Summing Up A Decade Of Work

As you know, I have recently made two Video Courses explaining the global economy. Here’s the link to the newest one, How The Economy Really Works:

The material I‘ve used in these courses was taken primarily from the three books I’ve written over the past ten years. Here, I’d like to very briefly summarize what I believe to be the most important findings from that decade of work.

An important breakthrough for me came when I read that there had been an automatic adjustment mechanism inherent to the gold standard that ensured that trade between countries balanced. Once I understood that, then the origin of economic bubbles in the post-Bretton Woods world where trade no longer had to balance became clear.

The theme of my first book, The Dollar Crisis (which was published in 2003), was that the US trade deficit was destabilizing the global economy by blowing the surplus countries (like Japan, Thailand and China) into economic bubbles; and also by blowing the US economy itself into a bubble when the central banks of the surplus countries accumulated (as Foreign Exchange Reserves) the trade surplus dollars entering their countries and then reinvested those dollars into US dollar-denominated assets in the United States. I pointed out that central banks can only accumulate Foreign Exchange Reserves by creating their own fiat money and using it for that purpose. In that way, I highlighted the link between trade deficits, fiat money creation outside the United States and the asset price inflation inside the US when those dollars were reinvested in US dollar-denominated assets.

At that time, it wasn’t generally understood that the growth in Foreign Exchange Reserves reflected the growth in fiat money being created by the central banks accumulating the Reserves. Once it was clear that Foreign Exchange Reserves equaled fiat money creation, then the massive surge in Foreign Exchange Reserves that was then occurring took on an entirely new significance. It revealed an explosion of paper money creation on an unprecedented scale; and it could then be understood what an extraordinary impact that surge in fiat money creation was having on the global economy. It became apparent that the “global savings glut” that Fed Chairman Bernanke had identified as the cause of the global imbalances destabilizing the world was actually a global fiat money glut instead. (Total Foreign Exchange Reserves now amount to $11 trillion, having increased by $9 trillion since 2000.)

By the time I wrote The Corruption of Capitalism in 2009, I’d worked out that the size of the US Current Account deficit relative to the size of the US Budget deficit was very important as a determinant of the direction of asset prices. Whenever the US Current Account deficit exceeded the size of the Budget deficit – as it did every year between 1996 and 2008 – it created very favorable liquidity conditions that tended to push up the price of stocks, property and other assets in the United States. That’s because the Current Account deficit threw off dollars into the global economy that were accumulated as Foreign Exchange Reserves (through fiat money creation) and then reinvested in US dollar-denominated assets. Therefore, when the Current Account deficit was larger than the Budget deficit, it not only financed the entire Budget deficit, but also resulted in the additional money being invested into other asset classes, causing their prices to inflate, bubble and, ultimately, bust.

I was inspired to write my third book, The New Depression, when I read Irving Fisher’s brilliant book, The Purchasing Power of Money, in 2011. I realized then that once the United States stopped backing dollars with gold in 1968, there was no longer any difference between money and credit. It became clear that the explosion of credit that followed that break in the link between dollars and gold made the Quantity of Money, that is the Money Supply, irrelevant and that what matters now is the Credit Supply or the Quantity of Credit. I then looked at the growth in Total Credit in the United States back to World War II and discovered that every time Total Credit (adjusted for inflation) grew by less than 2%, the United States went into recession; and that it didn’t come out of recession until there was another surge in credit growth.

Replacing the Quantity Theory of Money with the Quantity Theory of Credit turned out to create a very useful framework for understanding all aspects of the crisis in the global economy that was then underway: its causes, the government’s policy response to the crisis, what was likely to happen next and how that would likely impact asset prices going forward. The cause of the crisis was the inability of the private sector to take on any more debt (or even to repay the debt it already had). The policy response of trillion dollar budget deficits financed with trillions of dollars of fiat money creation was designed to make total credit continue to expand, even though the private sector was bust - because a contraction of credit would have caused a new Great Depression. What would come next would be determined by whether or not Total Credit began to grow by more than 2% (after inflation). Inadequate credit growth would require more fiscal stimulus or fiat money creation, while a surge in credit growth would require less. Asset prices would then tend to rise or fall depending on whether the government increased or decreased its stimulus.

I understood from the beginning that Globalization was very deflationary and that it, therefore, offset the highly inflationary influence of credit and fiat money creation. Without Globalization the rapid, credit-fuelled global growth between 1982 and 2007 would not have been possible.

Eventually, by the time I wrote The New Depression, I concluded that these changes were so profound that, in combination, they had changed the very nature of our economic system. Unlike Capitalism which had been driven by Saving and Investment, our system is driven by Credit Creation and Consumption. Creditism, therefore, is a more appropriate name for our economic system than Capitalism.

It’s the growth of Credit and fiat money (which is simply another form of Credit) that matters now. It’s certain that Credit Growth drives economic growth. In fact, it looks as though our economic system can only survive if credit continues to expand.

Our economy has changed radically during the 45 years since we abandoned gold-backed money in favor of pure fiat money. The mechanics of Creditism – as well as the dangers it poses and the opportunities it may present – are only gradually coming to be understood.

I hope you’ll watch my new course. If you do, you’ll have a better understanding of How The Economy Really Works.

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