Wagner's opera Gotterdämmerung
is about the twighlight of pagan gods. The most powerful
of the latter-day pagan gods that has been guiding the destinies of humanity
for the past two-score of years is Irredeemable Debt. Before August 14, 1971,
debts were obligations, and the word "bond" was to mean literally
what it said: the opposite of freedom. The privilege of issuing debt had a
countervailing responsibility: that of repayment.
On that fateful day all that was
changed by a stroke of the pen. President Nixon embraced the woolly theory of
Milton Friedman and declared the irredeemable dollar a Monad, that is, a
thing that exists in and of itself. According to this theory the government
has the power to create irredeemable debt -- debt that never needs to be
repaid yet will not lose its value -- subject only to a "quantity
rule", e.g., it must not be increased by more than 3 percent annually.
This idea is so preposterously silly that "only very learned men could
have thought of it". If the thief is thieving modestly, then he will not
be detected. It never occurred to the professors of economics and financial
journalists that a modest thief is an oxymoron, a contradiction in terms. How
did they get to believing in irredeemable debt? The explanation is most
likely found in Schiller's dictum: "Anyone taken as an individual is
tolerably sensible and reasonable. But taken as a member of a crowd -- he at
once becomes a blockhead". Economics professors and financial
journalists are no exception.
For a time it appeared that Milton
Friedman was right. The world has become dedicated to the proposition that it
is possible, even desirable, to expand irredeemable debt in order to make the
economy prosper. Never mind the default of the U.S. government on its bonded
debt held by foreigners. Never mind people victimized by theft. Thanks to the
quantity rule, they will never notice the difference.
For all its seductive
attractiveness Friedmanite economics is ignoring
the effect of irredeemable debt on productivity. It watches debt per GDP and
is happy as long as this ratio stays below 100 percent by a fair amount.
However, what should be watched is the ratio of additional debt to
additional GDP. By that indicator the patient's condition could be
diagnosed as that of pernicious anemia. It set in
immediately after the dollar debt in the world was converted into
irredeemable debt. The increase in GDP brought about by the addition of $1 of
new debt to the economy is called the marginal productivity of debt.
That ratio is the only one that matters in judging the quality of debt. After
all, the purpose of contracting debt is to increase productivity. If debt
volume rises faster than national income, there is big trouble is brewing,
but only the marginal productivity of debt is capable of revealing it.
Before 1971 the introduction of $1
new debt used to increase the GDP by as much as $3 or more. Since 1971 this
ratio started its precipitous decline that has continued to this day without
interruption. It went negative in 2006, forecasting the financial crisis that
broke a year later. The reason for the decline is that irredeemable debt
causes capital destruction. It adds nothing to the per capita quota of
capital invested in aid of production. Indeed, it may take away from it. As
it displaces real capital which represents the deployment of more and better
tools, productivity declines. The laws of physics, unlike human beings,
cannot be conned. Irredeemable debt may only create make-belief capital.
By confusing capital and credit, Friedmanite economics obliterates truth. It makes the cost
of running the merry-go-round of debt-breeding disappear.
It makes capital destruction invisible. The stock of accumulated capital
supporting world production, large as it may be, is not inexhaustible. When
it is exhausted, the music stops and the merry-go-round comes
to a screechy halt. It does not happen everywhere all at the same time, but
it will happen everywhere sooner or later. When it does, Swissair falls out
of the sky, Enron goes belly-up, and Bear-Sterns caves in.
The marginal productivity of debt
is an unimaginative taskmaster. It insists that new debt be justified by a
minimum increase in the GDP. Otherwise capital destruction follows -- a most
vicious process. At first, there are no signs of trouble. If anything the
picture looks rosier than ever. But the seeds of destruction inevitably, if
invisibly, have sprouted and will at one point paralyze further growth and
production. To deny this is tantamount to denying the most fundamental law of
the universe: the Law of Conservation of Energy and Matter.
The captains of the banking system
in effect deny and defy that basic law. They are leading a blind crowd of
mesmerized people to the brink where momentum may sweep most of them into the
abyss to their financial destruction. Yet not one university in the world has
issued a warning, and not one court of justice allowed indictments to be
heard from individuals and institutions charging that the issuance of
irredeemable debt is a crude form of fraud, calling for the punishment of the
swindlers issuing it, whether they are in the Treasury or in the central
bank. The behavior of universities and courts in
this regard could not be more reprehensible. Rather than acting to protect
the weak, they act to cover up plundering by the mighty.
The inconspicuous beginnings of
irredeemable debt have blossomed into a colossal edifice, a fantastic debt
tower that is bound to topple upon the prevailing complacency and apathy.
Actually 'tower' is a misnomer. Rather, what we have is an inverted pyramid,
a vast and expanding superstructure precariously balanced on a tiny and
ever-shrinking gold foundation -- the only asset in existence with power to
reduce gross debt. The construction has no precedent in history, and no place
in theory, whether Ricardian, Walrasian,
Marxian, Keynesian or Austrian. As a matter of fact, no one is analyzing the
process. Research has been placed under taboo by the powers that be, lest
diagnosis reveal the presence of cancer caused by irredeemability.
There is no known pattern or model that would apply to its mechanism in terms
of equilibrium analysis. Two negative conclusions emerge. One is that the
edifice of irredeemable debt must grow at an accelerating pace as markets for
derivatives providing 'insurance' to holders of debt proliferate. The insurer
of debt must also be insured, as must the insurer of the insurers, and so on,
ad infinitum. This is due to the fact that the risk of collapsing bond
values has been created by man. In contrast, the risk of price changes of
agricultural commodities are created by nature, and
the futures market provide insurance, with no need to re-insure. The other
conclusion is that the unwieldy size of the debt structure excludes the
possibility of a normal correction: a major liquidation would dwarf the
calamities of the Great Depression.
It is a delusion to think that the
government can splatter debt all over the economic landscape to cover up its
warts, and reap everlasting prosperity as a result. The stimulation and
leverage of debt has always caused stock markets to boom, so that the impact
of debt was aided and magnified by the added paper wealth which, in turn,
increased the propensity to spend and borrow still more. Businessmen are
supposed to be more realistic in contracting debt. Yet the pattern of increase
in corporate debt has also changed tremendously. Whereas traditionally
corporations used to finance their capital needs in a ratio of $3 in debt for
every $1 in stock, in the years leading up to 1971 they issued $20 in debt
for every $1 in stock, with the ratio sky-rocketing thereafter.
We hear arguments that economists
have by now learned how to control the economy with the so-called built-in
stabilizers. Debt has largely lost its sting as a consequence, we are told.
For example, bank deposits can now be insured. They couldn't in the 1930's.
But when the government itself is loaded with debt, and runs boom-time
deficits, the built-in stabilizers may backfire and destabilize the economy
further. The government has commitments so great that its endeavor
to offset a depression in our vast economy can only result in a loss of
confidence. Anxious withholding of purchasing power in the private sector
could far outweigh anything the government can add. To make matters worse,
government income is highly dependent on a prosperous economy. The magnitude
of the problem of offsetting a depression is grossly disproportionate to
One of the marks of great
delusions is that nearly everyone tends to share them. It is a sorry tale --
any delusion gives rise to a rude awakening in due course. Public attitudes
to debt have changed so radically since 1971 that today indebtedness is
practically a status symbol, instead of a shameful condition it used to be in
a by-gone era. The most striking reversal in traditional American attitudes
towards debt is the widespread acceptance of perpetual national indebtedness,
copied by perpetual personal indebtedness -- a never-ending lien on future
Perhaps the worst aspect of the
regime of irredeemable debt is the lowest level of morals followed by
governments in modern history. It is epitomized by an elaborate check-kiting
conspiracy between the U.S: Treasury and the Federal Reserve. Treasury bonds,
contrary to appearances, are no more redeemable than Federal Reserve notes.
It's all very neat: the notes are backed by the bonds, and the bonds are
redeemable by the notes. Therefore each is valued in terms of itself, rather
than by an independent outside asset. Each is an irredeemable liability of
the U.S: government. The whole scheme boils down to a farce. It is
check-kiting at the highest level. At maturity the bonds are replaced by
another with a more distant maturity date, or they are ostensibly paid in the
form of irredeemable currency. The issuer of either type of debt is usurping
a privilege without accepting the countervailing duty. They issue obligations
without taking any further responsibility for their fate or for the effect
they have on the economy. Moreover, a double standard of justice is involved.
Check-kiting is a crime under the Criminal Code. That is, provided that it is
perpetrated by private individuals. Practiced at the highest level,
check-kiting is the corner-stone of the monetary system.
But our world is still one of
crime and punishment, tolerating no double standard. The twilight of
irredeemable debt is upon us. The sign is that banks are reluctant to take
the promissory notes of one another. Significantly, this also includes
overnight drafts. The banks know there is bad debt at large, and they don't
want to be victimized by taking in some inadvertently. What the banks don't
yet know, but will soon learn, is that all irredeemable debt is bad
debt, and there is no way to rid the system of poison through administering
Redeemability of debt is not a superfluous
embellishment. It has a function of fundamental importance: the proper
allocation of resources to the different channels of their utilization. The
obligation to redeem debt hangs as the sword of Damocles over the government,
just as it does over the head of every economic participant. It compels
economy and foresight. It forces balancing of income and expenditures. It
adjusts claims and commitments. It limits expansion by shifting resources
away from the incompetent, and away from unhealthy projects. The regime of
irredeemable debt creates an escape route from commitments by the promise of
eliminating the pressure of solvency. Whether it promises eternal prosperity,
or it promises eternal subsidies, it does not matter. The results are the same.
They consist in misleading people, enticing them to skate on thin ice, and
luring them into financial adventures, private or public, which are not
warranted by the ability to pay. The logical consequence is wholesale
bankruptcy of individuals as well as that of the political setup. Losses
breed more losses, until they become an avalanche. The present crisis is just
the first sign of that denouement. More is on the way.
It is still possible to escape the
catastrophe which this process would entail. The way out is to open the U.S.
Mint to gold and silver, as advocated by presidential candidate Dr. Ron Paul. The logic of this remedy is that it would mobilize
potentially unlimited resources, presently tied up in idled gold, and
re-introduce the indispensable means of debt-retirement into the economy.
Failing to bring gold back, where
are we heading? The short answer is: we are marching into the death-valley of
collectivism. The alternative to re-introducing redeemable currency is that
the debt-behemoth will force the imposition of a capital-levy type of
taxation -- à la Solon, 594 B.C.
GOLD STANDARD UNIVERSITY LIVE
Session Four is to take place in
Szombathely, Hungary (at Martineum Academy where
the first two sessions were held). The subject of the 13-lecture course is The
Bond Market and the Market Process Determining the Rate of Interest
(Monetary Economics 201). The date is: July 3-6. For more information please
see www.professorfekete.com/gsul.asp or contact GSUL@t-online.hu. Registration can be made by e-mail, and by payment of the
pre-registration fee. The remainder of the registration fee must be paid at
least 3 weeks before the session starts.
Antal E. Fekete
Intermountain Institute of Science and Applied Mathematics
Missoula, MT 59806, U.S.A.
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY. THE
AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING THAT
IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL ANY
SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND SOURCES
BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT IT IS
COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS TO BE
TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright © 2002-2008 by Antal
E. Fekete - All rights reserved