Debt is Not Money
"Everything predicted by the enemies of banks, in the beginning, is now coming to pass. We are to be ruined now by the deluge of bank paper. It is cruel that such revolutions in private fortunes should be at the mercy of avaricious adventurers, who, instead of employing their capital, if any they have, in manufactures, commerce, and other useful pursuits, make it an instrument to burden all the interchanges of property with their swindling profits, profits which are the price of no useful industry of theirs."
--Thomas Jefferson letter to Thomas Cooper, 1814.
Are we standing at the edge of a Great Inflation (like Weimar Germany), a second Republican Great Depression, or a return to the middle class prosperity of the Roosevelt/Eisenhower New Deal era? Until Americans understand the difference between "money" and "debt," odds are its going to be one of the first two, at least over the next few years.
Money
"Money" is a convenient replacement for barter in an economy. Instead of my giving you five pounds of carrots, so you wash my car, then you trade the carrots for a new shirt, and the clothing store then trades the carrots to a trucker that brings them their inventory, we all just agree to use a ten-dollar bill. Because a nation's money supply represents that nation's "wealth" -- the sum total of goods, services, and resources available in an economy/nation -- it needs to have a fixed value relative to the number/amount of goods, services, and resources within the nation.
As an economy grows -- more factories, more goods, more services -- the money supply grows so one dollar always represents the same number of carrots. (And with a fractional reserve banking system like we have, that growth is created mostly by banks lending money and creating it out of thin air in the process.)
If the money supply contracts, or grows slower than the economy, then we experience deflation -- the value of money increases, goods and services become less expensive (fewer dollars to buy the carrots), but because the value of money has increased it becomes harder to get. When this happens quickly, because of its economically destabilizing influence (businesses and people can't get current money -- cash -- or future money -- credit -- because money is more valuable), it's called a Depression.
On the other hand, if the money supply expands or grows faster than the economy, there are more dollars than there are goods and services so the number needed to buy a pound of carrots increases. This is inflation, and when it happens suddenly and on a large scale, it's called hyperinflation.
Therefore, one of the most important jobs overseen by Congress and executed by a Central Bank (or the Treasury Department if we were to go with the system envisioned by the Founders and Framers of the Constitution) is to "regulate the value" of our money (to quote Article I, Section 8.5 of our Constitution) by making sure the number of dollars in circulation always steadily tracks the size of the overall economy. If the economy grows 2%, then that year there should be 2% more dollars put into circulation. More than that will create inflation; fewer will create deflation.
Debt
"Debt" is not money. Instead, it's a charge against future money. But even though it's a charge against future money, it can still be spent as if it was today's money -- except that it must be repaid with interest. And therefore debt must have some sort of a balanced relationship to the total size of the economy -- albeit the future economy -- for it not to be destabilizing.
In other words, if over the next twenty years (the term of a typical and healthy mortgage) the economy is expected to grow by X percent or X number of dollars, then the total amount of twenty-year debts that can be issued should be limited to X. But if it's greater than X, then when the future arrives there won't be enough circulating money to repay the debt, because the economy (and the money supply) won't have grown as great as the debt repayment demand. The only two options are for debt holders to default (bankruptcies, foreclosures, etc. -- Depression), or for the government to suddenly increase the supply of money (inflation).
The same is true of one-year debt (credit cards), four- or five-year debt (car loans, typically), and all other forms of debt. In aggregate, if the amount of debt is allowed to grow faster than the economy will grow over the term of the debt, when the debt is due there will be a problem, and if it's grown hugely, a disaster.
This is what we're experiencing right now. Over the past three decades -- largely since Reagan -- debt (both private and public/government) has expanded much more rapidly than the economy has grown. "Now" was "the future" when the debt was issued, but the economy hasn't grown to the point where there are enough dollars (in reality, enough value -- goods and services) to repay that debt. Thus we are experiencing a "wringing out" of that debt -- bankruptcies and foreclosures -- relative to the current wealth of the economy.
This is the most critical thing to see clearly -- without adhering to this simple concept, a government or central bank will always either create boom/bust cycles (depressions/recessions) or inflation. Without regulating debt, a government will be taken hostage and an economy destroyed by for-profit institutions that are able to create debt without regulation (banks).
Panics
Although Thomas Jefferson and Alexander Hamilton -- two opposite sides of the national bank debate -- both understood this simple concept, it wasn't brought into the realm of law until the mid-1930s with a series of strict regulations on the abilities of banks to create debt (loan money), and strong political limits on the ability of government to go into debt outside of wartime. That's why from the founding of this nation until 1935, we experienced a "banking panic" at least once every 10 to 15 years from 1776 until 1935.
Then Roosevelt took the banks in hand, by creating a series of regulatory agencies and empowering them with strict laws. The result was that for fifty years in the United States -- roughly 1937 to Black Monday of 1987 -- we didn't experience a single national "panic" or consequential bank failure. The stock market grew steadily (allowing for the blips surrounding WWII).
It was also hard to get a credit card (short term debt), buy a car (medium-term debt), or get a mortgage (long-term debt) without proving that you would be able to repay the amount in the future -- in other words, that there would be future expanded-economy dollars that you could lay claim to because of your particular job and skills. Credit was regulated.
Reagan changed the rules of the game, particularly when he brought in the anti-regulation Libertarian Alan Greenspan as Chairman of the Fed. He ran up a massive federal debt -- greater than that of every president from George Washington to Jimmy Carter combined -- in just eight years, and began the process of loosening the power of bank regulators.
That process was finished by a Republican Congress (particularly Phil Gramm) and President Bill Clinton (with help from Rubin and Summers) and then booted out the door by George W. Bush, who borrowed even more than Reagan. Bush even used an obscure 19th century law to fight states' attorneys general who wanted to regulate or prosecute fraud among banks and mortgage lenders in their states (see the article by Eliot Spitzer in the Washington Post just before his being outed for sleeping with a hooker).
Green Eyeshades
During the "Great Stability" -- that period from the 1935 onset of the New Deal and the beginning of its end with Reagan's massive tax cuts of 1981 and 1986, leading directly to the stock market crash of 1987 and the S&L debacle -- banking was, as Paul Krugman noted in a recent column, "boring." Credit and currency were considered part of the commons, not something off which a small elite should profit. Like the utilities in the game Monopoly, banks provided a predictable but relatively low profit. Nobody got rich, but nobody lost anything, either.
Bankers were the safe and predictable guys who wore green eyeshades at work and pocket protectors in their shirts. The nation's main products were goods and services; nobody "made money with money" in any big way.
Since the serial deregulations of the financial services sector brought on by Reagan, Bush, Clinton, and Bush, however, bankers became fabulously rich. They called themselves the "Masters of the Universe." They came to dominate contributions to politicians, and facilitated the takeover of most major US newspapers, all the while using debt as their mail tool to make money (burdening those newspapers with such debt that many are now going out of business because they can't repay it).
By 2005, fully 40 percent of all corporate profits in the US came from the financial services sector -- a group of people who didn't produce anything at all of value, nothing edible or usable, nothing that would survive into future generations. They invented fancy derivative "products" that they "sold" at high commission rates around the world so others could "make money with money." In fact, they weren't making money -- they were taking money. Behavior that would have been criminal during the Roosevelt, Truman, Eisenhower, Kennedy, Johnson, Nixon, Ford, and Carter administrations became "normal" and was even encouraged: more than half of all the graduates from many of America's top colleges and universities went into finance so they could get in on the very lucrative scam.
They created debt. As Ellen Brown notes at www.webofdebt.com, according to the Bank of International Settlements, they created and sold at a profit over 900 trillion dollars worth of debt- and risk-based "instruments." That's a pretty mind-boggling number when you consider that the GDP of the United States is around 14 trillion and the GDP of the entire planet is around 65 trillion.
All of these "products" were made and sold based on the assurance that when "then" became "now" the economy would have grown fast enough for there to be enough dollars to pay it back. But the reality of a debt bubble that exceeds the world's GDP many times over came crashing in on us in 2007 -- and still hasn't fully crested -- producing the "crisis" we currently face.
Are we there yet?
Are we recovering from it all now? Will things soon be back to normal?
If by "normal" we mean like life during the "Great Stability," the answer is: "Not a chance." Back then we had in place tariffs and trade policies, first initiated in 1791 by Alexander Hamilton, that protected our domestic manufacturing industries. We still made things -- in fact, the USA was the world's largest exporter of manufactured goods, and the world's largest creditor. Like today's China, for over 100 years we'd loaned other countries money so they could buy our stuff!
On the other hand, if by "normal" we mean how things were over the past 28 "Reaganomics" years -- a stagnating middle class, disintegrating manufacturing sector, and piles of money being made by bets and debts -- then maybe. After just the first decade of Reaganomics, we went from being the world's largest exporter of manufactured goods to being the world's largest importer; we went from being the world's largest creditor to being the world's largest debtor.
None of that has changed. We haven't repealed Reagan's disastrous tax cuts, which have exploded our nation's budget deficits. We haven't repudiated NAFTA and the WTO and gone back to an international trade policy that puts American interests over those of transnational corporations. We have not re-regulated the banks, and have not brought back 6000-year-old laws against usury (excessive interest rates on debt).
The bankers, in fact, are fighting it tooth and nail -- the financial services industry in whole has spent over $5 billion lobbying Congress over the past ten years -- and their acolytes like Lawrence Summers and Tim Geithner play major and consequential roles in the Obama administration.
It appears that the plan today is not to regulate the amount of debt that banks can create, but instead to both print more money and do everything possible to reinflate the debt bubble. (Lacking a return to Hamilton's national manufacturing and trade policy, as a nation we just continue to slip deeper and deeper into Third World status as an importer and debtor -- this may be our only choice if we don't wake up soon.)
If followed, the Summers/Geithner policy can have only one of two outcomes: inflation or another, more serious crash. It's possible we could have both. Apparently the bankers and Summers/Geithner's hope is that neither or both don't happen for at least three and a half years...
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Excellent article Thom. Truly excellent. Great "accounting" of our economic sickness.
The age of debt as an economy must come to an end. We need to take back the currency creation in this country by taking back the Fed and creating at least on National Bank so that people can have some trustworthy place to bank.
Yes, banking will be boring again and the neocons will fight to the death for the right to keep extorting money from our citizens, but we must get the message to Obama that we are NOT in favor of just bringing back the status quo. We need to get the population back to producing and saving rather than just spending.
The middle class is not just stagnating, it is being systematically destroyed so we can have a fascist country- poor people controlled by a central government of the rich, who will continue to stimulate the economy by going to war just enough to line their pockets.
This IS a turning point in this country's history. Which way will we go?
If what you mean is that the Fed should be replaced by a more pure, still arms length, central bank on authority of the US Congress built on the international model, I agree with you!
Ohhh man you're so close!
What you still don't seem to get is that in our current fractional reserve banking system, creating more DEBT is the only way to increase the money supply. Regulating the amount of debt created is the same as limiting the money supply and you will have inevitable depression. The only solution, and I know it sounds to good to be true, is to do EXACTLY what Article 1 Section 8 says, and have the government directly create the amount of new money (not debt money) needed to balance the money supply with the real growth of the economy. Instead of banks lending money into existence (and doing it too much because they profit), the government spends a limited amount into existence by, for instance, paying part of the universal health care bill.
With debt the only way to create money, you get an exponential increase in debt, look at the charts of the growth of the money supply, and the growth of debt, they are the same exponential curve and we are now at the point when the line goes vertical and shoots off the page. We can't keep creating new debt to pay off all the old debt plus compounded interest. The only solution is to END FRACTIONAL RESERVE BANKING.
In our current fractional reserve system, new money is only created if a bank is willing to borrow it. There is no sin in this. It creates a market that allows the government to measure how much new money to create.
In your scenario, the government really would create money out of nothing, and use it to purchase goods and services. This is funny money, and it does not work.
Article 1 Section 8 does not say that. Nothing like that. That is just a chant, displaying ignorance of what it does say.
End fractional reserve banking in your moral crusade against the evil debt based money called the US Dollar, and you will destroy the United States. There is nothing that can replace fractional reserve banking but full reserve or no reserve banking, either of which would lead to disaster.
And what is in place now is a success? For who? For how long, til the repeat of this cycle, in say I don't know, about 20 yrs should just about coincide with the last big one and make no mistake, this isn't it. This is a repeat of the small one of 1907, the big one is coming.
The FED and it's practices have to go.
"There is nothing that can replace fractional reserve banking but full reserve or no reserve banking, either of which would lead to disaster."
How can you verify this claim? Where is your empirical evidence?
Exactly -- did you watch Ellen Brown's presentation on YouTube? Thom Hartmann has had Ellen on his show -- he should know this and should be more pointed about discussing it.
Thanks, I have heard of Ellen Brown before but haven't looked her up yet. I came to these conclusions just from applying simple logic to looking at the monetary system as a whole closed system. My motivation was being mystified how a higher % of a larger population could be working more hours at higher productivity than ever, and be so buried in debt.
I made my own artsy fartsy video of my interpretation (working on a shorter more straightforward one).
http://www
Please help me out...
In one sentence you say....
Creating more debt is the only way to increase the money supply.
Then you say...
We can't keep creating new debt to pay off all the old debt plus compounded interest.
I'm confused. Also... I agree that the government has to spend more money to get the economy back on track (i.e. the recovery package and budget)... but like Thom, I am very critical of the banking plan (which I see as different from the government spending on the economy) which seeks to re inflate the debt bubble.
I feel like we're living on borrowed time. I don't see how we can sustain our national debt.
Thom, Paul Krugman, Frank Rich, Arianna and little folks like me--let's just keep pounding the drum on this issue.
I highly recommend John Bogle's new book. He's the founder of Vanguard Mutual Funds and a lifelong Republican, but he has been making these same criticisms of the financial service industry for DECADES. He's a voice from the free-enterprise right that needs to be recruited to this chorus. He also voted for a Democrat for the first time when he pulled the Obama lever. Thom should interview him.
My fear is Geitner and Paulson are just trying to restore what used to exist. It's over, and it'd be a shame for Obama to be a one-term president over this issue. Wake up! Bring us REAL CHANGE!!!!
1. Money does not replace barter but facilitates barter. Debt is a form of barter. Money remains intact in a debt transaction, it is bartered for a promise.
2. The money supply does not represent a nation’s wealth, just that fraction used to facilitate barter. Money changes hands more than once per year. How fast money changes hands is referred to as velocity.
3. Without understanding velocity, it is impossible to understand the current crisis.
4. Banks do not create money out of thin air. The Fed lends new money to the banks, and through fractional reserve banking, a little more new money is created. The Fed creates most of the new money, and indirectly controls how much is created, except that it cannot force the banks to borrow new money.
5. The government cannot directly set the growth of the money supply because it would require the government rely on a crystal ball to pace money creation and a dowsing rod to measure the economy.
Furthermore, neither the founders nor the Constitution envision the Treasury acting as a Central Bank. A central bank controlled by the Treasury directly issuing money free of debt to keep pace with the nation’s wealth would be creating a people’s script, and it would destroy the United States.
And that Jefferson quote is out of context, banks stopped issuing their own currency, as Jefferson wished. They use the US Dollar and US Treasuries instead, as he demanded in that letter.
Banks *do* create money out of thin air. That is the exact role of the banks in the economy, and why it is possible for the money supply to become out of sync with the actual wealth in the economy. What has gone wrong is that between the shift of the tax burden to from investors to earners, and the dismantling of financial regulation, the banks ceased to have any incentive to moderate debt creation.
and negative real interest rates had a lot to do with this also. I mean that the speculative run up in prices real estate, Treasury obligations, and even stock prices thems selves, was "floated" on a never ending stream of liquidity that flowed excessive because it was (essentially) free(negative real rates). This part of it all rests with Greenspan and his band of blindmen at the Fed.
I think it is important to separate criticism of how moderate certain credit practices are from the question of how money is created in the United States.
To say that all new money is created as debt is not to say that all debt is new money. The twain are not the same.
Certainly, I agree, the tax burden should follow the money, as the US Dollar is a fiat currency, and one of the underpinnings of a fiat currency, that gives it stability, is that taxes must be paid in that currency. If the tax burden does not follow the money, it leads to a lot of well known distortions, obvious to most who look at the current crisis, but a subtle thing that it does is that it weakens the fiat currency, itself.
See? It's the FED!
And we NEED TO END IT NOW!
Actually, this rather seemed to indicate that you need to strengthen the system at the central bank level, not destroy the central bank.
Thom,
President Obama has to succeed...
If he doesn't...
We are in MORE trouble than we are know....
Give the guy a chance....
Because there is no one else to turn to except God.
the end is near but denial is everywhere.
it had to happen.
imperialism has a price.
how few americans know they are imperialists.
700 bases around the world and a mega military budget and a mega industrial military complex and americans think they are the good guys.
lets fix every country in the world.
sad to watch your country self destruct.
afghan will be obama's vietnam.
he is following in LBJ's footsteps listening to his generals.
the mountains of afghan will defeat the americans like the jungle in vietnam defeated the americans.
few will understand my words very few. few understood my words about nam in the 60's.
one can only hope we can bring back the draft then watch americans take notice of their imperialism.
An economy that suddenly becomes unable to sustain the burden of being the worldwide bully, could uncomfortably remind you of how things went in Rome, couldn't it?
I am trying for brevity here---
We have three problems that overlap.
1. The economy is in trouble for fundamental reasons such as the loss of manufacturing, healthcare costs, etc.
2. Then we have the banking crisis which is one effect of the current deflation, following years of inflation, as noted by Thom Hartmann. Thanks for a fine post, BTW.
3. On top of it all we have insane gambling through derivatives.
My problem with Obama's response is that his team is ignoring the fact that the economy is fundamentally weak. They do not want to say a discouraging word because they think this crisis can be solved by restoring confidence. Confidence! If they reinflate the sick economy without making some basic changes the consequences will be instability. We will have the inflation-deflation cycle, or more likely stagflation, just as we did after the Viet Nam war.
There are better way to fix these problems but we need to listen to progressives, not Big Finance insiders like Summers.
Thermo, CONFIDENCE, that's the worst part of it. Just restore it and everything goes back to "normal". Total fantacyland!
I hope you are reading these comments, Thom, because I deeply respect you and would like your insight on my question, not just the insights of other comment makers. (I want to hear other comment makers too, though.)
How do we convince Obama to jettison the Summers/Geithner economics policy and return us to the one that created the "Great Stability"? I have heard you answer questions like this on your radio show by telling us to get active in the party and politics. But that's what we did last year to nominate and elect Obama. How do we now get him on the right track? Please also ask Bernie this next Friday?
Obama promised transparency.
The Geithner-Summers plan is like restoring Detroit without requiring higher mpg cars. The elements are similar- same old leadership, inefficient devices, reliance on confidence and subsidies to make the thing work (for a while). According to former regulator William K. Black this is not fully legal because statutes requiring a more progressive solution were enacted after the savings and loan collapse.
The consequence is instability. If we just rebuild the old house of cards any change will shock the system. We will have repeated bailouts because the fix is only a patch.
Progressives suggest that we break up the large institutions and impose new regulations before spending so much money. We could construct a resilient banking system and avoid hurting pension plans and individuals.
Peyton Young: "It is truly dismaying that the Obama administration, which publicly champions greater transparency, should put forward a proposal whose main object is to subsidise the banks without appearing to do so."
thank you ... end "free trade" ... ahhhhhhhh I get tired of repeating myself. but you are right... I wish someone in power thought so too.
progressive
Progressives suggest that we break up the large institutions and impose new regulations before spending so much money. We could construct a resilient banking system and avoid hurting pension plans and individuals.
conventional
The Geithner-Summers plan is like restoring Detroit without requiring higher mpg cars. The elements are similar- same old leadership, inefficient devices, reliance on confidence and subsidies to make the thing work (for a while). No transparency, and they imply that this is an offer we can't refuse, that here is not another way. According to former regulator William K. Black this is not fully legal because statutes requiring a more progressive solution were enacted after the savings and loan collapse.
the consequence is instability :
They want to get the old potlatch running strong again. If we just rebuild the old house of cards any change will shock the system. We will have repeated bailouts because the fix is only a patch.
The economy is not fundamentally sound. It is leaking value like a sieve because of persistent situations outside of the bank mess: loss of manufacturing base, healthcare costs, prison population, cost of military, costs related to low efficiency etc.
A few useful sources:
William K. Black, Joseph Stiglitz, Nouriel Roubini, Nassim Nicholas Taleb (author of Black Swan), Jeffery Sachs
Thank you, Tom! Always good to hear someone explain the mess in clear and easy terms to understand.
I just don't understand why the government is so oblivious to the problems the banks are causing for the people in this country. I want to keep hope with Obama, but could he please start looking at health care instead of banks for bailout? The results of the disastrous health care industry in this country is killing...
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