Premium Archives
by
Chris Martenson
Tuesday, September 23, 2008
In this report, I delve into the bailout plan and why it is destined to fail, no matter how it is configured. It is important that you at least consider the possibility that it very well could fail, with disastrous consequences for the dollar and the continued operation of the US government in its current form.
“See, you know the way a bailout works? Here’s the way a bailout works. A failed president and a failed Congress invest $700 billion of your money in failed businesses. Believe me, this can’t fail.”
~ Jay Leno
The recently proposed bailout of failed Wall Street banks represents the most brazen attempt at grand larceny ever in our nation’s history. Some have even likened it to financial terrorism, because Wall Street went so far as to repeatedly say; “Either we get this bailout or the entire system goes under.”
This echoes, more or less precisely, what happened in the years after Ronald Reagan deregulated the S&L industry in 1982. Within a few short years, excesses and fraud were rampant within the system, and taxpayers were forced to cover the inevitable bust that followed. Many well-connected individuals made out like bandits on sweetheart deals meted out by the Resolution Trust Corporation (RTC).
But this crisis, which has been presented as if it caught everyone by surprise, was no surprise at all. It was years in the making, and the response was carefully planned over the past year. The bailout proposal, as originally presented (on Sat. 9/20/08), was shocking.
First, there was the sneaky language that the $700 billion figure was the most that could be spent at any one time, meaning that there was no limit on the spending at all. Second, the right of review by any court of law or other administrative body was to be stripped away, a distinctly unconstitutional and anti-American provision if ever there was one. Third, the Treasury Secretary was to be embodied with complete unitary power in selecting who was to be empowered with an open-ended taxpayer checkbook.
No review, no limits, no questions.
So what happens when you have vague language and an unlimited budget? Fraud and self-dealing, that’s what. Mark my words, this is the largest looting operation ever in the history of the US, and it’s all spelled out right there in the delightfully brief bailout document that Paulson and Bernanke are attempting to ram through a scared Congress.
Folks, if it looks like a looting operation, smells like a looting operation, and acts like a looting operation, it’s a looting operation.
There are some in Washington DC who ‘get it,’ including Bernie Sanders, who recently stated:
[quote] “While the middle class collapses, the richest people in this country have made out like bandits and have not had it so good since the 1920s. […] The wealthiest people, who have benefited from Bush’s policies and are in the best position to pay, are being asked for no sacrifice at all. This is absurd. This is the most extreme example that I can recall of socialism for the rich and free enterprise for the poor.” [/quote]
Hopefully, for the sake of justice, the bailout will be significantly modified prior to passage.
However, it won’t really matter much in the end, because there is no possible way for any bailout to succeed, no matter how it’s configured.
Three simple truths
Instead, there are three simple truths that have to be recognized, if we are to navigate our way through this crisis:
- The United States government is insolvent.
- The entire US financial system is insolvent.
- There is no combination of new debt/borrowing schemes that can possibly correct #1 and #2.
The first rule of life is, “When you are in a hole, stop digging.” The past 25 years have witnessed the greatest accumulation of debt ever recorded by our nation. That is our hole. Yet our current leaders have ordered a backhoe and promised to use it.
Figure 1: This chart compares total debt (or ‘credit’) in the US to GDP (or Gross Domestic Product) on a percentage basis. Current total credit market debt stands at more than 340% of total GDP. As we can see on this chart, the last time debts got even remotely close to current levels was back in the 1930’s, and that bears a bit of explanation. The debt-to-GDP ratio back then didn’t start to climb until after 1929 (solid arrow), because debts remained relatively fixed in size, while it was the GDP that fell away from under the debts. With the exception of the Great Depression anomaly, our country always held less than 200% of our GDP in debt (gray dotted arrow). In 1985 we violated that barrier and never looked back. What each of us knows to be “just how the economy works” is really a historically unusual experiment with debt that is barely 25 years old. In the sweep of economic history, this barely qualifies as a blink.
This 25-year-long borrowing binge has so badly distorted our collective sense of right from wrong that we no longer seem capable of setting simple priorities. The consideration by Washington DC of a $700 billion bailout proposal in the same week that it passed a record-setting $612 billion defense budget is a perfect example of this dynamic. No trade-offs mentioned; “Yes, we’ll have one of everything” is the reigning mentality.
Our first challenge in confronting this crisis
This crisis is fundamentally one of insolvency (definition below), not a failure to have enough dollars floating around, which means that it is not a liquidity crisis.
Definitions:
• Insolvency. A condition where one’s assets are exceeded by one’s liabilities to an insurmountable extent. Distinct from bankruptcy, which is a legal event precipitated by a final inability of cash flow to continue to carry an insolvent entity any further. Insolvency nearly always precedes bankruptcy.
• Liquidity. A measure of how much money exists in a useable form. A person with a $10 million house but no money in the bank is said to be “illiquid,” not “poor” or “broke.” A “liquid” market, like the stock market, offers a reliable and fast way to exchange assets for money. When the Fed is said to be adding “liquidity,” they are taking assets from banks in exchange for cash.
The institutions in question are as insolvent as a minimum-wage janitor trying to make payments on a $2 million beachfront house using only his earnings. The aggressive lowering of interest rates by the Fed in their attempt to help provide liquidity to the banks was like assuring that the janitor’s checks cleared at the bank a little faster. But improving liquidity did not help. It couldn’t, because the problem was one of solvency, not liquidity.
But if liquidity won’t do the trick, what will?
Here we must face the hard truth that merely transferring the failed loans from the insolvent banks to an insolvent nation will do nothing but forestall the problem until a slightly later date (when it will be larger and more severe, by the way). The fact that both candidates for president are openly supporting the bailout says that reality has not yet penetrated the inner beltway.
So the first challenge will be recognizing that it really is not possible for an insolvent nation to bail out an insolvent financial system by borrowing more money. This is an absurd notion, and in total it really is no more and no less complicated than that. One cannot solve a crisis rooted in debt by issuing more debt.
Our second challenge in confronting this crisis
On September 23rd, 2008, before the Senate banking committee, Bernanke said, “I believe if the credit markets are not functioning, that jobs will be lost, the unemployment rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover.”
The palpably strong desire by the current politicians to “get the economy back on track” and to immediately return (if possible) to maximum consumption is absolutely the wrong response at this moment in history. We do not need to return to our borrow-and-borrow-more ways of the past. We desperately do need to demonstrate awareness that the future is loaded with challenges that only grow larger and more urgent with time. None of these challenges, ranging from energy dependence, to population, to a broken entitlement and pension system, will be helped by a return to our former credit-dependent ways. In fact, they will be exacerbated.
So our second challenge is to recognize that our first instincts to repair a broken system are wrong.
Instead, we need to have an honest accounting of our current economic condition, matched against the very real warning signs that our consumptive lifestyle is due for a radical overhaul. If we miss this chance to level with ourselves, we will have squandered an enormous opportunity.
Your biggest challenge
Recently, Senator Chris Dodd (CT) stated, “[W]e’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.” I know that the temptation is to trust that somehow these big players on Wall Street and in Washington DC have this all under control, or that they will fashion something workable to tide us over for a while. While they might be able to limp this along for a while longer, it might also fail sometime next Tuesday, and it will certainly fail sooner or later. When our economy finally suffers a complete meltdown, the resulting calamity will be as individually dramatic to each of us as if our homes burned to the ground. Your challenge is to accept that this crisis is fundamentally “unfixable” and that wherever the future takes us, it will not be a simple continuation of the past. With this acceptance, the challenge becomes assessing what might happen and what you can do about it.
Okay, so now what?
The immediate risk that I see here centers on a collapse in the international value of the dollar, which will rapidly morph into a massive financial crisis for the federal government. When all is said and done, I fully expect the federal government to be half its current size, with states, to varying degrees of success, picking up the slack as best they can.
The chance that the US dollar will go into a steep decline from here is very high. I personally place the risk that a major dollar decline will ensue within the next 6 months at 50%. Here’s how that would play out.
In its full wisdom, while times were good, the US government opted largely to finance itself with short-term debt in the form of 3 month and 6 month “T-Bills.” In essence, because these T-Bills ‘roll over’ every 3 or 6 months at whatever the current interest rate is, the US government opted to finance itself with an Adjustable Rate Mortgage (ARM). Hold onto that thought.
Now that the government has embarked on a course of massive deficit spending that is sure to top $1 trillion next year (and possibly go as high as $2 trillion), this money will have to either be borrowed from overseas or printed out of thin air by the Federal Reserve. In either case, there is a very high probability that either/both of these actions will cause interest rates to climb, possibly quite steeply and suddenly.
And here is where the “vicious spiral” comes into play, exacerbated by the short-term (ARM-like) borrowing stance described earlier. The more the government needs to borrow, the higher interest rates will go. The higher that interest rates go, the greater the need to borrow. So more borrowing begets higher interest rates, which beget more borrowing, which beget higher interest rates, which….ah, you get the idea.
If (or when) this dynamic gets started, its self-reinforcing nature will cause both the dollar to collapse in value and interest rates to shoot upwards. Either of these effects alone would provide a serious hit to our debt-based way of life, but together they promise to deliver earth-shaking changes to those who are unprepared. Concurrent with this death-spiral for the dollar will come massive (hyper?) inflation of imported goods, the most important of which, to our daily lives, will be oil. Gasoline at $10 or even $50 per gallon is not unthinkable.
This means that you, individually, need to begin thinking about ways to economically insulate yourself from this possibility, as does each state in the union.
My advice to you is the same as it has been for months.
- Trim your expenses as far as humanly possible.
- Don’t take on any more debt for any circumstances, unless you are speculating and can manage the risks.
- Hold gold and silver, physical only. How much? That depends on how many of your US-dollar-denominated holdings you’d like to be absolutely sure do not go to zero.
- Keep cash out of the bank. Three months’ living expenses, if you can.
- Develop a sense of community, and get to know the people you can count on and who will count on you.
- When you can, keep things topped off around the home. You never know.
I laid out my investment thoughts back in May, which you should read when you get the chance. That Martenson Report is titled Charting a Course Through the Recession and is free to registered users.
The Greatest Looting Operation in History
PREVIEW by Chris MartensonTuesday, September 23, 2008
In this report, I delve into the bailout plan and why it is destined to fail, no matter how it is configured. It is important that you at least consider the possibility that it very well could fail, with disastrous consequences for the dollar and the continued operation of the US government in its current form.
“See, you know the way a bailout works? Here’s the way a bailout works. A failed president and a failed Congress invest $700 billion of your money in failed businesses. Believe me, this can’t fail.”
~ Jay Leno
The recently proposed bailout of failed Wall Street banks represents the most brazen attempt at grand larceny ever in our nation’s history. Some have even likened it to financial terrorism, because Wall Street went so far as to repeatedly say; “Either we get this bailout or the entire system goes under.”
This echoes, more or less precisely, what happened in the years after Ronald Reagan deregulated the S&L industry in 1982. Within a few short years, excesses and fraud were rampant within the system, and taxpayers were forced to cover the inevitable bust that followed. Many well-connected individuals made out like bandits on sweetheart deals meted out by the Resolution Trust Corporation (RTC).
But this crisis, which has been presented as if it caught everyone by surprise, was no surprise at all. It was years in the making, and the response was carefully planned over the past year. The bailout proposal, as originally presented (on Sat. 9/20/08), was shocking.
First, there was the sneaky language that the $700 billion figure was the most that could be spent at any one time, meaning that there was no limit on the spending at all. Second, the right of review by any court of law or other administrative body was to be stripped away, a distinctly unconstitutional and anti-American provision if ever there was one. Third, the Treasury Secretary was to be embodied with complete unitary power in selecting who was to be empowered with an open-ended taxpayer checkbook.
No review, no limits, no questions.
So what happens when you have vague language and an unlimited budget? Fraud and self-dealing, that’s what. Mark my words, this is the largest looting operation ever in the history of the US, and it’s all spelled out right there in the delightfully brief bailout document that Paulson and Bernanke are attempting to ram through a scared Congress.
Folks, if it looks like a looting operation, smells like a looting operation, and acts like a looting operation, it’s a looting operation.
There are some in Washington DC who ‘get it,’ including Bernie Sanders, who recently stated:
[quote] “While the middle class collapses, the richest people in this country have made out like bandits and have not had it so good since the 1920s. […] The wealthiest people, who have benefited from Bush’s policies and are in the best position to pay, are being asked for no sacrifice at all. This is absurd. This is the most extreme example that I can recall of socialism for the rich and free enterprise for the poor.” [/quote]
Hopefully, for the sake of justice, the bailout will be significantly modified prior to passage.
However, it won’t really matter much in the end, because there is no possible way for any bailout to succeed, no matter how it’s configured.
Three simple truths
Instead, there are three simple truths that have to be recognized, if we are to navigate our way through this crisis:
- The United States government is insolvent.
- The entire US financial system is insolvent.
- There is no combination of new debt/borrowing schemes that can possibly correct #1 and #2.
The first rule of life is, “When you are in a hole, stop digging.” The past 25 years have witnessed the greatest accumulation of debt ever recorded by our nation. That is our hole. Yet our current leaders have ordered a backhoe and promised to use it.
Figure 1: This chart compares total debt (or ‘credit’) in the US to GDP (or Gross Domestic Product) on a percentage basis. Current total credit market debt stands at more than 340% of total GDP. As we can see on this chart, the last time debts got even remotely close to current levels was back in the 1930’s, and that bears a bit of explanation. The debt-to-GDP ratio back then didn’t start to climb until after 1929 (solid arrow), because debts remained relatively fixed in size, while it was the GDP that fell away from under the debts. With the exception of the Great Depression anomaly, our country always held less than 200% of our GDP in debt (gray dotted arrow). In 1985 we violated that barrier and never looked back. What each of us knows to be “just how the economy works” is really a historically unusual experiment with debt that is barely 25 years old. In the sweep of economic history, this barely qualifies as a blink.
This 25-year-long borrowing binge has so badly distorted our collective sense of right from wrong that we no longer seem capable of setting simple priorities. The consideration by Washington DC of a $700 billion bailout proposal in the same week that it passed a record-setting $612 billion defense budget is a perfect example of this dynamic. No trade-offs mentioned; “Yes, we’ll have one of everything” is the reigning mentality.
Our first challenge in confronting this crisis
This crisis is fundamentally one of insolvency (definition below), not a failure to have enough dollars floating around, which means that it is not a liquidity crisis.
Definitions:
• Insolvency. A condition where one’s assets are exceeded by one’s liabilities to an insurmountable extent. Distinct from bankruptcy, which is a legal event precipitated by a final inability of cash flow to continue to carry an insolvent entity any further. Insolvency nearly always precedes bankruptcy.
• Liquidity. A measure of how much money exists in a useable form. A person with a $10 million house but no money in the bank is said to be “illiquid,” not “poor” or “broke.” A “liquid” market, like the stock market, offers a reliable and fast way to exchange assets for money. When the Fed is said to be adding “liquidity,” they are taking assets from banks in exchange for cash.
The institutions in question are as insolvent as a minimum-wage janitor trying to make payments on a $2 million beachfront house using only his earnings. The aggressive lowering of interest rates by the Fed in their attempt to help provide liquidity to the banks was like assuring that the janitor’s checks cleared at the bank a little faster. But improving liquidity did not help. It couldn’t, because the problem was one of solvency, not liquidity.
But if liquidity won’t do the trick, what will?
Here we must face the hard truth that merely transferring the failed loans from the insolvent banks to an insolvent nation will do nothing but forestall the problem until a slightly later date (when it will be larger and more severe, by the way). The fact that both candidates for president are openly supporting the bailout says that reality has not yet penetrated the inner beltway.
So the first challenge will be recognizing that it really is not possible for an insolvent nation to bail out an insolvent financial system by borrowing more money. This is an absurd notion, and in total it really is no more and no less complicated than that. One cannot solve a crisis rooted in debt by issuing more debt.
Our second challenge in confronting this crisis
On September 23rd, 2008, before the Senate banking committee, Bernanke said, “I believe if the credit markets are not functioning, that jobs will be lost, the unemployment rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover.”
The palpably strong desire by the current politicians to “get the economy back on track” and to immediately return (if possible) to maximum consumption is absolutely the wrong response at this moment in history. We do not need to return to our borrow-and-borrow-more ways of the past. We desperately do need to demonstrate awareness that the future is loaded with challenges that only grow larger and more urgent with time. None of these challenges, ranging from energy dependence, to population, to a broken entitlement and pension system, will be helped by a return to our former credit-dependent ways. In fact, they will be exacerbated.
So our second challenge is to recognize that our first instincts to repair a broken system are wrong.
Instead, we need to have an honest accounting of our current economic condition, matched against the very real warning signs that our consumptive lifestyle is due for a radical overhaul. If we miss this chance to level with ourselves, we will have squandered an enormous opportunity.
Your biggest challenge
Recently, Senator Chris Dodd (CT) stated, “[W]e’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.” I know that the temptation is to trust that somehow these big players on Wall Street and in Washington DC have this all under control, or that they will fashion something workable to tide us over for a while. While they might be able to limp this along for a while longer, it might also fail sometime next Tuesday, and it will certainly fail sooner or later. When our economy finally suffers a complete meltdown, the resulting calamity will be as individually dramatic to each of us as if our homes burned to the ground. Your challenge is to accept that this crisis is fundamentally “unfixable” and that wherever the future takes us, it will not be a simple continuation of the past. With this acceptance, the challenge becomes assessing what might happen and what you can do about it.
Okay, so now what?
The immediate risk that I see here centers on a collapse in the international value of the dollar, which will rapidly morph into a massive financial crisis for the federal government. When all is said and done, I fully expect the federal government to be half its current size, with states, to varying degrees of success, picking up the slack as best they can.
The chance that the US dollar will go into a steep decline from here is very high. I personally place the risk that a major dollar decline will ensue within the next 6 months at 50%. Here’s how that would play out.
In its full wisdom, while times were good, the US government opted largely to finance itself with short-term debt in the form of 3 month and 6 month “T-Bills.” In essence, because these T-Bills ‘roll over’ every 3 or 6 months at whatever the current interest rate is, the US government opted to finance itself with an Adjustable Rate Mortgage (ARM). Hold onto that thought.
Now that the government has embarked on a course of massive deficit spending that is sure to top $1 trillion next year (and possibly go as high as $2 trillion), this money will have to either be borrowed from overseas or printed out of thin air by the Federal Reserve. In either case, there is a very high probability that either/both of these actions will cause interest rates to climb, possibly quite steeply and suddenly.
And here is where the “vicious spiral” comes into play, exacerbated by the short-term (ARM-like) borrowing stance described earlier. The more the government needs to borrow, the higher interest rates will go. The higher that interest rates go, the greater the need to borrow. So more borrowing begets higher interest rates, which beget more borrowing, which beget higher interest rates, which….ah, you get the idea.
If (or when) this dynamic gets started, its self-reinforcing nature will cause both the dollar to collapse in value and interest rates to shoot upwards. Either of these effects alone would provide a serious hit to our debt-based way of life, but together they promise to deliver earth-shaking changes to those who are unprepared. Concurrent with this death-spiral for the dollar will come massive (hyper?) inflation of imported goods, the most important of which, to our daily lives, will be oil. Gasoline at $10 or even $50 per gallon is not unthinkable.
This means that you, individually, need to begin thinking about ways to economically insulate yourself from this possibility, as does each state in the union.
My advice to you is the same as it has been for months.
- Trim your expenses as far as humanly possible.
- Don’t take on any more debt for any circumstances, unless you are speculating and can manage the risks.
- Hold gold and silver, physical only. How much? That depends on how many of your US-dollar-denominated holdings you’d like to be absolutely sure do not go to zero.
- Keep cash out of the bank. Three months’ living expenses, if you can.
- Develop a sense of community, and get to know the people you can count on and who will count on you.
- When you can, keep things topped off around the home. You never know.
I laid out my investment thoughts back in May, which you should read when you get the chance. That Martenson Report is titled Charting a Course Through the Recession and is free to registered users.
by
Chris Martenson
Friday, September 5, 2008
This is an article I was asked to write for the VT Commons, where it appeared on the front page in August 2008. It is largely a significant re-write of my The End of Money article. This article lays out the very foundation of my entire line of thinking, and I think it should be widely circulated and debated.
Full permission to reprint, post, and/or distribute is granted.
The greatest shortcoming of the human race is our inability to understand the exponential function.
~ Dr. Albert Bartlett
Within the next twenty years, the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices now are to either evolve a new economic model that is compatible with limited physical resources, or to risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today.
In order to understand why, we must start at the beginning. While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics that I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.
It is this: Our monetary system must continually expand, forever.
The US/world monetary system was designed and implemented at a time when the earth’s resources seemed limitless, so few gave much critical thought to the implications that every single dollar in circulation was to be loaned into existence by a bank with interest. In fact, most thought it a terribly “modern” concept, and most probably still do.
But anything that is continually expanding by some percentage amount, no matter how minuscule, is said to be growing geometrically, or exponentially.
Geometric growth can be seen in this sequence of numbers (1, 2, 4, 8, 16, 32, 64), while an arithmetic growth sequence is (1, 2, 3, 4, 5, 6, 7). In 1798, Thomas Malthus postulated that the human population’s geometric growth would, at some point, exceed the arithmetic returns of the earth, principally in the arena of food. To paraphrase, he recognized that the exponential growth of human numbers would meet with the constraints imposed by a finite world. As seen in the chart below, human population is growing exponentially, and is on track to reach 9.5 billion by 2050. To put this in perspective, it was only in 1960 that the world first passed 3 billion in total population, the same amount that is projected to be added over the next 42 years. Each new person places additional demands on food, water, energy, and other finite resources.
In parallel with exponential population growth, our monetary system is also exhibiting exponential behavior. Consider this evidence:
1) Money supply growth (see chart above). It took us from 1620 until 1973 to create the first $1trillion of US money stock (measured by adding up every bank account, CD, money market fund, etc). Every road, factory, bridge, school, and house built, together with every war fought and every other economic transaction that ever took place over those first 350 years, resulted in the creation of $1 trillion in money stock [1]. The most recent $1 trillion? That has been created in only 4.5 months. The dotted line in the chart is an idealized exponential curve, while the solid line is actual monetary data. The fit is nearly perfect (with a correlation of 0.98, for those interested). Data from the Federal Reserve.
2) Household debt has doubled in only 7 years, growing from seven to fourteen trillion dollars. Think about that for a minute. It is a stunning turn of events. Have household incomes also doubled in 7 years? No, not even close; they have grown less than half as much, calling into question how these loans will be repaid, let alone doubled again. Data from the Federal Reserve.
3) Total credit market debt (that’s all debt) had finally exceeded $5 trillion by 1975, but has recently increased by $5 trillion in just the past 2 years (from 2006 – 2008), and now stands at nearly $50 trillion. In order for the next twenty years to resemble the last twenty years, debt would have to expand by another 3 to 4 times, to somewhere between $150 trillion and $200 trillion. How likely do you think this is? Data from the Federal Reserve.
How do we make sense of money numbers this large and growing this fast? Why is this happening? Could it be that the US economy is so robust that it requires monetary and credit growth to double every 6-7 years? Are US households expecting a huge surge in wages, to be able to pay off all that debt? If not, then what’s going on? The key to understanding all three of the above money and debt charts was snuck in a few paragraphs ago; every single dollar in circulation is loaned into existence by a bank, with interest.
That little statement contains the entire mystery. As improbable as it may sound to you that all money is backed by debt, it is precisely correct, and while many of you are going to struggle with the concept, you’ll be in good company. John Kenneth Galbraith, the world-famous Harvard economist, said, “The process by which banks create money is so simple that the mind is repelled.” [2]
Here’s how money (and debt) creation works: Suppose we wipe the entire system clean and start over, so that we can more easily understand the process. Say you enter the first (and only) bank and receive the very first loan for $1000. At this point the bank has an asset (your loan) on the books, and you have $1000 in cash and a $1000 liability owed to the bank. After a month passes, and the first interest accrues, we peek into the system and observe that the $1000 in money still exists, but that your debt has grown by the size of the interest (let’s call that $10). Now your total debt to the bank is $1000 plus the $10 interest or $1010 in total.
Since there’s only $1000 floating around, and that’s all there is, clearly there’s not enough money to settle the whole debt. So where will the required $10 come from? In our system it must be loaned into existence, taking the form of $10 of new money plus $10 of new debt that must also be paid back with interest.
But if our system requires new and larger loans to enable the repayment of old loans, aren’t we actually just compounding the total amount of debt (and resulting money) with every passing year? Yes, that is precisely what is happening, and the three money/debt charts supplied above all provide confirmation of that dynamic.
In other words, our monetary system, and by extension our entire economy, are textbook examples of exponential systems. Yeast in a vat of sugar water, predator-free lemming populations, and algal blooms are natural examples of exponential growth. Plotted on graph paper, the lines tracking these populations start out slowly, begin to rise more quickly, and then, suddenly, shoot almost straight up, yielding a shape that resembles a hockey stick.
The key feature of exponential functions that our species desperately needs to understand is illustrated in this next example: [3]
Suppose I had a magic eyedropper that could dispense a drop of water with a most unusual trait – it will double in size every minute – and I place a drop of water in your hand. At first you’d just have a lonely drop of water sitting in your hand, but after one minute it would double in size, and after six minutes you’d have a blob of water that could fill a thimble. Do you have a sense of that growth? Now, follow me to Fenway Park, where I am going to place a drop from my magic eye dropper on the pitcher’s mound at 12:00 pm on January 1st of 2008. To make this interesting, let’s assume that the park is water-tight, and that I’ve handcuffed you to the highest row of bleacher seats. Way down there, on the mound, I bend over and plop a magic drop of water, so small you could not possibly see it from where you are sitting, and it begins to double. My question to you is, at what date and at what time would the park be completely filled? That is, how long do you have to escape from your handcuffs? Days? Weeks? Months? Years?
The answer is this: You have until 12:49 pm, on that same day, before the park is completely filled. You have only 49 minutes to escape your handcuffs. And at what time do you suppose that the park is still 97% empty space (and how many of you will appreciate the seriousness of your predicament)? The answer is that at 12:45 pm the park is still 97% unfilled. The first 44 minutes filled just 3% of the park, while the last 5 minutes filled the remaining 97%. From all of history until 1960 to reach a population of 3 billion humans; only 42 years from now to add another 3 billion.
And that’s why we need to appreciate exponential functions. For quite a while, everything seems just fine, and a few minutes later your park is overflowing. Time runs out in a hurry towards the end of any exponential growth system, forcing hurried decisions and limited options.
So how does this pertain to our economic problems, and why should you care? The truth is, there’s nothing inherently wrong with exponential growth, as long as you have unlimited room and resources. However, there are clear signs that several key resources on our planet are in their final minutes, to use our Fenway Park example.
And none of these are more important than crude oil. “Peak oil” is the global extension of the observation that individual oil fields, without exception, produce slightly more oil each year up to a point (“the peak”), after which they produce incrementally less and less oil each year, until their economics force abandonment. It is a fact that the US hit its peak of oil production in 1970 at approximately 10 million barrels a day and now produces barely more than 5 million barrels a day. It is now widely recognized that oil is a finite resource, and another cold, hard fact is that global oil discoveries peaked some 45 years ago. Because discoveries precede production (you’ve got to find it before you can pump it), we can be certain that production will peak too. We might disagree over the timing, but not the process.
I’m focusing on oil because energy drives an economy, not the other way around. The engine of any economy is energy, while money is merely the lubricating oil. Without energy, no amount of additional money would make the slightest difference in our lives. Economists love to say that higher oil prices will stimulate new oil production, as if demand could magically create supply. (Joke: If you lock three economists in a basement they won’t worry about starving, because they know their grumbling bellies will soon cause sandwiches to appear.) But just as there is no amount of additional price hikes that will cause more cod to come from the depleted oceans, oil fields will yield their treasures in accordance to geological limits, not human desire.
And here’s where the enormous monetary design flaw comes into the story. As Meadows, et al., in The Limits to Growth (1972) brilliantly predicted, we humans are now encountering physical, resource-constrained limits to our economic and population growth. So, on the one hand we have a monetary system that, by its very design, must expand exponentially in order to merely operate, while on the other hand we live on a spherical planet with finite resource limits.
When we started our exponential monetary system, initiated by the Bank of England around 1700 but kicked into high gear in 1971 with the international abandonment of gold settlement, nobody ever thought that the day would come when we’d find our ball park filled nearly to the brim. Who ever thought that oil production would hit a limit? Who knew that every acre of arable land, and then some, would someday be put into production? How could we possibly fish the seas empty? Yet all of these things have come to pass, and our monetary system demands that even more follow.
This is clearly an unsustainable arrangement. Someday soon, it will cease to be.
Repeating an opening sentence, our choices now are to either evolve a new economic model that is compatible with limited physical resources, or risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today. I wish this collision between a finite planet and an exponential money system was far off in the future. Alas, it is certainly within the lifetime of people alive today, and likely already upon us.
We are leaving a legacy of debt to our children, born and unborn. Just as the direct printing of money favored by Wiemar Germany in the 1920s destroyed German’s purchasing power, so, too, does America’s debt accumulation promise to ruin our economy. Thus the moral argument beneath exponential growth in a finite context is: Should one generation consume beyond its means and either expect or hope that the next generations will somehow pick up the tab?
In summary, because our economic model and our entire system of money enforce a doctrine of limitless growth, they have become anachronisms incompatible with the well-being of the planet on which we live and depend. Our global money system might be complicated, and it might be sophisticated, but it is soon to be a vestige of the past.
Your job, your savings, your investments, and your future prospects and standard of living depend on the continuation of an unsustainable system now drawing to a close. You owe it to yourself to get ahead of the immense changes that are coming like water roiling up the steps towards the bleacher seat to which you are chained.
Next time: We’ll use this understanding of our monetary system to examine where we are, and solutions that you and your community should consider before the system collapses. Remember, the end of one thing is always the beginning of another.
[1] Having trouble picturing a trillion? Think of it this way: If you had a single thousand-dollar bill, you could have a pretty good night on the town with your friends. If you had a stack of thousand dollar bills that was 4 inches high, you’d be a millionaire. If you had a stack just 40 inches high, you would be worth ten million dollars. How high would your stack have to be in order for you to be a trillionaire? The answer is, a solid stack of thousand dollar bills 68.9 miles high.
[2] If you need more help on this concept, please visit chapters 7 & 8 of my free, on-line Crash Course at http://PeakProsperity.com/crashcourse.
[3] I gained a much deeper appreciation for the power of exponential functions from transcripts of speeches given by the mathematician Dr. Albert Bartlett. This link goes to an exceptional example of his ability to make this complex subject startlingly clear.
Exponential Money in a Finite World
PREVIEW by Chris MartensonFriday, September 5, 2008
This is an article I was asked to write for the VT Commons, where it appeared on the front page in August 2008. It is largely a significant re-write of my The End of Money article. This article lays out the very foundation of my entire line of thinking, and I think it should be widely circulated and debated.
Full permission to reprint, post, and/or distribute is granted.
The greatest shortcoming of the human race is our inability to understand the exponential function.
~ Dr. Albert Bartlett
Within the next twenty years, the most profound changes in all of economic history will sweep the globe. The economic chaos and turbulence we are now experiencing are merely the opening salvos in what will prove to be a long, disruptive period of adjustment. Our choices now are to either evolve a new economic model that is compatible with limited physical resources, or to risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today.
In order to understand why, we must start at the beginning. While it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living, two characteristics that I fervently wish to continue. But every system has its pros and its cons, and our monetary system has a doozy of a flaw.
It is this: Our monetary system must continually expand, forever.
The US/world monetary system was designed and implemented at a time when the earth’s resources seemed limitless, so few gave much critical thought to the implications that every single dollar in circulation was to be loaned into existence by a bank with interest. In fact, most thought it a terribly “modern” concept, and most probably still do.
But anything that is continually expanding by some percentage amount, no matter how minuscule, is said to be growing geometrically, or exponentially.
Geometric growth can be seen in this sequence of numbers (1, 2, 4, 8, 16, 32, 64), while an arithmetic growth sequence is (1, 2, 3, 4, 5, 6, 7). In 1798, Thomas Malthus postulated that the human population’s geometric growth would, at some point, exceed the arithmetic returns of the earth, principally in the arena of food. To paraphrase, he recognized that the exponential growth of human numbers would meet with the constraints imposed by a finite world. As seen in the chart below, human population is growing exponentially, and is on track to reach 9.5 billion by 2050. To put this in perspective, it was only in 1960 that the world first passed 3 billion in total population, the same amount that is projected to be added over the next 42 years. Each new person places additional demands on food, water, energy, and other finite resources.
In parallel with exponential population growth, our monetary system is also exhibiting exponential behavior. Consider this evidence:
1) Money supply growth (see chart above). It took us from 1620 until 1973 to create the first $1trillion of US money stock (measured by adding up every bank account, CD, money market fund, etc). Every road, factory, bridge, school, and house built, together with every war fought and every other economic transaction that ever took place over those first 350 years, resulted in the creation of $1 trillion in money stock [1]. The most recent $1 trillion? That has been created in only 4.5 months. The dotted line in the chart is an idealized exponential curve, while the solid line is actual monetary data. The fit is nearly perfect (with a correlation of 0.98, for those interested). Data from the Federal Reserve.
2) Household debt has doubled in only 7 years, growing from seven to fourteen trillion dollars. Think about that for a minute. It is a stunning turn of events. Have household incomes also doubled in 7 years? No, not even close; they have grown less than half as much, calling into question how these loans will be repaid, let alone doubled again. Data from the Federal Reserve.
3) Total credit market debt (that’s all debt) had finally exceeded $5 trillion by 1975, but has recently increased by $5 trillion in just the past 2 years (from 2006 – 2008), and now stands at nearly $50 trillion. In order for the next twenty years to resemble the last twenty years, debt would have to expand by another 3 to 4 times, to somewhere between $150 trillion and $200 trillion. How likely do you think this is? Data from the Federal Reserve.
How do we make sense of money numbers this large and growing this fast? Why is this happening? Could it be that the US economy is so robust that it requires monetary and credit growth to double every 6-7 years? Are US households expecting a huge surge in wages, to be able to pay off all that debt? If not, then what’s going on? The key to understanding all three of the above money and debt charts was snuck in a few paragraphs ago; every single dollar in circulation is loaned into existence by a bank, with interest.
That little statement contains the entire mystery. As improbable as it may sound to you that all money is backed by debt, it is precisely correct, and while many of you are going to struggle with the concept, you’ll be in good company. John Kenneth Galbraith, the world-famous Harvard economist, said, “The process by which banks create money is so simple that the mind is repelled.” [2]
Here’s how money (and debt) creation works: Suppose we wipe the entire system clean and start over, so that we can more easily understand the process. Say you enter the first (and only) bank and receive the very first loan for $1000. At this point the bank has an asset (your loan) on the books, and you have $1000 in cash and a $1000 liability owed to the bank. After a month passes, and the first interest accrues, we peek into the system and observe that the $1000 in money still exists, but that your debt has grown by the size of the interest (let’s call that $10). Now your total debt to the bank is $1000 plus the $10 interest or $1010 in total.
Since there’s only $1000 floating around, and that’s all there is, clearly there’s not enough money to settle the whole debt. So where will the required $10 come from? In our system it must be loaned into existence, taking the form of $10 of new money plus $10 of new debt that must also be paid back with interest.
But if our system requires new and larger loans to enable the repayment of old loans, aren’t we actually just compounding the total amount of debt (and resulting money) with every passing year? Yes, that is precisely what is happening, and the three money/debt charts supplied above all provide confirmation of that dynamic.
In other words, our monetary system, and by extension our entire economy, are textbook examples of exponential systems. Yeast in a vat of sugar water, predator-free lemming populations, and algal blooms are natural examples of exponential growth. Plotted on graph paper, the lines tracking these populations start out slowly, begin to rise more quickly, and then, suddenly, shoot almost straight up, yielding a shape that resembles a hockey stick.
The key feature of exponential functions that our species desperately needs to understand is illustrated in this next example: [3]
Suppose I had a magic eyedropper that could dispense a drop of water with a most unusual trait – it will double in size every minute – and I place a drop of water in your hand. At first you’d just have a lonely drop of water sitting in your hand, but after one minute it would double in size, and after six minutes you’d have a blob of water that could fill a thimble. Do you have a sense of that growth? Now, follow me to Fenway Park, where I am going to place a drop from my magic eye dropper on the pitcher’s mound at 12:00 pm on January 1st of 2008. To make this interesting, let’s assume that the park is water-tight, and that I’ve handcuffed you to the highest row of bleacher seats. Way down there, on the mound, I bend over and plop a magic drop of water, so small you could not possibly see it from where you are sitting, and it begins to double. My question to you is, at what date and at what time would the park be completely filled? That is, how long do you have to escape from your handcuffs? Days? Weeks? Months? Years?
The answer is this: You have until 12:49 pm, on that same day, before the park is completely filled. You have only 49 minutes to escape your handcuffs. And at what time do you suppose that the park is still 97% empty space (and how many of you will appreciate the seriousness of your predicament)? The answer is that at 12:45 pm the park is still 97% unfilled. The first 44 minutes filled just 3% of the park, while the last 5 minutes filled the remaining 97%. From all of history until 1960 to reach a population of 3 billion humans; only 42 years from now to add another 3 billion.
And that’s why we need to appreciate exponential functions. For quite a while, everything seems just fine, and a few minutes later your park is overflowing. Time runs out in a hurry towards the end of any exponential growth system, forcing hurried decisions and limited options.
So how does this pertain to our economic problems, and why should you care? The truth is, there’s nothing inherently wrong with exponential growth, as long as you have unlimited room and resources. However, there are clear signs that several key resources on our planet are in their final minutes, to use our Fenway Park example.
And none of these are more important than crude oil. “Peak oil” is the global extension of the observation that individual oil fields, without exception, produce slightly more oil each year up to a point (“the peak”), after which they produce incrementally less and less oil each year, until their economics force abandonment. It is a fact that the US hit its peak of oil production in 1970 at approximately 10 million barrels a day and now produces barely more than 5 million barrels a day. It is now widely recognized that oil is a finite resource, and another cold, hard fact is that global oil discoveries peaked some 45 years ago. Because discoveries precede production (you’ve got to find it before you can pump it), we can be certain that production will peak too. We might disagree over the timing, but not the process.
I’m focusing on oil because energy drives an economy, not the other way around. The engine of any economy is energy, while money is merely the lubricating oil. Without energy, no amount of additional money would make the slightest difference in our lives. Economists love to say that higher oil prices will stimulate new oil production, as if demand could magically create supply. (Joke: If you lock three economists in a basement they won’t worry about starving, because they know their grumbling bellies will soon cause sandwiches to appear.) But just as there is no amount of additional price hikes that will cause more cod to come from the depleted oceans, oil fields will yield their treasures in accordance to geological limits, not human desire.
And here’s where the enormous monetary design flaw comes into the story. As Meadows, et al., in The Limits to Growth (1972) brilliantly predicted, we humans are now encountering physical, resource-constrained limits to our economic and population growth. So, on the one hand we have a monetary system that, by its very design, must expand exponentially in order to merely operate, while on the other hand we live on a spherical planet with finite resource limits.
When we started our exponential monetary system, initiated by the Bank of England around 1700 but kicked into high gear in 1971 with the international abandonment of gold settlement, nobody ever thought that the day would come when we’d find our ball park filled nearly to the brim. Who ever thought that oil production would hit a limit? Who knew that every acre of arable land, and then some, would someday be put into production? How could we possibly fish the seas empty? Yet all of these things have come to pass, and our monetary system demands that even more follow.
This is clearly an unsustainable arrangement. Someday soon, it will cease to be.
Repeating an opening sentence, our choices now are to either evolve a new economic model that is compatible with limited physical resources, or risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today. I wish this collision between a finite planet and an exponential money system was far off in the future. Alas, it is certainly within the lifetime of people alive today, and likely already upon us.
We are leaving a legacy of debt to our children, born and unborn. Just as the direct printing of money favored by Wiemar Germany in the 1920s destroyed German’s purchasing power, so, too, does America’s debt accumulation promise to ruin our economy. Thus the moral argument beneath exponential growth in a finite context is: Should one generation consume beyond its means and either expect or hope that the next generations will somehow pick up the tab?
In summary, because our economic model and our entire system of money enforce a doctrine of limitless growth, they have become anachronisms incompatible with the well-being of the planet on which we live and depend. Our global money system might be complicated, and it might be sophisticated, but it is soon to be a vestige of the past.
Your job, your savings, your investments, and your future prospects and standard of living depend on the continuation of an unsustainable system now drawing to a close. You owe it to yourself to get ahead of the immense changes that are coming like water roiling up the steps towards the bleacher seat to which you are chained.
Next time: We’ll use this understanding of our monetary system to examine where we are, and solutions that you and your community should consider before the system collapses. Remember, the end of one thing is always the beginning of another.
[1] Having trouble picturing a trillion? Think of it this way: If you had a single thousand-dollar bill, you could have a pretty good night on the town with your friends. If you had a stack of thousand dollar bills that was 4 inches high, you’d be a millionaire. If you had a stack just 40 inches high, you would be worth ten million dollars. How high would your stack have to be in order for you to be a trillionaire? The answer is, a solid stack of thousand dollar bills 68.9 miles high.
[2] If you need more help on this concept, please visit chapters 7 & 8 of my free, on-line Crash Course at http://PeakProsperity.com/crashcourse.
[3] I gained a much deeper appreciation for the power of exponential functions from transcripts of speeches given by the mathematician Dr. Albert Bartlett. This link goes to an exceptional example of his ability to make this complex subject startlingly clear.
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