The Pyramid Scheme
[courtesy Google Images]
The first danger is that debt is deemed to be form of wealth. As mad as it seems, under this presumption, the more debt we have, the wealthier we become (or at least appear to become). The wealthiest people would be those who lend the most currency to others, or at least those who acquire the most debt instruments (intangible promises to pay) rather than tangible assets.
Under the debt-based monetary system, if you borrow $250,000 to build a new home, the resulting paper-debt instrument (the promissory note to the bank bearing your signature) is deemed to be more valuable than the physical/tangible house that was built by means of that debt instrument (intangible promise to pay).
Think about that. Thanks to fractional reserve banking, your signature on your mortgage documents is more valuable that the tangible house the mortgage was used to purchase.
That’s because, under fractional reserve banking, banks can use your $250,000 note (promise to pay) as collateral to justify lending up to 10 times as much ($2.5 million) in additional currency to consumers to buy more flat-screen TVs, computers and groceries with their MasterCard or Visa. Your $250,000 promise to pay can be used to “stimulate” the economy with the creation of up to $2.5 million in additional consumer loans. As a result, the nation becomes seemingly richer every time someone borrows currency from a bank and signs a promissory note that can be used as collateral.
• Fractional reserve banking is not an example of higher economics or more sophisticated finances. It’s a brilliant Ponzi-scheme fueled by mere promises to repay debts.
Most Ponzi-schemes fail because they claim to generate fantastic returns on investments, but actually rely on attracting more customers to invest more assets into the Ponzi-scheme to create the illusion of wealth. The new customers’ deposits are used to pay off the earlier customers’ alleged “investments”.
For example, so long as Bernie Madoff promised to deliver a 18% to 20% return on investment, he attracted more clients who invested more money. Bernie used the new clients’ investments to pay 18% to 20% return on investment to his previous customers. Bernie claimed to earn 18% to 20% on the stock market each year, but most of his additional “income” really resulted from the growing deposits of his newest customers.
Bernie was robbing Peter to pay Paul. The scheme was based on fraud, but worked so long as new customers kept coming in the door to invest more of their money in Madoff’s investment firm. But once Bernie ran out of new customers, he couldn’t pay his phenomenal returns to his existing customers, the fraud was exposed, his business collapsed, he was sentenced to 150 years in prison and his son committed suicide. Like (almost) all Ponzi-schemes, the Madoff investment scheme collapsed when he ran out of “greater fools” willing to “invest” more currency in his company.
Fractional reserve banking is a far more brilliant Ponzi-scheme because, in the context of a debt-based monetary system, you don’t feed that Ponzi-scheme with ever more tangible assets—you feed it with evermore intangible debt.
Inevitably, every Ponzi-scheme that relies on attracting more tangible assets fails because there’s always an absolute limit to the supply of any tangible asset. There are only so many potential customers with ever more assets to invest in the scheme. When the Ponzi-scheme operators reach the limit their ability to attract more customers willing to invest more tangible assets, the scheme collapses.
With fractional reserve banking, people don’t invest actual assets. They invest debt. They invest promises to pay (debts) rather than actual payments (assets).
Fueled by mere promises to pay, the debt-based, fractional reserve banking system becomes a kind of cornucopia . . . a proverbial money tree . . . a perpetual monetary motion machine that produces a seemingly fantastic amount of “wealth” that doesn’t depend on actual work or tangible assets but only on promises to pay.
• The classic examples of fractional reserve banking were “liar loans” for “sub-prime borrowers”. It didn’t matter if borrowers actually earned enough money to repay their loans. Sub-prime borrowers (people who shouldn’t be able to qualify for a loan) could exaggerate their claims of income (lie) in order to borrow more money from the bank to seemingly purchase a home that was bigger and more expensive than they could truly afford.
The banks wouldn’t even investigate to see if these sub-prime borrowers were lying about their incomes. The banks knew they were lying. But the banks didn’t care because, in a debt-based monetary system, even a sub-prime borrower’s promise to pay (promissory note to the bank; debt) was deemed to be more valuable than the physical house (asset) that was purchased or built with the money from the loan.
Because a new Cadillac is enormously more valuable than a gallon of ice cream, you’d have to be crazy to pass up an opportunity to trade a gallon of Rocky Road for a new Escalade. Similarly, since a promissory note is more valuable than the house it’s used to purchase, the banks regarded it as crazy to pass up a chance to effectively trade a new, tangible house for an intangible promise to pay (debt instrument).
Given that anyone, even a sub-prime borrower, even a homeless bum, could promise to repay a loan and thereby create more debt, the fractional reserve Ponzi-scheme seemed almost foolproof. As long as people could get something tangible (a house, perhaps) for nothing (their mere intangible promise to pay), there would always be a steady stream of greedy and immoral people willing to exchange mere promises they couldn’t keep for valuable, tangible properties that they could keep or consume.
If the banks ran out of “prime borrowers,” they would lend currency to “sub-prime borrowers”.
If they ran out of “sub-prime borrowers,” they’d lend to young adults needing college loans.
If they ran out of young adults willing to issue promise to pay in return for their college educations, the government and fractional reserve system would rely on “deficit financing” by means of which they’d saddle future generations of as yet unborn children with “promises to pay” (full faith and credit of the American people) with the growing national debt.
If the native people of The United States of America became unable or unwilling to borrow more currency and produce more debt instruments, the government might even seek to stimulate immigration (even by illegal aliens) who would eventually borrow currency to build more homes.
• In a debt-based, fractional-reserve monetary system, so long as there were more people willing and even eager to trade their intangible promises to pay (debts) for tangible, valuable things like land, cars, factories, and homes (assets), we could live forever in the earthly paradise of consumerism. We could consume forever, without actually working to produce tangible wealth needed to actually pay our debts. All we had to produce were more promises to pay, and we could shop ‘til we dropped.
It was like having a checking account that never required your deposits. You could write all the rubber checks you wanted and no one would ever bother to send them to your bank. All you had to do was affix your signature to one of your checks, and people would give you things like homes, cars and computers.
So long as debt was deemed a form of wealth, and there was someone, anyone, willing to go deeper into debt, we were golden. The fractional reserve banking system could make us all rich without ever having to work to produce tangible assets.
We could consume without the need to produce. This seeming possibility might be part of the reason why our government was willing to send some of our industries and jobs to China and other third-world countries during the last twenty years. Who needed those stinking, polluting industries when we had an endless supply of borrowers willing to merely sign more debt-instruments and thereby create more apparent wealth? Let the idiot Chinks produce tangible things (assets) and life-threatening pollution, and we would consume those tangible assets by means of merely giving the Chinks our intangible “promises to pay” (US Treasuries; paper debt-instruments).
And that’s pretty much what happened. The Chinese became a primary supplier of tangible assets to the United States in return for our mere debt instruments (intangible promises to pay). Result? China now holds $1.2 trillion in US promises to pay (debt-instruments) which they know to be almost worthless.
But, can the Chinese complain?
No.
Why? Because once China admits or even acts as if their $1.2 trillion the US debt-instruments are nearly worthless, those US treasuries will actually become worthless in the eyes of the world. Then, China will lose the last illusion of having that $1.2 trillion in debt-based “wealth”.
If China hopes to ever exchange their $1.2 trillion in US debt-instruments (intangible promises to pay) for $1 trillion worth of tangible assets, they’d better keep their mouths shut and continue to support the illusion that debt is an asset. But, in truth, the real value (purchasing power) of $1.2 trillion in US Treasuries held by China may be falling by up to 10% per year towards the value of $1.2 trillion in Confederate dollars.
• In a sense, the Chinese (at least to the extent of their $1.2 trillion in US debt-instruments) have become a source of the “full faith and credit” in the US dollar and US debt instruments. The “wily Orientals” (and the rest of the world) have been conned to a degree that Bernie Madoff could only envy.
In the end, the difference between Bernie Madoff and our deb-based, fractional reserve banking and monetary system is that Madoff didn’t have access to nuclear weapons. If Madoff had had the bomb and was able to thereby intimidate his “customers” into silence, he’d still be in business rather than in prison.
The Chinese accepted the fundamental lie of the debt-based, fractional reserve system: That debt (intangible promises to pay) could be treated as assets (tangible wealth). Being dumb enough to accept that lie, the Chinese will inevitably lose much, probably most, of the purported $1.2 trillion in wealth (assets) stored in US Treasuries (debt-instruments).
It’ll be a good lesson for the Chinese. They deserve to lose $1.2 trillion because they were dumb enough, greedy enough, to believe that a promise to pay (debt) was not merely as valuable, but even more valuable, than an actual payment (asset).
It’ll be a good lesson for the American people, too, when they learn that an intangible promise to pay (debt) can never be as valuable as an actual payment (tangible asset). When they get that lesson, it’ll be painful. Americans will scream, shout and maybe even shoot. But the truth is that the American people were sufficiently ignorant, greedy and immoral to believe the lie that paper-debt instruments were even more valuable than tangible assets, that “consumerism” was a valid basis for a successful economy, that jobs and industries could be shipped overseas, and we could still shop ‘til we dropped.
Those who play the fool, inevitably pay the fool’s price: poverty. That’s true for men. It’s true for nations.