We use what I call a “virtual money” system. The Dollars we use aren’t backed by gold or some other precious metal, they’re backed by the “full faith and credit” of the United States government. The beauty of the virtual money system is that it can expand or contract to meet the country’s changing economic needs. Virtual Dollars are ephemeral in nature and, because of this, have an interesting characteristic: they can simply disappear.
This happens all the time in the stock market. Traders exploit the perceived value of stocks or futures or whatever to make or lose small amounts of money. From their perspective money disappears when stocks decline in value and magically appears when they increase in value. In the long run things average out. Some traders win, some lose and nobody really thinks anything of it.
But what happens when the market goes catastrophically bad as it did in October of 1929? That “Black Thursday” began like any other. Traders purchased stocks at the opening prices using borrowed or entrusted money. At some point during the day a sell-off was triggered and panic selling ensued. Stock prices declined rapidly and the market crashed.
From the traders’ perspective the money used to purchase stock in the morning was gone in the afternoon: vanished, gone, never to be seen again. Initially of course, the money went into someone else’s pocket but was now unrecoverable because the stocks that were purchased were worthless. Traders were jumping out of windows because they were left holding markers for hundreds of thousands – maybe millions – of dollars in short-term loans they suddenly had no hope of repaying.
The disappearance of all that money caused banks to fail, causing other banks to fail, and so forth and so on. Banks’ assets suddenly became worth ten cents on the dollar and the remaining ninety cents simply disappeared. Depositors’ money placed with banks as investments simply disappeared. Businesses failed causing more money to disappear. Billions of dollars literally disappeared from the U.S. economy in an era in which a million bucks was a lot of money. In the ensuing Great Depression people had no money because there was no money to be had. Bankrupt banks had no money to lend and businesses failed for want of short-term cash.
The exact same thing happened in the crash of themortgage-backed securities market (some sayscam) a few years ago. Money invested to purchase these securities simply disappeared when their value collapsed in the market crash. The traders didn’t care because they made (and got to keep) tons of money in the price bubble before its collapse. The banks didn’t care because they knew they were covered by the Federal Government.
The losses that produced the Great Depression ran into the tens of billions of dollars. On today’s money scale, the MBS losses were in the hundreds of billions. If the offending banks had been allowed to fail as some suggested, the money destroyed would have been in the trillions. The Federal Government really had no choice in propping up the banking industry. “Too big to fail” was literally true – not a political euphemism.
The MBS losses, the mortgage-failure losses, and all of the bankruptcy losses incurred over the years are money that has disappeared from the Money Supply. The losses have caused the Money Supply to contract, which has created a gap between it (the M3 specifically) and the National Debt. TheNational Debt currently stands at about $15.6 trillion and the M3 at about $14.5 trillion, which puts the gap at roughly 1 trillion dollars. This is money that is simply gone and unrecoverable.
Ultimately, the inflation of the National Debt and the Money Supply must be arrested. The Dollar must be revalued if it is to retain its credibility in the world’s marketplace. This can only be accomplished the old-fashioned way: by paying back the National Debt to some manageable and controllable level.
Interestingly, the Money Gap would prevent the National Debt from being completely paid off. Dollars borrowed go into someone’s account and are accounted in the Money Supply. Theoretically, the National Debt could be paid back to the point where the Money Supply reaches zero. That which is left would be the portion of the National Debt that is attributed to the Money Gap. Obviously, no money would be left to pay the cost of the Money Gap. The Money Gap is permanent.
We will eventually all pay for the MBS debacle and all of the other bankruptcies and money losses that have occurred. The politicians are talking now about raising taxes on the country’s billionaires. When they run out of billionaires, they will work their way down the ladder through the millionaires until they reach us. Low-income tax breaks will disappear and tax rates for everyone will go up. It’s simply unavoidable and we’re stuck with it.