Central banks are dangerous
I really thought that Michael Shedlock was overstating the case:
The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing…
Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem…
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
But then I read this piece, by Robert Shiller (hat tip Yves Smith), and all of a sudden I’m frightened. It’s one thing when Hank Paulson proposes turning the Fed into the macroeconomy’s philosopher king. Paulson will be gone in a blink of an eye. But Robert Shiller is an increasingly influential economist. He’s already got Mark Thoma signed up for the plan. These guys are smart, they matter, and they will continue to matter next January. So let’s think about this very, very carefully.
Shiller points out that…
In recent years, central banks have not always managed macro confidence magnificently. The Fed failed to identify the twin bubbles of the last decade — in the stock market and in real estate — and we have to hope that the Fed and its global counterparts will do better in the future. Central banks are the only active practitioners of the art of stabilizing macro confidence, and they are all we have to rely on.
He’s right on both counts. For now, central banks are all we have to prevent a catastrophic unwinding of our unstable financial system. But they had everything to do with getting us here. It’s not just the Fed, with its famous “serial bubble-blowing”, its cheering on of any novelty as beneficial innovation, its absolute refusal to peer into the magical sausage factory that Wall Street had become. The problem with central banks is much bigger than that. If you haven’t been obsessing over every word Brad Setser has written for the past several years, you owe yourself an education. A growing “official sector” has largely defined the global macroeconomy in the first years of this millenium. In the USA, Japan, China, Europe, central banks have indeed been “active practitioners of the art of stabilizing macro confidence”. For most of those years, it seemed like they were succeeding. They were never succeeding. Call it what you want, call it “Bretton Woods II”, call it “financial imbalance” or a “global savings glut” or “exorbitant privilege”. Each central bank, while trying to stabilize its own bit of the world, found itself with little choice but to support and expand unsustainable financial flows on a scale so massive they have reshaped the composition of every major economy on the planet. As Herb Stein told us, what cannot go on forever won’t. “When the music stops, in terms of liquidity, things will be complicated.” Remember that? The music may have stopped already for Citibank, but it’s still playing for the USA. The record is just beginning to skip.
The Federal Reserve can keep every major US bank and investment house on life support for as long as it wants to. The “credit crunch” can be made to disappear in an instant, if we are willing to pay sufficient ransom to hostage-takers. But what the US economy produces is no longer well matched to what Americans consume, and we are structurally unprepared to generate tradables, goods or services, in quantity adequate to cover the difference. The Fed’s magic wand will be of no use if manufacturers in Asia and oil producers in the Gulf stop giving us stuff for free, using central-bank financial alchemy to hide their generosity.
Things may turn out okay. We’ve already begun to “adjust”, and knock on wood, we’ll manage a worldwide reequilibriation before things get too ugly. But it’ll be a close call. That financial alchemy by central banks is the ultimate source of skyrocketing inflation in China and the Gulf states, and an ominous sign that Stein’s Law is beginning to bite. We may yet escape, but we have been drawn very close to something very dangerous, to a genuine crisis of scarcity in the United States and a catastrophic failure of Say’s Law in China, to mass unemployment, social instability, and fingers and missiles pointed in both directions across the Pacific. This is serious stuff. And central banks are largely to blame.
Private, profit-seeking actors would not have generated the corrosive financial flows that have characterized this millennium. “Financial imbalance”, a euphemism for real resource misallocation, would have quickly been corrected, had Wall Street and the City of London not learned that the official sector could be their best customer. Less politically-independent monetary authorities could have leaned against unsustainable financing. A bit of capital-account protectionism might not have been bad policy for the United States during this period, but a central bank blind to obvious “facts on the ground”, accountable only to an economic orthodoxy, did not even consider such a thing.
As readers of this blog know, I’m not a laissez-faire, the-private-sector-is-always-right kind of guy. I like to think about the “information architecture of the financial system”. That leads me to dislike actors large enough to unilaterally move markets, especially when their motives might not be aligned with wise resource allocation. I dislike large private banks, and think they should be broken into itty-bitty pieces or turned into safe, regulated utilities. For the same reason, I dislike central banks. They have the power to act consequentially, but they do not have, and cannot have, the information or the wisdom to always be right. And when they are wrong, the consequences are devastating.
So, what to do? For now, we have no choice but to “use the army we have”. Our long-term plan, though, ought not be to canonize central banks, but to render them obsolete. It won’t be easy. The usual “sound money” trope, reviving the gold standard, is not a good idea. Much as it is suddenly out of fashion, we will need some “financial innovation” to build a new monetary architecture. Just because we’ve had a glut of snake-oil on the market recently doesn’t mean there’s no such thing as penicillin. We’ll have to do a better job of distinguishing novel idiocies from good ideas. But we will need the good ideas. We can and should liberate money from the bankers, central and otherwise.
- 6-Apr-2008, 9:45 p.m. EDT: Replaced “manager” with “manage”, ‘cuz I wanted a verb there.
Increasing concentration of power is a recipe for hyperinflation for the mob. The Fed may not be enough to do the job. But the Fed, in conjunction with the US government is going to do the job.
April 6th, 2008 at 5:01 pm PDT
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Steve,
Well done, as usual. I am curious as to where you come down on the following: do you believe that the Fed is an inherently flawed institution and should therefore either be abolished or have its mandate redefined in a way that would limit its ability to create dangerous economic imbalances (blow serial bubbles)? Or, alternatively, is our current predicament primarily a function of character (or perhaps more accurately ideology)? Stated differently, had the Fed not, for most of the last two decades, been led by an inept, ideologically rigid, disciple of Ayn Rand but rather by Paul Volcker would we be where we are today? And if the answer to this last question is “no,” then is it imprudent to rely on politicians to appoint future Fed chairmen?
April 6th, 2008 at 7:39 pm PDT
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“reequilibriation”?
April 6th, 2008 at 8:18 pm PDT
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Viva Frederich von Hayek. Free choice in currencies. I favor the repeal of the Federal Reserve Act and have for decades. I am an Andrew Jackson (AJ) kind of guy. I am as favorably disposed to the Fed as AJ was to the Second Bank of the US. Kill the monster once and for all. Did not the master say something to the effect: “money changers out of the temple”? I’ll get a reference.
April 6th, 2008 at 8:20 pm PDT
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See my 11 and 24 December 2007 posts. You agree with Jefferson, “banking establishments are more dangerous than standing armies”. Matthew 21:12-13 has Jesus disbursing the money changers.
April 6th, 2008 at 8:27 pm PDT
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It seems to me that identifying the central banks as the culprit erases the distinction between central banks in these different countries. The central bank in China is not the same as the Fed, even if it has parallel functionality, because it has no political independence at all.
Whatever the Chinese central bank does has to be understood as a policy action of the central government.
One problematic issue of globalization which tends to be disregarded is the difficulties creating by the economic integration of such different political systems. In this instance that means that the issues of mercantilism and the currency peg are much bigger than the financial architecture (unfortunately).
April 6th, 2008 at 10:19 pm PDT
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Excellent piece!
Perhaps another way of phrasing your alarm is that while Shiller might be smart at housing econometrics, he is probably dangerous when he ventures into banking system architecture.
This dynamic is nothing special… for instance, Friedman was a godsend at public policy of economy, but deeply wrong on monetary theory (subsequent events have proven that central bureaucrats cannot be trusted to manage any fiat system).
That observation aside, I totally agree with you on “rendering central banks obsolete”. I also think a gold standard isn’t the answer, but that is really only because it is really no protection against fractional reserve banking run amok. The only “protection” I see is free banking, where the wayward are allowed to fail. This precludes government safety nets like FDIC, but does not preclude private ones, of course (so be still, ye “but who will protect the PEOPLE?!” critics).
I suspect, however, that in a free banking system, we would see a lot of precious-metals backed institutions and free currencies. But it would be emergent, not imposed.
April 6th, 2008 at 10:56 pm PDT
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FWIW, the dollar recycling which has run amok since 2001 and distorted the economy (low interest rates etc.) really isn’t fixable per se; it can only be “repaired” by cutting it off at the source. That means ending fiscal deficits, and possibly ending GSEs (which cause too much complacent capital to seek mortgage backed securities, as we now know to be folly). Without these no-brainer “AAA” securities available to foreigners, it would probably be harder to run a trade deficit as well. Where would the surplus be parked?
So the problem here also belongs to the Federal Government, not just the Fed. Of course neither they nor most of the American people really want to see an end to deficits or the GSEs. So instead we will get currency depreciation, capital controls, and trade protectionism to serve as band-aids on the underlying problem.
April 6th, 2008 at 11:05 pm PDT
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Hello all,
Imho, a key next step is motivating our elected representatives to enact legislation that provides taxpayers with a good payoff in return for bailing out speculators.
Enter my humble petition for The Learning and Earning Modernization, Moral Hazard Minimization and Entertainment Programming Talent Full Employment Act of 2008.
The petition is online at http://www.loveatmadisonandwall.com/petition/
The text of the petition:
We the undersigned (click here to sign) call on our elected representatives to see to it that the Federal Reserve opens its new loan program for non-banks — the Term Securities Lending Facility — to American media conglomerates that own a broadcast TV network. More precisely, to said conglomerates that use the loans to:
1. introduce particular online markets that provide people with new and improved ways to develop, demonstrate and profit from expertise (details below)
2. develop entertainment programming that, in part:
a) popularizes these markets
b) showcases high-performing market participants
Our reasoning:
The advent of price-transparent [1] markets that provide a barter currency [2] for buying and selling ad spaces on single-creator media (e.g., blogs) will provide people with improved ways to profit from their expertise. Details >>
New prediction markets will provide people with new ways to demonstrate their expertise. >>
The advent of workflow markets [3] for customized education (CE) will DRAMATICALLY improve the way that people develop expertise [4], and will provide a new way for people to profit from their expertise. >>
Owning popular markets of the aforesaid kinds is an ideal way to increase profits for an American media conglomerate that owns a broadcast TV network. >>
The less benefit individual speculators can derive from moral hazard, the more they will utilize said markets.
As such, the sooner media conglomerates have access to the Fed’s new loan program, the sooner a lot of top-quality entertainment programming will:
1. increase awareness of (proposed) public policies that (would) put taxpayers on the receiving end of gratuitous moral hazard (e.g., increase awareness via a next-gen Jed Bartlet channeling Jon Stewart and Vietnam-era Walter Cronkite)
2. showcase elected representatives who protect taxpayers from gratuitous moral hazard ;-)
Q.E.D. :-)
April 6th, 2008 at 11:42 pm PDT
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capekeeper1 — I think it certainly matters who is running the Fed, but I don’t think that helps much. It’s the oldest problem in political science. Benevolent dictatorship by an infinitely wise king might be a pretty good arrangement, but human beings are neither perfectly benevolent nor perfectly wise (plus, consider the internal contradictions — perfectly benevolent towards whom, since trade-offs must always be made?). Though I’m unsurprisingly fond of Paul Volcker, I don’t think appointing his clone forevermore to run the Fed would resolve the problems. There may be times (perhaps even now, as many would argue) when tight money is more dangerous than loose money. No one is smart enough to always figure out the right answer, not even Volcker. We want a better sort of information system making these decisions.
Also, suppose we did have a “wise” Fed for a long time. In an echo of recent financial markets, we’d open ourselves up to a Minsky moment. The more we trust something like the Fed to always get things right, the greater the lattitude we allow it, and the greater the damage we will endure when eventually someone incompetent or unlucky is thrown the ropes.
It’s just not a good arrangement.
Felix — actually, I’d prefer reinebriation myself. alas, that’s not on tap for tonight.
IA — This was definitely my “inner Hayek” (as Brad Delong often puts it) getting some air. I certainly am, as you suggest, skeptical of banks, but of course it’s never enough to call out what sucks, one also ought propose what would be better, and so far I’m hopelessly vague on that.
jjalkakdjfll — Excellent point. You’re right that by talking about “central banks”, I glossed over a lot of important distinctions between many institutions. But it’s important to recognize that our monetary system is, and will hopefully continue to be, in some sense global. One cannot understand the behavior of the Fed over the past two decades, for better and for worse, without thinking about the behavior of other central banks. The present monetary architecture is a part cooperative/part competitive game played by central banks around the world, each of which is subject to different constraints and driven by different goals and ideologies. That fact is part of why the present architecture is so unstable. We’ve no reason to believe such heterogenous players will find any “good” equilibrium anytime soon. We can see CBs play for short-sighted domestic approval, mercantilistic advantage, the interests of a banking or investment elite, the interests of a political elite, whatever. There are winners and losers, within and between nations, but why should we think any kind of “public good” is being optimized? There may not be a perfect system, but this one that has very little to recommend it.
Aaron — Ideally, I think you’re right, that letting different stores of value serve as bases for exchange would be best. In a sense that means replacing money with barter all over again, but that’s less impractical now than way back when, because it’s gotten easy to define many kinds if credible claims on commodities and services, and any such claim could serve as money. People needn’t bring live chickens (or gold coin) to the lunch counter. The main obstacle to that is currency conversion, but technology helps there a lot. With a device like the credit card swiper at every cash register, there’s no reason why vendors couldn’t “price” in any currency they choose, while buyers pay in an entirely different currency, and the “exchange” would take place automatically. The hardest part is price tags — we don’t want to have to take every item to a special barcode reader to get a price in the currency in which we intend to pay. But that’s not so intractable. (Think e-paper!)
That said, there’s no reason why states couldn’t still sponsor currencies, and obviously it will be hard to get them out of the business of trying to do so. They’d just be “disciplined by the market” more effectively than they are now.
More soon on this stuff, I hope…
April 7th, 2008 at 12:14 am PDT
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Mr. Waldman,
Your final comment on Mr. Krowne’s comment is a welcomed radical approach. There are small efforts in this direction already with organizations such as the Liberty Dollar, Bullion Vault and Everbank. This approach sure beats the Amero. Question is will the authorities ever give up their control? I don’t think so. Witness the recent harassment of the Liberty Dollars’ sponsor. But I think there will come a time where that power will be irrelevant. When people will just give up on the system and refuse to participate or be unable to due to not having a stake in the game (no money.) The majority of the population is headed there now. I think a much simpler life is around the corner where we don’t care about big screen TVs or the Lakers. Why generate wealth for the banksters when you can just take care of your local community. The work wouldn’t be as hard and much more rewarding. The mistake that the banksters, government and MSM make is that they think we need them. With abandoned homes and even entire neighborhoods sitting unattended there are places to live in that, with a little creativity, do not need the grid. Wouldn’t that be something, the triumph of the sheeple…. by default.
April 7th, 2008 at 3:28 am PDT
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Hear Hear!
The problem as I see it is that in any system there will be a pull for some players to get an unfair advantage (I define unfair advantage as one that a) self-reinforces b) cannot be easily, if at all, replicated by the competitors. Special legal status for few rating agencies is a prime example of such, as is access to the fed funds etc..). All it takes is for some of the succeed (and, on a balance of probability sooner or later some will), and the system will start becoming unstable.
Unfortunately, short of an unbribable alien arbitration, I cannot see how to fix the system.
That said, a system of “small worlds”, where the main rule is “you’re not allowed to become big”, is probably the best of the bad. Or (not that I can now figure how to implement it) something similar to democracy’s election cycle.
April 7th, 2008 at 8:58 am PDT
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Well, the Shiller piece in the NY Times almost reads like someone called in a favor; one gets the sense the a politics of support motivates it as much as any “analysis” might. That said, your statement that in the end it is all about the “informational architecture of the financial system” is so entirely right, so well understood, that one can only say huzzah! May you live forever and have great influence in the affairs of man.
April 7th, 2008 at 8:59 am PDT
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I am not an economist (just a blog reader), nor am I even a goldbug, yet as I read you post, I am left with same question many of your other reders raised: “Doesn’t gold do just this?”
The true is whatever system we choose, someone will always loose, and when they do, they will then try and change the system to avoid loss. If they successfully link their issue to enough other issues to gain a consensus, we majority change the system and we will all have to start over again.
This story will repeat itself till the end of time.
April 7th, 2008 at 2:32 pm PDT
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personally, i’ve had it with specious distinctions between central and private bankers. get out much? they’re the same people with the same interests. call it “class interests” if you like — i certainly do. the implication in waldman”s argument that, sans enabling, private banking interests would not have misallocated, is the worse kind of snake oil there is. this system is built for misallocation.
if you want “free enterprise,” don’t whine about corruption, and don’t act surprised when bankers start to consolidate political, in addition to merely economic, power. if you want a just society — heavily regulate banks or socialize large areas of finance. plan investment. limit speculation by levying heavy tobin taxes on derivatives. there are many things that can be done, immediately …
but that’s the other thing. none of the solutions mentioned here can be accomplished through economic readjustment alone. these are all political measures: regulating a central bank is politics; reducing oligarchic wealth is politics; dis-entitling bankers, lawyers, and accountants is politics. politics is about knowing who your enemy is. talk of “systemic risk” and “structural failure” is fine when you’re just posturing; but this “crisis” is about the guy next to me on the subway who just pocketed $15 million over the last 7 years in subsidized fraud. getting that money out of his pocket and back into social investment is what this is truly all about.
April 7th, 2008 at 3:38 pm PDT
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Alan Greenspan was “The Great Accommodator.” It didn’t matter who the President was, Al wasn’t going to tick him off. Ben is Al’s understudy. Total accommodation is the price of the *illusion* of political independence for the Fed. Our history of inflation confirms that. The exception: Jimmy Carter learned too late in office that to whip inflation you have to control money growth and hence appointed Volcker–if Jimmy’d learned quicker and taken his recession early in his term, we might have avoided supply-side economics and the disasterous budget-busting of the Republicans since then. Let the debt-deflation begin! The Depression starts in 2012!
April 7th, 2008 at 4:10 pm PDT
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“We can and should liberate money from the bankers, central and otherwise.”
Average Joe was as smart as the smartest Wall Street Investment Banker simply by saving and accumulating gold which could not be destroyed or created on whim of some centralized agency like the Fed.
No matter whether gold can be remonetized or not, I am amazed at the opinion here holding “hard money” people in disregard. They were and are right, despite any personality shortcomings.
What’s even more amazing is the persistent belief in socialistic, centralized, authoritarian solutions, rather than freedom, private property, and individualism.
April 8th, 2008 at 5:54 pm PDT
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Steve, as “counterfeiters of first and last resort” CB’s are, today, the State’s “go to guys”. They keep the States in business by allowing them to keep expanding year in and year out.
An ethical state would only expand its ventures with the blessing of its citizens with transparency and full disclosure of the long term implications of its policies.
None of this is happening today. In the US, the Tripartite of Treasury, Fed and Wall st act out their 3 card monte game with impunity. This is “Financial Terrorism” against its own citizens. The end result has been a lowering of the Real standard of living for a majority of the Public.
Leverage needs to be developed through the political process to persuade the Congress that it is in “their own special interest” to allow new financial processes that will create a vastly superior economic system with rising standards of living for the majority.
Very few steps are needed to get the US back on track to a very prosperous future. The first step is a peace agreement with China and Russia to freeze military development and expansion. The second step is a “Manhattan/Apollo energy project”; competitively developing any and all energy technologies with infrastructure. The third step is to unleash “private claims” as legal tender.
Credit was developed before money as a function of information analysis. Money is dumb, which the state has taken advantage of for its own benefit(counterfeiting).
Private counterfeiters go to jail, why are the members at the Fed currently out of jail?
Allowing legal tender private “real claims” with the information content verifiable with current/future technology is a “no brainer” in the years ahead.
April 9th, 2008 at 10:58 am PDT
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The Fed, though intended to be an “independent” agency has, like the Supreme Court, “followed the elections”. We don’t have captialism, we have “regulated capitalism”.
We have an “elastic” currency “aided and abetted” by “elastic” legislators. We have perennial Walter Wriston caricatures pressuring the House Committee on Financial Services &the U.S. Senate Committee on Banking, Housing, and Urban Affairs. We have a conspiratorial organization that goes by the name of the American Bankers Association – with its well funded lobbyists(PAC money).
The Board of Governors is self-described as: “subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute” Even so, the Fed is “connected at the hip” with Congressional allies, a la Greenspan, who the New York Times called a “three-card maestro”.
The Fed’s research is politically coordinated, targeted to justify its monetary policy objectives – those that appease the banking community. It’s as the university professor said: “innovate away from home”. Academic freedom has become the “barbarous relic”.
The great German poet and playwright Bertolt Brecht would have agreed and once said it was “easier to rob by setting up a bank than by holding up (one).”
Blame the profit proclivities of the American Banker for our speculative orgy.
April 9th, 2008 at 12:33 pm PDT
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Benjamin Franklin invented your answer.
Benjamin Franklin’s Solution ~ Dr Ellen Brown
Nationalization has traditionally had a bad name in the United States, but it could be an attractive alternative for the American people and our representative government as well. Turning bankrupt Wall Street banks into public institutions might allow the government to get out of the debt cyclone by undoing what got us into it. Instead of robbing Peter to pay Paul, flapping around in a sea of debt trying to stay afloat by creating more debt, the government could address the problem at its source: it could restore the right to create money to Congress, the public body to which that solemn duty was delegated under the Constitution.
The most brilliant banking model in our national history was established in the first half of the eighteenth century, in Benjamin Franklin’s home province of Pennsylvania. The local government created its own bank, which issued money and lent it to farmers at a modest interest. The provincial government created enough extra money to cover the interest not created in the original loans, spending it into the economy on public services. The bank was publicly owned, and the bankers it employed were public servants. T he interest generated on its loans was sufficient to fund the government without taxes; and because the newly issued money came back to the government, the result was not inflationary.7 The Pennsylvania banking scheme was a sensible and highly workable system that was a product of American ingenuity but that never got a chance to prove itself after the colonies became a nation. It was an ironic twist, since according to Benjamin Franklin and others, restoring the power to create their own currency was a chief reason the colonists fought for independence. The bankers’ money-creating machine has had two centuries of empirical testing and has proven to be a failure. It is time the sovereign right to create money is taken from a private banking elite and restored to the American people to whom it properly belongs.
April 13th, 2008 at 2:48 am PDT
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OK, this thread is still going and I feel compelled to add to those who seem to waver back and forth over the point of whether a central bank can be or is part of the problem.
The above poster mentions Franklin’s solution.
First I am among those believing that the Revolution was over nothing less and nothing more than the ability of the Colonies to run their own monetary system, a collective of state issues.
Having said that, today, there is a deep need for a look at alternatives to the global monied interests who control all of the non-sovereign central banks that create wealth by issuing debt, albeit in the form of credits.
I say the best description of the best alternative out there today is here.
http://www.neweconomics.org/gen/uploads/CreatingNewMoney.pdf
It is time to honor Franklin and Jefferson and Madison and especially Lincoln and other great Americans who saw the money-creation power of private bankers as the greatest threat to American liberty.
And, look where we are today.
Just a small revolution.
April 14th, 2008 at 11:43 am PDT
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Want to Save the Economy?
April 15th, 2008 at 2:09 am PDT
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