Money, Credit and Debt
This article is a part of my Best Reads of the Month section on my website www.mikegorlon.com. Each month I pick one or two articles or blog posts that I find on the internet which I thought were really insightful, interesting or moving. Then I share them with you. You can view the previous month’s articles by going to: https://www.mikegorlon.com/best-reads-of-the-month
April 2020: Money, Credit and Debt
Last month I wrote about the first chapter from a new book that Ray Dalio is writing for my Best Reads of the Month about the changing world order and what makes an empire rise and fall. As much as I tried to refrain from adding another piece of writing by Ray Dalio in back-to-back months, this month he came out with another chapter in the book that was a lot better than the first chapter so I couldn’t resist adding it.
In this chapter, Ray talks about what money, credit and debt are; the vital role they play in economies; how they influence the short-term debt cycle (recessions) and the long-term debt cycle and he also discusses the different types of backing that countries use for money and why they use them.
The US dollar is currently the world’s reserve currency today but it wasn’t always the world’s reserve currency which we learned in chapter 1. The reserve currency used to be the British pound but coming out of World War II the U.S. had the strongest economy and it more importantly owned the majority of the gold in the world. This set the tone for the U.S. dollar to become the world’s reserve currency and it also ushered in the end of the previous long term debt cycle and the start of a new long term debt cycle that is still going on today.
In 1944, the US dollar would be backed by gold until a large amount of government spending in the U.S. throughout the 1960’s mostly due to Lyndon Johnson’s guns (the Vietnam War) and butter (social policies toward poverty) policy led to other countries redeeming their dollars for gold. The U.S.’s gold reserves started to quickly deplete. This led to the closing of the gold window by Richard Nixon in 1971 which meant the dollar would no longer be backed by gold. This established a new monetary system which is the one that we use today — Fiat money.
Ray Dalio expands on this and goes into even more in depth in chapter 2 of his new book The Changing World Order.
Here are some other interesting takes from the chapter:
“This whole 1971–1991 cycle, which affected just about everyone in the world, was the result of the US going off the gold standard. It led to the soaring of inflation and inflation-hedge assets in the 1970s, which led to the 1979–1981 tightening and a lot of deflationary debt restructuring by non-American debtors, falling inflation rates, and excellent performance of bonds and other deflationary assets in the 1980s. The entire period was a forceful demonstration of the US having the world’s reserve currency — and the implications for everyone around the world of how that currency was managed…. After the 1980s debt restructurings were completed in the 1990s new global increase in money, credit, and debt began again, which again produced a prosperity that led to debt-financed purchases of speculative investments that became the dot-com bubble, which burst in 2000. That led to an economic downturn in 2000–2001 that spurred the Federal Reserve to ease money and credit, which pushed debt levels to new highs and created another prosperity that turned into another and bigger debt bubble in 2007, which burst in 2008, which led the Fed and other reserve currency countries’ central banks again eased, leading to the next bubble that just recently burst.”
“History has shown us that we shouldn’t rely on governments to protect us financially. On the contrary, we should expect most governments to abuse their privileged positions as the creators and users of money and credit for the same reasons that you might do these abuses if you were in their shoes. That is because no one policy maker owns the whole cycle. Each one comes in at one or another part of it and does what is in their interest to do at that time given their circumstances at the time.”
“Central banks want to stretch the money and credit cycle to make it last for as long as they can because that is so much better than the alternative, so, when “hard money” and “claims on hard money” become too painfully constrictive, governments typically abandon them in favor of what is called “fiat” money. No hard money is involved in fiat systems; there is just “paper money” that the central bank can “print” without restriction. As a result, there is no risk that the central bank will have its stash of “hard money” drawn down and have to default on its promises to deliver it. Rather the risk is that, freed from the constraints on the supply of tangible gold or some other “hard” asset, the people who control the printing presses (i.e., the central bankers working with the commercial bankers) will create ever more money and debt assets and liabilities in relation to the amount of goods and services being produced until a time when those who are holding the enormous amount of debt will try to turn them in for goods and services which will have the same effect as a run on a bank and result in either debt defaults or the devaluation of money.”
