The following is an excerpt of Jim's recent interview with Richard Duncan, author of "The New Depression: The Breakdown of the Paper Money Economy"
JIM: When the United States stopped backing dollars with gold in 1968, the nature of money changed. All previous constraints on money and credit creation were removed and a new economic paradigm took shape; economic growth was no longer driven by capital accumulation and investment as it had been since the beginning of the Industrial Revolution. Instead, credit creation and consumption became the new drivers of the economy. And over that period of time, the United States debt increased fifty-fold to 50 trillion dollars.
In 2008, however, that debt could not be repaid and the new depression began. And that’s the topic of today’s discussion, the title of a new book, The New Depression: The Breakdown of the Paper Money Economy; and its author joins me on the program Richard Duncan.
Richard, you argue in your book when the United States went off gold backing from the dollar in 1968, the nature of money changed and the result was a proliferation of credit. As you document in your book, we went from almost 1 trillion dollars to today we’re now over 50 trillion. Let’s talk about that.
RICHARD: Right. In the past, up until 1968 it was a law that the Fed had to maintain gold backing for every dollar that it issued. It had to keep 25 percent gold backing for each dollar. After World War II, the US central bank had no difficulty meeting that requirement because the US had so much gold at the end of the war, but in 1968 they came up against that constraint and they would either have to have stop issuing more dollars or somehow acquire more gold.
And in the end what they did is they changed the law and they removed that requirement, and afterwards there was no longer any requirement for the Fed to keep gold backing for the dollars it issued. And at that point, I believe that the nature of money changed. We moved from a commodity-based monetary system, a gold-standard system to a paper-money system, a fiat-money system. Before that time if a person took a dollar bill to the Treasury Department, at least in theory, he was meant to receive some gold in exchange for it, but now if you take a dollar bill to the Treasury Department, they will just give you another dollar bill in exchange.
So before, there was a very clear distinction between money and credit: Money had gold backing. Well, now that distinction has been blurred. If you take a dollar bill to the Treasury Department and they give you another dollar in exchange. Well, what’s the difference between a dollar bill now and a 10-year Treasury bond? In the sense that they’re both credit instruments, the 10-year Treasury bond pays interest, the dollar bill doesn’t pay interest. So we've moved from a system where there was a clear distinction between money and credit to a system where there is really no distinction at all between money and credit. Money, in a sense, has become credit and that really changed everything.
JIM: You know, credit-induced boom and bust cycles aren’t new. The Austrian economists Ludwig von Mises and Rothbard wrote extensively about them, but before we went off gold backing, we had several restraints on credit. One was the legal requirement that the Fed back its monetary base with gold, and the second is banks hold liquid reserves to back their deposits.
Richard, explain the changes that were triggered by going off gold backing of the dollar.
RICHARD: In 1968, when this requirement for the Fed to hold gold backing ended, afterwards, after 1968, the Fed has issued 20 times as many dollars as it had up until 1968. It issued roughly another 900 billion paper dollars and that 900 billion paper dollars acted as a foundation upon which this 50 trillion dollars of credit was created; that was the most important change.
The other change you referred to was over those last four decades the amount of liquidity reserve requirements that banks were required to hold against their deposits has steadily diminished.
Now, through the system of fractional reserve banking, banks are able to create money essentially, create deposits. Now, the way that works is that when someone deposits, let’s say $100 into a bank, that bank is required to set aside those liquidity reserve requirements. The liquidity reserve ratio is 10 percent and that first bank sets aside $10 of reserves and lends out $90. The $90 then circulates through the economy and it’s redeposited and Bank B then has to set aside 10 percent and lends out 80 — $81.
And this reoccurs again and again until in the end you have more or less 10 times as much deposit and credit as you started out with through this system of fractional reserve banking; in other words, the banks create credit and create money.
Now, the thing that has changed is that over time the liquidity reserve requirement that the banks were required to hold came down very sharply from roughly 14 percent — a ratio of 14 percent down to roughly 1 percent. And as the ratio became smaller and smaller, as the liquidity reserve requirement became smaller and smaller, the amount of credit that the banks could create became larger and larger. In fact, it moved toward infinity. And that was the second reason 50 trillion dollars of credit was possible, to create so much credit, was because the liquidity reserve requirement was reduced again and again by the Federal Reserve itself...
Now, in the old days when gold was money, there was only a limited amount of money. If the government had a big budget deficit and borrowed a lot of money, that would push up the interest rates and crowd out the private sector. So it was always a good thing if the government spent less money because if it spent less money the interest rates would drop and businesses and individuals could borrow more and probably spend more efficiently. But that’s not the world we live in anymore.
In the world we live in, the government already has trillion dollar budget deficits and interest rates are at rock bottom levels already. They’re at rock bottom levels because in our world there’s not a limited amount of money; the government is free to create as much money as it wants and that’s what it’s been doing. So it’s been financing the massive budget deficits by massive paper money creation.
So in our world, if the government spends less money now, interest rates are not going to go down; interest rates are already at rock bottom levels. So if the government spends less money, the GDP is going to shrink, not only by the amount the government spends less, but because when the government spends less, fewer will have jobs so that personal consumption will shrink and therefore business investment will also shrink. In other words, the economy will spiral into a severe recession/depression.
Now, that’s where we need to begin this national debate. It’s terribly unfortunate we've gotten ourselves into this situation where our economy has been fueled by a $50 trillion expansion of credit denominated in paper money, but it’s created a US and a global credit bubble that has been fueled by credit expansion. Now the credit can’t expand anymore and it’s only the government sector that can take on additional debt; the private sector cannot take on any additional debt because they don’t make enough, their salaries aren’t going up anymore because of globalization so they can’t afford anymore debt. So this means we're dependent on government spending whether we like it or not. This is truly regrettable but this is the truth.
So what you asked me is how do I really think it’s going to play out. Well, unfortunately, there’s no indication that anyone recognizes that there’s a tremendous opportunity. I really think that what we have, we have a new economic system. This system is not capitalism anymore.
Capitalism was a system that was dominated by the private sector and the growth dynamic of capitalism worked like this: businessmen would invest, some of them would make a profit, they would save that money through capital accumulation and they would invest and profit and capital accumulation, investment, profit, capital accumulation. And that drove the economic dynamic. That’s not the way our system has worked for decades. Our system has been driven by credit creation, followed by consumption, credit creation and consumption; and that’s driven our growth dynamic. And it’s worked wonderfully. It’s created very rapid economic growth all around the world. The problem is this new system is not capitalism. I think “creditism” is a better name for it.
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