Is Debt Creation Approaching Escape Velocity?

by: Economic Disconnect

This is going to be short because of two factors:

  • I simply do not have command of the subject enough to describe or explain the mechanics at work
  • The topic deserves a full-on post or even a series of posts that I cannot do at the moment

That said, I can point you in some directions and open a debate.

The discussion is about money creation and banking systems. This is important for many reasons and not the least is that the entire foundation of our financial structure is based on assumptions, confidence, and group subscription and these things can go away in a hurry.

Most can understand fractional reserve banking and I often use it as an example because it is easier to grasp than how money gets created in our system. I think if people really knew how things ran they would all panic because the whole thing is a sham. That said, here are relevant posts:

German Central Bank Admits that Credit is Created Out of Thin Air
George Washington posts at Zero Hedge and has some great reporting. Read the entire thing as it really helps, but a small excerpt:

Private banks don't make loans because they have extra deposits lying around. The process is the exact opposite:
(1) Each private bank "creates" loans out of thin air by entering into binding loan commitments with borrowers; then
(2) If the bank doesn't have the required level of reserves, it simply borrows them after the fact from the central bank (or from another bank);
(3) The central bank, in turn, creates the money which it lends to the private banks out of thin air.

It's not just Bernanke ... the central banks and their owners - the private commercial banks - have been running the printing presses for hundreds of years.

Of course, as I pointed out Tuesday, Bernanke is pushing to eliminate all reserve requirements in the U.S. If Bernanke has his way, American banks won't even have to borrow from the Fed or other banks after the fact to have reserves. Instead, they can just enter into as many loans as they want and create endless money out of thin air (within Basel I and Basel II's capital requirements - but since governments keep overtly and covertly throwing bailout money, guarantees and various insider-get-rich-quick schemes at the giant banks, capital requirements are meaningless).

The system is not based on assets. It is based on creating new debts, and then backfilling from there.

Not quite what you thought, huh?

Kid Dynamite Saturday offers more on Friday's post :
More on Bank Reserves and their Potential Meaninglessness
The comments section is where the meat is. It is worth some time.

My take was left in the comments section at Kid's site and I offer it here to frame how I see things:

What the summary here seems to be is that:
-As long as "liquidity" is available then money is fungible because you never really have to have it all at once.

Of course in the end the Fed has a printing press so the argument is that liquidity can never be an issue.

While true in the lawyer/legal sense of the argument, it is also bullshit.

In essence the banking system is built on the idea that money once in motion, stays in motion and there is never a "called all in" to borrow a poker term. Of course back at the apex of the crisis when money markets were being drained, this was a partial call and the Fed/Treasury wet their pants in fear over the removal of a small (relative to the "liquidity" out in the system) amount of real money from the system.

The evidence would make the pie in the sky argument that reserves are meaningless and money can be created from nothing as long as loans (credit) are made a failure because why did they bother to do anything if everything was all set?

Sorry to simplify but all the tangled paths of this make something so simple very complicated.

The oldest profession is prostitution because it is hard to screw up (pun intended) and it is very profitable. The second oldest is banking for the two same reasons. Of course over time smart asses with theories have bent things around theoretical constructs so much that banking is screwed up. Classic. Remember the models and theories that said people would never, ever "walk away" from a home mortgage and never pay a credit card or car loan before a mortgage? Working out nicely indeed.

Taken as a whole it makes sense that debt is created and then some form of payment is arranged some how. The US consumer makes up 70% of the economy? They need to to keep accumulating the debts (money) issued by the banking system. No wonder no one this side of Wall Street can get ahead, everything is designed to maximize separation of you from your "money". I often wondered why the Fed was so terrified of a recession and now we have the answer. Any speed bump in the debt accumulation race and things get ugly fast. Maybe debt has reached escape velocity and we cannot carry enough to backfill it. What then? Now I am dizzy.