"Everything predicted by the enemies of banks, in the beginning, is now coming to pass. We are to be ruined now by the deluge of bank paper. It is cruel that such revolutions in private fortunes should be at the mercy of avaricious adventurers, who, instead of employing their capital, if any they have, in manufactures, commerce, and other useful pursuits, make it an instrument to burden all the interchanges of property with their swindling profits, profits which are the price of no useful industry of theirs."
--Thomas Jefferson letter to Thomas Cooper, 1814.
Are we standing at the edge of a Great Inflation (like Weimar Germany), a second Republican Great Depression, or a return to the middle class prosperity of the Roosevelt/Eisenhower New Deal era? Until Americans understand the difference between "money" and "debt," odds are its going to be one of the first two, at least over the next few years.
"Money" is a convenient replacement for barter in an economy. Instead of my giving you five pounds of carrots, so you wash my car, then you trade the carrots for a new shirt, and the clothing store then trades the carrots to a trucker that brings them their inventory, we all just agree to use a ten-dollar bill. Because a nation's money supply represents that nation's "wealth" - the sum total of goods, services, and resources available in an economy/nation - it needs to have a fixed value relative to the number/amount of goods, services, and resources within the nation.
As an economy grows - more factories, more goods, more services - the money supply grows so one dollar always represents the same number of carrots. (And with a fractional reserve banking system like we have, that growth is created mostly by banks lending money and creating it out of thin air in the process.)
If the money supply contracts, or grows slower than the economy, then we experience deflation - the value of money increases, goods and services become less expensive (fewer dollars to buy the carrots), but because the value of money has increased it becomes harder to get. When this happens quickly, because of its economically destabilizing influence (businesses and people can't get current money - cash - or future money - credit - because money is more valuable), it's called a Depression.
On the other hand, if the money supply expands or grows faster than the economy, there are more dollars than there are goods and services so the number needed to buy a pound of carrots increases. This is inflation, and when it happens suddenly and on a large scale, it's called hyperinflation.
Therefore, one of the most important jobs overseen by Congress and executed by a Central Bank (or the Treasury Department if we were to go with the system envisioned by the Founders and Framers of the Constitution) is to "regulate the value" of our money (to quote Article I, Section 8.5 of our Constitution) by making sure the number of dollars in circulation always steadily tracks the size of the overall economy. If the economy grows 2%, then that year there should be 2% more dollars put into circulation. More than that will create inflation; fewer will create deflation.
"Debt" is not money. Instead, it's a charge against future money. But even though it's a charge against future money, it can still be spent as if it was today's money - except that it must be repaid with interest. And therefore debt must have some sort of a balanced relationship to the total size of the economy - albeit the future economy - for it not to be destabilizing.
In other words, if over the next twenty years (the term of a typical and healthy mortgage) the economy is expected to grow by X percent or X number of dollars, then the total amount of twenty-year debts that can be issued should be limited to X. But if it's greater than X, then when the future arrives there won't be enough circulating money to repay the debt, because the economy (and the money supply) won't have grown as great as the debt repayment demand. The only two options are for debt holders to default (bankruptcies, foreclosures, etc. - Depression), or for the government to suddenly increase the supply of money (inflation).
The same is true of one-year debt (credit cards), four- or five-year debt (car loans, typically), and all other forms of debt. In aggregate, if the amount of debt is allowed to grow faster than the economy will grow over the term of the debt, when the debt is due there will be a problem, and if it's grown hugely, a disaster.
This is what we're experiencing right now. Over the past three decades - largely since Reagan - debt (both private and public/government) has expanded much more rapidly than the economy has grown. "Now" was "the future" when the debt was issued, but the economy hasn't grown to the point where there are enough dollars (in reality, enough value - goods and services) to repay that debt. Thus we are experiencing a "wringing out" of that debt - bankruptcies and foreclosures - relative to the current wealth of the economy.
This is the most critical thing to see clearly - without adhering to this simple concept, a government or central bank will always either create boom/bust cycles (depressions/recessions) or inflation. Without regulating debt, a government will be taken hostage and an economy destroyed by for-profit institutions that are able to create debt without regulation (banks).
Although Thomas Jefferson and Alexander Hamilton - two opposite sides of the national bank debate - both understood this simple concept, it wasn't brought into the realm of law until the mid-1930s with a series of strict regulations on the abilities of banks to create debt (loan money), and strong political limits on the ability of government to go into debt outside of wartime. That's why from the founding of this nation until 1935, we experienced a "banking panic" at least once every 10 to 15 years from 1776 until 1935.
Then Roosevelt took the banks in hand, by creating a series of regulatory agencies and empowering them with strict laws. The result was that for fifty years in the United States - roughly 1937 to Black Monday of 1987 - we didn't experience a single national "panic" or consequential bank failure. The stock market grew steadily (allowing for the blips surrounding WWII).
It was also hard to get a credit card (short term debt), buy a car (medium-term debt), or get a mortgage (long-term debt) without proving that you would be able to repay the amount in the future - in other words, that there would be future expanded-economy dollars that you could lay claim to because of your particular job and skills. Credit was regulated.
Reagan changed the rules of the game, particularly when he brought in the anti-regulation Libertarian Alan Greenspan as Chairman of the Fed. He ran up a massive federal debt - greater than that of every president from George Washington to Jimmy Carter combined - in just eight years, and began the process of loosening the power of bank regulators.
That process was finished by a Republican Congress (particularly Phil Gramm) and President Bill Clinton (with help from Rubin and Summers) and then booted out the door by George W. Bush, who borrowed even more than Reagan. Bush even used an obscure 19th century law to fight states' attorneys general who wanted to regulate or prosecute fraud among banks and mortgage lenders in their states (see the article by Eliot Spitzer in the Washington Post just before his being outed for sleeping with a hooker).
During the "Great Stability" - that period from the 1935 onset of the New Deal and the beginning of its end with Reagan's massive tax cuts of 1981 and 1986, leading directly to the stock market crash of 1987 and the S&L debacle - banking was, as Paul Krugman noted in a recent column, "boring." Credit and currency were considered part of the commons, not something off which a small elite should profit. Like the utilities in the game Monopoly, banks provided a predictable but relatively low profit. Nobody got rich, but nobody lost anything, either.
Bankers were the safe and predictable guys who wore green eyeshades at work and pocket protectors in their shirts. The nation's main products were goods and services; nobody "made money with money" in any big way.
Since the serial deregulations of the financial services sector brought on by Reagan, Bush, Clinton, and Bush, however, bankers became fabulously rich. They called themselves the "Masters of the Universe." They came to dominate contributions to politicians, and facilitated the takeover of most major US newspapers, all the while using debt as their mail tool to make money (burdening those newspapers with such debt that many are now going out of business because they can't repay it).
By 2005, fully 40 percent of all corporate profits in the US came from the financial services sector - a group of people who didn't produce anything at all of value, nothing edible or usable, nothing that would survive into future generations. They invented fancy derivative "products" that they "sold" at high commission rates around the world so others could "make money with money." In fact, they weren't making money - they were taking money. Behavior that would have been criminal during the Roosevelt, Truman, Eisenhower, Kennedy, Johnson, Nixon, Ford, and Carter administrations became "normal" and was even encouraged: more than half of all the graduates from many of America's top colleges and universities went into finance so they could get in on the very lucrative scam.
They created debt. As Ellen Brown notes at www.webofdebt.com, according to the Bank of International Settlements, they created and sold at a profit over 900 trillion dollars worth of debt- and risk-based "instruments." That's a pretty mind-boggling number when you consider that the GDP of the United States is around 14 trillion and the GDP of the entire planet is around 65 trillion.
All of these "products" were made and sold based on the assurance that when "then" became "now" the economy would have grown fast enough for there to be enough dollars to pay it back. But the reality of a debt bubble that exceeds the world's GDP many times over came crashing in on us in 2007 - and still hasn't fully crested - producing the "crisis" we currently face.
Are we there yet?
Are we recovering from it all now? Will things soon be back to normal?
If by "normal" we mean like life during the "Great Stability," the answer is: "Not a chance." Back then we had in place tariffs and trade policies, first initiated in 1791 by Alexander Hamilton, that protected our domestic manufacturing industries. We still made things - in fact, the USA was the world's largest exporter of manufactured goods, and the world's largest creditor. Like today's China, for over 100 years we'd loaned other countries money so they could buy our stuff!
On the other hand, if by "normal" we mean how things were over the past 28 "Reaganomics" years - a stagnating middle class, disintegrating manufacturing sector, and piles of money being made by bets and debts - then maybe. After just the first decade of Reaganomics, we went from being the world's largest exporter of manufactured goods to being the world's largest importer; we went from being the world's largest creditor to being the world's largest debtor.
None of that has changed. We haven't repealed Reagan's disastrous tax cuts, which have exploded our nation's budget deficits. We haven't repudiated NAFTA and the WTO and gone back to an international trade policy that puts American interests over those of transnational corporations. We have not re-regulated the banks, and have not brought back 6000-year-old laws against usury (excessive interest rates on debt).
The bankers, in fact, are fighting it tooth and nail - the financial services industry in whole has spent over $5 billion lobbying Congress over the past ten years - and their acolytes like Lawrence Summers and Tim Geithner play major and consequential roles in the Obama administration.
It appears that the plan today is not to regulate the amount of debt that banks can create, but instead to both print more money and do everything possible to reinflate the debt bubble. (Lacking a return to Hamilton's national manufacturing and trade policy, as a nation we just continue to slip deeper and deeper into Third World status as an importer and debtor - this may be our only choice if we don't wake up soon.)
If followed, the Summers/Geithner policy can have only one of two outcomes: inflation or another, more serious crash. It's possible we could have both. Apparently the bankers and Summers/Geithner's hope is that neither or both don't happen for at least three and a half years...