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09 August 2012

True Stages of the Economic Cycle

1. Hard Money. A form of currency is established to facilitate commerce. In order to gain acceptance the currency is backed by something of intrinsic value such as precious metals. This is known as Hard Money.

2. Debasement of the Currency. It is immediately evident that “free” wealth can be created by Debasing the Currency. In its most fundamental form this involves the practice of charging interest (or usury, the meaning has been exactly the same throughout history up until recent times).

3. Enactment of Legal Tender Laws. Without Legal Tender laws, implied values are self correcting and always closely match true value. Legal Tender laws greatly facilitate the debasement of a currency. The Founding Fathers knew this, Thomas Jefferson wrote:

If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers conquered.

The U.S. Constitution, Art. I Sec. 10 Cl. 1, states:
No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts;

The Supreme Court ruled in U.S. Supreme Court - Wheaton 1827;

“The prohibition in the constitution to make anything but gold or silver coin a tender in payment of debts is express and universal. The framers of the constitution regarded it as an evil to be repelled without modification; they have, therefore, left nothing to be inferred or deduced from construction on this subject.”

How Abraham Lincoln circumvented this well-established doctrine and set the country on a path to ruin, is the subject of an entire essay.

4. The Accumulation of Debt is unavoidable with legal tender laws in general, and especially in a Central Banking scheme such as our current Federal Reserve.

6. An Illusion of Economic Prosperity is created by the accumulation of debt. This is no different in principle from a person going on a spending spree with credit cards. They have the illusion of being very prosperous, but in reality they are destined for a reckoning when the debt cannot be paid.

7. Monetization of the Debt. As the accumulation of debt becomes unmanageable, it become necessary to monetize the debt. The debt grows so large it cannot possibly be paid. There are a few ways to “resolve” this. The most obvious way is through taxation, but this is never politically acceptable. Another way is by directly devaluing the currency. This has been done many times in history, but is also not very politically acceptable. The third, and easiest (for leaders at least) is hyper-inflation. In simple terms hyper inflation erases debt by transferring wealth from individuals to government.

8. Dilution of Currency Value The process of monetization directly causes a Dilution of Currency Value.

9. Loss of Confidence. Consumer Confidence is a greatly misunderstood term. It is NOT what your neighbor thinks of the economy. In essence Consumer Confidence is a measure of how well the taxpayer is being fooled into thinking all is well. The dilution of his buying power caused by the dilution of currency creates a Loss of Confidence

10. Inflation. As buying power decreases, the consumer tries to make up the difference by charging more. The merchant charges more for his goods, the laborer demands more for his services. This is classic Inflation

11. Inflation Stabilizes as government  implements inflation control measures, but does nothing about the underlying problems, causing a:

12. Return of Inflation, quickly followed by:

13. Hyper-Inflation, which effectively erases the debt. If the U.S. experiences the level of hyper-inflation similar to Hungary in 1946/7 (42 QUADRILLION percent per month), the entire national debt could be paid off with less than a penny. This may sound like a good thing to some, but the truth is, wealth is simply transferred from private individuals to the government. This is the stage of Reckoning. It is obvious that there was no real wealth created in phase 2. This is the essence of my argument against the “Economy creates wealth” proponents. Economic trickery does not create wealth.
The wealth transfer causes:

14. Depression, which leads to:

15. Reorganization of Government. It is only at this point that a significant number of people understand the inextricable link between wealth and real money. This enlightenment leads to:

16. Return to Hard Money, and the cycle repeats.

It is important to understand that these phases are exponential in nature. The time from the debasement of a nations’ currency to the loss of confidence in that currency can be measured in decades or even centuries. The time between the loss of confidence and inflation however, may only be weeks or months. In the later stages of hyper-inflation the loss of a currency’s value and the accompanying price increases can double in days or even hours. In the Wiemar Republic in 1923 workers demanded, and were paid three times a day in order to be able spend the money before it lost further value. 

It should also be noted that inflation is not bad for everyone in equal measure. It is actually a good thing for those people of means who are in a position to borrow to purchase property. The reason is the same; the repayment of debts, is made in currency that is worth less than the currency originally borrowed. This is also the reason working people cannot prosper during times of inflation or hyper-inflation. Wages are generally not indexed to inflation and always lag price increases. Even in the case of the relatively few people whose wages are indexed to inflation, the adjustment is always done after the fact. Loses accumulated from the previous adjustment are never recovered.