Column #345      April 15, 2022M2 Money Supply from FRED

Why do we need to discuss this? Because everyone should understand how our nation’s money and credit system functions. The value of our currency touches everyone on a daily basis just like the food we eat. Both involve survival! If one doesn’t understand either one, they are just another lemming racing along with the mob. Unfortunately, most Americans believe there’s integrity in our financial system. But the integrity disappeared more than 100 years ago. Our modern financial system is not structured the same as it was 200 years ago and the majority of Americans have paid for it.

Prices for individual goods and services are always changing, even in a sound money and credit system. But over years and decades, in a sound money system the average price for nearly everything remains the same as measured by the money and the other goods and services. When prices for all goods and services are in a sustained rise, like what has occurred since 1933 and what we’re seeing today, that’s abnormal and is caused by bad monetary policy. In effect, watering down a currency is another form of taxation. It’s an old trick whereby corrupt governments require good coins for tax payments and then they pay their obligations in debased coins.1 2

For the first 150 years or so following our nation’s founding, prices of goods and services were stable. Even with that stability, short-term business conditions cycled up and down. Yet through it all, the gross domestic product still grew and people prospered even with the business cycles, wars, climate changes, and new technology.

The long period of price stability from 1800 to 1933 was due to the gold standard which was abandoned in 1933. With a gold standard, only gold was money and any instrument promising future payment was debt. Currency in circulation was a debt instrument redeemable in gold on demand. Banks were far more conservative under that system because, when they made loans, the currency they lent the borrower was redeemable for gold the bank held in reserve. That forced banks to be very fussy about payback terms and the liquidity of the collateral being held to secure the loans. Long-term loans were considered to be very risky. So banks did mostly commercial loans for funding inventories or highly liquid assets that either turned over quickly or could be liquidated almost instantly. Consumer loans, made to consumers to buy stuff, were considered very risky because often there was no collateral or the collateral was very difficult to liquidate.

Back in the days of yesteryear, prices went up when banks made consumptive loans that expanded the money supply faster than the supply of goods being produced—just the same as today. A sudden increase in the currency supply creates excessive demand for goods and that buying pressure is what pushes up prices. That can go on for a while, but eventually the people and businesses that accumulate the banks’ currencies begin to be concerned about whether or not the banks can redeem their currencies in gold. That’s when the currency holders turn their currencies in for gold which draws down the banking system’s gold reserves and forces the banks to stop making consumptive loans. In some cases the banks had to demand that its borrowers pay off their loans. That would further shrink the supply of currency circulating in the marketplace, slow down economic activity (create a recession), and prices would fall back to the baseline.

With a money-backed (gold-backed) credit system there was a limit as to how far the outstanding credit could contract. That’s because as debts were reduced and the banks’ currencies were redeemed, only the strongest credit instruments remained along with the physical gold held by the banks and the public. Since real money can’t disappear, the money and credit system could not contract to zero. That was a good thing because gold was the foundation for the next credit expansion.

There has always been a political battle advocating for a central bank—a government bank that manages the economy and creates perpetual prosperity. In 1914, under President Woodrow Wilson the banking crowd finally got their way and the Federal Reserve Bank was established. It was assigned the multifaceted and conflicting job of: maintaining full employment, keeping the currency stable, and regulating commercial banks—all at the same time. So far, in its more than 100 years of active management the Federal Reserve has been a dismal failure. Under its watch the dollar has lost 97% of its purchasing power, employment still gyrates up and down, business cycles are more volatile than ever, and debts have never been higher. These failures were caused by the Fed’s perpetual prosperity goals it “paid” for by exponentially increasing debt faster than the growth of our nation’s economic activity. The growth of debt has been so excessive it’s now no longer possible to pay off the accumulated debts without totally crashing the system.3

Before the creation of the Fed, credit liquidations would run their course wiping out misallocated resources which set the stage for a healthy rebound. With the Fed, the purging actions of credit contractions were cut short by printing more money. It’s like giving candy to a spoiled kid. Consequently, the misallocations of the past get carried forward into the future which weakens both the monetary system and the business community. As can be seen in the official Fed M2 Money Supply chart, the M2 money supply measure exploded higher by an unprecedented 43% from January 1, 2020 to April 14, 2022—only 27.5 months. Since our so-called “money” represents debt, this illustrates the seriousness of the government’s wayward policies. It also explains why prices are exploding higher.4

The really big problem with our current monetary system is that currency is created when loans are created—just like under a gold standard. BUT, none of our modern currency instruments are backed by gold. They are all backed by another IOU! That means when debts are paid off the $22 trillion currency supply (M2 Money Supply) shrinks by the same amount as the reduction in debt. Since there is no actual physical money (gold) in our modern monetary system to cushion imploding credit, today’s debt structure can collapse from its current $90 trillion level to zero. (This debt level doesn't take into account our country’s unfunded liabilities which total an additional $168 trillion.)5

Total debt in our country has reached a top-heavy point where the next credit contraction could morph into an uncontrollable credit implosion of debt liquidation and bankruptcies. And, I repeat, unlike when there was a gold-backed credit system, today’s credit structure consists of debt instruments backed by debt instruments. That means a credit implosion can cause a complete collapse of the money and credit structure right down to zero. Obviously, creating the Fed didn’t usher in more security. It made the entire financial structure more vulnerable.

The Fed created the inflation mess by promoting consumptive debt. If commercial banks weren’t liberal enough in lending money to consumers so they could rush out and buy stuff, the Federal government borrowed from the Fed to give dollars to people to spend for stuff. In the past two years trillions of dollars were handed out to people who weren’t even working. The result was a shock wave of demand for stuff that wasn’t being made. That caused today’s soaring prices for everything.

This inflationary mess can only be dealt with in one way. Credit growth has to stop and that calls for higher interest rates. Higher interest rates will cause bond and stock prices to fall. Demand for goods and services will slow and eventually shrink. Business earnings and employment will fall and that will cause even greater drops in the stock and bond markets. The Federal government’s deficit will get much worse as the interest expense on its debt soars. Something similar to this occurred during the 2008 and 2009 real estate and stock market collapses which caused the Fed and Federal government to panic and rush to the rescue with more debt. But this time, today’s everything-bubble cycle has further to fall.6

When price inflation is running 10% annually that puts tremendous upward pressure on interest rates. Who would lend money out at 2.5% when its purchasing power is depreciating at 10%? Consequently, the Fed is currently losing control of market interest rates. In other words, interest rates are going up ahead of what the Fed has planned. Since higher interest rates will retard economic activity, it won’t be long before interest rates continue to climb for fear of defaults and the Fed will really be stuck.

During the coming credit contraction, everything priced in dollars will fall in price. Yes, even oil and food prices will come back down. Big ticket items such as housing, new and used automobiles, airplanes, boats, motor homes, artwork, crypto, and commodity prices will be crushed. And they will all go down in price against the dollar because dollars will be required to meet dollar-denominated debt obligations. As the debts are paid off, dollars become more scarce causing prices to fall even faster. So it may not be too many more months before cash will be king.

Bear markets (declining prices) usually move quickly which is why they are often called crashes. Therefore, the coming crash will be a “surprise.” How the Federal government and the Fed react to the crash will depend on our country’s leadership. If the woke crowd is in control it will certainly panic as it has in the past and try to stop the contraction with consumptive debt. If they do, that might be when people should shift from holding dollars to holding gold. It may only take about $600 to buy an ounce of gold when that point is reached. But gold won’t stay at that dollar-based price for long if the Fed starts printing. Amazingly the Fed is still obsessed with the nonsensical idea that a good economy requires a 2 percent inflation rate. Therefore my guess is that when a crunch comes it will eventually start printing dollars willy-nilly. If that occurs, the United States will likely experience a hyperinflation that will be similar to its experiences with the Continental and Confederate currencies.7 8

John Exter used to say that “confidence is suspicion asleep.” Currently, many Americans still have confidence in the Federal government and they think the Fed can control the debt monster it created. But the bureaucrats and oligarchs have about as much control over the debt bubble as they do the virus. Following a total failure of the debt-backed credit structure, confidence will be shattered. This is why being prepared is important.9

It’s time to trade out of assets and accumulate cash—yes, dollars. This has to be completed before the masses discover that the Fed has removed the punch bowl from the party and increasing market interest rates will cause the dollar supply to shrink.

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:

1. They’ve Secretly Raised Your Taxes by James Rickards from The Daily Reckoning

2. Debasement from Wikipedia

3. The Fed Can't Fix the Economy, but It Can Break It by Jon Wolfenbarger from Mises Institute

4. M2 Money Supply Chart from Federal Reserve Bank of St. Louis

5. US Debt Clock

6. David Stockman on the Coming Bond Bear Market… And What Comes Next by David Stockman from International Man

7. Early American Currency—Continental Dollar from Wikipedia

8. Confederate States Dollar from Wikipedia

9. A World Upside-Down by Ted Slanker