During the fall of 2008, the big banks were bailed out.  They were bailed out by Bush, Congress, and the Federal Reserve.  The Fed more than doubled the monetary base in a short period of time.  This was a unique event in modern American history.

The massive increase in monetary inflation did not translate into massive price inflation.  The money that was created by the Fed went to the banks.  The banks have held this money as excess reserves.  Normally, the banks are only required to hold about 10% of deposits in reserve.  The other 90% is lent out.  If a bank dips below the 10% requirement, it borrows money at the overnight rate.  This is the Fed funds rate that is talked about so often.  Because most banks don’t have to borrow to meet their reserve requirement these days, the Fed funds rate is near zero.  The Fed says it is holding the rate near zero, but it is really the excess reserves held by banks that is keeping the rate near zero.  With massive excess reserves, most banks don’t have to worry about falling below the reserve requirement right now.

Since this money created out of thin air has been parked at the banks, it has not resulted in massive price inflation.  The money is not being lent out or spent.  It is also preventing the fractional reserve process from taking place.  In normal times, somebody would deposit, let’s say, $1,000.  Knowing that only a small number of people show up at any given time to withdraw money from their account, the bank would lend up to 90% of deposits.  In this case, the bank would lend out $900.  This $900 might end up in another bank and this bank would lend out 90% of $900 or $810.  This process keeps going.  This is fractional reserve banking.  It keeps going unless a lot of people start showing up at the bank to redeem their money.  This is a run on the bank.  The FDIC was created in the 1930s to protect people’s money.  This has prevented runs on banks (for the record, I’m not saying this is a good thing).  The fractional reserve process can also be reversed if banks stop lending money.

Two years ago, the Fed did something unusual, besides the massive increase in the monetary base.  The Fed bought mortgage backed securities instead of U.S. government bonds.  All or most of these mortgage backed securities were probably high risk loans.  Due to the popping of the housing bubble, there are a lot of bad loans that people can’t or won’t pay.  The Fed bought these for more than what they were worth.  This money went directly to the banks that used the money to increase their reserves.  The banks are probably scared to lend out this money because of what potentially lies ahead.

The next round of quantitative easing (QE2) involves the Fed buying $600 billion in U.S. government bonds.  This is a different scenario than buying mortgage backed securities.  However, this money could still end up parked at the banks.  Even if this newly created money went into the hands of average Americans, they will deposit it at a bank.  If the bank keeps this money on deposit and doesn’t lend any of it out, excess reserves can still go up more.  This would again prohibit the process of fractional reserve lending.  It would prevent a quick jump in prices.

This is a possibility, but it is also just as possible that this newly created money won’t sit at the banks.  This is what we need to watch.  If the excess reserves don’t increase with what is supposed to be an increase in the monetary base coming up, then we should expect high price inflation within a relatively short period of time, say a year.

After the market had a chance to digest the Fed announcement of buying an additional $600 billion in bonds, the dollar went down.  The major things that go up with dollar weakness were up big.  Oil was up.  Stocks were up.  Gold was up over $40 per ounce.  Silver was up really big.

There is some negative reaction from China, Brazil and other places.  Some, like politicians in Brazil, see it as a currency war.  If you are in another country, why should you care if the U.S. wants to destroy its own currency?  The only way it will affect you is by the U.S. having less to trade.  China has a reason to care though.  The Chinese government owns hundreds of billions of dollars of U.S. government bonds.  The Chinese are going to be paid back in depreciated dollars if they are paid back at all.

We’ll continue to watch the adjusted monetary base and the excess reserves held by banks.  If this additional inflation finds its way into the economy, we could see massive price inflation in the near future.  It is really time to pay attention.  The Fed is wrecking the dollar and it will have severe consequences.

I don’t think Bernanke is dumb enough to drive us into hyperinflation, but we can’t be 100% certain because the man is already doing stupid things.  He swore to Milton Friedman that the Fed would never let another great depression happen again.  He thinks the reason the Great Depression was so bad is because the Fed didn’t print enough.  If he really believes this, then he truly is a moron.

Be ready for prices to skyrocket.  Grocery bills will go up.  A trip to the gas station will be more expensive.  Shopping for clothes won’t be much fun when you see the price tags.  Don’t expect your wages to go up though.  If they go up, it will only be nominally.  They will not keep up with price inflation.  High price inflation is almost inevitable at this point the way Bernanke is running the show.  It probably isn’t a question of if, but when.

There have been two significant events this week.  First, the election results are in.  It turned out about as well as a libertarian could hope for, at least realistically in today’s world.  The Republicans will have a majority in the House and the Democrats maintain a slim majority in the Senate.  It is being seen as, not a win by Republicans, but as a repudiation of the Democrats.  A majority of people don’t like Obamacare, along with all of the big spending, and that is why the Democrats lost so badly.

I was disappointed to see that leftist California voted down an amendment to legalize marijuana.  Here is a state that is electing socialists all over the place and yet they can’t get a majority to vote on legalizing a drug that is one of the least harmful of illegal drugs.  It makes you wonder what hope there is.  It just means that libertarians have to work harder to educate others on individual freedom and how it is beneficial to nearly everyone.

The second important topic is the Federal Reserve.  An announcement came out today that the Fed will likely purchase long-term government bonds.  It will do this for the next 8 months, buying $75 billion per month.  This totals $600 billion.  It will also continue to rollover money collected from expiring bonds.  The Fed did include language that it would monitor the economy and make adjustments when necessary.

This announcement is about what the market had already priced in to this point.  The stock market did not make any really dramatic moves for an announcement this big.  The dollar fell, but not dramatically.  It will be more interesting to see how the market reacts over the next couple of days.

We’ll continue to monitor this whole thing and there will be many more posts on this topic.  We will have to keep an eye on excess reserves, to see what the banks do with this money.  Will it sit as excess reserves, similar to what happened with the last major increase in the monetary base two years ago?  Will the banks lend this newly created money out and spark high price inflation?  This is a significant amount of money being created out of thin air and it will only make things worse.  We will just have to see how it takes form.

If voting changed anything, they’d make it illegal.
~Emma Goldman

Voting is good and bad for freedom.  In a completely free society, voting would be a non-issue.  The only relevant voting would be in your private life.  You might be voting with your friends on where to go to dinner.  Voting for government politicians wouldn’t matter because either there would be no government or the government would have virtually no power over your life, so it wouldn’t matter who was elected.

In our current society, voting is a cover for politicians.  It makes people feel like they are in control.  In most cases, they aren’t.  People think that as long as there are elections, they are free.  This isn’t true.  You can live in a very oppressive society while retaining the right to vote.  India is an economic mess and they are considered a democracy.  Of course, democracy is part of the problem.  Democracy can mean that the majority oppresses the minority.  The ironic thing is, democracy usually leads to the majority oppressing themselves, while the minority live well.  But the minority makes the majority think they are in control.

There is a positive aspect of voting.  As Murray Rothbard wrote in 1978,


“Until or unless the United States changes from free elections to dictatorship, the question of armed revolution is, at the very least, totally irrelevant to the American scene.”


The only way for the U.S. or any other country/area to achieve freedom is by changing the hearts and minds of the people.  A violent revolution will achieve nothing, but not just because violence is not the answer.  In order to achieve liberty, the majority of the people need to understand and advocate liberty.  And if you get to a point where most of the people are liberty oriented, then the only thing that is necessary is for the people to withdraw their consent.  This holds true whether voting is allowed or it is a dictatorship.  But withdrawing consent is even easier where voting is permitted.


Things have changed a lot in the last couple of years.  With the Ron Paul presidential campaign in 2007/2008, with the power of the internet, and with the horrible government policies, there has been a shift in the general attitude of the American people.  There is a lot of work to do in educating others on the benefits of liberty, but we can see progress and there is much hope for the future.  It is not because we will elect the “right” people, but because people will simply turn away from government and look for other ways to solve their problems.

That is not exactly the headline from the media, but it’s close enough.  The headline is “Fed Likely to Announce $500 Billion of Purchases, Survey Shows”.  The bet is that the Fed will create inflation of half a trillion dollars.  This is huge, especially when it is added on top of the over 1 trillion dollars created 2 years ago.

The Fed and the economy are in trouble at this point, no matter what is done.  The best case scenario is for the Fed to stop creating money out of thin air and to start withdrawing its earlier money creation.  Of course, this would put some banks in jeopardy of failing, which then causes a problem for the FDIC which is bankrupt and would depend on a bailout from the Fed.  It is one big circular mess.  And the Fed won’t do this anyway because it is politically incorrect and goes against the Keynsianism of the establishment.

Instead, the Fed will continue to accommodate Congress and the big banks.  In the process, it will continue to weaken the dollar and set the stage for massive price inflation in the United States.  Assuming the headlines are correct and the Fed injects another half trillion dollars, the question will be what happens with the money.  Most of the previous money created is now sitting as excess reserves with the banks.  The banks are not lending this out because of fear.  They need to make sure they stay solvent.

So what will happen with this new money?  Will it add to the excess reserves or will it find its way out into the economy?  Either way, trouble lies ahead.  If it stays as excess reserves, we will continue to see a weak economy that resembles something like Japan.  If the banks decide to lend out the money, then we will be looking at high price inflation in the near future, along with more bubbles.

The Fed is in trouble.  It is trying to do the politically correct thing.  It is putting the dollar at risk.  It is lowering our standard of living.  It is misallocating capital on a grand scale.  Eventually, it will have to choose between a depression or a complete collapse of the currency.  Hopefully it will choose depression.

This coming week is a big one that we need to pay attention to.  No, it is not the election.  While the election will be interesting to see what happens, the real big news will be the following day when the Fed wraps up its meeting.

We can be reasonably sure that its stance on interest rates (the Fed funds rate) won’t change.  The market is keeping the rate near zero.  It is not really current Fed policy that is keeping it there.

The big news will be on what the Fed says about QE2 (more inflation).  How specific will the Fed get?  Will the Fed say exactly how much inflation it intends to create?  Will the Fed say what it is going to buy (short-term bonds, long-term bonds, mortgage backed securities, etc.)?

The next question will be if the market is disappointed.  We can only hope so.  If the market is happy with the Fed’s announcement, we really should be prepared for some massive inflation.

There is also the X factor hanging out there.  Is there anything that we’re not expecting that the Fed might announce?  Will the Fed announce that it will force the banks to lend?  Will it stop paying interest on excess reserves?  There is always the possibility, although highly unlikely, that the Fed could announce that it will pursue a higher reserve requirement for the banks so that all of the monetary inflation it is about to create is not all pumped into the system at once.  Again, it is highly unlikely, but you never know.

The elections won’t mean much to your investments.  A Republican majority in the House may slow down Obama a little bit, but we will continue to see massive deficits until the Fed refuses to inflate.  The more important happening this week for your investments is what Bernanke and the Fed says.

Ok, this post doesn’t have much to do with investments per se, but since election day is coming up, it might be a good time to discuss politics and political strategy.  If you are reading this blog, you are most likely a libertarian.

Some libertarians think you should try to choose the best candidate for each open slot.  Some believe that you should only vote third party.  Some think that you should only vote for certain races and certain people.  Some libertarians even think that you should not vote at all.

I come down in the third category.  I can understand the position of not voting at all and sometimes I do that, but I don’t necessarily agree that you are going against principles by voting.  It is true that if nobody showed up to vote that nobody would be elected.  Of course, the candidates and their families will always show up.  But I don’t think you are endorsing the system just because you are playing the game that has been set up, even if you disagree with it.

I agree with Murray Rothbard on this one.  If you were in jail (let’s say it was for a non-crime) and you got to vote on what was for dinner or who your warden would be, wouldn’t you do it?  You could stand on principle and not vote because you didn’t commit a crime and shouldn’t be in jail, but that doesn’t really change the situation.  Wouldn’t you at least like to get a good meal and a warden who might treat you decently?

With that said, I don’t think you should be voting for the lesser of two evils, unless one is dramatically less evil than the other.  In other words, you really shouldn’t vote in a lot of cases.  Unless you have a good third party candidate (unlikely) or a really good Democrat or Republican (highly unlikely), then it is better to leave your ballot blank or write in your own name.

Let’s say you have a Republican who says he wants lower taxes and less spending (where have we heard that before?).  If this person doesn’t offer any specific spending cuts, you can be pretty sure that he/she is not going to vote for lower spending.  These people tell you what you want to hear.  They will say anything to get elected.

That is the key to voting for candidates.  Only vote FOR candidates and not AGAINST candidates.  Only vote for candidates that can offer specifics on how to reduce the size of government.  If you aren’t hearing anything substantial, then don’t vote in the race.  Vote for and against the state amendments if you have them.  If there is nothing worthy to vote for or against and no worthy candidates, then stay away from the election booth.

In the last few months, there has been a very strong correlation between the dollar and the stock market.  It seems that when the dollar is down, the stock market is up, and vice versa.  This means that the main driver of the stock market right now is monetary policy.  It also means there is somewhat of a correlation right now between gold and the stock market.  A weak dollar is benefiting both.

If you are invested in the stock market, then monetary policy is the most important thing to pay attention to.  Forget about company earnings or balance sheets.  Maybe for individual stocks it is something to pay attention to, but for the broad market, it is the words and actions of the Fed that is driving it.

Right now, it seems that everyone is expecting QE2.  This is the second round of “quantitative easing” or money creation.  The big looming questions right now are how much and for how long.  Another question is what form it will take.  Will the Fed just buy bonds the old fashioned way?  Or will the Fed try something different for a “shot in the arm” for the economy.  Either way, it will be horrible policy, but it will affect the dollar and the stock market.

It will be interesting to keep watching this correlation.  If the stock market and the dollar start moving down together, then watch out.  It is unlikely that we will see them move up together.  Let’s see what Bernanke and the Fed actually do in the coming weeks.  We have heard a lot of talk up to this point, but we haven’t seen much action.

China has made incredible progress over the last 30 years.  China still has a communist government or at least that is what it is called.  It is still communist in some aspects.  In other aspects, it is less communist than many western governments, including in the U.S.  China does not have the Americans for Disabilities Act.  While the economy is still centrally planned in many ways, there is also less red tape in many areas compared to the U.S. and other so-called democracies.

China has been inflating at a high rate in the last several years.  China has a property/ real estate bubble that may be worse than what happened in the U.S. a few years ago.  Although the economy in China has grown tremendously and many people there have a higher standard of living for it, some of the recent prosperity is also illusory.  China cannot defy the laws of economics any more than any other country.  China’s boom will turn into a bust.

The Chinese government has already announced an interest rate hike to control inflation.  There is no other choice unless they are willing to risk hyperinflation.  The Austrian business cycle theory tells us that a reduced inflation rate will lead to a bust.  China is not immune to this.  China will face its very first recession/ depression, unless you consider almost the entire 20th century as one big great depression.

If you are considering buying Chinese stocks, don’t.  You would be better off to short the market.  There are ETFs to do that now.  The only problem is timing.  That is always our problem.  China is going to experience a major downturn, but we don’t know when.  It will likely be soon, but does that mean in one month, one year, or five years?  My bet is that it will be less than five years.  It is harder to say if it will be in the next year.

Don’t be surprised when China does crash.  The Austrian business cycle theory does not just apply to the U.S.  While much of China’s prosperity has been real, we can’t ignore that some of it is illusory and will come crashing down.  That’s what happens when you have a central bank managing a fiat currency.

There have been stories the last few days on Obama’s commission to reduce the deficit.  Of course, this is to reduce the deficit, not the debt.  It is like running up $10,000 a year in credit card debt and saying that you are cutting back next year and you will only run up $5,000 in credit card debt without paying it off.  The balance that you owe actually increases, even though you say that you are cutting your spending.

The federal debt is nearing 14 trillion dollars.  The yearly deficit is well over 1 trillion dollars.  If Obama could cut the deficit to 500 billion dollars, he could say that he cut the deficit by more than half.  The problem is, the national debt keeps getting bigger and bigger.  This was the same game that Bush played while he was in office (although the numbers were a bit smaller).  Bush promised to reduce the deficit in half by 2008.  That was in his first term.  He left office having signed the TARP bill, the biggest bailout in history.

The only way Obama is going to reduce the deficit with any significance, let alone the debt, is if the government goes completely broke and the Fed refuses to print more money because of the threat of hyperinflation.  Only then will Obama have a chance at getting anywhere near a balanced budget.  And technically speaking, the budgets do come from Congress, so it isn’t even up to Obama completely, although he could certainly have influence.

Even if the Republicans win big next week, don’t expect much to change.  Most of the Republican politicians have vowed not to touch Social Security or Medicare.  Of course, they wouldn’t dare touch their precious wars or any part of foreign or military expenditures.  They could eliminate the entire rest of the budget and that would barely balance the budget.  In other words, expect massive deficit spending until the Fed refuses to inflate and interest rates rise.  Then we will see something out of Greece where the politicians will have no choice but to cut spending.

Obama’s deficit commission is going to recommend tax increases.  It is easier for them to do that than to recommend any serious cuts.  They are going to recommend getting rid of certain deductions and tax credits.  This is a tax increase.  Let’s see if the Tea Party and the rest of the American people resist.  In order to resist successfully, they must advocate spending cuts.  It can’t be little things, although that would help.  We have to see massive cuts to military spending and a reduction in entitlement benefits.  The easiest reduction there would be is to raise the age that you can collect Social Security and enroll in Medicare.

I don’t know if the Tea Party and the rest of the American people have it in them yet.  We need massive spending cuts.  It will be painful, but not as painful as what hyperinflation would feel like.