Yields on US treasury bonds are the lowest in history. They have gone negative in countries around the world. Bank stocks in Europe have fallen 75% and even though stock markets have recovered, bank stocks are still decimated. We've entered uncharted territory.Traders as well as economists are asking, is something else going on that we can't see? Is there a black swan out there somewhere?

Well, I had the opportunity to ask Ludwig von Mises, one of the greatest classical economists of our time from the Austrian School of Economics, and who wrote the book "The Theory of Money and Credit", "Do economic problems cause monetary problems, or do monetary problems create economic problems?"

I was asking "What comes first, the chicken or the egg in monetary and economic theory?" I was looking for cause and effect. His answer was a long pause, and then he said, "I know of no situation where a problem in a nation’s currency did not precede a problem in the economy."

It is this statement that I think about when I ask myself, "What is happening to interest rates?" For an interest rate is the price of money.  The fact that both nominal and real interest rates are where they are tells me that money is in trouble.

I look at the balance sheet of central banks which has never been as high in all of history, and how interest rates are forcing everyone to push money into safe investments, and there can be little doubt that money is being mistrusted. 

Mistrusted money is a kind of bad blood that infects societies everywhere and perverts normal human action. That will inevitably infect the economy. It is one reason for this era of stagnation we are in today. Trouble in money eventually leads to trouble in economies. So,do we have trouble in our money?


The Nail

Let me tell you a story. Back in the 70s I was invited to a round table discussion on inflation and the world's monetary problems. We broke for lunch and six of us sat around a table and continued a more informal discussion. I happened to be seated next to the distinguished professor and economist Hans Sennholz. Hans was known at the time as one of the more popular Austrian Economists in that he had continuous commentaries in the Wall Street Journal.

The subject turned to inflation and Hans talked about his experiences in Germany. He told us of a man that bought a business, actually a factory that made nails. As the great inflation began to grip Germany the value of his factory grew, he got an offer and couldn't refuse such a tidy profit, so he sold.

Six months passed and property values continued to climb. The former owner of the nail factory was growing bored but knew nothing other than nails, so he sought another factory to buy. The problem was he could only buy a factory three quarters of the size of his previous factory. But knowing nothing other than nails he bought it.

Not long after that the value of his factory soared! It virtually doubled in value. He once again decided to sell for what must have been the highest priced factory of its kind that had ever sold. Time went by. The man grew bored once again and looked around for another factory. But prices had continued to soar.

To his dismay he could only find a factory that produced 10% of what he had been producing, but regardless he bought it. Then there came an offer that was so outrageous that he figured if he took it he couldn't go wrong -- he would be rich beyond his wildest dreams. He took the millions of marks offered and retired.

It wasn't long before he realized that he couldn't make ends meet; that everything he bought was going out of sight. He realized that if he didn't do something he would be impoverished. In a panic he went for the only thing he understood -- nails. When he went to repurchase his factory, he was offered only one large nail in return for the amount of money he offered. The man with all his millions -- was broke.

Han Sennholz paused. I asked what did the man do? He said he hammered the nail into a nearby wall and hanged himself.

Hans had just taught us all the difference between price and value and the illusion of inflation.


The Nature of Inflation    


We are on a fiat standard tied to nothing but the confidence in our money. Our money is backed by the confidence in our government, our judicial institutions, our financial system, and our productivity. The loss of confidence in institutions everywhere around the world is showing up in the search for safety. A further and continuous loss of confidence could result in all currencies reverting to their intrinsic value. Paper claims to goods are only good if someone else is willing to trade real goods for it.

Most people when they think of inflation think of prices going up at 2%, then 4%, then 6% until the Fed takes action to contain it. There is that. But then there is hyperinflation where people start dumping their money in a panic, and the value of money plummets daily. That's the story of the Nail.

Hyperinflation if it comes, will be insidious and we may not know about it until it happens. By then it's too late. Many rightfully worry that our runaway entitlements will lead to just such a scenario. We can't know at what point citizens lose confidence in their money, but if and when they do, it happens quickly.

We know that individuals are losing confidence in central bankers to control things. We know that they distrust their political leaders. We know that the sanctity of contracts are suspect. We know that people don't like bankers and they don't trust the banking system. And we see bank stocks falling to unheard of lows and the viability of the Euro and the Eurozone under question. And we now see our justice system is in question if not the integrity of the police departments themselves. The social fabric of society is breaking down. It is not a huge leap of logic,then, to conclude that the citizens of the world are not far from mistrusting their money too.

We are in an era of stagnation, low productivity, and growing mistrust and uncertainty. Now, at a time when inflation is considered to be dead, it's time to start worrying about inflation - if not the cohesiveness of the international monetary system itself.

Paul Nathan