May 3, 2012; Discretion Minus Rules Equals Uncertainty

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, what if we were watching a football game, and the NFL commissioner was there, and he started changing the rules as the game was going on, perhaps to keep people entertained – because runaway games aren’t entertaining?

David: You don’t want big winners, and you certainly don’t want big losers.

Kevin: What does that do for the game, though, if you start changing the rules in the middle of the game?

David: It definitely changes how people bet on the game, and to the degree that you can judge what the NFL commissioner is going to change next, you will either win or lose in Vegas. But as far as the consumer is concerned, the viewer of this great drama, yes, it is designed to be entertaining, but that is the key word – designed. There is nothing really natural here.

Kevin: Right, so you don’t really know what decision to make next, if you are a coach, and you don’t know whether the end zone is the touchdown, or whether we have decided to start kicking field goals for more points.

David: (laughter) The point, for us, is that when you look at monetary policy today, it is really not that much different than the NFL commissioner “making it up as he goes along” because it is the difference between discretionary policy measures and rules-based management of the monetary system.

What we have today, in the form of Ben Bernanke, and certainly, in the latter years of our esteemed former chairman, Mr. Greenspan, is that there has been more discretion given to the process, instead of rules that they were following. For years we saw the ECB do the exact opposite, in which everything was rules-based, and actually, by almost German hard-edged calculus. “You’re not meeting the rules – you’re out.” Everyone needs to be a winner in our economy. Everyone needs to be a winner because that is really what our education system has geared us toward today. Everyone is a winner – everyone.

Kevin: We have a debt-based, consumer society, which has been taught to just consume, borrow, consume, borrow, consume. The problem is, that doesn’t have sustainability. Back in the old days, the gold standard was a true rule. If you didn’t have the gold, you couldn’t go spend the money. You could still borrow, but you had to pay back in gold. Everything balanced out in the end.

David: And frankly, wealth was not based on how much credit you had access to, wealth was according to what you had saved, and foregone in terms of present pleasure, for future investment. You saw wealth grow over time, the classic way, via compounding. Now, in fact, we have an entire society that has compounding negatively working against them, because it is not assets that are growing exponentially, it is debt on their balance sheet which is growing exponentially, which really mirrors what we do at the federal level, too.

Kevin: Speaking of the federal, these guys aren’t truly federal, but they gave themselves the name. The Federal Reserve Act probably is where that discretion started. That was the seed. We may not have felt it completely until now, but the seed was planted back in 1913.

David: And it really was the argument that men in the intellectual elite can, and should, determine the market – that the market itself was not smart enough, there was not enough actual attention being paid. By the way, next year is the 100-year anniversary of the U.S. Fed. The U.S. Fed, and more recently, the European Central Bank, epitomize the move toward discretionary measures. That is in stark contrast to the gold standard, which was a rules-oriented system.

The Federal Reserve Act moved our monetary policies in the direction of being discretionary policies instead of operating on an automatic basis, those policies being less discretionary, dependent on Fed leadership, current leadership, and of course, that is what we know today, entirely discretionary.

Kevin: That brings up a great point. If we say it is unsustainable to continue to just borrow and spend, we are reaching that point where they are trying to make it look normal, but everybody knows there is a catastrophe about to occur. Give me some coming attractions. What are some of the possibilities as we go forward?

David: It would appear that there is a little window opening, and it could be in the next 2-4 years, where there is an openness, collectively, to a new solution. That new solution will be much better, or much worse, than what we currently have, and I think that this is where the discussion of the gold standard needs to be front and center. If there is a preview of coming attractions, I think we need to consider how we might reasonably return to the gold standard. Is there enough, in terms of a collective group of people, who care enough to create a well-grounded political and economic system for their children, and for their grandchildren, to inherit?

When you look at sound money, it is what leads to sound politics. Sound money is what leads to a sound fiscal state of affairs. This is one of the things that we discussed nearly two years ago with Giulio Gallarotti, the idea that in the post World War II era, with democracy has come the politicization of the U.S. budget. Everybody has a stake in what government is spending, and this is really the problem. They can ask for it, and the Fed will print it. Government will deliver on these fiat promises because they have access to an infinite amount of fiat capital.

Kevin: And there is no pain in that right now, David, and that is one of the reasons why Americans aren’t feeling the pain. In fact, that is one of the reasons we talked about last week why American buying is only about 2½ times Vietnam for gold purchases, so Americans aren’t feeling the pain yet. But here is my question: Can we keep our greatness as a nation, or are we all just getting tired enough to go for the security of having them continue to print money because there will be pain involved in rules?

David: I think we need to throw down the challenge, because, Kevin, as we talk to folks every day there is a sense of tiredness, as if they have done enough, and they assume that it is someone else’s turn to take a hand at the till. To be quite honest, this is when we need to press in and double down in terms of our commitment to this country of ours. This is a wonderful experiment, 200 years plus, and it is foundering, not because of bad political ideas, but because we handed the responsibility of money printing to a private organization circa 1913.

That is the problem, Kevin, and I say it is largely the problem because politics as we know it, as grand as it is, and economics as we know it, as out of balance as it is – both are driven by one thing: Access to unlimited money. That unlimited money is not on the basis of our wealth as a nation, but on the basis of a printing press, and that, unfortunately, has a moral component which we find repugnant.

Kevin: I hate to say this, but probably the innovation that has occurred in our lifetimes, is the innovation of just being able to come up with this free money, this credit money. But actually, if you look at a period of time – I look at my library, David, and there is a period of time of American literature that I seem to have more of than any other, and it has to do with the period of time between 100 and 130 years ago. There was something about America, and actually even Europe at the time – we call it the Industrial Revolution – when people were producing things. But there was also something that was going on at that same time. Everyone was on a relatively equal footing, because we had a worldwide currency system based on rules called the gold standard.

David: We like the success story of the gold standard. That era, at least for the United States, was 1879 to 1914, and there was a reflexive nature to that program. It was not driven by the “too clever for their own good” academics. I want to give credit where credit is due. We are talking about very bright individuals, smart in their own right, just lacking some basic things like humility, and really, a penetrating sense of the real world – these academics that run the Fed, and thus, really run the world from behind the scenes.

Kevin: David, when you are talking about “too clever for their own good” academics, I can think of one guy from Princeton who is a “too clever” kind of guy who is at the helm right now, using quite a bit of discretion.

David: CNBC interviewed him back in 2005, Ben Bernanke, and he was asked about the housing bubble, and he responded, “Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in housing prices on a nationwide basis, so what I think is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it is going to drive the economy too far from its full employment past, though.” That was his quote in 2005.

When asked about derivatives, and the threat that they posed, and of course Warren Buffet talking about them in terms of being weapons of mass destruction, he said, “I am more sanguine about derivatives than the position you have just suggested. I think, generally speaking, they are very valuable. They provide methods by which risk can be shared, sliced and diced, and given to those most willing to bear them. They add, I believe, to the flexibility of the financial system in many different ways. With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and use them properly. The Federal Reserve’s responsibility is to make sure that the institutions that regulate have good systems and good procedures for insuring that their derivative portfolios are well managed and do not create excessive risk in the institutions.”

And just a last quote by our resident genius at the Fed – at the Federal Reserve Bank of Chicago meeting in 2007 – the statement, “We do not expect significant spillovers from the subprime market to the rest of the economy, or to the financial system.”

Kevin: David, if this were the Gong Show, the gong would have gone off all three times. Every one of those quotes was wrong, and if you remember, on the Gong Show, once they were gonged, they were off the show. I am not quite sure why we are still listening to these guys, and watching them on financial TV, waiting with bated breath for their every statement, when they have been completely off on all of those other things.

David: Kevin, I think this is the fascinating thing. The difference between a successful investor today and a non-successful investor, will be the person’s ability to tune out all of the white noise which is put on by both the academics and our current media, because honestly, there are so many things that are supposed to be so very important, that catch our attention, that are supposed to be motivating factors for us to take “just the right action.” And the reality is actually quite different. If you simply ignored it all, if you sat back, and took long walks on a Sunday afternoon, if you never read the newspaper, do you know that you would be much better prepared to make intelligent decisions, as an investor?

Kevin: Let me bring up a good point, then. I had a client ask me the other day, on the concept of deflation, because these guys are the same guys who tell us to fear deflation: “Oh no, there might be a turn-down in prices, things might fall in price!” My client just said, “You know, Kevin, thinking about this, why would it be a problem if my money bought more goods instead of less every year?”

David: (laughter) That’s what is interesting. We have been taught to fear deflation, with the specter of the 1930s drug out and put on show as if to say, “You see, this is what you get with deflation.”

Kevin: “Oh, the pain, the suffering.”

David: “It’s cruel. The markets are determining prices. This is dangerous! Monetary barbarism.” Don’t you think we need a better, a cleaner, a more polished approach to the markets?

David: “We need to keep this from ever happening again.” In fact, that is a Bernanke statement.

David: (laughter) And Kevin, this is the response, this is what we see today – genius applied to the markets, genius applied to our monetary policies. There was a book written several years ago, and I think there might be a reprint coming out soon, but with a different cast of characters.

Kevin: Are you thinking of When Genius Failed? That was talking about a corporation failing. Are we talking now about a larger system failing?

David: Yes, and I think this is the reality. The reality of the gold standard period was that money bought more over time, not less. Real goods and services cost less over time, instead of more.

Kevin: That’s a natural balancing. When things slow down, things should cost less.

David: It’s impossible for us to even imagine that set of circumstances, because it is outside of our understanding. From 1913 forward, it really got ramped up in the 1930s and 1940s, really got ramped up even more in the 1960s and 1970s and 1980s – this idea that central banks intervene, central banks smooth out the business cycle, and keep corrections from happening, but only a pro-cyclical, grow-oriented direction for the economy. Kevin, this is where we have primary struggles, because actually, we are seeing genius fail, though no one is acknowledging it as of yet.

Kevin: I think we need to point out, too, that there is a misunderstanding that this is a free market dynamic that is causing inflation, but it is really not. The socialist academics … that which you learn in school … we live in a college town, and I was in the college parking lot today, and I saw bumper sticker after bumper sticker after bumper sticker, and I don’t have to tell you what they all said, but you can probably fill in the gaps. It is usually the socialist way of thinking that says, “Oh no, you don’t want deflation, you definitely don’t want a readjustment in prices.”

David: When, ironically, it is the only objection to this sort of purchasing power advantage, back in the day, when we had the gold standard, and as we were leaving, we left the gold standard in 1914, the Federal Reserve was created in 1913, for very different reasons, but there was simply a coincidence there in terms of when we left the gold standard.

But it was the young socialist academics and labor organizers in the 1880s, 1890s, and at the turn of the century, who were upsetting the American order on the basis of the influence of Marx and Engels. They did not like the capitalist system. They did not like the idea of the Industrial Revolution. They did not like the idea of a working class and a nonworking class – the bourgeois and the proletariat. They were arguing that wages were depressed via the gold standard.

Kevin: Sure, it was gold’s fault.

David: And they wanted something different for the working class. They wanted more inflation.

Kevin: David, we got to see a model of that. That is like the logic of Haverstein in the 1920s in Germany. You just print more and more money.

David: Exactly, “We just need a little more quantity of money and all will be made right.” And at least from the standpoint of those young socialist academics and labor organizers, all would be more equal if there was more money to go around.

Kevin: For them, they may have really wanted to see more equality, and they may have earnestly felt like that equality would have occurred, but it rings true with Orwellian types of logic, where all animals are created equal, and some are a little more equal than others.

David: It is interesting, because it was silver during that period of time – the 1880s, the 1890s – that was the inflationist’s friend.

Kevin: It was almost like printed money back then.

David: It was, because relative to gold, there was a heck of a lot more of it.

Kevin: David, I think you need to elaborate on this a little bit more. Take us back 100+ years when we had both metals, we had gold and we had silver, as our monetary units, but silver was favored by those who needed inflation, those who produced crops – people, maybe, who were in debt.

David: I certainly don’t want to cast a bad light on someone who is inclined toward social justice, and inclined toward looking for fairness of opportunity, and equal opportunity. These are issues that, in a fair and open discussion, will emerge. My concern is, really, that when we think of any system, if it embeds an inflationary component into it, it becomes subject to political manipulation.

Money becomes a means of entrenching politicians, as in the current system, of corrupt politicians maintaining their positions of power via the redistribution of tax dollars, and the extra capital required to meet those political obligations, compliments of none other than the Fed and the Treasury, the sort of enmeshed relationship that exists between them. So we can’t meet all the needs, we can’t promise pie-in-the-sky programs, we can’t give the sun, moon, and stars to our constituency groups, if we have a sound money policy.

In other words, you are limited in what you can promise, knowing that there are limitations on what you can actually deliver, and we would be much more inclined, in terms of the body politic, to not make outrageous claims about where we are going to spend money that we don’t have, if, in fact, we lived within our means as a country.

Kevin: David, just as an aside, we really like silver as an investment now because we are on a fiat currency system. Silver, as money, alongside of gold, had problems coming, because, look at Spain – the Spanish crown. When there was a massive infusion of silver into the market, there was all of a sudden was an inflationary and political pressure to move things over to silver.

David: Yes, and actually, we did see something of an inflationary trend with the California gold rush, when they found gold, but it was so infinitesimally small, it didn’t matter. And it was the same with the Klondike run, and the major rush in Alaska. What we saw affect the Spanish crown was a massive devaluation, they were on a silver standard, it was akin to hyperinflation, and ironically, it was their tangibles, as the mines of Central and South America flooded the money supply, destroyed the economy, and eventually the crown along with it.

Kevin: Isn’t inflation sort of deceptive? At first you think it’s your friend, especially if your wages are going up quicker than other things. But actually, inflation is no one’s friend in the long run.

David: In interim periods, the wealthy have assets which appreciate with inflation. As you mentioned, the poor, under certain circumstances have access to more money. But there is a circumstance that we know as stagflation, which doesn’t help anyone. If wages are not rising, the William Jennings Bryan fans of the world, the Bernanke fans of the world, are not being “taken care of.”

Kevin: David, we have talked about this financial repression before, and what we have right now is that everyone is wondering why they are running out of month just a little earlier. It is because inflation has been in the system for a long, long time, and we really haven’t experienced a true slowdown until about 2008, and even in 2008 we didn’t really experience a true slowdown, but it is catching up. We are starting to talk to people who are saying, “You know what? It is crazy, but I’m just running out of money.”

David: One of the very important things here is this: What we experience with snaps of inflation can be temporary and painful, but we have now had elevated levels of inflation. Of course, it has been disguised through use of a CPI. Now they are talking about using a chained versus non-chained number, which would give them the flexibility of calling currency PI an over-overstated number, if you can believe that.

But what we have today is a saturation throughout the economy. If you look at balance sheets across the country – income statements for corporations – there is a saturation which has occurred. Any additional inflation from here is of a terminal nature. It is not an inflation shock, a one-off deal which we can adjust to. We have been coping our best to adjust to the inflation which has already occurred, and has been obscured by government.

Kevin: David, you have brought out in the past that we, in America, may be able to experience inflation for quite a bit longer than the person who can only afford two or three bowls of rice a day. Inflation, for them, can actually result in them not eating.

David: It seems to me that we are at a critical point in history, and this is a conclusion that I think we need to come to grips with as individuals. We either begin to direct our national destiny, or assume that within the next ten years we have an absolute political and social free-for-all. And I would strongly urge anyone considering relocation outside of the United States to reconsider.

If you are identifying problems that need to be, and actually will not likely be solved, you are the exact type of person needed to stand in the political and economic gap, and invest all you are as an individual, all the capital that that brings to the table, as well as perhaps all that you have, to this great country of ours. Sound money equals sound economics. Sound money equals sound and bridled politics. There is no party solution. This is not Democrats, this is not Republicans. There is, however, a solution, which all parties must be governed by, and that is sound money.

Kevin: David, you have talked about this in past, that it is important to have some of your assets overseas, so that you still have a war chest and you can perform here in the United States, for what you need to do. But as far as leaving, one of the guys I was talking to said, “Okay, so you go to Ecuador. So you go to any of these different countries. You are still one bullet away from a banana republic.” (laughter)

David: (laughter) Well, Kevin, switching gears to Europe, we mentioned Spain, the Spanish crown and the devaluation of silver.

Kevin: What a surprise. Spain. Didn’t we talk about Spain, after Greece, and before Italy, and before Ireland. Isn’t there a sequence of events here that everyone is acting surprised about?

David: Right, and now they are in a double-dip recession. The real challenge here is that inflation is on the rise. Unemployment is also on the rise – 1 in 4 people are unemployed. If we look at youth unemployment, it is 1 out of 2 – 50% unemployed in terms of youth unemployment, in Spain, but across the general populace it is now 1 in 4 – 24.4%, nearly 25% of the nation is unemployed. Tell me that is not the seedbed for revolution.

We discussed this maybe 18 months ago, where just as a thought experiment, you have someone introduce a new, novel idea, into the political conversation, which is, we don’t work for the Germans, we don’t work for anyone in Europe, because frankly, we are Spanish before we are European.

Kevin: We are starting to see this in France, as well. At this point we are starting to see socialism return to France. That, in itself, is going to change the whole dynamic of the Eurozone.

David: You’re right, and we should talk about France in a minute. We had the U.K. last week, and we had Spain which announced over the weekend, no real surprises there. The list is growing: U.K., Spain, Greece, Italy, Portugal, Ireland, Belgium, Denmark, Holland, the Czech Republic, Slovenia – all of these countries are now back in recession.

Kevin: So it is more than just the acronym that works so well – PIIGS – there are a lot of countries here. (laughter)

David: Debt in the Eurozone right now is behaving almost like a pigeon, if you will. It wants to return to its roost. This is what is interesting, because with the introduction of the eurozone, there were a lot of cross-border purchases, where the rage was, at the outset of the euro project, to buy the debt of your neighboring country. Now there is not so much of an appetite, and new purchases are not the banks across the national borderlines, but are limited to the domestic commercial banks, and the domestic central banks.

Our challenge here is this: As we look back at history, and as we look forward, in our experience, the sponge, if you will, is more quickly saturated if you are dealing with a local market funding the debt markets alone.

Kevin: David, this sounds to me like it is inflationary, ultimately, because once these countries saturate, they either have to print money or come up with some other solution. They can’t tax it, we know that.

David: Yes, so hang in there, because that is how we would actually connect the dots. When you are dealing with a funding crisis, when you are dealing with an inability to roll over debt, where you are, right now, at least, dealing with a limited audience of people who are interested in your debt, ultimately you saturate that sponge. You run out of people who will continue to buy your debt.

When that occurs, then something critical happens. You have to decide what debts you are intending to pay, or, if you are intending to pay all of them, what resources you are going to use to make payment on that debt. You can increase taxes, of course, but the less contentious way is to try to subtly throttle the circumstance and increase inflation, print money to pay off those debts as times goes on.

Really, what we see in Europe right now, as we speak, we are anticipating a future-tense, terminal problem for many of the euro countries. Real, dire inflations can only begin in earnest when the debt markets have been fully throttled, to exhaustion, and there are no more savings to employ toward paying real-time expenditures.

Kevin: David, I am going to take you back over to the French question, because there is nothing unusual about France moving toward socialism, but what makes it unusual this time is that there is a Franco-German coordination that is occurring right now that we call the eurozone. These other countries, the PIIGS, and all the other acronyms, they are less important than this union between Germany and France, and of course, under Sarkozy, we had Merkel and Sarkozy.

David: Merkozy, a very cozy relationship between Merkel and her French counterpart.

Kevin: I will tell you then, we have an awful lot of people right now who are analyzing this European situation and saying that this new person who is likely to be elected is going to be changing that dynamic. How critical is that to the whole European project?

David: Of particular note to us is the fact that Monsieur Francois Hollande has never held a job outside of government. You know the statement: When you are 25, and you are socialist, it is legitimate, because everyone knows that you have a heart. But by the time you are 35, if you are still a socialist, everyone knows that you don’t have a brain. He was 26 in 1979 when he joined the Socialist Party. It is now 2012.

Kevin: He never matured.

David: He never matured. We know that he doesn’t have a brain.

Kevin: David, the question is, is this a death knell for the Eurozone? We have a socialist there, trying to work with the German side, which is operating on a rules-oriented basis. What is going to happen there?

David: It appears that there are more spending programs in the works, where fairness, justice and equality become the hallmarks, and it is difficult to say that there is anything wrong with fairness, or justice, or equality. But what we know from the French, honestly, is that how you define your terms is absolutely critical, and this may be just from an American perspective. This may not be the death knell for the eurozone, but from a decidedly American perspective, we interpreted liberty, equality, and fraternity a bit differently, as well.

So I would like to see what he means by fairness, justice, and equality. If it doesn’t include a massive dose of government spending, I would be shocked and amazed. For us, frankly, to the period of Mitterrand, and perhaps, that period where the franc was under attack because it was the means by which they were going to carry out every social program, they could over-promise, and actually deliver, as long as they were willing to compromise the quality of their currency.

Kevin: Liberty, equality, and fraternity, here in America, used to mean individual rights and responsibilities. It is that second part that a lot of people like to forget these days. They like their rights, but they don’t like the responsibility that comes with them. In America, liberty, equality, and fraternity used to mean individual rights, and individual responsibilities. Looking at the French situation, I think that probably we just need to stay tuned, because there is probably going to be some sort of compromise between socialism and the rules of German austerity.

David: It was Mitterrand who got to come in and criticize the European Monetary System, the EMS, that Giscard was involved in up to that point. They basically had a strong currency position, not unlike what we have with the euro and these strict rules that have to be applied. Mitterrand came in and said, “This is, frankly, balderdash. We have the ability to become a great nation again. We will do this. We have people who have needs and we are not meeting them.” Social programs galore, government spending galore, and it was at the expense of the French franc. It feels a little bit like a return to that with Francois Hollande.

Kevin: So, 1982 again.

David: Exactly. Do we have another 1982 in the offing for the French people? Someone is going to be very happy, because there are going to be more teachers, there are going to be more government programs, there are going to be more government employees. The question is, who will pay those bills?

Kevin: Well, they don’t have to, Dave. We now live in the day and age of inflation, and the European Central Bank is looking more and more like the Federal Reserve.

David: It is, as you pointed out a few minutes ago, Kevin, the old conflict between priorities of one country against priorities of another. This is the basic conflict that we still have within the euroland, because we deal with national politics, we deal with national interests, and yet we are all supposed to be thinking with a collective mind, and it is not working.

Kevin: David, you brought up discretionary policy measures, right from the get-go, when we first started talking. There is a difference between using discretion, changing the rules all the time, and actually having to play by a set series of rules. I am going to bring us back home, because Egan-Jones is a rating agency that is not paid by the guys that they are rating, so they are independent. This is another word that we talked about. They have a responsibility to report, not what they are paid to report, like some of the other rating agencies.

David: All of the other rating agencies.

Kevin: Okay, all of the other rating agencies. But these guys are the go-to guys if you want an independent report, a good audit. What is happening with Egan-Jones right now since they came out with some bad news?

David: The bad news, interestingly, was that the U.S. needs to be downgraded, that we are not the best bet, we are not the same bet that we thought we were as triple-A status.

Kevin: You are talking about Treasuries.

David: Yes, and so there is some compromise taking place on the U.S. balance sheet. They are willing to say that we have an issue here, and we need to pay attention to it. Now, wouldn’t you know, within ten days of talking about negative issues relating to U.S. debt, the SEC is saying…

Kevin: “Hmm, we need to investigate you.”

David: And lo and behold, Egan-Jones is being investigated by the SEC.

Kevin: This is almost like the NFL commissioner coming in and saying, “Wait a second. Yes, I understand that you ran the ball all the way down the field, in bounds, but guess what? We are going to move the in-bounds just a couple of yards, and now investigate this.”

David: Again, there are a couple of things that you have to know. One is, as you mentioned, they are the only rating agency in the market with independent relationships. They are not being paid by the people who they are grading, so to speak. Those are called “bought ratings,” if you will. If you want a triple-A rating, you basically belly up to the bar, and this is what was done.

This is what, in our view, was unconscionable, if you go back to the 2005-2007 period, the asset-backed securities market, the mortgage-backed securities market, if you needed double-A or triple-A, guess what? That is how the shadow banking system grew exponentially, because as long as it was double-A or triple-A, you had to have, as a financial institution, very little capital set aside against it. You could leverage your portfolio, leverage your balance sheet, considerably, as long as it as double-A or triple-A.

Who provided the double-A or triple-A? You fill in the blank. Every rating agency, except Egan-Jones. In fact, Egan-Jones was out there saying, in the 2007-2008 period, “Folks, we have a problem with mortgage-backed securities. Folks, we have a major issue with the quality of the paper you are talking about. We will have to disagree, this is not double-A or triple-A, we don’t think A even fits in the equation.” In retrospect, they are looked at as heroes for their work with mortgage-backed securities and in the asset-backed securities market. I think they will be exonerated, but the reality is, they are challenging the leviathan at its most vulnerable point.

Kevin: But David, I will tell you, in a day and age where managing perception of the people is more important than the rules, just as in managing the perception of this ballgame we were talking about as an analogy. When you are managing perception, and you are the little kid who comes out and says, “The king has no clothes on,” that can be very, very dangerous.

David: Right. If I wore the Machiavellian hat of no particular congressperson, actually, any of our congresspeople today, I might say to myself, “We are running out of money. Between you, me, and the fencepost, we are running out of money, and now, frankly, we are playing for time. What can we do to extend the time we have in order to address the fiscal disaster which is either immediately ahead of us, or if we are successful, perhaps we can push it into the future?”

Well, it is only a problem if people recognize that it is a problem. This raises the issue: Is anyone creating problems for us in this regard? In other words, is someone saying that we have a problem? Because if they are saying we have a problem, then we actually do have a problem to address. We can’t afford the general public to be concerned about things that they should be trusting us to address and take care of.

You see, Kevin, our education system, for 30-40 years, if not longer, has taught us to trust authority. If you have a Ph.D. behind your name, if you have any number of letters behind your name, that is the great social legitimizer. Your opinion is worth more with letters behind your name. It doesn’t even matter if you understand what those letters mean, if I have six letters behind my name, and you have never seen them before, you put more confidence in my opinions than otherwise. You can prove this statistically, but this is what is being challenged. The professional political elite have a lot at stake, and this is what they are having to conclude, again, putting that Machiavellian hat on.

Kevin: David, they are managing a potential catastrophe. Let’s face it. When you are talking about coming out and saying, “We are out of money, we are playing for time,” what you are talking about is actually addressing reality. We just passed the 100^th anniversary of the Titanic sinking. If you study what occurred during that just a little over two-hour period, it was so hard for people to get their heads around the fact that they were sinking.

The guy who actually designed the ship is the guy who said, “You know what? This think is going to sink. The five compartments have been torn open and it is flooding over the bulkhead.” So he knew, but not everybody knew. There were a lot of people who refused to get in the lifeboats because it was more comfortable on deck.

We talked about that a couple of weeks ago. If we do have a catastrophe that is coming – when you have too much debt, and it can’t be paid, and your monetary system is completely based on consumption, that sounds to me like a potential catastrophe – are there solutions that keep that from occurring?

David: That is, I think, what Congress and government is seeking right now. What needs to be done with, or to, those people who would reveal, for the “sake of the country” and for the system that we are set to defend? What needs to be done? And we find Egan-Jones literally under the gun.

Kevin: David, if we had a return to the rules, and everyone playing by the same rules – that doesn’t mean one team has one set of rules, and another team has another set of rules – then what you have is a diminishment of the uncertainty in the markets. Right now there is so much uncertainty that nobody is really willing to move. They don’t know who is going to win the election. They don’t even know if that makes a difference in the end. From the long-term catastrophic point of view, who has the solution?

It brings me back, David, to a book that you have recommended a number of times to our clients, and to the guys here, and we have all read it – Frederic Bastiat’s, The Law. What he is talking about, simply, is what is the rule of law, and what is it there for?

David: This is probably one of the most important questions that we can be asking in our generation, and it will be the braver souls of this generation who ask it. Who does the law protect? Any and every brave soul, I think, should read Bastiat’s, The Law, and frankly, consider it family required reading.

Kevin: You can read it in an hour, it is not that long.

David: It’s the kind of thing that you could put as a companion gift with next year’s Christmas gifts. As long as you are wrapping them up, put it in with every gift. Buy 50 copies and give them all away.

Kevin: If you are going to wrap it up, you may as well wrap it up in old fiat currency, the stuff that no longer has value.

David: (laughter) I have an entire bag at home of billion-mark notes, and I also have a bag of billion-franc notes. This is quite common. We do this with fiat money. We do this when we don’t have a sound monetary policy. And what we find is that when you get to the very end of the game, politicians are going to play for keeps. As we have suggested in the past, they will choose winners or losers, and guess what? Human self-interest defines them as the default winners. They will do anything, at any cost, to maintain their positions of power and prominence. The fiat money system that we have known has given them an advantage, and they are not likely to give it up easily, but I think it behooves us to determine how that game is actually played and what the expectations are that we have of our “representative” government.

Kevin: I think the strange irony about giving somebody the book, The Law, wrapped in fiat currency, is that the politicians that you are talking about are trying to tell people right now that the wrapping paper is far more valuable than what it is inside.

David: Again, if we were to identify a problem, one that we wanted to solve, we would ask everyone who looks at this grand social experiment, not what the French put in place 200 years ago, but what our founding fathers put in place 200 years ago, and look at the Constitution. Why did they have sound money as a basis for sound government? And if sound government can be supported by sound money, then so can sound economics. Let’s begin with the basics. Let’s insist that we go back to something that is beyond the Ph.D. standard. Let’s go back to the gold standard.