[At the invitation of the New York Federal Reserve Bank, Robert Wenzel spoke and had lunch in the bank's Liberty Room on April 25, 2012. Below are his prepared remarks.]

Thank you very much for inviting me to speak here at the New York Federal Reserve Bank.

Intellectual discourse is, of course, extraordinarily valuable in reaching truth. In this sense, I welcome the opportunity to discuss my views on the economy and monetary policy and how they may differ with those of you here at the Fed.

That said, I suspect my views are so different from those of you here today that my comments will be a complete failure in convincing you to do what I believe should be done, which is to close down the entire Federal Reserve System.

My views, I suspect, differ from beginning to end. From the proper methodology to be used in the science of economics, to the manner in which the macroeconomy functions, to the role of the Federal Reserve, and to the accomplishments of the Federal Reserve, I stand here confused as to how you see the world so differently than I do.

I simply do not understand most of the thinking that goes on here at the Fed, and I do not understand how this thinking can go on when in my view it smacks up against reality.

Please allow me to begin with methodology. I hold the view developed by such great economic thinkers as Ludwig von Mises, Friedrich Hayek, and Murray Rothbard that there are no constants in the science of economics similar to those in the physical sciences.

In the science of physics, we know that water freezes at 32 degrees. We can predict with immense accuracy exactly how far a rocket ship will travel filled with 500 gallons of fuel. There is preciseness because there are constants, which do not change and upon which equations can be constructed.

There are no such constants in the field of economics, because the science of economics deals with human action, which can change at any time. If potato prices remain the same for 10 weeks, it does not mean they will be the same the following day. I defy anyone in this room to provide me with a constant in the field of economics that has the same unchanging constancy that exists in the fields of physics or chemistry.

And yet, in paper after paper here at the Federal Reserve, I see equations built as though constants do exist. It is as if one were to assume a constant relationship existed between interest rates here and in Russia and throughout the world, and create equations based on this belief and then attempt to trade based on these equations. That was tried and the result was the blow up of the fund Long Term Capital Management — a blow up that resulted in high-level meetings in this very building.

It is as if traders assumed a given default rate was constant for subprime mortgage paper and traded on that belief. Only to see it blow up in their faces, as it did, again, with intense meetings being held in this very building.

Yet, the equations, assuming constants, continue to be published in papers throughout the Fed system. I scratch my head.

I also find curious the general belief in the Keynesian model of the economy that somehow results in the belief that demand drives the economy, rather than production. I look out at the world and see iPhones, iPads, microwave ovens, flat-screen televisions, which suggest to me that it is production that boosts an economy. Without production of these things and millions of other items, where would we be? Yet the Keynesians in this room will reply, “But you need demand to buy these products.” And I will reply, “Do you not believe in supply and demand? Do you not believe that products once made will adjust to a market-clearing price?”

Further, I will argue that the price of the factors of production will adjust to prices at the consumer level and that thus the markets at all levels will clear. Again do you believe in supply and demand or not?

I scratch my head that somehow most of you on some academic level believe in the theory of supply and demand and how market-setting prices result, yet you deny them in your macro thinking about the economy.

You will argue with me that prices are sticky on the downside, especially labor prices, and therefore that you must pump money to get the economy going. And, I will look on in amazement as your fellow Keynesian brethren in the government create an environment of sticky non-downward-bending wages.

The economist Robert Murphy reports that President Herbert Hoover continually pressured businessmen not to lower wages.

He quoted Hoover in a speech delivered to a group of businessmen:

In this country there has been a concerted and determined effort on the part of both government and business … to prevent any reduction in wages.

He then reports that FDR actually outdid Hoover by seeking to “raise wages rates rather than merely put a floor under them.”

I ask you, with presidents actively conducting policies that attempt to defy supply and demand and prop up wages, are you really surprised that wages were sticky downward during the Great Depression?

In present-day America, the government focus has changed a bit. In the new focus, the government attempts much more to prop up the unemployed by extended payments for not working. Is it really a surprise that unemployment is so high when you pay people not to work? The 2010 Nobel Prize was awarded to economists for their studies that showed that, and I quote from the Noble press release announcing the award,

One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.

Don’t you think it would make more sense to stop these policies, which are a direct factor in causing unemployment, than to add to the mess and devalue the currency by printing more money?

I scratch my head that somehow your conclusions about unemployment are so different from mine and that you call for the printing of money to boost “demand” — a call, I add, that since the founding of the Federal Reserve has resulted in an increase of the money supply by 12,230 percent.

I also must scratch my head at the view that the Federal Reserve should maintain a stable price level. What is wrong with having falling prices across the economy, like we now have in the computer sector, the flat-screen-television sector and the cell-phone sector? Why, I ask, do you want stable prices? And, oh by the way, how’s that stable price thing going for you here at the Fed?

Since the start of the Fed, prices have increased at the consumer level by 2,241 percent. that’s not me misspeaking: I will repeat, since the start of the Fed, prices have increased at the consumer level by 2,241 percent.

So you then might tell me that stable prices are only a secondary goal of the Federal Reserve and that your real goal is to prevent serious declines in the economy but, since the start of the Fed, there have been 18 recessions including the Great Depression and the most recent Great Recession. These downturns have resulted in stock-market crashes, tens of millions of unemployed, and untold business bankruptcies.

I scratch my head and wonder how you think the Fed is any type of success when all this has occurred.

I am especially confused, since Austrian business-cycle theory (ABCT) — developed by Mises, Hayek, and Rothbard — has warned about all these things. According to ABCT, it is central-bank money printing that causes the business cycle and, again you here at the Fed have certainly done that by increasing the money supply. Can you imagine the distortions in the economy caused by the Fed by this massive money printing?

According to ABCT, if you print money, those sectors where the money goes will boom; stop printing and those sectors will crash. Fed printing tends to find its way to Wall Street and other capital-goods sectors first; thus it is no surprise to Austrian School economists that the crashes are most dramatic in these sectors, such as the stock-market and real-estate sectors. The economist Murray Rothbard in his book America’s Great Depression went into painstaking detail outlining how the changes in money-supply growth resulted in the Great Depression.

On a more personal level, as the recent crisis was developing here, I warned throughout the summer of 2008 of the impending crisis. On July 11, 2008, at EconomicPolicyJournal.com, I wrote,

SUPER ALERT: Dramatic Slowdown In Money Supply Growth

After growing at near double digit rates for months, money growth has slowed dramatically. Annualized money growth over the last 3 months is only 5.2 percent. Over the last two months, there has been zero growth in the M2NSA money measure.

This is something that must be watched carefully. If such a dramatic slowdown continues, a severe recession is inevitable.

We have never seen such a dramatic change in money supply growth from a double digit climb to 5 percent growth. Does Bernanke have any clue as to what the hell he is doing?

On July 20, 2008, I wrote,

I have previously noted that over the last two months money supply has been collapsing. M2NSA has gone from double digit growth to nearly zero growth .

A review of the credit situation appears worse. According to recent Fed data, for the 13 weeks ended June 25, bank credit (securities and loans) contracted at an annual rate of 7.9 percent.

There has been a minor blip up since June 25 in both credit growth and M2NSA, but the growth rates remain extremely slow.

If a dramatic turnaround in these numbers doesn’t happen within the next few weeks, we are going to have to warn of a possible Great Depression style downturn.

Yet, just weeks before these warnings from me, Chairman Bernanke, while the money-supply growth was crashing, had a decidedly much more optimistic outlook. In a speech on June 9, 2008, at the Federal Reserve Bank of Boston’s 53rd annual economic conference, he said,

I would like to provide a brief update on the outlook for the economy and policy, beginning with the prospects for growth. Despite the unwelcome rise in the unemployment rate that was reported last week, the recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly. Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so. Over the remainder of 2008, the effects of monetary and fiscal stimulus, a gradual ebbing of the drag from residential construction, further progress in the repair of financial and credit markets, and still-solid demand from abroad should provide some offset to the headwinds that still face the economy.

I believe the Great Recession that followed is still fresh enough in our minds so that it is not necessary to recount in detail as to whose forecast, mine or the chairman’s, was more accurate.

I am also confused by many other policy-making steps here at the Federal Reserve. There have been more changes in monetary-policy direction during the Bernanke era then at any other time in the modern era of the Fed. Not under Arthur Burns, not under G. William Miller, not under Paul Volcker, not under Alan Greenspan have there been so many dramatically shifting Fed monetary-policy moves. Under Chairman Bernanke there have been significant changes in direction of the money supply growth five different times. Thus, for me, I am not at all surprised at the current stop-and-go economy. The current erratic monetary policy makes it exceedingly difficult for businessmen to make any long-term plans. Indeed, in my own “Daily Alert” on the economy, I find it extremely difficult to give long-term advice, when in short periods I have seen three-month annualized M2 money growth go from near 20 percent to near zero, and then in another period see it go from 25 percent to 6 percent.

I am also confused by many of the monetary programs instituted by Chairman Bernanke. For example, “Operation Twist.”

This is not the first time an Operation Twist was tried. An Operation Twist was tried in 1961, at the start of the Kennedy administration. A paper was written by three Federal Reserve economists in 2004 that, in part, examined the 1960s’ Operation Twist.

Their conclusion:

A second well-known historical episode involving the attempted manipulation of the term structure was so-called Operation Twist. Launched in early 1961 by the incoming Kennedy Administration, Operation Twist was intended to raise short-term rates (thereby promoting capital inflows and supporting the dollar) while lowering, or at least not raising, long-term rates. (Modigliani and Sutch 1966).… The two main actions of Operation Twist were the use of Federal Reserve open market operations and Treasury debt management operations. Operation Twist is widely viewed today as having been a failure, largely due to classic work by Modigliani and Sutch.…

However, Modigliani and Sutch also noted that Operation Twist was a relatively small operation, and, indeed, that over a slightly longer period the maturity of outstanding government debt rose significantly, rather than falling … Thus, Operation Twist does not seem to provide strong evidence in either direction as to the possible effects of changes in the composition of the central bank’s balance sheet.…

We believe that our findings go some way to refuting the strong hypothesis that nonstandard policy actions, including quantitative easing and targeted asset purchases, cannot be successful in a modern industrial economy. However, the effects of such policies remain quantitatively quite uncertain. (emphases mine)

One of the authors of this 2004 paper was Federal Reserve Chairman Bernanke. Thus, I have to ask, what the hell is Chairman Bernanke doing implementing such a program, since it is his paper that states it was a failure according to Modigliani, and his paper implies that a larger test would be required to determine true performance.

I ask, is the chairman using the United States economy as a lab with Americans as the lab rats to test his intellectual curiosity about such things as Operation Twist?

Further, I am very confused by the response of Chairman Bernanke to questioning by Congressman Ron Paul. To a seemingly near off-the-cuff question by Congressman Paul on Federal Reserve money provided to the Watergate burglars, Chairman Bernanke contacted the Inspector General’s Office of the Federal Reserve and requested an investigation. Yet the congressman has regularly asked about the gold certificates held by the Federal Reserve and whether the gold at Fort Knox backing up the certificates will be audited. Yet there have been no requests by the chairman to the Treasury for an audit of the gold. This I find very odd. The chairman calls for a major investigation of what can only be a historical point of interest but fails to seek out any confirmation on a point that would be of vital interest to many present-day Americans.

In this very building, deep in the underground vaults, sit billions of dollars of gold, held by the Federal Reserve for foreign governments. The Federal Reserve gives regular tours of these vaults, even to school children. Yet America’s gold is off limits to seemingly everyone and has never been properly audited. Doesn’t that seem odd to you? If nothing else, does anyone at the Fed know the quality and fineness of the gold at Fort Knox?

In conclusion, it is my belief that from start to finish the Fed is a failure. I believe faulty methodology is used. I believe that the justification for the Fed, to bring price and economic stability, has never been a success. I repeat, prices since the start of the Fed have climbed by 2,241 percent and there have been over the same period 18 recessions. No one seems to care at the Fed about the gold supposedly backing up the gold certificates on the Fed balance sheet. The emperor has no clothes. Austrian business-cycle theorists are regularly ignored by the Fed, yet they have the best records with regard to spotting overall downturns, and further they specifically recognized the developing housing bubble. Let it not be forgotten that in 2004, two economists here at the New York Fed wrote a paper denying there was a housing bubble.I responded to the paper and wrote,

The faulty analysis by [these] Federal Reserve economists … may go down in financial history as the greatest forecasting error since Irving Fisher declared in 1929, just prior to the stock market crash, that stocks prices looked to be at a permanently high plateau.

Data released just yesterday now show housing prices have crashed to 2002 levels.

I will now give you more warnings about the economy.

The noose is tightening on your organization. Vast amounts of money printing are now required to keep your manipulated economy afloat. It will ultimately result in huge price inflation, or, if you stop printing, another massive economic crash will occur. There is no other way out.

Again, thank you for inviting me. You have prepared food, so I will not be rude — I will stay and eat.

Let’s have one good meal here. Let’s make it a feast. Then I ask you, I plead with you, I beg you all, walk out of here with me, never to come back. It’s the moral and ethical thing to do. Nothing good goes on in this place. Let’s lock the doors and leave the building to the spiders, moths, and four-legged rats.

Afterword

Here are the details surrounding my speech at the New York Federal Reserve Bank. First, I am surprised it actually occurred.

Reaction inside the New York Fed to news of the invitation for me to speak was fast and furious, once it became public inside the bank.

I am not going to go into the specifics of who invited me. I believe that economist had a true curiosity about my views, but when he put out a formal invitation via email within the New York Fed (I received a copy), it was cancelled within 15 minutes of being put out (I also have a copy of the cancellation). So much for overall curiosity at the Fed about true differing views.

The economist who invited me assured me that he was still arranging the speech. Yet as the day grew closer, I feared that I would get word that my speech time would be cancelled.

When I arrived at the bank, the economist who originally invited me told me that there was a “schedule conflict” with a seminar and that the group meeting would be smaller than originally planned. That really didn’t bother me, I was in the Fed, and those wanting to hear my speech would.

However, I did detect tension in faces, while I gave my speech, and perhaps some anger. But the anger soon dissipated.

As soon as I finished my speech and to defuse the tension, I asked an immediate question as to whether the economists present believed that Austrian theory had a legitimate case to make. The eventual response came down to the statement by a Fed economist that there had been worse crashes in the economy before the start of the Fed. (Side note: this is a regular argument used by those supporting the Fed. They will claim that crises were worse before the Fed. I have seen fragmented work demolishing this view, but I think there is the opportunity for some economics student to delve into the pre-Fed period in America and delve into the crashes from an Austrian business-cycle viewpoint and point out clearly how government was involved in such crises, if they were — which I suspect they were. Such a study would be extremely valuable in knocking a peg out from under the Fed supporters who attempt to justify the Fed by this argument.)

I then asked one economist (a 20-year-plus veteran of the Fed) if he was familiar with Austrian economics. He said that in college he had taken two history-of-economics courses and then said that the Austrian School is part of the classical tradition. This told me that he was not aware of the important differences between the Austrian School and classical economics (and also the neoclassical tradition).

Later on in the Q&A, one economist remarked that he understood the Austrian School and that they were the group that wanted a constant increase in the money supply and developed the equation PV=MT. This, of course, is not the Austrian view, but a view held by the Chicago School. Thus, in one swoop, this economist demonstrated not only his ignorance of Austrian views on monetary policy but also confusion about Chicago School views.

To diffuse the tension a bit more, when one economist made a particularly Keynesian statement, I said, “It does not sound like you are going to be walking out of here with me after lunch like I recommend.” That brought laughter.

At another point, I told the story of how in a phone conversation with Lew Rockwell, Lew and I were discussing why I had received an invitation by the Fed, and Lew said, “They are probably sick and tired of all those boring speeches that they have to listen to.” That really brought laughter.

A good deal of the Q&A was about my Rothbardian view that prices should be allowed to decline. They were really fascinated by this view and clearly had never heard it before. One economist raised the question of how falling prices would impact assets. The answer is, of course, that an asset is valued based on its discounted value stream and that falling prices would be taken into account in the discounted-present-value models. However, I do not believe this view has yet been developed fully, and it is another good project for a budding economist.

Overall, I was simply amazed at the lack of knowledge of these economists about the Austrian School. It was very close to nonexistent. This points out the extremely important work being done by the Mises Institute and also Ron Paul. The number of students with an understanding of Austrian economics is increasing at an exponential rate. I can’t imagine that future economists, even those who work for the Fed, won’t have some acquaintance with Austrian economics thanks to LvMI and Ron Paul.

My experience at the Fed points out the importance of intellectual debate and study. Clearly, the economists whom I met at the Fed were brought up in an intellectual tunnel, where they had no exposure to Austrian economic theory. They read and study within a limited range of writers. But they were very curious about my view.

One economist asked me how I knew the housing market was going to crash. I responded that because of Austrian theory, I understood that money created by the Fed enters the economy at specific points and that it was obvious the housing market was one of the those points. I told him that I also knew that this would eventually result in price inflation (as the money spread through the economy) and that at that point the Fed would slow printing and the housing market would collapse, which is just what occurred.

I suspect that at the top of the Fed, there are some very evil types who understand that the game is to protect the banksters, but I don’t think that is the view held by the outer ring. They have been brought up in the system, and they don’t ask questions that threaten their pay checks (it was most difficult impossible to get the economists to discuss any of the erratic moves made by Bernanke) and work developing models within the twisted Keynesian model.

If you set a firecracker under them, like with the speech I gave, and then treat them with respect while discussing their opposing views and lighten things up a bit after the firecracker has gone off, perhaps some impact will be made to the tunnel thinking that they have been exposed to their entire professional life. Even more important, hopefully my speech will help budding students to understand that the Fed propaganda machine claims lots of justifications for their money-printing machines that when looked at closely can not be justified. The greater the number who understand the failures of Fed thinking and operations, the closer we will be to ending the Fed.

Robert Wenzel is the editor and publisher of the Economic Policy Journal. Send him mail. See Robert Wenzel’s article archives.

Both the text of this speech and the afterword originally appeared on EconomicPolicyJournal.com. The author gives special thanks to the following, who helped him research and collect data for the speech: Stephen Davis, Bob English, Jon Lyons, Ash Navabi, Joseph Nelson, Nick Nero, Antony Zegers.

Copyright © 2012 by the Ludwig von Mises Institute. Permission to reprint in whole or in part is hereby granted, provided full credit is given.

Todd provided this article for inclusion in Nelson Nash’s new book Building Your Warehouse of Wealth, due this summer.
Insurance companies have put numerous pages on the front of Equity Indexed Universal Life (EIUL) illustrations that describe the issues below, but most people (by design) will not take the time to read and understand what these pages are saying.  I would encourage you to read those pages thoroughly before depending on an EIUL policy to increase your assets or protect your family.  Similarly, Universal Life (UL) and its cousin Variable Universal Life (VUL) have some of the same problems so I’ve spelled out the issues below and placed an * next to the ones that are specific only to EIUL.  As stated earlier, all Universal Life policies are a side fund (money market for regular UL, mutual fund-like separate accounts for VUL, and index fund-like accounts for EIUL) plus annually renewable, or one year increasing premium term insurance for the death benefit..
#10  Internal costs are not guaranteed
#9    Mortality charges are not guaranteed
#8    Market drops cause double pain
#7    Late premiums kill any guarantees
#6    Dividends from the index don’t get credited*
#5    Participation ratios are often less than 100%*
#4    Returns are usually capped at various interest rates*
#3    Guarantees are not calculated annually*
#2    All of the above can be changed by the company
#1    The risk is shifted back to the insured
Now, let’s look at each of these individually and tell the whole truth about the matter.

10.  Internal administration fees charged against cash value on any type of Universal Life policy and shown on illustrations are run under current expense levels but those can change at the discretion of the company.  Since the insurance company uses this money to run its operations, as prices of office supplies and real estate go up, they may choose to adjust these internal costs after you have bought the policy.

9. Mortality changes, what the insurance company charges for the death benefit are removed from the cash value or paid by premiums.  In UL, these pay for annually increasing term insurance costs.  This is true for any type of UL, no matter what the side fund is invested in.  The cost for this one year term insurance can be changed at any time.

8. Market drops affect the side fund negatively no matter what the side fund is invested in.  Since the death benefit is comprised of the One Year (or annually increasing) Term Insurance plus the side fund, any market drop causes double pain.  Markets can drop regardless of whether they are supported by stocks or money markets.  When the side fund is reduced by a drop in the market or current interest rates, it now has less value so more Term Insurance must be bought to make up the difference which further reduces the side fund.  Consequently you have double pain; less cash value and higher costs.

7. Any late premiums remove any guarantees in the policy.  In most UL policies, even if the premium is finally paid, once it is late, the insurance company is off the hook for supporting any guaranteed premiums, cash value amounts or death benefits.  In many cases, the insured may not even know that a premium was late and that the guarantees have been forfeited.  Thinking about the time frame of a 50 year policy paid monthly (600 payments) ask yourself what the likelihood is of a mistake being made by the premium payer, their bank, the post office, the insurance company clerks or anyone else along the way?

6.*  Equity Indexed Universal Life policies provide the policy holder no credit for any dividends from the stocks making up the index.  The side fund of an EIUL isn’t actually invested in the index; instead the index is used to determine the gross crediting rate for the side fund.  If money were actually invested in the index, the investor would get both the change in Net Asset Value (whether up or down) AND the dividend income.  However, in the case of EIUL, only the change in value of the index is the determining factor and the dividend is left out of the calculation entirely.

5.*  Participation ratios are often less than 100%.  As mentioned directly above, the side fund is not invested directly in the index and many insurance companies only credit a certain percentage of the increase in the market.  Known as the participation ratio, this is often reported at 80% or less meaning you are getting only 80% of the increase in the market.

4.*  Capping returns in order to keep high returns in the market from crediting too much to the side fund is a strategy many insurance companies use.  The maximum return they’ll give credit for may be at a certain percentage rate even though the index may have generated a higher percentage rate.

3.*  Guaranteed minimum returns are not always calculated annually.  Most EIUL policies have a guaranteed minimum return so that if the index drops below this rate, the insurance company will still credit at the guaranteed minimum rate.  However, with some policies this guarantee is not applied annually but instead over an “indexing period” which could be 5-10 years.  So you could have negative years in the index (below the guaranteed minimum rate) which would be applied to the side fund.  This would cause a further reduction of value in excess of the guaranteed minimum rate in one particular year and as long as the overall average rate for the entire indexing period is not less than the guaranteed minimum rate, this would still count as meeting the minimum.

For example, if the minimum guaranteed rate is 2% inside a 5 year indexing period, you could have crediting rates of +13, -10, +10, -8 and +9% which would validate the promised guarantee because it would average more than 2% per year over the 5 years.  The implication is that you cannot have a negative return, but as shown in the example below, you can have a negative return as long the guarantee is not calculated annually.

You’ll notice another example below of the same interest rates, but with $100,000 of existing value instead of $10,000 per year of cash flow into the account.

2.  At the discretion of the company any of the above factors can be changed at any time for the benefit of the company even after the policy has started.  This is really one of the scariest aspects of all types of UL.  There is no way to calculate what the outcome might be.  Even if you analyzed the policy under the current structure and found it to be a viable tool, future changes could cause future problems.

1. Where as typically the point of all insurance purchased is to shift the risk from the insured to the company, all types of UL shift the risk backwards or from the insurance company to the insured.

With a mutual life insurance company, a whole life policy gives you a share of the entire profits of the company via dividends.  The carrot being sold with EIUL is that it might exceed the return of a whole life policy.  Yet this begs the question: How could the insurance company pay out more than the profits of the company and still be in business?
It has been explained to me that the insurance company buys options in the market to cover the risk of potentially having to credit any portion of high market returns in the index that exceeded their general portfolio rate to policy holder cash values.  If this was a sound investment strategy, why wouldn’t the insurance company use this strategy on their overall portfolio?  I think the insurance company knows that the stock market is going to under perform their portfolio rate over time.  This could reduce EIUL profits and increase the profits of the company, which then get distributed as dividends to whole life policy owners.
As a whole life policy owner,  I should be pleased that EIUL could contribute additional profits to the company which might increase dividends to Whole Life, my concern is that EIUL policies are going to create a detrimental effect on the life insurance industry as a whole.  I believe this may be the next major blight on the industry since under funded Universal Life (UL) so heavily promoted in the 1980’s.  The unfortunate outcome is that any negative media affects the entire industry because the media doesn’t differentiate between the new faulty products and the old tried and true whole life products that have been around for close to 200 years. As we know, the biggest danger with negative press is that is causes panic and the people will think the entire life insurance industry is bad and many perfectly structured whole life policies could get cancelled to the detriment of the policy holder and their family, just like what happened in the 1980’s.
Remember #2 above, since the insurance company has the ability to change #10- 3, they can always keep the Universal Life policies from outperforming their portfolio.  Why would I want to take the safe portion of my assets and the protection of my family and expose it to risk?  Doesn’t that defeat the whole purpose of insurance?  In my mind, I buy insurance and shift the risk to the insurance company, because they are experts at mitigating that risk and storing the cash to support it.

If you are seriously considering purchasing an EIUL product, please make sure you read and understand all the risks you and your family are assuming.  Because of the complexity and numerous moving parts for this product, many of the people selling it that I’ve spoken with don’t even understand it themselves.  For me, I prefer a number of simple, guaranteed, tried and true whole life policies.  These protect my Human Life Value and store my cash in the most efficient manner I know.

 The problem is that inflation and credit expansion always precipitates business maladjustments and malinvestments that must be later liquidated. The inevitable bust is always disastrous to the economy. For society at large, the end results are massive unemployment, recessions, and a possible collapse of the monetary system. Only now, with the current financial crises are individuals finally starting to assess how this all happens. What has surfaced as the primary cause no one would have believed during the heyday of easy credit and fast money. But slowly, over the course of recent years, the general public has finally become aware that somehow the Federal Reserve was directly responsible. And, of course, they are right.  After all, the Fed controls all of our money! The Federal Reserve, though created by the government, is nonetheless owned by private individuals and in important ways operates independently from the wishes of the government. As Austrian economist, Murray Rothbard, stated:

“The Federal Reserve, virtually in total control of the nation’s monetary system, is accountable to nobody—and this strange situation, if acknowledged at all, is invariably trumpeted as a virtue.” ¹

This startling realization, the fact that our money is not fully in our control can be immensely depressing once all of its moral and economic ramifications are fully understood. How in the world do you take away the printing press from government and the Federal Reserve once they have had full use of it all these many years? In fact, just exactly how would one go about changing such a monstrous problem?

How Privatized Banking Really Works

To answer these specific questions Robert and I wrote How Privatized Banking Really Works. It is a unique book in that it both diagnoses our nation’s economic problems, but then offers a realistic solution. Our quandary has very specific causes: fiat money and the practice of fractional reserve banking, coupled with government interventions that perpetuate them. All this we explained without the use of intimidating jargon that too often defies comprehension. The book’s overarching theme is that households do have the ability to secede from this chaotic financial system and ultimately force the upper echelons of government to make necessary monetary policy changes. In that respect, this is a book that answers the question of what one person can actually do that will make a difference in an economic environment that has gone terribly awry.

What we made clear was that the solution requires a movement that will ultimately change public opinion. However, the very first step to getting the ball rolling requires the implementation of the Infinite Banking Concept (IBC). To do this successfully one must fully grasp its meaning and see how it actually helps the individual financially. Once fully understood, this concept provides the basis for a formula with powerful turn-around dynamics. The result is a private economic enterprise that provides all of the financing capabilities to acquire cars, children’s education, retirement income and even house purchases. In an economic environment such as what we have today who would not want to know about such a concept? However, making the case for IBC is easier said than done. Today’s investing public is extremely cynical and skeptical, but there is yet another issue that can sometimes prove insurmountable— the closed mind. Many people have difficulty seeing past their preconceived ideas. Nevertheless, if we are to have any hopes of returning to sound money and returning money and banking to the competitive private sector, out of the hands of politicians and bailed-out big bankers, the public must be made to understand this very important piece of the financial solution. Here is where the financial professional who understands Austrian economics must step forward to do his part in properly explaining IBC.

One of the most compelling ways financial professionals explain the IBC concept is to compare it to one’s own private bank as Nelson Nash has done in his national best selling book, Become Your Own Banker. This is important because IBC is all about the banking business. But another way that is often used to explain IBC is to compare it to the perfect investment. Here the client is asked to list all of the attributes of the ideal investment. This exercise alone will do an incredible job of opening up the mind to the infinite possibilities if such a product existed. Although the lists may vary from client to client, the following qualities are the ones most often cited:

1. A consistent high rate of return
2. Liquidity
3. Guaranteed
4. Safe
5. Tax Free
6. No market volatility
7. Creditor Protected
8. Inflation Proof
9. Control
10. Transferable
11. Easy to manage
12. No fees or penalties
13. Reputable
14. Private

Try this exercise yourself and you will see that these are probably the top qualities you would select. In fact, a product that would contain all of these features would be too good to be true. But, when it is confirmed that all of these features are found in Whole Life, the client is stunned. It can’t be! Yet it’s true. If you can think of other qualities not listed here, the chances are pretty high that whole life has them. Furthermore, this is not an even an investment, it’s life insurance!

 Just imagine having an infrastructure with all these qualities and having full control of the asset. This is the power of IBC. The most popular investment vehicles are strong on some criteria but very weak on others. For example, gold is an excellent inflation hedge, but it does not provide a flow of income, its appreciation can be taxed as a capital gain, and the government has confiscated gold in the past. Real estate too can be quite volatile.  Stock market investments, though promising a high rate of return, also come with the risk of massive short-term losses.

The standard case for whole life insurance is that it is remarkably reliable on several of the above criteria. Even its weak points are not as bad as the critics think. In reality there is no such thing as a perfect investment, but the case for middle-to upper-income families including whole life, as part of their conservative financial plan, is quite compelling. When we supplement the standard case with Nelson’s Nash’s insights, and in particular the relationship of insurance and fractional reserve banking (as I will explain later in this article), the case for practicing IBC becomes stronger still.

In our experience, most people reject IBC out of hand because they have one or two “devastating” objections to the use of a whole life policy. The following example may help in defusing these common objections.

 Making Money

 Richard Russell has published the Dow Theory Letters since 1958. He gained wide recognition as a stock market analyst and writer for Barron’s from the late 50s through the 90s. He has also written for Time, Newsweek, Money Magazine, the New York Times and the Wall Street Journal. Recently he republished an article that he declares has been his most popular piece in 40 years of writing. It was titled Rich Man, Poor Man. In this article, Russell unveils the secret to making money.

Before telling us the secret, Russell makes an astute analysis that is worth repeating. He says that making money involves much more than predicting what the stock and bond markets will do or what fund will double over the next few years.

“For the majority of investors, making money requires a plan, self discipline and desire. I say ‘for the majority of people’ because if you are Stephen Spielberg or Bill Gates you don’t have to know about the Dow or the markets or about yields or price/earnings ratios. You’re a phenomenon in your own field, and you are going to make big money as a by-product of your talent and ability. But this kind of genius is rare.”^2.

Since we are not all geniuses, the rest of us need to rely on what Russell calls the “royal road to riches” which he defines as the power of compounding. To compound successfully you need time because compounding only works through time. But he says that the compounding process has two catches. The first is that it requires sacrifice, as Russell puts it, “you can’t spend it and still save it.” Second, compounding is b-o-r-i-n-g.  But Russell makes it a point to assure us that it is slow and boring only for the first seven or eight years and then it becomes downright fascinating! The money starts to pour in.

To emphasize the power of compounding Russell shows an extraordinary study of two investors. Investor (B) opens an IRA account at age 19. For seven consecutive periods he puts in $2,000 in his IRA at an average of 10% return (7% interest plus growth). After seven years this individual makes NO FURTHER CONTRIBUTIONS—he’s finished.

Investor (A) opens up an IRA at age 26 (this is the age when Investor (B) was finished with his contributions). Then A continues faithfully to contribute $2,000 every year until he is 65 (at the same theoretical 10% rate).

Now study the incredible results.      Investor A has 893,704.       Investor B has 930,641.

Investor B, who has made his contributions earlier and who only made seven contributions in total, ends up with MORE money than Investor A! But Investor A, who made a total of 40 contributions, only LATER in time, winds up with less money. How can that be? The difference in the two, Russell tells us, is that B had several more early years of compounding than A, and those seven early years were worth more than all of A’s 33 additional contributions.

Amazing! This is indeed the power of compounding. Richard Russell has certainly gotten our attention and made us realize how important it is to save money and to start as soon as possible. However, a closer examination of this example brings out several problems that are worth noting.

First of all, we should keep in mind that Richard Russell wrote this article years ago and his use of a 10% return would certainly be considered an above average rate of return today. But there is also the unmistakable consistency in the growth of this fund, a fact that would never happen in the real world. Russell even admonishes his readers that one of the cardinal rules to compounding success is to NEVER LOSE MONEY and most financial products do lose money. Even diversified mutual funds took a brutal beating in the 2000s. Depending on the composition of their funds, many households were lucky if they broke even during the entire decade. It is all well and good to tell someone, “Buy and hold,” but many breadwinners with 401(k)s and other comparable plans had to delay their retirement after the bloodbath in 2008. As of this writing and because Bernanke has halted QE, we are presently in store for another stock market crash.

Second, there is the factor of inflation that is not calculated into this equation. Inflation, although not visible, is real. Whether you use 3%, 5% or whatever factor you choose for inflation, the accumulated numbers will certainly change once its applied. But what is really missing is TAX.  Russell has this money inside of an IRA.  This means that the tax due on this pile of money is calculated at income tax rates, which can be as high as 35%! If you do the math the pile of money gets drastically small. The fascinating results we first observed with investor’s A&B suddenly diminish.

It is worth the time to stand back and look at this example from both the positive and negative sides of this equation if for no other reason than to realize just how difficult it is for Americans to pile up money over a long period of time and get to keep any of it at the end. The volatility of the bond and stock market, which keeps us from earning a consistent rate of return, is prompted by outside forces, which we know to be artificial bubbles in the economy, caused by monetary policy. The indirect and hidden tax of inflation and the direct tax we have to pay on the accumulation all serve to reminds us of the iron grip government has on our money.

Then there is the problem of control. Do we actually have control over the money we try and save? Individual Retirement Accounts (IRA), the 401(k), the 403(b), and other tax-qualified government sponsored plans for the most part have their underlying assets invested in the stock market through mutual funds. As we have already mentioned, this is not exactly a safe place for our life’s savings. Furthermore, these allocated funds are virtually untouchable till age 59½ unless one is willing to incur a 10% penalty, plus pay the federal income tax, which has only been deferred. After age 70 you must pay the tax. But more importantly, without the ability to tap into your pool of savings in case of emergencies or for large-scale purchases, Americans have very little recourse but to suffer great hardship or be forced to borrow and go into debt.

Astonishingly, the power of compounding that Richard Russell describes in his example can still be achieved if your money is stored inside a whole life policy. The rates of return in a whole life policy are guaranteed never to go below the rates quoted at the time a policy is underwritten. Consequently, a floor is immediately established that assures you of the consistency required to make compounding successful. If interest rates go up then the cash values in your policy will also appreciate.

In case the insured becomes disabled the “Waiver of Premium” rider (not available to those over age 55) guarantees the payment of all premiums at no out of pocket cost to the insured. Just another way the compounding process can be protected.

If the dividends, which are paid annually, are reinvested back into the purchase of additional life insurance, two important things happen. First, the increasing death benefit becomes the hedge against inflation. Second, the accumulating cash values are not subject to tax. Later on, if the policyholder elects to withdraw the dividend payments as income, these too are tax-free up to the point the dollars taken out are above the ones initially put in.

In case of untimely death the entire compounding process self completes immediately by the death benefit and the proceeds are passed on to the beneficiaries income tax-free.

By having one’s money inside a “private” contractual arrangement with an Insurance company instead of a tax qualified government plan such as an IRA, 401(K), or other similar vehicles, there is real control over your money without the typical restrictions and penalties. You have access to the cash values inside your policy whenever you need them through policy loans. Additionally, all of the other desired investment qualities already mentioned are present. Most importantly, you can spend it and still save it, so long as you replace it. If done properly, using a whole life policy as a financing enterprise makes complete sense.

Whole Life Policy Loans Are Not Inflationary

Nelson Nash has discovered that a traditional financial product—dividend-paying whole life insurance—can be used to immediately implement a form of privatized banking, one household at a time. But equally important, when major purchases are financed through whole life policy loans, the money supply is not expanded and there is no contribution to the boom-bust cycle.

Unlike a commercial bank, the insurance company can’t simply increase the numbers on its ledger, showing how much money the customer has “on deposit.” No, the insurance company itself must first raise the funds (from incoming premium payments, income earned on its assets, or through selling some of its assets) before transferring them to the policyholder as a loan. Percy Greaves, in his introduction to a book by Ludwig von Mises, drives home the central point.

“The cash surrender values of life insurance policies are not funds that depositors and policyholders can obtain and spend without reducing the cash of others. These funds are in large part invested and thus not held in a monetary form. That part which is in banks or in cash is, of course, included in the quantity of money which is either in or out of banks and should not be counted a second time. Under present laws, such institutions cannot extend credit beyond sums received. If they need to raise more cash than they have on hand to meet customer withdrawals, they must sell some of their investments and reduce the bank accounts or cash holdings of those who buy them. Accordingly, they (the insurance companies) are in no position to expand credit or increase the nation’s quantity of money as can commercial and central banks, all of which operate on a fractional reserve basis and can lend more money than is entrusted to them.” ³

 So we see that not only does IBC make sense on an individual level, but it also limits the ability of commercial banks to expand and contract the total amount of money in the economy. With each new household that embraces the IBC philosophy, another portion of the nation’s financial resources will be transferred out of the volatile commercial banking sector and into the conservative, solid insurance sector. As more people embrace IBC, the amplitude of the boom-bust cycle itself will be dampened. The social benefits of muting inflationary credit expansion are achieved.

Conclusion

 Unfortunately, there are powerful forces at work to disrupt our market economy. The student of history knows all too well that the rich and powerful turn to government for special privileges and handouts, and sabotage the peaceful operations of the market. This government interference leads to the financial crises that seem to inexplicably plague our country.

The beauty of Nelson Nash’s Infinite Banking Concept—and the crux of this article—is that IBC is effective both individually and collectively. Financial professionals should devote their efforts to showing households that they can provide themselves with a much more secure future. By accumulating their savings in whole life policies to finance their major purchases, families and individuals can contribute to the soundness of the dollar and dampen the boom-bust cycle.

The proponents of IBC and the scholars in the Austrian tradition can learn from each other, and in doing so can make their messages more attractive to their respective audiences. Financial professionals trying to show others the benefits of IBC can add a new point in its favor: its widespread practice would preserve the currency and strengthen the economy! These efforts can build the 10%. The movement we seek can actually happen. Public opinion can change. Monetary policy can be re-written.

Bibliography

1. Murray Rothbard, The Case Against The Fed (Auburn, AL: The Ludwig Von Mises Institute, 1994), p.3. Available at http://mises.org/books/fed.pdf.

2. Richard Russell, Article: Rich Man, Poor Man Available at
http://www.lewrockwell.com/orig12/russell-r4.1.1.html, February 2, 2011

3. Percy Graves, quoted in Huerta de Soto, footnote 106, p. 592.

Click to Download this PDF scanned from Fortune Magazine, September 1983.

By R. Nelson Nash

History seems to prove that mankind refuses to learn as much as it can from extremely valuable experiences. I can think of no better place to prove my point than looking at the Bible. Mankind has an eternal problem – we want to be God (in the pagan sense of the word). To witness the ultimate manifestation of this malady, watch what we try to do with our government. Let’s begin by going back several thousand years in the book of Genesis…

Click here to download this 23 page PDF

Instead of looking to the mainstream for answers to this crisis, why not look to those who saw it coming?

For those new to Austrian economics, this reader will offer an introduction to this unique school of thought. It is unlike any other school of economics you have likely come across. Instead of focusing on unrealistic mathematical models, the writers here build their thinking on human action and observations of how the economy actually runs.
What’s important is not necessarily the specific political opposition to this bailout, but rather educating people about the dangers of nationalization, central banking, and government regulation. Only when people recognize the dangers of the government’s “socialism for the rich” will we be able to get back on the road to prosperity. Unfortunately, a correction is necessary. There is no such thing as a free house. The more the government intervenes, the longer and more painful it will be. But this crisis gives the country a chance to rethink its previous assumptions about the economy and the government’s role in it. Hopefully, this reader will be a first step for many into an exciting, growing branch of economic thought.

The Bailout

• Stop the Bailout, Lew Rockwell, September 11, 2008.
• The Government is Not Promoting Stability, Bob Murphy, September 22, 2008.
• Day of Reckoning, Pat Buchanan, September 27, 2008.
• Economic Depressions: Their Cause and Cure, Murray Rothbard.
• Notes on the Fannie Mae/Freddie Mac Bailout, Bob Higgs, July 17, 2008.
• Get Out of the Way, Anthony Gregory, July 18, 2008.
• The Mises Institute’s Bailout Reader

The Bubble

• The Impending End of the Housing Bubble, Bill Bonner, September 19, 2006.
• Is the Housing Bubble Popping?, Mark Thornton, August 8, 2005.
• Pop Goes the Bubble, Gary North, August 23, 2003.
• The Land-Price Bubble, Doug French, June 10, 2003.

The Banks

• Anatomy of the Bank Run, Murray Rothbard.
• More Bank Failures, Doug French, August 25, 2008.
• Run for Your Money, Max Raskin, September 28, 2007.

The Fed

• War and Inflation, Lew Rockwell, June 9, 2008.
• The Fed’s Failure, Michael Rozeff, September 17, 2008.
• Why Not Abolish the Fed, Jacob Hornberger, February 5, 2008.
• A Run on the State, Bill Huff, September 27, 2008.

Short Selling

• Don’t Sell Short Selling Short, Gary Galles, April 7, 2007.

Ron Paul and Austrian Economics

• The Austrian School and the Meltdown, Ron Paul, September 26, 2008.
• The Creation of the Second Great Depression, Ron Paul, September 25, 2008.
• Ron Paul Against the Bailout, Ron Paul, September 25, 2008.

We Told You So

• Fannie and Freddie, Ron Paul, September 10, 2003.
• ‘Bull’ Market?, Mark Thornton, February 9, 2004.
• We Told You So, Mark Thornton, March 24, 2007.
• Falling Oil Prices: Told You So, Dom Armentano, September 10, 2008.

Podcasts

• Ron Paul on the Panic of ’08, September 18, 2008.
• Lew Rockwell on the Michael Reagan Show, September 26, 2008.
• Robert Higgs on War and the Economy, September 25, 2008.
• Steve Berger on Financial Markets, July 31, 2008.
• Robert Higgs on the “Crisis,” September 24, 2008.
• Joe Salerno on the Broke Banks, July 23, 2008.

Books

• America’s Great Depression, by Murray Rothbard
• The Causes of the Economic Crisis, by Ludwig von Mises
• The Politically Incorrect Guide to Capitalism, by Robert Murphy
• Economics in One Lesson, by Henry Hazlitt
• Prices and Production, by F.A. Hayek
• The Mystery of Banking, by Murray Rothbard
• The Case Against the Fed, by Murray Rothbard
• How Capitalism Saved America, by Thomas DiLorenzo

Copyright © 2008 LewRockwell.com

R. Nelson Nash discovered the formula to building wealth using the sound principles of an industry that has been deemed the foundation of the United States economy: Banking. He is the creator of the Infinite Banking Concept and renowned author of Becoming Your Own Banker. This concept uses dividend paying whole life insurance policies to create a personal bank.

1. Whole life insurance has been around for over 200 years. Yet, we still see strong hesitation to purchase this type of product. What do you feel are the biggest misconceptions of whole life insurance?.

The general public in America knows practically nothing about dividend-paying whole life insurance. It is all a matter of getting interested people educated about this wonderful idea.

2. In your book, you say that one’s infinite bank can take up to 7 years to capitalize. What do you suggest for individuals who are retiring today?

I suggest they attend one of my 10-hour seminars and get fully informed about what is possible. Please note that the “capitalization phase” in the equipment financing section of my book is only four years. Furthermore, I demonstrate that the policy can be used much earlier than that.

3. There are a lot of financial pundits out there that suggest buying term life insurance and investing the difference. What do you tell people when you hear this strategy?

I suggest they study the sixteen books that I recommend for people who are interested in the stock market. When they finish them, they are now qualified to talk about “Investments.”

4. There are numerous advantages to your Infinite Banking Concept such as the recapturing interest paid to other financial institutions, a growing death benefit, and the ability to leave behind a legacy. What, if any, are the disadvantages or drawbacks of this concept?

The disadvantages or drawbacks would be in not participating in the process!

5. Recently, we have seen many commercial banks shut down or acquired due to questionable financial decisions. This is causing a lot of people to be wary of where they keep their money. Can you speak to the stability of life insurance companies?

What is the most disastrous thing that has happened in the financial world in the last 100 years? Answer: The Great Depression. During that time life insurance companies were stronger than any other thing.

6. We enjoy the ability to access our cash value on a tax-free basis. Yet, I often see comments from naysayers like, “When the government finds out, they’ll change the tax laws.” Although tax laws are uncertain, are you confident that these tax advantages will stay in place for whole life insurance long term?

Life insurance is not a creature of the IRS Code (which has been around only since 1913). Life insurance has been around for about 200 years. Pension plans, IRA’s, HR-10 plans, 401-k plans, etc. are all a function of the IRS code. They are all “exceptions to the IRS code.” Please notice what is now happening to all those sort of plans. Yet, my life insurance policies continue to grow. (Please study the attachments.)

7. What would you say is most important in making one’s infinite bank successful and why?

Read my book. Do what it says. It is built on firm principles that have stood the test of time.

8. In your seminars and in your book, you show examples of financing cars and equipment. Are there any “out of the box” things you have done, or have seen people do, in utilizing an infinite bank?

It is limited only to one’s imagination. Again, attend one of my seminars and you will see any number of examples.

9. I’ve read your book and experienced your teaching in a live setting, so I can appreciate your humor. I think it would be entertaining to our readers if we play “word association”. I give a word, and you give your immediate response.

• Term insurance – Nonsense!
• 401k – Absurd!
• Social Security – Criminal idea!
• IRS – Equally criminal!

10. Today, a lot of people are fearful of the current economy. I believe a lot of it has to do with the media. Do you have any last words of advice you would like to give to our readers?

• Subscribe to Daily Reckoning (no cost) and read Bill Bonner every day.
• Read items on www.lewrockwell.com every day.
• Also, www.mises.org and www.fee.org.
• Read the 16 books for those interested in the stock market.

Using The Infinite Banking Concept to finance purchases without lending from banks

You probably don’t sit around calculating how much interest you pay to banks and other lenders each year, but chances are you have financed large purchases, such as homes, education, cars and major appliances.

The interest paid on these items can add up to hundreds of thousands of dollars, perhaps more, in the course of a lifetime. People often have to decide how much money to allocate for their retirement and how much to paying down current debt.

Click here to read the full article.

Jeanette set up an amortization table to repay the loan over five years at 10% interest. In making the “car payments” she is even accelerating
her own high interest schedule. This means she is going to repay the loan “before she runs out of the amortization schedule.”

If she doesn’t finish the schedule — then she is “stealing from her banking system.” This means — sometime in the next five years — she needs to see a life insurance agent and buy another policy to accommodate that extra money she is paying on her car. The earlier she makes that move, the better, because the earlier you start a policy and the longer it stays in force, the more efficient it gets.

When she completes the schedule, she will have proved to me that she fully understands the essentials of “being your own banker.” She will have “graduated from the Nash School of Finance” Summa cum Laude! At that point I will give to her the policy that I bought on her when she was age
2. My wife will have to join me in the gift and we will have to spread it over more than two years because of the IRS gifting limitations.

(Note: at this point she will have at least three policies.)

When she buys the next car, she simply repeats the process. When she is 40 years old, we can assume that buying a house is a high priority in her financial life. All she has to do to pay cash for it is call her life agent and say, “Get me a policy loan of $350,000 on my policies.” The agent needs to deliver the checks — along with an amortization table for 30 years at 10% interest. (The more interest she pays her banking system, the better, because she will get back all her cost basis at retirement time, tax-free!).

The agent also needs to tell her, “Jeanette, your next door neighbor bought his house last month — and he had to pay $12,000 in closing costs. You didn’t have to do that! To play ‘honest banker’ with yourself, you need to pay $12,000 back to your policies now to emulate what everyone else has to do in such transactions.”

This all means that she is going to pay off that “house loan” before she finishes the 30 year schedule. And this means she must buy another policy to accommodate that extra cash flow. And, remember, the earlier she does it, the better the whole system performs.

NOW — when she gets to be 70 years old, she can stop all premium payments and begin to withdraw dividend income in the neighborhood of $150,000 for the rest of her life. This won’t diminish the death benefit of about $3,000,000 regardless of how much longer she lives.

Copyright – The Infinite Banking Concept©