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     May 2, 2008
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The twilight of irredeemable debt
By Antal E Fekete

The most powerful of the latter-day pagan gods that have guided the destinies of humanity for the past two-score years is irredeemable debt. Before August 14, 1971, debts were obligations, and the word "bond" was to mean literally what it said: the opposite of freedom. The privilege of issuing debt had a countervailing responsibility: that of repayment.

On that fateful day all that was changed by a stroke of the pen. President Richard Nixon embraced the woolly theory of Milton Friedman and declared the irredeemable dollar a monad, that is, a thing that exists in and of itself.

According to this theory the government has the power to create


irredeemable debt - debt that never needs to be repaid yet will not lose its value - subject only to a "quantity rule", for example, it must not be increased by more than 3% annually. This idea is so preposterously silly that "only very learned men could have thought of it".

If the thief is thieving modestly, then he will not be detected. It never occurred to the professors of economics and financial journalists that a modest thief is an oxymoron, a contradiction in terms. How did they get to believing in irredeemable debt? The explanation is most likely found in Schiller's dictum: "Anyone taken as an individual is tolerably sensible and reasonable. But taken as a member of a crowd - he at once becomes a blockhead." Economics professors and financial journalists are no exception.

For a time it appeared that Friedman was right. The world has become dedicated to the proposition that it is possible, even desirable, to expand irredeemable debt in order to make the economy prosper. Never mind the default of the US government on its bonded debt held by foreigners. Never mind people victimized by theft. Thanks to the quantity rule, they will never notice the difference.

For all its seductive attractiveness, Friedmanite economics is ignoring the effect of irredeemable debt on productivity. It watches debt per GDP and is happy as long as this ratio stays below 100% by a fair amount. However, what should be watched is the ratio of additional debt to additional GDP. By that indicator the patient's condition could be diagnosed as that of pernicious anemia. It set in immediately after the US dollar debt in the world was converted into irredeemable debt.

The increase in GDP brought about by the addition of $1 of new debt to the economy is called the marginal productivity of debt. That ratio is the only one that matters in judging the quality of debt. After all, the purpose of contracting debt is to increase productivity. If debt volume rises faster than national income, there is big trouble is brewing, but only the marginal productivity of debt is capable of revealing it.

Precipitous decline
Before 1971, the introduction of $1 new debt used to increase the GDP by as much as $3 or more. Since 1971, this ratio started its precipitous decline that has continued to this day without interruption. It went negative in 2006, forecasting the financial crisis that broke a year later. The reason for the decline is that irredeemable debt causes capital destruction. It adds nothing to the per capita quota of capital invested in aid of production. Indeed, it may take away from it. As it displaces real capital, which represents the deployment of more and better tools, productivity declines. The laws of physics, unlike human beings, cannot be conned. Irredeemable debt may only create make-belief capital.

By confusing capital and credit, Friedmanite economics obliterates truth. It makes the cost of running the merry-go-round of debt-breeding disappear. It makes capital destruction invisible. The stock of accumulated capital supporting world production, large as it may be, is not inexhaustible. When it is exhausted, the music stops and the merry-go-round comes to a screechy halt. It does not happen everywhere all at the same time, but it will happen everywhere sooner or later. When it does, Swissair falls out of the sky, Enron goes belly-up, and Bear Stearns caves in.

The marginal productivity of debt is an unimaginative taskmaster. It insists that new debt be justified by a minimum increase in the GDP. Otherwise capital destruction follows, a most vicious process. At first, there are no signs of trouble. If anything the picture looks rosier than ever. But the seeds of destruction inevitably, if invisibly, have sprouted and will at one point paralyze further growth and production. To deny this is tantamount to denying the most fundamental law of the universe: the Law of Conservation of Energy and Matter.

The captains of the banking system in effect deny and defy that basic law. They are leading a blind crowd of mesmerized people to the brink where momentum may sweep most of them into the abyss to their financial destruction. Yet not one university in the world has issued a warning, and not one court of justice allowed indictments to be heard from individuals and institutions charging that the issuance of irredeemable debt is a crude form of fraud, calling for the punishment of the swindlers issuing it, whether they are in the Treasury or in the central bank. The behavior of universities and courts in this regard could not be more reprehensible. Rather than acting to protect the weak, they act to cover up plundering by the mighty.

The inconspicuous beginnings of irredeemable debt have blossomed into a colossal edifice, a fantastic debt tower that is bound to topple upon the prevailing complacency and apathy. Actually "tower" is a misnomer. Rather, what we have is an inverted pyramid, a vast and expanding superstructure precariously balanced on a tiny and ever-shrinking gold foundation - the only asset in existence with power to reduce gross debt.

The construction has no precedent in history, and no place in theory, whether Ricardian, Walrasian, Marxian, Keynesian or Austrian. As a matter of fact, no one is analyzing the process. Research has been placed under taboo by the powers that be, lest diagnosis reveal the presence of cancer caused by irredeemability. There is no known pattern or model that would apply to its mechanism in terms of equilibrium analysis.

Two negative conclusions emerge. One is that the edifice of irredeemable debt must grow at an accelerating pace as markets for derivatives providing "insurance" to holders of debt proliferate. The insurer of debt must also be insured, as must the insurer of the insurers, and so on, ad infinitum. This is due to the fact that the risk of collapsing bond values has been created by man. In contrast, the risk of price changes of agricultural commodities are created by nature, and the futures market provides insurance, with no need to re-insure. The other conclusion is that the unwieldy size of the debt structure excludes the possibility of a normal correction: a major liquidation would dwarf the calamities of the Great Depression.

The debt delusion
It is a delusion to think that the government can splatter debt all over the economic landscape to cover up its warts, and reap everlasting prosperity as a result. The stimulation and leverage of debt has always caused stock markets to boom, so that the impact of debt was aided and magnified by the added paper wealth which, in turn, increased the propensity to spend and borrow still more.

Businessmen are supposed to be more realistic in contracting debt. Yet the pattern of increase in corporate debt has also

Continued 1 2 

World chokes on bad spell on Wall St (Feb 1, '08)

Sorry, I wasn't pessimistic enough
(Mar 19, '08)

1. Push comes to shove in Afghanistan

2. The meaning of stage II

3. US's Pakistan policy under fire

4. Oil in 2012: $200 or $50?

5. Iran-US talks await new leadership era

6. At the center of a flood of debt

7. Fried in the financial sun

8. Big, bad, and the bill is rising

9. Iran holds key to India's energy insecurity

(24 hours to 11:59 pm ET, Apr 30, 2008)



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