With plunging dollars, it is that time again to discuss the monetary system. I dig up some old post of mine and would like to re-post it here after some editing:
1. The US has been effectively “defaulted” a few times, and each time they will just rewrite the rules while screwing the debt holders up. The closest time they did it was with Nixon when he lifted the gold-pegging requirement in the 70s. Or Americans can resort to find some excuse to wipe off their debt to China, by excuses on humanitarian ground or what not. Kind of like what they did to Libya/Ghaddafi’s asset as a “collateral” measure.
2. Due to the fractional banking system, the amount of money flowing is much more than the actual wealth created. M1 counts the amount of money that is immediately available (notes, coins, currency circulated and checking accounts). For the checking accounts banks can lend out the money in fraction dictated by reserve ratio (r). So the total amount of money out there would be a geometric series of how much they can lend out plus principle = P + P*(1-r) + P*(1-r)^2 + … = P/(1-r). So even small defaults will cause big systematic problem in the flow of available money. Now with bigger defaults, problem will spread quicker and may take down the system – not to mention that the small wealth that support the money circulation has been shrink much smaller. FDIC insurance can help, but to a limit.
3. Modern economy as a whole, is driven up by debt-based spending which creates inflation. Inflation encourages taking debt and punishes savings, and the cycle continues. Since the debt has been inflated so big and the collapse of it will be much larger, and it will ripple through many aspect of society. Interesting thing he points out is that inflation is not always there. There has been hundreds of years in the US where there was virtually no inflation. Inflation, at least in the US, was created by the government to wash away their war debt. On the flip side, inflation encourages investment and thus expansion of economy, but this only works for small inflation. Originally used as a control mechanism of the flow of money, the Fed now is basically printing money to finance the US Treasury. Remember how a loaf of bread cost billion of marks in Germany after WWI? Or the mayhem in Argentina back in the late 90s?
4. Production increase cannot keep up with resources spending (that goes more than oil). The collapse of modern civilization has been delayed by massive discovery of oil and lots of technological improvements with electronics. However we cannot expect technological improvement to always keep up with resources spending. Besides we need (cheap) energy to run the technology that we have. Do you know that most food in the US is fertilized by petro-based chemical and without oil US’ agricultural output will drop by >80%. Famine is almost guaranteed in foreseeable future, but this is off topic.