The Categorical Insanity of Central Banking

Currency debasement.  Asset price inflation.  Booms, bubbles, and busts.  Yes, folks, central bankers have succeeded at making full hash of the world at large.  This goes for the Federal Reserve too.

Tracing back recent financial disasters we find the mortgage meltdown coincided with the Fed’s interest rate raising cycle.  The Fed had dropped rates following the dot com bust and, in return, puffed up a massive housing bubble.  So they raised rates to let some air out and – pop! – the bubble exploded.

The dot com bust also coincided with Fed rate hikes.  Rates had been dropped to bailout financial markets from the Long Term Capital Management fiasco and to stem contagion from the 1997 Asian financial crisis.  The cheap credit was then channeled into the delusion that the internet would make everyone rich.  So the Fed raised rates to impart some reality back to the stock market and – kaboom! – the sock puppet was blown to bits.

And on and on these Fed exacerbated bubble and bust cycles go back through the decades.  And maybe these failures are all in the past.  And maybe they are of little significance to our present complications.  And maybe the Fed will, this time, get it right.  And maybe pigs will fly.

The hopeless truth is, central bankers always botch it.  For example, this week, following the Federal Open Market Committee’s (FOMC) January meeting, the FOMC announced it would continue to price fix the federal funds rate at 2.25 to 2.5 percent.

Is this the correct rate?  Is this the incorrect rate?  Given that it was decreed by a focus group of central planners – as opposed to a real open market – we can assure you that it’s completely and utterly incorrect.

If you don’t already get this, you probably never will.  So here’s what you need to know: The Fed always explodes financial markets and central bankers always botch it.

A Downright Disgrace

This premise, no doubt, is obvious and indisputable.  Still, like witnessing a slow motion train wreck, we can’t look away.  The ongoing disfigurement is transfixing…and has extended to every corner of the globe.

You see, several years ago, while visiting in-laws – and outlaws – in Mexico City, the true insanity of central banking was revealed to us in the most unlikely of places.  We recount this brief tale today as a salutary reminder of the quackery explicit to the central banking profession.  However, before we get to it, some context is in order…

To begin, currencies, both north and south of the Rio Grande, ain’t what they use to be.  Several generations ago they were as reliable as a rooster’s call at dawn.  Now they’re as crooked as a politician’s spine.  We know this not by reading the history books, nor by hearsay, but by the honest, verifiable, silver dollar and silver peso we’re holding in our hands.

One coin, the Peace Dollar, is a United States silver dollar minted in the 1920s.  At the time of its mint, one coin equaled one dollar and each dollar contained 0.77344 troy ounces of silver.  The other coin, the 1922 Un Peso, is a Mexican silver peso.  At the time of its mint, one coin equaled one peso, and each peso contained 0.3856 troy ounces of silver.

The exchange rate was real simple.  Based on their silver content, two pesos equaled one dollar.  Nowadays, both pesos and dollars are merely paper promissory notes issued by their country’s central banks.  Their value is derived by their track record of stewardship, the size of their country’s military, and the international currency market’s acceptance of their government’s ability to make payments on their debt.

Today it takes about 19.14 pesos to buy one dollar.  As you can see, the Mexican government has been less upright in managing its currency than the U.S. government has over the last 100 years.  But when you use silver as the measuring stick, the picture changes…

In the 1920s it took about $1.29 to buy an ounce of silver.  Today it takes $15.94 to buy an ounce of silver.  This means silver presently costs 1,136 percent more in dollar terms than it did in the 1920s.  This also means the U.S. Treasury, with aid from the Federal Reserve, has done an abysmal job managing the dollar.

In pesos, however, it’s a downright disgrace.  In 1922, it took 2.58 pesos to buy an ounce of silver.  Today an ounce of silver costs 305.09 pesos.  Astonishingly, in peso terms, silver now costs 11,725 percent more than it did in the 1920s.

The Categorical Insanity of Central Planning

It doesn’t take much time in Mexico City to observe that behind the hustle and bustle, not only has the government successfully vaporized their currency, they have successfully vaporized their middle class.  You can actually see its nonexistence everywhere you look.  Yet, at the same time, you can see the ashes of a middle classes prior existence within the cracks of decay.

As an aside, the appearance of a shrinking middle class is now highly visible when traversing through nearly all major U.S. cities today.  This is one of the tradeoffs of deficit spending based government stimulus that politicians fail to mention when promising free school, free drugs, free food, and a free retirement.  Yet this is a discussion for another day.

The current task at hand is to properly characterize the true insanity of central banking, as it was revealed to us from the small pueblo of Tepoztlán – roughly 80 kilometers south of Mexico City.  We’d made the trek out to the countryside to visit Tío Carlos (our mother-in-law’s brother); a man with unique capabilities.

Tío Carlos has never taken a medical course or formally studied medicine.  Certainly, he can’t perform open heart surgery.  We don’t know if he can even use popsicle sticks to set a broken finger.  But to the entire pueblo he’s El Doctor.

When someone fears their body has been overtaken by evil spirits they visit El Doctor for “Limpia” – spiritual cleansing.  With no more than a raw egg he’s able to transfer negative energy from a person’s body to the egg.  We were told the egg acts as a sponge in this process.

This all sounds a little crazy, we know.  But, apparently, these healings have been taking place in Mesoamerica since pre-Columbian times; much longer than central banking’s been around.

We doubt Tío Carlos knows much, if anything, about central banking.  Though we’re certain he fully appreciates that, within his lifetime, his country’s bank notes have been transmuted to toilet paper.

As far as we can tell, while a bit crazy sounding, Limpias are generally harmless.  Central banking, on the other hand, is categorically insane.


MN Gordon
for Economic Prism

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