If people knew how the banking system creates money, there'd be a revolution tomorrow...
WHEN A GOVERNMENT spends more than it collects, logically, there is a gap to fill. Depending on the sophistication and popularity of the government, it can fill this gap in two ways:
- Issue I.O.U.s (Treasury Notes) to raise money; or
- Print money
When the government of Brazil ran a large budget deficit in the 1990s, it began to print money and spend it. Hyperinflation followed and they eventually replaced the old "Cruzeiro Real" currency with the new "Real".
Of course, the banking systems of developed Western nations are a lot more sophisticated and governments are disciplined with their spending. Right?
These charts clearly demonstrate that over the last decade the United States' I.O.U.s are being issued at a more rapid pace than they are being repaid.
The debt growth rate is now higher than GDP growth, a recipe for an eventual hyperinflationary outcome.
Institutional and federal banks around the world are mainly an extension of their respective governments. Through fractional reserve banking, those banks have an unlimited supply of paper money to buy things, including the purchase of I.O.U.s issued by the government or, indeed, by anyone else.
Both the US Fed and the European Central Bank have publicly come out and said they will lend whatever support is necessary to keep the credit market afloat. They have also allowed Bank of America, JP Morgan, and Wells Fargo to issue unlimited amount of credit from the banking division to the brokerage division, where debt purchases took place.
Banks can issue Dollars at no cost, and lend it to the US government through various public and private vehicles. The end effect of issuing Treasury notes is no different from direct money printing.
Money printing is cleverly disguised through these tiered levels of the banking system. That's why so few care. Hence, as Henry Ford once said:
"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
While some supply-side economists argue that enhanced budget-deficit spending is for the good of the people – and therefore it shouldn't be frowned upon so much – central banks and governments have now taken advantage of the financial illiteracy of the public at a wholly new level.
With millions of Americans now unable to meet their mortgage repayments, and with liquidity in mortgage-backed securities completely dried up, the US government and the Fed are taking unprecedented fiscal and monetary steps to maintain the fragile fiat money system.
- They are looking into "forgiving" certain amount of mortgage loans by distressed borrowers on a nation-wide scale;
- They have injected about half a trillion dollars to the banking system, allowing any outfit qualified as an "institution" to borrow as much as needed, with the option to extend repayments until the they have the ability to pay.
In plain English, this is akin to the government saying that, because everyone is so indebted – but we still need to keep the system going – we will just forgive some of the consumer's loans, so his debt can come down to a reasonable level and he can begin borrowing again. To the institutions, the US government is saying that it will lend them as much as they need for as long as is needed until whatever problems the banks have go away.
All the checks and balances in maintaining even the illusion of a sound banking system have been blown away, and we are seeing direct money printing in its naked form.
There is only one place to go to preserve wealth in times like this: Gold.
Witnessing the breach of key resistance level of $700, we are ready to embrace the most spectacular rise in gold since the gold bull started in 2001 at $250.
Gold is primed for $850 and beyond in 2007, I believe. Now (early autumn '07) is the optimal entry point.