Financial Crisis

Pulling Ourselves from the Economic Abyss

By 911awake ⋅ December 8, 2008 ⋅  Email This Post ⋅  Print This Post ⋅ Post a comment

by Geraldine Perry author of the Two Faces of Money

Storm clouds are gathering as policy makers and opinion leaders awaken to the fact that we are facing the most grimly serious economic crisis in world history. De-leveraging, caused by collapsing debt, is occurring at such a rapid pace and massive extent that even the world’s leading central banks, including the U.S. Federal Reserve, the European Central Bank, and the Bank of England, are threatened by credit losses so large that at some point in the not-too-distant future even their substantial balance sheets – not to mention access to “capital” aka taxpayer funds - could become overwhelmed.(1)  And the fallout effects of this meltdown have only just begun.

Thus, as one investment advisor wrote in a recent e-letter:

“The real news is this: The planet is being remade. Entire nations are withering, entire neighborhoods are dying, and for millions of people left behind, the future will not exist in any meaningful way.. .

Please understand, I am no pessimist. For every householder trapped in a suddenly insupportable monthly mortgage payment, in a dying neighborhood, in a shrinking economy, stuck with a portfolio of wildly overvalued stocks…

there is another householder living debt-free in a burgeoning township, in a booming economy, sporting a portfolio bulging with stocks picked up for pennies on the dollar, who eagerly anticipates a living standard rising higher and higher, borne upward on a fabulous tide of wealth”. (2)

Investment opportunities notwithstanding, drastic corrective measures are clearly called for, given the sheer magnitude of the crisis. But so long as we remain wedded to the current monetary system we will collectively be forced to participate in a level and scale of human calamity never before seen or imagined. None of us will escape unscathed or untouched.

Moreover, any corrective measures devised within the current context will necessarily be more – far more - of the same patchwork of plans targeted at select groups and industries. The debt burden will explode and consume ever more of us as escalating numbers of “have-nots” are forced into an increasingly desperate, potentially violent battle for survival against the “haves”.

All this is predictable because continual transfer of wealth upwards into fewer and fewer hands is an unavoidable, mathematical certainty of the current monetary system. Thus, the practice of “picking up” assets for a “dime on a dollar” during downturns in the credit cycle has - for countless centuries - been a time-honored tradition among the more financially able.

Said credit cycle is in fact an integral feature of the current financial/monetary system and a principal means by which wealth is continuously transfered. Ominously, one proposed component of the patchwork of plans will only serve to reinforce and protect this and future credit cycles, calling as it does for the creation of a new global regulatory regime.

As two critics recently described it, this regulatory regime “will separate the largest banks, global by nature, from the rest thus creating an elite group of financial institutions with oligopolitical power at the top of the global financial pyramid. These banks will be so large and so “systemically important”. . . that they will never be allowed to fail; they will control all global finance. The very situation [means that] the privatization of profits and the socialization of risks will become a defining feature of the new system. As the G20 have stressed, these mega-banks will continue to operate within a system “grounded in a commitment to free market principles” and thereby able to speculate freely so as to amass even greater fortunes for the financial elite while the risks they take will be borne by us, the ordinary people. The new system will have moral hazard built into it”. (3)

Moral hazard notwithstanding, calls for a new regulatory regime - which depends on ever greater levels of taxpayer support and transfer to citizens of risk taken on as a result of the investment strategies of the financial elite - is little more than a desperate attempt to prolong a failing system. Just as importantly,  the whole endeavor will only prolong - and exponentially magnify - the misery of larger and larger portions of humanity.

As recent events show, the financial system remains precariously on life support despite the trillions in taxpayer dollars so far committed to its rescue. Even worse, said financial system is dragging the real economy - where ordinary people live and work - down with it. Most troubling of all is that there is no satisfactory way of putting Humpty Dumpty together again, because “ultimately, ‘all the king’s horses and king’s men’ cannot prevent the de-leveraging of the financial system under way. . .  The extent of de-leveraging is substantial and likely to take time. [And] As each of the global economy’s credit creation engines breaks down and systemic leverage reduces, money becomes scarce . . .” (4)

Simply put, we operate under a monetary system that requires constant expansion of credit. We now face the prospect of total collapse because the monetary liquidity provided by credit is freezing up. No one wants to lend because no one can afford to lend – there is simply too much bad debt which still needs to be written off. This is why governments have been so recently generous with taxpayer funds.

Unmentioned is the fact that credit is the “lifeblood of the economy” for the simple reason that money is created when banks extend credit through what are loosely termed loanable funds, also known as reserves, created via government debt paid for by taxpayers. In short and because money is created as credit (or debt), collapsing debt leads to credit contractions which then leads to a collapsing money supply.

It is, and always has been, money scarcity - not credit scarcity - which poses such an incredibly serious threat to the real economy and the ordinary people who work there. During downturns in the credit cycle, it is a shortage of money in the real economy that forces businesses to tighten their belts or go bankrupt, leading to elimination of worker benefits, reduced wages and fewer jobs. In turn, production drops and normal access to food and other necessities of life declines. If the producers have been especially productive during the preceding upturn, the markets will be overloaded  with goods too few can afford to buy, forcing prices to nosedive, often below the cost of production. And a vicious, downward cycle, once set in motion, can all too easily get out of control as more and more money evaporates from the real economy.

Yet in a bitter sort of irony, the productive capacities of the people has not radically changed. It is rather the reduced amount of available money which produces real, and often unspeakable, hardship for untold millions. The entire situation brings to mind an observation made by commentator James Crowther of the Great Depression: “Breadlines knee deep in wheat are surely the handiwork of foolish men”.  (5)

Injecting sufficient liquidity into the national system will allow it, eventually at least, to create more money (as loans) but the resultant runaway inflation will have a similar effect as a shortage of money. Thus the enormity of the current credit crisis carries with it the very real possibility of  massive, perhaps uncontainable civil unrest which could in turn threaten the very nature of civilization itself.

Unfortunately for ordinary people, the rapid decoupling of the real economy from the financial economy now underway means that the old stand-by approaches, including mammoth liquidity injections and new regulations, are not nearly enough to prevent the inevitable descent into the  mass economic destruction of real economies around the world.

The fact is that “[w]hen a long-dominant paradigm fails in its prescriptions, and it calls for more of its failed prescriptions to solve its failures, its circularity becomes terminal. What is not recognized is the underlying principle of the escalating failures: that financial crises always follow from money-value delinked from real value, which has many names but no understanding of what it is. Value is what serves life itself, and the global market paradigm has no place in its metric for the life factor at any level.” (6)

The financial economy is not the same as the real economy - and making money is not the same as earning it. Real value is in the earning, not the making, of money. The financial economy allows money to be created (made) as credit (or debt).

Money-value is built when interest and other fees are charged for the creation and use of this credit/money. These charges are made each and every time credit is extended or a loan is taken out, and they accumulate exponentially over time through the laws of compounding interest. Because all those fees and charges are not created as “money” they are essentially unpayable - unless more debt is incurred in order to pay said charges.

The system is inherently unstable because of the need to increase the money supply at ever faster rates as more and more money goes to pay the accumulating interest charges rather than for needed good and services. Constant expansion of both credit and markets is required or the system will face certain collapse. Paradoxically, the more an economy expands, the more it automatically goes into ever greater debt to the financial system. Market cycles must occur in order to keep inflation of wages and prices within a mathematically feasible range.

In this system, economic expansion is not simply a luxury but an imperative. One must always “[b]ear in mind that the meaning of ‘discounted cash flow’, which is the moving line and reference body of global market value, means that what is today $100 in real terms is the same as $100 + compound interest in one year ($110), two years ($121), or 20 years from now as the starting base from which every “worthwhile enterprise” is calculated. The system is a horizonlessly expanding money-demand machine engineering all that lives to extract more money value from it. (7)

In essence the current money creation process turns money (or currency) into a commodity - rather than allowing it to serve simply as a medium of exchange - by allowing it to “make a gain out of itself” through the application of interest charges and assorted fees. Yet, as Aristotle himself asserted long ago, “money was intended to be used in exchange, but not to increase at interest. . . . Wherefore of all modes of getting wealth this is the most unnatural.” (8)

The real economy is where money is earned, and shortages of money for the real economy have always existed - even in good times - in those monetary systems where credit has served as money. We only need look at money supply versus debt to understand the problem.

In the U.S. for example, the money supply has increased dramatically since 1980, going from less than $2 trillion in 1980 to an estimated $14 trillion in 2008. Far outstripping the money supply however is debt. In 1980 total public and private debt totaled roughly $5 trillion, with about $1 trillion of that representing public debt. Today public and private debt totals roughly $50 trillion, with over $10 trillion of that representing public debt.

Significantly, this situation exists for the undisputed “economic/financial powerhouse of the world”, one that has long been blessed with workers and businesses that are among the most productive the world has ever seen. Yet more and more of their productivity, and their wealth, is in a very real sense extracted from them in order to pay the interest on their private and public debt. The consequences are everywhere, as businesses, governments and individuals struggle to do what it takes to stay ahead of bankruptcy.

Tragically and for countless centuries, much of the world has been laboring ceaselessly under the tyranny of financial systems which are allowed to make - and profit from – debt-based, commodity money. Sadly, none of this has been necessary - once you recognize that monetary systems are nothing more than giant book keeping systems. You can make them as simple or complex as you like, but they are book keeping systems nonetheless.

So it is that we can say that “the [most recent housing] boom was in fact engineered through the injection of massive amounts of “liquidity” [i.e. Credit serving as money] into the system. This money needed a home. It was this need that drove the demand for ‘risk’. . . [But] ‘risk’ would be better termed as money needing a home that pays as much as possible in return. . .[The newly developed investment vehicles] created the illusion of low risk high paying investments coupled with low capital requirements. .  . It was the Fed that fueled the fire. . ..” (9)

In short, today’s meltdown was both predicted (by Warren Buffet and many others) and predictable, with ample historical precedent to serve as a guide as to both cause and effect. It was the direct result of the bursting of a massive, global speculative bubble made possible through a wide array of easy money (i.e. credit) policies, primarily promoted by the U.S. which then led to a veritable explosion of  highly privileged, highly leveraged, non-transparent, “off balance sheet” debt .

This debt was in fact credit - serving as money - looking for a place to go, for the highest return – and it found it primarily in the form of increasingly complex – and risky - derivatives instruments, now known as “bad assets”.  So it is that, “as every student of economic history knows, depressions, ever since the South Sea bubble, originate in excesses in the financial economy, and go on to ruin the real economy.”  (10)

Years before the current crisis, economist John Kenneth Galbraith was able to vividly describe the predictable scenario: “Whatever the pace of the preceding [speculative] build-up, whether slow or rapid, the resulting fall is always abrupt. Thus the likeliness to the ripsaw blade or the breaking surf.” (11)

Galbraith’s survey of financial panics included the South Sea Bubble of 1720 (known as one of history’s worst financial bubbles and now dubbed the “Enron of England”), the Great Depression of 1929 (which some experts say made the creation of a global monetary system imperative), and a sizable list of smaller, more isolated panics which occurred in the United States from 1819 forward. None of these matched the kind of devastation unleashed upon the world by the first – and so far the worst – global financial collapse which occurred after the world’s biggest banks went under as a result of the bursting of a worldwide speculative bubble that peaked in 1345.

Some rather disturbing parallels to today’s crisis might be gleaned from that 1345 crisis. The following excerpts from an article titled “How Venice Rigged the First, And Worst, Global Financial Collapse” shed some light on some of those parallels by providing a brief glimpse into why and how this collapse occurred – together with some of the results, which included a dramatic, worldwide drop in population due to famine and disease brought about by a severe shortage of money (or rather credit serving as money) and subsequent reduced access to food and other essentials of life:

[This 1345 collapse] was more than a bank crash—it was a financial disintegration [in which] ‘all credit vanished together,’ most trade and exchange stopped, and a catastrophic drop of the world’s population by famine and disease loomed. [It was] the result of thirty to forty years of disastrous financial practices, by which the banks built up huge fictitious “financial bubbles,” parasitizing production and real trade in goods. These speculative cancers destroyed the real wealth they were monopolizing, and caused these banks to be effectively bankrupt long before they finally went under. . .

. .  Since in Fourteenth-century Europe, important commodities like food, wool, clothing, salt, iron, etc., were produced only under royal license and taxation, bank control of royal revenue led to, first, private monopolization of production of these commodities, and second, the banks’ “privatization” and control of the functions of royal government itself.

. .. In Italy itself, these bankers loaned aggressively to farmers and to merchants and other owners of land, often with the ultimate purpose of owning that land. This led by the 1330’s to the wildfire spread of the infamous practice of “perpetual rents,” whereby farmers calculated the lifetime rent-value of their land and sold that value to a bank for cash for expenses, virtually guaranteeing that they would lose the land to that bank. As the historian Raymond de Roover demonstrated, the practices by which the Fourteenth-century banks avoided the open crime of usury, were worse than usury. . .

. . .Venetian super-profits in global currency speculation continued right through the bank crash and financial market disintegration of 1345-47 which they had rigged, and beyond.” (12)

The current crisis promises to be no less dire than that of 1345 and in fact has the potential to become much worse.  Surely, the time has come to break free from the clutches of a monetary system which mathematically guarantees the continuous transfer of wealth upwards and which must periodically collapse once irrational exhuberance has forced debt, including carrying charges, beyond the mathematical capacity of the system.

The task of course will not be easy, or it would have been accomplished long ago. And because certain entrenched powers are likely to resist - even resorting to force and all kinds of subterfuge if need be in order to retain the status quo - all options need to be left on the table.

These options might include the temporary use of barter between nations and within communities, until such time as a new, unpegged, debt “free” national currency gains the trust and respect of allied nations. “Free trade” agreements would need to be canceled and bilateral agreements used instead. Local scrip, and community currencies, operating alongside bartering and the national currency, could help facilitate exchange of goods and services at least at the local level until such a time as the money supply can be correctly managed.

In tandem with these activities, governments need to begin issuing their own debt “free” money, which should be used first to retire the public debt. Public projects could be drawn up as well, for public approval, including perhaps a one-time, emergency dividend for citizens. An appropriate amount of debt “free” money would be issued to support those projects.

As in the current system, the principle of extinguishment would be employed to manage the flow of money in and out of the system, but because interest fees and other charges will not be attached to this money, both public and private debt would decrease substantially – and real wealth would explode. Public debt would eventually disappear altogether. As nations are newly empowered with the ability to create their own wealth and sustain themselves, borrowing from the IMF or any bank would become a thing of the past.

Importantly and because money is power, the monetary system eventually adopted needs to be fully transparent, with its money flow formulas and rules and principles codified into law. It also needs to include a mechanism by which local communities and their local governmental bodies would retain a reasonable portion of the money creation power.

In the case of the Public Credit Money System, both adopted rules and the money flow formulas employed would require no more than a 5th grade education to understand. In addition, money creation power could be exercised by local citizens each time they authorize their local officials to borrow interest free money from the national monetary authority. The national government would have no say in these projects - it would only issue, in the form of a loan, the interest free money requested.

Local projects might include roads, bridges, water systems, market facilities or whatever other asset or service it is that the local citizenry deems important enough to borrow interest free money. This money (and the loan attached to it) would be extinguished as the approved local taxes or other fees are sent to the national monetary authority. At the end of the specified time period the local citizenry would own, control and benefit from the authorized project in question. No longer would officials be compelled to sell off local assets to the highest corporate bidder and public/private partnerships would take on a whole different meaning and format.

Such a system would not require endless expansion and growth. Instead, excess, waste and destruction of resources would become a thing of the past as individuals become vested in their communities and their collective and individual futures.

We can  no longer afford to simply sit by and wait for a miracle, particularly one formulated for us by the very people responsible for current - and past - crises. But, with sufficient courage, patience and resolve – together with a clear grasp of monetary systems – those of us concerned about the future of humanity and the planet can create a miracle. It’s time to not only mend this meltdown but engineer a true and permanent recovery.

Citations

1. Kenneth Rogoff, “Is There An Exit Strategy?” Guardian.co.uk , September 8, 2008. Accessible: http://www.guardian.co.uk/commentisfree/2008/sep/08/creditcrunch.economics?gusrc=rss&feed=commentisfree

2. Richard Young, “Nightmare on Wall Street”. E-letter, December 4, 2008. Website: http://investorplace.com/

3. Simon Davies and Donald Hunt, “Sleepwalking Our Way to Hell”, November 24, 2008. Accessible: http://www.sott.net/articles/show/169667-Sleepwalking-our-way-to-hell

4. ibid.

5. John Magdoff, John Bellamy Foster, Frederick Buttel, editors. Hungry for Profit. (New York, Monthly Review Press, 1999). p.192.

6. John McMurtry, “When Money Eats the World”. Accessible: http://landru.i-link-2.net/monques/moneyeats.html#WHEN

7. ibid.

8. Aristotle. Politics, Book 4. 350B.C.  Accessible: http://classics.mit.edu/Aristotle/politics.html

9. Davies and Hunt, “Sleepwalking Our Way to Hell”.

10. Robert Kutner,  Testimony before the Committee on Financial Services of the U.S. House of Representatives,  October 2, 2007. Accessible: http://www.house.gov/apps/list/hearing/financialsvcs_dem/testimony_-_kuttner.pdf

11. John Kenneth Galbraith, Money Whence It Came Where It Went, revised edition. (New York: Houghton Mifflin Company, 1995). p.109.

12. Paul Gallagher, “How Venice Rigged the First, And Worst, Global Financial Collapse” , reprinted from the winter 1995 issue of Fidelio Magazine by The Schiller Institute. Accessible: http://www.schillerinstitute.org/fid_91-96/954_Gallagher_Venice_rig.html

Geraldine Perry is co-author of The Two Faces of Money and is also the creator and manager of the related website: http://thetwofacesofmoney.com/ which includes recent reviews. This website also has an abundance of related material and links, along with a free slide presentation describing the two forms of money creation and the Constitutional solution, which is not the gold-backed dollar as popularly believed. Geri holds a Master’s Degree in Education and is also a Certified Natural Health Consultant.  As a means of imparting accurate information on health and nutrition to as broad an audience as possible she developed the web site  http://thehealthadvantage.com/.