In yesterday’s Part 1, we covered these lies:

Lie #1: Real estate always goes up.

Lie #2: It’s best to use Other People’s Money.

Lie #3: We can buy cheap goods from countries with cheap labor, and yet keep our much-higher salaries and benefits.

Lie #4: Government pension and medical programs will deliver on their promises.

Lie #5: Your money is in the bank

Lie #6: Your money is in your brokerage account.

Lie #7: It is OK for financial institutions to use huge leverage.

Lie #8: The government guarantees it.

Today, we’ll cover the final four:

Lie #9: Government bonds are safe.

Most people are told, and believe, that the big culprit in the Great Depression of the 1930s was the stock market crash. This is an intentional re-writing of history. At least 10 times more money was lost when governments defaulted on their bonds in the early 1930s. These defaults were the source of thousands of bank failures, which led to untold numbers of farm, business, and personal financial failures, so the actual losses were far larger than the “10 times” cited above.

Who re-wrote that history and why? Governments, and the academic henchmen they support through direct employment or research grants. Governments and these hired academics conveniently ignore these government bond defaults because they want you to have full trust in government bills and bonds. Again, why? Because these bonds underpin the entire financial regime. When a bank claims to have capital, much of that capital is in the form of government bills and bonds. Same for insurance companies, pension funds, brokerages, etc.

And why did governments default on their bonds in the 1930s? Because they borrowed more than they could pay back. Sound familiar? Let’s forget about the incomprehensible trillions for now. Let’s just treat the US government like a household.

Monthly Income:       $1,900.
Monthly Expenses:   $3,000.

Monthly Borrowing to meet current expenses: $1,100.

So if this household went to their bank and said, “Look, I know I’ve been borrowing 60% more than I make each month to meet my expenses, and that I’m adding $1,100 to what I owe you each and every month, but you know, I really need that money.” How long do you think the bank would keep lending them a new $1,100 each month? Money that gets spent as soon as it has been borrowed.

Convert those hundreds to trillions and you have a good picture of US fiscal finances. Japan is doing far worse. The UK is similar to the US. Despite the evidence of history, people treat governments as if they are eternal, as if they will never fall. That they’ll pay back what they owe someday. History looks askance at that idea as well, as we have seen from the 1930s.

And for those who think that the alleged economic recovery is going to make these numbers better for the US, that this “recovery” is real, think again: The borrowing that the US has been doing for the last three years is equal to almost 10% of GDP, that is, it’s almost 10% of all the spending on goods and services that happens in the US each year. And they are claiming that the economy is growing at about 2% per year, which is itself an over-estimate. So what would happen if they stopped this borrowing and spending of 10% of the economy? The math is easy, and it’s called a severe depression, with the economy shrinking big time every year and so the government would have lower income from taxes and higher expenses for unemployment, food stamps, etc., putting them even further in the hole.

So, aren’t the people who usually buy treasury bills and bonds getting antsy about all this? Some clearly are, including “small players” like China. So the US, Japanese, and UK governments are doing what they call quantitative easing. Since this is a system steeped in lies, they don’t just say “printing money,” they have to come up with a BS term for it. (And they aren’t entirely stupid about that. Ask a few people what quantitative easing is. Most don’t know.) So the central bank of each country prints up money to buy the bonds and bills issued by the treasury when the treasury needs to borrow more money. The US Federal Reserve bought about two-thirds of the bonds sold by the US Treasury in 2011, so they covered two-thirds of the borrowing with newly printed money. If our household above had done that, its inhabitants would soon be in jail for counterfeiting, but that’s a topic for another day.

And one might think that governments can simply raise taxes to pay for these gargantuan debts. That might be true if the people weren’t already up to their eyeballs in debt. Historically, when all the debt in a country gets near three times their Gross Domestic Product, the country groans under this unsustainable debt load and has events like the Great Depression of the 1930s. According to Lacy Hunt, former member of the Federal Reserve Board (and I only cite that credential so you don’t think these numbers come from some deranged blogger), that total debt ratio is now 3.6 times GDP in the US, after peaking at 3.8x in 2009. Think the Eurozone is any better? They are at 4.5x! The UK is at 4.7x. And Japan is at 5x! (From Strategic Investment Conference – Dr. Lacy Hunt)

According to Boston University Prof. Kotlikoff, a guy who is enough of an insider that his work is sometimes published by the US Federal Reserve, when you consider all the future spending commitments of the US Government: “US government liabilities (official debt plus the present value of projected future non-interest spending) exceed government assets (the present value of projected future taxes) by $211 trillion, roughly 14 times GDP.” (From Shattering the American dream: The US government’s Ponzi scheme) In other words, unpayable doesn’t even begin to describe the situation.

So, it is clear that government bonds are a fraud. At some point, the holders of these bonds will not get back their capital and their expected interest payments, as the buyers of Greek government bonds recently found out. The only way these bonds are being kept afloat is by newly printed money. It’s a scheme, a Ponzi scheme, where new money has to be brought in to satisfy earlier investors. Such schemes always fail. This one will as well. You can take that to the bank. But as I think you can tell, we don’t recommend that. Taking it to the bank, that is. Because the bank–at least if it’s a large one–is part of the scheme. And so are your insurance companies, pension plans, etc. Take action accordingly.

Lie #10: Derivatives reduce risk in the system

Derivatives, famously called “weapons of financial mass destruction,” are a big topic, but it’s an important topic to understand because, when the derivatives implode, the whole financial regime will implode. We will do our best to keep it simple and sort of brief. If the description of this lie makes your mind fog, move on to Lies #11 and #12. They are easier to understand, and not to be missed.

A derivative is a financial instrument, a contract, whose value is derived from the value of some underlying asset. Examples of derivatives that have functioned well for years are agricultural futures, where a farmer and a grain buyer agree in the Spring on the price of a railroad car of oats for delivery in December. Both enter the contract to make their pricing in December predictable, removing some of the risk of running their businesses.

But the banksters couldn’t leave it alone. They created derivatives to insure against just about every conceivable financial eventuality. But they sell this insurance without setting aside the reserves typically required for writing insurance policies. Such reserves are normally required to cover the flow of insurance claims that inevitably arise. They sell these instruments to entities who are trying to reduce some financial risk they face, like currency movements, interest rate changes, a default on some bonds they own, etc. Some of the modern derivatives are so complex that, when the parties to a derivative contract have ended up in court, the court ruled that the 600-page contract that defined the derivative didn’t sufficiently cover all the contingencies! These derivatives are sold by the big banks and insurance companies to all sorts of financial entities from corporations to school systems to hedge funds. The school systems are trying to reduce risk; the hedge funds use derivatives as a casino bet. Since the instruments are complex, the banks charge big fees for access to these contracts.

This is now so out of hand that there are over $700 trillion worth of derivative contracts out there in the world. Yes, that’s more than 10 times the size of the world economy. These are insurance policies that obviously cannot be paid if the claims come in. And when the claims come in, the big writers of these insurance policies, the big banks, will be understood, for yet another reason, to be entirely bankrupt. And that money everyone thought they had in the bank will be gone, vaporized. When all that money is vaporized, there will be no money coming from your ATM, no ability to withdraw some from the bank, no paychecks (the checks will bounce), no ability to pay bills, no tax payments going to governments, etc.

So instead of derivatives reducing risk, which is what their proponents claim that they do, derivatives have concentrated risk in the very large banks, which puts the entire system at risk for the sake of large bankster profits.

So why is it inevitable that the derivative market will implode? After all, while no one denies that there are over $700 trillion of derivatives, and no one claims to have anywhere near that amount of money available, the banksters claim they will never have to pay up on that insurance. Here’s their reasoning:

1. The things they write insurance for won’t ever happen, at least not to any extent that will have a big impact on anyone. And how do they know this? Because they have based their insurance on mathematical models designed by very fancy mathematicians and physicists. But the problem is this: their models are based on data from a small sampling of history. The data rarely even includes data from the era of the Great Depression. So here’s what happened in 2007-2009: some derivatives were based on pools of mortgages. These models assumed, because that’s what they saw in the historical data, that real estate prices always go up. As soon as real estate prices started going down in mid-2006, the payments on these mortgage-backed derivatives came due. And the banksters didn’t have the money to pay up. We all know how it ended, some failed, and the governments bailed out the rest. So when just one very small slice of the derivative payments came due, payments the banks and our beloved central banks said would never come due, the entire system was threatened. The rest of the derivatives in the world are based on similarly inadequate models. They will prove especially inadequate as the world faces the accelerating change that is apparent to so many of us. It is impossible that these mathematical models can account for events that have never happened on the planet before, or that only happen once every several thousand years.
2. The banksters claim that, even though they may have written contracts for $100 trillion, their book of contracts is balanced, that it is hedged. By this, they mean that, if Spain defaults on its debts, that they have contracts that say that it will and contracts that say that it won’t. They will lose money on one set of contracts and make an equal amount of money on the other contracts. While multiple cases have shown this claim of being hedged to be an outright lie, it has a deeper underlying problem. Let’s say JP Morgue has a bunch of customers who want to buy insurance against a default by Spain. That would be a very unbalanced position for the Morgue. So they go to Bankrupt of America and buy protection against Spain defaulting. Now they think they are hedged, balanced. But there are less than a dozen banks in the world handling the vast majority of this $700 trillion in insurance. Remember AIG in 2008? They were a big writer of mortgage-pool-related insurance in 2007. They were not hedged. They were unable to pay. That inability to pay would have taken down several other institutions who thought they were covered because of insurance they had purchased from AIG. AIG needed a government bailout of $185 billion or the other banks would have gone under. So all it takes is one of those banks to make an error, to not be hedged, to not be able to pay up, and suddenly each of the others is also going under. This is where the concept of the Too Big To Fail banks has come in. All of them are so interconnected that if one fails, they all fail.

So then you might say, well won’t there just be another bank bailout by the governments? Two problems with that. First, no one can come up with anywhere near $700 trillion to fix a cascading failure of the mega-banks. If they printed that much money, the money you currently have would be seen by all to be worthless. Think wheelbarrows of money, hyper-inflation. Second, as we have seen, people have less and less trust in government finances. A large part of the temporary system fixes done in 2008-2009 were not the actual printing of money, they were guarantees. But if everyone understands that a government providing a guarantee is broke, then what is that guarantee worth? Bupkas. Nada. Nothing.

But this is, in fact, what the TBTF banks are counting on: they have a gun to the head of the governments, saying “you have to cover our backs on this huge and very profitable game or we’ll take down your system.”

So when the derivatives implode, all the electronic money in the world will be known to be either gone (fully imploded system) or worthless (tens or hundreds of trillions gets printed up, making all currency worth a tiny fraction of their current purchasing power).

Lie #11: Central banks protect the interests of their country and its citizens

Let’s just get right to the truth about this lie: Central banks protect the interests of large commercial banks. And not all banks. Just the really large ones. The central banks we are speaking of are the international ones, namely the Bank for International Settlements and the European Central Bank; and the national central banks such as the US Federal Reserve, the Bank of England, the Bank of Japan, etc.

Whenever you find it difficult to understand an action by a central bank, apply the principle in the previous paragraph and that action almost invariably makes complete sense. Everything else that central banks say and do is window dressing, secondary at best to their prime directive. Central banks were founded to protect the interests of the large banks, to keep the game of those banks going, and that is what they do.

And what is that game? Being able to create money from thin air and charge for the privilege.

So are central bankers, people like Ben Bernanke, liars? Or have they drunk the Kool Aid so deeply that they believe their own nonsense? The evidence points to the idea that both are true.

This topic is covered in great detail by many on the web, so I won’t recap it here. Please e-mail if you would like more detailed information on this.

Lie #12: Your paper/electronic currency is a reliable store of value.

For most people in the industrialized world, money means two things: a little bit of physical cash on hand, and more money than that in one or more accounts with financial institutions. This reflects the reports on world money supply: maybe as much as 1% of money is actual physical bills and coins, the rest is stored electronically.

This has a big implication, one not readily recognized by most. Every electronic representation of money is a promise by someone to pay up if that money is requested for possession or use. In other words, that money is owed to you. While you may consider it to be cash in your account, it is actually a debt, owed by the bank or money market fund, to you.

Everyone knows that, in the 19th Century, for example, money was backed by gold or silver. You could go to a bank and convert national paper currency for gold or silver coins. Because this restricted the ability of countries to wage war, that right was persistently eroded starting with world War I until it was abolished entirely in 1971.

So what backs up the money now? It is the ability and willingness of those who owe you money to pay up on demand. And the confidence of all who use the currency that they can exchange that currency for goods and services of real value.

Ability and willingness to pay: If the party who owes you money goes belly up or is unwilling to pay you, you are out of luck. That money you thought you had? Well, you don’t have it. In the case of complete bankruptcy, the money no longer exists, it went to money heaven. In the case of a bank, there is a government guarantee that, up to a certain amount, even if the bank goes under, the government will make good up to that guaranteed amount. Such guarantees were put in place in the 1930s after million lost their money due to bank failures.

Confidence: Everyone has heard of situations where people lost confidence in a national currency. The poster child is the Weimer Republic in Germany, with it infamous photos of people carting around wheelbarrows full of currency. And there have been such losses of confidence in Brazil, Argentina, Turkey, Zimbabwe, Viet Nam, and many others. In these cases, governments printed so much currency that it became a “hot potato,” where people wanted to exchange currency for something real as soon as possible because the currency was known to be losing value by the hour.

People can also lose confidence in a currency when a government is known to be going under, perhaps because they are losing a war.

People say that such fiat money, that is, money by the command of a government, is a medium of exchange and a store of value. It certainly is a medium of exchange for goods and services. Until it isn’t. And it isn’t when people lose all confidence in that fiat money as a store of value. Then it becomes that “hot potato.”

And it is somewhat surprising that people still regard it as a store of value. Since the inception of the US Federal Reserve in 1913, the US Dollar has lost, by the US government’s own statistics, 95% to 99% of its value, depending on what method is used for that calculation. People think that a loss of value over that much time is meaningless to them, allowing them to think, for example, that they were real estate geniuses for owning a house in the USA from 1971 to 1997, during which time that real estate “went up so much” in value. Most of that apparent gain was from currency debasement. People hear stories of how their great grandparents paid five cents for a loaf of bread and think that price increases for bread over time are normal. They are not! When money was backed by metals, prices for goods often stayed stable over many decades, with price fluctuations reflecting real changes in supply and demand in the economy, not politician-supplied increases in the supply of fiat currency.

Why have people come to accept increases in the money supply as necessary, and price inflation of 2% to 3% per year as normal, even as “low inflation”? Because it is key to the functioning of a financial regime where money is debt. When all money is debt, the borrower typically has to pay interest to the lender. On most of the money out there, namely that 99% of it that is stored in electronic accounts, people want some payback, interest payments, on their deposits. So let’s just say that, on average, 3% interest is due on all of the money out there. So every borrower, think banks as an example, who are borrowing from you because you have deposited money with them, has to come up with at least 3% more money every year to keep paying interest owed. So what happens if the economy doesn’t grow by at least 3% and there isn’t an increase of the money supply by 3%? It means that some borrowers will not be able to pay the interest they owe. And some of them will go bankrupt. Meaning that the money deposited with them might go to money heaven, disappear, subtracting a lot of money from the system. And this is a system where the amount of money in circulation must grow by that 3% every year or the system starts to go in reverse: instead of the supply of money growing, it starts contracting because of bankruptcies.

So now, do you see why those who run the financial regime go into a complete panic when the economy doesn’t grow? Why they start printing more money every time the economy and, thus the supply of money, shrinks? This is a crucial concept. An economy based on money that is debt must grow. Always. Infinitely. This is why politicians and central bankers repeat the word growth like a mantra. But ultimately, economies are based, at least for now, on finite resources. So how can they grow to infinity? This is the fatal flaw in a system where money equals debt: it must always grow. Which means it must always, as our economies are currently configured, consume more physical resources, especially fossil fuel energy. A steady-state economy is not acceptable when money is debt. It must grow and gobble up more of the resources of the planet. Forever. Which of course is impossible, at least until alchemy is a common skill. But the politicians like to ignore this and just keep chanting growth, growth, growth.

And all things economic obey the Law of Cycles. Things are created, they flourish, and then they pass away, making room for the new. To retain their power, the entrenched elite are trying to subvert that law.

WHY ARE THINGS THIS WAY?

Simply, for the guaranteed profit of a few at the expense of the many. This too is a topic for another day, but that’s the accurate and brief description that fits the facts.

WHAT THEN MUST WE DO?

We could go on and on about other fatal flaws of this financial regime that threaten its existence. The coming disruption from the US Dollar’s loss of reserve currency status. The unfairness of bailing out and supporting the banksters who are engaged, by any human standard, in blatant criminal activity. The subversion of the rule of law as government and its agencies are purchased by the banksters. About the accounting lies that allow financial feces to be counted on corporate balance sheets as shining light.

And you may not agree that the chickens will come home to roost on all twelve lies above. But recall that the financial regime almost fell from the demise of just one of its minor lies, the lie that real estate always goes up in value. Other lies above are for more fundamental to the regime, much more foundational in nature.

And it is because of the foundational nature of the lies that reform of the current system is impossible. Tweaking the rules will not address fundamental flaws.

So what then must we do? We will address that topic in our next article.

Many thanks.
Thundering Heard