One of my readers sent the following question. It touches on some of the irrationality and outright foolishness that follows when a nation gives up it gold- or silver-based money and replaces it with a fiat (paper or digital) currency:
“I’m having a hard time understanding how Detroit or anyone can have a debt; if there is no real money, how can there be a debt?
“Without real money, how could there even be a bankruptcy court, or bankruptcy protection? If all we have is debt paper for currency, that debt paper is lent into existence, backed by nothing, how can there be a debt? I’m not trained in finance/accounting but this whole system is insane and makes no sense to dummies like me.”
First, your premise that our “debt paper for currency” is “backed by nothing” isn’t quite true.
It’s true that our fiat dollars aren’t back by anything tangible, like gold or silver. However, since A.D. 1971, paper dollars have been backed by the American peoples’ “full faith and credit”. “Full faith and credit” is fancy language for asserting that the American people will make good on the debts created and denominated in fiat dollars.
Thus, the national debt and the value of the fiat dollar are backed by your signature; by your presumed or implied promises to pay that debt.
The “official” national debt is $17 trillion; Shadowstats.com says it’s closer to $90 trillion; the Congressional Budget Office says that, including unfunded liabilities, the national debt is over $200 trillion. Depending on whichever total sum you choose to believe most accurately describes the true national debt, your personal “fair share” of that debt may be roughly $50,000, $300,000 or $650,000.
So, how much extra money do you have? How much of your fair share do you plan to pay?
I’ll bet that after you explain why you’re in a bind just now (the kid needs braces, Christmas is coming, etc.), your answer is Zee-ro. You aren’t going to voluntarily pay anything on the national debt.
How much of my “fair share” of the national debt do you think I plan to voluntarily pay? Answer: Zee-ro.
Do you think the rest of America is any different? Talk to 100 people. Explain that they each owe somewhere between $50,000 and $650,000 as their fair share of the national debt. Ask them how much of that debt they plan to pay and how soon government can expect their check. It’s conceivable that two or three out of one hundred might agree to pay their full “fair share”—but it’s not likely. It’s certain that at least 97% will refuse to voluntarily pay that debt.
Ask the same questions of all 310 million Americans, and you’ll probably get similar replies. Ohh, they may not object to other people being held liable for the national debt. But how much are they able and willing to personally pay? Just about Zee-ro.
Given that virtually no one is ready to personally pay his fair share of the national debt, what’s the true value of the “full faith and credit of the American people” that’s allegedly backing our national debt and our fiat dollars?
It’s also just about Zee-ro.
Why? Because you will break your presumed and/or implied promise to pay your “fair share” of the national debt. So will I. So will just about every other living American.
So, what are the real values of the national debt and fiat dollar backed by the “full faith and credit of the American people” if the American people aren’t able or willing to pay their fair share of the national debt?
Pretty close to Zee-ro.
Americans are no more likely to voluntarily repay our national debt than Greece, Cyprus or Zimbabwe. So, when that debt finally comes due, those creditors holding the paper debt-instruments (stocks, bonds, bank accounts, 401(k)s, etc.) are going to take a “haircut”—just like they did in Greece, Cyprus and Zimbabwe. Those creditors who trust in the “full faith and credit of the American people” are going to get just as screwed as those who trusted in the “full faith and credit” of Greece, Cyprus or Zimbabwe. They’re gonna lose their assets.
First, because you, and I and the rest of America don’t have the money or even sufficient net worth, to pay the national debt.
Second, because we say in our hearts, “Screw the debt–let someone else pay it.” We aren’t about to personally kick in $50,000 to $650,000 to pay off the national debt.
The purpose of this analysis is to illustrate that you will not personally pay your fair share of the national debt. If you won’t pay, what makes you think I will? Why should anyone else?
Once you recognize that you won’t voluntarily pay your fair share of the national debt, you can extrapolate that recognition to see that virtually no one will voluntarily repay that debt—and therefore, most of that debt won’t ever be paid.
Sooner or later, almost every creditor who loaned currency to the US government will come to the same conclusion. Sooner or later, everyone holding a piece of the US national debt or storing their wealth in the form of paper dollars will lose most of their purported wealth and recognize that they’ve been playing the fool.
If I borrow $100,000, I sign a note for $100,000. That note is my “promise to pay”. Someone then holds that note and treats it as an asset. If you ask them, they’ll tell you that they have $100,000 in “savings” because they have a piece of paper with my signature on it. (When you think about it, isn’t it almost laughably foolish for anyone to believe that piece of paper bearing someone’s signature is a form of wealth?)
But, if I go broke, I can’t pay my debts. I can’t make good on my promise to pay. If I can’t pay my debts, I destroy the value the paper debt instruments that memorialize each of my debts. If I go broke, my $100,000 note becomes worthless and the man who thought he had $100,000 in savings will learn the difference between a “payment” (receiving something tangible) and a “promise to pay” (receiving a signed piece of paper).
But it gets worse. In a debt-based monetary system, bankruptcy doesn’t just wipe out the debtor’s debts, and the creditor’s assets, it actually destroys that part of the money supply that’s based on the debt. Because bankruptcy in a debt-based monetary system (like our) makes currency disappear, bankruptcy diminishes the national money supply and attacks the economy itself. Thus, we have three “losers” in a bankruptcy proceeding: the borrower, the creditor and the economy.
• This three-party loss wouldn’t happen if we had a 100% gold- or silver-based monetary system.
I.e., if I borrowed $100,000 in gold and I went bankrupt, I couldn’t repay the $100,000 in gold and the paper debt instrument that memorializes that debt to my creditor would also be worth zero. I’d be broke and my creditor would lose $100,000 in gold.
But the $100,000 in gold would still remain in the hands of multiple people within the economy. I would’ve borrowed the gold and spent the gold (foolishly, perhaps). I might not have any more gold, but the gold I’d borrowed would still exist.
I’d be bankrupt for being a fool, and the man who was fool enough to lend me $100,000 in gold would also suffer a $100,000 loss. But the gold/money would still exist in the hands of people who were not so foolish and the economy, itself, would not be diminished. I’d be diminished; my creditor would be diminished; but the economy would not be impaired by my bankruptcy.
With paper debt instruments, that’s not so.
If I go bankrupt, my $100,000 note becomes worthless, my creditor loses $100,000, but so does the economy. The currency/credit which was created in the original loan and which became part of the national money supply would cease to exist.
More, because of fractional reserve banking in a fiat monetary system, if I signed a $100,000 note, the banking system could use my note as collateral to lend ten times that much ($1 million) to other borrowers. Therefore, if I go broke, my $100,000 note not only becomes worthless, but the bank may have to “call in” $1 million in loans based on my failed $100,000 note.
Now the economy is in big trouble. It hasn’t merely lost $100,000–it’s effectively lost over $1 million.
That couldn’t happen with a purely gold- and/or silver-based monetary system because banks can’t “spin” ten ounces of physical gold out of thin air for every ounce of gold they loaned out. Spinning dollars out of thin air is only possible—and highly profitable–with paper or digital fiat currencies. That’s why central bank love fiat currency and hate gold and silver. Bankers can’t make a fast buck off gold or silver. They can off fiat dollars.
• The obvious (but seldom recognized) point is that currency in a debt-based monetary system is made of debt (promises to pay) rather than tangible assets like gold or silver. The debt instruments generated by loans become part of the “money supply”. Therefore, every bankruptcy in a debt-based monetary system doesn’t merely destroy the debt owed by some unfortunate borrower and cause creditors to lose their assets—it destroys some of the debt-based currency itself and thereby threatens the entire economy.
That threat isn’t confined to individual bankruptcies. Suppose the US government is declared to be bankrupt—what happens? The national debt is wiped out and however much of that debt is held by foreign countries is also wiped out. The consequent loss of currency could cause the whole world economy to collapse.
Again, that can’t happen with a 100% gold- or silver-based monetary system. The US government could go bankrupt and there’d be a big problem for the US economy. Americans would be mad. A lot of politicians would be thrown out of office. But the actual money (gold/silver) that the US had borrowed would still exist. Those who’d treated the gold/silver foolishly would lose their gold/silver. But the gold/silver lost by fools would still exist in the hands of people who were more prudent and the economy would not be impaired.
• Bankruptcy punishes fools and teaches prudence.
In a gold- or silver-based monetary system, the only fools punished are the borrower who defaults and his creditors.
In a debt-based monetary system, the original borrower is punished for playing the fool. His creditors are punished for being fool enough to trust the borrower. But the entire public—and thus, the economy—are also punished by seeing their national money supply diminished.
Does it seem unfair that the people at large are punished? It’s not. The people should be punished for being fool enough to allow their government to subject them to a debt-based monetary system.
In a gold/silver-based monetary system personal bankruptcies can actually strengthen the economy by:
1) Taking gold and silver out of the hands of fools and placing it in the hands of the wise; and,
2) Serving as an object lesson to teach all others what kind of financial behavior is foolish and self-destructive and what behavior is wise and profitable.
But in an economy built on a debt-based monetary system, widespread bankruptcy poses an enormous threat that must be avoided wherever possible in order to avoid destroying the “money supply” that’s composed of nothing but debt made from an illusory fiat currency. If enough debt is destroyed, enough currency may be thereby destroyed and the result can be deflation, depression and economic collapse.
That’s why we have “too big to fail” banks. They’re not “too big to fail”; they’re “too big to bankrupt”.
Any bank that’s deemed “too big to fail” is, by definition, incompetent and foolish. Technically, they’re the worst banks you could possibly invest in or trust. In a gold- or silver-based monetary system, such banks would be executed in bankruptcy for the “sin” of financial recklessness and irresponsibility.
But in a debt-based monetary system, if government allows the “too big to fail” banks to slide into bankruptcy, under fractional reserve banking, the economy might suffer the loss of ten times as much currency from the “money supply” as the bank was worth. If the “too big to fail” banks were allowed to slip into bankruptcy, the resulting destruction of paper and digital dollars could be enough to collapse the US and even global economies.
• A fool and his money may be soon parted in an economy based on gold and silver money. But, in the fiat monetary system, the greatest fools (the “too big to fail” banks and governments) are protected and even rewarded for their foolishness by giving them even more currency. Because we can’t risk having our greatest fools slide into bankruptcy, we must keep them “alive” at any cost. Therefore, we have Quantitative Easing to give more money to our biggest fools.
Who are our biggest fools?
We can identify them by asking Who’s getting the currency under Quantitative Easing?
Answer: The Federal Reserve doles out $85 billion each month that’s being divided roughly 50/50 between the big Wall Street banks and the federal government.
Thus, America’s biggest fools are the big banks on Wall Street and the federal government. The Wall Street banks are technically bankrupt because they hold billions, even trillions of dollars in derivatives that will one day require payments that can’t possibly be paid. The federal government is technically bankrupt because it holds a national debt that can never be paid in full.
By protecting our greatest fools from bankruptcy, we become fools, ourselves.
1st Implication: The federal government and the Wall Street banks are our least competent institutions and biggest fools (with the possible exception of the American people who allow this crap to continue).
2nd Implication: Insofar as we allow our biggest fools to run our government, economy and nation, we are inevitably headed for a national catastrophe. (If you’re going to put your trust in fools, you are a fool—and you are heading for a fool’s reward: poverty.)
3rd implication: All of this foolishness (and our inevitable economy collapse) flows from the fundamental foolishness and irrationality of replacing a gold- and silver-based money with a fiat currency.