Our Debt Money System Explained
Posted August 23rd, 2007 by manystrom
by Michael Nystrom
August 23, 2007
Regular reader Rich writes:
I've read in a couple of places on the internet that if all outstanding debt was repaid, there would be no 'money' left in our debt money system. Is this true? If so, what happens to the interest that the bankers earn?
This is unbelievable to most people, but it is absolutely true. If all outstanding debts were repaid under our current debt-based monetary system, there would be no money left in existence. I stress our current debt-based monetary system because other types of monetary systems are possible. Most people never stop to think about this (usually because they're too worried about paying their bills), but our current system (which is controlled by the Federal Reserve) is just one of many possible money systems. There are in fact a variety of different kinds of monetary systems. The following illustration of a simple commodity-based monetary system will help us understand just exactly what money is.
I. The Commodity-based Money System of Prison X
It is well known that in prison, cigarettes often take on the role of what we traditionally think of as 'money.' In fact, given the circumstances, they are money. Inmates may not be free, but free markets can spontaneously arise in prison.
Imagine that the warden gives all prisoners at Prison X a ration of one pack of cigarettes per week. Many prisoners don't smoke, but the cigarettes they receive are not worthless. This is because many more prisoners do smoke, and they value those excess cigarettes. This gives the cigarettes an intrinsic value. Even if you don't smoke, you will still value the cigarette because it has value to someone else. Furthermore, cigarettes are small, uniform, easily stored, hidden and traded. In the absence of what we traditionally think of as 'money,' they become money. As a commodity in constant demand, they make a perfect medium of exchange. In fact, this is one part of the definition of money: Money is a medium of exchange.
Money is also a unit of measure: If you find yourself in Prison X, you might discover that a large metal file (a vital tool in your plan to escape) will cost you 500 cigarettes. At a pack a week, it will take you 25 weeks to save enough to get your file (assuming you don't smoke). Whatever you're looking to obtain in Prison X, you'll find that its value can be measured - i.e. priced - in cigarettes.
It is also worthwhile to note that different kinds and brands of cigarettes would undoubtedly have different values, because they taste different (as a smoker for over 10 years, I know this to be true!). American Spirits might be worth the most, and menthols might be worth more or less, depending on the preference of the smoking population. The raspy generic brands would no doubt be worth the least. An internal exchange rate between the different kinds of cigarettes would spontaneously arise, based on their intrinsic qualities (taste), and how those qualities were subjectively valued. This exchange rate would be equivalent to the different denominations of bills that we have in our system.
Finally - money is a store of value. As long as the number of cigarettes in circulation remains stable, the monetary value of each cigarette should remain stable over time. If the ration of cigarettes were to suddenly jump - say the warden increased rations from a pack a week to two packs a week - each cigarette would now be worth less. This is inflation. Simply put, inflation means more money in the system. As a result of this sudden inflation, that big metal file you were saving up for would now cost twice as much. As should be clear from this example, higher prices are not the cause of inflation they are the result.
Conversely, if prisoners suddenly began smoking cigarettes faster than they were being issued, the cigarettes that remained in circulation would increase in value. This is the definition of deflation. Deflation just means less money in the system.
II. Our Debt Based Monetary System
The purpose of the brief illustration above is to outline the essence of money. Some key points are: 1) Nearly anything can serve money, as long as it has intrinsic value and is therefore in demand by some members of the population. 2) Money doesn't have to be issued by the government - it will arise spontaneously as it is needed. 3) Sound money must serve three basic functions. It must be: a unit of measurement (serve a pricing function), a medium of exchange, and a reliable store of value. With this in mind, we can now take a fresh look at our Federal Reserve controlled debt-based monetary system.
Under our debt based monetary system, money is backed not by a commodity that is in demand like cigarettes or gold, but by debt. Ultimately it is the debt of the United States government that backs our currency. Since we are the government in the United States, or at least that is how it is supposed to work, it is our own debts that back our currency. Our paper currency has no intrinsic value other than that we need it to pay back our own debts.
Confused? This is how it works:
If you look at the green bills in your wallet, you'll notice two things. First, across the top, they all say 'Federal Reserve Note.' These are FRNs. Also, somewhere on the right side - depending on the bill - it says in small print, 'This note is legal tender for all debts, public and private.' In other words, this is the government's way of telling you that FRNs must be respected as a medium of exchange. If someone says he wants his debt to be paid off in FRNs, you must comply. This is the law, by fiat decree. This is what is meant by 'fiat' money.
This is extremely important, as we shall see later.
Where do FRNs Come From?
FRNs are created in an exceedingly simple transaction between the US Treasury and the Federal Reserve. The US Treasury (the government) creates a bond, and the Federal Reserve (a private bank) creates some money. The Fed loans the Treasury the money it just created and the Treasury gives the Fed the T-bond it just created as collateral. The bond is an IOU that serves as backing for the money that was just created.
I know. It sounds circular, confusing and insane, because it is. It is meant to be so that you don't understand it. It was this understanding that led Henry Ford to proclaim, 'It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.' The great economist John Kenneth Galbraith put is even more succinctly: 'The process by which banks create money is so simple that the mind is repelled.'
The Similarities and Differences
At this point, lets take a moment to examine the similarities and differences between our debt money and the prison's commodity-based cigarette money.
First, the prison warden did not stamp 'this cigarette is legal tender for all prison debts' on each cigarette. He didn't have to, because under the circumstances, cigarettes had intrinsic value. People could smoke them. There is always demand. The reason the fiat declaration is stamped on each FRN is because these pieces of paper are otherwise worthless. Who would want this crap? They were created from thin air, there is an unlimited supply, and they don't hold their value.
But given that this is true, why do people continue to use them? Why doesn't another monetary system spontaneously arise, the way it did in Prison X?
Here is the rub: Since there is no intrinsic demand for worthless FRNs, the government - specifically the Treasury, which is on the hook to pay the interest back to the Fed on those bonds - created one. You have to pay your taxes in FRNs. Nothing else is accepted.
The income tax is the mechanism by which the government creates artificial demand for an otherwise worthless currency. Is it a coincidence that the income tax and the Federal Reserve were both created in the same year - 1913? Emphatically I say, it is not. As Ron Paul says, '1913 was a bad year. We need to repeal that entire year!' (see the video)
Some Answers
So, to get back to the questions that began this piece: In Prison X, if all the cigarettes were smoked, there would be no more cigarette money. Likewise, if all debts were repaid under our current monetary system - all the credit card debt, auto loans, and mortgages, all the way up to the national debt - there would be no more debt money, either. I have explained how the Fed and Treasury create money from thin air. It is by this same process that money is created by the banking system throughout the economy. Your debt is the bank's asset. The interest you pay them is their income stream. The more assets it has, the more loans it can make. More loans means and increase in the money supply, and therefore inflation.
Our Competitive World
As for the interest that the bankers earn...first, the bankers don't 'earn' it. They collect it. There is a huge difference. 'Earning' refers to obtaining money by doing useful work. The banks, like the Fed, create money from thin air and 'loan' it to you. However, in creating the principal amount to loan you (from thin air), they never create the interest that you are to repay. So where are you supposed to get this extra interest amount to pay them back?
The answer is that you have to get it from someone else's principal that they borrowed. This is why it is such a competitive, dog-eat-dog world out there - not because of human nature. It is because the monetary system requires it of us. Everyone is scratching and clawing at one another, collectively trying to get their hands on more money than exists in the system. The system itself ensures that a certain number of people will go broke and lose everything. They have to so that others can repay their loans to the bankers.
The final thought that I would like to leave you with is this: If we change our money system, we will change the world. Are you ready for a revolution?
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Thank You.
Michael,
You have come a long way! Thank you for persevering in mastering this subject, you are doing your fellow man a great favor by propagating your knowledge.
-Sapiens
Sapiens
Thank you. It is nice to hear from you again.
Michael
Income Tax and Debt Based Monetary System
Since all Federal Reserve Notes are created out of thin air, there absolutely no need for an income tax or any federal tax for that matter.
What the income tax does do is to hide monetary inflation. In the absence of an income tax, monetary inflation would be a lot more self-evident, and the system would fall apart a lot faster.
David
Income Tax
Having an income tax creates an impression of budgetary constraint when in practice it has little or no effect. More importantly, it is the maintenance of having the authority to tax, which implies a right of claim on peoples' wealth by the governing authority. This is an important part of social conditioning that would prove to be important in leaner years to come.
Albert
Watch this video and fasten your seatbelt for a bumpy ride!
The political aspect of the political economy! What is in store for us if we don't act.
http://video.google.com/videoplay?docid=8545414779301935419&hl=en
Almost right
Excellent piece Michael, except for the last two sentences:
> The system itself ensures that a certain number of people
> will go broke and lose everything. They have to so that
> others can repay their loans to the bankers.
This it almost utter nonsence. Not complete nonsense, since of course some people do go broke and that is, to some degree, inherent in the system. But the idea that people need to go broke IN ORDER TO enable others to repay their loans is way off the mark. If this were true, consider the gargantuous numbers of people that would have been needed to have gone broke already to enable the credit bubble we're currently experiencing... Have you seen a couple of hundred million of those people lately? Of course not. What keeps the system afloat, indeed what drives it, it the constant creation of NEW debt (i.e. the sum of all debts needs to grow and not just to replace existing debts). All interest is payed out of the creation of new principal amounts (and not somehow out of repossed existing principals of defaulting borrowers, as your article implies). Interest is essentially a promise to pay FUTURE money, so in order for all pledges of interest to be sustainable, the total amount of money needs to grow perpetually. That in itself isn't necessarily a bad thing. After all, the total wealth of the world also keeps increasing - as the result of productive work we all add to the economy. The trouble only arises when total the amount of money grows faster than our productivy. And that is exactly what has been happening for some two decades now.
[My above comments are in debt(!) to Adrian Douglas' excellent and same-topic article Money & Democracy - Opus #2 at LeMetropoleCafe.com, 19 August 2007, subscription required]
DGW
Thank you
I appreciate your forbearance in not calling it complete nonsense. As to your question about where all the bankrupt people are:
We did not see hundreds of millions, but before the Bankruptcy "Reform" Act of 2005, we did see several million Americans each year declaring bankruptcy. They have now, in effect, made it illegal to declare bankruptcy. As a result, those figures have gone down - not because the economy is better, but because it is illegal.
However, these people are now suffering silently. Unable to pay off what they owe, they have taken on more debt to service their debt and continue with day to day operations. Just like the US Federal government. But that bill is coming due.
You actually provide your own answer later:
One of the points I tried to make is that with commodity money (like the cigarettes) it actually takes some work - some effort - some labor, materials & capital to create the money. This puts a limit on how much can be created. Nowadays with the FED, it is just a computer entry. There is no effort, labor, materials, capital -- NOTHING - required to create a few hundred billion. This being the case, the money is essentially worthless, so people treat it that way: People borrow excessively,
This is the way it always happens. As you say in the end, money supply has been growing faster than is sustainable for the past 20 years. We're in for a reckoning, and will no doubt see tens of millions of Americans go broke over the next few years, and I dare say, hundreds of millions of people experience the same fate worldwide.
Michael
Still
Point taken on my somewhat irrational exuberance of calling it nonsense...
On the merit of it, however, I think you just conceded that indeed there aren't those hundreds of millions of people who have defaulted, hence neither the 'missing' interest nor the credit bubble were created by people going bankrupt. As I mentioned in my opening remark: yours is an excellent article - and I agree with all of it, except for that single point at the end (actually I think it must have been a slip of, eh, your keyboard) that wherever that 'missing' interest would ultimately come from and be payed from, would somehow be linked to people defaulting. That really is not true - which is probably the more appropriate wording. The 'missing' interest is also simply created out of nothing, in exactly the same way as the principal was, but just +later+.
DGW
Well
To speak of "hundreds of millions" of people going bankrupt is excessive. There are only 300 million people in the nation, after all! However, there have been tens of millions of people that were forced to declare bankruptcy since 1980. That figure was about 6.5 million people between 2000 - 2005, and that was when we had an expanding economy. Look at this graph of the growing numbers of people that declared bankruptcy since 1980:
http://www.bankruptcyaction.com/USBankStats2006.png
The funny thing is that it rises just like the stock market. If we were truly experiencing prosperity from those years, one would expect bankruptcy filings to fall, or at least level off. They did not, until bankruptcy was made illegal.
I agree with you that the missing interest is created out of thin air, later. However, I stand by the point that I make at the end. The missing interest is created later, but only as someone else's principal. There simply isn't enough money to pay off all the debts in existence.
Does that make sense? The debts are created, but not the interest. Bankruptcies are kept to a minimum as long as the system keeps growing, but they are part of the system. That is why it makes no sense to try to outlaw it. It is akin to trying to outlaw nighttime.
If tens of millions of people are forced into bankruptcy while the economy boomed over the last 25 years -- and therefore the money supply was growing -- the number of bankruptcies will be orders of magnitude higher once the growth reverses.
Michael
Pfff...! (Sorry, I'm afraid I overdid this one...)
Michael,
Not that it really matters, but I think we tend to mix up several points - which makes it look as if we are fundamentally disagreeing on what-have-you-and-his-grandmother, while I think we actually agree on everything except for one basic thing. (And of course I believe most of the fog is caused by you misreading what I wrote, but I'm somewhat afraid you might be thinking the opposite - in which case you are clearly wrong, of course :)
Let's see if I can clarify things, just for the fun of it:
1. I did not say at all there were hundreds of millions of people bankrupt. In fact, in my first comment I tried to point out there are NOT such numbers of people anywhere: my question "where they were" was rhetorical - but my answer was not rhetorical at all, or at least not meant as such: they just aren't there. (And btw: I was thinking worldwide numbers, since the credit bubble is also worldwide.)
2. I completely agree with you that there are only (..!) some tens of millions of people who went bankrupt in the US since 1980 (either officially declared or merely de facto). Those people are indeed suffering terribly - and in my opinion not solely due to their own fault.
3. You stand by your point that "the missing interest is created later, but only as someone else's principal". I think that means I will have to try to convince you to come off of two errors. Your other point-in-error still being that "some people will have to go broke so that others can repay their loans".
Let me first try to take down your first point that I quoted:
3A - someone else's principal
Well, someone else's may usually be the case. But I think your missing the essential point about that newly created principal out of which the missing interest will have to be payed. Essential -in the sense of mandatory for the continuation of the system- is not who's principal it is; essential is ONLY that the missing interest will come from a future principal.
Think about it: the system would work just as well if everybody would endlessly renew one's own debt - provided each new loan would be larger than the previous one, which is exactly the same requirement that applies to the current overall debt-system. Sure, such an 'individualized' debt-system wouldn't last as long as our 'macrolevel' debt-system. But that would not be inherent in the system but rather due to the fact that a single individal's financial state will be much easier and earlier recognized as being bankrupt than a nation's or the world's. (Plus of course people do die, which would put an external blowup date in place - but suppose for the sake of argument we were all living forever.) Ergo: the who's-factor, if tweaked between self and others, does NOT carry the capacity to make the system crash immediately, i.e. it's an optional factor for the system's continuation.
On the other hand: the system would not work at all if the total interest over the full duration of the loan would have to be paid immediately after taking out the loan. THEN there would truly be not enough money (the total interest on say a mortgage would surpass the principal of the loan) and so the system would implode on the spot. Ergo: the future-factor, if tweaked between immediately and after X year, DOES carry the capacity to make the system crash immediately, i.e. it's a mandatory factor for the system's continuation.
Now, does that succeed in convincing you that your point 3A is invalid?
Next, let me shoot at your other point:
3B - some people will have to go broke so that others can repay their loans
If you do agree with me that 3A is invalid, then the fallacy of 3B more or less follows automatically. Once you accept the missing interest can come out of anyone's principal as long as it comes out of a future principal, there's no need anymore in the theory for a mechanism to 'free up' other people's principals in order for that money to serve as the source for the missing interest. (Since any future money can then serve as such.) Which means that Ockham's Razor (in this case; 'a theory shall not contain unneccesary rules') has just automatically killed your point 3B.
http://en.wikipedia.org/wiki/Ockhams_razor
If you don't agree with me on 3A, then let me try this to take down 3B:
Suppose your point 3B would be true - inherent in the system would indeed be that some people have to go broke in order to free up their principals to serve as interest for others. That would imply there would also have to be some mechanism which would roughly 'balance' the amount of bankrupted principals against the amount of required missing interest. What would that mechanism be??
I'd say it cannot be the mere fact that there's a need for whatever particular amount of missing interest - Nodody will voluntarily go bankrupt because his neighbour needs to pay his interest. It cannot be the other way around either - The amount of missing interest is determined by previously set loan conditions and not by whatever amount of principals went broke the other day. Those two conclusions also rule out mere randomness as explanation: we just established there's no direct causal relationship between the two amounts and in that case randomness will never produce two independent phenomena becoming balanced.
So if you want to maintain there's any connection whatsoever between the bankrupcies and the missing interest, then the burden is on you to explain how it works, other than just stating that is does.
However, if I maintain, as I do, there is no connection between the two, I don't need to explain any mechanism at all!
Even worse for you, I can very well defend a debt system in which no-one ever goes bankrupt (well, ok, there's allways a minor category bankrupcies due to 'acts-of-god') but which functions exactly like ours in all other respects. To achieve that, it would -for instance- be enough to basically outlaw risk, i.e. forbid lending to anyone but rocksolid debtors. That would of course slow the whole society down, but it would virtually eliminate bankruptcies, while still maintaining the debt-driven structure (in which the missing interest would, of course, be taken out of just any future principal). Such a system would be viable, but incompatible with your point 3B, since it states such a system cannot exist. Hence your point proofs to be invalid.
Ok, I guess that if all this doesn't convince you, we're doomed as a team. Sorry for going into so much detail, but it works like a tunnel: once I'm on my way I just keep on digging until I'm out, rather than turn around and take a plane or boat to the other side...
Cheers!
DGW
Splitting hairs
DGW - Thank you for the long explanation. I find it fascinating. However, I think at this point we are splitting hairs, as you alluded to near the beginning (or did I misinterpret that, too? ;-)
Just to clarify:
3A - if the interest comes from *future* principal, doesn't that have to be *someone's* principal? After all, a loan cannot be made to no one. I'd say it is a draw on this point.
3B - okay - I will concede this on technicality, but not in practice. It is possible that everyone could get an equal distribution of the new principal being created, so they could all continue to make their payments, and no one goes bankrupt. However, then it would be incumbent upon you to explain how that principal is equally distributed throughout society, so there is no bankruptcy. It is actually easy for me to explain why some people must go bankrupt in our current system, and that is just the nature of capitalism. I am not criticizing capitalism (at least not in this post), just pointing a fundamental fact: In capitalism, the more money you have the more money you can make. The less money you have, the harder it is to get ahead without a lucky break of some kind. And by lucky break I simply mean this: Two people can be equally skilled, work equally hard and be equally intelligent. One ends up with a job at Microsoft in 1986, and one ends up with a job at another software company that goes broke. The first one is a multi-millionaire simply because he was in the right place at the right time. The second simply works a wage for the rest of his life.
So in answer to your 2B challenge, part of it is simply random distribution: Under the current system, some will become wealthy, most will get by, and some will go bankrupt.
I don't think that we are doomed as a team, though I think the following point bould be the deal breaker.
Point 3 - the current system is unsustainable. Are you in agreement with me on that one?
Yes, but . . .
That is an excellent point that there actually needs to be creation of new debt to continue this cycle. But I don't see how everything should just keep running fine. Maybe the economy keeps running, but as people become more and more in debt, more problems are created - especially on a personal level. I don't know anyone that would say, "Hey, I'm a slave to my own spending but it's all worth it to keep the economy healthy!" Are we not a society of individuals? Should perpetual debt be required for society to function? Are we cogs in the wheel or human beings? It is true that as long as there is new debt, the system will work, but if "real" money is used, charging interest is a near impossibility and an immorality in many religions. Also, if the total wealth (or debt) of the world keeps increasing, what is that going to do to our natural resources?
This is a good book on the topic:
MONEY, BONA FIDE OR NON-BONA FIDE
by Dr. Edward E Popp.
-DL
Well, also almost
Eh, I for one wouldn't mind saying that I'm a slave to my own spending. I am allways really willing to spend more!
Or that's perhaps a bit over the top, but it shows more clearly where the problem lies: it's not with the borrowers - they will allways be happy to take out new loans. The key lies with the lenders: at some point they will call it quits - but not until they have stretched their lending willingness to the utter limit, since they -i.e. banks- are in competition with each other to make profits, and making profits to them means: making new loans! Yes, it's perverse and yes, they are merely deceiving themselves with their 'relaxed' loan conditions, but we have just seen it happening these past few years and it will happen again in ingeniously contrived other ways in the coming years (few left, I'd say). In a debt-driven system there is no alternative but to incur more debt. Until it finally blows up, to which we seem to have gotten as-yet-unclear close last week.
On your other point: no, charging interest isn't impossible in 'real' money systems. There too, the amount of real money can, will and should grow over the years. For instance, every year more gold is mined and added to the total available stock. In fact, if a supermegabonanza goldmine is found, even a gold money system will experience strong inflation! However, the point -or rather the essence- of real money systems is that the increase of the amount of money is perpetually and automatically limited by the scarceness of the money itself.
DGW
Touche
I see your point. Materialistic people have a hard time resisting the urge to buy!!! The lenders want to lend and the borrowers want to borrow.
I think the average American is feeling a good amount of "buyer's remorse." When I say slave to spending, I really mean slave to the bills that come in every month. Almost every house on my street has been trying to sell in the last year with no luck. My landlord wants to sell me her house for what is left on the mortgage. I don't even have to talk about credit card stats, etc. I think that most consumers are just trying to keep their heads above water. Even people I know with six-figure salaries are struggling to keep the status quo. Now, we do have an unprecedented standard of living but are we truly happier? To each his own, but the studies would say not. There is an old proverb that says something like, peace with one hand full is better than turmoil with both hands full. More is not always better. I suppose that we are learning our lesson the hard way.
Also, that is an excellent point that the amount of gold is also increasing. But it can't inflate the way fiat money is now, can it? I'm literally asking because I don't know. So where would inflation be left? In a simple model, wouldn't the annual rate of inflation be limited to the amount of new gold minus the increase of economic production due to population increases, etc.? (Or something like that.) I would think it would kind of balance itself out. I don't know if the gold standard is the best monetary policy, but it seems to make a lot more sense than centralized banking.
DL
In the balance
> But it can't inflate the way fiat money is now, can it?
Well, theoretically it could, but practically you would really have to keep-on-discovering an awful lot of supermagabonanza goldmines. Unlikely, to put it mildly. But then again: it would render gold as scarce as, well, dollars...
> In a simple model, wouldn't the annual rate of inflation
> be limited to the amount of new gold minus the increase
> of economic production due to population increases, etc.?
> (Or something like that.)
Absolutely, although i would define the latter as simply the increase in productivity, which basically takes all the 'like that'-factors into account.
So: inflation = increase in gold - increase in productivity.
My hunch would be that it would currently be more difficult to find enough gold to catch up with productiviy than the other way around. Gold is really scarce
(http://silverstockreport.com/2007/tiny_size_of_gold_market.html)
and we can't overnight increase it to the 2-2,5% average productivity gains...
Nevertheless, we could and thus would probably find more gold if we really needed to, so I agree with you that both would likely balance out over time.
DGW
more complex than that
The problem with this debate is that the initial posting about all the money in circulation having to be borrowed into existance is too simplistic. Whilst I agree with some of the principles, by boiling it down to the fact that capital is loaned and the interest must be found from someone else's capital that was also borrowed, in order to repay the loan is plain ridiculous. The problem is that wealth is not created by the central banks alone, as in the initial posting. Also wealth is not finite as pointed out by DGW.
A similar debate I answered previously stated that the banks sucked all the wealth out of the world because they got back more money than they lent and that the pool of wealth was therefore ever decreasing. This is rubbish. Firstly money circulates. Sure the banks get interest but they pay interest to depositors, dividends to shareholders, wages to staff etc etc, and so some of that money recirculates. Also the majority of people don't depend on loans to live they earn salaries, and that money circulates when spent.
Also a point no one has mentioned is that people and companies die. When they die their assets are redistributed as taxes and inheritances to others. So in the context of this discussion I suppose you would say that
their Capital was used to pay the interest on other peoples loans.
The key point I wish to make is that Central Banks do not create wealth, they monitise wealth. Someone made the point about real wealth requiring effort, and real wealth is created by mining, construction, manufacturing etc. When the Saudis pump oil they are creating wealth for their nation. That wealth is monitised by other people buying it and giving it a value.
currency is the process by which wealth is monitised.
The gold standard made for tight fiscal restraint in a way we could never adapt to today. The gold standard was invented by no less a personage than Sir Issac Newton (more famous for his theories on gravity.) Under that system all paper money was exchangable upon demand for gold at a fixed rate which seldom changed. This meant that a country's supply of money literally depended upon how much gold was held in the vaults of it's central bank. If a country ran a trade deficit it was effectively exporting it's gold and it's money supply abroad, which would lead to a credit crunch and recession very quickly. No printing presses then. Such a system would lead to austerity on a scale which most people cannot imagine today. The big problem today is that there seems to be no limits to how much currency can be printed.
Here is the real problem in a nutshell: The US government undertaxes and overspends and therefore runs up a huge deficit year on year. No problem, it just gets the fed to print up a load of currency and swaps it for some IOUs (Bonds) which it won't be able to repay anyway but hey who's counting. That cash plugs the deficit and off we go to the next budget wheyhey! All those borrowed dollars find their way through government over spending into the pockets of Companies and undertaxed citizens and they just love spending all that surplus cash and salary and whatever they can borrow on imported chinese goods. Next, that cash sure does pile up in beijing, and elsewhere. The problem? What to do with it all? Well firstly because of the increase in these country's foreign currency reserves it means that they can now issue more currency themselves, which inflates global money supply even more and causes inflation in those countries. But what to do with the dollars? Hey thats awfully nice of that ex us president fellow to visit our country. Oh yes of course we would love to buy some IOUs from the FED (who originally got them from the Government in the first place.) (US Accent) "Phew we sure got that load of cash out of the system before it caused us some inflationary problems." Next the chinese fancy some real estate. How about some equities, buy up some US companies, US mines etc. All this money flowing into the stock market and property market sure does make prices rise. Hey rising prices means a good investment lets borrow to the limit to speculate. Rising prices means everyone has more equity to borrow against to buy lots more foreign manufactured goods Yippee! More demand for borrowing means the fed increases the money supply which means more dollars for beijing, which means inflation of global money supply, which means.............................................
PJR
One other question . . .
If all debts were paid, how could there be no money? What about all of the cash? And what is the ratio of printed money to total "money" including loans? Thanks.
-DL
Notes and coins
DL - you bring up an excellent point that I failed to mention in the article - namely all the bills and coins in circulation. I failed to mention them because they make up such a tiny fraction of all of the money outstanding. However, if all debt were to be repaid, these coins and notes would presumably have to be returned to the Federal Reserve to repay the debt owed them.
They are the font of all liquidity in our society.
Regarding your second question, here are some definitions from Wikipedia:
M0: The total of all physical currency, plus accounts at the central bank that can be exchanged for physical currency.
M1: M0 - those portions of M0 held as reserves or vault cash + the amount in demand accounts ("checking" or "current" accounts).
M2: M1 + most savings accounts, money market accounts, and small denomination time deposits (certificates of deposit of under $100,000).
M3: M2 + all other CDs, deposits of eurodollars and repurchase agreements.
If you follow this link, you'll see a nice graph that shows the proportions of all these measurements in relation to one another. M0 is so small that it doesn't even show up on the graph!
http://en.wikipedia.org/wiki/Money_supply#United_States
- Michael A Nystrom (manystrom)
My bank deposit.
I have say, $100,000 in a bank as savings.
I don't carry any debt. I own my assets debt free.
What would happen to my savings?
Would they somehow disappear if all debts were repaid?
Or would my money still be in the system?
Thanks
Steve
Question
So . . . is the money just typed into a computer? Or is it printed?
-DL
Just bits
For the most part, it is all bits & bytes nowadays.
Funny money alternatives: a rat tail tale
During the time I was in Viet Nam during the American War, there was a lot of enthusiasm on the part of academics for contracts teaching the Vietnamese how to live. One such contract involved a Midwestern university agriculture department. Upon arriving in the Mekong Delta they first did a study that counted all the various live forms in a selected rice paddy. They were thrilled to find a lot of rats. Extermination of the rats, they reasoned, would increase yealds greatly and help save Viet Nam from Communism. They decided to offer a bounty of twenty piaster for every rat tail turned in. This was a hugely popular program. Shortly these rat tails became currency. You could pay for most anything with them and they circulated freely. Buses had bundles of rat tails hanging there by the driver. Unfortunately, they made the mistake of reevaluating the rice paddies the following year and found just as many rats as the previous year. It was just that a lot of them did not have tails. If they had not been the total idiots that they had to be to be involved in the Viet Nam debacle, they would have known that rice paddy rats, as opposed to city rats, were prized as a food delicacy at harvest time when these rats became so fat and slow that even small children could catch them. Roasted over a smoky fire they are really quite good, regardless of a missing tail.
a rat tail tale
This is a superb analogy, lessons worth learning. So, going back to reality, when the world central banks, incl fed, injected billions of fiat money (dollars, euro, etc) into the system, to clean up the subprime crises, would this be a kind of the rat tails outcome? I really hate to imagine the outcome of this storylines.....Those of us who follows whats is going on on this issue is so little....Most of the populations are total ignorance...Kind of "The Matrix". My last request to all of you in this SUPERB discussion...is...what is our course of actions...What should I do..I can't just keep watching being an observer...
Eagle0.
Great story
That is a great story.