Monday, June 18, 2012

What happens when the money runs out?

What happens when the money supply runs out? Capitalism is in crisis. For example, the U.S. finances it's consumption by borrowing from China. Otherwise it cannot afford to pay for imported goods. Example, Greece keeps getting more loans on top of previous loans it cannot service in order to maintain the status quo in the European Union. How long can this continue?
Look up Iceland to see what happens when the shit hits the fan. 

Money supply isn't infinite. You only have so much money and when you spend it all, then you run out.
If you borrow to finance your spending, then you have debt which at some point needs to be serviced by...real money.
Why is it imminent that the money supply will run out.
Two reasons,
1. Banks are over leveraged
2.Nations including the U.S.A as well as Greece, Spain, Italy have overspent and cannot service their sovereign debt.

First the U.S. government rescued the banks from the sub-prime crisis. Second the U.S. government raised its debt ceiling. These are signs that something is seriously wrong.

Here is the pivotal fact. The money supply isn't infinite. If a government prints more money, the value of the currency is diluted. That's a cause for inflation. Inflation gone out of control? Imagine people pushing a wheelbarrow full of money which is required to buy a loaf of bread. Germany in the 1930's. That's rampant inflation. Prices increasing faster than you can spend your money. The value of money deteriorating right before your eyes.

Now back to over leveraging by banks. Banks can be rescued by the government for the sake of the economy. A rescue is better than mass panic and total economic collapse.But there is a cost and that is inflation because the government has effectively increased the supply of money and devalued the currency in order to save the banks.
Similarly, when a government cannot service it's debt, it has to....yes, devalue the currency by printing more money.

The world is heading towards a crisis. Hints have been many with the U.S. economy increasing the debt ceiling from 14 trillion. Meanwhile, there is trouble brewing in Europe.

The sovereign debt default by Greece which is lurking in the background threatens to destabilize the entire EU. Why?
Just one country, poor little Greece and if it falls, the threat is that others will follow like dominoes...Italy, Spain...eventually the entire EU house of cards.The Greek public isn't happy about the prospect of austerity measures(reduced government spending and higher taxes). In fact, without a prosperous economy government revenue(tax) declines and sends the economy into a downward spiral. Not many options for Greece. The EU will prop up Greece for the same reasons that the U.S. government is bailing out the banks.
Stability versus chaos and depression. It's happened before but we're skating on thin ice and it will happen again.

Meanwhile China is strong. It's strength derives from it's ability to manufacture anything and everything and export to other countries including the EU, USA and Australia. If the economies of the western world collapse, then China will no longer be able to continue it's unbridled economic growth.. In fact US debit is largely financed from...China. That's interesting isn't it? Will it come to China bailing out the rest of the world? What conditions will China impose?

The US Sub-Prime lending crisis illustrated what happens when the money supply is stretched so far that the bubble finally bursts.. Leave it to the Federal government to clean up the mess.

The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages.
Approximately 82% of U.S. mortgages issued to subprime borrowers were adjustable-rate mortgages.[1] After U.S. house sales prices peaked in mid-2006 and began their steep decline forthwith, refinancing became more difficult. As adjustable-rate mortgages began to reset at higher interest rates, mortgage delinquencies soared. Securities backed with mortgages, including subprime mortgages, widely held by financial firms, lost most of their value. Global investors also drastically reduced purchases of mortgage-backed debt and other securities as part of a decline in the capacity and willingness of the private financial system to support lending. Concerns about the soundness of U.S. credit and financial markets led to tightening credit around the world and slowing economic growth in the U.S. and Europe.

In the seventies, Milton Friedman taught us that the money supply wasn't infinite.
Now the US government is also overspending the total value of US money supply. The debt becomes so huge that  government can no longer service the debt. What can they do? What do they do? Increase the debt ceiling. Problem solved at the stroke of a pen. Simple isn't it? Not quite.
So now the government owes even more money than before. What do they do? They can print more money to pay off the ever increasing debt. Remember that this is what causes inflation, when the value of the money supply is diluted.
Or, there are other alternatives           1. The government can reduce spending
                                                         2. The government can increase taxes

Either or both of these measures have an impact on the economy. They cause a decline in economic activity and profitability for corporations.Maynard Keyenes showed how a decline in government spending could plunge an economy into recession or an increase in government spending can pull the economy out of recession. This has a flow on effect known as the multiplier.A government that reduces spending means a slowing down of the economy and more unemployment,decline in economic growth. In other words a downward spiral.

So whichever way you want to look at it, things look grim..

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