How Do People Destroy Their Capital?

by | Nov 16, 2015

The flip side of falling interest rates is the rising price of bonds. Bonds are in an endless, ferocious bull market. Why do I call it ferocious? Perhaps voracious is a better word, as it is gobbling up capital like the Cookie Monster jamming tollhouses into his maw. There are several mechanisms by which this occurs, let’s look at one here.

I have written previously about the interest rate, which is falling under the planning of the Federal Reserve. The flip side of falling interest rates is the rising price of bonds. Bonds are in an endless, ferocious bull market. Why do I call it ferocious? Perhaps voracious is a better word, as it is gobbling up capital like the Cookie Monster jamming tollhouses into his maw. There are several mechanisms by which this occurs, let’s look at one here.

Artificially low interest makes it necessary to seek other ways to make money. Deprived of a decent yield, people are encouraged (pushed, really) to go speculating. And so the juice in bonds spills over into other markets. When rates fall, people find other assets more attractive. As they adjust their portfolios and go questing for yield, they buy equities and real estate.

Dirt cheap credit is also the fuel for rising asset prices. People can use leverage to buy assets, and further enhance their gains.

And it’s wonderful fun. A bull market, especially one that is believed to be infinite—if not Fed-guaranteed—seemingly provides free money. All you have to do is buy something, wait, and sell it. You can get your capital back plus something extra.

Many people spend most of this extra. This is their gain, their income. Their brokers, advisers, and other professionals also make their income off of it.

However, there’s a contradiction. Common sense tells us that it should be impossible to consume without first producing something. How can this be possible? How can an entire sector of economy get away with it?

It can’t. There is no Santa Claus. Something else is happening, something insidious.

The falling-rate-driven bull market is a process of conversion of someone’s wealth into your income.

Let’s look at how this works. Suppose Jennifer buys a condominium for a million bucks. If she pays cash, this is a large chunk of her life savings or inheritance. If she borrows to buy it, then she’s disbursing someone else’s savings. That saver has no idea what is being done with his savings. He probably thinks it’s safe in the bank.

Jen forks over this cash to the seller, David. Dave recovers his original cost to buy the asset, say six hundred grand. The rest, say four hundred, is profit. He goes out and uses much of the profit to buy a Ferrari, drink a 1983 Bordeaux, and dine on beluga caviar. Dave is driving, drinking, and eating Jen’s life savings.

What was Jennifer thinking? Why did she place so much of her wealth into his hands of David, who will only consume a large part of it?

Simple. Jen sees the bull market, and expects it to continue. She is hoping that after a while, she will sell at a profit. That is, she relies on the next guy to come along and give over an even larger chunk of wealth to her, so she can consume it. Maybe Ferraris aren’t her thing, but she fancies a cruise around the world, a diamond necklace, and she will enjoy some caviar too.

Charles Ponzi is now infamous for having promoted a scheme, where people who buy in later are enabling the earlier participants to cash out with profits. Such schemes can’t go on forever, because they are cannibalizing the participants. They do not generate real profits by increasing production. There are mere transfers, converting the wealth of some into the income of others.

Ponzi had nothing on the Fed, with its endless bond bull market, speculation, and capital destruction. Don’t blame Jennifer or David. Blame the Fed and its perverse game.

 

Gold is an international issue from China to Switzerland to India. It’s also a national issue in the US, as it is part of the Republican primary debate. And it is an issue in Arizona, soon to become (we hope!) the third state to pass a gold legal tender law. Please come to the Monetary Innovation Conference in Phoenix on Tuesday. Keith will discuss his ideas about falling interest rates and how it’s hurting everyone from savers to retirees. Entrepreneurs will discuss the problems they’re solving using gold. Please click here to register

Keither Weiner is the founder of the Gold Standard Institute USA in Phoenix, Arizona, and CEO of precious metals fund manager Monetary Metals. He created DiamondWare, a technology company which he sold to Nortel Networks in 2008. He writes about money, credit and gold. Visit his site at monetary-metals.com

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

9 Comments

  1. There is more here. What is consumption? Look at the most obvious example: A person consuming food, eats the food to produce waste products that indeed no one uses for anything else, and maintains his life. His life is used, typically, among other things to produce other goods and/or services later offered in trade. He consumes to live, and with his life he produces other values to trade. In trade, he obtains other values he needs and/or wants for the other endeavors of his life, and more food to consume to live, etc.
    Now. Take an example of one large farm that is the only farm, that produces the only food for a community. The farmer produces nothing else but food, which he trades with the people of the community. The farmer gets everything else he needs or wants from the other people in the community by trading food with them. The members of the community get and consume all of their food from the farm by trading with the farmer, using their own lives they sustain with this food to produce all the values they then trade with the farmer and each other, for all of the other things they need and/or want including the food; etc.
    What bit in all that is truly consumed? The food waste products. All else is profit for the individuals of the community, ever increasing in summation, ultimately obtained from the energy of the sun and the process of plant and animal growth in nature, and the productive choices from the minds of men and their labor in production (sustained by the food derived from the farmer’s thought and effort, from his life, which he puts to use in directing the energies of the sun, plants, animals, etc.)
    So. Do you see the little bit of true consumption (poo), and the great multiplying production driven by the sun, natural forces, and the mind and labor of man?
    You could do the same derivation with the Ferrari listed above in the article. At the end of the process there is only a tiny bit of poo in consumption and a huge mountain of production even and especially in the ostensible act of buying and driving a Ferrari.
    Where is the evil? The evil is found in counterfeiting the tool of indirect exchange – both in it’s creation as counterfeit money by the fed, and by the magnification of this counterfeit in fractional reserve lending. When you sit and think about what that process does, conceptually, you will realize that it means the power of government through counterfeiting the tool of exchange, allowed someone to obtain and use something from someone else, not by trading another value to them, but by trading a counterfeit unit of exchange to them. The counterfeit money does in fact in practice exchange value for value in every trade that it is used in. (Don’t freak out here, OC, -smile ) But it exchanges not a value that the person trading it owns, but a ‘fractional suction’ of value that everyone else has produced. Think that over. A transaction that occurs between the farmer trading food he has produced, with the, let’s say, owner of a business that has prospered on loans from a bank lending by fractional reserves which were obtained from a principle lender, who obtained them from fed fiat money creation, does in fact cause a trade of real value for real value, except that the value that the business owner trades is NOT HIS.
    When counterfeit money is used in trade (fiat money, further inflated through fractional reserve action) some of the value that everyone else has produced is stolen from them in the action of that transaction and handed to the producer of a real good/service, with the person trading the fiat money receiving the good or service for the value he has stolen from everyone else.
    When, finally, the counterfeit money is ‘evenly’ distributed across all people, then the stealing is done (for that round.) Those touching and trading with the fiat money at the beginning (and fractionally less so as the process continues through trade after trade over time) have simply stolen real goods/services from everyone else.
    To the extent that any of the thieves purchase food, eat it, then poop waste, or purchase some other good that they then destroy or wear out to no further use, then they have truly “consumed” other people’s wealth. But the real issue, the real evil, is that they have STOLEN the goods and services other people produce with their lives — not so much the ones that they got in trade with their fiat money, but the summation of a fraction of the value that is in every good / service that EVERYONE produces.
    The nearer a person is to the fed fiat money fabrication in terms of counting the transactions further and further from that point, the greater a thief that person is (or made, unknowingly to be).
    Let us ask. Who are these people?

  2. This is analysis is still not logical. The first lines are backwards. The buying of bonds is causing interest rates to fall, not vice versa, and the source of the problem is not elucidated because a simple question is not being asked. If bonds are being purchased, endlessly, then from where does the currency come required to make the purchases?

    Dirty laundery. The US Treasury is laundering counterfeit by way of the Federal Reserve’s primary dealers and their symbiotic international partners in crime.

    How this effects the decisions of honest persons is not the problem. People are not intentionally destroying their own capital. That is absurd. Criminals are forcing them to make decisions that they otherwise would not choose if force were not introduced.

    Please double check this premise:

    “If she borrows to buy it, then she’s disbursing someone else’s savings.” When she borrows to buy it, is there a debit that magically appears on her account that she is then expected to credit back or is the debit marked one-for-one against someone else’s already existent savings? Isn’t it the fractional reserve machinations that are the ponzification of the currency by actually introducing new currency that never existed, ex-nihilo, and not the expectation of higher demand that already exists, axiomatically?

    Why must the monster’s tentacles appear so distracting as if they warrant attention? Please go after the severance of the monster’s head. Per Thomas Jefferson: a national bank goes against the laws of monopoly.

  3. But fractional reserve lending is ok under laissez-faire and inalienable individual rights. Mike Kevitt

  4. You got it backards. The Fed, as per 1913 legislation (not law), rolls the presses. That’s why there’s low interest rates and high bond purchases. It all allows big gubmint and its funding at the expense of every producer’s pocketbook. True, honest persons don’t intentionally destroy their own capital. They’re just trying to cope as best as they can under the criminal regime. I, maybe naively, believe they don’t know the nature of what they’re dealing with, and that they’d raise a BIG STINK nationwide if they knew, but that they’d do it politically, not violently, believing they can win that way. If this is true, and if they learn and know, will the system established by the Founding Fathers work? Despite that system’s flaws, I naively bet it would work. But then, with those flaws corrected, we must be ever vigilant, thru government by law, to see that the Founding Fathers’ system is adhered to, FOREVER. Mike kevitt

  5. I’m not sure how you come to this conclusion. The concept of ‘hands off’ or ‘leave us be’ refers to the most just and productive relationship between government and business. I do not think anyone has seriously suggested that this should allow fraud, or theft, which is what fractional reserve banking accomplishes. “Allow to do” as laissez-faire has been used to describe an essential feature of free-markets has never meant “Allow to do crime.”

    It is a legitimate function of government to organize the just force that individuals rightly use to protect their lives, liberty, and property from those who would violate them. Since monetary inflation via lending on fractional reserves is theft , individual property rights are being violated when such fabricated money is used in trade.

    Fractional reserve banking does violate individual rights because lending more money than is kept in reserve does increase the money supply. Increasing the money supply out of thin air is effectively the same as counterfeiting of money. Using counterfeited money in trade is a theft from all producers who use not-counterfeited money as a tool of indirect exchange.

  6. Directionally, we have said the same thing with respect to the large quantities of currency as counterfeit (dollars) being presented to purchase the smaller quantiities of counterfeit (bills, notes, bonds) as the means of forcing involuntary rates lower.

    It is not naive to say that “they” don’t know what they are dealing with. This is fact. It is the undeniable intention of the authorities to deceive. The oldest sophistry in the world is simply to disconnect concepts from percepts, i.e., counterfeit is named and taught to be money, corruption is named and taught to be banking, theft is named and taught to be malinvestment, microrecklessness is eschewed in the name of macroprudential, etc. The purpose is to keep the obsequious Gullivers travelling through the smoke never to find the flame. The only path to the flame is cleared by re-attaching the correct concepts as represented by the words we choose to the originating percepts from which the words were established. This can only be done without any contradiction between our objects of thought and our objects of sense.

    What people do is the result of what they think and what they think is, mostly, the result of what they are taught. Therefore, until the politics of virtue embraces the correct language then the politics of corruption continues to rule the roost and this ends violently. Please do not overlook that the founders system was not simply “government by law.” After all, there are good laws and there are bad laws. The founders endeavored, per the teaching of Aristotle’s lectures on First Philosophy, Nichomachean Ethics, and Politics, to establish a constitution of justice. As I concretize these three integrated lectures in a sentence; Human life is (First Philosophy) and therefore has a purpose that must be happiness (Nicomachean Ethics) which can only be secured by citizenship which is free from impediment (Politics).

  7. My conclusion is based on what I understand banking to be. My understanding is this, as an example. You borrow $1,000.00 from
    several people by offering them interest. You get money to pay interest by loaning out some of the money you borrowed, say, 60% of it. You charge higher interest than you are paying, so you can make a profit. So you have $1000.00 in deposits, $400.00 in reserves and $600.00 in loans. That’s fractional reserve banking or lending. That’s what banking is all about. That’s what banking IS. You’re paying others for the use of their money which they can demand repayment of at any time. You use it by lending some of it at a profit. If you are a smart, competemt lender, your depositers will probably never all demand their money back at the same time. Incompetent lending might bring civil suit, a shrinking of your bank and maybe its failure. But there’s nothing counterfeiting, fraudulent or otherwise criminal anout it. And the existence of counterfeit money put
    out by private crooks or by the Fed. doesn’t make it criminal.

    Why do we have the term, ‘fractional reserve’? That’s a redundancy. Reserves are, by definition, a fraction of deposits if you’re running a bank. In a bank, deposits are the source of money to loan. That’s banking. Banking is part of the institution of division of labor and specialization. This way we have people in banking who know, under laissez-faire, what they are doing. This helps depositers and lots of others, everybody, actually, make money on the production of goods and services. There’s no increase in the money supply but what there’s a greater increase in production first. So we have, generally, non-deflationary falling prices.

    Your statement, by its actual wording, might seem to make your case. But if those words are, indeed, attached to meanings and definitions, and therefore to actual things, as I assume you intended and made them to be, they might not make your case. I think I’ve identified an honest,
    sound and productive way to make a living: fractional reserve banking, or simply, banking.

  8. When a bank lends on a fractional reserve it is doing two things simultaneously. It is lending money and it is supposed to be holding funds it has accepted from another person (the person who deposited money in the bank) as a demand deposit. As a demand deposit, the money is to be immediately available to the person who deposited it ON DEMAND. As soon as the bank lends out its demand deposits such that there is less money immediately available than there is outstanding in loans, then someone is having fraud committed against them. The bank is bankrupt by definition, and should all request their demand deposits, some one or some group would not get their money. If the bank can not cover its demand obligations, it is committing fraud. The idea that, ‘in general,’ everyone does not demand their deposits at the same time, does not mean fraud is not being committed, and there are plenty of historical examples to show that banks have exposed their bankruptcy on multiple occasions and people have indeed had some of their life efforts stolen from them.
    The situation of course changes if the money deposited in the bank is accepted under a time contract. In that case there is not both a person both using the money and another person expecting its current immediate availability.
    The further problem is that this process of fraud, which most have been taught to think is just ‘banking,’ is a form of cash based inflation. This allows the bank to profit from loaning money created out of thin air that steals value from every other money unit in the system in question.
    Take a very simple economy in which ten people have 100 gold coins each, and each person produces 10 units of product. If a bank stores everyone’s 100 gold coins in demand deposits, but loans one person 800 gold coins with a one year loan at 10% interest. Now look at the amount of money in existence. Each believes his demand deposit is at the ready. That’s 1000 coins total, but now one person has another 800 coins with which to bid for product. What has happened to the purchasing power of the coins of the others who did not get a loan? Money created out of thin air enters the market, stealing its power to trade for products from the ‘unfabricated’ money really owned by the depositors.
    This is hidden in all such fractional reserve operations, but is hidden by size and complexity. This is a fraud completely in addition to the fraud of hiding the bankrupt state.
    Hiding fraud and money supply expansion does not make it somehow not be a violation of individual rights.

  9. Today at 3:58 PM

    I must mention that by ‘demand deposit’, I mean regular savings accountswhich can be drawn on at any time, not checking accounts. Maybe my terminology was wrong, but let me now use the term, ‘savings accounts’.

    By your statement, if a bank loans ANY of its savings account deposits, even 1%, it is fraudulent and bankrupt.

    ‘Cash based inflation’? Money, actual cash, which is derived solely from
    production can’t be inflated. Counterfeit ‘money’ inflates its own
    value from zero to something by leaching value from real money according to the relative amount of counterfeit and real, until all units, of
    either, are treated as equal, because when done by ‘government’ you can’t tell the difference, so you must value all units equally. But we can
    tell the total effect, by something like what we call the consumer price
    index that measures what we call inflation. This is crime based, not
    cash based. In a free market, even huge gold discoveries and huge
    international gold transfers don’t cause inflation. Infesting, infecting and displacing actual government with crime expressed as counterfeiting does. ‘Banking as usual’ (fractional reserves) is not to blame.

    Banks contract, under contract law. with every single supplier and customer. If I deposit or borrow any amount of money, large or small, that transaction is done by contract under contract law. That’s all that is needed. Fraud is immediately subject to criminal legal action. Incompetence is subject to civil action.

    In the very simple economy you cite, no fiat or counterfeit money came into existence, and there was no effect on the purchasing power of any of the 1,000 coins. But the guy who borrowed the 800 coins (one of the ten guys, I assume) ended up with 820 coins (82% of the money). The other 9 guys shared the other 18% (180 coins) equally, or 20 coins each.

    Now the central bank and other counterfeiters will supply fiat money over and above the 1,000 coins. That DOES lower the purchasing power of all money. Fractional reserve banking doesn’t. It only borrows and lends money, whether the money is real or counterfeit. It doesn’t violate individual rights. Counterfeiting, especially by central banks, does. The central bank does it to ‘hide’ the actual bankruptcy of the state, by stealing everybody’s purchasing power, with counterfeit money. Mike Kevitt

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