7/31/2019 What We Are Scared to Talk About

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What We Are Scared to Talk About...Why the System is Stalling. Each week there is a new plan to save the system. Evidence of stress in the system is availableeverywhere, from possible defaults in Greece, Spain, Ireland and Portugal to the To Big to FailBanks in the United States, there has been a concentration of systematic risk in the globalmonetary system. A well functioning system, whether it be monetary or environmental, has a

mechanism that allows it to clear stress. The current manner that the global monetary systemoperates under seems to lack this clearing or equalization mechanism. Understanding of themonetary system is not widely distributed and because of this I think the partners involved intrying to solve these issues have spent their time debating the usefulness of a band-aid versus atourniquet and not discussing how the wound was developed.

To start to analyze our current scenario, we need to start with a discussion on how currency iscreated. Ever since the end of the Bretton Woods Agreement, that governed the monetarysystem, the Dollar Bill has ceased to exist and the Federal Reserve Note was born. This smallchange in terminology is important and before we go any further let us get some terminologyclear:

-Dollar Bill: The dollar bill was the US Dollar during the period of dollar convertibility.Convertibility is the legal agreement that a dollar is convertible into a certain weight of gold.The bill portion of the term refers to the nature of it being a Bill of Credit, a claim on anotherasset.

-Federal Reserve Note: After the end of dollar convertibility the US Dollar was no longer aclaim on an asset and ceased to be a Bill of Credit, but a Federal Reserve Note, an unit of debt.This will be explained in the next paragraph.

When the Bretton Woods Agreement was voided in the 1970's by US President Richard Nixonthe convertibility of the US Dollar into gold ended. However, this was just one aspect of howthe monetary system had changed. As a background, prior to the end of Bretton Woods, the USmoney supply outstanding was backed by a weight of gold. Each nation's currency exchangerate was then pegged to the US Dollar and indirectly measured in a weight of gold. If a countryspent beyond the nations means and could not acquire more gold the exchange rate wouldsuffer pressure to the downside forcing an adjustment in competitiveness. This would allow themarket to clear.

When the Bretton Woods Agreement was violated by the closing of the US "Gold Window",ending the convertibility of USD into gold, a fiat monetary system was created. This is a majorchange. The creation of currency under a fiat monetary system is different than under the goldexchange standard of Bretton Woods. This creates a very different system.

Under Bretton Woods, however flawed it was, each currency bill was exchangeable into a fixedamount of gold. If too much credit or currency bills are created, the exchange rate peg wouldface pressure. The Bretton Woods System provided a counter force against credit andmonetary creation and allowed a mechanism for reaching equilibrium. Expansion had to bebacked by production otherwise a nation suffered contraction and depreciation. Say's Lawheld. Much of the problems we face today is based in the attempt to contradict Say's Law.

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Say's Law has been interpreted in many ways, however, the basic interpretation is thatproduction proceeds consumption.

Under the fiat monetary standard, specifically the US Dollar system each currency note (notcurrency bill) is a claim of debt. In the current system the US Dollar is the "Reserve Currency"for the globe and the manner of how each US Dollar is created is important, as the expansion of credit and currency in the Reserve Currency nation forces credit creation in the peripherynations.

There are two manners that money supply, including more than just currency, is created. Thefirst manner is by the Treasury. When the US Government needs funds to cover the budget,the Treasury issues a bond to the Federal Reserve in exchange for newly created US Dollars.The Treasury then proceeds to spend this currency into existence through the manybureaucracies that require funding. This currency then is exchanged through the economy andis deposited in banks that further expand the money supply through the process of fractionalreserve banking.

The second method of money supply creation is through the "Shadow Banking System". Whena person uses their credit card to purchase an item, or takes a bank loan out to buy a car or amortgage to buy a house, new credit is created. MasterCard or Visa or TDCanadaTrust et al,(actually the banks that use the MC and Visa brand) do not have money sitting in an accountready to lend to the purchaser to complete the transaction. When a purchase is made, credit is"created" in an account that is to be paid off by the debtor and the profits to the bank is theinterest paid on the created credit that is eventually paid off. However, when someone does notpay their balance in full, this new credit is maintained and the broadest measures of moneysupply does not contract.

If you are following along at home you might notice the inherent weakness in the currentsystem of currency entering existence through the Treasury mechanism and the ShadowBanking System is that growth is a prerequisite of repayment. Imagine a scenario where thereis no growth. If this was the case the debt on currency and credit, due to interest accumulation,is greater than the stock of currency and credit in existence. When you sit back and thinkabout this, one realizes that if there is not a return, either in efficiency or profit expansion,greater than the interest rate on that newly created currency/credit the system is insolvent - ie.there is not enough funds to cover the original liability. Essentially the underlying assumptionfor this style of system to continue functioning properly is growth above and beyond the rate of interest.

For years the growth required to cover the interest expense of the Treasury and the ShadowBanking System was substantial enough to keep the system functioning smoothly, except when

there was price input shock - i.e. the oil shocks of the 1970's. However, when the IndustrialWorld began to display a declining birth rate the system showed it was unstable.

As population growth rates declined the necessary growth and productivity that was created bya larger younger generation disappeared. Essentially, a larger younger generation creates alarger market to sell goods into, easing the constraints on obtaining the growth needed to coverthe interest costs of Treasury debt. The decline in population growth (consumer markets) leadto a situation where corporations had to streamline enterprise and cut costs to maintain profitmargins high enough to cover the Treasury and Shadow Banking System debt incurred with

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spending money into existence. This created a negative feedback loop of cutting employees,further enhancing a scenario where the consumer could no longer cover the Shadow BankingSystem interest cost. This has created a necessary deleveraging of debt and Japan, who has theworst OECD demographics was affected first, followed by Europe, another region withdeteriorating demographics.

These seem like daunting challenges to conquer, however, there is three ways the World canovercome the current monetary system predicaments. The first method would be atechnological revolution that reset the costs of input for industry and leading to efficiency gainsand labour requirements. These efficiency gains could push the growth rate to levels highenough to offset the declining population growth. The natural gas revolution and a complete re-ordering of the economy towards this new base feedstock could create this efficiency gains afteryears of investment. The second method would require a substantial boom in OECDpopulation. This second solution is more of the status quo. The increase in births would justsustain the interest cost of both monetary expansion systems and allow the current system tocontinue. The third mechanism is the repricing of already owned balance sheet assets toeliminate the asset/liability mismatch. The US Government records the price of its gold asset on

the nations balance sheet at $42/oz. The US Government has claim to close over 8000 tons of gold, if this was repriced to around $10,000/oz and make the currency convertible again, theincrease in the balance sheet would be large enough to back the US money supply to end thePonzi nature of the current system and Bills could replace Notes.

The next time you hear an economist of politician discuss the need for fiscal stimulus, what heor she is really discussing is a program to increase spending to match the loss from decliningpopulation growth. The idea is to make up for spending for the "kids who are not here" thatwere needed to maintain the Treasury debt. This is a unsustainable solution unless populationgrowth returns to the levels prevalent when the system was created. Otherwise deleveraging isautomatic as we scale down growth to a slower growing population and absorb the overhang of the created Treasury and Shadow Banking interest cost.Posted by PofN-I at 12:14 AM http://philosophyofnonintervention.blogspot.ca/