The Debt Economy

December 5th, 2009

By Brianna Aubin

I remember once that I was writing a comment to an online newspaper article when I needed to reference the national debt figure, so I went surfing for one of the debt clock websites.  I promptly found one of those Java clocks that update the debt by the second, and used the number as a reference, but that’s not the important part of the story.  The important part was that, right next to the clock, the owner of the site had put up a sign to the effect that we could have gotten out of the Great Depression sooner, but Roosevelt hadn’t spent enough money to do the job.

For months, this contradiction came back to me at odd moments.  Not the ideas themselves; I’d heard the ideas that the government should curtail its spending and that government needs to play a larger role in the economy many times, albeit not at the same time from the same person.  But the fact that someone could put those two ideas together, that someone could go to the time and trouble of programming a debt clock to show what dire financial trouble our nation was in even as he believed that the government should go into even more debt in order to get us back out again, was simply astonishing to me.

Since then, however, I have done more research and now I know the cause that allows these two seemingly contradictory beliefs to work together in perfect harmony: the dollar is based on debt.

Think about it.  The Federal Reserve puts dollars into the economy by purchasing government bonds with manufactured dollars.  It then uses these securities as assets upon which to create even more dollars, which it gives to the banks.  The banks then use these dollars as the basis for even more loans under the fractional reserve system, which further multiplies the money supply.

But picture what would happen if people decided they didn’t want to be in debt.  If the people who took out the loans from the commercial banks paid them back and then refused to borrow anymore, all of that fractional money would disappear.  If the government paid back the bonds it had issued and then refused to issue any more, the assets upon which the federal reserve had printed all of those dollars would disappear.  In the words of G. Edward Griffin, author of The Creature from Jekyll Island (the “creature” is the Federal Reserve):

…if everyone paid back all that was borrowed, there would be no money left in existence…. There would be not one penny in circulation – all coins and all paper currency would be returned to bank vaults – and there would be not one dollar in any one’s checking account.  In short, all money would disappear. [emphasis in original]

Even the Federal Reserve acknowledges the fact that their financial system has been built on an edifice that could collapse at any time, provided enough people could be persuaded not to believe in it.  From a hearing of the House Committee on Banking and Currency in 1941:

Congressman Patman: “How did you get the money to buy those two billion dollars worth of Government securities in 1933?”
Governor Eccles: “Out of the right to issue credit money.”
Patman: “And there is nothing behind it, is there, except our Government’s credit?”
Eccles: “That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.”

Or in the words of Robert Hemphill, a former employee of the Federal Reserve Bank in Atlanta:

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation.  This is a staggering thought.  We are completely dependent on the commercial banks.  Someone has to borrow every dollar we have in circulation, cash, or credit.  If the banks create ample synthetic money, we prosper; if not, we starve.  We are absolutely without a permanent money system.  When one gets a complete grasp of the picture, the tragic absurdity of our hopeless situation is almost incredible – but there it is.

Put that way, people like Mr. Paul Krugman, Nobel Prize-winning economist and New York Times columnist, suddenly make perfect sense when they advocate that the way to get out of this economic recession is through massive deficit spending.  From Mr. Krugman’s book The Return of Depression Economics:

…the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots.  Nothing oculd be worse than failing to do what’s necessary out of fear that acting to save the financial system is somehow “socialist.”

The same goes for another line of approach to resolving the credit crunch, getting the feds, temporarily, into the business of lending directly to the non-financial sector.  The Federal Reserve’s willingness to buy commercial paper is a major step in this direction, but more will probably be necessary.

All these actions should be coordinated with other advanced countries.  The reason is the globalization of finance, described in Chapter 9.  Part of the payoff to US rescue of the financial system is that they help loosen up access to credit in Europe; part of the payoff to European rescue efforts is that they loosen up credit here.  So everyone should be doing more or less the same thing; we’re all in this together.

And one more thing: the spread of the financial crisis to emerging markets makes a global rescue for developing countries part of the solution to the crisis.  As with recapitalization, parts of this were already in place at the time of writing; the International Monetary Fund was providing loans to countries with troubled economies like Ukraine, with less of the moralizing and demands for austerity that it engaged in during the Asian crisis of the 1990’s.  Meanwhile, the Fed provided swap lines to several emerging-market central banks, giving them the right to borrow dollars as needed.  As with recapitalization, the efforts so far look as if they’re in the right direction but too small, more money will be needed….

The United States tried a fiscal stimulus in early 2008, both the Bush administration and congressional Democrats touted it as a plan to ‘jump-start’ the economy.  The actual results were, however, disappointing, for two reasons.  First, the stimulus was too small, accounting for only about 1 percent of GDP.  The next one should be much bigger, say, as much as 4 percent of GDP.  Second, most of the money in the first package took the form of tax rebates, many of which were saved rather than spent.  The next plan should focus on sustaining and expanding government spending – sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

Have the Federal Reserve print and spend even more money than it already has.  Expand the Federal Reserve’s lending power to the non-financial sector, Europe, the IMF, the globe.  The more debt we have in our economy, the better off we’ll be.  At least, until the inflation from printing all that money sets in.  As to how well the US and global economy will be doing after that…well, I hear Zimbabwe is really nice this time of year.


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10 Responses to “The Debt Economy”



  1. Brian Bagent |

    And it is said that we cannot afford to go back to precious metals. We cannot afford not to.

    It is as I’ve said before, the crash of our currency is as predictable as gravity.


  2. Cristla |

    My great grandfather did not trust banks his entire life. He chose to buy gold during his early years. After he married he began putting his money in jars and buried them in the back yard. For as long as i can remember if he needed to buy something that cost more than he had earned that week, he would take his shovel and disappear for awhile. Upon his return, he would get in his car make the purchase and then return home. He always stated, “the government will not use my money if i do not have a say in where it is being spent” as children we did not get it. Now i am thinking maybe more people should have done that.


  3. Harvey |

    If the basic concept of borrowing money ONLY to fulfill a need — and only if the borrower honestly feels that he/she/it (including the U.S. Government) will be able to pay it back under the terms of the loan . . . if this basic concept goes out the window or under a bus full of economists we might as well start packing for a move to a place where the currency is coconuts or sea shells.

    The paragraph: “The Federal Reserve puts dollars into the economy by purchasing government bonds with manufactured dollars. It then uses these securities as assets upon which to create even more dollars, which it gives to the banks. The banks then use these dollars as the basis for even more loans under the fractional reserve system, which further multiplies the money supply.” tells me that our money, the U.S. Dollar, is based on nothing but fantasy and, to a person who only understands personal economics, that is very scary.


  4. Brianna |

    Harvey – if you want to truly understand money, what it is, its history, how it affects a society, and what we’re doing to it today, then I would recommend The Creature From Jekyll Island. If you want to learn the basic history of our (American) currency, I would recommend The Biography of the Dollar.


  5. Tom |

    Brianna, another excellent, well-written article! I’ve read and thought about everything you and Brian have said in the past about the Federal Reserve, monetary supply, the gold standard, fiat currency, etc. What I don’t understand is given where we are now, what kind of system would you implement to replace what we have now?

    Would things be completely decentralized, to the point where states and even banks could issue their own currency? What mechanism would exist to manage, insofar as possible, severe fluctuations in the economy? How can we go on a gold standard when all the gold in U.S. possession, even at $1,000 per ounce, comes nowhere near the amount of dollars in circulation, without literally destroying the value of gold and creating worldwide inflation? What happens if foreign creditors demand payment in gold? The Bretton Woods regime made international currencies valued relative to the dollar, which was then valued in gold, but nothing now even remotely resembles that regime. And what happens with the value of a gold-based dollar when there’s a major increase in the amount of above-ground gold, as happened with silver in the 19th century? Who handles U.S. monetary affairs in the international system without the participation of the Federal Reserve — the Treasury Dept, where politics rules everything? How do we reconcile a U.S. dollar valued in gold with all the fiat currencies of other major nations and the Euro?

    It’s not enough to point out, accurately I’m sure, that the present monetary system is terrible and the Federal Reserve is rotten. Something has to replace the system that’s now in place, and it has to be a viable, workable alternative.


  6. Brianna |

    Tom – you’re right that replacing the Fed wouldn’t be easy. As to your questions, what you have to understand is that I’ve been writing these articles as I’ve been going along; I’d read a book on money or finance or the economy and then I’d share some of what I learned.

    I have some ideas on how to fix the system and replace the Fed, but they are far from fully worked out. Also, I am not a professional economist, just someone who spends way too much of my spare time reading, so my missing a couple of points is probably inevitable. Probably what I’ll end up doing is finishing making my case in a series of articles, then tie it all together with some sort of proposed solution. I’m busy finishing up the semester right now, but I’ll have nearly a whole month free during the Christmas season in which I’ll have nothing to do but reading and thesis work; hopefully I will be able to make a lot of progress then.


  7. Tom |

    That would be great, Brianna. There are probably ways to do things differently that would work, but I don’t know what they would be. I come at it from an academic background in politics, government, international relations, foreign policy, and history, and I’ll be the first to admit that I don’t do economics that well. My various academic departments tried forcing more economics on everyone, but my colleagues and I tended to write it off as truly “the dismal science.”


  8. Brianna |

    Tom – I have only taken a couple of very basic “official” economics courses, but based on what I saw in those compared to what I’ve been reading, I have a sneaking suspicion that economics is not a well-taught subject in general. This is just a guess, but I’m willing to bet that most economics programs train technicians as opposed to scientists, i.e. people who can run the machine and fix simple problems, but not people who truly understand how the system functions or what it’s based on.

    I also have a strong suspicion that my technical background allows me to approach the problem in ways that someone with a more liberal arts-based education would not, because of the way we are trained to look at information, integrate the data, and use it to solve problems.


  9. Brian Bagent |

    Brianna, you’re correct about most economics departments. Walter Williams has got lots of stuff out there. I’ll see if I can’t has a bit of it out over the next week or so. The problem with most economics departments is that they teach Keynes, not Friedman or von Mises.

    There’s another economist named Paul Zane Pilzer who has written some interesting things, and takes pains to point out where Keynes had everything inside out and upside down.

    In a nutshell, Keynes believed that we were too productive for our own good. At some point, he believed that everybody, or nearly enough, would have everything they wanted and stop producing. His failure was a failure to understand human nature. Some people may be satisfied with the things they have, even if it were a meager collection, but many would not be. The businessman with 3 or 4 suits of $150 value each, when he gets promoted, will be replacing those with suits in the $300 price range. Instead of Florsheims, he’ll buy Bostonians or Johnson and Murphy. He’ll get rid of the Malibu and buy a Lexus or BMW.

    What he also failed to grasp was what technological advances would mean to a free market. Nobody in the first half of the 20th century could have foreseen the exponential growth in the accumulation of knowledge. Up until about 150 or so years ago, the world’s body of knowledge doubled about ever 100 years or so. Today, the body of knowledge doubles at least annually, maybe faster.

    In 1935, most houses still didn’t have telephones. Today, even cellular telephones have become ubiquitous, and they were the province of the exceptionally wealthy just a scant 25 years ago. In the ’40s, IBM didn’t envision a need for more than 8 or 10 ENIACs for the entire country. Today, we have laptops with processing power that would seem like magic to electrical engineers from that era. Today, we can transfer more data over a cable modem connection in 2 or 3 minutes than those old computers had drive space to store.

    Keynes had a perfectly prototypical bureaucrat’s view of the world. He was unimaginative and dull, lacking the ability to realize that free people will be productive, that free people use their own carrots and do not require the stick of the government to motivate them to innovate and produce.


  10. Brian Bagent |

    Tom, there would certainly be some confusion and wild times if we were to switch back to precious metals, but it would be short-lived. The economy would stabilize.

    As far as the quantity of gold relative to the quantity of dollars, I’d suggest a little “thinking outside the box” is in order. What the disparity between gold prices and the dollar volume should tell you is that presently, as a commodity, gold is under-priced at $1100/Troy oz., meaning inflation is worse than what the current exchange rate would seem to indicate it is.

    The last time I looked, just a couple days ago actually, there are about 66 tons of gold in existence on earth, with contracts for something like 240 tons. Too many dollars chasing too few commodities is one useful definition of inflation.


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