Joseph George Caldwell
11 September 2008
Updated 17 December 2008
Copyright © 2008 Joseph George Caldwell. All rights reserved. Posted at Internet website http://www.foundationwebsite.org . May be copied or reposted for non-commercial use, with attribution to author and website.
[This piece, posted at http://www.foundationwebsite.org/APlanForAmerica.htm, is an addendum to The Late Great United States essay, posted at http://www.foundationwebsite.org/TheLateGreatUnitedStates.htm.]
Contents
A Major Collapse of the US Financial System Appears Imminent 6
What Matters Most Is How Interest Is Handled. 18
In the US, Banks Are Privately Owned, and the Bankers Get the Interest 20
Why Aren’t US Banks Public?. 22
Who Owns the Federal Reserve?. 24
Time to Change the Statute?. 30
Addendum: Who Owns the Banks That Own the Fed?. 31
Some Final Remarks on Banking. 33
The National Debt (Debt-Based Money, Compound Interest, the Income Tax System) 36
Desperate Measures for Desperate Times. 49
Why Derivative Markets Collapse. 51
A Financial Collapse Is Imminent 62
A Program for America’s Survival 68
Department (Ministry) of Defense. 70
Department (Ministry) of Population and Environment 72
Department (Ministry) of Industry and Infrastructure. 75
Department (Ministry) of Education and Culture. 76
Department (Ministry) of Finance. 77
As I stated in the introduction to this piece, it is my view that the United States as a nation (or viable culture) is finished. It is like a “dead man standing,” and all that remains is for it to fall over. I am asked from time to time whether there is anything at all that can be done to change things. Well, in the long run, the answer is clearly “no,” since the system of large human numbers and industrial activity is destroying the biosphere, and the US is the major component and proponent of that system. If that system continues, the biosphere is eventually destroyed and the US along with it. If that system is brought to a premature halt, then by definition the US as we know it ceases to exist.
So, if nothing can be done to “save” the US in the long term, the question remains whether there is anything that can be done to save it in the short term, i.e., to continue it in some semblance of its current status as a large-scale industrial society. Yes, there is. Before doing so, however, it would be necessary to determine whether this would be a good idea, i.e., to determine in what way a short-term extension of this industrial society would benefit the long term. To accomplish an extension, the policies that have brought it to its present condition would have to end, and some very fundamental changes made. If this were done, the US could continue as a major industrial power for some additional time. At some point, however, the oil that fuels this type of society runs out (Hubbert’s Curve), and it is finished. All that is possible is a brief reprieve, and that is possible only if a fundamental change occurs in America’s culture and system of operation.
Recently the pastor of our church delivered a sermon in which he related the story of King Hezekiah. At the point at which the story begins, King Hezekiah is dying, and he calls for the prophet Isaiah to comfort him. Isaiah tells the king that he is indeed going to die, and that he should put his things in order. At this point, the very distraught Hezekiah implores the Lord to save his life. Upon hearing Hezekiah’s earnest plea, the Lord takes pity on him and grants him 15 years’ additional life.
The US may be in a similar position. It is about to die, and soon, and that is that. It is possible, however, that through some sort of miracle, the US could be granted some additional time – sufficient oil remains to enable this to happen. (It is not a lack of oil that has destroyed US culture – it committed cultural suicide long before the end of oil or even the passage of Hubbert’s Peak.) For this to happen, the US would have to undergo a tremendous change. To accept fundamental change, the American people (or what remains of the traditional “core” Northern European culture) would have to see clearly – be totally convinced – that the United States cannot possibly continue as it has in the recent past, and that it may continue only if a fundamental change were to happen. For America to change, it must, in my view, experience a profound realization that its past ways were wrong, see and believe what is required to give it new life, and work hard to bring that about. In my view, the US culture would only come to this realization if it virtually collapsed, just short of total death, and was then “reborn.” That is, a “near-death experience” is the kind of shock that it will take to wake Americans up and motivate them to take the steps to rebuild a viable society.
Once Americans see that all that can be accomplished is a brief extension of their industrial society (because oil is running out), they may not be sufficiently motivated to work toward it. Also, simply because Americans have the desire for their society to survive for one more generation before suffering its demise is not at all sufficient. As Jared Diamond pointed out, some societies die because although they understand what is happening, but they do not know what to do about it. To accomplish an extension of life for the United States would require a leader who knows what to do and how to do it. He would have to identify a meaningful purpose for a brief extension of American society, and convince the people to work toward it.
What sort of “shock” would be sufficient to motivate the US people to reject their current system and adopt another? Probably only a massive failure of the financial system. If global nuclear war were to occur, America would not likely continue as an industrial power. Moreover, even if the country were not totally destroyed the people would view that the destruction by war was not necessarily the result of a fundamental flaw in the American system, and would seek simply to repair or rebuild it as it was before (and see it collapse again). It seems to me that the financial collapse of the US (and the world along with it) is imminent – that it is likely to happen within a few months’ time (don’t press me for a specific date – predictions with dates attached are bound to fail). With a financial collapse, people will see unambiguously that the current system has failed, but they will still possess the physical infrastructure to quickly resume operations. The following paragraphs explain my reasons for believing that a financial collapse will occur very soon, i.e., will occur long before the destruction of the biosphere occurs, and what type of financial system should replace it. The reasoning is a little complicated, and I will not discuss it in detail, but I will outline the major considerations.
My main reason for believing that a financial collapse is imminent is that it appears that it is already beginning – large banks and other large investment organizations such as Fannie Mae and Freddie Mac are failing. The only reason why they are not collapsing in larger numbers at the moment is that the US government up to now has been able to and is bailing them out, either by using taxpayer money, by increasing the national debt, or by printing new money (“monetizing the debt”). This is possible on a small or moderate scale, but not on a massive scale, which, it appears to me, will soon be required in a futile attempt to delay a complete breakdown: taxes are inadequate, US debt is increasingly unappealing to foreign investors, monetizing the debt (this much, this fast) will lead to rampant inflation, and covering the losses from a collapse of the derivatives market is impossible.
Most federal tax revenue (which is ordinarily used to pay for bailouts) comes from taxes on the middle class. Middle-class taxpayers are “maxed out,” deep in debt with both parents of most families working; the cost of living (housing, commuting, energy, food) is very high (because of our inefficient oil-based system); many good jobs have been exported and (real, adjusted for inflation) middle-class wages are stagnant or declining; and there simply is not sufficient tax revenue available for a massive bailout. The national debt is already very high (so that interest is a major component of the national budget), and pushing it higher may alarm foreign creditors (the value of US currency relative to others has plummeted in recent years). Interest rates have been rising (so that the interest on the debt will grow even faster). Printing more money will fuel inflation (which is increasing to alarming levels) increase interest rates and debase the US currency. We are not going to “spend” ourselves out of this problem (since the debt is increasing much faster than the economy can grow).
Various financial systems (of which money and banking systems are major components) have been in operation in different parts of the world for a long time. Depending on how they are set up, they may operate for a long time. Unfortunately, our financial system is not stable, and a major reason for the instability is the money and banking system. It is designed to promote rapid economic growth, and (in a “laissez-faire” free-market economy) it exhibits a fair amount of random behavior, including wild “swings” (economic expansions and contractions; “booms and busts”). It is designed to generate massive wealth for the wealthy elite, primarily at the expense of the masses. Our financial system promotes the transfer of wealth from the middle class to the wealthy in several ways: through private ownership of banks, which accrues interest to private bankers; through the mechanism of debt and compound interest, which continually transfers wealth from the borrowers to the lenders; and through periodic economic contractions, in which many of the middle class lose everything. (In addition to the financial system, other features of US society transfer wealth from the middle class to the wealthy, including the health system, subsidies that benefit the wealthy, and globalization (free trade, mass immigration, open borders). This reason for focusing on the financial sector here is the positing (in this section) of a failure of the US financial system as a possible major shock to the US, to motivate it to change.)
As discussed earlier, because our financial system is based on debt-based money and compound interest, the total amount of money and debt are, on average, over time, generally growing. As long as the debt is small relative to the budget, things continue pretty well. For various reasons (greed; inadequate government regulation and financial prudence; external shocks; the inherent random nature of a laissez-faire, free-market system; an inadequate tax system that promotes national debt; limited ability of the government to control the system), the amount of debt becomes unmanageable at times, and the system collapses. The larger the system grows, the larger are the collapses. The more interconnected the global system becomes, the greater the likelihood that when a serious problem occurs, such as bankruptcy of the US, the entire global system will come crashing down. The minor collapses are recessions (modest economic contractions) and depressions (severe economic contractions). In each collapse, a lot of people lose everything, and their debt is wiped out. The wealthy lose a lot of wealth, but are not wiped out. They hold the loans / mortgages of the losers and retain sufficient money to buy out most of the “little guys” who barely hold on.
The last major depression was the Great Depression that started with the collapse of the US stock markets in October of 1929. A major factor causing the stock market crash was the massive purchases of securities on credit (i.e., through debt by people of modest means). After the crash, the wealthy ended up owning most of the small farms in America. Since that time, the policy of the US and world financial powers has been to try to avoid severe contractions (because they may lead to revolutions – remember Hume’s Paradox). Since the Great Depression, the size and complexity of the US and global financial system has increased tremendously, with only minor contractions from time to time. Also, the financial systems of all countries are now (under “globalization”) tightly interconnected, so that if a collapse occurs, it will have a strong effect on all countries. Many countries escaped the brunt of the Great Depression because at that time their financial systems were not so interlocked at that time.
For a number of reasons, the likelihood of a US and global financial collapse has been increasing substantially in recent years. The US and global financial leaders have managed to avoid a major collapse for some time through various bailouts and “behind the scenes” activities (the “Great Moderation”), but there are indications that these actions may not be able to avoid a major collapse for much longer. To understand why this is so, and to understand what kind of money and banking system should replace the current system when it fails, it is necessary to understand some of the fundamentals of the present US money and banking system (which is similar to that of most other countries). (Also, there is a lot of confusion about the notion of debt and the role of the Federal Reserve. This discussion attempts to clarify this.)
[If you are not interested in technical details, skip the next several pages, and proceed to the section headed, “A Program for America’s Survival.”]
As was discussed earlier, the US money and banking system is a debt-based money, fractional-reserve banking system. Since our money system is based on debt, and since it is massive debt that generally causes a collapse of the financial system and will likely trigger the next one, it is necessary to know a little about the national debt (government debt, public debt). For an excellent description of the US money system, see Ellen Hodgson Brown’s The Web of Debt (2007, 2008). For brief summaries, consult the Wikipedia entries “money,” “money supply,” “debt,” “United States public debt,” “bank,” “central bank”, “fractional-reserve banking,” and “Federal Reserve System.”
“Money” refers to anything that is generally accepted as payment for goods and services and debts. To be useful, money must be fungible (one unit is equivalent to another), highly divisible and verifiable (authenticity and amount). The major types of money are commodity money (e.g., gold, silver), representative money (certificates or tokens that may be exchanged for a fixed quantity of a commodity), fiat money (money legislated by the government) and credit money (IOUs, bonds, not payable immediately). Most of the world’s money and banking systems today (including that of the US) are debt-based fractional-reserve banking systems. Our currency is backed by debt, and debt may be used as money. Money is debt and debt is money. (The word credit may be used in place of debt, since the two are complementary.) Several categories of money are defined, reflecting differences in how they respond to monetary-policy controls. These include M0, which is physical currency (coins, bills and central-bank deposits); M1: M0 minus those portions of M0 held as cash reserves plus demand deposits (checking accounts); M2: M1 plus saving deposits, non-institutional money-market funds, and small denomination time deposits (certificates of deposits of less than $100,000); M3: M2 plus all other CDs (large time deposits, institutional money-market funds, eurodollar deposits and repurchase agreements). Note that financial instruments such as government bonds are “money” (there are active markets in them). M0 is the “narrowest” definition of money, and the most easily affected by monetary policy; M3 is the broadest (widest) definition, including all forms of money, including credit.
There is a lot of room for confusion in the term “money,” and the specific meaning is often implied by context. “Money” may refer just to currency (coins and notes), but it can just as well refer to debt instruments (bonds and other securities) and credit. When it is important to make the distinction, the form of the money (e.g., currency notes or bonds) will be specified.
The national debt is all US debt securities (e.g., treasury bills, notes, bonds) held by nongovernmental organizations (individuals, states, corporations and foreign governments). The US has had a public debt since its formation, except for one year (1835) when President Andrew Jackson paid it off. (Jackson paid the debt off before the country adopted a debt-based currency; paying the debt off now is not possible without destroying the money supply.) Whenever the US government’s expenses exceed its revenues (i.e., it runs a deficit), it issues new debt (securities, bonds). The two main ways for this to occur is (1) to sell government bonds on the open market (and use the dollars from the proceeds to pay its bills); or (2) to “monetize” the debt, by placing government bonds with the Federal Reserve (the US central bank) and creating an equal amount of dollar currency, which may be printed bills (Federal Reserve notes) or simply an accounting entry in the Federal Reserve’s books (as before, the dollars are used to pay the creditors). (The process of monetizing the debt is what is loosely referred to as “printing money.”)
In the first case, no new M0 money (physical currency) is created, but M3 increases (since new government bonds are created). The existing currency that is received for the bonds (from the purchasers) is used to pay the government’s creditors. In the second case, new M0 money is created (in amount equal to the value of the bonds). (Note that M3 automatically increases, since M0 is a component of it). Moreover, the amount of money that may ultimately be created is much more than the amount of the bonds, since under the system of fractional-reserve banking, bonds deposited in the Federal Reserve constitute backing for loans made by commercial banks (M1 money). Each commercial-bank loan generates money (“checkbook money”). The total amount of the commercial loans must be backed by Federal Reserve deposits (bonds) equal to a certain fraction (the reserve ratio) of the loans.
Note that in either case, M3 increases by the amount of the deficit. In the first case, money is created by the government’s lending (it into the economy), whereas in the second case, money is created by the government’s spending. In the first case (selling bonds) the national debt increases; in the second case (monetization) it does not (the amount of the deficit is borne by everyone, whose currency is depreciated (the cost being proportional to their wealth holdings)).
Note that there is a profound difference in the role of bonds held outside the Federal Reserve and bonds held by the Federal Reserve (as backing for money). They appear identical, but their function is very different. The “outside” bonds represent real obligations to others; the bonds in the Federal Reserve are simply convenient accounting fictions to reflect the value of issued money. In fact, most of the “interest” charged on them (by the central bank, to the government) is simply returned to the government (which pays the interest on all government bonds), since there is no “consideration” involved. In many countries the central bank is owned by the government, and so this debt is literally owed to itself. In the US, the central bank (Federal Reserve) is privately owned by a consortium of private banks, but since the interest on the bonds backing the money supply is rebated to the government, the practical effect of this private ownership of the central bank is nil. (Many people complain of the fact that the US central bank (the Federal Reserve) is privately owned, but since the interest charged on the bonds backing the money supply is rebated to the government, this is of little practical consequence. It is not, of course, what the country’s founders intended when they vested the power to coin (issue) money with the federal government. The “bonds” held by the Federal Reserve as backing for the US money supply are really just a fiction (although they are in fact real bonds that generate real interest – which is rebated to the government). Unlike bonds held outside the Federal Reserve, they have almost no effect in changing either the relative wealth of anyone (since the interest is rebated). Because the bonds backing the money supply are of no real significance, they are not counted as part of the national debt, or as part of the M3 money supply. Hence, selling of bonds to cover a deficit increases the national debt (by the size of the deficit), whereas monetizing the debt eliminates it by placing the bonds in the Federal Reserve (and increasing the size of the M0 money supply).
The process of redeeming bonds (which may be done if the government runs a surplus rather than a deficit) is the reverse of the process of issuing them. Bonds may be redeemed from the market (outside the Federal Reserve) in exchange for currency (Federal Reserve notes), or they may be redeemed from the Federal Reserve in exchange for currency. In both cases, the size of M3 decreases by the size of the debt repayment. In the first case, the M0 money supply remains the same (money is taken from taxpayers and given to bondholders). The bond is destroyed (and M3 decreases). In the second case, currency is paid to the Federal Reserve, and it “voids” the bonds by destroying both the bond and an equivalent amount of currency (i.e., M0 decreases, as does M3, which includes M0). In this case, the money supply may decrease in two ways: for certain from a destruction of currency (M0 money) equal to the value of the bonds, and potentially because there is less reserve against which commercial banks may create loans (M1 money that is not M0).
If there is no deficit, the government may still sell bonds (or other IOUs) and simply store the currency it receives in payment. In this case, the money supply available to the public shrinks. Also, if the government repays a bond held by the Federal Reserve but the Federal Reserve does not void the bond (destroy both the bond and an equivalent amount of currency), then the reserve still exists and commercial banks may make loans (create M1 money) against it.
Although there are two basic categories of money – physical currency (central bank money) and money created through loans (commercial bank money, or checkbook money), this distinction is conceptual. In reality, money is fungible, and checkbook money, although it starts simply as a bookkeeping entry, may be redeemed for physical currency (although not all at once, since it is backed up only fractionally).
When currency (Federal Reserve notes) is created, it starts out equal in amount to the corresponding bond, but over time the bonds accrue interest, while the currency does not. (Where the interest comes from will be discussed later.) The bonds on deposit in the Federal Reserve also generate interest, but, as mentioned, because there is no “consideration” for this loan, most of the interest (which was paid by the government) is returned to the government.
Although there are just two standard ways of handling deficits (selling bonds on the open market or “monetizing” the debt), there are several different ways in which bonds may be redeemed. In later discussion, it will be helpful to understand these ways, and so they will be summarized here. In the discussion that follows, it is important to remember that when a government bond is deposited by the government in the Federal Reserve, an equivalent amount of (central bank, M0) money is created, and when a government bond is voided (by the Federal Reserve), an equivalent amount of money is destroyed.
The ways in which bonds may be redeemed are: (1) use tax revenues to redeem outstanding bonds held outside of the Federal Reserve; (2) use tax revenues to redeem bonds at the Federal Reserve, and void them – destroy the bond and destroy the currency associated with it; (3) place new bonds with the Federal Reserve and use the issued currency (Federal Reserve notes) to redeem outstanding bonds outside of the Federal Reserve; (4) redeem bonds outside the Federal Reserve, but do not void them; and (5) print money that is not backed by bonds in the Federal Reserve (US notes backed by the credit of the US government), and redeem bonds (held outside the Federal Reserve) with this money. In the first case, the national debt is reduced and the size of the M3 money supply decreases – the M0 money is transferred from taxpayers to the bondholders, and the national debt is reduced (the bond is destroyed). In the second case, the amount of the bonds at the Federal Reserve is reduced and the M3 money supply shrinks, at least by the amount of the bonds redeemed, and potentially up to the fractional-reserve-banking multiplier that allows commercial banks to make loans (create money) many times the value of the reserves backing them (e.g., ten times as much). In the third and fourth cases (which are equivalent) the national debt (bonds outside the Federal Reserve) is reduced, but simply by replacing it by bonds held by the Federal Reserve. The immediate effect is to reduce M3, but in this case, the money supply may actually increase since the new bond in the Federal Reserve may be used to back money created by commercial banks (in an amount many times the size of the bonds). In the fifth case, the M3 money supply remains the same and the national debt (bonds held outside the Federal Reserve) decreases (it is converted from bonds (non-M0) to currency(M0)). This method of retiring debt is rarely used. It would represent a significant departure from a system in which the US central bank was private to one in which it was public (i.e., the government would issue the currency directly, as envisaged in the US Constitution). In this case the debt is converted into legal tender (this is what Alexander Hamilton did in the early days of the Republic).
In cases 1, 3, 4 and 5 the national debt is decreased, whereas in case 2 the national debt does not change.
It is reasonable to ask why the US has a privately owned central bank, while many other countries have publicly owned (government-owned) central banks. This is done simply to give the impression that monetary policy is controlled by professional economists (“independent within the government”), rather than the politicians of a particular administration. As long as the interest on the bonds held by the central bank to back the money supply is rebated to the government, there is no significant difference between public and private ownership of a country’s central bank. It should be noted, however, that when the Federal Reserve was established, it did not rebate the interest on the bonds to the government. This was very outrageous – why should the government pay private bankers interest on the government’s own bonds? Congressman Wright Patman was responsible for correcting this absurdity.
As will be discussed, the ownership of the central bank is of little effect, if its role is restricted to storing of the reserves backing up the nation’s currency (and regulating banks and the money supply). What is of great effect is the ownership of the commercial banks.
Since the bonds held by the Federal Reserve as backing for the nation’s currency do not generate interest, that “debt” is of no real consequence, and it is therefore not considered a part of the national debt. It is always a small fraction of the total money supply. Under a system of debt-based money it cannot be repaid, without destroying (collapsing) the money supply. For the money supply to exist in a debt-based money system, someone has to hold the debt backing the money. The government bonds that are of real significance are the bonds (or other securities) held outside the Federal Reserve. These are real obligations to nongovernmental entities, and they generate real (non-rebated) interest. For the country to be in control of its destiny, these bonds (true debt, national debt) should be small or zero most of the time, created only to overcome financial crises (to stimulate a depressed economy, per Keynesian economics). The crisis that the country faces at the present time is that the national debt has exploded in recent years. Furthermore, much of it is held (currency and bonds) by foreign countries, such as China and Japan (i.e., it is “external” debt). It earns a high rate of compound interest, and is growing rapidly. If the government does not do something to control the growth of the debt (and reduce it) soon, the value of the US currency will decline further (since more money / debt must be created to pay the interest), and foreign owners of US money (currency, bonds) will dump it. At that time the US financial system will likely collapse (since we will no longer be able to participate effectively in global trade, upon which we are now totally dependent), taking the global financial system along with it (since it is such a large part of the global financial system).
Although the fact that the US central bank is privately owned does not matter much from the point of view of holding reserves backing the money supply (since the interest is rebated to the government), the fact that the commercial banks are privately owned matters a very great deal. If all banks were national (government-owned) banks, the government would collect all of the interest, and could use it (in lieu of taxes) to fund its operations. Under a system of privately owned commercial banks, private bankers collect all of the interest and become fabulously wealthy. The fabulous profits from banking operations are given to the bankers, rather than to the people. A key aspect of money and banking is how interest is handled.
In early cultures (e.g., Judaism, Christianity, Islam), charging of interest was generally forbidden, or debts had to be forgiven on a regular basis (e.g., every seven and fifty years in Judaism). This was done to prevent concentrations of wealth (that might rival the government or the church) and to prevent using wealth (rather than labor, earned income) to generate income and more wealth. Since private ownership of banking does not serve the people and enriches the bankers, it is of interest to examine why our banking system is set up this way. First, however, it is helpful to present a simple example that illustrates different ways that interest may be handled in a society. Consider the situation of a retired widow who owns a home that she wishes to dispose of, and a young couple who wish to acquire a home. The young couple are without savings, but they have income from work. We may consider three cases: (1) the widow sells the home to the young couple, giving them a 30-year loan for $100,000 at 5.3 percent interest (payments of $555.30 per month); (2) the couple borrows the same amount at the same terms from a private bank and purchases the house; and (3) the couple borrows the same amount at the same terms from a national bank (i.e., from the government) and purchases the house. To keep the example simple, let us suppose that the rate of inflation is zero, so that the value of things (such as the widow’s house) does not change over time. In case 1, at the end of 30 years, the widow has been repaid her $100,000 principal and an additional $100,000 in interest. She now has double the original value of her house – in effect, she now owns the equivalent of two houses. The second “equivalent house” was acquired by her holding the loan and receiving the interest on it. In case 2, the widow receives $100,000 for her home. If she doesn’t re-invest the money, at the end of 30 years she still owns one house. (If she reinvests the money, she will receive some income, but probably not as much as the bank’s mortgage interest rate.) The bank has collected the interest, and at the end of 30 years it now has $100,000, the equivalent of one house. In case 3, the widow receives $100,000 for her home and, as in case 2, if she doesn’t re-invest the money, at the end of 30 years she still owns one home. In this case, the government has collected the interest, and at the end of 30 years it now has $100,000, the equivalent of one house (or it may spend the interest any way it wishes, avoiding the need to levy $100,000 in taxes).
It is clear from this simple example that whoever lends the money receives the interest. If there is no bank at all, a private individual (the widow) makes the loan and retains the interest. If the bank makes the loan, it retains the interest. If the bank is privately owned, then the banker (private owner of the bank) retains the interest. If the bank is owned by the government, then the government retains the interest. This simple example shows that it is extremely important who owns the banks, since they acquire the interest.
The fundamental problem causing the national debt to be so large (as well as transferring massive wealth from the middle class to the wealthy) is the private ownership of the commercial banks, which create money every time a loan is made and retain all of the interest charged. If banks were nationalized, so that the interest on bank loans accrued to the government, there would be no public-debt crisis, we would not need an income tax, and the distribution of income and wealth would not be skewing as it is. Whether the central bank (the Federal Reserve) is privately owned or not is not the fundamental problem or issue. Of course, if all commercial banks were government-owned, it would be logically consistent for the central bank to be government-owned as well.
In the United States, banks are privately owned. Most money in the economy – commercial loans – is created by private banks (commercial banks). The central bank is hardly a bank at all – it simply stores the assets (government bonds) backing the national currency (and the interest on them is rebated to the government) and regulates the private banks (and the money supply). Most of the money in the economy is created in private commercial banks, and it is to these banks that the interest on the loans is paid. Our banking system has been set up to make bankers very wealthy, when it could have been set up – as a national banking system, with the government owning the banks – to return the interest to the government to be used in lieu of taxes. This is a profound difference, and it is important to understand why it is this way, how this set-up is destroying US society, and how simply it could be changed.
It might be argued, in the preceding example, that the widow is entitled to the interest because she owned the property and accepted the risk that the couple would destroy it before she was repaid. It might be argued that the bankers are entitled to the interest, because they accept the risk (which the widow no longer bears once the bank takes the title to her house and gives her the cash for it) and have to cover the cost of servicing (collecting) the debt. Or it might be reasoned, as was once done by the three Abrahamic religions (and Karl Marx) that interest (or rents, which are essentially the same thing) should not accrue to private individuals. (It is interesting to note that Judaism allowed charging of interest to non-Jews.) The issues here are whether unearned income (interest, rent) is moral and serves a useful social purpose. (The story of Jesus throwing the moneylenders out of the temple is worth keeping in mind.)
A key element of the situation is that the loan may be made only if the couple is trustworthy, i.e., has good “credit.” This credit is an essential ingredient of the transaction, and is of high value. In making the loan, the couple is giving the value of their good credit to whoever extends the loan – it is the assurance that they will pay. (The couple is also receiving the benefit of its good credit, in qualifying for the loan.) They may wish to give this value to the widow (who may in fact be a friend, or a relative, or their mother), or to the government (for the interest to benefit the public, of whom they are a part), but it is hard to understand why they would give it to anonymous bankers. This very scenario plays out in a large scale today, in the credit-card industry (and now debt crisis). When I was young, a person with good credit would arrange to purchase goods from a local merchant on his good name, sometimes receiving the goods right away (or after making a down payment) and other times after completing the payment (“layaway”). Today, a young person routinely forfeits the value of his good credit by letting a credit-card company pay the merchant, and then paying the credit card company an exorbitant rate of interest, such as 20 percent. He gives the full value of his credit to the credit-card company – and pays them for it!! (The merchant usually also pays a small fee to the credit-card company.) In the past, he could negotiate his good credit to receive the goods from the merchant without paying a penny in interest, and the merchant also did not have to pay anything to the credit-card company. He fully realized the value of his good name and credit, by not having to pay interest while he paid for the goods. Today, he gives the total value of this credit to the credit-card company (instead of to himself), and ends up deep in compound-interest debt – charged on his own credit! Why?
How did it happen that in the US the commercial banks, which create most of the money, are privately owned? Here is an excerpt from the Wikipedia article on the Federal Reserve System, which summarizes the history very succinctly:
“Agrarian and progressive interests, led by William Jennings Bryan, favored a central bank under public, rather than banker, control. But the vast majority of the nation's bankers, concerned about government intervention in the banking business, opposed a central bank structure directed by political appointees. The legislation that Congress ultimately adopted in 1913 reflected a hard-fought battle to balance these two competing views and created the hybrid public-private, centralized-decentralized structure that we have today.”
It is said that William Jennings Bryan, who had fought hard against a private banking system for years, was “tricked” into agreeing to support the Federal Reserve Act of 1913, and was utterly dismayed when he realized what he had done. The bill was passed by Congress on December 22, 1913, and President Woodrow Wilson signed it into law the next day, three days before Christmas. Wilson, too, later profoundly regretted what he had done, and commented, “I have unwittingly ruined my country.” The bill was difficult to understand. Even the use of the word “Federal” in the name is deceptive – the Federal Reserve is not a federal organization at all.
In any event, the bankers got virtually everything they wanted – the banking system is private in everything but the name of the central bank. The essential role of the bank is to store the reserves (government bonds) backing up the currency, and to regulate the private banks and the money supply (e.g., by setting the fractional reserve ratio). In the beginning, the Federal Reserve even kept the interest on these bonds, but, as I mentioned earlier, this ridiculous set-up was eventually modified so that the interest is “rebated” to the government (29 billion dollars in 2006). The crucial aspect of the system is that commercial banks create money whenever they create a loan, and all of the interest from the loan accrues to them. The bankers get it all. The interest, which could be used to reduce or obviate the need for taxes if the banks were publicly owned, goes to the wealthy elite (the owners of the commercial banks), not to the government and the people.
The Constitution is not clear about the role of the central bank and the matter of who issues money (although it does state that only the government may “coin” it, and the Preamble states that the government is to promote the general welfare). Thomas Jefferson was in favor of a public banking system and Alexander Hamilton was in favor of a private one. Eventually, Hamilton prevailed (in exchange for Jefferson’s agreeing to support moving the nation’s capital to Virginia).
The financial crisis represented by massive US national debt could be resolved by our government, through prudent fiscal measures (such as elimination of free trade, replacement of the income tax by a value-added tax, reduction in government spending, nationalization of all banking and moneylending, and prohibiting the charging of interest (per the original tenets of Judaism and Christianity, and of Islam today), but it is unwilling to do any of these things (since they would retard economic growth and generation of wealth for the wealthy elite). When the coming financial collapse occurs, it will be willing to do these things. (It is interesting to note that the solutions involve a return to the traditional morality of yesteryear. One might easily conjecture that religious “fundamentalists” will play a role in the “redemption” of the United States.)
There is a lot of confusion about the ownership of the US central bank, the Federal Reserve. Most people think that it is owned by the US government, but it is not – it is owned by a consortium of private banks. Here follows an excerpt from Ellen Hodgson Brown’s article, “The Fed Now Owns the World’s Largest Insurance Company – But Who Owns the Fed?” posted at her website, http://www.webofdebt.com/articles/time_to_buy_the_fed.php.
“Some people think that the Federal Reserve Banks are United States Government institutions. They are private monopolies which prey upon the people of these United States for the benefit of themselves and their foreign customers; foreign and domestic speculators and swindlers; and rich and predatory money lenders.”
– The Honorable Louis McFadden, Chairman of the House Banking and Currency Committee in the 1930s
The Federal Reserve (or Fed) has assumed sweeping new powers in the last year. In an unprecedented move in March 2008, the New York Fed advanced the funds for JPMorgan Chase Bank to buy investment bank Bear Stearns for pennies on the dollar. The deal was particularly controversial because Jamie Dimon, CEO of JPMorgan, sits on the board of the New York Fed and participated in the secret weekend negotiations. In September 2008, the Federal Reserve did something even more unprecedented, when it bought the world’s largest insurance company. The Fed announced on September 16 that it was giving an $85 billion loan to American International Group (AIG) for a nearly 80% stake in the mega-insurer. The Associated Press called it a “government takeover,” but this was no ordinary nationalization. Unlike the U.S. Treasury, which took over Fannie Mae and Freddie Mac the week before, the Fed is not a government-owned agency. Also unprecedented was the way the deal was funded. The Associated Press reported:
“The Treasury Department, for the first time in its history, said it would begin selling bonds for the Federal Reserve in an effort to help the central bank deal with its unprecedented borrowing needs.”
This is extraordinary. Why is the Treasury issuing U.S. government bonds (or debt) to fund the Fed, which is itself supposedly “the lender of last resort” created to fund the banks and the federal government? Yahoo Finance reported on September 17:
“The Treasury is setting up a temporary financing program at the Fed’s request. The program will auction Treasury bills to raise cash for the Fed’s use. The initiative aims to help the Fed manage its balance sheet following its efforts to enhance its liquidity facilities over the previous few quarters.”
Normally, the Fed swaps green pieces of paper called Federal Reserve Notes for pink pieces of paper called U.S. bonds (the federal government’s I.O.U.s), in order to provide Congress with the dollars it cannot raise through taxes. Now, it seems, the government is issuing bonds, not for its own use, but for the use of the Fed! Perhaps the plan is to swap them with the banks’ dodgy derivatives collateral directly, without actually putting them up for sale to outside buyers. According to Wikipedia (which translates Fedspeak into somewhat clearer terms than the Fed’s own website):
“The Term Securities Lending Facility is a 28-day facility that will offer Treasury general collateral to the Federal Reserve Bank of New York’s primary dealers in exchange for other program-eligible collateral. It is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. . . . The resource allows dealers to switch debt that is less liquid for U.S. government securities that are easily tradable.”
“To switch debt that is less liquid for U.S. government securities that are easily tradable” means that the government gets the banks’ toxic derivative debt, and the banks get the government’s triple-A securities. Unlike the risky derivative debt, federal securities are considered “risk-free” for purposes of determining capital requirements, allowing the banks to improve their capital position so they can make new loans. (See E. Brown, “Bailout Bedlam,” webofdebt.com/articles, October 2, 2008.)
In its latest power play, on October 3, 2008, the Fed acquired the ability to pay interest to its member banks on the reserves the banks maintain at the Fed. Reuters reported on October 3:
“The U.S. Federal Reserve gained a key tactical tool from the $700 billion financial rescue package signed into law on Friday that will help it channel funds into parched credit markets. Tucked into the 451-page bill is a provision that lets the Fed pay interest on the reserves banks are required to hold at the central bank.”
If the Fed’s money comes ultimately from the taxpayers, that means we the taxpayers are paying interest to the banks on the banks’ own reserves – reserves maintained for their own private profit. These increasingly controversial encroachments on the public purse warrant a closer look at the central banking scheme itself. Who owns the Federal Reserve, who actually controls it, where does it get its money, and whose interests is it serving?
Not Private and Not for Profit?
The Fed’s website insists that it is not a private corporation, is not operated for profit, and is not funded by Congress. But is that true? The Federal Reserve was set up in 1913 as a “lender of last resort” to backstop bank runs, following a particularly bad bank panic in 1907. The Fed’s mandate was then and continues to be to keep the private banking system intact; and that means keeping intact the system’s most valuable asset, a monopoly on creating the national money supply. Except for coins, every dollar in circulation is now created privately as a debt to the Federal Reserve or the banking system it heads. The Fed’s website attempts to gloss over its role as chief defender and protector of this private banking club, but let’s take a closer look. The website states:
· “The twelve regional Federal Reserve Banks, which were established by Congress as the operating arms of the nation’s central banking system, are organized much like private corporations – possibly leading to some confusion about “ownership.” For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.”
· “[The Federal Reserve] is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.”
· “The Federal Reserve’s income is derived primarily from the interest on U.S. government securities that it has acquired through open market operations. . . . After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.”
So let’s review:
1. The Fed is privately owned.
Its shareholders are private banks. In fact, 100% of its shareholders are private banks. None of its stock is owned by the government.
2. The fact that the Fed does not get “appropriations” from Congress basically means that it gets its money from Congress without congressional approval, by engaging in “open market operations.”
Here is how it works: When the government is short of funds, the Treasury issues bonds and delivers them to bond dealers, which auction them off. When the Fed wants to “expand the money supply” (create money), it steps in and buys bonds from these dealers with newly-issued dollars acquired by the Fed for the cost of writing them into an account on a computer screen. These maneuvers are called “open market operations” because the Fed buys the bonds on the “open market” from the bond dealers. The bonds then become the “reserves” that the banking establishment uses to back its loans. In another bit of sleight of hand known as “fractional reserve” lending, the same reserves are lent many times over, further expanding the money supply, generating interest for the banks with each loan. It was this money-creating process that prompted Wright Patman, Chairman of the House Banking and Currency Committee in the 1960s, to call the Federal Reserve “a total money-making machine.” He wrote:
“When the Federal Reserve writes a check for a government bond it does exactly what any bank does, it creates money, it created money purely and simply by writing a check.”
3. The Fed generates profits for its shareholders.
The interest on bonds acquired with its newly-issued Federal Reserve Notes pays the Fed’s operating expenses plus a guaranteed 6% return to its banker shareholders. A mere 6% a year may not be considered a profit in the world of Wall Street high finance, but most businesses that manage to cover all their expenses and give their shareholders a guaranteed 6% return are considered “for profit” corporations.
In addition to this guaranteed 6%, the banks will now be getting interest from the taxpayers on their “reserves.” The basic reserve requirement set by the Federal Reserve is 10%. The website of the Federal Reserve Bank of New York explains that as money is redeposited and relent throughout the banking system, this 10% held in “reserve” can be fanned into ten times that sum in loans; that is, $10,000 in reserves becomes $100,000 in loans. Federal Reserve Statistical Release H.8 puts the total “loans and leases in bank credit” as of September 24, 2008 at $7,049 billion. Ten percent of that is $700 billion. That means we the taxpayers will be paying interest to the banks on at least $700 billion annually – this so that the banks can retain the reserves to accumulate interest on ten times that sum in loans.
The banks earn these returns from the taxpayers for the privilege of having the banks’ interests protected by an all-powerful independent private central bank, even when those interests may be opposed to the taxpayers’ -- for example, when the banks use their special status as private money creators to fund speculative derivative schemes that threaten to collapse the U.S. economy. Among other special benefits, banks and other financial institutions (but not other corporations) can borrow at the low Fed funds rate of about 2%. They can then turn around and put this money into 30-year Treasury bonds at 4.5%, earning an immediate 2.5% from the taxpayers, just by virtue of their position as favored banks. A long list of banks (but not other corporations) is also now protected from the short selling that can crash the price of other stocks.
According to the Fed’s website, the control Congress has over the Federal Reserve is limited to this:
“[T]he Federal Reserve is subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute.”
As we know from watching the business news, “oversight” basically means that Congress gets to see the results when it’s over. The Fed periodically reports to Congress, but the Fed doesn’t ask; it tells. The only real leverage Congress has over the Fed is that it “can alter its responsibilities by statute.” It is time for Congress to exercise that leverage and make the Federal Reserve a truly federal agency, acting by and for the people through their elected representatives. If the Fed can demand AIG’s stock in return for an $85 billion loan to the mega-insurer, we can demand the Fed’s stock in return for the trillion-or-so dollars we’ll be advancing to bail out the private banking system from its follies.
If the Fed were actually a federal agency, the government could issue U.S. legal tender directly, avoiding an unnecessary interest-bearing debt to private middlemen who create the money out of thin air themselves. Among other benefits to the taxpayers. a truly “federal” Federal Reserve could lend the full faith and credit of the United States to state and local governments interest-free, cutting the cost of infrastructure in half, restoring the thriving local economies of earlier decades.
Beyond merely stating that all the shareholders of the Fed are its member banks, I’ve been asked to elaborate on who actually owns those banks. Are they owned by powerful foreign banking families as has been alleged? According to a discursive article by Dr. Edward Flaherty, condensed below, the answer is no – not to any provable extent. But that does not mean that the Fed and the U.S. banking system are not controlled from abroad. The central banking system has its own “banker’s bank,” the Bank for International Settlements (BIS) in Basel, Switzerland. The BIS does control the international banking system, in part by setting capital requirements -- the requirements that have now caused the entire U.S. credit market to freeze up. But that is a subject for a later article. Dr. Flaherty wrote:
“. . . Each of the twelve Federal Reserve Banks is organized into a corporation whose shares are sold to the commercial banks and thrifts operating within the Bank’s district. Shareholders elect six of the nine the board of directors for their regional Federal Reserve Bank as well as its president. . . .
“The SEC requires the name of any individual or organization that owns more than 5 percent of the outstanding shares of a publicly traded firm be made public. If foreigners own any shares of [eight banks claimed by Eustace Mullins to control the New York Federal Reserve], then their portions are not greater than 5 percent at this time. With no significant holdings of the major New York area banks, it does not seem likely that foreign conspirators could direct their actions.
“. . . The law stipulates a small portion of Federal Reserve stock may be available for sale to the public. . . . However, under the terms of the Federal Reserve Act, public stock was only to be sold in the event the sale of stock to member banks did not raise the minimum of $4 million of initial capital for each Federal Reserve Bank when they were organized in 1913 (12 USCA Sec. 281). Each Bank was able to raise the necessary amount through member stock sales, and no public stock was ever sold to the non-bank public. In other words, no Federal Reserve stock has ever been sold to foreigners; it has only been sold to banks which are members of the Federal Reserve System.
“. . . [E]ach commercial bank receives one vote regardless of its size, unlike most corporate voting structures in which the number of votes is tied to the number of shares a person holds. The New York Federal Reserve district contains over 1,000 member banks, so it is highly unlikely that even the largest and most powerful banks would be able to coerce so many smaller ones to vote in a particular manner. To control the vote of a majority of member banks would mean acquiring a controlling interest in about 500 member banks of the New York district.” [Prof. Edward Flaherty, University of Charleston, “Who Owns and Controls the Federal Reserve?” (July 18, 1997); citations omitted.]
[End of Hodgson article.]
Monetary policy includes establishing what type of money and banking system is used (e.g., gold-backed or fiat currency) and actions such as setting the fractional reserve requirement (fraction of a private bank’s loans that must have deposits at the central bank) and the discount rate (interest rate charged to banks that borrow from the Federal Reserve). The goal of monetary policy is to regulate the money supply to promote economic growth. One of the objectives is to keep inflation (of prices and of the money supply) at a moderate level. A very high inflation rate is undesirable because it destroys the value of savings and makes it difficult for businesses to do long-range planning. A negative inflation rate (deflation) is considered undesirable because investors stop investing (so that economic growth slows) and bankers lose the ability to control the money supply by adjusting interest rates. (Investors stop investing under deflation because it is prudent to save money; cash money is worth more in the future, not less (as is the case with inflation). And all political leaders want growth.)
A key aspect of a central bank is to regulate the money supply to avoid booms and busts. This is done, as mentioned, through the structure of the money and banking system and the tools of monetary policy. Canadian economist Robert Mundell hypothesized that it is not possible to have all three of the following at the same time: (1) a fixed exchange rate; (2) free capital movement; and (3) an independent monetary policy. (This situation is referred to as the “impossible trinity,” the “inconsistent trinity,” or the “triangle of impossibility.” Mundell also did much work in the theory of optimal currency areas. An optimal currency area is a geographical region in which it maximizes economic efficiency to have the entire region share a single currency. Economic efficiency, of course, is a primary rationale behind globalization – and the resultant destruction of societies and of the biosphere.)
A money-and-banking system can continue indefinitely in a “steady-state” (no growth, stable) economy if the government issues all money, and if something is done to prevent the accumulation of interest (e.g., it accrues only to the government, and the government then spends it or destroys it; or it is paid for by taxes; or if it is periodically forgiven). (The reason why the accumulation of interest cannot be allowed in the long run in a steady-state economy is that interest represents “new” money. (Recall that in making a loan, the bank creates the principal but not the interest. The interest must be created by means of additional loans.) Either it may be charged only by the government and spent by the government, or it cannot be charged (by others) or it must be forgiven (or paid for by taxes), or it must remain as a permanent debt (e.g., the national debt).) If all loans were made by the government, then all interest payments would accrue to the government. All interest would accrue to the government, not to private banks or individuals. It would not be necessary to tax income to pay interest on the national debt – the government’s interest income would be quite sufficient to cover this, as well as other budget items. The government could forgive any amount of debt. The government could spend the interest earned on any programs it wished. If properly managed, there would be no need for any taxes at all – all government expenses could be covered by interest earned.
A key feature of the Federal Reserve System is that private bankers keep the interest on loans, but the taxpayer pays the interest on the national debt (which includes the money created to pay the interest). This is typical of our governmental system, which serves the wealthy – the costs are borne by the public (“socialized”), and the benefits are given to the wealthy (“privatized”). This is done mainly via the income tax. (The income tax and the Federal Reserve were established at the same time, in 1913. The government wants the interest on the debt to be paid by taxes on earned income, not by taxes on interest (unearned income).) It is not practical to tax interest earnings on bonds at a high rate, or else there would be little reason for buying the bonds – that is one reason why capital gain taxes are low. Furthermore, the government cannot tax bonds owned by foreigners.
The government has to pay the interest on the debt that it creates (bonds), but the private bankers get to keep the interest on the loans that they make (using money that the government authorizes them to create). If the government owned the banks and collected all of the interest on loans made using the nation’s money, the government would have vastly more financial resources at its disposal. The amount of interest from commercial loans exceeds the income from taxes. If the government owned the banks there would be no need for income taxes. There would be little need for a national debt if the government made all loans and collected all interest from them (since the government would have so much greater financial resources). Fannie Mae and Freddie Mac would never have been privatized and looted, and there would be no mortgage crisis today. Their destruction and the massive losses associated with it were caused by the “privateers” who looted it, and the US government is now forcing the middle class to cover this loss.
The US money and banking system, based on debt-based money, compound interest and private ownership of banks, is an ingenious system for stimulating perpetuating growth, and for making bankers very wealthy. It leaves the government dependent on income tax revenues. Under “free trade,” income from tariffs, which protected the middle class (and were a major source of government revenue conceived by the Founders), is no longer a significant source of income – the major portion of income-tax revenue is taxes on the middle class. Unfortunately, the income tax produces inadequate revenue and is unstable. It fluctuates wildly, depending on the state of the economy. When the economy turns bad, the government is prone to go into debt to fund its operations. This tendency is amplified by reliance on “Keynesian economics,” which promotes deficit spending when the economy turns bad. The US financial system, including the tax system, is a complete mess. There is no need for a national debt; it could easily be avoided if the government owned the banks or had an adequate tax system. Just as the US financial system drives individuals and third-world countries into massive debt and bankruptcy, it does the same thing with the US government.
A major problem facing the US today is that the government has let the national debt get out of hand. This happened for a number of reasons: a private banking system; expensive health and welfare programs; wars; subsidies to the wealthy; and a tax system that drives the government into debt and places the US at a substantial trade disadvantage since it is not harmonized with the tax systems used by its major trading partners (the value-added tax)). As long as the government kept the national debt low, the system could continue, even with high individual debt bankrupting individuals (but not the country). With a system of private banks and an income tax system, under Keynesian economics the government incurs much debt (“deficit spending”) when the economy turns bad (as invariably happens in an open, laissez-faire free-market economy). Under the income tax system, the government does not have a stable or adequate source of revenue for its operations.
The national-debt problem is that (1) the national debt is high, the government owes the interest on the bonds to private entities, and they have no intention of forgiving the debt; (2) most of the interest on the national debt is paid for by taxes on the labor income (earned income) of the middle class, and the interest on the national debt is growing much faster than the labor-income-tax revenue. (Monetization of budget deficits is not a good solution since it inflates the money supply.) This is the fundamental problem – the government uses income taxes to pay the interest on the national debt, the debt is growing faster than the income tax revenues, and there does not appear to be any way of fixing this – with our current financial system (money and banking system, tax system).
Eventually, with the interest on the national debt growing faster than the tax revenue available to pay it, a point is reached where it is no longer possible for the government to pay the interest on the national debt with income taxes. Adding the interest to the debt is not a long-term solution. If the government monetizes the debt, the point will be reached where inflation reduces the value of US money (both the currency and the bonds) so low that they are of little interest to foreign holders. (Whether the central bank was owned privately or publicly would make no difference in the current crisis – the government would still owe massive interest payments to foreign countries.) At this point the entire system collapses. We are very near that point now. The government is dependent on income taxes and it is already taxing people heavily; the people are deep in debt; the cost of living has increased to high levels; both parents of most families are working; and the debt is to the size where the interest cannot be paid. The size of the population is increasing at breakneck speed (one percent per year), to the point where cultural assimilation is not taking place. The US has lost its manufacturing capacity, and must now buy most of its consumer goods from foreign countries. The country, quite frankly, is bankrupt. It is now beginning to “sell the furniture” – public infrastructure, land and US corporations – to foreign interests.
A common response of the government is to try to “spend” its way out of financial crises, by increasing the money supply and thereby stimulating the economy. This is the basis of “Keynesian economics” (deficit spending by the government when the economy turns bad). It is the reason why the government has encouraged banks and credit-card companies to create massive credit-card debt. It is the reason why the government encouraged granting of mortgages to people without sufficient credit. All of this debt is money. Unfortunately, all of the money is debt. Under compound interest at high rates, many credit-card holders are mired in debt, and can never recover. Many people who could not afford to purchase homes were induced to do so by adjustable-rate mortgages (ARMs) that have little or no interest for several years. They could not quality for a standard mortgage, and when the interest rate of the ARM rises after a few years (an increase in the monthly payment of up to 60 percent), they cannot pay. That is the reason for the current mortgage crisis, in which millions of home mortgages are going into default and the homes lost to foreclosure. The next major crisis may well be a credit-card crisis – people will start defaulting on credit cards en masse.
Using deficit spending to stimulate the economy has worked in the past, when the US had a strong manufacturing base. It has destroyed that base, however, so there is nothing left to “stimulate.” Injecting money into the system may enable some additional consumer spending, but it is spent on foreign goods, since the US hardly makes any!
In addition to debt-based money, another major problem in today’s financial system is the massive amount of financial derivatives. Derivatives are nothing more than bets on the outcome of a future specified event, such as the price of a commodity or bond, or the value of a foreign currency, or whether a firm fails. They are so-called because their price (value) is “derived,” or based, on the value of something else (e.g., a commodity or some other financial instrument). The simplest derivatives are bets (options; “puts” and “calls”) on the price of a commodity (e.g., cotton, copper, frozen pork bellies, soybean meal) at a future date. Trading in derivatives is considered little more than gambling, because the value of the derivative is not directly tied to a real (existing in the present) tangible asset, such as a share in a company or a bond earning a fixed rate of interest. (Buying and selling stocks and bonds is little more than gambling, too, but people are “used to” it and it is euphemistically called “investing.”) It is because they are considered essentially a form of gambling that derivatives are not closely regulated, as are stocks and bonds. Some years ago there was a move to make trading in derivatives illegal, but financiers argued that they were a useful tool in “risk management,” and therefore of value to the legitimate economy.
Like many things, derivatives started out as seemingly harmless but useful devices to control risk. The farmer wanted to be assured of a good price for his crop, and so he sold it in advance. He did not own the crop when he sold it, but it was his intention to raise it. The buyer of the crop future was buying nothing more than a good intention, but there was a basis for his confidence. The problem arose that if the farmer could sell something that did not exist, other people could, too. Selling something that you don’t own is called a “short sale.” Very quickly, the number of short sales in commodities exploded – the total amount of a commodity being sold (e.g., coffee futures) vastly exceeded the annual crop. Very few of the commodities traders – the farmer and the person who wanted his crop – were sincere. All of the others simply had different ideas about what the future value of the crop would be, and wanted to make money on their opinion. All that the gamblers had to do was make sure that their contracts were “closed” by the end of the growing season, so that they did not have to actually deliver or receive the product.
The concept works the same for any firm that does international business. The firm does not wish to incur a loss because of currency fluctuations, and so it sells its products or buys its raw materials (e.g., oil) in advance. This is a perfectly rational way of minimizing risk, allowing it to concentrate on its area of expertise (making its products) without having to worry that an adverse move in foreign currencies could bankrupt it.
Some argue that trading in derivative is so risky, and little more than gambling, that it should not be allowed, or tightly regulated, or taxed. But where do you draw the line? Should only farmers and agribusinesses needing crops be allowed to trade crop futures? Should only exporters and importers be allowed to deal in currency futures? Should only wholesale oil merchants be allowed to deal in oil futures? The argument of some is that commerce is facilitated by an active, liquid market in futures, and that this serves business well. Furthermore, because of the high risk (fortunes may be made or lost in minutes), it was assumed that only the very wealthy would play the derivatives game, and only they would get hurt. The current financial crisis, which stems mainly from derivatives, shows how very wrong this assumption was.
Since it was not practical to deny some people the ability to trade in options and not others, the government allowed trading in futures to the public. It regulated the commodities exchanges lightly, but allowed purchases of futures contracts to be made with very little margin (e.g., three percent). Since there is a fair volatility in commodities prices many months ahead of delivery, much money can be made – or lost – in a few days, or even hours or minutes, in the commodity futures markets. Whereas a trader in stocks or bonds has to put up most of the money and wait for a long time to see the result of his deal (e.g., several years – the “long term”), the commodities trader can be in an out of the market in a very short time. Futures trading hence became very popular as a legitimate form of gambling.
Once the government allowed the short selling that is fundamental to trading in commodities futures (i.e., selling something you don’t own, and that doesn’t even exist in the present), it was an easy step to allowing people to trade in anything. The derivatives markets expanded from commodities futures to puts (shorts) and calls (longs) on stocks, and then to contracts on anything, such as the value of a stock-market index. A popular form of derivative is a “credit default swap,” which is a bet on the future value of a bond. In order to make money in the derivatives market, it is necessary to determine an appropriate present price for the value of a stochastic process at some time in the future. This is a problem in statistics. The problem may be solved in “closed form” (i.e., with the answer given by a mathematical formula) for simple cases (e.g., the “Black-Scholes” model), but for complex situations it is necessary to use numerical methods to determine the price. The problem involves what is called “stochastic calculus,” and the solution of partial differential equations. Since numerical methods are involved, it is not possible to show anyone the “formula” for the price, as may be done, for example, in the present value of an annuity, or a monthly mortgage payment. The field of pricing of derivatives is arcane.
Derivatives are typically risky. They are deliberately so in order to produce a high return (per the Fundamental Theorem of Finance, which declares that higher returns must be associated with higher risks). In fact, the higher the risk, the higher the return. The perfect situation for a seller of derivatives is to insure an event that is catastrophic but has a very low chance of happening. The risk is tremendous, and the derivative seller reaps large premiums in the knowledge that it is very unlikely that he will ever have to cover the loss. This is the very kind of event that today’s derivative traders sought, and the very kind of derivatives they sold. For quite a while, the sellers of derivatives were making incredible profits, because the rare events that they insured against never occurred. The problem was, however, that the losses being insured were so large that the sellers could not possibly cover them if they occurred, particularly if many of them occurred at the same time. But they eventually did occur; and at the same time.
In today’s derivative market, many derivatives are insurance against catastrophic loss. Derivative sellers have made fortunes by insuring catastrophic events that are considered unlikely to occur. One party pays a small premium to insure against a potential future event that is very unlikely to occur, but if it does, the loss would be massive. A real problem with derivatives stems from the fact that, like life and hazard insurers, the derivative insurers insure vastly more than they possess, so they are bound to go bankrupt if many of their insured losses materialize at the same time (which is what happened in the current financial crisis involving mortgage-backed securities). With life insurance and hazard insurance, there is a sound statistical basis for the insurance. Not everyone is going to die at once, and not all buildings are going to catch fire at once, and the amount of “reserves” needed to cover expected losses in any given year with an extremely high probability can be determined with a high degree of confidence. Derivatives are not based on underlying natural and independent stochastic processes, however, and it is quite possible for all of the losses to occur at once (as in the case of the current financial crisis, in which a massive number of risky mortgages (to “subprime” borrowers) went bad at the same time because the only way the “subprime” lenders could pay was if the price of housing kept going up, and it failed to do so).
The original concept in allowing derivatives to be legal was that they would be traded mainly to control risk (e.g., buying and selling of commodities futures; hedging against international currency fluctuations) and traded by the rich. The problem that has arisen is that trading in derivatives became very popular, to the point where the potential loss associated with all derivatives is so monumental that if it occurs, the “loser” cannot possibly pay up (i.e., it exceeds the gross domestic product of all countries in the world by many times). If these instruments were in fact traded only by the rich, this would not matter – the losing party would simply be wiped out financially. What has happened, however, is that, lured by the large returns (e.g., 40 percent per annum) all sorts of people and institutions started buying them, including banks and pension plans and individuals. The major dealers in derivatives are “hedge” funds (a derivative is a “hedge” against something), but their instruments have been purchased by the general public. At this point, if the derivative “balloon” were to burst, financial ruin would be faced by all investors, not just the rich.
The current government bailouts of the financial industry are an attempt to prevent this total collapse, which can occur when just a few of the derivative “bets” go bad (because they are so large and interrelated). The government is using taxpayer money to prevent a large number of the insured losses (e.g., credit default swaps) from happening, in an attempt to avoid a total collapse of the derivatives market. The problem is that the derivatives market is extremely large. The total amount of insured risk is vastly more than the global gross domestic product, and so government bailouts can work only if a relatively few of the “big bets” go bad. If many of the losses insured by derivatives go bad, the government cannot possibly cover them all, and the derivative market collapses.
Many derivatives are bets involving very rare events. The loss that is being hedged against has a very low chance of occurrence, but if it does, the loss is very large. The risk is great, and the return is, also. The problem that has arisen is that, in the face of a general decline in the financial markets, many holders of derivatives face debts that they cannot possibly pay. Furthermore, now that so many institutions have invested in derivatives, that if the derivative system is allowed to “go bust,” the entire financial world will “go bust” along with it.
The financial event that threatens the derivative system at the present time is the mortgage crisis. Financial houses (e.g., Fannie Mae, Freddie Mac) created “mortgage backed securities” that included a massive number of unqualified (“subprime”) home purchasers. Homes were sold to totally unqualified people (“NINJA” loans – no income, no job, no assets), with inadequate checking of applications (“liar loans”). Homes were sold at “teaser” mortgage rates (adjustable-rate mortgages) that charged little or no interest at the beginning (e.g., for the first five years). When, after a few years, the interest charges began, the home purchasers could not pay and they defaulted in such large numbers that the whole market of mortgage-backed securities collapsed. World governments are injecting massive amounts of money into financial institutions in the attempt to avoid a collapse of the derivative “bubble,” but the total amount of value involved is now so massive relative to their tax revenues that it is very likely that a catastrophic collapse will not be avoided, and the global financial system will fail.
One large derivative scheme (“hedge fund”) – Long Term Capital Management (LTCM) – collapsed some time ago. This happens when the people who sell derivatives “misjudge” the risk (either its level, or the independence of the events involved), in which case their elegant pricing formulas (e.g., Black-Scholes) fail to work. In the particular instance of LTCM, the sellers of the derivatives did not count on Russia’s default. The potential loss was many billions of dollars. Out of fear that its collapse would lead to a total collapse of the financial system, the US government moved to bail it out (in this case by getting large banks to cover the loss). Now, because of the granting of mortgages to unqualified people in massive numbers, the two leading mortgage institutions (Fannie Mae and Feddie Mac) have collapsed. Once again, declaring that these organizations are “too big to be allowed to fail,” the government is stepping in to bail them out. Since there are inadequate revenues from income taxes to accomplish this, the government has just raised the “ceiling” on the national debt by 200 billion dollars. It appears that the collapse of the US financial system is well under way.
(The story of Fannie Mae and Freddie Mac is incredible. Fannie Mae was once owned by the government, and it was “privatized” – but with the government still backing it up. Freddie Mac was created to generate “competition” for Fannie Mae. The chief executive officers of Fannie Mae and Freddie Mac were paid about twenty million dollars a year. They engaged in risky behavior because of “moral hazard” – they knew that they could not fail, because the government guaranteed their mortgages. And now, after bankrupting the US mortgage organization, these individuals walk away scot-free, happy multimillionaires courtesy of the US government, paid for by the US taxpayer. In China, they would be summarily executed. As usual, the government gives the benefits to the wealthy, and sticks the middle class with the costs. The US government serves the wealthy; it no longer serves the people.)
Here follows an excerpt from Ellen Hodgson Brown’s article, “It’s the Derivatives, Stupid!”, posted at her website at http://www.webofdebt.com/articles/its_the_derivatives.php .
Until recently, most people had never even heard of derivatives; but in terms of money traded, these investments represent the biggest financial market in the world. Derivatives are financial instruments that have no intrinsic value but derive their value from something else. Basically, they are just bets. You can “hedge your bet” that something you own will go up by placing a side bet that it will go down. “Hedge funds” hedge bets in the derivatives market. Bets can be placed on anything, from the price of tea in China to the movements of specific markets.
“The point everyone misses,” wrote economist Robert Chapman a decade ago, “is that buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing.” They not only create nothing, but they serve to enrich non-producers at the expense of the people who do create real goods and services. In congressional hearings in the early 1990s, derivatives trading was challenged as being an illegal form of gambling. But the practice was legitimized by Fed Chairman Alan Greenspan, who not only lent legal and regulatory support to the trade but actively promoted derivatives as a way to improve “risk management.” Partly, this was to boost the flagging profits of the banks; and at the larger banks and dealers, it worked. But the cost was an increase in risk to the financial system as a whole.
Since then, derivative trades have grown exponentially, until now they are larger than the entire global economy. The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars – that’s 1,000 trillion dollars. How is that figure even possible? The gross domestic product of all the countries in the world is only about 60 trillion dollars. The answer is that gamblers can bet as much as they want. They can bet money they don’t have, and that is where the huge increase in risk comes in.
Credit default swaps (CDS) are the most widely traded form of credit derivative. CDS are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the “protection buyer” gets a large payoff from the “protection seller” if the company defaults within a certain period of time, while the “protection seller” collects periodic payments from the “protection buyer” for assuming the risk of default. CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes. In one blogger’s example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling “protection” on a risky BBB junk bond. The premiums are “free” money – free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims.
And there’s the catch: what if the hedge fund doesn’t have the $100 million? The fund’s corporate shell or limited partnership is put into bankruptcy; but both parties are claiming the derivative as an asset on their books, which they now have to write down. Players who have “hedged their bets” by betting both ways cannot collect on their winning bets; and that means they cannot afford to pay their losing bets, causing other players to also default on their bets.
The dominos go down in a cascade of cross-defaults that infects the whole banking industry and jeopardizes the global pyramid scheme. The potential for this sort of nuclear reaction was what prompted billionaire investor Warren Buffett to call derivatives “weapons of financial mass destruction.” It is also why the banking system cannot let a major derivatives player go down, and it is the banking system that calls the shots. The Federal Reserve is literally owned by a conglomerate of banks; and Hank Paulson, who heads the U.S. Treasury, entered that position through the revolving door of investment bank Goldman Sachs, where he was formerly CEO.
In an article on FinancialSense.com on September 9, Daniel Amerman maintains that the government’s takeover of Fannie Mae and Freddie Mac was not actually a bailout of the mortgage giants. It was a bailout of the financial derivatives industry, which was faced with a $1.4 trillion “event of default” that could have bankrupted Wall Street and much of the rest of the financial world. To explain the enormous risk involved, Amerman posits a scenario in which the mortgage giants are not bailed out by the government. When they default on the $5 trillion in bonds and mortgage-backed securities they own or guarantee, settlements are immediately triggered on $1.4 trillion in credit default swaps entered into by major financial firms, which have promised to make good on Fannie/Freddie defaulted bonds in return for very lucrative fee income and multi-million dollar bonuses. The value of the vulnerable bonds plummets by 70%, causing $1 trillion (70% of $1.4 trillion) to be due to the “protection buyers.” This is more money, however, than the already-strapped financial institutions have to spare. The CDS sellers are highly leveraged themselves, which means they depend on huge day-to-day lines of credit just to stay afloat. When their creditors see the trillion dollar hit coming, they pull their financing, leaving the strapped institutions with massive portfolios of illiquid assets. The dreaded cascade of cross-defaults begins, until nearly every major investment bank and commercial bank is unable to meet its obligations. This triggers another massive round of CDS events, going to $10 trillion, then $20 trillion. The financial centers become insolvent, the markets have to be shut down, and when they open months later, the stock market has been crushed. The federal government and the financiers pulling its strings naturally feel compelled to step in to prevent such a disaster, even though this rewards the profligate speculators at the expense of the Fannie/Freddie shareholders who will get wiped out. Amerman concludes:
“[I]t’s the best game in town. Take a huge amount of risk, be paid exceedingly well for it and if you screw up -- you have absolute proof that the government will come in and bail you out at the expense of the rest of the population (who did not share in your profits in the first place).”
It was the best game in town until September 14, when Treasury Secretary Paulson, Fed Chairman Ben Bernanke, and New York Fed Head Tim Geithner closed the bailout window to Lehman Brothers, a 158-year-old Wall Street investment firm and major derivatives player. Why? “There is no political will for a federal bailout,” said Geithner. Bailing out Fannie and Freddie had created a furor of protest, and the taxpayers could not afford to underwrite the whole quadrillion dollar derivatives bubble. The line had to be drawn somewhere, and this was apparently it.
Or was the Fed just saving its ammunition for AIG? Recent downgrades in AIG’s ratings meant that the counterparties to its massive derivatives contracts could force it to come up with $10.5 billion in additional capital reserves immediately or file for bankruptcy. Treasury Secretary Paulson resisted advancing taxpayer money; but on Monday, September 15, stock trading was ugly, with the S & P 500 registering the largest one-day percent drop since September 11, 2001. Alan Kohler wrote in the Australian Business Spectator:
“[I]t’s unlikely to be a slow-motion train wreck this time. With Lehman in liquidation, and Washington Mutual and AIG on the brink, the credit market would likely shut down entirely and interbank lending would cease.”
Kohler quoted the September 14 newsletter of Professor Nouriel Roubini, who has a popular website called Global EconoMonitor. Roubini warned:
“What we are facing now is the beginning of the unravelling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank-like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank.”
The risk posed to the system was evidently too great. On September 16, while Barclay’s Bank was offering to buy the banking divisions of Lehman Brothers, the Federal Reserve agreed to bail out AIG in return for 80% of its stock. Why the Federal Reserve instead of the U.S. Treasury? Perhaps because the Treasury would take too much heat for putting yet more taxpayer money on the line. The Federal Reserve could do it quietly through its “Open Market Operations,” the ruse by which it “monetizes” government debt, turning Treasury bills (government I.O.U.s) into dollars. The taxpayers would still have to pick up the tab, but the Federal Reserve would not have to get approval from Congress first.
[End of Brown excerpt.]
The fact that massive failures are occurring in the derivatives market is not a surprise. I know a fair amount about derivatives. In my PhD program in mathematical statistics, I studied stochastic processes, which is the mathematical foundation for the pricing of derivatives. I also have much experience in numerical methods (computer solutions to problems for which there is no closed-form analytic solution). The References includes a selection of books on derivatives (and related topics) from my personal library. (Although the field of derivatives pays well – a half-million dollars a year is a typical salary for a derivatives analyst – it is not very interesting. It is like actuarial science (used to determine premiums for life insurance and pension plans) – it pays well because a lot of money is riding on the outcome. It is complicated and complex, but not of great interest to me, so I never got into it in my career.) One of the necessary bits of knowledge required to value (set a price on) a derivative is the underlying variability (“volatility”) of the random processes from which the derivative’s outcome will be determined. This volatility is estimated by means of “time series analysis.” Early in my professional career, I developed and marketed the first commercially available general-purpose “Box-Jenkins” time-series analysis computer program (about 1970 – Morgan Guaranty Trust Company was my first customer). Another way of estimating volatility is to infer it from current pricing of derivatives. The way that a derivative is priced is to develop a mathematical model of the stochastic processes involved, and to set the price so that a desired expected return is obtained. The problem is that the mathematical model never corresponds exactly to reality. The mathematical model corresponds to special situations such as “stationarity” or “homogeneity.” It is generally based on simplifying assumptions, such as “stochastic independence” of various events and short-term prices behaving as a “random walk.” Mathematical (statistical) models are constructed by analyzing historical data. If the future were to continue in the same fashion as the past (e.g., no collapse of Russia, no collapse of the mortgage market), the risk of loss would be extremely low. But that is not the way things are. Shit happens.
The major problem with derivatives is that, although there may be millions of contracts involved (e.g., when a very large mortgage-backed security is “sliced and diced” into many small contracts), they are not statistically independent. The outcome for all or many of them can be the same at the same time. This is what happened in the case of the mortgage meltdown. The derivatives buyers and sellers did not gamble on the failure of an entire sector, which was caused when the government and the major mortgage houses (Fannie Mae, Freddie Mac) allowed unqualified people to purchase houses on a grand scale. The catastrophic collapse of the mortgage-based derivatives market might appear to correspond, in the life insurance business, to everyone’s dying at age 35, or if in the fire insurance business to all buildings burning down at once. Whereas people’s deaths and fires may be to a large degree independent, housing mortgage defaults certainly are not, since half of the mortgages sold recently were sold to “subprime” borrowers, who could only avoid default if the price of housing continued to rise. If it did not, many of them would default at the same time. While credit default swaps may be a form of insurance, the independence assumptions that apply to traditional insurance types (life, accident, health, hazard) do not apply. A derivative “collapse” can occur as easily as a “run” on a bank. While a central bank can provide reasonable insurance against losses from bank runs, there is no “central bank” large enough to insure against a collapse of the derivatives market.
The fact that was obvious to many people that a housing-market “bubble” was being created by the lax lending policies, and that the likelihood of a massive default (many lenders defaulting at the same time) was virtually inevitable. Many people wrote articles and books warning of the problem. The only way that the “subprime” lenders could possibly pay was for the price of housing to continue to rise – a rather absurd assumption. As soon as it failed to do so, massive numbers of lenders could not pay their mortgages, and the entire mortgage-based security / derivatives market was in deep trouble. Just as in the case of Katrina and 9/11, however, our government chose not to listen to these warnings. As Colin Campbell observed, it is easier for politicians to deal with current crises than with future ones.
Although derivatives are simple in concept, they are extremely complicated in practice. The buyers and sellers of derivatives know this. The people who price derivatives know all about the idealized mathematical models that they use to represent the real world, and they know full well that they are but approximations and that unanticipated catastrophic losses would someday occur. What is truly amazing, however, is that we have already seen several derivative meltdowns (e.g., Long-Term Capital Management, Barings Bank, Orange County) and the government has done absolutely nothing about it. Why? Because the government and the wealthy have no problem with financial catastrophes. When the Great Depression occurred, the wealthy bought up most of the farms in America. Every time there is an economic recession, there is a massive transfer of wealth from the middle class to the wealthy. The wealthy were “rubbing their hands” together when they saw the derivatives infecting the pension plans and investment portfolios of the middle class like a cancer. Derivative bubbles always burst, and when they do, the wealthy scoops up the shattered dreams of the middle class. If it were not so, the US government would have put an end to the derivatives market (e.g., by a small tax on derivatives) after the first major collapse occurred (e.g., LTCM).
The sellers of derivatives knew that one day their models would fail, and the government knew this, too. Even if they foolishly believed that reality followed their models, they had seen the collapse of Barings Bank, Orange County and LTCM. They knew from history that derivative bubbles collapse. They took no steps to control the derivatives market, when the amount of money required to pay off the derivatives exceeded all the wealth in the world. The merchants of derivatives and the government knew full well that this scheme would collapse again, as it had in the past. They did nothing to avoid it, because they knew that their policy was, as demonstrated in the collapse of LTCM, to put up taxpayer money (which is mainly from the middle class) to cover the losses of the wealthy, if necessary. Also, unlike the middle class, the wealthy do their investing through corporations, insulating themselves from loss. When large losses occur, they may simply declare their corporations bankrupt and keep their wealth intact.
Up to now, they have “managed” to deal with the fact that the total amount of derivatives now exceeds all of the non-derivative-based wealth in the world by many times, simply by allowing the writing of ever more derivatives, bailing out failed firms (using taxpayer money) so that the derivative seller does not have to, and keeping moribund banks and investment houses intact with “toxic debt” remaining on their books. In the long run, this approach will not work. The dike is about to burst. The Titanic is about to sink. As it does, all of the middle class’s wealth will be handed over to the wealthy. Even this will not prevent the collapse of the debt-based money, derivative-infected system, however, (since the amount of value involved is too large) and in the end the entire global financial system will come crashing down. At that point, the country and the world will be ready for change.
The wealthy Robber Barons who run the banks and financial houses have milked their firms dry. They have taken millions and billions in salaries for a con-game derivative scheme that they knew would collapse. They knew that their models were but a crude approximation of reality, yet they dishonestly told people that the expected time to a loss was greater than the lifetime of the universe. They knew that the amount of money owed in the event of a large-scale failure was vastly greater than their assets, but they sold more and more and more of their toxic wares. Even when their scam was exposed, as in the case of LTCM, they continue to ply their trade, with the blessing of the evil government that supports their con game, covers their ill-gotten incomes with taxpayer money, allows them to use corporations to avoid personal loss, and makes no attempt to recover this stolen wealth. Quite simply, the sellers of derivatives, with the collusion of the government, operated a gambling scam that had to collapse, in the knowledge that the government would use taxpayer money to cover their losses and allow them to keep their acquired wealth. The millions and billions that they now hold – with the blessing of the government – were in fact made possible by the current bailout funds.
It is not just the failed firms (banks, investment houses) that have cheated the US taxpayer, but all of the derivatives firms, even those still in operation. Their schemes will someday collapse. Their losses will be covered by the taxpayers (through government bailouts using taxpayer money). They are making vast sums simply by taking money (with government’s blessing and collusion) from future taxpayers. The scheme must fail, and they are cheating the American public. Sellers of derivatives are con-men who destroy entire societies, and they, and the government leaders who allow their vile practice, should be put to book. Life and hazard insurance contracts based on sound statistics, and perhaps even commodity and currency futures among legitimate traders can be justified. A derivatives market based on any underlying process, allowing any amount of short selling of future assets or events, has a place only in a casino, not in public finance. It is recognized that the insurance business is inherently risky, but it is accepted that it has a useful place in modern finance. There is no need to require an insurance company to have 100 percent reserves on all of its life insurance or fire insurance policies, since the odds of everyone dying at once or all buildings burning at once are low – mortality tables and hazard tables are well established for these events (and wars and “acts of God” are excluded). Similarly there is no need to allow 100 percent reserves for gold-based currency, or for commodities futures contracts, since the odds of a run or total market collapse are low, and the systems can be managed. But to allow massive trading in derivatives based on mortgage-backed securities for which half the mortgages are being given to unqualified buyers is sheer folly. It is criminal. It had to fail. Our government knew this. The traders of derivatives knew this. The banks and pension plans that bought those derivatives knew this. They should be taken to task.
As long as the government and the wealthy elite have any chance of propping up the present system, they will continue to do so. They do not want to move to a system that serves the people, such as a national banking system (as conceived by the Founding Fathers). They want a system that suffers from periodic recessions, depressions, and collapses, since that allows a massive and immediate transfer of wealth from the middle class to the wealthy. When the government leaders are wringing their hands and weeping over the current financial crisis, they are crying “crocodile tears.” Their wealthy masters want a system that collapses periodically. They want a system that requires periodic bailouts (which are simply transfers of taxpayer money to the wealthy – it is not the middle class that is being bailed out by the wealthy, but the wealthy who are being bailed out by the middle class). They do not want a system that works for the people. The wealthy do not want a national banking system in which all interest goes to the government and the middle class pay no taxes. They want a system in which all interest goes to them and all of their failures are covered by income taxes, which are paid mainly by the middle class. It is no coincidence that the privately-owned central bank (the “Federal” Reserve Bank) and the income tax were set up at the same time (1913).
When I was a young man, my father-in-law cautioned me never to buy bank stock. At that time, the owners of bank stock were not indemnified from loss in the event of a bank failure. The value of their stock could fall to zero and they would be further liable for all of the bank’s losses. This is not true today. Because of incorporation, the owners of a failed bank have little to lose. Their depositors are insured, and their own deposits are insured by the federal government. They make much of their money from “up front” payments (“points”) that are made at the beginning of a deal (e.g., a shopping center development), not from bonuses paid at the end of a successful project. In the recent Congressional hearings in which bank and investment officers were asked to testify about the recent collapse of the financial markets, the CEOs admitted to earning millions of dollars in salary and bonuses. When their banks and institutions fail, they get to keep all of this money. This is a complete outrage. Whenever a bank or investment house fails, all of the wealth of the previous owners should be confiscated. A return to the old policy of holding owners of bank stock responsible for the bank’s losses would be also be appropriate.
During the course of a Congressional investigation of hedge-fund managers, whose annual income averaged several billion dollars per year, one congressman commented on their incredibly large salaries, but quickly added, “Now, we’re not knocking you for this.” Of course not. The primary goal and function of today’s US government is to provide the political / economic system that funnels most of society’s wealth to the wealthy elite, and enable hedge-fund managers to make billions of dollars per year. The congressional enquirer should have been knocking them for this. The derivatives market is beginning to crumble, and will soon collapse, and the middle-class US taxpayer will be forced to cover the losses. The hedge-fund managers current salaries will end up being paid for by the US taxpayer. Through their exotic derivative schemes, they have in effect stolen their salaries from the US middle class – not just the taxes, but the collapsed pension plans and ruined personal investments that their venal schemes caused. They should be stripped of their ill-gotten gains and “run out of town on a rail.”
From time to time in Congressional hearings, members of the investigative panel appear to chastise the witnesses for their stupidity or venal ways. It did this recently, for example, in the hearings involving the failure of the financial community (the banks) and the automotive industry. This is a complete sham. The financiers are doing exactly what the controlling wealthy elite want them to do. Make as much money as you can, take on as much risk as you want, and if you fail, the wealthy will take over the lost properties and have the government use middle-class taxpayer funds to cover losses. This scheme is repeated over and over again. The wealthy do not care if the government looks stupid, since the government is nothing but a puppet doing its bidding. It does not care even if one of its own is disgraced, since its primary loyalty is to class and the system that funnels wealth to it, not to any particular national or ethnic group. If a politician such as Illinois Governor Rod Blagojevitch is disgraced, that is of no concern. If a financier such as Ponzi-schemer Bernard Madoff is disgraced, they could care less. The entire corrupt political-economic system is an immoral rip-off of the middle class. They don’t need Ponzi schemes to acquire massive wealth, when the system provides it to them.
There are two main reasons why banks have created and purchased derivatives. One is greed – the promise of a much higher return than is possible from normal banking operations (because of the higher level of risk). The other is “moral hazard” – the knowledge that if they fail, most of their depositors’ deposits are insured by the US government (the Federal Deposit Insurance Corporation) and that their bank, which is incorporated, may declare bankruptcy and they can “walk away” from the scene, retaining their millions and billions of dollars of ill-gotten gains.
There are other aspects to the financial crisis in addition to the ones that I have focused on here (debt-based money and derivatives). For example, since the US central bank (the Federal Reserve) is privately owned by a consortium of private banks, any assets that it may acquire by using “bailout” funds are paid for by the US taxpayer but owned by those banks. These and other aspects of the current financial crisis are discussed at length by Ellen Hodgson Brown in her book The Web of Debt and on her websites. The Web of Debt website has IP address http://webofdebt.wordpress.com/ . For an understanding of the current financial crisis, several “must-read” articles (posted at this website) are:
· Putting the “Federal” Back in the Federal Reserve (July 19, 2008)
· Fannie and Feddie: Giving Away the Farm (August 15, 2008)
· Wag the Dog: How to Conceal Massive Economic Collapse (August 15, 2008)
· Take a Load Off Fannie: Bailout or Nationalization for the Mortgage Giants (September 6, 2008)
· It’s the Derivatives, Stupid! Why Fannie, Freddie and AIG All Had to Be Bailed Out (September 19, 2008)
· The Fed Now Owns the World’s Largest Insurance Company – But Who Owns the Fed? (October 9, 2008)
· The Collapse of a 300 Year Ponzi Scheme: The Real Debate Is Crony Socialism or Financial Sovereignty (October 18, 2008)
· The Not-So-Invisible Hand: How the Plunge Protection Team Killed Capitalism (October 26, 2008).
The stock market crash of 1929 was caused by out-of-control debt, which eventually collapsed. Today, both the national debt and individual debt are high. Banks and other financial organizations hold massive derivative debt. The system is a very tall “house of cards,” and is very vulnerable to collapse.
Apart from general discussion of the US money and banking system, much of the preceding discussion has centered on the issue of the size of the national debt (and on derivatives). The national debt is very important, but it is just one aspect of our financial system. As mentioned earlier, the discussion here centers on the financial system, since a collapse of the financial system was selected as a possible motivation for the US people to seek fundamental change. Other important aspects (indicators of financial health) are the size of the external debt (the portion of the national debt owed to foreign entities); the magnitude of individual (private) debt; the distribution of income and wealth; budget deficits; trade deficits; rates of inflation (domestic and relative to foreign currencies); and foreign ownership of US land, infrastructure and other assets (e.g., stock in corporations). The issue of individual debt (and compound interest) has been discussed at length earlier, and will not be discussed further here. The issue of distribution of wealth has also been discussed (viz., the features of our economic system (free trade, globalization, subsidies for the rich, the health care system) that are shifting income and wealth from the middle class to the wealthy). Everyone is aware of the dramatic fall of the US dollar against the euro (from about $0.80 a few years ago to about $1.50 at the present time (about $2.00 for tourists). The US dollar has decreased in value relative to other currencies mainly because the US is importing far more than it is exporting, i.e., it has a massive trade deficit. The trade deficit is very large for several reasons: the US has exported much of its manufacturing capacity (it is no longer self-sufficient); the US tax system is not harmonized with the tax systems of other nations; free trade (which prevents the US from imposing tariffs to adjust for low labor rates in foreign countries). States are selling their public infrastructure to private (and foreign) interests. Foreigners are purchasing much stock in US corporations and much US land. By all of these indicators of financial health, the US economy is very ill. It is, in fact, in a terminal state.
Free trade didn’t just destroy the quality of life for the US middle class – it brought the country to economic ruin. When US manufacturing firms could not compete, without protective tariffs, against labor costs on the order of a dollar a day, they had little choice but to move their operations overseas, or pay US workers a dollar a day, or go out of business. They moved. This process has been going on for fifty years. At this point, the US has destroyed its manufacturing capacity. It is no longer self-sufficient. It now buys most of its consumer goods from foreign countries, such as China. We now have a massive trade deficit because we make so little of what we use. This was all caused by massive international free trade – globalization. When the US political leaders and economists proclaimed that free trade was “more efficient” and would make things better for everyone (“a rising tide lifts all boats”), they lied. They have destroyed the United States of America. They have not defended the country and they have not promoted the general welfare. They have betrayed the Constitution. They have committed treason. How and why the destruction of America happened is no mystery. It is a simple “case study” in economics. What happened served the wealthy elite, at the cost of the middle class. Why do the US people just lie back and take this? Some time ago, the US government and political leaders abandoned the purpose and goal of the Founders to serve the people. The US government now serves the wealthy elite. Why do the American people not take their leaders, who have deceived them, corrupted their system of government, and destroyed their quality of life, to task? Why do they not bring down the corrupt system that has brought the country to economic and social ruin, and replace it with one that benefits the people, as it once had? The concept of the Founders (a government “of, by and for the people”) as embodied in the Constitution and the new Republic served the country well for many years. What the government devolved to does not serve the people, and it has brought about the country’s demise.
It appears that a total collapse of the US money and banking system is just around the corner. Because of the large size of the US in the world economy and the strong interdependency of global financial markets, a collapse of the US money and banking system will cause the collapse of not just the US financial system, but the entire global financial system.
Although it is government policy that has caused the current global financial crisis (free trade, debt-based money, interest, derivatives), the government will not take steps to institute the changes necessary to solve it. The problem is that the system is set up for periodic financial crises to happen, and for the losses of the wealthy to be covered by income taxes from the middle classes, and the wealthy elite who control the government do not want to change this. They do not want to nationalize banks – they want all of the interest charged in society to go to private bankers, not to the people. They do not want a system that works for the people. They would rather see the entire global system collapse than have a system that had no financial sector and served the people. This is why not a single politician (of the three finalists) in the recent US presidential election proposed a fundamental change to our financial system, such as nationalizing the banks (or even the country’s central bank, the Federal Reserve), or elimination of the income tax, or the end of free trade.
The Wealthy Will Make Heroic Efforts to Save the Current System, and Will Not Consider Change Until It Collapses
Einstein once remarked that the kind of thinking that got you into a problem was unlikely to get you out of it. Economists created the monstrous system that is destroying the planet and our society, and they are unlikely to get us out of it. Of all the economists of whom I am familiar, only two – Nicholas Georgescu-Roegen and Herman Daly – have called out for a steady-state economic system. All economists are committed to growth, and the system of debt-based money and interest is superbly tailored to accomplishing this – and destroying the planet’s environment and the future of human society at the same time. Now that Barack Obama has been elected president, he is surrounding himself with the same people who created, nurtured and condoned the corrupt economic system that is destroying our society and the planet’s environment. These people will urge him to continue to use taxes from the middle class to cover the losses of the wealthy elite. Originally, George Bush promoted the giving of $750 billion in taxes (mainly from the middle class) to the wealthy elite to cover their losses, and Obama has just announced (November 2008) his intention to propose the giving of another $600 billion to them. This will not change the corrupt system; it will simply keep it alive a little longer to suck the life-blood entirely from the middle class. The wealthy will work feverishly to keep the present corrupt financial / political system alive, because it serves them well, and because they do not want to move to any system that reduces the flow of wealth to their coffers. There will be no proposals from the wealthy or from the government to effect change to the present system. The only way that meaningful change will occur is after the current system collapses.
It is not necessary to give one penny to the banks and financial institutions. They serve no useful purpose but to make money for themselves. Our society has no need for a private financial sector – it serves only the wealthy. We should not be giving one dollar of taxpayer money to the financial sector. If our government wishes to “free up” credit for our economy, it could do it within a week by issuing US Notes, and eliminating the Federal Reserve and debt-based money. Will it even consider such a thing? Of course not, since that would serve the people, not the wealthy.
Some people assert that it is necessary to “save the system” at all cost. This is incorrect and wrong. The system is the problem. The system must not be saved. The system must go. Propping it up is throwing money down a rat hole.
Under the present system of debt-based money and interest, inflation has to occur. Many decades ago, it was kept to a low level (e.g., under three percent per year), so that it was not greatly noticed and did not affect people very much over their lifetimes. How things have changed! My wife is on a short trip to Tucson to visit family, and I have been doing the shopping, for the first time in years. I can remember prices from when I was young, and they are radically different from now. Loaves of bread cost 9 cents (a short loaf) or 11 cents (a long loaf); a loaf of bread is over a dollar now. A box of Morton salt cost 9 cents, a box of sodium bicarbonate less than that – both are over a dollar now. Kiwi shoe polish cost 19 cents a can then, and Esquire (the leading brand at the time) cost 15 cents. I paid $3.49 for a can of Kiwi yesterday. A can of Campbell soup cost ten cents then. Prices range from 99 cents to three cans for $5 now. As bad as this is, “you ain’t seen nothing yet.” With the trillion-dollar bailouts, we are in for a massive wave of inflation. This does not bother the government very much. It wipes out old people on fixed incomes. The most important consideration for the government is that the tools of monetary policy work best when there is a fair amount of inflation. If inflation is too low, the device of lowering the bank interest (discount) rate has little effect on the economy. This happened in Japan a few years ago. The Bank of Japan lowered the discount rate to zero, and it had no effect on stimulating the economy. The US has just about entered that realm – the discount rate is now so low that recent and further cuts will have no effect in stimulating the economy.
The three major US automakers are failing, and have appealed to the government for some of the bailout funds. Congress is reluctant to give them any of the bailout money, because the finance sector wants it all for itself. (The financial sector produces nothing. It is very jealous that any assistance be given to a sector that actually produces something, such as cars.) Some people claim that the automakers should not be saved, since they have known for years that this time of expensive oil would come, and their large SUVs and pickup trucks would fail to sell well. The automakers claimed that they could not make small cars at a profit. That is probably true. Under US government policy, the game is heavily stacked against them. The VAT is against them. The low labor costs of foreign automakers is against them. The high cost of employee health care plans and interest on loans is against them (cf. countries like China). The loss of our steel industry to overseas manufacturers is against them. The only thing that will save the US automakers is tariffs that equalize the effects of these items. But all our government leaders can babble is that they are in favor of “free trade.” America thrived when tariffs were high, and it protected its industries and middle class wages. Under “free trade,” it has destroyed its manufacturing capacity and the high incomes of the middle class. This approach serves the planet’s wealthy elite well, but it has caused a serious decline in the quality of life for the US middle class and a massive foreign trade deficit.
Recently you hear the assertion that the finance industry should be bailed out because it is a “utility” that serves the entire public, whereas the automakers should not be bailed out because they represent a specific private-sector enterprise. This is really dumb. The government (and the wealthy elite who control international finance, such as the IMF) has been really big on privatizing utilities, for quite some time. It did the same thing with Fannie Mae. The infuriating thing is that the government allows these institutions, while “privatized,” to reap fabulous wealth while they are running them into to ground, and then uses taxpayer money to cover their losses when their scam collapses. As I mentioned, these organizations are simply stealing from the future. They are socializing the costs and privatizing the benefits. The fabulous incomes that they earn are paid for by the taxes from the middle class, after they go bankrupt. How is it that no one sees this? The heads of these organizations, the bankers who finance them, and the government leaders who approve and regulate their immoral activities should be taken to task. They should be stripped of their ill-gotten gains and banished.
In all of the public discussions about the troubles of the US automakers, there has been no discussion of the one thing that will save them – trade restrictions (tariffs and quotas). If no foreign-made automobiles were allowed into the country, or if tariffs were imposed to offset the lower wages of foreign-made automobiles, our automobile industry could produce millions of cars and pay its workers high wages. America prospered when it protected its industries and people. Under free trade, it has destroyed its manufacturing base and the high wages of its workers. Why is there never any discussion of tariffs and quotas? Because the US government is totally under the control of the global wealthy elite, who make more money under free trade. The US government does not have to spend one cent to “rescue” the automakers. All that is needed to make them healthy is tariffs or quotas. All of the billions that the government is planning to spend on “bailing them out” is simply to rip the middle-class taxpayer off and transfer his tax funds to the wealthy.
The US money and banking system is about to fail. When it does, the country will collapse. There will be great “knashing of teeth.” At that point, the citizens of the country will come to know, understand and believe the reason why it happened, and they will welcome fundamental change. At the present time, all power is concentrated in the hands of the corporatists. Governments are their slaves, their thralls, not their masters. Government and business are not even co-partners, as in fascism – business is in complete control. The people are not served by the government, as the Founders intended and arranged. When the present system fails, the people will call for a leader who will change this, and reestablish a government for the people. By Hume’s Paradox, they will accomplish their goal: they will throw out the present leaders and the present system. The next leader will be the king of the world. His authority will derive from the people, and from religion.
All of the nation’s financial woes were caused by its own policies and actions, motivated primarily by greed. The next section will describe some changes to our financial system that would avoid these problems. Financial problems are just one area in which the US system (society) is inadequate. In addition to recommending steps to improve the financial system, the discussion that follows will address a full range of recommendations for a viable economic-based society. The current financial system is just one of the factors that have led to the decline of the United States as a nation and culture, and reduced the quality of life for the middle class.
(I might point out that public finance is a particular area of interest of mine. During my career, I directed a number of public finance studies (e.g., development of matching and allocation formulas for public programs such as Medicaid and Vocational Rehabilitation; tax policy studies; cost-benefit studies; development of the MICROSIM microsimulation model for forecasting caseloads and budgets for the US Department of Health and Human Services Office of Human Development Services). Following passage of the Tax Reform Act of 1986 I wrote a book on US tax reform, focusing on the value-added tax (VAT, TVA, IVA) (posted on the Internet at http://www.foundationwebsite.org/VAT.htm ). I have considerable experience in banking, including consulting for commercial banks and a central bank.)
The paragraphs that follow present a summary of recommendations for change that would enable the US to survive for a while longer, following a collapse of its financial system. These recommendations represent simply one possible alternative to our present system. The selection of a particular solution for our society should be based on sound principles of systems engineering (similar to the “tax engineering” process that I described in my book on tax reform – specification of goals, specification of alternatives, specification of selection (performance) criteria, comparison of alternatives relative to the criteria, selection of a preferred alternative, top-level design, detailed design, implementation and test).
The US governmental system is a primary cause of our financial and social problems (the root cause is a decline in culture). The system was never very good, and it was simply a matter of time until it collapsed. It was designed “like Topsy” as the nation developed. It is not the product of competent systems engineering, but of “on the fly” design in a social contest between the rich and the middle class.
The government has evolved into a massively overgrown organism. It is not only poorly organized for survival, but grossly oversized and complicated. The first step is to reduce the number of government organizations (departments, agencies, commissions, etc.) to a much smaller number. The discussion that follows will assume the following governmental structure, consisting of five departments (ministries): Defense; Population and Environment; Industry and Infrastructure; Education and Culture; and Finance. The following paragraphs describe each of these major departments. The goal here is to make a minimal number of changes to the current system. Time (oil) is running out for America, and there is not sufficient time to implement a thorough redesign. The goal here is to take the basic system (democratic, free-enterprise, libertarian) and modify it minimally to get us through the next few years. Beyond this time frame, an entirely different system will be required (a long-term-sustainable system of planetary management, such as a synarchic government of a minimal-regret population).
America will continue as a nation of laws. For all of the recommendations made below, laws will be enacted to make them legal. You may view that some or all of the recommendations made below are “radical.” They are. They are suggestions for what to do if the current system collapses. The recommendations are, in fact, radical departures from the current system. If the current system does not crash, then the below recommendations may be “safely” ignored.
The following is simply a “sketch” of a possible replacement system to our current system, when it fails. For more details on another alternative, see http://www.foundationwebsite.org/Platform.htm. See also http://www.foundationwebsite.org/PositionStatement.htm.
The new Department of Defense would include all functions required for the internal and external security of the nation. It would subsume the activities now conducted by the current Department of Defense, the Department of State, the Department of Homeland Security, Justice, and various related agencies such as the National Security Agency (NSA), the Central Intelligence Agency (CIA) and the Federal Bureau of Investigation (FBI).
All violence against women is wrong, but only if women do not serve in combat.
The Department of Defense includes responsibility not only for military operations, but for local policing as well. The death penalty will be abolished (except in military cases, or treason). Prison terms shall not exceed one year. Persons deserving of punishment exceeding one year in prison or the death penalty shall be exiled to Mexico. (This is a reciprocal action for President Felipe Calderón’s proclamation that “Where a Mexican is, there is Mexico.”) All prisoners currently serving terms of more than one year shall be immediately released or exiled to Mexico. Prisoners seeking to avoid exile may elect (subject to approval) to serve one year in a prison camp on US soil. If they behave, they will be released; if not, they will be exiled. Shaming punishments such as stocks, pillories and caning shall be used. While in jail (prison is not the appropriate word here), inmates will be required to study or work, and they will be actively re-educated. “Victimless” crimes (e.g., unusual sex between consenting adults; use of psychotropic drugs) will not be actively prosecuted. The “war on drugs” (which has served mainly to increase criminal activity and enrich criminals and law-enforcement personnel) will be ended.
The goal will be for a “libertarian” society (Jeffersonian democracy), but within a nation that has well-defined goals and works diligently to accomplish them. America will strive for a maximal level of freedom in personal affairs, restricting freedoms mainly at the “macro” level, where they affect national and global security.
Immigration will cease. All goods leaving and entering the country will be subject to 100 percent inspection. All persons entering and leaving the country must possess visas.
To facilitate homeland security, English shall be the sole national language. All citizens must speak it well. The goal is such that a US citizen may be recognized instantly and easily by his accent (i.e., by shibboleths). People speaking with an accent will be challenged and required to verify their citizenship.
English common law will be restored. This means no mandatory sentences – the judge determines the sentence. A jury of one’s “peers” shall generally imply one’s local neighbors. All trials shall be concluded within three months or the defendant set free. The justice system will be inquisitional (judges seeking the truth, as in Britain), not adversarial (lawyers battling each other, as in present-day America).
Much of America’s current crisis has been the result of explosive population growth. The country does not have a stated population policy, but the de facto policy is one of a population growth of about one percent a year (three million more per year, added to a population of about 300 million). Some of this is from legal immigration (almost a million people a year), and more is from illegal immigration (about two million a year, including progeny from illegal aliens). The nation had achieved a “replacement-level” birth rate by about 1973, but the birth rate is now above replacement level (recent immigrants have high birth rates).
The massive wave of recent immigration followed passage of the Immigration Act of 1965. Following passage of this act, America was flooded by millions of immigrants from cultures quite alien to the Northern European culture that founded the country and made it great. Immigration rates are now so high that new immigrants are not assimilated, and the country is now highly fractionated.
When oil runs out, the global population and US population will decline to numbers that can be supported by solar energy. The US population is currently far above those levels. The population policy of the US in the future will be zero immigration. The borders will be closed, and defended militarily. Also, since the massive recent increase in US population has caused many problems (destruction of the environment, decline in the quality of life (overcrowding, long commutes, diminished access to nature, social strife), and increased energy use), steps will be taken to reduce the population as quickly as possible. This will include immediate deportation of all illegal aliens and their progeny (no birthright citizenship; annulment of birthright citizenship previously granted to children of illegal aliens and visitors (achieved by fraud, and not supported by the Constitution)).
The Department of Population and Environment’s primary concern is the physical population (its size and health) and the environment (its ecological condition). Education and culture are concerns of another department.
Population and environment are combined into one department since it is population size that is the primary factor determining the state of the environment. It is not possible to maintain an ecologically sound and stable environment with a large human population. The concept is to work for a small human population, so that the environmental problems disappear. The US has now destroyed about half of its topsoil, and about depleted the Ogallala aquifer; it has destroyed most of its original-growth (“virgin”) forest and native wildlife. This has been done not only to support a large US population, but to make money off the export of food to a near-infinite global population of starving people. This will stop. There will be no export of food. Food will be consumed at a much lower trophic level, i.e., no commercial raising of cattle for meat. Battery production of animals, which is intensely cruel (not to mention unhealthy), will be prohibited. Plantation growing of trees will stop. Monocultural latifundia will be discouraged.
The agriculture system will be totally revamped. Land will be redistributed to farmers as it was in the 1800s (160 acres per household). A central land registry will be established (no more “title insurance” and legal fees for land transfers). The government will supervise use of the land, and will reallocate it from those who abuse it. The government will allocate production for three quarters of the land. The farmer may produce what he wants on one quarter of it (including spiritual plants such as salvia divinorum, peyote / mescaline, ayahuasca, psilocybin (“magic” mushrooms). Small farmers (160 acres) will be subsidized (e.g., via price supports), to promote the survival of the family farm (as in France). With a stable population and proper husbanding of the land, a farm may stay in the family forever. Salmon rivers will be returned to nature (all dams removed). The open prairie will be reestablished, with buffalo (American bison), wild horses, wolves and panthers.
Only US citizens may own land.
The key to protecting and preserving our natural resources is preservation, not “sustainable development.” The US will put an end to the destruction (“exploitation”) of nonrenewable resources. Oil will no longer be burned (automobiles, heating, electricity generation).
The Public Health Service will be expanded to provide free basic health care for all (neighborhood clinics and local public hospitals). (Private health practitioners may practice (e.g., for cosmetic surgery, exotic procedures (e.g., organ transplants) or non-approved or unavailable medical procedures (e.g., traditional medicine).)
No abortion services will be provided.
All able-bodied adults will be provided with the opportunity for work.
The state will provide for homes for the disabled, orphans and the elderly lacking sufficient family (or community or church) resources. These homes will be operated by the government, not by private individuals or organizations.
This new department will include the functions of the former departments of transportation, energy, and housing and urban development. Industrial production and infrastructure development will be monitored and regulated to achieve the goals of the nation. Major industries upon which the welfare and defense of the nation depend will be nationalized, as in China (e.g., energy, infrastructure, transportation, communications; in China, the following seven industries critical to the nation’s economic security are under strict government control: defense, power, oil, telecommunications, mineral resources, civil aviation and shipping industries). The nation will be self sufficient – we will produce what we use. Foreign trade will virtually cease, except as required for national defense. Economic efficiency, which has been the root cause of the destruction of the Earth’s environment and US society, will not be a rationale for anything.
The urban sprawl of current US society, based on automobile transportation, will be eliminated. With a stable population, public transportation by rail electric vehicles is feasible. See James Howard Kunstler’s books, The Long Emergency (2005), The Geography of Nowhere (1993), Home from Nowhere (1996) and The City in Mind (2001) for the basis for accomplishing this (see also information on Masdar). An electric rail public transportation system will be established as quickly as possible. As soon as an adequate rail-transport system is in place, public support of the nation’s long-distance (interstate) road system will cease, and massive use of private automobiles along with it. In the interim (prior to the implementation of an adequate electric rail mass transportation system, electric- or propane-powered automobiles will be used in place of gasoline- or ethanol-powered ones.
With a stable population, energies will be focused on improving our infrastructure and quality of life, not on generating more urban sprawl and supporting economic welfare programs for the wealthy (growth-based economics).
The nation will move to end use of nuclear energy and large-scale hydroelectric energy (demolition of all large dams and decommissioning of nuclear power plants). Local water mills and wind mills will be encouraged. The nation will rely on fossil fuels (oil, natural gas, coal) until they deplete, at which time it, along with all other industrial nations dependent on fossil fuel, will cease operation. With a small, stable population, this will be easy to accomplish.
All education will be provided free of charge by the state, to those who pass qualifying exams. It may be provided at reasonable cost to those who do not qualify.
The goals of education will be to nurture US traditional culture, to provide individuals the means for self-fulfillment (including music, art, physical development (sports) and spiritual development (e.g., meditation)), and to provide training for work.
To assure quality and responsiveness to national goals, the education system will be regulated by the federal government. All elementary and high schools will be within walking distance (of homes or rail transport).
William James once observed, “The most significant characteristic of modem civilization is the sacrifice of the future for the present, and all the power of science has been prostituted to this purpose.” The reason why modern society robs the future for the present is based in the concept of interest and the time value of money. One you allow for interest to be charged, the economic value of things in the present is less than the value in the future – the “discounted” or “present value” of a future dollar is less than the value of a dollar today. Once the precepts of “growth-based economics” are adopted, there is always a mad scramble to create wealth for today at the expense of resources of the future, because their “economic” value is less. The traditional religions (Judaism, Christianity, Islam) were quite right in proscribing the charging of interest, because it is the great destroyer – not just of the future but of anyone who pays it (you could charge your enemies interest, because you wished to destroy them).
There will be no discounting of future costs in the evaluation and comparison of alternatives. The cost and benefits of an action or program to all generations will be assessed. This will make a big difference in society’s decisions. For example, once future costs are considered, nuclear power becomes totally impractical (since the undiscounted future cost of storing radioactive waste overwhelms any possible benefit to present users).
If a society is to be stable and endure for a long time, it cannot charge interest. For a little while longer (until the end of this age), however, charging of interest by the government will be permitted, in lieu of taxes. This phase of human activity – the economic phase – is about over. In the future, there will be no interest, no time value of money, no discounting of future values.
This chapter has been about economics. Economics is the driving force that has corrupted mankind and is destroying the planet. Economics – the dismal science. Mathematician John Maynard Keynes observed (in his 1930 essay, “Economic Possibilities for our Grandchildren”) the fatal limitations of economics as a long-term basis for human society:
“Some day we may return to some of the most sure and certain principles of religion and traditional virtue – that avarice is a vice, that the extraction of usury is a misdemeanor, and the love of money is detestable. But beware! The time for all this is not yet. For at least another hundred years we must pretend to ourselves and to every one that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little while longer.”
All banks will be nationalized (i.e., the central bank and all commercial banks). The government will hence collect all interest on “commercial” loans. Only the government will charge interest (and it will all be spent on public programs). All loans will be made to further the nation’s goals (rather than to enrich the wealthy). Private entities (individuals, corporations) may also make loans, based on 100-percent reserves (i.e., they may only loan money that they already have), but they may not charge interest. Private entities may lend physical property, but not charge rents for it (interest on money is equivalent to a “rent” on money). No loan may be made such that the total amount of interest and fees over the life of the loan exceeds the principal. Home mortgages will normally be for a term not exceeding 15 years, and require a 20 percent down payment. The government will charge not more than three percent simple interest on mortgage loans. There will be no financial sector. People will earn money from their labor and skill, not from rents on money or property. The purpose of a loan is first and foremost to achieve national goals, and secondarily to enable individuals to realize their full potential.
With national banks, there is no need for deposit insurance. There is no “moral hazard” for bankers to operate knowing that the government will bail them out.
Under this system, income will be generated by earnings, not by wealth or property. Under our present system, a wealthy individual may make $10,000 a minute, while he reads the Sunday comic strip, sleeps, or sits on the can. This serves no socially useful purpose. Without allowing for the accumulation of wealth, however, many of the world’s great accomplishments would not have been realized, and many exciting pursuits would not have been possible. This includes fascinating monumental objects such as the Pyramids of Giza, the Valley of the Kings at Luxor, Abu Simbel, Petra, the Colosseum at Rome, the Appian Way, Machu Picchu, Chichen Itza, Taj Mahal, Angkor Wat, Stonehenge and the Medieval Cathedrals of Europe. It should be recognized, however, that most of the fascinating discoveries of mankind have been made by individuals working alone (e.g., Mozart’s music, Gutenberg’s printing press, Pasteur’s germ theory, Newton’s classical laws of physics, Maxwell’s theory of electromagnetism, Einstein’s theory of relativity, Bell’s telegraph, Tesla’s radio, television, RNA/DNA, dynamite, crop circles, the Segway transporter, the laser, the transistor), albeit often working on the results of others. Many of the world’s fascinating inventions and discoveries have been accomplished by men motivated not only by the intrinsic gratification of the discovery, but also by the opportunity that the discovery affords to provide a comfortable life to him and his family. This opportunity serves mankind well, and should be protected. As the Founding Fathers asserted, the purpose of the American government should be to provide for the general welfare, and promote life, liberty and the pursuit of happiness. They set up a government of, by and for the people, but that government now serves the wealthy elite, not the people. The change that is needed is a return to the principles of the Founders, not simply a change of who is in charge of the government.
Attention will be paid to the income distribution. Over the past half-century, the ratio of the income of top managers to that of workers has increased from about 40 to 1 to about 500 to 1. This situation has caused much social stress.
It is important to realize that men are most free when they are constrained in large things but not in small things. The government will establish policies and regulations to promote “life, liberty and the pursuit of happiness” as intended by the Founding Fathers. Their vision was not of a country in which the middle class would be hobbled by debt and much of their earnings confiscated for wealthy oligarchs. The former CEOs of Fannie Mae and Freddie Mac were paid about 20 million dollars per year, for doing no more work and requiring no more skill than a person earning 1-2 hundred thousand dollars a year. This same statement applies to CEOs of banks and investment houses, who are paid hundreds of millions and even billions of dollars per year (and owners of hedge funds, who are paid billions of dollars per year). This is a gross misuse of society’s wealth. That they are able to do so, while our country is failing and the quality of life of the middle class is falling, shows just how sick our system is.
With a stable population, people will be inheriting their parents’ homes. New homes will be needed only as replacements or improvements, not for an expanding population.
It is noted that one of the great dangers of a powerful government is that it may work for ill, rather than the good of the planet or the people, as is now the case with the US government. One of the ways in which the danger of an all-powerful government is to allow alternative concentrations of power, as in the case of a country’s wealthy elite (e.g., private bankers). When the US was founded, there were private concentrations of power, but they rested mainly in land. Today, the concentrations of power are in finance, and to an increasing extent they are situated outside of the US borders.
The income tax will be abolished. Most if not all revenue for government operations will come from interest from the new national banking system. Tariffs will be imposed on all imports to compensate for the fact that other countries have lower labor costs than the US. A value-added tax system will be set up, and only business enterprises will be taxed (the only taxes that the private citizen will pay is the VAT on sales). The advantages of this system are numerous (see my book, http://www.foundationwebsite.org/VAT.htm, including imposition of the taxes on entities that naturally have the accounting systems in place to handle it; harmonization of our tax system with those of other nations (so that our goods are not “penalized” by imposition of a VAT on them); dramatic downsizing of tax-collection operations (there are three million taxpayers (businesses) for the VAT, versus of 100 million (businesses and individuals) for the income tax). The practice of confiscating a person’s property without due process will be ended (e.g., in tax cases), as required by the Constitution.
The importance of replacing the income tax with a VAT cannot be underemphasized. The income tax simply cannot produce sufficient revenue for the government. When the economy turns down, the government runs up a big national debt. If we used a VAT, we would not have the current deficit or the current national debt. If the government owned the banks, we would not have the current deficit or the current national debt. If we both used a VAT and the government owned the banks, the level of the VAT (which is often used as an argument against it) could be very low. If the country used the VAT or the government owned the banks, it would not be necessary to tax individuals at all (the VAT would be imposed only on businesses). Use of the income tax places the US at a tremendous disadvantage in international trade.
Corporations will no longer have the same legal protection and rights as natural persons. Their rights will be severely curtailed (e.g., restriction to a specific purpose and term). Taxes may be imposed only on corporations (or businesses), or on commercial activity (e.g., transaction taxes, tariffs on imported goods), not on individuals. The owners of a corporation will be responsible for its actions and its debts (i.e., no “limited liability”).
Use of debt-backed money has proved to be a disaster (it promotes economic growth, which ultimately destroys the biosphere). The nation’s currency shall be fiat money or gold-backed money. It is noted that the use of gold-backed money has not always proved satisfactory. The wealthy can hoard it (at which time economic activity grinds to a halt), and it can be stolen. Its main appeal is that people have a high degree of confidence in it, and the supply is usually stable. If gold-backed money is used it will be based on 100 percent reserves (e.g., gold coin or representational notes (gold certificates, backed by 100 percent reserves)). With fiat money, the backing for the money is the “good faith and credit of the United States.” See Ellen Hodgson Brown’s book, The Web of Debt (2007, 2008) for details on this. In the absence of interest, all wealth will not flow inexorably to the lenders.
The horrific US balance of trade has been caused mainly by three things. First is the acceptance of the principles of free trade, under which we are not allowed to impose tariffs to offset the low labor costs (and other costs, such as environmental damage) of other countries. This led directly to the second thing, the export of US manufacturing jobs, so that the US now makes little of what it consumes and has to purchase it from foreign countries. Third is the income tax system, which is not harmonized with the tax systems of our major trading partners (who can rebate the value-added tax on their own exports and impose it on our imports to them). Through the adoption of policies that serve only the wealthy elite, the US government has virtually destroyed the country’s financial well-being and the material well-being of the middle class. Our workers were put in direct competition with workers making a few dollars a day; this could have been totally prevented by tariffs. After giving technology to the world, the only way that wages of US workers may be kept high is via tariffs or quotas. Our manufactured goods are made uncompetitive in foreign markets because of our use of the income tax. Our businesses have been forced to shift their manufacturing operations overseas because of the government’s policies of free trade, or go out of business. Through a half century of this self-destructive behavior, the US government has converted the United States into a third-world nation. Whereas before it obtained raw materials from other countries and converted them into manufactured products, it is now we who are exporting raw materials such as cotton to China for their use in manufacturing.
If none of these things had been allowed to happen, we would not have a trade deficit, and the US dollar would not have declined against foreign currencies. The wages of US workers would still be high relative to the rest of the world. The US government caused the massive trade deficit through these policies, which serve the wealthy well but have destroyed our financial position and the quality of life of the middle class. The US government has destroyed our manufacturing capacity. It has degraded the quality of life of the middle class, while adding untold riches to the wealthy. To rectify this situation, it is imperative that the US once again become self sufficient (so that it does not have to import anything (except perhaps rare elements such as tantalum or neodymium)). This means re-establishing our manufacturing sector, so that we manufacture the things that we use or consume. All that we have to do to accomplish this is decide to do it. We can change our tax system and money and banking system with the stroke of a pen. Rebuilding our manufacturing capacity will take somewhat longer, but we can do this if we want to. America cannot survive if it is not self-sufficient. It cannot survive without a strong manufacturing base. To be secure and prosperous, America must produce what it uses.
The wealthy controllers of America had the government institute these destructive policies out of greed. They and their economists used the arguments that free trade was more “economically efficient” than the alternative of protecting our workers, and that everyone would be better off. This was a complete lie. Overall, economic production was in fact increased by free trade (globalization), but the environment has been seriously damaged by the increase in economic activity, and the relative position of the US worker has been severely degraded. As I mentioned earlier, economic efficiency should not be a rationale for anything.
It has been proposed recently that many jobs can be created if we undertake a massive infrastructure development program. While such a proposal may be a good idea (e.g., elimination of the private automobile and the establishment of electric mass transit and non-urban-sprawl housing), it does nothing to address the balance-of-trade problem, since we do not sell the infrastructure to foreigners. To avoid a trade deficit, the country must export as much in value as it imports, or adjust the terms of trade to compensate for the lower cost of foreign imports. While a large infrastructure project may be acceptable or desirable or even necessary at the present time, it is not at all sufficient to solve the nation’s crisis.
The new system will not be based on growth-based economics, but on “steady-state” economics and a low level of energy use. Today’s politicians are addicted to growth and high energy use. On a regular basis they point to increases in the number of jobs or new housing starts or gross domestic product. The local paper regularly decries the loss of jobs and lauds the arrival of new ones, even though this means more urban sprawl, more energy use, and destruction of the quality of life for everyone already here. In a recent speech, President-elect Obama was touting the anticipated creation of more jobs, and stated that “somewhere out there is a small business with the ‘next big idea’.” It would appear that he is oblivious to the fact that the last century of growth was enabled by increasing use of oil and other fossil fuels, and that the future is going to be one of decreasing jobs and production, not more. More jobs, more employment, and more economic activity are destroying the environment, both in the US and globally. What is more pertinent, however, is that increasing economic activity will not be possible as fossil fuels disappear. We need for our present population to work on things that will transition us to a long-term-sustainable society, not on useless things such as personal cars and highways, which consume massive amounts of energy and destroy the environment (through urban sprawl). We need to prepare for a drastically reduced population, not a larger one. We need to stop building new homes, and construct a society where everyone can walk to his destinations. There is much work to do, but it is not in building or maintaining useless things such as cars and highways for mass personal transportation. All work on new suburban homes and on maintaining highways should cease immediately. The energy used in their production and operation is totally wasted. The only automobiles (cars, trucks) that should be manufactured are those required for national defense.
It may be charged that capital punishment and charging of interest are not “Christian.” Note that no government can be Christian (see D. H. Lawrence’s Apocalypse and the Writings on Revelation (1931): “Pure Christianity anyhow cannot fit a nation, or society at large. The Great War made it obvious. It can only fit individuals. The collective whole must have some other inspiration”). As Jesus advised, “Render therefore unto Caesar the things that are Caesar's; and unto God the things that are God's” (American Standard Version). In the recommendations made above, the government charges interest, but it is all returned to the people.
FndID(11)
FndTitle(A Plan for America)
FndDescription(The United States is on the verge of catastrophic collapse. This article describes a plan for managing the collapse.)
FndKeywords(survival; planetary managment; overpopulation; synarchy; reinventing america; world government; geopolitics)