The Man in the Street

Attempting to understand the root cause of a problem should, in theory, contribute to finding its solution. Applying this to the global financial situation however is not as easy as it sounds. For the man in the street, trying to identify who might have, or what might be a workable solution to the ever increasing levels of debt is made difficult by two things.

Financial Jargon

Firstly there’s the financial jargon to plough through, derivatives, credit default swaps, unfunded liabilities, ratio of debt to GDP, budget deficits, quantitative easing, to name but a few. Secondly there’s the issue of the increasing number of zeros, from millions, billions, trillions, to 10’s of trillions, numbers which become increasingly meaningless as each new zero is added.

The average person however does recognize that we’re in a lot of debt, levels never seen before in human history, and they’re growing.

Looking back In Time.

How were transactions carried out in the past and how did we get to where we are today.

Society progressed from a barter system of exchange into other forms of currency and then to gold and silver.

For convenience people stored their precious metals in vaults with a trusted third party, the goldsmith, and traded the receipts for the coins. At any time the receipt could be exchanged with the goldsmith for the designated amount of gold or silver.

As trade expanded and credit was required, the goldsmith began loaning out a portion of the depositors’ gold by issuing more receipts and keeping a small amount of gold in reserve.

This worked because the depositors rarely came back to collect their gold all at once, and if they did, not all at the same time. We use a similar system today with fiat currency and fractional reserve banking.

Fiat Currency

Today we use fiat currency which is declared by governments to be legal tender, but it isn’t backed by anything physical, we can’t go to a bank and exchange our paper for anything of value. However as long as people believe it represents something of value and that they can exchange it tomorrow with someone else for something of value, the system works. Fiat currency is based on faith and confidence in the government.

How Money Can Be Created

New money comes into existence through debt.

In the same way the goldsmith loaned out his depositors’ gold and kept some in reserve, banks today operate the same way through fractional reserve banking. In the US a bank is able to loan out nine times the amount it has on deposit.

When bank credit is required, the amount of the new loan is typed into a computer screen which then appears as new money the bank created from nothing. In signing the credit agreement the customer agrees to pay it back, with interest.

This is how most new money comes into existence, the remainder is created by governments also through debt instruments by issuing bonds, IOU's offered for sale.

Money Printing

Many predict that if central banks don't provide liquidity, (money) there will be a deflationary collapse leading to more money printing than ever. In order to keep all the plates in the air there is no choice but to continue printing and adding zeros to computer screens.

Cutting Through The Jargon

How long we can carry on in our current situation is impossible to predict. But if it’s true that money printing may be the only way forward this would have a significant impact on the value of peoples’ savings. High levels of inflation reduce purchasing power. Money tomorrow will not be able to buy the same amount of things it can today.

Many believe that in addition to cash, owning some hard assets such as physical gold will offer some level of protection in such circumstances and with the recent drop in gold price now might be a sensible time to buy.