Credit in excess of available real savings is a fraud… And it produces fraudulent, unsustainable growth.
By Bill Bonner
Many years ago, before the invention of modern money or capitalism, people still had wealth – although limited. And they still had ways of keeping track of it.
The principle of “fair trade” seems to be in our DNA.
If you give something to your neighbor, you don’t expect him to hit you over the head. You expect him to give you something back. And if you give him a whole cow and he gives you half of a rabbit, some instinct tells you it isn’t “fair.”
Small communities could keep track of who owed what to whom. But as civilization evolved, a new kind of money was needed.
In a group of related people in an isolated valley, you could remember that your cousin should give you something roughly equal in value to the wild pig you gave him… and that you should offer your son or daughter to the family from which you had gotten your wife… and so on.
But as the group grew bigger, people needed a way to settle transactions without having to trust the people they were doing business with or remember who owed what to whom.
When Aristotle described “money” he had our modern money in mind – something that is not wealth but acts as a placeholder for wealth. It is information; it tells you how much real wealth you can command.
For the last 5,000 years, the best money has been gold (and to a lesser extent, silver).
Gold is very useful as money. With it, you can do business with complete strangers. It can be used to stand in for almost any amount of wealth. Later, paper money – representing units of gold or silver – made commerce even easier. Without this modern money, an advanced economy wouldn’t be possible.
Real money permits an elaboration of the division of labor, and it provides the whole system with the information it needs to operate. You can’t build an automobile, for example, without an extensive network of inputs – labor, steel, batteries, glass, rubber – from all over the world.
And to put them together in any sensible way, you need to know what each of them costs. Getting your rubber from Malaysia will be a lot more efficient than trying to get it from Finnish suppliers; the price, expressed in units of money, will tell you that immediately.
That’s one reason high levels of inflation bring an economy to a halt. The placeholder loses its place. You just don’t know what anything costs. And from one minute to the next, your place in line changes.
Another important feature of modern money is that transactions are final. I give you a chicken… you give me a small gold coin. Done deal. I don’t have to worry about what happens to you in the future. I’ve got my coin. I have no further claim against you. You’ve got no claim against me.
Yes, there is always a chance that gold might lose value… that it might not hold its place in line very well. It is not a great concern, though.
Prices go up and down. But according to The Golden Constant by Roy William Jastram, the value of gold today is about the same as it was – to the extent these things can be measured accurately – 500 years ago. And I don’t have to worry about a third party because there’s no third party, or counterparty, in the deal.
Gold is a “trustless” money. We don’t have to trust the guy we got it from. And it wasn’t issued or created by some government agency, so we don’t have to trust the feds to maintain its value.
A New Wrinkle
When the U.S. money system was changed in two moves – first when Lyndon Johnson asked Congress in 1968 to repeal the requirement for a gold reserve to back U.S. currency and second when Richard Nixon ended dollar convertibility to gold in 1971 – the U.S. government reintroduced a more primitive form of money. It also introduced a queer wrinkle. (See chart to the right)
With this new money, the U.S. economy – and, by extension, much of the world economy – has been shaped by credit above and beyond available savings. Trillions of dollars’ worth of new hotels, houses, companies, malls, factories, dinners, drugs – and just about everything else – have been financed with this empty credit.
Sooner or later, this debt must be reckoned with – either in deflation… or in inflation. But someone pays. With deflation, the creditor pays when his credit goes bad. With inflation, everyone pays as prices rise.
So far, since 1971, the typical American’s trust in the dollar has been rewarded with a huge loss – about 95% of the dollar’s 1971 value has disappeared. As you would expect. This new money is no longer trustless. Every transaction involves a third party – the custodian of the currency.
Say you build a business and sell it for $1 million. You know that you can exchange that money for a million dollars’ worth of goods and services. The money represents a million dollars’ worth of resources. It came from something with tangible value that was added to the economy.
But if that million dollars was lent into existence by the bank or printed into existence by the central bank, rather than honestly earned and saved, there would be no corresponding addition to the world’s supply of goods and services.
This is just another way to look at the classic quantity theory of money. The supply of goods and services always has to be balanced against the available money. If the amount of available money (or credit) doubles and the supply of goods and services remains unchanged, prices should double, too. Not immediately. But often suddenly.
Gold is distinct in that it cannot be mined easily. The costs of mining tend to increase with GDP and general price levels. So the supply of this type of money tends to rise more or less in line with the supply of goods and services.
Prices remain roughly stable. There is no custodian you have to worry about. It is a trustless currency. You can see above how gold’s dollar price remained fairly stable until the new money system was put into place in 1971.
Since the custodian – the third party – came into the deal, the value of the greenback has fallen from $40 per ounce of gold to $1,200 per ounce.
This is something to worry about, especially as debt levels are reaching new records and the custodian’s commitment to maintain the value of the dollar is demonstrably weak. The feds actually want a weaker dollar and don’t hesitate to say so.
But at least that threat is understood, if not fully appreciated. It is “textbook.” Add to the supply of money and, other things being equal, you will raise prices. You will not increase wealth levels nor GDP; you are only changing the relation of available goods and services to the available money.
Also textbook is this: In an ideal, honest money system, you cannot lend money you don’t have. You couldn’t lend out gold unless you had gold to lend. No lending in excess of available savings = no artificial increase in the money supply = no price inflation (neither in assets nor in consumer goods and services). No artificial boom = no consequent bust.
So, you see, there are obvious benefits to gold if you want to run an honest money system. And while the pre-1971 money system did not meet this ideal, the dramatic unreliability of the post-1971 money is well demonstrated in the chart above. Its dishonesty is illustrated by the amount of credit created since it began – about $59 trillion worth.
This is textbook, too. This is credit in excess of available real savings. It is a fraud, and it produces fraudulent, unsustainable growth.
Why You Will Need Gold
What troubles my sleep is what is not in the textbooks.
Central banks are in the process of making trillions in government debt disappear. Governments borrow money that doesn’t exist. The debt is bought up by the central bank, which creates money for that purpose. The interest paid to the central bank on the debt is paid back to the U.S. Treasury (that’s the deal between the Fed and the U.S. government).
Then, when the bond matures, the “normal” thing would be for the borrower – the U.S. government – to repay the loan. This repayment money would have to come out of the economy and into the Fed’s vaults, thus reducing the amount of money in circulation and triggering an economic slump.
The federal government would have to run a surplus in order to actually be a net payer of debt rather than a net borrower. That’s not going to happen. Instead, it borrows more – to repay the old loan – and adds further fuel to hot asset markets. The debt is never settled… it goes on forever… eternally unpaid, forgotten in the bank’s vaults. It is as if it had disappeared completely.
The debt may disappear. But the credit – the money put into the economy to create the debt – lives on. It spends its days chasing asset prices. Stocks, bonds, real estate, art – all go up. Bread and automobiles remain more or less where they were. Who complains?
Keynesian economists Larry Summers of Harvard and Paul Krugman of Princeton practically drool when they think of it… a paradise where governments can redistribute wealth and undertake huge capital investment projects – roads, hospitals, bridges, harbors – at no cost. The feds get to borrow money, hire people, and spend on pet projects. Then, as if by magic, the debt vanishes. What could be better?
The only thing that might be better would be negative interest rates, in which the government is actually paid to borrow. That is already happening. In Europe, rates have fallen so low that currently, Switzerland can borrow for 10 years at a MINUS 0.2% rate.
This allows the government – and only the government, because it is the only institution that can positively, absolutely guarantee that you will get your money when you are supposed to – to go to heaven without dying.
Further disturbing my sleep has been a report from Japan that the central bank has intervened directly in the stock market. The significance of this is staggering. Because now, the feds have in place the means – apparently – to take control of nearly all our wealth.
The government borrows. The central bank buys its debt. Then it never asks
to be repaid.
The government borrows. The central bank buys its debt. Then it never asks to be repaid.
As Japan shows, it can also buy stocks with the same free money. Bidding against a buyer who gets his money for nothing will be impossible. Gradually, the feds could acquire a controlling interest in almost all the world’s publicly listed companies. And who would object? Stock prices would go through the roof.
As for the nation’s debt – public and private – who minds if the feds buy it… and disappear it? Nobody.
As the price of debt goes up, the financial industry becomes richer. And government – and recipients of government money – are happy, too; the money just keeps flowing in their direction.
Leading economists – notably Ken Rogoff of Harvard and Willem Buiter of Citigroup – also encourage the feds to outlaw cash… giving them a trifecta of financial control. They would have a grip on America’s equity, debt, and bank accounts.
Already, government-sponsored agencies Fannie Mae and Freddie Mac are backing approximately 60% of new U.S. mortgages since 2008. Meaning the feds effectively own $4.8 trillion worth of U.S. housing. The Federal Reserve owns a further $4.5 trillion in debt. And through the student loan program, 40 million young people count on the feds to not foreclose on their lives.
The only significant asset that remains out of their grasp is gold. And they may grab that soon.
It wouldn’t be the first time. In 1933, Franklin Roosevelt’s Executive Order 6102 decreed that all gold should be turned in to the U.S. Treasury at $20 an ounce. Then, after the gold was in his hands, he was able to devalue the U.S. dollar by 75%, pricing gold at $35 an ounce.
Gold was cash back then. And Roosevelt was trying to avoid the very thing we’ve seen happen in Argentina, Cyprus, and, most recently, Greece – a dash for cash.
With free money available to them, the feds today could easily close that door, too – declaring private gold reserves illegal. They might offer to buy it for, say, $1,500 an ounce. Who would object to a 25% premium?
The feds are the lenders and buyers of last resort. As the quality of assets declines, more and more assets – debt and equity – end up in their hands. Gradually, they control more and more of the capital structure – bought with free money under cover of financial necessity. Gradually, there is less and less “free” in free enterprise. And gradually, there is less and less real wealth created.
Gradually, too, the noose tightens around your financial neck, as there are fewer and fewer doors open and fewer places that are safe to keep your wealth.
No one likes to have his wealth “nationalized” at the point of a gun. But everyone likes having it bought from him for more than it is worth.
This is what has happened already in the QE programs in Europe and America… and even more so in Japan’s QE program (with an extra helping of equity buying). How much more of it the world can take is anybody’s guess. No one knows how far this can go. But as far as I know, no economy has ever been successfully Sovietized by printing money and using it to buy assets.
Don’t Sweat the Ice Age
Many economists are foretelling a long period of sluggish growth and low price inflation. The economy may want to go into a deflationary hibernation, they say. But since the feds can print and spend with impunity, it may be a long time coming. Plus, if the government is able to force people into bank accounts – and out of cash – it will be able to tax savings and further stimulate spending.
With these new tools, the feds should be able to prevent a real correction for many years. They suggest that we prepare for an economic “Ice Age,” with little change year to year.
Asset prices won’t fall because the central bank is actively buying bonds, and maybe even stocks, adding new money to the financial economy. Consumer prices won’t rise because there is no real growth in demand. Debt will increase – but it is hidden and forgotten in central-bank vaults.
Maybe so. But I don’t think you should expect it. It could lead to a dangerous complacency. The feds might be able to hold this together and they might not. This
Ice Age formula – dousing a debt-soaked economy with more debt – is not a way to build a healthy economy. It is just a way to shift real resources to the government and its cronies without causing either a frightening spell of inflation or deflation.
It might work for a while. But the falcon of asset prices becomes deaf to the falconer of the real economy. Then, in a kind of financial never-never land, he gets lost completely and flies into a tree. Asset prices fall to the ground. Investors panic. Lenders call their loans.
Art investors rush to auction off their tableaux. Lines form at ATMs.
I am not going to speculate on how or when this occurs.
“If you’re in a theater and one person walks calmly to an exit, it doesn’t attract much notice,” said Vern Gowdie, an Australian colleague. “Two… three… probably not much reaction either. But if you have three people suddenly run for an exit, you’ll have a panic.”