Government Safety Nets Are Made With Fiat Money

Recently by Gary North: Ben Bernanke Sent Me a Letter


For every dollar of increased debt in the American economy, the gross domestic product rises by about 8 cents. From 1947 to 1952, GDP rose by over $4.60 for every increased dollar of debt, both public and private. From 1953 to 1984, it dropped to about 63 cents. From 1985 to 2000, it dropped to 24 cents. So, it is clear that we have reached the point of diminishing returns, or we are very close to it. The massive increase in total debt that is required to make even a marginal increase in GDP is now too high for the government or private agencies to get any bang for their bucks.

Nevertheless, the increase in debt at the federal level continues to escalate. Even though there will be no payoff in terms of rising productivity, and in fact will probably be a decrease in productivity, each $1 trillion increase in federal debt is accepted almost without debate by Congress. Congress has no idea of what the increased debt is doing to the private sector. Every dollar that goes to the federal government is a dollar that did not go to increase the nation’s capital base. We are starving the private sector’s capital markets, and this is unlikely to change in the next fiscal year.

We are facing an international economic slowdown at the same time we are seeing central banks increase their purchases of government debt. There is a symbiotic relationship between the governments, by which I mean national civil governments, and their central banks. The governments continue to run massive deficits, and increasingly the central banks are moving into the market, buying up the debt with newly created money. Investors are buying a decreasing percentage of government IOUs. Excess reserves by the banks are high, which means that they are not lending to the general population. Economic growth is therefore slowing.


In a recent article by multimillionaire hedge fund investor Kyle Bass, we learn that total global credit has grown by about 10% per annum over the last decade, which is contrasted with global population, which has grown in about 1.2% per annum. Global real GDP has grown by about 4%, but most of this growth has taken place in China and the underdeveloped world. It has not taken place in the Western industrial nations.

Over the last 10 years, central banks around the world have increased their monetary bases by at least $10 trillion worth of currencies. The total was about $3 trillion 10 years ago; the total is about $13 trillion today. This is a massive increase of what used to be called high-powered money. It is no longer high-powered money, because commercial banks are increasing their holdings of excess reserves at the central banks, rather than lending the newly created money into circulation. If they had lent the money into circulation, we would be experiencing price increases of something in the range of 50% or more per annum.

Central banks have become the primary purchasers of new national government debt. The private sector is no longer gobbling up all the debt which the government sector produces. The national governments are dependent upon their central banks to buy their IOUs with newly counterfeited money. The central banks now serve as lenders of last resort. This was always the official justification for central banking. This was the story which the central bankers gave to the national governments. Of course, the real purpose of central banks is to protect the largest commercial banks. It is the enforcing arm of the banking cartel. But that was never what the promoters of central banks told the politicians who were asked to vote for the creation of a central bank monopoly in each country.

You have probably heard the following. From the first year of the United States, which began in 1789, until 1981, the total increase of debt by the federal government was about $1 trillion. Of course, a good chunk of this was from monetary inflation, especially in World War II and then again in the 1970s. From 1981 until 2001, the government added an additional $4.8 trillion. Over the last 10 years, from 2001 to 2011, the debt increased by almost $10 trillion. It is now increasing by $1 trillion a year. I’m speaking here of on-budget debt, not the real debt, which is the present value of the unfunded liabilities of the United States government.


I think it is clear that we have gone way beyond the point of no return. There is no possibility that the federal government will be able to repay these debts, let alone meet the responsibilities of Social Security, Medicare, and Medicaid. It is statistically impossible.

Nevertheless, Congress ignores this, and continues to run massive deficits. The financial media have ignored this with respect to the unfunded liabilities of the federal government. The financial media argue that the on-budget deficits can be taken care of by economic growth. We will somehow grow our way to such an extent that will be able to meet the interest payments without suffering reductions in capital investment.

There is no thought in any place of influence that the federal government should ever repay all of its debt. It did that in 1837; it never did that again. The assumption is that the government needs to have a large debt, and that this is good for the economy. The economic system needs a constant increase of working capital. But working capital exists only in the private sector. Increases in the federal deficit do not fund additional output. On the contrary, they restrict output, because the money that is used to buy the government’s IOUs cannot be used to make capital investments.

This being the case, we are now in a situation in which the system of ever-increasing federal deficits are demanded in order to keep the overall economy stimulated. It is funded by means of increased counterfeit money issued by the Federal Reserve. The Federal Reserve keeps creating money, and it uses the money to buy federal debt. The debt gets larger, but productivity does not increase. We cannot grow our way out of the escalating debt, because the rate of growth in the overall economy is not sufficient to fund each additional dollar of debt.

We have therefore entered the phase sometimes called “Banana Republic.” The federal government borrows the money that it needs to make interest payments on the debt. So, the debt keeps getting larger.

Keynesian economics always has argued that this increased government debt will lead to increases of national productivity. The whole idea behind the Keynesian redistribution of wealth is that this government-spent money would not have been used for productive purposes, but now that the government has access to it, the government will dutifully spend, and the spending will jolt the economy into another round of expansion.

We see that the deficits since 2008 have been above $1 trillion a year, but the recovery is anemic. The next fiscal year may bring a recession. This is what has taken place in both Japan and Europe. We seem to be heading in that direction.

Meanwhile, as investors seek safety, and therefore invest in fixed-income IOUs, interest rates have dropped to their lowest level in the postwar period. As a result, pension funds are no longer able to make sufficient gains on their investments to meet the actuarial responsibilities of paying off buyers of annuities in the future. They will not begin in the future, because the pension funds and the insurance company are making such low rates of return, that all of their assumptions regarding their possession of sufficient assets to sell in the market in order to fund their retirements of the policyholders have been smashed.

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November 28, 2012

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 31-volume series, An Economic Commentary on the Bible.

Copyright © 2012 Gary North