Monday, May 16, 2011

Jefferson the American Prophet

Among the many inspirational and insightful quotes collected for Brett Sizemore's book 'Here's a Straw, Suck it Up.' is this gem from Thomas Jefferson in 1802 that's eerily relevant today:

"Banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and the corporations that will grow up around them, will deprive the people of all their property until their children wake up homeless..."

Here's how that works. First, consider the purchase of a home. Now hold the value of the home constant and consider it is the value of the currency that fluctuates. During a time of inflation, or rapidly rising home prices, you buy your house (with a mortgage) at $200,000 with the expectation that prices will continue to rise. Now, deflation hits the housing market instead. Prices fall. Your house is now worth $100,000. You were counting on rising home prices to allow you to take out a mortgage to cover your other bills. Now you can't afford the payments and you can't sell the house for enough to cover the mortgage.

Whether you foreclose or walk away, the bank gets the house back. Not only that, they were insured against losses with companies like AIG, so they also get the other $100k. On paper it looks as though the bank just broke even, or took a loss after expenses. In reality, if we're still keeping the value of the house constant, they started with the house, ended with the house + $100k minus expenses and insurance premiums. They did fine. The fluctuating value of the dollar is a smoke screen.

In the simplified scenario above, a number of players are inclusive in "the bank". I don't believe banks and real estate financing are inherently evil, but they are susceptible to great abuse if customers are not wary.

Banks give currency value in that they provide an orderly, secure delivery and storage system. They are run by human beings, who must not be entrusted with all our cash unsupervised and unchallenged. Trust, but verify.

The recipe is simple: Inflate, Deflate, Repeat.

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