Genom of Capitalism Explanation of state debt origins & profit creation sources

12. Methods of monetary reform

If government is supplementing the missing buying power through transfers, which are financed either through monetary policy (monetary easing) or debt, system is functioning. Functioning but there are certain negative processes occurring, that will sooner or later stop it or significantly worsen its performance.

a)      Growth through debt

In case that state is complementing buying power of its citizens through growing state debt, this debt is getting bigger and bigger until it reaches certain psychological threshold. At that point certain politicians will get their heads spinning and they start thinking along these lines:  Hmm, something is definitely wrong, we are eating out our future generations.

Further factor, that is influencing politicians as a break against further debt increases is increase of interest paid to service the debt itself. The idea that can get into their heads is: How much could we have done just for these interests!  Let´s repay the debt and we shell save loads of money!

Economy based on profit needs additional resources so the planned sales can be realized at all. Otherwise only the part equal to the paid wages would be realized and that would mean no profit.

The fact that debt needs to be repaid is just an inconvenient aspect of this financial instrument. The creditors are asking for that and they would be really unhappy if they did not get their money back.

In case of above mentioned head twisting there are usually 3 basic options:

1)      The country starts brutal austerity measures as a method to decrease indebtedness

But it brings only:

-          Fall in government spending
-          Fall in buying power, sales
-          Increase in unemployment
-          Fall in collected taxes as consequence of fall in sales
-          Increase of state deficit
-          Ratio debt to GDP is not better or even worse because of recession

 This phenomenon is seen at Greece, Spain, Portugal, and Italy – in all southern Europe, which is trying through austerity to restore its “competitiveness”.

They cannot succeed, it will only deepen the recession. Debt was the factor, that was allowing the growth and so naturally by its decrease it will lead them to exactly opposite situation – deep recession.

By theoretical repayment of all debt the whole country would be totally paralyzed, with astronomical unemployment and totally devastated economy.  Gradual repayment of debt during recession will erase all companies, their products will have no consumers to buy. The people need money to trade, they cannot use seashells, mirrors or beads.

After such debt repayment the only way how to restart the economy again would be to create it as big as before! This is the only way to get money between the people as an absolute necessity to restart the trade again.

So why bother with repaying if at the end we shall have no other option than to incur it again?

If there would be a way how to save the pain connected with recession, which can last many years and destroy whole industries, it would be worth trying it.

2)      Therefore the second way how to solve the debt is monetary easing.

Soooo….  Inflation!!!!
No, just monetary adjustment of money that is missing in economy. Whether inflation follows depends from prevailing character of businessmen. More about that in chapter Collectors vs. Inflators.

It is the most guaranteed method and it is directly related with method of growth through monetary easing. The point of this method is easy: Government directly repays part of its debt through monetary policy (next chapter). It is the same method as with growth through monetary policy, but here growth is first realized through debt and is then amortized through new money.

3)      The fully fledged monetary reform – capital destruction.

It is rather drastic way how to get rid of debt but works fast and reliably.

The government is borrowing and accumulating the debt and the result of this activity are redistributed financial resources that supplemented missing buying power and at the end parked at somebody’s bank accounts. The ways how these money get there were different as are the final owners. Today it is impossible to say who the final beneficiary of original transfers is. But we can clearly say that the debt of state is an equivalent of certain amount of money which after many transactions ended again in banks.

Therefore instead of lowering the government expenditures by which we are lowering the additional resources that are contributing towards supplementing the buying power we can tax directly the money at the banks.

If it is done as a once of operation, it is indeed a monetary reform where all citizens will lose part of their savings based on some proportional principle. The ratio is determined as proportion of individual savings on total bank deposits compared to debt we need to eliminate.

It can be named as partial destruction of capital as it includes partial erasure of past profits (savings).

This method is indeed radical and citizens can see (and do!) it as a theft. Its impact on psyche was already tested in history, where it was used for example in past Czechoslovakia in 1953 (for different reasons, but based on same principle). The consequences were devastating, people felt great injustice, many committed suicides, there were riots on the streets and army had to intervene. In their understanding the government took away from them their life savings.

 These saved money could had been saved only because the state incurred the debt. Without that debt there would be no additional buying power, which allows the wheels of economy to turn and substitutes the savings and unused profit.

In its essence the monetary reform of this type is just, if it is done fairly (proportion of one’s savings on society savings is the same as ratio of taxed capital) as it hits mostly these, who withdrew most capital from the economy and so contributed towards inevitable debt.

To make this reform work you need to have fully digital financial system, which is not allowing cash payments. If the currency would exist also as cash, it would be necessary to change whole cash supply for new type, otherwise there would be immediate run on banks in order to avoid such taxation by withdrawing as much as possible.

Sounds drastic, but definitely less harmful then gradual repayment of debt connected with recession, with no hope for success.

During once off “destruction of capital” there is no lengthy agony of decline in economic activity, mass unemployment and destruction of very inner relationships in society and economy. It is a once off write off of assets and liabilities without any changes to continuous buying power (if we forget the psychological impact of reform to spending). People continue getting the same wages, their monthly buying power is not changed. Companies are not losing customers, they can produce as before and continue to record the same profits as before reform. State can start borrowing again and growth of debt can restart as well. (By taxing of deposits the government will repay the existing debts and so this money will end at the accounts of lenders – and so they can start lending again). Economy activity remains unchanged, there is no recession and the debt is repaid from to say “unused” capital that is rotting in the banks and is no longer willing to finance further transfers of the state which are necessary to maintain the cycle.

b)      Growth through monetary policy (monetary easing, monetization)

In this variant state is supplementing missing buying power with monetary easing adjustment through central bank. Even it may sound as heresy, this method is producing better results as debt.

The result is the same, added buying power will allow the cycle to continue, profits are made and economy is producing its millionaires who are appropriately proud how they achieved their goals by their own activity and productivity.

In this part it is important to say that monetary easing, if applied with reason constitutes the same inflationary factor as money made through bank multiplication.

So what is the correct scale?

If we take into account that every 1000 $ deposited at the bank and subsequently loaned at reserve 20% creates 4000 $ new money (every new loan is lower by reserve requirement, then returns back to bank as new deposit which is again loaned out....1000/0,2 – 1000 original depozit) so creation of 4000 $ by central bank creates the same inflationary effect as is created in expansion phase through banking system.

Compared to banking system it is not causing the reverse phase of contraction, which occurs during repayment.

While bank expansion is in fact not increasing aggregate buying power of individual during his life ( what he borrowed, will have to return – see chapter growth through loans) but is indeed lowering it (through impact of interest), monetary easing and their subsequent redistribution through transfers represents its permanent increase.

Therefore monetary easing is the only way of profit creation without negatives of cyclical development. State debt is working only until repayment begins. Then recession starts, and all profits are erased.

Of course, there must be certain limits to new money injection, otherwise situation like Zimbabwe follows, where hyperinflation destroys the whole economy. These limits are determined by level of expected/desired profits in the economy that is new money should be no more than planned profits.

And here we come to the problem linked with this method:  After certain time now the heads of businessmen will start spinning. They will realize that something is not right, where are all these money coming from?

The business results are looking good, economy is working, profits at the bank accounts are growing and millionaires are becoming billionaires.

If such question would not come to light there would be no problem and the system could continue to eternity. It is indeed the same dilemma as with ever growing state debt. As long as investors are willing to finance it, its growth can continue forever.

From the point of supplementing the buying power the result during ever growing debt is the same as with monetary easing.
Debt, same as monetary easing can go forever if new owners of redistributed money are willing to lend it again to state.

But the psyche will again start playing its role and businessmen will start asking what is the value of the money that are making them millionaires. In reality its value is the same as with profits created through debt and so is nil. 

It is impossible to create profit without debts or additional monetary easing.

The same way the debts will have to be repaid some day and by doing so the past profits will be erased, new money have no value as well as they represent only worthless pieces of paper.

Businessmen trust more profit, which arose through debt, as this represents certain obligation of the state to return the borrowed. As this obligation was never seriously tested in the past (but for examples of some countries  of the third world and now in Europe) they are not expecting massive failure of banking system that would inevitably follow after this obligation would be broken and the following erasure of their profits deposited in that system.

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