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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Printing Debt not Money

Interest-Rates / Quantitative Easing Jun 10, 2009 - 03:01 AM GMT

By: Adam_Brochert


Best Financial Markets Analysis ArticleWe often hear and read about the government “printing money” like there’s no tomorrow. Our federal government has certainly passed out enough money to the people who got us into this mess that it seems as though hyperinflation is theoretically possible. But every US Dollar printed in our current fiat monetary system is actually a debt.

Whenever we hear the phrase “printing money” what if we substituted “printing debt” instead? What if instead of “credit” we substituted “debt”? Would we be wrong in making these substitutions?

If you are an owner of the private, unconstitutional, for-profit federal reserve central bank, then “printing money” and issuing “credit” make sense. However, if you are the U.S. government or a citizen, “printing debt” and issuing “debt” is a more precise explanation for what is actually happening to you.

You see, when the U.S. government “stimulates” the economy, they put their palm out and ask for the money from the private federal reserve corporation. The federal reserve happily gives up this money, which they print/create digitally out of thin air, but the federal reserve asks for one small favor in return. They ask for the U.S. government to issue them a bond for the amount of money given. This bond also requires interest payments to be made to the federal reserve.

These bonds are U.S. government debt, which means they are a debt owed by the citizens of the United States. Perhaps a more basic experience in our lives brings home the point in an easier-to-understand fashion, as there is no question that our monetary system is unnecessarily complex to help confuse the average individual and congress member.

"It is well enough that the people of the nation do not understand our banking and monetary system for, if they did, I believe there would be a revolution before tomorrow morning."  - attributed to Henry Ford

If you take a credit card, insert it into an ATM machine and obtain a cash advance, are you “printing money out of thin air”? To me, you are incurring a debt to the credit card company (or should I say the “debt” card company?). Though it is true that if you take that money and go out and buy things you are stimulating the economy, there is a price to pay isn’t there?

But back to the analogy. If every day of every week a person just kept getting cash advances until the debt card limit was reached, then got new debt cards and maxed those out as well, eventually the end would be reached. The debt merchants would collectively cut off that person’s access to debt. The party would be over. Even if the access to debt was never cut off, a person would need to make an exponentially increasing number of ATM withdrawals each day to simply pay the minimum payments on all the other previously used cards (even if the interest rate was 0%) until the Ponzi scheme collapsed.

During a big / excessive secular (i.e. measured in decades) boom cycle there is a lot of excess debt granted to a lot of people. Towards the end of the cycle, things tend to get out of hand. Literally, those who can fog a mirror are allowed to take on an excessive amount of debt relative to their ability to pay.

There is a mathematical limit to the amount of debt that can be assigned to an economy before that economy becomes highly unstable. We have reached that limit. Once you get to that limit, printing more debt only compounds the problem.

At this theoretical debt tipping point, which we have already reached, taking on more debt only makes things worse. If someone who makes $20,000/year buys a $1 million home with a 0% teaser rate and negative amortization, does it really matter what the interest rate eventually resets to once the teaser rate ends? When the entire economy reaches this tipping point, the bankers or whoever has bought the debt from the bankers is out of luck.

In such cases, the government has historically stepped in an agreed to “help.”  It is not in a politician’s nature to sit back and do nothing, especially if it is anywhere near election time or doing “something” would get a politician’s picture in the newspaper or on television. So, just like in the 1930s, the federal government is rushing around adding debt on top of the excessive debt already in the system. The private federal reserve corporation is playing the debt card company and the U.S. government is digging itself an awfully big hole by maxing out more and more debt cards.

However, when the tipping point is reached, new debt has no magical effect as with a “typical” recession. Such secular turns in the debt markets precipitate deflationary economic depressions. A new one has started. The Ponzi scheme has already collapsed and the current green shoots will turn into debt-stained crusty brown shits in the blink of an eye.

Printing debt does not effectively stimulate inflation in such a cycle, because the debt created by the government does not restore the “animal spirits” needed to fire up a new bull market in assets. Confidence evaporates (excluding short-term swings like the one that is ending now) and fear runs high in this environment, as it should. A return of capital becomes more important than a return on capital, as the largest financial institutions in the world are currently insolvent and desperate. The multiplier effect of money that causes inflation requires risk taking, leverage/new private debt issuance and good investment opportunities, all scarce in this environment.

A housing market crash that wipes out tens of trillions of dollars of paper wealth is not fixed by creating ten trillion in new government debt and paying off the bankers and investors holding those mortgage notes. A housing market crash does wipe out banks, however, as has already been happening. Bankers get fearful and refuse to extend debt to all but the most trustworthy borrowers. However, the most trustworthy borrowers realize something is wrong in the economy and begin to wait for lower prices or a more certain business environment before taking on new debt.

A vicious, although temporary (like all cyclical financial phenomenon) cycle ensues that generally lasts 15 to 25 years. It is during this time that debt must be squeezed from the system though defaults and increased savings (i.e. paying off the debts and living within one’s means). Unemployment soars as consumption and business activity contract.

By insisting on taking on new debt to replace the debt gone bad in the private sector, the government unfortunately makes the situation worse and prolongs the economic depression. Nothing has changed - the cycle is repeating according to script. It doesn’t matter whether or not we are on or off the Gold standard, it doesn’t matter what the federal reserve set discount rate is or was this month or next month and it doesn’t matter how much we “stimulate” ourselves with more debt. The Kondratieff Winter has begun and cannot be stopped by the federal reserve or U.S. government. Bureaucrats do not create or reverse the primary economic trend and never have, they simply react (and usually too late and clumsily to do anything but make things worse if they have any effect at all).

In a secular deflationary economic depression, history teaches that stocks, corporate bonds, real estate and commodities are lousy investments. Cash is actually one of the safest and only reliable long-term investments in such an environment and Gold, as the ultimate debt-free currency, is the best form of cash to hold. By maintaining wealth, one is able to purchase a much greater number of stocks, bonds, etc. when the carnage is over.

Because fear and uncertainty run high in this environment (e.g., look at the number of people starting to call for hyperinflation of the U.S. Dollar and other fiat currencies and look at the geopolitical instability being induced by this debt crisis), Gold benefits. Needless to say, Gold rarely does well when all is peachy keen in Wonderland. Get some physical Gold as an anchor to your life savings/investments (real coins or bars, not the risky GLD ETF).

Gold stocks are the go to asset class to actually make money in this environment. After an anticipated choppy sideways correction in the majority of established medium-to-large cap Gold stocks this summer and possibly into the early fall, I believe massive gains in Gold stocks will occur for at least 3 years. The first leg up in this new secular Gold stock bull market is likely over but the next leg up (and the one after that) will be even more spectacular. Now is the time to sell all general stocks and raise capital to get ready to invest in the incipient great Gold stock bull market.

Visit Adam Brochert’s blog:

Adam Brochert

BIO: Markets and cycles are my new hobby. I've seen the writing on the wall for the U.S. and the global economy and I am seeking financial salvation for myself (and anyone else who cares to listen) while Rome burns around us.

© 2009 Copyright Adam Brochert - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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