Lehman Bros. an Example of Massive Wall St. Fraud

Lehman Brothers' bankruptcy examiner Anton Valukas has issued a damning report revealing just how corrupt the now bankrupt Wall St. institution really was.

Apparently, fraud, cheating, lying and the manipulation of its books were simply a way of life at Lehman, The once-venerable investment bank was institutionally corrupt, and likely an example of just how routine illicit business practices have become on Wall St.

The examiner's exhaustive 2,200-page report illustrates the unethical (perhaps illegal) practices of former Lehman executives, as well as its auditor, Ernst & Young.

The whole affair is entirely reminiscent of the Enron scandal, in which its accounting firm, Arthur Andersen, cooked the books and helped the energy giant cover up its absolutely massive and historic fraud.

The new report reveals a brazenly fraudulent accounting practice, known as Repo 105.

Using this scam, assets were shifted off Leman's books at the end of each quarter in exchange for cash. This was done via a clever accounting maneuver that made its leverage levels look lower than they really were. Then Lehman would bring the assets back onto its balance sheet days after issuing its earnings report.

Lehman was determined to make its quarterly reports look more appealing.

To create the appearance that its leverage levels were within reason, Lehman would “sell” assets (typically highly liquid government securities) to another firm in exchange for cash, which it would then use to pay down its debt. The assets were typically worth 105 percent of the cash Lehman received. Several days later, after reporting its earnings, it would subsequently repurchase the assets.

Normally, this would be considered a loan, or repurchase agreement, but instead it was booked as a sale.

Massive sums of money were flowing in and out of Lehman in successive quarters.

According to the examiner’s report, “Lehman reduced its net balance sheet at quarter-end through its Repo 105 practice by approximately $38.6 billion in fourth quarter 2007, $49.1 billion in first quarter 2008, and $50.38 billion in second quarter 2008.”

The latter were the final two quarters before the investment bank's inevitable collapse.

What is now clear is that Lehman was engaged in an institutional practice of deception. The well-crafted ruse was designed to fool investors and creditors about the investment bank's health.

According to Valukas' report, Lehman executives used "materially misleading" accounting gimmicks, and former CEO Richard Fuld was "at least grossly negligent in causing Lehman Brothers to file misleading periodic reports."

But what is most stunning about the report is that a team of officials from the Securities and Exchange Commission and the Federal Reserve Bank of New York had moved into Lehman Brothers' headquarters while this scam was being perpetuated. And they were either so inept as not to notice, or they willingly looked the other way.

How's that for regulation?

At any given moment, there were as many as a dozen government officials inside Lehman’s offices, with access to all of Lehman’s books and records.

And yet they found nothing until June 2008, when a lower-level executive sent a letter to management taking issue with the firm’s practices. Despite being ensconced inside Lehman's headquarters, the S.E.C. and Fed officials found nothing amiss.

If nothing else, this is a reminder of the corruption on Wall St, and why it cannot be trusted. Its valuations seem to be nothing more than pure fantasy.

And the notion of regulation is equally fantastical. After all, Lehman perpetuated this fraud right under the noses of supposed government regulators.

Perhaps these government agencies cannot be trusted either.

It's worth noting that current Treasury Secretary Tim Geithner was heading the New York Reserve Bank at the time. And it was Geithner that sent his "regulators" into Lehman, as well as Goldman Sachs, Morgan Stanley, Merrill Lynch, and others.

Who knows what else we still don't know?

The question is this; were government regulators inept, or complicit? Were these officials useless buffoons, or criminal participants in a massive fraud? Either answer effectively ruins their credibility, as well as any previous faith the public may have had in these regulatory agencies.

With all of this in mind, it's good that the unethical Lehman collapsed, a victim of its own lies and excess.

And the other Wall St. firms, likely equally fraudulent and wracked by their own excess, should have been allowed to collapse along with it, just like Bear Stearns.

Good riddance.

Mortgage Delinquencies at All-Time High

The latest report from Lender Processing Services shows that mortgage delinquencies have reached an all-time high.

More than 7.4 million home loans nationwide are in some stage of delinquency or foreclosure. And another one million properties are either bank-owned or have been sold out of foreclosure.

But what's truly stunning is that 10% of all U.S. loans are delinquent.

That huge volume of delinquent loans will assure another wave of foreclosures, a terrible sign for the housing market, as well as the overall economy.

As goes housing and employment, so goes the economy. And right now, it's a perfect trifecta of misery.

The difference between now and, say, a year ago is that delinquencies are hitting borrowers with good credit who have regular fixed-rate mortgages.

The other disturbing statistic is that older loans make up a higher percentage of new delinquencies.

All of the resulting foreclosures will result an ever-increasing inventory that will only serve to drive down home prices even further.

It's weird when the good news is that, "The pace of deterioration has slowed," as LPS noted. That sounds kind of hollow at the moment.

The worst-hit areas are the usual suspects: the boom-and-bust states of Florida, Nevada, Arizona and California, plus the economically savaged areas of Michigan and Ohio. However, few states are escaping the problem.

As further evidence of the crippled market, the government reported today that new home construction and building permits fell in February.

And once again, the good news was that the declines were better than some economists had forecast.

Feeling optimistic yet?

The fact that new home starts and building permits declined is a natural outcome of a market flooded with inventory. Who wants to buy a brand new house when there are so many foreclosures for sale?

Considering all the government intervention and price supports in the housing market, this may be as good as it gets.

The Fed is scheduled to end its purchases of mortgage-backed securities at the end of the month. That intervention has been artificially holding down interest rates. And the home-buyer's tax credits are set to expire on April 30.

How bad the market will become when those programs end is anybody's guess. But it doesn't take a soothsayer to predict that it won't be good.

Unless and until unemployment makes a significant change for the better, the housing market won't just remain in distress; it will just continue to deteriorate.

Lots Of Banks Are Going Broke, And So Is The FDIC

A total of 30 banks have failed as of March 12, putting 2010 ahead of last year's pace when 140 banking institutions went under.

That was the highest total since 1992, when 181 banks failed at the tail end of the S&L crisis.

As of the end of last year, the FDIC said that 702 banks were at risk of going under, a number that has been steadily growing. And still, that seems to be a very conservative estimate.

CreditSights, which tracks bank failures, predicts that in the current cycle, from 2008 through 2011, as many as 1,100 banks will fail. That would wipe out 13.4% of all U.S. banks, representing 7% of U.S. banking assets.

Veteran bank analyst Gerard Cassidy of RBC Capital Markets agrees, expecting as many as 1000 banks to ultimately go bust.

Most of the troubled banks are concentrated at the regional and community level, and are weighed down by commercial real estate and construction loans.

The problem is that the $6.4 trillion commercial real estate market is under duress as businesses across the country go under. Stores are closing, mall vacancies are increasing, office space is all too available, and construction projects across the country have halted as builders have gone belly-up.

Between now and 2012, more than $1.4 trillion worth of commercial real estate loans will come due, according to real estate investment firm ING Clarion Partners.

However, the collateral value underlying many of these loans is depreciating. That means many borrowers will have trouble rolling over their loans, resulting in continued defaults and heavy bank losses.

Banks face up to $300 billion in losses on loans made for commercial property and development, according to a report by the Congressional Oversight Panel

The report also said that on nearly half of all commercial real estate loans, the borrowers owe more than the property is worth, and the biggest loan losses are expected for 2011 and beyond. In other words, the worst of the problems are just getting started.

And the money to cover this coming tidal wave of losses simply doesn't exist. The FDIC's deposit insurance fund was $20.9 billion in deficit as of December 31, the agency reported.

FDIC Chairman Sheila Bair said the fund is expected to bottom out this year, and that further bank failures are expected to cost the fund around $100 billion through 2013.

So, the FDIC is essentially broke. It will soon have to ask the equally bankrupt Treasury for a bailout. What an absurd proposition.

The true scope of the problems on bank balance sheets has been hidden as the government placated banks by radically changing age-old, sound, and transparent accounting rules.

This much we know; $6.4 billion in commercial real estate investments didn't qualify for refinancing in the first ten months of 2009. And nothing has changed. The problems are only worsening.

Since banks are not required to mark their loans to market prices, no one knows the true values of the loans on their books. But as the commercial real estate market nose dives, many more banks will go down with it.

Banks in jeopardy of failing simply aren't going to take on any risky loans. And in this environment, that means most loans.

When all these commercial loans can't be rolled over, it will only result in a very bitter irony.

The banks are damned if the do loan, and damned if they don't. But ultimately, American taxpayers will be stuck with the bills.

Decline In Trade Deficit A Bad Sign For The Economy

In years past, word that the US trade deficit had shrunk was generally greeted as good news. Not so today.

This week we learned that the trade deficit shrank unexpectedly, from $39.9 billion in December, down to $37.3 billion in January. This was due to a big drop in the importation of oil and foreign autos.

But here's the strange part; US exports declined as well, yet the gap still shrank. That's how low consumer demand is in the US right now.

Both are very bad signs for the US economy.

With American consumers financially tapped out, the US needs a strong export base to help begin its recovery. Though the US exports have been continually declining for years, the sales of civilian aircraft, machinery, and agricultural products dropped in January, a worrisome sign that the global economy is still on weak legs.

Of equal concern, a decline in oil imports indicates a decline in energy usage. While many may herald that as a positive sign for our oil addicted nation, it portends the continued sluggishness of the US economy. A lack of energy consumption indicates a slackened economic base and a lack of growth.

What's more, the nation's bill for imported petroleum plunged 5.4% in January to $25.4 billion, despite a higher average price for a barrel of oil. So, even as oil got more expensive, Americans spent less on it.

And the decline in foreign auto imports indicates the lack of demand by US consumers. Though car sales increased by 6%, year-over-year, in January, they were generally sluggish and disappointing since most fell from December levels.

For the most part, even the car companies that reported increases still suffered from declining sales to consumers, a sign of the continuing challenges facing the industry. The increases were due to big jumps in fleet sales to government and businesses, particularly rental car companies.

Though China reported that its exports rose in February by 45.7% from a year earlier, US consumers clearly weren't the reason why. Imports from China fell to the lowest level since June.

As the US manufacturing base has declined in recent decades, and as imports of oil and cheap foreign goods have increased, the trade imbalance skyrocketed. In 2006, the trade deficit rose to a record $817 billion, before coming down during the Great Recession.

In fact, things have been so out of balance that the last time the US had a trade surplus was 1975.

A trade surplus is preferable to a trade deficit since it generally implies that a nation's goods are competitive on the world stage, its citizens are not consuming too much, and that it is amassing capital for future investment and economic pursuits.

However, every year that there has been a major reduction in economic growth, it has been followed by a corresponding reduction in the US trade deficit. And, historically, the deficit has shrunk more so during times of recession – like right now.

That's a reason for concern since the trade gap had reached an eight-year low in 2009. In other words, the shrinking trade deficit contradicts any suggestion that a recovery is taking root.

A drop in global oil prices and the deep recession that cut the demand for foreign goods (even as it hurt US exports) has led to the trade deficit's decline.

A weaker dollar has also made US goods cheaper in foreign markets.

However, with exports accounting for just 13% of the US economy, the nation can't expect to export its way out of this recession. And the decline in imports is just further evidence of the retrenchment of US consumers.

The broad view indicates that we're still a long way from recovery.

Unemployment's New Normal

While there is presently optimistic talk of "green shoots" and economic recovery, as far as employment goes, we're a long way from recovery. In fact, we're a long way from what has traditionally been viewed as normal.

There is a growing concern – perhaps even sentiment – amongst many economists that the US has entered a new normal in unemployment. Gone, perhaps, are the days of a standard 5-6% unemployment rate, replaced by a new normal of roughly 10% unemployment.

How long will this new "normal" last? By many accounts, perhaps the rest of this decade. There are a number of reasons why.

During the Great Recession, the US has seen almost a doubling in the share of the long term unemployed (meaning those who have been jobless for six months, or longer) to 40%. And the median duration of unemployment has doubled over the past year, according to OMB Director, Peter Orszag.

Collectively, nearly 16 million Americans remain jobless. That number doesn't include those who have lost unemployment benefits and are no longer counted. Nor does it count those who have part-time jobs but want full-time work.

When those people are included, a whopping 17% of Americans are currently under-employed or unemployed. According to respected analyst John Williams, the true number is 22%. That's a sobering statistic which gives an indication of just how bad the employment problem is.

Of particular concern, a total of 6.3 million Americans have been unemployed for at least six months, the largest number since the government began keeping track in 1948. That's more than twice as many as in the early '80s recession.

According to Lawrence Katz, a labor economist at Harvard, for every job that becomes available, about six people are looking. That creates an enormous amount of competition and leaves many out of luck.

It's a trend that's expected to continue. Many older workers of retirement age are putting off retirement out of necessity. That leaves fewer positions available for younger workers.

As it stands, there are about 1.2 million unemployed college grads in America. The average graduate is carrying $20,000 in student loans. Those loans can't be paid off without jobs.

According to the National Association of Colleges and Employers, job offers to graduating seniors declined 21 percent last year, and are expected to decline another 7 percent this year.

All of this has negative consequences for our consumer driven economy. Obviously, there is less consumption when fewer people are working, and there is less disposable income directed back into the economy. And it also means that there will be lower government tax receipts at both the state and federal levels.

And if unemployment remains stubbornly high, wages will also remain stagnant. That could create a negative feedback loop that continues to lower consumer spending and economic output.

Between 1989 and 1999, 21.7 million new jobs were generated. But due to the Great Recession, job creation was negative in the last decade, declining by roughly eight million jobs.

It's part of a long trend; job creation has been slowing for decades.

According to the Economic Cycle Research Institute, during periods of American economic expansion in the 1950s, ’60s and ’70s, the number of private-sector jobs increased about 3.5 percent a year. But during expansions in the 1980s and ’90s, jobs grew just 2.4 percent annually. And during the last decade, job growth fell to 0.9 percent annually.

And it's taking longer and longer to recover from each successive recession. The last time the jobless rate reached double digits, in the early 1980s, it took six years to bring it down to normal levels.

According to the Federal Reserve, the jobless rate could remain as high as 7.6 percent in 2012. And it would take two or three years after that for the job market to return to normal, the Fed says.

By some estimations, that's a best case scenario.

Many workers were in low-skill jobs that are never coming back. Millions of Americans are unprepared for the 21st Century workforce. The jobs for unskilled and low-skill workers have been permanently off-shored to Third World nations.

We've lost our manufacturing base, so we won't export out way out of this recession and into a job recovery. As it stands, exports make up just 13 percent of our economy.

And the nation doesn't just have to make up the eight million, or so, jobs wiped out during the Great Recession; it needs to keep up with a labor market that requires the creation of about 125,000 new jobs each month. But we've lost jobs in 24 of the last 25 months. Obviously, we're way behind.

To provide some perspective of the hole we're in, consider this: the government says that 1.3 million jobs needed to be created every year from 2006-2016 just to keep up with the growing labor force. Naturally, that hasn't happened.

Businesses will first shift some part-time workers to full-time positions before engaging in any new hiring. And many businesses will be happy to maintain part-time workers because they cost less; no benefits and no overtime.

When so many people are out of work, there is no incentive for employers to offer wage increases or high starting salaries. Beggars can't be choosers, and many professionals are working in jobs for which they are considerably over-qualified.

Since the dot-com bubble burst in 2000, workers wages grew by a meager 13 percent over the next 10 years, adjusted for inflation. That was the slowest pace in five decades, according to Moody's Economy.com.

And, also adjusted for inflation, median household income has gone backwards, from a peak of $52,587 in 1999 to $50,303 in 2008, according to the U.S. Census.

In addition, interest rates will eventually rise from their abnormally low levels. When they do, that could also have a dampening effect on job creation and economic expansion.

Ours it a credit-based economy. Yet, banks are reluctant to loan after suffering massive losses, much of it brought on by their own greed and negligence. Last year, 140 banks failed. This year may be worse.

Meanwhile, consumers and companies, scarred by the recession, are likely to restrain borrowing, spending and investing for years to come. Consumers are strapped and burdened by debt. We will not spend our way out of this. Taken as a while, all of this will only perpetuate economic stagnation.

Yet, our government, which is mired so deep in debt, needs a robust economic expansion to climb out of the hole it's in. But that isn't happening. At the same time, millions more Americans are now receiving government support in the form of food stamps and unemployment payments just to stay afloat.

The costs of providing unemployment benefits to all these millions of Americans is enormous requiring states and the federal government to take on even further debt.

The White House estimated the cost of unemployment compensation to exceed $140 billion for fiscal 2010, which began in October.

The Labor Department projects that eight million Americans will exhaust their regular 26 weeks of unemployment benefits in 2010. And the government is now allowing benefits up to 99 weeks.

Unless millions of Americans get more education and new job training, those payments will have to go indefinitely. Many of the old jobs are never coming back. Our economy is simultaneously attempting to recover and restructure.

Even if the nation started adding 2.15 million private-sector jobs per year starting this past January, it would need to maintain this pace for more than 7 straight years (7.63 years), or until August 2017, just to eliminate the current jobs deficit.

That seems highly unlikely. Sadly, our nation's unemployment problem will be with us for many years to come.

The Goldman Sachs / Govt. Connection

"AIG exploited a huge gap in the regulatory system. There was no oversight of the Financial Products division. This was a hedge fund, basically, that was attached to a large and stable insurance company."
- Fed Chairman, Ben Bernanke

Financial industry giants have taken hold of our government. By becoming "too big to fail," they are living out a calculated, self-fulfilling prophecy.

According to a TIME Magazine story from last year, Goldman Sachs and AIG made huge, irresponsible bets, seemingly with the explicit knowledge that the government would back them if/when they failed.

Goldman entered into a series of highly expensive contracts with AIG, surely knowing how risky they were. Yet they did it anyway. Only the assurance of a government bailout could have compelled such recklessness. The whole thing seemed almost orchestrated to blow up.

As the article pointed out, the government is absolutely littered with former Goldman execs. Obviously, that is a huge conflict of interest.

In a rare interview, former AIG CEO Hank Greenberg told TIME that once the company lost its top credit rating, AIG FP should have stopped writing swaps and hedged, or reinsured, its existing ones.

But AIG FP President Joe Cassano's unit doubled down after the spring of 2005, writing more and more subprime-linked swaps as the ratings plunged, which made the possible need for collateral enormous in the event its debt was downgraded.

The downgrades eventually occurred in 2008.

Ultimately, AIG, which was bailed out by US taxpayers, ended up bailing out the same Wall St. banks that had already been rescued by those same taxpayers.

Despite the investment banks having taken such enormous risks with such obvious consequences, the Fed still paid many of them in full. Heads, they win; tails, the taxpayers lose. Gains are private, while losses are public.

Ostensibly, the intention was to keep the financial system fluid. But this moral hazard was perhaps a bigger scandal than the highly controversial bonus payouts.

Many experts wondered why AIG paid 100 cents on the dollar. Among the biggest beneficiaries of the AIG pass-through, at $12.9 billion, was Goldman Sachs, the investment-banking house that has been the single largest supplier of financial "talent" to the government.

Critics have been quick to note — and not favorably — the almost uncanny influence of former Goldman executives.

Initial phases of the rescue were orchestrated by ex–Goldman chairman Hank Paulson, who was recruited as Treasury Secretary in part by former White House chief of staff and Goldman senior exec Josh Bolten.

Goldman's current boss, Lloyd Blankfein, was invited to participate in meetings with the Fed.

Recent AIG Chairman Edward Liddy is a former Goldman director and an ex-CEO of Allstate.

Another alum, Mark Patterson, once a Goldman lobbyist, serves as chief of staff at the Treasury, while Neel Kashkari, who ran TARP, was a Goldman vice president.

Goldman has repeatedly declared that its exposure to AIG was "immaterial" and fully hedged. But some rivals point to the fact that Goldman had uncharacteristically piled into contracts with a single counterparty.

"I am shocked that Goldman had this much exposure [with AIG]," says an analyst at a competing bank. "This was a major failing, but they got bailed."

How was AIG able to live so dangerously for so long? In part because for years Washington has looked the other way.

The company befriended politicians with campaign cash — $9.3 million divided evenly between Democrats and Republicans from 1990 to 2008, according to the Center for Responsive Politics.

And it spent more than $70 million to lobby them over the past decade, escaping the kind of regulation that might have prevented the current crisis.

So, in essence, our elected leaders were bribed to look the other way and allow these egregious transgressions to take place. And Wall St. was given carte blanche to do whatever it likes. It has essentially written its own rules.

In February 2000, one of Wall Street’s most powerful executives petitioned the Securities and Exchange Commission (SEC) to allow his firm and other investment banks to raise their levels of leverage.

He wanted the commission to alter something called the net-capital rule, which he said was “the single most important factor in driving significant parts of our business offshore.”

That exec was Henry Paulson, then the CEO of Goldman Sachs, and the previous U.S. Treasury Secretary.

So, in 2004, after hard lobbying by Paulson and other Wall Street execs, the SEC complied. It reversed its 1975 rule limiting investment banks to leverage of 15-to-1.

The amended rule allowed banks and other Wall Street firms to borrow even more money to finance their businesses. The new limit could be as high as 40-to-1 if the investment banks' own computer models said it was safe.

The most aggressive investment banks gladly took on these absurd leverage ratios. What this meant is that, for every dollar in equity capital a firm had, it could borrow $40.

Now those ratios are being unwound with a vengeance, and we taxpayers are being held hostage to the process.

What has been hatched is a public/private partnership – amounting to a good ol' boys network – that is absconding with our tax dollars.

Nothing less than a revolving door exists between Wall St. and Washington DC, and back again, just like military-industrial complex. The whole scheme is appalling.

It is now abundantly clear that Goldman Sachs is nothing less than a mammoth criminal enterprise. The following video illustrates this fact quite clearly.

http://www.youtube.com/watch?v=7SFywA_LQuU&feature=player_embedded

Alan Greenspan's Gold and Economic Freedom

Alan Greenspan wrote Gold and Economic Freedom in 1966, when he was 40-years-old. It appeared in Ayn Rand's Objectionist newsletter that year, and in her non-fiction book, Capitalism, the Unknown Ideal, in 1967.

In it, the middle-aged Greenspan makes a strong and persuasive argument for the gold standard and against central banks.

After reading Gold and Economic Freedom, one can't help but wonder what happened to that Alan Greenspan. It hardly sounds like a man who would eventually go on to head the Federal Reserve.

As a fully formed adult, Greenspan underwent a total conversion as Fed Chairman and became a hypocrite. He completely betrayed his own ideals and abandoned the beliefs he had once argued so articulately.

The selection of Greenspan as head of the Federal Reserve was a curious one. Greenspan was a believer in Ayn Rand, a believer in free markets. That seems incompatible for a central banker, because central banking is nothing less than a massive intervention in the market through the setting of interest rates.

Greenspan recognized this incongruity himself, as he noted in his book, The Age of Turbulence:

"I knew I would have to pledge to uphold not only the Constitution but also the laws of the land, many of which I thought were wrong."

"I had long since decided to engage in efforts to advance free-market capitalism as an insider, rather than as a critical pamphleteer."

Included here, in its entirety, is the full text of Gold and Economic Freedom. It is an excellent read and clearly illustrates why holders of the US debt have good reason to be worried.

It is absolutely full of amazing quotes such as:

"The gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state).The welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes."

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation... The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves."

"Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process."

Without further adieu, please enjoy....


Gold and Economic Freedom
By ALAN GREENSPAN

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense-perhaps more clearly and subtly than many consistent defenders of laissez-faire-that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.

In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.

The existence of such a commodity is a precondition of a division of labor economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.

What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. First, the medium of exchange should be durable. In a primitive society of meager wealth, wheat might be sufficiently durable to serve as a medium, since all exchanges would occur only during and immediately after the harvest, leaving no value-surplus to store. But where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible: every unit is the same as every other and it can be blended or formed in any quantity. Precious jewels, for example, are neither homogeneous nor divisible.

More important, the commodity chosen as a medium must be a luxury. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable. Wheat is a luxury in underfed civilizations, but not in a prosperous society. Cigarettes ordinarily would not serve as money, but they did in post-World War II Europe where they were considered a luxury. The term "luxury good" implies scarcity and high unit value. Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron.

In the early stages of a developing money economy, several media of exchange might be used, since a wide variety of commodities would fulfill the foregoing conditions. However, one of the commodities will gradually displace all others, by being more widely acceptable. Preferences on what to hold as a store of value, will shift to the most widely acceptable commodity, which, in turn, will make it still more acceptable. The shift is progressive until that commodity becomes the sole medium of exchange. The use of a single medium is highly advantageous for the same reasons that a money economy is superior to a barter economy: it makes exchanges possible on an incalculably wider scale.

Whether the single medium is gold, silver, sea shells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has always been considered a luxury good. It is durable, portable, homogeneous, divisible, and, therefore, has significant advantages over all other media of exchange. Since the beginning of Would War I, it has been virtually the sole international standard of exchange.

If all goods and services were to be paid for in gold, large payments would be difficult to execute, and this would tend to limit the extent of a society's division of labor and specialization. Thus a logical extension of the creation of a medium of exchange, is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security for his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.

When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available. But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion. Thus, under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth.

When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a world-wide division of labor and the broadest international trade. Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold the economies of the different countries act as one--so long as there are no restraints on trade or on the movement of capital. Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest paying banks in other countries. This will immediately cause a shortage of bank reserves in the "easy money" country, inducing tighter credit standards and a return to competitively higher interest rates again.

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold, and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post- World War I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline- argued economic interventionists-why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely--it was claimed--there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (paper reserves) could serve as legal tender to pay depositors.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates.

The "Fed" succeeded: it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930's.

With a logic reminiscent of a generation earlier, statists argued that the gold standard was largely to blame for the credit debacle which led to the Great Depression. If the gold standard had not existed, they argued, Britain's abandonment of gold payments in 1931 would not have caused the failure of banks all over the world. (The irony was that since 1913, we had been, not on a gold standard, but on what may be termed "a mixed gold standard"; yet it is gold that took the blame.)

But the opposition to the gold standard in any form-from a growing number of welfare-state advocates-was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.

Under a gold standard, the amount of credit that an economy can support is determined by the economy's tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government's promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited.

The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which-through a complex series of steps-the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets.

The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.


After the financial crisis, Greenspan was called to Capitol Hill to testify before Congress. In his testimony, Greenspan clearly seemed to regret his earlier conversion, refuting the views he had professed for 18 years as Fed Chairman. These views had led him to continually inflate the nation's money supply and manipulate its interest rates.

“I made a mistake in presuming that the self-interest of organizations — specifically banks and others — were such as that they were best capable of protecting their own shareholders and their equity in the firms."

Greenspan also said that he was “shocked" and professed, “I still do not fully understand why it happened, and obviously to the extent that I figure out where it happened and I — I will change my views. The facts change; I will change.”

"I found a flaw," said Greenspan. "I don’t know how significant or permanent it is. But I have been very distressed by that fact.

"I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works."

"In other words, you found that your view of the world, your ideology, was not right, was not working," replied Rep. Henry Waxman.

"Precisely. That’s precisely the reason. I was shocked because I’d been going for 40 years or more with very considerable evidence that it was working exceptionally well."

Until suddenly it didn't.