This is a paradox built out of a paradox. I think it might be the end result of charging interest. My mother most likely correctly puts it at the feet of wiping out usuary laws back around 1980. That was maybe the start.
The problem with the financial system is multifaceted, but the primary problem is that assets are liabilities and liabilities are assets and the assets that are liabilities cannot pay the liabilities that are assets. If this confuses you, then you have to learn something before you can even start to talk about this or understand that the banking system is based on fraud or at least misconception of the participants, quite often even the ones intentionally engaged in fraud or better yet a game with no mathematical solution. Who can pay switches from one side to the other, but when a particular group,the banks can't pay, we are at end game.
I would quit discussing the dollar as for what it is worth. The Dollar is the collateral for the world financial system and you can't use the dollar and Argentina in the same breath unless you talk about Argentina not being able to pay off its dollars. The dollar could really care less about the Euro, Pound, Franc, yen, yuan or peso. The values are reversed, those currencies against dollars, weighed by bankers, not by the man on the street or by the governments around the world. Let the flow of dollars get interrupted and the rest of the world becomes insolvent. We saw that happen almost overnight last month.
There isn't a solution because there isn't a solution to a math problem that presents no solution. A potential solution would be for the governments of the world to seize all the gold, lets say at $1000 an ounce and coin money, lets say at $5000 an ounce. If you took this to mean 1/2 the gold in the world, it would amount to about $12 trillion and a profit of $9.6 trillion. In any case, this would maybe produce enough spare money to pick up the debts and rebalance the banks around the world for another 25 to 50 years if we were careful. It would be a way of creating debt free money maybe to the extent necessary to bail out the insolvency. The debt would have to shrink by means of an interest rate so low that money supply would shrink along with debt. This would mean we would have to give up the growth formula for a few years in order to get out of the abyss.
Here is the problem. When banks create money, they do it through lending, usually against assets. The assets might be the credit of a business or the home of a consumer or the future earnings of either. This includes the central banks, who originally created currency off of gold and commercial paper. The problem with this method is they lend the principal and never the interest, so the amount of money created is never enough to pay the loan. There is probably a way to do banking, keep the money supply relatively extinguished and compensate the banker reasonably, but man hasn't agreed yet on how to do that yet.
Here is the problem in a nutshell. The rich get richer and the poor go along with this system. That isnt' so bad because it is very likely that both would be much poorer without it and the depression would probably be better than prosperity without this system. This is only speculation and it is clear that the trauma associated with depression is probably worse than anyone could stand and no one would choose it intentionally. But going forward, all rich don't get richer and all poor don't get poorer. In fact, Wall Street and the hedge funds are loaded with men and women for moderate and even lower middle class backgrounds that are now filthy rich. The only difference is there are well to dos that are there in some cases only because they had someone set it on the tee for them. I don't intend this to be a philosophical argument, but to say the successes and failure come from all directions, which is one reason our system, even with its collapses and depressions works better than the alternative.
In any case, most of this revolves around the seasonal need for cash and the need for one person to have access to his cash and for another to have access as well. It would be real difficult to keep a system liquid where you might have to find 100 people with $1000 to borrow $100,000 and keep them all happy as well, so banking makes it possible for those 100 people to put in their $1000 and for even 5 or 6 people to have access to the entire sum, as long as the $100,000 doesn't leave the bank and go into a wall safe or under the bed. In that case, the central bank is there to create liquidity, as the banker should also have matching funds or somewhat close to the original deposit. This works very well as long as the sum of public liabilities in the system are kept relatively close to the bank liabilities. Thus, the first thing to know about this is the liabilities and assets and to realize that one is the other and the other is the one. This means that the banks credits are the publics debits and the banks debits are the publics credits. For those that need an accounting lesson, as all money really is, even if it is gold is who has it and who owes it or who has it that owes it and who owes it that has it and so forth. In any case a banks ledger is made up of loans and other assets on the debit side and deposit liabilities and shareholders equity including paid in capital and retained earnings on the other side. Basically all deposits are owed back to the bank.
I put that in bold because in a nutshell, this is the problem that has to be solved. It is the root of all growth from the start in an interest bearing, return earning system and it becomes the problem at the end. There is more, because we have seen non-banks get involved and securitize money to the moon, but they really have no power to create money without using the banking system for something. I theorized long ago that it would be the non-banking part of the equation that became illiquid and the system would lack close to the bone money to liquidate it. Thus the assets of these non-banking organizations would fail and their liabilities would have to be liquidated. We are seeing this in the SIV's and the commercial paper money market accounts around the world, along with the securitization of credit cards and the mortgage messes of FNM and FRE. It could have just as well happened inside the banking system, but this corporate financial structure outside of banking was the trigger now and I believe it probably was in the 1930's as well. Wall street firms and companies like GE and AIG dominated finance more so than most of the commercial banks.
As long as the banks operate in a sense where the flow of loans go to those that can gain access to cash to pay them back and the cash banks owe to depositors is owed to those that generally use it to transact trade and have the intent of paying it back to those that took out the loans the system works fairly well. I have believed for a long time and this is coming true that once the assets of the financial system become loans that bear little link to those that own the liabilities of the banking system, the game is up. As long as the pile of money owed by banks is quite likely to flow in a direction where it can be used to service the assets of the banking system, the system works okay. Bank profits are moderate and their need to get their deposits back is not so great that they have to pay the checking accounts interest. Those that can't pay the banks back, what are usually a marginal few, can file bankruptcy and the system remains in relative balance.
I am going to venture that if you throw your house out of the equation, that most people on this board have more near cash assets than they owe for the rest of their debt. I would venture that those of you that day trade likely have 6 or 7 digits of cash in accounts in excess of what you owe to credit cards, on auto loans and other secured and unsecured debt. Most of you didn't get that money by running up your credit card balances and in some cases taking the equity out of your homes, though I would venture that a great deal of middle class cash balances did come out of the equity of their last home and indirectly borrowed out of the loan balance of their next home. In any case, if you cashed in your chips and put it on the table, the banking system wouldn't have near all your cash outside of your mortgage and your personal property and even your stocks. I am merely talking about what your net position is with the banks.
Now you could go out and pay cash for 10 cars if you had that much and that would extinguish your net position with the bank to the extent of what 10 cars are worth and maybe help extinguish GM's or their autoworkers or the dealers net negative position with the bank. This is known as a reduction in the money supply. There are problems with it, because the money supply is needed to service debts and create demand. At least it is believe to be so.
But, in any case where we are is the people that owe the financial institutions are not the people that the financial institutions owe. We aren't talking now about what used to be commerical banking, where a business borrowed $2 million for liquidity purposes and their account balances floated between lets say $1 million and $4 million, depending on the inventory cycle and the bank could call the note if they wanted. No we are talking now about credit cards that created cash to do commerce that are now owed by someone with 25 cents in his account or a home mortgage financed through some leveraged fund and the money market, that is on a house of declining value where the equity is insufficient to pay the loans off and the tenant (you don't call people that owe their entire equity to the loan company homeowners)can't pay the difference. There are trillions of financial assets that can't be collected to pay the financial liabilities. Technically the system is always marginally in this shape, but it is managable. Not when the financial system becomes insolvent, where the collectable assets of the banking system fall well short of their liabilities.
Here is why the solution is next to impossible. If you are a person with lets say $1 million in near cash assets (if your stock holdings are $500K and you are a speculator who goes from cash to stock, back to cash, you are playing in the street, but you could count the $500K as cash because there is likely someone on the other end doing the same thing, but both of you can only account for $500K together and not the $1 million combined you would think you have, so maybe you count half of it and the other guy counts half of it, but money cannot come out without another putting it in and extinguishing their cash balance) and you don't owe anyone, are you going to give up your $1 million to fix the problem? We could dissolve the banks, require the depositors to take only 80% of their money and take the other 20% in stock and for the time being it would be fixed. But, the money supply would drop 20% immdediately. Hopefully the non-cash assets of the bank would then make up the shareholders equity and you might have a chance. In some fashion, the depositors have to be the ones that recapitalize the banks because they are the only ones with the bank liabilities that can't otherwise be extinguished.
Now, who wants to go first? There is talk that the government put money into the banks. I don't believe this. I think they put good assets into the banks in order to have something to liquidate to satisfy deposit liabilities. If they loan money, they create more deposit liabilities. Money is a liability in the sense that if it had been put in the banks, it would be owed back to the Fed. This game was created in the fashion the injection was somewhat equivalent to normal capital and not owed back in a classical sense, meaning it wasn't a bank liability. Only the preferred dividend is a bank liability and it can be suspended if needed. A Federal Reserve note ia a liability of the people to the Fed, one more backwards instance of banking. The Fed owes us nothing for a FRN, but we owe the Fed the debt they acquire in return for the cash plus the interest,meaning more than they put out. As long as the Fed's assets are good collateral, the dollar can't go to nothing.
In any case, who goes first? If we reduced the money supply to the point that this entire game could be serviced, then we get into international debt problems. But, in a no inflation situation, the interest on a trillion dollars is reduced to $20 billion or $30 billion if you want to use the real rate of interest game. A $20 billion trade surplus fixes that problem, so that might not be impossible. In any case, for a long time the world would be looking at a reduced level of economic activity and people would be forced to build better mouse traps, rather than just put it on their credit cards. I don't know that this solves anything or not,but it moves toward the solution of an imbalance between financial assets and liabilities.
The problem is that the assets and liabilities in the financial system don't match and the problems cannot be fixed in typical fashion by the normal actions of the system over the short term. The New Deal solutions were merely band-aids, the FDIC to prevent runs on the banks, the removal of gold, the devaluation against gold, the social spending (this solution, as they are going to rudely find out has already been used up, as putting more uncollectable debts out there isn't going to fix anything). We need a world bankruptcy re-organization, where the acting bankers are forced to give up their seats, illiquid institutions are liquidated and new capital derived out of existing bank liabilities used to recapitalize, not government debt. The US could technically pay their debt to the Chinese by minting a big $2 trillion coin because the government can mint dollars and we owe dollars, not yuan. That is what separates the US from China, but we would probably see WW III against them and our other creditors if we pulled that trick. Plus, the dollar is the collaeral for the Yuan, the yen, the Franc, the Euro, the Pound, and all assortments of pesos and dollars around the world so it can't be abandoned.
The problem with even trying to deal with deleveraging is that it means paying down the debts, which would leave the unpayable debts and the unencumbered liabilities of the banking system, meaning the insolvency grows and the money supply shrinks and we deflate. All you are doing is wiping out the bank assets than can be paid and leaving the ones that can't be paid. All that is left in deposits are those owed to those that don't owe anything. Deleveraging cannot be done, which is why I laugh every time I hear about it, like the problem will be solved. It is like the often stated notion of money coming out of bonds into stocks. How?