Brazil Is the New America: How Brazil Offers Upward Mobility in a Collapsing World (22 page)

When debt expands beyond the carrying capacity of consumers and economies, the natural tendency would be for debt to contract, as uncollectable obligations are written down; borrowers go bankrupt; and their remaining assets are auctioned off for the benefit of creditors. But this implies a deflationary collapse of the banking system and a sharp contraction of the economy. To avoid this purging of the system, the fallback position of the authorities is to perpetuate bad private debt by transplanting it onto the sovereign balance sheet. If you can't pay your mortgage, it will end up as part of the national debt to be borne by generations of desperate debt slaves so long as the status quo endures.

When Karl Marx criticized the capitalist (
Kapitalist
) mode of production in
The Communist Manifesto
(1848), he focused his attack on capital. According to Marx, the evil of capitalism was that it enabled the owners of capital to extract “surplus value” from workers. While all previous societies had extracted surplus labor, capitalism was new in doing so via the sale of produced commodities. Note that Marx's criticism was essentially an abstract complaint about the character of mass employment. The “exploitation” involved in debtism is far more predatory. It entails the wholesale diversion of the purchasing power of money into artificial asset bubbles for the benefit of a small sliver of the population.

Debtism has trumped capitalism as a mechanism for concentrating wealth. (I say this as someone who has never been an invidious egalitarian.) Inequality of income doesn't particularly bother me, per se. But I think it notable that the movement away from gold-backed (which is to say, asset-based money) to pure fiat money, based entirely upon debt, has led directly to increasing concentration of wealth.

You need only look at the dispersion of income in the United States before and after Richard Nixon repudiated the Gold Reserve Standard in 1971. As Kenneth Gerbino has pointed out, the shift from a quasi-asset based money to a pure fiat money, or unalloyed debtism, resulted in a drastic loss of income by those who work and save:

It is the paper money created out of thin air that creates the unfair distribution of wealth that is making the middle class fall more behind and the poor more poor. Newly created money and credit in a paper money system benefits those that can access the money first and buy capital goods and real property at one price before the new money circulates and makes all prices go up. Wages also do not keep up with inflation and that creates another squeeze on the middle class . . . the bottom 90% of our citizens went from owning a big piece of the income gains (65%) in the 1960's to being squashed in the 2002–2007 period to 11%.
1

Part of the mechanism by which debtism impoverishes the masses is by transforming incentives and rewards for work and savings. To most outward appearances, the United States continued to seem like a free market, capitalist economy. But it changed in important ways that advantaged the few at the expense of the many.

The first perversion that arises from fiat money is the substitution of debt for capital as the mother's milk of economic growth. In a fiat system, such as that prevailing in the United States over the past four decades, production is not based upon savings and invested capital, it is spun out of money aggregates that expand as debt expands. Indeed, fiat money itself only comes into existence as debt. Extinguish the debt, and you extinguish the money supply.

Obviously, where money is borrowed into existence, the primary beneficiaries of the new money are those who have first access to it. Typically, it is those who are already well-heeled. It is they who have the good credit and collateral to borrow anew.

Another hidden expropriation of average people arises from the fact that a “pure credit” (fiat) money devalues earnings. With asset-backed money like the gold standard, the price level tends to fall as more goods and services are produced while the money aggregates rise slowly or not at all. With gold-based money, there is no way to produce a sustained credit expansion. The money supply only expands as a consequence of gold discoveries and increased mine output, or an improvement in the balance of trade that leads to the import of bullion. In short, with a real gold standard, the money supply expands very slowly.

Of course, to speak of a gold standard before the Civil War means trading in stylized facts, as the U.S. political system has rarely been hardy enough to sustain the rigors of sound money.

The nineteenth-century U.S. banking system was a confused proliferation of note-issuing banks, mostly chartered by states, with few or no branch offices. These banks tended to issue far more paper certificates for gold than their actual gold holdings would permit. Notoriously, note-issuing banks tended to locate their offices in remote corners of states, where it would be costly and inconvenient for customers to travel in order to redeem their paper notes for gold.

The reality was that the early nineteenth-century gold standard was diluted by the inflationary issue of bank notes that were purportedly redeemable for gold, but actually circulated in sometimes-generous excess to the underlying bullion. Furthermore, what passed for a gold standard was usually suspended during wars. This led to periods of more pronounced inflation, followed by contractions as credit tightened after the gold standard was reestablished in peacetime.

This happened in the United States after the Civil War. During that conflict, on February 25, 1862, Congress passed the Legal Tender Act, which forced Americans to accept paper money at par with gold and silver, thus allowing the government to pay its bills in paper money. After the war, the greenbacks were withdrawn from circulation. A long, deflationary phase began in 1873, and lasted until 1896. According to analyst Nikhil Raheja,

During these years, production increased due to excessive savings/investments and high productivity, while the money supply grew at a slower pace, causing a mismatch between the total money available for consumption and the value of products on sale, and resulted in a fall in prices.
2

I don't necessarily see the nineteenth century fall in prices as a mismatch but rather as an example of the free market dynamic at work, in which money tended to grow in value as productivity rose. This made the poor richer, as income they earned grew more valuable. According to economist Murray N. Rothbard, in A
History of Money and Banking in the United States: The Colonial Era to World War II
, general prices in the United States fell 1 percent on average each year during this period. In total, prices fell about 20 percent over 23 years. Note that with prices falling as a result of economic progress, the income of a person with stagnant wages grew 20 percent.

This was very different from what happens today under the debtist system of pure credit money, with concerted inflation of the money supply as debt proliferates. From 1970 through 2008, the money supply (M-2) in the United States skyrocketed by 1,314 percent, from $624 billion to $8.2 trillion. Meanwhile, real economic goods, the actual things that comprise the good life that people want to buy with money expanded barely at all. Naturally, prices increased when the dollar was cheapened as the debt orgy proceeded, with each new dollar of debt tending to result in an equivalent increase in the money supply.

If you have been tracking economic statistics with even one eye in recent years, however, you know that consumer prices have not increased by 1,314 percent in the past four decades. As measured by the government's slanted CPI calculations, you needed $5,549.05 in 2008 to attain the purchasing power of $1,000 in 1970. Obviously, a worker with stagnant wages lost quite a bit of purchasing power. But an even more powerful explanation for the growing inequality of wealth created by the debtist system becomes clear when you consider which prices were inflated disproportionately by all the trillions in new money borrowed into existence since 1970.

Put simply, the newly created money was put to use funding investment booms in both financial and hard assets. Wall Street analyst Kel Kelly is unusual in looking at this from the perspective of Austrian economic theory. He writes:

the only real force that ultimately makes the stock market or any market rise (and, to a large extent, fall)
over the longer term
is simply changes in the quantity of money and the volume of spending in the economy. Stocks rise when there is inflation of the money supply (i.e., more money in the economy and in the markets). This truth has many consequences that should be considered.
3

In other words, the currency was depreciated largely to stimulate investment booms. Kelly quotes Austrian economist, Fritz Machlup, saying,

It is impossible for the profits of all or of the majority of enterprises to rise without an increase in the effective monetary circulation (through the creation of new credit or dishoarding). . . . If it were not for the elasticity of bank credit . . . a boom in security values could not last for any length of time. In the absence of inflationary credit the funds available for lending to the public for security purchases would soon be exhausted, since even a large supply is ultimately limited. The supply of funds derived solely from current new savings and current amortization allowances is fairly inelastic. . . . Only if the credit organization of the banks (by means of inflationary credit) or large-scale dishoarding by the public make the supply of loanable funds highly elastic, can a lasting boom develop. . . . A rise on the securities market cannot last any length of time unless the public is both willing
and able
to make increased purchases.
4

Of course, the issue is even more basic than that. Asset booms do not arise solely because banks are prepared to lend funds “to the public for securities purchases.” Partly, they are a function of the fact that fiat money makes it easier for many businesses to grow and earn a profit. This is a policy that suits the fiscal imperatives of the state. Inflation increases nominal profits and therefore increases tax receipts.

There is probably also a political imperative to ramp up GDP, which happens automatically with inflation. Kelly puts it this way:

. . .a rise in GDP is mathematically possible only if the money price of individual goods produced is increasing to some degree. Otherwise, with a constant supply of money and spending, the total amount of money companies earn—the total selling prices of all goods produced—and thus GDP itself would all necessarily remain constant year after year.. . .

. . .[I]f there were a constant amount of money in the economy, the sum total of all shares of all stocks taken together (or a stock index) could not increase. Plus, if company profits, in the aggregate, were not increasing, there would be no aggregate increase in earnings per share to be imputed into stock prices.. . .

In an economy where the quantity of money was static, the levels of stock indexes, year by year, would stay approximately even, or drift slightly lower—depending on the rate of increase in the number of new shares issued. And, overall, businesses (in the aggregate) would be selling a greater volume of goods at lower prices, and total revenues would remain the same. In the same way, businesses, overall, would purchase more goods at lower prices each year, keeping the spread between costs and revenues about the same, which would keep aggregate profits about the same. . . .

Under these circumstances, capital gains (the profiting from the buying low and selling high of assets) could be made only by stock picking—by investing in companies that are expanding market share, bringing to market new products, etc., thus truly gaining proportionately more revenues and profits at the expense of those companies that are less innovative and efficient. . . .

The stock prices of the gaining companies would rise while others fell. Since the average stock would not actually increase in value, most of the gains made by investors from stocks would be in the form of dividend payments. By contrast, in our world today, most stocks—good and bad ones—rise during inflationary bull markets and decline during bear markets. The good companies simply rise faster than the bad.
5

If you consider the evolution of stock picking as an art during the twentieth century, it followed the indicated path of change informed by the changing character of money. Early in the twentieth century, when bank credit was far less elastic than at present, analysts tended to recommend stocks based on their dividend yields. As implied by Kelly's argument, there were not many capital gains to be had. The Dow Jones Industrial Average closed at 68.13 on January 2, 1900. It didn't rally decisively above 100 until 1920—after the inflation engendered by World War I had taken hold.

Unlike the recent period, when companies have tended to go public even before they became profitable, and many high-tech companies prided themselves in paying no dividends, in the days before debtism replaced capitalism as the organizing principle of the U.S. economy, it was hard to achieve a public listing. Companies could not file a prospectus around a business plan scribbled on the back of a napkin and raise hundreds of millions on the expectation of capital gains as they had during the dot-com boom.

Kelly argues that GDP growth, as measured in money and stock market values as reflected by broad indices like the S&P 500 and the Dow Jones Index, rises only as a result of the increase in money caused by the expansion of bank credit. Note that the DJIA went from 809 on January 2, 1970 to 12,800.18 on January 4, 2008, a gain of 1,582 percent, even greater than the increase in the (M-2) money supply in that period.

Clearly, a big percentage of the newly created money that was borrowed into existence during recent decades of growing wealth inequality went into increasing stock market values and bidding up other assets, including real estate. Who benefited most from these asset bubbles caused by the hydraulic force of credit expansion working its way through the economy? Obviously, persons who were already well-off, and had collateral to offer when borrowing money, gained the lion's share of the advantage of access to new credit.