The cause of the distortions in our modern economy is a misunderstanding of basic economic principles combined with the corrupt self-interest of politicians, central bankers, and other leaders in power who have unleashed a tsunami of unrealistic promises and unnatural credit that stormed through the decades like a runaway force erecting our social structures at a pace and in a form that is destined to deflate because the ideas at the rotten core of it all disregard the natural laws and limitations of sound economics. The two fundamental concepts most distorted by self-interested human interference are sound money and free markets, so I'd like to express these concepts in a clear, concise way to illuminate the flaws in the thinking that currently dominates the people in power.
What Is Money?
For the longest time I couldn't figure out how seemingly intelligent people could say such bizarre things like: deficits don't matter; or we owe the debt to ourselves; or the problem with the world is there isn't enough debt; or...let's not even bring up the trillion dollar coin. Paul Krugman, the Grand Puba of the Keynesian Alchemists, has immense economic knowledge, but all of it is built upon a flawed understanding of money.
I've come to realize there are two reasons people afflicted with Keynesian tendencies go astray. The first is a left brain/right brain issue. The left brain deals with math, logic, language, abstract concepts, and operates in a theoretical universe based on models that only sometimes reflect the actual workings of the physical universe; the right brain tends to be anchored in the physical world and derives ideas from it, so it tends to be more practical and grounded. Clearly, the most ideal mindset is a balance between the two spheres of thinking, but when someone's thinking is dominated by the left brain they tend to be the stereotypical academic with perfectly sound theories in the classroom that crumble when enacted in the physical world.
The other way Keynesian thinking becomes unsound is the tendency to conceive of money in accounting terms. They will say things like debt is one person's liability but it's another person's asset. While this is true, thinking of money in accounting terms creates an abstract concept that is unhinged from the limitations of money in the physical world, so it becomes easy to get lost in the numbers and equations and lose touch with what I'll call the natural laws of money.
The book "Debt: The First 5,000 Years" does an excellent job of debunking the economic myth that money was invented to solve the problems inherent in barter and then evolved into the credit based system of today. The historical facts show that credit existed from the very beginning. In fact, it predated the invention of money itself, but it was restricted to situations built on trust. The real need for barter, and then money, emerged to solve issues of exchange between strangers, or travelers, or when an exchange needed to be made but there were legitimate concerns about being paid back, so using credit wasn't a viable option. But all of this doesn't quite define what money is, and I'm not referring to the medium that allows the exchange of three chickens for a bushel of wheat. I'm referring to the value behind the exchange and where it is derived from.
It takes time, effort, and previously acquired resources to bring a product like wheat, or chickens, to the market, so the value that is actually being exchanged is not the chickens or the wheat, but the time, effort, and cost to produce the product, all of which are limited by the hours in a day. And while there are many complex and uncontrollable factors that influence the price of a bushel of wheat, like the available supply from other nearby farmers, or the demand and outlook of potential buyers, the point is that money is reflective of the time, effort, and cost of the products being exchanged. It is anchored to the limited physical world of production, which is restrained by the hours in the day, and the number of people, and efficiency of the technology, doing the producing.
If we view all the workers in the field acquiring the resources needed to produce the products that are brought to market, we can see the base of capital growing from, and restricted by, the collective human labors of production. In order for prices to remain stable, and the value of each unit of money to maintain itself over time, the money supply would need to stay in proportion to the expansion of production as the population increased and the technology evolved to make it more efficient.
One of the least talked about but most important qualities of using gold as the medium of exchange is the way it keeps the money supply anchored to the natural pace of production because as the population expanded, or the technology evolved, there would be a proportionate number of more people looking for gold, or equally improved technology to mine it. Using gold as the medium of exchange also has a self-correcting mechanism built-in, so when the demand for money is high the price will go up, enticing more production and an increase in the money supply, and when demand for money is low the price will go down and production will slow, halting the increase in the money supply until the rate of production picks up again. This is reflective of the typical business cycle the Keynesian Alchemists think they can avoid through human manipulation of the money supply. (I'm not suggesting a pure gold standard is the ideal system, but more on that later.)
So let's define capital as the accumulating products produced by human labor, which is limited by the hours in the day, the number of people doing the producing, and the efficiency of the available technology. Money is the medium of exchange that allows trade to take place between different forms of capital (two cows for three suits...). The money supply should stay in proportion to the production of capital as it expands by an increase in population or through innovation in technology. If the money supply exceeds the rate of production, it can lead to inflation as more money in circulation chases fewer goods. If the money supply expands at a pace slower than the rate of production it can lead to deflation of prices as less money chases more goods. In both cases, the money supply is only the fuel. The spark that lights the inflationary or deflationary fire depends on the overall economic outlook of the consumer and the confidence they have in their job security to keep their future income stable or expanding, which is greatly affected by their age and the amount of debt they have. Meaning, the effect of the increase or decrease in the money supply is amplified by the degree of spending or saving by the consumers, which creates the velocity of money, and is highly dependent on the optimism or pessimism they have of the future of the economy.
Debt & Fractional Reserve Banking
In order to highlight the flaws and benefits of our debt-based system of fractional reserve banking, let's juxtapose it with a theoretical monetary system without banks or paper currency. Let's also assume the market of this theoretical world chose gold as the medium of exchange since it has roots in history. The well-known reason gold won the Darwinian process of natural selection for money throughout history is because it had all the qualities needed for a medium of exchange to function properly: portability, divisibility, durability, and it was sufficiently rare, fungible, and unconsumable.
In our theoretical world without banks, debt, or paper currency, the money supply (mined gold turned into coins) maintains a natural proportion to the expanding capital base of the production of goods because there are a proportionate amount of more people with comparable technology mining for gold as there are making the other products for society to function. In this system, the finished gold coins are used as a medium to exchange cattle for clothes and there is no debt, so if someone has an idea for a new business they need to get a loan from someone with a lot of gold in savings, presumably in his basement since there aren't any banks. But here's the point of this entire theoretical example: ALL of the money available to be loaned out comes from money already in existence, representing labor and hard work from the past.
I'm not suggesting this theoretical monetary system without debt, which is essentially a pure gold standard, is the ideal system because the available money supply without the ability to borrow from the future is too restrictive, which would slow down the evolution of technology to a glacial pace. In this regard, the greatest benefit of restricting the abuse of the money supply by anchoring it to gold is also its greatest curse. The problem is once you stray from this system and allow for the creation of debt, which is borrowing from future production, you open Pandora's Box to temptations to manipulate the money supply that human beings throughout history have proven they simply can not handle. You could make the argument that the glacial pace of evolution in a pure gold standard is the wiser, more steady and balanced system to use. But as we head into the digital age there are ways to implement a monetary system that takes the power of greed and manipulation of the money supply away from humans by automatically limiting the degree of credit issued to the rate of production and the discretionary income of the individuals involved, but more on that another time.
The most egregious error of the Keynesian Alchemists is their concept of money is not connected to the production of goods, and their concept of debt is not connected to the reality of borrowing from future production. In our debt-based fractional reserve system, when an individual takes out a loan at the bank, he is borrowing from his future labor, which allows him the ability to enjoy the fruits of his future efforts now, but it also restricts his ability to spend in the future since he will have a debt to pay that reduces his discretionary income. On a mass scale it is taking economic growth from the future and bringing it forward into the present.
If this power of debt is abused, or misunderstood, eventually the individual (or society), reaches the debt saturation point where they can no longer pull growth forward from the future because all of their limited income is being used to pay current expenses, and to service the debt they already have, so no one will lend them anymore money because they are a credit risk. When an individual or society becomes saturated with debt, a period of slow or no growth will follow until they either work off the debt or the lender writes it off as a loss. If default occurs then the ability to borrow from the future becomes limited because no one will loan them money, so the slow or no growth continues until they are no longer a credit risk. There is only so much growth you can borrow from the future before you run into the reality of having to pay it back, and no amount of stimulus, which is essentially adding more debt, will change that. Debt and deficits matter, and ignoring this reality will prove very foolish, and costly.
A common misconception of banking is that banks simply accept money from depositors and loan it out to borrowers, capturing the difference between the interest they pay on deposits from the interest they collect on loans. But what banks actually do is create money out of thin air for most of the loans they grant. They aren't loaning out money that's already in existence, which would be savings that reflect labor from the past; what they're actually doing is borrowing from the future and therefore bringing labor and growth forward into the present. With a reserve ratio of 10% they can create 9 dollars of out thin air for every 1 dollar of actual savings they have on deposit. This is a completely arbitrary ratio that is not restricted by, or connected to, the rate of production, but in theory it can work as long as the loans are wisely issued and there aren't any structural anomalies in the population or the economy that cause a widespread reduction in demand or downward pressure on wages that leads to a deflationary spiral of the previously issued inflationary borrowing bubble, but more on that later. (It should be noted that the source of the credit makes no difference. What matters is whether the credit issued comes from money currently in existence that reflects labor from the past, or money created out of thin air that reflects labor borrowed from the future, so this distinction applies to shadow banking as well.)
An economy is essentially driven by a delicate balance between production and consumption. Meaning, there is nothing for the consumer to buy if it isn't produced first, but if the producers see a lack of demand from the consumer they will slow down the supply, which, if sustained, can lead to the loss of jobs, and if widespread, a further lack of demand. The typical business cycle reflects this ebb and flow dynamic between consumption and production in a minor way as a boom in demand leads to optimism and oversupply, which then self-corrects as the producers have to slow down until demand clears the supply.
However, if the causes of the drop in demand are structural in nature like the waning spending of an explosion in population like the Baby Boomers, or the mass reduction in employment due to offshore migration of manufacturing from globalization, or a system of consumers saturated with debt, then the slowdown turns into a downward spiral of unemployment and lack of demand until the causes are resolved.
The Baby Boom
When an anomalous population explosion combines with a flurry of innovations in a fractional reserve banking system that allows everyone to borrow from their future, it creates an unnatural increase in the money supply that fuels an inflationary boom of unsustainable demand as everyone simultaneously moves through the same lifetime spending patterns together as they purchase houses and cars, and raise their kids with debt borrowed from the future, which was clearly expressed in the inflationary explosion of the 70s, the secular bull market in stocks in the 80s and 90s, and the housing bubble that ended in 2008, aided, of course, by financial engineering and government guarantees. Naturally, if the next generation is smaller, or less optimistic, the drop in demand for bank loans will lead to a decrease in the velocity of money as the new debt being borrowed into existence does not offset the money destruction of the Baby Boomers as they pay off their debts and spend less so they can save for retirement.
The Keynesian Alchemists see this slowdown of the velocity of money and think the answer is to counteract it by stimulating demand for more debt and spending through repressing interest rates and encouraging government deficits. But there is a limit to how much debt an individual can be tempted to take on if it's not in their best interest. The younger generations are saturated in debt due to the unnatural incentive of government guaranteed loans in the education and housing sectors, which distorted the market prices higher, but the lack of discretionary income to offset the drop in demand from the Baby Boomers is not the only structural problem. The job prospects for the high paying work that creates confidence of a secure and expanding source of income have been crushed by globalization.
A healthy economy consists of a balance between service sector and manufacturing jobs, but there is a profound difference between them. Service sector jobs don't produce anything. There is no capital or wealth created. There is only an exchange of money already in existence. To illustrate the difference, here's an extreme example of a theoretical world that consists of only one type of service sector job.
Imagine every morning you wake up with the sun, head outside and join your neighbors to form a shoulder-to-shoulder line down the street that stretches across the entire country and includes everyone. At 8am a whistle blows and everyone turns to their left, places their hands on the shoulders of the person in front of them, and gives them a massage. At noon another whistle blows, everyone turns to their right, puts their hands on the shoulders of the person on the other side, and gives them a massage. At 4pm another whistle blows, everyone exchanges $100 with the person on their left and $100 with the person on their right, then returns to their home after a job well done. You might have some questions. Where do they get their clothes? And their food? Who built their houses? What was created all day? My point is not to criticize service sector jobs. They are an important part of society. The point is to emphasize the vital foundation of manufacturing. If a country has to import the goods it used to produce, a river of money will flow out in the form of a trade deficit that over time hemorrhages the country's wealth and lowers its living standard.
The United States became the richest country in the world through innovations created in the free market and supported by a democratic political process that granted inalienable rights to individuals to pursue their own happiness under a rule of law that encourages peace. As these ideas spread to the rest of the world, our corporations, protecting their own interests by seeking to increase profits through cheap labor, moved their manufacturing jobs overseas, which enriched the poorer nations with life-evolving technology, and jobs, but stripped away our higher paying work that created and sustained the middle class. The result is a downward pressure on wages, which acts as another structural deflationary force preventing an increase in the borrowing and velocity of money as the younger generations, already saturated in debt, lack the discretionary income and optimism to borrow and spend like their parents did due to the missing manufacturing jobs that built and supported the country.
Normally, in a free market, new competition forces the established company to lower their prices to stay competitive, so when cheap offshore labor became a viable competitor for our manufacturing jobs, the free market response should have been to lower our wages to keep the jobs onshore, but the government-imposed minimum wage, and unions demanding higher wages, created a structural obstacle that prevented it from happening, so the jobs moved overseas, and our labor participation rate has dwindled ever since, even as the Status Quo's obsession with the unemployment rate masks the degree of the problem. Not counting someone as unemployed if they are so discouraged that they give up looking (among some of the other strange ways of not counting someone as unemployed) is like a baseball player hitting .600 but only if you don't count the outs on the right side of the field. Why everyone isn't shouting form the rooftops about the seriousness of the loss of manufacturing jobs is beyond me. An economy dominated by the service sector leads to slow economic growth that isn't reflected in any economic data that doesn't distinguish the difference in spending from jobs exchanging money already in existence like service sector jobs from jobs that create new capital like manufacturing jobs.
(I do think it's important to point out that the modern version of resource gatherers in the fields to make physical products is synonymous with gathering resources in "mental" fields to produce lines of computer code and create digital products. A reasonable way to separate "digital manufacturing" from more of a service sector job is whether the digital product can be exported. If it can then it's a digital version of the physical production process, so it should count toward the economy's strength and wealth because there is a product created, as opposed to a service performed. I don't think service jobs should count toward the real measurements of an economy's strength since the creation of a product is reflective of the accumulation of capital and wealth as technology evolves, whereas a service job is just the exchange of capital that's already been created and circulating. I consider this an important distinction that is not reflected in a lot of the economic data.)
The two structural anomalies of globalization and the Baby Boom are deflationary forces that expose the flaws of a fractional reserve monetary system and the false impression that inflation is synonymous with growth. The inflation of the last 100 years was caused by the banking system allowing generations of people to borrow from their future, which created money out of thin air at a pace faster than the natural rate of production. More money chasing fewer goods, combined with technological expansion, and fueled by optimism about the future, created a high demand and velocity of money. The government and central bank are trying to keep the inflationary expansion of the Baby Boomer debt-fueled spending wave continually expanding by stimulating false demand through deficit spending and easy monetary policy to repress interest rates and induce more borrowing, but their misdiagnosis of the problem as cyclical, and their misunderstanding of money, are causing them to implement fiscal and monetary policies that distort the economy, mask the underlying problems, and make the situation worse.
The Federal Reserve sees the downward pressure on inflation but doesn't distinguish the difference between "healthy" inflation caused by the natural high demand for capital in a fractional reserve banking system from the "insidious" inflation caused by a weak dollar. Trying to stimulate growth by conducting monetary policy to weaken the dollar only drives up the price of commodities and increases the input costs of production, which leads to higher prices without real economic growth. The resulting loss of purchasing power of each unit of money increases the cost of living, and reduces discretionary income, especially if wages don't keep up with prices. Since it's not real economic demand causing prices to rise and only the artificial weakening of the dollar, the resulting increase in inflation is temporary, lasting only as long as the monetary and fiscal policies continue to create a weak outlook for the dollar in relation to competing currencies, particularly the Euro since it has the highest weighting in the dollar index. The currency war that ensues creates the illusion of growth as asset bubbles and unnatural borrowing falsely boost the perception of wealth, but inevitably the market imposes limits through a currency crisis that forces the central bank to raise rates in a rapid manner and exposes the entire race to the bottom as a foolish delay of the inevitable depression the free market was trying to impose to clear the excess debt and create the necessary conditions for a natural recovery.
The Free Market vs. Government & Central Banks
Another grave error in the Keynesian Alchemist thinking that dominates the people in power is their disrespect for the natural self-organizing power, and honest price discovery, of free markets. The idea that a small group of people who run a central bank could somehow determine the proper interest rate for every transaction in the entire economy is not only absurd, it corrupts the free market to efficiently allocate capital based on individuals pursuing and protecting their own self-interest.
Interest rates in a free market would be set by the natural supply and demand for capital. There is no power on Earth that could possibly know such a fundamentally important price better than the market participants, but the Keynesians have a blind spot when it comes to interest rates and get seduced by the temptation that their data points and models can somehow instruct them to make all the right adjustments in exactly the right degree at exactly the right time without distortions and unintended consequences. Enforcing a top down approach of imposing interest rates by decree instead of the supply and demand dynamics of a free market will never work. You might not like the result of the free market left unfettered by human intervention but once you realize all the attempts to improve it come with unforeseen side effects that make the "improvement" worse than the conditions that existed in the first place, you finally become a true adherent of the free market. Interest rates operate according to the same laws of supply and demand that affect all other markets, and since Keynesian tendencies die hard, consider this extreme example of how it would affect the oil industry.
What if the government determined that a low oil price was good for the economy because it would free up discretionary income that could be spent on other things and stimulate growth, so they decide to intervene in the oil market by shorting WTI and Brent crude contracts until oil reached $2 a barrel where they would hold it for years (or they could impose a price control). The market distortion would be devastating. Most of the industry would go bankrupt. But no worries because the government will step in and keep the oil pumping by taking over production. Cheap gas makes for more travel, so the transportation industry would boom. Money would flow to companies that would benefit from the artificially repressed oil and away from companies that would be hurt by it, leading to a massive misallocation of capital. Eventually, this scheme would burst at the seams because you can't repress the natural order of things forever and all the distortions would unwind, leading to consequences far more dire than the temporary improvement for the consumer from the artificially repressed oil. How come it's so obvious to see the destructive effects when oil is the target of the free market interference, but it's somehow different when the far more fundamentally important price of interest rates, and the money supply, are the targets of the manipulation?
The Federal Reserve was originally intended to be a backstop of emergency liquidity in a fractional reserve banking system vulnerable to bank runs, which is actually a good idea, but the "evolving mandate" of manipulating interest rates at the discretion of flawed models and incomplete data points is not only impossible, it's foolish, and it punishes savers, creates asset booms, alters behavior, and forces a hunt for yield that deforms the entirety of the capital markets. In a free market unhindered by a central bank, inflation and deflation are self-correcting as the market-driven interest rate rises and falls to cool off or heat up the demand for capital in each unique situation. Trying to eliminate the ups and downs of the business cycle with interest rate manipulation, or deficit spending, is like trying to eliminate winter by magnifying the sun.
The Keynesian idea of deficit spending is to counteract the temporary lack of private sector demand by having the government issue Treasury bonds so it can spend more than it collects in tax revenues on unfocused, unneeded, and price insensitive projects, which is somehow supposed to stimulate the private sector into sustainable spending again. Before I breakdown the layers of foolishness inherent in deficit spending, can anyone point to all the benefits from the 13+ Trillion dollars the US government has spent since the year 2000 above its tax revenues? That's a lot of money. What did we get for it?
Let's start deconstructing the destructive force of deficit spending by pointing out that the government does not produce anything. Government jobs are services and while some of those services are necessary, all of the money to fund them is taken from one person via taxes and given to another person to perform a service, which siphons resources away from the private sector that creates capital and value and grows the wealth of the economy.
I'm not an anarchist. I understand there are certain services like the fire department, police, and military that must be provided by the collective pooling of money from citizens for the benefit of all because the private sector business model doesn't work for problems like a house fire that could affect everyone in the neighborhood if it isn't extinguished, so payment for fire service can't be voluntarily determined by free market participation. And while there will always be a debate about where the line should be drawn and which government services are necessary, if a society even allows its government the possibility of deficit spending without a restraint that is beyond the power of the politicians and voters, like gold backing its currency, it will always result in a dysfunctional and destructive hemorrhaging of a democratic nation's wealth because a perverse relationship will arise that balloons the government debt through unrealistic and unpayable promises by the politicians to get elected by appeasing the unquenchable desires of the voters for change.
So the Keynesian philosophy, which doesn't understand the true nature of money, the free market, or government spending, is a Godsend to politicians and ignorant voters who want "more everything." Deficit spending should not even be legal. If the politicians can't pay for what they want out of current tax revenues, it forces them to raise taxes, which creates a self-enforcing limit because the voters will only allow them to raise taxes if it's truly necessary. Deficit spending allows the politicians and voters to steal from future generations who have to pay the bill when the bonds mature. When individuals take on debt to enjoy the fruits of their future labor in the present, they are the ones who will be paying it back through their own hard work, but when the government takes on debt, they are enjoying the fruits of the labor of future people whose hard work will be taxed to pay for the spending, which is the height of immorality. So, please, Paul Krugman, tell me again how deficits don't matter.
There are Keynesian critics of the sound money/free market philosophy who will say it's heartless to let the economy collapse and do nothing about it, but that's not a fair criticism. It's like saying after someone becomes a heroin junkie that it's heartless to let them suffer withdrawal symptoms as they return to the natural state of sobriety. whereas the cure of the Alchemists is to inject more heroin. The Keynesians simply do not realize the cure they are prescribing is the cause of the disease, which is issuing debt beyond the level of income and the natural rate of growth to repay it. They also don't seem to understand the suffering it causes both the retirees trying to survive on savings that collect zero interest, and the suffering that will come from the inevitable bursting of the bubble as the world goes through the withdrawal symptoms of the monetary heroin.
Once in awhile I'll come across the argument that the debt 'doomers' are only looking at the liability side of the balance sheet and not seeing the true wealth of the country. These debt 'enablers' argue that the US has trillions of dollars of assets that can be sold if necessary, so the debt issue is overblown because our country is so rich it can handle more debt. This is a very dangerous argument that disregards the corrupt and dysfunctional reality of Congress and how it recklessly spent us into this predicament without the slightest resistance from the mainstream public, or the slightest accountability for their actions since most of them will be out of office before we hit the consequences of having to pay it back. Their argument rests mostly on the estimated $100+ Trillion in underground oil and natural gas deposits, but let's break that down because even if the estimate in the article I read is true, it was done when oil was trading at nearly $100 a barrel, but with oil now trading closer to $40/barrel our massive wealth deposit just got cut by 60%. Except at $40/barrel it's not worth the risk to drill for it since it's barely profitable, so if oil stays at these prices or goes lower there won't be many willing buyers unless it's severely discounted.
Let's say the worst case scenario plays out over the next decade and the world slumps into a depression from the bursting of the unsustainable debt bubbles the banking system created. What's the actual market value someone would be willing to pay for this oil? Twenty-five cents on the dollar? Let's say this mystery buyer will pay fifty cents on the dollar, and oil will somehow stay at $40/barrel in a depression. All of a sudden the market value of the original $100 Trillion just became $20 Trillion. But who has a cool $20 Trill to be throwing at a value buy of the US oil deposits? China? How much debt of theirs are we going to take for the oil? Answer: not much. We can do some kind of asset swap, but all of a sudden we're down to a few trillion of actual market value for what we can realistically sell. But even if I'm underestimating the true market value of our assets, this argument does not factor in how dangerous and foolish it is to give the power to Congress to spend at will because we can always have a fire sale of everything we own if their price insensitive and reckless spending gets us in trouble. It also doesn't factor in the projection of entitlement spending. I've read estimates that range from $75-$100 Trillion in liabilities that are currently mandated by law over the next couple decades between Social Security, Medicare, and Pension shortfalls. Since we can't even pay for our current obligations, where's the money going to come from for that? And all of these projected liabilities are based on unrealistic expectations of future growth, which are distorted by the unsustainable reflation of the asset bubbles by the central banks.
Other people with good intentions propose the answer to our problems is for the government to take advantage of the historically low interest rates and invest heavily in infrastructure, and research groundbreaking technology that will hopefully result in products that can be rolled out by the private sector to renew the growth we need to increase our income so we pay off the existing debt and the new debt this would entail. While I admire the intention and agree that a laser focused vision of how the money was spent would be a much wiser way to allocate the $13 Trillion dollars squandered in the last 15 years, ultimately this is more unsustainable Keynesian alchemy, but it does bring up the question of whether there is such a thing as "good" government spending beyond the essential services and infrastructure we need.
Spending the money of future generations without their permission on things that might become obsolete, or not result in anything productive, is a long-term risk with no accountability. Risks like that are best left to entrepreneurs who are typically dealing with smaller projects that more efficiently use capital because they are personally accountable so they are very price and market sensitive. Massive government spending will always result in a distorted bubble that crowds out private investment, needs to be repaid, and risks becoming wasteful. Here's an example:
Two criteria for a massive government spending project would be isolating the venture to an improvement of current technology to eliminate the risk of researching a dead end, and it would eventually have to pay for itself by generating a revenue stream, as opposed to the "dig a hole and fill it in" Keynesian nonsense designed to stimulate growth through blind fiscal spending. Let's say the government decides the best project would be developing a high speed rail system that connects every city in the country.
First, the finished project would steal business from the private airline, train, and bus industries. But let's set that aside and focus just on the risk. The project would take twenty years to complete and create millions of jobs. The money to pay those workers would come from $30 Trillion in 30-year "high speed rail" bonds issued as needed (because where's that money going to come from) (answer: the Fed), but it also means the bonds would have to be rolled over until the completed project generates the cash flow to pay them off.
So let's assume for years the project goes as planned and the economy booms from the resurgence of employment-generating spending for the millions of newly employed on a society-improving project that will eventually pay for itself. What if, after ten years, a private company invents a hovercraft and suddenly makes the high speed rail system obsolete? Oops. Now we built half of a very impressive high speed rail system that nobody will ever use because hovercrafts are way cooler, man. So the future generations have a $30 Trillion bill to pay off with none of the high speed rail income that was projected. There is no government project that wouldn't face these risks. The only answer to an unsustainable debt problem is to create a system wise enough to have built-in limits to prevent it from happening in the first place.
The whole 20th century is a giant debt bubble fueled by a fractional reserve banking system that has the power to issue the nation's currency with no restraint to the natural rate of production, and a government allowed to issue debt beyond the revenues it collects in taxes with little regard to the consequences as long as they can get elected and stay in power. The flaws of this system were exposed when an anomalous population boom, combined with an explosion of innovation, led to a demand for borrowing that increased the supply and velocity of money as everyone progressed through their lifetime spending cycles, simultaneously expanding our housing and cities and bidding up the prices of everything at a pace that is impossible to sustain.
The slowdown in spending of the Baby Boomers as they pay down debt and save for retirement is not being offset by the next generations who are burdened with lower paying job prospects due to globalization, a mountain of debt from artificially inflated education and housing prices, and a currency with a fraction of the purchasing power, all of which consumes their discretionary income and creates a more pessimistic economic outlook that slows down the velocity of the money. Combined with the deflationary forces of globalization, the government and central bank are trying to fight the slowdown with deficit spending, quantitative easing, and the repression of interest rates to entice more borrowing, but they are misdiagnosing structural problems as cyclical and applying cures that reveal their misunderstanding of money, free markets, and the real cause of inflation and growth. Their misguided solutions ignore the lessons of history and reflect the dysfunctional relationship between the politicians and the voters based on unrealistic "kick the can" Keynesian ideas.
Human beings have never been able to handle the temptation of issuing debt without restraint, and while there is no way to prevent the coming deflation of a century of currency erosion and unnatural inflation of the money supply, Keynesian fiscal and monetary stimulus will only delay the inevitable depression and make the consequences of the end game worse. There is no theory, model, or math equation that can override the natural laws of money and the psychology of the free market participants.
We are entering the era of developed world sovereign defaults. Maybe it takes 5+ years before we hit the wall of consequences, but there's no possible way we're going to pay back the national debt, and when you factor in the current legal obligations of future entitlement spending as the Baby Boomers continue retiring and need increased medical care, the pressure on the people in power to "do something" is only going to intensify over time. For anyone who disagrees and sees nothing but blue skies ahead, I will back off my assessment the moment the US gov't can post a single dollar in surplus and the Fed raises interest rates to historically normal levels without causing a recession and bursting the bubbles it created. It's mathematically impossible for that to occur.
Every fiat currency in history has failed for the same reasons every empire has failed: the politicians couldn't resist the temptation to grow the government, the military, and the debt beyond the point of the private sector's ability to pay for it, which leaves only one option that comes in two varieties of urgency and severity: default; or devalue.
Devaluing the debt will always be the first choice because it's widely misunderstood, so it allows the people in power to delay the public backlash and political consequences. The entire 20th century can be viewed through the lens of politicians and central bankers attempting to break the chains of monetary restraint, but there is a physics to money that is crystal clear to the ultimate arbitrator of modern monetary authority: the Forex market. Even a government that issues its own currency with a central bank setting the interest rate is not independent of market forces, much to the dismay of Modern Monetary Theory, which is another form of Keynesian alchemy that says deficits and debts don't matter because the government has no limit on the amount of money it can borrow at the short-end, or directly from the Fed itself.
One idea the MMT-ers throw around is "quantitative easing for the people," which is a form of fiscal stimulus via transfer payments or tax breaks monetized directly by the Fed. The first objection of "helicopter money" is the fact that the Federal Reserve Act does not currently allow the Fed to buy bonds directly from the Treasury, nor can they buy other types of assets other than the Mortgage Backed Securities and Treasuries they've been buying, so there is a limit to how much money the Fed can inject into the system because there is a limit to the available assets they can buy. In order to bypass that limit, Congress would have to alter the Federal Reserve Act, and since every 6-year-old not raised by a Keynesian knows that direct debt monetization is the road to hyperinflation demonstrated throughout history, it would likely take a dramatic deflationary crisis for Congress to pull that off. It will likely happen, but not without a crisis first.
The only way the Fed will achieve its inflation target is to push the dollar toward its all-time lows and flirt with a currency crisis that entices people to spend their money before inflation eats it away. But even if Congress allowed direct debt monetization, the reason the Fed would still have limits on its monetary madness, and the reason that deficits and debts do matter, is because the Forex market will sell the dollar and cause commodity prices to soar, which will eventually checkmate the Fed and force it to raise interest rates to prevent a currency crisis, thereby increasing borrowing costs, which will pop the stock and bond market bubbles dependent on zero interest rates, and result in developed world sovereign defaults that cause the worst financial crisis in history.
The Fed will never normalize interest rates voluntarily. If they manage to raise them at all, it won't be long before they are forced to retreat to prevent the bubble from collapsing. Since the entirety of their foolish and ignorant plan depends on the inflated stock market boosting the retirement accounts of the nation enough to create a "wealth effect" that causes everyone to spend like drunken lotto winners, they can not let the stock market crash or their whole plan blows up in their face. Their other problem is the destructive force of a soaring dollar and its deflationary effects on emerging market currencies and their dollar-denominated debt, not to mention the downward pressure on the earnings of international corporations. So the Fed has to prevent the dollar from getting too strong and too weak. Ultimately, though, they are not in control. Eventually, the market will reveal this.
Whether the Fed realizes it or not, what they are trying to do is devalue the burden of debt on the nation, but since the total outstanding level of public and private debt had no practical restraint upon its issuance, it dwarfs the potential supply of assets the Fed can purchase, so the limited supply of assets to monetize. and the backstop limitation of the Forex market checkmating the Fed, leaves only one inevitable option to relieve the burden of debt on the nation: overnight devaluation ala FDR in 1933. The problem is the US dollar is the reserve currency for the world, so what do they devalue the dollar against?
I argued a couple years ago that the world leaders are not going to return to the restraint of gold as the reserve currency after a century of breaking every monetary chain restricting their ability to increase the power and reach of government. The most likely option would be introducing a new reserve currency they can manipulate like the SDR, which would allow any nation overburdened by debt to devalue their currency against it. Most likely, this would only happen as a response to a severe crisis, but unfortunately we're on the path to have one, so it's worth the time to consider how an overnight devaluation would affect everything because if the devaluation happens all at once, gold won't protect you anymore than any other asset. Meaning, if gold is worth $1,000 and a house is worth $100,000 and the dollar gets devalued 3:1 against the SDR, then the new value of gold is $3,000 and the house is $300,000. You might argue the likely response would be for gold to rally after the devaluation, which might be true, but the actual devaluation itself affects all assets the same.
However, if you stored the gold overseas then you would be able to exchange it into the unaffected local currency, but how can you be sure they won't be devaluing their currency at the same time? Gold benefits the most from a psychological runup during a slow devaluation process like the Quantitative Easing programs, but if it happens all at once, every asset will be affected the same because you have to exchange the gold for something that was also devalued. I've always thought of gold as an insurance policy against the madness of central banks destroying the currency, so I do think anywhere between 5-10% of your liquid assets is reasonable to keep in gold, depending on your level of confidence, but it should be understood that gold will not protect you from overnight devaluation unless you can exchange it for a currency that is not devalued, which is the same as owning that currency outright. The only real protections during times like this are position size and diversification.
The reason for the overnight devaluation of the nation's currency is to make debt more manageable to pay off. If the number on the "value" of all assets in a nation are increased overnight by a factor of three, wages and prices would adjust accordingly, but the debt stays the same. So if GDP tripled from 16 Trillion to 48 Trillion as wages adjust, all of a sudden the 18 Trillion dollar national debt doesn't seem so daunting. This would be the same for everyone in debt. Prices and wages would adjust but the debt stays the same, so the people who get screwed the most are the owners of debt, which includes savers since all dollars are borrowed into existence as debt. You might argue the reason they won't do it is because it hurts the banks, but the banks created the money out of thin air to begin with, and keeping the system alive would be better than a deflationary nightmare of debt destruction for them too. To be clear, an overnight devaluation is destructive. It makes the nation poorer, even if it relieves the burden of debt. Without proper understand and reform, the same problem would reoccur in the future until the dollar itself is devalued into oblivion and a new currency replaces it.
One of the more perplexing reasons why the Keynesians think our current debt problem is different this time is because history is filled with various cultures running into the limitations of the natural laws of money. Every possible solution of default or devaluation has been tried. One of those is the debt jubilee.
There are two major problems with a modern debt jubilee: the debts are owed to so many different creditors; and the Forex market would make it very complex or impossible to accomplish. In the past when most, if not all, of the debt was owed to one source like a king, when he realized the indebtedness of the population became self-defeating, or immoral, he could cancel all the debts owed to him by decree. But the modern financial system is so complex the only way to cancel debts would be to send a check to everyone for the median amount of debt per citizen.
If we put aside the moral hazard, the problem would be how to implement it without causing the Forex market to create a currency crisis? One idea would be requiring that the "bailout" money could only be used to retire debt, which would actually be deflationary since it's essentially money destruction. The only way to prevent the massive inflationary spending spree that would follow as the nation suddenly had an abundance of paid off credit available is to force the banks to reduce everyone's available credit by the amount of debt being paid off by the jubilee, so it would very much be a deflationary credit destruction. And what would the banks do with the money? They don't need money to lend out. They create loans out of thin air. So they would be flush with cash with no place to go. Since this money originates at the Fed, you could require the banks to return it to be retired, but since debt is an asset on the balance sheet of banks it would create collateral and solvency issues since debt is so intertwined throughout the system. Not to mention a large percentage of the population doesn't have the median amount of debt, so the only way to prevent an inflationary spending spree by them is to break up the total bailout amount and spread it out over ten years, or create a firestorm of immorality and injustice by not giving money to them and only to people with debt.
The idea of a debt jubilee is right in the sense that it recognizes the mathematical problem of too much debt being self-defeating as it restricts growth and therefore the ability of the system to repay it, but the implementation of a public bailout would be extremely complex and difficult to pull off. I don't consider myself an expert on the intricate inner working of the banking system, so unless a bank expert could explain how a jubilee could be implemented without causing an inflationary currency crisis from the sudden explosion of available credit, or a deflationary nightmare from the sudden loss of bank assets via debt destruction, then I'd be skeptical of it being another dose of magical Keynesian thinking. But I do think the only possible way to soften the inevitable pain as the current system reaches its limits is through some form of debt forgiveness. Whether it happens naturally as individuals and countries go bankrupt one at a time, or whether there is a solution to apply to the system all at once, the only answer to our debt problem is to reduce its burden, not add more of it. Since the banks created most of the outstanding debt out of thin air and not from assets they own or the savings of depositors, why should it be unjust if it was nullified? It wasn't theirs to begin with. The government gave them the power to issue the currency, so we should be able to take it away.
Most importantly, once we hit the consequences of the inevitable end game, the monetary system needs to be redesigned around the idea of restricting the issuance of debt to a percentage of current discretionary income the creditor must verify, which could be done by backing the currency with gold, or using a new system based on digital technology that I will write about another time. (It's not Bitcoin)
This is my take on the sound money/free market thinking I've done over the years and my own conclusions. And while I don't know if they would agree with my take on these ideas, I was most influenced by other free market/sound money people like David Stockman, Peter Schiff, Harry Dent, John Mauldin, and the contributors and editors of Zerohedge, as well as anyone with an Austrian/Libertarian viewpoint like those at the Von Mises Institute. I'd encourage you to read their books and blogs and have the courage to hold up your own views with the objectivity and desire to discover the truth. It's the only way real reform is possible.
We can debate the nuances of how the end game plays out, but in the spirit of eradicating Keynesian thinking from this world, if anyone agrees with the bulk of this post and wants to share it, you have my permission as long as you include a link back to this blog.