Too Much Debt!

Update: January 11, 2013

Congress lived up to their reputation and kicked the can once more.  Essentially, tax rates were raised (such as on those making $450,000 or more and estate taxes went up from 45% to 40%) but spending cuts were deferred for a couple months, entailing yet another round of political saga to come.  So, as the following chart from Casey Research shows, the deficit situation has not gotten any better.  In fact, according to the CBO, it’s worse – earlier estimates had not even considered the interest payments, so the annual deficit will be $60 billion more than originally anticipated.

Fiscal Cliff - Budget Deficit Details

September 22, 2012

On January 1, 2013 the US will face the real possibility of falling off a fiscal cliff and may take down much of the global economy with it. Specifically, the cliff is represented by three factors, which policy makers must overcome in order to avoid another severe recession – or worse, depression.

  1. The Bush Tax Cuts are set to expire at the end of 2012.  At a time such as this, when the economy is stagnant, any tax increases will only serve to further sour any potential business activity. On the other hand, the government annual deficit spending is already at $1.2 trillion and if revenues aren’t increased, budget deficits will only get worse.
  2. Mandatory budget cuts are set to take affect. Last year, when congress was unable to agree on a long-term plan to tackle the never-ending growth of the national debt – now over $16 trillion – the temporary measures they initiated allowed for a small ceiling increase, while putting in place a special super-committee to study the situation and recommend policy. The super-committee came and went without any agreement, which automatically instituted a $1.2 trillion cut in government spending – half from domestic spending and half from defense spending. These cuts are set to go into affect starting in January, 2013 at about $100 billion per month and last for nine years.
  3. The debt ceiling is again being breached. Last year, when the ceiling debate was the centerpiece of discussion, lawmakers were unable to reach agreement on a debt reduction policy. They were only able to conclude a temporary measure, allowing for a small increase in the ceiling while the super-committee furthered the discussion. The current debt ceiling limit of $16.394 trillion is coming up fast.

It should be obvious that the real problem is that there is simply too much debt!  But then again, what should one expect when the whole monetary system has become based on debt? In today’s world, money only comes into existence when someone is willing to borrow it from the banking system. This is why the Fed and all the other central banks try so hard to keep interest rates low – as  more money is borrowed, the banks are able to use fractional reserve banking methods to increase money availability even more. The economy keeps chugging along as long as people and companies are willing to borrow more.

But this debt-based system obviously has its limits, as the current economy has been showing. People and companies are unwilling to burden themselves with more debt.  The Fed’s policies have been trying to overcome that by keeping interest rates low so that the government can keep spending borrowed money in order to sustain the perception that the economy is okay.

It is impossible for the governments to ever repay these debts, which is why the central banks will continue to employ “QE” measures, just as they did in early September, when the ECB in Europe, followed by the US Fed, and finally the Bank of Japan all embarked on major money-printing policies to keep the debt-game going a bit longer.

In relative terms, it wasn’t that long ago when money was based on real, tangible assets, such as gold and silver – assets that couldn’t simply be conjured up out of thin air.  These are the real assets that people should be seeking now, especially since saving cash in a savings account yields next to nothing in interest. Plus, as the governments of the world continue to print money to cover unpayable debts, the value of all fiat paper money will only continue to decline.

However, investors in precious metals will want to get their priorities straight.  Many gold bugs, for example wish to keep their precious metals close – where they can actually touch them. Possession is nine-tenths of the law, after all.  Having physical possession of one’s precious metals has benefits, especially in the case of a complete financial collapse, which some say is inevitable, given the shape of the current over saturated debt system.  Having real money to barter with under those circumstances may be priceless.

On the other hand, not everyone is comfortable holding physical precious metals in substantial quantities. Private storage can be a risk, which should be weighed carefully.  For those concerned about the safety of private storage, or even those seeking diversification can look into alternative ways to hold precious metals. One convenient method is to use Exchange Traded Funds (ETF) traded on stock exchanges. Whether open-ended funds like GLD and SLV or closed-ended funds like PHYS and PSLV, the investor should be aware that there are still risks to overcome, such as the stock market itself.

Yet there are other ways people can invest in precious metals.  Companies such as BullionVault allow their clients to buy and sell precious metals online, via an internet browser.  Once purchased, the metal is physically stored in various geographically separated regions of the world. This immediately accomplishes two things – diversifies assets across national boundaries, which reduces some sovereign risks and also relieves the investor of personal storage responsibilities.

Perhaps some combination of all of the above methods, or others not covered can be sought after for the potential precious metals investor.  When the debt-system finally collapses, people will wake up and remember what real money really is and wonder why they never thought about it before.  It’s funny, isn’t it?  Something so vital to every day activities, yet so little thought is given to what money really is. It’s good that some people are waking up early.

Ponzi Economics

Casey Research provides a lucid interview with David Stockman, former Reagan administration budget director and author of The Triumph of Crony Capitalism.  Stockman explains that in today’s economy, companies are reporting profits today that are “based on a debt-bloated economy that isn’t sustainable.”  Furthermore, “This market isn’t real. … the 2% on the 10 year, 90 basis points on the 5 year, 30 basis points on the 1 year – those are medicated, pegged rates created by the Fed, and which fast money traders trade against as long as they’re confident the Fed can keep the whole market rigged. Nobody in their right mind wants to own the ten year bond at a 2% interest rate, but they’re doing it because they can borrow overnight money for free … put it on Repo, collect 190 basis points on the spread and laugh all the way to the bank.”

“The Fed has destroyed the money market, it’s destroyed the capital markets.  They have something you can see on a screen called an interest rate – that isn’t a market price of money…. that is an administered price that the Fed has set and that every trader watches by the minute to make sure that he’s still in a positive spread. … You can’t have capitalism if the capital markets are dead, if the capital markets are simply a branch office (a branch casino) of the central bank and that’s essentially what we have today.”

The 12 members of the FOMC are the western world’s Monetary Politbureau – “monetary central planners who are attempting to use the crude instrument of interest rate pegging and yield curve manipulation and essentially buying debt that no one else would buy in order to keep this whole system afloat. It’s Ponzi Economics!!

Gold Becoming Widely Recognized as a Collateral Asset

Gold may not “do anything but just sit there on the shelf” but it is becoming more recognized as a safe haven for investors and now, it seems, for bankers too!   There is so much outstanding debt in the global banking system that finding ‘good’ collateral to back it is becoming more difficult. Furthermore, as the debt increases, and maturing debt is rolled over into new debt, traditional asset-backing collateral becomes more scarce.  The Basel Committee for Bank Supervision (BCBS) is considering making gold a Tier-1 asset, which would escalate the desire for banks to hold more of it in their vaults to provide backing for all their debt activities.  Read more at SafeHaven.

John Exter's Inverted Pyramid

Ron Paul on CNBC

Which presidential candidate would you be most be confident would NOT lie to you?  Here’s Ron Paul on CNBC taking up the philosophical arguments no other candidates are discussing, including one hell of a debate on gold and the debasement of the dollar with Morgan Stanley’s Stephen Roach.

A Little Too Close for Comfort

Fox has fired Judge Napolitano after this rant. His intimations were a little too close to the truth.  No, the main-stream media, controlled by the established powers, cannot have a loose cannon like this, can they?

But in a beautifully articulated monologue in his final episode, Napolitano sums up America’s root problems and encourages the people to fight for their freedoms against the tyranny of government!

The U.S. Fiat Currency System

A Discourse on the Federal Reserve System
October 25, 2011

Many politicians and economists always talk about ridding America of its debt.  But the truth is, the system depends on debt to sustain itself.  There wouldn’t be any currency for people to spend unless there was debt that inspired the creation of it in the first place. If the debt is reduced, there will be a corresponding reduction in the currency supply. And if the debt is erased completely, there wouldn’t be any currency at all.  It’s amazing, but true – the system traps its users in a perpetual debt cycle. It’s a scam of epic proportions and only a tiny percentage of the population have grasped the significance of what that means.

Every dollar represents no more than simple debt. A dollar is an IOU from the Federal Reserve.  That’s why every bill actually says “Federal Reserve Note” – a piece of paper which represents a promise by the Federal Reserve to pay you a quantity of dollars. It’s not a promise to pay in gold, silver or anything else of any value.  It only promises the reimbursement of dollars.  The obvious question, then, is why would someone turn in such a note in order to receive back exactly the same note?  It’s a good question, but most people don’t know enough about the currency system in order to pose that question.

The Creature from Jekyll IslandThe following is an explanation of the way the Federal Reserve System works in the United States. It’s a crazy system indeed.  For verification of these facts and a history of central banking in America, the reader is urged to read G. Edward Griffin’s book, The Creature from Jekyll Island.

1. U.S. Treasury creates Bills, Notes & Bonds

The United States Government needs money to operate.  So, the U.S. Treasury sells Bills, Bonds & Notes.  All of these are debt instruments which promise to pay back to the buyer the original purchase price, plus interest, at some time in the future.

2. Federal Reserve buys the U.S. Treasury Debt

Certain banks, known as Primary Dealers, buy the U.S. Treasury’s debt instruments during Treasury auctions. But these Primary Dealers are really only “middle-men” because through Open Market Operations (OMO), the Federal Reserve ends up holding the Treasury’s debt and writes a Federal Reserve Check to cover the cost.

But here’s the important thing to remember – the Federal Reserve doesn’t have any money to cover this check.  The check represents money created out of thin air!!! This is what prompted Griffin to refer to this system as the “Mandrake Mechanism,” referring to a magician of the early 1900’s who was famous for making things appear from nothing.

3. Federal Government gets the Cash & Spends

The Federal Reserve’s check is credited toward the Federal Government in a Federal Reserve Bank account.  From this account, the Federal Government is able to disburse funds as necessary among the various branches of government in order to pay for all the deficit spending, welfare programs and wars.

4. People & Contractors get the Cash & Make Deposits

Government employees and soldiers in the military receive their paychecks.  Contractors get paid for their crony-acquired government projects. The employees, soldiers and contractors then make deposits into their personal bank accounts across the nation. Now the currency creation starts to happen in the commercial banks.

5. Banks Take Deposits & Practice Fractional Reserve Banking

Once the commercial banks get these deposits from their customers, they employ Fractional Reserve Banking to create yet more currency into existence. In Fractional Reserve Banking, the banks are able make loans to other people in amounts much greater than the sum they actually have in their reserves.  For example, if a bank gets a deposit of $1000 from someone, it only needs to keep $100 for its reserve base. The bank is therefore able to multiply that original deposit by 90% and make a new loan to someone else for $900 (90% more currency created out of thin air).  The bank now has reserve assets made up of the $100 from the original deposit plus a $900 loan that generates monthly income from the new borrower. But the original depositor still has a claim on the entire $1000.

6. New Loans are Re-Deposited

All the people receiving these new loans take the money and re-deposit it into their banks. And again, those banks take the deposits and turn them into even more currency by re-employing the fractional reserve banking concept and loaning out more to others.  Following the example used above, the new $900 deposit becomes a source for a new loan by taking 90% of that – a new loan of $810 for someone, generating yet another blast of currency out of thin air.

The above steps are repeated over and over again.  Repetitive iterations of steps 5 & 6 produce slightly less currency in the system than the previous iteration, but in the end, the commercial banking system has been able to create almost 10 times the amount of currency that was created by the Federal Reserve in the first place.

The really interesting point here is not the mere currency creation out of thin air, because many people are already familiar with the printing press concept. What’s really amazing is that all this currency creation cannot happen unless someone borrows it into existence. Our government takes the original loan from the Fed in the first step. All subsequent steps depend on the public to take on debt.  It’s truly a perpetual debt system.

Here’s Mike Maloney explaining all this at the Casey Summit, When Money Dies

There are two more ways which the Fed creates debt currency, which are just additional ways of creating money out of thin air.  These are the following:

  1. The Discount Window. The Federal Reserve uses the Discount Window to allow banks to borrow money to increase their own base supply.  Sometimes banks run short of money because they experience temporary surges in customer withdrawals.  Additionallly, bad loans become problematic for the bank – the underlying assets sometimes need to be written off.  In these cases, the bank’s currency reserve is reduced, placing in jeopardy their ability to maintain their miminum fractional reserve base.
    The Federal Reserve is the “banker’s bank.” The Discount Window allows the banks to increase their currency reserve by simply taking a loan from the Fed. But remember, the Fed doesn’t have any money, so this is just more currency creation out of nothing!
  2. Reserve Ratios. In the examples above and in Mike Maloney’s discussion, a reserve ratio of 10 to 1 (or 90%) was used as the fractional reserve base. But the Fed can alter this ratio specification at any time depending on what it deems necessary.  Essentially, this allows them to increase or decrease the rate at which the currency supply grows at any time by simply re-defining the rules for banks keeping a certain percentage of reserves in relation to their loans.

So the Federal Reserve System is quite a remarkable thing indeed. One wonders how long it will be before the populous wakes up to the scam!

Here are a couple of videos discussing the Federal Reserve and central banking concepts.

Money, Banking, and the Federal Reserve from Mises Media on Vimeo.