by Steve Stofka
few things before I continue the saga of our mountain community. Bond yields
have sunk to remarkable lows as the prices of those bonds climb higher in
response to global demand for safe assets. Governments have borrowed trillions
since the financial crisis, yet there is not enough debt to meet demand.
private market created a huge supply of “safe” assets called
Collateralized Debt Obligations, or CDOs, based on house mortgages. When the
housing market imploded, it left a big hole in the market for safe assets. As
countries around the world have adopted capitalistic market structures, the
living standards of millions of people have improved and that has led to more
savings in search of safe investments.
U.S. still pays a positive interest rate on its debt and that is attracting a
lot of foreign capital to our country – capital that is driving down the
interest rates on our savings and pension assets. Unlike some other countries,
capital moves freely across U.S. borders. It doesn’t wait in crowded spaces
behind chain link fences.
Trump’s family business relies heavily on borrowing, and most of that has come
from a single source, the German firm Deutsche Bank. No other bank is willing
to risk capital on a family business with a history of failure. The family’s
business depends on the free movement of capital across national borders, yet
Trump himself is adamantly opposed to the free movement of labor across
requires a legal framework of property rights protection, a robust banking
system capable of servicing that capital, and a political system that protects the
profits generated by investment from graft and corruption. Labor requires a social
framework in addition to a legal system that enforces basic personal rights. Capital
comes to this country because we spend a lot of money to nurture and protect it
more than some other countries. Labor comes to this country for the same reasons
– a higher return on their effort, an educational system that nurtures their
families, a social and legal system that offers some protections.
taking our jobs!” some people complain of immigrant labor, yet few Americans
are affected by an immigrant labor force that takes mostly lower paying jobs. The
flow of capital into our country creates a competition that affects many more Americans
– anyone who has a savings account, a pension fund, a 401K, an IRA. Where is
the outcry against foreign capital?
us return to those dear souls who inhabited an abandoned mining town. In last
week’s story, they had formed a homeowner’s association which created Money,
Debt, and traded with another community called the Forners.
The board of the homeowners’ association complained often about the expense of handling the Money that it had created. The association decided that it would be more efficient to reduce the use of paper Money. It gave each homeowner a bank account and a Money shredder which scanned and tabulated the Money that each homeowner shredded. Homeowners didn’t have to go to the community center when they needed to pay another homeowner or the association. When they did receive Money, they deposited it in the shredder, which added the amount to their balance. When they wanted to pay someone, they tapped some buttons on their shredder and the amount went from their account to the other homeowner’s account. Paying their monthly homeowner fees was so much more convenient.
A homeowner called Mary decided to re-open the old restaurant, but she would need more Money than she had. What to do? The association could print the Money and loan it to her. Mary would put up 10% of what she needs, and the association would print the other 90%. She would pay the money back over time with interest. One of the homeowners asked, “How will we be paid if we do work for Mary’s restaurant?” Someone answered, “With the same Money that you get paid when you work for the association.”
That was acceptable to everyone. With the extra Money earned by fixing up Mary’s restaurant, several other homeowners put down deposits and opened businesses with loans from the association (Note #1). The association held a mortgage on each business, but the business owner decided how to run the business and received the profits from the business.
Stan’s business failed, the homeowners discussed what to do. Stan had spent the
printed Money that the association had loaned him, so the Money had not
disappeared. Like all the printed money, it was spread around the community. The
effect of Stan’s business failure was the same as if the association had
started the business, hired people to do work, paid them and then closed the
business after a time. The printed Money went out into the community but never
made it back to the association in the form of loan payments. Someone said,
“There is extra Money in our community because Stan’s business loan won’t
be paid back.”
agreed that this was so but what to do about it? They all had some extra Money
because of Stan’s business loan. “What if more businesses fail?”
someone asked. “What will we do with all the extra money the association
will go up,” someone else said. “That’s what happened last
more businesses failed, I would be more careful and buy less stuff,”
another offered. Several heads nodded. “I’d deposit some extra Money in
that doesn’t make the Money go away,” someone argued. “The money is
still in your bank account with the association.”
prices won’t go up because people are spending less Money, isn’t that
right?” someone asked. That was the confusing part. The last time there
was extra Money, prices went up. But in this case, prices were likely to go
down if more businesses failed and there was extra Money.
stood up and said, “I’ve got the answer. When we all worked fixing up
Stan’s business, the Money was exchanged for our labor and supplies. Since the
Money was exchanged for goods and services, there is no extra Money.”
else countered, “What if we all started businesses, borrowed Money from
the association and we all failed? There would be a lot of extra Money.”
other person answered, “Yes, the amount of circulating Money would be
suitable for a thriving community. Too many people with a lot of Money and
nowhere to spend it would drive up prices. But just one or two business
failures has such a small effect that it is negligible.”
decided to continue printing and loaning money but formed a loan committee
whose job was to review an applicant’s business plan before loaning the money.
the community’s propane dealer, bought his supplies from the Forners. One
month, the Forners got very angry at the whole community and would not sell
propane to Bob. He contracted with another community for propane but there
wasn’t enough for everyone’s needs. Bob raised the price of propane then began
rationing propane by selling only to those who were in line at his station at 6
A.M. After two hours, he shut off supplies until the next day. Some homeowners threatened
Bob and so he had to hire a few people for extra security (Note #2).
used a lot of propane for cooking, so she had to spend several hours each day
buying propane. Naturally, she raised prices to account for the additional time
and higher price of propane. Homeowners ate fewer meals at Mary’s and she had
to let go of several employees.
As prices rose, some homeowners who had bought association debt at low interest rates began to complain. “We loaned the association money at 5% interest and prices are going up at 10% a year. We’re losing money!”
Everyone agreed that this wasn’t fair, but no one knew what to do about it. Should they cancel the old debt and reissue debt at higher interest rates? That would lead to higher homeowner fees for everyone. “You want us to pay extra so that your interest income will keep up with inflation? Why should I take money out of my pocket and put it in yours?”
Tempers flared. “I’m not loaning this
association money ever again,” complained one homeowner and several
stormed out of the clubhouse. True to their word, these homeowners would not
renew their loans to the association unless it paid much higher interest rates.
After several months, the Forners resumed propane deliveries but a vicious
cycle of higher prices had started. Homeowners had to pay higher association
fees and wanted more money for their labor to pay those higher fees. No one
knew how to fix the situation.
“We need to charge high interest
rates on the Money we print and loan to homeowners for their businesses and
homes,” a board member said.
“Are you crazy?!” Several
complained. “Rates are already too high. People can’t afford to start
businesses or buy a home!”
“We need to raise them so high that
it will hobble the economy for a while,” the board member said.
“That’s the only way to bring prices down. It won’t take long.”
It took much longer than anyone anticipated, and the economy declined for almost two years. This period of higher prices followed by high interest rates caused a divide among the homeowners – between those who relied on the association for services and help during hard times, and those who formed a deep distrust of the association (Note #3). No one fully understood how deep the divide would grow.
- The process where loans generate
income for others which generates more loans is called the Money Multiplier in
- In the 1970s, two gas embargoes led to
This is a retelling of the high inflation of the
late 1970s, followed by nose-bleed interest rates that caused back-to-back
recessions in the early 1980s. The recession of 1981-82 was the most severe
since the 1930s Depression.