Diagnosing Government Dyscalculia.

October 16, 2014

This week, researchers in our office arrived at a clinical diagnosis that will forever change the way you view government, as well as most other public institutions.
The premise? Government institutions, big and small, from Neolithic student council to our current Federal government, suffer from a genetic mutation passed from one generation of government to the next. This mutation is responsible for a great number of the decisions made, and consequences rendered, at and from the highest levels.

The mutation shows itself in the form of mass dyscalculia in large public institutions. Those diagnosed with dyscalculia suffer from an inability to learn or comprehend numbers, analytics or mathematic principles.
This inability to comprehend simple mathematical functions has translated into a never-ending series of public economic miscalculations. Miscalculations that would have been otherwise avoidable.
Consider the business cycle, accepted today by most entrepreneurs, executives and government economists as almost biological. Part of the natural industrial and commercial process. Taught within business schools and economics programs nationwide. Respectfully covered in serious books and periodicals.
Yet, today's diagnose reveals that we have been duped.
Today's business cycle, as we know it, represents an elaborate and repetitious pyramid scheme. Created and sustained by errors in economic thought.
The business cycle was born in the mid-eighteenth century. Before then, there had been recessions and depressions. But their catalysts were easily discerned. Perhaps a king required capital to wage war. Or simply wished to bolster his treasury. So, he'd send his henchman out to forcefully confiscate money from his subjects. A process since renamed, "taxation."
This confiscation would lead to a slump in commerce as the kingdom's subjects were deprived of their ability to conduct daily affairs.
Or maybe, during the actions of warfare, one nation would deprive an opponent of a critical resource. As the North deprived Great Britain of cotton during the civil war. Resulting in a slump in those industries dependent upon that resource.
Whatever the cause, it was easily identified. And rectifiable. Short of these exogenous events, economic activity occurred at a moderate pace in a more or less steady, upward trend line.
In the mid-eighteenth century, however, the industrial revolution and the rise of central banking emerged. Both of which, combined, brought on recurring, cyclical economic fluctuations within industrialized nations. Fluctuations that were not so easily explained.
Of course, Keynesians and other former mercantilists will dispute this. But, what the hell do they know? Other than ill-conceived economic tactics, they've created a national debt of nearly $18 trillion. A near $500 billion budget deficit. Accompanied by an economy that has barely managed to maintain altitude. Instead of the spending induced frenzy of economic activity most had expected.
Some clear-headed observers believe that government intervention into the money and credit markets have brought about the persistent booms and busts we know today as the business cycle. Of course, many will disagree. To the point that the Keynesian school of thought dominates today's global economic debate. Accordingly, central banks operating by the fractional reserve system exist in every industrialized nation.
You may accuse us at this point of succumbing to Curry's paradox, as it occurs in naïve set theory or naïve logics. That being the derivation of an arbitrary sentence from another self-referring sentence and some simple rules of deduction. But, you'd be wrong.
Just because central banks exist coincidentally to booms and busts, does not cause us to inextricably link the two. We require more proof than that. Some anecdotal evidence. Of which there is plenty.
Today, we'll look at once such example known today as the Mississippi Scheme, which occurred in eighteenth-century France.
Our story begins with King Louis XIV who, from 1643 to 1715, enjoyed a long and lavish reign. In fact, his 72-year rule was the longest of any major monarch throughout European history.
Alternately known as the Sun King and Louis the Great, he helped to eliminate the remnants of French feudalism, fought three major wars, and established France as the leading European power.
Yes, the Sun King was doing alright. Until he destroyed the French economy. And left the government's solvency being called into question at the time of his death. Not to mention a huge national debt. Massive budget deficit. Leaving many to wonder if the government should simply declare bankruptcy.
Otherwise, he was the picture of leadership.
Following his death, France tackled its fiscal problems by devaluing the currency by 20 percent. New coins were issued weighing 4/5ths of the old coin, but carrying the same face value. Concurrently, the public was "legally ordered" to exchange old coins for new. The net effect of which was to throw the nation's commerce into further disarray.
Soon there emerged on the scene a Scotsman named John Law. Notable for his wanderlust, gambling habits, and, well, lust in general, Law fled his native Scotland after killing a man in a duel for a woman. So, he ended up in France. Where he found a home for his penchants. Those being gambling, womanizing, and odd ideas regarding money, credit and the government's role in national finance.
Those traits firmly established, is it little wonder he found safe harbor in France? Now, back to our story.
Upon arriving, Law contacted his friend, the Duke of Orleans. The Duke was serving as a regent of France. Employing his powers of persuasion, Law convinced the Duke that France required a private central bank. One capable of utilizing his currency and credit theories in order to restore France's former economic nobility.
You guessed it. The Duke complied.
In 1716, the regent issued a royal edict authorizing Law and his brother to create Law & Company, a private bank. Moreover, Law's bank would be capitalized by the sale of 12,000 shares of stock valued at 500 livres apiece. Then, the regent authorized Law's bank to issue bank notes instead of coin. Decreeing that the notes would be acceptable as tax payments, essentially conferring legal tender status upon them.
No neophyte to banking, Law realized the key to the scheme was the public's acceptance of the notes. So, worked to buy the public's confidence. Announcing that his bank notes were payable on sight in the current coin at the time of issue. Given the public's fear of further devaluation of the coin, they naturally preferred holding Law's bank notes. Which resulted in valuing the notes at a premium to the precious metals.
Public confidence in Law & Company skyrocketed. The bank notes soon commanded a 15-percent premium to the metal coin currency. The bank opened branches in five major French financial centers. Confidence had been restored to the French currency. Commerce enjoyed a resurgence. Taxes were paid. So long as French consumers believed in the bank's ability to redeem the notes in kind at any time, the bank notes were literally as good as gold.
Now, the Duke of Orleans was an astute politician. But, he lacked economic wherewithal. In fact, he had no understanding as to what had actually transpired. He knew only that France's economic woes had been solved by this magical paper currency. From ignorance sprung opportunity. The Duke determined to retire the nation's debt in one fell swoop. In so doing, he committed two mistakes.
First, he rewarded John Law by authorizing him to create a company with exclusive trading privileges in the Louisiana Territory. Capitalized the enterprise by selling 200,000 shares of the company at a par value of 500 livres each.
Second, the regent took Law's bank public. Called it the Royal Bank of France. Then, over the next few years, printed over one billion livres in paper currency. Which were provided as public loans. Quickly inflating a huge credit expansion and an inflation of the paper currency.
Then, attempting to retire all of the state's former debts, the regent ordered the production of an additional 5,000 livres which would be exchanged for 4,000 of the former coins, plus 1,000 livres from a former currency at face value.
The result? A speculative frenzy. Businesses, merchants, consumers, cobblers, farmers and blacksmiths borrowed money to buy goods both foreign and domestic. Domestic production expanded. Imports increased. Construction grew.
Law's Mississippi Company spearheaded the boom. Selling bounty from India, China and the South Seas. In fact, Law had changed the company's name to The Company of the Indies. Then sold an additional 50,000 new shares, complete with a big dividend.
Of course, believing Law to be a financial wizard, everyone went mad for the newly issued stock. Filled the streets outside his home, attempting to grab shares. The credit expansion fueled the fire. Sending the stock up 10 to 20 percent every few hours. Stable boys made fortunes. Stoking the belief that this magical font of prosperity would never end.
But, as with all credit-driven booms, it did.
Paper currency inflation drove prices higher. Making foreign goods cheap relative to domestic products. As imports increased, so did payments to foreign governments. Some of which wouldn't accept the paper currency. Slowly, the gold and silver backing the paper currency left France for its trading partners. Worsened, as French insiders realized the dwindling gold and silver reserves and began converting their paper back to coin. Then transported the coins to foreign banks.
By 1720, the scarcity of coins became an impediment to foreign trade. So, attempting to end the run on gold and silver, the bank depreciated the remaining coins. Then, the government, at Law's suggestion, issued a decree whereby it become illegal for anyone to hold more than 500 livres in coin. Outlawed the exchange of coins for precious stones and jewelry. Which, counter productively, destroyed the remaining faith in the paper currency. And brought France to the brink of revolution.
The bubble burst. Stock prices collapsed. The paper currency became worthless. Commerce stopped. Law, once a hero, became the government's scapegoat. He left the country just ahead of the murderous hordes. All because the government attempted, proactively, to eradicate its debt problems.
Eventually, corruption was revealed at the highest levels of government. Eventually leading, as you know, to the French Revolution and the reign of Napoleon.
Mind you, the Mississippi Scheme serves as the perfect microcosm of the economic impact of credit expansion. Historically, every boom-and-bust cycle follows a similar trajectory. Perhaps not as dramatic. But similar, indeed.
Following a period of economic decline, there arises a social clamor for the government to do something. As the market begins its own natural adjustment process, some economic genius partners with the government to create a recovery plan. The plan calls for an end to inflation, balancing the budget, lowering deficits and stabilizing the currency.
BUT, in order to achieve these noble ends, the government condones some form of interference in otherwise normal free-market dynamics. Eventually catalyzing a new credit expansion. Another boom-and-bust cycle.
Why does central bank interference always result in such boom-and-bust cycles?
Because inevitably, there is an artificial misallocation of resources that confounds real economic calculations to such a level that, like a drug addict feeding his habit, more and more doses of credit expansion are required to remain one step ahead of the inevitable bust.
The South Sea Scheme. Tulip Mania. Railway Mania. The 1929 Stock Market Crash. The Japanese Economic Bubble. The Dot Com Boom. The Credit Crisis.
The monikers may differ, but the stories do not. Behind each speculative frenzy rests the same government-induced cycle that has preceded every speculative bust throughout history.
Yet, we seemed doomed to repeat ourselves. Because, while history is an excellent teacher, we remain poor excuses for students.

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