The Debt Bubble

May 10, 2004 – Catching up on my reading last week, I was very much taken by comments made recently by Congressman Ron Paul of Texas. From his position on the House Banking Committee, he has over the years rightly criticized this country’s fiat currency monetary system. Given that the Federal Reserve is the heart of that system, Congressman Paul has often directed his criticism toward Alan Greenspan and his Fed colleagues.

In a recent newsletter sent to his constituents, Congressman Paul made a very important observation that is all too often misunderstood in this country, if it is even recognized at all.

“Judging by Mr. Greenspan’s statements to a Senate committee in February, Fed economists are confusing debt with wealth. Mr. Greenspan praises the “sustained expansion of the US economy,” but then goes on to highlight the real reason for the expansion: loose monetary policy and near-zero interest rates. Since Fed bankers set interest rates artificially low, the cost of borrowing money is very cheap. This leads to more and more consumer spending, which Mr. Greenspan touts as the driving force for economic growth. In fact, he expressly cites the benefits of increased household spending made possible by mortgage refinancing.But new debt is not wealth, and it’s impossible to borrow one’s way into prosperity.” [emphasis added](www.house.gov )

Then shortly after reading Congressman Paul’s statement, I was struck by the following chart by the Grandfather Economic Report that appeared in Jay Taylor’s most recent newsletter [See: www.miningstocks.com]. Please study this chart carefully.

This above chart graphically demonstrates the wisdom of Congressman Paul’s observation – ‘Debt is not new wealth’. In fact, debt is the opposite of wealth, and what’s worse, debt can lead to serious financial problems, as it is now doing in the United States.

This chart was prepared by M.W. Hodges of the Grandfather Economic Report. I don’t know Mr. Hodges, but he is doing a great service by maintaining his website, which includes many different charts presenting important economic and social trends. I highly recommend that you visit: Click Here.

This chart is one of the most important on his website, and it shows that the level of debt in the US economy is growing much faster than national income. Clearly, this trend is not sustainable.

Income must grow more or less in tandem with debt growth. Otherwise there is insufficient income to service the debt. This state of affairs then eventually leads to problem loans, a banking crisis and inevitable monetary problems because today’s fiat monetary system is built upon debt, not gold or other sound assets. The banks monetize debt – they turn loans they hold as assets into currency that then circulates through the economy. If those loans are bad, the currency created from them must also therefore be bad.

The conclusion from this chart is that the US economy is not built upon a solid foundation. It is a house of paper built upon debt. The US is living far beyond its means, and this chart clearly demonstrates to me that the US economy – indeed, the US financial and monetary system – are due for a severe shock. In fact, it seems safe to say that it is long overdue.

Our fiat monetary regime – which is the mechanism that has allowed this debt to grow to unsustainable levels – has lasted now for nearly thirty-three years. A whole generation of Americans knows nothing else. But they will learn what great minds like John Exter were saying years ago: “The notion that the Fed can make us all better off by intervening in money markets is preposterous on the face of it — an offense to common sense. If they continue, and they will, for the Fed is locked into an expansionism it dares not stop — a prisoner of its own expansionism — the market will in the end destroy it by refusing to accept its IOU-nothings, making [the dollar] worthless, a disastrous punishment for all the rest of us too.”

Is there any doubt that the dollar is becoming worthless? The dollar today only purchases less than 10% of what it purchased when the fiat money regime began in 1971. Inflation erodes the dollar year-in and year-out, and present inflationary trends are alarming. In a recent report, economist Michael Evans made the following statement:

“Suppose I told you that since the middle of last year, the rate of inflation has been 39.2%. You’d probably assume it was a pretty bad joke. Nonetheless, the U.S. Labor Department’s core Producer Price Index (PPI) for crude materials, which excludes food and energy, has indeed risen at a 39.2% annual rate — about 3% per month — since last July. And if energy price changes are included, the gain is even larger.”  (www.industryweek.com)

With crude oil over $40 per barrel and gasoline at or above $2 per gallon, it is only a matter of time before the economy dips back into a recession and consumer confidence plummets. In the words of noted economists Van Hoisington and Lacy Hunt: www.hoisingtonmgt.com.

“The consumer sector would be vulnerable to a downturn in normal circumstances, but conditions are far from normal since we are experiencing the fifth oil shock since 1970. Total consumer fuel expenditures have advanced from a 2001 low of 6.3% to 7.7% of wage and salary income in the quarter just ended, and energy prices are even higher now. This is a dead weight loss to the domestic economy. All of the four prior oil shocks led the economy into recessions.”

This oil shock will lead to a recession too, but don’t blame OPEC. Put the blame where it rightly belongs – on the Federal Reserve and the politicians who allow the fiat monetary regime to continue. The following chart shows without a doubt that it is with them that the blame lies.

This chart shows crude oil prices from 1945 indexed to 100, measured both in dollars and goldgrams. The price of crude oil today is no different than it was 50 years ago when measured in terms of gold. But look at what has happened to the dollar’s purchasing power since the fiat money regime began in 1971.

In summary, the US economy and the dollar are in trouble. Get ready for a major crisis. It is only a matter of time.