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Prophets of Gold – Part 3 – The demons debt and deficit

Posted by Don McLenaghen on January 25, 2012

Having discussed that gold does not provide economic stability; the prophets of gold shift their focus to debt…gold doesn’t create stability but will prevent debt.

They literally demonize inflation

The prophets’ second fundamental plank is the idea of debt, both government debt and this idea of “money as debt”. It is held that thanks to the non-fixed nature of fiat money, a nation can just print dollars infinitely and that when it ‘sells’ this currency on the open market via bond sales, the debt of the nation increases. Well, that’s true. A nation, issues bonds to back its currency. It’s not limited because you can just issue more and more bonds (and more and more debt) and print more and more dollars.

Borrowing cost for the US has seldom been better. The lower the interest rate, the more confidence the market has in the economy and the government (longterm) will pay its debts.

I should stop here and explain how money gets its value. A national government, like USA, issues bonds and sells them in an open market, usually to banks. These bonds have an interest rate associated with them, the more desirable the currency the less the interest and visa-versa. This is the only point where the national government incurs a debt obligation. The value then of the bond, and not the currency, reflects the financial stability of a nation.

On the global stage, not all nations are equal. Proponents of the gold standard often point to the USA debt crisis or the current Euro crises as examples of why debt is bad. However, this is largely a fallacy. The USA crisis was PURELY political, in fact USA bonds were very desirable at reflecting confidence in the American economy. It was only when the GOP refused to honour American debt by holding up the increase in the debt ceiling did the rating agencies begin to question the USA…not its economy but its poor governance. Remarkably interest rate on USA debt is lower than it has been in decades.

The issue in the Euro zone is not debt par sa but the inability of smaller nations to ‘control’ their currency; a right they gave up when joining the Euro. Now initially Greece, Italy and others are in a hole of their own making thanks to bad management. But the Euro crisis is what one would expect when bad management meets an inflexible currency. In the past, Greece (for example) when confronted with debt obligations would inflate its currency and solve that problem. Smaller nations cannot abuse this mechanism because of the limitations of their tax base (more on the downside of this later).

Major nations, like the USA (and I think Canada) do not have the same risks smaller nations have. Many say the USA is bankrupt…this if of course not true. The government of the USA will (in the coming century) always have a sufficient tax base to cover its debts. The USA debt is huge…largest in history…however so is its economy. A simple small tax increase (10% of the top 1%, 2 % for the rest) would largely cover the deficit, a Tobin tax (tax on financial transactions of about 0.05%) could be used to reduce the debt by almost a trillion a year. So, in the USA debt it not a driving factor.

Okay, I have to add a caveat to the above. I am NOT advocating unlimited debt and am not one of those who say “the debt is really fictional and can be ignored”. The debt is, again for major economies, important in the amount of money spent to service the debt (that is the money spent on interest on the debt) because it is money that could be used to improve the country. The interest charged on the national debt is a reflection of the RELATIVE stability of that nation to another.  A great example of this is the USA and Euro are both in trouble; however bond investors have been flocking to the US Treasury bill because it is seen RELATIVELY the safest bet. Another example, Japan has a much greater deficit (gross, per capita and as a % of GDP) than Greece and yet it is not suffering largely because it has control of its currency and a sufficiently large tax base. The Euro’s issue is not based on its debt or fiat currency but on the unwieldy governance structure they have adopted; a structure that is proving to be almost completely unable to deal with the current issues. The Euro effectively acts as a fixed currency to Greece and is pushing into the abyss but more on the connection between the fixed currency and depression later.

Debt is cyclical. When an economy is struggling, it is the role of the government to stimulate it so as to minimize ‘busts’ and limit recessions; however the counter weight to that is during boom periods, the government redirects its efforts to bring down (or eliminate) the national debt. What tends to happen is during busts a government spends but during booms it cuts taxes. The current economic system does need reform but the gold standard will not only fail to help but exasperate issues.

Next we will discuss the idea that money is created out of debt.


For more info from a Nobel Prize Economist: Nobody understands debt


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