Why the Bankers Are Trapped

Few seem to grasp that we have arrived at an historic turning point: a nation and a world confronted with profound structural change.  The hope to recover the past will not be helpful. We must pick ourselves up, hit the reset button, and respond to a rapidly changing reality.

I cannot accept assumptions about political policies or intentions without asking practical questions. I want to understand a complex transition that is having an immense impact on us all.

There are many aspects to the changes we are experiencing, some with immediate implications, others longer-term.  To seek solutions we must recognize structural change.

I have given attention to the continuing financial crisis in recent posts because I believe that is where the closest danger lies.

So, I begin here with a financial question with structural implications: Why is the Federal Reserve unable to return the economy to some semblance of fairness and order? Or, to put it another way: Why have our financial liabilities not been corrected since the crisis in 2008?

The short answer is that they want to believe they are dealing with a cyclical crisis rather than a structural crisis.  Again, why?

Because the truth represents an unbearable existential threat.

Here we find a powerful example of the problems presented by structural change.

The economy has shifted into a long-term deflationary trend, which presents banks and governments with an impossible situation.

I refer you again to James Rickards’ best-selling book, “The Death of Money: The Coming Collapse of the International Monetary System”.  A monetary economist and former banker, Rickards has been advising the Pentagon and CIA concerning financial warfare and terrorism.

Using simple math, Rickards’ explains how, “in effect, the impact of declining prices [deflation] more than offsets declining nominal growth [GDP] and therefore produces real growth.”

Most of us would think this is a good thing.

He writes: “Despite possible real growth, the U.S. Treasury and the Federal Reserve fear deflation more than any other economic outcome. Deflation means a persistent decline in price levels for goods and services. Lower prices allow for a higher living standard even when wages are constant, because consumer goods cost less. This would seem to be a desirable outcome, based on advances in technology and productivity that result in certain products dropping in price over time….”

Why is the Federal Reserve so fearful of deflation that it resorts to extreme measures to oppose it? Rickards gives us four reasons.

First, deflation has a severe impact on government debt: “U.S. debt is at a point where no feasible combination of real growth and taxes will finance repayment…. But if the Fed can cause inflation…, the debt will be manageable because it will be repaid in less valuable nominal dollars. In deflation, the opposite occurs, and the real value of the debt increases….”

Second, deflation impacts the debt-to-GDP ratio, causing foreign creditors to lose confidence in the dollar and demand higher interest rates. This is an urgent problem because the debt is continually increasing. Budget deficits require new financing, and interest payments are already being financed with new debt.

Third, deflation is a major problem for banks. As Rickards’ puts it, “deflation increases money’s real value and therefore increases the real value of lenders’ claims on debtors…. But as deflation progresses, the real weight of the debt becomes too great, and debtor defaults surge.”

The fourth problem with deflation is about taxes. When a worker receives a raise, the additional income is subject to taxes. But, if the cost of living drops by the same amount, the worker in effect receives the same raise and the government cannot tax it.

“In summary,” writes Rickards, “the Federal Reserve prefers inflation because it erases government debt, reduces the debt-to-GDP ratio, props up banks, and can be taxed.”

“Deflation may help consumers and workers,” he says, “but it hurts the Treasury and the banks…. The consequence of these deflationary dynamics is that the government must have inflation, and the Fed must cause it. The dynamics amount to a historic collision between the natural forces of deflation and the government’s need for inflation.”

Such are the challenges of structural change.

Tom

Note to readers: You can support this blog and the book project by suggesting that your friends and associates take a look.  And, watch for the next post on or about November 3.

When Money Dies

Americans experienced a major financial crisis in 2007-8.  Some would argue that it began far earlier, and clearly it is ongoing today.  We may be more aware of this crisis than others because it confronts us daily.  In preparing for what is to come, we would do well to listen to those who saw it coming and who continue to warn of its’ inevitable consequences.

Beyond all the foolishness and greed running rampant in the financial world, one great threat hangs over our future more than any other: The greatest expansion of debt the world has ever seen.  This is in large part due to non-stop deficit spending by governments.  Corporate borrowing has recently exploded similarly.

However, we need to understand that this has been made possible by a credit-based monetary system.  Easy access to credit, which is money created out of thin air, has led to the belief that credit is wealth.  This fantasy has infected society from top to bottom.

When a credit-based monetary system functions the way central bankers wish, the money supply should expand only slightly faster than economic growth.  Enough additional money must be created to cover the growing cost of servicing the expanding debt.

But, since 2008 the central bank (which we call the Federal Reserve) has expanded the monetary base almost four-fold while the economy has grown very little.

They call this “money”, but it is mostly debt.

The arrangement is extremely profitable for banks and the wealthy elite.  It allows for all kinds of mischievousness.  And, it depends on inflation, which is a long-term problem for the rest of us.  If it sounds to you like a Ponzi scheme, you are not alone.

In managing the money supply to avoid the growing threat of another banking crisis, the Federal Reserve has facilitated repetitive cycles of booms and busts, each more severe than the last.  This has perpetuated major social and economic distortions and dislocations.  It has stifled any possibility of restoring normalcy to the lives of ordinary Americans.

The economy has not been permitted to return to a normal and balanced condition.  Nothing has been fixed.  Extremely low interest rates have encouraged rapid growth of corporate and government debt, so the situation has been steadily worsening.

At such extreme levels, there are only two paths forward: default or devaluation.

Debt must default and be liquidated before economic productivity can recover.  But, the immediate pain of bankruptcy is too great for the bankers and policy-makers to bear. Consequently, they are struggling to gradually devalue the currency in relation to the cost of goods and services.

The government hopes desperately to meet the nominal cost of Social Security, Medicare, and other long-term budgetary obligations without defaulting.  This means the value of the dollar must fall significantly.

By altering the method of measuring price inflation, rising prices have been masked and social security payments held to a minimum.  Only those who live in the real world know the truth.

The devaluation of currencies is taking place around the world as budget deficits grow. Central banks attempt to minimize the interest costs of huge debt loads, while at the same time trying to avoid the failure of banking institutions that depend on interest rates.

Monetary economist and former banker, James Rickards, has written that “financial crises have supplanted kinetic warfare at the center of complex system dynamics. Financial crises in 1998 and 2008… are warnings – tremors ahead of a misfortune beyond imagining.” (“The Road to Ruin”, 2016, p.204)

The consequences of all this are profound and unpredictable.  We face a deepening crisis that will exaggerate all others, severely limiting the capacity of businesses to grow and create jobs, undermining our standard of living, and making it impossible to address pressing needs without worsening monetary instability.

The dependability of a productive, self-sustaining economy has been sacrificed to the tyranny of selfish interests.

Strangely, however, the wealthy elite have behaved like parasites that destroy their host.  They have wrecked the healthy economy upon which their profits depend.  And they have exposed themselves, as well as the rest of us, to the evaporating value of credit-based money.

Tom

Please look for the next post on or about October 6.  We will take a look at the problem of complexity, and the realities of financial markets and other systems that have vastly exceeded the human capacity to fully understand or control.

Civil Society and American History

We find ourselves now at a turning point, confronted by the consequences of the past and the anger and confusion of the present.  Yet, this is an opportunity – a time that calls for clarity of purpose, and for coming to terms with the history that brought us here.

It is not political change that I speak of, but a far more profound transition.  We are confronted with questions of principle, of values, of the meaning of moral responsibility.

Such concerns often come into sharper focus amidst disruption and conflict.

Answers do not come easily, but history leaves silent lessons etched in our national experience.

In my view, we have lost a sense of purpose, and thus the conceptual framework upon which rational judgment depends.  This has made us vulnerable both to our own vices and to the predatory interests and manipulative power of institutions that know our weaknesses.

We have indulged ourselves increasingly over time in our attraction to meaningless spectacle and thoughtless voyeurism – a wasteland of sex, violence, greed and materialism.

In his recent book, The Great Degeneration, economic historian Niall Ferguson provides a persuasive view of what has come to pass in the United States.  He considers four areas in which the degeneration of values and loss of social stability have had devastating consequences.

In my own words these are: 1) the loss of personal and social responsibility, 2) the disintegration of the market economy, 3) the role of the rule of law, and 4) the essential qualities of civil society.

Dr. Ferguson reminds us of past strengths, and in particular the vigorous civil and cultural life of nineteenth century America.

“I want to ask,” he writes, “how far it is possible for a truly free nation to flourish in the absence of the kind of vibrant civil society we used to take for granted?  I want to suggest that the opposite of civil society is uncivil society, where even the problem of anti-social behavior becomes a problem for the state.”

He goes on to cite Alexis de Tocqueville from his famous commentary, Democracy in America, published in 1840:

“America is, among the countries of the world, the one where they have taken most advantage of association and where they have applied that powerful mode of action to a greater diversity of objects.

“Independent of the permanent associations created by law under the names of townships, cities and counties, there is a multitude of others that owe their birth and development only to the individual will.

“The inhabitant of the United States learns from birth that he must rely on himself to struggle against the evils and obstacles of life; he has only a defiant and restive regard for social authority and he appeals to its authority only when he cannot do without it….

“In the United States, they associate for the goals of public security, of commerce and industry, of morality and religion.  There is nothing the human will despairs of attaining by the free action of the collective power of individuals.”

Dr. Ferguson writes that “Tocqueville saw America’s political associations as an indispensable counterweight to the tyranny of the majority in modern democracy.  But it was the non-political associations that really fascinated him.”

Consider Tocqueville’s description:

Americans of all ages, all conditions, all minds constantly unite.  Not only do they have commercial and industrial associations in which all take part, but they also have a thousand other kinds: religious, moral, grave, futile, very general and very particular, immense and very small; Americans use associations to give fêtes, to found seminaries, to build inns, to raise churches, to distribute books…. Finally, if it is a question of bringing to light a truth or developing a sentiment with the support of great example, they associate.”

What happened?  Once upon a time Americans succeeded in overcoming the constraints to freedom through their own initiative and a sense of community.

Today inaction has replaced action.  A once vibrant culture of engagement has been replaced by a self-centered attitude and the isolating influences of technology, mass media, and corporate society.

Will we recreate what we once did so well?  Shall we rebuild the American spirit and character to meet the challenges ahead?

Tom

A Note to Readers: A project description and a draft introduction to the book can be found on this page.  Please look for the next post on or about March 10.