to avoid recessions and shorten them when they occasionally sneak through. How? By buying even more government debt.
"Here's how it works!" The recession is said to be caused by insufficient demand by sellers of money, who for some reason hoard their money. So, the central bank buys more debt, and people have more money to spend. This doesn't raise prices because sellers are so scared of going out of business that they offer discounts just to unload their inventory. The new money pushes prices up, but prices were falling. Now they will merely stay stable.
There is a word for this system: Japan. The central bank inflates, but prices are slowly falling.
The problem with bait #1 is that, to the degree that it is successful — retail prices stop falling, and companies don't go bankrupt — sellers of money (consumers) expect even more money next month, so that they can pay off new consumer debt, and sellers of goods (manufacturers) expect consumers to have more money next month, to buy this month's output.
Where are consumers going to get more money next month?
From the central bank, which will buy more government debt.
And the month after that, too.
Pretty soon, the system is dependent on new issues of government debt, or at least new purchases of existing government debt certificates by the central bank. It's a one-way process: more money. The only way to go backward is to strip off your shell. Shell-stripping is called a recession.
Consumer prices in Japan should be falling, due to increased productivity. They are falling, but very slowly. Everyone is counting on more fiat money next month.
The Bank of Japan buys U.S. government debt in addition to its own nation's debt. It creates new fiat money and buys dollars in the open market, which it then uses to buy T-bills. That keeps up demand for dollars.
The U.S. government spends these dollars. (Trust me; it does.) These dollars can then be used by American importers to buy yen to buy goods from Japan, which increases demand for exported goods in Japan, which keeps prices higher. Of course, we Americans get the TV's and Walkmans and such. The Japanese get a central bank filled with T-bills paying under 2%.
The Japanese are a nation of lobsters. The Bank of Japan is an organization of lobstermen. You and I are consumers of lobsters. With respect to the rest of the world's goods, the United States is a franchise called "Green Lobster."
The trouble is, Americans think this franchise is eternal. But at some point, the lobstermen in Asia will find that the local waters have been fished out, so to speak. No more large, succulent lobsters will be found in the traps. Fat lobsters will have to lure them in with bait other than Americans' promises to pay.
At that point, the Green Lobster franchise will be in big trouble.
LOBSTERS ARE STUPID
People really do want to believe in something for nothing.
This makes them do silly things.
In the middle ages, alchemists sought ways to convert lead into gold. (The most famous alchemist was Sir Isaac Newton, who kept secret this side of his scientific career.)
We regard ourselves as sophisticated. We don't believe in alchemy. Not us! Yet we hand our money over to banks on the assumption that we can get our money back at any time, and we will be paid interest for the privilege. ATM really means "Alchemy: Trustworthy Magic!"
We see the results of central banking around the world. One result is public's trust in the wisdom supposedly possessed by salaried employees of a government-created monopoly. Investors smile when Alan Greenspan talks gibberish to Congressmen and Senators, who cannot get straight answers from him. "That Greenspan. He's really something." Yes, he is. He is the chief lobsterman, and we are the lobsters.
Another result is the creation of a series lobster traps that lure in fat, succulent lobsters. The U.S. stock market was one such trap, 1982—2000. The residential real estate market has been its replacement.
So it was in Japan, 1980—1989. Since then, the Japanese stock market has been "fished out." Not many juicy specimens have pushed their way into the traps. Fifteen years after the Nikkei hit 39,000+ it is in the 12,000 range — up from 8,000. Lobsters may be stupid, but they have learned not to trust the bait. What's a central banker to do?
Today, China is central bank paradise. The waters are teeming. The central bank is pumping in new money by buying T-bills like a drunken sailor. Why? So as to run a $100 billion trade surplus with the United States. Rural Chinese lobsters have begun to move into the urban waters by the tens of millions. They must be fed long enough to fatten them up. Their output is being exchanged for the digital equivalent of green pieces of paper with Presidents' pictures on them. It's a sweet deal at the Green Lobster franchise.
China is not experiencing mass inflation. Why not? Because Communism was a gigantic lobster trap that could barely feed skinny lobsters. Mao was chubby; nobody else was. By converting those state-managed traps to a modified trap system based on private property, the lobstermen are doing a lot better. The productivity unleashed by the shift to free enterprise, even when central-bank dominated, is so great that China has become a net creator of wealth. Central banking operated under Mao, too. The difference is, the lobsters today are a lot fatter.
The rulers of China, like rulers everywhere, have persuaded the masses that central banking and government debt are a marriage made in heaven, or seventh heaven, depending on cultural traditions. The bait has been inserted into the traps. The only way to feed the growing supply of urban lobsters is to keep replacing the bait. That means an ever-growing supply of fiat money. The day the bait slows or even reverses is the day that the system collapses: no more lobsters in the traps.
LOBSTERS MUST RETAIN FAITH IN THE BAIT
In 1946, Congress passed and President Truman signed the Full Employment Act of 1946. It is still the law of the land. Congress by this act promised to pursue policies of full employment. The law established the President's Council of Economic Advisors and Congress's Joint Economic Committee. These two bureaucracies, filled with economists, are supposed to provide advice on how the government can keep the economy operating at full employment.
This law was the aftermath of the Great Depression, in which governments around the world could not maintain full employment without setting up slave labor camps. It was also the aftermath of World War II, whereby governments solved the unemployment problem by expanding the military draft in a war that killed between 40 million and 60 million people: lobster slaughter on a uniquely scientific scale.
In 1996, economist Murray Weidenbaum wrote a cheerleading essay, "The Employment Act of 1946: still working after 50 years." He described the Act.
When enacted, the Employment Act declared that "it is the continuing policy and responsibility of the Federal Government to use all practical means consistent with... other essential considerations of national policy... to coordinate and utilize all its plans, functions, and resources... to promote maximum employment, production, and purchasing power."
The idea here was "the power to tax is the power to create." By expanding the government's ability to tax and spend, the government would be able to make life good for lobsters.
More was needed than the ability of bureaucrats to extract money from taxpayers. There also had to be a way to get more money into the hands of taxpayers, so that the state could extract even more money from them — for their sake, of course. Americans need employment, just as China's masses need employment. It is the task of the economists of the CEA and JEC to provide scientifically valid advice to politicians as to how the government can skim off the largest percentage of this output without hindering the lobster-fattening process. The experts are agreed: when it comes to lobster-fattening, the Federal Reserve System plays an important role.
The debates of the 1960s and 1970s on the relative effectiveness of monetary and fiscal policy changed the basic focus of U.S. economic policy. The Federal Reserve Bank now is looked to as the primary mechanism for achieving short-term economic stability, while tax and budget policies are viewed in terms of the longer-run impacts on investment, economic growth, and income distribution.
Of course, this view is not shared by Milton Friedman and the monetarists, who want to substitute an automatic money creation system for the Federal Reserve System, which has too much discretion, they think. Monetarists want lower taxes. So do supply-siders, who are happy the have the FED create lots of money during recessions. So do Austrian School economists, who don't want the Federal Reserve System or an automatic money-creation system. But the politicians want more money to skim off, so they pay very little attention to monetarists, supply-siders, and Austrians. Weidenbaum surely doesn't.
In an informal, but universal, reinterpretation, the reference in the Employment Act to "purchasing power" has been cited as the basis for government concerning itself with controlling inflation. Subsequently, the Humphrey-Hawkins Act of 1978 formally added the goal of eliminating inflation. The original primary emphasis on "maximum employment" — which was a legislative compromise to break the deadlock over the more controversial term "full employment" — generally has taken a back seat in Federal economic priorities. Perhaps this is a compliment to the flexible language of the legislation. More basically, the new emphasis may reflect changing national priorities resulting from the country's success in avoiding the massive unemployment of the 1930s and earlier periods.
Of course, the purchasing power of the dollar has continued to fall, but that's not a worry for policy-makers who work for the government. What matters most for them is that the voters maintain faith in the system that extracts 25% of their output at the national level, plus another 10% to 15% at the state and local level. And so they have.
Viewed in the most fundamental light, however, the legislation has been successful. The two institutions the 1946 act established remain in operation and the act's then-controversial statement of policy has become accepted as part of the Federal government's bureaucratic fabric. A substantial government responsibility for the over-all performance of the American economy now is widely assumed. In fact, politicians of the opposition party readily hold the administration in office accountable for whatever economic short comings occur.
We have seen in Japan that investors who were lured into the stock market bubble and the real estate bubble have lost large portions of their wealth. The government keeps spending on boondoggles, and the central bank still buys U.S. T-bills — or did until last March. The politics of mercantilism — government-aided lobster exporting — are still dominant in Japan.
The same politics are alive and well in China, which is in the boom phase of the fattening-up process.
The United States is somewhere in between Japan and China, though closer to Japan. The FED is still pumping in fiat money, but has not had to pump at double-digit rates because Asian central banks have bought T-bills and have thereby kept America's interest rates low. For as long as the lobstermen of Japan and China are fishing their own waters by persuading the lobsters to keep walking into the traps, America's Green Lobster franchise will stay in business.
But at some point, Asian lobstermen will figure out that the Green Lobster franchise is all debt and no repayment. Americans are putting the bill on their credit cards. When the bills come due, what then?
The bills will come due. We just don't know when. Sooner rather than later, I suspect.
October 13, 2004
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