UNDERSTANDING THE GAME

Chris Temple is Editor of The National Investor the foremost "America-First" financial/economic newsletter in the U.S. For a sample issue and subscription information, call (715) 635-4300, or e-mail NatInvstor@aol.com. Temple's web site is located at http://www.nationalinvestor.com

"All the perplexities, confusion and distress in America arise, not from defects in the Constitution or confederation, not from want of honor or virtue, so much as from downright ignorance of the nature of coin, credit and circulation."

Many of you reading this are familiar, I would surmise, with the above quote. Like others, it is used by "hard money" advocates to call for a return to some type of "gold standard" for U.S. currency, if not for a wholesale return to using physical gold and silver coin in our economy (that is a position we will take some issue with herein, as it misses the point of what money's purpose is.)

It's been my observation that the larger context and meaning of Adams' statement--and its particular application to today's economy and monetary system--has not been fully understood, even by some students of monetary matters. Most observers, serious though they may be, often lose sight of the nature of money, the process of its "creation" today and the methods by which it is controlled in what, to me, is a relatively unimportant issue of what substance money is.

No, there is nothing "magical" about the craft of what some have called "fractional reserve banking" (a "craft" it can indeed be called.) Money creation is a deliberate, definable process; its volume and "price" fairly identifiable. Few have been able to put all of the pieces together, though and identify--and understand--"The Game," and how it works. As the British economist John Maynard Keynes wrote in his 1920 book entitled, The Economic Consequences of the Peace, "not one man in a million" is able to diagnose the intricacies of central banking, its inflationary component, and how over time it robs the masses of wealth.

When we do-once you understand what follows-you will immediately have more insight into what makes this whole mechanism called the U.S. economy work than does your local banker. You'll have a much better idea of which way the financial markets and interest rates are going than does your most tenured local stock broker (who, if he or she is like most, is nothing more than a glorified salesman anyway.) And, of course, you'll be in a better position than most to generate profits in your investments and, just as importantly, to know how to preserve them as well.

You'll know why it is that, when GOOD news comes out for the economy-when people are finding jobs, productivity is increasing, and people have food in their bellies-the financial markets recoil in horror. Conversely, you'll understand why the markets-particularly the bond market-get a warm feeling all over when the economy sinks.

To understand it all, we must first understand what we use as money; what it is, where it comes from, how it comes into being, etc... For the purposes of this article, at least, it makes no difference whether what we use AS money is gold, silver, paper, bookkeeping entries, or numbers on a computer screen. If gold were used AS money today, with all other things being equal, our lot as consumers, workers, investors and Americans would be no different (with the exception being that some would need tighter belts to keep their pants from falling down!)

In doing seminars, radio, and otherwise sharing this critical understanding over the years, my favorite prop has been an ordinary deck of playing cards. When possible, I'll take four people and place them at a table. I am the "banker"; thus, I have the ownership and ultimate control of the deck.

To show how what we use as money today (essentially, bank credit) comes into being, and how it works, I deal each of the four people five cards. I inform them that they have until this evening to play one or a number of games among themselves with those cards, provided they play by some general, "fair" rules that I establish.

I also inform them that when I return each player will be obligated to repay me; not five cards, which was the amount of the "principal" I loaned, but six cards. After all, the cards are mine; I am entitled to a profit, or interest, for loaning them to each of the players. Thinking that they each might have a reasonable chance, since they're all experienced card players, they agree.

Oh, and one final condition. If any of the four is unable to pay me six cards when I return, I will be the new owner of their home.

More often than I care to tell you, it's taken quite a while for anyone in the audience to tell me what is fatally wrong with this scenario. Of course, you all know already...I did not put enough cards on the table! I don't care how good these four card players are, nor does it matter that their very lives might even be forfeited if they are unable to repay the debt. Simple mathematics dooms at least one of these sorry individuals to losing his or her home.

Of course, it would be cruel and heartless of me to foreclose on this person; after all, the "luck of the draw" doesn't always go your way. Therefore, I'll make him a deal (and SUCH a deal at that.) He now owes me six cards (the other three wiped him right out.) I'll loan him the six cards with which to "roll over" his debt--but now, he'll owe me eight in the end. "No problem," he says to himself, "I need only come up with two more. My luck is bound to change!"

And so, the game goes on, and on, and on...but it cannot--and will not--go on forever.

Now, let's relate that analogy to "real" banking itself. In an old Newsweek magazine story on the Federal Reserve system, that publication stumbled upon but then dropped a critical truth of "fractional reserve banking." In its February 24, 1986 issue, in a piece entitled "Making Money Out Of Thin Air--The Fed Is The Economic Equivalent of The Kremlin" their reporter Bill Powell reported, "The Fed controls the supply of money banks have to make loans...With the stroke of a few computer keys, the Fed creates money out of thin air, adding funds, known as reserves, to the (local) bank. The bank is able to lend out those reserves several times over, creating even more money."

So, in part through what is known as its "open market operations," the Fed thus generally sets the amount of money that commercial banks can loan--money created literally "out of thin air."

It is these funds--multiplied several times over--that local banks loan into being each day in the form of business, personal, mortgage, credit card and assorted other loans. That is how what we use as money--bank credit created out of thin air--comes into existence.

Let's suppose that you and nine other people go to the bank and take one-year loans of $10,000.00 each. The banker puts a total of $100,000.00 in circulation, correct? If he requires 10 per cent interest over the course of the year, you must each pay him back $11,000.00, for a total of $110,000.00, right? Do we not have the same problem as our card players?

As time marches on, the banker (actually, the entire system, up to and including the Federal Reserve) must continue to make loans--to increasing numbers of people, and in increasing amounts--to keep the whole game going. As you hopefully see already, principal amounts previously loaned are all that is out there for everyone to use to make payments of both principal and interest. NOTHING has ever been put into circulation to make interest payments on all our public and private debts--do you see that, my friend? We all, public and private sectors alike, compete for money that has been "created" previously as principal amounts of loans. And, as the total debt bubble grows ever larger, the portion attributable to interest grows geometrically, eventually dwarfing the original amounts of everyone's borrowings--a point we have reached. Talk of occasional Federal Reserve "tightening" aside, this makes it critical that the rate of growth of the nation's "money supply" continue to rise--just so everyone can keep up with their payments!!

The Fed must, through the commercial banking system, continue to get more and more people to take on ever-larger amounts of debt--just to keep "The Game" going. In this month's "Financial Potpourri," we mention Fed Governor Lawrence Lindsey's dismay at the fact that consumer debt is growing, and that people who previously would not qualify are being granted credit. He obviously doesn't understand his own business because, as you can see, the banking system has no choice at this point but to make loans every day that would have given a banker a couple generations ago a heart attack!! It is vital to keep "The Game" going--it's that simple.

Come on, now. Did you really think that the proliferation in recent years of "no money down" or "no payment for twelve months" deals on virtually every big-ticket consumer item imaginable is due entirely to industry's benevolence? Or is it rather that the only way to continue to grow the debt bubble (but at a slower pace)--and to enable consumers to bear the additional burdens that they MUST bear in order for "The Game" to go on--is to string out new consumer debt in this fashion, and, in a sense, damn near GIVE stuff away? Do you think all of this might be telling us that the moment of truth--either a deflationary spiral or the "upright spike" of hyperinflation written about over twenty years ago by Dr. E.L. Anderson in his book entitled The Upright Spike--is nigh at hand? After all, what can the bankers do next - PAY consumers to keep their malls and bazaars going??

Understanding the game now, you know that the Federal Reserve must do one of two things to keep things together. They must continue to accelerate the growth of the "money supply," while at the same time, if possible, keeping interest rates down so that the geometric growth in the interest portion of the overall debt doesn't get completely out of hand. Therein lies the problem where the financial markets are concerned. Those two desired policies on the part of the Fed are mutually exclusive on Wall Street. Talk about higher economic growth and an expanding monetary base, and the bond market wants higher interest rates. This is why you see the bond market spooked by good economic news. Yet, if the Fed doesn't keep the money supply expanding briskly, the economy will sink into recession, and debt delinquencies will rise.

Thus, the Fed tries increasingly in vain to pursue two very different courses--caught between Wall Street and Main Street (see "Whither the Markets" for more on the current interest rate outlook.)

In our next issue, we'll pick up this discussion, sharing with you, among other things, the reasons why the Federal Reserve "created" the long-running bull markets in stocks and bonds.

Note from Devvy Kidd: I encourage everyone to read the book, Debt Virus by Dr. Jacques Jaikaran. Try your local bookseller or Amazon.com. This book is by far and away the very best and easiest to understand book on what is money, how it is created, its use and of course, how America [and the rest of the world] are being bankrupted by these central banks, ours being the "FED." Debt Virus is also listed in my reference section on this site.

“CONSPIRACY THEORY” GAINS NEW CREDIBILITY Leaked Gold Report Reveals Trouble Ahead. . .

INCREDIBILITY You didn’t hear about this on the national news, CNBC, or in your local newspaper. After all, most of these controlled/scripted sources of “news” are still trying to keep us all believing that all is well with the world, even as the stock market and economy show new cracks. For all its obvious faults, “the system”—i.e, the fractional reserve monetary system administered by the Federal Reserve—is still sound, according to these pundits. Thus, and in spite of the rally in gold and gold stocks in...

gata.org Gold Antitrust Action Commitee

THE ROLE OF DERIVATIVES-Chris Temple

I have long warned that our fractional reserve monetary system actually NEEDED speculation and creative ways of "wealth creation" just to keep itself from imploding. In this brief item, I discuss how DERIVATIVES have played a central role in the Fed's continued levitation of the dollar/monetary bubble.

***A DIFFERENT KIND OF RALLY-Chris Temple

In his most comprehensive analysis of the gold market to date, Editor Chris Temple--whose track record on gold has been more accurate and profitable than anyone's in both down and up markets--recaps the reasons why gold has moved steadily to the $325 per ounce area, and will go higher still.

Monetary Freedom and Accountability Act-Congressional Record, Rep. Ron Paul

"While the Treasury denies it is dealing in gold, the Gold Anti-Trust Action Committee (GATA) has uncovered evidence suggesting that the Federal Reserve and the Treasury, operating through the Exchange-Stabilization Fund and in cooperation with major banks and the International Monetary Fund, have been interfering in the gold market with the goal of lowering the price of gold. The purpose of this policy has been to disguise the true effects of the monetary bubble responsible for the artificial prosperity of the 1990s, and to protect the politically-powerful banks that are heavy invested in gold derivatives. GATA believes federal actions to drive down the price of gold help protect the profits of these banks at the expense of investors, consumers, and taxpayers around the world."

AN INVESTMENT STRATEGY FOR UNCERTAIN TIMES (5/2001)-The McAlvany Intelligence Advisor Special Report

In recent years, we have seen the Fed, the GSE's and Wall Street create the biggest speculative financial bubble in world history, literally out of thin air - via trillions of dollars of artificial liquidity [ED. NOTE: And don't forget the $103 trillion derivatives bubble], with the highly revered Alan Greenspan as the maestro of this financial orgy. And we have seen that bubble begin to collapse with the collapse of the Internet/tech bubble (i.e., a bubble within a larger bubble) with $5 trillion in wealth extinguished in the stock market alone in about 12 months. The gargantuan multi-trillion dollar real estate and derivatives bubbles are next in line for major trouble.

'Fannie and Freddie Were Lenders': U.S. Real Estate Bubble Nears Its End-June 21, 2002, Executive Intelligence Review,Richard Freeman

The U.S. financial system is now dependent to an unprecedented degree upon one prop: the greatest housing-real estate bubble in human history....

Default rates on mortgages insured by the Federal Housing Administration—used primarily by families of middle or modest income—have recently reached 10% in some urban areas of the United States....

In testimony on April 17, before Congress' Joint Economic Committee, Federal Reserve Board Chairman Alan Greenspan foolishly denied that there is a housing bubble, and asserted that housing conditions are "scarcely tinder for a speculative conflagration." Greenspan's statements fall under the heading of "he doth protest too much."...

According to the U.S. Department of Housing, the total monthly "home cost" should not exceed 28% of a household's gross income. The "home cost" consists of the mortgage interest and principal payment, plus the home insurance payment, plus the home property tax due.

Millions of households have bought homes by "getting in over their heads." They are paying 35%, 45%, and even more of their annual income, on the home mortgage. This makes them dangerously vulnerable.

So, whereas before one had one economic catastrophe—the default of some mortgages—because of the way the housing market is structured, this produces a second catastrophe—the default of Fannie Mae's bonds. Fannie Mae's bonded debt is at least ten times greater than that of any corporation in America. No company in America has ever defaulted on as much as $50 billion in bonds, and Fannie Mae has over $700 billion. With a bonded debt of that magnitude, a default would put an end to the U.S. financial system, right then and there....

Yet a second obligation compounds the problem. In addition to the mortgage bonds, Fannie Mae has put its guarantees on $859 billion of Mortgage-Backed Securities. In a crisis in the housing mortgage market, Fannie Mae could never meet the terms of its guarantee, that it would pay "the full and timely interest and principal," on the mortgages to which it gave a guarantee....

Households are finding two ways to get their hands on some of the fictitious value of their homes: cash-out refinancing, and home equity loans. Under cash-out refinancing, a homeowner takes out a new, larger mortgage on his home, whose value has been artificially pumped up by general speculation. With the new cash, he pays off his first mortgage, pays off his credit card debt, and has money to buy a spate of consumer goods....

The amount of home equity loans outstanding stagnated between 1990 and 1995, only rising from $235.9 billion to $289.3 billion. Then, as "Bubbles" Greenspan et al. pumped the bellows, the amount of home equity loans soared, reaching $701.5 billion in 2001. The amount of home equity loans is larger than all borrowing by credit cards in the United States....

A Federal Reserve Board economist told EIR that half of the value of all home equity loans does not go for home improvements, but for consumer expenditures and paying down credit card debt. Others indicate that as much as 60% of home equity loans—over $400 billion a year—is for consumer cash and credit card expenditures. The banks have made it very easy to get home equity loans since the mid-1990s, and now promote "home equity lines of credit," where the homeowner borrows, not a fixed amount—as was the case with the old home equity loan—but an almost unlimited amount of credit....

Bump for recognizing the great bulk of this as drivel.

The assumption contained throughout is that wealth cannot be created by a citizen or group of citizens, and that said wealth cannot be readily converted into any other sort of property the wealth creator(s) desire. One wonders how Rockefeller (pre-Fed) or Gates (post-Fed) ever managed to create a dime of wealth. Certainly their stockholders had and have, respectively, the illusion that SOME wealth was created SOMEwhere. Come to think of it, neither of these gents ever incurred any debt (Rockefeller was fanatical on this point, btw), so neither of them contributed to this so-called 'debt bubble', Rocky because he made his pile before the Fed, and Gates because he wouldn't play the 'let's increase debt' game?

Well, good luck to those who buy into this twaddle, and please come and trade against me in the futures and options markets (wups, my bad, mean old nasty corrupt derivatives trader that I am), because I can definitely use your money.

What rubbish.

Can you detail how you reached that conclusion?

Feel free to assume I have infinite ignorance on the matter and am not going to be shamed or intimidated by that fact... but it seems to me the following is fundamentally valid:

The debt money system allows an underwriting of percieved or 'market value' of assets, goods and services. While it is true-in-a-sense that market value is the best and ultimate method for determining 'price/worth/value', underneath all this we have a true-value which is a more concrete function of supply and demand: It doesnt include our belief-based distortions, the air in the bubbles.

A lot of this air has been chased-back-into the real estate market via our consumer credit system assuming increasing risk. The debt money unleashes ties to physical reality and puts us in a realm where the only constraint is faith itself.

You complain that the assumption throughout is that citizens cannot create wealth -- and go on with "Certainly their stockholders had and have, respectively, the illusion that SOME wealth was created SOMEwhere"...

Illusion of wealth is not wealth, just because you found some sucker to pay you $3000 for a $1000 car does not make the car worth that amount -- all products values are a function of the human, technical, and physical resources needed to produce them versus how well that product fullfils the lifestyle demands of the consumer... a consumer in a market relatively free of distortions.

Its almost like you are saying bubbles are not possible because value is whatever-we-are-led-to-believe it is.

Lenders have a vested interest in supporting these real estate valuations, and the debt money system is open-ended in allowing us/them to monetize fantasy.

You should not attempt to trade futures or futures options with a capital account of less than $10K. Not because the trading itself is particularly capital-intensive -- it isn't, but rather because of two other conditions.

First, and no offense to you or anyone, the average citizen who begins trading does not have a practical appreciation of the danger posed by leverage. Leverage is great when you're winning and absolutely horrific when you're losing. Futures markets are by nature highly leveraged, and the practical (and successful) traders routinely refuse to apply all the leverage available. Very small accounts, OTOH, do not have a choice in this matter; they will perforce have to use too much leverage. Secondly, beginning with a very tiny account places an unrealistic burden on the trader. To succeed, he must make winning trades literally from the get-go. This is certainly not an impossibility, but it is an extremely unlikely result.

The problem for the very small account is the size of the contracts in the market -- $500 is just a 10 cent move in soybeans and corn, 1.25 cents in hogs, $5.00 in gold, $0.05 in natural gas, and 40 pips in the major currency markets. ALL of these markets regularly move this much (and, occasionally, a LOT more) within a single day's trading. With literally one misstep, the very small account can be vaporised and the trader might end up owing the broker a good bit more.

I might try, as an exercise, to see if I could turn a $5000 account into an ongoing profitable account, and I might succeed...but I have the advantage of having traded in these markets for 30 years. Far better to begin with more capital, set an absolute loss limit ('...if I lose 35% of capital, I quit...), something like that, and then try.

FRegards!

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