A HISTORY LESSON ON INFLATION / MACLEOD FINANCE

A history lesson on inflation

The history of money and credit is that the separation of the two always ends in the destruction of credit. We appear to be edging close to that event again.

ALASDAIR MACLEOD

“While it is the duty of the citizen to support the state, it is not the duty of the state to support the citizen” 

– President Grover Cleveland (1885—1889)

The point President Cleveland made back in the 1880s was that individuals and vested interests had no rights to preferential treatment by a government elected to represent all. 

For if preference is given, it is always at the expense of others.

Those days are long gone, and the last president to take this stance was Calvin Coolidge in the 1920s, a whole century ago. 

He was followed by Herbert Hoover, who was very much an interventionist. 

As Coolidge reportedly said of his Vice-President, “That man has given me nothing but advice, and all of it bad”. 

Hoover was criticised for his disastrous intervention policies by Franklin Roosevelt, who succeeded in ousting him in the 1932 election, and then outdid him with even more intervention. 

The outflows of gold generated by accelerating government spending and the Fed’s monetary policies led to the suspension of gold convertibility for American citizens in 1933 and the devaluation of the dollar in 1934 from $20.67 to $35 per ounce of gold.

Interventionsism has increased ever since, not just in America but in all other advanced nations. 

The socialisation of earnings and profits and the regulation of our behaviour by governments dominates economic activity today. 

Despite the warnings of sound-money theorists, a process that commenced a century ago has not yet led to economic collapse, though the dangers of escalating state liabilities to buy off this inevitable outcome are a growing threat to economic stability.

A point that is ignored by nearly everyone is that government spending is an expensive luxury for any economy, tying up capital resources in the most inefficient way. 

Furthermore, governments through taxation, the diversion of savings to government spending, and by monetary inflation destroy personal and national wealth. 

Yet, it is clear through observation and economic logic that a successful economy is one that maximises personal prosperity instead.

However, the problem is likely to become more of a public issue in the coming months, triggered perhaps by an increase of US Government bond issues to cover a rising budget deficit, particularly if the US economy slides into recession. 

We have already seen a sharp increase in bond yields over the last two months, with the benchmark 10-year US Treasury yield increasing from 3.6% to 4.3% currently despite markets expecting lower short-term dollar interest rates.

On an historic basis and given that the Fed’s inflation target of 2% is not too far away, current T-note yields might appear reasonable. 

Assuming, that is, consumer price inflation is at the level officially stated. 

But perhaps markets should give more credence to independent estimates such as Shadowstat’s as measures of price inflation which are consistently higher than self-serving government estimates. 

And the currency debasement story of persistent and growing budget deficits, which is the engine driving consumer price inflation, is clearly not over and looks set to accelerate.

Therefore, when thinking about risk, the economics of currency debasement must be central to our thoughts. 

And as bond yields adjust by rising to offset currency depreciation, we will be increasingly aware of the debt trap facing the US Government.

The pressure on all major governments to increase the rate of wealth-transfer from the productive private sector will simply increase as bond yields rise. 

And the more wealth is transferred, the less there is left to transfer. 

This was the underlying reality faced in the Roman Empire, when the spendthrift Nero reduced the silver content of the denarius to pay his soldiers, having run out of funds. 

Among other costly acts, he set much of Rome on fire in order to rebuild it, through which legend has it he fiddled. 

This was perhaps a metaphor, because according to Suetonius, Nero was dedicated to the arts, sex and debauchery. 

But if Nero fiddled with anything, it was the currency.

Some forty-three emperors following Nero continued the debasement process through the replacement of the denarius by the antoninianus (there is some uncertainty over the name) until the final monetary collapse, a time span of over two centuries. 

The replacement of the former with the latter recalls the French revolutionary replacement of the assignats with the mandats territoriaux and possibly bank credit with CBDCs today.

Today, the current century’s-worth of deficit-led monetary debasement includes the additional burden (that is additional to Roman military profligacy) of promises to the general public, in defiance of President Cleveland’s maxim. 

Depending on the rate at which these future financial liabilities are discounted to a net present value, these are anything between five- and ten-times current GDP for America, and probably considerably more proportionately for Japan and many EU member states. 

Not even heavily doctored price inflation figures can suppress the debt trap in which governments are now visibly ensnared, which all precedence tells us will be met with accelerating monetary debasement.

Since Herbert Hoover’s presidency, the US Government has been unconsciously rhyming the American economy with the Roman in a speeded-up version. 

Just as Rome’s emperors debased the coinage to pay for their profligacy and soldiery, so have America and her western allies debased their currencies to pay for welfare and military spending. 

This is the dollar’s value measured in money, which is physical gold:

Excessive military spending was a Roman theme: pay the soldiers or the emperor is deposed. 

Over two centuries after Nero, Diocletian went on to issue an edict in stone banning traders from raising prices above preset maximum levels. 

Trade ceased, and Rome and other cities emptied for lack of food and other necessities. 

We have yet to reach that point, though even President Nixon froze prices briefly in 1971.

Western nations have overseen more sophisticated methods of achieving the same result. 

For the last forty years, prices for goods and services have been officially controlled by doctoring the inflation figures, though the reality is prices have continued to rise. 

The government’s inflation-linked spending commitments have been curbed and the state’s beneficiaries cheated creating additional tensions. 

That cannot go on for ever.

Wage increases, which normally keep pace with rising prices, have been replaced by the simple expedient of encouraging the expansion of bank credit to fund personal consumption, along with a Keynesian encouragement to dissave. 

Consequently, US household debt now stands at 71.5% of GDP. 

It amounts to modern smoke-and-mirrors deflecting attention from an underlying problem.

The comparison with Rome has a further, worrying similarity. 

Roman coins were the principal currency for the known world. 

The US dollar is the world’s reserve currency today, and nearly all the other 170-odd government fiat currencies are aligned with or refer to it. 

An accelerating dollar collapse will take nearly all of them down, just as surely as the Roman debasement propelled the world into the Dark Ages. 

That is, unless working gold standards are introduced which is the same thing as calling an end to the fiat currency era.

So far in this article, we have seen that the US economy has provided us with an example of a modern debt trap, that if not addressed will inevitably lead to an acceleration of currency inflation and ultimately a final collapse of purchasing power for the dollar.  

Most other nations are in the same position, though the high levels of personal borrowing are more endemic to America and the UK than elsewhere.

The next phase of today’s monetary debasement

The next major expense facing governments and their central banks appears to be a future credit crisis, likely to tip the inflation story into hyper-drive. 

Possibly, it will be a modern Diocletian moment, a final act of debasement, and we (only metaphorically, one hopes) leave the cities to forage in the country.

The time for the next credit crisis is rapidly approaching — the price of gold tells us this. 

Crucially, inflation prospects for the following year or two will be set by the response of central banks. 

If they do not bail out the commercial banks with currency inflation when interest rates rise, the global banking system will almost certainly collapse. 

Assuming this disaster will be addressed, it will require the injection of enormous quantities of extra credit far greater than was required to bail out the global banking system in 2008/09.

A currency crash is a growing risk

The future is by definition unknown, and we can only speculate about how things will evolve. 

However, unlike the Roman experience which took 225 years to completely destroy the denarius, for its successor nations today’s wave of monetary destruction looks like terminating soon after only a century or so from Coolidge’s presidency.

Central banks have been aware of some systemic dangers, which is a reason that they have been keen to move us to a cashless society. 

With no cash, there cannot be an old-fashioned bank run. 

And their response to every successive credit event has been to restrict how businesses and people can protect themselves in the event of a systemic meltdown.

But now, long after President Cleveland made the remark that heads this article, his successors’ attempts to intervene in economic outcomes have led to escalating costs, increasingly beyond control. 

The combination of a debt trap sprung on governments by higher interest rates, and the unsustainability of private sector debt threatens a financial and monetary crisis world-wide, from which any rescue through accelerating credit creation at the currency level becomes the ultimate destruction of value.

The rate at which inflation and the annihilation of paper currencies accelerates from hereon will be determined by how swiftly the financially aware and the ordinary public wake up to the true scale of the monetary fraud governments have perpetrated on them and continue to so do. 

The consequences of expanding base money and bank credit over recent decades have not been reflected adequately in official price statistics, which have been hedonically manipulated to hide the evidence. 

An awakening to the reality, that fiat currencies have been badly abused by all governments, can be expected to have a suddenness about it. 

And rather like entrapped vermin, ordinary folk will find all escape routes closed.