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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