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Why the U.S. Need Not Fear a Sovereign Debt Crisis: Unlike Greece, It Is Actually Sovereign

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  • Fri, Jul 30, 2010 - 02:03pm

    #51
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

You read and responded to my original post which had all instances of “interest” and “principal” backwards by accident.  That has been corrected.

[quote=Thomas Hedin]

Let me ask you this:  what happens to the money that was originally lent against the loan that defaulted?  That’s right, it stays in the economy, offsetting whatever principal the bank absorbs to cover the loss

This is simply not a true statement.  When loans go bad the bank has pay off the remaining principle part of those loans.  When this process occurs it destroys money and dries up the money supply even faster.

In point of fact, however, the principal that is so-called absorbed by the bank does not leave the economy.  It stays on the bank balance sheet as reserves  and could be liquidated eventually.  The point is, it is not “extinguished”, but the greater point is that the money originally created against the defaulted loan, stays in the economy, offsetting even the reserve reduction required of the bank.

Can you source this information please from a creditable source.  When principle is extinguished it is simply destroyed.  It gets written off the books.  It does not get transfered anywhere else.

That has been answered above.  The principal circulates through the bank, to expenses, shareholders and investments.  The notion that principal payments dissapear from the economy or cause a net reduction in the money supply is patently and demonstrably false

But I asked you where was the money created to pay all this interest, not what is used to pay interest.  Do you read what I type or only read it for what you want it to say?

The notion that principal payments dissapear from the economy or cause a net reduction in the money supply is patently and demonstrably false.

Its a well known fact that when a principle payment is made that money is extiguished and does not exisist anymore.  I’m willing to have a discussion but we both have to try to be as honest as possible.

If money was created and never destroyed there would be no debt because final payment would exsist within the system.

[/quote]

  • Fri, Jul 30, 2010 - 02:07pm

    #52
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

[quote=Thomas Hedin]

The “only” reason?!!!   You’ve got to be kidding me.  I do run a business and a rather large one at that, and I can assure you there are many businesses that go out of business for all sorts of reasons having nothing to do with debt service.

I’m listening.  Please explain.[/quote]

Are you saying that 0% of debt-free businesses go out of business? 

[quote]

Sorry, but I have never seen a bank commercial, bank propaganda, or any other kind of bank communication that seeks to promote the idea that businesses should base their pricing based on measurements of the money supply.

Are you trying to tell me that you’ve never been told an increase in the money supply devalues the rest?

[/quote]

Yes, but not by banks.  Are you saying your position is that such a statement is false?

  • Fri, Jul 30, 2010 - 02:26pm

    #53
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

I do run a business and a rather large one at that, and I can assure you there are many businesses that go out of business for all sorts of reasons having nothing to do with debt service.

Please explain the reasons.  I want to hear at least some of them.

Are you saying your position is that such a statement is false?

I know we’ve all been told an increase in money devalues the rest (and this is true with commodity money such as gold/silver) but since all we use for money today is numbers an increase or decrease in numbers has no effect on the other numbers already in circulation unless you believe there is a magical force controlling all the pricing.  Either that or you’re in the camp with me that believes that pricing is controlled by people.

  • Fri, Jul 30, 2010 - 03:08pm

    #54
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

[quote=Thomas Hedin]

I do run a business and a rather large one at that, and I can assure you there are many businesses that go out of business for all sorts of reasons having nothing to do with debt service.

Please explain the reasons.  I want to hear at least some of them.

Are you saying your position is that such a statement is false?

I know we’ve all been told an increase in money devalues the rest (and this is true with commodity money such as gold/silver) but since all we use for money today is numbers an increase or decrease in numbers has no effect on the other numbers already in circulation unless you believe there is a magical force controlling all the pricing.  Either that or you’re in the camp with me that believes that pricing is controlled by people.

[/quote]

Thomas, it is this sort of circular discussion that is so frustrating for some of us that are trying to understand root cause systemics of debt based currency.

I also run a business, a debt free business at that, and I can tell you that the statement that business go under for no other reason than inability to service debt is way, way off track. Specifically, the most important parameter for an operating business, a real one not a theoretical one, is cash flow. The delta between (revenue) inflows and (expense) outflows is cash flow. If outflows exceed inflows for any reason, in any measured time increment, the business is for that period of time unsustainable. What mitigates this problem is the businesses reserve capital, the business must operate from reserves to bridge the periods when outflows exceed inflows. Most, if not all, businesses have periods where this occurs. If you do not understand this, you do not understand business.

The ability for a business to sustain itself then focuses on two key parameters:

1.)    The requirement for inflows to exceed outflows on balance.

2.)    The presence of reserve capital to bridge periods where item 1 is not captured.

So to continue, one of the line items on the expenses side of the ledger may be debt service. Operative word being ‘one”. There are many items on the expense side. If the aggregate of any of these expenses exceeds inflows, we have a potential risk of bankruptcy if:

3.)    Reserve capital is either non existent or insufficient in quantity to bridge the gap until inflows can recover to the point where they again exceed outflows.

4.)    The expenses cannot be reduced sufficiently to meet the realities of lower inflows(Reduced sales). If we use labor as an expense example, at some point simply laying off workers (reducing expenses) will degrade the operations side to below the critical mass where it can no longer service the business model.

In anticipation of your likely response to suggest that the business simply borrow money, this is where a practical understanding of business is imperative. Owning a business is most certainly not a speculative activity. Many business owners will not do this (borrow money) unless the prospects for future positive cash flow can be reasonably and confidently predicted. If economic conditions discourage this conclusion, most business owners will not borrow money. Many will instead scale back, some to the point of collapse. (See item 4).

No business that I know of prices their product or service on the money supply. As I have posted earlier, businesses create pricing strategies based on many criteria, cost of goods is certainly one, but there are also intangibles, such as what price point will the market bear. The final pricing is usually a convergence of costs overlaid with what the market will bear. To cite another example of a business failing outside of debt service, sometimes the price the market will bear is less than the cost of goods, even in a business without debt. In this case, the business will also fail.

  • Fri, Jul 30, 2010 - 03:18pm

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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

If outflows exceed inflows for any reason, in any measured time increment, the business is for that period of time unsustainable.

My point proven.

  • Fri, Jul 30, 2010 - 03:20pm

    #56
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

No business that I know of prices their product or service on the money supply

Thank you.

  • Fri, Jul 30, 2010 - 03:40pm

    #57
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

[quote=Thomas Hedin]

I do run a business and a rather large one at that, and I can assure you there are many businesses that go out of business for all sorts of reasons having nothing to do with debt service.

Please explain the reasons.  I want to hear at least some of them.[/quote]

Darbikrash has given an excellent explanation and I’ll leave it at that.  If you still think debt is the only reason businesses close, I’m sorry, but I do not have time to elaborate upon what Darbikrash has said and what should be obvious. 

[quote]

Are you saying your position is that such a statement is false?

I know we’ve all been told an increase in money devalues the rest (and this is true with commodity money such as gold/silver) but since all we use for money today is numbers an increase or decrease in numbers has no effect on the other numbers already in circulation unless you believe there is a magical force controlling all the pricing.  Either that or you’re in the camp with me that believes that pricing is controlled by people.

[/quote]

Please clairfy these statements.  Are you denying that an increase in the money supply,  all else being equal, does not result in increased prices?

 

I would also like your responses on what I wrote earlier.  You only responded to the original version of my post, in which I mistakenly reversed the use of the words “interest” and “principal”.  I corrected it immediately, but apparently not before you had time to copy, paste and reply to it.  You have not responded to the corrected post which is copied below for your convenience.  I look forward to your reply:

[quote=Farmer Brown]

[quote=Thomas Hedin]

Farmer,

Ah yes, I forgot that you believe that interest payments go under a banker’s mattress never to re-enter the economy again.  So basically, your theory rests upon the erroneous assumption that interest payments on loans dissapear upon payment and therefore a net decrease in money compared to debt results due to time and interest kicking in.  Why do you believe this?  What do you think happens to interest payments?  Clearly you cannot believe it extinguishes money, since you’ve already stated only principal payments extinguish money. 

So you must believe something else happens to interest payment money which results in it forever and inextricably being unavailable to the economy again. Someone should inform GS, JPM, WF, C, BAC, and the thousands of other banks in the world and all their tens of thousands of shareholders of this development posthaste.

Please explain whatever it is you believe happens to this money

Some of the interest payments that a bank receives never enter circulation in the economy again.  Banks have a bad debt reserve account to cover bad loans.  When a loan goes bad, the bank uses that money pay off (destroy) the remaining principle on a loan.[/quote]

Let me ask you this:  what happens to the money that was originally lent against the loan that defaulted?  That’s right, it stays in the economy, offsetting whatever interest payments the bank absorbs to cover the loss.  In point of fact, however, the interest portion that is so-called absorbed by the bank does not leave the economy.  It stays on the bank balance sheet as reserves  and could be liquidated eventually.  The point is, it is not “extinguished”, but the greater point is that the money originally created against the defaulted loan, stays in the economy, offsetting even the reserve reduction required of the bank.

[quote]

 

So basically, your theory rests upon the erroneous assumption that interest payments on loans dissapear upon payment and therefore a net decrease in money compared to debt results due to time and interest kicking in.  Why do you believe this?  What do you think happens to interest payments?  Clearly you cannot believe it extinguishes money, since you’ve already stated only principal payments extinguish money.

We agree that when a principle payment is made that money is extinguished.  The question is where is the money created to pay all this interest if only principle is created?[/quote]

That has been answered above.  The interest payments circulate through the bank, to expenses, shareholders and investments.  The notion that interest payments dissapear from the economy or cause a net reduction in the money supply is patently and demonstrably false.

 

Edited:  I mixed up my use of “interest” and “principal”  in my original post and this has been corrected.

[/quote]

  • Fri, Jul 30, 2010 - 04:21pm

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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

[quote=Thomas Hedin]

No business that I know of prices their product or service on the money supply

Thank you.

[/quote]

They certainly do in an indirect manner. Thomas, you stated that “projected future earnings” are a factor businesses use to price their products. These projected earnings should be based on consumer demand. If consumer demand is very high (due to a large expansion in the money supply), and supply is relatively constant, then prices should go up to increase profit margins/cash flows and remain competitive. I’m not sure why you are denying the simple economic fact that an increase in the money supply chasing the same amount of goods/services, all else being equal, will lead to an increase in consumer prices.

  • Sat, Jul 31, 2010 - 12:10am

    #59
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

Sorry for falling behind in this thread but two early questions came up that I had to think about before attempting a response. Both are insightful and very similar and I think they provides us with an opportunity to break new ground. 

goes211 wrote (Post 12):

What I don’t see is how any equilibrium is reached in a system that creates money and spends it on infrastructure. Without some sort of negative feedback on too much money creation, the system will surely become unstable and eventually fail.

And, later a similar question was asked:

JAG wrote (Post 15):

I’m aware that the creation of debt-free money would be tied to production, and this does seem to balance the money supply in the short term. But the problem, as I see it, is that once it’s been created, debt-free money will accumulate in the economy over generations. The money supply of future generations will not just consist of the money created with their production, but also include all the money created by the previous generation’s production.

For example, lets say the next generation is exactly the same size as the current generation. Now if both generation’s production are roughly equal, that means the future generation’s money supply will be roughly double the current generation’s money supply. Removing velocity from the equation, this means prices will be roughly double for the next generation, or 100% inflation in 20 years time. And what if there is a war or natural disaster that drastically reduces the population and economic production in the future? You could easily have 10 times the amount of money relative to production/goods in that scenario.

If we are ever to build a sustainable economy, it is imperative that we look down the road – the questions raised above need to be explored and discussed.

Summary:

  1. At this point, it is almost impossible to inject enough “debt free” money into the system to keep it from deflating into a full blown depression; at least for the dependent and middle class
  2. Under a “productivity standard”, the potential to create new debt free money is regulated by the available capacity of the people, resources and energy – this also endows the money with value
  3. The volume of money is always greater than the amount available for general circulation, which means additions to the money supply may or may not be inflationary
  4. Even if we allow government to monetize wealth, the larger part of the economy will remain debt based
  5. How do we as a nation and people, accumulate wealth if all the money is eventually destroyed?

Response:

1. At this point, it is almost impossible to inject enough “debt free” into the system to keep it from deflating into a full blown depression; at least for the dependent and middle class

In round numbers, M3 is almost $14 trillion and the total amount of private and national debt is over $57 trillion, not including interest. The shortfall ($43 trillion) must come from somewhere to prevent massive defaults that could crush the middle class.

In the past, we simply pushed off the debt to future generations but we are soon to hit the point where we will be unable to make the minimum payment (interest due) on the debt. Somehow, a lot of debt free money must be added to the system over an extended time period. And it should be targeted towards the productive part of the economy.

2. Under a “productivity standard”, the potential to create new debt free money is regulated by the available capacity of the people, resources and energy – this also endows the money with value

In 2008, the U.S. GDP was around $14.6 trillion. If 10% of the GDP could be spent into circulation, debt free, it would add around $1.4 trillion to the money supply. And, 20% of GDP, a huge amount, would be around $2.8 trillion.

Our infrastructure is crumbling, the electrical power grid and generation equipment are operating way above design capacity, oil is running out, new transportation systems are needed and sustainable energy alternatives must be implemented on a massive scale. We could easily invest trillions of dollars per year without wasting a penny.

As we approach our combined human and natural capacity to intelligently produce, backlogs and lead times will increase which will reduce the opportunity to spend money into the economy. The system would regulate itself under a productivity standard with the ultimate goal being low unemployment.

Under the Federal Reserve Charter, its first basic responsibility includes “conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment…” They have failed miserably as unemployment is reaching record numbers and the nation finds itself skidding into a depression. People usually think that the Fed’s most important function is to avoid inflation and deflation by implementing an elastic money supply. That’s not the case as the Fed’s FOMC policy has been to try (unsuccessfully) to maintain around 2% inflation. At 2% inflation, the value of our money would be reduced by half in around 35 years.

Abraham Lincoln understood that the most basic duty and function of government is to create and issue the national currency:

“The government should create, issue, and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government’s greatest creative opportunity. The financing of all public enterprise and the conduct of the treasury will become matters of practical administration. Money will cease to be master and will then become servant of humanity.”

3) The volume of money is always greater than the amount available for general circulation, which means additions to the money supply may or may not be inflationary

It is often assumed that an increase in the money supply is inflationary but this rule of thumb assumes that the **M2 (see definitions below) aggregate is also increasing. The total amount of money (*M3+MB+MZM, see definitions below) may increase while simultaneously, the amount available for circulation (**M2, see definitions below) may decrease.

This is happening now as the money supply is increasing while the available circulation (**M2 see definitions below) is shrinking (deflating). The **M2 aggregate has dropped since the high point in 2009. **M2 is a key economic indicator used to forecast inflation.

M2 and M3 have been decreasing (deflation)

 

The money supply is growing at a huge amount (*M3+MB+MZM)

The money supply has been rapidly growing but the lions share has been created as excess bank reserves as you can see in the above chart. Theoretically, excess reserves enables banks to lend more money, which may become part of **M2 if it is borrowed.

The problem is that you can’t add money to circulation (**M2) without someone going further into debt. There aren’t enough willing and worthy borrowers in the private to increase the circulation. The government has stepped in as the borrower of last resort but like the private sector, government is close to “peak debt.”

Definitions:

  • *M3+MB+MZM – Broadest monetary aggregates reported by the Fed; includes:

    Notes and coins (currency) in circulation and in bank vaults, Federal Reserve Bank credit (minimum reserves and excess reserves), traveler’s checks, checking accounts (demand deposits), other checkable deposits (OCDs), savings deposits, time deposits, institutional money market funds and all money market funds.

    Note that many investment vehicles (e.g. stocks, PMs) and credit cards are not considered to be part of the M3+MB+MZM aggregate money supply

  • **M2 – Money and “close substitutes” potentially available for circulation. M2 is a key economic indicator used to forecast inflation. Included in the M2 monetary aggregate are:

    Notes and coins (currency) in circulation, traveler’s checks, checking accounts (demand deposits), other checkable deposits (OCDs), savings deposits and time deposits (less than $100,000 and money-market deposit accounts for individuals).

    Note that credit cards are not considered to be part of the M2 agregate money supply

4) Even if we allow government to monetize wealth, the larger part of the economy will remain debt based

Almost all private borrowing would continue as debt money (monetization of debt). For example, if a mortgage is used to create money, as the principal is repaid, the money would be extinguished. Some, but not all, of the interest paid would be returned to circulation.

In essence, it would be a hybrid system with some permanent (wealth) and some temporary (debt) money. Some of the permanent money would be used to pay debt and interest.

5) How do we as a nation and people, accumulate wealth if all the money is eventually destroyed?

Thomas Edison said “It is a terrible situation when the Government, to increase the national wealth, must go into debt and submit to ruinous interest charges…” Unfortunately this is true as the nation cannot add to the national wealth without adding more (principal + interest) to the national debt.

When people are productive and a nation prospers, it is natural for the public wealth to increase. So to, when people are allowed to keep the fruits of their labor, they may rightfully begin to save and accumulate wealth.

This doesn’t mean that it will be inflationary as much of the money will be used for savings and investments which are not considered part of the money supply.

Larry

  • Sat, Jul 31, 2010 - 04:31pm

    #60
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    Re: Why the U.S. Need Not Fear a Sovereign Debt Crisis: …

Recycling Money

If debt free money is spent into the economy it provides us with an opportunity to develop a strong permanent money supply that can be recycled.  Under the current system, new money is created with every new bank loan but it doesn’t have to be that way.  As part of the plan, the monopoly to create money would be taken from the banks and rightfully restored to the treasury.

In making loans, banks would need to first acquire the money that they lend from three basic sources:

  1. They could borrow it from the treasury; as the debt is repaid, the money would be destroyed similar to our current system
  2. They could borrow money from private individuals and companies and then re-lend it at a profit; existing money would be recycled rather than creating new money
  3. They could accumulate money from profitable operations and use it for loans; again, existing money would be recycled

Transformation from a debt to an ownership society

There isn’t enough money in our current system for the middle class to collectively buy the things they need.  Credit cards, equity loans and leasing are used because there isn’t enough money in circulation.  A permanent base in our money stock would provide the opportunity for people to actually buy things without incurring more debt.

As the permanent money stock increases, the need to borrow decreases.

Larry

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