The US Debt Ceiling Debate In The Light Of Monetary Fundamentals

By mid-October, the US will have reached its debt limit … again. Most have lost track of the exact debt limit and of the number of increases. Give or take a trillion, the limit currently is between 16.5 and 17 trillion US dollar.

Zerohedge specifies that the current US debt ceiling is 16.7 trillion dollar, and that it was hit back in May of this year. “The minimum required permitted debt at December 2014 will be an increase of $1.1 trillion, or $17.8 trillion in total, or about 105% of GDP.”

The following two quotes are from a recent Wall Street Journal article:

“As that [the recent bond market turmoil] settles down, the next major political hurdle is the debt-ceiling debate.”

“President Barack Obama has said he won’t negotiate over the debt ceiling, but Republicans want new spending cuts. House Speaker John Boehner said in late August that he’ll only vote to increase the limit if there are major cuts and other budget changes.”

This story triggered some questions here at Gold Silver WorldsFirst, what are the risks associated with the increasing debt burden? Second, are the governments helping us [ordinary people] in providing protection? In other words, should we act before it is too late or believe that someone will take care for us? Third, how could this debt story end up? Although answers to those questions are to be found across many articles on our and many other similar sites, we considered it useful to look again the monetary fundamentals. They put the coming debt ceiling debate into perspective.

The basics: Money is backed by debt and created out of thin air

In order to answer the three aforementioned questions, we should go back to the roots of today’s monetary system. The underlying question is: where does money come from in the first place?

An answer is provided by Global Gold’s recent video How our monetary system works and fails, a must-see micro-documentary. A shorter explanation comes from Positive Money‘s video in which a ten year old child explains where money comes from and the problem associated with it (source):

Every bank note has [the Central Bank] printed on it. But the Bank of England only creates 3% of all the money in the UK. Where does the other 97% come from? It’s just numbers in a computer system. It’s electronic money created by high street banks. When you borrow money, it doesn’t come from somebody else’s savings. The amount you borrow is actually brand new money, created by the push of a button.

Martin Wolf at the Financial Times explains: “The essence of the contemporary monetary system is the creation of money, out of nothing, by private banks’ often foolish lending.”

We need money for everything we do, but the only way we can get it in the first place is to borrow it from the banks. That’s why the government wants to get banks lending again — to get them to create even more money. But the whole problem is there’s too much debt. So how can the answer be for us to borrow even more? As long as banks create money by lending it to us, we’ll always be in debt!

Moreover, as we all know in the meantime, the monetary base of Western economies has exploded since 2009. In an attempt to stimulate the economy by providing liquidity, it is increasingly clear that central planners need bigger efforts to reach their goal. The following up-to-date chart shows the US central bank monetary base increase in blue and the money supply increase in red. Mind the pace to which the blue line must rise to keep the red line growing. The importance of the money supply should not be understimated in our current monetary system, because of its strong correlation with GDP growth. Courtesy: St. Louis Fed.


As a sidenote, it seems unbelievable what the most powerful man on earth, when it comes to monetary matters, has to confess about the destination of the newly created money. Check it out in this video (listen for one minute).

Boom and bust cycles are the underlying issue

The debt based monetary system we are living in, combined with the efforts of central planners to magically create wealth by pumping liquidity into the market, results in a misallocation of investments and economic resources. The following quote from Positive Money makes this point clear (source):

“Banks are systemically biased towards lending to property. This is a fundamental problem. In the capitalist system, the main idea is that money will flow to productive businesses. What we have got now is a system where the banking sector does not want to lend to the productive part of the economy. It can only lead to the collapse of the system.”

The essence of this monetary system is that it feeds a boom-bust cycle. Banks are the ones who CREATE money in our economy (hence increase the money supply) which they do by providing loans. The money associated with loans is almost entirely created out of thin air. The fundamental issue is that banks provide loans primarily to the public and not to productive businesses. Those “consumers” of the loans are able to spend more, and it goes on till a bubble is created which ultimately pops (think the real estate bubble, entirely created by foolish lending by banks). Then suddenly banks panic and stop lending which results in the contraction of the monetary supply. A recession is the result with rising unemployment and bankruptcies. All that can be avoided by a stable money supply and hence a stable economy. Boom bust cycles are the issue, not psychology of businesses.

Central bank liquidity as the main driver

The power of central bankers goes beyond the power of politicians. In that respect, think of central bankers from the large economies (Mr. Bernanke, Mr. Draghi, Mr. Carney, Mr. Abe). By conjuring never seen amounts of (cheap) money they are perceived to have saved the economic system. The reality, however, is that they have postponed a fundamental issue to a later moment in time, making the issue bigger meantime. What none of these powerful men have talked about is the destructive consequences of their actions. In fact, they have ruined a lot of lives of innocent people. Savings do not yield anything anymore in real terms (a savings account is losing value), and some pension funds are cutting back the benefits of their retirees. One of those ordinary citizens in the UK testifies “I do not understand what Quantitative Easing is apart from printing money. What I do understand, however, is that I do hold 50% less as a result of that.” (source)

The central bankers have engineered a massive transfer of wealth from the old savers (who have no yields) to the young borrowers (who have cheaper debts). The Bank of England has admitted that Quantitative Easing has cost savers and pensioners in Britain 100 billion dollars so far.

Mr. Mark Carney his answer basically points out that the unintended consequences of quantitative easing could indeed be painful, but the world would have been in a much worse shape WITHOUT quantitative easing. So we should still be happy! Listen to his answer in the video.

“The underlying economy that would normally support this isn’t there. It is a false kind of tide that everybody is riding. The entire world is in a bubble. Every asset class is in a bubble: real estate, bond market, stock market. Something is going to prick it.”

A nightmare scenario: our monetary system has reached its limits

We are not into conspiracy nor do we like to talk about collapses. But, unfortunately, facts and data point to the real possibility of a nightmare scenario which is centered around the idea that this debt based monetary system could be reaching its natural limits. Moreover, it is fed by the unprecedented monetary expansion which is showing signs of exhaustion in terms of its effectiveness. It is a fact, for instance, that every dollar of incremental debt is resulting in 0.08 dollars of economic output (GDP); the same dollar of debt yielded 4.61 dollars of economic output (GDP) in the fifties. Chart courtesy: Incrementum.


From a recent presentation by Darryl Schoon:

When a credit and debt based economy slows down it is called a recession;  when it contracts it becomes a depression. Credit and debt based economies (which we call capitalism) must constantly expand because the money fed into it goes in the form of DEBT. All money created in capitalist economies comes in the form of loans. There is so much debt because that phantom of money is nothing but a debt machine with a happy face plastered on it loaning you money so you can pursue your dreams (whether it is to buy your house or – in the US – to take education).

What you don’t realize is the cost of paying the loan back. In that respect, a former Goldman Sachs employee did a great service with the following calculation. The average credit card account of an American family is $14,000. Let’s say you did not pay it down but kept the balance at $14,000 over the next 40 years. That credit card balance would throw off to the bank a profit of 2.4 billion dollars. You would think that the bank would have loaned you their money and that they are at risk. Well, they never loaned you their money. They loaned you a sum of money which they were allowed to do by the government based upon the aggregate amount of savings deposits in their bank. They are able to take the aggregate amount of savings in their bank which is not their money (it is your money); they loan it back to you 10 or 15 times the original amount. If the original amount of savings happens to be 1 billion dollars, commercial banks are legally enabled to loan it out 10 to 15 billion at whatever interest rates they wish to do. Let’s say your savings are in that bank making a part of that billion dollar, how much are they paying you for those savings? Two or three percent. For the use of your aggregate savings which they will pay back to you on your credit card at any interest rate between 16 and 24 percent. Whose money was it that they loaned? Was it theirs? No, that’s their shareholder assets. Was it yours? No, your money is on loan to the bank at some nominal interest rate of 2 to 3 percent. So whose money was it that they loaned back to at 16 to 24 percent? It’s nobody’s money; it’s money that they made up out of thin air!

This is how banking has operated since 1694 when England put the Bank of England into place. When the Federal Reserve did the same thing in the US, this is the heart and soullessness of banking. Banking is a Ponzi scheme which is put in place to drain off the productivity of all human beings. It is a Ponzi scheme that was once put in place, and that is now reaching the end of its lifespan. Now it is collapsing. Capitalism works as long as it is expanding. Why? That is why the focus is on GROWTH. Because time itself has become valuable, and everything has become monetized and tied to a loan. The longer that loan is outstanding, the more interest has to be paid on that loan which compounds CONSTANTLY. The reason why economies have to expand is because the aggregate amount of debt is constantly expanding. So to pay off that constantly compounding aggregate amount of debt, credit has to go into the system hoping that it will induce enough new economic activity and profits to pay off the constantly compounding aggregate debt that is constantly growing larger. As long as it does everyone is happy. Everything has its day; every system has its limitations. The fact that we are reaching these limitations now in 2014 does not mean that you will get through it like the in 2009, 1999, or 1984. All those crises were followed by recoveries because the bankers’ Ponzi scheme was able to get enough aggregate debt back in the game and give it another jolt of juice. That is why interest rates are now down to zero percent! United States interest rates have never gone to zero. Why? Because these are extremely consequential times.

Gold, along with the other precious metals, is the only financial asset that is free of counterparty risk. If a nightmare type of scenario will occur, the metals in physical form will save your financial health (or wealth, for that matter). Are your prepared? Own physical precious metals outside the banking system!

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