We have now reached the era of the trillion dollar expenditure.
This past September, the national debt surpassed the 10 trillion dollar mark. Total estimated costs for the War on Terror range from one to three trillion dollars. On November 25th, ABC News reported that the government’s financial bailout will be the most expensive single expenditure in American history, potentially costing $7.5 trillion.
A trillion here, a trillion there, and after several times of hearing the trillion dollar figure, it actually sounds affordable.
So, how much is a trillion dollars?
A dollar bill is approximately 6" in length. If you started laying one-dollar bills end to end, by the time you laid out your trillionth dollar, you would have a length of dollar bills that would extend from earth to the other side of the Sun.
So, where do you suppose all those dollars are going to come from? Well, they will be created out of thin-air and dumped into the economy, thus diluting the value of the dollars that already exist.
Imagine that our economy was still based on the gold-standard. If an alchemist discovered a way to create gold from the combining of elements, what do you suppose would happen to the value of everyone’s gold?
The same scenario exists when a “private” entity can create dollars out of thin air via the printing press. But now, as we are entering the realm of the cashless society, it’s even easier. There is no printing to be done, all that’s necessary is an electronic ledger entry.
Expect to hear the term “hyper-inflation” in the not-to-distant future.
There are many reasons to distinguish between bad monetary policy and a rejection of a system of fiat money.
One aspect is that no private entity can simply “print more money” in our system-the federal reserve can, but it’s both not really a “private” entity as we think of one, and it doesn’t have the same goals as a private entity.
More importantly, if we were on a gold standard today, the system would break down in weeks.
According to the most recent figures, the U.S. has a trade deficit of 181.3 billion in 2Q 08. That means that (in simple terms) the amount we spend on things from other countries is 181.3 billion dollars more than the amount they buy from us.
So we owe other countries 181.3 Billion dollars. So what-we send them dollars.
Well, under a gold standard, they’d probably want the gold. Similarly, unless the rate gold was set at was just right, people would arbitrage our currency if it was on the gold standard-they’d buy things from americans, would trade the dollars they got for gold, and then take the gold to where it was worth more money and sell it. Again, disaster—we’d be out of gold.
And if we proposed a system in which we could fix this by revaluing the dollar–that’d be the same thing you’re now afraid of–a gross devaluation of the currency.
Yes, the system, as it is managed today, would break down in weeks. Instead, a system was created that trades irresponsible economic policy for a false illusion of economic prosperity. So, instead of breaking down in weeks, it took decades. If we were on the gold standard, our elected officials wouldn’t be as tempted to be so irresponsible with the economy, as the breakdown would occur on their watch instead of several administrations in the future, putting the responsibility of cleaning up the mess on future generations. Like us.
I wasn’t making the assumption that the debt was ever going to be paid, I was illustrating that the debt is so large, that repayment is now virtually impossible. In the private sector, when repayment is impossible, that’s known as bankruptcy.
Countries cannot, per definition, go bankrupt. This since they have the means to tax their population. An theoretically, they could tax the populae 100% which (yet again, in theory) most likely would be enough to pay the debt.
A current example would be my own dear Iceland, which is in a helluva worse place than the US at the moment (search for my threads on it).
Think about what “bankrupt” is. For you or I, it’s when our assets are smaller than our debts, and we go through a legal process to sell the assets and fairly divide the proceeds between creditors-after which point the creditors’ debts are discharged.
So for bankruptcy, you need three things. You need some assets, you need some debts that are bigger, and you need a legal process that forces the creditor to use those assets to pay those debts.
Well, the U.S. has assets. Lots of them.
264 Million acres of public lands in the western states. http://www.blm.gov/wo/st/en.html
A whole army, navy, and air force. A bunch of atom bombs.
(on that alone, you can see why bankruptcy will never make sense-can you seriously contend that the U.S. government would go through a process that would require selling THESE assets off to pay creditors).
So we go to the second point-are the assets greater or less than the debts?
I haven’t done the math-but just talking about the assets I’ve pointed out, it’s entirely likely they’re worth much more than our debts. (for those who understand the details: I know treasuries aren’t backed by our assets. But I’m using them to make the point that traditional conceptions of bankruptcy don’t make sense)
Well, usually we ask if the person who owes money can pay off their debts when they come due–if they can’t, that’s a very strong indication of bankruptcy.
The U.S. has Never defaulted on a debt in the modern era. It doesnt’ look like it will, either.
Third, we need a process that can force the person who owes money to sell his assets and divide them up among creditors.
We run into two problems here:
We have a LOT of creditors and a LOT of assets. Any process to sell them off will be the most complicated economic action ever taken-the mere practical process of selling assets off is in effect, impossible. There aren’t enough lawyers in the world to resolve the fights between debtholders.
The U.S. doesn’t take kindly to someone telling it what to do. If you can find a court that can order the U.S. government into bankruptcy, I’d like you to point it out. I’d contend that one doesn’t exist.
So what does happen when a country can’t pay its creditors? It repudiates the debt. It just says it won’t pay the money it owes. It can do that.
Why don’t governments do this? Because the only thing that makes people willing to lend money to a country is its record in paying back debts. Countries need to borrow money to function, and if they repudiate any debt, it becomes at least much harder and more expensive, if not impossible, to borrow what they need.
Well, yes. But in my experience, when someone makes a statement like that about the fed being in some way a private entity, I usually find that they’re making a point about the fed not being an institution that is designed to operate to manage monetary policy, not to make money for shareholders like a normal commercial bank.
If you weren’t asserting a point like that, I apologize for my own confusion.
Might I note that my points about the gold standard had little to do with monetary policy (which, I might note, ceases to exist under a gold standard, as the government can no longer try to manage the interest/inflation rates), and much to do with balance of trade and comparative exchange rates. (also, even if we have a favorable balance of trade, but our trading partners aren’t on the gold standard, we see the same problem-either they’ll pay for exports in currency and get payment in gold (end result=we have no gold, no currency, and no economy), or we’ll demand payment in gold (end result=they refuse to trade with us, we have no imports, the interconnected global economy breaks down, we lose the benefit of trading with others to take advantage of our respective comparative advantages, and we have no economy).
So if those things are the problem, and by going on the gold standard, we lose our primary tool to manage them, then we are… where exactly? I don’t see very many paddles where that leads.
Further, even if the gold standard made sense in theory, or if we had been on it all along, here we are. Right here and now.
You don’t seem to disagree that putting us on the gold standard now, and the transition that would require, would create a nationwide (and probably global) financial meltdown of a scale the world has never seen. Hence, even if it was a theoretically good idea (which I dispute), and even if it was wrong to take us off the gold standard (which I dispute), it’s unreasonable to argue we could practically fix anything by going back on it now-it’s just impractical to do so in any manner that happens in the next century or so, and that would avoid an even bigger financial meltdown.
The only reason I brought up the issue of the gold standard was to illustrate the inflationary effects of printing additional dollars and dumping them into the economy. As I said, the effect would be the same IF we were on the gold standard, and an alchemist discovered a way to make gold. Everyone’s existing gold would decrease in value, just as everyones existing dollars decrease in value by adding additional dollars into the economy.
In the ubiquitous fractional reserve banking system, private entities essentially do the same thing as “print more money”. Someone deposits $10,000 with the bank, and the bank loans out $90,000 based on the $10,000 deposit. The bank never had the extra $80,000 it magically created out of thin air.
Ok maybe I mangled the logic or the explanation, but the bottom line is that banks lend money they don’t have, and absurd as it sounds it’s how the system works.
That’s true enough. The banks have a reserve requirement, so they have to keep at least 10% of their depositors’ cash on hand.
However, once that 8k is lent out to buy a new car or whatever, the person who receives that 8k will bring it back to a bank. And the bank can again lend out 90% of that 8k to a new borrower, who will buy something with it. And the new person who receives this new cash will (again) take it to a bank. Where the bank can (again) lend out 90% of the cash. So that original 10,000 will be multiplied many times. Eventually, the banks will be able to create around 80,000 of new money from an original cash infusion of 10,000. It’s hyperbole to say that this is “magic”, but it is true that the banks have more short-term obligations than they can possibly meet at one time. The depositors can’t all get their money back on the same day, because that money has been given away to other people (and received back and given away again).
For this reason, the original 10,000 is called “high-powered money”. Just a little bit of it can be multiplied by banks into quite a lot of cash. And here’s the distinction that was missed earlier: only the Fed has to ability to create this new high-powered money. This is the monetary base. After the monetary base is created, the banks then create the rest of the money supply with the fractional-reserve system. Most of our money supply is created by banks, but only the Fed has the ability to create the base.
The problem right now is that the banks aren’t lending money like they’re supposed to be. The Fed has significantly increased the monetary base in the last several months. The Fed chair, Ben Bernanke, is an expert on the Depression, and he’s trying to avoid the mistakes of the past by attempting to dodge the deflationary pressure that made the Great Depression so unbearable. So the Fed has been creating a whole helluva lot of high-powered money recently. They’re hoping to create some healthy inflation, which is exactly what we need right now. This deflationary crap is killing us. But the banks just aren’t spending it, so the normal money multiplier isn’t working. They’re not lending out money, which is to be spent, and brought back to banks and lent out again.
Our economy relies on that process to function, and yet it isn’t working. This is why the government needs to pass a fiscal stimulus. If the government spends money directly, then we can get the economy moving again even though the money supply is stuck in a liquidity trap.
Now in normal situations, I wouldn’t recommend this. For the dot-com bubble, we quite wisely relied just on monetary policy to fix the problem. Greenspan lowered interest rates until people were interested in investing again. But monetary policy isn’t working anymore. Interest rates are hitting rock bottom. The short term rate on T-bills reached 0%. The government is able to borrow money for free, which is completely fucked up. It’s like throwing a rock and watching it skip countless times to the other side of the lake instead of sinking. There’s something quite unnatural going on here.
And in the midst of this deflationary hell, the OP is worrying about hyper-inflation. Bernanke would sacrifice one good lung if he could create some healthy inflation, and yet the concern here is wheelbarrows full of dollars? Ridiculous. When you’re worried about hypothermia, you light a fire. Our chief concern is warming things up right now. We can worry later about burning the house down.
A bank gets 100 dollars from a depositor. The bank then has $100. It also has an obligation to pay the depositor $100.
The bank then lends out $80 of those dollars. The borrower has $80 in cash, and owes the bank $80, for a net worth of zero. The bank has $20 in cash, $80 in assets-an IOU, and liabilities of $100-again, net worth of zero. (and then the person it’s lent to gives it to X for something–and then X has $80, the depositor has $100, and everybody else has assets and liabilities that are equal-it’s only when the borrower spends the loan that we actually see money creation)
Most of the time, this is done with credit balances, it might well be done with the $100 in dollar bills I deposited yesterday. My bank then has 100 dollar bills. It then lends 80 of them out.
But it never lends out a dollar that at least conceptually isn’t the bank’s. In fact, my bank is PAYING ME INTEREST for the right to use my dollars. Most banks are implicitly paying you for the right to do so, as I note below.
Look at the guy who the money was lent to. Forget the loan was from a bank. Say I lend you $100.
Now you spend $80 of it on an antique chair that you aim to sell for $120.
Have you just “spent money you don’t have?” Nope. You’ve spent money you’ve borrowed from me, and we both understand you’re borrowing for the purpose of spending it on something valuable, which you intend to use the profit from to pay me off.
And that’s exactly what a bank’s doing.
A bank would be spending money it doesn’t have if it opened my safe deposit box, and took the quarter I keep in there, and lent it to someone–that’s because I’ve given it to the bank for safekeeping, not as a loan.
That’s why a safe-deposit box costs money-because the bank gets no benefit from it, and a big obligation.
So why is your checking account free (as most are, above a certain minimum balance?)
The cost of the bank storing your money is paid for by your agreement to let the bank loan the money out.
I give $10.000 to bank A. It must keep 1k, but can lend 9k off it to someone. That someone puts it in bank B, who in turn must keep 1k (let’s round up, shall we ?) but can lend 8k off of it.
So bank A ends up with $1000, Bank B has another $1000 and there’s $8000 out there as the last loan - total 10k, no ? Doesn’t matter how many iterations there are if the following banks are only allowed to lend a fraction of the original amount they’ve been entrusted with. Or am I missing something ?
Now, I understand that at any given time, the bank may or may not have as much “real” money as there is on your account - in Pratchett’s words, “The bank promises to give you your money back anytime you want, provided you do not to ask it to”. From what little I’ve studied the subject back in high school, the Depression happened when people stopped trusting the banks and all asked for their money back en masse, thus starting a vicious circle. You don’t want to take the fiat out of a fiat-based system.
But again from what I can understand of the principles of it all before I go into a brainspin (economics tend to do that), the total amount of money in circulation doesn’t increase from bank trades - in fact, wasn’t the mandatory fractional reserve put in place specifically so that banks would quit lending more money than they have ?
