The Lobster Trap of Central Banking
Gary North
A lobster
trap lures a lobster in. The more he pushes forward to get at
the bait, the less able he is to back out. A lobster trap is a
forward-only device. The lobster thinks he will get the bait.
In fact, the trap gets him. It doesn’t kill him. It immobilizes
him. Then the person who set the trap comes back, hauls the trap
out of the water, and extracts the lobster. Then he re-uses the
trap.
Central banking
is a gigantic lobster trap. It is set by the commercial banking
industry and the government, which grants the central bank a monopoly
over the control of the monetary reserves (government debt) that
are used by commercial banks to issue loans.
The trap’s
bait is a two-part promise: (1) establishing an economy that does
not suffer from economic depressions; (2) establishing price stability.
The Federal
Reserve Act was passed in 1913 in the aftermath of the recession
of 1907. Its success can be measured by (1) the recession of 1921,
the Great Depression of 1929–39, the recessions of 1957,
1970, 1975, 1980, 1981, 1990, and 2001; and (2), the decline in
the value of the dollar – approximately 95% since 1913. (Inflation
Calculator.)
Like any
good lobster trap, the lobster is caught, removed, and consumed.
Then the lobsterman replaces the bait. To get a nice, fresh lobster,
you have to replace the bait.
From time
to time the central bank suffers a setback: a recession or a bout
of price inflation or both. This is part of the extraction process.
The lobsters that got caught in the trap are wiped out, or at
least suffer losses. The little ones are tossed back in to fatten
up and be lured back in a second time. Lobsters are stupid. They
don’t remember. The larger ones are consumed.
The same
promise works over and over. "This time you can trust us.
This time, there won’t be another recession. This time, you can
count on us to keep prices stable." And another batch of
trusting lobsters is lured back in.
THE
PROBLEM WITH THE BAIT
There are
no free lunches in life, not even for lobsters. Lobstermen are
not in the business of feeding lobsters. They are middlemen for
those who eat lobsters. Lobsters, however, are short-sighted.
They don’t understand cause and effect.
Neither do
voters.
Commercial
banking is based on a promise: "Deposit your money, and we
will pay you interest, and you can get your money back at any
time."
Now, if the
deposit were gold, you would have doubts. You would think: "If
I put my gold coin into a jar and bury it, there will be only
one coin there when I dig it up. So, if I hand it over to a banker,
he will put it in a vault. It won’t multiply in a vault any more
than it will multiply in my jar in the ground. If I want to get
it back on demand, it had better be there. But if it’s there,
the bank can’t do anything with it. There is no way a bank can
pay me interest, any more than my jar can pay me interest."
This is logical.
But men,
like lobsters, rarely think straight. They are unable to apply
the logic of the gold coin to paper money. They surely can’t apply
this logic to bank accounts. They don’t say to themselves, "I’ve
seen this one before. He can’t pay me interest and also let me
get my money back at any time."
It’s the
wonderworld of alchemy: the logic of gold no longer applies. Pieces
of paper or digits somehow make the law of matter go away. The
same item can somehow be in two places at the same time. "It’s
a miracle!"
The government
allows commercial banks to lure in depositors by making a promise
that cannot always be fulfilled: "interest, plus withdrawal
at any time." Banks lend out money that they take in from
depositors, and are paid interest by borrowers, part of which
they share with depositors. The banking system rests on a premise:
not many people will ask for their money back at one time. When
a few people do – the ATM phenomenon – money that is
held in reserve can be used to pay them off. A fraction of the
money is held as a reserve, "just in case." This is
fractional reserve banking.
Enter the
central bank. It buys a government T-bill. It writes a check to
buy it. The money it just created to buy the T-bill is spent into
circulation by the government. If a non-authorized private company
did this, it would be called counterfeiting. But because a central
bank does it, it is called enlightened monetary policy. Its money
creation is legal because the government has authorized the central
bank to create money out of nothing in order to buy a T-bill created
out of nothing. It’s a wash!
Well, maybe
not a wash. It’s more like an acid bath. The new money that the
central bank just created is added to the total money supply.
It gets deposited in a commercial bank. Wonder of wonders: the
banker now has more money to lend at interest.
If there
is new money in the hands of consumers, then they will be able
to go into the marketplace and bid up the price of goods and services.
The free market is a gigantic auction in which buyers (sellers
of money) bid against each other, and sellers (buyers of money)
bid against each other. Out of their competing bids – buyers vs.
buyers, sellers vs. sellers – comes an array of prices. But some
buyers (sellers of money) now have more units of money to sell,
thanks to the central bank’s purchase of government debt.
Remember
lobster bait #2? Price stability. How can the auction keep prices
stable if some sellers of money have more money to spend as a
result of the central bank’s purchase of a T-bill? The answer:
sellers of goods must produce more things to sell for money at
a profit. But if sellers can really do that, then they would have
done it without the additional fiat money. But then prices would
have fallen: some of the bidders to buy money would be out there
lowering the prices of whatever they are trying to sell.
The bait
of price stability has to be paid for. There are no free lunches,
not even for lobsters. The bait is paid for by people with money
to spend who would otherwise have been offered a deal by sellers.
"Tell ya what I’m gonna do. For you, this week and this week
only, there’s a special discount available."
Prices are
stable because there aren’t as many discounts.
Lobster bait
is paid for by the lobsters.
It’s a terrific
deal for lobstermen and gourmets. Butter producers are also in
on the deal. (In the central banking game, the butter producers
are called economists.)
PAYING
FOR BAIT #1
Bait #1 is
the promise of recession-free living. The central bank promises
that it has the ability to avoid recessions and shorten them when
they occasionally sneak through. How? By buying even more government
debt.
"Here’s
how it works!" The recession is said to be caused by insufficient
demand by sellers of money, who for some reason hoard their money.
So, the central bank buys more debt, and people have more money
to spend. This doesn’t raise prices because sellers are so scared
of going out of business that they offer discounts just to unload
their inventory. The new money pushes prices up, but prices were
falling. Now they will merely stay stable.
There is
a word for this system: Japan. The central bank inflates, but
prices are slowly falling.
The problem
with bait #1 is that, to the degree that it is successful – retail
prices stop falling, and companies don’t go bankrupt – sellers of
money (consumers) expect even more money next month, so that they
can pay off new consumer debt, and sellers of goods (manufacturers)
expect consumers to have more money next month, to buy this month’s
output.
Where are
consumers going to get more money next month?
From the
central bank, which will buy more government debt.
And the month
after that, too.
Pretty soon,
the system is dependent on new issues of government debt, or at
least new purchases of existing government debt certificates by
the central bank. It’s a one-way process: more money. The only
way to go backward is to strip off your shell. Shell-stripping
is called a recession.
Consumer
prices in Japan should be falling, due to increased productivity.
They are falling, but very slowly. Everyone is counting on more
fiat money next month.
The Bank
of Japan buys U.S. government debt in addition to its own nation’s
debt. It creates new fiat money and buys dollars in the open market,
which it then uses to buy T-bills. That keeps up demand for dollars.
The U.S.
government spends these dollars. (Trust me; it does.) These dollars
can then be used by American importers to buy yen to buy goods
from Japan, which increases demand for exported goods in Japan,
which keeps prices higher. Of course, we Americans get the TV’s
and Walkmans and such. The Japanese get a central bank filled
with T-bills paying under 2%.
The Japanese
are a nation of lobsters. The Bank of Japan is an organization
of lobstermen. You and I are consumers of lobsters. With respect
to the rest of the world’s goods, the United States is a franchise
called "Green Lobster."
The trouble
is, Americans think this franchise is eternal. But at some point,
the lobstermen in Asia will find that the local waters have been
fished out, so to speak. No more large, succulent lobsters will
be found in the traps. Fat lobsters will have to lure them in
with bait other than Americans’ promises to pay.
At that point,
the Green Lobster franchise will be in big trouble.
LOBSTERS
ARE STUPID
People really
do want to believe in something for nothing.
This makes
them do silly things.
In the middle
ages, alchemists sought ways to convert lead into gold. (The most
famous alchemist was Sir Isaac Newton, who kept secret this side
of his scientific career.)
We regard
ourselves as sophisticated. We don’t believe in alchemy. Not us!
Yet we hand our money over to banks on the assumption that we
can get our money back at any time, and we will be paid interest
for the privilege. ATM really means "Alchemy: Trustworthy
Magic!"
We see the
results of central banking around the world. One result is public’s
trust in the wisdom supposedly possessed by salaried employees
of a government-created monopoly. Investors smile when Alan Greenspan
talks gibberish to Congressmen and Senators, who cannot get straight
answers from him. "That Greenspan. He’s really something."
Yes, he is. He is the chief lobsterman, and we are the lobsters.
Another result
is the creation of a series lobster traps that lure in fat, succulent
lobsters. The U.S. stock market was one such trap, 1982–2000.
The residential real estate market has been its replacement.
So it was
in Japan, 1980–1989. Since then, the Japanese stock market
has been "fished out." Not many juicy specimens have
pushed their way into the traps. Fifteen years after the Nikkei
hit 39,000+ it is in the 12,000 range – up from 8,000. Lobsters
may be stupid, but they have learned not to trust the bait. What’s
a central banker to do?
Today, China
is central bank paradise. The waters are teeming. The central
bank is pumping in new money by buying T-bills like a drunken
sailor. Why? So as to run a $100 billion trade surplus with the
United States. Rural Chinese lobsters have begun to move into
the urban waters by the tens of millions. They must be fed long
enough to fatten them up. Their output is being exchanged for
the digital equivalent of green pieces of paper with Presidents’
pictures on them. It’s a sweet deal at the Green Lobster franchise.
China is
not experiencing mass inflation. Why not? Because Communism was
a gigantic lobster trap that could barely feed skinny lobsters.
Mao was chubby; nobody else was. By converting those state-managed
traps to a modified trap system based on private property, the
lobstermen are doing a lot better. The productivity unleashed
by the shift to free enterprise, even when central-bank dominated,
is so great that China has become a net creator of wealth. Central
banking operated under Mao, too. The difference is, the lobsters
today are a lot fatter.
The rulers
of China, like rulers everywhere, have persuaded the masses that
central banking and government debt are a marriage made in heaven,
or seventh heaven, depending on cultural traditions. The bait
has been inserted into the traps. The only way to feed the growing
supply of urban lobsters is to keep replacing the bait. That means
an ever-growing supply of fiat money. The day the bait slows or
even reverses is the day that the system collapses: no more lobsters
in the traps.
LOBSTERS
MUST RETAIN FAITH IN THE BAIT
In 1946,
Congress passed and President Truman signed the Full Employment
Act of 1946. It is still the law of the land. Congress by this
act promised to pursue policies of full employment. The law established
the President’s Council of Economic Advisors and Congress’s Joint
Economic Committee. These two bureaucracies, filled with economists,
are supposed to provide advice on how the government can keep
the economy operating at full employment.
This law
was the aftermath of the Great Depression, in which governments
around the world could not maintain full employment without setting
up slave labor camps. It was also the aftermath of World War II,
whereby governments solved the unemployment problem by expanding
the military draft in a war that killed between 40 million and
60 million people: lobster slaughter on a uniquely scientific
scale.
In 1996,
economist Murray Weidenbaum wrote a cheerleading essay, "The
Employment Act of 1946: still working after 50 years."
He described the Act.
When enacted,
the Employment Act declared that "it is the continuing
policy and responsibility of the Federal Government to use all
practical means consistent with... other essential considerations
of national policy... to coordinate and utilize all its plans,
functions, and resources... to promote maximum employment, production,
and purchasing power."
The idea
here was "the power to tax is the power to create." By expanding
the government’s ability to tax and spend, the government would
be able to make life good for lobsters.
More was
needed than the ability of bureaucrats to extract money from taxpayers.
There also had to be a way to get more money into the hands of
taxpayers, so that the state could extract even more money from
them – for their sake, of course. Americans need employment, just
as China’s masses need employment. It is the task of the economists
of the CEA and JEC to provide scientifically valid advice to politicians
as to how the government can skim off the largest percentage of
this output without hindering the lobster-fattening process. The
experts are agreed: when it comes to lobster-fattening, the Federal
Reserve System plays an important role.
The debates
of the 1960s and 1970s on the relative effectiveness of monetary
and fiscal policy changed the basic focus of U.S. economic policy.
The Federal Reserve Bank now is looked to as the primary mechanism
for achieving short-term economic stability, while tax and budget
policies are viewed in terms of the longer-run impacts on investment,
economic growth, and income distribution.
Of course,
this view is not shared by Milton Friedman and the monetarists,
who want to substitute an automatic money creation system for
the Federal Reserve System, which has too much discretion, they
think. Monetarists want lower taxes. So do supply-siders, who
are happy the have the FED create lots of money during recessions.
So do Austrian School economists, who don’t want the Federal Reserve
System or an automatic money-creation system. But the politicians
want more money to skim off, so they pay very little attention
to monetarists, supply-siders, and Austrians. Weidenbaum surely
doesn’t.
In an informal,
but universal, reinterpretation, the reference in the Employment
Act to "purchasing power" has been cited as the basis
for government concerning itself with controlling inflation.
Subsequently, the Humphrey-Hawkins Act of 1978 formally added
the goal of eliminating inflation. The original primary emphasis
on "maximum employment" – which was a legislative compromise
to break the deadlock over the more controversial term "full
employment" – generally has taken a back seat in Federal
economic priorities. Perhaps this is a compliment to the flexible
language of the legislation. More basically, the new emphasis
may reflect changing national priorities resulting from the
country’s success in avoiding the massive unemployment of the
1930s and earlier periods.
Of course,
the purchasing power of the dollar has continued to fall, but
that’s not a worry for policy-makers who work for the government.
What matters most for them is that the voters maintain faith in
the system that extracts 25% of their output at the national level,
plus another 10% to 15% at the state and local level. And so they
have.
Viewed
in the most fundamental light, however, the legislation has
been successful. The two institutions the 1946 act established
remain in operation and the act’s then-controversial statement
of policy has become accepted as part of the Federal government’s
bureaucratic fabric. A substantial government responsibility
for the over-all performance of the American economy now is
widely assumed. In fact, politicians of the opposition party
readily hold the administration in office accountable for whatever
economic short comings occur.
CONCLUSION
We have seen
in Japan that investors who were lured into the stock market bubble
and the real estate bubble have lost large portions of their wealth.
The government keeps spending on boondoggles, and the central
bank still buys U.S. T-bills – or did until last March. The
politics of mercantilism – government-aided lobster exporting
– are still dominant in Japan.
The same
politics are alive and well in China, which is in the boom phase
of the fattening-up process.
The United
States is somewhere in between Japan and China, though closer
to Japan. The FED is still pumping in fiat money, but has not
had to pump at double-digit rates because Asian central banks
have bought T-bills and have thereby kept America’s interest rates
low. For as long as the lobstermen of Japan and China are fishing
their own waters by persuading the lobsters to keep walking into
the traps, America’s Green Lobster franchise will stay in business.
But
at some point, Asian lobstermen will figure out that the Green
Lobster franchise is all debt and no repayment. Americans are
putting the bill on their credit cards. When the bills come due,
what then?
The bills
will come due. We just don’t know when. Sooner rather than later,
I suspect.
October 13, 2004
At age 25, Dr. Gary North was the youngest elected
member of the Economists' National Committee on Monetary
Policy. He served as a senior staff member of the
Foundation for Economic Education and as a research
assistant to U.S. Congressman Ron Paul. For a free
subscription to Gary North's newsletter on gold click
goldwar@kbot.com
Copyright
© 2004 LewRockwell.com
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