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US Debt In The Age Of Unrestrained Central Banking
Submitted by Eugen Bohm-Bawerk
We have shown in the previous three episodes (episode 1, 2 and 3) how the US economy structurally changed after Nixon took the US off gold, letting the Federal Reserve do what it does best. Obviously, with the “hard” anchor of the US dollar cut loose, the rest followed suit. It is telling that the so-called post-Bretton Wood “gold standard” of all currencies, the Deutsche mark lost 65 per cent of its purchasing power from 1971 to 1990.
Also note that the French, with its inferior Franc lost 84 per cent of its purchasing power over the same, time hated the Germans for it. As a “victorious” nation of the Second World War, the French had a right to veto German unification, and would only agree to re-merge east and west if the Germans would give up their coveted mark and join the euro.
But we digress, in the this episode we will focus on debt levels within the context of unrestrained central banking.
Throughout history the US economy used to be leveraged, on average, 1.5 times GDP; total credit market debt fluctuated more or less within a tight range of maximum one standard deviation from its long term mean. Prior to 1971 the only time debt levels really got out of hand was during the Great Depression on back of a 45 per cent decline in nominal GDP. Total outstanding debt, in dollar terms actually fell by 12 per cent over the same time span.
So, the US economy was leveraged 1.5 times its annual output from 1840 to 1971 before fundamentally changing its trajectory. Needless to say, this low debt period was also when the US economy became the world’s largest and most sophisticated (see here) and ultimately a global hegemon.
Growth, on the other hand have moved inversely to the debt level. On a decennial CAGR basis growth in 2015 is only beaten by 1935 in terms of under-performance.
So why did debt levels rise so dramatically after the final central bank restraint was removed? It is essentially due to the massive subsidy central bankers provided. If you tax a thing you get less of it (think all the tax on labour) but if you subsidise it you will get more of it. As time went by, debt obviously grew ever larger and eventually large enough to become an integral part of the business cycle. In other words, central banks could not stop the subsidy for fear of creating, well, a 2008 financial meltdown.
So every time spending growth came to a halt, the central banks would step in and lower rates and consequently also debt servicing cost. With more money in consumers’ pockets spending could resume.
As debt continued to grow, debt servicing cost obviously rose along with it, and the high in interest rates could never reach its previous peak before a new slump in spending occurred. In addition, the central banks always had to lower rates to a lower level than in the preceding cycle to reinvigorate spending.
When debt funded spending could not be stimulated even at zero rates the necessary deleveraging started with devastating consequences for global finance, trade and output.
This process, which Stockman refers to as dishonest market pricing, had even more perverted effects than just rising the overall debt level. It allowed the emergence of debt that consumed current resources without adding to future production. The massive increase in mortgage loans (which per definition must be repaid out the production of the mortgage holder) and financial sector debt helped increase what we call counterproductive debt.
While we get much pushback on this concept – a house is claimed to be productive as it provides housing services – the point is simply that the future productive stream of goods and services needed to repay the resources used in the process to build the house cannot come from the house itself. Taken to its logical extreme, a two week vacation in Spain to recuperate, paid for by consumer debt is also productive in the sense that its can help bring forth a more motivated worker upon return.
The jet fuel, food and services consumed during the two week vacation on the other hand is consumed and can only be repaid by future production; but it did nothing to actually provide the means for which future production can emerge. Unless paid for by prior production, through honest savings, debt funded consumption make society poorer and less capable of meeting its future liabilities. That this is lost on the Keynesians in charge has led to more destruction than any war have ever done.
It is the same with a mortgage. Allocate too much resources to the building of houses paid for by promises to repay from future production and the promised income stream will never materialise, because the means it was predicated upon are no longer available to make the investments necessary. They were consumed in the process of building the houses.
Whilst counterproductive debt rose exponentially from the 1970s, debt taken on with the intent of making a subsequent sale on the other hand remained relatively constant. Productive debt, presumably the kind that is self-liquidating, did not take the central bank subsidy bait to the same extent.
Combining zero interest rates and a massive pile of counterproductive debt leads to a very toxic mix for sound and sustainable growth. Central banks, shell-shocked by the fact that they cannot goose spending at zero interest rates fear peak debt will lead to a massive deflation, starts programs to fund their governments, which can spend.
And spend they do. Government debt is under the category we call destructive debt, pure consumptive in nature without even leaving traces of wealth behind. Mortgage debt, while counter-productive, at the very least leave behind a house.
As the counter-productive part of the outstanding debt went into free-fall, the government, funded by its central bank, started spending and bailing out the very same counter-productive debt. In this phase of the global debt debacle, destructive debt rises to maintain the status quo. This is obviously also the very last stage as there will be no one to bail out the governments of the world when the next deflationary down-leg starts.
It is also worth noting that velocity of money falls when counter-productive debt rises too high in proportion to society’s productive capacity. By this logic, peak debt was actually reached as early as in the mid-1990s, but ever lower central bank rates, the emergence of China with its massive recycling of dollar inflation (more on this later) helped postpone the day of reckoning.
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And why has the debt clock been stuck on 18.3 trillion for months?
Probably waiting for Uncle Hymie to announce Shemitah this year so that we can all be relieved of our crushing personal debts and make merry and have picnics at the lake.
Smegma...yes yes, jewish mysticism, based on bonejawed Gregorian and Kabbalistic timelines has something to do with it.
Prison for central bankers
Death for central bankers
This is a poll - please vote
The next move they will make is to eliminate the debt ceiling completely. It may happen sooner than many may think.
Besides the majority of the general public doesn't even know what it is!
That is a very fair question. I'm thinking until the fiscal year Sept 30 passes and the 500b deficit gets added in- it will ratchet up.
Time to end the FED and go back to the gold standard.
Not just end the fed, but renounce it. Get the supream court to declare the law that created the fed unconstitutional. Just make sure to pack as much garbage as possible on their balance sheet before you do it!
Yeah, let's get the same institutions that have done such a great job in the past, to secure our freedom. It'll be different this time. /s
The supreme court is an organ of that very same system, which includes the gov and Fed. Don't rely on others for your freedom. Don't abdicate your protection to others. Especially, don't hold up those institutions that have proven to be inadequate as a solution, lest you get captured in the tyranny of politics, covered by the illusion of democracy. The Constitution is great in principle, but impossible in long term execution. Best to shrink government to zero.
Okay,I may be guilty of trying to work within the current system. Any way to take down the fed is good with me!
All banks must have physical gold/silver on hand to exchange for paper currency on demand or the paper is useless. I already have some worthless paper.
...and eventually large enough to become an integral part of the business cycle.
anyone who talks about the "business cycle" as if it were an act of god immediately loses my respect. there is no business cycle, there is only the fed gangsters.
anyone who talks about the "business cycle" as if it were an act of god immediately loses my respect. there is no business cycle, there is only the fed gangsters.
No business cycle? What? Cycles are everywhere and you don't see them? Nothing moves in a straight line forever. That's an argument for perpetual motion. Maybe we have a different understanding of what "cycle" means.
I like sound comments.
So you re saying absent the Fed and a stable currency with stable rates- we might never experience the "business cycle." Agree.
If you imagine the "business cycle" as a sine wave around an equilibrium, in the absense of gov and Fed disruption you'd have a smaller amplitude, not no "business cycle". The idea of being in equilibrium without their presense is false. There will always be flucuations around the equilibrium, and that equilibrium will be constantly adjusting itself as technology and culture changes.
Agree. If equilibrium held, there would be no motion. I would go as far as saying existence could not exist.
So you re saying absent the Fed and a stable currency with stable rates- we might never experience the "business cycle." Agree.
No. I'm saying it is impossible to eliminate business cycles. That's what Marxists thought they could do.
What the Fed did was change their nature. Where they were irregularly dispersed throughout different sectors, the Fed has them all syncronized.
If the money supply is in the hands of people who benefit from expanding it (through the interest on loans) then they will over expand it causing a boom. Boom and bust is caused by the banking mafia expanding and restricting the money supply and is not naturally occuring.
We have shown in the previous three episodes (episode 1, 2 and 3) how the US economy structurally changed after Nixon took the US off gold, letting the Federal Reserve do what it does best.
Boy these Mises Monks are prolific.
Richard, "I am a Keynesian", Nixon abandoned the ridiculous gold standard after France recognized it for the "con" that is was. And he didn't do it until the street price of gold was twice the official price. Thus France took gold in exchange for trades which had now become worth twice as much as the dollars the USA government created to make the trades in the first place. The dollars lost their value due to USA government counterfeiting ... and being on the gold standard obviously didn't prevent that.
When you have a hopelessly mismanaged Medium of Exchange (MOE) process, you are going to have these kinds of aberrations.
And tying trading promises to something which is in such short supply as gold and can never deliver zero inflation of the MOE itself and perfect balance between supply and demand ... well, that is action of imbeciles.
I think you are a bit confused about what Nixon did.
The US had been off the 'gold standard' for decades.
http://www.history.com/this-day-in-history/fdr-takes-united-states-off-g...
If you want to get into a large war and transform your economy to do it, you certainly want as few limits as possible.
In my view, FDR was one of our very worst presidents, along with Wilson and LBJ and Shrub.
I don't throw Lincoln in there because, and I've read all the arguments, had the South gone its separate ways, it would have been a battleground between France and England in short order. The South could have dropped slavery, could have proposed a transformation period in terms of their economy. Instead, they hid behind 'liberty' to preserve an economic status quo in which a very large chunk of the population were literally slaves.
The apologetics for the South make a lot of sense...
until you give them a moment's thought.
The apologetics for the South make a lot of sense...
until you give them a moment's thought.
Read Jefferson Davis and Robert E. Lees biographies. Visit their museums ... particularly the Jeff Davis Presidential Library in Mississippi. It takes more than a moment, but has the advantage of "not" being introspective ... i.e. not learning by contemplating your own naval.
It's probably a good idea to read Grant, Sherman, Lincoln, and other northern faction biographies as well. And read about the prison camp in Andersonville. There is much revealed in that history about what the north was really like ... especially the NYC culture.
There's a real contrast that reveals significant disinformation. And we all know, to the victor goes the history. I was brought up northern. As they say, it's easy to fool people. It's tougher to un-fool them. It's taken me lots of work and study ... far more than a moment. The north and the USA I have come to learn has been an embarrassment and a shame throughout my lifetime, as well the lifetimes of my parents and grandparents.
Sooner or later
you run out of other people's credit.
And, sooner or later, you run out of natural resources on our finite planet.
What is missing in this article is the "growth assumption" explicit or implied in all economic models. All are flawed, from Smith, to Marx, to Keynes, to the "Austrian School" and the "Chicago School" of neo-liberals.
Credit obviously depends upon faith that in X numbers of years there will still be plentiful oil and other crucial resources to enable servicing compounding interest on loans, but that is just not possible.
Debt is "borrowing from the future" but, right now, the future for many natural resources looks grim - from oil, to precious/rare metals, to water.
Taking 1750 as the approximate start of the Industrial Revolution (and a bit later for the start of modern economic theories) we have had over 300 years of Industrial Civilization and attendant empires, with the Washington Empire gradually gaining dominance from 1776, so we have reached about the limit for any empire in history ... but it IS different this time.
We have run out of planet to grow/expand into and it can NEVER be replicated, simply because resources have been used up and no amount of credit creation, nor QE can alter that.
"As time went by, debt obviously grew ever larger and eventually large enough to become an integral part of the business cycle. In other words, central banks could not stop the subsidy for fear of creating, well, a 2008 financial meltdown."
Math says one is coming anyway. 100% of bubbles burst. 100% means no exceptions. 1+1 always = 2. Math is also additive. The bigger the boom, the bigger the bust.
Bernanke wrote deflation, making sure it doesn't happen here. What he did was fuel deflation. Inflate a bubble, it deflates. The math never changes. Inflation causes deflation, creating a cycle.
The people have been fighting against bankers for thousands of years. I think it is time we end this nonsense and put them into prisons and turn the banking system over to the people to whom it rightfully belongs. Make the financial system a limited cryptocurrency, publicly owned and operated, and make it run on open source software. Stop the wars, the elite, the corporations and Lloyd Blankfein.
But, but, the Banksters feel that they are mightier than the Gods. Some in fact, have claimed that they are doing "God's Work." The moneychangers have been in power for so long, they feel immortal, that they are the chosen few to lead, rape, pillage, plunder, loot, steal, defraud, rehypothecate and deficate on the many... Simply because they are "better than us useless eaters." Hell, even Mitt Rommney said as much during his unedited fundraiser.
Until, and only until the "many" decide to rise up, and remove the shackles of the few, will we be able to rid ourselves of the degenerative pond scum that call themselves bankers...until then, we are only Muppets, serfs and plebes.
I don't know if you can do away with Banksters, so assuming that, they must be controlled.
Start with the assumption that Banksters will act in their own best interests and by definition, it is not the same as anyone elses best interest. Go from there...
Inasmuch as the creation mechanism of currency is not generally known, and currencies are managed publicly by the FOMC, or foreign equivalents, a pubicly managed cryptocurrency is what you have.
At their initiations they all had procedures intended to insure against run-away currency production. They were universally breached. The temptations involved with voluntary currency limitations have proven beyond men's strength to resist time and again. The lesson is that some confluence of necessity and rationalization in the context of that temptation UNIVERSALLY leads to where we are now.
They would eventually change the mathematical limitations in the currency.
To be secure, it must lie outside human discretion.
Can you imagine how much exponential growth and advancments society could have made without fractional reserve banking and oil consumption?
1) Exponential growth is impossible (On a long enough time line.) on a finite planet.
2) It is precisely fractional reserve banking and the discovery and utilization of oil which has enabled exponential growth and advancements so far.
3) Minus oil we would still be reliant on horses and steam-power, so it puzzles me what "advancements" you imagine?
4) Where do you think advancements like gasoline, plastics, fertilizers and a myriad petro-chemical products come from?
Personally I would settle for my young days when steam engines were common, horses were still common and the bicycle was one's greatest ambition to own, with very few people aspiring to "own a house".
If your comment is sarcastic then that's OK but, taken at face value your comment is absurd, because both exponential growth and "advancements" (howver defined) are the result of fractional reserve (debt/credit) banking AND oil consumption ... along with many other finite resources.
BTW there is no "society". There are just plutocratic rulers of very diverse people within arbitrary geo-political state borders. Tribes were real societies with real cultures. We are a mish-mash who often do not know a next-door neighbour, let alone extensively share beliefs with him/her.
Nationalism has replaced real social ties, so that a mob of thousands chant, "USA, USA." Or, "Yes we can." Without having a clue that each of them have very different ideas about what constitutes the USA, let alone what some drummed-up "enemy" comprizes, such as the Russian Federation, Iran and the myriad countries the Washington Empire has designated "enemies" since 1776.
Nationalism is the last refuge of scoundrels, such as the Austrian Hitler, who invented a mythic Geramanic 'culture' of tall, blue-eyed "Aryans", though being nothing like his ideal ... but millions fell for it in exactly the same way Usans fall for any charismatic showman, "Heil Trump."
While I agree with what we mostly accept as facts here (especially the end of you comment), I beg to differ with your list.
Concerning (2), oil should have merely been a step (your #4) to something else (your item #3) while fractional reserve banking, which benefits remain to be proven, probably deserve retirement today. They remain only because TPTB captured them to ensure their reign. Take that away from them...
Finally your (1), it's your loss if your world is that small: we were never meant to remain on earth. Our survival as a species depends on it (finite earth ressources as you said, end of our solar system etc...).
I should have put a (sarc) tag in there somewhere
http://www.barrons.com/articles/quantitative-easing-redux-1440826605
Quantitative Easing Redux?
Fed officials always try to disconnect the bank’s actions from stock-market gyrations, but history doesn’t support that indifference.
By Vito J. Racanelli
August 29, 2015
If a “rate hike” is Wall Street’s obsession this year, the effective opposite, “quantitative easing,” gets much less mention after three mammoth rounds of central-bank asset buying, or quantitative easing, in the past few years. But what’s that we hear? Another thing the Fed’s Dudley said last Wednesday was, “I’m a long way from quantitative easing. The U.S. economy is performing quite well.”
Fed officials always try to disconnect the bank’s actions from stock-market gyrations, but history doesn’t support that indifference. “It will take less than a 20% decline in U.S. stock prices for the Fed to begin discussing a new round of quantitative easing,” says Darren Pollock, a portfolio manager with Cheviot Value Management.
On several occasions in recent years, a Fed official has stepped in with easing statements following market routs. The Fed knows it can’t let the stock market fall without backpedaling on its tough monetary talk, Pollock says. It must try to keep stock prices from plummeting and pulling down consumer confidence, which could affect the economy.
Stocks recovered big-time last week, but remain vulnerable. Should the market fall some more, Pollock says, “It may force the Fed to do a U-turn and speak of a willingness to provide more stimulus—like QE.”
The Fed won’t let all the effort and money invested in propping up the economy since 2008 go to waste. It won’t stand at the plate and strike out looking. The Yellen put lives.
Competition in all things is the least bad solution to that human stupidity born of arrogance, and it corrollary, human corruption. Market competition should apply especially to the note issue. It doesn't, and hasn't since the 19th century. Although Bretton Woods incorporated some link to gold, it was only marginally better than the totally undisciplined system we suffer with now. Both are based on the notion of legal tender, not competition. Bretton, both during and after, is a distinction made in theory that had no fundamental difference in practice. Stop making it.
Competition in all things is the least bad solution to that human stupidity born of arrogance, and it corrollary, human corruption. Market competition should apply especially to the note issue. It doesn't, and hasn't since the 19th century. Although Bretton Woods incorporated some link to gold, it was only marginally better than the totally undisciplined system we suffer with now. Both are based on the notion of legal tender, not competition. Bretton, both during and after, is a distinction made in theory that had no fundamental difference in practice. Stop making it.
Duplicate post, perhaps for emphasis.
This article clarified some concepts of productive debt (self-liquidating) versus comsumption debt (paid off in the future by unknown means) that helped me understand debt better. Turns out that most of my expenditures are now geared toward turning a profit in the future. Still difficult to predict the future though.
We should talk about Debt to GDP less and talk about Debt to Revenue more. We're #3 in the world behind Japan and Greece!
Debt-based consumption has to be deflationary because for the money-lenders to make a profit they need to extract more than they put in.
Credit front-loads demand in the short term but the net effect in the medium term is a reduction in demand to pay off the debts.
With enough restrictions placed on debt-based consumption the damage done to an economy by the banking mafia is no worse than a bit of vampiric bllod sucking but when all the restraints come off - which is what happened over the last 30 years or so - then the target economy is doomed and incredibly fast.
Who are the shareholders of the Fed?
The lesson Bretton-Woods taught us in 1971 is that a currency system disciplined by gold exchange at the Treasury or Central Bank, ensures no exchange, no discipline, and no gold.
If it is not excusively produced by nature, and currency of itself, not requiring exchange... then it is merely a human promise, easily made and even more easily broken.