Auerback: You Can Thank Ben Bernanke for Higher Food Prices

By Marshall Auerback, a portfolio strategist and hedge fund manager who writes for New Deal 2.0

Although I have consistently taken the line that QE is totally useless, in effect an accounting trick which does little for real economic activity, I should have at least acknowledged its powers in terms of fomenting casino-like speculation in the financial markets. Mind you, that’s nothing for the Federal Reserve to be proud about, and it is certainly inconsistent with its stated mandate of controlling inflation and promoting employment.

That said, you can lay a lot of the current gyrations in the commodities complex, bonds, equities and currencies at the doorstep of the Federal Reserve. My friend, Michael Hudson of UMKC, has made the same point: “What is to stop U.S. banks and their customers from creating $1 trillion, $10 trillion or even $50 trillion on their computer keyboards to buy up all the bonds and stocks in the world, along with all the land and other assets for sale in the hope of making capital gains and pocketing the arbitrage spreads by debt leveraging at less than 1% interest cost?”

This is the game that is being played today as a consequence of the Fed’s embrace of “QE2”. So when the Financial Times warns of a global food crisis, one can put 2 + 2 together and begin to understand the damage the Fed and its perversely Wall Street centric approach to economic policy is doing to our economy.

In fact, one has to query whether the increasing “financialisation” of the commodities complex has played a significant role. Previous to 2000, pensions could not buy commodities because these are purely speculative bets. There is no return to holding commodities unless their prices rise—indeed, holding them is costly. However, Goldman Sachs promoted investment in commodities as a hedge, on the basis that commodities prices are uncorrelated with equities. This is understandable, given the historic lack of involvement of Wall Street in the commodities complex. Hedging activity was generally restricted to end-users like farmers.

That all began to change in the aftermath of the Commodities Futures Modernization Act of 2000, another legacy of the Clinton/Rubin/Summers regime. Of course, the whole basis of the arguments for commodities as a “defensive hedge” non-correlated to financial asset went out the window the minute this legislation was passed. By definition, when managed money flows into an asset class that had previously been uncorrelated with other assets, that asset will naturally become correlated. Hence, by opening up the commodity complex to Wall Street via this legislation, Congress found another potential bubble for Wall Street. Naturally, this garnered huge profits for the investment banks, but ultimately collapsed along with everything else (leaving your average American poorer in the process as usual).

We saw a recent example of this during the oil price spike of 2008. Recall that the Federal Reserve began to cut rates and flooded the system with liquidity in response to the subprime collapse of 2007. Markets for speculative credits were already under great pressure by late 2007. There were no more returns to be earned from leveraged bull speculation in these markets. It appears that leveraged speculators descended on the smallest of all markets – the commodity markets – because they were small enough to squeeze, corner, and thereby generate with lesser financial resources both bubble action and bubble returns.

In spite of the clear deceleration in the US economy, and the correspondingly sharp deterioration in global economic activity, the falls in the stock market and real estate markets, oil prices almost doubled during the first half of 2008. The financialization of commodities, including the growth of OTC markets, pushed prices well out of line with fundamentals. Finally, after midyear marks were posted by leveraged speculators at the end of June 2008, the commodity markets started down. In percentage terms they fell by more in six months than they had ever fallen in history.

Voters might not understand collateralized debt obligations or credit default swaps, but they do understand the ramifications of paying $4.00 plus per gallon of gasoline. The energy bubble popped in what is known as the great Mike Masters inventory liquidation, as pension funds pulled out of commodities on the fear that Congress was coming after them. They didn’t want all the bad publicity that would be caused if workers knew that it was their own pension funds that were driving up gas prices at the pump.

We have just had some pretty spectacular moves in agricultural commodities. They were triggered by adverse weather events around the world which have resulted in production shortfalls. But are these production shortfalls sufficient to explain the percentage gains in these agricultural commodity prices? Probably not. Microeconomic theory says that commodity prices should be driven by the stock to consumption ratios in these markets as well as the rate of change of these ratios as a function of current and projected surpluses and deficits. This used to be more or less the case before Wall Street got its hands on the commodities complex.

Below is a chart of the price of wheat and the global stock to consumption ratio. What do they tell us? Though wheat’s stock to consumption ratio fell into 2007, the decline probably did not warrant the gigantic rise in the price of wheat which then ensued. More importantly, by the first half of 2008 the wheat market was in surplus and global stocks were building to very comfortable levels. The price of wheat should have fallen. Instead it spiked to a degree not seen in a generation.


And take a look at this chart:


More recently large global surpluses have resulted in a high global wheat stock to consumption ratio. This stock level might be in fact higher than the historical data suggests because there has been a tendency across all markets for inventory to sales ratios to fall in a secular fashion. So surely several months ago global wheat stocks were on the high side.

As Frank Veneroso has noted in a recent report (“Commodities: Speculation Driven by Expectations of QE Now Dominates” Oct. 8, 2010):

We have now had a weather shock. It has reduced greatly the Russian crop, as well as crops elsewhere. This supply shortfall has thrown the global market into a deficit. However, this deficit is not that large. Based on the latest USDA data and projections the global wheat stock and the wheat stock to consumption ratio will retrace only a small part of their large rises over the prior year.

Long-time commodities trader and portfolio manager Mike Masters discussed this phenomenon with me in a recent email exchange. According to Masters:

Speculation in commodities can be exemplified from the following illustration. Money can be “created” by fiat. Because there is already much more capital available in the world than hard commodities, and also because money can effectively be created in a nearly infinite way; speculators, without limits, and with determination, can increase the price of consumable commodities, like food stuffs or energy, much higher than traditional consumers and producers (hedgers) can react. When derivative markets are linked to real commodity markets, this nearly unlimited capital from the financial sector can cause financially driven excessive price volatility. This is because in the derivative markets, a nearly infinite amount of new commodity derivative contracts can be created to satisfy the demand of financial sector speculators armed with fresh capital. However, because there is only a FINITE amount of bona fide actual hedgers (producers and consumers of the actual commodity), any speculative demand that exceeds the real amount of commodities that can be hedged at that time must be sourced from other speculators. However, these speculators will only supply new contracts via price- i.e. a new speculative demand that exceeds hedger supply must be sourced from new speculative supply at ever higher prices.

I believe that the activity in the soft commodities illustrates that investment and speculative demands still prevail in spite of the horrific crash sustained in this complex in 2008. The casino behavior of the bubble era – actively fomented by the Federal Reserve and accelerating today – still predominates, and investor and speculator attention to underlying fundamentals is disparaged.

This is all about the coming QE via “Helicopter Ben” Bernanke. He and his cohorts in the Fed are actively inciting greater speculative risk and no doubt will attempt to backstop these bets when they go bad. In the meantime, as my colleague Randy Wray has noted,

Wall Street just happens to be marketing commodities futures indexes to satisfy the demand it has created. It also provides a wide array of complex hedging strategies to shift risk onto better fools, as well as credit default ‘insurance’ and buy-back assurances in case anything goes wrong. If all of these “risk management” strategies were completely successful, the pension fund would achieve a risk-free portfolio.

There is growing evidence that the global economy is now slowing, yet commodity prices are rising in tandem with equity prices. Bond prices are rising as well. In the third quarter of 2010, the prices of equities, government bonds and gold all went up – by 11%, 4% and 5% respectively. Such a conjunction of asset returns is a rare event in the financial markets. In the 123 calendar quarters since 1980, there have been just 4 other quarters, each in the 1980s, when all three asset classes have gone up by 4% or more. The rarity of this event is because there are virtually no economic or financial scenarios that favor equities, government bonds and gold at the same time – at least under normal circumstances.
This is all being driven by the expectation of “QE2”. From the Fed’s perspective: mission accomplished. Animal spirits have been re-ignited in the financial markets (would that the Fed could do the same for the real economy, but unfortunately, that’s in the hands of governments which are totally ignorant of the true uses of fiscal policy).

In effect, we are re-establishing another bubble, seeking to restore the status quo ante that prevailed in 2006 when the creation of bubbles was the main driver of economic activity. Typically, these bubbles prevail because our governments repeatedly succumb to political pressure from the conservatives and either don’t expand fiscal policy enough or prematurely abort fiscal expansion. These episodes have repeatedly occurred in history.

The end result is that the onus is left totally on monetary policy, which has over the past quarter century been conducted with a view toward ensuring the well being of Wall Street, than enhancing the productive sectors of our economy. If quantitative easing by the Fed and other global central banks turns out to be dramatic, the desire to hold physical assets may increase – no matter how high their cost of carry and how weak the global economy may become. Commodity prices will then remain high relative to stock availability, and might go much higher.

But the current state of affairs is unlikely to last. On the previous occasions that equities, bonds and gold moved up together, at least one of the assets ultimately proved to be mispriced. At the end of 1980, bond prices declined by 20%, while gold plummeted by 40%. In 1983, bond prices fell 10%. Serious collateral damage can occur in the real economy when the Federal Reserve incites speculative bubbles. So the next time you are wondering what’s happened to all of your discretionary spending power, as you plunge into that pricey breakfast cereal, or ponder your rising grocery bills, you can thank Ben Bernanke and the Federal Reserve.

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  1. attempter

    It’s a moral axiom that speculation in commodities should be outlawed. It’s a crime by any human measure, and a system which allows it is a criminal system.

    So let’s tie this all together. We have:

    1. Peak Oil will force agriculture back to its normal state. Industrial food production and distribution are unsustainable. For that reason we have to grow our own food.

    2. The existing food pricing system is in the hands of criminals who, if we stay in their power, will render eating ever more expensive for us and our children. Our children will go hungry. For that reason we have to grow our own food.

    3. Those same criminals claim to be the “owners” of all the existing farmland and all the potential farmland (the land currently mired in unproductive “suburbia”, land which we cannot afford to allow to remain unproductive, for reasons 1 and 2 above). But they never had any moral or rational ownership of this land, and as the MERS meltdown demonstrates, they’ve even abdicated their “ownership” according to their own rigged law. Meanwhile as housedebtors and as many other forms of debtor we stagger under the tyranny of these gangsters. They’ve done nothing but rob us and assault us, and they’ve given nothing in return. NOTHING. Who could accept this state of affairs?

    4. So how to solve 1, 2, and 3 at one stroke? We must restitute the land and grow our own food on it. That will be simple to do – just stop paying the fraudulent debts, and start working the land.

    So there’s the basic plan for our liberation and survival. It’s just a matter of organizing it.

    1. NS

      The buy local markets are growing nationwide. The push back from subsidized large AG who grow sterile seed crops is gaining traction as well as industrialized treatment of animals. It is a tough row to hoe (pun intended) for small farmers trying to make a living in these niche markets. It is a growing movement as quality and variety over quantity with growing awareness by consumers increasingly supports small and medium producers who are brave and hard working in a nation that turned its back on local producers.

      Family farmers, diaries, ranchers, orchards, etc. were and continue to be punished, bought out and wiped out. The quality and variety of food continues to decline as near monopolies cut corners for profitability.

      Finally and apologies for harping but the CFMA opened a Pandora’s box. It is a mere 11 years old; without this legislation the financialization in trading futures and commodities would not be nearly as profound as it is now.

      Lastly and again apologies for harping. Attaching fuel (ethanol from corn) production to food production is fools folly. This also increases the incentives in large AG and in futures trading that further pressures real production and supplies of food commodities.

      Without reforms in futures trading and who can trade in OTC markets incentives will continue to punish everyone from family farmers to children on assistance for food as those funds buy less and less.

      I consider it criminal in every sense of the word. The masters of high finance have created a monster. The incentives rewarded using our land in perverse ways to perverse ends. Our diversity in land, producers of food was squandered, financialized, politicized and ruined.

      The consequences for these sins against our land, people, farmers, animals and nature itself will be profound.

      1. attempter

        I wonder how many people reading this blog are aware of the true nature of the Food Tyranny bills looming in Congress.

        While government cadres and system hacks tell soothing lies about what the bills intend to do, the fact is that their language empowers total federal control over ALL food production and distribution.

        As for their true intent, we can judge it be actions like this

        which are becoming more and more common.

        And like you said, the ethanol mandate has to be repealed as well. It’s nothing but a destructive boondoggle which does tremendous socioeconomic and environmental harm but benefits no one but a few racketeers.

    2. Howie

      Google “how to raise your own vegetables” and get busy.

      Today is the time to start building these skills, gathering materials and starting something. If you live in a place without a yard, you might want to rent or buy or arrange
      a place with land, even if it’s small. A large percentage
      of the Russian population survived the post Soviet era
      because they had a small garden plot.

  2. skippy

    Some people like to play with their food, before they eat it.

    Skippy…bad table manners…me thinks.

  3. john bougearel

    The CFMA of 2000 was more than a legacy of the Rubin/Summers regime.

    One can look back at that act and say that it was precisely intended for creating speculative new investment vehicles to profit off of the inevitable dollar devaluation game that got underway in 2001 shortly after the act was passed and the Fed cut rates to 1% in 2003 then to 0% in 2008.

    As Yves might say, the unusual pricing behaviors we find in the commodity mkts today is a feature not a flaw of the CFMA

  4. Jim Haygood

    Here’s the chart that Marshall Auerback forgot to include in his essay — the US dollar index:

    I mean, how can you write a whole essay about rising commodity prices without even mentioning the external value of the dollar, which shows a strong inverse correlation with gold and other commodities?

    Not coincidentally, the dollar index was scraping bottom in mid-2008 when commodities hit their last peak. Moreover, in the idealized business cycle, the traditional sequence of peaks is bond prices (June 2003), stock prices (Oct. 2007) and commodity prices (July 2008). Although the amplitude of the mid-2008 commodity spike may have been turbocharged by financial speculators, its timing was unremarkable from a cyclical point of view.

    Auerback’s dig at ‘conservatives’ for interfering with fiscal stimulus is unsupported by evidence. The spending profiles of George W. Bush and Lyndon Johnson (Rep/Dem, Lib/Con, etc.) were indistinguishable. The tiresome, obsolete liberal/conservative axis is a useless framework for economic analysis.

    Auerback is quite right that sequential bubbles are the intended result of QE II. Ben Bernanke is a modern-day Johnny Law. It’s been this way since ‘full fiat floating’ commenced in August 1971, which one MMTer has bizarrely celebrated as ‘monetary independence day.’ The independence of an unelected elite to spin leveraged bubbles, of which they are the primary beneficiaries, is one that the rest of us could do without!

    1. Tao Jonesing

      Quantitative easing, by definition, devalues the dollar. He probably should have included a chart, but he probably thought it was unnecessary.

      The worst part about your chart is that the recent devaluation of the dollar started with talk of QE2, not actual QE2. I’ll be interested in seeing how much further devaluation we see when the full magnituded of QE2 is announced.

      At the end of the day, I wonder how QE is reasonably calculated to maintain stable prices (i.e., keep the prices of consumer staples down) and produce maximum employment. Given the macro situation in the U.S., the only thing more QE can do is increase speculation for commodities in the consumer area, which will dive consumer prices up and likely lead to more unemployment as demand is soaked up by buying the necessities like food and gas.

      1. Jim Haygood

        Commodities are no exception to the adage of ‘buy the rumor, sell the news.’

        It’s entirely possible that if QE II commences on Nov. 3rd, most of the moves in the dollar, bonds and commodities already will have occurred.

        Although rising gasoline prices are a drag, a falling dollar (with a lag) should boost US exports and GDP.

        More importantly, I think, the Fed’s statement that inflation is uncomfortably low should be taken at face value. Though it’s playing with fire, a 5% rise in the CPI (including house prices) for a couple of years would ameliorate a lot of problems with negative-equity property.

        The risk is an overshoot in which the dollar gets sold down so hard that it’s abandoned as a reserve currency. This is going to happen anyway — an overindebted, chronic capital importer’s irredeemable currency can’t aspire to this role.

        So Banzai Ben Bernanke and his merry pranksters have decided to lace the Fed’s proverbial punchbowl with LSD instead of vodka, and see what happens. Ben’s thinking ‘Magical Mystery Tour;’ I’m thinking ‘They’re Coming to Take Me Away.’

  5. john bougearel

    Thanks Richard

    Overall a very nice treatment of a fairly challenging topic.

    I would like to point out that the rarity of all asset classes going up simultaneously in 2H 2010 (including foreign currencies which you left off) is the result of Great Unwind in the worlds reserve currency that is going to be devalued through the Fed’s QE program. The severity of the Dollar Unwind is also a function of not knowing the exact size of the next QE program.

    The Fed has created some uncertainty with respect to the size of QE 2, and that uncertainty is increasing the volatility in these highly correlated trades in bonds, equities, commods, and fx. The Great Unwind in the worlds reserve currency can also be viewed as an “anything but dollars” investment strategy. This investment strategy will be more or less viable for the foreseeable future until the global trade imbalances amongst debtor and creditor nations find some sort of harmonic convergence or equilibrium. Getting there is going to create tremendous disequilibrium. And yes, we will see some highly correlated bubbles across all asset classes along the way, but not all asset bubbles will burst simultaneously. US Treasuries for instance may not burst until all the foreign debt and private sector debt has been restructured….then investors will turn on US treasuries with a vengeance…But until then, treasuries have staying power that won’t be possible in other asset classes….

    And don’t think the Fed is not totally aware that increased uncertainty in the financial mkts = increased volatility….

  6. DownSouth

    When I read things like this post, or like Tim Duy’s Must Read from yesterday’s Links, it just makes my head spin. It’s like viewing a massive machine, with all these interlocking gears in constant motion, moving this way and that, some gears hidden from view, so that it becomes impossible for the human mind to encompass and understand it all.

    But what comes out of this machine is pretty simple, and not difficult to understand at all. As my retired brother living on a limited fixed income says, the necessities, like food, grow rapidly more expensive. But the things you don’t need, like flat-screen TVs, grow cheaper and cheaper.

    But because cost-of-living adjustments in Social Security benefits are automatically set by a measure adopted by Congress in the 1970s that orders raises based on the Consumer Price Index, which is based on things you don’t need as well as things you do need, senior citizens are bracing for a Social Security freeze.

    And while senior citizes are enduring a social security freeze, they are drawing almost nothing on their savings.

    And to add insult to injury, while all this is going on the banksters grow richer and richer.

    Could it be that this machine is just too complex for policy makers to foresee what the final result of their policies will be, or for them to control the final outcome? Or are we being conned?

    1. Siggy

      The machine is the construct of humans. It’s not a mushroom, people made it.

      To understand it you need to look to that which is the fuel for the system, the money supply. Money exists in two primary forms, the coinage and currency; and credit money which exists largely as demand deposits.

      Our current problem is centered on the fact that we have created more credit money than can be repaid. You should treat that unserviceable debt as that amount of credit money which is the basis of inflation. The reciprocal of inflation is a loss of purchasing power.

      It is this business of declining purchasing power that is the incentive to speculate and to steal. QE??, pick an iteration number, avoids the fundamental problem which is how do we liquidate all that excess credit money.

      Politically, liquidation and/or deleveraging is a painful process that tends to severly constrain economic growth. In that, recognize that the house price bubble is being supplanted by a treasury instrument bubble. The treasury instrument bubble will continue until such time as the Fed and the Treasury are forced to cease and desist in their madcap effort to forstall the deflation that is necessary to restore a reasonable balance between aggregate demand and aggregate supply.

      That restoration will not be accomplished in a short period of time. Moreover, current pain avoidance policies are contributing to the creation of an even greater problem that could lead to civil unrest.

      While Mr. Auerback is correct in faulting Mr. Bernanke, the blame for our current predicament is wider in responsibility and much much older in orgin with the Full Employment Act of 1946 being the probable date and event of conception.

      As I reflect on our current circumstance relative to earlier empires, I’m struck by how much peril we face as a nation. As much as there are external threats, it is more probable that a few financial/politcal insiders will destroy the Republic and their instrument of destruction will be their ignorance as to the necessity the currency having a stable and inherent redeemable value. Absent that quality of being a reliable store of value in the presence of all the ingenuity for conivance and theft that humans can conceive, I see the demise of the US as being inevitable. It’s not that the US will go away, it’s that it will no longer be the master of it’s destiny.

      1. patient_anarchist

        to sum up your post: i’m invested in the current system and am hysterically frightened.

        i personally am cheering on this much needed collapse of market capitalism. for someone who desires social justice witnessing the ululations of the bourgeoisie is pure schadenfreude.

        “The life of a single human being is worth a million times more than all the property of the richest man on earth.”


        1. traderjoe

          I don’t believe our current system is “market capitalism”. You might be able to argue that it be the inevitable evolution of market capitalism (where large corporations capture government and regulators). But it is most certainly not market capitalism. I’d also work with an argument against the granting of corporate status, as it gives an entity all of the rights, but none of the liabilities of a natural person.

          My fears of a system that promotes more “social justice” instead of more “individual liberty” is that the next logical steps are more fascism, socialism, or some other “ism”. Out of the frying pan, into the fire. Not so long ago (before the Fed/Income Tax), government spending was 2% of GDP. No standing armies, no military/industrial complex, no FIRE skimming off of America.

      2. F. Beard

        As much as there are external threats, it is more probable that a few financial/politcal insiders will destroy the Republic and their instrument of destruction will be their ignorance as to the necessity the currency having a stable and inherent redeemable value.

        When you pay taxes with that currency, you redeem your property from being seized or your body being thrown in jail.

        Absent that quality of being a reliable store of value in the presence of all the ingenuity for conivance and theft that humans can conceive, I see the demise of the US as being inevitable. Siggy

        If the US falls, it will not be because of fiat money; it will be because it gives bankers the privilege of creating money from nothing (credit).

        1. traderjoe

          Yes, I would date the beginning of the inevitability of our collapse to 1913 – the creation of our third central bank, a privately-held institution given a monopoly in the creation of our money in contravention of our constitution.

    2. Hugh

      I take the opposite tack. I see the US economy as large but not particularly complicated. It isn’t that the economy can’t be managed. It is, in fact, being managed now. The problem is essentially that those currently managing it are a self-serving assemblage of thieves, kooks, dopes, and conmen. They are not managing the economy for our benefit, but theirs. It doesn’t have to be this way. And because the current system is inherently self-destructive and unsustainable, for good or ill, it won’t be this way for that much longer. Personally, I find economic optima pointless fictions, but that said, there are reasonable, sensible ways of running an economy so that it is sustainable and socially responsible and fair.

  7. killben

    If renominate people like Ben Bernanke and let them set monetary policies this is what you are like to get. Only this genius can figure out what he is trying to achieve.

    Talk about bull in a china shop.. in this case the shop is the world ..

  8. sherparick

    Bretton Woods II was not a happy time for the American Middle Class as this chart from Edward Harrison dated to 2008 shows.

    Certainly, U.S. real wages have declined further over the last two years with high unemployment. Peter Boockvar wrote recently on “The Big Picture” that “U.S. Business will start spending once costs are reduced…” He was probably referencing the current meme in the business community that there is a Galtian “capital strike” due to the supposed tax increases, health care costs, and environmental rules imposed by the Obama administration. Since to date the only thing the Obama administration has passed is business tax cut, the health care reform taxes and fines are well into the future, and the environmental policies of the Obamaites are nothing much more than what Reagan and Bush I imposed in the late eighties and early nineties, this is a joke. But 70% of the cost business is personnel, especially in services. Pressure on manufacturing wages eventually pulls down service and white collar wages, especially white collar jobs that the internet and telecommunicaitons revolution allows to be outsource and minimal cost to low wage countries.

    Economic crises and the end of Empire are very hard on the national states that suffer them. It looks like we are about to elect a Republican majority, who glory in their moral obtuseness, intellectual stupidity, and authoritarian, resentment filled, inclinations make the will o’ wisp Democrats (who lack all conviction in their alleged pro-worker policies) look good. They may well crack the country and its institutions open.

    1. DownSouth

      “…the end of Empire are very hard on the national states that suffer them.”

      True, but unrealistically clinging to former imperial glories makes the hardship far worse than it needs to be.

      Spain also became the first example of an anomaly that the United States runs the risk of repeating as our own century ends: that of being a poor empire, debt-ridden, incapable of solving its internal problems while insistent on playing an imperial role overseas, but begging alms from other, surplus-wealthy nations in order to finance its expensive role as a world policeman.


      The Spanish writer Fernando Diaz Plaja finds a provocative parallel in the situation between Spain and the United States. Both, at the height of their influence, joined military and economic force to an obsessive belief in their own moral justification. Whether against Protestantism, in the case of Spain, or against communism, in the case of the United States, the nation overextended its power, postponed solving internal problems, and sacrificed generations. And even when the enemy ceased to be menacing, the desire to use power persisted, inebriating addictive.
      –Carlos Fuentes, The Buried Mirror

      [Olivares] was also the heir to another tradition which had found powerful advocates in the Spain of Phillip III—-the great imperial tradition, which believed firmly in the rightness, and indeed the inevitability of Spanish, and specifically Castilian, hegemony over the world.


      [Olivares] believed…that Spain could remain true to itself only if it remained true to its imperial tradition, and [he] despised the defeatist policies which had, in [his] opinion, brought it to its present miserable state.


      [Olivares embarked upon a number of military adventures which proved disastrous.] In 1637 the Dutch recaptured Breda, whose surrender to Spinola in 1625 had been immortalized by Velazquez. In December 1638 Bernard of Weimar took Breisach—-a far more serious loss, since it meant that the Spanish road from Milan to Brussels was cut, and that the Spanish armies in the Netherlands could only be reinforced by sea through the English Channel. Then in October 1639, Admiral Tromp defeated the fleet of Don Antonio Oquendo at the Battle of the Downs, destroying at a single blow both the navy on which Olivares had expended so much effort, and the chances of sending relief to the Cardenal Infante in the Netherlands. On top of this came the failure of the combined Spanish-Portuguese armada which set out from Lisbon in September 1638 to attempt the reconquest of Brazil.


      So passed the first and the last ruler of Hapsburg Spain who had the breadth of vision to devise plans on a grand scale for the future of world-wide Monarchy: a statesman whose capacity for conceiving great designs was matched only by his consistent incapacity for carrying them through to successful conclusion.


      [Spain’s] currency was chaotic, its industry in ruins, its population demoralized and diminished…. [T]rade itself was now largely controlled by foreign merchants, who had secured numerous concessions from the Spanish Crown. Castile was dying, both economically and politically, and as the hopeful foreign mourners gathered at the death-bed, their agents rifled the house.
      –J.H. Elliott, Imperial Spain: 1469-1716

      1. Jim Haygood

        ‘On top of this came the failure of the combined US-NATO armada which set out from Washington in October 2001 to attempt the reconquest of Afghanistan.’

        Nine years later, and the NATO clown posse is in deeper doo-doo than ever.

        World War II ended 65 years ago, but the troops have yet to be demobilized from rich democracies such as Germany, Italy, Japan and South Korea.

        What a monumental failure of vision!

        Our ‘superpower’ military fantasy is an economic doomsday machine, slowly bleeding the US economy to death.

        Don’t the Joint Chiefs have any economists or economic historians working for them? Foreign enemies aren’t the main threat; it’s the homebrewed mismanagement and decay, of which they are a prominent part. An intelligent parasite doesn’t kill its host.

  9. F. Beard

    Nice article. Thanks Mr. Auerback. As usual, the banks’ ability to counterfeit is the root of the problem.

    I’ve been reading “The Lost Science of Money” by Stephan Zarlenga. It cost me $81 but is worth it.

    1. Jeff65

      I agree, good article, but it’s amazing the degree to which people take away the message they already “know.”

      I took away this message:

      Allowing the investment banks to play in the commodities markets is a bad idea.

      The banks had the ability to “counterfeit” prior to the speculative problems starting.

      The banks ability to “counterfeit” is simply a private – public partnership. If the banks didn’t do this, the government would have to do it.

      1. F. Beard

        The banks ability to “counterfeit” is simply a private – public partnership. If the banks didn’t do this, the government would have to do it. Jeff65

        I disagree. What is at play here is George Soros’s Theory of Reflexivity. The banks create temporary money (credit) which drives up prices which in turn is used to justify more money creation which drives up prices further and so forth till the bust.

        If government issued all new money and outlawed fractional reserve lending then a finite money supply and the resulting high interest rates would preclude significant speculation.

        That is not what I advocate,BTW. I believe government and private money supplies should be separate. No partnership is necessary or desirable.

        1. Jeff65

          The problem clearly isn’t the creation of money itself; it is whether the banks follow the rules by lending to credit worthy borrowers. If prudent public lending is enforced (why not force the banks to keep all loans they originate?), there can’t be a bust without fraud. If there is fraud, the disincentive should be jail.

          Without the competition of public lending (which the banks perform with consent of the government), the toll-booths erected to access existing private capital would destroy the economy.

          The banks should be doing the functions the government would have to do in order to perform public lending. The Glass Steagal Act kept this function somewhat separate from the casino. That’s where things really went off the rails.

          The banks have gotten to keep their standing as “counterfeiters” while we’ve taken all the constraining rules away. We need to keep the public lending function and put the rules back (and add some new ones.)

          Fractional Reserve Banking is a gigantic canard. Most people hyperventilating don’t understand the difference between bank reserves and capital requirements.

          1. F. Beard

            The problem clearly isn’t the creation of money itself; … Jeff65

            Indeed it is the problem. Banks extend credit in OTHER people’s goods and services because they deal in the government enforced monopoly money supply. The purchasing power for that credit (temporary money) is stolen from all money holders, including the poor.

            it is whether the banks follow the rules by lending to credit worthy borrowers. If prudent public lending is enforced (why not force the banks to keep all loans they originate?), there can’t be a bust without fraud. Jefgf65

            Prudent theft? And in fact, the bust does not require fraud at all. Credit worthy? In aggregate, the entire population is NOT credit worthy because FRL creates the principle for loans but NOT the interest. Some defaults are thus guaranteed no matter how “credit worthy” those unlucky defaulters are.

            If there is fraud, the disincentive should be jail. Jeff65

            FRL is based on this fraud: “Your deposit is available on demand even though we lent it out.” Every FR banker should be in jail by that standard,

            Fractional Reserve Banking is a gigantic canard. Most people hyperventilating don’t understand the difference between bank reserves and capital requirements. Jeff65

            Fractional reserve banking is a deliberately mysterious topic which is indicative that it is dishonest. However, an increasing number of people are wising up to it. Your reverting to insults is indicative of your shaky defence.

            Even Karl Denninger blushes to defend FRL. There are alternatives to usury for our private money supply such as common stock, futures contracts and perhaps some others. As for government money, it should be pure fiat and legal tender for government debts only.

          2. Jeff65

            F Beard,

            Wow. Stating a fact is not an insult.

            Good luck with the twin money supply idea. I can’t imagine what purpose such an arrangement will serve, but from your response it is clear you don’t believe in exposition.

  10. Hugh

    My initial interest in economic issues came from watching gasoline price movements post-Katrina. I then started looking at oil prices. A little before the big price spike in 2007, I became interested in historical oil prices. I quickly noticed that oil prices started going off the rails in 2004. You see on the oil futures market you would expect there to be reactions to events that threatened disruptions in supply but after these passed (a war scare in the Middle East, a hurricane that missed), you would expect prices to return to their previous levels. But beginning in 2004, they don’t.

    At about this time, a friend who knew of my ideas came across this Senate report:

    written in 2006 which had come to the same conclusion I did, that excess speculation had entered the oil market in 2004.

    It is still there. I have been saying for an age that the “real” price of oil, that is the price without the effects of excess financialized speculation, should be somewhere around $35/bbl, given the weak state of the world economy.

    For those who would invoke Peak Oil, I would just say that while we are already in Peak Oil, the peak at the moment is more of a plateau and the descent has not yet begun. And its effect on markets so far has been negligible.

    A couple of other notes, the entrance of non-commercials into the futures oil markets like the NYMEX was allowed by the CFTC in 1993 by the swaps loophole. The 2000 CFMA allowed OTC trading of future like instruments via the Enron loophole. Things were opened up even further in 2006-2997 with the London-Dubai loopholes which allowed this kind of trading in exchanges outside the US. While there has been some retrenchment in terms of the London-Dubai parts, the other loopholes remain wide open or easily circumventable.

  11. Cathryn Mataga

    It goes down like this. Speculators bid
    up the prices of of commodities, as described
    in this article. Then, the best profits
    are made by hoarding and then selling
    commodities to the next higher bidder. Why use
    a pound of copper to make a water pipe, when
    you can hoard it and sell it to a speculator
    for even more money?

    With impossibly high commodity prices,
    production of tangible goods
    declines. With declining manufacturing
    wages decline, then demand declines, and
    manufacturing declines even more. We
    end up like that Klingon prison planet,
    where everyone is digging in mines to
    haul up hoards of materials for the
    super-rich to speculate on.

  12. Dan

    The primary purpose of the FED, as it was sold to the public in 1913, was to prevent system wide collapses and control deflation / inflation in response to the Panic of 1907.

    When it becomes the entity (conspiracy or not) that creates the system wide collapses (See Louis T McFadden’s impeachment efforts and exacerbates deflation / inflation, it no longer can justify its existence under the original mandate.

  13. Cedric Regula

    Recent comment from Yellen:

    “Second, recent research has identified possible linkages between monetary policy and leverage among financial intermediaries. It is conceivable that accommodative monetary policy could provide tinder for a buildup of leverage and excessive risk-taking in the financial system.”

    Next thing you know they will postulate that unprotected sex could lead to babies.

    Tis hard to keep up with the knowledge effusing from these folks.

  14. Eric L. Prentis

    Emperors, kings, dictators and tyrants would enjoy power still if massively monetizing debt solves economic problems. It’s unworkable, period! The QE2 threat is driving up food and energy prices which hits Americans hard, slowing down the real economy, causing a disastrous double-dip recession. Having a private company control the US money supply is unsound. Expect the Fed to lose this valuable franchise when their failed QE2 causes the second, and much worse, recession. Our leaders are either idiots, or Machiavellian villains.

    1. F. Beard

      Emperors, kings, dictators and tyrants would enjoy power still if massively monetizing debt solves economic problems. It’s unworkable, period! Eric

      First, those folks were usually limited to non-fiat solutions. Second, a direct bailout of the debtors (savers too for the sake of fairness) would by definition fix their balance sheets. Third, a bailout of the population would be JUSTICE.

      I agree that indirect methods, such as QE, to cure debt should be shunned. But a direct bailout of the victims of the counterfeiting cartel should work.

      ref: Deuteronomy 15, Leviticus 25, “Thou shall not steal”, etc.

      1. Nathanael

        Quite right. “Jubilees” involving the cancellation of all debt were a common feature of the ancient world…. and they *worked*. They cleaned out the system but good and things started to get going again.

  15. Eric L

    I guess I’m the only one who finds this rhetorical question (quoted, with apparent approval, from the linked article) absurd on its face:

    “What is to stop U.S. banks and their customers from creating $1 trillion, $10 trillion or even $50 trillion on their computer keyboards to buy up all the bonds and stocks in the world”

    In a nutshell, what is to ‘stop’ them is the fact that banks and their customers they don’t control a recognized fiat currency.

    Banks and their customers may, if they have debt securities to sell to central banks, find themselves in a position where it makes sense for them to sell, thus increasing their liquidity. From that position, they may be inclined to seek other investment vehicles with their cash.

    But they are still assuming risk, and they certainly aren’t ‘creating $1 trillion’, or any other amount, by clicking their keyboards.

    This link is the kind of amateur hysteria-mongering that should be beneath NC.

    1. F. Beard

      This link is the kind of amateur hysteria-mongering that should be beneath NC. Eric L

      The quote was from Michael Hudson, a well known and respected economist. And banks do create temporary money (credit) via keyboard entry in exchange for a promise to repay it. It is called fractional reserve lending but more properly it should be called “new-money-for-debt”.

      “The process by which banks create money is so simple that the mind is repelled.” John Kenneth Galbraith

      1. Eric L

        “And banks do create temporary money (credit) via keyboard entry in exchange for a promise to repay it. It is called fractional reserve lending but more properly it should be called “new-money-for-debt”.”

        They need borrowers to do that. Non-financial household debt is still declining. I have absolutely no idea how Hudson could possibly think that the banks are able and willing to now generate $1tn, or $10tn, or $50tn in new debt issuance (this latter number is about 10 times the total expansion in the shadow banking system over the past decade). In fact, we are seeing ongoing contraction in bank lending.

        Hudson’s remark makes no sense. Someone publishing comments like that is exhibiting confusion; it doesn’t matter what their credentials are.

  16. F. Beard

    Wow. Stating a fact is not an insult. Jeff65

    A fool’s anger is known at once, but a prudent man conceals dishonor. Proverbs 12:16

    Perhaps I’m at fault. My apologies.

    Good luck with the twin money supply idea.


    I can’t imagine what purpose such an arrangement will serve,

    It would insulate the private sector from the follies of government dictated money policy and it would insulate the government (and the population) from the usury class. And it would not be a twin money supply; there would be one government money supply and any number of private money supplies. So basically it would allow the private sector to go about its business without worrying about the Fed and the government could go about its business without having to deal with a nation wide boom-bust cycle. And it would allow the gold bugs to be humiliated, in the free market, by non-usury forms of money such as common stock. I contend that usury REQUIRES government privilege.

    but from your response it is clear you don’t believe in exposition.

    It is difficult to be both truthful and verbose:

    When there are many words, transgression is unavoidable, but he who restrains his lips is wise. Proverbs 10:19

    I enjoyed the chat. I apologise for being testy. Money is a mindblowing topic fraught with pitfalls and sanity traps. My headaches sometimes spills over.

  17. Westcoastliberal

    Remember all the awful villians from the James Bond movies? Dr. No, Goldfinger, etc. That’s what we are facing now. Evil motherfuckers bent on taking over the last penny. Bend over.

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