Money, Credit, Growth and Depression: It's Complicated

If "growth" is all that matters, that leads to depending on credit and asset bubbles, which are self-liquidating in ways few see because, well, it's complicated.

Many people anticipate the demise of fiat currencies, for good reasons. This is the motivation for calls to return to the gold standard--currency backed by the tangible value of gold--or the equivalent use of bitcoin.

What few seem to ask is: why did authorities embrace fiat currencies in the first place? What prompted them to replace a gold-backed monetary system with a fiat currency system?

Were they misled by monetary theories, or delusional, or merely desperate?

Let's consider the complications of money in a system that demands "growth." As I noted in my recent post for subscribers, Not What We Expected: Why Our Fixes Will Fail, if banks are allowed to originate loans based on reserves--fractional reserve banking--then most of the "money in circulation" is created not by adding gold or bitcoin to the system but by originating mortgages, commercial credit, etc.

If credit is limited to loaning out a percentage of cash deposits, credit becomes scarce, and everything that depends on abundant, affordable credit--vehicle sales, real estate purchases, college diplomas, consumer credit--all dry up and blow away. This collapse of "growth" is called a depression. Without credit, assets collapse in value, savings are depleted to pay bills as employment shrinks, and so on.

This is why the early American economy was starved for credit: everybody wanted to do something great but they had no access to the money needed to do something great. Banks arose and failed, wiping out savers and borrowers alike, as loans were called and assets were liquidated for pennies on the dollar.

So how do you expand credit without expanding money in circulation? You can't, as credit-money is money, period. So $1 billion in gold or bitcoin backs the money supply, but what happens when banks issue $10 billion in mortgages and loans, money that is created out of thin air and enters circulation? Every dollar that was backed by X quantity of gold or BTC is now backed by 1/10th of X.

Then there's foreign trade. If imports and exports don't zero out--$1 billion in imports is balanced by $1 billion in exports--then the balance is paid in gold. Nations running trade deficits eventually run out of gold.

This was the case for the US in the late 1960s and early 1970s, when the US ran sustained trade deficits with its allies for geopolitical reasons: it was deemed essential to prop up our allies to ward off the threat of the USSR and the appeal of Communism. Let your economy slide into Depression, and the promises of Communism start looking very attractive to people immiserated by impoverishment.

Once a nation runs out of gold, trade deficits are no longer possible. The problem is that sometimes trade deficits make economic or geopolitical sense, and so ending trade deficits is catastrophic for both importer and exporter.

OK, it's complicated. But it gets more complicated.

There's an interesting phenomenon we call The Network Effect: the more people that start using a network--for example, an online platform--the more useful and valuable the network becomes to both the users and the owners.

For example, Meta/Facebook. When FB was limited to university students, it was of limited value to users. Once it expanded to a global user base of 3 billion people, it became more valuable to users and its owners, as the data collected from users and sold to advertisers became much more valuable. Meta is now worth $1.9 trillion, larger than the GDP of Spain or South Korea. That's The Network Effect.

Currencies also manifest The Network Effect: the greater the sum in global circulation, the more valuable the currency becomes. (Note that issuing $1 trillion in a currency isn't the same as $1 trillion in global circulation: the currency must have some value and utility to be circulating in the global economy.)

The utility of a currency isn't based solely on the quantity in circulation, of course; a currency's value is based on trust in the currency as a reliable store of value over the duration of the trade, its status as a commodity of known value that everyone will accept in payment, its liquidity, i.e. the ease of converting it into some other currency or commodity, and the "backing" of the currency: the central bank and national economy that issues it.

The nation that issues the currency with the greatest Network Effect has an exorbitant privilege: it can issue bonds and emit fresh currency in size that enter circulation, in effect trading fiat currency backed by The Network Effect for real-world commodities.

As many have pointed out, this is both a blessing and a curse. But it's hard to part with the power generated by The Network Effect--not just for the #1 currency, but the #2 and #3 and #4 currencies as well.

The real problem here isn't just the complications of money: it's the insanity of needing "growth" by any means available, including borrowing more money than can ever be paid back and debauching the currency to maintain the illusion of "growth" even as the resulting inflation slowly impoverishes the majority of the population who have been reduced to debt-serfs or speculators counting on credit-driven bubbles in stocks and real estate to maintain their lifestyle and financial security.

If "growth" is the Prime Directive, then credit and fiat currency become the means to achieve it. That's the story of the 20th century. That was the "blessing" phase. The story of the 21st century is the "curse" phase, and there is no exit if "growth" is all that matters, because that leads to depending on credit and asset bubbles, which are self-liquidating in ways few see because, well, it's complicated.




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