Those who live by Fractional Reserve Banking . . . .

[Image caption/credit: Sovereign Debt Crisis (courtesy Google Images)

This article is conjectural.  The conjecture flows from the idea that a monetary system that’s based on debt (mere promises to repay) rather than on assets (actual payments denominated in physical gold or silver) and leads us to some very strange economic implications.

For example, in a debt-based monetary system:

1) Debt is our measure of wealth. I.e., the more debt you have, the wealthier you become (or at least, appear).  Could you enjoy the apparent “wealth” of living in a $250,000 home, if you hadn’t first been able to go into debt for a mortgage?  Could you enjoy the apparent “wealth” of driving a new car, if you couldn’t first go into debt for an auto loan at the bank?  Our apparent wealth is a function of each debtor’s capacity to make promises rather than engage in productive work.  As an extreme example, think “liar’s loans” (people who couldn’t possibly repay their loans were still entitled to move into expensive homes based on mere “promises” to repay).

2) If debt is wealth, then destroying debt (through bankruptcy) destroys wealth and, more, destroys whatever fiat currency that’s based on that debt.

3) The governments and creditors of the world should have a vested interest in restricting debtors’ access to bankruptcy laws.  If debtors can’t file for bankruptcy, they can’t destroy the debt and debt-instruments that support the debt-based monetary system.

•  In an asset-based (gold or silver) monetary system, bankruptcy laws allow courts to seize all of an insolvent debtor’s remaining assets and possessions and divide them among his creditors. Bankruptcy was ruinous for the insolvent debtor (he lost virtually everything), bad for his creditors (they received only part of what was owed to them) but not so bad for the economy.

Why? Because, in the asset-based monetary system, the creditors loaned hard assets (gold and silver coin, or cash redeemable in gold or silver) to the now-insolvent debtor.  The bankruptcy might deprive both the debtor and creditor of that original gold, but the monetary assets/gold still existed within the economy.  Therefore, the economy’s money supply was not significantly reduced and the economy was not particularly damaged by the individual’s bankruptcy.

Today, however, in our debt-based monetary system, if a debtor files for bankruptcy, he destroys the value of whatever paper debt instruments (promises to pay) he’d issued to his creditors.  For example, if a man files for bankruptcy, the value of his mortgage is destroyed and falls to zero.  The destruction of his mortgage (and other debt-instruments he’d signed) may have a significantly adverse effect on the economy since the destruction of debt-instruments (the mortgage, etc.) used to as collateral to increase the currency supply could reduce that supply.  If enough people filed for bankruptcy at the same time, the currency supply might be reduced sufficiently to push the economy into a recession, depression or even collapse.

Thus, in order to preserve the currency supply in a debt-based monetary system, the debtors’ ability to file for bankruptcy should be restricted.

We see some support for this conjecture in the Bankruptcy Abuse Prevention and Consumer Protection Act of A.D. 2005.  This act provided tighter eligibility requirements for those wishing to file for bankruptcy—which made it harder for most people to file for bankruptcy.  Under the A.D. 2005 bankruptcy law, most insolvent debtors who wish to file under Chapter 7 must meet new eligibility requirements under a “means test” and/or instead file under Chapter 13.   In either case, they’ll be forced to continue to make some payments on the existing debts, even after their bankruptcy petition is granted.

Previously, if they filed under Chapter 7, debtors could wipe out virtually all of their existing debt.  Since A.D. 2005, insolvent debtors may be bankrupt, alright, but they’ll still have to pay something on their debts after they’ve been through the bankruptcy court. Takes all the fun out of bankruptcy.  Fewer people file.

 

•  In order to protect the debt-based currency supply and the debt-based economy, government should reduce most public access to bankruptcy courts.

There’s also more recent evidence to support this hypothesis.  For example, the Associated Press reported in “Greece readies for bailout talks as Plan B details revealed,” that:

 

“The Greek government was poised Monday for the imminent start of intricate bailout discussion . . . . The talks have been delayed but are due to start Tuesday with technical teams paving the way for high-level discussions possibly by the end of the week.”

That week has come and gone, and they’re still talking.  In fact, for at least the past seven months, Greece and its creditors have been engaged in “intricate bailout discussions,” “talks” and “high-level discussions”.  All that talk has come to nothing.

Is the situation really that difficult?  If Greece can’t pay, why not simply let Greece file for bankruptcy and be done with it?  Could it be that the debtors have an ulterior motive?  Are they more worried about Greece filing for bankruptcy than they are about losing the remainder of the money Greece owes?

If Greece files for bankruptcy, the pretense that Greek debts are payable and that Greek bonds are still valuable will be lost.  The only way for creditors to avoid openly admitting that the Greek debt-instruments are worthless is by continuing to lend more currency to Greece to be used to seemingly “pay” existing Greek debts.  But, in truth, Greece won’t be able to repay its current debt or any significant new debt for at least another decade.

Why is the truth that Greek bonds are already worthless being denied?

 

•  Two weeks ago, Reuters wrote,

 “Greek debt restructuring is inevitable, says IMF chief.”

“Greece’s international creditors will have no choice but to accept an easing of the terms of Athens’ debts, the head of the International Monetary Fund said on Wednesday.”

 

The IMF is admitting that Greece is already technically bankrupt.  The new Greek government openly admitted to being bankrupt last January.  Greece wanted to declare bankruptcy.  But, so far, the only thing that’s come from all the endless drama is that Greece hasn’t filed for bankruptcy.

Given that Greece can’t pay its existing debts, there are only two options:

1)  Greece declares bankruptcy and extinguishes virtually all of its debts—and renders all Greek bonds officially worthless; or,

2)  The creditors agree to “restructure” (reduce) the existing debt of € 540 billion down to, say, €270 billion.  Dramatic reduction in the debt, might enable Greece to pay, avoid filing for bankruptcy and retain pretense of value for at least some Greek bonds.

But even if the debt is reduced by 80%, it’s virtually impossible that Greece will be able to repay all of the remaining debt. So, why not face the truth, let Greece file for bankruptcy, and be done with it?

 

  • “The IMF has teamed up with the European Union and the European Central Bank in recent years to lend Greece money repeatedly to save it from a debt crisis.”

 

When we read that IMF, EU and ECB have teamed up in recent years to lend Greece even more money to save Greece from a “debt crisis,” does that make sense?  If Greece is already so indebted that it can’t pay its current debts, how can it make sense to lend even more money to Greece to “save” Greece by putting Greece even deeper into debt?

The answer may lie in the fact a “debt crisis” only exists before an official bankruptcy is filed.  In a “debt crisis,” the debtor may be insolvent, unable to pay his bills and technically bankrupt—but he’s not yet officially bankrupt.  So long as Greece remains in a pre-bankruptcy, “debt crisis,” its bonds can be carried by banks as valuable assets.

On the other hand, if Greece were officially bankrupt, that would mean that Greece had gone through a legal bankruptcy procedure, virtually all of its debts had been extinguished, its debt-instruments (bonds) were void and worthless.  The creditors would have to admit on their own accounting records that 1) they’d lost hundreds of billions of euros loaned to Greece; and worse, 2) that all of existing Greek bonds were worthless.

However, if the Greeks can be kept in an indefinite state of “debt crisis,” the creditors might not ever have to admit that the remaining €540 billion in Greek bonds were worthless.

So long as Greece (or any other insolvent debtor, including you, me or the US government) can be prevented from declaring an official bankruptcy, the creditors can maintain the illusion that the paper debt-instruments (bonds) that memorialize the €540 billion loaned to Greece (or the $18 trillion loaned to the US government) are still valid and valuable.  So long as those bonds are presumed valuable, they can be used by banks as collateral in fractional reserve banking to lend even more fiat currency to more consumers and thereby stimulate the economy.

 

•  Once we define a “debt crisis” to be the state of affairs that exists before a debtor files an official bankruptcy, we can see that it actually makes some sense for creditors to lend more money to insolvent Greece (or to the insolvent US government).

I believe the creditors want to prolong the Greeks’ “debt crisis” as a means to avoid the Greek bankruptcy.

Why?

Because an “official” bankruptcy would destroy the value of the Greek debt-instruments (bonds) and used as collateral for other loans.

Why?

Because under fractional reserve banking, banks holding €540 billion in Greek bonds might be able to “create” and lend up to €12 trillion to other bank customers.  Get that?  Under fractional reserve banking, the €540 billion in Greek bonds might’ve been ”multiplied” as into €12 trillion in additional loans.  If the Greek bonds were “officially” declared to be worthless in a bankruptcy proceeding, the banks might have to call in up to €12 trillion in loans made to EU customers.

Could the EU’s €14 trillion annual GDP economy withstand the loss of €12 trillion in loans and might collapse?  I don’t think so.

Written by Alfred Adask
Full report at Adask’s Law

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