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Statism and the Small Saver

Millions of investors were led over an investment cliff into the financial abyss during the recent economic calamity caused by the profligacy of the Federal Reserve and its counterparts around the world. More than a few people have asked me how the average Dick and Jane saver/investor can stand a chance. The short answer is they don’t.

This goes far beyond understanding how the stock market works and becoming a financial wonk. The very nature of government controlled economies and fiat currency regimes guarantee huge booms and busts which must suck in all but a very few participants in the financial markets.

In a market economy operating under a true gold standard the small saver is spared the problems and angst. People could put their savings in a cookie jar and earn more than a 1% compounded annual tax free return because consumer prices generally drop by that amount as productivity increased.

For those seeking more, super conservative investments in AAA bonds of nearly all maturities would yield about 3% annually. This brings our annual after tax, real return to about 4%. This was the U.S. experience in the 19th century when we had a gold standard and no income tax.

Today an investor must aggressively invest in the stock market to achieve similar inflation adjusted after tax returns. Worse, the cookie jar or super conservative vehicles like bank CD’s guarantee loss of purchasing power. This is a crusher for the lower income classes. The rich can hire me.

I can hear the howls already! What about the rampant bank failures? As with so much commonly received orthodoxy, that is a myth. Prior to national banking regulation less than 1% of all banks failed each year. They were almost always the smallest banks as well, which means that the failures represented a tiny fraction of 1% of all assets in the banking system.

Worse, the failures were largely caused by truly corrupt government action. Many states required, as a condition for the state bank charter, that their banks hold state bonds as a significant portion of their reserves. When a state screwed up its finances the value of those bonds dropped thereby impairing the value of bank reserves. This in turn would cause depositors to get nervous and withdraw their funds. Those banks holding too large a portion of state bonds for their reserves then failed.

The next howl is that under the gold standard our country was in recession two-thirds of the time. This was the position of Jimmy Carter’s economic advisor Charles Schultz in an interview on Wall St. Week during the 1980 campaign with consumer price inflation running to double digits.

Recent research reveals this to be utter nonsense. Reevaluation of the 1870’s, for example, shows dramatic growth instead of the previously estimated stagnation and contraction. The problems stemmed from modern economists difficulty in dealing with an economy where consumer prices decline sharply.

Rather than bore you with the trivia, I will ask you to consider that at the beginning of our constitutional republic in 1790 we were a federation of 3 million plus people huddled along a sliver of the east coast of north America. One hundred twenty three years later, when we exited the gold standard with the establishment of the Federal Reserve, we were the richest, most powerful nation on earth. America had exploded to over 110 million people that had built a continent. You do not do that contracting over half the time.

The next myth is that the gold standard exacerbated the great depression, effectively handcuffing policy makers to destructive policy actions. In fact, we left the gold standard when we embraced the fed.

What happened in the early 1930’s was the fed had to respond to an outflow of gold as the economy tanked. What wonks never consider is exactly why an outflow of gold should have been of any concern. Under an honest gold standard currency is issued by the treasury only after being presented with the equivalent value in gold. When the currency is redeemed, the gold is returned.

Under this regime, it doesn’t matter whether people prefer gold or currency. It only matters if the treasury doesn’t have enough gold to cover all the claims in the form of currency. That is exactly what happened when we created the fed. Currency creation exceeded gold deposits. This is why the fed became concerned with the outflow of gold in 1930 and 1931. Also in 1931 England left the gold standard because the Bank of England had been getting away with cheating for centuries. Of course, as any Austrian economist would have predicted, the charade could not last and Nixon was forced to admit as much when he officially defaulted and closed the gold window in 1971.

Since establishing national banking regulation and leaving the gold standard we have experienced dramatic and chronic consumer price inflation and, by far, two (perhaps three) of the greatest economic contractions in our history. Unfortunately, the book on our current contraction is only in the early chapters. As the plot unfolds, even most rich people will feel real pain.

As bad as it is in the rich west, conditions for the small saver are far worse where poverty predominates. There is no chance for growth without accumulation of capital generated by the savings. The policy prescriptions of statist, western economists have only made matters worse.

The necessity of aggressively investing to, at the very least, avoid loss of purchasing power contributes mightily to our current cultural embrace of speculation and leverage. This only amplifies the peaks and troughs of our government induced credit cycles, which are incorrectly referred to as the business cycle.