Many years ago, I worked at a bank. One of the first things you learn as an employee of a bank is that a whisper of doubt can cause the bank to experience a bank run, and the bank will collapse. There is not a bank in this country that can survive a bank run.

All banks are vulnerable to bank runs, and this is due to the simple fact that no bank is 100% capitalized. The way banks make money is by lending deposits out and hoping that they have enough money to cover their customer’s needs. With Central Banking, the member banks (retail banks) all have their own bank (the Central Bank) where they can borrow money from each other if they need to meet needs for their customers and don’t have the cash. Finally they can borrow money from the Federal Reserve who acts as a lender of last resort to institutions.

Back in my day (I say this un-ironically) banks had reserve requirements. The reserve ratio was 10:1. This meant for every $10 in deposit, a bank could make $100 in loans.

Right before the pandemic started, the Federal Reserve suspended the reserve requirement and instead borrowed a model from other Central Banks. In this model all that matters is capitalization, not cash deposits. A bank is considered capitalized if it had enough “assets” to meet withdrawal requirements. Assets include cash, loans, and other financial instruments.

The problem with this model is that a bank considers itself to be solvent until a loss occurs. During recent bond market turmoil, low rate bonds lost a substantial amount of value. Some banks, SVB, being one of them, realized that they needed more cash. They attempted to liquidate some bonds and realized at that point that their bond portfolio was no longer valued at the same amount as it had been earlier. They went from solvent to insolvent just like that.

The Federal Reserve exists primarily as a means to allow banks to take on substantial risk lending money. Why is this? It’s because new money is created from the issuance of debt. Borrowers not only create new money, they create demand for products they could not buy otherwise.

Lending:

Lending activity is how an economy grows. As we stated early, the old reserve ratio of loans to cash was 10:1. Today the reserve ratio is essentially undeterminable since banks can count non-cash assets as capital that can be lent against. There are figures banks use to determine withdrawal requirements, but the metrics are not so cut and dry like they used to be.

A bond itself is promise to repay a debt that is issued by a company or government. The new Fed policy allows a bank to count a loan made to the US government to be used just like a cash reserve and as collateral for another loan. They see this debt as good as cash, except it’s not due to the fact that bonds are priced on the secondary market based on their interest rate. If rates go up, like they have recently, bonds with lower interest rates must be discounted. Additionally if the credit rating of the issuer takes a hit, the bond must be discounted. This does not happen to cash deposits.

During the last 10-15 years the Federal Reserve made a lot of money through the various programs they used to stimulate the economy. They currently have over 8 trillion dollars on their balance sheet. One Fed representative named Neil Kashkari has said on tv that the Fed has “unlimited cash” to keep banks solvent, and the Fed will lend banks money at full face value if they are holding these bonds. This means that the only entity that decides if a bank is insolvent or solvent is the Federal Reserve. Bank failures threaten the entire banking system, which is why the Federal Reserve has worked to make sure that they very tightly control the process.

Since deposits generate loans and the ratio is unknown, we will still assume for the purpose of this article that loans are made at a basis of 10:1 of assets. This is probably a close enough approximation. This means that if you deposit $10 the bank can lend $100 to someone else. Where does that money go once spent? Back into the banking system. Let’s illustrate:

You deposit $10. Your friend now uses his credit card issued by your bank and buys dinner for the two of you. $100 worth. The restaurant deposits $100 into their bank, and now 10 more people are able to borrow $100 each. This is how new money is created in our system.

Before we had paper money, new money was only created when miners dug gold or silver out of the ground. This process by which money was added to the economy was a lot slower and less predictable. Governments could not simply will more gold into the economy. If the mines weren’t producing then they could fight a war or try to get some tribute but it wasn’t as simple as changing an interest rate. In a metal based economy, demand for goods and services typically grew faster than the supply of physical pieces of money (coins), we had a deflationary economy. Your money bought more stuff every year because there were fewer pieces of physical money to go around the economy. This is good for savers and bad for debtors.

The adoption of paper money creates an environment where money is created faster than the demand for goods and services. While the target inflation rate is about 2% per year, some years it’s much higher, additionally due to volatility in the market, food, energy, and housing among other categories are not counted in the official measurements. This is done to hide the true rate of inflation.

Inflation causes a devaluation of money. As more and more money flows into an economy, it buys less and less. This is good for debtors and bad for savers.

A high inflationary environment also gives the government the ability to punish groups they don’t like, or reward groups they do like. We’ll talk more about that below.

Inflationary Forces

Consumer Borrowing:

As we discussed already, consumer borrowing is inflationary. Every dollar you hold in debt is a dollar you put into someone else’s bank account. Let’s imagine you have $300,000 in debt. That is backed by approximately $30,000 of assets and it can generate $3,000,0000 in loans throughout the banking system. Prior to Covid, these were all cash, after Covid, a portion of these assets could include loans already made to other entities.

Wage Growth:

As wages increase, people have more money to spend. They put more pressure on the demand side and companies can either try to increase production or they can raise prices. Technology is a deflationary force. For example if the demand for burritos increases and instead of using people at restaurants to prepare burritos, I open a robot burrito chain that can make burritos hot and fresh 24/7, I am freed from human inefficiency and can lower the cost of my burritos to continue to supply the market. Without my burrito bot, I will have to hire more workers and in a shortage of workers or under a system with rising minimum wage requirements, I must raise wages to attract them. To do that, I must raise the price of my burritos or shrink my burrito (shrinkflation).

Consumer Spending:

During the pandemic people depleted their savings stocking up on hand sanitizer, masks, guns, ammo, deep freezers, gym equipment, work from home supplies, hair clippers and anything else that made them feel safer. Unlike borrowing, moving cash from one account to another doesn’t change how much capital is in the banking system, but it does put pressure on the demand side. When demand rises faster than supply, prices rise to meet that demand, until equilibrium is found.

Supply Chain Disruptions:

During covid where “non-essential” jobs were shut down, the supply side also experienced pressure. This helped propel prices of some categories of items through the roof.

Government Stimulus

During covid, the governments shut down the factories which was inflationary, they suspended debt payments, also inflationary, and then they printed money and gave away billions of dollars. Free money to buy products that were all experiencing shortages and disruptions.

Business Borrowing

Business borrowing is also inflationary. Small businesses borrow money like you or I. They simply get a credit card or a line of credit. However when a Wall Street firm wishes to borrow money they so through the bond market. These loans can be in the order of hundreds of millions of dollars.

Thanks to the recent changes at the Fed, it is now possible that bonds issued by highly rated firms may be used as capital to meet capitalization requirements. 1 billion of corporate bonds can become 10 billion in new loans. Remember, every loan you take is a deposit someone else makes, which finances more loans.

Low Interest Rates:

Low interest rates encourage borrowing. Borrowing is inflationary, therefore low rates are inflationary. Since savers are paid interest based upon the interest rate climate, low rates for borrowing means low rates for saving. It disincentivizes saving, and encourages people to spend every penny. This is also inflationary as it puts pressure on the demand side. Additionally in a high inflation environment borrowing is incentivized not only by the low rate but also by the fact that the debt becomes smaller over time. If you can borrow money at a rate that is lower than the rate of inflation, it costs nothing to borrow. This is one of the biggest Aha’s of money. If you can use someone else’s money to obtain capital such as machines or other assets, and generate a return greater than the cost of borrowing, you are making profit.

But who would be dumb enough to lend money to others at a guaranteed loss? The answer is we all would be. We deposit money into the bank and earn nothing on it. The bank can lend it out below inflation and still make a profit because they are making approximately 10x the loan volume all the while we get little for our troubles. Here’s an example: Inflation is at 6%. Sally deposits $2,000 into her savings account which earns 0.25% APY. The bank uses her $2,000 to generate a loan for $20,000 at a rate of 4%. At the end of the year, Sally has earned $5.01 in interest, but the bank has earned $814 against the $20,000 they’ve lent out.

Banks use our money to generate fees from transactions (interchange), and from selling mortgages to Fanny Mae and Freddy Mac. They also earn money from overdraft and other bank fees, selling cashier’s checks, providing vaulting services, and earning money from real estate appreciation on their facilities bought with the profits of banking.

Government Borrowing

Here’s where things get interesting. Who owns the most government debt? Most people say China. Wrong. Japan? Wrong again. The correct answer is U.S. taxpayers.

The Government created the Social Security Program as a backstop to retirement planning. Right? It’s to help old people and others who wouldn’t save for retirement. Maybe. How it’s used though is as a guaranteed government lender. The Social Security Administration invests funds into government bonds. That’s right, we are forced to contribute money which the government then borrows. Who pays the interest on the debt? If you guessed taxpayers, you’d be right again! We pay, they borrow, they spend and we pay back.

Now here’s where things get cute. Where does all of the money that the government “borrowed” from us go? The answer is to Government contractors and other aid programs. The Government’s borrowing activity generates new dollars by borrowing money from Social Security and spending it with contractors. These contractors are paid billions of dollars and their deposits create tens of billions worth of lending capacity for banks.

The Federal Reserve sets the interest rates, low rates are another inflationary force mentioned above. As we know inflation benefits debtors, because as the value of money falls, it becomes cheaper to repay debts. This is because debt is fixed, if you borrow $150,000 today the value of the debt to the owner does not increase with inflation (unless you have a variable interest rate). In ten years inflation may have eaten 20-60% of the value of your loan.

As more money pours into an economy from borrowing activity, bigger debts become smaller debts because it becomes easier to obtain more money due to wage growth and price increases. Remember, inflation is simply the ratio of pieces of money in an economy to the supply of goods or services available to buy. When money supply increases faster than the supply of goods and services in an economy then it takes more money to buy goods and services. Labor is a service.

Since inflation benefits debtors and the Government is the biggest debtor of all, they favor a high inflation environment.

The Government Hides The True Rate Of Inflation:

The government previously provided inflation numbers (the Consumer Price Index or CPI) using a formula that measured a basket of goods and services to determine the rate of change in the prices. In 1995 the Boskin Commission introduced changes to how inflation was calculated. They claim this was done to create a “more accurate” picture of inflation. One example of the changes made was the introduction of Hedonic Quality.

The commission argued that since things improve over time people would naturally have to pay more for these improvements. For example, computer chips get faster, cell phones add features, clothes are made more sustainably, and these improvements are not necessarily indicative of inflationary price movement. So while the effect to consumers is the same, higher prices, the Boskin Commission found a way to reduce their inflation statistics by attributing some portion of higher prices to arbitrary and subjective metrics.

Here are some key changes summarized by ChatGPT 3.5:

1. Chain Weighting:
   • Before: The original calculation of the Consumer Price Index (CPI) used a fixed basket of goods and services that didn’t account for changes in consumer spending patterns. Price changes in the basket items were treated equally.
   • After: The Boskin Commission introduced chain-weighting, which adjusts the weights of goods and services in the basket over time. This accounts for consumers’ ability to substitute items when prices change. As a result, if consumers shift to lower-cost alternatives, the index reflects this change in spending habits, providing a more accurate measure of inflation.
2. Hedonic Quality Adjustments:
   • Before: The original CPI calculation did not account for changes in the quality of goods and services. Price increases were assumed to solely reflect inflation, even if some of the increase was due to improved quality.
   • After: The Boskin Commission introduced hedonic quality adjustments, which factor in changes in the quality of items over time. If a product’s quality improves, a portion of the price increase is attributed to the quality improvement rather than solely to inflation. This adjustment acknowledges that consumers are getting more value for their money.
3. Geometric Mean Formula:
   • Before: The original CPI calculation used an arithmetic mean formula, which calculated the average price changes of the basket items without considering the relative sizes of price increases and decreases.
   • After: The Boskin Commission recommended using a geometric mean formula. This formula considers the relative sizes of price increases and decreases, providing a more accurate reflection of overall price changes. It gives greater weight to larger price movements and reduces the potential bias introduced by the arithmetic mean.

These are just some of the key changes made by the Commission. When using the original method used between 1913 to 1996 the rate of measured inflation is often much higher than what is reported using the modified calculation. In 2022, CPI was around 6% but using pre-Boskin math, it was around 13%.

The Government also hides inflation another way. It publishes “core” inflation, which removes volatile components of CPI, namely food and energy. Over the last few years eggs went from 7¢ per egg to 50¢, an increase of 614% and we watched as many other food items spiked in price. Organic milk for example was $4.99 a gallon and now is often found for $9.99 a change of 100%. Core CPI ignores these changes.

Wealth Dilution

When new money is generated through borrowing, it is the borrower that has the power to distribute the new money. For example, if I borrow $2000 to build a home gym, the bank has minted $1800 new dollars (remember $200 backs the loan). I get to decide which company gets that money.

It’s the same with the Government. Governments borrow money and distribute that money to contractors. Contractors are often giant wall street firms who then thank the government for their business by donating millions of dollars of dark money to super pacs, and campaigns, and by providing jobs to high profile government workers who leave Federal employment.

When new money is created, it is not distributed evenly. Instead it goes to the richest people with the closest ties to political power.

If your income does not keep up with inflation your slice of the economic pie stays the same size, but the pie as a whole grows. This means your share of ownership of the economy shrinks. The Government being the primary source of new money supply through their borrowing and spending activities allows them to redistribute wealth to their friends and allies while normal mom and pop businesses are put out of business. This is why the middle class in this country has evaporated and the rich have only grown richer.

How it Ends

Inflation is a time-bomb. Every fiat based economy eventually fails. By giving the government the ability to grow the economy through their own borrowing and spending activity we become completely dependent on their largess. We become engulfed by their programs that influence commodity prices, and help pay for the very inflation caused by the programs. People rely on stimulus and aid just to get by.

The debt the government takes on increases their need for taxes and the more we’re taxed, the more they can spend and borrow. This is due to the compounding effect of fiat money. Inflation makes government spending possible and cheapens government debt.

Deflation is good for people who save. In a metals based economic system, where there is no expansion of the money supply through credit or fiat money, savers remove money from the economy. Removing pieces of money from the economy where it cannot be lent or spent increases the value or buying power of every ounce of gold in the system. In a deflationary system, you don’t need credit as goods and services get cheaper as the economy grows and the value of money increases. We can see this demonstrated with the hyper deflation seen in bitcoin. The bitcoin economy is still more of a proto-economy, not a real economy – however 12 years ago bitcoin was $8 and today it’s $26,000 – we measure bitcoin in dollars, but another way of looking at it is the buying power of 1BTC was $8 worth of goods and today it buys $26,000 worth of goods due to deflation.

Of all of the deflationary forces in a fiat economy, nearly all are related to an unhealthy economy. These include waning demand for goods and services, economic uncertainty, depopulation, high debt levels, high interest rates, etc.

Healthy Deflationary Forces in a Fiat Economy

There are two deflationary forces that are healthy for an economy. As we discussed earlier, in a metals based economy the primary deflationary force is simply removing money from the economy through the process of saving, which benefits everyone with money in the economy as saving increases the buying power of all remaining circulating money. A fiat economy must rely on competition, which can lead to higher efficiency and technological innovation which leads to lower inefficiencies and faster production of goods and services.

Whether governments are willing to admit it or not, the basic way that our modern economy functions relies on deflationary forces suppressing or mitigating inflationary forces.

China, Competition, and Globalism

We have been getting by on slow and steady population growth through immigration and a break even birth rate to keep enough workers funding the economy while technological improvements and automation have dramatically lowered commodity prices, improved manufacturing processes, and made transportation faster, easier, and more economical.

As competition became more intense we achieved economic gains by exporting American jobs to lower wage workers overseas but the good times are coming to an end as Chinese and other overseas workers require higher wages to survive in their own economies.

Much of our economic growth here in the states has relied on unique and unsustainable aspects of China’s emergence as an economic powerhouse. However, China has started to stumble. Their population decline is just beginning to catch up to them thanks to their 1 child policy. Additionally, their communist politics stifles competition and many of their technological innovations have come from piracy and theft. They are woefully behind in key areas including militarily and with their semiconductor tech.

The governments of this world have been played by the by the merchant class, true power lies in the hands of a few hundred billionaires. Governments have been checkmated, their only move left is to hinge their future on automation. Automation requires computational power, primarily in the form of GPUs and ARM processors manufactured by Nvidia and AMD. They’ll also need to develop a tax framework that taxes the labor of automated systems and replaces tax revenue lost by missing human workers.

To summarize, the monetary policies of world governments assumes 1) an ever growing workforce which will be able to shoulder the debts of the government 2) Ever advancing technological innovations that will reduce the cost of goods and services.

Why We Can’t Just Exploit Another 3rd World Country

The rise of China is unique. They have many ports, a large labor force, a unique culture, political, and regulatory climate. According to ChatGPT here are some factors that make China unique:

1. Proximity to Major Markets: China’s ports are strategically located near major global markets, including Europe, North America, and other parts of Asia. This proximity reduces shipping times and costs for exporting goods to these markets.
2. Access to Global Shipping Routes: China’s ports are situated along key maritime trade routes, such as the East China Sea, South China Sea, and the Pacific Ocean. This enables efficient connectivity to different parts of the world.
3. Containerization and Transshipment: China’s ports have invested in containerization and transshipment facilities, allowing goods to be easily moved between different vessels and routes. This enhances their efficiency and connectivity.
4. Infrastructure Development: China has invested significantly in port infrastructure, including deep-water berths, modern cargo handling equipment, and efficient logistics facilities. This has improved the speed and efficiency of cargo movement.
5. Special Economic Zones: Many of China’s ports are located within special economic zones, offering favorable policies for trade, manufacturing, and foreign investment. These zones facilitate trade and attract international businesses.
6. Industrial Clusters: Ports are often located near industrial clusters, where manufacturing and production facilities are concentrated. This proximity minimizes transportation time and costs for raw materials and components.
7. Inland Connectivity: China has also invested in developing a strong network of inland transportation, including railways and highways, that connect manufacturing hubs to its ports.
8. Economic Growth and Export Focus: China’s economic growth and export-oriented policies have led to increased demand for efficient port facilities to handle the growing volume of goods being exported.

Birth Rates

Birth rates are complex, because they can be inflationary, if population growth creates consumers who have needs that outpaces supply. One example is housing, another energy, as these cannot be as easily scaled as t-shirts or electronics. However, generally speaking more population means more workers, more workers pay more taxes. Specifically Social Security taxes. This allows the government to borrow and spend more money. Generally stable population growth is ideal for governments who need to grow the economy, which is largely accomplished through their own financing activity.

Birth rates are in the proverbial toilet. The reasons women are choosing fewer children or no children at all is complex. A hallmark of an advanced society is the education of women and girls. Anywhere women can obtain an education women choose to have fewer children. The reason educated women want fewer children boils down to the fact that society does not value motherhood but instead values direct economic contribution. Parenthood costs society in the short term and does not pay off until children grow into adults and can work and pay taxes. Our economy is in a stranglehold of time debt. We need every person putting money into the Social Security Program so that the government can continue to survive long enough to figure out what to do next. We don’t have time for children to grow up. Our strategy has been to import H1B visa workers and to leave the borders open. Illegal immigrants are working in our economy and they are legally obligated go pay all taxes on their income, including into Social Security.

Governments want the quick hit of women’s labor and the tax revenue it generates but they need new blood to supply the Social Security system with money. This puts the fate of the government solely in the hands of the female population and their willingness to risk life and limb to bear children. What modern countries are doing is relying on the free labor provided by women from economically depressed areas as they immigrate (often illegally).

This fate is also shared by all of mankind, as the human species cannot survive without mothers willing to bear and rear children. The mistake governments and our society as a whole are making is that they assume the biological need for women to produce children will outweigh the practical need of work. They believe women will continue to produce enough children for us to eek by.

While we are stuck with the economic and governmental systems that we have, the simple fact remains that society cannot have an expanding population to work and pay off ever expanding government debts without women. Since women are having fewer children, Governments simply cannot continue to spend as they have been. Population growth is stalling, birth rates are plunging, and at this rate there will be far fewer workers to pay taxes than the Government is planning on. This is the case in every country on every continent with the exception of a few South American and Africa. Countries that still remain above replacement rate.

The only way a government will be able to survive falling birth rates is by finding another way to tax the labor of automated systems.

The Limit of Technological Innovation

The government has to find a way to replace tax revenue from jobs lost to automation and from a tax base that hasn’t seen real wage growth since the 1970s. Their only hope is that technological advances will lower the costs of goods and services and that the market will find an innovative solution to curbing consumer demand for energy and housing.

Commodities, the building blocks of “stuff”, IE raw materials, are already extremely cheap. The costs that have increased most significantly and which impact prices heavily are energy and labor. How much more efficiency can we gain in areas of mining and manufacturing?

The real interesting area of automation is replacing service workers like accountants, retail workers, and delivery drivers with software. From what I’ve seen robots at this point can draw pictures and hold boring conversations. While they can do some neat tricks innovation and creation are not anywhere close. Robots can flip a burger but they can’t create a new burger flavor combination and a bot that flips burgers can’t fold a burrito. We are a long way off from cars that can drive themselves and robot accountants. Whether we get there or not seems doubtful, whether we get there in time seems impossible.

America’s Exorbitant Privilege Is Ending

After World War II, discussions took place to discuss the new re-ordering of the world. These talks took place at Bretton Woods. This agreement between 44 nations led to the creation of the IMF or International Monetary Fund. It also rested in the US Dollar becoming the reserve currency for the world.

Under this model, the entire world needed dollars to transact international trade. Predominately the need for oil necessitated much of this trade and demand for dollars. Having a global marketplace backed in dollars

According to the Economist, it was called America’s exorbitant privilege “…Because its currency, the dollar, served as the world’s reserve asset, America could live beyond its means, unconstrained by the periodic shortages of foreign exchange that haunted other, less privileged nations.”

Other nations have coveted America’s ability to print money without consequence, knowing that growing economies around the world demanded more dollars to buy more imports, like oil.

BRICS

Brazil, Russia, India, China and South Africa make up a trade coalition referred to as BRICS. These countries are no friend of America, with the exception of India and Brazil. China is using it’s relationship with these countries to jump start a dollar alternative called the Petro-yuan. These countries will agree to trade deals denominated in yuan instead of dollars, to reduce their dependency on American currency.

Just a few days ago, 6 other nations were invited go join BRICS. These include Saudi Arabia, Iran, Egypt, Ethiopia, and the UAE. The Saudis and UAE have oil, China is one of the largest importers of oil in the world. When China doesn’t need dollars for imports, America will have a much smaller pool to sink dollars into. This will put a major break on America’s ability to print dollars ad-infinitum and will further compound the other issues America faces with a declining population and the loss of our manufacturing base over the last 50 years.

America’s fate is sub-optimal to say the least. Our oligarchs are plundering our country’s resources, shipping our jobs overseas, concocting schemes which justify the spending of billions of dollars in aid including the Covid-19 response and the war in Europe.

If you’ve ever been a victim of a financial scam, the US economy is exhibiting classic signs of fraud. This is usually a short term indication that the ruse is ending as the fraud operator tries to get as much money as possible out of the operation before the victims realize what’s going on.

During Covid, the government shut down the economy for months at a time and placed burdensome restrictions on labor that disproportionately effected small and medium sized businesses. For the last year we have lived covid restriction free under the guise that the virus, while still prevalent in our communities “evolved” to became less deadly.

The reality is that this is disputed by common sense and easily obtained evidence which suggests the vaccine program which was expensive and unsuccessful, and the restrictions were largely unnecessary. While we all suffered under the draconian lockdowns, America’s largest companies profited greatly. Hundreds of billions of borrowed dollars were pumped into stimulus programs that benefited Big Pharma and the medical industry. We were all given $2000 checks for our troubles which we all promptly spent at Amazon and Wal-Mart.

As the Covid drama was wound down, a war in Europe occurred between a 3rd world country and Russia, who could end Ukraine’s existence with the launch of just 1 hydrogen bomb. We are all supposed to believe that somehow funneling money into a war nobody can win will somehow make the world a better place, and just like with Covid, regular people like you and I have no say over the borrowing and spending of our nation’s assets.

Money laundering is a privilege only powerful people are allowed to take part in. All of this money that’s being spent on Covid and on Ukraine’s defense is being washed through contractors and NGO and cycled back to the campaign funds of the politicians writing the checks.

The only way to win this game is to not play it. Taking steps to reduce your exposure to this fraudulent and failing economy will be outlined my next post.