Criticism of fractional reserve banking

Main article: Fractional-reserve banking

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Criticisms of fractional reserve banking and central banking have been put forward from a variety of perspectives, although the most vigorous and sustained criticism now comes from libertarians and anarcho-capitalists such as economists Jesús Huerta de Soto and Jörg Guido Hülsmann, American politician Ron Paul, and commentators such as historian Thomas Woods, Jim Grant of Grant's Interest Rate Observer and former US Budget Director David Stockman. Most in the mainstream (both on the left and right) remain silent on the issue of fractional reserve banking and central banking, although past critics have included mainstream economists such as Irving Fisher, and Milton Friedman. Within the economics profession, most criticisms are from the Austrian School. There are also critics from outside the economics profession who advocate monetary reform.

Terminology

Critics of fractional reserve banking and the related fiat paper monetary system may refer to it by the term debt-based monetary system, or credit-based monetary system. They may also refer to money created in parallel with debt as debt money or endongenous money, reflecting the fact that virtually all new money is currently created by people or businesses or governments further indebting themselves to banks. This monetary system is called "endogenous" because the money supply is flexible, expanding in parallel with the demand for debt and stalling or contracting when demand for debt declines. Some consider this a perverse and dysfunctional way of introducing new money into the economy.

The term, "debt-based monetary system," and related terms such as "debt money" are not used by conventional economists or academic mainstream economists. Mainstream economists often refer to "debt money" by its antonym "credit" and distinguish between types of money only after the money is created. The very definition of "money" and the distinction between "debt" and "money" (and their respective economic effects) are still sources of vigorous ongoing debate. Mainstream economists rarely if ever discuss the origins of modern money and generally do not actively discuss or comment on the fact that virtually all money is now created through individuals, or businesses, or governments going into debt to government-sponsored commercial banks. Discussion around the nature of "debt-based" money and the arguments over its effects on the economy are notably absent from most established mainstream academic economic publications and most mainstream economists instead argue that the origin of different kinds of money (and the volume of their issuance) does not really matter, at least in the long run. This mainstream idea is referred to as the theory of "money neutrality". Some commentators have speculated that the unusual "silence" around the topics of fractional reserve banking and central banking (and the staunch refusal to consider alternative theories of money) is due to the simple fact that many economists are on the payroll of the major commerical or central banks of the world and are unprincipled or, at worst, corrupt.

Typical criticisms

Norm Franz states in his Money and Wealth in the New Millennium:

Gold is the money of kings, silver is the money of gentlemen, barter is the money of peasants – but debt is the money of slaves.

12th century Chinese scholar Hu Zhiyu stated:

Paper money, the child, is dependent on precious metals, the mother. [Inconvertible paper notes are therefore] orphans who lost their mother in childbirth.

Robert H. Hemphill, credit manager of the Federal Reserve in Atlanta, stated in 1939:

If all the bank loans were paid, no one would have a bank deposit and there would not be a dollar of coin or currency in circulation. This is a staggering thought. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. When one gets a complete grasp of the picture the tragic absurdity of our hopeless position is almost incredible, but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.

British monetary reformer Michael Rowbotham states the following in his book, The Grip of Death (the title being derived from the literal origin of the word "mortgage"):

It is actually not in the least surprising that nations are chronically in debt, governments have inadequate resources, public services are under-funded and people are beset by mortgages and overdrafts. The reason for all this monetary scarcity and insolvency is that the financial system used by all national economies worldwide is actually founded upon debt. To be direct and precise, modern money is created in parallel with debt. The reason for the failure of economists to question patently invalid monetary data becomes clear - there is a total acceptance by them of the most extraordinary method for supplying money to the modern economy.

The creation and supply of money is now left almost entirely to banks and other lending institutions. Most people imagine that if they borrow from a bank, they are borrowing other people's money. In fact, when banks and building societies make any loan, they create new money. Money loaned by a bank is not a loan of pre-existent money; money loaned by a bank is additional money created. The stream of money generated by people, businesses and governments constantly borrowing from banks and other lending institutions is relied upon to supply the economy as a whole. Thus the supply of money depends upon people going into debt, and the level of debt within an economy is no more than a measure of the amount of money that has been created...

All around us, the gross failure of modern economics screams out to be addressed. The towering indifference of those shining offices scraping the sky above the menacing ghettos of Brooklyn; the speculative channelling of billions of pounds of volatile international finance, which can leave a country prosperous one week and plunged into decline the next; the ludicrous production of cheap goods of poor durability, so that jobs are 'protected', and we can recycle the materials and make the goods all over again; the ridiculous export drives by which every country simultaneously attacks the economies of every other nation, under the pretence that such global free trade improves the general wellbeing; the staggering waste of a throwaway, quick-growth, all-new spiral of constant economic change; the outrageous financial debt which Third World countries have actually paid many times over, but which, due to interest, is now larger than ever before - a debt which forces those impoverished nations to compete to supply goods already in surplus; the cynical manipulation of human emotions into buying fashion-obsessed trivia; the burgeoning transport demands of escalating economic growth and centralisation, with identical goods crisscrossing the globe, regardless of environmental cost; the fact that despite the incredible productive capacity of the modern economy, people are obliged to work harder, with ever greater efficiency, forever forced to adapt and retrain or face a life of indignity and misery as one of the unemployed.

Both those in work and out must watch, as the world they know and understand changes almost in front of their eyes like some nightmarish Kafka-esque novel. This is the era of accelerating economic change. The benefits are highly dubious, and no-one even pretends that the economy is responding to what people actually want. The only justification offered for the changes is that this is 'the age of progress', and 'you can't stop progress', even if you are human and the progress you are discussing is supposed to be about people and the lives they might lead in the future. The world of economics has got mankind by the throat and everyone knows it, and no-one has a clue where we are going or why we are going there.

But is this surprising? If a monetary system is invalid or flawed, then the entire economy is based on the mathematics of error, and must be riddled with the effects. If the financial system upon which our economies are built is defective, and yet monetary considerations dominate our economic decisions, should we be surprised if the results are less than satisfactory?

The major role played by bank credit, which forms over 95% of the money stock in most developed nations, suggests that it cannot but be implicated in these trends. This is further suggested by the way that banking has literally become the focal point of modern economic management, through manipulating interest rates. The stargazers of Whitehall and the Federal Reserve hold their councils, trying to tread the non-existent tightrope between growth and recession by debating quarter percentage-points of interest rates. Alan Greenspan, the Chairman of the Federal Reserve, engagingly describes his task in controlling the American economy through adjusting interest rates as a matter of 'taking the champagne away once the party has started'. Businessmen around the world hold their breath, measuring his every word, wondering what he will decide. There could be no greater indictment of contemporary financial economics than this; that a fluctuating financial digit on a single computer system in a single street in a single country should have the ability to dominate the economies of an entire planet...

The past thirty years are almost unique by comparison with the previous three centuries in the lack of attention that has been directed at debt and the financial system. Throughout the eighteenth century, there were repeated calls for reform. During the nineteenth century, excessive banking was held by many to be directly responsible for the waves of appalling poverty that swept Europe and America during a period of increasing industrialisation and agricultural development. In this century, during the depression of the 1930s, the financial system effectively seized up and brought virtual collapse to the economies of the world in an age which was, perhaps for the first time, obviously wealthy, and in which technology offered people real freedom as well as material prosperity. One observer judged that over 2,000 schemes for monetary reform were put forward at that time - all with a common theme in their outright rejection of the debt-based financial system as it then operated. The same system continues to this day, modified in small details, but unchanged in principle; and the recent financial crisis in Asia shows the potential for collapse still exists.

However the issue of economic volatility through booms, slumps, crises, and collapses has never been the sole point of criticism. It is the long-term trends that a debt-based financial system fosters which are most destructive. The most obvious of these is declining personal solvency. Mortgages support over 60% (£420 billion) of the money stock in the UK and over 70% ($4.2 trillion) in the US. Housing-debt statistics for the UK and the US show that there has been a dramatic decline in true home ownership as mortgages become higher and ever more widespread. There can be little question that relying upon housing debt to supply money to an economy lacks economic and political justification. However, taken in conjunction with the marked rise in commercial debt, mortgages have a knock-on effect. In an economy where the price of goods is elevated by commercial debt and consumer incomes are deeply eroded by mortgage debt, there is a persistent and subtle advantage given to low-quality, mass-produced goods, and growth is fostered in this direction. The persistent decline in product durability and the growth-culture of a rapacious consumer society can be directly traced to the debt-based financial system.

The financial system has also generated a serious distortion of agriculture. Excessive farming debt has driven out the most efficient producers - small/medium sized farms. Meanwhile, the relentless pursuit of farming and processing methods oriented towards a low-price market now involves the production of foodstuffs of poor nutritional value, inferior to that which the land can provide and inferior to that which consumers actually desire.

The nature of growth within a debt economy affects not only the quality of output, but distribution and marketing. Intense competition for sales within a debt-based economy results in the use of transport as a competitive strategy by businesses. This has led to a progressive breakdown of local and regional supply networks, and marketing over ever-greater distances, leading to escalating commercial traffic demands.

At the international level, trade is deeply affected by the debt-based financial system. The aggressive pursuit of maximum export revenues, rather than seeking a simple balance of trade, is entirely due to the fact that even the wealthiest nations operate from a position of gross insolvency. International trade has degenerated into a competition between nations to alleviate their indebtedness, rather than a process involving a mutually beneficial exchange of goods and services.

Endemic Third World debt is also directly attributable to the reliance upon debt and banking to supply money. The theoretical model of borrowing from the World Bank/IMF, investing in development and repaying loans from export revenues, is one of the great failures of contemporary economics. The persistent inability on the part of debtor nations to repay these loans suggests strongly that the nature of the indebtedness suffered by the Third World has absolutely no actual legitimacy or validity...

The more one explores the broad impact of debt, the more apparent it becomes that bank-credit constitutes a dysfunctional form of money. An economy based almost entirely upon bank-credit and debt experiences an intense drive for growth, regardless of need or demand. Bank credit engenders financial dependence, injects instability and fosters growth-distortions, both within an economy and throughout the international arena.

Reform of the debt-based financial system is clearly not a minor issue. It is not a matter of fiddling around with taxes, incomes and allowances to make things apparently more equal, more efficient, or perhaps more straightforward. Changing the debt-based financial system involves gradually altering the very foundations upon which national and international economics is based. Monetary reform is concerned with attempting to determine a new principle for the supply of money to an economy - the purpose being to create a supportive financial environment in which more constructive economic trends are allowed to emerge, and in which more benign systems of overall economic management become possible. In view of the rapacious onslaught on the environment, the waste of natural resources and the social and political friction caused by de-regulated commerce and capital flows, this is at once a promising, but a sobering prospect.

Ron Paul states in his book End the Fed:

American presidents actually worked to implement and defend the gold standard, which put a brake on the ability of the largest banks to expand credit without limit. The gold standard worked like a regulator in this way. Ultimately, banks had to function like every other business. They could expand and make risky loans up to a point, but when faced with bankruptcy, they had nowhere they could turn. They would have to contract loans and deal with extreme financial pressures. Risk bearing is a wonderful mechanism for regulating human decision making. This created a culture of lending discipline.

In the jargon of the day, the system lacked "elasticity." That's another way of saying that banks couldn't expand money and credit as much as they wanted. They couldn't inflate without limit and count on a centralized institution to bail them out...

The banking industry has always had trouble with the idea of a free market that provides opportunities for both profits and losses. The first part, the industry likes. The second part is another issue. That is the reason for the constant drive in American history towards the centralization of money and banking, a trend that not only benefits the largest banks with the most to lose from a sound money system, but also the government, which is able to use an elastic system as an alternative form of revenue support. The coalition of government and big bankers provides the essential backbone of support for the centralization of money and credit...

Consider the Soviet case: to my knowledge, no business ever went under with the Soviet system but society in general grew ever poorer. Think of that Soviet system applied to the banking industry and you have the Fed.

In the foreward to Fiat Money Inflation in France, Mr John McKay wrote the following:

The story of "Fiat Money Inflation in France" is one of great interest to legislators, to economic students, and to all business and thinking men. It records the most gigantic attempt ever made in the history of the world by a government to create an inconvertible paper currency, and to maintain its circulation at various levels of value. It also records what is perhaps the greatest of all governmental efforts—with the possible exception of Diocletian's—to enact and enforce a legal limit of commodity prices. Every fetter that could hinder the will or thwart the wisdom of democracy had been shattered, and in consequence every device and expedient that untrammelled power and unrepressed optimism could conceive were brought to bear.

But the attempts failed. They left behind them a legacy of moral and material desolation and woe, from which one of the most intellectual and spirited races of Europe has suffered for a century and a quarter, and will continue to suffer until the end of time. There are limitations to the powers of governments and of peoples that inhere in the constitution of things, and that neither despotisms nor democracies can overcome.

Legislatures are as powerless to abrogate moral and economic laws as they are to abrogate physical laws. They cannot convert wrong into right nor divorce effect from cause, either by parliamentary majorities, or by unity of supporting public opinion. The penalties of such legislative folly will always be exacted by inexorable time. While these propositions may be regarded as mere commonplaces, and while they are acknowledged in a general way, they are in effect denied by many of the legislative experiments and the tendencies of public opinion of the present day. The story, therefore, of the colossal folly of France in the closing part of the eighteenth century and its terrible fruits, is full of instruction for all men who think upon the problems of our own time.

C.J. Maloney wrote of the desperation of Henry VIII of England to counterfeit gold by engaging charlatan-alchemists:

Despite his formidable education and great historic reputation, the disastrous interventions into the economy, the lifelong dishonesty with the currency in his care and, most of all, his laughable attempts to bring a sorcerer into his court to conjure gold, mark the great King Henry VIII as a fool. Yet there is no reason, be warned, for anyone to feel superior to the King; one only needs to pick up a newspaper to see that though alchemy may be a dead science, it has merely taken up new forms.

This has always been and always will be, for its immortality is powered by economic man’s most dangerous, fondest wish, the one that will drive us to endless imbecilities and repeated destruction – the ardent desire to believe that you can get something for nothing. His adherence to that belief made King Henry VIII a man of his times – and ours.

In his treatise, The Ethics of Money Production, which was published by the Mises Institute in October 2008, Jörg Guido Hülsmann presents (at pages 238-239) the following description of the perverse rise of fiat money and fractional reserve banking:

There is no tenable economic, legal, moral, or spiritual rationale that could be adduced in justification of paper money and fractional-reserve banking. The prevailing ways of money production, relying as they do on a panoply of legal privileges, are alien elements in the capitalist [i.e., true free market] economy. They provide illicit incomes, encourage irresponsibility and dependence, stimulate the artificial centralization of political and economic decision-making, and constantly create fundamental disequilibria that threaten the life and welfare of millions of people. In short, paper money and fractional-reserve banking go a long way toward accounting for the excesses for which the capitalist economy is widely chided.

We have argued that these monetary institutions have not come into existence out of any economic necessity. They have been created because they allow an alliance of politicians and bankers to enrich themselves at the expense of all other strata of society. This alliance emerged rather spontaneously in the seventeenth century; it developed in multifarious ways up to the present day, and in the course of its development it created the current monetary institutions.

…The driving force that propelled the development of central banks and paper money was the reckless determination of governments, both aristocratic and democratic, to increase their revenue, if necessary in violation of good faith and of all established rules of commerce.

Many monetary reformers claim that a fiat money/fractional-reserve based banking system is inherently destructive and inevitably generates debasement of the currency, extreme inequality, the destruction of the middle class and wrenching business crises. Vladimir Z. Nuri has analyzed fractional reserve banking and considers it a form of economic parasitism.

These views are not accepted by mainstream government-supported economists. For example David Andolfatto, Vice President in the Research Division of the Federal Reserve Bank of St. Louis, has openly called Dr. Ron Paul a "pinhead" for holding such views. He later tried unsuccessfully to delete or retract his statements and expressed his regret over making the comments.

Critics of fractional reserve banking frequently argue that since money creation requires loans from the banking system, people are required to go further into debt in order for any new money to be created. They theorize that this eventually causes credit cycles (or business cycles) and necessarily debases the means of exchange.

Many critics find it problematic that banks "create money out of nothing" and consider this fundamentally immoral, akin to counterfeiting and/or embezzlement.

Some also link the alleged negative effects of fractional reserve banking with central banking and a government-enforced "paper" or fiat currency, which they claim allows the practice of fractional reserve banking to continue without a "natural" limitation on the growth of the money supply, thereby causing inherently unsustainable "bubbles" in asset and capital markets, which are vulnerable to Ponzi-like speculation by highly leveraged hedge funds and other bank agents.

Reformist economists such as Murray Rothbard support a "full reserve" banking system and criticize fractional reserve banking as inherently fraudulent. Murray Rothbard held this view very strongly throughout his life. Other reformist economists are more tolerant of fractional-reserve banking and support free banking instead of full reserve banking.

Basic debate

The economic, environmental and social effects arising from money creation through fractional-reserve banking have been subject to much heated political debate for well over two centuries.

Many Austrian economists and monetary reformers focus on the combined use of fiat currency, fractional-reserve banking and central banking as a negative feature of modern monetary systems. These commentators use the term "debt-based monetary system" to refer to an economic system where money is created primarily through fractional-reserve banking techniques, using the banking system. This form of money is called "debt-based" because as a condition of its creation someone must go into debt in order for the money to be created and it must be paid back plus interest at some time in the future.

To some commentators, this implies that as the money supply and the economy grows, the general populace becomes increasingly indebted at the same time due to the fact that debt grows in parallel with money supply growth, and increasing interest payments (from either taxpayers or indebted consumers) are needed to pay bondholders as the money supply grows.

One argument posits that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. To some, this implies that debt must grow exponentially in order for the monetary system to remain solvent.

Others argue that there is in fact no mathematical necessity for the stock of money in a debt-based system to grow, as the "turnover" or "flow" or "velocity" of money can increase to allow for compounding interest payments. However this does imply that some consumers would increasingly have to consume and transact to expand the GDP sufficiently to allow the fixed stock of money to turnover sufficiently to pay for the interest compounding on top of the debt. This may mean that Ponzi-like dynamics bubble up in "pockets" of the economy with interest payments being allowed in a fixed money economy, but these debt-fuelled bubbles of higher spending or speculation would pop and die out relatively quickly.

Gold, silver and other precious metals have in the past been used as money. Because of the difficulty in increasing the supply of precious metals quickly, some monetary reformers believe a return to the gold standard, or a similar system of "hard" or "real" asset-backed currency, is the only way to stabilize the growth of the money supply. These monetary reformers often refer to the gold standard and silver standard as "sound money" or "honest money".

Main criticisms

In a 2003 statement to the U.S. House of Representatives, Ron Paul stated "if unchecked, the economic and political chaos that comes from currency destruction inevitably leads to tyranny".

Some economic thinkers (primarily members of the Austrian School) and political commentators believe that a debt-based monetary system amounts to a subtle form of monetary "fraud" in that it creates money "costlessly" through the use of fractional-reserve banking techniques.

Michael Rowbotham is an active proponent of monetary reform, and argues that this system of money supply is perverse and inherently monopolistic and "anti-democratic", as it creates an inflationary exponential growth imperative in the economy which leads to over-centralization and environmentally damaging and unstable over-consumption. Critics such as Rowbotham argue that the indebted are forced to induce new consumers to spend their way into debt so existing loans can be repaid with new debt-created money. Failure to achieve this goal results in foreclosure for those businesses and insolvency in the banking system that leads to economic collapse due to the sudden contraction of the money supply.

Mark Anielski as well as some political thinkers such as Rowbotham and some economists (such as Hyman Minsky, Steve Keen and Mike Shedlock) argue that this system of money supply has characteristics similar to a pyramid scheme, where the newly indebted are compelled to induce others into debt to pay off their own debts. It is therefore argued by a number of monetary reformers that fractional-reserve banking and the associated exponential growth of money in the economy "forces" the economy towards indebted consumerism.

Rowbotham argues that a major negative side-effect of the debt-based monetary system is its effect on agriculture, claiming that residential development produces by far the greatest continuous injection of debt money into Anglo-sphere economies. Therefore, significant super-normal profits can be generated by re-zoning agricultural land and replacing it with low-density housing. If this is correct, this trend will lead to the destruction of fertile arable land, as farmers cannot compete to retain fertile arable land from property developers at the periphery of major population centers, and as this land is then progressively re-zoned for speculative new residential development. Rowbotham predicts that the global supply of fertile arable land will systematically and catastrophically decline as perverse incentives favor short-term speculative land development over long-term food security, leading to a broad decline in the quality and nutritional value of agricultural produce and, eventually, a dramatic increase in the prices of many "soft" commodities - which could then lead to actual food shortages for poorer segments of the world population. This has been referred to as the problem of "Peak Everything".

If for any reason the monetary system broke down, urban populations (nominally "rich" but poor in terms of direct access to food supply) could find basic foodstuffs either rationed or unavailable at any price, ultimately resulting in food security becoming a major public policy issue - particularly if combined with oil supply shortages or an oil price spike, as major population centers worldwide are almost entirely reliant on mass transportation of food from distant (or even foreign) locations to survive day-to-day.

Others consider that the core problem is not food security, nor overpopulation, nor environmental destruction, nor excessive carbon emissions due to non-pricing of energy producing externalities, nor excessive "specialization" of labor in the midst of monetary dysfunction, but excessive government regulation, causing capital destruction.

The fundamental problem with the current monetary system that all Austrian economists agree on is that in the midst of constant credit creation and monetary dysfunction is it impossible to know what unsustainable malinvestments are taking place in the economy, except to acknowledge that they must be taking place somewhere in the midst of unsustainable credit growth.

Effects on economic health: Ponzi Scheme Dynamics

According to Michael Rowbotham the expansion of money through debt is unsustainable and necessarily fuels and creates economic bubbles. This concentrates wealth in the hands of private banks as the populace is forced into debt simply to own a home and educate their children, hoping that the loans can be repaid by others going into debt in greater amounts later to purchase the assets they themselves have purchased through incurring large amounts of personal debt. However, debt expansion leads to price appreciation of assets through speculation as the financial market becomes riskier and this process is unsustainable in the long run, with the last cycle of indebted being wiped out when they cannot find anyone to buy the assets they themselves have purchased by going into massive debt. Doug Noland, Steve Keen, Edward Chancellor, Bill Bonner and many others have compared this type of market to an enormous State-sponsored global monetary Ponzi scheme.

The bust phase of this Ponzi-like business cycle where "debt-based" money growth cannot continue because the debt levels are at saturation levels, meaning growth in debt money slows or contracts, catching newly indebted businesses and consumers who are left out of the growth cycle, triggering a combined liquidity and solvency crisis when markets seize up due to a collapse in the artificially-supported prices in financial markets.

Effects on the environment

There are also critics in the left-wing and environmentalist camps who contend fractional reserve banking (by creating a necessity for indefinite economic growth) leads to environmental destruction and a sudden, catastrophic depletion of the earth's natural resources as the unsustainable, exponential consumption of the world's scarce natural resources reaches its inevitable limits.

Inherent problems with the system

Some monetary reformers predict that there will be an increased incidence of financial crises in the developed world, as economic and population growth inevitably slow and as the success of financial sector lobbying results in increased tax loopholes and a reduction in effective redistributive taxes which, combined with the debt-legacy of the welfare state, allows an intense and unsustainable concentration of wealth and political power in the financial services sector.

Some monetary reformers argue that perverse incentives in the financial services industry lead to a collusive relationships between governments and bankers which are economically and socially destablizing in the long run.

Given that the financial system requires ever higher levels of indebtness from the general populace for its solvency, it is vital that the indebted "victims" who must sink deeper into debt for the system to survive do so voluntarily and willingly and are not made aware of the consequences of purchasing consumables with debt money. Some isolated politicians have previously highlighted the fact that mainstream media organizations appear to downplay or minimize the seriousness of deficit spending by government and debt-sourced spending of all kinds. Euphemisms for debt and personal and national bankruptcy associated with debt have been developed to delay a mass panic away from government bonds or debt. For example, the associated growth of debt-based derivatives during the upward phase of the debt money cycle was referred to as "innovation" in financial markets.

Bankruptcy laws differ to a small degree in different jurisdictions but in all developed economies unpaid debt results in legal penalties, property confiscation on behalf of the creditor and income sequestration. Although in Christian, Jewish and Muslim religious practice there have been traditions of debt relief or laws against usury, in no modern Western jurisdiction are any debts periodically forgiven or cancelled in recognition of the inherent impossibility of repaying debts in circumstances where the debt-based monetary cycle has inevitably resulted in too little new debt money being injected into the money supply to pay for the currently outstanding debts.

On a national level, if the issuance of government bonds becomes unsustainable, sovereign bankruptcy can occur - and has occurred many times in history. Sovereign debt crises due to the inability of nations to pay interest on government bonds have occurred frequently and regularly in the third wor and less frequently (every 30 years or so) in the first world as a result of high levels of unsustainable public debt - often because private debts are assumed by a corrupt government through large private bank bailouts. The Latin American debt crisis is an example of sovereign debt levels becoming unsustainable, resulting in a currency crisis and economic collapse, as interest rates rise precipitously due to the inability of the national government to attract financiers to purchase new government bonds to inject new debt money into the ailing economy.

At such times, it is the responsibility of the IMF to come in as a kind of supranational central bank to mediate between the national government and international financiers. The role of the IMF as central bank to the world has similar responsibilities and risks inherent in central banking which are described below in relation to the role of the Federal Reserve. If the IMF repeatedly intervenes to save financiers from loss when sovereign bankruptcy occurs, this has a tendency to induce moral hazard and can encourage the financing of reckless government spending and borrowing.

A single currency regime such as the Euro can mask national liquidity or solvency crises, by ensuring that a national currency is not quickly exchangeable for another, thereby restricting the ability of national governments to depreciate their currencies and cutting off the possibility that the real value of government bond interest repayments could decline relative to other currencies. This may however increase the risk of bond default where indebted national governments cannot pay back the interest payments in the denominated common currency.

Types of downturns

Main article: Austrian Business Cycle Theory

Austrian Business Cycle Theory states that artificially low interest rates set by any coercive price-fixing entity will inevitably stimulate malinvestment in the wrong capital projects which will inevitably lead to an unsustainable boom followed by a bust. However, the precise nature of the downturn and the way in which losses are allocated within the economy are both dependent on the actions government and bankers take to forgive debt or control credit and there are two main kinds of debt money contraction that can cause a collapse in the value of inflated assets.

A "credit squeeze" occurs where new debt money is difficult to access without a high credit rating. At such times marginal borrowers, or those who have borrowed at the end of any debt-induced asset bubble, get "squeezed" out of further borrowing and a contraction in the growth of new debt money occurs, triggering a slow down in the growth of inflated assets. Those assets can then be "harvested" by the private banks through widespread foreclosure or bankruptcy and re-sold to those with the money to buy the distressed assets.

A "credit crunch" occurs where new debt money is not available at any interest rate - even for those with previously acceptable credit ratings - due to widespread insolvency in the banking system. At such times, it is the banking system itself that is insolvent and other financial institutions (including overseas financiers) become reluctant to lend to the domestic banking system, resulting in the domestic banking system being unable to issue loans even to credit worthy borrowers.

At any stage during the downward spiral of a "credit crunch", the central bank in a modern economy can try to save the system from complete economic meltdown by purchasing (either indefinitely or temporarily) the failed debts of the private banks. This involves swapping depreciating "failed" assets with hard cash, thereby allowing the banks to maintain their net asset position and continue to give the impression of solvency to their auditors and depositors. However, doing so results in cash being transferred to the private banks in exchange for bad debt, thereby violating the general economic precept to avoid moral hazard and effectively makes liquid the failed lending decisions of the private banks. In the U.S. banking system this is called "opening the Fed discount window", where the Federal Reserve temporarily purchases the failed investment portfolios of distressed private banks in exchange for cash. However, this rescue measure may only delay, rather than avoid, the realization of losses in the banking system, as the central bank cannot "force" new borrowing into the system to inject new debt money into the money supply. Somebody has to be a counterparty to borrow the debt money that is being offered. If all market participants realize a "bubble" has formed in assets markets, there will be few (or no) buyers for new debt money, as no one wants to borrow to buy inflated assets no one else will buy. Money markets can therefore remain illiquid even with intense central bank support.

Furthermore, banks can go bust even with intense central bank support, if the issue is not one of liquidity, but one of solvency.

Pushing on a string

Some monetary economists describe the opening of the Fed discount window after the bursting of an asset bubble and swapping of "junk" with new money as "pushing on a piece of string", as this measure does not solve the key problem – creating new credit (or debt money) to keep up the growth in the money supply and maintain the required level of liquidity in credit markets. This is because unlimited central bank money and low interest rates allow credit creation, but cannot not force it into the system. In order for any new debt money to be created, somone has to borrow the excess reserves in order for the money to be injected into the system. With an endogenous money system, money is only created if someone wants to borrow money from a bank. If corporations and individuals are already heavily indebted (or insolvent after the bursting of another debt-induced bubble) there are no credit-worthy borrowers to lend to. This means there are no buyers at the margin to keep asset prices at high levels. If there are no marginal buyers, "liquidity" - or debt growth - dries up and volumes and prices drop suddenly, forcing liquidation and creating a sudden cascading effect in highly leveraged markets very similar to the end of an unsustainable Ponzi scheme.

To encourage fresh borrowing, central banks generally combine these rescue measures with an interest rate cut to encourage more new borrowing to allow the existing (failed) debts to be liquidated at or close to their original value. When Alan Greenspan repeatedly resorted to this tactic to revive illiquid money markets this became known in the market as the "Greenspan put", as the effect of these repeated reductions in interest rates was similar to a put option in the stockmarket, insuring banks' lending mistakes would be covered up by the Federal Reserve.

When interest rates cannot go any lower (the so-called "zero bound" monetary problem) and people still will not - or cannot - load themselves up with more debt, then the Keynesian solution is to run large public deficits and indebt future generations (who, they hypothesize, are more likely to be able to pay through increased future growth). Fabian socialists, and Keynesian economists such as Paul Krugman and Robert Shiller, argue that governments must take charge of the responsibility of spending more (and taking on more debt) on behalf of the public (who are too fearful to take on more debt themselves) in order to compensate for the immediate and urgent present insufficiency in total private consumption. Paul Krugman is a prominent advocate of the policy of spending trillions of government money to help stimulate the economy, if spending billions does not work. For economists such as Paul Krugman, if the "more and more government spending" solution does not work initially, it is a sign that not enough government money has been spent. It is his view that the "deflationary" Japanese recession from 1991/2 could have been cured by the Japanese government going into even more debt than the current net debt to GDP ratio of 110%. Although some commentators have puzzled over exactly which group Krugman blames for the crisis, Krugman repeatedly calls for the government "to do more" as the way out of the crisis, regardless of the true culprits or cause of the crisis.

Although there is active debate as to whether this policy (indebting future generations by the government spending debt-sourced money on projects the private sector would not touch) can actually help the economy long term, there is no argument that this would undoubtedly help the present group of private bankers, as increased income from the interest payments on new government bond issuance offsets the decline in private sector debt and allows banks to survive when otherwise they may face collapse due to the fatal impairment of their balance sheets through private debt write-offs after an unsustainable debt-fuelled bubble bursts.

As government debt is effectively an asset on the books of the banks, increasing Treasury bond issuance necessarily increases the profitability and net asset position of the debt-issuing banks - at least until government insolvency or mass tax evasion renders the value of those bonds worthless.

Inequities in system

Many inequities arise because of the damage an overly leveraged financial system can have on the real economy. The standard government strategy to help the banks out of the "tailspin" of an insolvency crisis follows a standard chronology:

The government first tries to stimulate the economy and spend money into the markets directly without individuals needing to borrow and spend, thereby "inflating" its way out of economic crisis by causing asset prices to rise and bank balance sheets to appear solvent. It does this by colluding with the central bank to print money and then spending this new money on random (or pre-planned) projects that the private sector is not already engaged in.

Unfortunately, there is no easy solution to an economy-wide insolvency crisis caused by credit expansion. Although superficially and politically appealing, government spending only further distorts the economy through widespread malinvestment and makes things worse over the medium term. Later, after the immediate crisis, when bond yields rise, governments are often forced to reduce basic social services or welfare to the poor to pay for the increased bond payments to bankers and other wealthy investors, making those least responsible and least able to pay for the crisis suffer wrenching economic hardship.

Antal E. Fekete compares quantitative easing to the repeated supply of opium by an immoral drug dealer to a dependent drug addict:

The explanation for this self-destructing behavior is the addictive, debilitating and mind-corrosive nature of paper money, in direct analogy with that of opium. The high caused by administering the opium pipe to the patient (read: administering QE) had to be repeated when the effect faded by a fresh administration of more opium (read: more QE2).

Aside from the moral hazard issue, the key risk with quantitative easing is that the central bank exposes the financial system to disruptive inflation, as the growth in the money supply spirals out of control due to the need to save the banks from themselves. This eventually tends to precipitate a currency and/or government bond crisis, as the debt-based currency becomes completely dysfunctional when either the currency becomes worthless or when debtors - including government debtors - cannot even pay interest on the debt money.

For these reasons, a collapse in confidence in the solvency of the domestic banking system (and the central government) is one of the most complex and difficult policy issues any central government can face. If central bank continues to try to save the current players in the banking sector by continually printing money and inflating its way out of the crisis, at some point hyperinflation suddenly appears, and has appeared many times in history.

Some comentators have observed that the media and the Fed have to constantly come up with new terms (such as "quantitative easing") to hide the fact that they are simply repeating the same failed policy of monetary inflation that corrupt sovereigns have deployed at the end of failed regimes many times over the millenia. This is also now referred to by some monetary reformers and economists as "socialism for the rich and capitalism for the poor", as many indebted consumers will still lose their houses and be declared bankrupt regardless whether or not the central bank intervenes to save marginal lenders who have been made insolvent through their mis-timing of the credit cycle. Future generations of innocent taxpayers may ultimately finance any bail out of reckless lenders, as the money used to fund any bail out will be funds diverted from the general revenue of the central government.

In times of crisis, some bankers still refer to Walter Bagehot's 1873 commentary on monetary crises, Lombard Street, in an attempt to gain insights into the way in which central bankers should revive illiquid banking systems. However this old text may be outdated in circumstances where the community's debt limits have been reached and where the banking crisis arises from insolvency or environmental depletion rather than illiquidity. A prime example where aging demographics combined with reckless bank lending in a purely fiat debt-based monetary system resulted in economic problems which no amount of money printing or government spending could fix can be found in the case of the Japanese asset price bubble. Some believe the West will repeat the mistakes of the Japanese and the result will be worldwide monetary disorder.

The Keynesian Endpoint

Keynesians often refer to Keynes' dictum "In the long run we are all dead" to justify artificially low interest rates and short-term stimulus spending by government to "kick start" a stalled economy where pre-existing private debt levels have caused spending to collapse. Tyler Cowen has responded to this Keynesian rejoinder with the following response:

The famous Keynesian rejoinder, “In the long run we are all dead,” is less comforting when that long run comes into sight. Short-run planning is a hard carousel to stop, especially when there are frequent election cycles, but the federal government must act soon...

The technocratic Keynesian recommendation was to run deficits in bad times and surpluses in good times. But except for one stretch during the Clinton administration, this notion has been broken since the early 1980s. In the United States, at least, Keynesian economics has failed to find the necessary political institutions to enact and sustain a wise version of the theory.

Now that fiscal constraints are starting to bite, many politicians are afraid to reform or even to discuss changes in the largest problem areas...

Fiscal austerity may sometimes sound like a dogmatic religion, but fixed principles often help us do the right thing, especially when temptation beckons. Professor Buchanan argued that the real choice was between a religion of budget balance and a rule of illusion.

...the rigor of the numbers will soon sweep away the fiscal illusion. The only question is whether we will end the charade on our own terms or continue to play the fool.

No current commentator predicts bankers, politicians or government employee unions will spontaneously reform themselves. Noted commentator Bill Bonner has described politicians, welfare recipients, bankers and other tax beneficiaries as economic "zombies" unable to adapt or adjust to new economic realities and has predicted that the "zombies" will continue to coercively suck as much wealth from the economic system as possible until it completely collapses. The difficulty with any attempt at reform measures is that the "Ponzi" elements of finance are inextricably tied to pension funds and "real" elements in the economy, making it impossible to eliminate the "cancer" without damaging the wealth-creating structures as well. Commentator Max Keiser has coined the term "Suicide Banking" to describe the paradoxical situation where virtually every politician and economist acknowledges that "Too Big To Fail" is a dysfunctional policy but no one has a viable solution, given that the banking system is "rigged to blow" if threatened. He also refers to the current crisis as a fight to the death not between countries or ethnic groups or political ideologies but between future-oriented, prudent and conservative "Savers" on one side and present-focused, imprudent and overconsuming "Speculators" worldwide on the other.

Many non-mainstream financial commentators believe the U.S. and the E.U. will soon experience terminal financial crises, but there is vigorous on-going debate amongst numerous commentators regarding whether this terminal currency crisis will end in hyperinflation and currency destruction (making government bonds worthless) or repeated bouts of deflation and depression (making government bonds more valuable). Most - but not all - commentators now believe the denouement will inevitably result in hyperinflation and render the U.S. dollar near-worthless in real terms, as U.S. bond and dollar holders compete to offload excess holdings in the face of massive ongoing issuance. Mike Shedlock and Antal E. Fekete are amongst a small group of deflationists who believe contracting credit will continue to have a deflationary impact on the economy, causing government bonds to become even more valuable over time.

Regardless whether the government chooses hyperinflation or periodic delfationary depression as the way out, throughout history, only two real alternatives occur in the midst of economic or financial crisis: ever greater centralization (often on a "higher level") or disintegration of the core power structures and (eventually) rejuvenation. Accordingly, many of the more extreme monetary reformers and conspiracy theorists anticipate repeated and ever more desperate attempts at higher-order centralization, as the exisiting coordinated domestic central bank architecture becomes discredited through repeated economic failure and environmental crises caused by the need for unsustainable exponential debt-driven economic "growth" within the current debt-based financial architecture. This centralization is anticipated to include the empowerment of the UN to increasingly intervene in the domestic political affairs of nations, the IMF and EU to increasingly intervene in the domestic financial affairs of nations, and the declaration of martial law and the imposition of fascist-style restrictions on civil rights and freedom of speech by the political Establishment to physically protect it from anarchy or military coup when the bubble of debt completely bursts, through a precipitous currency crisis, debt-created depression, environmental crisis or oil shortage. Ultimately this is anticipated to yield either repressive world government or chaos (or most likely both), with a world central bank stationed in Basel, Switzerland. During this transition period, some analysts and conspiracy theorists anticipate multiple wars to force governments into the BIS financial "net", impotent and counterproductive price controls, repeated sell-offs of monopoly state assets in a desperate attempt to feed private domestic banks with steady, coercively acquired income to keep the value of government bonds collapsing, and then, once this attempt (to feed unsustainable compounding debt with any remaining basic infrastructure) destroys any remaining parts of the productive economy, there will be in the end coercively-enforced rationing of basic essentials to ensure continued supply of food and oil to senior government officials, bankers and their associates amidst widespread general starvation and chaos, as the coalescence of a corrupt banker-government coalition solidifies to eliminate potential dissent and ensure the forced elimination - by any means necessary - of any actual or potential competing currencies that could threaten the viability or legitimacy of the monopoly currency, which could include war against any country considering using any currency other than US dollars to price essential commodities such as oil and the compulsory confiscation of all privately-owned gold (gold being the ultimate reserve currency, still used by central banks as a universally accepted medium of exchange for the settlement of international debts).

There have been many monetary crises throughout history and there are a number of standard warning signs of impending depression or hyperinflation caused by a complete breakdown of trust in any monetary system. Just prior to the complete collapse of the pyramid scheme of public and private debt, the economic system tends to feed on itself, and in the past, where debt-created depressions or periods of hyperinflation have occurred in Europe, the U.S. and China, there has been a sustained spike in predatory economic behavior, as the heavily indebted central government and producers are forced to find more extreme (previously considered unethical) methods to extract any remaining wealth from increasingly desperate and impoverished consumers, who are either unwilling or unable to go into further debt without forceful coercion. Long-term investment and sustained capital investment are almost impossible in this environment because the "measuring stick" of return on investment (the real value of money) is so uncertain at times of debt-induced credit crunch, depression or hyperinflation.

As potential new borrowers and international financiers are scared away from participating in the pyramid scheme of debt and borrowing further, the monetary system seizes up, starved of the fresh injections of debt money it needs for its survival, thereby precipitating economic anarchy, widespread lawlessness and insolvency of the monetary and banking system. Some have described the moment when governments cannot borrow any more from banks to keep up the growth in debt money as the "Keynesian Endpoint" or "Keynesian Endgame" or point of "Debt Saturation" - which is the point in time when in extremis "emergency" measures by the government to kick-start the economy by increasing total gross debt have no lasting positive effect on GDP. Antal E. Fekete identifies this "crisis" point as the point when the marginal increase in total gross debt has no positive marginal effect on GDP. According to Professor Fekete, once the marginal productivity of debt turns negative, a disastrous depression is inevitable.

This final denouement is triggered when borrowers cannot be found to buy depreciating heavily indebted assets, and international financiers reduce lending as they experience losses on pre-existing loans either through asset or currency depreciation. Some analysts predict that the monetary system will seize up due to a deflationary depression or a sustained period of stagflationary hyperinflation resulting in a "final and total catastrophe of our fiat monetary system."

Examples of debt and monetary crises can often be found after failed wars, when international financiers realize the heavily indebted government they funded will not gain the resources it planned to seize as a result of the waging of aggressive war. When this pay-off does not materialize, the losing government is left with the debt of war without the ability to offset this government debt through the imposition of reparations on the defeated nation and the acquisition of the defeated state's resources, thereby boosting the victorious state's GDP and tax revenues. This sudden monetary collapse occurred to Germany after the First World War and Japan after the Second World War.

Whatever the trigger, the key warning sign of any impending monetary crisis and economic anarchy is a sudden currency crisis, or a sudden spike in domestic interest rates, or a sudden credit crunch. Early warning signs that the private banks themselves are aware of an impending breakdown in the solvency of the financial system would be any combination of some or all the following: a spike in the prices for oil (which is an internationally accepted, inherently limited, store of value, and therefore can act as a modern form of hard currency, oil sometimes being referred to as "black gold"), gold, silver and other stable, non-perishable, inherently limited natural resources essential for non-discretionary industrial production; a spike in the futures contracts for vital agricultural commodities such as sugar, corn, wheat, soybeans and rice, as investors realize the debt-based monetary system has squeezed supplies of arable land; a sudden flight of money to Treasury bills and/or a sudden spike in the interest rate differential between short-term Treasury bills and asset-backed corporate paper (or a sudden spike in the LIBOR rate in London) - and then, in the very late stages of a credit crisis, a sudden and disorderly flight of money away from government bonds and a "shock" or "panic" collapse in government bond prices, as banks perceive that some governments will ultimately find it impossible to pay interest on their debt from coercively acquired taxes.

Shortly thereafter, some monetary reformers predict that there would be desperate, but ultimately futile central bank intervention involving massive, repeated bouts of "quantitative easing", then a currency crisis, then a panic run on a number of marginal, insolvent banks and hedge funds as desperate wealthy investors try to get cash out before the pyramid scheme collapses to invest in inherently limited, non-perishable, in-demand commodities such as oil and gold (and undeveloped agricultural and industrial land in areas of the world with strong economic growth), followed by a recession or depression in the broader heavily indebted economy as the credit contracts but base money continues to rise exponentially.

In 2010 Ireland and Greece experienced simiilar financial crises along the lines described above and many financial commentators and politicians expect more countries to go through the same debt crisis. In 2011, Tunisia experienced a financial and political crisis that was almost identical to those already experienced on the poorer European periphery, except that in this case the pre-existing political establishment quickly fled the country in fear for their safety - with some allegations that the wife of the deposed leader, Leila Trabelsi, ordered the country's central bank to transfer 1.5 tonnes of gold to Zine El Abidine Ben Ali and his family. The Egyptian uprising resulted in Hosni Mubarek fleeing after desperate attempts were made by him and his associates to preserve his family's wealth and power. Several newspapers have reported that, once again, appropriating the nation's gold reserves was a major priority for the fallen leader. Following the overthrow of the ruling elites in Tunisia and Egypt, other North African countries have experienced similar uprisings - all attributable to higher food prices, according to some noted commentators, who have accused Fed Chairman Ben Bernanke of literally having "blood on his hands" due to the encouragement of food price inflation via sustained inflationary loose-monetary policies. The central banker has denied that his inflationary loose-monetary policies have contributed to food inflation. Implicit in Mr Bernanke's argument is the assumption that the central bank can create "good" inflation in some markets and avoid "bad" inflation in others. This alleged central bank power to direct good inflation and abate bad inflation is derided by a number of commentators.

Noted British Telegraph commentator Ambrose Evans-Pritchard has called these the first Malthusian "Food Revolutions" of the modern era, as agflation causes political instability on the periphery of major economies worldwide - particularly those countries that have already denuded their agricultural base and have to import grain and other foods to survive.

It is also reported that very complex, delicate negotiations are taking place between debtor and creditor nations to swap government bonds with gold at prices far in excess of the declared "market price" of gold. These so-called "off-market" deals are a sign the Keynesian Endpoint has arrived.

Finally, it should be noted that, with the destruction of the fascist regimes in Italy, Germany and Japan post-WWII and the collapse of communism in the 1990s, there no longer exists any major economy where the banking system is fully government-owned or has any strictly enforceable social responsibilities beyond pure profit motive. All major world economies have now adopted essentially the same monetary system, with profit-driven private banks (government-licensed institutions legally permitted to engage in unlimited credit creation) able to pocket profits during upswings and socialize losses during downswings by use of central bank asset swaps. If critics are correct that all such systems are doomed to severe boom-bust cycles because of excessive expansion of speculative credit and endemic moral hazard, it is to be expected that all major economies will also experience essentially the same kind of environmental and food crises, and even allegedly "strong" economies such as China will experience severe economic downturns at some stage. However, equally, if critics are correct that fractional reserve banking, excessive credit expansion and artificially low interest rates are at the root of all financial crises, then higher reserve ratios and capital requirements for domestic banks (or the existence of heavily controlled nationalized banks) should reduce the severity of economic crises in those economies with higher reserve requirements for their own banks.

Proposals for monetary reform

Potential solutions

Many consider it too late to reform the financial system. The relentless exponential growth in retirement and welfare benefits alone will be enough to bankrupt many Western governments (including the United States). No one in power today appears willing to tackle either the corrupt banking industry or government largesse. Too many in power now have a vested interest in the continuation of the system of spiraling inflation and debt to stop it, even if it could be stopped. Whilst the general economy suffers, many retailers go bankrupt, millions are foreclosed and real incomes are decimated, perversely, banking bonuses and lobbyists' incomes have skyrocketed. Noted gold investor, Jim Sinclair, has publicly stated that today's bankers are little more than irredeemably shallow "sociopaths", unable to grow a conscience and unable to forsee or care about the broader societal consequences of their actions beyond their own inbred groupings. He suggests that many senior participants in the international banking and derivatives industry should be jailed to protect the public from repeatedly being "raped" by their scams and has the following conclusion on his website:

For years I have been telling you that there is NO PRACTICAL SOLUTION to the total of all the mistakes that have been made since Roosevelt, in a depression, started it all.

Jim Sinclair considers it too late to save the system and recommends people become self-sufficient and buy gold to await the inevitable collapse of the political and economic system and the associated breakdown in the division of labor.

Max Keiser has stated that the culture of actual physical sexual coercion and rape allegedly exhibited by such dominant financial figures as former IMF head Dominique Strauss-Kahn and others is simply symptomatic and an outgrowth of a culture of financial rape and exploitation. In order to be part of the system, you must be blind to its consequences. Therefore, no one with a conscience can become powerful enough within the system to fundamentally change trajectory from its current catastrophic path.

John Perkins, author of Economic Hitman, has openly stated that the U.S. government is merely a front runner for major corporate interests and has assassinated leaders of countries where reform has been attempted. The zealotry and extremism against genuine and honest monetary reformers on the one hand and the payoffs and largesse given to unprincipled and corrupt supporters of the current monetary regime on the other ensure there is no path of reform left for those potential leaders with a conscience.

Dimitry Orlov, author of Reinventing Collapse, has written extensively about the striking similarities between the collapse of the USSR and the multiple environmental, economic and social crises facing the USA. He also predicts economic, political and social collapse in much of the West and in particular predicts that peak oil will result in some countries being cut off completely from oil supplies resulting in sudden social upheaval and starvation and believes that it is too late for any kind of meaningful reform:

(US military adverturism overseas) is just a very striking example of being unable to stop, even though what you're doing isn't actually working...

By demolishing as much of the social infrastructure as exists in the country... you will end up with an even less literate population that will be unable to oppose the government, unable to stand up for themselves and demand that their rights and needs be met...

People who think they can somehow skirt the financial system are wrong. They will be dominated by the Bernankes of this world and others. There isn't really a way out except to make do without money. And that's kind of what I try to explain to people is: Reduce your needs for any kind of interaction with the official economy and you will do better.

On a national level, for unsustainably indebted nations, the simplest and cleanest solution for any debt-fuelled crisis is to default. Bankers generally despise this solution because it (a) reduces the value of their asset (debt-based government bonds) (b) reduces or even destroys their income stream (interest on bonds) and therefore may affect their retained earnings in future (and their credit rating and compliance with Basel III rules on Tier 1 capital) (c) can result in a systemic crisis as many banks will be using that government debt to satisfy their liquidity requirements under Basel III (which requires a minimum proportion of "liquid" assets to be held by the banks - and those "assets" mainly consist of government bonds) and (d) signals to other countries that it is possible to escape debt without consequence and so potentially reduces the value of government debt in surrounding countries. Self-interested bankers are therefore often desperate to avoid government debt default, and generally much prefer an economy to be strangled by debt rather than be freed of it.

As an example of the consequences of the two alternatives, Iceland did not try to save its private bankers but instead permitted them to default on private bond payments. Ireland on the other hand guaranteed private bank debt and in doing so subjected the taxpayers of that country to decades of payments for debts that were not incurred on their behalf or for their benefit. Many commentators have observed that in 2010 Iceland recovered much faster than other countries such as Ireland. In his extensive analysis of the aftermath of the banking panic in Ireland, Michael Lewis wrote of his puzzlement that the Irish government thought it was beyond the bounds of acceptable political discourse to consider default on privately issued Irish bank bonds, when Iceland successfully and easily defaulted and only after this did they nationalize their banking system.

In the absence of outright default, time is the only other remedy for monetary crises (allowing re-inflation of the markets through the gradual injection of new debt money into the system through new borrowings). It is a rare "black swan" event for a cluster of private businesses or banks to default at the same time and governments often hope that this will not happen again once it has happened already. However, if the crisis is one of national solvency, waiting passively for recovery may only delay - and exacerbate - the final catastrophe as the debt-based monetary system pushes all businesses slowly towards the next crisis by confusing and misleading market participants with false price signals, particularly as they relate to interest rates. Once the next crisis hits because of even more confused price signals due to government interference in the market for money, time is something panicked financiers and investors are least likely to want to give up when the threat is never getting their money out of the imploding investment bubble. In extreme cases banks could set up "independent" corporate investment vehicles to buy the assets associated with the bad debt, thereby allowing borrowers to liquidate their investments and allow time for the markets to re-inflate. Alternatively, these "sour" loans, that have gone bad through too much debt overwhelming the markets, could be dumped or "hidden" on the central bank's balance sheet, and swapped for more secure government debt (financed through compulsorily acquired taxes, which are immune from the risk of private bankruptcy). However the holding costs involved in these measures would be extremely high and would not guarantee that the losses could be averted if no new gullible investors could be found to offload these distressed assets. More fundamentally, these short-term "parachutes" used after bubbles burst do not save ordinary borrowers from foreclosure and bankruptcy, nor do they address the pernicious long-term dysfunctional aspects of fractional reserve banking described above. These problems are temporarily averted, only to be dealt with yet again by the next generation of indebted governments and peoples.

Given these repeated financial crises arising from the fiat monetary system, many monetary reformers predict that there will inevitably be widespread default or hyperinflation or depression - or most likely all three simultaneously in what Ludwig von Mises predicted would be a "final and total catastrophe" of our unsustainable, Ponzi-like, fiat monetary system. After this "catastrophe" in which a significant proportion of the population may die through starvation or war a spontaneous market-induced return to the gold standard is anticipated to be the most likely result. Other possible solutions following the catastrophe include a return to legally enforced full reserve banking combined with the issuance government-issued debt-free fiat currency, or free banking and the issuance of private coinage and private money. If these solutions are not initiated soon, it can be expected that a complete financial "meltdown" will ensue at some stage, as environmental crises and destruction of arable land slow GDP growth in developing nations and fewer young people in developed economies can be found who are willing to go into debt in sufficient magnitude to pay off the debts that have already been accumulated. As extreme inequality increases, foreclosures mount and financial crises repeatedly erupt, many believe a political crisis will eventually result in calls for revolution and fundamental monetary reform. However, as noted above, some commentators consider that it is already too late to avoid a combined financial, environmental and demographic catastrophe even if reform is now attempted.

On-going, worsening, debt-created crises in the economy and society (and the unsustainable damage to the environment caused by debt-created overconsumption) are likely to turn monetary and economic policies either to the extreme left or to the extreme right, as there are a number of competing solutions to the debt-based monetary "problem".

Libertarians, Austrians and commodity money

Libertarians and Austrian School supporters envision a voluntary society of free markets, free banking, small government and the abolition of legal tender laws, allowing money backed by a free market gold standard or silver standard to come back in circulation. A necessary pre-condition in establishing a true free-market order would be the complete abolition of all legal tender laws and the abolition of monopolistic central banking, including repeal of the Federal Reserve Act of 1913. Some Libertarians would also support experimentation with full reserve banking, recognizing that when fractional-reserve banking is combined with the gold standard a strong cyclical bias (and the systematic transfer of real wealth to the banking system) is normally inevitable. Those Libertarians who support full reserve banking would strongly support more flexible and forgiving bankruptcy laws in a fractional reserve banking environment, recognizing that no stigma should be attached to bankruptcy given the anti-Libertarian "unjust acquisition" of real wealth implicit in central banking, compulsory legal tender laws, fractional reserve banking and taxation.

Regarding the current accumulation of government bonds and private debt, some Libertarians believe that the creation of the Federal Reserve under the Federal Reserve Act of 1913 was unconstitutional and some Libertarians consider that at least some of this accumulated debt should be canceled or forgiven prior to a return to the gold standard in recognition of its fundamental illegitimacy. Arguably this would be supported by the "just acquisition" jurisprudence of legal philosopher Robert Nozick and Libertarian advocate Murray Rothbard.

In late 2010, financial commentator Max Keiser started the Buy Silver Crash JP Morgan Campaign 2010 in an attempt to expose the flaws underlying the fractional reserve banking system.

Free Banking and Full Reserve Banking

On the issue of the required level of bank reserves, Austro-libertarians are sharply divided on the optimal solution to eliminate the parasitic and destructive forces inherent in fractional reserve banking.

Some Austrian scholars advocate "free banking", where banks are legally permitted to engage in fractional-reserve banking activities provided they comply with the standard laws against fraud and are not supported in any way against the possibility of bank runs and are forced into bankruptcy should they not be able to pay their debts as and when they fall due.

Advocates of this system of banking include Lawrence White, Steven Horwitz, George Selgin, and Kevin Dowd, amongst others. F.A. Hayek also advocated the de-nationalization of money production and implicitly supported a free banking financial system in some of his works on monetary reform.

Other Austrian scholars advocate "full reserve banking", considering fractional-reserve banking and the associated issuance of irredeemable paper money to be inherently fraudulent, unethical, unjust, disruptive and dysfunctional, akin to embezzlement and counterfeiting. Full reserve banking would require banks to retain in reserve all deposits that are legally available for immediate withdrawal, and permit lending only from longer-term deposits.

Advocates of this system of banking include Murray Rothbard, Jesus Huerta de Soto, Jörg Guido Hülsmann, amongst others.

Most recently, in late 2010, two British MP's, Douglas Carswell and Steven Baker, sought to introduce legislation into the British Parliament that would allow depositors to decide if their money should be lent out and for what period. If this legislative reform were to pass, British depositors would have the option to elect to save their money in full reserve bank accounts.

Debt-free money

The concept of debt-free money is most notably represented by Michael Rowbotham, Stephen Zarlenga of the American Monetary Institute and Ellen Hodgson Brown. They advocate various forms of "pure" fiat money issuance by government, without the need for the government to issue a bond to print or issue the fiat money.

Currently virtually all money issued in modern economies is sourced from debt; in other words, it is "debt money". "Debt money" is money created in parallel with debt or credit via the process of fractional reserve banking.

"Debt-free money" is a "true" or "pure" fiat currency issued by the Treasury of a central government, where there is no requirement for its eventual return as a condition of its creation (except by way of payment of taxes). It is argued by Rowbotham and others that this would allow for the substantial lowering of tax rates, would allow public works projects to be funded cheaply, and would stimulate economic development, if the fiat money is spent sensibly on inflation-lowering long-term capital projects.

Properties

According to its proponents, government-issued debt-free fiat currency (such as debt-free notes and coins) can circulate perpetually in the economy as "stable" money and although not as secure as hard currency, government-issued debt-free notes and coins (such as United States Notes and silver certificates) do not have the same effects of debt-based money. It should be noted however that fiat currency can be a source of hyperinflation if its production is not controlled, as the government has the potential to issue unlimited amounts of fiat currency - provided it is accepted as "money" by the private banking system. Notes and coins in circulation (being defined as M0) now account for a tiny fraction of the total M3 money supply in all developed, debt-based capitalist economies (and M0 is also generally less than 10% of the total M2 money supply in most developed economies).

Instead of money being created "indirectly" and "furtively" at the point of loan creation by the private banking system, with periodic bailouts to already-rich bankers, it would be created directly and openly by the democratically elected government and issued to its citizenry by way of instruction to the private banking system.

Michael Rowbotham and Ellen Hodgson Brown both argue in their books that this would not raise consumer prices (or at least would not be as inflationary or as dysfunctional as the present system). This would also reduce overconsumption and the associated environmental damage associated with debt-based consumerism. It would also give individuals the free time to engage once again in non-marketable religious, artistic and recreational activities if they chose to do so.

It is to be expected that these policies would be violently opposed by the private banking "elite", as it would render impotent their control over the money supply, dissipating this crucial decision-making power away from its current power base. It would also be likely to reduce economic growth, dramatically increase the cost of labor and, potentially, result in an exacerbation of price inflation and malinvestment. However, Rowbotham argues that this proposal would address the problem of inequality inherent in a debt-based monetary system and reduce the devastating impact of personal bankruptcy and allow individual citizens to quickly recover from financial hardship. He also argues that this social security measure (and government spending in general) would not have to be paid for by future generations from future streams of income tax.

Related proposals

Ex-U.S. Treasury Department analyst Richard C. Cook also supports the issuance of debt-free money and zero-interest credit by the central government and has provided a detailed blueprint of monetary reform recommendations to transition to a debt-free money supply.

Stephen Zarlenga and Ellen Hodgson Brown also call for the nationalization of the private banking system once the full losses on the banks' portfolios are recognized.

Brown also supported "QE2" - which she described as a necessary and desirable funding of government spending via money printing rather than by the indirect means of issuing of interest-bearing government bonds, which simply allows private bankers to profit from costless money creation.

Michael Rowbotham seeks the cancellation of "unjust" debts (such as third world debt), but would also support the re-introduction of strongly redistributive tax policies involving higher financial transaction taxes (such as a Tobin tax), land taxes and inheritance taxes, and, crucially and most importantly, a social security safety net involving a guaranteed minimum debt-free income (sourced from government-issued debt-free money independent of any central bank) for all citizens in the debt-based economy. Under this proposal, every adult citizen would be given a livable debt-free income transferred electronically into their bank account, simply by virtue of their citizenship. They could then use this debt-free money to pay off their mortgages or to live, debt-free, without being compelled to work as a wage slave in the market economy if they chose not to. The government would finance these payments simply by ordering the private banks to accept their electronic instructions as legal tender. It would therefore not result in the expansion of government debt.

Many monetary reformers who call on the government to take back the money creation from debt-sourced banks also call for full reserve banking to remove the bank's alleged "embezzlement" and "counterfeiting" abilities.

Criticisms

In late 2010, Ellen Hodgson Brown and Austrian School commentator Gary North engaged in an intense debate over the direction of monetary reform, with gold-standard supporter Gary North accusing Brown of going down a path that inevitably leads to the economics of fascism and hyperinflation. Government deficit spending is not a substitute for private consumption due to the inability of coercive goverment to invest rationally long-term, given the economic calculation problem inherent in socialized economies. North argues that it is not possible to trust a coercive, non-market entity - government - to limit its spending in circumstances where pure fiat money is in the hands of politicians and that inflation, being an invisible tax, is much harder to resist than regular taxes. Greedy, corrupt, short-sighted politicians could buy off special interest groups to get elected and the general public could only watch on the sidelines as the purchasing power of their dollars steadily declines; this decline would be blamed on currency speculators and eventually foreign currencies (including "natural" monies such as gold and silver and copper) would have to be banned and confiscated from the public to ensure continued use of depreciating fiat. The fundamental error of Brown's analysis, according to North, is that Brown expects the source of the problem - corrupt governments bought and paid for by bankers - to be the source of the solution.

Mike Shedlock agrees with the abolition of fractional reserve banking, but criticizes the concept on similar grounds as North. Commenting on a bill to end the Fed introduced by Representative Dennis Kucinich, he wrote: "Neither sound money nor the free market comes from printing money into existence. Arguably the only thing worse than the Fed printing money out of thin air is Congress printing money out of thin air for the purpose of full employment and/or any other absurd ideas Congress has."

Left-leaning ideas

Many left-leaning social democrats would also support the taxing of the banking system and the enforcement of strongly redistributive income and land taxes to ensure the financially dispossessed are "replenished" with income. They would also support a social security safety net involving the provision of unemployment benefits and government-supplied free medical care, education and other essential services and public goods. It is to be expected however that, without the issuance of debt-free fiat currency, this system would result in the persistent, exponential, accumulation of government debt, financed by the private banking system by the issuance of government bonds. If not properly managed, this could result in a progressively higher tax burden and may result in higher interest rates in the long term, as financiers require higher interest rates to lend to the increasingly indebted central government. Without the issuance of debt-free money these policies can be self-defeating, with the net result simply being that a larger stream of guaranteed income goes to the private banking system via the issuance of interest-bearing government bonds (which are purchased by the private banks "out of nothing" through fractional reserve banking techniques). This government debt must then be financed in perpetuity by compulsorily acquired taxes from future generations.

It could be argued that the early success of extreme so-called "right-wing" (but socialist government-guided) fascism in Nazi Germany and Italy in the period after World War I was a response to the economic chaos created by the debt-based monetary system in early 20th century Europe. Some of the economic policies introduced by Hitler and Mussolini were in direct response to the economic collapse and social anarchy caused by soaring government and personal debt levels in both countries in the post-Versailles Treaty era, and (indirectly) arose from the writings of Silvio Gesell and others on the nature of the problems associated with a debt-based monetary system. Although many historians justifiably criticize many of the non-economic policies of the fascist governments of Germany and Italy during this period, the economics of fascism seemed to provide a degree of prosperity to the populace, and their stated objective of restoring economic and social order during the pre-World War II era. These economic policies and their results are the subject of vigorous debate even today. (See also Inflation in Nazi Germany.)

Similarly it could be argued that socialism and communism were movements inspired by the inequalities caused by the intense (and in Karl Marx's view unsustainable) concentrations of monetary wealth, power and influence inherent in the practice of fractional reserve banking in a laissez-faire, monopoly capitalist environment (particularly when fractional reserve banking is combined with a gold standard or other hard currency monetary system).

The communist/socialist solution to the problem of fractional reserve banking is simple: re-enfranchising workers through widespread organization and unionism, complete removal (and if necessary, violent non-democratic removal) of the allegedly "parasitic" financial, capitalist and upper classes, wholesale repudiation of government debt resulting in complete debt default; forced expropriation of land and wealth from the upper classes to the dispossessed and needy working classes; nationalization of the private banks (which has required armed coups by the military in some past revolutions); and the return of the banking function from a dominant, speculative to a subordinate, administrative institution, where the banking system is reduced to a subservient arm of the centralized Leviathan. In this system, government-owned banks are directed by government policy; often provide different kinds of loans to different industry sectors at different interest rates depending on the perceived "needs" of the economy and the community; normally have a significant proportion of non-performing loans due to weak or non-existent bankruptcy laws; and periodically "forgive" failed debts in recognition of the impossibility of some businesses in paying this debt money back. In addition, individuals are prohibited from possessing large property holdings, in excess of their individual needs.

It is to be expected that the profitability of the government-owned banking system would be more stable - but dramatically lower - than that in a debt-based capitalist economy. It is also to be expected that a significantly higher misallocation of resources could occur in this system, where lending decisions are "infected" by political considerations and are not made on the basis of expected return on investment. The risk of corruption in the banking system is also expected to be higher where there is no separation between the political and monetary systems in an economy. Market-oriented monetary reformers and neo-classical economists therefore do not support nationalization of the private banking system.

It should be noted that partial nationalization of the private banking system would only be temporary, as any remaining private banks could still engage in unlimited fractional reserve banking and facilitate the eventual acquisition and control of any strategic assets in a partially socialized economic system. It is to be expected that in the absence of complete nationalization of the banking system, the private banking system would eventually dominate the financial system in any nominally socialist society.

Status under current systems

Whatever their political leanings, nearly all monetary reformers agree that the current financial and economic system imposed on the populace by governments worldwide, involving the perpetuation of government-protected private banks (organizations legally permitted to engage in unlimited and inherently speculative fractional reserve banking activities during boom times, with recourse to monopoly central banks - and in some cases corrupt governments - to provide bail outs of fiat money during downturns), "deregulated" labor markets (which have the effect of increasing the marketization and commodification of human activity), strictly enforced bankruptcy laws (which permit the periodic transfer of assets from failed bankrupt investors to the private banks and their associates) and personal income tax (which, combined with periodic economic collapses, dispossesses the majority of the populace from their accumulated income and wealth and transfers this wealth to the owners of government bonds) amounts to an inherently unstable, unjust and dysfunctional economic system resulting in environmentally damaging over-consumption, the systematic and irredeemable destruction of fertile arable land and the government-sponsored (and ultimately unsustainable) oppression of the indebted, impoverished and economically enslaved majority.

See also

• Austrian Business Cycle Theory
• Central bank
• Monetary reform
• Murray Rothbard
• Ron Paul

External links

• Fractional Reserve Banking as Economic Parasitism
• Monetary Reform websites
• I want the Earth Plus 5%
• Money As Debt (videoplay animation)
• Financial Armageddon
• Jim Sinclair's MineSet
• LewRockwell.com
• Market Oracle
• Max Keiser
• MISH
• PrudentBear.com
• RGE Monitor
• Web of Debt
• Zero Hedge