If you understand how the financial system works – and it doesn’t work very well – you will see that our government ran up the debt on purpose and actually has a good reason for it.
The mortgage loan crisis and the recession that followed caused banks to stop lending. I’m going to breeze over why this part happened and say that it had to do with their reduced liquidity (ability to lend) and dismal growth forecasts (desire to lend).
In our financial system – and the financial systems of other developed nations – money is created through debt. When you borrow money to buy a car, the bank does not lend you its own money. It takes a very low-rate loan from the Federal Reserve Bank and lends you their money at a markup. The Federal Reserve Bank that “loans” money to your local bank does not draw from cash sitting in an account. Instead, it actually creates money out of thin air. When it writes a check, money is created.
Only 5% of money in our nation is hard cash; 95% is numbers on a screen, and it is created when businesses, individuals, and governments take out loans. So when the stock market nearly collapsed in September of 2008, those “numbers on a screen” dropped precipitately in value, and the result was a reduction in the available money supply.
I’m sure you understand how the money supply relates to inflation and deflation. An increase tends toward inflation – each dollar is worth less. A decrease, however, tends to cause deflation in the absence of competing factors. Deflation means that each dollar is worth more. This might sound like a good thing at first glance, but it really means that all your debts, expenses like rent and food, along with consumer goods, effectively become more expensive and burdensome. Do you see why? There are fewer dollars to go around and so they are more difficult to come by, while expenses stay the same for a period of time.
That period of time is not indefinite, but long enough to have a devastating spiral effect on our economy and then the global economy because they are all intertwined. The only known way to avert this is to pump massive amounts of money into our economy. Banks were unable and unwilling to do it themselves, so our government did it. As mentioned above, in our current financial system, the way to create money is by taking debt, and that is exactly what happened. Our national debt exploded, but our lives continued without a great depression.
Politically, leaders in government cannot say they are increasing the debt solely to increase the debt. But that is what they’re doing and they have sound financial and economic reasons for it. Is this okay? In our current system it is necessary, but I would like to see a new system where government creates its own money rather than the Federal Reserve creating it through loans.
What effect will this have on our quality of lives? We’ll probably have another lost decade or two of economic growth. We’ll work longer, retire later, cut back our lifestyles, and spend a greater share of our income on necessities. However, there is still the possibility there could be a financial collapse similar to the one the bailout and stimulus averted.
One more thing: Republicans understand how the financial system works, and they don’t want the economy to collapse on their watch. Expect most of them to say one thing and do another concerning the national debt.
Alexander Typaldos
I genuinely loved engaging in your blog site these days and locating out just how essential this topic is to people. It would be so advantageous for friends of mine to visit this website and see your beneficial subject material as well. Thanks for sharing!
Comment by Fomc Meeting — September 21, 2011 @ 10:05 am
You are correct in identifying reduced liquidity and dismal growth forecasts as a call for action for the FED to step in and pump cash into the system to ward off recession ( and I will give you the pass on the cause of this situation), but there was a choice of how to pump these debt created dollars into the system. The FED chose to reward, protect, and insulate from failure the bankers and wall street top 1 percent at the expense of the masses. They protected the wealth at the top, but in doing so did nothing for stimulating demand and improving growth forecasts.
The more moral choice would of been to give the money directly to the citizens to spend as they saw fit. The bailout was/is about 4.6 trillion and citizens over 18yo are approximately 225,746,457. So each citizen over 18 would of received $20,376. This is how you have a fair bailout while increasing demand and growth forecasts.
Unfortunately since the end of WWII decisions on finance have focused on entwining the worlds currencies to protect the wealth of the banking class at the expense of the masses.
Enslave the little man by extending him high interest consumer debt verses increasing his wages. One approach enslaves the other empowers………
Thanks for your thoughtful journals!
Comment by Mark Cable — October 31, 2011 @ 11:31 pm