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The Truth about Debt and Deficit

Image courtesy of heraldsun.com.au

Image courtesy of heraldsun.com.au

A guest post from John Kelly, putting the complexity of debt and deficit into simple English and exposing the hypocrisy of Joe Hockey’s references to Labor’s economic management.

Why Joe Hockey will rue the Howard Government’s fiscal mis-management.

Have you ever thought what would happen if everyone in Australia went to their bank and asked to withdraw all their money, all on the same day? Ask Joe Hockey. He will tell you the crisis such an event would kick start doesn’t bear thinking about. He’s right about that. The first customers to arrive would be successful but somewhere down the queue the rest would be told the money had run out. Surprised? No, and you shouldn’t be, but that is just the beginning. Have you ever asked why the banks could not pay out their customers’ deposits? No prizes here; the answer is relatively simple: they lend most of our money to entrepreneurs like you and me so that we can build houses, start businesses and so on. In turn, they receive interest on those loans some of which comes back to us as interest credits.  All sounds good doesn’t it?

In fact, it isn’t good. It’s nothing more than a smoke screen cleverly masking something far more sinister; something that makes fools of all of us and which, if we wanted to, we could collectively act to bring undone. We won’t, of course, because in destroying this obscene arrangement we would also destroy ourselves.

Over the latter half of the 20th century the money game has become incredibly sophisticated. It has evolved to a point where, today, it is so complex and difficult to understand, only a few at the core actually know what is driving it and only those at the core know what disastrous consequences await the world should it ever be dismantled. Yet, dismantled it should be because it offers nothing but misery and uncertainty for generations to come. Why? Because  today, we are living off the expected profits of future generations and they will only have to do the same when their time comes or suffer the same fate we are desperately trying to avoid. One thing is certain: it has a use-by date.

It’s all to do with debt and deficit and where the money that funds debt and deficit comes from. We call it money but it is really currency. Money is something of value, something that can be bought and sold. Coal is money. Currency is the transfer of securities posing as money.  Issuing bonds to finance infrastructure, social services and wars, is currency. What we deal with today is currency. When a government wants to undertake a project that it can’t pay through taxation revenues it issues bonds that are usually snapped up by banks. Banks love bonds because they are a cash cow in ways the average man or woman on the street doesn’t understand. If they did, they would be outraged. When a bank buys government bonds it receives interest on those bonds but it also uses those bonds as collateral to receive currency from the Reserve Bank. So, it wins twice, because it calculates its asset value by including both the value of the bonds as well as the currency it receives from the Reserve Bank. That currency is then used to lend to other interest producing sources. The thing to understand here is that the Reserve Bank doesn’t have the money to do this either, so it also borrows or simply creates money by writing a cheque to finance the deal with the banks. In turn it gains interest on the deal which it uses to pay a dividend to its depositors. All along this weird currency trail, debt is building up for all the players. In fact, none of them are solvent in the true sense of the word. They are all hedging on the future. It’s a vicious cycle where each institution is receiving currency and passing it on while receiving and paying interest along the way. None of these institutions actually has the money in their vaults to support their transactions. Their borrowings expose them in ways that make a mockery of the true value of money. This could be demonstrated easily if everyone went to their bank on the same day and withdrew their money. It would expose a flawed system that lives off credit to a point where, one day, this paper thin economy will collapse. When that collapse comes, as it most certainly will, the hammer will fall hardest on the countries who have the highest national debt levels. The US is the most vulnerable right now and the only way it can avoid total collapse is to continue borrowing and printing currency. It is gambling on future generations creating wealth, i.e. money. But those future generations are going to be so overburdened by debt inherited from what is happening today, that they will not have the capacity to create real money. They will simply opt to continue borrowing. There’s a well known saying that if I owe the bank $100,000 and I can’t pay, I’m in trouble. The bank will sell up my home. But, if I owe the bank $1,000,000 and I can’t pay and my home is not worth $1,000,000 then the bank is in trouble. Now multiply that by trillions of dollars, money that has no security to support it and what is the outcome? This, as everyone knows now, was the blueprint for the GFC. There was a time when a country’s risk value was based on its gold and silver reserves; real wealth…money. Today it is based on pure speculation of short term return. Value today, is no more than numbers in a computer. It is not backed up by hard cash.

The only upside to this depressing story is that here in Australia, we have a very low debt . . . for now. But, Joe Hockey knows only too well that the present situation is going to change. By 2016 our national debt will be around $400 billion up from $244 billion as at the end of August 2013. The Treasurer acted quickly to increase the debt ceiling to $500 billion in full knowledge that forward projected revenues will not be sufficient to cover what we intend to spend. He doesn’t want to do it again, but he may well have to if China continues to take less and less of our coal. The tragedy is that it could have been a good deal less if the Howard government had been more fiscally responsible; the government in which Joe Hockey was a minister. Back then, China was our best friend generously contributing a windfall of money to our revenue stream that, had it not been wasted in unnecessary vote buying in the form of middle class welfare programs, could have been deposited in the future fund and placed us in a much stronger position than we are now. The Howard government, to its credit, did pay off our national debt, thanks to China, but had a lot left over. It opted to spend that excess to make itself look good. It rode on the wave of a private debt bubble that ended with the Global Financial Crisis. Long term management was overlooked in favour of political expediency. Hockey will be reflecting on this lost opportunity now as he grapples with the reality of having to increase national debt in the absence of a wave of private debt that kept our economy on such a firm foundation in the 1990’s and early 2000’s. And, while he will do everything in his power to convince us that Rudd and Gillard’s Labor is the culprit, it is his own former government’s actions coupled with the international abuses of real money, present and past, the constant merry-go-round of currency trading between banks and governments that must assume the guilt. When the GFC hit, private borrowing stopped and only government debt saved us from disaster. Nothing has changed. If Hockey doesn’t know this now, he will soon. Six years is no more than a blink on the horizon in currency trading.

John Kelly

 

16 comments

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  1. musteryou

    What a nice, well-explained article.

  2. mikestasse

    There was one important thing left out of this: Limits to growth……. When banks create money out of thin air to lend it to you as debt, the money (or currency) to pay the INTEREST on those debts does not yet exist. So where does it come from? GROWTH……

    To pay that interest, more money has to be created, as debt of course. More people or businesses MUST borrow to buy real estate, vehicles, machinery, or build roads and airports, whatever. This is economic growth. It is why the powers that be start having kittens when the economy goes into recession, because when growth stops or even merely slows down, there’s not enough money around to pay the interest on debts, and people/businesses go broke.

    The trouble with this ponzi scheme is that the interest makes the debts grow faster than the GDP. So the growth in money creation has to grow exponentially (meaning faster, and faster, and faster, and……..) until the shit hits the fan. Which is on the cusp of occurring.

    To fuel (literally) the ponzi scheme, one very important commodity is ESSENTIAL…… and that commodity is OIL.

    To cut to the chase, Peak Oil happened sometime before 2008. In fact, the price of oil reaching $147 was THE straw that broke the camel’s back in 2008 and triggered the GFC. It wasn’t THE reason for the GFC, there were several, but I have no doubt it triggered it…..

    Now that oil is getting really hard to get, at a price that is affordable and a flow rate that allows ‘stuff’ to happen, and happen faster and faster and faster, economic growth is stagnating, and GDP is not growing fast enough, while debt IS. Nations’ Debt to GDP ratios everywhere are rapidly increasing everywhere as a result. There was a neat chart of this recently at http://catallaxyfiles.com/files/2013/03/Kouk-debt.jpg As you can see, Government debt is hardly Australia’s next crisis…… but our PERSONAL debt is, because it’s five times bigger than the Government’s!

    Australia is bang on target to completely run out of oil by ~2020. http://damnthematrix.wordpress.com/2013/04/04/australia-still-on-target-to-run-out-of-oil-by-2020/ And the world is due to hit Peak Uranium AND all fossil fuels by ~2017 http://damnthematrix.wordpress.com/2013/03/22/peak-fossilsuranium-in-2017/

    These events will trigger what I call Peak Debt. What happens next will be interesting…

    For a graphical explanation of fractional banking, watch this:
    http://damnthematrix.wordpress.com/2013/10/22/why-the-debt-ceiling-is-a-complete-oxymoron/

  3. lawrencewinder

    Clarity at last… and pricking the balloon of Hockey’s fatuous claims of Liarbril fiscal rectitude.

  4. Peter Hamrol

    With Hockey’s proposal to lift the debt ceiling a forecasted budget deficit by 2016 will not eventuate and thus be another lie from the LNP … Do they really think that Australians are that dumb? Well, it did appear to be so on 7th September 2013 because the Coalition won government due to the stupidity of Australians who had no idea of what they were voting for in the first place; with the help of the MURDOCH MSM bias favouring the LNP of course … In 2016 I hope that Australians will ignore the main stream media and analyse the facts of how the LNP has sent our once great country down the road of ruin. Once this occurs the LNP will be a spent force who are currently barren with real progressive ideals …

  5. DC

    Wish I had the figures with me but the hypocrisy of the Liberals regarding fiscal/budget “discipline” is on a whole new level….

    no wait…

    its pretty much about the same level as their hypocrisy on broadband and their (carbon emission reduction) policy …

    no wait…

    its not quite on the same level as the hypocrisy the liberals show on broadband or their (carbon emission reduction) policy, but its still pretty bad..

    Any economist will tell you when assessing fiscal policy you must differentiate between a “cyclical” deficit/surplus and a “structural” one.

    Cyclical ones are cause by the global economy and out of the governments control. That is what Labor inherited with the GFC. Howard and Costello on the other hand had a structural deficit meaning that their taxing and spending policies were always going to cause a growth in long term debt over the business cycle. They were just able to hide this structural deficit by rapidly speeding up the previous government’s privatization agenda (selling off even more government assets than Hawke/Keating did) and by being lucky enough to be in power during a global economic boom that caused a cyclical surplus.

    Since Labor won in 2007 they made many structural improvements and they did so not by increasing overall taxation but by reducing overall spending (under Labor, both spending and total taxation as a % of GDP was lower than it was under Howard this even taking into account the mining and carbon tax and the post GFC stimulus spending) but these structural improvements were masked by the cyclical deficit cased by the GFC and global downswing causing a cyclical deficit.

    When the Liberals snuck their final costings to treasury 48 hours before the election after the media blackout, the 4 year treasury forecasts based on their election promises showed NO STRUCTURAL IMPROVEMENT UNDER COALITION POLICY! It was basically the same as Labor (unless you count less than 1% difference as significant). And remember this is in spite of them increasing income taxes for the average income earner and replacing a Ferrari model NBN with a second-hand Datsun NBN that will require constant upkeep, plus completely abandoning assistance to the emerging renewable energy sector.

  6. mikestasse

    I know this is a political blog………. and we all love hating the new guvmint, but this issue is much much bigger than the three stooges at the top of the article. It’s a global problem of CAPITALISM which is basically flawed……. debt will cause the global collapse of the world economy, and Australia may well be the last to go down with the ship, like the band playing on the Titanic…….

  7. doctorrob54

    Brilliant article Michael and thank you John Kelly,F**k I love this site,great work and thanks again.:-) .

  8. debrochelle152

    Good article and comments. Love reading it.

  9. Daniel Boon

    no real arguments with article; however, paying off debt by selling income producing assets is not good fiscal practice ..

  10. olddavey

    For a split second I thought the title of the piece was “Debt and Deceipt” and after reading all it could well have been.
    Excellent work!

  11. Ricky Pann

    Anyone with the most rudimentary grasp on economics and the meaning behind the acronyms that Murdoch mangles for his means; who does not read or consume the dribble from the MSM knows this to be true….The only emergency is Morons are in control of the country with Goofy running the show and donanld duck cooking the books

  12. kgb16

    These LNP no hopers should be locked up & the key thrown away!!!!!!!

  13. kizhmet

    A testament to AIMN that an article written 18m ago still has “currency” (i know … sick pun) today. Still a great read second time round.

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