Debt: An Inescapable Concept Part 5: Central Banking

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 currency.

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.

“The 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.


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

Individuals 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 1980.

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.

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. When the government’s bills come due and tax revenues don’t.When interest rates soar, causing a depression and widespread private bankruptcies.When mass inflation depreciates the major nations’ currency systems.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 useful.

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.

I 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.

May18, 2007

Gary 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.

Copyright © 2007