Dark Skinny

The majority of American citizens probably have no actual idea of their country’s real fiscal debt. From the film I.O.U.S.A., David Walker describes it this way:

‘When many Americans think of debt and deficits, their knee-jerk reaction is to blame the war in Iraq, or defense spending. Some people think that we can solve the country’s financial problems by stopping fraud, waste and abuse, or by canceling the Bush tax cuts. The truth is, the United States could do all three of these things and still wouldn’t come close to solving the nation’s fiscal challenges.

‘The U.S. already has $11 trillion in fiscal liabilities, including public debt. To this amount, add the current unfunded obligations for Social Security benefits of about $7 trillion. Then add Medicare’s unfunded promise: $34 trillion, of which about $26 trillion relates to Medicare (parts A&B) and about $8 trillion relates to Medicare D, the new prescription drug benefit which some claimed would save money in overall Medicare costs. Add another trillion in miscellaneous items and you get $53 trillion. The United States would need $53 trillion invested today, which is about $175,000 per person, to deliver on the government’s obligations and promises. How much of this $53 trillion do we have? Nada.’

U.S. Debt History

But this ongoing and sad story of unmanageable U.S. Debt hasn’t always been the case. In Wikipedia and within early American History, the first recorded National Debt was $75,463,476.52, on Jan 1, 1791. The lowest point of the public debt was recorded in 1835 and was $33,733.05 !! And right throughout the 19th century - with a strong, rising economy - America’s greenback was fully backed by gold and always very stable. In those heady days noone had heard about Keynesian Economics or Monetarism. In terms of debt, part of this theory maintains the Debt represents Economic Strength. So the more debt a country has, according to the Monetarist Theory, the stronger the country is economically. But right now America is in deep debt. Do you think America is a strong, rising economy now without any economic weaknesses ? Seems to me there is also a principle called “Too Much and Too Little” which is similar to the Chinese Yin and Yang principle.

The Dollar’s Downward Slide

The stability of the Dollar was evident right up until 1913. Between 1913 and now, the American Dollar has declined in value by 96% . The Fed was also formed in 1913. In 1944 with the Bretton woods Agreement the dollar had a stellar rise in its importance, and became the World Reserve Currency. One of the principles that the US signed up to in Bretton Woods was that that US Dollar must always be backed by gold. So all other major currencies in the world confidently backed their currencies against the dollar(which was backed by gold). But in 1971 the greenback suddenly became a fiat currency, no longer backed by gold according to Executive Order decree by Richard Nixon. As well as this huge monetary turnaround, this also disconnected all the other major currencies of the world from the gold standard(without any option), because by making the Dollar a floating currency, all the other currencies that depended on the Dollar were consequently disconnected from gold. And by this action, Nixon greatly weakened the World Reserve Dollar, whose value and stability is patently no longer the hegemon it once was.

The Fed, The Dollar and the Great Importance of the Printing Press

The main way that the Fed deals with its mounting Debt is by selling its debt in the form of Sovereign Bonds, T-Notes, T-Bills etc. Foreign countries mainly buy these debt instruments for a fixed time period with a fixed interest which is guaranteed by the US government. These instruments are printed by The Fed and purchased in vast quantities by foreign countries (especially by Japan and China) with dollars from their reserves and dollars come back to America to help pay its vast debt. This mechanism undoubtedly inflates the dollar, driving its value South - continuously.

Interestingly enough there is another result from the The Fed’s creation of these debt instruments. This is called Fractional Reserve Lending or Banking which is defined as:

Fractional-reserve banking is a banking practice in which banks are required to keep only a fraction of their deposits in reserve with the choice of lending out the remainder while maintaining the obligation to redeem all deposits upon demand. This practice is prevalent worldwide and is considered to be the customary form of banking.

So, as an illustration of this banking principle, if the Fed creates - say - $1 million worth of T-Bills or dollars for purchase by China, then - according to US Banking Law - The Fed is allowed to create $9 million more dollars (out of thin air) for its own use in the ratio of 1:9. So, that’s 1 million T-Bills for China and $9 million for The Fed, who then lends this money out at low rates to the US banks and financial institutons (who again lend out these funds at the 1:9 ratio) who in turn lend this money out at very high and exorbitant credit rates to businesses and the public. This type of over-practice constantly inflates the Dollar and should need no explaining.

As well as this, the US government is also allowed to purchase it’s own debt instruments, thereby resulting in what seems to be an immediate profit of 9 times the worth of its investment out of thin air !! Multiples of this government practice can seem astounding. The mind boggles at all the possibilities here.

Another way that The Fed makes money is through something called seigniorage which can be defined as:

Seigniorage derived from coins arises from the difference between the face value of a of a coin (or note) and the cost of producing, distributing and eventually retiring it from circulation.

Here is a good illustration of this banking principle from Wikipedia:

No seigniorage occurs in the following situation: A person has one ounce of gold, trades it in for a gold certificate (which allows him to redeem the certificate for one ounce of gold), keeps that certificate for a year, and then trades it in for gold — he or she ends up with exactly one ounce of gold again.

Seignorage does occur in the following situation: A government does not issue gold certificates and instead converts gold into currency at the market rate. A person trades in an ounce of gold for its worth in currency, keeps that currency for a year, and then trades the currency back in for an amount of gold — he or she may receive a different amount of gold from that which he or she started with, if the price of gold has increased or decreased during that year. Even if he or she were then to use the currency to buy something, someone is holding the bill for the entire time and the government still has the gold.

But in the current economic climate, and particularly in the US, there is a very apparent rise in the cost of living which can be explained further:

Seigniorage can be seen as a form of tax levied on the holders of a currency and as such a redistribution of real resources to the issuer. The expansion of the money supply causes inflation. This means that the real wealth of people who hold cash or deposits decreases and the wealth of the issuer of the money increases. This is a redistribution of wealth from the people to the issuers of newly-created money (the central bank) very similar to a tax.

The above definition applies to all paper currencies as well. As an example, lets say The Fed prints a million 1 dollar bills. Let’s say the actual cost - since we’re talking about a commodity that consists of just paper and ink - to the government (as profit for The Fed which is a part-private financial institution) is about 2.2 cents per note. So when the Fed puts the bills out there, it is making a profit from the government, because these are $1 dollar bills that have already devalued by 2.2% (through cost to the govt.).And as these costs rise through this inflation, the value of the dollar thus becomes less and less.

Perhaps this “inflation tax”(represented by the year by year inflation rate of the dollar currency that occurs with expansion of the money supply) levied by the US government on its own people is actually a very discreet and constant form of income tax. What else can you call it except, perhaps, a super-stealth citizens tax ? I wonder whether US citizens fully realize what is happening here.

In the descriptive words of Congressman Ron Paul upon the rampant money printing habits of The Fed:

“Strictly speaking, it probably is not necessary for the federal government to tax anyone directly; it could simply print the money it needs. However, that would be too bold a stroke, for it would then be obvious to all what kind of counterfeiting operation the government is running. The present system combining taxation and inflation is akin to watering the milk: too much water and the people catch on.”

The US Dollar - Current Status and Health Prospects

Well, everybody in the US is heaving a sigh of relief now, since the dollar has recently recovered its strength. Isn’t The Fed just wonderful !!? Their policies have worked just a treat haven’t they ? Great job guys !!

I hate to burst your bubble(Ouch, sorry about that..!!) but The Fed’s singular policies certainly had nothing whatsoever to do with the dollar’s recent quick recovery in August 2008 - because China will soon be purchasing vast quantities of US debt instruments for her own ends. This news is the real reason for the dollar’s sudden recovery. China has done this purely to maintain downward pressure on her Renminbi and Yuan, keeping her currrency well undervalued against the dollar - therefore her goods and services stay cheap. Cheaper than US exports.

The other far more disturbing thought is that for the first time ever, China has managed to successfully grossly manipulate the US Dollar for its own gain. Easily. And if it is capable of strengthening the Dollar for its own ends, China is equally capable of selling off that same currency for her own gain. Very disturbing indeed to see clear evidence that the US government has fully lost control of its own trade currency to China….