So I was on a thought experiment the other day while reading Pragcap.com, and I came to a somewhat startling conclusion: that dollar creation results in debt-serfdom. I don’t tend to be one of those whacko-conspiracy nuts, but I do read a lot of material considered controversial for the kernals of truth it might contain. Face it, behind every conspiracy theory is at least some fact that bears exploring – regardless of where the source of the fact might have come from and regardless of whether there is any conspiracy at all.
Fiat Money and the Death of the Gold Standard 1971
One of the more pivotal moments in modern history was the decision by the US (under the leadership of then President Richard Nixon) to discontinue the use of the gold standard relative to US currency. Instead of being able to redeem dollar bills for gold at the US mint, people could now only redeem goods and services (and pay taxes) in exchange for dollars. It would still be possible to buy and own gold, but doing so would require purchase on the open market rather than a fixed exchange with the Treasury.
What were the implications of this? It meant that the money supply of the country would no longer be constrained by an arbitrary amount of metal in a vault owned by the US Government. Instead, the money supply would be controlled by the willingness of either the government or the private sector to borrow money – ie go into debt. How is it that money and debt are tied together? It has everything to do with making a system of payments work. Each time you or I make a transaction in the economy, money changes hands and (eventually) moves from one bank to another, or to cash in your wallet. But where does the money come from in the first place? Neither you nor I own a printing press capable of creating a dollar bill (at least I hope you don’t for your sake!), but yet dollars exist everywhere. Where did they come from?
The answer should be obvious – ultimately all dollars in existance come from the Federal Reserve acting at the behest of the US Treasury (and further at the behest of Congress). Treasury (in effect) writes checks (or sends electronic deposits) to vendors and or citizens every day and ultimately the Fed changes the account levels of the associated banks where the checks (or electronic transfers) were deposited / directed. Dollars created in this manner are paid for via IOUs (debt) of the US Government – bonds, bills, and notes issued by the US Treasury and sold to the public by means of auction. Each dollar of debt carries an interest burden however – ie promises to make future payments of (more) dollars in the future. Hopefully you can see the circular logic starting to form here… more dollars owed in the future means… more debt creation. Technicians would note that it is the deposits which create the money supply, not the debt – however without generation of some debt somewhere there is no currency in circulation.
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So Do the Treasury and Federal Reserve Control all Dollars / Money Creation?
This is a very important point: the answer is a resounding NO. In a more “normal” economic state (ie, not today) deposits based on newly created debt (public or private) expand the number of dollars in existence. Unfortunately credit / debt creation has essentially stopped on the private side, and been absorbed via Quantitative Easing on the public side (see this from Zerohedge for a great piece on the divergence from a normally functioning banking system post Lehman). This is what is making the world so unbalanced today. Especially attractive financing rates are available in vast amounts to a select few while everyone else fears taking on more debt – unless they intend not to repay it!
Meanwhile for the rest of us not cashing in on the zero-interest bounty of available financing our days consist of (if we’re lucky) going to work, collecting a paycheck that hopefully keeps us afloat, and wondering when (if ever) our balance sheets will be above water. Many Americans have run the numbers and decided the answer to when they’ll ever be above water is never! Essentially anyone who financed a house with more than 75% loan to value in the last decade has a low probability of breaking the surface financially. So whether we like it or not, we’re committed to servitude of a wholly different master than our ancestors, and one that is far less personal: debt.
Fiat Money and the Wealth and Income Gap
This is the legacy of fiat money. It is only created by debt or (at present) the whim of the Federal Reserve and the depository institutions who (can) demand infinite supply of currency and pay next to nothing for it. Meanwhile asset prices continue to climb, non-substitutable consumption item prices rise (until demand dives short term), and those who have access to the money spigot see their vast incomes and wealth expand over the rest of us with ever wider gaps. Each dollar created is encumbered by interest – which is multiple factors higher for folks like you and me (figure 40x higher than the Fed Funds rate so we’ve essentially stopped borrowing) than Wall Street (which borrows presently at around 0.09% if the Fed tables are to be believed). With rate differentials like that is it any wonder the wealth and income gaps continue to expand parabolically?
Bitcoin and the Race to Leave the Government Sponsored Fiat System
We recently (like many) have become intrigued by the cryptocurrency craze lead (at present) by bitcoin. We explored earlier the notion and value of earning bitcoins in an earlier piece. There is something of a mania surrounding the notion of a stateless monetary system. Wealthy individuals have seen the writing on the wall in countries such as Cyprus and the rest of the Eurozone where the bail-in (confiscation of unsecured deposits) has become a reality. How better then to protect precious wealth deposits than by owning a convertible (yet stateless) electronic currency which is deposited (and held) on an electronic hard drive you own and control (and presumably no one else has access to). Dollars, Euros, and Chinese yuan disappear from unsecured regulated bank accounts remain physically (albeit electronically) as cash in hand. Of course the bitcoin exchange where these state-backed currencies have moved now have the Yuan, Euros, etc. (and hence have the challenge of avoiding deposit theft by governments).
Suffice to say that the bitcoin story is still to be written, and it is a fascinating one at that. How does that relate to Debt Serfdom of fiat state-backed currency? Consider that electronic currency is not created the same way as dollars or Yen. There are a fixed number of bitcoins (or other similar cryptocurrencies) and they are mined / created into existence as transactions are processed (solved / encrypted / stored). The point is there is no debt service on bitcoins, only a miniscule transaction fee (orders of magnitude smaller than international wire fees) for cross border payments. This is a vast improvement on the existing highway robbery that goes on when sending cross-border payments today. The end result is that by transacting in bitcoin, the average joe or small business owner like you and I save a high percentage of money in transaction fees – and if you know your investing math at all – you know it’s the percentage based money game that kills the little guy and further enriches those already who are wealthy.
The point being is that the more people that wake up to the realization that each dollar currently in existence represents an even greater future liability, the more people will try to find ways to opt out of the system (dollars, Euros, Yuan, Yen, you name it) and transact and invest in payments systems that don’t create future encumberance.