Leithner & Co Pty Ltd - The Other Notable Buffett: A Primer for Value Investors

THE OTHER NOTABLE BUFFETT:
A PRIMER FOR VALUE INVESTORS

Part IV

15 November 2003

...continued from Part III

Today Congress is constantly besieged by [special interest] groups seeking benefits from the public treasury. Often these groups control enough votes in many Congressional districts to change the outcome of elections. And so Congressmen find it difficult to persuade themselves not to give in to pressure groups. With no bad immediate consequence it becomes expedient to accede to a spending demand. The Treasury is seemingly inexhaustible. Besides, the unorganised taxpayers back home may not notice this particular expenditure, and so it goes …

The Hon. Howard H. Buffett
The Commercial and Financial Chronicle
5 June 1948

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens … Lenin is said to have declared that the best way to destroy the Capitalistic System was to debauch the currency... Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose.

John Meynard Keynes
The Economic Consequences of the Peace (1919)

When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it.

Frederic Bastiat, The Law (1850)

According to Alan Greenspan, “an almost hysterical antagonism towards the gold standard is one issue which unites statists of all persuasions. They seem to sense – perhaps more clearly and subtly than many consistent defenders of laissez-faire – that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.”

Under a gold standard, since every instrument of credit is ultimately a claim on some tangible asset, the amount of credit that an economy can support is determined by the economy’s tangible assets. Hence under a gold standard the government’s ability to run deficits is severely limited. But this brake disappears when the gold standard is debased or abandoned. Under these circumstances, government bonds are no longer backed by tangible wealth: instead, they are financed through the government’s promise to repay bondholders out of future tax revenues. Accordingly, governments have greater and greater incentives disguise their profligacy by issuing more and more bonds (see Roger Garrison, Time and Money: The Macroeconomics of Capital Structure, Routledge, 2001, ISBN: 0415079829).

Hence, too, a large volume of new government bonds can be sold to the public only at progressively higher interest rates (see Paul Kasriel’s The Fed: A Failure to Communicate or Communicated Only Too Well?). The abandonment of the gold standard thus enabled welfare statists to use monetary and banking arrangements to “create” hitherto unimaginable amounts of credit – and thereby to finance hitherto unprecedented government expenditures and deficits. Contemporary state finance has created paper reserves in the form of government bonds and, through a complex and convoluted series of steps, commercial banks accept them in place of tangible assets and treat them as if they were actual deposits, i.e., the equivalent of what were formerly private deposits of gold. The holder of a government bond or bank deposit created by paper reserves often believes that he has a valid claim on a real and existing asset. In actual fact he has a claim on an intangible and not-yet-existing asset (i.e., the taxes that will be levied in future upon taxpayers).

This arrangement, in Ron Paul’s words (Paper Money and Tyranny), “is immoral because it allows government to finance special interest legislation that otherwise would have to be paid for by direct taxation or by productive enterprise. This transfer of wealth occurs without directly taking the money out of someone’s pocket. Every dollar created dilutes the value of existing dollars in circulation. Those individuals who worked hard, paid their taxes and saved some money for a rainy day are hit the hardest, with their dollars being depreciated in value while earning interest that is kept artificially low by the Federal Reserve easy-credit policy. The easy credit helps investors and consumers who have no qualms about going into debt and even declaring bankruptcy.”

Paul, echoing Buffett, continues: “if one sees the welfare state and foreign militarism as improper and immoral, one understands how the license to print money permits these policies to go forward far more easily than if they had to be paid for immediately by direct taxation. Printing money, which is literally inflation, is nothing more than a sinister and evil form of hidden taxation. It’s unfair and deceptive, and accordingly strongly opposed by the authors of the Constitution. That is why there is no authority for Congress, the Federal Reserve, or the executive branch to operate the current system of money we have today. A central bank and fiat money enable government to maintain an easy war policy that under strict monetary rules would not be achievable. In other words, countries with sound monetary policies would rarely go to war because they could not afford to, especially if they were not attacked. The people could not be taxed enough to support wars without destroying the economy. But by printing money, the cost can be delayed and hidden, sometimes for years if not decades. To be truly opposed to pre-emptive and unnecessary wars one must advocate sound money to prevent the promoters of war from financing their imperialism.”

It is no coincidence that during the period following the establishment of the Federal Reserve (1913) and the elimination of the gold standard (1933 to 1971), astronomical growth in the size of the U.S. Government and its debt has occurred (see, for example, the U.S. National Debt Clock). Believers in big government, whether they are on the left or right, vociferously reject the constraints on government growth that the gold standard enforces. Liberty, then, is virtually impossible to protect when people allow their government to print money at will. Inevitably, the “left” will demand more economic interventionism and the “right” more militarism, empire building and war. Both sides, either inadvertently or deliberately, will foster the leviathan state. Although left and right have different goals and serve different special-interest groups, they are only too willing to compromise and support each other’s programs. Those whose greatest interest is individual liberty, self-reliance and a government small enough to fit inside its constitution will inevitably be lost in the shuffle.

This, as Alan Greenspan put it during the 1960s, “is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the ‘hidden’ confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.” One also has no difficulty in ruing the passing of politicians such as Howard H. Buffett. “With a restoration of the gold standard, Congress would again have to resist handouts. That would work this way. If Congress seemed receptive to reckless spending schemes, depositors’ demands over the country for gold would soon become serious. That alarm would soon be reflected in the halls of Congress. The legislators would learn from the banks back home and from the Treasury officials that confidence in the Treasury was endangered.” Under these conditions “Congress would be forced to confront spending demands with firmness. The gold standard acts as a silent watchdog to prevent unwarranted public spending.”