Economic Lessons #1 - How can the US run such a huge debt?

Posted by FeelingAwake
FeelingAwake
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on Thursday, 07 June 2012 in Sign Posts

This is such an obvious question. Yet how many people on CNBC or MSNBC have ever answered it for you? You are left to assume that the US is such an incredibly efficient and hard working nation, that everyone trusts us to pay that debt off at some point in the future…. Right? Anyone? Bueller? (Ferris Beuhler’s Day Off reference for our non-US readers).

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This is such an obvious question. Yet how many people on CNBC or MSNBC have ever answered it for you? You are left to assume that the US is such an incredibly efficient and hard working nation, that everyone trusts us to pay that debt off at some point in the future…. Right? Anyone? Bueller? (Ferris Beuhler’s Day Off reference for our non-US readers).

It is a long and boring story of how we became the largest debtor on the planet. I will do my best to make it understandable and possibly even exciting. Because understanding this subject is the first step to your awakening; once you understand, the answer to the question I posed above, it will forever change how you view the United States and how we run our foreign affairs.

Remember that this is a high-level history/economics lesson and should not be seen as an academic piece. I will have to glaze over some parts of history and make some imperfect analogies. But in the end, if you have an inquisitive mind, this article should spark an interest to dig further and to keep learning.

The story of the United States as we know her today starts not surprisingly before the Great Depression. We are taught that the Great Depression was started on Black Monday October 28, 1929. We are further taught that the Depression was caused by the irrational exuberance of the roaring 20’s and the system crashed as everyone started selling everything at the same time.

This is true to a point. But it is like saying the plane crashed because air stopped flowing over the tops of the wings. Well no shit the plane crashed because there was no airflow. WHY DID THE AIR STOP FLOWING is the question you really need to know the answer to, and it is here that we will start our lesson on why the United States can run such a huge debt.

I will save the Great Depression and the great deflationary collapse for another lesson. I will just give you some high level points that should be understood about the 1920’s and 1930’s. The most important thing to understand about pre-1920’s world economics is that Great Britain was the big dog in the world. The British Sterling Pound was to the world what the US Dollar is presently. Great Britain held sway over the entire world’s markets, her naval fleet, and was at the center of a worldwide system that extracted the wealth of the then third world and brought it back to the home island. However, there was a problem brewing in Great Britain as the 1920s started. The UK was overextending themselves at almost every single turn. They were carrying a huge debt burden that in the past was never a problem.

In the past, Great Britain just needed to pull more third world nations under her “protection” and they could extract more wealth to keep their debt in check. The game they were playing started to end in the 1920’s as people started to question the British Sterling Pound system that was at the heart of international commerce during that time.

Again, I will skip some very important history here to keep the story moving. Just understand that it was the collapse of the British Sterling Pound system, which directly led to the Great Depression and ultimately World War 2.

By the1930’s almost all of Europe was caught up in a massive depression and towards the end of the decade, open war. In the United States, the 1930’s saw a massive economic depression the likes of which our country had never seen. Our history lessons state that FDR saved the country through his miraculous government spending programs and his non-stop intervention in the US economy. The reality was (as it is now) that nearly all of the programs initiated in the 1930s failed miserably. It wasn’t until December 7, 1941 that things started to turn around for the United States.

I will come back to this period in time during another lesson, as it is deserving of probably several articles. I know FDR is seen by many as a figure beyond reproach. And on some levels he was. I just don’t want to detract from the lesson here by getting bogged down with debates regarding FDR, The Depression and World War II.

We will flash forward towards the end of the War and 1944. It becomes apparent to the eventual victors of the war (France, US, and England) that if nothing is done to prevent it; another Depression is going to take hold as millions of men return home to factories that are no longer producing tanks and airplanes. The ultimately victorious allies met in a place called Bretton Woods, New Hampshire, where they hammered out the framework for an international monetary system to replace the failed English system.

Since the United States was the largest economy at this point and had such a deep and strong economic base, it was decided that the US Dollar would act as the world’s reserve currency. This is beyond important to grasp, as it is this crucial fact that underpins our entire existence to this day.

What is a Reserve Currency?

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To put this in easier terms to understand, let us use trading cards as an example. Let’s say we have 10 different people wanting to trade. You have Pro Bowling Tour trading cards, one of the other guys has Pro golfer trading cards and another guy has Pro Hockey trading cards. Now nothing against people who trade these types of cards, but they are not the most popular trading cards in the world. I ON THE OTHER HAND HAVE BASEBALL TRADING CARDS! Everyone on the planet whether they actually like baseball or not, will understand the worth of valuable baseball cards. So in this world we decide that my baseball cards will be at the center of our trading system.

Everything is “denominated”(meaning the price is fixed on this currency) on BOB’S BASEBALL TRADING CARDS. So if you want to buy gasoline for your car, your Pro Bowling Tour trading cards are no good. You have to trade them in for Bob’s trading cards first. With Bob’s cards in hand, you can then go and buy your gasoline.

The guy selling the gasoline can then use those cards to buy other things, as Bob’s baseball cards are very valuable. OR he can just sit on them and hope they continue to gain in value, which they do for decades.

So relating this back to the real world, what does this mean? Well after 1945 and the end of the war, the victors decide to place the US Dollar as the reserve currency of the world. This means that all commodities like oil and wheat and gasoline and gold and silver and all the rest are primarily denominated in US Dollars.

So if you are a country without oil or gasoline and you are in need of these things, you must trade. At this point in time, the United States was by far the largest oil producer on the planet. The US controlled the international price of oil. Regardless of whether you bought the oil from the US or the fledgling oil producer in the Middle East, you purchased that oil with US Dollars. So if you are French and you are buying oil from Saudi Arabia, the transaction must be done in US Dollars. This means that you must exchange Francs (France’s monetary unit before the Euro) for US Dollars.

There was a lot that went into determining the relative worth of a countries monetary unit and I won’t bore you with the details today. Suffice it to say there was a market that determined what the Franc’s worth was, compared to the US Dollar. So as a French company in need of oil, you exchanged Francs for USD (US Dollars) and you purchased your oil from Saudi Arabia. Now Saudi Arabia is sitting on a bunch of USD’s and they have very small needs as they are a somewhat simple country. They have two choices. They can spend it on lavish palaces or building up a military OR they can save it for a rainy day. Saudi Arabia in those days did both. They bought US military hardware to protect themselves from their neighbors AND they sent the USD’s back to the United States and bought US Treasuries.

Either way, those dollars ended up back in the United States. The first method helped to prop up arms dealers and manufacturers in the United States and employed hundreds of thousands of American’s in high paying military contract jobs. The second method helped the United States take on an almost permanent debt load. Remember that US Treasuries are nothing more than US Debt that is sold on the market. The holders of US Treasuries are promised a modest return on their money over a period of 1,3,5, 10 or 30 years. The US wracks up 1 billion dollars in debt and it sells treasuries on the market to help cover that debt. It only has to payout when the Treasury matures. Saudi Arabia was known to buy long term US Debt in the 30-year range.

This meant that so long as they had confidence in the US economy, they would continue to make more money the longer they kept their money in US Treasuries. And this was the same for anyone else that held US Dollars. Remember that from 1946 until the late 1960’s, the United States was far and away the largest exporter of everything from Automobiles and Televisions, to Grain and Petroleum products.

During this timeframe, it was a net benefit to hold US Dollars in the form of Treasuries, because our currency was by far the most stable and paid the best return. And our needs became insatiable as the Cold War churned on and on. From the end of World War II, we had the Korean conflict and the Vietnam War, which were huge deficit creating events, but we also had innumerable smaller conflicts and covert operations that cost the US tens of billions of dollars. ALL OF THIS WAS FUNDED BY THE US DOLLAR RECYCLING SYSTEM.

We could run huge deficits, because our currency could be created at will by creating debt in the form of US Treasuries. These treasuries were usually in demand as US Dollars were stacking up in foreign banks with nothing else to do with them. If they weren’t buying US Treasuries, they were buying US military hardware or the growing number of consumer goods like refrigerators and washing machines. The entire western banking world (and all its subordinates around the world) centered on US Debt creation. It is the lubrication that keeps consumption rolling on and on.

This system worked wonders throughout the decades of the 1950’s and 1960’s. It wasn’t until the last part of the 60’s and early 70’s that cracks began to appear on the surface of this “wonderful” system. Much like the English system in the 1920’s, people began to question the debt load of the United States and the diminishing prowess of our manufacturing base. It was at this time that the US also stopped being a net exporter of Oil.

The combination of these two events (US becoming a CREDITOR nation importing more than we exported, and the fact that we CONSUMED more oil than we produced) that led to a near collapse of the Bretton Woods system in 1971. It was triggered by France, and their reluctance to buy US Treasuries with their spare US Dollars. Instead, they demanded the gold equivalent of those US Dollars. This would have been catastrophic had it been allowed to happen. Because there was way too many US Dollars out in the system to be all converted to Gold. And it was feared that if France was allowed to cash out USD’s for gold, that there would be a rush of other countries doing the same.

In reaction to this panic, President Nixon closed the so-called Gold Window; meaning that the US would no longer convert USD’s for gold on the international markets. This led to a financial crisis that many feared would lead the world back to 1929 and the worldwide depression. The leaders of the financial world met back in Bretton Woods NH and hammered out another agreement.

It is this agreement that has led the United States to wrack up an astounding 16 trillion dollar national debt (nearly 70 trillion if you count unfunded liabilities, such as Social Security and unfunded wars). The agreement was called The Bretton Woods Agreements and was signed on to by nearly all the major (and minor) economic powers of the world.

It is a system that no longer relies on Gold as a backing for international currencies. It is strictly a paper system that pits one currency against another, based on relative worth as determined by the open markets.

But there is something the world forgot. Or more likely, they couldn’t figure out how to extricate themselves from the hole they found themselves in. They forgot that the US Dollar still denominated every single thing of worth on the planet. The biggest of which was (and still is) OIL. By the 1970’s it was OPEC that was determining oil prices world wide, and the United States had to come up with a way to keep these small oil rich countries from sinking the US into another Great Depression.

The answer was PETRO DOLLAR RECYCLING. This is a term I am sure you all have heard but maybe you don’t fully appreciate what it means. If you are familiar with Mr. Ruppert’s work on narcotics, I am sure you have heard the term Narco Dollar recycling. It is the same concept. Starting in the mid to late 1970’s the United States made hard agreements with Saudi Arabia and in essence agreed that an attack on the Middle East was the same as an attack on the United States itself. Known ultimately as the Carter Doctrine (officially announced in 1980), it was understood that any country that messed with Saudi Arabia or any of the other large oil producers in the Gulf, ran the risk of being on the receiving end of the United States’ military might.

To this day, it is what keeps the Bretton Woods agreement in affect. From the 1970’s to this day, our entire existence is shaped by this agreement. What this meant was from that day forward, DEFICITS IN THE UNITED STATES DID NOT MATTER.

It took nearly half a decade for this agreement to cement itself and for the economies of the world to start to stabilize and in the end it took the economic genius (insanity) of a group of men that surrounded a new president in 1981 to fully utilize the power the world had given the United States. It became known as either “morning in America” or “voodoo economics”. It was a realization by those in charge in the United States that they held the reigns of a never ended money-printing machine that could literally continue forever.

If you look at every single chart regarding debt and spending in the United States, you would see a steady and never-ending acceleration of debt and spending starting in the late 1970’s and continues right up to the minute I typed this sentence. The world gave the United States carte blanche to spend at will… WHY? Because there is no other option.

If you are Greece and you want to buy oil from Kuwait, you must still do so in US Dollars. You must exchange euros for US Dollars first, buy the oil from Kuwait and then Kuwait has pretty much one of two options on what to do with those dollars. They either buy US Military hardware, or they buy US Treasuries.

So the insatiable appetite for oil worldwide only strengthens the United States with every single transaction. It allows us to spend over ONE TRILLION DOLLARS more than we take in every single year. The amounts are absolutely irrelevant though. We could move the bar to TWO trillion and the system could still keep pumping away.

WHY? Because at its very heart is military force. It is why we invaded Iraq after 9/11, it is why we threaten to invade Iran. It is why Iceland was punished for turning its back on the system several years ago, and it is why Greece is being forced to eat Austerity instead of doing what is in its best interest and throw the Euro overboard and shirk its “responsibility”.

Without the world accepting US Dollars as an intermediate for payment in the global economic system, the US and by proxy the entire US connected world would fall into a complete and devastating global depression the likes of which have never been seen.

That is the stakes they are playing against and is why you are here. It is why you should be religiously working towards local solutions to the problems that face you and your community. Because just like the British system in the 1920’s, the US System is going to fail and when it does it will make the Great Depression look tame. And the unfortunate end to most global monetary systems is war and famine.

If you look at history through the lens of economics and monetary systems, you will see that what we are living through right now has happened countless times. Just never on the global scale, we are threatened with now. Almost to a one, there is a war that meets the end of any global or regional monetary system’s demise.

It can happen again. Only the stakes are so much higher now than they were even during World War II. I wish this lesson could end on a happier note, but reality is reality. Moreover, ignoring history can be fatal to ones family and friends (and one’s self); best to understand the stakes and the dangers and move forward with a plan that can insulate you from the worst of what may be coming our way.

Sorry for the length of this post and if you made it this far, please drop me a note below and tell me what you think. This feedback will help me construct better lessons in the future.

 

Robert F Denner

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