The Huffington Post had a story on Tuesday about the briefing on the Treasury Secretary’s financial bailout plan that White House aides gave to Congressional aides prior to his speech yesterday. It was met with laughter. Bipartisan laughter.

 

The stated goal of the plan is to restore “faith” although the lack of any real details seems to require faith as a starting point rather than a goal. What we do know is that Mr. Geithner is committed to the securitization of debt instruments – that means that he sees derivatives as a central component of the monetary system. In a way, one can understand this mindset. The derivatives marketplace, although seriously damaged over the last five months, dwarfs the equities and bond markets of the world. We keep hearing news reports that the CDS (credit default swap) market has a face value of $62 trillion – that’s about equal to the GDP of all the nations in the world and CDS’s are but a small subset of all derivatives.

 

So that means that the guts of the global economic system is based on the value of a promise to pay. Derivatives are contractual agreements derived from a debt instrument (bond, mortgage, loan, etc.) that supposedly has some underlying value (a company, a car, a student loan or a house). But there are some fundamental problems that are not going to go away and presage a bad ending to the Treasury Secretary’s plan.

 

In our monetary system we can only create money through debt. People can make a product or a service that has excellence and utility and sell it in the marketplace, but that doesn’t create money. The only way we can create money is through banks lending money to companies or individuals or the Federal Reserve lending money to banks. They are the only entities that can create money and, despite the Fed’s virtually non-existent interest rate, our system is never in balance because the interest required to pay a loan is not created when the loan is created.

 

So how does a plan that proposes that banks create more debt (we like to call it credit but credit is useless to the economy unless it is used and then it is a debt) to get rid of bad debt? There is a model for this in the recent past, but we need to understand that it is not really applicable. In 1989 the Resolution Trust was formed to deal with the assets of nearly 750 savings and loan banks. Essentially, these banks had made bad investments in an inflated real estate market (sound familiar?). Over the next six years the Trust purchased the assets and sold them off and, we are told, made a profit.

 

But there is a big difference between those savings and loan assets and the ones that Mr. Geithner is talking about. The S&L assets were loans made against real things – shopping malls and condo complexes. The derivatives that we are talking about now are at least once removed from any underlying asset. In many cases there are no underlying assets (student loans, consumer loans, credit card debt, etc.). So it is hard to see how we are going to be able to value financial instruments that have no value.

 

The other aspect of this plan that we need to understand is that, with the exception of the $350 billion left in TARP money, none of the $2 trillion that Mr. Geithner is proposing to spend will be taxpayer money. That may sound unbelievable and you may be relieved but it is true and you should not be relieved. We are used to loosing taxpayer money. We get mad about it but we have been conditioned to expect it – look at the billions lost and unaccounted for in the Iraqi reconstruction. 

 

The money that will be used for the bailout of the banking system will be created out of thin air by the Federal Reserve. Let’s follow that thread for a moment. We have a private corporation (The Fed) established by an act of Congress in 1913 that is owned by the banks that will create money to essentially give to the banks to cover their losses. It would be wonderful if that could be done without some very serious repercussions, but it can’t.

 

The effect that this will have on the value of our currency will be devastating. Some of the people in the news media are focused on deflation – less money chasing goods and services resulting in lower prices – but the real disaster that is coming is hyperinflation – vast amounts of money chasing less and less goods and services. We may want to point to the strength of the dollar these days and convince ourselves that all will be well but a brief reading of the history of fiat currencies (money that is not backed by a precious metal) is pretty grim – none of them survive for very long.

 

And yet we have to ask ourselves, what else could the government do at this point? There is not yet the awareness of how our financial system works to support a massive move to re-establish a gold-backed currency. There is also not yet the awareness to begin to ask the questions about whether or not the monetary system should be in the hands of a private corporation. We had a vigorous and spirited debate in this country for 150 years about whether or not we should have a central bank but somehow we have all forgotten that history. It’s as though we are afraid to look at how the system works and ask the questions that need to be asked.

 

Until that happens, until more people in public and private life understand how our system works through a dispassionate analysis we are going to keep walking down this road of trying to keep a system that has already collapsed alive in the minds of our citizens. The longer we wait the more spectacular the collapse and disillusionment will be. Perhaps the laughter was a good sign. Perhaps this has all gotten so outrageous that enough people will want to understand what is happening. That’s the kind of change that I think we were all expecting.