You Can’t Solve a Debt Crisis With More Debt

The green shoots of economic recovery are now seemingly everywhere, and we are constantly reminded of their presence by the economic ‘experts’ –  the bank stocks are up in the last 6 months  and the DOW has again breached 10,000. The same commentators and economic analysts who never saw the recession coming (and didn’t notice how serious it was for several months after it started) are now absolutely 100% sure that it is over and recovery, while it may be gradual, is now inevitable.

“Insanity: doing the same thing over and over again and expecting different results.” -Einstein

However there are several problems with the idea that we are now on the road to recovery. The most obvious is that our solution to a buildup of large and odious debts has been simple: create more debts to pay for it. With the way our system of money functions this has been the easiest response, and one that is in keeping with historical trends. To understand what is happening now we must step back to the last recession: the dot.com bust of 2000.

During dot.com mania,  the usual cheerleaders shouted about how the ‘fundamentals’ had been changed overnight, that price/earnings ratios and traditional means of valuing businesses were now essentially meaningless, and there was one rational response: buy,buy,buy! An orgy of wild speculation and silly money being thrown at crazy schemes followed. Remember boo.com?

The banking sector was heavily involved in creating this bubble. After the repeal of the Glass-Steagal Act in 1999 the seperation between retail and investment banking was removed, meaning that banks were now one-stop-shops for all aspects of managing money, advising some clients where to invest and also managing IPOs for the new dot.com companies looking for investors! The resulting conflict of interest should have raised alarm bells but as long as the profits kept rolling in (and as the banks got a % of all IPOs they managed for big companies, as well as a % of all transactions they managed for their clients who had decided to follow their investment advice, the banks did particuarly well) but as long as the market kept rising there was no problem.

“When the tide goes out, we find out who’s been swimming without a bathing suit.” -Warren Buffett

The end of the dot.com boom cam in early 2000 led to fears of a rapid contraction in the ‘real’ economy. The response of policymakers was swift and simple – one collapsing bubble of over-priced internet ‘assets’ with no connection to the real economy and unjustified stratospheric valuations was rapidly replaced with another rapidly inflated bubble to compensate for it’s loss. This time, the asset was property, and it was no longer nearly as divorced from the real economy as the internet bubble was. Everyone either owns or rents property, and all would be dramatically affected by the events that followed.

To inflate the bubble, access to money suddenly became very cheap. The Federal Reserve lowered interest rates from 5.5% in January 2001 to 3.5% in August ’01. After September 11th attacks, interest rates were again lowered. (Figures available here) Money flowed into the economy as new debt was created to meet the seemingly insatiable demand for it. As interest rates had fallen below the rate of inflation money was effectively free to borrow. Cheap money proved to be very addictive. Property prices went through the roof, the house was reborn as your personal ATM to fund consumption, and economic growth resumed it’s ‘inevitable’ upwards trend.

This process was mirrored across the world, for example house prices in England.

So as ‘free’ money flowed into the economy and asset prices became vastly overinflated what was the Fereral Reserve doing? It’s strategy was simple – start obsfucating how much money was being created.

The US stopped publishing figures for it’s M3 money supply in March 2006. The definition of M3 is as follows:

M2 =easily spendable cash reserves. There is a good explanation on Wikipedia here.

M3 Equals M2 + large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets.

Not publishing figures meant that even less information was available to investors now buying assets denominated in dollars. The Federal Reserve, it is important to note is not part of the Federal Goverment, but is owned by a consortium of private banks in America.

Money = Debt / Debt = Money

It is important to realise what exactly the relationship between debt and money are, and how each are created in a modern fractional reserve banking system. The creation of debt, and of money, are one and the same.

To understand this, we need to realise that a very low percentage of transactions are carried out for cash. We have cheques, electronic funds transfers, debit cards etc. Banks are well aware of this, and have taken advantage of this to leverage their deposits into large loans.

For example: A customer deposits €10 in a bank. The bank knows that on average, only €1 of this will be withdrawn in physical cash. This means that they can loan out €9. This €9 is loaned out to another customer, who lodges it in his own bank account. However, the bank knows that again only 10% of the money will be asked for in cash. So they can loan €8.10 to another customer, and the process keeps repeating. A small initial deposit can grow into a vast increase in money supply. Debt (money) can be simply created witha fractional reserve system.

This is the essential point to remember about the global banking system: if everyone goes to the banks today and asks for all their deposits in cash, that money simply does not exist. It is, quite simply, the biggest pyramid scheme in the history of mankind.

This issue has been raised in American Court – you can read about it here. During the case, the manager of a bank admitted the following:

[The president of the First National Bank of Montgomery] admitted that all of the money or credit which was used as a consideration [for the mortgage loan given to the defendant] was created upon their books, that this was standard banking practice exercised by their bank in combination with the Federal Reserve Bank of Minneaopolis, another private bank, further that he knew of no United States statute or law that gave the Plaintiff [bank] the authority to do this.

And it is important to remember, the Federal Reserve in the US is not part of the Federal Government – it is owned by a private consortium of banks. The Chairman of the Federal Reserve is appointed by the President, but he is simply given a shortlist of candidates by the banks and chooses from this list. Placing this power in private hands has had catastrophic consquences.

Interestingly, there were some who saw all this coming.

“I sincerely believe… that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale.” –Thomas Jefferson to John Taylor, 1816. ME 15:23

The levees break…..

or, what goes up must come down…

When the economic crisis/collapse accelerated in September 2008 with the collapse of Lehman Brothers, the response from the American Treasury Department and Federal Reserve was swift. Interest rates were lowered again and massive amounts of money were flooded into the system. Banks had their assets and liabilities guaranteed, and whether it was physical money being printed, or ‘quantitative easing‘, the effect was the same. Massive amounts of risk were transferred from the private to public sectors. Governments are also running massive current account deficits caused by both stimulus spending (which consisted almost entirely of bailouts for banks…) and a massive downturn in tax revenues due to the collapse in the real economy. They quickly ran up massive debts.

But as we’ve seen, any money printed allows the banks to create yet more debt. Any money borrowed by a government is more debt. We are mortgaging our future to finance a financially and ecologically unsustainable present.

Debt is money, and money is debt. It really is quite simple: you can’t solve a debt crisis with more debt.

Back to the good news, the ‘green shoots’

San Francisco - 80% of College Graduates Moving Back Home

UK – Government Debt May Be 300% Higher Than Reported

US – Foreclosures – Worst 3 Months Of All Time

UK – Longest Recession Ever, Economy Still Declining

Former Assistant Treasury Secretary Paul Craig Roberts – The US Is A Failed State

I will leave you with a quote from Paul Craig Roberts about the US, which I happen to think describes what is happening around the world particularly well:

“The US has every characteristic of a failed state.The US government’s current operating budget is dependent on foreign financing and money creation. Too politically weak to be able to advance its interests through diplomacy, the US relies on terrorism and military aggression. Costs are out of control, and priorities are skewed in the interest of rich organized interest groups at the expense of the vast majority of citizens.”