A Tsunami of Debt

By Bill Bonner, Chairman, Bonner & Partners on October 31, 2013

The Dow sold off a little yesterday, after hitting a new all-time nominal high on Tuesday. (Adjusted for inflation, the story is a little different. The Dow’s inflation-adjusted high is about 16,000.)

Investors must feel confident. Sentiment is overwhelmingly bullish. Investors don’t think the Fed will taper any time soon.

They’re right about that. The betting is that tapering will not occur before mid-summer or fall of next year. Our guess is that it won’t happen then either…

But who knows? We’re ready for anything… Boom? Bust? Bubble? Anything is possible.

This financial world we live in is completely new. There are very few historical data points that help us understand it. And those that do exist tend to be incomplete and inconclusive.

President Nixon changed the money system on August 15, 1971. Since then, we’ve been in a brave new financial world. From a gold-backed monetary system, we switched to a system based on paper money, managed by people with PhDs.

The idea was that, rather than be stuck with a fixed quantity of money, academics could instead figure out how much money and credit was needed and provide them as necessary.

This was not the first time governments have tried to put in place an elastic monetary system. Several times in history nations found paper money a convenient way to pay their bills – typically when they were at war and had run out of real money.

But this was the first major episode during peacetime in which the world’s financial systems had come to depend on a paper money controlled by a single nation: the United States of America.

Gresham’s Law

Gresham’s Law tells us that “bad money drives out good.” If people have a choice between holding a debased or deteriorating money (paper) or holding real money that is not losing value (gold), they will choose to hoard the good money and pass along the bad stuff.

In effect, that’s what happened. The good money (gold) disappeared from circulation. The bad currency (dollars) became what everyone recognized as “money.” Central banks in the developed world generally decided that the prudent thing to do was to hold some gold… as well as US dollars.

And now that the developing countries are becoming more prosperous, unsurprisingly, their central banks are also accumulating gold.

Dollars are not the same as real money. They are liabilities of the US federal government – Federal Reserve Notes – much the same as Treasury bills, notes and bonds. In this way, dollars are the opposite of money. Instead, they are debt instruments of immediate maturity.

Washington tells us to use them as “legal tender for all debts, public and private.” But it provides no guarantee of their value.

Real money has intrinsic value. Once a debt is paid in real money, the transaction is finished.

Earlier but your cialis dosage drying hair spots!

Over. Complete. Not so with US dollars. They are debt instruments, just like all government-issued paper. And debt depends on the debtor. If he defaults, his paper promises can become worthless – including his dollar bills.

Drenched in Debt

As dollars replaced gold, the capitalist system became a strange and grotesque amalgamation of market-based transactions, but with less and less real capital involved.

Debt replaced real money. Gradually, debt spilled over and saturated all sectors. Households, businesses – everyone became drenched in debt… from the recent college graduate with his student loans… to the young family with its mortgage and credit-card debt… to the retirees, depending on the unfunded liabilities of the Social Security and Medicare systems.

And when this tsunami of debt threatened to drown millions in the deleveraging crisis of 2008-2009, the powers that be rushed to the scene with aid. But what help could they give? More debt!

There was no way they could afford to let so many debt-soaked institutions sink. They made it clear they would give the economy as much new liquidity as it needed.

And now, even the faint suggestion that they might be getting tired of pumping so vigorously – $85 billion a month – staggers the market for stocks.

But where does all this new liquidity go? No one knows. Some say it gets trapped, because the banks are unwilling to lend. Others maintain it is preparing another tidal wave to wash over the markets; they expect to see stocks, houses… everything that can float… rise up to unheard-of levels.

One way or another, it may be that Mr. Market is preparing some real excitement.

It will be fun to watch… from a distance. Like a Hallowe’en bonfire!



  1. Wags

    Nothing has intrinsic value. Value is imputed by people. Dollars are valuable because they can be used in exchange, or to pay off debt. They are also deemed “legal tender” by the US government. Gold can’t say that. Maybe gold has intrinsic qualities that make it valuable. It’s certainly more honest than paper.

    1. bh2

      It should not be necessary to pont out that gold is also hoarded as a “monetary asset” by central banks, who are now steadily acquiring more. Of course it’s money — precisely because central bank behavior says it is.

    2. tim

      Gold is the ultimate extinguisher of debt. Dollars transfer the debt to the party that accepts them. There’s no counterparty risk with gold.

    3. ManAboutDallas

      You’re another one of Lenin’s “Useful Idiots” who knows the price of everything and the value of nothing. Also, a useful example of someone marinated in an education “system” where Relativism has been raised to the level of religion.

      1. Crabby(ManAboutWesternAustralia)

        @M.A.D., Can’t we all be wealthy? I think not but at the rate the Central Banks of the World are acting, we have no choice. We have to invest to “get ahead” if there is such a thing when the whole system is rotten to the core. I’m looking forward to becoming an Investor very soon so I can outpace the “Losers”.

  2. Colm O'Dwyer

    Interesting Wags… I’ve wondered the same. People have been trying to figure out the best money for tens of thousands of years, and for whatever reasons (durable, divisible, consistent & convenient), gold is it!

    Fiat money on the other hand has a very short history of instability and failure.

    There’s no telling what the future holds, but if track-records are any indicator, people will still think gold is valuable 100 years from now. The US dollar on the other hand will surely have imploded by then, if not much sooner.

  3. Nuno

    Gold ? Let me tell you what is happening to gold (and silver).
    The monstruous voracity of gold extraction each year is unparaleled!
    Every year now it is mined more gold than took humanity 500 years to mine in the past.
    Soon gold will be as abundant as silver, and silver as copper…
    This can’t be good for the price.

  4. Known

    Yes, Gold is mined but that takes work and machinery. Dollars are actually not made or printed now; dollars are made out of thin air almost! The Fed’s must pay a person (NO! the taxpayers or China(?) pay him, not sure which…) to type some numbers on a computer key board (O! and the computer cost the taxpayer a bundle too!). WOW! I’m an Economist ! Actually NO, I’m not really; I’m not QUITE totally STUPID or MEAN SPRITED enough!

  5. jimbo

    The Gov can’t possibly pay back all of this nations debt. So I believe they will issue a new script. They will invent a crisis, like saying there is too much cash money in the hands of drug dealers. So to “flush-out” this money they will print all new currency and exchange it for the old currency. But the exchange will not be 1 to 1. they need to make the “little guy” feel good. So the ratio will be 4 to 1. You get 4 new dollars for every 1 old dollar. Then after the exchange, everyone will find out they just got screwed. A 1 dollar loaf of bread (old) will not cost 4 dollars (new). It will be 8 dollars. The government already did this once with gold.

  6. Sam Lisobonner

    jimbo is correct. This is exactly what happened in the Netherlands when they went over to the Euro. They converted 2 Dutch Guilders for 1 Euro, and within 2 years almost everything that cost 2 Guilders now cost 2 Euros. 100% inflation, and the Dutch people could not go back to the old system.

  7. will hudgins

    Hmm. History could be helpful here although we are in uncharted, incompetent waters. No fiat currency has ever survived the test of time or the test of stupid government “leaders”.
    Gold may become worthless…but tell China that.
    What else can you hold but precious metals that are not annually taxed? What else can a family pass down to the grand kids without paperwork? Gold, [above ground ounces] are growing annually, this is true. However, currency is being printed at a much faster rate than gold is being pulled from the ground.
    In the 1930’s, so I have heard, only insurance companies and the mob had money. Al Capone kept it out of the banks. That seems to be a good idea today.
    Where am I going with this? I am betting that the dollar will not become worthless. No one has it because everyone is in debt.
    If I am wrong gold will skyrocket. Hold some of both OUTSIDE
    the banking system…and try to sleep well. The dogwoods are beautiful. Yup. beautiful.

  8. Harold Coffman

    Money need not be defined as Currency.
    Nations need their OWN separate currency … (definitions, fractions and tax laws).
    For International trade the present bid / ask price ratio is working and in place (now).
    Bit-Coin concept , at this time , is added complication.
    As foreign transaction needs a slow-moving stable ANCHOR (based on the bid/ask futures pricing of Gold …( 9 times the year-ago moving average price + todays price, divided by 10).
    Bid/ask pricing can allow a slow stable Gold ANCHOR for foreign transactions, governments and large legal contracts.
    This is Money. A good money Anchor is needed … while Gold is a poor anchor it is the BEST anchor. (It has 5000 yeas of history, and if priced right has a total sufficient to cover all international flow of money) .
    Define MONEY as an international Anchor , and Currency as that within each nation that is also bid/ask flexibly anchored to
    that. This gold Anchor gives a more level , honest , playing field with national flexibility and allows present currencies to adjust to that anchor over time.


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