Where are we, why are we here, and what will happen? This post is my attempt to answers these questions as simply as I can. I have broken this post into three parts for ease of presentation.
This post will link to several other posts that will expand on a point. I will add links as time goes on, so please check back often.
Before I start, it’s important to point out that money and debt are almost the same thing in today’s world. If you have $1000 in the bank, your bank statement records that the bank owes you $1000. The bank is in debt to you for $1000. Companies buy and sell debt like they sell anything else. In today’s world, the easiest way to counterfeit money is to create bad debt and sell it to someone else before they realize that the debt is bad. If the debt changes hands many times before it goes bad, it may not even be possible to figure out who created the debt in the first place and if they knew the debt was bad. With that in mind, please read on.
Why are we in this economic crisis?
Because the shadow banking system (investment banks, banks and hedge funds) “counterfeited” a large amount of money over the last five years, by creating bad debt.
If someone was counterfeiting US Dollars, why didn’t the value of the dollar go down relative to other currencies?
It did. A lot of the counterfeiting went on in other currencies too, so it didn’t go down relative to other currencies as much as it could have.
If someone was counterfeiting US Dollars, why didn’t we see lots of inflation?
We did, but most of the inflation was hidden in house prices, and the US Government reports inflation in such a way that ignores this, which produced artificially low inflation numbers. The rest of the inflation was expressed in bank leverage ratios, but most people ignore this.
So why are we having problems now? Isn’t the actual problem some kind of credit crunch?
Aaah. Now we start getting down to the meat. In today’s world, money and credit are almost the same thing.
The shadow banking system managed to create lots of counterfeit money (credit) using various credit tricks. But, like some kind of fairy gold, the money eventually turns back into something worthless. The problem is that everyone had been using the fake money. It’s everywhere. Now that that money is evaporating, everyone is afraid of three things:
- That they are bankrupt, because all their money will evaporate.
- That the people they do business with are bankrupt.
- That any money they get from other people is actually fairy money.
So the fundamental reason for the credit crunch is a lack of solvency, and a lack of trust?
Yes! Large parts of the shadow banking system decided to use its own fake money, and it will probably kill those parts. They reasoned that if it ever looked like it would evaporate, they would get out before anyone noticed. Entities that are bankrupt are desperately trying to hide it, and all entities are refusing to do business, because they don’t know who is bankrupt.
So what’s all this about house prices then?
Mortgages were used as one of the primary ingredients in making the fairy money. Everybody was selling mortgage debt to everyone else, and using the debt as collateral to borrow more money. If bankers were turning lead into fairy gold, you could say the mortgages were the lead. This dramatically drove up the demand for lead, which increased its price and made it quite valuable. So, lenders did everything they could to make mortgages. ie. They lent to everyone they could at whatever rate they could, then sold those mortgages on to other entities to use in their counterfeiting operation. The next stage was to make “Mortgage Backed Securities” using the mortgage.
So what is this I hear about “Mortgage Backed Securities” being “illiquid”?
It’s a polite lie. The mortgage backed securities are part of the counterfeiting method, and they are now worth very little. They are fairy gold and everyone knows it. You cant sell the stuff more for than a few cents on the dollar. However, if you were willing to sell it for a few cents on the dollar, it would sell like hotcakes. It’s not “illiquid”; it’s just that the people who own it aren’t willing to sell it at the correct price.
So everything will be alright if we get the price of houses back up?
No. In the end, what matters is whether people can pay the mortgages off that they have bought. Any variation on them not being able to pay the mortgage in full means that the fairy gold turns back into lead.
Because it was so easy to “buy” a house, lots of people did it. Because it was so easy to get so much credit, they paid far more for the house than if reasonable amounts of credit were available. In the end, the houses are simply too expensive to be paid for. It is not possible for people to pay of those houses. It can’t happen. If house prices were magically restored to their peak values, nobody could buy them because there is no longer any way to make it possible to buy them. Meanwhile, those currently holding the houses would be in as much trouble as they were before prices started crashing.
So how do we make houses affordable?
Easy. We let the prices go down. Making it easier to borrow money just makes everything more expensive as people are willing to pay more for the same item. This just turns people into debt slaves.
So what does the future hold?
It depends on what the government does. There are three basic outcomes that could occur:
- We have a deflationary crash.
- We have an inflationary crash.
- The US Government is forced into bankruptcy and defaults on all debt, making the US Dollar worthless.
Outcome (3) could actually happen in parallel with outcome (1) and (2).
I have presented the most extreme outcomes. In reality we’ll get something between 1 and 2, with potential for 3.
So which will happen?
It very much so depends on the US Treasury and the Fed (A private bank with a federal mandate). To date, they have been claiming (and may even believe) that this is a liquidity problem. That is, they claim that there is plenty of money, but it’s just not free right now to move around. If they pump more money into the system, then money will start moving around and all will be well. This is untrue unless they replace all fairy gold with real money.
So the current government solution is to replace all the fairy money with real money?
They would like to do that, but it’s probably not possible. There is too much fairy money out there. Also, real money has value because it’s hard to make. The US Government makes our money by selling treasuries (debt) to other countries. The other countries pay us for those treasuries, and we use the money they give us to make US Dollars. However, the US Government has to pay interest on those treasuries, and eventually the treasuries expire and the US Government has to take them back and give the foreign countries back their money.
So a “treasury” is a way to get money from someone else and then pay rent for the use of the money?
Exactly. If I sell you a treasury, you give me money for it, but for as long as you hold the treasury, I have to pay you rent. You can think of the treasury as a rental agreement, but you’re renting money, not a house.
But what does the US Government use to pay the rent?
Your taxes. The US Government can choose to not borrow money and just use your taxes directly. But, if they do borrow money, they pay rent on that money using your taxes. And, they have to give the borrowed money back eventually, too. If they borrow too much money, they have to increase taxes or not be able to pay the rent.
So the US Government would have to borrow money in order to replace the counterfeit money, and our taxes would pay the interest on the borrowed money?
Yes. However, there is a LOT of counterfeit money out there. It will be very hard for the US Government to borrow enough money. Eventually everyone else will be afraid that US tax income won’t be enough to cover the interest payments. So, they will demand higher rent on new money to cover the risk, which will make it even harder to borrow the money.
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