Wednesday, June 6, 2012

Money (4): There are more Debt than Money in our Economy

It turns out that my calculations regarding the Fractional Reserve System could be wrong. One source I came across is stating that 1K of deposit can generate as much as 100K of loans!

Whatever the amount is, for all intent an purposes, the Fractional Reserve Banking allows practically unlimited capacity for the banks to create money. Some countries even abolish the need for reserve. UK is one example.

Now I want to bring you something that will makes you jaw drop.

There are more Debt than Money in our Economy!

I almost fell off the chair when I came across it. How is it possible? How it is possible to be debt free when there is more debt than available money?

I checked a few sources. The basic fact is true, but there is no definitive explanation of how it gets to be so and what it means. Let me try to summarize it here.

Let me bring you back the core fact about our monetary system - over 95% of our 'money' are actually created out of thin air and extended as credit to borrowers. That means that almost every dollar in circulation are borrowed from the commercial banks - and incur interests.

The amount that we borrowed from the banks constitutes our money supply, and the amount that we have to pay back eventually is our debt. The difference between them is the interest spread.

What it means that the society as a whole has to borrow ever larger amount of money to pay back the old debts. The economy can function this way - as long as the banks are willing to continue to extend credit to roll over the old debts. This is like playing musical chair. Everything will appear OK as long as the music keeps playing.

 But it should be clear the total debt will increase at a compounding rate. This is exponential growth in mathematical terms, but in reality defaults do occur, especially during the periodic bust cycle, so the rate of growth will be dampened somewhat.

It should be clear now that our society can never be free of debt. It is a mathematical certainty. Some economists argue that growth in debt is OK as long as the economy is growing at a faster rate. For example it is OK for the debt of a company to grow at the rate of 5% p.a. if the company is expanding at the rate of 7% p.a.

This is one key characteristic of our monetary system - it assumes and demands the economy to grow at an exponential rate. This is clearly an impossibility with real world constraints like limits in natural resources, the decreasing and aging population in developed countries. The periodic boom and bust cycle is inevitable with our current monetary system.

It is clear that the sovereign debt crisis the world is facing now is impossible to resolve without changing the current monetary system. No amount of austerity measure is enough to bring down the debt. The only way debt can be reduced in our economy is via massive defaults, massive reduction of our money supply, and the resulting massive recession.

The way we are trying to solve the problem now is by massive printing of money, in the name of quantitative easing. It is essentially creating more debt and injecting more of the same poison that is killing our economy.

Think about it. Every country in the world (Germany inclusive!) are seriously in debt. Please let me know if you find a country that is not in debt. But just to whom are these money owed to? Something very fishy and very sinister is happening here.

Next: Money (5): Endgame - The End of the Debt Supercycle and How It Changes Everything

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