Debt: An Inescapable Concept Part 5: Central Banking

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Debt is an
inescapable concept. It is never a question of debt or no debt.
It is always a question of which kind of debt, owed to whom, when.

The modern
economy is addicted to government debt by way of central banking
debt. The system is self-reinforcing. Governments spend more money
and make more unfunded promises than taxes can fund. So, governments
turn to debt as a way to make up the shortfall. To keep interest
rates low, governments license privately owned central banks to
create money in order to buy government debt. This has been the
pattern ever since the creation of the Bank of England in 1694.

Central banks
create money when they purchase government debt, which is mainly
what they invest in. This adds new money to the economy: monetary
inflation. To eliminate all government debt, as the United States
did in only one year, 1835, the central bank would have to sell
government debt and purchase some other asset to replace it. Otherwise,
the bank’s sale of government debt to the public or to the government
(debt reduction) would shrink the money supply.

For a central
bank to fold up shop and go away, it would have to sell all of its
assets. This would create price deflation on a massive scale. It
would create a depression far worse than the Great Depression of
the 1930’s. This is why, once begun, the central banking system
is self-reinforcing. It is like an addictive drug. It means lifetime
employment for the pushers: central bankers.

The modern
system of debt-based money is therefore as close to politically
inescapable as anything in the modern world — even the welfare state.
The modern world is addicted to central bank debt. In theory, central
bank debt is not inescapable. Once begun, however, it is politically
inescapable. The organization of debt into money is politically
irreversible short of what Ludwig von Mises called the crack-up
boom: the breakdown of money in mass inflation. It leads to ever-greater
monetary inflation.

This is a worldwide
phenomenon. Around the world, central banks control national monetary
systems. A free market in money is universally opposed by politicians,
academics, and of course commercial bankers, who want a lender of
last resort to protect them from bank runs by their depositors.


The United
States government is the largest debtor in history. From all over
the world, but especially from Asia, money is flowing in to buy
Treasury debt. This money is from central banks, mainly — money
created by government-licensed counterfeiting operations.

If this money
were going into the U.S. stock market, Americans would at least
be the beneficiaries of better tools of production. They would not
be laying up wealth in their old age. Instead, foreign central banks
would be doing that: establishing ownership of wealth-producing
assets. But central bankers are not investing their own money or
depositors’ money. They are investing recently counterfeited money.
They buy government promises to pay. It is a gigantic con job between
government-licensed counterfeiters and elected liars who know the
debts will never be paid off.

You and I are
caught in the middle.

Here is how
the system works. Foreign central bank-produced counterfeit money
is used by foreign central banks to buy Federal Reserve-produced
counterfeit money, which is then used to buy a large chunk of the
U.S. government’s debt. No one expects the debt to be paid off.
All that anyone expects is interest payments.

The #1 principle
of national government debt is this: "Old debt must be rolled
over, not repaid." The idea that national government debt must
ever be repaid is considered ludicrous — by bankers, voters, politicians,
and academic economists. This assumption lies at the heart of the
modern political order. We have bet the political order on this
assumption. It is a false assumption. As King David wrote 3,000
years ago: "The wicked borroweth, and payeth not again"
(Psalm 37:21a).

What is legitimate
in one realm — private debt — is not legitimate in another realm:
government debt. Private debt gets paid off by individual debtors.
Government debt is perpetual.

Let me explain
the logic of the two realms. First, debt is correctly seen as the
engine of wealth creation in the private markets, which it can be
when it is used to purchase tools of production. Second, debt is
also regarded as the engine of prosperity in private markets when
it is used to purchase consumer goods. This position is much less
defendable than the first, but if consumers want to do this, there
is nothing morally wrong, so long as they repay the debt.

Then the defense
of productive debt in private markets is applied to the government.
Here, the logic of debt breaks down. Would you loan money to a known
counterfeiter? Only if the counterfeiter is the government. To lend
money to a counterfeiter is to guarantee repayment in depreciating

The fact is,
the modern economy is based on money lent to a debtor who is in
league with the largest counterfeiter on earth: the Federal Reserve
System. These days, the FED is not cranking the digital printing
press at a high rate to buy U.S. government debt. This is because
other counterfeiters are doing it for the FED. The Bank of China
is producing fiat money at a rate above 15% per annum. It is then
taking billions of dollars worth of this newly created money to
buy the debts of its trading partners’ governments, including the
United States.

The world’s
economy runs on officially counterfeit money. Technological innovation
is accelerating worldwide, but this innovation does not require
counterfeit money. Hundreds of millions of Chinese and Indians are
moving off the once collectivized farms and heading for cities.
They are moving out of the world of 1950’s-era socialism. This is
highly productive for them and for consumers all over the world,
but it did not require counterfeit money to make possible this transition.
It required only a reduction of government control over the economy.

Asian central
bankers are well aware that the U.S. government has no intention
to pay off its debt. They also know that the Federal Reserve System
stands ready to fund the U.S. government’s budget by creating fiat
money. But Asian bankers seem not to care. Why should they? They
are buying this debt with fiat money. They buy dollars. They then
buy T-bills. This money is then spent by the U.S. government. The
recipients of the U.S. government’s money then buy Asian currencies
to buy Asian products. This helps the Asian economies to grow.

But couldn’t
the Asian central bankers just buy the government debt of their
own nations? Couldn’t they eliminate the middlemen, namely, the
U.S. government and U.S. consumers? Of course they could. But we
are still living in a world of mercantilist economics. It is as
if Adam Smith’s Wealth
of Nations
had never been written. In the world of Asian
central banking and politics, mercantilist economics rules supreme.
The way to wealth, they believe, is by letting foreign governments
run up huge debts that will never be repaid in order for foreigners
to buy consumer goods exported from Asia.

You may think:
"Wait a minute. This means giving away valuable consumer goods
to foreigners today as a way to get rich in future depreciated money.
This is nutty." If so, you have obviously been influenced by
the logic of the free market. Asian policy-makers haven’t.

While the world
is getting rich through the efforts of inventors, entrepreneurs,
savers, and day laborers who are not part of governments, it is
operated in terms of digits — counterfeit money — that are controlled
by an alliance of national politicians and private central bankers.
These digits keep multiplying, and every one of them represents
a debt.

Money today
is based on debt. To repay this debt would require a massive contraction
of money back to gold and silver. This process would create a massive
depression. So, government debts are not intended to be repaid.

wicked borroweth, and payeth not again."

But to keep
the game going, there must be the illusion of repayment. There must
be debt rollovers. There must be prompt payment of interest. There
must be official solvency.

In short, there
must be widespread acceptance of an illusion.


deal in illusion. This is their two-fold specialty: illusion and

monitor their own level of debt. They are careful not to let their
debt load get beyond their ability to repay. They do not let themselves
get into a position of having to default. They know that bankruptcy
is a painful option. They know that creditors can repossess every
mortgaged item they own. This is why the household
debt payment/disposable income ratio
has risen very slowly since

In contrast
is the United States government. It
keeps rolling up massive debts
, year by year. It has on on-budget
debt of almost $9 trillion, plus an off-budget debt in the range
of $70 trillion.

There is no
way that this can be paid off with money that possesses today’s
purchasing power unless political steps are taken today to stop
the expansion of debt. But no such steps are ever taken. Politicians
have no incentive to stop making promises. The unfunded liability
keeps growing.

Because nobody
can foreclose on the U.S. government, politicians have no incentive
to create a schedule for repaying the government’s debt. They would
be thrown out of office if they suggested that the expansion of
future obligations must cease until a means of repayment is set
up. Remember the rule:

"Old debt
must be rolled over, not repaid."

The illusion
of repayment must be maintained. It will be maintained, nation by
nation, all over the world. It will be maintained by the creation
of more counterfeit money. Your check will be in the mail — or deposited
directly into your account. You will get paid. Have no fear.

The illusion
of solvency of the government will be maintained by the insolvency
of the currency.

In the Soviet
Union, there was a common saying among the workers: "The government
pretends to pay us, and we pretend to work." The result was
the nation’s bankruptcy in 1991. The USSR could no longer service
its debt of about $60 billion to the West. Today, Russia’s central
bank has something in the range of $350 billion in IOU’s from Western
governments. That’s what oil and natural gas can do for a government.

Russia’s central
bankers are now caught in the absurdity of mercantilist economics.
The government has sold off Russia’s energy assets in exchange for
Western governments’ promise to pay counterfeit money. Dumb.

And so it goes,
nation by nation. The politicians and central bankers finance the
sale of valuable present goods in exchange for promises to pay counterfeit
money years in the future.

How will all
this end? Poorly. In what form? There are various possible scenarios.

  1. When there
    is an interbank payments crisis — gridlock — due to an unforeseen
    event, such as an airborne anthrax attack on New York City or
    London or both.
  2. When the
    government’s bills come due and tax revenues don’t.
  3. When interest
    rates soar, causing a depression and widespread private bankruptcies.
  4. When mass
    inflation depreciates the major nations’ currency systems.
  5. When old
    people cannot survive on the income they have been promised, and
    must return to their children’s households for relief.

The international
currency system is based on two primary factors: (1) central banks’
counterfeiting operations; (2) debt-based money. The first guarantees
long-term price inflation: debt servicing with depreciating money.
The second prevents any long-term reduction of government debt that
serves as central bank reserves, i.e., monetary deflation. This
is a ratchet upward in the government debt markets of the world.


We are all
debtors. We are all creditors. The political question is: Which
way will we vote? As debtors or creditors?

I think most
voters vote as debtors. They feel the pressure of debt right now.
They do not think of themselves as long-term creditors: pensioners,
Social Security members, future Medicare recipients. In a choice
between a little inflation vs. deflation (personal bankruptcy),
they will choose inflation. They want to be able to meet their monthly
payments, even if this means accepting long-term depreciating money.
They fear next month more than they fear age 65.

One way to
defend yourself against depreciating money is by accepting long-term
debt. Consider your mortgage. Depending on your age, you probably
still owe money for the home you live in. If you sell it, you will
probably buy another one. You will use debt to purchase it. If you
buy a nicer home, you will owe more on it than you owe on the one
you are living in now.

You may have
made a decision to spend your life in debt. Tens of millions of
people do. I know I have. I am not a net debtor, but I plan always
to have a mortgage. Why? Because I do not trust the U.S. dollar.
I am a creditor: Social Security. I have been promised a lifetime
of income in dollars. I want to be able to do something useful with
these dollars. Paying off a fixed-interest mortgage is something

In other words,
I have seen that I am both a creditor and a debtor. I would like
to break even on the deal. A fixed-rate mortgage should allow me
to do better than break even. Of course, I will be a lifetime net
loser. I paid into a retirement system that is a gigantic chain
letter. I would be far better off today if I had invested the money
that I paid into Social Security. But what’s gone is gone. I must
make my decision today based on conditions today. I think I will
be better off using my Social Security income to pay off a mortgage.

There are people
my age or older who own their homes debt-free. These people grew
up in a different generation from those starting families today.
They either remember the Great Depression, as my parents do, or
they grew up in households run by people who remember it, as I did.
They know the stories of families that were evicted from their homes
for non-payment of their mortgages. They may even know the true
horror stories: families that were evicted from their farms for
non-payment, yet who simultaneously lost everything they had in
the bank when the local bank went bankrupt. They were wiped out
as debtors, and they were also wiped out as creditors. These people
learned that debt can be destructive. They decided early to avoid
all but mortgage debt, and to pay off their mortgages rapidly.

They learned
the wrong lesson. They should have bought one or two rental houses
per year, using debt. They would now own 40 to 80 homes, mostly
debt-free, each worth $250,000. They did not recognize that a new
era had dawned after 1940: an era of irreversible price inflation.
They did not buy appreciating assets using borrowed money.


Like addicts,
we are trapped in the modern debt-based economy. Every institution
is part of this web of debt. Some debt is productive. Government
debt is unproductive. Central bank debt is addictive.

With governments
and central banks in charge of money, monetary inflation is inevitable.
This would not be true in a free market for money, where banks would
not be allowed to violate contracts with their depositors and suspend
payment in gold or silver coins.

We therefore
seek ways to protect ourselves against the guaranteed inflation
of central banking. Yet the obvious way to protect ourselves from
depreciating money is to take on long-term, fixed-rate debt. This
is why the organization of debt into money is self-reinforcing.
The individual’s best defense — long-term debt — extends the central
banking system.

In 1949, Ludwig
von Mises identified the end result of the policy of central banking:
mass inflation. Prices rise, and this gets built into the economy’s
long-term contracts: a price premium. He wrote:

It is necessary
to realize that the price premium is the outgrowth of speculations
anticipating changes in the money relation. What induces it, in
the case of the expectation that an inflationary trend will keep
on going, is already the first sign of that phenomenon which later,
when it becomes general, is called "flight into real values"
and finally produces the crack-up boom and the crash of the monetary
system concerned.

The destruction
of purchasing power through monetary inflation, as well as the boom-bust
cycle, is the product of the government-central bank alliance. There
is no pain-free way out of the addiction to fiat money. This is
why neither politicians nor central bankers have any intention of
paying off the national debt. They see debt as forever.

do not. Debts can be paid off through mass inflation. I think this
is the way they will be paid off. Conclusion: don’t be a long-term
creditor for very long.

18, 2007

North [send him mail] is the
author of Mises
on Money
. Visit
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible

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