The exploitation that creates hard times is easy to sell and rationalize when the economy constantly cycles from boom to bust and jobs are of critical importance to so many people. Boom. Bust. Hard times. Repeat. This inevitable cycle is built into a fractional reserve money creation system.
There has been a boom and bust about every 7–12 years for at least the past two centuries – some more consequential than others. Banks continuously cycle through confidently creating too much money that fuels an asset bubble, followed by a market crash that extinguishes a big chunk of the money supply, and then on to creating too little money. In the past 35 years we had the Savings & Loan collapse in the late 1980s, the Dotcom bust of 2000, the Big One in 2007. History and the math of an exponential curve says an even bigger one will hit in 2018–2019.
Typically, and repeatedly, the banks begin with a confident outlook that generates an escalating loan spree, preferably against assets like houses or stock certificates. There is little in the law to stop banks from creating as much money as they want. Bankers’ confidence in their ability to keep a bubble expanding dictates how much money they create by their lending. Incentives push them to create as many loans as they can; every loan is an opportunity to collect interest and/ or a fee. They make even more money when they bundle loans, take a big fee and pass them off their balance sheet to less knowledgeable investors. This frees up space on their balance sheet to increase loan production still further.
More and more money floods the economy. Prices for homes, or stocks or some other assets go up and up, and people develop a feverish desire to get in on the profit-taking. But, the game is rigged. Bankers and their buddies in the financial sector have first access to loans; they are in the best position to score. When they score, they take greater risks. The price of some assets gets higher and higher – houses, stocks, bonds, Bitcoins!, and in 17th century Holland, tulips! At the peak of a tulip mania, in March 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman - one of the earliest market bubbles.97
Confidence fuels increasing levels of debt for investments. Speculators jump in and borrow to buy. Banks are willing to make loans and create new money because, with asset prices rising, it looks like a sure bet to them too – you better get in on the game!
We measure economic success by the volume of transactions, not the actual production or well-being of people. So when the money supply is expanding and an asset bubble is forming, this is interpreted as a booming economy. In a booming economy people are happy and confident and take even greater risks.
The years from 2000 to 2007 are a perfect example: from 2000 to 2007, household debt doubled from $7 trillion to $14 trillion (roughly equivalent to the GDP). Debt related to housing was responsible for 80 percent of the increase. By 2008, the household debt to GDP ratio reached its highest level since 1929–99 percent.98
Households borrowed against the continuously inflating value of their homes. The money created by this borrowing increased buying and selling. From the year 2000 to the housing market crash in 2007, our financial wizards were using a formula to calculate the risks of home mortgages and bundles of mortgages that did not include the possibility home prices could ever drop.99
Countless reports admired our healthy and booming economy, and attributed it to innovation, or a new world of never-diminishing property prices, or President Clinton’s deregulation of banking and the commodities market, or President Bush’s leadership. But, nearly every pundit and politician ignored that the boom was almost entirely fueled by increasing debt.
A version of this movie is replaying from 2009–2018 with the bubble in the stock market and in the bond and non-investment grade debt markets. The stock market quadrupled in this decade, and these latter debt markets doubled to $2.4 trillion.100 In addition to these debts, after the Republican tax cut, the US Treasury is set to issue nearly $1 trillion in debt in 2018 due to the 2017 Republican tax cut.101 Again, this bubble is being praised as a healthy economy. During the boom bankers are giddy issuing loans and asset bubbles are inflating. Everyone seems to have a fair chance at benefitting.
The bubble inevitably pops. Like a Ponzi scheme, a few make money because they buy in early when prices are cheap, sell high and use their profits to buy cheaply again after the bust. The early in-out at peak are generally the bankers, their investor friends, and the professional investors with enough information to gauge when to get in and when to get out, and who have the ability to borrow to buy. The general public gets in late, plays the last sucker, and is left holding the bag of debt when the market collapses.
In 2009 – just one year – Americans lost $3.3 trillion in housing equity and $6.9 trillion in stock market valuation. This was an historic one-year loss of $10.2 trillion from a bubble high valuation. According to the Fed, over three years from 2007’s high to 2010, the average American family lost nearly 40 percent of its wealth.102 The value of shares on the stock market dropped by half. Real Estate website Zillow reported about $6.1 trillion in property value was lost by 2009.103 This value disappears out of the average person’s pocket and from the value of their assets. The wealth is lost, but the debt that purchased the assets is mostly still on the books of the privileged money creators who will eventually collect their pound of flesh. The overhang of unsecured debt is a drag on the economy.
These periods of devaluation and desolation are periods of opportunity for the wealthy few who have the resources to weather and take advantage of depression. They snap up assets and property while it is at fire sale prices – with either their own cash on hand or using their ability to borrow. These recurring money expansion and contraction cycles are a major reason why our middle class is shrinking and the disparity between the very rich and the poor is growing (Chapter 6.68).
For about 99 percent of the population, the bust period of this money cycle is a hard time. Downturns in the economy place a lifetime burden on some people. Children go hungry, which means so much more than empty bellies: it means they don’t have the nutrition during critical developmental periods for mind and body; it means they will miss opportunities for education or career growth. Adults lose health insurance; disease strikes and they die, leaving behind a family at risk. People lose their retirement savings just as they are retiring, leaving them bereft at a time when they are too old or too impaired to work. The stress from financial hardship creates real physical pain and reduces the health and productivity of everyone. People die. We waste a lot of lives and potential.
To see how quickly a money creation system can go from stable to collapse when privatized and deregulated, watch the documentary, Inside Job (2010), Directed by Charles Ferguson. It begins with the story of Iceland, which privatized and deregulated its banks in 2000. It took Iceland less than seven years to arrive at national bankruptcy. Three of the four major banks collapsed. (Only the bank run by women survived.)
To Iceland’s credit, their government jailed over 60 bankers and re-nationalized their money creation. In 2007, Iceland’s population was only 311,566. If we’d put the same percentage of our population in jail for banking fraud after the collapse of our economy, we’d have about 600,000 new inmates. But, none of our bankers went to jail. It took our bankers the same seven short years to go from boom to bust after the 2000 deregulation of our banking and financial sectors. We bailed out our bankers and gave them bonuses instead of putting them in jail. Then we got right back on the boom to bust cycle.
When you look at where we are on that exponential curve, the size of the next meltdown is terrifying. Alarm bells should be clanging as the central Fed increases its assets by an average annual rate of 18 percent from 2006–2016. But in our system any words that shake confidence must be quashed.
A simple change to our monetary system will stop this madness (Chapters 8–10).