(This is Part 3 of a series. Go back to Part 2.)
It's no secret that the United States is faced with huge and mounting mountains of debt, both publicly and privately. From being the world's largest creditor only a few decades ago, the U.S. is now the largest debtor in the history of the world. Its deficits, both foreign and domestic, are in the range of a half trillion dollars annually.
However, the U.S. is not alone in this situation; this debt mountain is true of most every country in the world right now. It's just that the U.S. is by far the largest example.
So what we have is a phenomenon of a gigantic Global Credit Bubble, with resultant daughter bubbles in stocks, bonds and real estate. And, of course, with unprecedented levels of debt among consumers, businesses and all levels of government.
Now bubbles are normally associated with baths, and the financial world is no exception. There is no example in history that I know of where a credit or asset bubble did not ultimately mean-revert, that is, collapse back at least to the point where it began. This is the bath that follows the bubble.
But governments don't like this unpleasant truth. So when a bubble starts to collapse their normal reaction is to flood the system with liquidity, creating fountains of fresh new money and credit. So fortified, the bubble doesn't collapse but instead lurches forward to an even larger size.
However, nature will not be denied, even (or especially) in the financial world. So the larger a bubble becomes, the larger its eventual collapse. It's actually better to let a bubble collapse sooner rather than later, because then the collapse is much smaller and less traumatizing.
But as mentioned, governments don't like this idea, since it's politically unpopular to "take" a recession—let alone a depression. So they almost always take another course.
Historically, governments faced with prodigious amounts of debt and deficit have had essentially three choices:
1) They can raise taxes. This is almost always politically unpopular. And the current American administration is dead set against this option.
2) They can cut spending. Also politically unpopular. The current U.S. federal budget contains large increases for the military and homeland security and leaves the costs of the Iraq and Afghanistan wars off-budget.
Interest on the federal debt consumes $250 billion this year—and this is during a time of historically low interest rates. What happens when interest rates rise?
Fully 80% of the U.S. federal budget is "off-limits"—
not available for cutting. That leaves 20% of the budget, which is being cut 1%. Suffice it to say that no serious spending reductions are occurring or will occur.
3) The third option, which virtually all governments with huge debts choose eventually, is to inflate their way out of the situation by creating more and more money and credit.
These days that is usually done by something known as "monetizing the debt."
In essence, this means that the Federal Reserve buys U.S. bonds, notes and bills from the U.S. Treasury and pays for them with the stroke of an electronic pen. It simply records a reserve credit on its books and poof!—money is created out of thin air.
Other countries are doing exactly the same thing. This is possible because all currencies now are fiat currencies, that is, currencies backed by nothing and created by fiat.
It wasn't always this way. During the 19th century and early 20th most countries were on the gold standard, which meant that the currency was freely convertible into gold. Because the supply of gold is limited by nature, a currency backed by gold cannot be increased at will.
However, by 1934 most countries of the world had left the gold standard. Too inconvenient in terms of creating money. And in 1934 the United States left it as well, at least domestically. No longer was the dollar convertible into gold within its borders.
But internationally the U.S. dollar was still redeemable for gold by foreign central banks. This security is why the dollar became the standard reserve currency in the central banks of the world.
Then in 1971 President Nixon "shut the gold window"
and the U.S. dollar also became a fiat currency. Since that time the dollar has lost 80% of its value, because so many of them are being created.
And every country is doing it. The statistics on rises in global liquidity (money and credit creation) have become truly staggering. Global liquidity increased by 20% in both 2003 and 2004.
And rampant liquidity creation is the real underlying cause of inflation of prices, which we're beginning to see now—though there is far worse to come. But there is a time lag, which disguises what is actually happening.
Indeed, when inflation finally appears the public tends to blame it on scapegoats such as greedy merchants, greedy unions, etc. The real cause, rampant money and credit creation by the government, almost always escapes the public's attention.
People then turn to the government for a "solution", when ironically, it is the government itself, behind the scenes, which is creating the problem.
(This is the end of Part 3. Go to Part 4.)
—jim sloman, 03.05.05
|
