Why the US is collapsing

Hello, visitors from Digg, Reddit, StumbleUpon, and Slashdot. Summary in one paragraph: This is the leader of the Swedish Pirate Party explaining how the US went bankrupt in 1971, and has been covering it up through an accelerating whack-a-mole borrowing frenzy that is bursting right now. It has been paying rapidly growing VISA bills using MasterCard and vice versa for 37 years. The creditors are catching up, and the US is about to go extinct as a superpower. Become irrelevant. It is not yet on its death bed, it is still walking, breathing and capable of entertaining a conversation in public. But there are ominous bloodstains on its hands used to cover the painful coughing.


Last summer, I wrote (in Swedish) about how the US is in grave danger of becoming the Fourth Reich. I also said that such a state would not last for more than 15 years, because of a number of factors I would elaborate on later.

I was right about the sequence of events, but horribly off on the timing. Where I had expected them to happen gradually in about ten or 15 years, instead they are unfolding before my eyes at an accelerating pace.

Some people believe that pirate politics is somehow about the right to obtain music and movies without paying. Some, a bit more initiated, believe it is for fight for civil liberties. In that, they are correct. But few understand the scope of this fight. It is not against the music industry. It is not against entertainment cartels.

I see the pirate fight as being against corrupt governments that systematically curtail civil liberties as the primary and only defense of a gigantic and growing financial bubble, built over four decades. A fight against a small elite that are literally killing people to be able to keep living in luxury without paying the bills for it. Some bloggers have called this Fascism 2.0. The entertainment cartels are just a small part of this bubble, and fascism is used here in its most lexical sense.

fascism n. a merging of the interests of big corporations and government, adjoined with a systematic curtailment of civil liberties

In order to understand what pirate politics are really about, you need to understand global economic politics in ways that most people will never encounter. You need to understand the gold coin of Bretton-Woods, Toyota's impact on Detroit, the strategic dollar advantage of the Marshall Plan, why the WTO and UN WIPO are rivals, how and why the US uses threats of trade sanctions, and how money is created and ceases to exist on today's financial markets. I will cover the basics in this blog post.

The most prominent of these bubble-pumping governments is the US. And their bubble is bursting. The dollar is not just falling in exchange rate, as in "oh, the curves are on a downslope, interesting, btw I wonder what's for lunch today". The US dollars are about to become as irrelevant as the rubles, the deutschmarks, and the sesertii.

For these empires - the Soviet, German and Roman empire - followed the exact same pattern. And if history is a teacher, future empires will do so too.


Part I: Background

Some of you may have noticed that the dollar has lost some of its value against other currencies, the euro in particular. Usually, with a healthy currency, this would not be a cause for alarm, other that a sign that the American households might be overborrowing and overmortgaging, and thus increasing the money supply, causing the rate to fall due to supply/demand rules.

It is much more serious than that.

Let's go back to 1947. The US did two extremely strategic moves at that point. One was called The Marshall Plan and looked like charity, giving money away to all of war-torn Europe, officially to help repel communism.

Three years prior, it had established the Bretton Woods system, which put the US Dollar at the center of rebuilding the countries, and guaranteed an exchange in gold for the US Dollar. Every 35 US Dollars would be exchangable and refundable with one ounce in gold.

I genuinely believe that these two deals were good for everybody involved. The ruined Europe got a foundation for rebuilding its nations.

But what the US accomplished was much more important than that: it succeeded in making its own currency into a world currency. The dollar became the trade standard.

This status is extremely important. In fact, it carries the entire US economy and its continuous overspending. Let's stop for a moment to understand why.

Every nation has a currency reserve today. Savings in a piggy bank, if you like. This currency reserve was filled with the world's most stable and standard currency, the dollar.

Let's take that again: every nation has been buying dollars for the past 60 years just to stockpile it, because the US Dollar has been the standard currency.

And since they are buying the dollar, this means that the US is getting something else of value in return. In effect, the US has been able to print money at a rate that outpaces its industrial production, just because countries have been buying its currency.

At the end of 2007, this stockpile across the world was two and a half trillion dollars. More specifically, it was 2,445,180 million dollars.

What this means, is that unless the US has an equivalent on two and a half trillion dollars in cash on hand, which it absolutely doesn't, the US has consumed goods and services for two and a half trillion dollars that are not yet paid for. The countries bought dollars in exchange for yen-or-whatever, the US bought shiny toys for the yen-or-whatever, and never gave it a second thought.

This is like going on a shopping spree and paying with checks, and having the luxury of the checks never arriving at the bank to charge the account.

But the checks for that two and a half trillion dollars haven't vanished. They are sitting in vaults. And they are starting to trickle in to the bank. A barely noticeable dripping at first, it is now starting to turn into a small stream, and once people figure out what is happening, it's going to be a burst dam torrenting down the valley of global finance.

How much is two and a half trillion dollars? Actually, it isn't a lot of money in the global economy. It's about $7,500 for every man, woman and child in the US. It is about four years' worth of American military spending. It's about one-quarter of the American GDP.

The key here, however, is not how much money it is. It is that there is no financial coverage for it. Spending $1,000 on a TV set isn't a lot of money, but it can cause a lot of bad consequences for you and your standing if you don't happen to have those $1,000, and no more creditors are willing to lend you a hand.

And the US is running out of new creditors fast.



Part II: The war bankrupted the US

I wrote previously, that under the Bretton-Woods agreement, the dollar was essentially an IOU. A loan paper, an obligation to the US. Every 35 dollars was good for one ounce of gold, to be paid at any time of the creditor's choosing. However, the war tore through the American economy like a plough through a golf course. At the start of the war, the gold coverage was 55%, which is healthy by modern bank standards. During just 1970, however, that coverage dwindled from 55% to 22%.

Wait. 1970? Right. I'm not talking about Iraq. I'm talking about Vietnam.

At this point, economists no longer believed in the US' capacity of regulating its expenditure and making good on its promises. International pressure mounted to exchange dollars for the promised gold, particularly from France, which converted large amounts of its dollar currency reserves into gold at this time. It was a run on the bank to withdraw the savings while the bank was still alive.

On August 15, 1971, president Nixon declared bankruptcy. It wasn't worded like that, of course. But what Nixon did was to state that the US would no longer honor its creditors and pay gold for the dollar. He declared the credit documents invalid. This event has been dubbed The Nixon Shock. In any other milieu, cancelling payments is the same as declaring bankruptcy. Here, it was "just an executive order", and the world at large didn't really appreciate its consequences.

One such consequence was that the US was free to print as much money as anyone was willing to buy, inflating the bubble without any check, balance, or irritating warning light.

At the end of 1995, the foreign US Dollar stockpile was 610,337 million dollars. As I wrote earlier, today that number has grown to 2,445,180 million. That's close to two trillion in 13 years. A fourfolding of the debt. A 300% increase. Who is buying all of these dollars?

Asian countries, it turns out. A small handful of countries have been derogatorily called ODIC - Organization of Dollar Importing Countries.

The U.S. trade deficit was 763.6 billion dollars in 2006. This means that the United States bought goods and services for three-quarters of a trillion more than it was able to sell to other countries. Where did the US get three-quarters of a trillion dollars to fund this trade deficit in 2006? And an equal amount in 2007? And 2005?

You should start to get the answer by now. It didn't. Part of it came for printing money for foreign cash reserves, predominantly Asian ones. In any case, the US spent that money anyway.

To put this in context, in a list of global trade balances for 164 countries, the US is at the bottom of the list. The worst of all measured countries.

Not only that, but the silver medal goes to a country with a trade deficit of 125 billion dollars. That means that the US' trade deficit is six times larger than the second worst! We're not talking about a goal photo here to determine who's the worst offender, folks, we're talking about piles of money that are burning so big and fast you can see the smoke from weather satellites!

The US is running a federal budget deficit as well, with a current official debt running over nine trillion dollars and increasing fast.



Part III: Compensating by enforcing lopsided trade terms

Towards the end of the 1970s, economists in the US administration panicked. The Japanese cars, which flooded the market, struck at the heart of the American pride.

Foreign cars were better than American cars from proud Detroit. This just could not happen. Toy-o-ta. Even the name didn't sound very American. And yet, people in America were rejecting the pinnacle of American engineering - cars - for a foreign-produced equivalent.

So the administration concluded quite simply that American's dominance in industrial production was over. Far from throwing in the towel, another question was asked: "How can the US have a continued economic dominance in a world where the US does not have an industrial production of tradeable value?"

The answer came from an unexpected source.

Some time in the early 1980s, the then-CEO of Pfizer, Edmund Pratt, was frustrated with competition from foreign companies that (quite legally) copied and improved Pfizer's products. At the point, however, there was no way to change foreign laws to create a trade environment where such competition would be outlawed.

To cut a long story short, Pratt ended up on the ACTN - the Advisory Committee on Trade Negotiations - and recommended a plan to the Department of Commerce that would guarantee American trade superiority.

In short, it involved a two-pronged approach. The first part of it was to enforce trade laws that favored American interests, and then establishing "free trade" within that framework, set up to favor US interests. The second part was to threaten trade sanctions against countries that did not agree to this lopsided "free trade" agreement.

At first this was believed a risky business, since trade sanctions had never been used as part of a systematic policy before, but only used in exceptional cases. However, the strategy - focused on intellectual "property", i.e. mostly-American monopolies - turned out to work extremely well.

A forum was sought to establish the new American trade terms as a world standard. Pratt and ACTN went to WIPO, the UN-controlled World Intellectual Property Organization, to seek their blessing. They were basically thrown out on their faces, when the UN realized what they were trying to accomplish.

So hijacking another vessel became necessary. That vessel was the GATT, General Agreement on Tariffs and Trade.

Using a combination of unilateral threats, bilateral agreements of "free" lopsided trade, and multilateral agreements once enough countries had agreed to the terms, an all-encompassing and lopsided trade agreement was devised. It would prohibit third world countries from manufacturing medicine to save lives in their own population. It would make sure that established players, primarily in the US, could outmaneouver upstarts not by building better products, but through the legal framework. The companies in the agreement, such as the record industry, are now lobbying for warrantless searches of people's mail and homes to find out when their monopolies are infringed.

Using a combination of deceit and tricky negotiations, the agreement was signed by many enough countries. That agreement is called TRIPs. The vessel enforcing it is GATT, which was renamed World Trade Organization, or WTO.

And that is how America came to enforce its monopolies over civil liberties of the people in the US and elsewhere. The key takeaways here is that America deliberately skewed international trade through a combination of threats and coercion, in an attempt to irrelevantize the fact that American industry didn't produce anything sellable.

With the US now having a record trade deficit, the strategy has ultimately failed.

(The full background to the TRIPs agreement can be found in the book Information Feudalism. A very worthwhile, although very heavy, read.)


Part IV: Understanding the monetary system

Most people, I would say it's so "most" it can be approximated to "all", do not know where money comes from. How does a dollar appear? If there is $1,000,000,000 in the total economy, who makes the decision to change that number to $1,000,000,100?

Most people would answer "the government" or "the central bank". This is wrong.

The correct answer is: you do. When you borrow a hundred dollars, those hundred dollars appear magically in the economy. They did not exist before and will not exist after they have been repaid.

The monetary system works like this, somewhat simplified: a bank must have a certain fraction of its outstanding loans as savings accounts. If that fraction is 1/9 (a common number), and you deposit $1,000 in a bank, that bank has the right to lend $9,000 to other people, at a higher interest.

UPDATE II: the above paragraph has received a lot of comments on various forums. To clarify: I simplified it a bit to not go into too much detail. In the full somewhat more complex picture, the $1,000-becomes-another-$9,000 involves a cascade of deposits in different banks, multiplying the original limit. The first bank can only lend $900 for the $1,000 of deposit, but those $900 becomes a deposit somewhere else, generating another $810 in debt and magical new money, which becomes a deposit in turn, etc, and that's how $1,000 of deposit generates another $9,000 of magical new shiny money in the economy. If you're interested, I reiterate - take 45 minutes to watch the Money As Debt animation.

This is called the Fractional Reserve banking system. It is now doing its third tour of the United States, introduced by President Wilson in 1913. Before that, Andrew Jackson killed the second tour in 1836.

Lately, through lobbying and obscurity, the fractional reserve requirement has all but disappeared. Banks can now practically create as much money as you want to borrow.

In short, while Andrew Jackson was able to remove the central bank, he wasn’t able to eliminate unsound fractional reserve banking. When one such unsound bank in Massachusetts collapsed, it was discovered that its bank note circulation of $500,000 was backed by exactly $86.48. Why is this obvious absurdity, and the banks’ protection from criminal prosecution if they suspended payments, not called into question?

This has a number of interesting consequences. From a monetary perspective, it means that if the interest rate is 4%, then 4% of all credit will default, as that money must be used to pay interest on the remaining money pool. Since every dollar in the system is borrowed, every dollar is also owed interest on. Every single one. Where would the money come from to pay that interest? The answer is that it doesn't. The system is designed so that a certain percentage of people must go bankrupt.

Europe has had a similar system since the 1600s. If you're interested in more about this, I would very much recommend the 47-minute movie Money As Debt.

But the most important aspect is that the money supply is tightly tied to household borrowing. If people were frugal and economical, and everybody paid off all their debts, there would not any money left in the economy! There would be a shortage of money, meaning that there would not be any money to pay wages, rents, or creating new businesses.

On the other side, the more people borrow (particularly using house mortgages), the richer everybody feels because it increases the money supply, without increasing actual value of goods, commodities and services.

In 2006, this household debt was $45 trillion, compared to $5 trillion in 1969. The money supply has been expanded ninefold.

This is significant because a collapse of the credit system means a collapse of the money supply, and therefore create a society where nobody will have any money.

You can see where I'm going with this with the recent subprime mortgage market collapse, which is now snowballing.

Oh, and you've heard about the crash of 1929? The crash which everybody talked about as the worst in history? That crash saw a mere 27% reduction in the money supply. Compare this with the fact that if the US is forced into going back to a pre-1971, pre-bubble economy, we'll see an 89% reduction in the money supply.

To be absolutely clear: These numbers mean that in a worst case scenario, every working citizen in the US is about to receive an 89% pay cut on average. The best case scenario is hard to predict but I'm betting my money that the money supply will reduce a good bit more than the 27% of 1929.

The United States is heading for something that will make 1929 look like just an ordinarily disturbing day with some red numbers. And its fall will affect the rest of the Western world, as well.



Part V: The fall of the dollar and of the US

Like I wrote previously, the US' money printing machine is dependent on the dollar being the world standard currency. It was so by legacy even after the collapse of Bretton-Woods in 1971. No other economy was large enough to back another currency. There was no competition for a world standard.

Until 1999.

Since a few years back, the European Union has a larger economy than the United States. This is according to three different sources, all American: CIA, the World Bank, and the International Monetary Fund.

Let's take that again, because it is a shock to many: The European Union has a larger economy than the United States. A larger economy with which to back its currency, the euro. Reuters reported this the other day, but incorrectly attributed it to the decline of the dollar. It has been true since at least 2005.

When the euro debuted in 1999, it was introduced at just above the US dollar, but quickly fell to about .89, lower than the dollar. Today, it is trading at 1.55 dollars per euro. Two euros is more than three dollars.

To put fuel to the fire, the American Federal Reserve is expected to cut interest rates on the dollar from 2.25% to 1% by mid-2008. In contrast, the European Central Bank has been holding interest steady at 4%.

What do the central banks' interest rates have to do with this?

When keeping a national reserve, choosing between the dollar and euro here is like having a choice of two different banks with different interest rates. Everything else being equal, anybody rational would choose the euro as savings account, because it gives a better interest rate. But as I have already said, everything else is not equal. The dollar is losing value quickly, too.

Many empires have overspent on their military using borrowed money, and collapsed as a result. This was a major reason for the fall of the Soviet Union, for instance. It is generally agreed that the macroeconomically sustainable limit for military spending hovers around 2% of GDP.

The US is currently spending 5% of its GDP on its military. It tops the league of military spenders with an expenditure of 625 billion dollars yearly. (That's before emergency expenditures for the ongoing war.) To hide the real numbers, only $515B are allocated to the Pentagon openly. You need to dig deeper to discover that the funds for building and maintaining the expensive nuclear arsenal lies with the Department of Energy. The funds for funding and training insurgents across the world lies with the Secretary of State. And so on.

To put this number in perspective, the world's second largest spender - China - spends $60 billion. About one-tenth. The total world military spending is $1.1 trillion. This means the US spends more on its military than the rest of the world combined.

The same U.S. military is also used to enforce the dollar bubble.

Like I said earlier, the dominance of the US depends on the dollar being a standard currency. But with Bretton-Woods gone, the dollar's status as a world standard instead depends on many other things.

One of these things is oil trade.

Oil is currently - mostly - traded in dollars per barrel, which creates a defacto dollar-based economy. A few years back, one prominent oil producer switched to trading in euros per barrel.

This threatened the entire stability of the dollar as a world currency, and by extension, the US' economic bubble. After some chaos and turmoil involving the bubble-funded US military, that particular country is now exporting oil by the dollar again, thus once again contributing to the dollar bubble.

That country was Iraq.

(The interpretation that the US administration invaded to protect its currency bubble is mine and mine alone. But in this light of things, it would have made perfect sense to do so. The alternative to spending trillions on the war would have been risking a collapse of the entire economy, one that now seems inevitable anyway. When I have checked this hypothesis with Americans, though, they generally brush it off, saying that I vastly overestimate the intelligence of the current president.)

Today, Venezuela is trading in euros per barrel, and Iran has announced plans to open a euro-based oil bourse in Teheran. (Yes, the same Iran that the Republican candidate McCain is now singing about bombing.)

In international trade, more and more agreements are being signed in euros where anything else than dollars would have been unthinkable a few years back. In New York, tourist shops are now brandishing "we accept euro" signs - equally unthinkable a few years back. In Amsterdam, most exchange offices have stopped accepting dollars for currency altogether. It is falling so fast, they can't resell it for profit any longer.

In China, exporters are complaining about the cost of currency insurance on trade deals signed in dollars, and are switching to the euro. In Germany, Volkswagen is not selling one of its top models to the US solely due to the falling dollar. In Tchad in Africa, people on the streets have switched to the euro.

The thing that happens when we reach a critical tipping point - which may already be here - and currency reserves start switching from the dollar to the euro en masse, is that the collection agencies of the world's economy will come for two and a half trillion dollars of US debt, which is currently held in stasis in currency reserves.

There is nothing that can pay these two and a half trillion dollars of debt when the repo man comes knocking.

That tipping point will kill the dollar as a currency, sending it plummeting to levels previously inconceivable. It will kill the dollar as a world trade standard, the American economy, the American military, and the United States' status as a superpower. Just like when the Soviet union collapsed. It is even conceivable that the United States will fracture as a nation, just like the Soviet Union did.

But unlike the Soviet Union, the American public will be hit hard. In the Soviet Union, not much changed when the government-owned homes weren't paid for. They hadn't been before either. Not much changed when the food supplies were formally not coming, for they had not come before either. People had learned to live with a malfunctioning system. In the US, however, a lot of people will lose their homes and might not be able to get food. This is not a recipe for a happy society.

One prominent US economics professor recommends immediate investments in precious metals: "gold, silver, and copper-jacketed lead".

This difference in functionality of society before and after a collapse is called the collapse gap. And it's much larger in the US than what it was in the Soviet Union, Germany, or Rome.



Final words

This is what the pirate fight is about, in my eyes. Preventing fascism from spreading amongst corrupt administrations; defending civilization against the systematic curtailment of civil liberties in order to maintain a false image of prosperity and enrichen a self-serving elite. You could even say "defending democracy". The file sharing debate is but the symbol, but a very powerful symbol. Like the insignificant Belgian village of Waterloo, or the small overlooked Pennsylvanian town named Gettysburg. They, too, were important battlegrounds.

The US is already lost. I can think of no action that would prevent its downfall. My fight is for Europe, which has copied every US "intellectual property" policy in what can only be described as cargo cult economics, and risks a similar fate.


UPDATE I at Mar-22 17:23 CET - added links to Amsterdam story, Orlov's Collapse Gap, Information Feudalism

UPDATE II at Mar-23 11:30 CET - fixed some typos, added clarification on federal reserve requirement

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