by L. Carlos Lara
This Lara-Murphy Report (LMR) article was reprinted with permission. This and many more articles related to IBC and Austrian Economics are published monthly in the LMR.
There is no other way to put it. Americans have been tricked! The hidden process of money creation that artificially manipulates interest rates and creates economic booms has misguided society’s views of money and credit. This has been especially noticeable in our modern view of savings. Once considered the bedrock of a household’s financial strategy, traditional savings plans lost favor with the public because they were seen as too slow and boring in an economy that was flush with money and low interest rates. The lure of the stock market and the promises of quick money through investing turned Americans into a nation of speculators. Riding the wave of inflation, the idea was to buy low and sell high. The strategy was all about making money—fast!
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
5. Tax Free
6. No market volatility
7. Creditor Protected
8. Inflation Proof
11. Easy to manage
12. No fees or penalties
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.
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.
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.
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.