Mark W. Hendrickson

Mark W. Hendrickson is a faculty member, economist, and contributing scholar with the Center for Vision and Values at Grove City College, Grove City, Pennsylvania. These articles are from V & V, a web site of the Center for Vision & Values.

Gold's Meteoric Rise

The price of gold has gone on a tear this summer, from slightly under $1500 per ounce to well over $1800 per ounce, and it looks like it wants to go higher. What gives?

Well, if you bought gold last spring, you're looking pretty smart. And if you bought gold a decade ago at $300 per ounce, you're looking like a whiz. Imagine buying a stock 10 years ago, having it appreciate fairly steadily over the decade, and then watching its price increase in less than two months by more than your original purchase price. For a commodity to increase at such a rate is truly extraordinary, even portentous.

For an investor, gold is an insurance policy, a way to preserve some purchasing power regardless of what happens to the official currency or a country's banking system.

For a society, the rising price of gold is not a good thing. When investors flock to gold, it means they are not investing in wealth-creating enterprises. Money (which is what gold is once again becoming) is the oil that enables a country's economic engine to run smoothly. Gold can't make our country wealthier any more than engine oil by itself will get you from point A to point B, so while owning some gold may be individually prudent, it won't make our country more prosperous.

Gold is a barometer that warns of financial and political storms. When its price goes up as much as it has this summer, it is telling us that our country is in deep, deep trouble. "Gold's meteoric rise" is just another way of saying "the dollar's sickening plunge." Because the dollar is our normal frame of reference, we think more in terms of the price of gold rising than the value of our currency falling. Gold provides a mirror image to the dollar, and the golden mirror is telling us that the Federal Reserve Note is critically ill.

Actually, the dollar has been sick for a long time. Forty years ago this month, President Richard Nixon "closed the gold window" - that is, the United States defaulted - yes, "defaulted." Nixon broke our country's solemn promise to redeem our foreign trading partners' paper dollars for gold. There had been another default in 1933 when President Roosevelt "closed the gold window" domestically by refusing to let Americans exchange paper dollars for gold (Americans were free to own gold again without restrictions in 1975). Indeed, FDR even made it illegal for Americans to own gold, just as the Soviet Communists forbad Russians to have dollars. But August 15, 1971 was the day that the dollar's last link to gold was severed.

Nixon's decision to default began the slow death process that is the inevitable fate of fiat currencies. It also means that we have been engaged in a partial default on our debts for the last 40 years, for we have been repaying our debts with Federal Reserve Notes that have less purchasing power than what we borrowed.

The dollar has now begun its death throes. (Don't panic, the process could take years.) The perception of increased likelihood of U.S. default by monetary debasement, triggered by the pathetically ineffectual debt-ceiling agreement earlier this month, has shaken the confidence of millions, if not billions, of people in Federal Reserve Notes. People just don't believe that our government will get spending under control. They have doubts about the paper Federal Reserve Note and, by extension, the "faith and credit" of the government whose creditworthiness undergirds the Federal Reserve Note for better or for worse.

Some may argue that gold is irrelevant and that the dollar really hasn't taken a hit because its exchange value against a basket of foreign currencies has remained fairly steady this summer. This is hardly reassuring.

The currencies from smaller-GDP countries don't compete with the dollar. What is your average American or European going to do with South Korean won or Mexican pesos? The only two currencies that compete with U.S. dollars are the euro and the Japanese yen.

Europe is a mess, suffering multiple sovereign-debt crises. The E.U. is on life-support and the euro could implode, yet the dollar can't rise against it. This is a sign of incredible dollar weakness, not strength. The yen has been the strongest of the three, which is astounding, since Japan has a debt-to-GDP ratio more than twice as high as ours and has been devastated by March's massive natural/nuclear disaster. If Japan, with its massive economic problems, is deemed the strongest major currency in the world, then the world's fiat currencies are a joke, and it is no wonder that the price of gold is setting new record highs.

Buckle up, folks. Things are getting very interesting, and it isn't going to be fun.

The Limits to Bernanke's Power

As chairman of our country's central bank, the Federal Reserve Board, Ben Bernanke is expected to put the economy on a sound footing and foster strong economic growth. Unfortunately, Bernanke faces "mission impossible" - partly because the policies implemented by Congress, the president, and bureaucrats account for much of what happens to the economy, and partly because the Fed has already done most of what it can do.

The Fed's favorite policy for stimulating economic activity is to lower interest rates to encourage individuals and businesses to buy more things and hire more workers. The problem today is that the Fed has already lowered interest rates about as much as it can. Currently, interest rates for U.S. Treasury debt obligations of one-year and shorter durations are at zero percent, and 10-year debt instruments yield only 3.125 percent. Despite these historically low rates, economic activity remains sluggish.

At his June 22 press conference, Bernanke said: "We don't have a precise read on why this slower pace of growth is continuing." His critics have been merciless and vicious in heaping scorn and derision upon him. Some have labeled him an "idiot" or "evil."

While I am no fan of Ben Bernanke or the Federal Reserve System, the name-calling is revolting. Intellectuals can be blinded by their theories, and one of the blind spots that Keynesians like Bernanke have (one shared by many members of the Chicago monetarist school) is that rapid expansion of monetary reserves is crucial to counteracting a recession. As the quick recovery from the severe economic and monetary contraction of 1920 demonstrates, a falling money supply need not lead to prolonged economic stagnation if there is flexibility in prices and wages so that supply and demand can quickly rebalance.

Even if Bernanke doesn't personally grasp why his monetary stimulus hasn't revived the economy, the Fed has plenty of researchers who could supply him with truthful talking points, such as, "there is still a housing glut," "spending is muted because the economy is saturated with debt," and "the uncertainty caused by Obama's anti-business policies has discouraged entrepreneurial risk-taking."

The problem is: Bernanke can't say those things. Unelected central bankers aren't supposed to meddle in the legislative process. (To his credit, Bernanke did warn Congress last year that it needed to get its fiscal house in order before there is a calamity.)

A more charitable interpretation of Bernanke's statement is that it was "Fedspeak" for the honest admission that, "The Fed can't do anything more to stimulate economic growth."

Here is Bernanke's problem: As of June 30, the Fed's "Quantitative Easing Two" program ended. Under it, the Fed had purchased approximately $80 billion of federal government debt every month since last fall. If nothing else changes, the removal of $80 billion of demand for government debt means lower prices for bonds and consequently higher interest rates.

Higher interest rates could abort a sustainable economic recovery. According to former director of the National Economic Council Lawrence Lindsey, if interest rates were to rise merely to normal levels (heaven forbid they should go higher!) the federal government's interest expenses would increase $4.9 trillion over the next decade. Thus, interest payments alone would consume over a third of Uncle Sam's revenue from income taxes. Spending on everything else, from entitlements to national defense, would be squeezed. Austerity, anyone? In short, higher interest rates must be avoided at all costs.

There are only two ways to avert a painful rise in interest rates in the post-QE2 environment. One would be for the supply of treasuries to fall. In other words, Congress and the president would have to agree on spending $80 billion less per month. Think: "snowball in hell." The other option would be if other buyers lined up to replace the Fed. But who could take up so much slack? The Chinese, Russians, and others are already reducing their purchases of U.S. debt, and the Europeans are engulfed in their own sovereign debt crises.

I wonder if Bernanke and Elizabeth Warren's new super-regulatory creature, the Consumer Financial Protection Bureau, will use their political leverage over financial institutions to compel them to borrow short-term treasuries to buy long-term treasuries on the grounds that not to do so would create systemic risk. Could Bernanke make a deal with European banks and governments, with whom the Fed has already been cooperating: You buy our debt, we'll buy yours, and we'll figure out how to stick the taxpayers with the cost later on? These are speculative musings, not assertions. Bottom line: either massive new buying of federal debt appears or interest rates rise, plunging a dagger into the heart of economic recovery.

Bernanke and the other powers that be in Washington are almost out of tricks to paper over our government's bankruptcy. Whatever you think of Bernanke personally, be grateful that you aren't in his shoes. He is fated to be a very unpopular individual.

Big Deal or No Big Deal?

As the August 2 deadline for a debt-ceiling deal drew near, many expected a big deal that would significantly change the direction of federal fiscal policy. After weeks of tumultuous negotiations, partisan bickering, and impassioned histrionics, the agreement that finally emerged was, to put it bluntly, no big deal. Ironically, the most accurate assessment I read about it was Russian Prime Minister Vladimir Putin's comment that it "was not that great overall because it simply delayed the adoption of a more systemic solution."

In exchange for raising the debt ceiling by another $2.4 trillion, federal spending will be cut next year by all of $21 billion (that's from projected increases, not an actual cut) and $42 billion (ditto) in 2013. It will be business as usual in Washington. Political gridlock has preserved the status quo of rapidly escalating federal spending and debt. After an unprecedentedly emotional rendition of what I term "the debt-ceiling dance," the big spenders prevailed yet again.

Washington's failure to forge a big deal over the debt-ceiling issue is turning out to be a very big deal for the rest of us. In a year when we are on target to pay more than $500 billion (close to 40 percent of personal income-tax revenues) in interest on the existing federal debt, our elected leaders have authorized $2.4 trillion in additional debt over the next year-and-a-half.

Anyone who thought that a debt-ceiling deal would reassure markets was sorely mistaken. Stocks cratered. Gold, which has been warning of serious political / economic / monetary malfunctions since its price was much lower, has exploded to over $1800 per ounce, signifying a grave deterioration of conditions.

One outcome of the debt-ceiling agreement has been Standard & Poor's downgrade of federal debt from the highest rating, AAA, to the still very high rating of AA+. Standard & Poor's announcement has turned out to be a really big deal, triggering panics in financial markets around the globe and eliciting indignant denunciations from Democrats and Republicans alike.

Team Obama adopted a "kill the messenger" tactic. Treasury Secretary Geithner cited a hastily produced CBO (Congressional Budget Office) statement asserting that S&P had made a $2-trillion miscalculation. Defenders of S&P claim that CBO manufactured the discrepancy by using a different time frame. Regardless, in today's fantasy world, when Uncle Sam is on the hook for a total financial shortfall of $75, $150, or $200 trillion - depending on one's time frame and other assumptions - $2 trillion, though a colossal number, really doesn't alter the picture.

The Senate Banking Committee appears to be trying to intimidate S&P by raising the prospect of a senatorial investigation.

Even conservative Republican Steve Forbes has blasted S&P. While Forbes is technically correct that the United States can't default, because the Federal Reserve can always create more dollars, cheapening the dollar amounts to a stealth default. Furthermore, a downgrade to AA+ in no way suggests that there is an imminent danger of default, but for S&P not to look down the road and report the possibility that all federal debts may not be repaid in full would be a dereliction of duty.

What has happened since the debt-ceiling agreement is that people around the world have voted "thumbs down" on the current government policy of racing further into debt. The agreement, as per President Obama's insistence, was designed to schedule the next debt-ceiling debate for after the 2012 election so that it wouldn't be a big deal in next year's political campaign. That is astounding. There could hardly be a bigger deal for Americans than making the choice between spending ourselves into the poorhouse and shrinking the federal leviathan to forestall such an outcome.

I anticipate that the debate over federal spending will be the principal election issue regardless of when the next debt-ceiling dance begins. If a majority of Americans want to be the Western hemisphere's Greece, a banana republic suffering from the mass delusion that government can economically support everyone indefinitely, then the Democrats will prevail. On the other hand, if a majority of Americans truly want less government, they will vote Republican (assuming the GOP can convince enough voters that they really would slash spending).

I wonder whether the GOP really would significantly cut federal spending. Ultimately, it is the voters, not the political parties, who decide how much government we'll have. Polls may show that a majority of Americans favor less spending, but the real test will be whether a majority of Americans will support reforms that include cuts to programs that personally benefit them. I hope I'm wrong, but I don't think a majority of Americans want that kind of change.

Solutions for the "Tax Gap"

In 2010, there was a "tax gap" - i.e., the difference between federal taxes owed and those actually paid - of $410-$500 billion.

Some of the gap stems from the complexity of the tax code. Much of it, though, is deliberate: self-employed individuals working for cash, table-servers under-reporting tips, taxpayers claiming unauthorized credits and deductions. And don't forget the highly paid White House, congressional, and federal agency staff (including some at the Internal Revenue Service) who, according to reports last year, collectively underpaid their taxes by tens of millions of dollars.

Unpaid taxes are unfair to the millions of taxpayers who pay their full tax obligation. What can be done?

Some suggest beefing up the IRS's budget and manpower. Many oppose this out of concern that an enlarged IRS would be like the Transportation Security Administration, making life miserable for millions of law-abiding citizens.

President Obama estimates that increased enforcement would capture 10 percent of the tax gap. That sounds accurate. Completely eliminating the tax gap is no more possible than completely eliminating waste and fraud from Medicare. When systems become as gigantic and convoluted as our tax code and the Medicare system, all the king's horses and all the king's men can't extirpate fraud, waste, and loss.

Since the tax gap is so intractable, we should investigate alternatives to the reflex political "solution" of hiring more government workers. I do not condone breaking the law, but if millions of otherwise law-abiding Americans are defying a law, then maybe something is wrong with the law itself.

Millions of Americans despise our tax laws. They believe that taxes are excessive and that the tax regime is arbitrary, discriminatory, and oppressive. One potential reform is to adopt a low, flat tax rate, such as those that Russia and other erstwhile Communist countries now have. Low, flat taxes reduce the incentive to cheat. Fewer people risk criminal prosecution for 12 or 15 percent of their income than when 28 percent or more is at stake. In addition to greatly simplifying the tax code (which would also reduce the portion of the tax gap resulting from miscalculations), a flat tax lessens the rebellion fueled by discriminatory progressive taxes.

An even more effective way to eliminate the tax gap would be the appropriately labeled "fair tax," which would replace all federal taxes on income with a national tax on consumption. The fair tax would restore taxpayer privacy, save the colossal amount of time spent calculating (or miscalculating) one's tax liability, and would bring the vast underground economy above ground into the taxpaying realm.

Either a flat tax or a fair tax would be better than the existing tax code, but the problem underlying the tax gap goes beyond our crazy, convoluted tax code. The fundamental problem is the widespread perception that our political system itself is immoral, dishonest, and corrupt.

Is it any wonder that taxpayers are cynical and demoralized when politicians routinely break promises; the government's own accounting watchdogs refuse to vouch for the accuracy of government's official budget figures; rich people and businesses with expensive tax attorneys and accountants can legally avoid taxes; and well-funded, politically-connected special interests get billions in handouts and bailouts from government?

Citizens perceive that our democratic process has degenerated into what H. L. Mencken dubbed an "advance auction of stolen goods." Trillions of dollars per year are redistributed according to who has power, connections, and lobbyists. American politics has become a never-ending donnybrook in which nearly everyone wants the government to make somebody else pay for the benefits they receive.

In the moral lawlessness that characterizes a redistributionist state, respect for property rights atrophies. When politicians, intellectuals, clergymen, the media, etc. demagogically denounce "the rich" and have the effrontery to call income that they grudgingly let a taxpayer keep "a tax expenditure," it is not a good situation for property rights. In this "every man for himself," "grab what you can get" culture, many individuals will defy the law.

The root cause of our elaborate, confusing, costly, maddening, and unfair tax system - and of the tax gap - is our delusional belief that we are entitled to a free lunch and our morally bankrupt insistence that government subsidize our lifestyles with wealth from others. Until we correct those errors and quit worshiping at the altar of Big Government, the tax gap will not go away.

Bernanke and the Potemkin Economy

On July 11, The Center for Vision & Values posted my article decrying the insulting name-calling directed toward Federal Reserve Board Chairman Ben Bernanke. The very next day, Bernanke made me question my forbearance by telling Congress that a third round of "quantitative easing" or "QE3" could be a near-term option.

Now it's my turn to call Bernanke a name, but I'll use a clinical label, not a crude one. He is an inflationist, although he may prefer the label "anti-deflationist." He so fears a deflationary spiral that he will create however many dollars he believes necessary to avert deflation.

Bernanke's repeated attempts to patch over the nation's economic weakness, rottenness, and dead wood with newly created dollars remind me of the "Potemkin village" ruse. The Soviet Communists duped foreign visitors into thinking that Communism was a viable and prosperous system by steering them to sham factories, stores, villages, etc. that appeared productive, bustling, and attractive. In reality, Potemkin villages were like movie sets, built to disguise the widespread poverty and backwardness that characterized life in the "workers' paradise."

Official statistics insist that the Great Recession ended two years ago. Yet unemployment is creeping up, record numbers of workers are remaining unemployed for record lengths of time, income is down for small proprietors, and millions of people feel as though the recession never ended.

It is a maxim that statistics lie. One such statistic is the gross domestic product. GDP has risen modestly the last two years, supposedly indicating growth rather than recession. Here is the flaw in GDP: By definition, GDP=C+I+G. In other words, GDP equals the sum of consumer spending, private investment, and government spending. (There is also a problematical addendum of net exports, reflecting the mystical mercantilist notion that a country is richer if foreigners obtain more goods and services than domestic residents do, but let's omit that here.)

In the last few years, GDP has increased by approximately one-third of a trillion dollars, while the government component has risen by closer to a full trillion dollars. That means that the private sector (consumption and investment) has shrunk. Government has cannibalized private sector spending and jobs. GDP creates a Potemkin-like superficial appearance of economic growth, but the private sector, the heart of the economy, is suffocating. The private sector share of GDP has contracted to its 1998 level.

Another Potemkin-like aspect of our economy involves the chasm between the economic fortunes of Wall Street and Washington on the one side, and Main Street on the other. Chairman Bernanke's QE1 and QE2 policies helped to propel a huge advance in the stock market over the last two years. The political and financial elite has been prospering, but, relatively speaking, aside from potentially unrealized gains in his 401K, that Fed-generated glitter may not have helped Joe Six-pack.

Here is what we need to understand: Bernanke and Co. have immense powers, but they don't have the right power. They can control short-term interest rates; virtually dictate the policies and practices of American financial institutions; artificially boost asset prices by purchasing whatever quantity of them they choose; bail out politically connected enterprises; and do many other things by virtue of their power to create dollars without limit. Yet, the one thing that Bernanke and the Fed cannot do is generate prosperity and thereby raise standards of living. They can benefit some at the expense of others by deciding which assets to purchase and where to deploy new dollars - that is, they can redistribute wealth, but they can't create it.

Question: Are there any grownups who really believe that our country can get richer by printing more money? If so, why not just mail everybody a check for $20 million? Even better, why not give every household its own little printing press so that whenever someone gets laid off or isn't generating enough income, he can create the wealth he needs by printing it?

There is really only one way out of Ben Bernanke's Potemkin-like economy. It isn't to replace Bernanke with a supposedly "better" central banker. Rather, we need to abolish the central bank and foreswear the fiat money that enables the Fed to create the cruel faade of Potemkin-like illusions on the rest of us. *