We start with William Volcker, considered to be the true “father” of classical liberalism, libertarianism and modern conservatism. In 1932, the ultra-wealthy Volcker created the William Volcker Fund as a charitable foundation whose mission it was to subsidize the promotion and dissemination of “free market” economics ideas.

Establishing a pattern that would later become the hallmark of similar foundations, the Volcker Fund “started to spin-off organizations by the boatload, each intended, not just to serve specific purposes but to give the appearance of many ‘independent’ efforts spawned by a ‘mass’ appeal.”² Among the first of these spin-offs were complimentary institutions including the Earhart Foundation and the Reim Foundation as well as think tanks such as the Intercollegiate Society of Individualists (ISI), later renamed Intercollegiate Studies Institute, and the Foundation for Economic Education or FEE.

The Foundation for Economic Education or FEE was established in 1946. Dubbed the grand daddy of all Libertarian think tanks, it produced The Freeman, which became the founding journal of Libertarianism.

In 1947 FEE initiated the Mont Pelerin Society meetings from which would be spawned some 500 additional “free market” foundations and organizations in nearly 80 countries. Some of these foundations in turn led to the creation of umbrella foundations that were global in scope and reach. One such foundation which came out of the early Mont Pelerin meetings was the Institute of Economic Affairs based in London and created in 1955. The Institute of Economic Affairs led to the creation of the global Atlas Economic Research Foundation, which in turn created a network of over 50 think tanks in 30 countries.

According to its website, “The Atlas Economic Research Foundation serves as a catalyst and connector to link free-market organizations and individuals to the ideas, people and resources they need to promote a free society.” On the “Sound Money Resources Page” of the website you will find Mises Institute luminaries Murray Rothbard, and many others. On the main page is a link to “The Atlas Shrugged” project, promoting Ayn Rand’s “influential novel Atlas Shrugged”.

As it happens, the lofty-sounding goals of the Atlas Economic Research Foundation dovetail nicely with public-private partnerships – that is to say privatization of public resources – advanced by the United Nation’s Committee on Economic Cooperation and Integration (CECI)³ as well as many governments around the world, including the United States.⁴ According to UNECE (parent of CECI), one of its main areas of expertise involves “global economic cooperation and integration”.

UNECE’s “expertise” in turn fully supports the Atlas Economic Research Foundation’s “Campaign for Free Trade” which is designed “to combat harmful economic nationalism”. Whether coincidentally or otherwise, it is the type of synergy created through the complimentary goals of these seemingly disparate groups, institutions and agencies which is fast propelling the entire globe toward the new economic/police state.⁵

The Atlas Economic Research Foundation was just one of a myriad of descendants of the Mont Pelerin Society, whose first meeting was held at an out-of-the-way posh resort in Switzerland in 1947. There were a total of thirty-nine participants at that meeting. Ten of the thirty-nine were American – giving the United States a noticeable presence in Switzerland. The Volcker Fund paid the way for all ten American participants, including Frederick von Hayek who served as meeting coordinator. Milton Friedman and Ludwig von Mises were also among those ten American participants.

FEE was the conduit through which the Volcker Fund provided its largess. According to an undated “Welcome letter” written by former FEE staff member and board member Gary North, FEE has been replaced by the Mises Institute. Thus says North, while FEE had been blessed “with piles of money” among other things, the Mises Institute itself was blessed with the name Mises, a popular website, an even more popular feeder website (LewRockwell.com), multiple mailing lists, a facility located in an affordable area attractive to young scholars, and more.⁶

A second think tank, the Intercollegiate Studies Institute or ISI was created through the Volker Fund in 1953 to combat what would eventually be called “political correctness” and “‘left-bias” in colleges and universities. Today, ISI consists of 50,000 college students and faculty and the organization sponsors dozens of programs representing the entire spectrum of Libertarian causes through generous subsidies.

Yet another think tank, The Institute for Humane Studies was created in 1961 by Floyd “Baldy” Harper, after he had served as a star recruiter for the Volcker Fund. The IHS identified and subsidized thousands of students friendly to the new Libertarian doctrine, and it also spawned dozens of similar organizations throughout the world. It was the strategic successor to the Volcker Fund.

After the Volcker Fund closed, subsidies for the IHS shifted to The Scaife Foundation, Koch Family Foundations, The Bradley Foundation, and the Carthage Foundation. The Volcker fund itself was replaced with the short-lived Center for American Studies. Ten years later, the remainder of Volcker Fund money, some $7 million, went to the Hoover Institute.

Early Volcker protégées included Frederick von Hayek, Milton Friedman, Ludwig von Mises and Murray Rothbard among others. The following excerpt from author Eustace Mullins provides a 1984 snapshot of the Volcker-inspired “free market” movement:

The present star of the Hoover Institution is Milton Friedman, who is credited with bringing economic disaster to Chile, Israel, the United States, and other countries in which his ‘monetarist’ theories have been introduced. Friedman’s ‘monetarism’ is the same old bankers’ swindle of endless creation of more interest bearing debt money, requiring ever increasing taxes merely to meet the interest payments…

Friedman came to the Hoover in 1977 as senior research fellow, simultaneously accepting a post as economic consultant to the Federal Reserve Bank of San Francisco. He and his consort, Murray Rothbard, dominate a closely interlocked network of ‘hard money, ‘conservative’ groups, which includes the Heritage Foundation, Mont Pelerin Society, Cato Institute, Ludwig von Mises Institute, and American Enterprise Institute … Their mentor is the late Ludwig von Mises …

Their economic principles stemmed from the ‘Viennese School’ founded by Karl Menger and Eugen von Bauwerk … At that time, Vienna was dominated by the House of Rothschild, which had controlled the national debt of Austria since the Congress of Vienna in 1815. Austria’s Tyrol silver mines were owned by the Rothschilds, as were her railways.”⁷

In the United States, Friedman, von Mises and Hayek, together with dozens of other early Volcker Fund recruits, shared in common the fact that all had their teaching positions and various forms of financial, publishing and public relations assistance arranged for them by Volcker Fund associates.

For example, “in 1950, the Fund arranged for Hayek to secure a position at the University of Chicago…. When the University only granted an unpaid position, the Fund arranged for the Earhart Foundation to pay him a salary.” The Fund also made arrangements for the republication of Hayek’s book Road to Serfdom by the University of Chicago (which itself provides a recurring and important connection to the gatekeepers). These arrangements for republication were undertaken despite the fact that the book had been almost universally rejected by the Economics establishment. A year later the Fund arranged for the book’s serialization in Reader’s Digest.²

Book sales for Hayek, Friedman and other Volcker protégées were given massive levels of financial and promotional support through the National Book Foundation, which was among the first “front organizations” of the Volcker Fund. Importantly and although “the Foundation’s affiliation to the Volker Fund was not hidden, it was circumspect enough to suggest, even to most ‘Libertarians’, that it was independent…. [But] As the Volcker efforts geared up, the Foundation began to distribute millions of books [to college libraries and through other channels] from dozens of authors, all coming from the Fund’s stables. Many educational ‘incentives’ were initiated such as ‘teach a course on Hayek, get 10 (or 100) textbooks for free.’”²

Similar to Hayek, “the Fund and its progeny identified Friedman early on, shepherded his career at the University of Chicago, subsidized him through a paid lecture series …, paid his way to Mont Pelerin, arranged for the serialization of his book by Reader’s Digest, and bought a significant number of the books that Friedman was so proud of ’selling.’”²

A slight deviation in the pattern occurred with von Mises, who actually had taught at the University of Vienna — but again in an unpaid position. In point of fact the University had turned von Mises down on four separate occasions for a paid position.

After von Mises emigrated to the United States in 1940, associates of the Volcker Fund obtained an unpaid visiting professorship for him in 1945 at New York University. Further arrangements allowed for von Mises’ salary to be paid by Volcker Fund associates for a total of 25 years. “This was typical of the Fund’s ‘bait and switch’ tactic for developing resumes. In the United States, von Mises was the ‘famed economics professor from the University of Vienna.’ In Europe, he would become the ‘famous American economist from New York University.’”²

Murray Rothbard never held a Volcker-arranged teaching position. Instead, from 1951 through to 1962 when the Volcker Fund was dissolved, Rothbard served as a consultant to the Fund. He would later call this the best job he ever had.

A large portion of his work “consisted of reading and evaluating books, journal articles, and other materials. On the basis of written reports by Rothbard and another reader — Rose Wilder Lane — the VF’s directors would decide whether to undertake massive distribution of particular works to public libraries…. The VF also asked Rothbard to submit reports on particular questions, such as how to rank sundry economists in terms of friendliness to the free market, [and so on -- all of which] shed ‘much light’ on how the Fund decided which ’scholars’ to promote, and which to attack.”²

Over the many decades since William Volcker was first inspired to subsidize the promotion of “free market” principles, there has been “[t]ens, perhaps hundreds of billions of dollars, hundreds of millions of books, hundreds of journals, dozens of universities, tens of thousands of people and thousands of professorships, and so on in a network touching virtually everyone in the ‘Western Democracies’ — all of it centrally planned, all of it subsidized, none of it capable of existing by itself in the commercial marketplace or in the ‘marketplace of ideas’ and all of it failing dozens of times until hooked into the river of cash produced by the simple subsidies of the rich designed to derail the ‘free’ evolution of ideas …”²

In contrast to “free market” think tanks which spread their ideology through countless independent-appearing spin-offs, we have the findings of the Reece Committee whose final report to Congress was made in 1954. Essentially, what this committee discovered was that the foundations they had studied, including the Ford, Carnegie and Rockefeller Foundations, were occupying themselves with financing liberal political groups, civil rights groups, and political extremist groups. The committee further found that these foundations, along with a number of others, were in effect supporting revolutionary activities throughout the world.

One avenue through which this support was achieved was through the cross-financing of organizations that were concerned with internationalism, including the Institute of Pacific Relations, the Royal Institute of International Affairs and the Council on Foreign Relations. Thus, as the Committee reported: “Substantial evidence indicates there is more than a mere close working together among some foundations operating in the international field. There is here, as in the general realm of social sciences, a close interlock.”

We might want to ask how all of this might be playing out in the current “war of ideas.” As it happens, the increasingly heated debate over immigration provides one example. For some insight, we can look to one of the largest coordinated marches in history which occurred on April 10, 2006. One journalist vividly describes this event and then cogently relates its occurrence to money flowing from tax exempt foundations:

In the streets of Dallas, Texas, a human tidal wave surged through the streets. The immense crowd carrying the Mexican flag … [was] estimated to be at least 100,000 strong, with other estimates running as high as 500,000 …

The scene was the same in countless cities around the country. One of the largest … was held, predictably, in Los Angeles. There at least 500,000 people poured into the streets. Of them, 25,000 were students released from Los Angeles public schools in order to take part in the demonstration …

… The demonstrations … were organized by a number of radical groups, with one of the primary sponsors being LULAC (League of United Latin American Citizens) …

But the demonstrations were large enough, and widespread enough, that they were more than the work of just one special-interest pressure group…. The size of the April 10 demonstrations, and their national coordination, hints at the existence of a massive organizational structure pulling the strings behind the scenes. The lifeblood of such an infrastructure is money, and lots of it …

In fact, it turns out that the radical Hispanic groups that orchestrated the marches are not the grass-roots groups they seem to be. Instead, they are funded, and in some cases were created, by money flowing from pedigreed “establishment” sources, primarily the large tax-exempt charitable foundations, like the Ford Foundation and others.”⁸

While it is true that the above article was written for a publication of the John Birch Society — itself a beneficiary of “right gate keeper” largess — this fact alone does not diminish the importance of the points made. This is particularly true in light of what has been discussed in Part III of this series.

It is important to note however, that the article emphasizes the impact of “left gate keepers” without informing us as to how the right gate keepers might be contributing to the “created conflict.” And yet, however repugnant and foreign it may seem to the unsuspecting critic, the fact is that each and every one of us alive today has been held captive to — and in a very real sense become victims of — the largely phony “war of ideas”. This war has in reality been orchestrated with astonishing success and almost endless financial support by the “winning organizations” of both left and right gatekeepers, for the express purpose of advancing those interests, not the interests of you and me.

The net result has been mass marketing — and indoctrination — of corporate-sponsored history, science, economics, medicine, diet and nutrition, law, politics and more, all brought to you by “the money trusts.” It is through our educational and other formal institutions that gatekeeper spin has managed to obtain a significant degree of credibility and legitimacy in this phony war of ideas.

But in the end, it is you and I who not only allow it to continue but who help sustain and nurture it as well. The ONLY way to break free of this trap is to clearly identify and focus on the underlying causes of what John Perkins and others have alluded to as “created conflict.”

The escalating conflict over illegal immigration is a case in point. It is wholly a man-made conflict stemming primarily from the economic havoc wreaked upon Central and South America by NAFTA, as well as the TRIPS agreement and the Agreement on Agriculture which were delivered to the WTO to enforce in 1995. These portions of what might be called the economic matrix have been added on top of the phony War on Drugs which has allowed the U.S. Government to rain down lethal chemicals on peasants living in foreign countries, in what is at best a misguided attempt to eradicate coca crops.

As usual, ordinary American workers along with peasants and small farmers bear the brunt of BOTH the so-called “free” trade agreements set up to benefit the investment classes⁹ and the phony war on drugs which serves to fuel the economic engines of the industrial north.¹⁰) So untenable has the situation become for South and Latin American peasants that they are willing to literally risk life and limb to come to the U.S. in an increasingly desperate search for a way to sustain themselves and their families. The massive influx of immigrants in turn creates a pronounced drain on local resources and living wage jobs — and serves to inflame passions on all sides.

Tensions between illegal immigrants and residents in the American Southwest — particularly in Arizona and Texas — have become sufficiently severe that many ordinary citizens have taken it upon themselves to take the law into their own hands, even in some cases going to the extreme of organizing armed patrols to protect their lives and property. Meanwhile human rights groups work feverishly to provide water and other vital, life-saving support to those secreting their way across the border. Ironically and alarmingly, a growing portion of these illegals includes a dangerous criminal element.

Within the context of this particular battle, as in all similar “created conflicts,” rarely is it ever mentioned that the root of the problem can be found within the fabric of the economic matrix itself. Any real resolution will require addressing this economic matrix in all its segments – beginning with a sovereign, debt “free,” Constitutional money system.⁵

Whether Ron Paul, Lew Rockwell and associates understand the extent or exact manner in which the “right” gatekeepers affects them or their politics — or indeed is a factor to be reckoned with — is open to question, and in the larger sense beside the point. After all, they, like the rest of us, have been shaped by the phony “war of ideas” created and paid for by both right and left gatekeepers.

The important thing is what you and I choose to do about it.

1. Left Gatekeepers.com.
2. “Mr. Anonymous and the Not-So-Spontaneous Birth of the Libertarian Movement” by anaxarcos, December 22, 2008. Scoop Independent News.
3. United Nations Committee on Economic Cooperation and Integration for Europe.
4. The National Council for Public Private Partnerships.
5. “The Encroaching Economic/Police State” slide presentation by Geraldine Perry.
6. Gary North “Welcome Letter,” undated.
7. The World Order by Eustace Mullins. 1984.
8. “Sponsoring the revolution: illegal immigrants are pawns in a game aimed at fomenting revolution and funded by the nation’s major tax-exempt foundations” by Dennis Behreandt. The New American, February 19, 2007.
9. Whose Trade Organization? by Lori Wallach, etal. New Press, 2004, 2nd edition; Stolen Harvest by Vandana Shiva. South End Press, 2000.
10. “American Drug War: The Last White Hope.” 2007 documentary, available online. Beyond Bogota by Garry Leech. Beacon Press, 2009. Whiteout by Alexander Cockburn and Jeffrey St. Clair. Verso, 1999.

Thus, the phenomenon has the potential to become the basis for a viable third party, particularly if other portions of the disaffected populace could be brought on board. Whether this eventuality materializes positively pales in significance when compared to our collective lack of understanding of the manner in which our personal ideologies and political choices are being shaped by a phony “war of ideas.”

This understanding must begin with an examination of the central role that tax exempt foundations and the money powers behind them have long played in the creation of both past and present political movements, now labeled “phenomenon.”

To begin this journey, we delve again into the questions of authorship and purpose of those “ancient history,”and highly controversial newsletters, otherwise known as The Ron Paul Political Reports. While Paul and his spokesman have given varying accounts over the years of just who wrote those newsletters, at least “a half-dozen longtime libertarian activists—including some still close to Paul—all named the same man as Paul’s chief ghostwriter: Ludwig von Mises Institute founder Llewellyn Rockwell, Jr.”²

So, who is Lew Rockwell?

For starters, Rockwell was Paul’s congressional chief of staff from 1978 to 1982 and a vice president of Ron Paul & Associates – which was the publishing company for the infamous Ron Paul Political Report as well as The Ron Paul Investment Letter and the Ron Paul Survival Report. Rockwell “remains a friend and advisor to Paul – accompanying him to major media appearances; promoting his candidacy on the LewRockwell.com Blog; publishing his books; and peddling an array of the avuncular Texas congressman’s recent writings and audio recordings…”²

A number of writers have identified a 1980’s collaboration between Rockwell and Murray Rothbard as the key to those infamous Political Reports. The purpose of the collaboration was to build a coalition of populist “paleoconservatives” via Machiavellian style methodology. Theirs was a deliberate “politics of hate” strategy that was at its most extreme between 1989-1994, the same time period during which the most incendiary Paul newsletters appeared. The works and writings of both Rockwell and Rothbard during that time period mirrored the most controversial of the Paul newsletters.³ Moreover, and as a result of those efforts, the 2008 Ron Paul Campaign was able to tap into the financial and networking resources of that coalition.

Those newsletters are only one of the ties that bind Rockwell, Rothbard and Paul together. The Ludwig Von Mises Institute is another, with Paul serving as a “distinguished scholar,” lecturer and frequent visitor. Rockwell is its founder and President.

According to its website, “The Ludwig von Mises Institute is the research and educational center of classical liberalism, libertarian political theory, and the Austrian School of economics. Working in the intellectual tradition of Ludwig von Mises (1881-1973) and Murray Rothbard (1926-1995), with a vast array of publications, programs, and fellowships, the Mises Institute … seeks a radical shift in the intellectual climate as the foundation for a renewal of the free and prosperous commonwealth.”⁴

The Mises Institute is a type of tax exempt foundation known as a think tank. Most but not all think tanks in the United States are tax exempt foundations, which as a group came about as a result of charitable foundations being granted tax exempt status by Congress in 1913. As of 2007, there were 5080 think tanks in the world, with 1776 in the United States. This represented a 91% increase since 1951 with more think tanks having been established since 1970 than in the previous 50 years.⁵

Examples of think tanks include The World Business Council on Sustainable Development, The American Eugenics Association, American Petroleum Institute, Accuracy in Media, The Advancement of Sound Science Coalition, The Council on Foreign Relations, Bilderberg, Southern Poverty Law Center, World Economic Forum, Rand Corporation, Progressive Policy Institute, Global Climate Coalition, as well as the Ludwig Von Mises Institute among thousands of others.⁶

For the most part modern day think tanks owe their existence to tax exempt foundations, which had caught the attention of Congress over fifty years ago. In 1952, the Cox Committee was set up by Congress specifically for the purpose of investigating the political and economic impact of the largest of these foundations. When Cox died unexpectedly, the Reece Committee took up where the Cox Committee had left off. Norman Dodd was appointed Director of Research and Rene Wormser served as general council. Wormser subsequently wrote a book, now out of print, called Foundations: Their Power and Influence.

A scanned copy of the Dodd report submitted May 10, 1954 to Congress can be found on the internet, as can copies of both the Cox Committee and Reece Committee hearings. The conclusion of the Dodd report reads as follows: “It seems incredible that the Trustees of typically American fortune-created foundations should have permitted them to be used to finance ideas and practices incompatible with the fundamental concepts of our Constitution. Yet there seems to be evidence that this is so. I assume it is the purpose of this committee to gather and weigh the facts.”⁷

The Rockefeller, Carnegie and Ford Foundations were the focus of both the Cox and the Reece Committees, and the committees together essentially documented the manner in which these foundations had been deliberately developing tools and strategies with which to influence and control education, government, the media and the country at large. Moreover, both committees found that the actions of these foundations were often the opposite of their stated purposes.

The work of the Cox and Reece committees led to a flurry of research into what became known as the left gatekeepers – the term used for the interlocked network of foundations which controlled the ideological “left.” One popular left gatekeeper chart archived on the internet identifies the Council on Foreign Relations, The Schumann and MacArthur Foundations, The Soros Foundation, The Trilateral Commission, and the Carlyle Group – together with the Rockefeller, Carnegie and Ford Foundations and a number of smaller foundations – as part of the left gatekeeper structural network. The CIA is also identified as one of the most influential of these left gate keepers.⁸

In 1961 Texas Congressman Wright Patman began another Congressional investigation into tax exempt foundations. Described as a “fierce populist,” his effort lasted a full eight years, culminating in 1969 with the first major regulatory controls over foundations (which perhaps not unpredictably have been watered down since then). His first report to Congress in December 1962 decried the fact that ownership of an increasing number of corporations was finding its way into tax exempt foundations. The resultant concentration of power and influence, Patman maintained, called for an “immediate moratorium on the granting of tax exemptions to foundations.”

His reasons included evidence which showed that foundations were not subjected to adequate or appropriate scrutiny by the IRS as well as the fact that many of the foundations under study had been found in violation of the law as well as Treasury regulations. Just as troubling was his discovery that some foundations were being used only to provide tax breaks for their principals and, further, that certain trustees were able to channel foundation money to themselves, their relatives and even their friends. Essentially and perhaps not surprisingly, Patman’s evidence showed that “foundation-controlled enterprises possess[ed] the money and competitive advantages to eliminate small business.”

In the forward to his 1962 report, Patman refers to the Ways and Means Committee hearings of 1948-49 which “revealed that educational institutions and private charitable foundations had moved into commercial and industrial fields. Some had inherited substantial business interests, as was the case of the Ford Foundation. Others had purchased control of businesses. A tax exempt cancer research organization, for example, had acquired a variety of industrial firms … In fact, the [1962] record lists about 40 different types of businesses controlled by educational and charitable organizations …” Incredibly,” continues Patman, “as far back as 1916, we were amply warned by the Walsh Committee of the abuses that might flow from the creation of those privileged, tax exempt entities…”⁹

Drawing from Rene Wormser’s book Foundations and other sources, the author of a 1971 book titled The Money Manipulators provides additional, important insight into the way foundations work and the problem they present to the average citizen:

We must not overlook the interlocking directorship which exists within corporations and often extends into an invisible international government. Highly placed members of the Council on Foreign Relations occupy positions of prominence in many of our giant corporations and their influence extends beyond corporate corridors into the national, state and even local legislative bodies. Foundations are one of the most important power centers on our national scene. Their numbers have proliferated rapidly …

A recent [1971] Treasury Department study revealed that there are at least 100 major United States corporations in which foundations owned at least 20 per cent of the stock. It is the belief of this writer that many corporations pay dividends primarily for the benefit of this class of stockholder…

The most serious flaw in the structure of the foundation setup from the standpoint of the average citizen is the element of thought control which is exercised. Since the officials are generally men of wealth and position, they attract followers. This is true not only in business and industry but in the educational fields as well. A bright young student will usually identify favorably with the foundation which offers him a much needed fellowship or research grant. He will tend to develop attitudes sympathetic toward the objectives and thinking of foundation officials. This is the indirect method of thought control. The more direct one is the Fullbright or similar type scholarships which are generally awarded only to students who, when properly investigated, are found to be intellectually reliable…

The Reece Committee found that the foundations tended to develop a bureaucratic structure within and were usually managed by professionals. They also found “interlock” or cooperation among the powerful big-name funds… It is also difficult to live in a vacuum. Since the money power is so extensive, any opposing voice is usually either neutralized or bought off. If occasional cries of agonized individualism persist, the time-honored technique of smear and other propaganda devices are used to discredit them sufficiently so that their protestations are rendered valueless.¹⁰

As might be expected, the use of foundations to advance an Orwellian style agenda hidden behind lofty-sounding goals did not originate with Rockefeller, Carnegie and Ford. In 1984 author-researcher Eustace Mullins penned a brief history of foundation influence in the United States, as follows:

We have read ad nauseam about men of great wealth who, after careers of astounding ruthlessness while amassing their fortunes, suddenly underwent a profound conversion, like [the Biblical] Paul, and became men of goodwill… From the outset, American foundations have exhibited a twofold image – in front is the tireless do-gooder who balks at nothing if it serves a good cause. Behind him are the evil conspirators who are intent on preserving and increasing their wealth and power.

The foundation in its present form, originated in the concept of a Boston family, the Peabodys. Henry James in his novel “The Bostonians”, ridiculed a family friend, Elizabeth Peabody, for her fifty years of relentless humanitarian zeal, portraying her as the legendary Miss Birdseye.

[Meanwhile] George Peabody, after slave trading operations in Washington and Baltimore, moved to London, where he was set up as a front by the Rothschild family. He amassed a fortune by buying up depressed stock in American panics, and chose a Boston trader, Junius Morgan, to carry on his business. In 1865, Peabody set up the first large-scale American foundation, the Peabody Educational Fund, endowing it with $1 million in government bonds. By 1867, this had grown to $2 million; by 1869, $3.6 million.

Ostensibly set up to educate Southern Negroes after the Civil War, it was a key operation in the carpetbagger strategy to gain control of Southern lands and to control their state governments. These states had to borrow heavily from Wall Street bankers to rebuild their services, and they remained deeply in debt for the next century.¹¹

With respect to the Civil War, evidence clearly suggests that the Civil War itself was a carefully laid plan to usurp the monetary independence of the United States and create a financial empire centered on Wall Street from which the country as a whole would be governed from behind the scenes. Trial attorney and former law professor John Remington Graham summarizes the conclusions for the case he lays out as follows:

The divisive antagonisms between the North and the South, finally erupting in the spring of 1861, were not unfortunate historical accidents, nor the result of some inexorable momentum in events. Those antagonisms, rather, were deliberately agitated during the 1850s by great international banking houses with a preconceived motive of provoking secession. And secession was to be used as a pretext for a bloody war of conquest…

The war was planned to generate a stupendous national debt, mostly represented by bonds … the private interests acquiring these bonds successfully plotted to secure the passage of legislation which enabled them to convert them to the paper by them acquired in financing the war into a new and dominant system of banking and currency under their ownership and control. And those private interests fully succeeded in their sinister program, and set up a huge financial empire centered on Wall Street from which they have ever since governed the United States behind the scenes…

[Moreover], the great banking houses in Philadelphia, New York, London and Paris did not like [the Lincoln greenback, originally issued debt “free” by the Treasury] because they could not “control” it – in other words, they could not convert it into a profitable venture for themselves.¹²

Graham essentially lays out the case, in lawyerly fashion, that over the two or three decades leading up to the Civil War the international money powers were able to manipulate we the people and our government in such a way that radical voices on both sides of the manufactured divide became the only voices heard. Passions thus aroused created fertile ground for war.

Like Graham, general council for the Reece Committee Rene Wormser was not content to focus on the narrow issues prescribed by the media or the propagandists. Speaking of the post World War II period during which we faced the “communist threat” Wormser would bemoan the fact that “the emphasis on a search for organized Communist penetration of foundations absorbed much of the energy of the investigators [for the Reece Committee] and detracted somewhat from the efficacy of their general inquiry into subversion.”¹³

In similar fashion to Graham, Wormser became far more concerned with the broader picture of a newly emerging American financial elite that could wield massive amounts of political clout through the size of its wallet and the strength of its own intricate, interlocked power structure. Neither the media nor the Congress paid attention to Wormser’s broader concern, and national attention remained directed at the so-called Communist threat until it was replaced by the Cold War. Antony Sutton and others tried to expose the “Communist threat” and the Cold War for what they were but no one listened to them either.

It is worth noting that tax exempt foundations were not the only tool employed by “money powers” because concomitant with them came the deliberate infiltration of grassroots groups and development of tools such as the “left/right” political spectrum as a means by which to control the “public debate.”

Thus, as Georgetown professor Carroll Quigley wrote in his 1966 Tragedy and Hope: “More than fifty years ago the Morgan firm decided to infiltrate the Left-wing political movements in the United States. This was relatively easy to do, since these groups were starved for funds and eager for a voice to reach the people.”¹⁴

In 1913, and writing about the same time period as Quigley, Charles Lindberg Sr. wrote in his book, Banking and Currency and the Money Trust that “The [money] interests have done everything that has been possible for them to do in order to divide the people of this country into factions commonly known as political parties, because it was in their interest to do so… Partisanship is factional government and not national government … Partisanship has been the cause of retarding all social progress.”¹⁵

In 1983, Antony Sutton would write in his book America’s Secret Establishments , “More effective than outright censorship is use of the left-right political spectrum to neutralize unwelcome facts and ideas or just condition citizens to think along certain lines.”¹⁶

So it is that in the final analysis and despite the evidence uncovered by the Cox and Reece Committees about “left” gate keepers, it strains credulity to think that only the ideological left was – or is – controlled by “gate keepers.” As it turns out, Wormser was right: there was the broader concern of subversion that needed attending to.

1. “Ron Paul: Republican or Revolutionary?” ABCNews Report, October 18, 2007.
2. “Who Wrote Ron Paul’s Political Report? by Julian Sanchez and David Weigel, January 16, 2008, ReasonOnline.
3. “Angry White Men,” by James Kirchick. January 8, 2008. The New Republic.
4. About at Mises.org.
5. “The Think Tanks and Civil Society Program,” James G. McGann, Ph.D. Foreign Policy Research Institute. 2007.
6. “Think Tanks,” SourceWatch Encyclopedia.
7. Norman Dodd Report to the Special Committee of the House of Representatives to Investigate Tax Exempt Foundations, submitted May 10, 1954.
8. Left Gatekeepers.com.
9. Tax Exempt Foundations and Charitable Trusts: Their Impact on the Economy. Chairman’s Report to the Select Committee on Small Business. Wright Patman, Chairman, House of Representatives, 87th Congress. December 31, 1962.
10. The Money Manipulators by June Grem, Enterprise Publications, Inc. 1971. Chapter VIII.
11. The World Order by Eustace Mullins. 1984.
12. Blood Money by John Remington Graham. Pelican Publishing 2006, p 15-16 & 48.
13. Foundations: Their Power and Influence, by Rene Wormser. 1958, p vii.
14. Tragedy and Hope, by Carroll Quigley, 1966.
15. Banking and Currency and the Money Trust Charles Lindberg Sr. 1913, Private Reprint, p 95.
16. America’s Secret Establishment by Antony Sutton, 1983.

As such, the “phenomenon” may now be in the process of sowing the seeds for a viable third party that could unite not only the more impassioned elements of the far right and the far left but also a good portion of the more mainstream segments of the electorate. The problem is that there is the very real possibility that this shared dream (and potential third party) may yet again be subverted or destroyed altogether.

The importance of that truly extraordinary, yet-to-be-realized American dream requires that you and I together carefully examine how it was that the “phenomenon” came to be. In so doing we will be better equipped to detect fault lines and possible pitfalls we might need to avoid if we are to keep at least the promise of our shared dream alive. It must be said that this endeavor will also ultimately require a coming together of ALL of us, not just a few target populations, and it must rest on the principles that are actually contained in the founding documents — not just someone else’s interpretation of them.

To begin real movement toward our goal, each of us must examine — with as much deliberate care and objectivity as we are able to muster — the facts as they exist for each of the various components of the larger phenomenon that goes well beyond Ron Paul the man. One such component concerns what Paul himself has described as “ancient history”; that is to say the long defunct “racist” newsletters going under various titles including The Ron Paul Political Report and The Ron Paul Survival Report.

The lingering questions over authorship of these newsletters only add more questions as to exactly who might now be responsible for all or most of Paul’s current and future work and writings. If indeed other individuals assist with — or provide the bulk of — Paul’s material, we might also wonder whether the agenda of these unidentified others completely matches — or subtly re-frames — Paul’s own thinking and philosophy.

Another aspect to consider is that — if it is true that the original purpose of those newsletters was part of a Machiavellian style campaign strategy designed by Paul’s associates in order to build a support base that may not in fact be aligned with Paul’s own sentiments — what assurance do we have that Paul (or his handlers) may not yet again utilize at least a mutated version of such tactics? This is especially troublesome in that Paul himself has so far made NO move to either satisfactorily explain or sever the ties to the relevant, controversial portion of his support base or the tacticians who dreamed it all up.

In the long run, the whole newsletter issue is far less about racism than it is about campaign tactics and what we as voters are willing to tolerate or accept as “part of doing business.” Thus a good portion of our undertaking necessarily involves considerable self-examination. Our own individual responses to and opinions of those old newsletters will tell us as much about ourselves and more importantly how we approach politics in general and our leaders in particular, as they can tell us about Ron Paul the politician. This is a critical element of the task at hand because all too many of us are inclined to take short cuts which eventually can come back to haunt us.

I for one confess that I had watched various reports of the nature of these controversial newsletters which made it to CNN, Tucker Carlson, Wolf Blitzer, and the Bill Moyers Journal. But, like a lot of people, I summarily accepted the answers Ron Paul gave in those interviews.

Suffice it to say, my decision has come back to haunt me, and so today we revisit those old newsletters in order that we might together examine the facts as they exist. We begin with a very cursory review of a few of the statements that were again garnering a flurry of criticism in 2008. We include a series of rebuttals, some of which charged that the quotes cited were made up.

You can be the judge of all of this by carefully investigating scanned copies of the recently recovered original documents for yourself. But as you move through this material, please remember to ponder carefully the real implications of your personal reactions and opinions — as well as the potential long range consequences of even tacit acceptance of this sort of campaign strategy.

Selections from the newsletters are as follows.

“Hmmm. I hate to agree with Rev. Al, but maybe a name change is in order. Welfaria? Zooville? Rapetown? Dirtburg? Lazyopolis…”¹

“Order was only restored in L.A. when it came time for the blacks to pick up their welfare checks. . . Many more are going to have difficulty avoiding the belief that our country is being destroyed by a group of actual and potential terrorists — and they can be identified by the color of their skin…”²

And: “They [homosexuals] enjoy the attention and pity that comes with being sick…”³

A May 1990 issue⁴ cites a man by the name of Jared Taylor, who six months later would go on to found the eugenicist and white supremacist periodical American Renaissance. A May 1991 issue⁵ offers a subscription to American Renaissance.⁶ Four years later, in July 1994, Taylor was cited by The Ron Paul Survival Report, this time as a “criminologist.”⁷

In 1996, Paul said that the newsletters were taken out of context. Five years later he said he didn’t write them — but he took “moral responsibility” for them. The chronology goes something like this.

When interviewed separately by the Houston Chronicle, the Austin American Statesman, the Dallas Morning News and elsewhere in 1996, Ron Paul and his staff all claimed that Paul wrote the Political Reports — but insisted the media was taking them out of context. Later, in 2001, Paul claimed someone else had written the controversial passages. “‘Old News’? ‘Rehashed for Over a Decade’? ” by Matt Welch, January 11, 2008. Reason.

Then in January 2008, during an interview on the Tucker Carlson Show, James Kirchick of The New Republic said that Paul spokesman Jesse Benton told Kirchick that he (Benton) had written those newsletters. Shortly thereafter Benton changed his story somewhat by saying the offensive parts were ghostwritten.⁸

Immediately after this interview, long time friend and one time congressional chief of staff Lew Rockwell posted a short rebuttal to Kirchick on the Lew Rockwell Blog beginning with the charge that “TNR [The New Republic] has a long and checkered history of pro-fascism, pro-communism, and pro-new dealism…”⁹ Concurrent to Rockwell’s post, a much longer article asserted that “Another hack journalist intent on making a name for himself in the establishment media peanut gallery is the latest to spuriously attack presidential candidate Ron Paul, making completely baseless claims … Ron Paul is a hero. He stands for uncompromised integrity and unwavering adherence to the core principles of the Constitution.”¹⁰

These rebuttals notwithstanding, a few days after the Carlson/Kirchick interview, Congressman Paul told Wolf Blitzer that he had “absolutely” no idea who “wrote those things”and allowed that it is the editor, not the publisher (in this case Ron Paul & Associates) of a magazine, who has responsibility for the daily activity of such publications. Paul also stated that there were “some hirings” during that time period, but since “people come and go” he did not know any of their names.¹¹

So we might ask: how and why is it that several of the Political Reports listed Paul as the editor? How often is it that Paul places his name on articles or books he may not even have read? How is it that no one can identify the true authorship of those newsletters inasmuch as there were only four primary employees listed during this time period — Paul’s family and Lew Rockwell — together with another seven nationwide.¹² Moreover why were these newsletters (with one exception which carried the byline of another writer) all published under the banner of Ron Paul’s name, thus creating the impression that they were all written by him, and therefore reflective of his views?¹³

Another question arises: and it has to do with what the nature of those newsletters say about Paul’s supporters, past and present. Specifically, why were there apparently few or no complaints or cancellations from past supporters — and presumably newsletter purchasers — over the twenty year period they were written and during a time period in which their publisher, Ron Paul & Associates, was earning some $940,000 annually?

In other words, were the majority of Paul supporters at that time all racist or “homophobes” — or were only selected publications used to target such groups? Moreover, and given the fact that Paul convincingly asserts that he is not a racist, should we now be at all concerned that the kind of language used in those newsletters clearly appealed to racists and similar “hate” groups who seemed to have helped establish a support base that is still with him?

Additionally, why have so many present supporters, myself included, been so readily dismissive of the many inconsistent explanations — and in turn remiss in considering the long term implications of such campaign tactics (assuming that is indeed what they were)? Part of the explanation rests with the simple fact that the pressure and activity of everyday life often seduces us into relying more on emotion and assumption than might be warranted or required in our decision-making processes, but might this just as easily be as much an excuse as an explanation given the extent of our national problems?

There are of course some thought-provoking assessments of those old newsletters and how they might be related to campaign strategy. Here is one such assessment:

The whole newsletter campaign was marketing genius, in a Machiavellian, the-ends-justify-the-means kind of way. It was a bare-knuckled attempt to build a list of donators and supporters that could be mined when Ron Paul returned to the political scene in the 90’s–it was pre-meditated… In the end, the strategy was entirely successful, and worked masterfully. Ron Paul crushed his political rivals, despite voting almost entirely according to the Libertarian platform … I’m sure that the rural Texans were unaware of Ron Paul’s progressive positions … Ron Paul has shrewd (if not always politically correct) campaign strategists working for him. I now see Ron Paul with eyes wide open. He is human, and a political animal.¹⁴

In considering the above, we might also want to ask what relationship or relevance these “rural Texans” might have to certain high profile supporters and even certain employees. For example a man by the name of Randy Gray was employed by Paul as the Midland County Coordinator in Michigan for Paul’s 2008 presidential campaign. It so happens that Gray is a member of the KKK, and is also a “white nationalist” who posts under the user name “Central Michigan” on the Stormfront website which carries the motto “White Pride Worldwide.”¹⁵

Stormfront brings us to Don Black, another Paul supporter, who donated $500 to the Paul campaign — about which incident Paul spokesman Jesse Benton said, “Ron is going to take the money and try to spread the message of freedom.”¹⁶ The fact remains however that Don Black is an avowed white supremacist, owner of the Stormfront website and a former Grand Wizard of the KKK. Black had succeeded David Duke as Grand Wizard of the KKK, and David Duke was another Paul supporter.

To be sure, politicians cannot handpick supporters. But the methods employed to cultivate — and maintain — a support base are by their nature deliberative acts. Thus the strategies employed by those newsletters, together with who is selected for key positions in a campaign and the manner in which issues are framed are all matters which should be of concern to any of us who consider ourselves to be part of the voting public.

So it is that portions of Paul’s more contemporary politics, upon examination, likewise raise some questions within the context of those old newsletters.

For example, Paul wants to end “birthright citizenship” so as to allow the deportation of children of undocumented workers — and he leads an effort to “secure our borders.” One could, and perhaps should, ask whether Paul’s framing of immigration issues might be construed (or misconstrued) by certain factions as a perhaps more subtle form of racism and as such still function as a part of campaign strategy. Some of his 2008 campaign ads and posters indeed seem to support this possibility.¹⁷

Importantly, this suggestion in NO way is meant to minimize the severity of the situation that exists along the US/Mexican border. As anyone who has visited or has friends and relatives in the affected areas can well attest, the problem is not only showing no signs of letting up, it is becoming untenable for those living there. Moreover, accusations of “racism” hurled at those who dare to suggest that illegal aliens are, well … illegal are little more than the expressions of the phony war of ideas we are all being subjected to through the work of tax exempt foundations — an issue we will explore in future articles.

This being said, it must be recalled that prior to NAFTA, migrant workers moved freely across the U.S. Border and back without incident. Now they must sneak over as illegal aliens in order to work for pennies on the dollar, and outside US labor laws. Moreover, prior to the TRIPS Agreement and the Agreement on Agriculture which in 1994 became a part of the WTO, many peasant farmers from Mexico and points south were at least able to eke out a living for themselves in their own countries without the need to become migrant workers.

The cumulative economic fallout of these various “free” trade agreements has either forced these peasants off the land and into the cities and newly built industrial border towns — or they have become unwilling pawns of the drug cartels, or they must risk life and limb, quite literally, in order to have a chance at earning a very marginal, fear-infused living. Most troubling is that a big percentage of these illegals are women and teenage children, many of whom, once in the U.S., must risk their lives daily in order to work in slaughter houses, meat packing plants and similar situations where the Clinton-inspired “Have a Cup of Coffee and Pray” regulatory rules now apply.

Moreover, the increased efforts at border security since 9-11 have in fact decreased the numbers of these job-hungry illegals, while at the same time there has been a marked increase in drug-related violence along the Southern border. So it is that peasants seeking to do little more than feed themselves are — together with working Americans — the real victims in a much, much bigger economic game.

With this in mind, wouldn’t it be far more productive, and less open to misinterpretation, for Paul to maintain a primary focus on the root of the problem — which is the WTO, the TRIPS agreement and other portions of the “economic/police state matrix” against which Paul himself so eloquently and frequently expresses strong opposition?¹⁸

In the interim, why not demand that appropriate authorities take actions against employers who hire illegal aliens — under current laws already in effect. Why call for still more laws and most importantly why allow employers to escape penalty when it is — to a significant extent — their actions which pit American workers against immigrants, illegal and otherwise? Finally, why not expose the phony drug war for what it is, which is a tool by which to fuel the economic engines of the “industrial north” at the expense of the peasant farmers in the south?

Without question, Paul’s biography reveals an impressive individual who seems to be endowed with almost super human abilities — even if others do substantial ghost writing for him. In addition to his medical and political careers, Paul co-owned a coin dealership, Ron Paul Coins, for twelve years, and is the author of numerous books.

Paul also had what was reportedly a minority stake in the publishing group known as Ron Paul & Associates (which was dissolved in 2001), out of which variously came the infamous Ron Paul Political Report along with The Ron Paul Investment Letter, and The Ron Paul Survival Report. Indeed, Paul and his associates seem to have a “midas touch” if the earnings from Ron Paul & Associates alone are any indication.

Impressively, these diverse careers are in addition to his being the father of five children and now grandfather of 18.

Adding to a VERY long list of activities, publications and books together with multiple careers and an apparently full family life, Paul has also established a number of foundations, together with a variety of political action committees or PACS.

For example: Paul established the non-profit (tax exempt) “think tank” known as the Foundation for Rational Economics and Education or FREE in 1976, while on the House Banking Committee and after a political career was added to his medical career. FREE was “intended to be a vehicle to increase understanding of the economic principles of a free-market society.”

In 1989, FREE established the National Endowment for Liberty (NEFL) in order “to develop programs that take advantage of electronic media.”

Paul is also a “distinguished scholar” for the Von Mises Institute, even teaching at its seminars. The institute has also published a number of Paul’s books — and is itself a tax exempt foundation.

It is the tax exempt foundations which leads us to the subject of Part 3 of The Ron Paul Phenomenon Is NOT Dead. Stay tuned.

1. October 1990 issue of The Ron Paul Political Report, 4.
2. June 15, 1992 Special Issue of The Ron Paul Political Report, 6.
3. January 1994 of The Ron Paul Survival Report, 5.
4. May 1990 issue of The Ron Paul Political Report.
5. May 1991 issue of The Ron Paul Political Report, 3.
6. American Renaissance Magazine
7. July 1994 issue of The Ron Paul Survival Report.
8. ”Ron Paul Revealed,” Tucker Carlson Interview with James Kirchick.
9. “The New Republic” post by Lew Rockwell, LRC Blog, January 8, 2008.
10. “Vicious Ron Paul Hit Piece Hits the Barrel of Yellow Journalism,” by Paul Joseph Watson and Steve Watson. Prison Planet, January 8, 2008.
11. ”Ron Paul Accused of Racism by CNN’s Wolf Blitzer.”
12. “More Selections from Ron Paul’s Newsletters”, January 14, 2008, The New Republic.
13. “Angry White Men”, by James Kirchick. January 8, 2008. The New Republic.
14. “Ron Paul’s Klansman Kampaign Koordinator”, by “phenry”, Jan 15, 2008, The Daily Kos.
15. “The Authors of Ron Paul Newsletters: Discovered”. January 16, 2008. Intellectually Stimulating.
16. “Paul Keeps Donation From White Supremacist”, Associated Press, MSNBC, Dec. 19, 2007.
17. ”Ron Paul: The Deep Dark Details Part 2,” 7 minute mark.
18. “The Encroaching Economic/Police State” slide presentation by Geraldine Perry.

Evidence can be found in the growing plethora of both established and newly developing grassroots groups which either grew out of the Ron Paul Campaign or else network with it. Not a few of the new groups fall under Paul’s own newly created foundation, Campaign for Liberty. Most interestingly, a large percentage of the members of these groups do not confine themselves to standard political niches, and their remarkable dedication and independent ways set them apart from mainstream politics.

What was most unique about the Ron Paul 2008 Presidential Campaign was it’s almost uncanny ability to tap into a deep, almost palpable hunger for “outside the Beltway” leadership that has been growing within the populace for quite some time. It was this hunger which enabled the campaign to attract heartfelt and often impassioned support from a surprisingly diverse range of people who spanned the political and social spectrum.

This “phenomenon” in its larger sense carries the very real potential for developing into a viable third party, particularly if it can recombine with other disaffected portions of the populace. Therefore, and whatever our own political persuasion, it is perhaps in our own best interests if we use this brief respite from campaign season mania to engage ourselves in a sincere effort to understand, as objectively as possible, the “Ron Paul Phenomenon” in all its facets.

We begin here with an evaluation of one of the central messages of the Paul campaign, having to do with Constitutional issues. To be sure Paul has for decades been an outspoken and frequent critic of what more and more people are recognizing as a key problem: that of a dangerously over-bearing, over-grown Federal government which has gone far beyond the limited government established by the Framers.

It is because of increasing government willingness to use all means necessary to achieve and maintain military and economic dominance all over the world — and over its own citizens — that ever greater portions of the populace are embracing anew George Washington’s prescient sentiment: “Government is not eloquence, it is not reason. Like fire, it is a dangerous servant and a fearful master.”

Paul’s prolific newsletters, networking systems and speeches provided him with a ready platform from which to publicize his stance against the Iraq War, the Patriot Act and militarism overall. So it was that Paul’s well broadcast anti-war, anti-police-state position won him significant support from within the ranks of all the major anti-war groups, who were in turn able to further augment Paul’s anti-war, anti-militarism message through their own ample, well established networks.

At the same time Paul was able to tap into the opposite end of the political spectrum by calling for a repeal of the 16th amendment as a means of ending the income tax, and limiting government spending. Herein lies a conundrum because (rightly or wrongly) not only are the peace groups unlikely to support strictly limited government spending — except insofar as reigning in war and militarism are concerned – but a fair study of the income tax issue makes it clear that the Sixteenth Amendment did not grant the federal government any new taxing power, nor is it the source of the federal government’s power to impose income taxes.¹ ,²

In other words, and while a perfectly reasonable case can be made that all amendments after the Bill of Rights need at the very least to be re-examined and for a variety of reasons even abolished,³ a repeal of the 16th amendment will not end the income tax or help limit government spending. So how did such a serious misconception gain such a foothold in the public mind?

Interestingly enough, some researchers have charged that one of the main objectives of the 16th amendment was to serve as a diversionary tactic by which the productive classes — that is farmers, laborers, small businessmen and the like — would be taxed while the wealthiest of the wealthy would escape tax free, or nearly tax free.⁴ Thus these chosen few might be in a better position to “manipulate the public mind”, to borrow a phrase from one of the leading business intellectuals of the 20th century, Edward Bernays.

One of the main methods for the wealthy elite to escape taxation was through the charitable foundations which were given tax exempt status by Congress in 1913. It was through these foundations, and other means, that the public mind could, and should, be manipulated — thus maintaining a long held sentiment among certain elements within the more privileged circles of society. Edward Bernays summed up this notion in his 1928 book Propaganda: “The conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government which is the true ruling power of our country.”

So, might tax exempt foundations have played a role in disseminating the misconception that the 16th amendment did indeed grant Congress a new power of taxation? Well, it seems that the efforts of well respected tax exempt foundations such as the Cato Institute, the Heritage Foundation and others have, in a sense, created a kind of consensus on this issue, despite learned dissension from within their own ranks.²

As one example, we have the very well received The Heritage Guide to the Constitution published in 2005. An analysis of this book led two Constitutional writers to observe that while the book claimed that the Sixteenth Amendment “not only expanded Congress’ power to tax, but it exempted income taxes from the requirement that all direct taxes be apportioned among the several States, [t]hese assertions… have no basis in fact. [This was a peculiar situation inasmuch as] the Heritage Foundation had legal scholars from all over country collaborate on their analysis of the Constitution… [Therefore] these misrepresentations concerning the effect and scope of the Sixteenth Amendment cannot be attributed to sloppy research. [Moreover] Leaving the two most important cases on the Sixteenth Amendment out of an analysis of the Amendment cannot be by accident. The reader can draw their own conclusions concerning these omissions.”⁵

The subject of taxation is irrevocably tied to money creation, and here too Paul misses the mark, or at least conflates issues. For example, he writes “The drafters of the Constitution were well aware of how a government armed with legal tender powers could ravage the people’s liberty and prosperity. That is why the Constitution does not grant legal tender power to the federal government, and the states are empowered to make legal tender only out of gold and silver.”⁶

Paul is far from alone in his misunderstanding of what the Constitution actually says about money, not to mention who actually is currently in charge of creating it. For example, very often misconstrued is the wording of Article 1, Section 10 of the Constitution: “No state shall emit bills of credit, make any Thing but gold and silver coin a Tender in Payments of Debts…” Briefly stated, this is a limitation on the powers of the states only.

It is in fact through Article I, Section 8 that the national government is granted legal tender power: “The Congress shall have the power to … coin [as in create] money, regulate the value thereof, and of foreign coin, and fix the Standards of Weights and Measures.”

Thus the government — and NOT the privately owned banking system as is currently the case — is Constitutionally charged with legal tender power. The states are limited in what they can use as money.

The reason behind this was that prior to the Revolution all the colonies had issued their own money. Then, “[f]rom 1776 to 1789 under the Articles of Confederation, the Colonies continued their practice of emitting bills of credit and coining money, which circulated along with Continental currency and other types of money. After the adoption of the Constitution, the states were now prohibited from issuing money. Since the national government had banned the state’s money-issuing powers, colonial script could not be received in payment of debts owed to the central government. This is the reason for the insertion of [Article I, Section 10]. It never was intended to establish a metallic basis for money…

“[Moreover] the framers of the Constitution wanted to be totally free from having to borrow money into circulation. None of the colonies had used the goldsmith’s fractional reserve method of issuing bills against gold or any other metallic backing. Their currency had been issued on the basis of the commercial needs of the colonies.”⁷

Supporting the above and fleshing out more legal detail is a recently published scholarly article on original intent appearing in the Harvard Journal of Law & Public Policy which concludes, in part, that: “According to the original understanding, the Constitution’s Coinage Clause granted to Congress the express power to coin money and bestow legal tender quality upon that money…. In addition, the money thus “coined” did not need to be metallic. Paper or any other material that Congress selected would suffice.”⁸

A good deal of the present-day confusion over how and who is charged with the creation of our money seems to stem from the works and writings of Alexander Hamilton. What is most important to keep in mind is that the early, hard fought money debate centered on whether the Hamiltonian model of using “implied powers” to allow a privately owned banking system to create our money out of debt was in fact Constitutional.

Author Olive Cushing Dwinnel offers some intriguing insight into Hamilton’s arguments. After citing relevant quotes from Hamilton, she writes:

Pointing out the fraud of these arguments, it was one of the principles of the Colonial governments (even in that earliest Convention in Albany when the colonies met for protection, and peace with the Indians), as well as in the old Continental Congress and the Constitutional Convention, to create a uniform currency under Union authority, and discontinue the use of state power over issuing currency or emitting bills of credit…

The [Hamiltonian] argument that because the States were not permitted to continue issuing money after the Federal Government was established, as pointing to the same policy for the Federal government, is not based in fact or on the Constitution, for the Constitution provides that the Congress SHALL have the power to coin money….

Such arguments of Hamilton show either his complete lack of confidence in our Republican form of government, or else a clever trickery and sophistry of words to force the use of a foreign and usurious system of banking and private control of money issuance on the new government…. Also his statement that government cannot be trusted to use its power to issue sufficient currency while private banks and money lenders can be so trusted is another proof of his well known monarchial and imperialist sympathies and his complete distrust of a people’s government.⁹

In another portion of the Ron Paul article previously cited, Paul does indeed point to the real problem when he states that “the primary beneficiaries of legal tender laws are financial institutions, especially banks, which have been improperly granted the special privilege of creating fiat irredeemable electronic money out of thin air through a process commonly called fractional reserve lending.”⁶

It is absolutely true that the privately owned banking system — and NOT the government — is the prime beneficiary of current money creation laws. Why? Because the banks in this system, primarily the big banks, are allowed to create money — not really out of thin air — but out of public and private debt. This “debt/money” is thus able to “make a gain of itself” through interest and other fees associated with debt creation. The problem is not fiat money, or paper, or even for that matter digital currency.

The problem is that the government has abandoned its Constitutional duty to “coin” debt free money and instead allows the banks to create our money as interest-bearing debt, through “implied powers”. This creates an untenable situation in which both public and private debt (through the fractional reserve system) must expand exponentially over time following mathematical law — thus devaluing the currency over time.

Put into perspective, we currently have a money supply of some $14 trillion using estimated M3 figures. Meanwhile our total public and private debt is some $53 trillion. Not only is there NO way to pay off the debt with the current money supply, but any new money that comes into circulation must be in the form of new debt, adding to the debt load as well as the money supply — all compliments of the banking system. Importantly, the money supply is managed by Fed-determined policies in tandem with the government’s willingness (or presumed need) to borrow from the Fed.

The difference between the money supply and the debt represents the accumulated interest charges and other fees that are associated with debt/money creation. Your own mortgage provides a more personal example, since the loan principal is what was created as “money” so that you might complete the purchase of your house. The “money” you got from your mortgage is what you gave to the home seller and he in turn was able to spend that “money” into circulation.

The accumulating interest charges and loan origination fees were separate and apart from the money/mortgage you used to make your purchase. Those charges were NOT created as “money”. In order for YOU to pay off those charges other people must take out ever more loans — thereby creating “money” through their loan principal. The accumulating interest charges then cause debt to exponentially increase as time goes on, hence the difference between our current national money supply and debt.

Most importantly, the above examples illustrate the amount of real wealth that is extracted from the working population and handed over to the banking system for payment of interest and fees — just so we might have the privilege of using money that is designed to “make a gain of itself.”

Within this context the income tax is little more than a tool to insure payment of the exponentially accumulating interest on the public debt — and to persuade we the people that taxes are needed to “pay” for government projects. In point of fact, in an honest, Constitutionally appropriate money creation system, taxes, fees or any similar revenue-producing device would NOT be required to pay for government services or projects!

The ONLY need for such devices would be to “extinguish” Constitutionally created money that has served its purpose, thereby “regulating the value” and preventing inflation. And because there is NO exponentially accumulating interest under a debt “free” system, the combined amount needed from federal revenue sources would be reduced by 75% or more. This is, therefore, one crucial component for dramatically reducing government “spending.” For a more detailed explanation see “Money Owed and Owned.”¹⁰

Again in the same article, Congressman Paul continues with a justification for his “competing currency” proposal: “As Dr. Edwin Vieira … states: ‘A free market functions most efficiently and most fairly when the market determines the quality and the quantity of money that’s being used.’”⁶

This is true, insofar as a transparent, non-discriminating, well regulated money creation system is concerned. But the efficient, fair functioning of a market has little to do with whether or not “competing currencies” are brought into existence. In fact, competing currencies were the precise reason the founding fathers saw fit to require the federal government to create our money and “regulate the value thereof” of both coin and paper.

Additionally one might ask, if private mints were allowed to produce a portion of our coins, would this not give us yet another form of currency that is allowed to “make a gain of itself”? After all, these private mints would presumably want to earn at least a modest profit for their efforts, as would the mining monopolies the raw metals come from.

Finally and in the same article Paul writes that “While harming ordinary citizens, legal tender laws help expand the scope of government beyond that authorized under the Constitution.”⁶

It is NOT the legal tender laws per se which help expand the scope of government, but rather it is the sovereign power structure that surrounds the Federal Reserve, effectively built by the “money powers” in the years immediately following the Civil War and continuing to the present day. This power structure can be described as the “economic/police state” which Paul himself vociferously and frequently objects to, and includes the WTO, the North American Union, militarization of local police and the national guard and more. For a more detailed explanation of this power structure see “The Encroaching Economic/Police State.”¹¹

Paul’s recent, controversial earmark vote this past February¹² is only one example of philosophical inconsistency with respect to his voting record. But far more problematic is the extremely unfortunate misinterpretation of the Constitution itself, because this leads to false solutions and not just behavior that is inconsistent with campaign promises. One explanation for all this may in fact be that Ron Paul, like the rest of us, is merely a product of his environment.

But far more important, and more to the point, is that each of us is charged with the very serious responsibility to carefully evaluate the messages our leaders articulate. Whenever we as individuals fail to diligently execute that responsibility, none of us comes out a winner — not even Ron Paul.

1. “The 16th Amendment Is Not the Source of the Federal Income Tax,” by Robert Greenslade August 22, 1999.
2. “Constitutional Challenge: Repealing the 16th Amendment Wouldn’t Kill the Income Tax,” by David B. Levenstam. January 1999, Reason Online.
3. The Two Faces Of Money by Geraldine Perry and Ken Fousek.
4. The Money Manipulators by June Grem, Enterprise Publications, Inc. 1971.
5. ”The Heritage Guide to the Constitution’ Misrepresents the Effect of the Sixteenth Amendment by Robert Greenslade & Claude Ellsworth. January 9, 2009.
6. “Bring Back Honest Money,” by Rep. Ron Paul, M.D. Lewrockwell.com, July 25, 2003.
7. The Money Manipulators by June Grem, Enterprise Publications, Inc. 1971.
8. “Paper Money and the Original Understanding of the Coinage Clause” by Robert G. Natelson, University of Montana, 31 Harvard J.L. & Pub. Policy 1017, 2008.
9. The Story of Our Money by Olive Cushing Dwinnel. 2nd edition. Private reprint. p69-70.
10. “Money Owned and Owed,” slide presentation by Geraldine Perry.
11. “The Encroaching Economic/Police State,” slide presentation by Geraldine Perry.
12. “Texas Lawmakers Rip Budget, But Seek Millions” by Stewart M. Powell and Richard S., Dunham, Feb. 28, 2009.

To be sure, derivatives, along with “innovative” accounting techniques, are a unifying theme of these and similar eye-brow raising, but effectively submerged, stories. Chief among these submerged stories are those which surround Carlyle Capitol and its parent company the Carlyle Group. Here’s what can be said about each.

The derivatives-heavy Carlyle Capitol had been the first of 55 funds the Carlyle Group took public between July 2007 and March 2008. It went belly up as its mortgage-backed assets began to implode and a group of the world’s biggest banks, including JP Morgan, refused to hold off on margin calls and liquidation of assets — moving instead to seize and sell what was left of the fund’s assets. While the losses to the Carlyle Group were “minimal from a financial standpoint”, it nevertheless represented a major embarrassment for the giant private equities firm — which, it must be mentioned, had $76 billion tied up in exactly the same kinds of “derivative investment tools” as its “separate legal and business entity” aka the Carlyle Capitol Corporation.

Perhaps it is mere coincidence that the Carlyle Group is registered in Britain (but based in Washington, D.C.) while Carlyle Capitol was based on Guernsey Island off the British coast. Nevertheless the question persists as to whether Carlyle Capitol was functioning as an offshore entity created as a means of misstating, or perhaps burying, certain material financial statements. You know, the kind of activity that subjected JP Morgan to Congressional Investigation in 2002, proof of which activity the Congressional Investigating Committee was given audiotapes and copies of incriminating emails.

The Carlyle Group itself has what can only be described as a controversial history with trails leading to 9-11, the current war on terror, the first Gulf War, Afghanistan and elsewhere. It also has had extensive “counter party links” to Enron, Arthur Andersen, Global Crossing, the Saudi Royal Family, and yes, even the Bin Ladens.

Its main business is buying and selling large corporations. Described as a powerful merchant bank and leading defense contractor, the Carlyle Group also is a key player in the privatization of public resources within the U.S. Known as the ex-presidents club it is surprising to say the least that so few have ever even heard of the Carlyle Group, especially given the scope of its activities. Perhaps this is because, as an October 31, 2001 Guardian UK article tells it.

This is exactly the way Carlyle likes it. For 14 years now, with almost no publicity, the company has been signing up an impressive list of former politicians – including the first President Bush and his secretary of state, James Baker; John Major; one-time World Bank treasurer Afsaneh Masheyekhi and several south-east Asian power brokers — and using their contacts and influence to promote the group. Among the companies Carlyle owns are those which make equipment, vehicles and munitions for the US military, and its celebrity employees have long served an ingenious dual purpose, helping encourage investments from the very wealthy while also smoothing the path for Carlyle’s defence firms.

… But what sets Carlyle apart is the way it has exploited its political contacts. When Carlucci arrived there in 1989, he brought with him a phalanx of former subordinates from the CIA and the Pentagon, and an awareness of the scale of business a company like Carlyle could do in the corridors and steak-houses of Washington. In a decade and a half, the firm has been able to realise a 34% rate of return on its investments, and now claims to be the largest private equity firm in the world. Success brought more investors, including the international financier George Soros and, in 1995, the wealthy Saudi Binladin family, who insist they long ago severed all links with their notorious relative. The first president Bush is understood to have visited the Binladins in Saudi Arabia twice on the firm’s behalf.

… But if the Binladins’ connection to the Carlyle Group lasted no more than six years, the current President Bush’s own links to the firm go far deeper. In 1990, he was appointed to the board of one of Carlyle’s first purchases, an airline food business called Caterair, which they eventually sold at a loss. He left the board in 1992, later to become Governor of Texas. Shortly thereafter, he was responsible for appointing several members of the board which controlled the investment of Texas teachers’ pension funds. A few years later, the board decided to invest $100m of public money in the Carlyle Group. The firm’s magic touch was already bringing results.¹

Despite its lack of notoriety, one can find Carlyle connections turning up everywhere. For example and in addition to the “counter party web” of the Texas teachers pension fund mentioned above, an August 10, 2005 NewsMax article revealed that the Carlyle Group had caught the attention of federal prosecutors after Illinois Teachers Retirement System officials raised concerns about the $4.5 million in fees offered by Carlyle to one Robert Kjellander (a lobbyist, Bush campaigner and newly appointed treasurer of the Republican National Committee) for helping land business with the Illinois teachers pension fund.

A spokesman for Carlyle of course maintained that Kjellander’s fees weren’t unusual and in any case, the average returns on these funds investments was 45% per year. After all, who could complain about that, even if the earnings themselves had the unmistakable taint of blood and corruption written all over them?

Interestingly, the article also revealed that “Kjellander had previously raised eyebrows in 2003 when he received an $809,000 consulting fee from Bear, Stearns Inc. after Democratic Governor Rod Blagojevich picked that investment house to handle $10 billion in pension fund bonds. The firm received $8 million for handling the bond issue…”²

Bear Stearns, J.P. Morgan, Carlyle Capitol, the Carlyle Group and a VERY long list of other rarefied corporations are (or were, as the case may be) all heavily involved in derivatives instruments that are still in the process of unwinding themselves from their myriad counter party entanglements across the globe. Many, if not all, of these firms have long used their financial clout to influence government officials, not to mention the media and educational institutions – and many are either directly or indirectly heavily invested in the defense industry among other industries. But when all is said and done, there is no other private business which has so successfully navigated the heady waters of what is known as the Iron Triangle — a place where industry, government and the military converge – than the Carlyle Group. ³

A most striking example can be found in Iraq, where we find two former Secretaries of State heading up a secret investment deal involving a “complex transfer of ownership of as much as $57 billion in unpaid Iraqi debts.” Seems that former Secretary of State James Baker (and senior counsel for the Carlyle Group) just happened to be appointed by Bush II as the special envoy to negotiate Iraqi “debt relief”. The objective of this envoy was to see to it that “[t]he debts, now owed to the government of Kuwait, would be assigned to a foundation created and controlled by a consortium in which the key players are the Carlyle Group and the Albright Group, which is headed by another former Secretary of State, Madeleine Albright.”⁴

We also have Frank Carlucci, who not only served as Chairman of the Carlyle Group at the time of the September 11 attack, but had served as a former Secretary of Defense in the Reagan Administration and a Deputy Director of the CIA during the Carter Administration. Perhaps even more curiously — and again at the time of the September 11 attacks — Carlucci was serving on the RAND Corporation Board of Trustees and was also the co-chair of the Rand Center for Middle East Public Policy Advisory Board. The Rand Corporation, it can be said, is one of many nonprofit (non-taxpaying) “think tanks” where people get paid to think, and Frank Carlucci was among those who were being paid to think about the situation in the Middle East.⁵

Fortuitously for the Carlyle Group, it “cashed out many of its investments when the stock of defense companies rose dramatically in the aftermath of September 11 and the buildups to the Afghanistan and Iraq wars.”⁶

In the aftermath of the September 11 attack, the Carlyle Group, together with Halliburton, has made millions of dollars off the Iraq War. In addition Carlyle has “reaped millions of dollars from government contracts on things such as cleaning up anthrax-infected buildings — including the Hart Senate Office Building – making X-ray scanners, providing logistics support to the U.S. military, making metal-bond structures in fighter jets and missiles, and providing employee background checks for the government.”⁷

Although Carlyle’s counter party webs are seemingly endless, its growing involvement in public/private partnership ventures is also exceedingly troublesome, and strangely under-reported. In addition to the already established afore-mentioned partnering activities, the announcement of a newly formed team whose sole objective was to engage in public/private ventures came after a public furor had been created over the fact that DP World, a company owned by the United Arab Emirates, had acquired a British company that manages operations at six U.S. Ports. Soon after this news became public, the House Appropriation Committee voted on March 8, 2006 to prevent DP World from taking control of six U.S. Ports, and that story quickly faded into oblivion.

Perhaps by happenstance and the very next day after the House vote — the Carlyle Group announced that it had established an eight-person team co-headed by Robert Dove, former executive vice-president at Bechtel and Barry Gold, former managing director and co-head of the structured finance group at Citigroup/Salomon Smith Barney. According to the Media Room section of its own website, the team’s objective is to invest “in the [public] infrastructure sector, including investments in transportation and water facilities, airports, bridges, ports, stadiums and other public infrastructure … primarily in … transactions ranging from $100 million to more than $1 billion. The team will engage in public-private partnerships (PPP) with governments at all levels as well as purchase projects outright or through long term concessions.”⁸

Increasingly, cash strapped local governmental entities are looking to these public-private partnerships for relief for their liquidity problems. To be sure, the argument for such projects carries a certain appeal because, as the logic goes, what other options do state, county and municipal governments have, after they downsize and increase taxes, besides holding what amount to giant fire sales in which public assets are sold to the highest bidder or public-private partnership deals are struck? What all too often is not clearly and completely understood by the average citizen — or even for that matter, his elected officials — is that “[i]n this arrangement, government and business “co-own” the former government asset and their purpose is to make a profit.”⁹

Moreover, and given the allure of very handsome profits that stand to be generated by this “new asset class” it is no surprise that “banks and private investment firms have fallen in love with public infrastructure. They’re smitten by the rich cash flows that roads, bridges, airports, parking garages, and shipping ports generate—and the monopolistic advantages that keep those cash flows as steady as a beating heart. … But are investors getting an even better deal [than the public]? It’s a question with major policy implications as governments relinquish control of major public assets for years to come. The aggressive toll hikes embedded in deals all but guarantee pain for lower-income citizens—and enormous profits for the buyers. … What’s more, some public interest groups complain that the revenue from the higher tolls inflicted on all citizens will benefit only a handful of private investors, not the commonweal.”¹⁰

What should likewise come as no surprise in all this is the fact that “[i]nvestment firms including Goldman Sachs, Morgan Stanley, and the Carlyle Group are approaching state politicians with advice to sell off public highway and transportation infrastructure. When advising state officials on the future of this vital public asset, these investment firms fail to mention that their sole purpose is to pick up infrastructure at the lowest price possible in order to maximize returns for their investors. Investors, most often foreign companies, are charging tolls and insisting on “noncompete” clauses that limit governments from expanding or improving nearby roads.”¹¹

With respect to the Carlyle story in particular, what is most unfortunate is that “[o]utside of the conservative Judicial Watch and the muckraking Center for Public Integrity, there has been little public interest in the Carlyle system of capitalism and where it is going. Congress, meanwhile, is too busy seeking Carlyle’s advice even to ask the question. The people who run Carlyle may hate the word secrecy, but their words and actions make it impossible to know where the policy-making ends and the money-making begins.”¹²

So it seems that the military/industrial/governmental complex — and the Carlyle Group in particular — is perfectly positioned to profit handsomely from both the endless war on terror and the privatization of public resources, with nary a complaint from government officials and next to no meaningful media coverage of the long term ramifications of such “profit centers”. Behind it all are the Faustian bargains which are struck daily through the speculative derivatives markets in the increasingly rapacious quest for the “fast money” that only these markets can provide.

In his 2002 Enron-related testimony before Congress, attorney Frank Partnoy makes the following important observations concerning the effect derivatives have on business (and it might be said government) behavior:

The temptations associated with derivatives have proved too great for many companies, and Enron is no exception. The conflicts of interest among Enron’s officers have been widely reported…. But too much focus on Enron misses the mark. As long as ownership of companies is separated from their control — and in the U.S. securities market it almost always will be — managers of companies will have incentives to be aggressive in reporting financial data.¹³

As Mr. Partnoy’s comments reveal, the lure of “fast money” promised by derivatives can be as morally deadly as it is irresistible. What gets lost in the mix are the nuts and bolts for which a company (or indeed our country) was founded — even as an unending parade of enticements are created for exaggeration of profits and a host of other forms of deceptive and even unscrupulous behavior.

Without question, mammoth, globally-scaled financial empires and unfathomable personal wealth have been created through derivatives. But all this has come at a heavy price that must be measured not just in dollars but in terms of blood and honor as well.

It falls to ordinary citizens to reclaim the practical tools and the moral high ground established by America’s founding documents — which not only created the United States but which once served as a beacon of hope to the rest of the world.

1. “The Ex-Presidents Club,” by Oliver Burkeman and Julian Borger. Guardian Unlimited, October 31, 2001.
2. “Feds Probing Carlyle Group’s Payment to RNC,” NewsMax, August 10, 2005.
3. The Iron Triangle: Inside the Secret World of the Carlyle Group, by Dan Briody
4. “James Baker’s Double Life in Iraq: The Carlyle Group Stands to Make Killing on Iraqi Debt,” Amy Goodman interviews Naomi Klein, Democracy Now, October 13, 2004.
5. “The People We Pay to Think”.
6. “Investing in War: The Carlyle Group Profits from Government and Conflict,” M. Asif Ismai, The Center for Public Integrity, November 18, 2004.
7. “Carlyle Group, Halliburton Getting Rich off the Iraq War,” Chuck Baldwin. News With Views, March 27, 2003.
8. “The Carlyle Group Establishes Infrastructure Investment Team,” Press Release, The Carlyle Group, March 10, 2006.
9. “Chicago Inc.,” Joan Veon, News With Views, August 31, 2003.
10. “Road to Riches,” Emily Thornton, Business Week, May 7, 2007.
11. “Privatization of America’s Infrastructure,” Student researchers Rachel Icaza and Ioana Lupu, Faculty Evaluator: Marco Calavita, Ph.D. Top 25 Censored Stories for 2008. Project Censored.
12. “Crony Capitalism Goes Global,” Thomas Shorrock. The Nation, March 14, 2002.
13. Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law, Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002.

Simply put, this architecture is based on a monetary system in which one man’s savings are in effect another man’s debts, which are ultimately debts to the large financial conglomerates. It is a system mathematically dependent on boom/bust cycles which foster both greed and gluttony and facilitates continual redistribution of wealth upwards, and away from the real producers of wealth. The architecture for this system has evolved over centuries as a means by which to moderate speculative activity — particularly that kind of speculation which involves increasingly sophisticated and complex derivative instruments.

With few exceptions, derivatives today are an exclusive investment tool for very select groups and individuals who have massive financial resources and lines of credit at their disposal. These groups and individuals include large institutional investors, insurance companies, high net worth individual investors and family offices, U.S. endowments, foundations and pension funds, select private banks, sovereign wealth funds and the like – whose business in turn is handled by a relatively few “high rolling” dealers. Thus, as Warren Buffet wrote, “Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers…”

The end result, as Chossudovsky suggests, is that “Federal, State and municipal governments are increasingly in a straightjacket, under the tight control of the global financial conglomerates [where] the creditors call the shots on government reform.”¹

Because of this rather undemocratic and peculiar set of circumstances it is not unreasonable to conclude that a relatively small handful of select groups and individuals, together with their dealers and financial managers, are able to exert hitherto unimaginable influence over whole economies, governments, and even world events, not the least of which is the current economic crisis. This becomes particularly obvious in view of the explosive growth of the world wide derivatives trade which went from approximately $100 trillion in 2002 to a very shakily estimated $681 trillion by the end of 2007.

No one knows the extent of leveraging that went into that estimated $681 trillion, but even assuming the more conservative, and traditional 10 to 1 debt-to-asset ratio, this means that potentially some $600 trillion could disappear from the world’s economy. This is due to the fact that collapsing debt means a collapsing money supply, since money is created when banks extend credit through what are loosely termed loanable funds.

The manner in which money is created (as debt) is the real reason why “credit is the lifeblood of the economy.” And it is why governments are rushing to inject liquidity — aka taxpayer debt — into their banking systems through a growing plethora of stimulus packages, assisted buyouts, takeovers, and bailouts. As in the case of the U.S. where “fighting the financial crisis has put the U.S. on the hook for some $5 trillion … so far”² it is also why bailout and stimulus packages are exploding worldwide.

Perhaps the worst part about all this is that the lure of fast money, together with the pressure of mounting debt and the phenomenon created by counter party risk, has effectively married all levels of government, non-profits, educational institutions, pension funds and much more to the incredibly risky — and exclusive — global derivatives trade. The global derivatives trade has, in other words, become so intertwined with the lives and welfare of governments and ordinary individuals that talk of divorce is studiously avoided, despite the increasingly obvious warning signals.

The current credit crisis, caused by the unwinding of “bad asset” derivatives, is the most evident example of this financial marriage as governments and central banks are called upon to intervene and regulate, while taxpayers are called upon to foot the bill for losses incurred in the global casino, where only a select few can enter and signs of corruption are painstakingly overlooked.

How much longer can this fragile house of cards be propped up through abject fear and a total lack of understanding of alternatives? How much longer will ordinary citizens and their elected officials tolerate increasingly obscene levels of wealth redistribution and outright thievery in their midst?

A case in point is JP Morgan Chase, for whom Christmas indeed seems to have come early this year. The first Christmas present came in mid-March in the form of the privately arranged, emergency takeover of the highly respected, privately owned Bear Stearns by the highly respected, privately owned JP Morgan. This takeover was, as you may recall, facilitated by the Fed and the largess of the American taxpayer — one of many such “deals” in which taxpayers are increasingly getting the short end of the stick.

The claim that this takeover — quietly arranged behind closed doors on a Sunday when no one could effectively object — was done in order to avert a seize-up of the entire global derivatives market is not of course without merit or significance. Although Ben Bernancke maintained in testimony to Congress that the Fed’s intervention was done to prevent a seize-up of American financial markets he also disclosed that another major factor was Bear Stearns’ “interconnectedness with thousands of counter parties” which of course are based all around the globe.

Importantly, as analyst Mike Whitney points out, “Bear Stearns had total (derivatives) positions of $13.4 trillion. This is greater than the US national income, or equal to a quarter of world GDP — at least in “notional” terms. The contracts were described as “swaps”, “swaptions”, “caps”, “collars” and “floors”. This heady edifice of new-fangled instruments was built on an asset base of $80bn at best… On the other side of these contracts are banks, brokers, and hedge funds, linked in destiny by a nexus of interlocking claims. This is counter party spaghetti.”³

As reported by Mortgage News Daily the demise of Bear Stearns was not entirely unanticipated since it “had been one of the biggest gamblers (although we were calling them “investors” at the time) in the mortgage securities business”. The price tag on the other hand was a “real stunner”. Although later forced by irate shareholders to up the ante fivefold (to $10 per share), the initial deal struck in secret negotiations on Sunday March 16 for $2 per share essentially handed over the 85 year-old Bear Stearns to JP Morgan for about $236 million. This was a fraction of Bear Stearns’ market value of $3.5 billion on Friday, when its shares had plummeted to $30 a share at Friday’s close from a high of $170 per share one year earlier. To facilitate the deal, the Federal Reserve provided “as much as $30 billion of taxpayer monies in financing for Bear Stearns’ less-liquid assets such as mortgage securities. [So] If these assets lose even more value it will be the Fed [and the taxpayer via the government] that will take the hit, not JP Morgan.”⁴

Curiously, JP Morgan itself held some $77 trillion worth of the exact same kinds of “less liquid” and highly leveraged derivatives contracts that brought down Bear Stearns. Curiouser still is the fact that that Jamie Dimon, CEO of JP Morgan, also sits on the board of the New York Fed.

And one does have to wonder: just what might be the real reason that Michael Alix, chief risk officer for Bear Stearns from 2006-2008 and global head of credit risk management from 1996-2006, has recently been named a senior vice president in the Bank Supervision Group of the Federal Reserve Bank of New York — to “supervise bank soundness.” As one blogger points out: “Who would know better what was in the dreck pool that the Fed has parked over at BlackRock than the former chief risk officer? If Alix knows a few embarrassing things, might be wise to give him an incentive not to talk them up.”⁵

To this growing list of curiosities we can add what can fairly be described as another early Christmas present for JP Morgan. This particular present came a mere six months after the Bear Stearns deal — this time with timely assistance from the FDIC in a brokered sale of Washington Mutual. WaMu, as it was affectionately known, represented the largest bank failure in U.S. history. Happily for JP Morgan, this deal made it the largest U.S. depository institution — with over $900bn of customer deposits.

Sebastian Hindman, an analyst at SNL Financial describes the WaMu acquisition as a “definite win for JP Morgan. They are only paying $1.9 billion to the FDIC, and they are getting this incredible expansion into a lot of solid markets.” Unfortunately, “[t]he seizure by the government means shareholders’ equity in WaMu was wiped out…. Some bondholders will also be wiped out by the deal. [Additionally] JP Morgan Chase is not acquiring any senior unsecured debt, subordinated debt or preferred stock of Washington Mutual’s banks, or any assets or liabilities of the holding company, which will be left in the receivership. The government [courtesy of the taxpayer] will be left to sell the soured mortgage assets of the holding company…”⁶

Coincidentally (or not) and less than three weeks after the September 25 WaMu acquisition, JP Morgan got yet another early Christmas present. As reported by Joe Nocera of the New York Times, JP Morgan CEO Jamie Dimon “agreed” to take a $25 billion capital injection courtesy of the United States government — and the Fed. No surprise then that “[t]he U.S. government’s $160 billion handout to banks from Niagara Falls to Beverly Hills is going mostly to lenders that need it least, putting weaker rivals at risk of being shut down or taken over …”⁷

What makes this $25 billion present particularly interesting is revealed by Nocera’s report of a portion of a private, recorded conference call in which one JP Morgan executive disclosed that the $25 billion was less likely to be used to create loans to help an ailing economy than it was to help JP Morgan take advantage of “opportunities”:

“Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase,” he began. “What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”⁸

The hubbub over JP Morgan’s current good fortunes, controversial though they may be, almost too conveniently obliterates a 2002 Congressional investigation concerning allegations that JP Morgan helped Enron and similar corporations defraud their shareholders. According to analyst Adam Hamilton, by July 23, 2002 — the day its stock took an historic nosedive, JP Morgan’s name was not only “suspiciously popping up in virtually all the major corporate scandals in the States” but “JPM control[ed] 51% of the total notional value of all the derivatives of all the US banks playing the incredibly dangerous derivatives game [while it commanded just] 11% of the total assets of all the banks dabbling in derivatives. [JPM was looking] more like a hedge fund gone mad than a commercial bank, a vast Frankenstein’s Monster created by the hasty stitching together of countless cryptic off-balance sheet OTC derivatives contracts.”

Amazingly says Hamilton, the bad news for JP Morgan was not of a derivatives implosion but rather that “United States Congressional investigators told the media that JPM specifically structured deals explicitly designed to mislead the investors in major public US corporations by almost magically erasing unfavorable numbers from corporate balance sheets. … US Senator Carl Levin, the Chairman of the Senate Permanent Subcommittee on Investigations, actually released an excerpt from an incredibly damning e-mail from a JPM executive. It said, ‘Enron loves these deals as they are able to hide funded debt from the equity analysts.’ [Moreover and] according to the US media, the Congressional subcommittee has audiotapes … where JPM officers are telling accountants exactly how to structure offshore entities so they appear independent.”⁹

The investigation into JP Morgan’s relationship with Enron dealt with commodity-related trades between JP Morgan, Enron and an offshore vehicle called Mahonia that was set up a decade before by Chase Manhattan, the bank that JP Morgan had merged with 18 months before the Congressional investigation was launched. Unhappily for JP Morgan, this investigation came on the heals of reports concerning JP Morgan’s heavy exposure to the financial crisis in Argentina as well as the then looming threat of heavy losses on loans extended to Global Crossing, the collapsed telecoms group which at the time was itself subject to numerous regulatory investigations.¹⁰

The news of JP Morgan’s relationship with Enron and its off-shore vehicle was accompanied by revelations that energy giant Enron actually made the bulk of its money in OTC derivatives. Moreover, the size and scale of Enron’s derivatives business dwarfed that of the leveraged and derivatives-heavy Long Term Capital Management which just four years before had caused the New York Fed to quietly engineer a bailout. In 2002 testimony to Congress, law professor and attorney Frank Partnoy provides the following details, and a conclusion about the role of derivatives in Enron’s collapse:

Enron has been compared to Long-Term Capital Management, the Greenwich, Connecticut, hedge fund that lost $4.6 billion on more than $1 trillion of derivatives and was rescued in September 1998 in a private bailout engineered by the New York Federal Reserve. For the past several weeks, I have conducted my own investigation into Enron, and I believe the comparison is inapt. Yes, there are similarities in both firms’ use and abuse of financial derivatives. But the scope of Enron’s problems and their effects on its investors and employees are far more sweeping.

According to Enron’s most recent annual report, the firm made more money trading derivatives in the year 2000 alone than Long-Term Capital Management made in its entire history. Long-Term Capital Management generated losses of a few billion dollars; by contrast, Enron not only wiped out $70 billion of shareholder value, but also defaulted on tens of billions of dollars of debts. Long-Term Capital Management employed only 200 people worldwide, many of whom simply started a new hedge fund after the bailout, while Enron employed 20,000 people, more than 4,000 of whom have been fired, and many more of whom lost their life savings as Enron’s stock plummeted last fall.

In short, Enron makes Long-Term Capital Management look like a lemonade stand. It will surprise many investors to learn that Enron was, at its core, a derivatives trading firm…

I believe there are two answers to the question of why Enron collapsed, and both involve derivatives. … My testimony — and Enron’s activities — involve the OTC derivatives markets.¹¹

Some may recall that a mere few weeks before the very controversial, taxpayer-assisted JP Morgan takeover of Bear Stearns we witnessed the abrupt implosion of derivatives-heavy Carlyle Capital. In the case of Carlyle Capital, the unheeded pleas of its parent company, The Carlyle Group went out to involved banks to hold off on margin calls and liquidation of mortgage assets. Led by Deutsche Bank and JP Morgan, the group of “the world’s biggest banks” that had lent Carlyle Capital about $21 billion — or $20 for every dollar of initial capital — quickly moved to seize and sell what was left of the fund’s assets. It is interesting to note that as of the end of 2007, counter parties for Carlyle Capital’s repurchasing agreements included Bear Stearns, Citigroup, Duetsche Bank, and JP Morgan among several other big banks.

In the midst of the furor created by Carlyle Capital came wind of the Bears Stearns takeover. Incredibly, as journalist Marine Cole pointed out, “The government-supported sale of Bear Stearns announced last week may have halted a run on investment banks, but its pending acquisition by JP Morgan Chase would increase the buyer’s already hefty exposure to possible failures by other banks and financial institutions, an exposure known as counterparty risk…”¹²

So we might ask, what is the difference between JP Morgan, Enron, Carlyle Capital, LTCM and Bears Stearns or for that matter Washington Mutual and Lehman Brothers? Why did our government and the Fed see fit to ignore signs of conflicts of interest and signs of malfeasance on the part of JP Morgan and facilitate the takeover or rescue of Bear Stearns, Washington Mutual and LTCM, while Carlyle Capital, Lehman Brothers and Enron were allowed to implode? Certainly all were very highly leveraged, and all were heavily involved in the mortgage securities/derivatives market. Could the difference simply be the counter parties involved?

Whatever the case, it is more than a little problematic that Bear Stearns, Carlyle Capitol and JP Morgan all had leverage ratios of about 32 to 1 (according to published estimates) at the time of the Bear Stearns crisis. Worse still is the nagging suspicion that the implied derivatives leverage on equity may have been far, far greater than what has been reported.¹³

JP Morgan is of course still standing, but both it and other financial institutions — including the giant government-sponsored entities Fannie Mae and Freddie Mac — have required massive amounts of taxpayer assistance and perhaps not a small amount of favoritism to boot. How many more such rescues remain in the pipeline is almost too chilling a thought to contemplate — particularly if you happen to be a taxpayer. Hopefully sooner rather than later, we might actually get some answers to some very troubling questions, beginning with why it is that “[t]he Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral…”¹⁴

But in the final analysis, we have to ask ourselves — in an artificial world where risk is limited by governments willing to overlook blatant evidence of malfeasance and instead resort to using their citizens to subsidize business failures, and where the opportunity for financial gain is exaggerated by extreme levels of leveraging and non-transparent bets on bets otherwise known as derivatives — why wouldn’t financial heavyweights of all stripes engage in these types of bookie transactions — Faustian Bargains though they may be?

1. Who Are the Architects of the Economic Collapse? Michel Chossudovsky. Global Research, November 9, 2008.
2. Washington’s $5 Trillion Tab, Elizabeth Moyer. Forbes, November 12, 2008.
3. The Bernanke Politburo’s Next Big Plan, Mike Whitney. The Market Oracle, March 31, 2008.
4. Stockholders Socked as J.P. Morgan Acquires Bear Stearns in Weekend Rescue. Mortgage News Daily, March 17, 2008.
5. Fed Hires Bear Stearns Chief …To Supervise Bank Soundness. naked capitalism, November 4, 2008.
6. JPMorgan Chase Buys WaMu Assets After FDIC Seizure, Marcy Gordon, Sara Lepro and Madlen Read, AP Business Writers. YAHOO! Finance, September 25, 2008.
7. U.S. Treasury Program Shuns Banks That Need Cash Most, David Mildenberg and Linda Shen. Bloomberg, October 29, 2008.
8. So When Will Banks Give Loans, Joe Nocera. New York Times, October 25, 2008.
9. JPM Derivatives Monster Crashes, Adam Hamilton. ZEAL Speculation and Investment, July 26, 2002.
10. Enron Crisis Grips JP Morgan, David Teather and Jill Treanor. Guardian.co.uk, February 23, 2002.
11. Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law, Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002.
12. Bear Churns: Bear Stearns Deal Boosts JP Morgan’s Derivatives Exposure, Marine Cole. Financial Week, March 24, 2008.
13. JPM Derivatives Monster Grows, Adam Hamilton, ZEAL Speculation and Investment, January 4, 2002.
14. Fed Defies Transparency Aim in Refusal to Disclose, Mark Pittman, Bob Ivry and Alison Fitzgerald. Bloomberg, November 10, 2008.

While too few have chosen to seriously consider the consequences, there are those who have sounded alarms. For example, in a working paper titled “Governing Global Finance”, author William D. Coleman “explore[d] the relationships between derivatives markets and the capacity of nation-states to govern” and “raise[d] the question whether the very global character of these markets and of their key players restricts the freedom of states to follow policy styles consistent with domestic institutional arrangements.” Coleman further argued that “global governance arrangements have supplanted to some extent the efforts undertaken by nation-states.”¹

No surprise then that while the public and their elected officials occupy themselves with assigning blame to isolated scapegoats, leading policy and opinion-makers have begun to openly call for the creation of a new “global authority” to fill the financial regulatory vacuum. Issues of national sovereignty notwithstanding, it is almost impossible to imagine how any such “authority” might neutralize, much less overcome, the systemic risk posed by derivatives given the structural flaws inherent within them. This is especially — though far from exclusively — true for OTC derivatives.

With seemingly rare insight and three years before Warren Buffet penned his famous warning about derivatives in 2002, Martin Mayer, Nonresident Guest Scholar, Economic Studies, at the Brookings Institute wrote that …

derivatives create a felt need for their own employment. … Unfortunately, over the counter derivatives—created, sold and serviced behind closed doors by consenting adults who don’t tell anybody what they’re doing—are also a major source of the almost unlimited leverage that brought the world financial system to the brink of disaster last fall [of 1998, due to the threatened implosion of the relatively small Long Term Capitol Management]. These instruments are creations of mathematics, and within its premises mathematics yields certainty. … But … The more certain you are, the more risks you ignore; the bigger you are, the harder you will fall. … The one lesson history teaches in the financial markets is that there will come a day unlike any other day. At this point the participants would like to say all bets are off, but in fact the bets have been placed and cannot be changed. The leverage that once multiplied income will now devastate principal.²

Bad as the aforementioned pitfalls of irrational exuberance coupled with nearly unlimited leveraging, high risk and built-in lack of transparency may be, there is much more to the myriad of problems associated with derivatives in general, as Professor Coleman and others clearly detail. For example, derivatives — along with other speculative tools — are illiquid assets due to the fact that their performance determines the timing and amount of pay-offs.

So it was that in the early 19th century, well before the modern age of OTC derivatives, small country banks would help speculators build up localized asset bubbles through leveraged loans on assets such as land or railroads. As with the modern derivatives trade — much of which is based on bundled loans or debt on debt — when the speculative fever forced prices to an unsustainable level, the bubble burst. Asset illiquidity then forced a dramatic drop in prices and bad debt forced banks out of business — taking with them whatever assets ordinary citizens may have placed in their trust and simultaneously creating a credit contraction. Those lucky few still left with money in their hands then bought up depressed assets for “a dime on a dollar”and another transfer of wealth took place.

Devastating as they were to ordinary people and their communities, these were isolated bubbles with relatively limited causative factors and effects. Today, the very size and nature of the global derivatives bubble looms large as the newest and most ever-present threat of the seize up, and subsequent destruction, of the entire global marketplace. The negative effects of the predictable deflating of the credit bubble will be felt most acutely and for years to come by ordinary citizens around the world, with the U.S. leading the way as more and more of its now enticingly priced resources are sold to the highest bidder and more and more of its citizens are forced to accept ever lower wages, fewer jobs, increasing taxes and reduced expectations.

As the world’s largest economy, the United States has long played a leading role in the global financial system and cannot escape its share of blame in the current fiasco. Its policies and actions have unquestionably played a key role in the most recent explosion of both U.S. and global use of derivatives — not only as money-making tools, but also as an extremely privileged “off-balance sheet” money creation tool.

In 1997, Thomas F. Siems, who is a senior economist and policy adviser at the Federal Reserve Bank of Dallas penned a Policy Analysis titled “10 Myths About Financial Derivatives.” Here he posited that “the explosive use of financial derivative products in recent years was brought about by three primary forces: more volatile markets, deregulation, and new technologies.”

Ten years later, in 2007 testimony before Congress, economist and former investigator for the Senate Banking Committee Robert Kuttner was able to draw a number of parallels between what is happening today and the “unregulated” 1920s. Government response to the 1920s fiasco led to the 1933 adoption of the Glass-Steagall Act, the purpose of which was to regulate the banking industry. Echoing Siems earlier assertions, Kuttner also discussed the long history of both de facto and legalized deregulatory efforts which have occurred since Glass-Steagall and the manner in which new technologies and volatility have interplayed with deregulation to “supercharge” old problems, while “federal breakwaters” have served — up until now — to stave off collapse:

Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s — lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn’t paper at all, and the whole process is supercharged by computers and automated formulas. An independent source of instability is that while these credit derivatives are said to increase liquidity and serve as shock absorbers, in fact their bets are often in the same direction — assuming perpetually rising asset prices — so in a credit crisis they can act as net de-stabilizers. …

… Beginning in the late 1970s, the beneficial effect of financial regulations has either been deliberately weakened by public policy, or has been overwhelmed by innovations not anticipated by the New Deal regulatory schema…

Of course, there are some important differences between the economy of the 1920s, and the one that began in the deregulatory era that dates to the late 1970s. The economy did not crash in 1987 with the stock market, or in 2000-01. Among the reasons are the existence of federal breakwaters such as deposit insurance, and the stabilizing influence of public spending, now nearly one dollar in three counting federal, state, and local public outlay, which limits collapses of private demand.³

Following close on the heels of the 1999 repeal of the Glass-Steagall Act (through the Gramm-Leach-Bliley Act) mentioned by Mr. Kuttner, came the Commodity Futures Modernization Act. Passed by a lame-duck session of Congress in the fall of 2000, it was signed into law by then President Bill Clinton. Known as the “Enron Loophole,” this Act was considered to be the most significant modification to the regulation of derivatives trading to occur in 25 years.

While the loophole specifically refers to exemption from meaningful oversight and regulation of the electronic energy commodities market, the Act itself may have had much broader ramifications for the securities markets. At the very least, according to independent analyst Mike Whitney, this bill “effectively kept much of the market for derivatives and other exotic instruments off-limits to agencies that regulate more conventional assets like stocks, bonds and futures contracts…” (”The Bernanke Politburo’s Next Big Plan,” Mike Whitney, Market Oracle.)

Defacto and actual derivatives deregulation aside, there are a number of additional factors which have contributed to the veritable explosion in global growth of the derivatives trade seen over the last seven or eight years, with ominous implications for both policy-making decisions and the economic climates of the world’s nation states. Analysts say this explosive growth has essentially been fueled by the United States through a number of key, converging factors that include:

• The Fed’s cheap money policies which then led to the current sub-prime crisis, global in its reach and effect
• Ballooning public outlays for war-related expenditures which extend down to the local level, as a response to the new, open-ended “war on terror”, again global in its reach and effect
• Burgeoning trade deficits and corresponding increase of foreign ownership of U.S. assets, occurring as a result of “economic globalization” which in turn is enforced through a growing plethora of “free” trade/investment agreements and rising militarism around the world

Preferential tax treatment of derivatives is yet another factor contributing to their growth in recent years in the U.S. and elsewhere. So favorable has this tax treatment been that Alex Raskolnikov, a Columbia Law School expert on federal income taxation and tax policy, told members of the House Ways and Means Committee’s Subcommittee on Select Revenue Measures in March of this year that “financial derivatives offer unprecedented opportunities to reduce or eliminate capital income taxation.”

Hence, according to analyst Paul B. Farrell, “derivatives have become the world’s biggest ‘black market,’ exceeding the illicit traffic in stuff like arms, drugs, alcohol, gambling, cigarettes, stolen art and pirated movies. Why? Because like all black markets, derivatives are a perfect way of getting rich while avoiding taxes and government regulations.”⁴

The trouble is, says Farrell, that Wall Street knows derivatives provide a lucrative business despite the current slowdown and a volatile global marketplace. So it is that “[t]he financial crisis exacerbated by credit derivatives is costing so much to fix that speculators are now using those same instruments to bet on governments …”⁵

Just as troubling is the fact that the domino effect of bank failure created by irrational exuberance coupled with lack of transparency, illiquidity, heavy leveraging, and counter party risk has quietly become an embedded feature of the newly emerging “global credit system” as Warren Buffet, bond fund king Bill Gross and others well knew. No longer are the old stand-by “federal breakwaters” of deposit insurance and public spending for infrastructure or health care enough to stave off collapse of national economies.

For example, a May 2002 white paper prepared for the IMF Legal Department and IMF Institute Seminar on Current Developments in Monetary and Financial Law bore the descriptive title “Emergency Liquidity Financing By Central Banks: System Protection or Bank Bailout?” Its purpose was to

consider ways in which emergency liquidity funding (ELF) may be provided by central banks to individual banks that are experiencing financial difficulties. ELF takes the form of loans from, or guaranteed by, the central bank that are designed to assist one or more commercial banks that are either undergoing a run on deposits or as a result of concerns about safety and soundness or that are experiencing a systemic financial crisis.

The conclusion of this white paper was as follows:

The rules for providing ELF should be revisited, and the tilt toward providing financing for every bank experiencing a run addressed. At the same time, there should be sufficient flexibility in the law to allow a central bank to provide ELF on an unsecured basis when needed in a banking crisis. Central banks will do so regardless of the rules, therefore the law should reflect the practical realities. In the case of a banking crisis, as provided in the model law, consideration should be given to having the state liable for ELF, since the health of an essential part of the economy is at stake. [present author's emphasis]

Whether the rules have been changed or not seems almost a moot point because making the “state” — for example the United States government and its taxpayers — liable for “emergency liquidity funding” provided by the Fed or other central banks to individual, privately owned banks experiencing trouble is exactly what has been happening since the “credit crisis” began in earnest last August 2007. Curiously, “[t]he U.S. government’s [latest October 2008] $160 billion handout to banks from Niagara Falls to Beverly Hills is going mostly to lenders that need it least, putting weaker rivals at risk of being shut down or taken over … ”⁶

What lies ahead for American taxpayers was driven home by the recent $700 billion bank bailout and at least partially revealed in an April 9, 2008 article in the Wall Street Journal: “The Federal Reserve is considering contingency plans for expanding its lending power in the event its recent steps to unfreeze credit markets fail… Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed … The internal discussions are part of a continuing effort at the Fed, similar to what is under way at foreign central banks, to determine its options if the credit crunch becomes even more severe.”⁷

Perhaps it was these “internal discussions” which led Pimco director Bill Gross, aka the Warren Buffet of the bond world, to remark last year that “What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August [2007].” In essence says Gross we are operating in large part under a “shadow banking system” which uses derivatives as a new method of creating money outside the hitherto standard liquidity rules of central banking operations.⁴

So it is that, in the maniacal effort to maintain the current, mathematically impossible money creation system “we are now in the process of designing a new global economy”. How will this be done? By “redesigning the global credit system” in which “the US appears to be a helpless giant, needing all the help it can get.”⁸

The end result? A massive and continually accelerating transfer of assets and wealth from the real economy to the financial economy, compliments of governments and their taxpayers.

We can of course sit idly by, as we have long done, while the global credit system is redesigned for us and as more and more of us fall victim to the ravages of unpayable interest and the greed and corruption it breeds. We can even wait, if we choose, until the system completely collapses into cataclysmic chaos, perhaps bringing with it horrors hitherto unimagined.

OR we can demand the solution handed to us by our forefathers, that the Congress “coin” (as in create) Constitutional money and regulate the value thereof, with the states being limited to using what the Congress “coins” (or creates) as money. But maybe first, we need to understand the true function of money, which is to create abundance for all — not just the fortunate few.

1. “Governing Global Finance,” William D. Coleman, Department of Political Science, Institute on Globalization and the Human Condition. McMaster University, Canada.
2. “The Dangers of Derivatives,” Martin Mayer, Wall Street Journal, 1999.
3. Testimony of Robert Kuttner before the Committee on Financial Services of the U.S. House of Representatives, October 2, 2007.
4. “Derivatives are the New Ticking Time Bomb,” Paul B. Farrell, Market Watch.
5. “World According to TARP No Laughing Matter for US,” Abigail Moses and and Shannon D. Harrington, Bloomberg.
6. “U.S. Treasury Program Shuns Banks That Need Cash Most,” David Mildenberg and Linda Shen, Bloomberg.
7. “Fed Weighs Its Options in Easing Crunch,” Greg Ip, Wall Street Journal.
8. “Welcome to the New World of Financial Innovation,” Bruce Nussbaum, Business Week.

More troubling still is that both history and recent events reveal that when the speculative bubble bursts this “off-balance sheet” money, created through heavily leveraged debt, evaporates. What happens next is graphically described by John Kenneth Galbraith in his book Money Whence It Came: “Whatever the pace of the preceding build-up, whether slow or rapid, the resulting fall is always abrupt. Thus the likeliness to the ripsaw blade or the breaking surf. So did speculation and therewith economic expansion come to an end in all of the panic years from 1819 to 1929…”

In 2007 testimony before Congress, economist and former investigator for the Senate Banking Committee Robert Kuttner painstakingly drew numerous parallels between what is happening today to what happened during the years leading up to the 1933 Glass-Steagall Act.

Interestingly the Glass-Steagall Act — which was repealed by the Gramm-Leach-Bliley Act in 1999 — was designed as a method by which to protect depositors from risks associated with securities transactions. It did this by prohibiting commercial banks from participating in investment banking activities and from collaborating with full-service brokerage firms, but as Kuttner says later in the same testimony the lines quickly became blurred by de facto and actual, subsequent regulatory measures. It is also well worth noting that the Glass-Steagall Act then led to the creation of the FDIC, which put taxpayers on the hook as final guarantors of all deposits and assets in private, for-profit banks — perhaps setting the stage for today’s virtual tsunami of taxpayer funded assistance to the banking industry.

The following excerpts from Mr. Kuttner’s testimony sheds important light on what happens to the real economy and real people when “traditional” (albeit fractional reserve) banking practices are ignored and derivatives are allowed to serve as “off-balance sheet” money creation tools:

The most basic and alarming parallel [to the Depression Era] is the creation of asset bubbles, in which the purveyors of securities use very high leverage; the securities are sold to the public or to specialized funds with underlying collateral of uncertain value; and financial middlemen extract exorbitant returns at the expense of the real economy. This was the essence of the abuse of public utilities stock pyramids in the 1920s, where multi-layered holding companies allowed securities to be watered down, to the point where the real collateral was worth just a few cents on the dollar, and returns were diverted from operating companies and ratepayers. This only became exposed when the bubble burst…

A second parallel is what today we would call securitization of credit. Some people think this is a recent innovation, but in fact it was the core technique that made possible the dangerous practices of the 1920s. Banks would originate and repackage highly speculative loans, market them as securities through their retail networks, using the prestigious brand name of the bank — e.g. Morgan or Chase — as a proxy for the soundness of the security. It was this practice, and the ensuing collapse when so much of the paper went bad, that led Congress to enact the Glass-Steagall Act …

A third parallel is the excessive use of leverage. In the 1920s, not only were there pervasive stock-watering schemes, but there was no limit on margin. If you thought the market was just going up forever, you could borrow most of the cost of your investment, via loans conveniently provided by your stockbroker. It worked well on the upside. When it didn’t work so well on the downside, Congress subsequently imposed margin limits. But anybody who knows anything about derivatives or hedge funds knows that margin limits are for little people. High rollers, with credit derivatives, can use leverage at ratios of ten to one, or a hundred to one, limited only by their self confidence and taste for risk. Private equity, which might be better named private debt, gets its astronomically high rate of return on equity capital, through the use of borrowed money. The equity is fairly small. As in the 1920s, the game continues only as long as asset prices continue to inflate; and all the leverage contributes to the asset inflation, conveniently creating higher priced collateral against which to borrow even more money.

… In the 1920s, many of these securities were utterly opaque. Ferdinand Pecora, in his 1939 memoirs describing the pyramid schemes of public utility holding companies, the most notorious of which was controlled by the Insull family, opined that the pyramid structure was not even fully understood by Mr. Insull. The same could be said of many of today’s derivatives on which technical traders make their fortunes.

By contrast, in the traditional banking system a bank examiner could look at a bank’s loan portfolio, see that loans were backed by collateral and verify that they were performing. If they were not, the bank was made to increase its reserves. Today’s examiner is not able to value a lot of the paper held by banks, and must rely on the banks’ own models, which clearly failed to predict what happened in the case of sub-prime…²

The Panic of 1907 revealed similar oft-forgotten lessons. The following passage described by then U.S. Representative Charles A. Lindbergh his 1913 book Banking and Currency and The Money Trust adds a political layer to such events which may be instructive:

The king bankers put in motion, in 1907, a great scheme. They had gambled and speculated on Wall Street until so many watered stocks and bonds had been manufactured on speculation, that numberless speculators, big and small, sprang up all over the country, and stocks and bonds, and credits were pyramided, and re-pyramided. Of course such a condition could not last and a crash was the inevitable result … There was to be a panic in the fall of 1907 that would be advertised as the result of our bad banking and currency laws…

So it is then that history, together with present day circumstances, indeed provides important lessons for understanding the destructive effects of derivatives — and the ensuing, predictable response of the public and their elected officials to sales pitches, propaganda and economic pressure put forth by the “king bankers”.

One of the most important features of the derivatives trade, as Mr. Kuttner said, is that unlike “traditional banks” which require both transparency and reserves, these speculative, privately negotiated “off-balance sheet” derivatives contracts require nothing to back them up — so the possibilities of creating “off-balance sheet” money are virtually limitless. We can see for ourselves this growth of “off-balance sheet” money by looking at M3 figures.

The total money supply is, or rather was prior to March of 2006, measured primarily by three categories. M3 was considered to be the “broadest measure” of the money supply. M1 represents the most “liquid” form of money and it should also be noted that M1 — which represents cash and checkbook money — is the basis by which our money, as loans, is created through standard fractional reserve banking practices.³.

M2 adds passbook and savings accounts to M1 figures. M3 of course adds the huge institutional funds to the calculations for the M1 + M2 money supplies. What is most remarkable about this is that since the 1980’s, the growth of the M3 money supply has increasingly outstripped M1 growth. In March of 2006, the Fed discontinued publication of M3, claiming that “M3 did not appear to convey any additional information about economic activity that was not already embodied in M2.”⁴

Despite the Fed’s action, reconstituted M3 estimates can now be found on the internet which tell an intriguing, if somewhat frightening, tale. What these charts show is that somewhere around mid-2005 the growth of the M1 money supply began to trend significantly downward to zero and below while the growth of the M3 money supply began to trend dramatically upward, increasing some 12% in a little over three years. [John Williams' Shadow Government Statistics: Alternate Data Series]

Because the only difference between the M1 + M2 measurement and the M3 measurement is the addition of huge institutional funds it is clear that these funds are where nearly all the new money was being created — and it was being done primarily through the highly leveraged, non-transparent, risk-laden, “off-balance sheet” derivatives market. This market of course is the exclusive playground of heavy rollers who have the where-with-all to deal with large institutional funds not to mention incredible risk.

In other words, a new “off-balance sheet” highly leveraged and highly privileged money creation system — a shadow banking system if you will — has in effect been operating through the derivatives markets. Until recently and without question, this new system of money/debt creation has been on steroids, as reflected in M3 growth.

But what goes up must come down, and that means that tax-payers will increasingly be put on the hook for “capital building” otherwise known as taxpayer debt — which helps to increase M1 figures. This is born out by data provided at John William’s Shadow Stats website for the relevant months of 2008 showing an up-tick in M1 as “liquidity” was being pumped into the system through taxpayer funded bailouts — and a corresponding down tick occurring in M3, as the “off balance sheet” money supply began to implode.

Interestingly, the most recent M1 data posted at Shadow Stats shows a decisive down-tick in M1. Could the reason for this be due to the Fed’s aggressive use of its reserves to inject liquidity into the global market place as well as here at home? If so, the decline in reserves may be at least part of the reason why taxpayers were required to immediately fund a $700 billion Wall Street bailout, since the corresponding government debt would increase reserves. No matter, because as one analyst remarked, “Net net, all these liquidity injections are merely moderating the collapsing credit facilities, and not actually injecting much in the way of credit into the economy.”⁵

Despite the current and substantial contraction taking place in the M3 money supply, the fact is that over the long term — and especially since the 1980’s — the U.S. money supply has increased dramatically, going from less than $2 trillion in 1980 to an estimated $14 trillion in 2008. Significantly, in 1980 total public and private debt totaled roughly $5 trillion, with about $1 trillion of that representing public debt. Today public and private debt totals roughly $50 trillion, with over $10 trillion of that representing public debt.

What these figures clearly show is that total debt has been outstripping the money supply for many decades due to the cumulative effects of unpayable interest. This fact alone makes it ever more difficult to deny — among all but the most hardened apologists — that the entire money creation system is, as Dick Distelhorst of the American Monetary Institute wrote in a recent newsletter, “an oxymoron — ‘the more money we have, the deeper in debt we are.’ This is ridiculous on its face, and yet we continue to accept it.”

Tragically, our collective, continued acceptance of the current money creation system means that we will be forced to participate in what may well be the most massive upward transfer of wealth in history, even as we face the potential of an almost limitless, globally connected daisy chain of meltdowns, for which governments will increasingly be looking to taxpayers for the funds needed just to keep their economies going.

1. Derivatives Are the New Ticking Time Bomb, Paul B. Farrell.
2. Testimony of Robert Kuttner before the Committee on Financial Services of the U.S. House of Representatives, October 2, 2007.
3. Money in the Economy, Federal Reserve Bank, San Fransisco, 1981.
4. The Money Supply, Federal Reserve Bank of New York.
5. Money Supply Growth? It’s Much Worse Than That! Barry Ritholtz.

Of course, obligatory lip service and mostly illusory assistance will be offered to a select assortment of hapless homeowners, struggling businesses and vociferous taxpayers. But despite the ballyhoo, deal sweeteners and leftover crumbs tossed around by politicians, the bulk of support, financed largely if not wholly by taxpayers, will be directed toward shoring up selected banking institutions and blocks of international bondholders who, through the global casino, have speculated heavily in sophisticated derivatives instruments made up of bundled debt, or “debt on debt”.

Moreover, it is through these types of “assets” that foreign countries and sectors with large blocks of bondholders are able to influence, if not dictate, governmental policies. So it was that “the U.S. government’s decision to take control of foundering mortgage giants Fannie Mae and Freddie Mac was driven not by worries about the fading U.S. housing market, but by concerns that foreign central banks in China, Japan, Europe, the Middle East and Russia might stop buying our bonds.”¹

History is replete with speculative bubbles so we are not without insight into how they occur, and what the results are — even if we stubbornly refuse to learn from them. The difference this time is the extent to which these extremely risky, highly profitable, highly leveraged “bad assets” have become embedded in economies around the globe. The current crisis was an accident waiting to happen and we — or at least our policy-makers and financial elite — were duly warned about the cause, extent and potentially lethal outcome of the problem.

Red flags have been going up everywhere for years. For example, and about the time that Warren Buffet was laying out his concerns about derivatives in his famous 2002 Berkshire Hathaway report, attorney Frank Partnoy was testifying before Congress that “OTC derivatives markets, which for the most part did not exist twenty (or, in some cases, even ten) years ago, now comprise about 90 percent of the aggregate derivatives market, with trillions of dollars at risk every day. By those measures, OTC derivatives markets are bigger than the markets for U.S. Stocks.”²

At the time of Mr. Partnoy’s 2002 testimony the total derivatives market was $100 trillion. Five years later, by June of 2007, it had reached an astonishing $516 trillion, with some $400 trillion of that in the exceptionally risky OTC market. This explosive growth, driven as it is by the insatiable quest for “fast money”, has led many analysts to conclude that derivatives speculation is what is now driving the markets — and the value of our money. More so today than ever before, it is the speculative phenomenon that has long existed in international markets which prompted former central banker Bernard Lietaer to declare in his book The Future of Money that “Your money’s value is determined by a global casino of unprecedented proportions.”

Too often overlooked is the manner in which the value of our money — whatever form it may take — has long been influenced, manipulated and controlled through the global casino. Ominously, the sheer volume of modern day derivatives take this influence to a whole new level and represents yet another step away from the true function of money as a stable medium of exchange.

Money — as a stable medium of exchange and therefore a stable measure of value — is of course the best means by which to facilitate a fair and equitable exchange of goods and services within an economy. Whether this money takes the form of gold, paper, sea shells or any other form in many ways misses the point as to what the true function of money is, and how that function might best be met. Briefly stated and in order to function properly as a stable medium of exchange, money must be a stable measure of value — and it must be supplied in amounts commensurate to the needs of the economy and the people.

Neither gold, nor any other single commodity or small group of commodities, is sufficient to meet the true productive capacity of the people. This in fact may have been at least part of the reason that the gold changers in ancient Babylonia first developed an early version of the fractional reserve system when they began to loan out more in gold receipts than the gold they actually had in their vaults.

Other problems with using a commodity such as gold as the basis for money include the fact that commodities are subject to monopoly control. In addition and just as importantly is the fact that the value of commodities — as we all know — are subject to the whims of the global and local marketplace, which means they cannot serve as a stable measure of value.

Derivatives can even more seriously undermine the ability of our money to serve as a stable measure of value because not only are they subject to monopoly control, but they carry with them the almost irresistible allure of “fast money” for those select few who are both willing and able to accept heavy risk. Thus derivatives can and do result in wild windfall profits or stupendous overnight losses through highly leveraged bets made on the potential for future profits or fluctuations in the value of a commodity such as gold, housing, or any other type of tangible asset. This fact alone dramatically increases financial instability — as has been made most apparent by recent and still unfolding events. Additionally, non-transparent leveraging provides a way of creating virtually unlimited amounts of “off-balance sheet” money, which further erodes the value of our money and the stability of our money supply.

Last but not least, and inasmuch as they are the domain of a small, select group of traders and dealers, derivatives have become the fast-track method of shifting assets and wealth to the financial markets at the expense of the real economy — which is where the goods and services, including commodities, are actually being produced. It is in this real economy where the global race to the economic bottom is always the most acutely felt.

Unfortunately for you and me, America’s real economy has joined the global race to the economic bottom. Seemingly overnight this real economy has been transformed into a giant fire sale for our “new financial colonial masters” and derivatives have played a crucial role. Here is how one blogger starkly described the transformation process:

The blowback that I repeatedly warned about from the monetary loosening and crony capitalist interventions has succeeded in transforming the United States into the world’s biggest Blue Light Special [BLS]. The crackpot theories that got us here should be spelled out for the record: 1) Lack of transparency (causing total breakdown in trust) 2) Systemic faulty evaluation of credit (the credit rating process) 3) Credit insurance (underwriting with little/no reserves) 4) Tremendous leverage (consumer/business/financial debt) 5) Massive US dependence on foreign capital 6) Deliberate heavy handed attempts to manipulate and massage both economic data and markets …

The lethal add-on effects of a trashed currency, Mad Max inflation eCONomics in addition to the housing/credit rout has created a busted United States and left it open for a Blue Light Special liquidation. Meet your new financial colonial masters, America. We should see this BLS primarily conducted by foreign corporate and elitist interests, sovereign wealth funds (SWFs), and private equity firms. The criminals on Wall Street will also play a role accelerating the process, as there are fees and commissions to be collected. These will mostly be cash on the barrel head purchases paid for with US Dollars, which will be exchanged for American owned economic units and assets. For me it just don’t hold that USDs will just be continually dumped another 30-50% in a Panic or into non-income producing CUB assets like gold and oil. When prices for American held assets are cheap enough (already happened in many cases), your new masters will convert their to the moon piles of USDs into economic and financial assets. This is one of the greatest colonial opportunities in centuries.³

What nearly everyone fails to understand — or in some cases understand sufficiently well — is that the real root of the problem lies with our money creation system. Presently we have bank credit serving as money. It is a money of accounts, rather than a money of exchange. Put another way and as former Senator Robert Owen, original co-sponsor of the 1913 Federal Reserve Act, later complained, some last minute back-door tweaking of the Fed Act gave us a currency with debt-creating power instead of a currency with debt-paying power.

As a result our money is essentially being created by the Federal Reserve and other banks through the making of loans or providing of credit. Up until now, this has been done primarily through the fractional reserve system, which allows the banking system, as a whole, to create many times more “money” as loans than what the initial reserves amount to. In point of fact the initial reserves are not themselves “money” but actually loans — or perhaps more accurately, credit — provided by the privately-owned Federal Reserve to our government.

Thus, it is the privately-owned banking system that controls our money supply because it is through this system that our money gets created. Today, a shadow banking system is also creating our money through the highly leveraged “off balance sheet” activities of the derivatives market.

Some refer to this type of money as false money or substitute money because money is in effect created when banks make loans to a borrower. These loans always have interest attached and yet no money is created to pay the interest charges due on this debt. The only way to pay these interest charges is by creating more debt as “money” — and this then serves to increase the “money” supply.

Again, accumulating interest charges are in effect unpayable — unless more debt is incurred — due to the manner in which out money is created. You can use yourself as a way to understand this concept. If you take out a loan for $1000 and then spend your newly created “money” (in the form of bank notes or promises to pay back the debt), you will have placed your loan “money” into circulation where others can use it. To keep things simple, let’s say no one else is able to secure a loan, so $1000 is all the “money” in circulation. At the end of the year you owe your lender $1000 plus interest. Since only $1000 was created as “money”, how can you pay both the principal and interest, even assuming you have been able to earn back all the loan/money you spent? Answer: You must take out an additional loan. OR, you can negotiate to defer payment, which only compounds the interest you owe.

Even worse — and because the exponential function of compounding interest comes into play, unpayable interest charges must accumulate exponentially over time. The phenomenon created by the need to create ever more debt as “money” in order to meet the demands of accumulating, unpayable interest becomes integrated into the value of false money — decreasing its value over time and simultaneously increasing the demand for ever more “money” as credit or debt just to pay growing debt.

This is the real reason why we have an economy built on debt. And because the money supply is never adequate enough to pay accumulating interest, unbridled greed and the attendant pursuit of “fast money” become increasingly difficult to control. Rampant corruption soon follows and must grow ever more problematic as unpayable interest accumulates.

Greed and corruption aside, what this money creation system means for you and me is that the purchasing power of the dollar is eroded over the long term due to the demands of accumulating interest — and this then increases the cost of doing business and the overall general cost of living. These increasing costs are then reflected in overall, long term increases of prices for goods and services.

In other words, inflation within our current debt-based money system is actually due to debt-induced currency devaluation, caused by accumulating, unpayable interest. The problem has grown so huge that some researchers say that some eighty-five cents of every dollar are now going to satisfy the needs of this accumulating interest, rather than the real economy.

Bottom line is that the whole system is governed by mathematical law and as it stands now, it is a mathematical impossibility. Once the debt load becomes unsupportable the system will crash. Meanwhile and as the debt burden grows ever larger the economy will go through increasing periods of instability and volatility, despite the best efforts of the Fed to tweak interest rates and the money supply — or for that matter the government’s willingness to increase the debt ceiling on the backs of taxpayers.

Ours is not the only country facing these issues and so today, in response to the fallout generated by the shadow banking system that arose within the derivatives market, we are in the midst of redesigning the global credit system, according to bond fund king Bill Gross and many others. What we all need to understand is that any redesign of the global credit system will require continually increasing government reliance on taxpayer dollars — so long as we continue with the current money creation system.

Essentially and due to the exponential function for calculating compounding interest, taxpayer debt must explode as we are forced to pay ever more interest on outstanding interest. This will continue until the labor and assets of the people can no longer be mortgaged. We are in other words essentially being destroyed by the tyranny of unpayable interest — not the tyranny of paper money.

1. Foreign Bondholders – and Not the U.S. Mortgage Market – Drove the Fannie/Freddie Bailout, William Patalon III
2. Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law, Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002.
3. The U.S.: The World’s Biggest Blue Light Special. The Wall Street Examiner, July 20, 2008.

One of the derivatives instruments that LTCM used was total-return swaps, contracts that facilitate 100% leverage in various markets, including stocks. For example, Party A to a contract, usually a bank, puts up all of the money for the purchase of a stock while Party B, without putting up any capital, agrees that at a future date it will receive any gain or pay any loss that the bank realizes.

Total-return swaps of this type make a joke of margin requirements. Beyond that, other types of derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts. When Charlie and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don’t understand how much risk the institution is running.

Most importantly, it was not the spectacle of speculators “blowing themselves up” that caused Buffet to worry that derivatives were such potent weapons of financial mass destruction. It was the “daisy chain”of counter party risk attached to them and the fact that these highly speculative, highly leveraged, privately negotiated contracts are not backed by any type of collateral.

Instead, as Buffet later says, “their ultimate value depends on the credit worthiness of the counter parties to them.” Said value has precious little to do with actual assets. Moreover and as Buffet correctly warned, one weak link in the unplumable chain of counter parties could potentially lead to global economic meltdown.

Counter party risk has expanded in recent years to include broker-dealers, multinational corporations, hedge funds, and insurers. Using the derivatives business GenRe Securities that came attached to his purchase of the parent company GenRe as an example for how difficult it can be to close down a derivatives business, Buffet says that after ten months of effort to wind down its operation, GenRe Securities still had 14,384 contracts outstanding — involving 672 counter parties around the world.

Counter party risk is commonly believed to be minimized by having an organization or entity with extremely good credit act as an intermediary between the two parties, since it is they who can make good on the trade should a default on the agreement occur. Typically, banks such as J.P. Morgan and brokerage houses such as Bear Stearns will serve as intermediaries. But we all know what happened to Bear Stearns despite its having survived the Great Depression.

September has brought with it wave after wave of more bad news, including the announcement that mortgage giants Freddie Mac and Fannie Mae would be placed under conservatorship of the government. One week later, we watched as the venerated 158 year old Lehman Brothers was allowed to go under — making this the biggest bankruptcy in U.S. History. We also watched as the privately owned Fed orchestrated an $85 billion dollar bailout (or as some posit, purchase) of insurance giant AIG — and as Bank of America arranged for the purchase of the ailing Merrill Lynch. Alarm bells were also going off about Morgan Stanley, Washington Mutual and that “national treasure” Goldman Sachs. In every case, the faltering institution had become entangled with “bad debt” derivatives.

Meanwhile the Fed felt compelled to inject an additional $180 billion — for a total of some $247 billion — of taxpayer money as part of the international effort being coordinated by central banks around the world to prevent total seize up of the global financial system.

None of this was enough, and on Friday September 19 Treasury Secretary Hank Paulson announced a new plan for what he described as a comprehensive program intended to get at the root of the problem, which was centered in the derivatives markets. Some pundits have begun referring to this initiative as the “nuclear option” and in the figurative sense at least, it may well be.

An estimated $700 billion of yet more taxpayer dollars are to be used to purchase problematic derivative securities as the government assumes an unprecedented level of responsibility for their “unwinding” so that “liquidity” might be brought back to the markets. Troubled Freddie Mac and Fannie Mae are to begin the process of what amounts to a massive bailout of Wall Street, and the government will assume the role of “intermediary” using the full faith and credit of its properly panicked citizens as backing.

Princeton Professor Markus K. Brunnermeier makes some noteworthy observations about the predictability of the current derivatives-based liquidity crisis in the conclusion of a May 19 draft article for the Journal of Economic Perspectives:

While each crisis has its own specificities, it is surprising how “classical” the 2007-08 crisis is. From the trigger set off by an increase in delinquencies in subprime mortgages, a fullblown liquidity crisis emerged, primarily because of a mismatch in the maturity structure that involved banks’ off-balance-sheet vehicles and hedge funds. What was new about this crisis was the extent of securitization. Not only did it make more opaque the exposure of institutions’ structured credit products to credit counterparty risk, but it also made these products more difficult to value . . .

The additional uncertainty created by these factors later led to spillover effects in other market segments that were not directly linked to subprime mortgages. While it is difficult to say at this early stage how the crisis will ultimately play out, we should expect to see the financial turmoil spilling over to the real economy with potentially sizable macroeconomic implications…¹

Of particular interest here is Dr. Brunnermeier’s assertion that while the current crisis contains “classical similarities” to past crises, it is the extent of securitization — and the concomitant, “unplumable chain” of counter party risk — which sets this crisis apart from others. Thus the turmoil spilling over to the real economy could have “potentially sizable macroeconomic implications.”

More than a decade earlier, John Kenneth Galbraith had provided an astonishingly clear if somewhat grim picture of “classical similarities” for previous U.S. panics, and also provided some clues as to why contemporary gurus such as Warren Buffet and scholars such as Dr. Brunnermeier are so apprehensive — and so seemingly prophetic:

Speculation occurs when people buy assets, always with the support of some rationalizing doctrine, because they expect prices to rise… This process has a pristine simplicity; it can last only so long as prices are rising. If anything interrupts the price advance, the expectations by which the advance is sustained are lost or anyhow endangered. All who are holding for a further rise — all but the gullible and egregiously optimistic, of which there are invariably a considerable supply — then seek to get out. Whatever the pace of the preceding build-up, whether slow or rapid, the resulting fall is always abrupt. Thus the likeliness to the ripsaw blade or the breaking surf. So did speculation and therewith economic expansion come to an end in all of the panic years from 1819 to 1929.

… Also, as the nineteenth century passed and gave way to the twentieth, speculation became less of a local, more of a national, phenomenon. Land speculation occurred in the farm country and on the frontier. So did that which anticipated or followed the arrival of the railroads. The collapse of such speculation affected primarily the country banks. Securities speculation, in contrast, was the business of the financial centers. Loans to buy securities were made by the big-city banks. These banks also underwrote and bought stocks and bonds. When these collapsed in price, it was the banks of the cities that were affected, and it was their depositors who took alarm and came for their money.²

Today, it is not just country banks or even the big financial centers in select cities that are seriously threatened by collapse — said collapse always being due to bank leveraging of their loans, it might be pointed out. Since Galbraith penned his words, the potential for mass financial destruction has been magnified exponentially by “innovative forms of derivatives” which are heavily traded through what amounts to a global casino.

Moreover, as Dr. Brunnermeier points out, the extent of securitization and the attendant uncertainty created by counter party risk and lack of transparency has already led to spillover in market segments other than housing and, further, that we can anticipate still more of the financial turmoil spilling over into the real economy. The turmoil is global, but the effects will this time around be quite acutely felt in the United States.

In the case of real estate, especially housing, this turmoil is painfully evident as overly inflated housing values continue to plummet and millions of defaulting homeowners and hapless renters alike are kicked to the curb. But housing is hardly the only asset class whose values are impacted by the irrational exuberance which has for years permeated throughout the global derivatives market. The spillover is also appearing in year-over-year escalation and increased volatility of prices for key commodities — you know the kind of things we need to carry on daily activities, things like food and gas — and it is derivatives which are again playing a crucial role in valuations.

An April 16 staff report for the online Westport News put it this way when discussing derivatives and energy prices: “Over the last five or six years investment banks, hedge funds and pension funds have forced up demand in [oil and energy] contracts above and beyond the basic rules of supply and demand …” Many experts, including Steve Forbes, agree with this assessment. Although estimates vary as to just how much of current oil prices are reflective of pure speculation, author and researcher F. Wm. Engdahl recently asserted that “perhaps 60% of today’s oil price is pure speculation.”³

The Westport News report mentioned above also makes these important observations: “The price for these commodities [including food] is actually set on international commodities markets such as the New York Mercantile Exchange (NYMEX) and other exchanges around the world… What’s problematic about this situation is that traders from all over the globe can play with our energy [and commodities] market … And, these are commodities, not stocks or bonds or other financial instruments. We have to buy them.”⁴

In other words the global casino — propelled by the privately negotiated, highly speculative, heavily leveraged “off-balance sheet” derivatives market and controlled by a relative handful of players — is determining to a remarkable degree the value of the necessities of life.

What is especially troubling is that the potential profits from derivatives are magnified many times over through heavy, multi-tiered leveraging with no actual investment in an asset required, or even desired, making their appeal almost irresistible. Moreover, derivatives extract their value from fluctuations in the value of assets such as bundled mortgages and loans, stocks, bonds, currencies, interest rates, indexes and other assets which often are not themselves fixed or tangible. Derivatives have become, in every sense, bets on bets — extracting value rather than preserving or enhancing value through real investments in the real economy.

Conversely, the real economy is a reflection of the goods and services produced and consumed by real people and it depends on the viability of tangible and/or fixed assets. The true value of these assets can be and are dramatically affected by the activities of the global financial economy. Tangible, fixed assets of course include things like land, homes and other buildings, gold, platinum, and so forth. Other tangible — but less fixed — assets include farm crops and livestock, gas, oil, and even water.

Of course, fixed assets require a degree of care and maintenance — and the financial value of less fixed assets expires once they are consumed. But we need them nonetheless. Perhaps we could think of these types of assets as “value added,” because they often give back as much as they take out of the economy.

Derivatives on the other hand are “bookie transactions” with mere promises to make some “fast money” with no real investment in, appreciation of, or concern for the underlying asset. In the obsessive pursuit of fast money, derivatives can and do — to a large degree at least — artificially drive up prices for the very things we must buy and use everyday, even as they exponentially expand debt and the “off-balance sheet” money supply through an increasingly volatile global casino.

Perhaps even worse, both the elevated risk associated with derivatives and the faceless aspect of the global casino create a fertile breeding ground for environmental and human rights abuses, as well as rampant corruption and crime. There can be no mistaking the fact that derivatives speculation requires a good deal of dancing with the devil.

1. “Deciphering the 2007-08 Liquidity and Credit Crunch”, Markus K. Brunnermeier, Princeton University.
2. Money Whence It Came, Where It Went, revised edition 1995, by John Kenneth Galbraith.
3. “Perhaps 60% of Today’s Oil Price is Pure Speculation”, F. William Engdahl. See also the August 21, 2008 Washington Post article titled “A Few Speculators Dominate Vast Market for Oil Trading” by David Cho.
4. “Free Market or Free-For-All?– westport-news.com

As early as Monday, reports began circulating that “The government’s takeover of Fannie Mae and Freddie Mac may lead to one of the largest ever payments in the credit default swap market … Losses to protection sellers, however, are expected to be minimal because of the high trading levels of the $1.6 trillion of outstanding Fannie Mae and Freddie Mac debt.”¹

A Bloomberg report put another twist on this latest derivatives blow-up story when it related that “Thirteen “major” dealers of credit-default swaps agreed “unanimously” that the rescue constitutes a credit event triggering payment or delivery of the companies’ bonds, the International Swaps and Derivatives Association …”²

No one can say they weren’t warned about long-standing “Enron-style” accounting problems with Fannie Mae and Freddie Mac. For example, in 2003 testimony to Congress, Peter Wallison asserts that “From press accounts, it appears that Freddie attempted over many years to manage its earnings by manipulating the valuation of its derivatives…”³

Reading between the lines, one analysts tells the reader to “imagine betting on a default, getting it, and losing your ass. It seems to me that is what happened.” Among the betting winners in this latest debacle are the thirteen “major” dealers of credit-default swaps… and PIMCO. The losers? U.S. Taxpayers and small banks and investors holding F(annie)& F(reddie) preferreds and/or F(annie) &F(reddie) common.⁴

Freddie Mac and Fannie Mae are not alone. Threats of implosion permeate the entire banking industry, due to the derivatives markets. Thus it was that market guru Warren Buffet explicitly warned in a 2002 letter to Berkshire Hathaway shareholders that “derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal”. Yet despite clarion warnings from Mr. Buffet and many others before and since, the growth of the global derivatives markets over the last five years has escalated beyond comprehension or belief.

Mind-numbing numbers tell the tale. For example, when Buffet penned those extraordinary words in 2002, the derivatives trade had grown worldwide to an estimated $100 trillion, from an estimated $40 trillion a little over a year earlier. As of June 2007, a mere five years later, they totaled an estimated $516 trillion according to the Bank of International Settlements, or BIS.⁵ Even more eye-popping third quarter figures were given in an article appearing in Bloomberg last December, which began with “Derivatives traded on exchanges surged 27 percent to a record $681 trillion in the third quarter, the biggest increase in three years, the Bank For International Settlements said.”⁶

Located in Basel, Switzerland, the BIS officially acts as the world’s “clearinghouse” for central banks. However, a somewhat more apt description is provided by analyst Paul B. Farrell, who likened the BIS to “the cashier’s window at a racetrack or casino, where you’d place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy.”⁷

How can we comprehend such staggering numbers and the kinds of activities that may be associated with them? We can start by looking at what the real economy is producing versus what is taking place in the newly burgeoning “global casino”. As of June of last year, total world GDP stood at $52 trillion whereas worldwide derivatives contracts amounted to some $516 trillion — which means that gambling out-paced the production of real goods and services by a factor of ten to one. Today the ratio may well be too outrageous to mention in polite circles.

What accounts for such incendiary and disproportionate growth in the global derivatives trade? How might it be contributing to our economic and social woes? And, lastly, can the current monetary system be saved from the imminent collapse that such numbers portend?

The answers to these questions are immediately important, for the course we take now will set us on a path toward peace and abundance for all, or propel us ever faster toward certain global economic meltdown and, to borrow Mr. Buffet’s phrase, mass destruction.

Derivatives may seem to have sprung up out of nowhere. However, senior economist and policy adviser at the Federal Reserve Bank of Dallas Thomas F. Siems points out that Aristotle’s writings provide an example of the world’s first options contract — a type of derivative — occurring some 2500 years ago. This type of derivatives contract was developed as a method by which a farmer could protect himself from downward fluctuations in the value of his crops.

These contracts, offered by the farmer for a fee, allowed him to secure buyers for his crops months before the crops were even planted — so long as the farmer agreed in advance to sell his crops for a set price. If the price of crops at time of harvest were significantly higher than the contract price, the buyer got his goods at a bargain price and the farmer got the contract fee to help make up the difference. If, on the other hand, crop prices were significantly lower at harvest time, the buyer could walk, but the farmer had the contract fee as a hedge against his loss. These were relatively straightforward contracts, particularly when compared to the far more complex financial instruments derivatives have evolved into today.

What are derivatives? Former merchant banker-turned-novelist Linda Davies provides the wonderfully succinct description of derivatives as “bookie transactions once removed, taking a bet on a bet”. More pedagogically speaking, derivatives are complex financial instruments that are merely a promise to convey ownership at some later date. Their value is derived from fluctuations in the value of an asset, rather than from the asset itself. Thus they themselves do not constitute ownership of an asset and so have no intrinsic value. Rarely is the asset in question ever exchanged, since the primary objective of these contracts is to realize profits or hedge against losses.

In addition and as Mr. Buffet so richly put it: “Essentially, these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices or currency values… The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen)… [So] say you want to write a contract speculating on the number of twins to be born in Nebraska in 2020. No problem — at a price, you will easily find an obliging counterparty.”⁸

The primary purpose of modern day derivatives is ostensibly to reduce risk for one party (such as a farmer) or group (such as tulip growers), although a cascading web of interconnected “counterparties to risk” may be, and increasingly are connected to these transactions. The secondary purpose for investing in derivatives is, of course, to gamble that your bet on a future asset valuation will win — and bring in “fast money” for you with no investment in the asset, and at minimal upfront cost.

Common derivative contract categories include options, swaps, forwards and futures. Although some argue that the lines have been blurred in recent years, there are two main methods for trading in derivatives: over-the-counter or OTC and exchange traded.

Futures for example are typically exchange-traded. Because they must go through a clearinghouse, the parties to exchange-traded futures contracts are required to maintain deposits whose size depends on the contracts, similar in nature to the role that capital requirements play for banks. And unlike over-the-counter trades which are privately negotiated agreements between two parties, buyers and sellers of exchange-traded securities must make a contract with the clearing house. This means these contracts must be standardized in such a way as to allow buyers and sellers the ability to know what it is they are buying and selling – thus creating a level of transparency that is non-existent in OTC trades.

As part of the “secondary” market, over-the-counter trades also include stocks, bonds, and commodities, and it is in this market that the bulk of derivatives are traded. In contrast to traditional trading floor operations, OTC trades take place in a decentralized global marketplace, where geographically disconnected dealers conduct business electronically via faxes, telephones, and computers. The scale and speed with which these transactions occur further reduces transparency and significantly impairs regulatory oversight.

The SEC has deemed OTC traded stocks to be “extremely risky”. The Morningstar group takes this assessment a step further when it says that “Trading in OTC stocks is a lot like gambling, and it is not something we recommend for beginners.”

Not surprisingly, a certain exclusivity is built into OTC markets in particular, with trading taking place among brokers — who arrange transactions between buyers and sellers — and dealers, who are people and firms within the securities business that own securities and trade for their own accounts. In truth this is the domain of heavy rollers who play a high stakes game with pricey entrance fees. This fact creates a series of related problems because, as Mr. Buffet details,

Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others. On top of that, these dealers are owed huge amounts by non-dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant [author's note: read “privatized”] power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems.

The recent growth of the OTC derivatives trade has been nothing short of phenomenal. For example, analyst Kevin McFarland relates in an article for Advanced Trading that “Since 2002, the outstanding notional value of all OTC interest rate, currency, credit and equity derivatives has grown nearly 30 percent a year. Additionally, between 2006 and 2007 that growth rate rose to over 40 percent… As of mid-2007 (the latest available data), there was over $400 trillion ” with a T ” of notional value in outstanding OTC derivative contracts.”

Leveraging is a major fault line embedded within various derivatives products, including futures, options, swaps, margin and other financial instruments. While the “effect” of borrowing is implicitly built into the cost of purchasing the derivative contract itself, derivatives allow considerable leverage without any actual borrowing — or for that matter investment in an asset.

Opportunity for profit is of course maximized considerably by leveraging. However risky derivatives may be, the lure of potentially huge profits and “fast money” makes these kinds of “bets on bets” as irresistible as they are deadly.

1. Reuters, September 9, 2008, International Herald Tribune.
2. Fannie, Freddie Credit-Default Swaps May Be Settled by Oliver Biggadike and Shannon D. Harrington.
3. TESTIMONY on Fannie Mae and Freddie Mac by Peter J. Wallison before the House Subcommittee on Commerce, Trade and Consumer Protection: July 22, 2003.
4. Big Non-Event In Fannie, Freddie Credit Default Swaps, Mike Shedlock.
5. Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2007 – Final results press release, December 19, 2007.
6. Derivative Trades Jump 27% to Record $681 Trillion by Hamish Risk.
7. Derivatives Are the New Ticking Time Bomb, Paul B. Farrell.
8. Berkshire Hathaway 2002 Annual Report