–Understanding Federal Debt. Full Faith and Credit

An alternative to popular faith

Why do we have recessions and depressions? Are they inevitable and unavoidable? Why do we have inflations? Are they preventable and curable?

This short post will give you a basis for answering these vexing (especially to the politicians, the Fed and the media) questions.

1. By definition: A larger economy has more money than does a smaller economy. California has more money than does Los Angeles, which in turn, has more money than does Anaheim.

2. Therefore: To grow larger, an economy requires a growing supply of money.

3. All forms of money are debt. Although there are many definitions of money, every form of modern money – bank accounts, money market accounts, traveler’s checks – is a form of debt. Even currency is a debt of the government. That is why a dollar “bill” has “federal reserve note” printed on it. “Bill” and “note” are words signifying debt (as in “T-bill” and “T-note.”)

4. Therefore: To grow larger, an economy requires a growing supply of debt/money.

5. The safest form of debt/money is federal debt/money. There are many types of debt – personal debt, corporate debt, state and local government debt, federal debt – but after 1971, the end of the gold standard, only the federal government has had the unlimited ability to create money to service its debt. All other debtors go bankrupt when they are unable to service their debts. The end of the gold standard marked the biggest change in economics during the 20th century. Most key economic hypotheses became obsolete in 1971; economists who did not change in 1971 are themselves obsolete.

6. All debt requires collateral. The collateral for federal debt is “full faith and credit.” This may sound nebulous to some, but it actually involves certain, specific and valuable guarantees, among which are:
A. –The government will accept only U.S. currency in payment of debts to the government
B. –It unfailingly will pay all its dollar debts with U.S. dollars and will not default
C. –It will force all your domestic creditors to accept U.S. dollars, if you offer them, to satisfy your debt.
D. –It will not require domestic creditors to accept any other money
E. –It will take action to protect the value of the dollar.
F. –It will maintain a market for U.S. currency
G. –It will continue to use U.S. currency and will not change to another currency.
H. –All forms of U.S. currency will be reciprocal, that is five $1 bills always will equal one $5 bill and vice versa.

7. The value of debt (money) is based on supply and demand. An increase in supply makes the value go down. An increase in demand makes the value go up.

8. The demand for debt (money) is based on risk and reward. The risk of owning debt (money) is the danger of inflation. The reward for owning debt (money) interest rates. High reward with low risk makes demand go up which makes value go up.

9. Inflation compares the value of debt (money) with the overall value of goods and services. Fighting inflation requires increasing the reward for owning debt (money) and/or reducing the supply of debt (money). However, because a growing economy requires a growing supply of debt (money), reducing the supply leads to recessions and depressions, making supply-reduction a poor choice for fighting inflation.

10. For every borrower there is a lender. To the degree lowering interest rates helps borrowers, it equally hurts lenders, both of whom are part of the economy. The Fed lowers interest rates, believing this helps businesses that are borrowers, neglecting the fact that it equally hurts businesses that are lenders. That is why the 20 rate reductions preceding and during the recession, neither prevented nor cured the recession.

You now know how to begin to answer the questions in the first paragraph.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

–Deficits: The Possible vs. the Certain

An alternative to popular faith

Human beings have difficulty distinguishing threat levels. Despite the absolute fact that airline travel is safer per mile than auto travel, some people drive, even long distances, because they fear the safer air travel more than the dangerous auto travel.

Then think of the people who won’t vaccinate their children against the H1N1 flue, because they fear any unknown, possible adverse effects of vaccination more than they fear the known, deadly effects of the flue.

I was reminded of this human failing when I read an article in which the author claimed the economic recovery was not “real,” because it relied on government funding rather than on private funding. The author seemed to feel government funding was, in some way, artificial – as though we were using saccharine, rather than sugar, to sweeten our coffee.

Of course, money is money, and federal money is indistinguishable in effect from private money. But I suspect the author had something more than artificiality in the back of his mind. He probably understands that the federal government has the unique and unlimited ability to create money from thin air, and repeatedly has proved it never can run out of money. So, what is his concern? He must fear two things: Federal deficit spending might cause inflation and our grandchildren might have to pay for deficits.

As for inflation: Despite current, massive deficit spending we do not now experience an unacceptable level of inflation, and are unlikely to soon. Moreover, in the thirty-five years since we went off the gold standard, large deficits never have caused inflation. Clearly, something is askew with the deficits-cause-inflation hypothesis.

Even if deficits did cause inflation, private spending is identical with public spending; both add money to the economy. So the author should fear the supposed inflationary effects of private and public spending, equally.

As for grandchildren, I am a grandchild of the adults who saw the gigantic deficits of WWII and of President Reagan. Yet, because tax rates have gone down, I never have paid one penny toward those monster deficits. Similarly, if tax rates continue to stay level or decline, as they should, my grandchildren will not pay a penny toward today’s deficits.

What has this to do with the human difficulty distinguishing threat levels? The debt hawks know with certainty, that many millions of people now suffer the devastating effects of unemployment and loss of homes and lifestyle. People are dying, financially, emotionally and yes, even physically.

These same debt hawks believe that at some unknown time in the future, their children, grandchildren or great grandchildren may have to pay some unknown amount toward today’s debt. Yet they fear unknown future damage more than the certainty of today’s. That is why you see people rail against deficits. In essence, they are so afraid they one day may run short of water, they will let a home burn to the ground rather than allowing the fire fighters to save it.

The shame is that many professional economists, who should know better, foster these misguided fears, leading to misguided actions.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com/

–Fool’s gold

An alternative to popular faith

I always am puzzled by the mystical faith in gold.

First, gold has minimal utility. Yes, some is used for jewelry and a bit for dentistry and electronics, but essentially gold is useless. At one time, its value was based on the same faith that supports the dollar bill. Today, its value is based on less faith than that, because the dollar at least, is supported by the U.S. government’s full faith and credit. Gold is backed by nothing.

Second, the Great Depression occurred while we were on a 100% gold standard. Some have argued that was one cause of the Depression. In any event, gold did not prevent that Depression, nor did it prevent any of the prior depressions.

Third, the current recession is being cured by the government’s unlimited ability to pump money into the economy, something that would be impossible if we were on a gold standard or on any other standard based on a physical product or “basket of products” as has been suggested.

Fourth, the U.S. government can control both the supply of, and the demand (interest rates) for, the dollar. That control over supply and demand gives the U.S. complete control over the value of the dollar. The U.S. would have little to no control over the value of gold, a serious problem when trying to control our economy.

In short, gold is one of those commodities, the value of which is based solely on faith. Just as there have been real estate bubbles, stock market bubbles, oil bubbles, tulip bulb bubbles, sugar bubbles, coffee bubbles and diamond bubbles, there have been gold bubbles, the biggest coming in 1980 and perhaps again, today.

Gold Price Chart 75-09
Is this the picture of another gold bubble?

The fact that people traditionally have coveted gold is irrelevant to today’s world economy. It also is irrelevant to the future safety of gold, which could disappear with the discovery of, for instance, a massive undersea or antarctic gold vein.

Because gold is supported by no nation, it is less safe than the dollar. Worse yet, it is expensive to own. While saving a dollar will earn you interest, saving gold will cost you for storage, insurance and shipping. In essence it is a wasting asset, the value of which is based on the “greater fool” theory (“A fool buys it because he expects to sell it to a greater fool.”).

We finally went off the gold standard in 1971 for a good reason: A growing economy requires a growing supply of money, and basing money on gold prevents that money growth. Had we stayed on the gold standard, the U.S. today would be bankrupt – unable to pay its bills.

Those who yearn for the good, old, gold standard days, should be careful what they wish for.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

-What triggers recessions and depressions?

An alternative to popular faith

        Readers of this blog know debt growth is necessary for economic growth. The graphs and data in the various posts, for instance The federal debt and federal deficit are necessary for economic growth, show that surpluses preceded every depression in U.S. history, and reductions in debt growth preceded every recession in the past 50 years.
        While this degree of correspondence transcends coincidence, it leaves a troubling question: What is the trigger? The recession of 2001 was preceded by ten years of deficit growth reductions, while the recession of 2007 was preceded by only three. Other recessions also were preceded by varying periods of reduced deficit growth or surpluses. Similarly, the 1929 Great Depression was preceded by nine years of surpluses, while the 1819 depression was preceded by only two.
        This makes predicting a recession difficult. While running a surplus seems to be a fairly prompt causative agent for recessions or depressions, debt growth can decline for several years before a recession begins. Reduced deficit growth is a necessary detonator of recession or depression, but some other event must serve as a more immediate signal, a trigger. For example:

*The recession of 1960 may have been triggered by the Vietnam war, which began in 1959
*The 1970 recession: Possible trigger: Also may have been the Vietnam war, this time by the protests and the public realization the war was going poorly.
*The 1973 recession: Possible trigger: The first Arab oil embargo
*The 1980 recession: Possible trigger: The Iranian revolution causing another oil crisis
*The 1990 recession: Possible trigger: Desert Storm
*The 2001 recession: Possible trigger: The bursting of the “dot.com” bubble.
*The 2007 recession: Possible trigger: Collapse of the subprime mortgage market
        All recessions and depressions share one factor – reduction in debt growth – but all have had different triggers. It appears if we have only reduced deficit growth without the trigger, no recession or depression will result. And, a trigger event, without reduced deficit growth, will not cause a recession. The recession/depression bomb requires both a detonator (reduced debt growth) and a trigger.
        Triggers are difficult to evaluate (i.e., how serious they are), but as one small step toward predicting recessions we should keep in mind that a recession is far more likely during federal deficit growth rate decreases.