by Michael Doliner
(Swans - March 23, 2009) Suppose I bought a house and in return gave the previous owner a note for $100,000. That note is a promise, a promise to pay the money to the owner of the note. Now suppose that my credit within the community was so good that the owner of the note could give it to someone who would, in return, give him something worth $100,000. This second person would be accepting my promise to pay as if it were as good as cash. And suppose this would go on, with my note changing hands again and again. Even if the note were to come into my hands again I could immediately exchange it for something valuable. To be sure the bearer of the note might want interest, but suppose my credit was so good that I could pay the interest simply with other notes, like checks, that were further promises to pay. Now there is no reason why this couldn't go on indefinitely with my promise to repay along with my further promises to pay interest continuing to circulate forever without my ever having to keep those promises.
Every person would give something of real value to get the note and get something of real value in exchange for it. Seems fair enough, right? Of course the cute part is that the first person, moi, makes out like a bandit at the expense of everybody else without anybody noticing it. There is no real reason why I would ever have to actually pay the $100,000 just so long as my credit within the community remained solid. Nor is there anything stopping me from making further promises to pay, perhaps promises worth far more than my net worth, and even far more than what I could ever hope to earn. For as long as my credit within the community remained solid, no one would actually ask me to make good on the promises. I will have obtained a house and much more for a promise that I need never keep. I can live quite handsomely on my promise to pay without actually ever paying. Who needs a Ponzi scheme if you've got this going for you?
Now, of course if I were asked to pay I would have to pay with money, Federal Reserve Notes. Federal Reserve Notes are notes just like my note is a note. It is a promise to pay, but with this difference, that nobody makes the promise. It is well known that the Federal Reserve is not the government, but a private corporation, but that is not the real problem. For even if the government were to back Federal Reserve Notes, what would they back them with? Aside from Congress, what does it have to sell? On the face of the Federal Reserve Note it says, This note is legal tender for all debts public and private. This means that you, gentle reader, are required to accept a Federal Reserve Note in exchange for something valuable -- food, oil, a house, or whatever -- if you want to exchange that thing at all. You have to keep this promise behind this note. Yes, what the government promises is that you will give something valuable for the Federal Reserve Note. People accept the Federal Reserve Note not because the government is an upright citizen, but because it is the law that they must accept it. The government makes you do it, and they are not fooling. The U.S. destroyed Iraq in part because it did not accept the Federal Reserve Note as legal tender. Now, of course, as with my note, no one along the chain actually gets obviously burned, so there are few complaints. But, just like with me, the first person, the one who writes the note, a commercial bank, makes out like Bernard Madoff could only dream of making out. The first person, the one who can write the note, is the cat that gets the cream.
But, and here is the rub, no one can tell you how much of real value you will give for the Federal Reserve Note. This has to remain vague. Why? Because if the Federal Reserve Note were to be worth some definite amount of something real, if there was a real promise of, for example, gold, then the game might flop. We found that out in 1971 when Charles de Gaulle wanted the gold that then backed US currency. The country went broke and we figured out the current much cleverer system. Now the government can print ever more Federal Reserve Notes without worrying about anyone cashing them in for something we haven't got. There's nothing they can cash them in for! The Federal Reserve promised zip. So the game goes merrily along with no worries, mate. And anyway, if you're in the middle of the line, giving and taking, the game doesn't look that bad.
Exchange rates between things always vary; so what's the problem? Well, when something is backed by say gold, it is worth something. It won't just shrink away to nothing, no value, but Federal Reserve Notes are backed by nothing. Will it be a bushel of wheat, or only a cup, or zip-a-dee-do-dah? We have to accept a Federal Reserve Note for all valuable stuff, but not any particular amount of valuable stuff. So there is nothing stopping the government from printing ever more of these promises obligating us. And as long as people accept these notes, because they are forced to, these promises can build up endlessly, just like mine in the first paragraph, without ever being redeemed.
This is the source of some unease. The peculiar promise made by no one that is a Federal Reserve Note is not a promise to pay any particular amount of anything. Since the value of the note might drop precipitously, someone might not want to hang onto the note for long. And if that someone had a lot of Federal Reserve Notes, his cashing in would be a disaster because the system runs on making a lot more empty promises than Americans have any fucking possibility of keeping.
All debt, all notes, are promises to exchange that debt for Federal Reserve Notes (legal tender for all debts). Now the US debt is about $52 trillion (see the stats), way more than we can ever hope to pay, but as Dick Cheney might say, "so what?" Remember my scheme at the beginning. As long as all those holding this debt are happy to hold it, it doesn't matter that it's way beyond our ability to pay. And anyway, (heh, heh, heh) we never said just what we would give in return for all these Federal Reserve Notes. So the question becomes: At what point do those holding Federal Reserve Notes become uneasy and decide to exchange them for whatever they can get that's valuable right now because they fear inflation? So far, even though the amount of Federal Reserve Notes out there far exceeds the putative value of what those who hold the notes expect to get for them, they are still holding on. Why?
The answer seems to be that they, the Chinese, Japanese, Russians, and others don't want to upset the "system." They know all the Federal Reserve Notes and securities they might exchange for Federal Reserve Notes could not all be exchanged for something real without soon exhausting all real stuff or, what is more likely, popping the mother of all bubbles and creating wheelbarrow inflation. So these holders of Federal Reserve Notes hold them not because they think they are really valuable (no one in his right mind would think that) but because they are afraid of bringing the whole clever, bizarre game to a sudden popping end. For the truth is that they are playing the very same game with their "fiat" currencies, though not as well as we play it. If one goes they all will.
What would make everybody decide to unload Federal Reserve Notes at once, bringing the "system" crashing suddenly to the ground? Who knows? It seems to be a question of psychology. If the Chinese or maybe the Japanese or maybe the Russians panicked and decided to unload their notes, then, suddenly, all Federal Reserve Notes would buy less, and everybody might, probably would, sell as fast as possible. But, since that would crash the system, maybe the Chinese won't sell even though their notes are worth less and less, because they don't want to blow the whole delicious game and bring civilization to an end. Will they, won't they? To decide they peek at the Russians, the Japanese, the Saudi Arabians. What kind of cards are they holding? Are they going to unload? Oh, shit! Then we had better unload. It's like musical chairs without the music.
Now everybody says that this can't go on forever. But why? If $52 trillion hasn't set off massive redemption of Federal Reserve Notes why would $100 trillion or a quadrillion? Whoopee! Since Federal Reserve Notes were never backed by anything, no real promise of anything, no real reputation for probity, no guarantee of any tangible value, what could possibly discredit them? They don't need credibility; they have military might behind them. You are free to choose between the Yankee buck and a toe in your ass.
It is with this in mind that I propose the following guaranteed solution to the entire financial mess. Take all the delinquent subprime borrowers, the Bernie Madoff victims, the homeless bums, the credit junkies, the laid-off workers, all your tired, your poor, and those yearning to breathe free, and allow them to issue Federal Reserve Notes. All our problems would be solved. Since Federal Reserve Notes do not depend upon the probity of those who issue them (Congress is part of the government) it doesn't matter what any of these people have done in the past. Nor does it matter that they are all stone cold broke. They themselves would not be making any promise to pay! Since the Federal Reserve Bank, in issuing a Federal Reserve Note, promises nothing, why not let the wino in the alley promise nothing instead? Both the new and old notes would be backed by the whole American people and everyone else we can intimidate. It's a win-win situation!
Subprime borrowers would pay off their mortgages with notes that they themselves issued; the Madoff victims, able to write their own tickets, wouldn't care any more; credit junkies would binge on, and the unemployed would just kick back, safe in the knowledge that when they needed food for their children they could just issue another Federal Reserve Note! The Chinese would just keep sopping up the excess Federal Reserve Notes to keep the system from popping. And the party would roll on!
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