Sunday, November 07, 2010

Formula for Disaster

Anyone watching the Debt Clock knows that our nation is in a perilous state. I looked today. The National Debt is at $13 trillion, personal debt is at $16 trillion. Unfunded liabilities stand at $111 Trillion.

The reason for this sad state of affairs is the stupid way we fund things.

We do several stupid things: The first is that we adopted a fractional reserve banking system. Banks lend out multiple dollars for each dollar saved. Anyone familiar with math knows that fractions show up as multiples when looked at from a reciprocal perspective.

A fractional reserve banking system effectively multiplies the debt of the people.

Oddly, the fractional reserve devalues savings. It is the bank that gets to multiply savings, not the saver. The dollar I put in the bank is equal to all of the other dollars on the market. It has to compete with the dollars created when the bank uses it as a base for multiple loans.

The history of fractional reserve lending is bleak. Historically banks that create their own fractional reserve scheme have failed. They get rich and implode in a panic when investors realize the bank has inadequate reserves to pay investors.

A fractional reserve banking system depends on constant regulation to stave off panics.

One can argue that, by increasing debt, fractional reserve banking creates systemic risk. One can also argue that fractional reserve banking is counter to the free market. In the market described by Adam Smith, people re-invested the profit of real capital. Fractional reserve banking creates a multitude of paper money for each real dollar increase in capital.

A well regulated bad idea is simply a study in stupidity.

A second stupid mistake that we made was to move from save-and-pay systems for health care and retirement to ill conceived pay-go schemes.

The idea behind both Social Security and Insurance is that people can fund basic human needs through a stable Ponzi Scheme. A Ponzi Scheme is an investment scam where a con artist builds market credibility by paying higher than average returns from the investments from other schmucks in the system.

Ponzi schemes tend to implode when investors discover their investments are at excessive risks. Small insurance companies tend to fail because they develop inadequate reserves for their promised benefits.

Bernie Madoff had a Ponzi scheme that ran for several decades before investors realized their billions of dollars of savings were fluff.

Through the years, a large number of people have been hurt by insurance schemes that failed to maintain adequate reserves.

To maintain stability, insurance requires substantial regulation.

The need to regulate insurance is interesting in that the promise made by insurance is that insurance would help people regulate their health care expenses by placing their health care money in a pool.

The deregulation that took place in the Clinton years failed because we removed the political regulation away from financial schemes that were dependent on regulation. Bush failed because he did not figure out basic laws of finance.

Many people would like to transition away from the Federal Reserve and fractional reserve banking.

To do so requires a concurrent effort to increase savings.

Wouldn't it be wonderful if someone happened to have a plan to replace insurance with a system of structured savings?

Golly, if only there was someone who's been talking about the need to move from insurance to structured savings for the last several decades. Such a person might even have a ready made product that allowed companies to replace their insurance benefit with some sort of Medical Savings and Loan.

For progressive minds driven by wealth envy. I should point out that it's the fractional reserve system that created the disparity of income between the rich Wall Street bankers and middle class. Transitioning back to save and pay would have the reverse effect and decrease the gap between rich and poor.

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