"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Tuesday, January 4, 2011

Confusing Mathematics and Morality in Viewing the Economic and Monetary Collapse

In all my years of reading economics articles and books, watching hundreds of financial interviews, and following other blogs, I have come to a simple conclusion.  A cognitive dissonance exists that blinds many people when it comes to understanding the current economic and monetary crisis.  I too, am frequently guilty of this confusion.  Why?  I think the human mind is designed in such a way that before it begins to critically think about an issue, it needs to understand the foundational problem, and then proceed from there.  And this is where faulty logic begins.  It is rare that a person challenges foundational knowledge. Rather, a person looks to the obvious symptoms of the problem and starts the analysis from there.

Which brings me to the crisis.  Everywhere we look to understand this crisis we see two views.  One (rare) view is based on Mathematics, and the other on Morality.  Do they overlap?  I think so.  But let's separate the two for a moment to better understand the issue(s) we are faced with.

The Morality issue in this Crisis

The Morality issue in this crisis has been excellently handled by many well respected academics, analysts, and politicians.  And when I speak of the Morality issue, I speak of the Bank Bailouts, the socialization of private sector losses, political corruption, Wall Street control of the government, etc...  We do have a crisis of Morality - that is not something that is up for debate, in my view, unless you are the CEO of a large bank.

The Movie "Inside Job" tackles this issue.  And although I have not seen it yet, I have read enough reviews to understand that its primary focus is on the Banking Sector's capture of the US Government and Academia for its own benefit, but unfortunately to the detriment of the general economy.  Here is the trailer:

It looks like a great movie, and I plan to see it.  However, this movie, or rather, the pure focus on the Morality and Political view of the crisis has a fundamental flaw:  It ignores the Mathematics of the crisis.  It ignores the foundational problems of the underlying monetary system.

Most analysts accept the current monetary system as being sustainable, and instead focus on the Morality or Political issue.  Simon Johnson, Economics Professor at MIT and former Chief Economist at the IMF, recently wrote:
Our leading bankers looted the state, plunged the world into deep recession, and cost us 8 million jobs. And now many of them stand by with sharpened knives and enhanced bonuses – also most willing to suggest how the salaries and jobs of others can be further cut. Think about the morality of that one. 

Simon Johnson is correct to a degree. However, I have yet to see him challenge the current monetary system, or at least seriously criticize its shortcomings. He accurately describes the beast (Wall Street), but he ignores the beast's diet, if you will. How did this beast get so powerful? How does it exist? And is this beast the only thing we should worry about?

Don't get me wrong, Democracy is threatened by the capture of Big Banks. Actually, let me be more clear - Democracy has already been captured, and so too has Capitalism. The large Banks have succeeded. They own governments and they are immune to the Darwinistic Laws of Capitalism. They don't fail, others do in order to support them. They feed on everyone and everything else to the detriment of society as a whole.

But that is the Morality view - a correct one, but not the complete picture, in my view.

Mathematics and the Crisis

We cannot ignore the Mathematics of the issue - the underlying paper debt based monetary system that requires perpetual and ever increasing year over year growth, even if that growth needs to be speculative and non productive when productive growth is lagging.  It's growth however, also creates global trade imbalances as there are no early checks on trade deficits until it is too late (as there were under a gold standard) and its growth also creates a corresponding growth in unsustainable interest costs.  It reaches a ceiling, and then collapses.

We have reached that ceiling and have already organically collapsed, and so, we need to continue to deficit spend (see my prior post) and the Federal Reserve needs to continue to create money.  Yet many commentators once again revert to the Morality issue. They demonize Ben Bernanke and the US Congress for being "irresponsible."  Technically, they are not.  They are merely playing the game as it exists, hoping for a miraculous period of organic growth in the economy to get us out of the crisis.  Their actions should not be debated per se, the underlying economic system needs to be up for debate.  But that won't happen.  Next time you see a commentator you agree with, ask yourself:  are they looking at the big picture?  I bet that the vast majority are not.  And that's what worries me.

Michael Hudson once combined the two, in my opinion - Mathematics and Morality, emphasis mine:
A crash occurs at the point where this disparity is widely recognized. To bankers, the antidote is to lend enough new credit to re-inflate prices real estate and other assets, enabling new buyers to borrow the credit to buy property from defaulters. Rather than scaling back the U.S. economy’s over-indebtedness, for instance, the Treasury and Federal Reserve have bailed out the banks to save them from taking a loss on debt write-downs. [34] The dream is to keep the compound interest scheme expanding ad infinitum. But the pretense that fictitious finance-capital claims can be paid must be dropped at the point where financial managers desert the sinking financial ship. Their last act before the bubble bursts is the time-honored practice of taking the money and running – paying themselves as large bonuses and salaries as corporate treasuries (and public bailouts) allow.

But how has the current system evolved into such a Pyramid Scheme?  It was through incremental change, over decades.  This is how I see the last forty years, since the end of Bretton Woods, and the advent of the paper money debt-based monetary system:

At the end of the 1960s, a limit to productive economic growth was reached in the US.   The post World War II reconstruction rebuilding based growth era was ending.  The new and increasing costs of Vietnam and Great Society social programs were too burdensome for this "new normal" to support and so the US went off the gold standard and adopted a purely government debt based system.  In order to support this new system, banks, over time, were greatly de-regulated.  To combat the inflation inherent in a change in monetary system from hard assets to paper, interest rates increased, and at the same time, manufacturing was shipped off to cheaper countries.  Offshoring always existed, but this new era required the acceleration of it.  A FIRE economy began to grow to fill that void.  FIRE is Finance, Insurance, and Real Estate.  It is purely speculative in nature, and it is not geared to producing things as much as it is in owning things whose value increases.  Debt based consumption followed.  And as in the early stages of any Ponzi or Pyramid Scheme, extreme "wealth" was produced.

But this wealth required ever increasing asset values just as manufacturing wages were being depressed by offshoring, outsourcing, and de-industrialization.  More debt based consumption followed.  Lending guidelines were weakened to continue the debt game.  After all, the more people exposed to debt, the better.  Even a janitor can buy a large house now.  This was not a symptom of a greedy, decaying, immoral society - mathematically, the system required this.  The mathematical requirements of the new monetary and economic system required society to change its morals and views on consumption and debt - not the other way around, as many suggest.

But eventually, a limit was reached in the private sector.  Just as wages have limits, debt loads too, can only grow for so long.  The FIRE economy collapsed in the Fall of 2008.  Having nothing else to "grow" the economy, the US Government and Federal Reserve stepped in to maintain FIRE's growth.  Fannie Mae and Freddie Mac were nationalized.  Long term debt and other securities were purchased to keep rates low and asset values artificially high.  Price discovery was interfered.  The game has continued, but the economy is no longer growing organically, it is growing purely on the Government's ability to create money.

So we have a debt ownership game.  The debt started in the private sector until it could no longer grow - then to a large degree, it was passed onto the Government sector.  But is that sustainable?  And what of malinvestment and its consequences?  Yes, the US Government does not need to technically "finance" its debt, as it creates money whenever it spends.  But it does need to manage the value of its currency.

And so, we have reached the end of debt transfers.  No other entity exists that is larger than the US Government for that debt to be passed on once again.  And at this stage, those with the most power grab what they can, while they can.  The rest debate topics such as  irresponsible government spending or Wall Street greed, and no one thinks about a basic mathematical concept:  compounding interest.

So why did I write about Mathematics and Morality today?  I think it is important to understand the two individual components, yet use both in analyzing the crisis.  But unfortunately, when the endgame comes, when economies collapse due to prior unsustainable malinvestments, very few will understand why, and I fear the blame game can become a dangerous one.  The political and societal fallout will be severe.


Anonymous said...


I don’t know which is worse, “elites” panicking or wild masses taking control.
Actually masses have always had some higher leadership, some men behind the curtain.
If we are to get an open dictatorial system it can come from both, the majority of world population not knowing how money works will get drunk with speeches, morality tirades and end up just as bad as now or even worse, more the latter.
I’ve seen a good youtube vid which explained the flaw of the word “democracy”:


What kind of democracy can you expect when ppl are completely dumbed down?
Mob democracy?

About maths. Yes, incredibly even maths has become tool. That viral vid about quants
says nothing else. Maths in servitude for a virtual non-productive system, maths as superior
tool to manipulate us even more with false stats, financial hocus-pocus, etc. It’s common sense shouting how bad the situation is, not manipulative maths alone. Homeless people, wages/price relation, real unemployment not faked data and models.
As long as maths is a tool to virtually mask and deploy even more opaque financial instruments nobody understands (combined with political decisions) we are helpless.

We will have our showdown some day. Our questions are when and how?
My believe/hope is that damn RPG /freegold theory could come true. I can’t prove it but it looks like that when you hear Zoellick, when you watch that damn euro I hate so much.
If that’s in the works we cannot know. I think they want to bring us to a higher level of despair, to achieve a great wealth transfer, to destroy the social systems - which were a clientele policy to extend the power of the social state redistributing income – and then come with a solution that again most of the people won’t understand.

Misthos said...


Henry Ford once said:

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

I think Henry Ford's observation holds true even today, however, the revolution would take place after the monetary system implodes first.

I say that because I think it is the general population's ignorance that is keeping things going. A sudden revelation would cause extreme panic.

It's a lose-lose situation either way. If the people understood - there would be widespread panic, and yes, Freegold or some process like it would indeed take place.

The political fallout would take place immediately.

And if paper does vanish in a turbulent and trying period, Governments will look elsewhere to fund themselves. They will take the gold. Hopefully, the gold will be purchased and not taken without compensation.

Anonymous said...

In Germany the population has 7,200t of gold. Most of the oligarchs are prepared. There will be no confiscation, just in case we will have a Stalin or a Mao this might come true. And if they close the borders like in Eastern Europe. And only if All governments do so. My two cents.

Misthos said...


I cannot speak for Germany. I don't have the knowledge of the history and the political climate that you do.

But let me be clear about what I mean by "gold confiscation."

I can not rule out gold confiscation - and I mean in general. I can't say which countries will do it and which will not. But I also can't say it can't happen anywhere either. Keep in mind, the US confiscated and then banned gold investments for nearly 40 years.

And when I say gold confiscation, I mean all the various ways it can be done - outright takings, heavy taxation, fair value compensation, and compensation followed by devaluation of the currency - which is what happened in the US in 1934.

Actually, the US already taxes individually held gold sales at a much higher rate than many other countries. Whereas the US classifies gold as a capital gain in the same category as fine art, the EU classifies gold as a financial asset. And so, relative to many other countries, there is already a "gold confiscation" of sorts occurring right now, in the US.

Full disclosure: I still have and believe in gold investment.

Misthos said...

I want to further explain what I wrote above regarding gold. Again, when I say a high gold tax is a "confiscation of sorts" I don't just mean the literal physical taking, but the excessive taking of the monetary value of gold. Would the US government or any other government increase taxes on gold if its value increases? I can't rule that out either.

But here is the current US Tax treatment of gold:

From the IRS website.

"Investment Property

Investment property is a capital asset. Any gain or loss from its sale or trade is generally a capital gain or loss.

Gold, silver, stamps, coins, gems, etc. These are capital assets except when they are held for sale by a dealer. Any gain or loss you have from their sale or trade generally is a capital gain or loss."

Source: http://www.irs.gov/publications/p17/ch14.html

For US Citizens - Please consult a tax expert as to how this applies to you. Your tax bracket, and the duration of your gold holdings ultimately affect the tax treatment of gold.

From Wiki on capital gains:

Fauvi - I'm curious as to how Germany treats gold sales. Do they tax it differently? I looked up the EU laws, but I can't find anything that states how different EU members may treat gold sales. Or is there an EU wide law on it?

Anonymous said...
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Anonymous said...

In Ger-money you pay taxes on your „capital gains” if you sell it sooner than one year after buying it. Of course nobody does. If you sell it privately it’s like you didn’t ever have that gold. In France seems to be more complicated, I don’t know the details. Ger-money is the gold shop in Europe as we have about 100 online shops which also some sell without registration if you go there and buy up to 15,000 euro value.

About confiscation in the US. There has been a special situation. The US citizenry didn’t suffer on a personal level any loss at that time. They had, still have the world reserve currency and a high life standard compared to the rest, even to Europe after WWII. They simply forgot gold as it was unnecessary up to now. Even now the most of them don’t get it. Why ? We will see immediately.

In Europe we had uncounted monetary reforms in every country (?), in G. especially the Weimar inflation is not quite forgotten. Older people, baby boomer are more aware of gold and its power. Not so the younger generations but even they may hear it from their parents.
I know some 40+ who bought gold without knowledge of any much discussed fundamentals. They don’t watch prices, economical press, nothing. They simply hold to their gold. It’s an insurance and they are not rich, they hedge their fixed income. Even reading only MSM they smell the coming danger.

When we speak about confiscation I think there are more aspects to take into consideration. Mental confiscation is the worst. This happens on a daily basis, this happened historically in the US, Eastern Europe and some other countries under dictatorship. Sure we are now too under a masked dictatorship, a subtle one where the dog leash is long enough for us to feel free and short enough to be kept under control.

Second in line is lethargy. People cannot MAKE decisions nobody else makes. My neighbour has a life insurance and I should by Gold??? There is also discretion about gold talks. It’s like it were a venereal disease.


Anonymous said...

A teacher told my child that gold is/was always something for rich people, of course meaning “normal” people should not even look at it save Christmas jewellery (which is many times more expensive!). That’s socialist mentality hindering them and at the same time confiscating the impending idea of gold.

These are the extremes. My observation is that many so called intellectuals are very adapted to the system, more gullible than simple minded, less questioning the reality and easier accepting (MSM) propaganda.

As the percentage of gold property in small amounts is quite spread, in big quantity more concentrated in special hands I don’t think a physical confiscation might happen. When people will have lost everything they had in paper money the governments, at least in Europe I think will be happy to let the masses recapitalize themselves and have the populace happy with their bargain.
The next step of confiscation will take place as everybody will sell some/all their gold just to get next cash they need or want to invest. Selling to whom? To the banks maybe? Which will be the next flow of gold? I expect much the same old one.

Misthos said...

Fauvi - thanks for the information. For some reason, Google blogger keeps tagging most comments as spam. I retrieved another comment of yours above.