monitoring the abyss

If we look again at how money works, we see why banks have to fail in order to fix the world economic system.

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If you take a look at my examples of how money works, we see that the impact of "fake money" only occurs at the time it is injected into the system. Thereafter, the transactions between individuals are essentially barter transactions.

What do I mean by this? Ordinary buyers and sellers cannot create money. Money in their hands is nothing but a talisman to which they have accorded a specific (though ill-defined) value by common social convention. It could just as well be a meteorite that fell out of the sky, as a piece of paper with a picture of a dead president printed on it. It could just as easily be a completely counterfeit picture of a dead president, so long as neither the buyer nor the seller is aware the talisman is counterfeit. They, in good faith, exchange goods and services in exchange for "money" at the presently accorded and perceived "value" of that money.

Now, the "manipulation" of that monetary system occurs primarily at two ends. The first is when new money is created and put into the system. Somebody benefits by getting something for nothing. To the extent a borrower has no reasonable possibility of repaying the money borrowed under the currently accepted valuation of that money, the borrower is getting something for nothing. The money thereafter vaguely represents the borrower's promise to give goods and services in the future -- but as we have seen in earlier posts, at the "high end" of these transactions, the borrower has no conceivable way of making good on the promise unless he games the variables on which the existing monetary value is based.

When the amount of these false promises in circulation exceeds any reasonable expectation of manipulating the valuation system, the only hope must be to remove money from the system. The classic method for doing this is via inflation.

However, those at the monetary controls do everything in their power to prevent inflation, since inflation will take away the very foundation on which their ill-gotten wealth is based. So, at this point we have a game of musical chairs. If we are not going to allow inflation (thereby devaluing everyone's holdings across the board) then we have got to remove money from the system somewhere. Where that will be ends up being a political decision and someone (or someones) are going to be losing their fortune. What a lot of those "someones" refuse to accept is that because of their vast paper holdings, the someones will have to be from the wealthy elite and not merely impoverished retirees. This is especially true in our times, since so much working class value has been extracted via inflated costs for housing, medical care and commodities. There are not many places left where people can be manipulated into working more productively for less return.

But money does not just "evaporate." Once placed into circulation, it is there forever and forever, unless it happens to burn up in a fire or something. And, as the system has increasingly relied on accounting entries for the creation of money, actual physical destruction of money can't have a significant impact.

Now, when someone files bankruptcy and discharges his debts (or alternatively, has the bad grace to simply die without paying them) the creditors remain unpaid. BUT, that does not actually destroy any money. Unless, of course, the creditor is a bank.

As we have seen, banks have numerous ways of creating money out of mere bookkeeping entries, such as "fractional banking." So, if we are not going to inflate money to bring it in to line with the actual productive capacity of society to back it, then we've got to remove a lot of bookkeeping entries. And this can only occur by massive defaults on the bank's books. What accounting giveth, accounting taketh away.

Unfortunately, the people in charge of those books become very used to being wealthy and powerful. They therefore will do anything they can to prevent their wealth and power from slipping away. We thus see various governments "guaranteeing" or "replacing" the evaporating capital.

This obviously won't do any good, for two reasons. The first is that such an approach expressly prevents the destruction of fake wealth that is necessary to get the system back to functional. And the second reason is that even if you enslave the entire working populace, they lack the productivity to make good on the promises their government is making to the banks. So, inevitably, most of the bailouts we see will essentially prolong the Depression, rather than end it. And, the depression cannot come to an end until internal or external forces wreck the remaining money supply. Moreover, by placing burdens on the public that cannot be met, the various governments imperil their own continued existence.

So, why does "stimulus" and "deficit spending" seem to have worked historically? A shortage of money reduces the productivity of society. As we have noted, a certain amount of money-fraud is apparently essential for a healthy economy. Otherwise, there will not be enough money in circulation to fuel the economic engines. This is why commodity-backed money (eg., gold-backed currency) doesn't work well. It is not elastic enough to meet the needs of successful commerce, since everyone is sitting around idle waiting for some gold miner to find a new vein of gold. (He then gets rich -- the one time injection of capital into the system; and thereafter the gold circulates as the necessary talisman of commerce.)

If there is untapped productive capacity in society, then that productive capacity can be put to work by stimulating the economy with more money. The new-found productive capacity then will increase the actual productivity necessary to back the money in circulation. In this respect, it effectively reduces the amount of "fake capital" in the system, by backing it with real production.

The general growth of population (and the efforts of people to lead decent lives even in the face of monetary crisis) also adds productivity, though much more slowly.

So, if we look again at 1930s Germany, we see a glimmer of light -- since people have massive over-productive capacity, once we make the collective decision to end the pain, the economy can right itself again fairly rapidly. But again, consistent with my analysis, what did Germany do? It simply bailed on the existing monetary scheme altogether and started a brand new one, purging the system of vast quantities of fake money.

Theoretically, those who manage government monetary policy use various tools to avoid reaching this situation. But, basic greed repeatedly and inevitably causes them to fail in their mission. Responsible money managers and money management policy are shoved aside in favor of irresponsible "get rich" policies that benefit a tiny subsegment of society. And then, after awhile (and quite predictably) the crash arrives.

The present crash was therefore entirely predictable -- what could not be predicted is when the crash would hit. We could not be certain how long the purveyors of smoke and mirrors could avoid the collapse while continuing to fuel it. But, what was also entirely predictable was that the longer the collapse was put off, the more severe it would be. And one need only go into the internet archives to see that various prognosticators said as much 10 and 15 years back.

There is another unfortunate side effect of delay. As we watch industries completely tank, we have to realize that human productive capacity is constricting. You cannot shut down car factories one day and bring them back to life a couple of years later as though nothing has happened. In the meantime, the ability to operate and maintain the equipment is completely lost.

To give an example from GM, sometime back GM produced an electric car called the EV-1. It was a great car with wonderful performance that charged on pennies a day. But, GM repossessed them all. The electronics were removed and most of them were smashed in a large pyramid in the Arizona desert. A few of them were given to Universities and museums -- after removal of the electronics and an explicit agreement that the University or museum not make any effort to restore the vehicle to actual operational condition.

This was back in 1990s. Some of us yapping chihuahuas have suggested -- since GM management keeps hyping the [allegedly] upcoming Volt -- that they might just open up their old EV-1 factories and build some. GM maintains (and I think it is probably true) that in the interim (about 10 years) they have lost the suppliers and technology to simply re-open the assembly line. Even though there would seemingly be a market for those vehicles right now (and the R and D cost has long since been written off the GM books.)

So, the longer the Wall Street games-players continue to demand that the public (ie "federal government") bailout Wall Street firms, the more damage is done to human productivity. And, the more damage that is done, the harder it will be for us (collectively) to claw our way back to reasonably affluent times.

But, how can we turn the right direction when the likes of Paulson, Geithner and Bernacke remain at the helm? These are the very people who have dedicated their careers to bringing the system to its present condition. They will of course defend and protect it to the bitter end. When what is really called for is letting the air out of the Wall Street tires while continuing to say, "we're doing all we can to save you," [wink, wink; nod, nod.] Whatever policy choices might constitute such an approach, it is most decidedly NOT to have the government guarantee, buyout or otherwise buoy up banking paper assets. There is a reason they are referred to as "toxic assets". And what do you do with toxins? You call the HAZMAT squad and dispose of them -- you don't pretend they have some sort of recoverable economic value.