“Obviously, no. A gives something to B in exchange for something else and both get what they bargained for. No deficit is possible.”

“So how is it that when the farmer, or the migrant worker, or the Chinese shirt maker trade their goods and services for money, that suddenly the deficit problem pops up?”

“Because when individuals trade real goods, the exchange is complete. But when one half of an exchange is for money, the government enters the picture. Individuals create real goods and services with labor and capital, while governments create the money by “fiat” (i.e., by law), simply pushing computer keys and running printing presses. The newly created money, which cost next to zero to print, buys up real goods and services. And as the money percolates through the economy, it leaves a swath of destructive imbalances, including such things as inflation and trade deficits. Governments then step in with more laws and restrictions that purport to solve the economic problems that their fiat money policies spawned.”

“Money creation is a form of theft (and, as my friend Richard Maybury once said, theft is just a nice word for taxation), albeit so subtle that the public never seems to catch on. In a world where individuals and not governments were sovereign, the marketplace couldn’t have trade deficits or inflation, as the marketplace has feedback mechanisms to deal with anyone who creates irredeemable money. But when governments usurp the freedom of individuals by passing laws defining legal money as the money printed by the government, all manner of economic evils follow.”

“What can a sovereign individual do? Forget futile efforts to influence the politicians, and assume everything they do to ‘solve’ the trade deficit will reduce your freedoms even more. Go to the root of the problem, which is fiat money. Historically, gold and silver have been the free-market’s choice for trade, and the ultimate refuge from fiat monies. You can regain some sovereignty in the monetary arena by holding and dealing in real money whenever possible. Gold and silver, whether held as assets to defend against depreciating currencies, or as mechanisms for trade through free-market exchanges like GoldMoney.com, or LibertyDollar.org, are real money. Hold and use real, free-market money whenever you can.”

Source: Trade Deficit = Freedom Deficit

This from Sovereign Society:

“Lenin said the day would come when gold would serve to coat the walls and floors of public toilets.” -Premier Nikita S. Khrushchev

Ancient, mysterious gold is being pushed to the forefront of investors’ minds these days, as the inflationary policies of the worlds’ central banks meet uneasily with the deflationary pressures of the housing industry’s collapse. Most expected this year’s air of uncertainty to push gold prices into the stratosphere, and all seem to be relatively shocked by the yellow metal’s lackluster performance thus far.

But for me it’s all just déjà vu…perhaps for you too. We’ve been here before. Not just during the great gold bull market of the 1970s, but way back in the 1920s, and the 1860s, and the…well, let’s not go back to Ancient Rome.

Since gold and freedom have had a long, torrid, and often clandestine affair, the market’s current attraction to the yellow metal makes it apropos that gold looms large in our discussions here at The Sovereign Society.

We hear predictions of US$1,000 or even US$2,000 an ounce. Well…before you or I are swept along in the excitement, let us analyze this euphoria through the lens of economic principles, and ponder the lessons of history.

You may have profited, as I did, in the tumultuous gold bull market of the 1970s. It was heralded in advance by my late friend Harry Browne, who saw it coming and showed investors how to get rich in his prophetic best-seller, How to Profit From the Coming Devaluation. I, too, joined the ranks of “gold-bugs,” writing enthusiastically about the metal’s glory…along with Jim Dines, Doug Casey, Howard Ruff, and many others.

With hindsight, and with gold prices currently stagnating, can we learn anything from history? Tracking the ‘real’ price of gold offers some clues.

In 1915, the dollar was defined as one-twentieth of an ounce of gold. Paper currency consisted of gold certificates that could be exchanged for gold on demand. The ‘double eagle,’ the US$20 gold piece, was one ounce of gold.

In 1915, US$20 would buy a lot. Wages were 35 to 75 cents an hour, or US$500 to US$1,000 per year. A man’s tailor-made suit cost US$25-$30 (with two pairs of trousers), while a Sears & Roebuck ready-made, but stylish pure-wool worsted suit sold for US$16.50. A movie ticket cost 15 cents (10 cents for kids).

Adjusted by the CPI, what cost US$20 in 1915 would hypothetically cost over US$450 today. Meanwhile, an ounce of gold that equaled US$20 in 1915 would cost US$726 as of this writing.

What happened? It’s known as fiat money creation.

What Happens When Paper IOUs Replace Solid Metal Currency

The prices of goods and gold diverged because the newly created Federal Reserve gave banks free reign to expand loans, massively inflating the quantities of gold certificates in circulation, with no increase in the banks’ gold reserves. As the gold IOUs flowed into the economy, boom times arrived. Prices rose and stocks and real estate soared.

Sadly, as the masses discovered, the “roaring twenties” were fueled by paper promises. In 1929, the stock market crashed, unemployment rose, people became fearful of banks, and the public began turning in their bank notes for the gold they had deposited. Of course, most banks didn’t have enough gold to cover the outstanding notes, one by one they failed, and the economy plunged into the Great Depression.

The bankers and politicians were quick to blame the free market, greed, and gold itself. Roosevelt, elected in 1933, closed the banks to stem a rising wave of bank failures, abruptly revalued gold to US$35 ounce (depreciating everyone’s dollars by 75%), and outlawed ownership of gold by U.S. citizens.

It was easy to rob American citizens at gunpoint by confiscating their gold, but what about foreigners? They could still choose between U.S. dollars and gold. The answer was to play the same game the Fed had played 30 years earlier: promise to redeem dollars in gold. In 1944, at the historic United Nations Monetary and Financial Conference at Bretton Woods, New Hampshire, every participating country pledged to keep its currency within a percentage point or two of an agreed dollar value providing the U.S. indemnified foreign central banks against a depreciating U.S. dollar by backing the dollar with Treasury gold. The dollar became the world’s reserve currency.

Credit Swells and Gold Freezes

The credit expansion began again, and the price of gold remained frozen at US$35 an ounce for another 27 years. Again, as happened in the 1920s, consumer prices began to rise. But just as worried Americans had begun to run to the banks in the 1930s, the rest of the world began a run on U.S. Treasury gold. In 1971, with Treasury holdings perilously low, Nixon abrogated the Bretton Woods agreement and gold, free of government chains at last, soared to US$800 an ounce in 1980.

At that price, it was wildly above its historic exchange value with other goods, so it was inevitable that the lines would converge again, and they did.

Politicians depend on fiat currency to fund wars and giveaway programs, and therefore always disparage gold. In 1924, in the euphoria of the Federal Reserve money bubble, John Maynard Keyes denigrated sound-money advocates by calling the gold standard a “barbaric relic.” Even after a half century of turmoil caused by fiat money, in 1975, Secretary of the Treasury William Simon continued to argue against gold due to its “destabilizing effects” on the world monetary system. The IMF formally sought ways to “insure that the role of gold in the international monetary system is gradually reduced.” Gold sales by both the IMF and the Treasury were undertaken to suppress the price and discourage investors.

Gold is a commodity…a tangible, useful mineral extracted from ore and refined for use. The very fact of its unique properties (divisibility, durability, scarcity, and its recognizable luster) make it an unmatched medium of exchange, and also a safe haven for citizens. Thus, it will always be a threat to the creators of fiat money.

What’s Next for Gold?

History teaches that gold will hold its value relative to other goods. In terms of inflating currencies, all goods, including gold, will hold their relative value to each other, and rise relative to currency. Right now, for the last 6 years the price of gold has risen more rapidly than other prices, and is now higher than the norm.

Since 1980, consumer prices have risen by almost 150%. Many analysts today assume that gold will repeat the price pattern that occurred in the decade of the 1970s, and argue that gold could go as high as US$2,000…or higher.

Warren Buffett once said that what we learn from history is that people don’t learn from history. Thus, it’s probable that the current bull market in gold is not over in spite of the fact that gold’s dollar price relative to goods is higher than the historical norm. The public has yet to discover just how much world currencies, and particularly the U.S. dollar, have been inflated in recent months and years. As this becomes apparent, dollar holders will, as they did in the 1930s, and again in the 1970s, try to redeem those dollars for tangible goods. Price inflation will return with a vengeance, and probably soon.

What are the best ways to own gold?

For myself, owning physical gold in the form of coins and bullion for conservation of purchasing power, and seeking out the shares of undervalued and overlooked gold mining companies for investment and speculative growth are the best choices.

In addition, to promote a return to sound money and to enjoy its benefits to every extent possible in the meanwhile, you should begin using “electronic” gold. The most reliable and safest purveyor of this new technology is Goldmoney. Check them out at www.goldmoney.com/?gmrefcode=sovsoc.

I opened this essay with a quote by Lenin, who argued that gold should be assigned to the toilet. Not only was Lenin an economic ignoramus, he was the ultimate enemy of individual sovereignty. Ancient, mysterious gold is the ultimate antidote to fiat money, and we can be certain that mankind’s love affair with this lustrous commodity will never end.

Source: Gold and The Lessons of History

This from the Sovereign Society:

Lunacy dominates world stock markets, as a tug of war ensues between fear and greed. For two wildly fluctuating months, stock and real estate markets bounced down the stairway that easy credit built. Then on Tuesday, greed was king for a day. The market exploded into one of its biggest rallies in half a century, with the Dow Jones industrial average closing up 10.9%.

Does the rally signal a bottom in this schizophrenic market? Well, unfortunately there’s no way to know except in hindsight.

Sowing the Wind & Reaping the Whirlwind

We don’t need hindsight to know that the current meltdown was inevitable. It is the consequence of events that began a century ago with the birth of the engine of 20th century boom and bust: the Federal Reserve. Nor were the effects of the new central bank immediately apparent.

The effects of credit expansion didn’t show up the next day or the next month. It took more than a decade for the credit creation to result in the Roaring Twenties and the Crash of 1929. Again, the famous October 29 market selloff didn’t cause an economic catastrophe the next day…or the day after that, or even the year after that.

It took three years for the Great Depression to truly grip the nation, triggering more government action – the abandonment of the gold standard and massive federal bailouts. Again, the results weren’t instantaneous. It took decades to inflate another boom, and reach the monetary crises of the 1970s.

Economic theory can predict the consequences of credit expansion, but only in hindsight can we see the timing as the consequences unfold. Today’s economic storms are the consequences of seeds first planted a century ago. And once again – as the credit bubble collapses – new seeds are being sown.

The official budget deficit for the fiscal year that ended September 30, 2008, was $455 billion, but most private analysts say the current fiscal year will end with a gap of one trillion dollars. How are the presidential contenders planning to deal with rising deficits?

Both John McCain and Barak Obama promise tax cuts and increases in government spending. It won’t show up tomorrow, but vast government deficits ahead guarantee that price inflation will demolish the purchasing power of the dollars that fearful investors are so eager to lend to the U.S. government.

When will the market bottom, and when will price inflation roar? We won’t know that except in hindsight, but both will happen.

Buy When Blood is Running in the Streets

But how deep should the blood be? Only value investing can provide the clue.
As markets are gripped by fear or euphoria – plunging one day and soaring the next – it’s clear that very few are following the advice of the most successful long-term investors of the past century. Money masters like John Templeton, Benjamin Graham, Peter Lynch and Warren Buffett piled up enormous profits throughout one of the most tumultuous centuries in history, and their advice is there for all to follow.

Benjamin Graham, said it clearly in The Intelligent Investor, “Don’t get carried away by enthusiasm. Don’t get carried away by despondency. …Know in advance that you are going to have to live through bear markets.”

Let me re-tell Graham’s parable from his book, The Intelligent Investor.

Imagine owning shares of a small business that cost $1,000, and every day your partner named Mr. Market knocks at your door and announces what he thinks those shares are worth that day. He offers either to buy your shares or sell you more at that price. Even though the business is trudging along without significant change, each day his opinion is wildly different. Frequently Mr. Market’s enthusiasm or his fear seems completely divorced from anything happening in the business and his valuation seems ridiculous. One day he offers to buy or sell you shares for $2,000 each, and a week later he makes the same offer for $500. Should you let Mr. Market’s wild enthusiasm or shaking fear determine your view of the intrinsic value of the business?

That’s obviously irrational. As Graham puts it:

The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He would not be far wrong if this motto read more simply: “Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”

Since we can never know in advance whether shares will be higher or lower tomorrow, the only rule to follow is to accumulate them when they are significantly underpriced by value analysis. Mr. Market is definitely letting his fear override his reason, and is making us offers that become increasingly difficult to refuse. As was the case after 1929, there are great opportunities being born out of the chaos. Don’t let Mr. Market’s trembling hands cause you to lose sight of the outstanding values he’s offering.

A sound and lasting investment strategy requires searching for assets that have true value and will retain it – those include all types of commodities that will rise in price as money falls in value, currencies that are not being debased, and ownership of profit-making companies that have not fallen into the trap of trying to leverage profits through debt.

Source: Blood in the Streets: How to Profit from Stock Market Schizophrenia

Suddenly, economic pundits are debating two brow-furrowing questions: Should the Federal Reserve hang tough on interest rates to fend off higher price inflation? Or, should the Fed continue lowering interest rates to stabilize a slowing economy?

With the specter of inflation receding, the consensus is rallying behind the risks of recession. Many commentators argue that if the Fed doesn’t act quickly, the nation could even be plunged into a 1930s-style depression. Worse yet, we could be on the brink of the ultimate economic catastrophe — deflation!

Deflation – Bernanke’s Worst Nightmare

Deflation is defined as a fall in the general price levels. And it seems to be Mr. Bernanke’s worst nightmare. As he warned in a 2002 speech: “Sustained deflation can be highly destructive to a modern economy and should be strongly resisted.”

According to him, the sources of deflation are no mystery. “Deflation is in almost all cases a side effect of a collapse of aggregate demand – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.” And falling prices, we’re told, open Pandora’s box. “[The] economic effects of a deflationary episode…are recession, rising unemployment, and financial stress.”

For the majority, monetary economics is a mystery wrapped in gobbledygook. From childhood to old age, we desire money, work for it, use it, save it, invest it and generally spend our lives agonizing over how to keep what we have and get more.

Yet the masses understand money’s origin about as well as they understand quantum mechanics. With general ignorance about the source and nature of money, any economist worth his salt can easily confuse the public about economic policy.

Deflation – Destructive? Nonsense!

Sustained deflation is highly destructive? Give me a break! Nothing is more nonsensical than to argue that falling prices, per se, are bad for the economy.

Was it a disaster when computer prices fell dramatically over the past four decades? Of course not. The lower the price, the better. The same is true for shirts, TVs, and rutabagas. Consumers win when competition and innovation increase output. And increased output results in deflation – as long as it remains undisturbed by monetary intervention.

Bernanke says that a collapse in aggregate demand causes deflation “in almost all cases.” Piffle! His “almost all cases” really refers primarily to the collapsing demand that apparently caused the Great Depression in the 1930s.

As Murray Rothbard pointed out in his classic America’s Great Depression, demand collapsed because of easy money. The new Federal Reserve had poured easy money into the financial system and created a speculative bubble that the economy simply couldn’t sustain.

In 1929, in a population of 120 million, 30 million families were involved with the stock market, and a million investors were classed as speculators. Of these, nearly two-thirds, or 600,000, were trading on margin, on borrowed funds. That is, they were trading with funds they either didn’t have or couldn’t easily earn.

Does that seem similar to the current real estate market? Millions of individuals have leveraged themselves into homes they can’t afford – all because the central bank created easy credit policies. Like the stock market bubble of the 1920s, the real estate bubble of the past two decades has reached its limit.

At the time, Keynes explained to the politicians that “falling demand” caused the Great Depression. It’s also the argument politicians used to justify massive government spending programs. Mr. Bernanke is following a well-worn path: First pump more credit into an already overheated economy and then, when the bubble bursts, do everything in your power to organize government rescue operations.

History Makes Bernanke a Liar

History also proves that Bernanke’s statement is a fraud when he said that deflation comes from a collapse in demand “in almost all cases.”

For three decades in the 19th Century, from 1865 to 1895, the general price level fell steadily, dropping by almost 50%. Did this sustained deflation “ravage” the American economy? Hardly. The real, inflation-adjusted, per-capita GNP nearly doubled over the same period! For 113 years, from 1800 until 1913, consumer prices in the U.S. fell 42%. That’s an average annual deflation rate of 0.5%. Meanwhile, expanding output created more wealth than ever before in history.

Why didn’t innovation and technological advances continue to drive prices downward in the 20th century as they had in the 19th? Because the politicians created the Federal Reserve.

Given the keys to unlimited credit creation, the Fed put the brakes on good, honest, beneficial deflation, and inflation took over. After falling for over a century, the price trend reversed, and from 1913 through this past November, consumer prices rose 2,048%!

Considering the fact that Mr. Bernanke is determined to fight the downturn with more infusions of “the hair of the dog that bit us,” the long-term danger ahead is inflation, not deflation.

Meanwhile, as Warren Buffett said in his 2006 annual report of Berkshire Hathaway, “Be fearful when others are greedy and greedy when others are fearful.” For the moment, the short-term is gripped by fear, so for us at The Sovereign Society, it is the time to be greedy.

JOHN PUGSLEY, Chairman

But against this background of staggering losses by the big banks, only five small banks have failed in the last 12 months. These are…

1. Metropolitan Savings in Pittsburgh
2. Douglass National Bank in Kansas City, Missouri
3. Miami Valley Bank in Lakeview, Ohio
4. NetBank in Alpharetta, Georgia
5. Hume Bank in Hume, Missouri

It Only SEEMS like the Banking System is Relatively Sound

In truth, that number is deceptively low compared to crises of the past. In fact, the list of possible problem banks remains at historically low levels. There are only 76 institutions on the FDIC’s “watch list.” In 1990, as the S&L crisis unfolded, there were close to 1,500 banks on the list, and 800 failed between 1990 and 1992.

However, while it might seem that the banking system is sound, federal banking regulators are gearing up for potential problems. The FDIC announced that it plans to hire at least 140 new employees to deal with a possible increase in bank failures over the next year.

You Have to Treat the Disease – Not the Symptoms

Dealing with economic problems is like treating a disease. Treating your symptoms without finding the cause of the symptoms can lead to disaster.

You could treat a mild headache with aspirin. But if an undetected brain tumor is causing your headache, then failure to identify and treat the cause will be fatal.

What is the cause of the recent failures of both large and small banks? Simply put, it is the monetary policies of central banks, the very entities that now are struggling to solve the crisis. Unfortunately, they are prescribing exactly the same medicine to cure the problems that caused the problems in the first place.

Central Bankers Are Passing Out Placebos to Cure This Crisis

This past week Mervyn King, Governor of the Bank of England, announced that the bank was prepared to swap £50 billion (US$100 billion) in government bonds for securities backed by mortgages and credit card debt. On this side of the Atlantic, Ben Bernanke has loaned triple that amount, US$360 billion, to troubled banks again, against collateral made up of securities backed by sub-prime IOUs.

The Federal Reserve was the first central bank to begin discounting the sub-prime securities that triggered the widespread banking problems of the past months. But now, other central banks are following suit as the ripples of the crisis spread in ever-widening circles around the world. Some observers suggest that these loans secured by sub-prime debts will rise above US$1 trillion. That could be just the beginning.

So what caused this credit crisis disease? It’s simple. But to fully understand it, you have to step back and view the evolution of the U.S. dollar over the past 200 years.

The Evolution of the Falling Dollar…
That Led Us to This Mess

In the 19th century, the dollar was defined as 1/20th of an ounce of gold. At the time, banks simply took deposits in gold and issued their own private IOUs in the form of banknotes redeemable in gold on demand. This process naturally restricted credit expansion, because you had to have tangible gold to back your dollars.

Then Congress created the Federal Reserve in 1913. Congress gave the Fed a monopoly on printing U.S. dollars. Also, initially, the Fed held reserves of gold to back its issues of Federal Reserve Notes.

However, eventually, the U.S. government wanted to break free of the restrictions on credit expansion. So they gave the Fed the authority to “discount” commercial paper from banks. In other words, the Fed could buy IOUs and pay for them with newly printed dollars.

Eager for profits, banks made loans, then sold the IOUs to the Fed, and then made more loans. The federal government financed its expenditures for World War I through borrowing from banks. Banks sold enough of those federal IOUs to the Fed to keep the credit supply growing.

The banks also loaned to businesses, investors and speculators, ultimately financing the asset frenzy called the Roaring Twenties.

As loan demand grew, the amount of notes rose against the fixed amount of gold the Fed held in reserve. Eventually, the speculative frenzy drove stock and real estate prices to unsustainable levels, and the bubble popped in 1929.

A credit contraction ensued as borrowers began to default on debts they shouldn’t have held in the first place. This should have turned into a short-lived economic correction that purged bad loans and punished those that made them. But the government stepped in to stop this healthy correction and wound up seeding the Great Depression.

So Similar it’s Scary

Today’s credit crisis is essentially identical to the 1930s. It’s a consequence of failed monetary policies. Just like the Roaring Twenties, those in power refuse to allow the bad loans to be purged from the system. The federal government allows central banks to buy these loans for newly printed money.

And meanwhile, Mervyn the Magician and Helicopter Ben ensure that their currencies will drop in value and the economy will suffer.
As mentioned, a century ago the dollar would buy 1/20th of an ounce of gold. Today it will buy only 1/950th of an ounce. In truth, it should buy less than half of that. Gold is underpriced. This is clear when we recognize that the dollar has lost far more purchasing power in terms of other goods.

The dollar today will buy what a nickel would buy at the turn of the last century. If you factor in productivity growth from advances in technology, then today’s dollar is worth less than 1% of what it was then. This is all the consequence of 10 decades of relentless credit expansion.