The empirical and arithmetical reality that cannot be refuted…

In the past 50 years, we have done this:

Graph of Real Gross Domestic Product, 1 Decimal

The above is indeed impressive.

The question of course is: how was this achieved.

If the above was achieved purely by ingenuity, productivity and efficiency, one would rightly have to be in awe at the prodigious nature of human kind if not at the effectiveness of the modern political construct.

But… but… as platitudes go, saying “the devil is in the detail” really does no justice to the followoing:

Graph of Federal Government Debt: Total Public Debt

That is not a “detail” by any stretch of the imagination.

Anyone that has ever had to handle a budget even only at domestic level knows that if you are borrowing progressively more than what you are earning in wages or sales, you are soon doomed.

However, there is a current of thought which, incidentally, happens to be the prevailing current of thought, that says, alternatively, that debts do not matter and/or that sovereigns that can print their own currency cannot become insolvent.

To which I can only say… well, I could say, but instead I’ll say that they should go back to reading some history.

Other than to say that if indeed debts do not matter, than why all the hand wringing and the emergency meetings taking place throughout the world to solve what would ostensibly be a run of the mill socio/economic crisis? Get printing, distribute cash liberally to corporations and individuals alike and presto, we should be off on our merry way once again. Better still. Lets put every single man, woman and child on a government salary and corporations will once again be making profits hand over fist in no time. Everybody wins.

If indeed debts do not matter and as monetarily independent entity a sovereign cannot become insolvent than why not put every single person on government payroll? Poverty would be a thing of the past and a new age of prosperity would immediately be ushered.

The reality of course is that debts do matter and sovereigns do go bust regardless of whether they have control of their currency or not. 7000 years of human history cannot be refuted. Either that, or we have discovered perpetual motion.

The reason is strikingly simple. It comes down to the monetary system and the socio/economic decisions that are dictated upon society by the choice of one system over another.

This is how it works.

Money can only be the result of economic activity. Money cannot be the instigator of economic activity.

(We are talking here of fiat money which is the standard today in the West rather than value based money)

Money cannot exist unless you have something to exchange. At the most basic level, you must have an idea or an item that others deem useful in order for there to be a need to create a medium of exchange (and in order to obviate to the problem created by barter known as the “Coincidence of Wants“) to trade your item for something else that you deem necessary or useful to your well being.

Therefore, in a fiat money system, economic activity is necessarily the precursor to fiat money. The construct cannot operate the other way around. If it does operate the other way around, then the demise of the system is inevitably dialed-in.

You may ask why.

Simply because unless the amount of fiat money created is fixed, then each additional unit of currency circulated erodes the purchasing power of all units created prior.

If you can get your head around that, then you will also understand that if politicians impose a fiat monetary system unilaterally and arbitrarily AND they reserve the right to manage it by decree behind closed doors, the inescapable conclusion is that the expansion of the monetary base and credit is guaranteed.

Graph of St. Louis Adjusted Monetary Base

Unless you have never looked into these matters with a modicum of interest, then you will also be unaware that our monetary system is predicated on something called “Fractional Reserve Banking” (FRB for short).

FRB is at once a genial concept but it is also the proverbial sword of Damocles that will kill you unless you are able to maintain all previous trends as evidenced by the charts posted above.

The reason is, once again, rather simple.

In order to expand debt in this manner:

Graph of Federal Government Debt: Total Public Debt

You have to hope that GDP expands at a faster clip than the debt you are assuming:

FRED Graph
But that is glaringly not the case. Can anyone refute the above?
The alternative is to progressively lower interest rates.
Graph of Interest Rates, Government Securities, Government Bonds for United States
Yup! There it is. Since 1980 interest rates have been manipulated inexorably lower thus enabling the monetary base and debt to be expanded as it has been.
But even a casual observer can, or should, wonder the following:
If in order to do this:
Graph of Real Gross Domestic Product, 1 Decimal
We had to do this:
Graph of Federal Government Debt: Total Public Debt
and the above was enabled by this:
Graph of Interest Rates, Government Securities, Government Bonds for United States
What happens when we reach the zero bound of interest rates?
And that is, or should be, a damn good question. What happens then?
If you are any of the pundits and economists that think that money and credit can be expanded at infinitum, obviously the answer is: “nothing happens”.
If you are a sensible person with a modicum of sense of observation, then you must be wondering what the options may be once interest rates reach the zero bound. Because, 40 years of economic history tells you that’s where we are going.
If anyone thought the late 80s were happy times when interest rates were declining, they are probably suffering from a severe case of dissonance at present. How good are times today compared to then when interest rates are at all time lows?
And if low interest rates = good times, then, by extension, negative interest rates should = a whale of time.
… hmmm…
This is where the evil of Fiat Money and, in particular, the evil of Fractional Reserve Banking which gives you Debt Based Fiat Money becomes clear.
Once we are at the zero bound of interest rates, our leaders could enact all sorts of creative tricks to keep the monetary system they have imposed going. But anything that will be done will transfer whatever vestiges of wealth may be left in the hands of society to a restricted band of people residing in the rarified air of the banking world.
You may ask why.
I will surprise you by saying that the reason is deceptively simple.
Once at the zero bound, whatever assets or, Ye Gods, cash left in the hands of economic entities (including you and me) will forcibly be removed. For example: negative interest rates mean that you will pay the bank to keep your money in a savings account. Which in turn will make you dispose of whatever savings you may have. By disposing of your savings you will
inherently need to make use of debt which you may think comes at zero cost. But that is not so.
As you help expand total credit outstanding, you are also helping to debase the currency. Thus you are making it increasingly difficult to service your debt till you no longer can service your debt.
The point at which most economic entities can no longer service their debt, either of two things happen. Either the debt is written off or it must be paid off. There is no third way.
Since this latest crisis has erupted, it has become abundantly clear that the banks are not in the mood to write anything off. Even when, as was the case in the latest settlement relative to the foreclosure scandal, government pretends that debt is being written off, in truth, whatever write off the banks agree to will be largely made up by incentives and compensation extracted from public funds – i.e. you and me.
And there you have it. As interest rates progress towards zero gradually, society is being robbed and made thoroughly dependent on government hand outs which, incidentally, are also being curtailed.
Why are government hand outs being curtailed?
The short answer is illustrated by the chart of GDP to Debt. Hand outs are being curtailed because capital is no longer being generated. All we are left with is debt. The reason this happened is simply because monetary policy is in the hands of a very restricted band of entities that reside outside of society and who benefit from the immense privilege of being able to create something that has no cost but that society must, under penalty of incarceration, make use of and must pay interest on. And in order to entice you to make use of their product, these entities tell you that no longer is work necessary to create capital. Today, unlike times past, it is banks that create capital for you so you don’t need to bust a gut. Just borrow it and borrow oodles of it to live your life and have access to all the things you never thought you could have access to. And since you don’t need to bust a gut to create capital, then you needn’t save anything either because your friendly local politicians will promise you all sorts of social safety nets that will keep you in the style of life you feel is appropriate even when you retire.
In other words. With this monetary system, the banks are selling you all the rope you need in order to hang yourself. And, granted, the time line is rather long. But hang yourself you will and you have.
And just to be clear. Doing anymore of this:
Graph of Federal Government Debt: Total Public Debt
can only result in a conflict of global proportions.
You may ask why.
That’ll have to be for another time.
And that is the evil of choosing one monetary system over any other that might be viable.

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11 Responses to “The empirical and arithmetical reality that cannot be refuted…”

  1. Patrick Donnelly Says:

    Oceania destroyed by EastAsia and the ocean. Irony?

  2. Patrick Donnelly Says:

    Read about the tsunami weapon…… There are several entries, some quite old. JoeVialls and I corresponded. America may reap what it has sown…..

  3. Patrick Donnelly Says:

  4. Stanley Says:

    Nice summary post of the current mess. I can’t remember how I discovered your blog but I have read it off and on since ~2008. Maybe it was a link from cynicuseconomicus if that rings a bell?
    Anyway thought I’d drop a line to say thanks for the posts.

    Do you read FOFOA at all? Similar attitude of this is the end of the $IMF system – but he hasn’t mentioned anything about war. I do see where you are coming from though. America can’t default on the Chinese without some repercussion.

    • guidoamm Says:

      Thank you Stanley. I am flattered you should still be reading this rag. FOFOA is indeed reported on my blogroll but as far as Cynicuseconomicus is concerned, I am not familiar with that blog. Will definitely take a look.
      Thank you

      • Stanley Says:

        fyi – I haven’t read Cynicus Economicus for some time – he wrote a goodbye post in 2010 so i deleted it from bookmarks (but having just checked he seems to have restarted posting).
        I just remember i was reading it about the same time as I was reading your stuff. its not a particular recommendation to read.

        hmm. well I have no idea how i found your blog then – it has been lost in the mists of time 🙂

  5. CK Watt Says:

    “Of course, Japan had the advantage of a huge pool of savings that had been built up since the end of WWII. ”

    I don’t fully understand why an economy based on ‘saving’ is any more sound than one run on debt. Just because a person did something mildly useful, or had a lucky break like buying a house at the ‘bottom of the market’ (God how I hate such bullsh*t jargon), a number of decades previously, I don’t see why the rest of the world should now honour the ‘contract’ – at least if circumstances are no longer benign, and it is obvious that the new, productive intake are not going to have the same opportunity to ‘game the system’ and retire in luxury at 55, themselves.

    And if a country’s circumstances have changed, or its productive assets have withered, or it is now demographically a land of pensioners, or it has lost against the competition, what use are its ‘savings’ to the rest of the world?

    • guidoamm Says:

      Hello ck,

      The reason has to do with the diminishing marginal utility of debt. Economists will tell you it has to do with the real pool of funding. In either case, as evidenced by the ratio chart of gdp to debt, in a debt based fiat monetary system the productive capacity of society is gradually transferred to financial entities.

      The reason that is so, is obvious. There is one entity that despite having no cost of production creates something that the entirety of society must make use of and pay for it. The asymmetry of this relationship guarantees that as the entity gradualy debases the purchasing value of its product which costs nothing to them, it commands ever greater quantities of assets that society must dispose of or pledge in order to repay the debt to the entity.

    • guidoamm Says:

      And by the way. in terms of having the “rest of the world” honoring contracts, a debt driven economy mortgages everyone’s future irrespective of whether they make use of debt or not. The mere fact that monetary policy should be opaque, outside the democratic system and debt driven, ensures that the monetary authority will debase the currency thus gradually absorbing the entire productive capacity of society. This is not opinion. It is an arithmetical truism.

      This is not to say that other monetary systems do now have their problems. But in a fiat system based on a fixed amount of money or in a value based monetary system, the systems is not geared towards systematic institutionalized theft.

  6. guidoamm Says:

    I should think it is.

    Of course, Japan had the advantage of a huge pool of savings that had been built up since the end of WWII.

    I don’t know enough about Japan to say whether the authorities thought they could play fast and loose with debt because they were backed up by national savings or whether they were induced to by the USA. After all, Japan is a full member of the Floating Exchange Rate (FER) mechanism thus, like all other Western sovereigns, they are not in charge of their own currencies.

    Western sovereigns may have retained the name of their currencies (Sterling Pound, Yen, Euro whatever) but due to FER, they have all Dollarized their monetary system. This is how the USA were able to overcome the insolvency crisis of the late 60s which, through the abrogation of Bretton Woods, allowed them to export pent up inflation that had been building up since 1913.

  7. Patrick Donnelly Says:

    Is Japan a fit example of this?

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