The Importance of Equal Weights and Measures

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A Look At This Weeks Show:

• Treating the value of the dollar as a constant is a rookie mistake.
• Will QE2 end early only to be replaced later with “emergency” QE3?
• How inflation affects the four players of the economy: The Debtor, The Saver, The Creditor and The Consumer.
  Who wins, who loses and why.

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, on this program, I think we should talk about what is the value of what we measure things in? We measure things in dollars, we talk about dollars, we talk about the printing of dollars, we talk about inflation and deflation concerns, but, in reality, unless we understand the grassroots of the basic value of the dollar, how in the world can we measure the rest?

David: I think this gets to the basic point of what is a currency? It is a unit of measurement, and by it, we value or measure other things. But it still has to have the ability to be that unit of measurement, and there is a degree to which we assume a constancy, when, in fact, starting in 1971, and before that, a slow deterioration in this 100-year period, we have moved away from a constant reference point to begin with.

Which leaves us in a very difficult position, because it really is impossible to look at stocks, it is impossible to look at bonds, it is impossible to look at real estate or ranch land, with any appreciation for what the real value is, and we will explore that a little bit today.

Kevin: David, before we go into that, there is another question that has been on everyone’s mind. Of course we all know that QE-I and QE-II dilute the value of this dollar that we are talking about, and we will go into more detail, I am sure, as to just how it is being devalued, but QE-III is on the minds of people. We are hearing some people say, “Well, gosh, maybe we should just cut QE-II short, maybe we can go without QE-III, when, in reality, isn’t the economy running completely on stimulus money?

David: That is right, Kevin, and if you took away the stimulus money, you are talking about an economy that cannot survive. We are seeing aggregate demand supported to roughly the tune of 10% of GDP, so the fact that the government is willing to step in and spend, in the absence of the consumer, is very significant. Can we get away with QE-II ending? Will we have a QE-III, QE-IV, QE-V? I think the case is best made that we will see an infinite number of QEs. The question is, what will they look like? Are they rebranded? And how strategically are they rolled out?

Kevin: Let me ask you this, then, because there is a lot of public criticism right now for the printing of money and the QEs, and the Fed is actually starting to feel a little bit of heat. How in the world are they going to be able to do that without making the public mad, and actually causing the inflation fears to increase?

David: On top of that, Kevin, you have Bernanke, who on 60 Minutes a month or so ago, said, with 100% certainty, that he would pull back the liquidity at exactly the right time. I think this is a perfect case in point where things can be staged such that they look like heroes in the midst of offering the QE-III and QE-IV, but the step-sequence to get there is critical.

What they need to do, and we do not know that they will, but it sure makes sense that they would take away QE-II and not complete the full 600 billion between now and June. Maybe that is sometime in May – we are at 450, we are at 500, we are at 550, but, like knights on a white horse, they ride in and say, “Do you see the economic recovery? Do you see the success of our policies? We have achieved what we wanted to, and it is not necessary to go the full 600. We are ending it short.”

Kevin: Charles Plosser, of the Atlanta Fed, has already made comments about possibly being able to end QE-II early.

David: He said last Friday, monetary policy will have to reverse course in the not-too-distant future and begin to remove the massive amount of accommodation that is supplied to the economy. Failure to do so in a timely manner would have serious consequences for inflation and economic stability in the future.

I think what they are setting themselves up for is this hero status. “We told you that our policies were working. We told you that we were in control. We told you that we knew when to take away the stimulus.” But here is the thing, Kevin. As we get into the summer or fall, we look at the landscape that we are in today and there are hundreds of different things that could cause the need for another quantitative easing.

Kevin: Didn’t Plosser even mention a couple himself? That is, assuming Japan can stabilize its nuclear reactors and that the Saudi family is not threatened, he is already throwing things out there that indicate that there is a problem here that they are not solving.

David: But what has to be proven out is, “We are in control, and you need to trust us. And we told you that we would take it away if necessary, and if we had that luxury, and in fact, we did, we took it away. Now, the fact that we have QE-III, or QE-IV, this is a separate issue. This was foisted upon us by exogenous, or external, events – things that were out of our control. Now we have to respond to them as we would to any particular instance. We solved the past problems. Now we have new present and future problems because of these new circumstances.”

Kevin: The Federal Reserve trying to talk about austerity is like a drug dealer offering a rehabilitation program. He is not going to offer it for long.

David: (laughter) It could be his best way of cornering the market and figuring out who the competition are and squeezing them out. Certainly the Fed is good at that.

Kevin, speaking of austerity, I want to go back to the German elections because it was just this last weekend, we looked at the Baden-Wurttemberg elections, critical for Merkel’s party.

Kevin: Merkel is in trouble.

David: Yes, she lost again. The argument was that the Green Party got more votes in Germany, and that they did so on the basis of Merkel’s response to the nuclear issue. But what that ignores is all of the other states throughout Germany where she has lost when the nuclear issue was not an issue, at all.

Kevin, what you really have is the austerity measures being viewed as a bit ridiculous, where taxpayers are bearing the burden that should have gone to bond-holders and banks. This is the point, Kevin, we are seeing a revolt in Europe against this very thing.

Kevin: Do you think people actually understand what is going on, or do you think they are just feeling the pain?

David: I think it is a combination of feeling the pain and seeing that someone else is not feeling the pain and that is very frustrating, when you know that you are paying a price, and it is all well and good if, socially, I pay a price and you pay a price, but somehow it just does not seem fair when I pay the price and you do not have to.

Kevin: We are feeling that here in America, as well. Think of how many blue collar workers, even white collar workers, are out of work right now, yet bankers are receiving record bonuses at this point.

David: Again, Kevin, this is more interesting from the standpoint of social commentary than it is critique, because what you have is a growing social instability wherein blue collar workers are saying, this just is not fair. We have this new movie receiving ample awards and accolades, The Inside Job, and again, does art reflect culture, or culture art? You have this movie which is acting as a voice for the blue collar worker, saying, “Hey, this just isn’t right!”

What is my position on that? It does not matter. What I am particularly interested in is that there is a development, there is a movement at the grass roots level, where the banks are going to have to pay. Over in Europe, the bond-holders will pay, they will take the haircut, not just the man in the street. It is not just us, subject to austerity measures, but everyone has to be on the same level of pain.

Kevin: A couple of hundred years ago this led to the guillotine in France, Dave.

David: (laughter).

Kevin: David, let’s go back, then, to the dilution of currency, because that is what we were talking about, with gold, we have talked about before, being a CPI indicator. You were saying, it is very hard to value things such as stocks, bonds, whatever, when you have a change in the value of the currency, but isn’t gold keeping up very well with meter of the CPI?

David: It depends on your perspective on that. If you look over long periods of time, then it is a very good mirror for inflation. If you are looking at a quarter-to-quarter report and saying the CPI is up, gold is up or down, then you could crucify gold as some sort of a corresponding relationship, but it is over that long period of time, a five-year period, a two-year period, a ten-year period, a 20, 30, 40-year period…

Kevin: A thousand-year period, whatever.

David: Exactly, you see gold mirroring the increase in the money supply and the way that is reflected in the repricing of real goods and services. What is interesting is that the CPI, at least the way we measure inflation here in the United States, and that correspondence to the gold price, started to fall apart in 2008. I do not know if that is because of an increased interest in gold, or because there has been an excessive amount of manipulation in the CPI and in the various indicators there. Maybe they have chosen the wrong things to measure. Maybe they need to re-look at how they measure inflation in the first place.

Kevin: Which is what a former guest of ours continually says. John Williams, who just publishes the real numbers, says we are not seeing the real inflation.

David: Kevin, as we will explore today, it may be that the understatement of CPI is actually the desired reading. Before we lose the reader’s interest in the bottom line here, the CPI and sort of the financial jargon, let’s review that. The CPI, as we know, measures the rise in the cost of goods. Inflation, itself, is growth in money and credit, which precedes the re-pricing of those goods and services. It is a little bit like measuring the number of inches of rainfall. The rain is one thing. The measurement is an indication of the quantity of rain, which is something different, even if only by a minor nuance. At the consumer level, we have the CPI, which is supposed to measure price changes. Take out food, take out fuel, and throw in a generous percentage, reflecting rent, because that is how they calculate it.

The real back-story here is the increase in liquidity, either through a change in interest rates, or money supply growth. That is what is behind the scene, ultimately showing up in a CPI measurement, now understated, but still some indication of inflation.

Kevin: I hear from so many people who have had standard economics courses, or who have just read the paper, that a couple of percent inflation is actually preferable. Is it? Is it something that puts money in people’s pockets, or is it something that takes away?

David: Well, if I am the thief, I would prefer that you be very comfortable with making that voluntary donation to me, but that is essentially what inflation is. It is legalized theft. Inflation is, in fact, theft.

Kevin: So basically, we have had a whole generation of people instructed that they should look for inflation, and fear deflation.

David: That is correct. What is the number on a coin, on a bank note? It is the value that is implied that currency note or coin represents. If you take that bank note and you cut it in half, you are going to find very few people who are willing to accept the bank note at all, let alone believe that they are being given full value for the note. In fact, the note is so impaired, it is probably no longer exchangeable.

Kevin: David, you were talking about shaving coins. This is something that has been done throughout the centuries, when gold and silver coins were used, or even other types, like copper. The way inflation would occur is either with the dilution of the metal – just put other metals in until the original precious metal is no longer there – or they would shave the edges. A lot of people do not really know that the ridges around the coin on a quarter are to keep that from happening.

David: That is the exact point. Government acknowledged that people would try to cheat the system by shaving coins, so they created a design on coins that did not have a smooth surface on the edge, but instead had this reeding, or fluting, on the edge. What happens when you shave the coin? It is very obvious, and you take it out of circulation immediately.

Kevin: The government cannot do that to you, you cannot do it to the government, everybody continues with a constant weight and measure.

David: But in fact, that is what government has foisted on the public. They are shaving coins and people pretend that is not happening to them, with that stated inflation rate of 2% per year.

Kevin: Isn’t it curious that investors assume constant value with their currency, even though the opposite fact is the case?

David: Take the dollar as primary example. From 1950 to present, a dollar has been cut to 11 cents in its purchasing power, leaving that venerable bank note, if trimmed with scissors, as nothing more than a bookmark, a memory for the owner of some nostalgic state that currency had – a value of yesteryear.

So what is the piece of paper worth? If you look at the full bank note, and even though inflation has eroded its value and cut away 89% of its value, you and I pretend to ignore, and still spend that money as if it is a representative value, as if it is a unit of measurement, as we were talking about earlier, and there is some solid, objective value to it.

Kevin: That is an interesting point, because we think back and say, “Gosh, we have lost 89% of our value in the currency, but that was yesterday, that is not today. Today, we are being told 2% is the goal. That is the goal. At 2%, someone ran these numbers for us. 100,000 dollars at 2% inflation, in ten years, is only worth 81,707 dollars.

David: So you have lost about 19,000 dollars in purchasing power in the course of a decade.

Kevin: That is only 2%.

David: Yes, but that is the intention of government, to steal only 19,000 of your 100,000 dollars over the next decade. That is supposed to be acceptable to you, Kevin, that is supposed to be acceptable to me, and we exist with this as normal.

Kevin: So for people with kids or grandkids that they are saving for – 20 years at 2% takes it down to about 66,000 dollars – 100,000 dollars is reduced to 66,000 dollars. That is 2%. What if it is 4%? What if they are not telling us the truth?

David: You are having to pay for this monetary policy, and that is the price, and that is if the inflation rate is 2%. As we have discussed a number of times before, you have the magician or the entertainer who uses the art of misdirection to focus your attention on what he or she wants you to see, so that they can, in turn, work their trickery without being noticed. You have the target of 2%, which does not reflect the flexibility the Bureau of Labor Statistics has in coming up with a number to show the Fed’s success.

Kevin: We know they doctor it.

David: Yes, the looseness of the modeling, the CPI over the years, has put the Fed in the position to essentially grade their own work. They can call it a success. They can call it 2%. How do we know that they have met their number? Through the years they have actually changed the constituent parts in the CPI in order to achieve an A grade.

Kevin: What you are saying is, not only do they flute the coin, but then they shave the coin and re-flute the coin, and tell you everything is fine.

David: Exactly. It is far more important, if they are, in fact, understating inflation. Misdirection, in this case, is the discussion of the “successful” monetary policy operation which has achieved 2% inflation. Again, their excuse is that this is geared to spur economic growth, while, in fact, the real number is closer to 4-5%. John Williams says it is closer to 8% currently, but let’s take a conservative look at that and say, “No, just 4%, they are understating it by 2% and they are doing it on purpose.”

Kevin: So that 4% – we just talked about the run – that takes it down, instead of to 66,000 dollars, that 100,000 dollars is reduced to 44,000 dollars in buying power. That is just with 4%.

David: If I get a little hot under the collar, Kevin, it is because that is what I am talking about. Inflation is theft!

Kevin: Yes.

David: It is theft, and you have been conditioned, and I have been conditioned, to believe that this is healthy. You are donating, not only your tax dollars to the treasury, but now the Fed is absolutely sticking it to you, and you are supposed to smile about it.

Kevin: As a student, David, I was taught that a little bit of inflation is really, really quite nice. It is like what we were talking about the other day, “Hold still, little fish, while I gut you.”

David: Exactly, that was Malcolm Bryan, who worked for the Federal Reserve Bank of Atlanta earlier in this century. He was absolutely opposed to the idea of targeting inflation.

Kevin: Not even fractional inflation?

David: No, not at all. He said if a policy of active or permissive inflation is to be a fact, then we can rescue the shreds of our own self-respect only by announcing the policy. That is the least of the canons of decency that should prevail. We should have the decency to say to the money-saver, “Hold still little fish, all we intend to do is gut you.”

Kevin: And this is somebody who worked for the Federal Reserve, so actually, they are not all bad guys.

David: (laughter). I don’t think he was particularly popular at the Fed. The question is, Kevin, if, in fact, this art of misdirection is in play, and they are saying, “Look over here, we have succeeded with our 2% inflation rate, and it is healthy. It is spurring economic growth and the growth in the economy more than makes up for the 2% that we have just stolen from you,” although they would not use that term, what if, in fact, the art of misdirection is 2%, covering over the fact that the real world inflation rate is 4-6%? Is there a really big difference?

Kevin: There is a difference for the owner of assets, obviously.

David: And there is also a difference for creditors, owners of the liability.

Kevin: But how about the debtor? If the bank is going to take a risk, and let you pay 4% or 4½% for your house, and we know that inflation may be higher than that, isn’t the debtor winning?

David: In fact, that is the case. Allowance of any inflation favors debtors to creditors, but it also encourages speculation for some, while, for others, it encourages rampant consumption – consumption beyond your means, and certainly, again, it discourages saving altogether. Let’s look at each one of those: The debtor, the saver, the creditor, the consumer, and see what ways in which it actually benefits.

Kevin: All four: The debtor, saver, creditor, and consumer. And if it is understood, a person can actually possibly protect themselves, or at least understand why they are being hurt – why they are being gutted.

David: And I might even suggest that there is a moral dimension for the debtor here, which you should be very careful of, because someone ultimately pays the price. In taking advantage of this system, just understand that someone has to make up the difference somewhere, and maybe that is just that in a big boy world we all figure out someone else is on the hook for that, they place their bet, you place yours, and you won.

Kevin: So you are talking morals and ethics here? It is 2011, Dave.

David: I know, it might be inappropriate to discuss those things when it comes to money and politics, or anything else, but let’s look at the debtor. Over time, a fixed rate debt is paid back with devalued currency, if you have inflation in the mix. Inflation, to the debtor, is a form, actually, of debt forgiveness. To a debtor, this is probably something that sounds intriguing, and even desirable, but there are two parties that, as we mentioned, do pay for that debt relief. So what benefits one party is a price that has to be paid directly by another. Think of this, instead of debt forgiveness, as substitutional payments.

Kevin: That brings me to a point. Someone the other day was so angry, they had just seen a commercial for a guy who owed over 100,000 dollars on his taxes, and it was one of those commercials where it said, “We owed 100,000 dollars on our taxes and we called this number, and we have only had to pay 2000 dollars.” What made the person mad was, he knew who was covering the rest of the bill – and it was him! It was the guy who actually just pays his taxes.

David: Right. Then you have the saver, another category. The saver has a high hurdle to get over, for those saving to maintain a positive rate of return. You have inflation, plus taxes, and that equals the number that a saver has to reach just to break even, let alone have something in excess to either live off of, supplement income, or grow the asset base.

Kevin: That is called a positive rate of return, positive over-inflation.

David: Exactly, positive over-inflation on your taxes. Oftentimes, if interest rates are low, and inflation is high, a saver loses money every year. Keynes was keen on this idea, because he thought that savings were a bad thing. Punishing the saver was just fine to John Maynard Keynes, because the more you could force savers to spend, the more economic activity you could stir and generate. So, by all means, take away all the benefits from the saver.

When you look at Keynesian policy, low rates, ample liquidity, which is inflationary, who pays the price? The saver. Who was in John Maynard Keynes’ crosshairs? That’s right, the rentier class – a landlord who had capital tied up in a particular asset, be that real estate, or a farm, and was receiving lease money from the farm, or income from the person who was living on that property.

Kevin: That allowed him to be an owner, and someone who could profit from his assets versus having it spent into the economy and profiting the whole.

David: And Keynes’ system was all based on the cumulative effect of all assets working in the economy at all times.

Kevin: Which means you should not save?

David: But that is the point. The saver is looking for a net positive income from his assets, instead of consuming. Instead of buying, he has given up the consuming tendency, and said, “No, I would like to do something else with this. There is a reward for doing this.” Assuming that there is a reward, he will continue to save.

Kevin: But for every borrower, there has to be a lender. What about the creditor in this market? If you have inflation, what happens to the creditors out there?

David: Kevin, before we go there, one more thing on the savers, because this is important. It is an important dynamic that takes place in an environment just like this. If a saver does not have a net positive income, they are often forced to seek risky assets to remain in positive territory. The rate of return has to stay positive, but they cannot keep it down at the bank, so now they have to go buy something far more speculative, just to have the same rate of return, in order to afford their lifestyle, or pay their bills.

Kevin: That is just self-sacrifice at that point. David, I have talked to people for years about their money, and so have you. Age 50-60 is what I call the danger years, because guys hit 50, 51, 52, and they start saying, “I don’t have enough to retire. I had better get in there and start taking more risk.” And what happens is, whatever little or large nest egg they have, goes under extreme pressure in those years, because they are taking extra risks. They are realizing they do not have the buying power to retire.

David: And that is true of a demographic. This is the case where monetary policies are forcing savers to become speculators. It creates that same kind of circumstance you are talking about, but artificially. It does not matter what age you are, if you are just a little old lady with 100,000 dollars at the bank who is just trying to supplement her income, it is not working. So you either spend principle, or go speculate. That is what modern monetary policy is doing to savers.

Kevin: Now let’s talk about the creditor, Dave.

David: Kevin, when we talk about a creditor, we are talking about an organization like a bank, or any lending institution. If they have loaned money, they have done it with a certain understanding of an economic backdrop. If they are accepting of the CPI numbers, then they are assuming that inflation today is no issue at all, and they probably will ignore the slow erosion of value. Specifically, what I mean by the slow erosion of value is, they lent out money at a particular point in time. Each year they are receiving payment of principle and interest back, but they are getting it back at a discount from the original loan price, if, in fact, those CPI numbers are too low. So if CPI is understated, the creditor is getting his head handed to him.

Kevin: David, you were talking about the creditor being a bank or some lending institution, but you and I are also lending institutions every time we buy a bond. Every time we put money into a bond, we are really lending money to somebody, so in reality, it also is me. That banker can be me.

David: Exactly, so what about the creditor trying to factor in a real-world inflation number? What you will see is that interest rates have to be pushed up in order to compensate for that increased rate of inflation. This is something that is interesting, because it means that investors and creditors are at odds and are potentially being abused by central bank monetary policy decisions, as well.

Kevin: Right. These interest rates are staying unnaturally low right now. There is no possible way that a bond-holder, especially with a safe bond such as a government type of bond, is keeping up with inflation.

David: No, it will take significantly higher interest rates in the future to reflect the several variables which are neglected today. Not only a change in credit quality, which is happening right now – we are watching balance sheets continue to erode, particularly in the public space, as the private sector has cleaned up their balance sheets by shifting all their bad loans onto the public ledger, now the public has to figure out how to pay those bills, and we are looking at downgrades. We are already seeing that in the municipal space and we will see that in the treasury markets, I think, in 2011 and 2012.

But debtors are, in effect, being marked to market, and this is what I mean by that: If you have the U.S. government, which has an awful balance sheet, but they are being treated like an A quality credit, and they are almost insolvent, eventually you are going to have to quit pretending. Eventually you are going to have to quit “marking to make-believe,” and assuming that the government is always going to be solvent, and there will be a revolution in value as the credit quality is questioned, and the bonds are re-valued overnight.

You also have the other side of that, which is, in an era of eroding or changing monetary values, specifically, inflation, you are going to have to see those bonds reflect an imputed inflation rate.

Kevin: So, David, John Maynard Keynes, in his perfect world, gets his perfect way, and we are all just consuming. We take in money, we spend it. What about the consumer? This consumption is 70% of our GDP, so obviously, that applies to a couple of people who are listening to this show right now.

David: Absolutely. This is the thing. You create a world where there is no real advantage to saving, with no real return on your savings, or flat returns, if we are going to be generous. You can look at former savers who have turned into consumers, and guess what? They are going to spend, simply because they do not want to lose value, and there is really no reason. I mean, if you are out on a Friday night with a couple of friends, and you say, “Gosh, I really should watch my budget because I have been trying to save for x, y or z, and you look at how discouraging real-world inflation is, you say, “What the heck, it just doesn’t matter. I am never going to get ahead anyway. Eat, drink, and be merry, for tomorrow the Fed has taken me to the cleaners.”

Kevin: David, this reminds me of a missionary who visited us years ago from Belarus, and that country had an inflation rate that just destroyed their currency. About every six weeks, whatever they were paid before was no longer worth anything. He actually gave me some of his currency. It was not worth anything when he handed it to me, it is hanging on my wall. He was puzzled as to why Americans save. It was outside of the realm of his world. They did not save anything. When they got paid, they spent. What they did not spend, they gave to the church, or gave to orphanages, but there was no way they were going to actually try to save money, because they had never experienced a currency that was not devaluing faster than any asset or any type of investment that they could buy.

David: In an environment where there is no inflation, investors or savers will have a reasonable choice as to how to allocate their assets. With mild inflation, you have savers which are discouraged from doing that very thing. With radical inflation, you actually have an encouragement of consumption on a day-by-day, or even hour-by hour basis.

Kevin: Like this person from Belarus.

David: Exactly, because the process of currency devaluation is shrunk into a perceivable time frame. This is how the Fed can get away with creating 2% to 4% inflation and the average consumer does not care.

Kevin: Because they do not really feel it day to day, right?

David: This is curious, but if you look at a 2% inflation rate, and that is the current Fed target, over a 365-day period, if you stretch that 2% out over a one-year period, you are talking about 0.00005479% of inflation per day.

Kevin: Hardly noticeable.

David: You don’t notice it at all. But here is the thing. Even with an annual inflation rate of 10% per year, you may think, “Now we are talking about real money.”

Kevin: Sure, now I know.

David: But you know what? On a daily basis, you are still not going to react to it. You are still not going to freak out. Why? Because you are talking about 0.00027% per day. The first issue is that there is no upside on savings. The second issue is that you panic into spending whatever you have, because you really have to get something for it at some point. Somewhere in between is the Keynesian dream. He was not after an inflationary nightmare, but he certainly did not want to see people sitting on savings. He wanted to see full employment, he wanted to see full usage of capital.

Kevin: He loved the velocity of money. Let’s face it, if he loved anything, he loved the velocity of money. David, you were talking about how little we can actually feel on a daily basis, but even in today’s market, people will still call a trillion a sizable amount of money, and with all of our debts, nationally, adding up to about 52 trillion, we are talking a 2% inflation rate sucking over a trillion dollars a year, just in buying power, out of the system.

David: Right. This is why when you wonder if inflation is the answer, if the Fed is open to having a stated 2%, and running, perhaps a real-world of 4% or 5%, this is why: Because the number that you quoted does not include unfunded liabilities. Throw in the unfunded liabilities and it takes us not from 52, but up to 70 trillion, over 70 trillion dollars, that over the next 25-30 years we have to pay.

Kevin: We have 1-1/2 trillion, almost, being sucked out of the system, using the Fed’s number where they say, “2% – that is our goal.”

David: As boring as this may sound, this is the value of compound interest, because just as a savings rate and a positive rate of return grows your money, having a debt with a negative carry on it – guess what that does? It compounds negatively.

Kevin: That is negative compound interest.

David: It is a negative compound interest. The best hope that the Fed has, and this is why inflation is already baked into the cake, is to allow that 2% to be there, misdirect our attention to the 2%, allow the 4% to carry. Over the next 18 years, at a 4% rate of inflation, we are going to cut that 70 trillion dollar liability into a 35 trillion dollar liability, something that is more attainable and more affordable. If, on the other hand, it is an 8% rate of inflation, now we are talking about cutting our debt in half, not over an 18-year period, but we are shrinking the time-frame, and all of a sudden, that does not matter.

Kevin: And David, as you have pointed out before, this brings us to the moral issue. This is the moral, ethical issue, because even though the nation may be decreasing its debt in real dollars, the real losers are the people who are not involved in that elite system.

David: Right. I guess one of the arguments is that if you are an owner of assets, then certainly you benefit from a re-pricing of inflation.

Kevin: A lot of our listeners are sitting here listening to this saying, “Well, I have taken care of that. I own assets that I can trade in for more dollars later.”

David: Right, and with a consistent and mild inflation, you see an increase in asset values, and over a long period of time, a significant step up in return on your original investment. Let’s say, for instance, that you built a plant in 1950 for a million dollars, a significant investment at the time, and today, are looking at walking away. You are now at an age where you want to retire, you want to pass this on to someone else, and you are liquidating the asset, for 9 million dollars.

Kevin: You think you have made money.

David: You think you have, and yet if you look at the purchasing power of money from 1950 until now, and your million dollars, now 9 million, is still only the million that you had.

Kevin: So what if you got 6 million, or 5 million?

David: Not only are you a loser, because the dollar has lost value during that period of time, but guess what else? The treasury is going to ask you to pay a capital gains tax on the liquidated value. The reality is, with a constant unit of measurement, that would not be the case, but you are going to pay a tax on a fictional profit, and that fictional profit is based on an inflated value as a result of a devalued currency.

Kevin: And you are paying an inflated tax, let’s face it. The treasury still gets away with murder on this one, because the tax that you are paying is inflated on buying power.

David: I guess this brings us back to the critical issue. As investors, we assume that we understand our money. We look at a bank statement, we look at an investment statement, and we assume that it means something to us, and yet, it means something different every day, depending on the time slice we choose. What is the dollar worth today, versus yesterday, or ten years ago, or 20 years ago, or even tomorrow?

Kevin, I think this is where we are assuming that we are using a value that is a constant unit of measurement, when, in fact, we are not, it is utter fiction, and we have been duped into playing this game, and we have been robbed blind. We have been robbed blind. This is the value of monopoly central banking. I wish I had one. I would have to check my spirit and soul at the door, because ethically, I do not think it flies, but in terms of a business model, where you market yourself as being the stabilizer of the system, while at the same time robbing the system blind, you realize that the idiots out there are the ones who are in Sing-Sing prison because they tried to walk in the bank through the front door and hold up the bank.

Kevin: Instead of being the banker for themselves.

David. Yes. And you could do the same thing with a gun to the head of every depositor, and who cares? If you are a central banker, you get to rob the public, year in, and year out.

Kevin: David, I think about how we have to make decisions every day based on certain standards, certain constants. Even the way we get up in the morning and walk around the room, we are basing that on our knowledge of gravity, which does not change much in our lifetimes. I am thinking about in Sevres, France, in a climate-controlled locked vault, there is an international prototype of a kilogram. I think it is made out of platinum. Why is it important to have something that is exactly 1 kilogram?

David: Because they do not want it to atomically deteriorate at all. We need to know what our kilogram is, the constant value through time. Through this, we derive grams, we derive micrograms, and we derive all of the other variations.

Kevin: All of our scientific measurements. This thing has been around 120 years and they have made more, and they test them against each other. They are continually testing, because they need to have a standard. A kilogram is supposed to be exactly what a liter of water would weigh at a certain temperature. With that care being taken, if you look at the monetary system, what if we actually took care in that way? What would something be worth – our work, our eight hours a day for a lifetime – what would that be worth if we would have had a standard unit of measure in our money?

David: I remember the Harvard study by two women over ten years ago, in which they were talking about dual-income families, the fact that today, for the same lifestyle that we had 30-40 years ago, it takes two people working. We have grown socially accustomed to the fact that we want opportunity, and we want it now. We want two cars, a two-car garage, a house that we like, with a white picket fence. We want the American dream, and we want it now. But guess what? That used to be achievable, even if you had to wait a few years.

Kevin: With a single income.

David: With a single income. But again, there have been a lot of social arguments for why we need to break down gender barriers and everyone gets to work. That is not our point. We are not having that discussion today. What we are talking about is when you destroy a currency, and it happens over a slow period of time, there will be justifications for why two people need to work. But the baseline is this: You have to! You have to have two people working to do what one person used to be able to do. That, too, is a present to you, a gift from the Federal Reserve.

Kevin: David, to bring a little gallows humor into this, because I am sure no one was laughing when it actually happened, but about a dozen years ago we had our Internet connection set up, I was here at the office, and I normally do not do this while we are working at the office, but I was at Jet Propulsion Laboratory’s website, and I was ready to listen to the first audio from Mars. They had never actually taken a microphone…

David: This was the Mars probe that they sent, and now they are sending the recording? The recording is supposed to come back?

Kevin: This was in the late 1990s. I had tracked this mission. I am sort of a space geek anyway. I had watched when it was launched, I couldn’t wait for it to get there, I had it on my calendar to turn everything on, because I wanted to hear the wind, and I wanted to hear the sand, I wanted to hear everything on Mars. There was a strange silence, Dave, and it just stayed silent. Minutes passed, and it stayed silent. Scientists scratched their heads and they asked, “What happened here?”

Well, it took months, but they finally figured out, and they still do not know whether it slammed into the planet, or if it burned up in the atmosphere, or if it just flew past the planet, but the point is, when they got together they asked, “Hey guys, did you use meters, or did you use feet?” Half of them had used meters, and half of them had used feet. Well, when there is not an agreement on a unit of measurement, you have no sounds coming from Mars, I’m sorry.

David: I know you are studying celestial navigation right now, which is kind of fun – using the old sextant. If you were out at sea and had no GPS, how would you make your way from island A to island B, or across the Atlantic? How would you do that, just navigating from the stars? You have all of these variable factors, things that are not in your control.

Kevin: The sun is moving, the stars are moving, the moon is moving, there are declinations changing, but what you do have is a sextant that is very, very precise in measuring angles. That is all you need – precise measurements of angles, and knowing the constants of, what seem like variables, but are actually constants. GPS is the same thing, using the sextant is just an older form of GPS. You can measure down to a very, very small area of error, so you know where you are going and you do not run into the rocks.

David: I think this is the frustrating thing for me, Kevin, because when I think about investing today, and we have had this conversation many times, the need to analyze value in relative terms, is because we do not have a measurement which helps us appreciate that relationship, a relationship of value between one item and another, on its own. If things were, as they were during the gold standard era, 1860 to 1914, priced in gold terms, then you would just be looking at one item versus another, and determining its value in a constant. We really do not have that anymore, which means the best that we can do is suck dollars out of the equation, since that is the variable which we do not know – up, down, short-term, long-term, what direction it goes.

Kevin: Real things versus real things, is that where you are going?

David: Right, because a real thing used to actually be our money system. That is not the case with a fiat money system anymore, and it puts an investor at an extreme disadvantage. How do you measure one asset versus another? How do you allocate, into assets, one class versus another, when you have no constants, when the gauge is a variable?

Kevin: Is this why you have been a proponent of the Dow-gold ratio, or the silver-gold ratio, or the real estate-gold ratio?

David: All of these things are, unfortunately, necessary, because our money is not telling us the story of value.

Kevin: So, without a calculator, you are really not going to know what things are valued at. Without a calculator, and maybe what today’s price for gold is, you really do not know what anything else is worth.

David: Having to price things in relative terms signifies how far we have come in bankrupting this idea of sound money. We left it in the 1960s and 1970s, completely, on a global basis, and that leaves investors at an extreme disadvantage. To understand and appreciate where we go from here, Kevin, I think it is worth looking back to that period when we had a unit of measurement that signified something of constancy.

Kevin: David, it doesn’t just apply to Mars probes, and it doesn’t just apply to celestial navigation. It obviously applies to our livelihoods.