I just finished reading a copy of a book entitled "The Monetary Elite vs. Gold's Honest Discipline" by Vincent R. LoCascio.

LoCascio makes a compelling case that although it's possible to maintain the integrity of money in a fiat system, historically only the discipline of a gold standard has succeeded in preventing massive abuses by the monetary elite.

Of course the above should be painfully obvious to everyone by now, but unfortunately it is not. I offer as proof Ron Paul's final debate with Greenspan before the House Financial Affairs Committee, July 20, 2005.

Ron Paul:

To me, this system that we have today is a convenient way to default on our debt - to liquidate our debt after the inflationary scheme.

Even you, in the 1960s, described the paper system as a scheme for the confiscation of wealth.

And, in many ways, I think this is exactly what has happened. We have learned to adapt to deficit financing. But in many ways, the total debt is not that bad because it goes down in real terms.

As bad as it is, in real terms, it's not nearly as high.

But, since we went on a total paper standard in 1971, we have increased our money supply essentially 12-fold. Debt in this country, federal debt, has gone up 19-fold - but that is in nominal dollars, not in real dollars.

So my question is this: Is it not true that the paper system that we work with today is actually a scheme to default on our debt? And is it not true that, for this reason, that's a good argument for people not - eventually, at some day - wanting to buy Treasury bills because they will be paid back with cheaper dollars?

And, indeed, in our lifetime, we certainly experienced this in the late 1970s - that interest rates had to go up pretty high and that this paper system serves the interests of big government and deficit financing because it's a sneaky way of paying for it.

At the same time, it hurts the people who are retired and put their money in savings.

And aligned with this question, I would like to ask something to dealing exactly with gold, is that: If paper money - today it seems to be working rather well - but if the paper system doesn't work, when will the time come? What will the signs be that we should reconsider gold?

Even in 1981, when you came before the Gold Commission, people were frightened about what was happening - and that's not too many years ago. And you testified that it might not be a bad idea to back our government bonds with gold in order to bring down interest rates.

So what are the conditions that might exist for the central bankers of the world to reconsider gold?

We do know that they haven't given up on gold. They haven't gotten rid of their gold. They're holding it there for some reason.

So what's the purpose of the gold if it isn't with the idea that some day they might need it? They don't hold lead or pork bellies. They hold gold.

So what are the conditions that you might anticipate when the world may reconsider gold?

Greenspan:

Would there be any advantage, at this particular stage, in going back to the gold standard?

And the answer is: I don't think so, because we're acting as though we were there.

So I think central banking, I believe, has learned the dangers of fiat money, and I think, as a consequence of that, we've behaved as though there are, indeed, real reserves underneath the system.

As for me I can not believe Ron Paul let him Greenspan get away with that response so easily. Perhaps his time was up or perhaps he was too staggered by the silliness of Greenspan's reply to fire off another round of questions.

No matter how one slices it, money supply going up 12 fold and debt 19 fold since Nixon defaulted on the gold standard is hardly acting as if we were still on the gold standard. Indeed, what little discipline we once had was thrown out the window long ago and has not been seen since.

LoCascio writes:

Today each country's central bank, in conjunction with commercial banks, can create and distribute money without limit. This process does violence to what should be the most sacrosanct characteristic of sound money: its scarcity integrity. Fractional reserve banking, by its very nature, compromises the monetary unit's scarcity integrity.

With debt up 19 fold in conjunction with Greenspan's latest and all time biggest bubble otherwise known as housing, exactly where do we go from here? Given the illiquidity of housing, I am inclined to believe housing is the "bubble of last resort". With global wage arbitrage, outsourcing, and rampant speculation in housing and the credit markets, this is the end of the line. There are no bigger bubbles to be blown.

The picture in my mind at this point is that of Greenspan playing The Sorcerer's Apprentice. (If you have not yet seen Fantasia, I highly recommend doing so).

At any rate, if you can relate to the scene in Fantasia where buckets of water were splashing around everywhere as the apprentice unleashed a "nightmare of liquidity", then you have the right image in your head.

OK Mish, where to from here?

Good question. Let's consider the Wisdom of Ludwig Von Mises:

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

"The boom squanders through malinvestment scarce factors of production and reduces the stock available through overconsumption; its alleged blessings are paid for by impoverishment."

"The individual does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about."

"Credit expansion is the governments' foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous."

I had to laugh when I saw that Von Mises quote referring to "the magic wand". Indeed, history will not be so kind to Greenspan. He will be not be remembered as "The Maestro" but as "The Sorcerer's Apprentice" looking for the easy way out of every problem to the point of his own undoing.

If the theory that housing is the "bubble of last resort" holds true, we will not have long to find out whether or not this grossly absurd credit expansion is over.

Back to the book....

LoCascio explains "If meaningful reform is not forthcoming, a financial crisis dwarfing all previous crises is probably in the cards. One can not know when the crisis will occur but one will know why: the lack of scarcity and distributional integrity in the monetary unit".

Obviously LoCascio is an optimist. I think it is far too late to prevent a calamity that wipes out the malinvestments and excesses of a twenty year boom that were built upon bubble after bubble of reckless credit expansion.

Nonetheless, LoCascio attempts to address the challenge of creating a "Moral Monetary System". He argues that the root of the current problem is that inflation is perverse because increases in the money supply are distributed unevenly an unfairly. Any solution must remove the ability of the FED to create and distribute money. He also mentions two related problems that must be rectified: First our monetary unit must be defined. Second, money needs to be distinguished from credit.

I will save a discussion of money supply for a later date, but LoCascio as others before him, have pointed out numerous flaws with current measures such as M1, M2, M3, MZM etc. The preceding measures blur credit with money in varying degrees and have other flaws as well that will be a subject for further discussion at a later date. For now, let's just say that credit is so often blurred with money in our current system that it is hard not to be confused.

The heart of his proposal is to use money that has 100% backing with no more fractional reserves on demand deposits (checking accounts). Thus money can not be at one's disposal in a checking account while simultaneously being lent to someone else. "Money is only money if it is available to the owner on demand at face value". Finally, money would be once again be backed by gold.

To date no one has put together a way to get from here to there. LoCascio attempts to do just that with an eight step program in which

1. Credit is distinguished from money
2. A preliminary money supply figure is determined and published based on step 1
3. A day of reckoning (DOR) announced on which money supply would be "corrected"
4. Fractional reserve banks will cease to exist
5. Time deposits will be kept distinct from demand deposits
6. Leading up to the DOR money totals and credit totals will be fine tuned
7. On the DOR existing federal reserve notes (dollars) will be replaced with Treasury Certificates (TC) that are payable on demand in gold
8. Taking the number of ounces of gold held by the treasury and dividing that by the TCs, one gets a price value for gold and notes are redeemable at that price. A dollar once again has a value associated with it.

Note: The above is a very short summary of what was proposed and LoCascio admits more work is needed to get everything correct. Obviously, there would be a huge windfall to anyone owning gold (unless gold profits were once again confiscated) and there would be other consequences as well. In a brief phone conversation as well as in his book, LoCascio emphasized the odds of his plan happening are very remote and that this was primarily a theoretical exercise.

One such difficulty that LoCascio did not deeply delve into is the global problem required in getting all the Central Bankers to agree to carry out such a plan simultaneously. Also, given our current trade imbalances, there would be huge pains for the US to go back to an honest system right now.

While I think LoCascio underestimates the theoretical difficulties of such an endeavor, it is very clear that the current system is broken beyond repair. In that regard, I am more of an optimist than LoCascio. Something will have to replace Bretton Woods II given that the current system is clearly not sustainable. Why not use the ideas outlined in his book as a starting point?

Like it or not, the US will have to start thinking about long term consequences or the markets will eventually force the issue. My guess by now should be obvious. Time will be ripe for a "fresh honest start" after the repudiation of Greenspan's wizardry comes via an enormous deflationary collapse. Unfortunately, that final collapse may be years away if we follow the Japanese Model.

Regardless of whether or not one thinks it is either desirable or even possible to return to a gold standard as described, the book is a very good read on the problems of the current fiat system in which money, backed by nothing, can be created at will by the elite for the sole benefit of the elite.