When Your Money Is Worthless

In these dark times, much has been made of the TARP, along with various other bailout programs and their future effects. Will any projects be "shovel ready"? Should the money be used for tax cuts? Should more money be used for the middle class, or should we cut taxes for small businesses?

For all the problems with the bailout (which seems sure to land in the neighborhood of 825 Billion USD), there is a deeper issue that needs examination:

During the process of distributing money from the first portion of the TARP, it was discovered that the Federal Reserve had given out nearly 2 Trillion USD to parties that they will not disclose. They still have not told, despite calls from Congress and the general public to make their records known.

Why can't anyone get these guys to go public with how the money was spent? For one thing, the Federal Reserve is a private corporation. Whilst many in the US think that the Fed is a part of the Treasury Department, nothing could be further from the truth. The only way that the Fed is in any way accountable to the public is through the Executive branch of the Federal Government.

The President of the United States makes all appointments to the Federal Reserve, but once there, he has no more power over them. The Fed operates independently of Congress, the President, and of the American people. It can do anything it pleases.

Zero oversight is a problem, however, it is not the greatest problem that the Fed creates for the financial markets of the world. In 1973, the US depegged the value of the dollar from gold, becoming what is known as fiat currency. This basically means that while someone may be willing to pay $1000 for 1 oz. of gold, there no longer had to be a certain amount of gold to back it up. The Fed was now free to print as much money as it wanted to, in unlimited quantities.

This sounds great, in theory. I mean, what if we could all write checks without anything in our actual accounts. Essentially, that is what we do every single day, but more on that later. Anyhow, the American government has been borrowing from other countries to finance its domestic endeavors for quite a while now. How has it been doing this? By paying them back in US Dollars?

Does the reasoning seem a bit circular to you? I am borrowing money from you, to be paid back at a later date, with interest in US dollars. This money is technically worth the cloth it is printed on, and nothing more (yep, money is printed on thinly woven cloth. Why do you think money is still intact after going through the washer). All that keeps it afloat is the world's confidence that the USA will pay them back. If that is ever endangered, the US dollar will sink like a stone.

This would be an issue, even in the best of times. With the current debt clocking in at 11 Trillion USD, the addition of another 3 Trillion on top of that puts the US' credit on extremely shaky ground. This would put each American's share of the debt at almost 45k dollars per person.

Remember what I said about writing worthless checks? Well, as Americans, we do it every single day. A bill is not actual hard currency. You can redeem it for assets, so long as people believe it is valuable, but what you hold in your hands is debt. The bank note is a promise to pay, not actual payment. When you hand someone a 100 dollar bill, you are actually handing them something that claims someone else will pay, not actual payment. If this seems strange, its only because we have been trained to think that the green paper with words on it is actually worth something. It is this faith that keeps our dollar afloat.

Eventually, all foreign countries will begin calling in their debts, as they won't want to get stuck holding a bunch of worthless money. This will cause a panic worldwide, as thousands of investors worldwide will drop the dollar in favor of a more stable currency. Piles of wealth will be worth nothing overnight, unless it is an asset. The days of cheap imports will be over.

How can we keep this from happening? People have been griping about balancing the budget for years now. The only problem is that the US can't afford to just have a balanced budget. The government must now begin to spend less than it takes in yearly taxes. They could also raise taxes. The only problem with that is the unpopularity that any politician who votes for such a measure will certainly take with him into the next election.

So what is the Fed to do? They have only one way out: Print more money. If they print out more money, they can easily pay back all their debtors with nothing. In the process, however, they will reduce the value of the existing money supply down to nothing. This in turn will kill Social Security and Medicare for good, as no cost of living increase will be able to turn things around. This would put America in the league of a 3rd world nation for at least some short period of time. Eventually, it would result in a new currency, perhaps of a regional variety.

That's the best case scenario. There is one more unlikely scenario: The US gets rid of the Federal Reserve system, with the power to create money from nothing, and replaces it with a stable currency system based on hard assets. This has met with nothing but resistance throughout history, and does not seem plausible this late in the game.

We can either wait things out, and take things as they come down the pipe, or put redeem our bank notes for hard assets. There is not much more we can do to prepare, as our economy sits on a precipice, and must eventually give way to the financial gravity that will send it down a cliff.