The Fundamental Difference between WHAT IS and WHAT SHOULD BE

A good analogy of our financial system is that "a crowded arena is on fire and everyone is attempting to exit at the same time". Those who first saw the fire coming and got out will be saved. In fact, they may be able to better their situation by first noticing. Others will die, being burned before they can make it through the impossibly-congested exit ways. Others still will be forced into a situation where they must attempt to put the fire out; once the exit doors are burned down, there is no way out. Despite this, many people do believe that the show should go on or simply have faith in the illusion that fires don't happen.

America, and most of the world, is in such a situation, only it won't be a fire in the arena. It will be more like a napalm bomb. And rather than noticing that there is a devastating fire bomb at the center of the whole show, most people are simply distracted by a circus - it is the center of the show. It is the consumerist system of entertainment, advertising, ignorance, and artificial money. Most mainstream news media is firmly supportive of our financial system. They are mostly owned by conglomerate corporations, not dedicated solely to news, but to a wide variety of industries including big entertainment (Disney) and big industry (General Electric). There are a variety of reasons big business enjoys our current system. Big government definitely enjoys it. And big business enjoys big government privileges. Thus, this media circus chooses to offer us our financial news as a series of opinions about the future, not the facts on the ground about what has already happened. The sheer distraction of the circus causes most people to fail to see the bomb while elephants dance around it. The circus knows it's there, but it can't tell the people. If it does, it won't have an audience.

Thus, we are told "we are safe" and "growth is good" when we worry over how the negative financial news will effect us. We are assured there are people working around the clock to look out for us, and that these people have optimistic views of the future. We are told that the collapse and buyout of Bear Stearns, one of the five largest banks in America, with hundreds of billions in assets, is equivalent to the news of President Bush blaming 500,000 layoffs on teens working during the summer. We don't hear things like how Bear Stearns's office building cost more than what it was bought for. Shouldn't we be a little more concerned when a bank this size sells for less than the cost of its $1.1 billion office? No bank would even buy Bear Stearns, even at $2/share, unless $30 billion of its loans were "insured" (*cough*...bought) by the federal government...by you through taxation.

Even more distressing is that Bear Stearns didn't simply suffer from extremely horrible mismanagement from January 2007, when its stock price was $120/share, until March 2008, when its stock hit a low of $2/share. In fact, it turned a profit in its last quarter. It was playing the same game that most to all of the banks were. What happened to Bear Stearns is the same thing that will soon happen to the average American: in the arena, they will be at the back of the line on their way out the exit door when the fire reaches and consumes them.

What is this mysterious fire/bomb? This is the difference between WHAT IS and WHAT SHOULD BE.

WHAT IS, what we currently have, is a financial system that depends upon our ignorant confidence. When economic outlooks are grim, we are encouraged to save less and spend more. We are told to invest without worry. We are told to believe in the system, and everything will be fine by the time you wake up tomorrow. The difference between JP Morgan buying out Bear Stearns (and assuming its debts) and allowing Bear Stears to declare bankruptcy is that its debts, and what it owed is liquidated. All that credit in both directions disappears. Credit can disappear, but tangible wealth cannot. Most of our tangible wealth today is based upon greater promises tomorrow. This system depends on everyone being willing to put what they perceive to be their wealth on the line to protect this system. It is a structurally unsound skyscraper that will topple if a significant amount of people decide to leave. Everyone is on the line, even for decisions they never made or were forced to take.

WHAT SHOULD BE is a financial system that generates confidence. In other words, the government shouldn't be forcing us to pay for other people's bad loans, claiming that our lives will be hurt if the system collapses. If this kind of financial system is what we want, we will choose it freely. It will benefit us. The fact that DC is forcing everyone to accept this system that generates tremendous private profits for some small groups clearly points to one conclusion: the financial and banking system we have is a special interest, better served by coordinating with the force and privileges of government than offering the people a good deal.

All institutions that take risk must anticipate the future. Insurance companies, hedge funds, stock brokers, and banks must generate confidence that they are correctly anticipating the future for individuals to purchase or invest in their services. The best way for them to grow market trust is by offering a good deal to those who have already given them their trust. If a company mismanages the money already trusted to it, it is doubtful that people will continue to have trust in it.

Thus, we have a strange system when our government proclaims some risk-taking institutions as "too big to fail" and puts our money on the line to "save" them. Aren't these the exact conditions that should destroy confidence in an institution, making them unfavorable to consumers? Should we invest in companies that have a reputation of wasting our money or buy goods from a store with high prices? Would we let the federal government manage our stock portfolios when it has only managed staying within $100 billion over its budget once in the past twenty years?

Even more important than any of those questions is why we have banks that are "too large to fail"? What does that mean?

First we must understand the basic reason why banking requires trust. When a bank appears to be making shaky loans, there is a chance the loans won't be repaid. The customers' deposits have been used to make those loans, and there is a chance they will be unable to get their money out the bank. IE, The bank owes $100 in deposits but only has the cash to cover $15. If everyone tries to get out at the same time, the bank will not be able to meet its debts, and default on them. Some will withdraw their deposited money; they will make it safely unlike many of those behind them.

This is the nature of artificial credit. The banks are loaning out money that has a double claim. You are owed the money, but the bank has given to someone else. Your prior wealth depends on whether someone else produces the wealth to repay the bank. Rather than loaning something already created (such as the bank's past profits), creditors loan you something that might be created. In limiting credit to existing wealth, credit cannot exceed that which has already been produced. Artificial credit, on the other hand, is unlimited.

The most confident system of banking would be to simply safeguard money, for a small fee, against which you could write checks. The money the bank makes it may use for its own investments.

The means by which artificial credit comes to dominate the market is simple. It is called counterfeit. Rather than loan out the money in the bank, banks loan claims to money; and when these claims outnumber the money that it actually has, this is counterfeit, a specific form of fraud. Our financial system has merged counterfeit and artificial credit into one. This "money" does one of two things. It either destroys the purpose and value of money, or it allows some group to benefit at the expense of others.

Just as banks require confidence, so does money. Let's look at how both these tasks were accomplished back before our central bank. Then let's see how it worked with the central bank, and then we'll take a look at it today.

Money was simply a form of indirect exchange - a common good that everyone would desire for its ability to exchange with all other goods. Its desirable qualities: portability, durability, divisibility, and inability to be counterfeited.

Gold, and other precious metals, have a unique property in relation to most other forms of money. Only the supernova of a dying star can create them; no human can counterfeit them. This simple fact, combined with their intrinsic value were the reason the market chose them as the most trustworthy forms of money.

Last century, individual banks and money often were merged: banks issued their own money (bank notes), redeemable in a more common money (precious metals - gold and silver). If they issue more notes than they hold in general money, they are committing counterfeit; when they loan these out, they are creating artificial credit.

While artificial credit put some depositors at risk, people generally understood the bank could enjoy a little flexibility in using it. Using too much, however, would increase the money supply and cause prices to rise and confidence to fall.

If it is revealed that just one depositor was unable to redeem his claim, all remaining depositors will instantly lose confidence; the bank cannot redeem the notes and they are no longer usable in place of the actual money. Thus, the money supply will rapidly shrink. This is often called a credit crunch. This causes price fluctuations downward in all goods, and as producers struggle to accurately price, they will be stuck with either shortages or unsold surpluses, which signify inefficient use of resources. The economy will survive and even prosper later on, but there is a period of extreme pain as the economy adjusts. Money is the life-blood of an exchange economy. Any shocks in this one area effect all other areas, and not necessarily equally.

The situation I just described may sound nasty, but it was arguably the best way to balance artificial and natural credit. Banks weren't con-men who could leave town in the middle of the night. Banks knew the risks they were taking when issuing artificial credit. The credit they issued had their name on it. Customers could withdraw at any time. Their competitors could notice and create mistrust and panic...or simply offer better services. And those who withdrew withdrew into gold, which couldn't be manipulated by any banker.

Thus, the old system of "wildcat banking" (allowing individual banks to manage their own risk in issuing artificial credit), policed itself. Reserve ratios (gold to bank notes) adapted to the confidence of the bank's customers. Should a bank run happened, it could borrow from another bank to survive the bank run, which would generate consumer confidence. If both the customers and other banks lost confidence in that bank, it would fail. The careers of its managers are permanently stained. Depositors, even those who didn't lose their money, would lack confidence in such men. This is a good thing. What we get is a system that is required to generate trust. When it does not, bad things happen, not only to some depositors, but to the bankers. When it is trusted by many, many usually benefit, as the trust is a result of past mutual gain.

Extravagant speculation using artificial credit grew as the stock market became profitable. Yet, instead of allowing bad debts and their issuing institutions simply be wiped out, they were loaned money to meet bank runs and re-establish confidence. Those performing the bail-outs suggested having a central bank to instead perform this function. It could finance such with artificial credit. Thus, the problem became the solution.

In the central bank system, the individual banks partially back up deposits with the central bank's bank notes. Thus, if an individual bank is in trouble, it can borrow from the central bank, or other banks, in a common form of bank note, which the central bank can create nearly at will. The central bank will exchange its bank notes for gold; however, not all the notes are backed by gold. They can also be "backed" by government debt, which is backed by the ability to tax. Thus, government debt becomes the original artificial credit, created as claims on wealth not yet produced.

This system had the same inherent problem - it was required to generate trust while being based on artificial credit. Furthermore, it was a monopoly. During the Great Depression, the people tried to get their gold out; yet there was far more Federal Reserve Notes than corresponding gold. So, FDR, by executive order, not congressional law, prevented Americans from doing so. He not only allowed the central bank to fail to redeem notes for gold, but forbade the ownership of gold. Yet, foreign governments were still allowed to trade notes for gold. This created another run during the Vietnam War, as we tried to finance the war by counterfeit. Here, Nixon allowed the central bank to completely sever the link between its notes and gold.

Now, the system has been turned upside down. There is a monopoly provider of counterfeit, none of which has a fixed exchange rate with something of real value. The money supply can increase indefinitely. For every new piece of credit that is created and used as money, all existing money becomes less valuable. For every addition to government debt, the stock of circulating federal reserve notes, or total outstanding bank loans that is created, the system becomes that less trustworthy.

When people lose faith in an individual bank, the central bank and government prevent it from suffering a bank run in many ways. First, the FDIC insures all deposits under $100,000, so in the case of failure, it doesn't matter if you got the money out before it fails or not. Second, the banks are all operating cooperatively to preserve their artificial credit policies, so another bank is more likely to loan such a troubled bank the required funds to meet any bank run. Third, the central bank can loan money directly to troubled banks. Finally, the central bank can buy government debt with its own counterfeit, thereby increasing the money supply and lowering interest rates, from member banks and itself.

But what can we do if we lose faith in the entire system? We cash out. The equivalent of a bank run can occur against the central bank. The public cannot demand another form of money for its Federal Reserve Notes or bank account balances from the Federal Reserve; however, it can exchange them for alternate forms of money on the market. As such, as confidence is lost in central bank money, it will become less and less valuable. Ultimately, it's value will crash like a stock price, quickly and sharply, until it is nothing more than decorated paper.

This is not far from happening. When individual banks fail, their corresponding credit collapses. When big banks collapse, there are credit crunches. Artificial credit disappears and prices fall. People get worried about the economy. They start to consider bank deposits less secure than cash on hand, withdrawing deposits. Banks cannot keep up, requiring more and more counterfeit from the central bank. This situation can lead to hyperinflation, when counterfeit is occurring so fast that it can no longer be reliably used as money. If the central bank lets a few banks fail, the FDIC will start having to cover depositors. It only has enough money to cover about 1% of them, so once the FDIC busts, a massive banking panic will happen. Again, the central bank can counterfeit a bailout, risking the rejection of the system entirely, or it can allow massive banking collapses, bringing the greatest credit contraction of all time to occur.

There will be many who didn't see the situation, and didn't head for the exit door. They listened to the media, full of confidence in a system they never understood, and they bore the brunt of the pain. By the time they attempted to sell their counterfeit for actual money, they'll find their life savings are worth mere pennies. Some may wise up. Others will still put confidence in government, who will characteristically blame the wise among us who abandoned faith in a system of forced counterfeit. They will accept the mantra of WHAT IS: do as you're told, by the media and by the law, and place your faith in a system that goes unexplained and is purposefully confusing. They will listen to people on TV's that they've never met, not their neighbors who understood the situation and avoided economic ruin.

When the napalm bomb that is our artificial credit system eventually explodes, and most to all people feel the pain and start running to the exit, it is then we'll notice WHAT IS: our government waiting outside, sipping champagne, sympathetically telling us they feel our pain, while barricading us in. If only the people would stand up to the politicians and fight for WHAT SHOULD BE...