About what I like to call the "COMPOUND INTEREST PARADOX":
Is This the Beginning of a Worldwide Depression?
Diary Entry by Paul Rye
Is an end-of-the-world-as-we-know-it Great Depression in the making, or will the Fed save the day and send us on our way none-the-worse for wear except for the sentence of an eternity in Hell on the debt/inflation treadmill?
The housing and stock market crashes taking place, the fall in the value of the dollar, and the apparent lack of foresight or leadership by the banking industry or Government leading up to the current situation are due to the nature of our monetary and banking system and Government’s relation with it. It is not a result of free markets, capitalism, corporate malfeasance, “normal business cycles”, etc.
The situation we find ourselves in was completely foreseeable by those within the top tier of the international bankers and national central bankers. To doubt this is to believe that the banking elite does not understand how credit creation via fractional reserve banking and lending at interest works, which is absurd.
Our monetary system contains only about 3% of money that is not debt. If all debts were paid or defaulted, about 3% of our money would remain in circulation or as deposits at banks.
In 2006 there existed approximately $10 trillion in the M3 money supply. The total amount of money that would remain, if all debt was paid or defaulted, would be 0.3 trillion. Obviously, a contraction in the money supply of 97% is a worst case scenario, technically possible but not likely. However, a much smaller drop in the money supply would also be disastrous.
From 1929 to 1933 the money supply dropped by one-third, choking off credit and making it impossible for many individuals and businesses to spend or invest. Some argued that the drop in the money supply strangled the economy. Others argued that the worldwide depression that followed was caused by a lack of world economic leadership. The latter explanation contains a grain of truth, but it diverts attention from the monetary crux of the problem by suggesting that proper Government leadership might have increased liquidity and world economic growth at a critical time and averted the drop in the money supply.
Such “leadership” would only have postponed the problem, because a monetary system dependent on a credit-based money supply, lent into existence at interest, is inherently unstable.
The crux of the problem is that mathematically, credit-based money is lent into existence at interest by a fractional reserve banking system that does not create the money needed to pay the interest. All debts cannot be repaid, because not enough money is lent into existence to repay both the principal and interest. Therefore, the interest must come from the existing pool of money. No matter what the quality of the participants, there must be losers.
The pressure on the losers to pay their debts makes the economy unnaturally competitive and growth-oriented, leading to excessive exploitation of natural and human resources. And, the only way to avoid an excessive number of losers is to keep increasing the total amount of debt, continually pumping more money (credit) into the system. Therefore, monetary inflation is necessary and endless.
There can be only two possible outcomes under this system: the game moves forward, the money supply expands, there is monetary inflation and economic expansion at the same time. Or, the game regresses, the money supply contracts, there is monetary deflation and economic and contraction at the same time. The reason there are only two outcomes is that the “third way”, a forever expanding money supply without price increases is not possible in a finite world.
If the U.S. and world economy fail to grow exponentially, then the banking elite temporarily lower interest rates to “stimulate” the economy. Under low interest rates, people are more willing to borrow, and more money is created to slosh around in the economy. If the economy still does not grow, then the effect of the extra money will noticed immediately as increases in prices of products and services. Because wages never increase as fast or as high as the price increases, society must accept ever increasing prices of all products and services and a decreasing standard of living.
If money cannot be pumped into the system fast enough or the people receiving the money cannot be encouraged to spent it in ways that support and maintain economic growth, then the money will not get distributed around the economy in a way that permits all borrows to pay their debts. Then, big trouble begins. When people fail to make payments, mortgages fail, and banks fail; when banks fail, the money supply contracts; when the money supply contracts, wages and Government tax receipts fall; when wages and tax receipts fall, both Government and people can pay even less. So, a vicious reinforcing cycle develops. Yes, the details on how this scenario can be triggered and progress can be mind-numbingly complex. Suffice it to say, a “Great Depression” is very bad.
A significant contraction in the money supply for whatever reason can lead to a Great Depression style economic contraction. People fear Depression because people can lose their jobs, their houses, and worse. No investment is safe in a Depression. Even if you think you can make a killer investment by say selling short in a stock market crash, you just might never collect it, if the brokerage that made your trade goes bankrupt, or so does the bank to which you transfer the funds. Banks fear Depression more than anything else, not just because it is bad for the neighbors, but because it is bad for them, and it can lead to questions about the legitimacy of the entire monetary/banking system.
If this vicious cycle develops, not just a few banks will be affected. The U.S. dollar is the most widely used currency in the world. Some 60%-70% of all currency in the world is U.S. dollars, and foreign banks keep their largest foreign reserves in dollars. World banks are now all interconnected via complex relationships and investments, including derivatives. A monetary crisis that begins with a subprime mortgage crisis in the U.S. or a failure of major debt insurance companies can snowball into a worldwide depression. Let me be perfectly clear. It is a credit-based money supply, lent into existence under a fractional reserve banking system, that makes this Great Depression scenario possible.
Now, at the risk of being repetitive, the international bankers do not care if you go bankrupt, but you can be certain they do not wish to join you, nor do they wish to lose their monopoly on the world’s money supply in the throes of a worldwide depression. So, the banking elite will do practically anything to avoid a disorderly contraction in the U.S. dollar and world money supplies.
One way the Federal Reserve can expand the U.S. money supply is to lower interest rates. That is why the Fed just announced an emergency 0.75% interest rate cut, today January 22, 2008. That move cut short what was shaping up to be a 400+ day drop in the Dow Index. What they did not say was than any tangible effect of a rate cut will not be felt in the economy for six months. The move was purely psychological. If the bleeding does not stop, more cuts will come, and the Fed will use other tricks as well. But, rest assured that the Fed will fight tooth and nail to prevent a contraction in the money supply. Ben Bernanke arrogantly believes the Fed has all the tools and methods today needed to always successfully increase the money supply and avoid depression. He might be right. Then again, he might not. The Titanic was unsinkable until it sank.
If the bankers succeed in preventing depression, there will be inflation, and lots of it. Gold and silver will be excellent investments. And, the horrible monetary/banking system will continue until world population growth and resource exploitation can no longer be maintained. Then, the mother of all crashes will occur.
If the bankers fail to prevent depression, then there will be no good investments, except maybe a six months supply of food suitable for long term storage. Cash money will be king, and because physical gold and silver are essentially cash money, you will not lose anything by keeping something invested in physical gold and silver instead of cash. And, there will be a chance, just a chance mind you, that the people and the Government will reconsider the wisdom of permitting this horrible monetary/banking system to continue.