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THE FATAL FLAWS IN WALL STREET'S ECONOMIC THEORY

By Michael Rivero

Back in 2008, in testimony before Congress in the wake of the crash of Wall Street's mortgage-backed securities scam, fromer Federal Reserve Chairman Allan Greenspan made the admission that his "ideology" had a flaw.

Greenspan and the members of Congress relied heavily on euphemisms like "ideology" and spoke in vague terms to obfuscate from the American people that there are fundamental flaws in the way the US Financial system works.

The first and largest flaw in the system is the Federal Reserve itself. Not actually a part of the government (the Federal Reserve is no more "Federal" than Federal Express), the Federal Reserve is a privately owned central bank which has been given the authority by the US Congress to create money, something which under any other circumstances would be called counterfeiting. Created by act of Congress in 1913 and signed into law by President Woodrow Wilson, the Federal Reserve now exercises the power to create money originally granted to the government itself under the Constitution. It might be argued that such a dramatic reassignment of constitutional powers should have required a Constitutional Amendment, but that is a discussion for another article. What is germane is that the Federal Reserve system is unstable because by design it creates more debt than it creates money with which to pay that debt.

"I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is now controlled by its system of credit.We are no longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men." -- Woodrow Wilson 1919

What few Americans realize is that under the private central banking system, all currency enters circulation as a loan at interest from the central bank. The money you are paid for work, the money you pay for food; all of it first entered the economy as a loan at interest form the Federal Reserve. Loans to the US Government, loans to other banks, loans to businesses and loans to consumers. As that money circulates, passing from hand to hand to hand to hand, it accrues interest on that loan, which must eventually be repaid through higher prices and increased taxation.

The trap of private central banking lies in the fact that the moment that first paper note enters circulation, more money is owed to the private central bank than actually exists. The only way that interest can be paid is if new money is created through more lending, with part of that newly created money used to pay the interest on the old money. The system can only perpetuate itself as long as ever-larger generations of new borrowers can be found to allow the creation of that new money. It is because of this basic principle that private central banks are little more than pyramid, or Ponzi schemes, albeit cloaked with an image of respectability.

It is also because of this principle that every nation enslaved to a private central bank is drowning in accumulated debt, and unable to find the money with which to pay that debt. That debt, in turn, is used to exercise control over that nation and its people.

"This is the very essence of the banking industry; to make us all, whether we be nations or individuals, slaves to debt!"

But there are three other flaws which doom the economy as it is currently constituted to failure.

The first flaw is inside modern economic theory itself, and even Allan Greenspan admitted before Congress that the best minds of Wall Street missed (or did not want to see) what was going on.

There are two kinds of purchases, goods and assets. Goods are items you purchase to use and expect to sell (if ever) at a reduced price. Assets are things purchased with the expectation of re-selling at a higher price. Normal rules of supply and demand (the wisdom of the crowd) are that as the cost of goods rises, demand will lessen, and commerce will slow until the price of the good succumbs to market pressures and comes back down. This is a naturally stable system that needs little interference.

The mistake that the Federal Reserve and Wall Street made was assuming the same stability also applies to assets. As the price of gold rises, demand will slacken, for example. But this is not always true.

Houses inhabit a grey area. They are bought to use, like goods, but their price will usually increase like an asset. But Wall Street still viewed houses primarily as goods, with the increase in value really the accumulation of mortgage interest carried forward to the next buyer. And that was where they failed.

During the early 2000s, more and more Americans started viewing housing purchases as assets. As housing prices rose, demand actually increased as the promise of overnight profits lured more people to mortgage out the equity in their homes and invest the cash into additional houses. That demand in turn stimulated greater price increases, which stimulated more demand, etc.

This is a naturally UNstable system, chaotic in the mathematical sense. Controls should have been imposed, but were not, and that is how the housing bubble was created. Everyone on the inside was too busy getting rich to realize the obvious smell of tulips in the air.

Worse, they were also too busy to notice two other major problems.

For any economic system to work, all parts of the system must work. Money must flow to all sectors and all levels to maintain a stable economy.

Capital is invested in factories, farms, new product development, as well as home mortgages and consumer debt. The investment in factories and farms provides jobs with which consumers can repay their consumer debt and home mortgages, keeping the system stable and self-sustaining.

However, with real-estate and mortgage-backed securities paying such high rates of returns (until the crash), investment money was lured away from other capital ventures like farming and manufacturing. Profits were higher investing in consumer debt than in investing in businesses with which to provide jobs so that consumers could pay that debt! American entrepreneurs outside the financial services sector were starved for investment cash and never opened their doors. This accelerated the loss of jobs, which triggered the mortgage and retail crashes.

Put simply, essential parts of the US economy were allowed to starve to death because they did not provide the highest immediate profits.

This illustrates very clearly that Adam Smith was wrong about individual greed being good for the society as a whole. And this also proves John Nash was correct that one must keep an eye on the system as a whole to have the best outcome. Keeping that eye on the whole is, of course, the advertised job of the US Federal Government, and obviously, they dropped the ball on this one; too busy selling us solutions to make-believe crisis to notice the real disaster that was unfolding before them.


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Again, Greenspan admitted that simply allowing bankers to do what served their own interests did not work out.

In essence, Greenspan admitted that the deregulation of the financial system in 1999 had not worked out; hardly a surprise to anyone who studied the events leading up to the passage of the Glass-Steagal act in 1933.

It is for this reason that Russia is correct to take control of their central bank, to make certain that instability (greed) does not strangle essential parts of the entire system for the sake of a quick profit.

The final flaw relates to the issue of stability versus chaotic markets. Obviously, stable markets are best for normal investors, businessmen, government, banks, and homeowners. The flow of cash is reliable and predictable. Long term planning is easy as forecasts and expense are reliable. There is little excitement.

But for the growing population of hedge fund managers, arbitragers, and players in derivatives, profits (and the emotional thrill that goes with them) are faster and greater during times of chaos and instability. And just like drug addicts and gamblers, money junkies will consciously or unconsciously reinforce those parts of their existence which feed their addictions.

The US economy has thus become more unstable over time under the influence of money-junkies, who favor the volatile over the calm. This psychology of the money-junkies as an influence over financial practices was a factor totally overlooked by the bankers and the US Government, who see the economy wholly as numbers and never looked into the psychology of the Wall Street crowd, possibly out of fear as to the very unflattering mental illness they would find.

But that the US economy under the control of private financial interests is deeply flawed is inescapable. The Federal Reserve and Wall Street bankers do not serve the nation or the people; they serve only themselves. It was for this reason that the Founding Fathers of this nation, after fighting a revolution to free themselves from the then privately owned Bank of England (and King George IIIs Currency Act), created a revolutionary economic system of government created value based money; a public currency operated as a public utility instead of a private wealth transfer system by the private bankers, a system which worked for the people.

Maybe it is time to return to that wisdom.

Maybe it is time to accept that allowing private bankers to control the nation's money supply makes as much sense as allowing drug addicts to control the nation's pharmacies!




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