Between a Rock and a Hard Place
Column #371 October 7, 2022
If Americans only have one blind spot in their educations, it most likely involves money. Maybe that’s because it takes blind faith in our current credit system for it to function. Very few people actually know the history of money, its classical definition, why the dollar lost 97% of its purchasing power since 1776, and why paper money is actually an IOU—and can never be money.
Everyone knows they can pay for stuff with our nation’s clad coins and paper currency. That’s very easy to grasp. They also know that debt is a liability and having too much debt can make life miserable. On the positive side, today there’s a growing minority that seems to understand that when too many dollars flow into the marketplace prices of commodities, goods, and services go up.
But, when it comes to the big picture, the vast majority of people believe our nation’s Federal Reserve Bank is capable of managing the nation’s “money” supply so that over the long-term the integrity of the currency and full employment is assured. It’s the classic utopian dream of perpetual prosperity. The very idea that our nation’s credit system can reach a point where it’s between a rock and a hard place never enters their minds. But that’s exactly where we are right now.
A few days ago the New York Times explained the predicament this way: “America’s central bank, the Federal Reserve, is trying to strike a delicate balance: It has to take steps to slow down the economy to bring inflation under control—but it wants to do so without causing a severe recession.” Unfortunately that’s an explanation for novices that leaves out the really important details.
To stop currency debasement, slowing down the economy is not the goal. What must happen is that first the supply of dollars must be reduced versus the supply of goods and services available in the marketplace. Then when prices stabilize, credit growth must be kept in balance with goods and services with lending for consumption greatly restricted. The result of that approach is the growth of debt will slow down significantly. Since our highly leveraged economy depends on people, corporations, and the Federal Government spending all their incomes plus what they borrow, a slow down in debt accumulation means business conditions will slow down which can cause a recession or depression.
Looking back, since 1932 our country has been on a debt binge to the point where today’s outstanding debt has reached unsustainable levels. The Federal debt is $31 trillion. Six percent interest on the government’s debt would be $1.86 trillion yet its tax revenue is only $4.9 trillion. The nation’s total debt is $92.4 trillion. The nation’s Gross Domestic Product (GDP) is $24.8 trillion. Six percent interest on the total debt is 22.35% of GDP. These interest expenses cannot be handled which brings us to our current predicament.1
The rock is hyperinflation which will quickly destroy the currency and eventually cause a depression. The hard place is a collapse of the credit system (liquidation of debt) and a depression. Both are possible outcomes. Both options bring financial hardship. Both options may lead the other. Here’s how that happens.2 3
Our currency is not merely a piece of paper with ink on it that says it’s legal tender. It’s a Federal Reserve Note—an obligation of the Federal Reserve Bank. When the Federal Reserve creates a dollar it also creates a one dollar liability. In other words, our currency is only created when it’s also borrowed. Either the Federal government (or other entity) sells bonds that the Federal Reserve purchases with new currency or the Federal Reserve purchases assets in the marketplace with new currency. Therefore, the Federal Reserve Note (which is printed on all of our currency) is backed by Treasure Bills, mortgages, and corporate bonds all of which are payable in dollars. Yes, our “money” is a credit-backed credit instrument and it’s value totally depends on confidence.
When the overall price level for commodities, goods, and services are increasing at accelerating rates, this can quickly morph into hyperinflation. The demand to borrow more currency takes off and the Federal Reserve buys everyone’s debt instruments with its Federal Reserve Notes. Then as total debt grows exponentially the currency quickly loses its purchasing power. Interest rates will increase because who would want to buy a ten-year $1,000 bond that only pays $30 per year when price inflation is 10%? To compensate for the interest rate change, the price of the 10-year bond must drop to $570 so its yield to maturity is 10%. When new bonds are issued, they will pay $100 annually on a $1,000 dollar bond. So you can see that at some point higher inflation rates cause increasing interest rates that eventually shut down the entire system.
To avoid a hyperinflation-induced stagflation, the Federal Reserve is trying to stop the current inflation cycle by slowing down the rate of borrowing. It started by “letting” interest rates increase. Then it started reducing its asset holdings by selling bonds and mortgages or simply letting them be paid off without buying new ones. Those asset sales reduced the Federal Reserve’s balance sheet, shrinking the supply of currency chasing goods and services. As borrowers decide to pay off debts that also shrinks the money supply.
This is where the hard place really comes into play. During the years when interest rates were dirt cheap and borrowing cheap money was a fad, borrowers took on debt like drunken sailors to buy way more than homes. People bought new cars, planes, RVs, boats, and splurged on fancy clothes and good times. Corporations even borrowed money to buy their own stock. Home owners flocked to adjustable rate mortgages. Pension funds got short-term loans at close to 0% and invested the borrowed funds in long-term bonds paying 3% to juice up their income in order to meet their pension obligations. Debt was painless and most purchases lost value over time or were consumed. But the debt remained.4
Unfortunately as interest rates increased holders of adjustable rate mortgages saw their interest rates double and their payments increase. Pension funds saw their long-term bonds plunge in price as their short-term loans came due! Overall, as the money supply shrinks and mortgage refinancings and inventory loans roll over at higher interest rates, business conditions will slow down. That significantly degrades the ability of highly leveraged debtors to service their more expensive debts forcing many into bankruptcy. When a debt goes bankrupt it disappears in a flash and so does an equal amount of the money supply.
Every bankruptcy weakens the financial position of the lender which can force the lender into bankruptcy. This deepens the depression and other businesses and individuals start to lose money and they too then fail. This defaulting action can quickly morph into an implosion of the debt structure which rapidly shrinks the money supply compounding the financial squeeze. Once this starts to happen the falling dominos just keep falling until there isn’t any left to fall.
That’s what happened between 1929 and 1932. The debt structure imploded in a spectacular collapse. But back then the credit system was based on gold (actual money) and gold can’t default. Therefore even though the credit system collapsed the money remained as a base for future credit growth. Today, with our debt-backed “money” system, where Federal Reserve Notes are backed 100% by other debt instruments denominated in Federal Reserve Notes, a debt implosion is a far more serious issue. A debt implosion nearly occurred in 2008. But with a lot of luck, the Federal Reserve Bank and the Federal government were able to get the debt structure growing again and the cleansing of the weak credit structure was a can that was kicked down the road.
Because debts in our country are denominated in Federal Reserve Notes, as the debt structure implodes the demand for Federal Reserve Notes to meet debt obligations will soar. This means prices for ALL things will plunge versus Federal Reserve Notes. To everyone’s amazement currency will be king.
As the Federal Reserve Bank and the Federal government promoted borrowing and spending over the past 90 years by outlawing the lending restraints of being redeemable in real money, the nation finally reached the point where it’s between a rock and a hard place. Interest rates actually got down to zero while the Federal government borrowed from the Federal Reserve Bank and mailed money to consumers. That ignited inflation. Now interest rates are on the rise and will continue to rise for two reasons. One is to compensate for the loss of purchasing power (rock) and the other is the increasing risk of future defaults (hard place).
This means that no matter what the Federal Reserve Bank and the Federal government say they are going to do, they can only use head fakes to manage monetary policy. For the first time in decades, the action of the free market is more in control of our nation’s monetary policies than is the Federal Reserve Bank or the Federal government. At the same time the Federal government is insisting on fighting a proxy war with Russia, while rattling sabers with Iran, North Korea, and China. All this is taking place when the treasury is empty.
The rock and a hard place are basically this: If the powers-that-be want to stimulate the economy inflation will quickly get worse and interest rates will soar. If instead they want to subdue inflation, illiquid debtors will default and interest rates will soar as the currency supply shrinks dramatically. The primary financial defense is to get liquid and hold Federal Reserve Notes—CASH. Yep, everyone will think you’re nuts. But all dollar-denominated debts demand dollars to pay the interest and pay off the principle. Because of that dollars will soon be in great demand as weak borrowers are forced to liquidate assets for dollars.
To your health.
Ted Slanker
Ted Slanker has been reporting on the fundamentals of nutritional research in publications, television and radio appearances, and at conferences since 1999. He condenses complex studies into the basics required for health and well-being. His eBook, The Real Diet of Man, is available online.
Don't miss these links for additional reading:
2. Value of $1 from 1776 to 2022 by Ian Webster from Official Data
4. FRED Charts from the Federal Reserve Bank of St. Louis
● Consumer Price Index for All Urban Consumers: All Items in U.S. City Average
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