Often an idea can be quite sound and reasonable and seem to explain things very well, but won’t work out very well in the execution, when made manifest in the decisions of both elites and millions of people throughout the society and the economy.

So it might seem to be with those who believe that it is workable to combine the existence of a central bank with a currency tied to,  well, nothing real. One of the most persuasive of these thinkers was the great ecnomist Milton Friedman. His thinking on the matter can be quite persuasive on the theoretical level and as indicated by his explanations of economic history.

Nonetheless, many quite sensible people demur. A few months before everything in the U.S. economy hit the fan, for example, an interesting and well-argued article highlighted the consequences of abandoning the gold standard. Acting on advice from Milton Friedman, in 1971 President Nixon legalized a different approach to capitalism that entailed irredeemable debt.

And it worked—for a while.

A few excerpts from the article will give the flavor of the author’s argument:

Before 1971, the introduction of $1 new debt used to increase the GDP by as much as $3 or more. Since 1971, this ratio started its precipitous decline that has continued to this day without interruption. It went negative in 2006, forecasting the financial crisis that broke a year later. The reason for the decline is that irredeemable debt causes capital destruction. It adds nothing to the per capita quota of capital invested in aid of production. Indeed, it may take away from it. As it displaces real capital, which represents the deployment of more and better tools, productivity declines. The laws of physics, unlike human beings, cannot be conned. Irredeemable debt may only create make-believe capital. . . .

The captains of the banking system . . . are leading a blind crowd of mesmerized people to the brink where momentum may sweep most of them into the abyss to their financial destruction.. Yet not one university in the world has issued a warning, and not one court of justice allowed indictments to be heard from individuals and institutions charging that the issuance of irredeemable debt is a crude form of fraud, calling for the punishment of the swindlers issuing it, whether they are in the Treasury or in the central bank. The behavior of universities and courts in this regard could not be more reprehensible. Rather than acting to protect the weak, they act to cover up plundering by the mighty. . . .

Two negative conclusions emerge. One is that the edifice of irredeemable debt must grow at an accelerating pace as markets for derivatives providing "insurance" to holders of debt proliferate. The insurer of debt must also be insured, as must the insurer of the insurers, and so on, ad infinitum. This is due to the fact that the risk of collapsing bond values has been created by man. In contrast, the risk of price changes of agricultural commodities are created by nature, and the futures market provides insurance, with no need to re-insure. The other conclusion is that the unwieldy size of the debt structure excludes the possibility of a normal correction: a major liquidation would dwarf the calamities of the Great Depression. . . .

The government has commitments so great that its endeavor to offset a depression in our vast economy can only result in a loss of confidence. Anxious withholding of purchasing power in the private sector could far outweigh anything the government can add. To make matters worse, government income is highly dependent on a prosperous economy. The magnitude of the problem of offsetting a depression is grossly disproportionate to resources available. . . .

Treasury bonds, contrary to appearances, are no more redeemable than Federal Reserve notes. Itʼs all very neat: the notes are backed by the bonds, and the bonds are redeemable by the notes. Therefore each is valued in terms of itself, rather than by an independent outside asset. Each is an irredeemable liability of the U.S. government. The whole scheme boils down to a farce. It is check-kiting at the highest level. . . .

The regime of irredeemable debt creates an escape route from commitments by the promise of eliminating the pressure of solvency. Whether it promises eternal prosperity, or it promises eternal subsidies, it does not matter. The results are the same. They consist in misleading people, enticing them to skate on thin ice, and luring them into financial adventures, private or public, which are not warranted by the ability to pay. The logical consequence is wholesale bankruptcy of individuals as well as that of the political setup. Losses breed more losses, until they become an avalanche. The present crisis is just the first sign of that denouement. More is on the way.

—Mike Gray