Economics 101 and the Donald

“Money is what money does.” This economic fundamental explains how trillions of dollars can disappear overnight, just by simply stopping “doing”.

Many of us think that somehow our governments have piles of gold equivalent to the paper notes in circulation, but there’s not a chance. There’s not enough gold on earth to back the world’s economies.

Money is nothing more or less than a network of promises. I go to the restaurant and enjoy a good meal, after which I present my “credit” card to the merchant, who in turn processes it and is assured by my bank that it has taken money from me and put it in the merchant’s account. But the bank has no such money from me, only my promise that at the end of the month I will cough up enough money to cover that promise. In other words, the bank paid the merchant on the basis it trusts me to settle with them at the end of the month. And if I don’t, in most cases the bank is happy to continue to rent money to me at a rate of about 25%, at least as long as it thinks I’m good for it. It’s all based on the Latin “credo”, meaning to trust or believe.

In other words, money is all about trust or faith. When your bank, your mortgage company, or your suppliers no longer believes you, you get no more “credit” and then you have no more money. If this happens universally, it gets ugly for everyone.

So what happens when an entire country runs out of credit? When the world economy no longer believes its promises to pay? Well, we’ve seen that with Argentina and Greece. In simple terms, the World Bank puts you into bankruptcy protection, gives you a small allowance to survive, and restructures the debt. It’s pretty grim, but it sort of works for smaller countries.

But what happens when the world’s largest economy runs out of credit? Well, you really don’t want to think about it. There’s a saying that if you owe the bank a thousand dollars and can’t pay, you’re in trouble, but if you owe the bank a million dollars and can’t pay, the bank’s in trouble. That’s more or less where the world stands today – terrified that the biggest player, by far, can no longer be trusted.

The United States has had a really good run since World War Two, and particularly since the end of the Cold War. With the largest economy in the world, by far, the largest military in the world, by far, and utter dominance of language, culture, education, and with most of the rest of the world content to do business with the behemoth, the American dollar has become what we call “the reserve currency”. It’s “as good as gold”. Effectively, America was too big to fail, and acted as the bank for the world, making everybody’s string of promises come true most of the time. And as the bank to the world, it gave itself the very best credit rating.

What few of us noticed in the recent run on the stock market was not just a freefall of stock prices (i.e. the value of companies), but a freefall in the bond market for American government bonds, that is, US government borrowings from the world. In other words, the universe got nervous about America’s willingness or ability to pay up when called upon.

That’s terrifying. What that says is that the world isn’t so sure anymore that Uncle Sam is good for his promise to pay. The next step is that Uncle Sam can’t run a tab anymore, and that’s catastrophic for the US, that’s catastrophic for the rest of us.

When the world cuts off the American government’s access to cheap credit, the Americans are in serious trouble. But so are all the rest of us. Remember, nobody has a piggy bank, except maybe Norway and Saudi Arabia. When the music stops for Uncle Sam, it stops for all of us. When the promise to repay starts getting broken here, then there, then somewhere else, money ceases to flow, in fact, it ceases to exist. Remember, money is what money does.

I’m not sure what courses Donnie took at Wharton, but Economics was surely not one of them.

(Think this is all voodoo? Consider that you and I and the entire planet, everything we think is real, are composed of trillions of atoms, which are just bundles of whirring energy. Money’s like that– it’s not what it seems. Just ask the guy with a suitcase full of Czarist roubles or Confederate dollars. I’ll bet my last Saddam Hussein dinar!)