Liberty Planet Weblog

False Premises

Posted on: June 19, 2012

The sub-prime mortgage debacle triggered the A.D. 2008 financial crisis that nearly plunged the US and global economies into an economic depression. The ultimate reason for the sub-prime mortgage crisis was a faulty, fundamental premise. It was falsely believed that the prices of American homes had risen steadily since WWII and were certain to keep rising into eternity.

So long as the price of homes continued to rise, bankers could safely lend even to sub-prime mortgagors. If sub-prime mortgagors failed to make their payments, the lenders would foreclose on homes that (thanks to endlessly rising home prices) were worth more than the original loan. Thus, the lenders couldn’t lose.

But (“best laid plans,” etc.), it turned out that—Surprise! Surprise!—the prices of American homes were not destined to rise forever and, in fact, could fall dramatically. Once the fundamental premise behind the sub-prime mortgage theory was exposed as false, the whole sub-prime mortgage theory collapsed like a house of “sub-prime” cards.

• Government is overly influenced by a bunch of smooth talking con-artists and/or fools (often with a PhD behind their names) who sometimes devise new-and-improved economic theories. These new theories are typically based on one or more premises that seem plausible and even desirable, but have never been true in the past.

The argument underlying most new economic theories is usually, “This time it’s different—and therefore that which was irrational in the past can be rational now.”

One “this-time-it’s-different” economic theory is the “debt-based monetary system”. For most of 30 centuries, the world has relied on monetary systems based on assets such as gold, silver or even barter. But every so often, a smart guy persuades the world to accept a monetary system based on debt. These debt-based monetary systems always fail and typically lead to catastrophe. But, before they collapse, they create an economy as bright and effervescent as the bubbles in champagne.

Since A.D. 1971, the US dollar has been a pure, debt-based currency.

According to Wikipedia,

“A debt-based monetary system is the system where paper money is supplied as a bill of credit to an economy primarily by the purchase of debt, such as government bonds. This form of money is called ‘debt-based’ because as a condition of money creation, it is required to be paid back at some point in the future, usually with interest. A monetary system that introduces full-reserve banking into the system is still “debt-based” if the economy’s base money remains a creation of government debt.”

This definition implies that the deeper the government goes into debt, the more currency that’s available to stimulate the economy. Thus, the more indebted our government is, the wealthier and/or more prosperous we become. More debt = more wealth.

But does that make sense to you? Yes, you can sustain an illusion of wealth by going deeper and deeper into debt, but inevitably a day or reckoning comes when the debt must be paid or repudiated and the illusion of wealth is destroyed.

It is presumed that the gov-co (our alleged “sovereign”) can go almost endlessly into debt, because, one way or another, the “sovereign” will be able to persuade, cajole, or force its subjects to pay the gov-co’s debt. Thus, the debt-based monetary system is ultimately based on the premise that a nation’s people will always be able and willing to pay their gov-co’s ” debt (just as it was formerly presumed that the prices of American homes must always increase).

However, the premise that subjects will always pay their “soveriegn’s” debts is being shown false in Greece, Spain, and other European nations. Over the past four years, that premise has been absolutely refuted by Iceland.

Note that Wikipedia’s definition of “debt-based monetary system” includes a requirement that the underlying debt “be paid back at some point in the future”.

OK, repayment sounds reasonable. But a question remains: “Paid back” with what?

A debt-based currency is not a payment—it’s a mere promise to pay. When the day of reckoning requires that the debt underlying the debt-based currency be “paid back,” can that payment be made with another wheelbarrow full debt-based currency (promises to pay), or must a true payment be made in terms of something tangible like gold, silver, land, tools, factories, etc.?

• For most of the past 30 centuries, “money” has been defined and accepted as an asset-based. Typically, money was gold or silver coin. That coin had intrinsic value.

Thus, if I bought a pound of steak at the grocery store and paid with, say, one-quarter of an ounce of silver, the grocer would be actually paid at the moment we executed the transaction. The transaction would constitute an “exchange” wherein the grocer gives me title to the steak and I, in return, give the grocer title to the quarter-ounce of silver. The transaction would be complete as soon as I received the steak and the grocer received the silver. Once the exchange was completed, there’d be no lingering debt.

The importance of title to any transaction is hard to see with something as temporary as a steak. In essence, I don’t actually own title to the steak until I pay for it. If I purchase the steak with credit (a promise to pay), the title and right to the steak remains with the grocer, until he is paid in full by me. Of course, if I eat the steak tonight, and I don’t pay by next Wednesday, the grocer won’t want to claim title to his steak.

But, in the case of a house, the significance of title to property is more apparent. If I essentially “borrow” a house today based on my promise to pay a mortgage over the course of the next 20 years, and if I fail to make my promised payments, then the lender still has a title to the house and the right to foreclose, and repossess it. Although I may have lived in that house for ten or fifteen years, I can’t actually own title to it until I’ve actually paid the original debt. Until I actually paid in full, our mortgage transaction was a transfer rather than an actual exchange.

• Credit is convenient. A customer can eat steak tonight, even though he can’t pay for it until next week or next month. A grocer can sell his steak today and avoid a loss to spoilage and make a sale he might otherwise miss.

Credit (accepting promises to pay instead of payments) is almost irresistible.

More, credit’s not new. 3,000 years ago, the Old Testament provided rules to regulate borrowing and lending. Credit is so ancient as to be almost genetic (“You givum me buffalo meat today; I givum you stone spear-head tomorrow.”)

More, although credit can be dangerous, it’s not necessarily bad. Credit can be a great economic advantage—provided that the terms of the credit agreement are actually fulfilled.

That is, if (in return for a pound of steak today) I promise to pay the grocer a quarter-ounce of silver next Wednesday, I must actually pay my debt by delivering an asset (the silver) next Wednesday. I.e., in return for the tangible asset I received (a steak or a house), I must also pay back a tangible asset (gold, silver or some other bartered item) to the seller to extinguish the debt.

So long as the promises to pay are kept, the concept of credit is great.

• However, every so often a man or a nation gets a bright idea: instead of actually paying our debts with an asset (like gold or silver), we could “discharge” those debts by merely giving the seller someone else’s debt-instrument (i.e., a third-party’s promise to pay).

For example, suppose the grocer didn’t trust me to make good on my promise to pay for his steak next Wednesday. He might nevertheless trust someone else who promised to pay in my stead. Therefore, instead of giving the grocer my promise to pay, I could give him Federal Reserve’s promise to pay (fiat, paper dollars) whereby the Fed promised to one day “pay” for the steak. The grocer is implicitly accepting the promise of the Federal Reserve to someday “pay” the debt that I incur by purchasing the steak.

In fact, neither I nor the Fed will ever actually pay for the steak by giving the grocer something tangible (gold, silver or barter). But, the grocer doesn’t mind not being paid by me or the Fed because he has confidence that he can take Federal Reserve Notes (FRN’s; debt-instruments; intrinsically-worthless promises to pay) that I offer him in return for the steak, and go down to Billy Bob’s Bar tonight and buy a couple of beers. Or maybe the grocer can use those FRNs to put some gas in his car or purchase a toy for his daughter.

So long as the public retains confidence in the FRNs (fiat dollars; cash), those debt-instruments (promises to pay) will seemingly spend just like payments (assets) and virtually no one will know or care that purchasers are not actually paying their debts.

It’s a fundamental premise for any fiat monetary system (like fiat dollars) that the public will never understand the difference between payments (assets) and promises to pay (debts)—and even if they do, they won’t care. So long as the public retains confidence in the purchasing power of fiat currency, that currency will “spend” and retain an illusion of value. So long as the premise that the public will never understand fiat currency remains valid, the fiat monetary system becomes a virtual money tree.

I.e., it’s hard work to dig a hole in the ground, find some gold, refine it and manufacture some coins (assets) to use for making payments. It’s so much easier to merely make promises to pay. It’s a lot easier to promise to dig a hole in the ground than it is to actually dig one. Anyone can make promises. Promises to pay can be spun out of thin air. While gold is limited and only found with hard work, promises are unlimited and can be found almost anywhere. (Witness sub-prime mortgages wherein lenders accepted promises to pay from people who couldn’t possibly keep their promises.)

• But the largely unspoken fact remains that in a debt-based monetary system like ours, no one is actually paying their debts. No one is being paid. All are merely making or receiving promises to pay (debts) as if they were payments (assets).

Get that? No one is being paid.

Everyone who thinks they have “assets” (wealth) stored in their bank accounts, 401(k)s, pension funds, stock market accounts, and government bonds are mistaken. They don’t actually have any assets (tangible payments) in those accounts. All they have are a pile of debt-instruments—promises to pay.

Get that? Most Americans’ perceived “wealth” is nothing but a promise to pay and therefor dependent on the capacity of a third-party promissor (notably the US gov-co and/or Federal Reserve) to someday, somehow, make good on all those promises that are currently circulating in the form of paper and digital “dollars”.

But—if the gov-co and/or the Fed can’t make good on their implied promises to pay (by ultimately redeeming the paper dollars for gold or silver), those holding their wealth in the form of paper dollars or other debt-instruments will see their “promised” wealth disappear.

Under the debt-based monetary system, no one is actually paying their debts. That fact may seem bewildering or even irrelevant (“it all spends”) to most people. But those who have a little bit of sense should find that fact unnerving.

• Why?

Because the whole fiat monetary system is based on public confidence that somebody, anybody (gov-co, Fed, taxpayers) will someday make good on all those promises to pay (debts) that we call “dollars”.

But gov-co admits the national debt is $16 trillion—about $50,000 in debt for every man, woman and child in this country; $200,000 for a family of four.

How many people do you know who have personal assets worth $50,000? How many do you know who have an extra $50,000 they’d be willing to contribute to pay their “fair share” of the national debt? What percentage of Americans do you suppose have the requisite $50K needed to repay and make good on the national debt?

If most Americans don’t have $50K in tangible assets or are unwilling to contribute $50K towards the national debt, that debt won’t ever be paid in full. Insofar as the national debt’s not paid, those holding gov-co’s debt-instruments must suffer significant losses.

John Williams at calculates that the real national debt is closer to $75 trillion—about five times greater than the gov-co currently admits. I believe him. If Williams is right, each American man, woman and child’s fair share of the national debt is about $250,000; each family of four implicitly owes $1 million.

I don’t have an extra quarter million to make good on my fair share of the national debt. Do you?

How many people do you know or see who you believe have an extra quarter million dollars? I’d bet that about 99% of the American people don’t have an extra quarter million to pay towards the national debt. I’d be surprised if the average American owned more than $25,000 to $50,000 in tangible assets. If I’m right, somewhere between 80% and 90% of the current national debt can’t and therefore won’t be paid.

As I’ve preached for at least four years that tell me that sooner or later, those who hold their presumed “wealth” in the form of paper dollars (promises to pay) will lose 80% to 90% of their paper “wealth”.

The sheer magnitude of the national debt (promises to pay) is so great that the promises can’t possibly be kept. Therefore, the promises (debt instruments) must be repudiated by an overt bankruptcy of the US gov-co, or by hyper-inflation. And that means that those who are currently unable or disinclined to distinguish between a promise to pay (debt) and a payment (asset), will ultimately be forced to learn that difference under circumstances both shocking and painful.

• The national/sovereign debt is essential to creating the debt-based currency needed to “stimulate” and keep our economy afloat. The fundamental premise underlying America’s debt-based monetary system is that taxpayers can and will pay the government’s debt. That premise is being exposed as false.

Implication? The economy will decline precipitously and the fiat dollar will die.

In the 1600’s, during the “Dutch Golden Age,” the Dutch people entered into “Tulip Mania”. During that “Mania,” tulips (mere flowers) were accorded enormous and irrational value. At the Mania’s peak in A.D. 1637, a single tulip bulb could sell for ten times the annual income of a skilled craftsman.

Ultimately those who invested in tulips were ruined and the Dutch economy suffered a severe shock.

In retrospect, Tulip Mania seems incredibly dumb. It’s scary to suppose that any nation could be so stupidly self-destructive. We look back and wonder “What th’ hell were those silly-ass Dutchmen thinking?”

I guarantee the day is coming when the world looks back at America’s “Debt-Based Currency Mania” and wonders, “What th’ hell were those silly-ass Americans thinking?”

If you only receive a promise to pay for your work or your property, take the fiat currency you receive and convert it into a payment. Buy gold. Buy silver. Hold on tight.

Source: Adask


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