Tuesday, January 15, 2013

Peter Schiff: There's a Limit to How Much You Can Con the Public

The Trillion Dollar Trick
By Peter Schiff

The birth, and the apparent death, of the trillion dollar platinum coin idea may one day be recalled as a mere footnote in the current debt crisis drama. The ultimate rejection of the idea (which was to use a loophole in commemorative coinage law to mint a platinum coin of any denomination) by both the the President and the Federal Reserve seems to offer some relief that our economic policy is not being run by out-of-touch academics and irresponsible congressmen. In reality, our government has been creating more than one trillion dollars out of thin air every year for the past five. The only difference is that the blatant dishonesty of a trillion-dollar platinum coin is so easy to understand that the public simply couldn't be expected to swallow it. The American people are more than willing to be fooled, but they won't tolerate so simple a ruse.   

People have a long and intimate history with coins. Some of us collected them as kids, and we all touch and see them every day. Unlike currency bills, we know intuitively that a coin's value is supposed to come from its metal content. That's why quarters are bigger than dimes. As a result, most people have viscerally rejected the platinum coin idea. To assign an arbitrary, sky high, valuation to a small piece of metal strikes most people as a deceitful, desperate act. They are right. 

However, the same people have no problem with images of thousands of crisp paper notes flying off the printing presses. The acceptance is not impacted by how many zeroes the bills contain. People simply believe that paper money derives value from the numbers, not the paper.  This was not always so. Paper money originally entered the public awareness as promissory notes to pay different amounts of gold. Once people got used to the paper, few really cared when the gold backing was finally removed. As a result, the public would likely have been much more accepting of the Fed printing a trillion dollar bill than the government minting a trillion dollar coin. But there was no legal pathway for the Fed to simply give that money to the government. 

The government, not the Fed, mints coins, so they did not have to rely on the Fed to create value out of thin air. That is why the platinum coin idea was so seductive, if ultimately unsellable. 

But the Fed does the exact same thing all the time using sophisticated accounting and state of the art computing. The Fed "expands its balance sheet" by buying government bonds from private banks. In exchange for these securities, the Fed credits the banks with funds it creates out of thin air. The banks then pass the funds to the general public through loans. But it's important to realize that the Fed does not have any money to actually buy the bonds in the first place. The funds are "created" by a Fed computer. The process is easier (and equally duplicitous) than minting a trillion dollar coin (which at least requires the production of something other than computer code). The only difference is the lack of window dressing. It's a shame that the platinum coin episode did not result in a wider recognition of this brutal truth. 

A similarly silly and meaningless distinction is being made with respect to raising the debt ceiling. In his press conference yesterday, President Obama said the Republican reluctance to raise the debt limit was the equivalent of a diner who had ordered and enjoyed a meal who then decides to leave the restaurant without paying the bill. The President is actually arguing that if the diner had no cash on hand, it would be much more responsible to simply use a credit card. In taking this moral high ground, the President ignores the fact that the diner (who has indebted himself through habitual restaurant meals) intends to pay his credit card bill with another card, and then repeat the process until he runs out of cards. So in the end, it's not the restaurateur who gets stiffed, but the issuer of the last card the diner is able to acquire. As with the platinum coin, this is a distinction without a difference.

Currently the Federal Government counts more than $16 trillion in funded obligations. Over the next 10 years we are expected to add another $10 trillion or more. At no point in the foreseeable future are we expected to approach balance in our annual budget. All of our future bills are expected to be paid by future borrowing on a massive scale. Anyone with an ounce of integrity would have to plan for the possibility that an ever increasing debt rollover is a limited prospect. Such an understanding will mean that eventually someone will get stuck with the bill. How is this any more responsible than dining and ditching?   

In truth, a failure to raise the debt ceiling is not a commitment to renege on obligations. It is simply a decision to stop borrowing. The government could still meet obligations by cutting spending, raising taxes, or making reforms to entitlements. But it chooses not to take this difficult step.

More important than that is the message America is sending its creditors. By informing them that the United States will not use its taxing power to repay its debts, but will only rely on its ability to borrow more (ironically from the same creditors), it signals its refusal to tackle our fiscal deficiencies through responsible means. It's a shame that more people can't seem to grasp these very simple truths.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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  1. Schiff: "It's a shame that more people can't seem to grasp these very simple truths."
    I know plenty of Americans who are at least as smart as me.
    EVERY one of them grasps the truth that the government is bankrupt. They just ignore that and go on with their lives. It's sort of a Luddite libertarianism, if you will.
    They seem to think it won't affect THEM because it hasn't YET? Has it?
    I think it was Schiff himself who used the analogy of Wiley Coyote treading air at thousands of feet just before the plunge.
    Those of us here are the ones who have looked down into the abyss. The others haven't yet. Soon they'll be forced to.

  2. There are two kinds of politicians:

    1. Those who don't have a clue and are blissfully ignorant about what is looming (think of Nancy Pelosi); and
    2. Those who know better but are unwilling to do what's necessary to avoid a complete meltdown (most of them).

    Whether they are ignorant or spineless, you know they'll kick the can until the bitter end.

    The trillion dollar question: will they know when that point is reached, or will they try another kick of the can? You know, the one that ushers in a hyper-inflationary depression. With the likes of Obama and Bernanke at the helm, it doesn't exactly inspire confidence.

    1. Don't think for a second Pelosi is clueless or blissfully ignorant. She has been overtly cocky on more than one occasion. She knows how the game is played and plays it very well (with the exception that she flaunts her power a little too openly). Just remember, as Hayek stated, the worst rise to the top.

  3. I still have the impression that average people would react to the monetary system the same way they reacted to the Platinum coin if they understood two simple facts:

    a) inflation is purposeful government policy; and

    b) those getting the new money first are stealing purchasing power from those holding the existing money.

    Without the public having a firm grasp of those concepts, I don't think Austrians will get very far with the public. If the public ever did come to grasp these concepts, I think they would laugh the Keynesians and Krugmans off the stage if they then tried to claim that money dilution causes prosperity.

    1. unfortunately the simple economic facts you list a) and b) will never be absorbed by the (vast majority) of average people for 1 of 2 reasons:
      1) college-educated individuals are inhaling economic facts from the 95% of mainstream economists who spout the government line and kiss the Federal Reserve's Ring.
      2) non-college educated individuals, if they watch CNBC or even the Wall Street Journal, will get basically the same government-approved, regurgitated Keynesian nonsense that consumer spending, cheap money and responsible, wisdom-infused inflation grow the economy.

      my answer? the present is bleak, but the near future is bright: we need more (free-market, austrian) history, government/economics teachers, economics/business professors, financial writers and pundits(although Judge Napalitano's experience demonstrates the establishment isn't quite ready for austrian pundits).

  4. John Carney of CNBC (who in the past has said good things about the Austrians) has swallowed the MMTer kool-aid:

    In today's Wall Street Journal, Alan Blinder points out that running into the debt ceiling would provoke a severe fiscal contraction.

    "At current rates of spending and taxation, federal receipts cover less than 74% of federal outlays. So if the government hits the debt ceiling at full speed, total outlays—which includes everything from Social Security benefits to soldiers' pay to interest on the national debt—will have to be trimmed by more than 26% immediately. That amounts to more than 6% of GDP, far more than the fiscal cliff we just avoided," Blinder writes.

    The fiscal cliff, by contrast, would have erased 4.5 percent of GDP.

    Any sustained captivity below the debt ceiling, in other words, means that the economy will enter a severe recession. This recession will be made far worse because the so-called automatic stabilizers that kick in when the economy slumps—think unemployment insurance—will not be able to function because of the budget constraint. So unemployment will grow while unemployment insurance contracts. This will not only pose a hardship on the people out of work, it will mean that the spending power of the American consumer will shrink rapidly.

    Where the fiscal cliff might have led to a recession, this is downward spiral toward depression. The shrinking economy will shrink the government's tax revenues. And since the budget deficit cannot increase, the spiral will go unchecked. Falling taxes will trigger falling spending. "Downward spiral" may be too mild. Economic black hole better fits the bill.

    "In short, the consequences of hitting the debt ceiling are too awful to contemplate—worse even than going over the fiscal cliff. A sane Congress wouldn't even think about it," Blinder writes. He's absolutely correct.

    Blinder goes on to propose a plan to avoid a crises based on the assumption that Congress is sane. Let's hope that assumption is correct.


    That's because government "spending" is exactly the same as the negotiated prices of voluntary transactions and economies require and can lack "traction" that comes from government "spending".

    1. These guys seem to think that the "government economy" is the only economy there is. What is this? a COMMUNIST country?!?!? Oh, uh, wait...

  5. As usual Schiff is spot on. Unfortunately, the majority of Americans are economically illiterate, or follow the failed policies of Lord Keynes.

    Government plan:
    1. Dumb down the American public through government schools
    2. Follow isane economic policy that doesn't work, and works to the benefit of some, while at the detriment to others
    3. Profit because the populace [having gone through government schools) is now too stupid to catch onto your game.