• 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 http://www.garynorth.com.
    He is also the author of a free 19-volume series, An
    Economic Commentary on the Bible

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