(This is Part 3 of a series. Go back to Part 2.)
It's no secret that the United States is faced with growing mountains of debt, both publicly and privately. Consumer, business and government debt are all at nosebleed levels —and increasing.
From being the world's largest creditor just 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 United States is by far the largest example.
So what we have now is The Great Global Credit Bubble, with resultant daughter bubbles in stocks, bonds and real estate. Part and parcel of this is unprecedented levels of debt among consumers, businesses and government.
Bubbles are 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.
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 just "take" a recession—let alone a depression. So governments with fiat currencies almost always take another course.
A government faced with prodigious amounts of debt has essentially three choices:
1) It can raise taxes. But this is almost always politically unpopular, since it involves pain. And the current American administration is implacably and ideologically opposed to this option. It’s just not going to happen.
2) It 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.
Moreover, interest on the federal debt consumes $250 billion a year—and this is during a time of historically low interest rates. What happens when interest rates rise?
Then there’s the various social net programs such as Social Security and Medicare. 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 every government with overwhelming debts has chosen eventually, is to inflate their way out of the situation by creating more
and more money and credit.
These days that is usually accomplished 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. Pretty neat, huh?
The U.S. isn’t alone in this. Other countries are doing exactly the same thing. This process is possible because all currencies now are fiat currencies—currencies backed
by nothing except confidence and created by fiat.
It wasn't always this way. During the 19th century most countries were on the gold standard, which meant that their currencies were 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 dollar was still redeemable for gold by foreign central banks. This security of value is a main reason why the U.S. dollar became the standard reserve currency in the central banks of the world.
However in 1971 President Nixon "shut the gold window" internationally as well, so that the United States dollar finally became a full fiat currency. Since that time the dollar has lost 80% of its value, because so many dollars 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.
Rampant liquidity creation is the real underlying cause
of price inflation, which we're beginning to see now—though there is far worse to come. However, there is a time lag between money inflation and price inflation, which disguises what is actually happening.
So when price inflation finally does appear the public and the media invariably blame it on scapegoats such as greedy merchants, greedy unions, raw materials prices and so forth. The real cause, rampant money and credit creation by the government, almost always escapes the public's attention.
The public then turns to the government and demands a "solution", when ironically, it is the government itself, behind the scenes, which is creating the problem.
The government then usually obliges by instituting price controls, which do nothing to stop the underlying inflation (because tremendous quantities of money are still being created) but do invariably create shortages by removing incentives for production.
When the price controls are lifted, as inevitably they must be, price inflation then "catches up" with a vengeance and becomes even more virulent.
(This is the end of Part 3. Go to Part 4.)
—jim sloman, 03.05.05
|
