Sub-Title: The Breakdown of the
Paper Money Economy - John Wiley & Sons, N. Y., 2012, 179 pgs., index,
notes, tables, graphs
This is a very important book. The author is correct in his warning about the
results coming from the massive expansion of credit. I probably should not
quibble, but I disagree with his idea that credit has taken the place of money,
narrowly defined as currency and demand deposits. No, because credit was always
a component of money. What has happened is that credit has become a vastly
larger component of the money supply relative to currency. Since credit=debt is
itself most of the money supply, a reduction in debt creates a reduction in the
money supply just as if, or worse then, if someone burned billions of $100
dollar bills. And this massive bulge of credit is composed of both government
debt and private debt. The linguisticd mix of terms 'money, currency, credit
causes more than semantic confusion. It leads to false conceptions about what
to do about the dangerous situation. And we see this result in his
recommendation in the final chapters for government to 'perpetuate the boom' by
increasing massive expansion of debt.
Mr. Duncan begins with: "When the United States removed the gold backing
from the dollar in 1968, the nature of money changed. The result was a
proliferation of credit that not only transformed the size and structure of the
U. S. economy but also brought about a transformation of the economic system
Granted the removal he cites was a very significant event, but credit=debt has
always been an important component of the American money supply and for that
matter important since ancient times. Credit was already expanding before 1968
and actually the elimination of the gold backing was a forced result rather
than a cause. I believe the author is correct about the dire consequences of
the huge expansion of credit, but not the cause he cites. Yes, he rightly notes
that 'credit expanded 50 times between 1964 and 2007' - but note his date of
1964 is 4 years BEFORE the 1968 event, and it was expanding before that. And it
had expanded previously, for instance in the later 1920's. Yes, as he notes,
credit began to contract in 2008. This effectively reduced the money supply,
triggering deflation. In this preface the author briefly outlines the topics he
will discuss in each chapter. He concludes with this: "The price the
United States ultimately pays for abandoning sound money may be devastatingly
high, both economically and politically". Very true, but let us see what
his recommendation is in the final chapters.
Chapter 1: How Credit Slipped Its
He begins with: "Credit induced boom and bust cycles are not new."
Exactly - He continues that this one is 'extraordinary' due to its magnitude,
and I agree. He cites the two legal constraints on credit creation, true
enough, but in my opinion rather flimsy given prior history. Duncan then cites
President Johnson's request to end the backing of dollars by gold, to which
Congress agreed. But why did the President make the request? My answer, for the
same reason the Federal Reserve was created in 1913 - to expand the money
supply needed for expanding government to achieve its policies. Duncan provides
a graph and explanation that dramatically depicts his point. The credit
component of the money supply did expand massively. Among his points: "In
1968 credit exceeded GDP by 1.5 times. In 2007 , the amount of credit in the
economy had grown to 3.4 times total economic output." (that is GDP).
More, "Total credit in the United States surpassed $1 trillion for the
first time in 1964. Over the following 43 years, it increased 50 times to $50
trillion in 2007." Of course I agree fully with his data and conclusion,
but only point out that the $1 trillion already in 1964 was far too much.
To expand his theory he writes: "The Federal Reserve Act of 1913 created
the Federal Reserve System and gave it the power to issue Federal Reserve Notes
(i.e. paper currency). However, that Act required the Fed to hold 'reserves in
gold of not less than forty percentum against it Federal Reserve notes in
actual circulation' In other words the central bank was required to hold 40
cents worth of gold for each paper dollar it issued." Very true, but
already paper currency was a smaller and smaller component of the real money
supply. Massive amounts of credit were being created by the commercial market.
In my opinion he is focused too much on currency and gold and not enough on
For instance. "Once dollars were no longer backed by gold, the nature of
money changed. The worth of the currency in circulation was no longer derived
from a real asset with intrinsic value. In other words, it was no longer
commodity money. It had become fiat money - that is- it was money only because
the government said it was money."
In my opinion this misunderstands money. First, all money is only money because
the government says it is - it is all fiat money. Second, there is no such
thing as 'intrinsic value' and for sure gold has no 'intrinsic' value but only
relative value just like very thing else. Third, again, currency is but a
component of money. The governments are not the only creators of money, but
they are the source of the value of what is used as money because they pass
laws that ensure the validity of contracts and the safety of private property.
He continues with very correct data about the FED increasing the quantity of
paper dollars, but links this - 'it still served as the foundation upon which
new credit could be created by the banking system." But credit was being
created by many other agencies than the banking system. In fact we eventually
learned about the economists new entity the 'shadow banking system' composed of
non banks, for instance, airlines. Mr. Duncan then describes the 'fractional
reserve banking' phenomena, a system that has been the core of banking itself
since banks were created. He gives the standard, simplistic, description but
asserts that this is the only mechanism for credit creation. He correctly does
note that banks shifted from reliance on demand deposits to time deposits, but
does not mention that banks borrow (that is go into debt themselves) the funds
they then lend. Eventually he gets around to discussing non-bank credit
creation, dating it as of 1970. I believe the 'shadow banks' were creating
credit before 1970, but agree with his depiction of the dramatic expansion of
credit he shows in graphs and text related to the creation of 'asset-backed
securities' and entities such as Fannie Mae.
His fundamental point is the critical one. "Because credit growth now
drives economic growth, the flow of funds in the key to understanding
developments in the U. S. Economy." (I hate this term 'growth' - it should
be 'expansion'. His exhibit 1.9 is very important as it shows the breakdown by
owner of the debt from 2006 to 2010. He shows in Exhibit 1.7 and text another
important category - That 15 percent of all credit in the U. S. by 2007 was
held by 'the rest of the world."
Chapter 2: The Global Money Glut
In this chapter Mr. Duncan describes the world money system starting with
Bretton Woods. This system also broke down in 1971 when many central banks
began 'printing' money. The short chapter is devastating in its depiction of
massive world-wide credit creation. I am pleased to read Mr. Duncan's debunking
of the so-called 'global savings glut' one of former FED chairman Bernanke's
excuses for FED incompetence.
Chapter 3: Creditopia
In this chapter the author explains what the '$50 trillion' credit expansion
did to the U. S. economy. It ain't pretty, Magee. He focuses first on who
borrowed money. The many graphs show what happened. He writes: "Credit did
more to the U. S. economy than make it grow (sic). It also radically changed
its composition. His graphs depict the change. One shows that the manufacturing
section, which had contributed more than a quarter of all economic output
during the first two decades after the war (WII), went into steep decline just
as the Bretton Woods System broke down in 1971." "Meanwhile the share
of economic output of the finance and real estate sector grew, particularly
after the credit boom of the early 1980s got underway."
Of course I dispute the basic data on 'economic output' (nominal versus real)
but deny that the financial sector contributes anything to either - it is a
parasite on the economy that extracts wealth from those who create it.
He continues, "The nature of money changed in 1968, and that change
transformed the economy. It has become increasingly difficult to distinguish
between money and credit. Moreover, the amount of credit has grown so large
relative to the amount of what was previously understood to be money, that it
has made money irrelevant."
This is only true because Mr. Duncan persists in failing to realize that credit
has always been a component of money, only varying in extent over the
centuries. Of course it is difficult to distinguish between money and credit.
Credit IS money. Now it certainly is true that the credit component of money
has expanded to unprecedented extent and relegated currency to inconsequence
and with dire results..
Chapter 4: The Quantity Theory of
Again, the author begins with a misconception. "So long as gold was money,
credit creation was limited by the supply of gold." But gold has never
been the significant component of money even though the U.S. dollar was defined
on the basis of a fixed quantity of gold. For centuries currencies were mostly
silver, not gold. And, as I have noted, credit has always played a significant
role as well. The role of the 'gold standard' he is thinking of was a very
brief interlude in the history of money. But his topic here is the 'quantity
theory of money'. Another dubious theory.
Nevertheless, due to his insistence that credit is something different from
money he invents a new theory 'the quantity theory of credit'. He asserts:
"Focusing on credit instead of money, the quantity theory of credit
creates a powerful analytical framework that explains the causes of the new
Depression, as well as the government's policy response to it thus far."
But all we have to do is recognize that local bank creation of credit as an
important component of the money supply repeatedly in the 19th century and the
subsequent collapse of that credit generated the repeated bank crises and short
depressions that are discussed in any course on American history. He then
brings in Irving Fisher's theory of money and economy with the famous equation
- MV=PT. Naturally, he has to comment of this imaginary V - velocity and create
an equally imaginary concept of velocity of credit. Well, I will skip
discussion of this V - velocity here. But point out that David Hackett Fischer
in his real history of prices "The Great Wave' showed that waves in rising
prices since the 12th century were due to many other factors than the 'quantity
theory of money'. Mr. Duncan discusses all this at length including the
confusion amongst 'monetarists'.
My point is that Mr. Duncan is correct in his focus on the unsustainable volume
of credit but that he introduces an unnecessary confusion by calling it
something other than money.
Chapter 5:- The Policy Response,
Perpetuating the Boom
The author begins on a high note. "What a pity that Bernanke did not read
Ludwig von Mises instead of Milton Friedman in graduate school. If he had, he
would have known that credit creates the boom and that all booms bust."
Simply outstanding. Again, I believe this is the central issue and that the
author correctly focuses on it. He points out that Bernanke and the FED have
been basing their faulty response in 2008 to their misunderstanding of the
causes and failed responses to the Depression in the 1930's.
"Those who want to understand what lies ahead must understand that the
FED's one and only policy has been and will continue to be to perpetuate the
boom by ensuring that credit continues to expand." The chapter describes
what will result from this mistaken FED policy. Again a key comment: "The
Austrian economists provided the best explanation for the business cycle, the
alternating boom and bust pattern that has characterized the economic process
in capitalist economies since the beginning of the Industrial Revolution. They
identified credit expansion as the catalyst" Just what I was trying to
point out in comment on the previous chapters, because credit WAS money. The
chapter contains an excellent critique of FED policies such as QE1 and QE2 and
monetizing the debt. Then the author turns to "Diminishing Returns".
He writes that the impact of these policies such as QE are subject to the law
of diminishing returns. So right. The more credit expands the less favorable
impact can be achieved by a further unit of expansion. In other words the FED
puts the country on a tread mill that requires more and more credit expansion
to sustain economic activity.
Chapter 6: - Where are We Now?
Answer, "We are at the top of a forty year, credit induced economic boom
without any obvious means of expanding credit further." "One of the
themes of this book is that credit growth has become the driver of economic
growth during recent decades."
But my question is "Is this real increase of wealth? The author is
concerned that credit cannot continue to expand. He discusses each major
economic sector such as 'household debt' to see. He provides graphs and data
that indicate that household debt cannot expand - nor the private sector as a
whole. Now we are becoming scared at what is coming.
He notes, 'It was only a $4.6 trillion increase in government debt since the
end of 2007 that prevented a contraction in TCMD (the economy) so sharp that it
would have produced a replay of the Great Depression." And of course there
has been more debt increase since 2007. He then discusses the 'safety' of the
banking industry - especially the big banks. His conclusion is that the
situation has not improved.
Chapter 7: How it Plays Out
Mr. Duncan focuses on the business cycle (that is this boom and bust cycle). He
quotes von Mises again that booms always result in busts. But then we become
alarmed when we read. "It is important to understand that the increase in
government debt did more than just offset the contraction in private sector
debt. Had government debt not increased by so much, the economic crisis, would
have been far worse and consequently private sector debt would have shrunk by
far more." He gives year by year data on decrease in private debt with
increase in government debt. He is concerned that private debt will contract
more. He writes: "Credit growth, inflation, and fiat money creation will
determine the fate of the U. S. economy over the years immediately ahead."
Certainly true, but what to do? Now, this book was written in 2011 so the
author's predictions are for 2012.
Chapter 8: - Disaster Scenarios
The author begins with: "The New Depression and the Great Depression were
both caused by credit-fueled economic booms. In both instances, the boom began
when the link between money and gold was broken."
The first sentence is right but the second is not. The were indeed caused by
credit expansion, but so were the many boom=busts in the U. S. during the 19th
century and many others around the world including famous ones in England and
France. What made them worse was the creation of a more unified bank system
thanks to the creation of the FED. Again his concept of money betrays him.
He writes: Consider first what happened last time. In 1930, the United States'
money supply comprised currency held by the public (9 percent) and deposits
held at commercial banks (91 percent). Banks fund their loans with their
But currency was and is only a component of the money supply. Already in the
1920's credit=debt was created not only by banks. Among other sources of
credit=debt were margin accounts with stock brokers. And there were debts in
But his description of the cascading result of the collapse of credit is
excellent. In fact he notes that the contraction of credit was a shrinkage of
the money supply. Well, which is it? No one was burning paper money, currency
was not contracting, it was unsupported credit that contracted. And the reason
it created a 'systematic' collapse was because the FED created a 'system' that
had not been so unified before. He provides more graphs and text to describe
the wide spread results of this contraction. Among them he notes: "The
most rapid descent into disaster would occur through a collapse of the banking
system." Exactly, because individual banks were now linked into a system
since 1913. Just as it is today, when one institution's assets are another's
liabilities and reverse. When liabilities cannot be paid by A then B's assets
shrink and the results are contagious. He then correctly describes how a
contraction today of (for instance the $52 trillion in the U.S. to $35 trillion
would cause a massive contraction throughout the economy. I just wish he would
not persist in calling this credit 'new money' or conger up an abstract concept
that there is a 'velocity' of credit. Volume - Volume, not velocity is the
culprit. Otherwise, his descriptions of other results are also valid.
Chapter 9: - The Policy Options
Now we get to the meat of the whole exercise. We discover that the author's
extensive descriptions have been prepared as the intellectual basis for the
policy prescription he proposes to save us from Armageddon. He begins thusly:
"Capitalism was an economic system in which the private sector drove the
economic process through saving, capital accumulation, and investment. The
government's role was very limited. The United States has not had that kind of
economic system for decades."
Note the past tense. Well, he is right, although the leftist progressives
continue to blame every problem on the free market and capitalism. He
continues: "This is not capitalism. Market forces no longer drive the
economy. The current system is government -directed, but not planned. "
Well, now he has hit the proverbial nail. But wait. He has more: "The new
credit-based economic system is now in crisis because the household sector
cannot bear any additional debt. The gap between its income and its debt has
become too great." All too true. Next, he describes the credit based
economy and claims that the situation is beyond repair by reduction in
government created credit-debt. With more graphs and text he determines that
the only solution is for MORE government debt-credit. Never mind that history
shows the huge number of economic collapses due to a crisis in government debt.
Finally, after claiming there is no private sector solution but only a massive
government expansion of its debt-credit, he gets to specifics of what this
great government 'investment' should be. We have been waiting for it. Answer -
SOLAR ENERY. By going more trillions into debt the government can save the
world. He actually writes: 'The benefits would be both immeidate and
never-ending." (Really) "From the beginning, government borrowing and
spending, if on a large enough scale, would create jobs and prevent the economy
from collapsing into a New Great Depression. Moreover, as mentioned before, the
program itself would cause the price of oil to plummet, which would not only
boost domestic consumption in other products, since the public would spend less
on oil, but sharply reduce the country's trade deficit." BINGO - here we
have both fallacies at once. First, expanded government subsidy for solar
energy goes mostly to China. Note requires that this industry be totally
government controlled. (Imagine the result of that.) Second, the wages lost by
the very high paid oil workers won't generate added consumption and would never
be equalled by solar panel installers. Third, the increase in oil production
now promises to Reduce the trade deficit once the government stops prohibiting
export of oil and natural gas into the world market. But he continues to extol
this 'new' credit based economy,
There is more. "A large government directed investment program to develop
genetic and biotechnology would create medical miracles. Heavy government
investment into nanotechnology would generate a new Industrial
Revolution." Unfortunately, history shows the opposite results.
The chapter ends with these assertions. "The point to grasp, however, is
that our global civilization has been built on and around those distortions
(caused by abandonment gold and creation of the 'new' credit money) and that it
could very possibly collapse into ruin if those distortions are not perpetuated
through further credit expansion." "That REQUIRES government to
borrow and invest." Would that be capitalism? No. We do not have
capitalism now, however," The question is not whether we are going to
abandon capitalism and replace it with a different kind of economic system. We
did that long ago. The question is: are we going to allow the economic system
now in place to collapse."
This is really a brilliant effort to insist that SOLAR ENERGY created by
government debt is inevitable.
Chapter 10: - Fire and Ice -
Inflation and Deflation
Well, this chapter is based on erroneous ideas about both the causes and
results of inflations and deflations throughout history. But, given the policy
prescriptions advanced in the previous chapters, the author has to find a way
out. Remarkably, he does mention the deflations of the 1830's and 1870's even
though they disprove his previous discussion, and while mentioning them he
fails to note that their overall result was very positive and greatly renewed
economic expansion. He also discussed previous inflation but only of the 20th
century (ignoring those of previous centuries). For this he cites at length
Irving Fisher's explanation.
He does make one valuable comment. "In the very harsh economic environment
that is likely to prevail over the next ten years, it is likely that a great
deal of wealth is going to be destroyed." He concludes by offering some
basic, typical, ideas about diversifying one's private investment portfolio.
In two pages the author cites his previous books as evidence that the public
and policy makers should take heed.