What’s Debt You Say?

Bad news in the UK. People are paying down debt. Likewise in the US, where increases in income are being saved rather than spent (Wall Street Journal 02.02.2012). What’s an economy to do?

The UK article is instructive for its title, especially the part after the comma: UK Consumers Repay Debt, Money Supply Shrinks. The shrinkage, we are told, portends a slippage on the part of the UK back into recession. In other words, debt is bad (it is at the root of the global financial crisis) but it is also bad if we pay it off. Is anyone else confused?

Though the phenomenon underlying this odd state of affairs is nearly as old as money itself, a more recent story explains it graphically. It is the story of John Law. Law, son of a Scottish goldsmith and banker, was colorful–a gambler and ladies man.* He lost his family’s fortune during his exploits, which included killing a man in a duel, for which he was sentenced to hang. Law escaped jail and fled to France.

Fortune made Law an acquaintance of the Duke d’Orleans, who was temporary regent for the 11-year-old Louis XV. The Duke found that France was horribly in debt and Law, having published a paper on the virtues of paper currency, saw a grand opportunity. He was given a bank and the right to issue paper currency.

For a while, things went splendidly. Luxury goods were available, houses were built, and everyone felt rich. Law became a hero. Then inflation took hold and people rushed to convert their paper currency to gold, then silver, and then even copper. Like people trying to escape a burning building, the first ones made it out while the others roasted. Law died broke and reviled.

Moving forward 200 years, we find the US falling to a similar temptation. In 1913, the Federal Reserve was formed. Accountable to and audited by no one, it is a private entity with vast power over the economy. Much of that power comes from its ability to print money.

There are a lot of ways to “print” money, including the Fed’s control over interest rates. Recently, it made clear that low, low rates would prevail through most of 2014. That makes it easier for banks to borrow money–money that is created out of thin air. And it doesn’t stop there. When you make a deposit in your local bank, the bank then turns around and makes a loan, not on the money you deposited, but on more imaginary money. That money is also created out of thin air. It is called fractional reserve banking and it makes less sense than Gary Busey.

As we realize four years with over a $trillion deficit in the US, our instincts tell us to pay it down. Yet if we pay it down, the money supply shrinks. Every dynamic in our fiat currency system screams for more paper money, but every imaginary dollar created raises the specter of inflation. We are caught between the devil and the deep blue sea.

There is no good way out of this mess, but some ways are not as bad as others. For starters, let’s remember Will Rogers’ admonition: “When you find yourself in a hole, stop digging.” The proliferation of entitlements must stop. Now. Next, the regulatory crusaders must be brought to heel. Domestic energy of all kinds must be allowed to be developed. And please don’t try to tell me the world will end if we rationally balance the cost of a pristine environment against the cost of not developing energy. Affordable energy is the basis for nearly all other kinds of business. Without a healthy, vibrant business sector, nothing else much matters, and we sure won’t get out of debt.

Last, we must replace our fiat currency system with real money. Ron Paul has the best idea so far–to allow people to use any form of money they choose in their personal transactions. This has the virtue of liberty and the practical advantage of allowing a smooth transition toward a voluntary “standard,” probably gold, if history is any indication.

At present, we are caught in an irreconcilable contradiction. Because our currency is essentially a form of debt, every attempt to rein it in shrinks the money supply, which retards efforts to grow the economy (at least under a fiat system). Our currency is a sham and every effort to mask that fact only makes the problem worse. At some point, we will face Law’s Law–after a brief honeymoon, paper currency starts to look at lot like your mother-in-law.

No candidate, with the exception of Ron Paul, gets this. Thank heaven more people are listening. Hopefully, enough will listen to allow us to move sensibly back toward an economic system that is not set to explode in an instant.


Much of the material in this blog concerning John Law and the formation of the Federal Reserve is based on Michael Maloney’s Guide to Investing in Gold and Silver, 2008.

*He also had some faults.

About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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