By Karl Denninger
I wrote about this in "Monetary Flat Spin" but it keeps coming up in the forum, and reading back through that posting it appears a bit, uh, "obtuse."
So here's a second attempt - one that hopefully is simple enough that everyone in America, including Congress and Obama, can understand.
We must start with what "money" in the context of "Federal Reserve Notes" (whether electronic in your bank account, bills in your wallet, or "new bank reserves" created by Bernanke) actually are.
You think of a "dollar" as money. But what, in a modern monetary system, is money?
It is in fact always debt.
The "usual means" by which "money" is created is that the Treasury prints up some T-bills and gives them to The Fed, which in turn gives Treasury dollars. Treasury then spends those dollars into the economy, increasing the monetary supply. In theory the economy grows, Treasury collects taxes, and (in theory) can pay off those Treasuries, which would destroy the money (and debt) thus created.
But recently Bernanke has been buying up things like mortgages and simply creating new bank reserves (dollars.) The important thing here is that he is doing this with existing debt (mortgages) for which someone already paid - this is said to be "printing", or issuing dollars not backed by a debt instrument. This is alleged to be why what he's doing "can work" to unclog markets and help our economy and gives rise to the "Helicopter" analogy.
Bluntly: He's wrong and if he, and Congress (along with Obama) do not cut this crap out they will destroy our economy.
Why does a dollar have value? A dollar in fact has value only because people believe in the Federal Government's ability to continue to exist. Should The US Government cease to exist for any reason, dollars would instantaneously be severely devalued, and might become worthless.
How does the Government continue to exist? The Government continues to exist because it is able to levy taxes on your productive output. That is, your income and other activity generates a tax liability to the government, which you are then obligated to pay. This "siphoning off" of production is how the government funds itself.
So therefore, a dollar is in fact an indefinite-maturity bond carrying zero interest written upon the future production of the citizens of The United States.
That is, money is always, irrespective of how it comes into being, debt!
To be plain, a dollar is a debt instrument written against you just as certainly as is your mortgage or car loan. Yes, it is by a more circuitous route, but in truth it is exactly the same thing when one strips away all the BS and games.
To the extent that these dollars that are created are exactly matched against actual production (defined as growing something, mining something or manufacturing something - that is, an action that can ultimately be traced in it's energy to the sun, the only source of a "freebie" in our solar system) there is no inflationary or deflationary impact, as the debt in the system is exactly matched against the output in the system. The monetary system is in balance.
This is true for all modern (non-hard-asset backed) monetary systems.
We are in this mess because we created too much debt for the balance of the system. That is, too many people bought houses with too much leverage (that is, too much debt was being taken on compared to actual production represented by salary), companies were purchased with too much leverage (the "M&A" game) and so on. Mortgage-backed securities, credit-default swaps, all of these are forms of debt and their issuance was deregulated to the point that people's "animal spirits" drove prices much higher, as leverage was employed at higher and higher levels.
It is obvious that you can't do this forever; ultimately someone asks to be paid with actual production (instead of more shuffling of paper) and oops - there's not enough production to pay with!
You get BOOM!
That, by the way, is exactly what happened in 2000.
But our wonderful government who either didn't understand the essence of what money is and that it is debt, or was intentionally misled by a few who did, decided to paper over what should have been a really serious recession (9/11 didn't help!) and deceive the public.
Did it work?
To those who argue yes - we went from 260% of GDP (that is, ~$26 trillion dollars) to over 360% of GDP (that is, ~$50 trillion dollars) in outstanding debt, public and private from 2000 to 2007.
At the same time, the aggregate GDP went from $10 trillion to $14 trillion; if that increase was linear then it was ~2 trillion annually (on average) over seven years, or $14 trillion in total (that's a mathematical simplification; don't shoot me for it!)
But we added $24 trillion in debt.
So in fact Greenspan's policies and those of the rest of our government did not produce growth in GDP. It simply "pulled forward" demand from future years and left us with a bigger problem - we actually suffered a net contraction, on aggregate, of $10 trillion, or about 3/4 of a trillion dollars annually in real aggregate GDP (represented by production and current-day consumption, not pulled-forward demand financed by new debt.)
This is why if you are in the middle class you have been squeezed relentlessly over the last seven years. Your wages have actually gone DOWN in terms of purchasing power because of the debt taken on - it has pulled forward demand but that "growth" is in fact illusory as the debt remains but the consumption has taken place and is finished, leaving you only with principal and interest payments on that debt that depress your current purchasing power.
So the 00-03 "stimulus", including the tax cuts, interest rate cuts and even direct checks did not actually stimulate the economy; it simply hid the contraction in a way that tried to make you feel good and allow you to keep your standard of living intact for a short while by borrowing from the future! That, of course, made the inevitable contraction worse because we now must default all the new debt used to paper over the previous mess along with the all the old!
What our government has proposed and done now is several times worse. We took seven years to go from $5.7 trillion dollars in public debt to $9.2 trillion - a gain of 61% - but in the last year alone we have gone from $9.2 to $10.7 - a gain of 16%! Annualized over seven years this would be a two hundred and ninety percent increase, and Treasury isn't counting the seven trillion in forward commitments that aren't reflected in that number, nor are they counting the five trillion more represented by Fannie and Freddie.
Has that 16% increase - a $1.5 trillion addition to the debt - made the economic situation worse or better over the last 12 months? The stock market - has it gone up or down? Employment - has it increased or decreased? Has your credit card and home equity line become more or less accessible to you? Has your house value risen or fallen?
Please note - the growth in debt necessary in the attempt to prevent the liquidation (that's a fancy word for "Bankruptcy") of the bankers who overextended credit (and the consumers who took it on) is in fact an exponential function. That means that it compounds upon itself, as we have now seen - we have now spent or committed more new debt in the last twelve months (nearly $7 trillion dollars!) on The Federal Government's part alone than we committed over the entire previous seven years.
You cannot cut taxes to get out of this, you cannot deficit spend to get out of this, nor can you raise taxes to get out of this box. The only way to get out of the box is to pay down or default the debt, both of which are by definition destructive to GDP and the economy, until the level of debt in the system as a whole is reduced to a sustainable level.
What government has done to date and proposes to do cannot work any more than it did the last time. We know this for a fact because it was done just seven years ago and failed to produce lasting prosperity.
These actions failed (and will again) not because they were "not big enough" or "ill timed" or any such claptrap - they failed because it is mathematically impossible for them to succeed.
The problem is that there is too much debt in the system; adding more debt to the system simply makes the problem worse at an exponentially-increasing rate.
It is impossible to fix a problem that is best explained as "too much" of something by adding more of that same thing.
This is true whether the "too much" is a drunk who wants a bottle of whiskey, a crackhead who wants another hit, or a heroin addict who begs for another shot.
You can't solve any of their problems with more of what ails them any more than you can solve a debt problem with yet more debt.
Our government's actions to date and Obama's plans will fail; any "benefit" that appears will be fleeting and simply compound the necessary pain that we must take in order to clear the economy.
Irrespective of whether the bankers, homeowners and government like it or not, the insolvent will be forced into the open and bankrupted. We are only arguing over whether the government does the right thing and forces it to happen now or whether it occurs as part and parcel of a full-on economic (and possibly government, if they don't quit taking on debt themselves!) collapse.
Those are the only two choices.
There is no other solution that is mathematically possible, no matter what you are told - or by whom.
I strongly suggest that you prepare for our government to do the wrong thing, and to lie to you for as long as it is able.
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