by Don Fredrick, The Complete Obama Timeline, ©2022
(Feb. 20, 2022) — Insolvency is the inability to pay one’s debts. If you borrow $1,000 from someone and later have no ability to pay the lender back, you are insolvent. Whether the loan participants are individuals, businesses, banks, or governments is irrelevant. The only difference is the number of people negatively affected by the insolvency and the degree of the damage. Failing to make your car payment may result in you losing your car. Failing to pay your mortgage may result in you losing your home. Failing to pay a crime syndicate loan shark may result in you losing your life. Failing to pay national debts can result in a government collapsing, causing colossal turmoil, massive unemployment, and even war.
Commercial banks, like those that lend you money to buy a car, do not actually have enough money in their vaults to cover withdrawals if all of their customers were to show up on the same day to empty their savings accounts. That is normally not a problem, of course, because not everyone shows up at the same time to withdraw all their funds. The system is called “fractional banking,” meaning that banks are required to retain only a “fraction” of the cash needed to immediately return to their customers all of their deposits. Under fractional banking, most large banks need to retain only 10 percent of deposits. That is, if a bank has assets of $10 billion, as much as $9 billion of that total can be distributed via business and consumer loans.
Again, the system generally works because the customers do not all show up on the same day to take their money out. If they did, the bank would be “insolvent.” The bank would simply run out of money because not all of the dollars that have been deposited by customers are sitting in the bank’s vault. Many of those dollars have been loaned to others. The interest Customer A receives on his savings account comes from the bank lending some of his money to Customer B. If banks made no loans, they would have no income from which to pay interest to the depositors.
The argument in favor of fractional banking is that it boosts the economy and creates jobs because consumers can borrow what they need to buy houses, cars, furniture, and appliances in the present rather than having to save enough money to buy them in the future. The argument against fractional banking is that it gives an illusion of wealth that does not technically exist. After all, a sizable percentage of Americans do not actually own their cars or homes; their bank owns a portion of them until the final auto loan or mortgage payment has been made.
The low fractional reserve requirement is what makes banks susceptible to collapse during an economic downturn. The lower the requirement, the greater the risk. (The requirements are low because the federal government is naturally more than willing to place your money at risk, in exchange for a booming economy that generates support for the politicians in office.) If too many of a bank’s depositors lose their jobs and they all show up to withdraw their life savings, only a small percentage of them could be accommodated. The first people to withdraw their money would get it, while the people at the end of the line would not. (An example of such a “run on the bank” is depicted in the Jimmy Stewart movie, It’s A Wonderful Life.)
Of course, if this were to happen, the Federal Deposit Insurance Corporation (FDIC) would step in and rescue the depositors. But the FDIC only has enough assets to cover a handful of large bank closures. If too many banks fail at the same time, the FDIC would itself run out of funds. That is why the federal government had to intervene during the 2008 housing market collapse. Encouraged by the government, many banks had made risky “below prime” real estate loans that proved to be unsound. That caused some banks to fail the fractional reserve requirement. The government rescued those insolvent banks with new money authorized by Congress — money that was created out of thin air. (Similar to the FDIC is the Pension Benefit Guaranty Corporation. The PBGC was created to bail out retirees in the event of a pension fund failure. But, like the FDIC, the PBGC does not have anywhere near enough assets to rescue every pensioner if more than a few large pension funds fail.)
The FDIC exists to insure commercial banks. But there is no equivalent FDIC to rescue governments or “national banks” like the Federal Reserve Bank (which is not really a bank). Although banks are limited by fractional reserve requirements, the Federal Reserve and the national banks of other nations generally have no such restrictions. They can create new money as they please — and they typically do. Not surprisingly, the national banks have created and loaned far too much new money to governments for far too long, and they are now approaching what some would call “insolvency.” The term “insolvency” arguably does not apply to a national bank because, having the power to create new money, it can never actually run out of money. The problem is that so much additional new money is being created that it loses its value, as happened in Zimbabwe, Venezuela, and Germany in the 1930s. (Those who argue “It can’t happen here” are grossly mistaken.)
Like all governments, the U.S. government pays its bills primarily with tax revenue. But when spending exceeds tax revenue — which it has in almost every year since the creation of the Federal Reserve in 1913 — the government can cover its annual deficits by only two methods — neither of which can be relied upon forever. The government can borrow money, or it can create new money, backed by nothing of value. Because of president Franklin D. Roosevelt and Richard M. Nixon, the nation is no longer on a gold standard. The U.S. dollar is worth only what people are willing to believe it is worth. Its value is based on nothing more than blind faith in the government. If that is not a sobering thought, nothing is. (Note that the U.S. government will go to extreme lengths to ensure that “faith in the U.S. dollar” continues. As an example, Iraq’s Saddam Hussein and Libya’s Moammar Gaddafi had to be “taken out” because they wanted to trade their oil for gold, rather than dollars. The U.S. government did not care about human rights in Iraq or Libya as much as it cared about maintaining the dollar as the world’s primary medium of exchange. Similarly, it is less concerned about Russia absorbing eastern Ukraine than it is with the rest of the world buying gas and oil with euros, Russian rubles, or Chinese renminbi. Russia has been stockpiling gold for a reason.)
Under a gold standard, paper currency can readily be exchanged for the shiny, precious metal. For many years, a $20 bill could be exchanged for one ounce of gold. In 1933, Roosevelt ordered the confiscation of all gold other than jewelry. For each ounce turned in, the government gave the citizen a $20 bill. After the gold had been confiscated, Roosevelt arbitrarily declared that gold was “worth” about $35 per ounce. In 1971, Nixon took the nation completely off the gold standard. Purchasing an ounce of gold today costs just under $1,900. The less confidence people have in the paper dollar, the more the price of gold increases. (This author invests in gold and silver.)
Tax revenue is not unlimited. Increasing the tax rate increases government’s tax revenue, but only to a certain point. That point seems to be about 18-20 percent of the nation’s gross domestic product (GDP). If the taxes are raised too high, tax revenue can actually decline — because exceptionally high taxes discourage work and production. Every business and individual has a breaking point. The company eventually closes its doors, and the workers throw in the towel. Retirement, unemployment benefits, or welfare eventually have more appeal than spending 25 out of 40 working hours paying taxes to the federal, state, and local governments.
When the federal government spends much more than 18 percent of GDP it cannot collect enough tax revenue to fully fund operations. It therefore has to borrow money. But there is not only a limit to the amount of taxes it can reasonably collect, there is also a limit to the amount of money it can borrow. When the government cannot find enough investors and lenders (including foreigners) to buy enough Treasury Securities, Bonds, Bills, and Notes to cover its deficits, the Federal Reserve then artificially expands the money supply to come to the government’s rescue. It creates new money via bookkeeping entries to enable the government to pay its bills.
There are therefore three options for the government: (1) balance the budget, (2) borrow money, or (3) inflate the money supply. Option one — spend no more than is collected in taxes — is the most sound and reasonable. It has also generally been the least chosen option. Since the creation of the Federal Reserve in 1913, the government has almost exclusively relied on a combination of options two and three.
Borrowing more money increases the national debt and leads the nation further down the path of insolvency and bankruptcy, while inflating the money supply causes consumer prices increases. Note that inflation is not rising prices. Inflation is the expansion of a nation’s money supply, which causes price increases. Inflating the money supply is why a nickel candy bar now costs more than one dollar. The candy bar is not worth more; your nickels, dimes, quarters, and dollars are worth less.
World governments now have tens of trillions of dollars in accumulated debts, and those numbers only represent specific promises to pay back lenders who bought bonds. Those trillions of dollars in national debt do not include unfunded liabilities such as future Social Security payments and Medicare obligations. Adding such future liabilities pushes the total world debt well past $200 trillion.
If nations continue to print money to cover their annual deficits, consumer prices must necessarily continue to increase, because goods and services are not being created as quickly as the money is being printed. (We do not have a “supply chain” problem as much as we have a “too much currency” problem.) The Federal Reserve, in continuously creating new money for the U.S. government, is like a bank approving new car loans and mortgages faster than cars and homes can be built, faster than customers can make deposits, and faster than existing borrowers can pay off their loans. But at least a bank can expect the borrowers to pay off their car loans after 48 or 60 months and their mortgages over 15 or 30 years. The U.S. government, on the other hand, will never be able to pay back the more than $30 trillion it has borrowed to pay its bills. It can start paying off that debt only if it collects more in taxes than it spends, and the likelihood of that is close to zero.
As deficit spending continues, governments borrow more. But fewer people are willing to finance that debt when the interest rate they receive in return is low, and when consumer prices are going up faster than the interest rates on their Securities, Bonds, Bills, and Notes. When prices go up constantly and dramatically, consumers choose to spend their money rather than earn almost no interest lending it to the government. Why put $100 in the bank if next year it will only buy what $85 buys today? (The government is currently claiming prices are increasing at an annual rate of about 7.5 percent, but its calculations are questionable — to put it kindly. A 15 percent rate is more accurate. Shadowstats.com paints a more precise picture of reality than does the government’s manipulated Consumer Price Index.)
For some reason, the Federal Reserve has long tried to keep the “inflation rate” at about two percent, when zero should be the goal. The “elites” believe it is acceptable for your savings to lose two percent in value year after year, in perpetuity. But with consumer prices increasing rapidly (regardless of whether the rate is 15 percent or “only” 7.5 percent), the Federal Reserve is now faced with a major problem. The government’s spending has ballooned to absurd, never before seen levels, which further increases the annual deficit. The government therefore needs hundreds of billions of dollars more each year to balance the budget, but if it were to raises taxes enough to cover that shortage it would motivate the voters to shop for pitchforks, tar, and feathers.
Faced with this predicament, the Federal Reserve can raise interest rates to encourage more people to lend money to the government to finance the massive deficits. But the more investors and individuals buy Treasury Securities, Bonds, Bills, and Notes (the more money they lend the government), the less money they have to start new businesses and buy consumer goods and services. Lending $500 billion to the government means $500 billion less invested and spent in the private economy. When consumers purchase fewer goods and services, demand falls. Prices then stabilize — or even go down — because stores have unsold inventory and businesses have excess capacity. Raising interest rates results in an economic slowdown and reduced job creation. People who are not working do not pay income taxes, and that also increases the deficit. Further, paying people a higher interest rate to lend it money costs the government even more, which further impacts the deficit. It is a downward spiral that can without warning spin out of control.
Government deficits are now so large, national debts (around the world) are so high, and governments are printing so much money that consumer prices are going up faster than can be held back by a minimal boost in interest rates. Raising interest rates by only a small percentage will not keep consumers from buying. (A one-half percent increase in the loan’s interest rate will not keep people from buying a new car in 2022 if they expect the vehicle’s price will be $3,000 higher in 2023.) Demand will therefore continue to exceed supply and production, and prices will continue to go up. But if the Federal Reserve boosts interest rates by a large enough percentage to reduce consumer demand and “cool the economy,” it risks causing a massive recession or even a depression. The nation could end up with higher interest rates, and higher prices, and higher unemployment. (See: Carter, Jimmy; stagflation.)
We are now at a point where no matter what it does the Federal Reserve could trigger a disaster. It has run out of options. Printing more money will cause even greater consumer price increases, but raising interest rates enough to slow down price increases could cause a recession. Doing nothing will not help, but doing something will hurt. What will the Federal Reserve do? Its choice is to either depress/crash the stock market (by raising interest rates significantly) or depress/crash the dollar (by expanding the money supply even more).
The “geniuses” at the Federal Reserve will try to finesse their way through the crisis by doing a little of both. They will raise interest rates (but by only a small percentage), and they will continue inflating the money supply. The result will be continued rising prices and an economic slowdown with increased unemployment. But because a minor increase in interest rates will not result in a significant decline in the stock market, the politicians will continue to pretend the economy is booming. “Look at the Dow Jones Industrial Average! America is back!” they will say, ignoring the miseries faced by unemployed Americans who cannot afford $8 milk or $7 gas. The nation will experience artificial good times for some (investors in the stock market), while hurtling toward horrendous bad times for almost everyone else. The Federal Reserve’s efforts to save us from a 1929-style depression may result in something much worse. As Ludwig von Mises wrote:
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
The optimal solution to the national economic problem is, of course, for Congress to balance the federal budget and stop running deficits. But the politicians cannot do that because they buy votes by giving away “free stuff,” paid for with both borrowed money and new money, and if they turn off the federal faucet the voters will revolt.
The looming economic disaster has been caused by decades of deficit spending by governments around the world. Eventually the piper has to be paid. If a family spends too much for too long and maxes out its credit cards, it eventually has to slash spending (causing a “family recession”) or borrow even more money (causing the “inflation” of its monthly debt bills). At some point everything collapses, and the family is forced to sell the house and file for bankruptcy. Several world governments are now approaching that point. It will not be pretty…