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09 August 2012

Full Faith and Credit

In a previous post, Financial Crisis, it was mentioned that Federal Reserve Notes are not backed by anything other than the "Full Faith and Credit of the United States" This term has been in use since pre-Revolution times, but is very misleading in the current context. On it's face, it means exactly what it says; particular obligations of the U.S. government, such as Federal Reserve Notes, are backed by the "Full Faith and Credit" of same.

But what is the underlying basis for faith and credit in the U.S., or any other government? After all, governments don't actually produce anything. But they do have the ability to tax those who do. That is what establishes the faith and credit of a government. The ability and the willingness to tax.

When the economy is strong, the ability to tax is taken for granted. Even during times of economic stress few people doubt the governments ability to raise funds, albeit at a reduced rate. The term "The government just prints more money" is a clique in our society. Of course, the government doesn't create more money, and in fact, they have nothing to do with the process. The money is created by the Federal Reserve out of thin air. 

But there is a limit to this ponzi scheme. When money is created by loaning it, (again, see Financial Crisis post) there is always interest attached. This is the ultimate downfall of the scheme.

 The money to pay the interest on the new loans doesn't exist yet in the system, and can only be created by creating more money.  

This has the effect of skimming value from the economy. At some point, the amount of value removed from the system hinders the ability of the government to collect taxes. Interest on the debt rises and rises until servicing of the debt becomes the primary expense of the government. Taxes are raised or "austerity" measures are implemented to patch the system. Both measures only delay the inevitable. Eventually ALL the value in an economy is owed as interest. Taken to its extreme, bankers own everything and governments become irrelevant. We are witnessing this now in Greece, and it is the ultimate fate of the U.S. system as well. 

Many pundits, especially on the Right argue that deficit spending is the cause of economic problems. This is not exactly true for the above mentioned reasons. Even if spending is in line with revenue, the fact remains that a portion of productivity is required to pay the interest created at the time the money was created. Deficit spending only speeds the process of ruin. 

Everyone makes the mistake (or believes the lie) that Federal Government spending is exactly like personal spending. It isn't. The source of personal income is work. The source of government income is the Federal Reserve, laundered through the economy, with the Fed skimming a non-earned profit. If you don't manage your money well, and spend more than you take in, you will go bankrupt. But the government is guaranteed to go "bankrupt" no matter what. It is only a matter of time.