When Money Vanishes into Thin Air

I can recommend this as essential reading.

What Happens When All The Money Vanishes Into Thin Air?

Charles Hugh Smith, Of Two Minds

Zero Hedge,

24 April, 2012

Issuing debt and printing money do not create wealth. All they can create is a temporary illusion of wealth.

I could have written "if all the money vanishes," but that would be misleading, for all unbacked money will most certainly vanish into thin air. The only question is when, not if. Frequent contributor Harun I. explains why:

Those who fail to understand that the Status Quo is impossible to maintain will be shocked when the disintegration is undeniable. But the whole thing was perverse to begin with. Words like capitalism and meritocracy are thrown around to make people feel good when, in reality, we have never owned anything, not even ourselves.

How can we own ourselves when the very thing we use for subsistence can be cheapened or reduced to nearly nothing, not by market forces, but by central banks acting at the behest of governments? When a person does not control his labor, what is he?

I have been studying the monetary history of the world for the past few weeks. I can tell you that the second oldest profession is currency debasement. Nothing is new.

Of course, this should be no surprise, everything is cyclical. Humankind is like the trader looking for the Holy Grail. There is no perfect monetary system, there is only better and worse. And this one ranks among the worst.

I wait patiently for people to come to the understanding that the only way for everyone to get their money would be to destroy its value completely, meaning that a loaf of bread would be a million dollars. If a small fraction of what has to be printed to keep the system afloat has caused the price spikes in energy and everything else, imagine what happens as the disintegration picks up speed.

As the exponential debt curve moves closer to the pure vertical, the rate at which debts come due will approach infinity. Of course, while this is the ultimate mathematical outcome, the reality is that the system will collapse before this point is reached. But don't think governments will throw in the towel. If history holds true the rise of a totalitarian government is just over the horizon.

Then there are those who get it right and wrong in the same breath. John Mauldin, in a KWN interview, thanked Europe for keeping the heat off the US. Mr. Mauldin apparently does not understand that our monetary policies are transferring what we do not want to the rest of the world, at least for a time, but not much more.

How many more food items be made smaller and sold at the same price? In effect this is a slow starvation of those at the margin. The 46 million American souls on food stamps will soon find their food stamps to be worthless.

Those who assert that a credit system cannot go hyper-inflationary may not have thought through the exponential effects on the relationship of the debt and productivity curves within the context of all money is debt and the only way to create money is for debt to be created. Eventually the debt curve accelerates away from the productivity curve, then the productivity curve collapses all together. Sovereign debt crises caused by governments stepping in to keep the debt system going is the last stage. Then comes the debt/currency collapse.

Even if the Fed stopped printing money, I fail to see the difference between too much money that is worth nothing, and no money at all. It's not going to matter to a starving man that a loaf of bread is $1 million and he is a dollar short, or if it's $1 and he is a dollar short.

Thank you, Harun. Many observers have addressed the key concept here, which boils down to this: paper money is an abstract representation of the real world.

This can be explained by a simple example. If there is $100 in the money supply, and $100 of goods and services to trade, then $1 will be exchanged for $1 of goods and services. If the money supply suddenly increases by $100, then the value of the existing $100 declines by half, as the money supply is now $200 and the supply of goods and services remains unchanged. Thus it now takes $2 to buy what $1 once bought in goods and services.

Holders of the currency have had half the value of their currency (what we call purchasing power) stolen by the central bank that issued the additional $100 in money supply.

Here is the primary point: issuing debt and printing money do not create wealth. All they can create is a temporary illusion of wealth.

(This is drawn from Chapter One of Resistance, Revolution, Liberation: A Model for Positive Change; you can read Chapter One for free.)

Here is another example. Let's say that a small group is stranded on a desert island that supports a handful of coconut palms. Each palm produces a limited number of coconuts each season. To facilitate trade, the group issues a currency that represents one coconut. (Lacking a printing press, they have to laboriously carve out a pattern on a rock to imprint a difficult-to-counterfeit stamp on the currency.)

This system works well, as the currency issued matches the number of coconuts harvested annually (for simplicity's sake, let's say that's 100). 100 pieces of currency are issued to match the 100 coconuts that exist in the real world. The currency (let's call it the quatloo) is an abstract representation of the goods available, i.e. the coconuts.

But then a wise-guy (i.e. the "central banker" on the island) realizes that if he prints another 100 quatloos, he and his buddies can buy up all the coconuts and fish without having created any real goods in the real world: the abstraction is used to con people out of their real coconuts.

The residents quickly catch on, and the "price" of coconuts rises to 2 quatloos. The wise-guy is addicted to the scam, and so he prints 1,000 quatloos, and then issues quatloos in denominations of 1 million.

Soon enough, each coconut costs 1 million quatloos.

Creating debt and paper money does not create real goods and services or real wealth.

As Harun observed, we have been promised trillions of dollars that can supposedly be traded for trillions of dollars in real goods and services, and buyers of bonds have been promised trillions of dollars of the same artificial exchange of paper for real goods.

Just as on the desert island, the growth of actual goods in the real world lags the growth of money, i.e. abstract representations of real goods.

The U.S. Central State (Federal government) has borrowed and squandered $6 trillion over the past four years, and the actual production of goods and services has not risen at all when adjusted for inflation. The central bank (the Federal Reserve) has expanded its balance sheet by $2 trillion, and yet all the assets it have tried to force higher are actually lower when measured in real goods such as gold, oil, wheat, etc.

It's easy to expand the money supply and difficult to expand the actual production of real goods in the real world. Expanding the money supply and issuing debt that lacks collateral is just like printing quatloos on the desert island: you can print a million quatloos but that doesn't create a single additional coconut.

If you print enough quatloos, then people will no longer accept them in exchange for coconuts. You will actually need a real coconut to exchange for fish.

This is why Greek towns are reportedly reverting to barter, the exchange of real goods for other real goods. We can anticipate that silver and gold will soon enter the barter as means of exchange that can't be counterfeited or printed by wise-guys (central bankers).

We can also anticipate the issuance of letters of credit, a practice that stretches back to the trading fairs of Medieval Europe, as described by Fernand Braudel in his three-volume history of early capitalism, The Structures of Everyday Life (Volume 1), The Wheels of Commerce (Volume 2) and The Perspective of the World (Volume 3).

Since gold was in insufficient supply, letters of credit were issued and accepted on a basis of trust. At the end of the great fairs, the letters were exchanged and payment of balances due made in gold or silver. Thus 99 coconuts could be traded for 100 dried fish via letters of credit and the balance due in gold or silver was the value of 1 dried fish--a mere 1% of the total value of goods exchanged.

This is what happens when abstract representations, i.e. "money," vanish into thin air. Alternative systems of exchanging goods and services arise: actual goods are exchanged via barter, tangible concentrations of value that cannot be counterfeited such as gold and silver are used as a means of exchange, letters of credit or equivalent are traded and settled with tangible goods or gold/silver, and eventually, a means of exchange ("money") that is backed by tangible goods in the real world that can be trusted to actually represent the value being traded might enter the market.

That which is phantom will vanish into thin air, while the real goods and services remain to be traded in the real world.