Inflation, booms and busts, politics, and the Federal Reserve, part 2

In a prior post we pointed to the Federal Reserve System (the Fed) as the engine of inflation and the source of repeated booms and busts. See “Inflation, booms and busts, their pathology and their cure,” at

In this post, inspired by responses of readers of the prior post, we augment our comments about the Fed and the U.S. banking industry as follows.

One perceptive reader remarked that it is highly unlikely the Fed will be abolished before the currency has lost all value. He asked whether there is any historical precedent for those in control of state finances and banking taking action to prevent a permanent collapse of a fiat currency.

History seems to indicate that eventually all fiat currencies will lose all their value given enough time for the debasement process to continue. However, there are some instances of nations whose financial authorities stepped back from the abyss of total currency destruction, at least for a while. That is what the Fed under Paul Volcker did in 1979-81 when it appeared that the U.S. dollar might be headed towards a hyper-inflation.

In Germany after WW II, a hyper-inflation had destroyed the value of the German monetary unit for the second time in 25 years. The Nazi era Reichsmark had been losing value rapidly during the course of Nazi Germany’s destruction by its adversaries during WW II. Post-war conditions in Germany were miserable after the fall of the Nazi regime in 1945; there was hunger and extreme social and economic chaos. In 1948 West German Finance Minister Ludwig Erhard took decisive steps to clean the slate and start all over with a new fiat currency, the Deutsche Mark, which has been one of the most stable currencies in the world ever since, even though it is a fiat currency. 1

Israel suffered from very high inflation that reached the annualized rate of 450% in 1984. The state of Israel stepped back from the brink and managed to reduce annual inflation to less than 20% within two years. 2

Another reader commented that abolishing the Fed would not be enough unless the legal tender laws were abolished too. He is right. The legal tender laws arrogate to the U.S. the sole right to issue money. The legal tender laws are epitomized by the statement on every Federal Reserve Note that the note is legal tender for all debts public and private. If there were no Fed it is a certainty that the U.S. Treasury would issue fiat money and assert and enforce a monopoly of money under the legal tender laws.

The first Post did not mention fractional reserve banking, the practice by which commercial banks make loans amounting to a large multiple of their cash reserves. Murray Rothbard posited that fractional reserve banking is a legally authorized fraud on depositors. Banks never have nearly enough good funds to honor all deposits. They rely on the probability that depositors will not all ask for their money bank at once.

During the financial crisis of 2008 a number of fairly sizable banks were in danger of being wiped out by depositors’ demands for cash in excess of the amount of deposits insured by the Federal Deposit Insurance Corporation (FDIC). That agency was itself made bankrupt by the crisis. The U.S. stepped in to bolster confidence and stop bank runs by raising the deposit insurance guaranty from $100,000 per account to $250,000 per account.

Some depositors actually lost some of their deposits when their bank failed before the U.S. raised the deposit insurance maximum to $250,000.

Although Rothbard published his book in 1994, the book that posits that all fractional reserve banks are insolvent, and that federal deposit insurance is a fraud, his analysis was borne out fully by the events of 2008.

The U.S. can and did bail out banks and depositors, but it did so by enormous increases in already high deficits. These bailouts of banks and depositors were another fraud on the public. Outrageous federal deficits, which understate the true amount of the insolvency of the U.S., are a Ponzi scheme device to push current liabilities out to the future where they must be paid by future generations that will be unable to pay them.

Proof of these assertions appears in chapters 11 and 18 of the book that is the main part of this website, Capitalism: The Liberal Revolution. Those chapters are entitled, respectively, Political Democracy in America and Kleptocracy.

One astute bank analyst concluded that twelve of the thirteen largest U.S. banks would have failed but for federal bailouts in 2008. 3

Thoughtful observers are commenting recently that another and perhaps even bigger round of federal bailouts of banks is appearing inevitable. A revealing anecdote and analysis appears in the latest issue of the investment newsletter Investment Values published by Southern California investment firm Cheviot Value Management (CVM). 4 CVM is a company co-founded in 1985 by the author of this Post.

We quote as follows from the CVM newsletter above referred to.

An intelligent investor that we have long known and admired likes to share worthwhile finance or investment-related stories at a blog he calls “Adventures in Capitalism.” In a note titled, “This is How the Banks Created the Last Crisis, Part II,” Harris Kupperman describes a recent encounter he had in his local bank (a branch of one of the country’s largest banks), whereby a “commission-hungry” teller aggressively thrusted a home equity line of credit (“HELOC”) offer at Kupperman, a loan he neither sought nor needed.

Kupperman writes as recently as last December that, due to his irregular income, he did not qualify for any type of standard mortgage loan product. However, merely six months later, “quantitative easing has even further deranged the lending landscape, [and he] now qualifies for a 130% loan-to-value HELOC.” Kupperman continues to explain that the terms of the loan were incredibly favorable, 10-years interest-only with the first five years fixed at 2.9% and the next five years at Prime + 1.0% (not to mention elimination of other bank fees).

No paperwork was required, the bank would conduct a “drive-by appraisal,” and the teller explained, “as your home appreciates, your HELOC limits increase as well.” As he left the bank, less than an hour later with a generous new credit line, Kupperman recognized that the same tinder that caused the housing meltdown of 2008 was kindling a new fire. He writes, “If I’m doing this, I guarantee you that all sorts of lower quality credit risks [i.e., individual borrowers] are doing the same thing.

There’s a reason that condo prices in [his hometown of] Miami are going parabolic. “The Federal Reserve has horribly distorted the entire risk-pricing mechanism, just like it did in 2007 when my illegal gardener bought the home I was renting. It has been five years since the great credit collapse, and no one has learned a thing. People are borrowing too much and banks are in a hurry to lend to anyone with a pulse. They practically mobbed me—I have assets and a pulse. I don’t want to name the bank involved… [but it] got the mother of all bank bailouts just five years ago. At some point in the next few years, they’ll get another bailout—it’s inevitable. These guys haven’t learned the right lessons from 2009.

Another perceptive observer, Nicole Gelinas, writes: “. . . [T]he real reason we have too-big-to-fail financial firms is because they provide Washington what it really wants: cheap debt for voters. As veteran financier Daniel Alpert notes in his book “The Age of Oversupply,” since the 1980s, “the bottom 60% or so of households” — that’s a lot of people — have seen their wages either “stagnate” or “sharply decline” after inflation. Working-class people took the biggest hits.

What did the government — from Ronald Reagan through George W. Bush — do to make up the difference? “The public was showered with easy credit that allowed them to make up for lost income and maintain living standards — at least for a while,” Alpert notes.

Indeed, between 1980 and 2008, mortgage debt alone quadrupled after inflation (the population rose only 31%). Other consumer debt, auto loans and credit-card borrowing and the like, nearly tripled.

Who gave Americans the cheap credit? The big banks.

They would not have done so if their investors thought they’d be out of luck when reality bit. And when reality did bite, Washington pushed it back. Federal Reserve intervention as well as President Obama’s decision to keep Fannie Mae and Freddie Mac have pushed mortgage rates down to record lows, buoying house prices. It’s not just mortgages. Since 2009, the going interest rate for a four-year car loan has fallen from 6.7% to 4.5%. The average credit-card rate has fallen from 13.4% to 11.8%.

People are tempted. After falling since 2008 — back to 2004 levels — total debt has started to creep back up over the last year and a half. And everyone thinks that’s a good thing, as auto and retail sales, too, are up. Quoted from “Too big to fail equals too eager to borrow,” by Nicole Gelinas, Op-Ed, Los Angeles Times, July 27, 2014. 5

We conclude this Post by remarking that the Fed, which was ostensibly created to stabilize the American financial and banking system has, by all accounts, destabilized the economy, caused successive booms and busts almost since the inception of its existence, was a major contributor to the financial crisis of 2008, and is a big part of various political actions that appear to be making it inevitable for there to be another and perhaps still larger financial crisis.

Given the comments of Harris Kupperman and Nicole Gelinas above we are not alone in this opinion.

It is a rare politician or federal official who wants to see action taken to make money and banking honest and stable. Any suggestion to that effect is rejected out of hand by the Fed and by elected officials and regulators from the President of the U.S. on down. This is so because the political elite wants to buy votes of the public through making it easy to borrow money.




  1. After its defeat and unconditional surrender in 1945 Germany was divided into communist East Germany and democratic West Germany, a division that lasted until 1989.
  2. See Wikipedia, 1985 Economic Stabilization Plan,
  3. See Exile on Wall Street (2012) by Mike Mayo, page 5.
  4. In the July newsletter of Cheviot Value Management, LLC, at
  5. Nicole Gelinas is the Searle Freedom Trust Fellow at the Manhattan Institute and a contributing editor of City Journal. She is a Chartered Financial Analyst (CFA) and a member of the New York Society of Securities Analysts. Her most recent book is After the Fall: Saving Capitalism from Wall Street and Washington (2009).
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