The Coming Meltdown

by Alex Gore

The economies of the United States and Europe are disintegrating. We are living in a huge economic bubble that never fully corrected itself during the crisis of 2008-09. The crisis I believe that is coming  is actually a continuing of the 2008-09 one that never ended. Most of the problems that surfaced during last crisis are still present. Back then, the Fed didn’t step in and “save” the system. They merely delayed the inevitable while making the situation a lot worse.

No politician or president will be able to fix the problem. The system can’t be fixed, because the system was by design a broken system to begin with. It is a Ponzi scheme. Any type of “fix” has the effect of making the situation worse, not better. It’s like a person who’s dying of cancer. Once you’re at the late stages of cancer, treatment no longer works. In the case of the financial system, the cancer has spread and spread. The Fed’s fix has allowed them to buy time and extend it’s life. But this patient will too, die. In this case, the action of the Fed has the effect of making the patient more miserable with bigger and nastier lumps.

The Federal Reserve and Fractional Reserve banking:

The current problem starts with the Federal Reserve and the fractional reserve banking system. It took me a while to figure out how our banking system worked, but once I learned I began to realize how corrupt it was. The video Mike Maloney below does an excellent job explaining this system.

The way I come to understand this system is that an increasing amount of loan issuance is required to prevent the system from collapsing. Under fractional reserve banking, the creation of loans increases the money supply. Many people incorrectly believe that it is the money printing from the Federal Reserve that creates inflation. In actuality, most of the inflation is generated by banks through loan creation. Loans are created by taking the money from our deposits (such as from checking or savings accounts) and loaning this to someone else. The borrower uses this money to buy, for instance, a home. The seller of the home then takes the money from the borrower and deposits this money in his/her account. The money again, sitting in a bank account, is loaned out. And the process continues ad infinitum.

Whenever a loan is created from reserves (for instance, money deposited in a checking or savings account), it is considered new money and this money gets circulated throughout the economy. The increased amount of money in circulation causes inflation in the price of goods and services. A borrower also sees his paycheck go up as a result of inflation because the company he works for is able to increase salaries as a result of increased revenue. The borrower can then pay off his loan more easily with his fatter paycheck. This pretty much sums up how the model has worked for the last 50+ years.

The global economy during the last several decades have been geared towards increasing levels of spending by governments, corporations, and individuals. At the same time savings and capital investment have plummeted. The foundation of today’s artificial economy is now built on financial engineering rather than manufacturing and tangible goods. Plants that once stood tall in rust belt cities such as Pittsburgh, Buffalo, and Cleveland are a faint memory today.

There is an endgame:

Many pundits think this system can continue forever. I am not one of them.

Today’s economy is built on a pyramid of debt. US national debt is nearly $18 trillion, credit market debt (mortgage, corporate, student loan, and consumer) is just over $40 trillion, federal unfunded liabilities debt (pensions, social security, medicare, etc) is over $125 trillion, and derivatives debt is more than $1 quadrillion (that’s $1000 trillion). There is massive debt everywhere. After a brief hiccup in 2008-09, debt continued it’s uptrend albeit at a slower pace.

 photo fredgraph_zpstwg4cgrm.png

Debt had been increasing faster than the GDP (gross domestic product) since about 1950.

 photo debtbb-as-a-percentage-of-gdp_zps3wmkcanv.jpg

But since the last crisis, the debt/ GDP ratios have been coming down from the lofty levels of 6-7 years ago. As of Dec. 2014, the ratio stood at 332%, down from about 370% in 2009.

 photo serveimage_zpsqhq2at7z.png

Since the crisis, the Fed went into high gear and bailed out all sorts of troubled institutions – at taxpayer’s expense. They’ve replaced the bank’s toxic assets with freshly printed money.

20090625-chart_b

But this fresh money, to the tune of $4 trillion, did not have much an effect on increasing the money supply. The chart below shows the velocity of the growth of the money supply has been decreasing sharply. The money supply is still increasing, but just at a slower rate.

 photo z4.24.3-1024x818_zpszihpcvmz.png

What does this all mean?

Increasing debt requires increasing amount of interest payments. But if debt is going up faster than income is rising, then a higher proportion of our income goes into servicing that debt. There is so much debt in the system, that a tremendous amount of capital is required just to service the interest on it. That squeezes out money that can be used for real productive purposes such as the expansion of plant and equipment for industry.

The 2008-09 crisis seen the bursting of the real estate bubble and to this day it hasn’t fully recovered. The loan industry lost a significant portion of their income. But wait, it’s not over yet, because they’ve invented all sorts of gimmicks since that time to keep the game going. The student loan industry cropped up as an antidote to replace the mortgage industry’s fallout from a few years ago. Car loans of seven years has become more common. Now the new gimmick are negative interest rate loans which have hit the scenes in Europe. These loans essentially pay the borrower for borrowing money.

Negative interest rates:

The banking industry has to devise all sorts of new tactics to continue finding ways to loan money, including to those who are broke or will be broke. That’s where negative interest rates come in. Negative rates are an extreme measure should it be implemented here in the US. That basically means paying someone to borrow money! Bankers know that their days are numbered but they want to do anything to buy time. Evidently zero percent wasn’t low enough for them.

Despite the talk of recovery in the mainstream media, the fact that negative rates are even brought up, is a telltale sign of how weak the economic “recovery” really is. Although rates have now risen slightly, it is still very low. The chart below is as of 2014.

 photo zserveimage_zpsig4orrsm.jpg

I think the system will collapse before negative rates have much of a chance to be implemented. By the way, a negative interest rate policy could only be implemented by either banning cash or taxing it, because people will withdraw their money from the banks rather accepting a negative rate on it.

Deflation is coming:

serveimage

Many would ask, how can deflation exist in an era of fiat currency? After all, it seems that the Fed can just print money to avert deflation. The reality is the Fed hasn’t so much printed money as it has facilitated the issuance of debt. As you recall from above, much of the expansion of money supply came from banks. Second the Fed can’t force people to borrow or spend money. When debt gets paid down and/or defaulted on, it is deflationary. When there are more loans that “disappears” then loans that are created, the situation is deflationary.

The coming crisis in the US will be deflationary. Deflation is already a reality in a number of European countries. My main reasons for deflation are 1) near zero percent interest rates for six years 2) collapsing asset prices 3) the nature of fractional reserve banking which is inherently subject to busts and 4) consumers and businesses being maxed out on debt.

The US has been stuck at zero percent interest rates since 2009. This is unprecedented in American history and is something the naysayers and inflationists have a difficult time explaining. Interest rates are as low as there are because consumers cannot afford to borrow at even slightly higher rates. They are broke and are up to their eyeballs in debt.

Conclusion:

A true recovery cannot begin until most if not all of the cancer is eliminated. This is the purging process and is a necessary part of “renewal”. What is being purged are the immense amount of debt created by the fractional reserve banking system and the massive imbalances and distortions in the economy. Unfortunately this readjustment means a lot of pain. Major cuts in government programs such as social security, medicare, law enforcement, and education should be expected. Capital controls will likely be implemented. Fascist government policies will be on the rise. And there is likely to be an outbreak of rioting and looting.

However, as dire as the situation is, the good news is that after the period of turbulence ends much better times lie ahead. I see real money (for example, backed by gold) replacing fiat money, I see the comeback of manufacturing, I see businesses and individuals no longer buried with mountains of debt, and I see the power of the ruling class greatly diminished. That will be truly when the greatest opportunities begin.

Updated – April 10, 2016

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