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  • Our exponential debt system

    Gold coins The word “debt crisis“ has made it into everyone’s vocabulary by now. People are talking about how we were “living beyond our means” and are debating how spending cuts, tax raises or some combination of the two could be used to salvage the situation. However, often times there is a gross misunderstanding about why there is so much debt in the first place and why it seems to constantly grow. Many people fail to see that growth within our current monetary system relies on exponential increases in debt.

    To understand the debt crisis, you have to understand that in reality this is a “money crisis”. Let me explain this further.

    Today, all money is created in the banking system. It originates from the central bank and is brought into existence by an extension of its balance sheet. This means that there it is a simple booking entry: new money on the liabilities side, and debt on the assets side. Yes that’s right: money is created through credit – which is nothing but a nice word for debt. In contrast to most of human history – where money has been a tangible asset with intrinsic value attached to it, such as gold and silver – today all dollars, euros, pounds and all other currencies are based on debt. This is taken on by governments, companies and private citizens all over the globe. Implicit in this is trust on the part of lenders that this debt will be repaid one day in the future.

    So what's the problem? Let’s say you take out a loan for $100. The money you receive will be created from nothing once you sign the paper to take out the loan and you are then obligated to pay back $105 after say one year. Now here is the all-deciding question: Where is the interest coming from that you need to pay back the loan? At the moment the only money in circulation is your $100. The only way to solve this riddle is that somebody somewhere in the economy has to take out another loan to create the money that enables you to pay back the first loan.

    This in essence is how our so-called “modern” monetary system works. It can only work if there are always people who are willing to take on new debt. This is because if people start paying down debt instead of borrowing more, then bank lending collapses – leading to drops in broad money supply measures such as the Federal Reserve’s M2 measure. (The Fed used to publish an even broader money supply measure, M3, but stopped reporting this number back in 2006). This will make it even harder for the remaining debtors to find the money they need to pay back their debts, because to recap: the interest is always missing and there is always more debt than money. This is what many call the “deflationary death spiral” in which more and more money (credit/debt) disappears leading to the insolvency of remaining debtors (which equals wealth destruction on the side of the creditors). This leads to a standstill in economic activity (companies fail, because falling prices halt consumption) and therefore skyrocketing unemployment. This is every politician and central bankers’ worst nightmare.

    This is the reason why in our current system it is deemed politically impossible to reduce overall debt. There can be deflationary shocks – as seen in 2008 – but central banks will fight such deflation tooth-and-nail in order to prevent the aforementioned deflationary death spiral. In practice, this means buying lots of bonds (public and private) off of banks – purchases that are funded by newly created electronic money. In order to maintain debt-based growth and avoid short-term economic collapse, government debt must expand in order to compensate for the collapse in private debt growth. This also applies in reverse: the government can reduce its debt, but only if the private sector increases its debt, so that total debt and therefore the money supply doesn’t shrink.

    So why can this debt based system only work for short periods of time? Think about what happens if we do not pay down debt. Due to compounding interest the amount of debt will keep rising automatically – and exponential. The current financial structure can therefore only be stable if economic activity increases along with the debt so that the debt is still backed by something (the labour of the debtor) and doesn’t turn “toxic”. This experiment has been going on for over 40 years now, ever since Nixon "closed the gold window" in 1971. We’ve come to the point at which economic growth can no longer hold pace with the unmerciful debt machine. Therefore the relative debt levels (debt to GDP) are constantly rising – a clear signal that should have anyone worried.

    During the last deflationary shock in 2008 the world’s major governments stepped in to prevent the system from collapsing by rescuing many bankrupt institutions. By doing so they have become insolvent themselves – as is becoming more and more apparent in Europe. But all developed economies are to one extent or another facing the same problem. The fiat money system is in dire need of somebody still able and willing to take on debt to keep everything running. But we’ve reached a point of debt saturation. And even if we were to find new debtors this would only buy us a bit more time – and a greater altitude – before the inevitable fall.

    By mathematical certainty the debt money system must and will collapse. Either through the described deflationary collapse or through ever-larger "rescue packages” (a euphemism for money printing) whereby the public is forced to take on the toxic private debt by devaluing the currency. As people lose faith in fiat currencies, a resulting hyperinflation will produce the same result as the deflationary collapse. Promised payments from debt instruments will implicitly or explicitly be defaulted on.

    To sum up: In a debt based fiat money world there will always be debt for if there was no debt there would be no money. Since debt is not paid off, the compounding interest on it forces us to grow at the same pace. Since this experiment has failed we are now facing the collapse of this debt system. Prepare yourself accordingly by diversifying into tangible assets such as gold and silver, and by educating yourself and your loved ones about the nature of the economic challanges they are likely to face in the years ahead.


    Author: Chris Volke
    Jan 19 10:10 AM | Link | Comment!
  • Who is going to buy all that debt?
    2012-JAN-03

    A pyramid of debtThe price of gold started the year on a positive note, rebounding from support at $1,550 per troy ounce back towards $1,600 and extending its decade long bull market. The future looks just as bright for the yellow metal, as real interest rates remain negative around the world and, as Bloomberg reports the world’s largest governments are facing the daunting task of refinancing over 7 trillion dollars in 2012. As the markets’ appetite for sovereign bonds dries up and the perception of fixed income as “riskless assets” goes the way of the dodo, the easiest way out for the debtors will be to print and inflate.

    Improving macroeconomic numbers from the US are being seen by some economists as the first signs of accelerating inflation, especially given the rise in key energy and agricultural commodities, while others are playing the “green shoots” song again. Meanwhile the Chinese slowdown, exemplified by the Hang Seng Index’s 9 month and 25% drop, has sparked increasing concern over whether the Asian giant will see a soft or hard landing, and how that will affect the world economy. Both Japan and China will be less enthusiastic buyers of US sovereign debt, unless of course it is done with newly printed money and for currency manipulation purposes.

    The demoralizing end of year drop in the price of gold spooked many gold bugs, however, “If you can keep your head when all about you, are losing theirs…” and take a few minutes to look at the fundamentals, you will see the wisdom of holding onto your gold, and perhaps even deciding to buy some silver, which at under $30 per troy ounce is looking like a real bargain. As long as the long term bullish trend is undisturbed and the fundamentals remain in place, the best plan is quiet, steady and methodical accumulation. Emotions are always the enemy of prudent investment and saving.

    Spain’s announcement today that the budget deficit will overshoot 8% (when the official target was under 5% just a few months ago), casts a long shadow over the euro. We are well past the point where the euro-periphery trembled but could hope to be bailed out by the euro-core.

    In the US the primaries, starting with the Iowa caucuses today, will see foreign policy compete with the fiscal crisis for the spotlight. Whatever the outcome, precious metals will remain the only store of value that do not depend on someone else’s promise and that cannot default.

    Jan 03 8:16 AM | Link | Comment!
  • Euro crisis: the end of the beginning?
    2011-DEC-21

    Dow Jones ticker A slew of better-than-expected US economic statistics and improved German economic data resulted in a boost for stocks and commodities yesterday. Gold and silver prices also rose as demand for the US dollar slackened. The European Central Bank has also started a major new lending programme today, encouraging hopes that – to paraphrase Churchill – though this may not be the beginning of the end of Europe’s debt crisis, this ECB move might at least mark the end of the beginning.

    As explained by Ambrose Evans-Pritchard at the Telegraph, and mentioned in a previous GoldMoney News article, European banks will now be able to borrow unlimited amounts from the ECB for up to three-years at 1%. The ECB has loosened the collateral requirements on these loans, meaning that banks are free to buy higher yielding eurozone sovereign debt – yielding 5-6% – and use these bonds as collateral for 1% loans from Draghi’s ECB. These “long-term repo operations” (LTROs) will thus allow banks to earn an easy 4% spread – bolstering their balance sheets and (it’s hoped) increasing demand for distressed eurozone sovereign debt. The ECB has also lowered reserve requirements in the hope of freeing up an additional €100 billion for bank lending.

    As with the moves a fortnight ago by the world’s central banks to increase dollar swaps with the US Federal Reserve, this LTRO move is essentially a camouflaged form of quantitative easing. Though as with all these measures, the plain English phrase “money printing” is as ever conspicuous by its absence from media reports on this development; “new liquidity” is the euphemism of choice. Initial reports suggest (unsurprisingly) strong demand from banks for these loans, with €489bn lent where analysts had expected just €300bn.

    Thus, we get another demonstration of the lengths central banks will go to in order to keep the financial system inflated. As famed American investor Richard Russell puts it, central banks must “inflate or die”. Certainly, anyone who still harboured any illusions about the ECB’s “hawkishness” should have been disabused of such notions by now, with the British think tank Open Europe releasing a report yesterday analysing the ECB’s growing “exposure to struggling eurozone economies.”

    Open Europe notes that “contrary to popular opinion, the ECB is already heavily intervening in markets… its exposure (to peripheral eurozone debt) now stands at €705bn, up from €440bn in early summer – an increase of over 50% in only six months, raising fresh questions about its credibility, independence and possible losses it may face in the case of future sovereign defaults.”
    Author: The GoldMoney News Desk

    Dec 21 9:28 AM | Link | Comment!
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